Business context and reporting period
Prospect Capital Corporation is a non-diversified business development company and regulated investment company that lends to and invests in middle-market private companies. Its strategies include first- and second-lien lending, control investments, real estate and structured credit/CLO investments. The filing is a Form 10-K for the fiscal year ended June 30, 2023, not a 2022 Q4 filing. It includes fourth-quarter activity for the three months ended June 30, 2023.
Key financial metrics
| Metric | FY2023 | FY2022 |
|---|---|---|
| Investment income | $852.2 million | $710.9 million |
| Net investment income | $420.9 million | $343.9 million |
| Net investment income per basic share | $1.06 | $0.88 |
| Net realized and unrealized investment losses | $522.4 million | $248.8 million gains |
| Net decrease in assets applicable to common stockholders | $172.5 million | $556.6 million increase |
| Net asset value per common share | $9.24 | $10.48 |
| Common distributions declared and payable | $287.2 million, or $0.06 monthly | $281.4 million |
| Portfolio investments at fair value | $7.725 billion | $7.603 billion |
| Total assets | $7.862 billion | $7.663 billion |
| Cash and cash equivalents | $95.6 million | $35.4 million |
Investment income increased 19.9%, while net investment income increased 22.4%. Net investment income represented approximately 49% of investment income. The higher income primarily reflected increased floating-rate earnings as LIBOR and SOFR rose above portfolio floors. The weighted-average rate earned on performing interest-bearing investments increased to 10.73% from 9.42%.
Cash flow from operating activities was negative $220.8 million, compared with negative $795.3 million in FY2022, reflecting lower investment purchases and repayments. Financing activities provided $281.1 million and included $299.1 million of dividends and distributions paid.
Debt, liquidity and capital structure
- Total debt principal outstanding was $2.610 billion, down from $2.769 billion.
- The revolving credit facility had $1.015 billion outstanding, $1.913 billion of commitments and $697.3 million of remaining borrowing availability. It matures September 15, 2027, with the revolving period ending September 15, 2026.
- Debt maturities include $81.2 million of 6.375% notes due January 2024, $156.2 million of convertible notes due March 2025, and $400.0 million of 2026 notes.
- Asset coverage was 297.0% for senior securities representing indebtedness and 186.2% for senior securities representing stock, compared with 273.3% and 215.6%, respectively, in FY2022.
- Preferred stock classified as temporary equity had a carrying value of $1.418 billion. The company issued $759.7 million of preferred stock proceeds, net of underwriting costs, during FY2023.
Material changes versus the prior comparable period
- Portfolio fair value increased 1.6%, but net asset value per common share declined 11.8%, from $10.48 to $9.24, due primarily to $522.6 million of net realized and unrealized investment losses.
- Investment originations declined to $1.076 billion from $2.322 billion, while repayments and sales declined to $462.9 million from $1.122 billion.
- The portfolio shifted toward first-lien debt and away from subordinated structured notes and equity. First-lien debt fair value increased to $4.303 billion from $3.758 billion; subordinated structured notes declined to $665.0 million from $711.4 million.
- Non-accrual investments increased materially: cost basis was $421.2 million and fair value was $86.4 million, versus $181.4 million and $31.5 million, respectively, in FY2022.
- PGX Holdings filed for Chapter 11 bankruptcy in June 2023 following litigation concerning telemarketing practices. Prospect recorded a $294.9 million unrealized loss on PGX and valued its first- and second-lien investments at $70.6 million.
- FY2023 included a $481.3 million net change in unrealized losses, compared with a $262.0 million gain in FY2022. The largest disclosed adverse valuation item was PGX; NPRC also recorded a $55.9 million unrealized loss.
- The company repaid the remaining 2023 Notes at maturity in March 2023 and the remaining 2022 Notes at maturity in July 2022.
Outlook, management commentary, risks and unusual items
- Management continued to declare a $0.06 monthly common dividend through the post-year-end declarations disclosed in the filing. The filing provides no earnings or NAV guidance.
- Management expects continued sensitivity to interest rates. Approximately 84.7% of interest-earning investments were floating-rate, while the credit facility is also SOFR-based. A 100-basis-point increase was estimated to increase annual net investment income by approximately $26.3 million after incentive fees; a 100-basis-point decline was estimated to increase it by approximately $1.2 million.
- Key risks include rising funding costs, borrower defaults, recessionary conditions, illiquid private investments, CLO leverage and cash-flow deferrals, valuation uncertainty, LIBOR-to-SOFR transition risk, refinancing risk and dilution from convertible preferred stock.
- Most investments are Level 3 fair-value measurements based on unobservable inputs. The auditor identified valuation of Level 3 investments as a critical audit matter.
- The company reported approximately 1.1% of total assets at fair value in non-accrual status. PIK income was $132.1 million and may create taxable income without corresponding cash receipts.
- Previously reported material weaknesses involving CLO valuation review controls and the control environment were reported as remediated during FY2023. Management and BDO issued effective-control conclusions as of June 30, 2023.
- The company disclosed no material legal proceedings as of June 30, 2023.
Most important facts for an investor to verify
- Confirm the intended reporting period: the supplied filing is FY2023 and includes June 2023 quarter-end information, rather than 2022 Q4.
- Reconcile the $9.24 NAV per share with the $6.20 June 30, 2023 market price and assess the continuing discount to NAV.
- Review the valuation, collateral and recovery prospects for PGX and other non-accrual or materially discounted investments.
- Assess the sustainability of distributions against net investment income, cash collections and the level of PIK income.
- Review near-term debt maturities, refinancing plans and compliance with credit-facility covenants.
- Evaluate the impact of preferred-stock issuance and conversion provisions on common-stock dilution and NAV.
- Examine Level 3 valuation assumptions, including market yields, discount rates, EBITDA multiples and real-estate capitalization rates.
- Verify the final tax character of FY2023 distributions, which had not been finalized at the filing date.