Prospect Capital Corporation (PSEC) Q2 2026 Earnings Report, Transcript and Summary

Good day, and welcome to the Prospect Capital Second Fiscal Quarter 2026 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, Michael. Joining me on the call today once again are Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?

Thanks, John. This call contains forward-looking statements that are intended to be subject to safe harbor protection. Future results are highly likely to vary materially. We do not undertake to update our forward-looking statements. For additional disclosure, see our earnings press release and 10-Q filed previously and available on our website, prospectstreet.com. Now I'll turn the call back over to John.

Okay. Thank you, Kristin. In our December quarter, our net investment income was $91 million or $0.19 per common share. Our NAV was approximately $3 billion, $6.21 per common share. At December 31, our net debt to total assets ratio was 28.2%. Unsecured debt plus unsecured perpetual preferred was 85.3% of total debt plus preferred. We are announcing monthly common shareholder distributions of $0.045 per share for each of February, March and April. Since our IPO nearly 22 years ago, through our April 2026 declared distribution, we will have distributed $4.7 billion or $21.93 per share. Our preferred shareholder cash distributions continue at their contract rates. We continue to make progress with our strategic priorities, including: number one, rotation of assets into our core business of first lien senior secured middle market loans with our first lien mix increasing 728 basis points to 71.4% since June 2024. We are focusing on new investments in companies with less than $50 million of EBITDA, including companies with smaller funded private equity sponsors, independent sponsors and no third-party financial sponsors. Number two, reduction in second lien senior secured middle market loans with our second lien mix decreasing 371 basis points to 12.7% since June 2024. Number three, exiting subordinated structured notes with our subordinated structured notes mix decreasing 818 basis points to near 0 since June 2024. Number four, exiting targeted equity-linked assets, including real estate, with 5 additional real estate properties sold in the current fiscal year more targeted and certain corporate investments sold, including significant assets within Echelon Transportation in July and December 2025 and other exits targeted. Number five, enhancement of portfolio company operations, especially where we hold equity-linked investments; and number six, utilization of our cost-efficient floating rate revolver, which significantly matches our floating rate assets. Thank you. I'll now turn the call over to Grier.

