Business Context and Reporting Period
Prospect Capital Corporation is a Maryland-incorporated business development company and regulated investment company that lends to and invests in middle-market private companies. The filing is a Form 10-Q for the three and nine months ended March 31, 2023; the supplied metadata labels it “2022 Q3,” but the filing period is fiscal 2023 third quarter. Financial statements are unaudited and presented in thousands, except per-share data.
At March 31, 2023, Prospect held 127 long-term portfolio investments and CLO investments with fair value of $7.593 billion. The portfolio was primarily first-lien debt, second-lien debt, structured credit and equity investments, with significant exposure to real estate, health care, consumer finance and structured finance.
Key Financial Metrics
| Metric | Three months ended March 31, 2023 | Nine months ended March 31, 2023 | Comparable period |
|---|---|---|---|
| Total investment income | $215.1 million | $630.7 million | $181.4 million / $526.3 million |
| Operating expenses | $112.9 million | $322.6 million | $94.4 million / $272.4 million |
| Net investment income | $102.2 million | $308.2 million | $87.0 million / $253.9 million |
| Net realized and unrealized investment losses | $(191.1) million | $(417.2) million | $78.2 million / $386.3 million gains |
| Net assets resulting from operations | $(89.0) million | $(109.2) million | $164.3 million / $630.0 million increase |
| Net income applicable to common stockholders | $(108.9) million | $(158.5) million | $157.2 million / $613.3 million increase |
| Basic earnings per common share | $(0.27) | $(0.40) | $0.40 / $1.57 |
- Net asset value applicable to common shares was $3.799 billion, or $9.48 per common share, versus $4.119 billion and $10.48 per share at June 30, 2022.
- Investment income increased principally because of higher LIBOR/SOFR-based yields and a larger average interest-bearing portfolio. Weighted-average interest earned on performing interest-bearing investments increased to 11.00% in the quarter from 8.95% in the prior-year quarter.
- Annualized net investment income to average net assets applicable to common shares was 10.53% for the quarter and 10.37% for the nine-month period, compared with 8.31% and 8.40%, respectively.
- Cash, cash equivalents and restricted cash were $65.1 million at March 31, 2023, up from $35.4 million at June 30, 2022.
- Operating cash flow was $(101.2) million for the nine months, while financing activities provided $131.0 million. Dividends and distributions paid totaled $222.1 million.
Material Changes Versus Prior Comparable Period
- Quarterly investment income rose 18.6% and nine-month investment income rose 19.8%, but net investment income increased less rapidly because interest expense, management fees, overhead and other expenses also increased.
- Interest and credit facility expenses increased to $37.5 million for the quarter and $109.2 million for the nine months, from $29.2 million and $87.0 million, respectively, primarily due to higher floating rates and increased average debt.
- Investment valuation losses reversed the prior-year gains. The nine-month unrealized loss was $378.1 million, including significant declines in PGX Holdings, affiliate investments, NPRC and several stressed or downgraded investments.
- Other income declined to $15.1 million for the quarter and $60.3 million for the nine months, from $33.6 million and $83.1 million. Structuring and amendment fees fell substantially because of lower origination and transaction activity.
- Portfolio fair value declined modestly from $7.603 billion at June 30, 2022 to $7.593 billion, while amortized cost increased from $7.197 billion to $7.565 billion. The portfolio’s fair value was approximately 199.8% of common net assets.
- Preferred stock outstanding increased materially. Preferred stock carrying value rose to $1.328 billion from $692.1 million, and preferred dividends increased to $49.3 million for the nine months from $16.7 million.
- The company repaid the remaining $282.1 million principal amount of its 2023 Notes at maturity on March 15, 2023. Total debt principal outstanding declined to $2.481 billion from $2.769 billion at June 30, 2022.
