Business Context and Reporting Period
Prospect Capital Corporation is a Maryland-based business development company and regulated investment company that lends to and invests in middle-market private companies through first- and second-lien debt, structured credit, real estate and equity investments. This unaudited Form 10-Q covers the three months ended September 30, 2022, the company’s fiscal first quarter of fiscal 2023, with comparisons to September 30, 2021.
Key Financial Metrics
| Metric | Three months ended September 30, 2022 | Comparable period |
|---|---|---|
| Total investment income | $202.7 million | $169.5 million |
| Net investment income | $99.3 million | $81.4 million |
| Net investment income as a percentage of investment income | 49.0% | 48.0% |
| Net realized investment losses | $23.2 million | $0.6 million |
| Net change in unrealized investment losses | $168.5 million | Net gains of $136.7 million |
| Net decrease in assets applicable to common stockholders | $105.2 million | Net increase of $209.7 million |
| Basic loss per common share | $0.27 | Earnings of $0.54 |
| Net asset value per common share | $10.01 | $10.48 at June 30, 2022 |
| Cash at period end | $43.4 million | $35.4 million at June 30, 2022 |
- Investment income increased 19.6%, led by higher interest income and royalty/net revenue interests. Interest income was $174.3 million, dividend income was $2.9 million and other income was $25.5 million.
- Operating expenses were $103.4 million, including $38.3 million of base management fees, $21.6 million of income incentive fees and $33.9 million of interest and credit facility expenses.
- Cash used in operating activities was $76.9 million. Cash provided by financing activities was $84.9 million, resulting in an $8.0 million increase in cash.
- The investment portfolio comprised 128 long-term portfolio investments and CLOs, with amortized cost of $7.35 billion and fair value of $7.58 billion, equal to 191.3% of net assets applicable to common shares.
- Interest-bearing investments had an annualized current yield of 12.4% excluding equity investments and non-accrual loans, and 9.9% across all investments, according to management.
- Approximately 88.15% of interest-earning investments at fair value bore floating rates. Loans on non-accrual status had a fair value of $23.6 million, approximately 0.3% of total assets at fair value.
Debt, Liquidity and Capitalization
- Total debt principal outstanding was $2.67 billion at September 30, 2022, compared with $2.77 billion at June 30, 2022. Net carrying value was $2.64 billion and estimated fair value was $2.42 billion.
- The revolving credit facility had $799.9 million outstanding, $659.6 million of remaining availability and total lender commitments of $1.63 billion. The facility matures in September 2027, with the revolving period ending in September 2026.
- Contractual debt maturities include $283.9 million of Public Notes due during the remainder of fiscal 2023, $81.9 million due in fiscal 2024 and $156.2 million of convertible notes due in fiscal 2025.
- The asset coverage ratio was 283.3% for senior securities representing indebtedness and 204.9% including preferred stock, versus 273.3% and 215.6%, respectively, at June 30, 2022.
- Preferred stock carrying value increased to $943.3 million from $692.1 million following issuance of Series A1 and Series M1 preferred shares. Preferred stock dividends totaled $12.8 million during the quarter.
- The company paid or declared $0.06 per common share in monthly distributions for the quarter and subsequently declared $0.06 monthly common distributions for November 2022 through January 2023.
Material Changes Versus Prior Comparable Period
- Total investment income increased by $33.2 million and net investment income increased by $17.9 million, primarily reflecting portfolio growth, higher base rates and increased royalty/net revenue income.
- Interest expense increased by $5.6 million as average debt outstanding increased and floating borrowing costs rose.
- The company shifted from net unrealized investment gains of $136.7 million in the prior-year quarter to net unrealized losses of $168.5 million. Major unrealized losses included PGX Holdings, Targus, First Tower Finance, Credit Central and certain control investments.
- Net asset value per common share declined 4.5% from $10.48 at June 30, 2022 to $10.01 at September 30, 2022.
- Gross portfolio originations were $304.5 million, consisting of $110.3 million of new investments, $169.6 million of follow-on investments, $0.5 million of revolver advances and $24.2 million of PIK interest. Repayments and sales totaled $150.5 million.
- The $60.5 million of remaining 2022 Convertible Notes matured and was repaid in July 2022. The revolving facility was extended and upsized during the quarter.
- Other income composition changed materially: royalty and net revenue interests rose to $20.7 million from $9.8 million, while structuring and amendment fees declined to $4.6 million from $12.0 million.
Guidance, Outlook, Commentary and Risks
- The filing does not provide formal earnings or NAV guidance. Management expects to continue investing in middle-market companies through direct lending, controlling investments, real estate and structured credit, but results may fluctuate materially with interest rates, credit spreads, portfolio performance and valuation changes.
- Management stated that higher LIBOR and SOFR rates increased portfolio income, although the benefit was partly offset by higher borrowing costs. A 100-basis-point increase in applicable base rates was estimated to increase annual net investment income by approximately $44.3 million before incentive-fee effects, or $35.4 million after incentive-fee effects.
- Most portfolio investments are Level 3 assets valued using unobservable inputs. Changes in market yields, discount rates, capitalization rates, enterprise-value multiples or portfolio-company performance could materially change NAV and earnings.
- CLO and subordinated structured-note investments are highly leveraged and subordinate to senior tranches. Covenant failures, defaults, prepayments or higher funding costs could reduce distributions and fair values.
- Portfolio concentration is significant. Real estate investment trusts represented 18.6% of investments at fair value, and California investments represented 10.2%. NPRC represented approximately $1.63 billion of fair value.
- The company identified material weaknesses in internal control over financial reporting, including controls over CLO valuation data, documentation of management review controls and monitoring of control deficiencies. Disclosure controls were therefore not effective as of September 30, 2022; remediation efforts were ongoing.
- COVID-19, economic weakness, inflation, credit-market volatility, higher interest rates, LIBOR transition, covenant-lite loans, leverage and limited liquidity of private investments remain material risks.
- The company reported no material legal proceedings as of September 30, 2022.
- Subsequent to quarter-end, revolving commitments increased to $1.68 billion, and the company issued additional 5.50% and 6.50% preferred stock. The filing also disclosed continued common and preferred distributions.
Most Important Facts for Investors to Verify
- Whether the reported $168.5 million unrealized investment loss and $0.47 decline in NAV per share represent temporary market-driven valuation pressure or deterioration in portfolio-company credit quality.
- The sustainability of net investment income relative to common and preferred distributions, particularly given PIK income, non-recurring fees and higher funding costs.
- Refinancing plans for the $283.9 million of 2023 Notes and other near-term maturities.
- The effect of continued base-rate increases, LIBOR transition and SOFR-based borrowing on net investment income and portfolio fair values.
- The performance and valuation support for NPRC, PGX, CLO investments and other large or materially discounted positions.
- Progress in remediating the disclosed material weaknesses in internal controls, especially controls over CLO valuations.
- The dilution, fees and seniority implications of the expanding preferred-stock offerings and any future common-stock issuance below NAV.