Prospect Capital Corporation (PSEC) Q1 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to the Prospect Capital First Fiscal Quarter Earnings Release and Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to John Barry, Chairman and CEO. Please go ahead.

Thank you, Anthony. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?

Thanks, John. This call is the property of Prospect. Unauthorized use is prohibited. This call contains forward-looking statements that are intended to be subject to safe harbor protection. Actual developments and results are highly likely to vary materially, and we do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings release and 10-Q filed previously and available on our website, prospectstreet.com. Now I'll turn the call back over to John.

Thank you, Kristin. In the September quarter, our net investment income, or NII, was $81.4 million or $0.21 per common share, exceeding our distribution rate per common share by $0.03. Our basic net income attributable to common stockholders was $209.7 million or $0.54 per common share as the overall value of our investment portfolio increased for the sixth consecutive quarter due to a combination of positive company-specific and macro factors. Our NAV stood at $10.12 per common share in September, up $0.31 and 3.2% from the prior quarter and representing our sixth quarter in a row with NAV growth. Our NAV per common share is now at the highest level since September 2015 or 6 years ago. We have outperformed our peers during the past multiple quarters of macro volatility as a direct result of our previous derisking, not chasing leverage as well as other risk management controls. We are staying true to the strategy that has served us well since 1988, controlling and reducing portfolio and balance sheet risk both to protect the capital entrusted to us and to protect the ability of such capital to generate earnings for our shareholders. In the September quarter, our net debt-to-equity ratio was 48.2%, down 25.9 percentage points from March 2020 and down 7.7 percentage points from the June quarter as we continue to run an under-leveraged balance sheet, which has been the case for us for multiple quarters. In May 2020, we moved our minimum 1940 Act regulatory asset coverage to 150%, equivalent to 200% debt to equity, which not only increased our cushion but also gave us flexibility to purchase our subsequently announced -- to pursue, I'm sorry, to pursue our subsequently announced junior capital perpetual preferred equity issuance, which counts toward '40 Act asset coverage but which gets significant equity treatment by our rating agencies. We have no plans to increase our actual drawn debt leverage beyond our historical target of 0.7 to 0.85 debt to equity, and we are significantly below such target range now. Prospect's balance sheet is highly differentiated from peers with 100% of Prospect's funding coming from unsecured and nonrecourse debt, which has been the case for prospect for over 14 years. Unsecured debt was 96% of Prospect's total debt in September 2021 or about 33 percentage points higher than around 63% for the typical listed BDC. On the cash shareholder distribution front, we are pleased to report the Board's declaration of continued steady monthly distributions. We are announcing monthly cash common shareholder distributions of $0.06 per share for each of November, December and January. These 3 months represent the 51st, 52nd and 53rd in a row, consecutive stable per share rate, continuing over 4 years of stable monthly cash shareholder distributions. Consistent with past practice, we plan on our next set of shareholder distribution announcements in February. Our goal over the long term is to maintain and ideally grow this steady monthly cash shareholder distribution as we seek to provide low volatility stability to our shareholders amidst the macro market backdrop that delivers greater volatility elsewhere. Since our IPO over 17 years ago through our January 2022 distribution at the current share count, we will have paid out $19.14 per common share to original shareholders, aggregating approximately $3.5 billion in cumulative distributions to all common shareholders. Since October 2017, our NII per common share has aggregated $3.15, while our shareholder distributions per share have aggregated $2.88, resulting in our NII exceeding distributions during this period by $0.27 per share. Our NII covered distributions in the June 2021 fiscal year and has exceeded distributions in the 2021 fiscal year-to-date by $0.03 per share. We are also pleased to announce continued preferred shareholder distribution on the heels of successful launches of our $1 billion 5.5% preferred program and $150 million 5.35% listed preferred. We have raised over $394 million in preferred stock to date with strong support from institutional investors, RIAs and broker-dealers, including the recent addition of 2 top 5 sized independent broker-dealer systems as well as top wirehouse and regional broker-dealer systems. We are currently focused on multiple initiatives to enhance our NII, ROE and NAV in accretive fashion, including our $1 billion perpetual preferred equity program, our $150 million, 5.35% listed perpetual preferred stock issuance, greater utilization of our cost-efficient revolving credit facility with an incremental cost of approximately 1.44% at today's 1-month LIBOR, retirement of higher cost liabilities, including multiple recent successful tender offers and repurchases, issuing lower-cost notes, including recent 5- to 30-year senior unsecured notes with coupons of approximately 2.25% to 4% and increased originations of senior secured debt and select equity investments to deliver targeted risk-adjusted yields and total returns as we deploy available capital from our current under-leveraged balance sheet. We believe there is no greater alignment between management and shareholders than for management to purchase a significant amount of stock, particularly when management has purchased stock on the same basis as other shareholders in the open market as we have. Prospect management is the largest shareholder in Prospect and has never sold a share. Senior management and employee insider ownership is currently approximately 28% of all shares outstanding, representing approximately $1.1 billion of our common equity. Thank you. I'll now turn the call over to Grier.

