PSEC

Business Context and Reporting Period

Company: Prospect Capital Corporation (Prospect)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: Prospect is a closed-end, non-diversified Business Development Company (BDC) and Regulated Investment Company (RIC). It primarily invests in senior and subordinated debt and equity of middle-market, privately-held companies. The company is actively deploying capital raised through equity offerings and the acquisition of Patriot Capital Funding, Inc. (Patriot) in December 2009.

Key Financial Metrics

Liquidity and Debt:

• Credit Facility: $210,000 total commitment; $54,200 outstanding as of March 31, 2010.
• Cash and Cash Equivalents: $21,249 (Cash) + $23,011 (Money Market Funds) = $44,260.
• Portfolio Investments: Total fair value of $697,001 (Cost: $675,534).

Material Changes vs. Prior Period

• Net Assets Growth: Net assets increased by $116,890 (21.9%) from June 30, 2009 ($532,596) to March 31, 2010 ($649,486). This was driven primarily by $208,306 in capital share transactions (including the Patriot acquisition) and $108,858 in proceeds from new equity offerings, partially offset by $94,125 in dividends paid.
• Operating Performance: While Net Investment Income increased to $18,974 for the quarter (from $11,720 in the prior year quarter), the nine-month Net Increase in Net Assets from Operations dropped significantly to $2,709 (from $35,853 in the prior year). This decline is primarily due to a net realized loss of $51,231 related to the impairment of Yatesville Coal Holdings, Inc.
• Portfolio Yield: The weighted-average interest rate earned on debt investments increased to 16.75% for the quarter ended March 31, 2010, compared to 12.13% in the prior year period, largely due to assets acquired from Patriot.
• Non-Accrual Status: Eight loan investments were on non-accrual status as of March 31, 2010, representing approximately 5.6% of net assets. This is an increase from five loans on non-accrual status at June 30, 2009.

Guidance, Outlook, and Risks

Management Commentary:

• Capital Deployment: Management notes that significant equity capital raised in the prior fiscal year and the current period has not yet been fully invested, resulting in excess cash that temporarily depresses earnings per share. The company is actively deploying this capital into new investments.
• Market Conditions: While the economy shows signs of recovery, credit markets remain volatile. The company expects to enter into a new extended three-year revolving credit facility prior to June 25, 2010, though completion is not guaranteed.
• Merger Proposal: Prospect terminated its solicitation to acquire Allied Capital Corporation in March 2010 after Allied declined the offer. Prospect incurred $925 in expenses related to this potential acquisition.

Risks and Contingencies:

• Portfolio Impairments: Significant realized losses were recorded due to the impairment of Yatesville Coal Holdings, Inc. ($51,228 loss). Other control investments (Ajax, Iron Horse, Manx) also experienced unrealized depreciation.
• Non-Accrual Loans: Continued non-accrual status on several loans (e.g., Yatesville, Iron Horse, Manx) poses credit risk and results in forgone interest income ($16,604 for the nine months ended March 31, 2010).
• Liquidity: The company relies on its credit facility and equity markets for liquidity. The credit facility has a revolving period ending June 24, 2010, with an amortization period thereafter.

Key Facts for Investor Verification

• Yatesville Impairment: Verify the details of the $51,228 realized loss on Yatesville Coal Holdings, Inc., which was the primary driver of the nine-month operating loss.
• Capital Deployment Rate: Monitor the rate at which the company deploys the significant cash reserves ($44M+) and proceeds from recent equity offerings to avoid further dilution of earnings per share.
• Credit Facility Renewal: Confirm the status of the new three-year revolving credit facility extension expected before June 25, 2010.
• Non-Accrual Portfolio: Track the performance and potential recovery of the eight loans currently on non-accrual status, which represent a material portion of the portfolio.
• Dividend Coverage: Assess whether Net Investment Income ($18,974 for the quarter) continues to cover the quarterly dividend declared ($26,403 payable), noting that the company has historically distributed more than its net investment income.