Thank you, John. Over the past 2-plus decades, Prospect Capital Corporation has invested approximately $13.1 billion in over 350 exited investments out of over $22 billion in over 450 total investments that have earned a 12% unlevered investment level gross cash IRR to Prospect Capital Corporation. This multi-decade time period includes the GFC and has been dominated in general by low prevailing market interest rates. In Prospect's primary business of primary -- of middle market lending over the same nearly 22-year time period, Prospect's exited investments resulted in an investment level exited gross IRR of approximately 14.5% based on total capital invested of about $11.2 billion and total proceeds from such exited investments of about $14.3 billion with an annualized realized loss rate of 0.2%. In Prospect's core targeted business of middle market lending to companies with less than $50 million of EBITDA over the same nearly 22-year time period, Prospect's exited investments resulted in an investment level exited gross IRR of approximately 17.2% based on total capital invested of about $6.3 billion and total proceeds from such exited investments of about $8.3 billion, with an annualized net realized loss rate in this segment of 0.1%. Prospect's EBITDA to interest coverage for our primary business of middle market lending is about 210%, which increases to about 230% for Prospect's core targeted middle market lending to companies with less than $50 million of EBITDA. As of December 2025, we held 91 portfolio companies across 32 different industries with an aggregate fair value of $6.4 billion. Our portfolio at cost included 2.8% of investments in software companies, which is significantly less than the 22% average across business development companies with publicly traded unsecured bonds from a recent Wall Street Fixed Income Research report. We primarily focus on senior and secured debt, which was 84% of our portfolio at cost as of December. Our middle market lending strategy is the primary focus of our company, with such strategy as of December representing 85% of our investments at cost, an increase of 878 basis points from June 2024. Middle market lending comprised 100% of our originations during the December quarter with a continued prioritization of first lien senior secured loans. Investments during the quarter included follow-on investments in existing portfolio companies to support acquisitions, working capital needs, organic growth initiatives and other objectives. We've essentially completed the exit of our subordinated structured notes portfolio as of December with such portfolio representing only 0.2% of our investment portfolio at cost, which represents a reduction of 818 basis points from 8.4% in June 2024. Our real estate property portfolio at National Property REIT Corp, NPRC totaled 14% of our investments at cost as of December and continued its focus on developed and occupied cash flow multifamily investments. Since the inception of this strategy, 14 years ago in 2012 and through December 2025, we've exited 56 property investments, earning an unlevered investment level gross cash IRR of 24% and cash-on-cash multiple of 2.4x. We exited 4 property investments in the current fiscal year through December 2025 that earned an unlevered investment level gross cash IRR of 21% and cash-on-cash multiple of 2.4x. NPRC exited one additional property investment after December 31, 2025, and has multiple additional properties in various stages of an exit process. The remaining real estate property portfolio included 54 properties and paid us an income yield of 5.4% for the December quarter, providing an opportunity for potential income enhancement from a portfolio rotation strategy. Prospect's aggregate investments in NPRC included a $270 million unrealized gain as of December. We expect to continue to redeploy future real estate property exit proceeds primarily into more first lien senior secured loans with selected equity-linked investments. Our interest income for the 12-month period ending December 2025 was 92% of our total investment income, reflecting a strong recurring revenue profile for our business. Payment in kind interest income for the last 12-month period ended December 2025 was reduced by 46% from the 12-month period ending December 2024 and was 8.6% of total investment income for the December 2025 quarter. Nonaccruals as a percentage of total assets as of December stood at approximately 0.7% based on fair market value. Investment originations in the December quarter aggregated $80 million and consisted of 100% middle market investments with a significant majority of first lien senior secured loans. We also experienced $79 million in repayments and exits as a validation of our capital preservation objective, resulting in net repayments of $1 million. Thank you. I'll now turn the call over to Kristin. Kristin?

Thanks, Grier. We believe our prudent leverage, diversified access to match book funding, substantial majority of unencumbered assets, weighting toward unsecured fixed rate debt and avoidance of unfunded asset commitments all demonstrate balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of liabilities extending 26 years into the future. On October 30, 2025, we successfully completed the institutional issuance of approximately $168 million in aggregate principal amount of senior unsecured 5.5% notes due 2030, which mature on December 31, 2030. Our unfunded eligible commitments to portfolio companies totaled approximately $34 million, of which $23 million are considered at our sole discretion, representing approximately 0.5% and 0.3% of our total assets as of December 2025, respectively. Our combined balance sheet cash and undrawn revolving credit facility commitments stood at $1.6 billion as of December, and we held $4.2 billion of our assets as unencumbered assets, representing approximately 64% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, a nonrecourse SPV. We currently have $2.12 billion of commitments from 48 banks, demonstrating strong support of our company from the lender community with the diversity unmatched by any other company in our industry. The facility does not mature until June 2029 and revolves until June 2028. Our drawn pricing continues to be SOFR plus 2.05%. Outside of our revolver, we have access to diversified funding sources across multiple investor types and have successfully issued securities in an array of markets. Prospect has issued multiple types of unsecured debt, institutional nonconvertible bonds, institutional convertible bonds, retail baby bonds and retail program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We've tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 26 years with our debt maturities extending through 2052. With so many banks and debt investors across so many unsecured and nonrecourse debt tranches, we have substantially reduced our counterparty risk. At December 31, 2025, our weighted average cost of unsecured debt financing was 4.68%. Now I'll turn the call back over to John.

Thank you, Kristin. We will now answer any questions.

[Operator Instructions] And your first question today comes from Finian O'Shea with Wells Fargo.

