Business Context and Reporting Period
Company: Prospect Capital Corporation (Prospect Capital)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2008
Business Overview: Prospect Capital is a closed-end investment company organized as a Business Development Company (BDC) under the Investment Company Act of 1940. It primarily invests in senior and subordinated debt and equity of middle-market, privately-held companies, with a historical concentration in energy and industrial sectors. The company is a non-diversified company.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2008 | Six Months Ended Dec 31, 2008 | Dec 31, 2008 Balance Sheet |
|---|---|---|---|
| Total Investment Income | $22,213 | $58,012 | - |
| Net Investment Income | $11,960 | $35,462 | - |
| Net Increase in Net Assets from Operations | $6,524 | $20,522 | - |
| Net Asset Value (NAV) Per Share | $14.43 | $14.43 | $14.43 |
| Total Assets | - | - | $587,977 |
| Total Liabilities | - | - | $160,174 |
| Net Assets | - | - | $427,803 |
| Credit Facility Outstanding | - | - | $138,667 |
| Cash and Cash Equivalents | - | - | $25,044 |
Note: All figures in thousands except per share data.
Material Changes vs. Prior Period
- Operating Performance: Net increase in net assets from operations for the six months ended Dec 31, 2008, was $20.5 million, a significant improvement over the $4.9 million increase in the same period in 2007. This was driven by higher investment income ($58.0M vs $34.0M) despite higher operating expenses ($22.6M vs $15.4M).
- Unrealized Losses: The company recognized a net change in unrealized depreciation of $16.6 million for the six months ended Dec 31, 2008, compared to an appreciation of $5.0 million in the prior year period. This was primarily due to write-downs in several portfolio companies (Deb Shops, Iron Horse, Qualitest, RMC, Resco, WEPI, and Yatesville) partially offset by appreciation in Gas Solutions Holdings, Inc. (GSHI).
- Debt Utilization: Borrowings under the credit facility increased from $91.2 million at June 30, 2008, to $138.7 million at December 31, 2008, to fund new investments and follow-on capital.
- Portfolio Composition: The portfolio grew to 31 long-term investments with a fair value of $555.7 million. Control investments represented 37.4% of the portfolio, while non-control/non-affiliate investments represented 53.2%.
Guidance, Outlook, Risks, and Unusual Items
- Market Conditions: Management notes that global capital markets remain turbulent with weaker liquidity and credit quality. However, the company maintains a conservative debt-to-equity ratio of 0.32 to 1 (well below the 1.0 to 1.0 BDC limit).
- Credit Facility: The $200 million revolving credit facility with Rabobank Nederland matures on June 6, 2009. Management is negotiating an extension and expansion but cannot guarantee completion.
- Non-Accrual Status: As of December 31, 2008, three loans totaling $55.7 million in principal were on non-accrual status: two to Integrated Contract Services, Inc. (ICS) and one to Worcester Energy Partners, Inc. (WEPI). Income foregone on these loans was $4.98 million for the six-month period.
- Unusual Items:
- Net Profit Interest Settlement: The company settled net profit interests in IEC Systems LP and Advanced Rig Services LLC for $12.6 million, which was immediately reinvested as incremental senior secured debt.
- Dividend Reinvestment: No new equity was raised via public offering during the period; capital share activity was limited to dividend reinvestments ($1.5 million).
- Risks: Key risks include the concentration in energy-related industries, the creditworthiness of lower-middle-market portfolio companies, and the potential inability to extend the credit facility on favorable terms.
Investor Verification Checklist
- Credit Facility Extension: Verify the status of negotiations for the $200 million Rabobank facility maturing June 6, 2009, and the terms of any new agreement.
- Non-Accrual Loans: Review the recovery prospects and collateral coverage for the $55.7 million in loans to Integrated Contract Services and Worcester Energy Partners currently on non-accrual status.
- Valuation Methodology: Confirm the Board's valuation of Level 3 assets (unobservable inputs), which comprise the vast majority of the portfolio, particularly given the $16.6 million in unrealized depreciation.
- Portfolio Concentration: Assess the impact of the continued concentration in energy and industrial sectors amidst the 2008 economic downturn.
- Dividend Sustainability: Evaluate the ability to maintain the $0.40 per share quarterly dividend given the unrealized losses and the reliance on investment income to cover distributions.