Debt, Liquidity and Portfolio Risk
| Item | March 31, 2023 |
|---|---|
| Revolving Credit Facility outstanding | $888.4 million |
| Revolving facility commitments / available borrowing | $1.778 billion / $609.1 million |
| Public Notes carrying value | $1.063 billion |
| Convertible Notes carrying value | $154.4 million, maturing in 2025 |
| Prospect Capital InterNotes carrying value | $348.6 million |
| Total debt principal | $2.481 billion |
| Debt asset coverage ratio | 306.2% |
| Non-accrual investments | Approximately 0.2% of total assets at fair value |
- The revolving facility matures in September 2027, with the revolving period ending in September 2026, and bears interest at one-month SOFR plus 205 basis points. Prospect reported compliance with applicable facility covenants.
- Approximately 83.05% of interest-earning investments at fair value bore floating rates. Management’s sensitivity analysis estimated that a 100-basis-point increase in base rates would increase annual net investment income by approximately $30.7 million after incentive fees; a 100-basis-point decrease would reduce it by approximately $0.9 million, subject to the stated assumptions.
- Approximately $54.1 million of undrawn revolver and delayed-draw commitments to portfolio companies remained outstanding.
- All investments were predominantly Level 3 fair-value measurements based on unobservable inputs. Changes in market yields, discount rates, capitalization rates, operating performance and valuation multiples can materially affect NAV.
Guidance, Outlook, Commentary and Unusual Items
- The filing does not provide formal earnings or NAV guidance. Management emphasizes current income and long-term capital appreciation, with origination strategies spanning direct and syndicated lending, control investments, real estate and structured credit.
- Monthly common-stock dividends remained $0.06 per share. The filing disclosed subsequent declarations of $0.114583 monthly dividends for 5.50% preferred stock, $0.135417 monthly dividends for 6.50% preferred stock and $0.334375 quarterly dividends for 5.35% Series A preferred stock.
- During the quarter, gross investment originations were $91.7 million, including $46.9 million of PIK interest, compared with $114.0 million of repayments, sales and other reductions.
- PIK income was $98.0 million for the nine months. PIK income increases reported investment income without producing current cash and may increase realization risk.
- PGX was materially revalued following litigation by the Consumer Financial Protection Bureau concerning telemarketing practices and a required shift toward an online customer-acquisition model. PGX’s loans were valued at $184.7 million, a $66.0 million discount to amortized cost.
- Other notable valuation pressure included Engine, Rising Tide Holdings, Research Now, Shutterfly, Precisely and several CLO investments. Engine’s valuation methodology changed because of deteriorating operating performance; the investment was valued at $2.1 million.
- Prospect disclosed that its disclosure controls and procedures were not effective because of material weaknesses in internal control over financial reporting, particularly controls and documentation surrounding CLO valuation. Management has begun remediation, but stated that execution and a period of testing are required to demonstrate effectiveness.
- Prospect disclosed no material legal proceedings as of March 31, 2023. Key external risks include rising rates, credit-spread volatility, inflation, geopolitical events, banking-system stress, LIBOR transition, market illiquidity, CLO leverage and potential covenant or default events at portfolio companies.
Most Important Facts for Investors to Verify
- Whether the reported investment income, including $98.0 million of nine-month PIK income, converts into sustainable cash receipts.
- The recoverability and valuation support for large Level 3 positions, especially NPRC, PGX, CLO residual interests and control-company equity.
- The effect of higher funding costs on net investment income as the revolving facility resets to SOFR.
- The timing and funding sources for debt maturities, including $81.2 million in 2024, $156.2 million in 2025 and $436.7 million in 2026 contractual principal payments.
- Whether non-accrual exposure remains near 0.2% of total assets and whether stressed investments migrate to non-accrual or require further write-downs.
- Progress in remediating the material weaknesses in internal controls over CLO valuation and the impact of any future control deficiencies.
- Whether preferred-stock issuance, conversions and any below-NAV common-stock offering authorization dilute common NAV or alter leverage and distribution coverage.
- The final tax character of distributions and continued compliance with regulated investment company and business development company requirements.