Business Context and Reporting Period
Company: Prospect Capital Corporation (Prospect)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: Prospect is a closed-end investment company organized as a Business Development Company (BDC) and a Regulated Investment Company (RIC). It primarily invests in senior and subordinated debt and equity of middle-market privately-held companies. As of March 31, 2011, the company held 64 long-term portfolio investments.
Key Financial Metrics
| Metric | Three Months Ended Mar 31, 2011 | Nine Months Ended Mar 31, 2011 | Net Assets (Mar 31, 2011) |
|---|---|---|---|
| Total Investment Income | $44,573 | $113,085 | $912,921 |
| Net Investment Income | $23,956 | $64,031 | |
| Net Increase in Net Assets from Operations | $33,759 | $91,279 | |
| Net Asset Value (NAV) Per Share | $10.33 | $10.33 |
Balance Sheet Highlights (in thousands)
- Total Assets: $1,338,862
- Total Investments at Fair Value: $1,213,517 (Cost: $1,173,639)
- Cash and Cash Equivalents: $97,314 (Includes $94,919 in money market funds)
- Total Liabilities: $425,941
- Debt Obligations:
- Senior Convertible Notes: $322,500
- Credit Facility Payable: $47,500
Cash Flow (Nine Months Ended Mar 31, 2011)
- Net Cash Used in Operating Activities: $(368,400)
- Net Cash Provided by Financing Activities: $369,714 (Driven by issuance of Senior Convertible Notes and common stock)
- Net Increase in Cash: $1,314
Material Changes vs. Prior Period
- Investment Portfolio Growth: Total investments at fair value increased from $748,483 (June 30, 2010) to $1,213,517 (March 31, 2011), a 62% increase. This was driven by $632,526 in new and follow-on investments.
- Net Investment Income: Increased 26% for the three months ended March 31, 2011 ($23,956) compared to the same period in 2010 ($18,974), primarily due to a larger asset base and increased structuring fees.
- Realized Gains/Losses:
- For the nine months ended March 31, 2011, the company reported a net realized gain of $7,094, primarily from the sale of Miller Petroleum common stock ($7,976 gain).
- This contrasts with the nine months ended March 31, 2010, which reported a net realized loss of $(51,231) due to the impairment of Yatesville Coal Holdings.
- Debt Structure: The company issued $322,500 in Senior Convertible Notes (6.25% due 2015 and 5.50% due 2016) during the period, significantly increasing leverage compared to the prior year-end.
- Non-Accrual Assets: The principal balance of loans on non-accrual status decreased from $163,653 (June 30, 2010) to $91,905 (March 31, 2011).
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Market Conditions: Management notes continued recovery in credit markets but acknowledges a challenging environment. The company is well-positioned with a 1:1 debt-to-equity ratio limit.
- Investment Strategy: Originations are focused on secured lending, specifically first-lien loans, to reduce credit risk. The portfolio's annualized current yield decreased from 14.6% (March 31, 2010) to 12.9% (March 31, 2011) as the company prioritizes senior secured assets over higher-yielding junior debt.
- Liquidity: The company maintains a $285,000 syndicated revolving credit facility (expandable to $400,000) with $207,467 available as of March 31, 2011. It also has a shelf registration for up to $750,000 in additional equity securities.
Risks and Contingencies
- Portfolio Concentration: Despite diversification efforts, the portfolio retains a concentration in energy and energy-related industries.
- Control Investments: Several control investments (e.g., Yatesville, Change Clean Energy, Freedom Marine) have been valued at zero or significantly below cost due to operational failures or market conditions. Yatesville operations were discontinued in 2009.
- Interest Rate Risk: Approximately $776,521 of loans bear floating interest rates, though most have LIBOR floors.
- Dividend Policy: The company declared monthly dividends ranging from $0.101150 to $0.101200 per share during the quarter. Failure to distribute 98% of taxable income could result in excise taxes.
Key Facts for Investor Verification
- Valuation of Level 3 Assets: 99.9% of the portfolio ($1,213,350) is classified as Level 3 (unobservable inputs). Investors should review the valuation methodologies and the specific write-ups (e.g., Biotronic, NRG) and write-downs (e.g., H&M Oil & Gas, ICS) detailed in the MD&A.
- Convertible Note Conversion Rates: Verify the conversion rates for the 2010 and 2011 Senior Convertible Notes, which are subject to adjustment if monthly dividends exceed specific thresholds ($0.101125 and $0.101150, respectively).
- Non-Accrual Status: Confirm the status of the eight loans on non-accrual (including Borga, Deb Shops, and Manx Energy) and the potential for further impairments.
- Equity Dilution: The company issued 18.5 million shares during the nine-month period, raising $177.6 million net of costs. Investors should assess the impact of this dilution on NAV per share.
- Subsequent Events: Note the public stock offering of 9 million shares at $11.40 per share completed on April 7, 2011, and the increase in credit facility commitments to $325,000 on April 21, 2011.