I wanted to ask on Tower, sort of a 2-parter. One is to the extent that tax refunds are higher this year, do you anticipate that's a headwind to loan balances? And then seeing Tower, it's been a really big winner for you. Is that part of the optimization strategy to say, exit the equity-linked types of investments? Or is that still one of sort of a firm hold for now, one that you definitely want to keep?

Well, Fini, this is John. I would say that we want to stick with our great winners and First Tower is absolutely one of them. We have a fabulous CEO there, frankly, be very hard to find a better CEO. So we have no current plans to do anything but continue to work with Frank. Grier?

Sure. Thank you for your questions, Finian. On the second one on potentially exiting Tower, we have no such plans, as John mentioned. Recall that we have substantial tax advantages as a regulated investment company under subchapter M, paying no income taxes as a business development company. And the income generated by First Tower is quite favorable, good income under our tax regime. So we're able to hold First Tower as a tax partnership rather than a C-corporation, thereby avoiding an extra level of taxation. Any prospective buyer of Tower given its scale, would quite likely either be a C-corp or have potential future plans to maybe IPO the business to become -- and that would require a C-corp under the tax law, which would immediately create significantly tax drag. So that's a way of saying that we are the logical lowest cost of capital, most tax-efficient owner of that business. On top of it, it's a very yieldy strategy that we like in our business. Whenever we open up a new branch, it has an expected IRR typically of well over 30%. It's attractive income type of business with low-cost third-party ABL financing that's going lower, still enhancing the yield as SOFR continues to drop, also part of the forward curve. The business is also firing on all cylinders with in recent periods, record low on a multi-decade basis, delinquencies, record low on a multi-decade basis charge-offs. The company has optimized its strategy, not overexpanding, but expanding prudently and thoughtfully into new states and new offices within existing and new states, Florida and Tennessee, for example, are significant opportunities for expansion on top of Texas, which has been a more recent area for expansion. So the business is doing well, and again, we have no plans to rotate out of it. In terms of your first question from a tax refund standpoint, yes, the dynamic of consumers borrowing money for holiday spending in the December quarter and then repaying some of those borrowings in the first half of the following calendar year based on tax refunds is not a new phenomenon at all. That's been the case for decades, creates a little bit of seasonality, which is fine and not problematic. I hadn't heard that tax refunds would necessarily be abnormally large or cause any distortions to Tower's business in any way. And of course, there are multiple drivers of consumer demand, not just holiday spending, but other aspects as well, including what's going on in the bank and nonbank borrower and lender markets. There's a very high barrier to entry in the nonbank installment finance business. There's not a whole lot of new lending going on to new entrants. There's a fairly well-defined existing group of banks that are lenders to that business and don't tend to, from our observation, be that desirous of expanding into new entrants, but rather sticking with incumbents creating a benefit to being already in that business with an established bank group and a history in the case of Tower that spans over 40 years. So we see strong demand. We also see a phenomenon in which Tower and other companies have determined this over time, Tower is not alone in this and some of our other companies have also optimized on this basis. The best indicator you have of consumer credit is your existing customers and your existing credit experience with those customers. So as they demonstrate a strong history over time of repayment and delevering, providing additional financing to those solid credit customers in the form of larger loans becomes a very smart way to enhance profitability, not the only way, but a meaningful driver to avoid potential charge-offs or reduce that risk for new borrowers for which one does not necessarily have a prior credit experience. So hopefully, that's a little bit of context on First Tower, which we first invested in 2012, 2013 time frame. So we're going on 12, 13, 14 years roughly of a history with that management team, which is outstanding, which is very well aligned with us, has made additional growth investments in the business right alongside us, and we couldn't be more pleased with how that business and team is performing.

That's great. I appreciate the color. A follow-up on the prefs. Conversions are stable. One thing you've touched on in the past, you've given us color on that market. In terms of impacts from other products in the nontraded channel. So today, as we all know, there are a lot of headlines sort of hitting the larger nontraded BDC market. Does that have an impact, good or bad, on your convertible pref product line?