Thank you, John. Our scale platform with around $7.5 billion of assets and undrawn credit continues to deliver solid performance in the current dynamic environment. Our experienced team consists of around 100 professionals, which represents one of the largest middle market investment groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that spans third-party private equity sponsor related lending, direct non-sponsor lending, prospect sponsored operating and financial buyouts, structured credit and real estate yield and total return investing. Consistent with past cycles, we expect during the next downturn to see an increase in secondary opportunities, coupled with wider spread primary opportunities with a pullback from other investment groups, particularly highly leveraged ones. This business diversity allows us to source a broad range and high volume of opportunities, then select in a disciplined and bottoms-up manner the opportunities we deem to be the most attractive on a risk-adjusted basis. Our team typically evaluates thousands of opportunities annually and invests in a disciplined manner in a low single-digit percentage of such opportunities. Our nonbank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans. As of September 2021, our portfolio at fair value comprised 49.4% secured first lien debt, 16.5% other senior secured debt, 11.6% and subordinated structured notes with underlying secured first lien collateral, and 22.5% as a combination of unsecured debt, other debt and equity investments, resulting in 78% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral. Prospect's approach is one that generates attractive risk-adjusted yields. In our performing interest-bearing investments, we're generating an annualized yield of 11.6% as of September, down 0.1% from the prior quarter. We achieved an increase of 30 basis points from June 2020 despite a headwind from the past year decline in LIBOR, though we expect reasonable stability now due to our LIBOR floors. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors as such positions generate distributions. We've continued to prioritize senior and secured debt with our originations to protect against downside risk while still achieving above-market yields through credit selection discipline and a differentiated origination approach. As of September, we held 124 portfolio companies, stable with the prior quarter with a fair value of $6.4 billion, an increase of $229 million from the prior quarter. We also continue to invest in a diversified fashion across many different portfolio company industries with a preference for avoiding cyclicality and with no significant industry concentration. The largest is 17.9%. As of September, our asset concentration in the energy industry stood at 1.3%. Our concentration in the hotel, restaurant and leisure sector stood at 0.4% and our concentration in the retail industry stood at 0%. Non-accruals as a percentage of total assets stood at approximately 0.5% in September, down 0.1% from the prior quarter and down 0.4% from June 2020. Our weighted average middle market portfolio net leverage to 4.88x EBITDA, substantially below our reporting peers and down $0.13 from the June 2021 quarter. Our weighted average EBITDA per portfolio company stood at $95.3 million in September, an increase of $6.2 million and 7% from June 2021 as we continue to achieve solid profit growth with our portfolio companies. Originations in the September quarter aggregated $425 million. We also experienced $324 million of repayments and exits as a validation of our capital preservation objective, resulting in net originations of $101 million. During the September 2021 quarter, our originations comprised 94.5% middle market lending, 3.2% middle market lending and buyouts and 2.3% real estate. To date, we have deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily workforce, stabilized yield acquisitions with attractive 10-plus year financing. NPRC, our private REIT, has real estate properties that have benefited over the past several years and more recently, from rising rents, showing the inflation hedge nature of this business segment, strong occupancies, high collections, suburban work-from-home dynamics, high-returning value-added renovation programs and attractive financing recapitalizations, resulting in an increase in cash yields as a validation of this income growth business alongside our corporate credit businesses. NPRC as of September has exited completely 34 properties at an average IRR of 24.1%, with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships. We currently have multiple other property exits in process that we expect to add to our growing track record of positive realization. Our structured credit business has delivered attractive cash yields, demonstrating the benefits of pursuing majority stakes, working with world-class management teams, providing strong collateral underwriting through primary issuance and focusing on attractive risk-adjusted opportunities. As of September, we held $751 million across 39 nonrecourse subordinated structured notes investments. These underlying structured credit portfolios comprised around 1,750 loans and a total asset base of around $16 billion. As of September, the structured credit portfolio experienced a trailing 12-month default rate of 26 basis points, down 74 basis points from the prior quarter and representing 9 basis points less than the broadly syndicated market default rate of 35 basis points. In the September quarter, this portfolio generated an annualized cash yield of 20.4% and GAAP yield of 12.2% with the difference representing an amortization of our cost basis. As of September, our subordinated structured credit portfolio has generated $1.37 billion in cumulative cash distributions to us, representing around 97% of our original investment. Through September, we've also exited 10 investments totaling $287 million with an average realized IRR of 15.7% and cash-on-cash multiple of 1.45x. Our subordinated structured credit portfolio consists entirely of majority-owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same tranche. In many cases, we receive fee rebates because of our majority position. As majority holder, we control the ability to call a transaction in our sole discretion in the future, and we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion rather than when loan asset valuations might be temporarily low. We as majority investor can refinance liabilities on more advantageous terms, remove bond baskets in exchange for better terms from debt investors in the deal and extend or reset the investment period to enhance value. We completed 30 refinancings and resets since December 2017. So far in the current December 2021 quarter, we booked $226 million in originations and experienced $87 million of repayments for $139 million of net originations. Our originations have consisted of 100% middle market lending. I'll now turn the call over to Kristin. Kristin?