I mean not really directly. I think that interest rates are a meaningful factor, Finian. And in the current environment, folks are -- some folks are deprioritizing floating rate investments or vehicles that have significant underlying floating rate exposure. Everybody likes to float up and get a higher yield. They don't necessarily like to float down and get paid less, right? So you see that dynamic, not just with nontraded BDCs that, of course, rode the wave up from 6 yields to 10 yields to investors and now have been riding the wave a bit downward with distribution reductions based on underlying loans paying less with prevailing SOFR going down. You see that dynamic with interval funds and anything that's floating rate in nature. I think it makes fixed rate investments to our sector, no matter what that form might be, all the more compelling. And I'm talking not just about fixed rate preferreds, which is essentially what all our preferreds are and newly issued preferreds, but also bonds for BDCs. So prioritization of investors from what we see is rotating back towards fixed rate and wanting to lock in a nice yield should rates continue to decline, at least on a short-term basis as evidenced by the forward curve. So I think that's a nontrivial dynamic at play here, which maybe keeps folks in their seats when it comes to sitting on fixed rate paper.

That's helpful as well. And I try to stay disciplined according to convention. But if I could throw in a bonus question. You guys have avoided software historically, which is pretty favorable to you at this point. That's causing a lot of the market consternation. Curious if you have any view on those sort of -- that sort of overhang being too heavy? Is it time to maybe pivot into enterprise SaaS software that's sort of a mainstay of a lot of your BDC peers portfolios. And that would be all for me.

Grier, just one second. Fini, thank you for your questions. I always hesitate to comment on what other people are doing or their investment strategies, whether I have an opinion or not. I'm very focused on our company. So I really don't know what's happening or going to happen with AI, software. And I don't think anybody else does. So I just want to preface anything that anyone has to say here with intellectual modesty and admitting that not only am I unable to forecast what might be happening in that sector. I have no first-hand information about what any of our competitors are doing. So that's my two cents on that, an admission of intense ignorance, if you will. All right, Grier?

Sure. Yes, we can only speak as to our own underwriting and thoughts. It's really a big difference in private credit compared to the broadly syndicated market for what the exposures are for software in the 2. In the broadly syndicated market, there's a nontrivial amount of software, I think, 10% or so, give or take, last I saw. And in that market, they tend to be cash flowing software companies. And the reason for that is you need to get a rating. That's a very rating-centric market. With the BDC market, less rating-centric. And what a lot of folks have done is to invest in annual recurring revenue loans that have less than a 1.0x fixed charge coverage. Those loans, when you go get a rating, whether it's credit estimate or private rating or what have you, tend to come back as CCC and with the lower type of rating. And of course, there's risk attached to that because there's no cash flow exit when you're below 1.0x fixed charge coverage, you're consuming cash and you need growth of the business to enable repayment, coupled with liquidity of a burgeoning software market. And that was always antithetical or has been to date to our underwriting culture of seeking multiple sources of repayment, seeking downside protection, principal protection in the loans we make. We'd like to see delevering occur from the underlying cash flow available for debt service out of the business. We historically have underwritten with around a 1.5x fixed charge coverage or better with each deal. And those annual recurring revenue or ARR deals never offered those, and we thought looked quite risky from our point of view. So we passed on every single one of them. We've never done a single such deal. We understand that others in the industry have pursued that sector, and we'll see what happens. I don't think we're in a position to prognosticate on what's going to happen with AI impacting those software companies. We'll just note that if anyone, whether they're an equity investor or a bond investor is worried about software exposure, then you not worry about it when it comes to Prospect Capital Corporation. We are the absolute lowest with software exposure at less than 3% compared to the BDC average, which is around 22% for bond issuers.

Seeing no additional questions, this concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Okay. Well, thank you, everyone. Have a wonderful day now. Bye.

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