Thank you, Grier. We believe our prudent leverage, diversified access to match book funding, substantial majority of unencumbered assets weighting toward unsecured fixed rate debt, avoidance of unfunded asset commitments and lack of near-term maturities demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of liabilities extending 30 years into the future. Today, we have 0 debt maturing until July 2022. Our total unfunded eligible commitments to noncontrolled portfolio companies totals approximately $42 million, representing less than 1% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $1.1 billion. We're a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop a notes program, issue under a bond and equity ATM, acquire another BDC and many other lists of first. In 2020, we also added our programmatic perpetual preferred issuance to that list of first, followed in 2021 by our listed perpetual preferred as another first in the industry. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken toward construction of the right-hand side of our balance sheet. As of September 2021, we held approximately $4.61 billion of our assets as unencumbered assets, representing approximately 71% of our portfolio. The remaining assets are pledged to Prospect capital funding, a nonrecourse SPV, where in April 2021, we completed an upsizing and extension of our revolver to a refreshed 5-year maturity. We currently have $1.2775 billion of commitments from 41 banks, an increase of 11 lenders from March 2021 and demonstrating strong support of our company from the lender community. The facility revolves until April 2025, followed by a year of amortization with interest distributions continuing to be allowed to us. Our drawn pricing is now LIBOR plus 2.05%, a decrease of 15 basis points from before. Our undrawn pricing between 35% and 60% utilization has been reduced by 30 basis points. We also now have an improvement to our borrowing base due to a change in concentration baskets, which we estimate increased our borrowing base by approximately $150 million. Of our floating rate assets, 92.9% have LIBOR floors with a weighted average floor of 1.62%. Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect included in the past 5 years, multiple types of investment-grade unsecured debt, including convertible bonds, institutional bonds, baby bonds and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We enjoy an investment grade BBB rating from S&P, an investment-grade Baa3 rating from Moody's, an investment-grade BBB negative rating from Kroll and investment-grade BBB rating from Egan-Jones and an investment-grade BBB low rating from DBRS. Earlier in 2021, we received the latter investment-grade rating, taking us to 5 investment-grade ratings more than any other company in our industry. All of these ratings have stable outlooks. We've now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 30 years. Our debt maturities extend through 2051. With so many banks and debt investors across so many debt tranches, we've substantially reduced our counterparty risk over the years. In the September '21 quarter, we completed successful redemptions, tender offerings and repayments, retiring $214 million of our InterNotes and $51 million of our 2022 notes. In the current December quarter, we have retired $24 million of our InterNotes. In the September 2021 quarter, we achieved $300 million in unsecured debt maturing in October 2028 with a coupon of 3.47%. We have continued to substitute more expensive term debt with significantly lower cost revolving credit with an incremental 1.44% cost, coupled with our newly issued 2028 notes. We also have continued with our weekly programmatic InterNotes issuance on an efficient funding basis. To date, we have raised our $394 million in aggregate issuance of our perpetual preferred stock across our preferred program and listed preferreds. We now have 8 separate unsecured debt issuances aggregating $1.7 billion, not including our program notes, with maturities extending to June 2029. As of September 2021, we had $382 million of program notes outstanding staggered maturities through September 2021. At September 30, 2021, our weighted average cost of unsecured debt financing was 4.56%, a decrease of 0.30% from June 30, 2021 and a decrease of 1.17% from September 30, 2020. In 2020, we added a shareholder loyalty benefit to our dividend reinvestment plan or DRIP that allows for a 5% discount to the market price for DRIP participants. As many brokerage firms either do not make DRIPs automatic or have their own synthetic DRIPs with no such 5% discount benefit, we encourage any shareholder interested in DRIP participation to contact your broker. They should have specify you wish to participate in the Prospect Capital Corporation DRIP plan through DTC at a 5% discount and obtain confirmation obtained from your broker. Our preferred holders can also elect to DRIP at a price per share of $25. Shareholders participating in our common stock DRIP for the 12 months ended September 30, 2021 receive a return 3.2% greater than non-participating shareholders for a total return of over 70%. Now I'll turn the call back over to John.

Thank you very much, Kristin. Okay. We can answer any questions.

[Operator Instructions] Our first question comes from Matt Tjaden with Raymond James.

First one for me on the preferred issuance. So obviously, a strong quarter of preferred issuance. And apologies if I missed it. Any color you can give on kind of how preferred issuance is shaping up subsequent to quarter end? And then maybe any additional color on the timing of the ramp up to the $1 billion target range?

Sure. Thank you, Matt. We had disclosed that as of right now, cumulative issuance is about $400 million. That's inclusive of the $150 million traded perpetual preferred that we issued this summer. So about $250 million approximately of our $1 billion nontraded program has been issued to date. We're tracking at approximately $30-or-so million per month -- sorry, yes, per month, about $15 million per intake, which is every 2 weeks. This is a rough approximation. It can vary, of course, which doesn't fully reflect the onboarding of some significant new systems as we had mentioned have joined the selling group of late. So we expect that to ramp up accordingly. And we're quite pleased with our preferred program, which has received wide and pause acceptance really of all investor types, large and small from institutional to various types of high net worth and in between with the RIA community. So it's been a very successful program and yet another innovation that we brought to our industry alongside many others in our history.

Got it. That's helpful. Maybe it's following up again on the preferred. So obviously, with the dividend flowing below the NII line, have there been any internal discussions regarding a -- maybe an adjusted NII figure that takes out the preferred dividend, again, given that it's recurring and impacts common shareholder dividend coverage?

Sure. It's a great question. I mean historically, we've been wary of showing a whole lot in the way of adjusted numbers. In fact, the regulatory push had been sort of the opposite of that for many years. But it's something we have an active dialogue about. It's fairly simple arithmetic to disattract the preferred interest rate, which is another item shown on the income statement but something we'll keep talking about.

Fair enough. Last one for me, just more of a housekeeping item on the other income line, so obviously, a healthy quarter of other income. It looks like $3.8 million of structuring fees from PGX Holdings. Correct me if I'm wrong, I haven't seen that name flow into that line item kind of post COVID. Is that kind of a recurring level? And how should we expect that line item to shake out over the next couple of quarters?

It's not a recurring item. It's not a controlled investment where we would take ongoing distributions, for example. But this pertains to a maturity extension and associated fee revenue of same.

This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Okay. Thank you, everyone. Have a wonderful afternoon. Bye now.

Thanks all. Bye now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.