PROSPECT CAPITAL CORP quarterly report, Q2 FY2024

Business Context and Reporting Period

Prospect Capital Corporation is an externally managed business development company and regulated investment company that lends to and invests in middle-market private companies. This Form 10-Q covers the quarter and six months ended December 31, 2023, the company’s fiscal second quarter of 2024, with comparisons to December 31, 2022 and June 30, 2023.

Key Financial Metrics

Metric	Three Months Ended Dec. 31, 2023	Three Months Ended Dec. 31, 2022	Six Months Ended Dec. 31, 2023	Six Months Ended Dec. 31, 2022
Total investment income	$210.9 million	$212.9 million	$447.2 million	$415.6 million
Net investment income	$96.9 million	$106.7 million	$222.5 million	$206.0 million
Net investment income margin	45.9%	50.1%	49.8%	49.6%
Net increase in net assets from operations	$(27.7) million	$72.3 million	$88.9 million	$(20.2) million
Net income applicable to common stockholders	$(51.4) million	$55.6 million	$42.6 million	$(49.6) million
Basic earnings per common share	$(0.13)	$0.14	$0.10	$(0.13)

At December 31, 2023, total investments were $7.63 billion at fair value across 126 portfolio investments and CLOs. Net assets applicable to common shares were $3.68 billion, or $8.92 per common share, compared with $3.73 billion and $9.24 per share at June 30, 2023. Cash and cash equivalents were $97.3 million.

Interest income increased to $397.1 million for the six-month period from $365.2 million, primarily reflecting higher floating-rate income, while structured-credit income declined to $25.6 million from $48.9 million.
Operating expenses rose to $224.6 million for the six-month period from $209.6 million. Interest and credit facility expenses increased to $80.6 million from $71.7 million, and administration overhead increased to $14.4 million from $6.7 million.
Annualized current yield was 12.3% on performing interest-bearing investments, excluding equity and non-accrual loans, and 10.1% across all investments.
Cash provided by operating activities was $174.5 million for the six months ended December 31, 2023, compared with cash used of $197.4 million in the prior-year period. Financing activities used $172.8 million, including $173.3 million of dividends and distributions.

Debt, Liquidity and Capitalization

Total debt principal outstanding was $2.49 billion at December 31, 2023, down from $2.61 billion at June 30, 2023. Net carrying value was $2.47 billion and fair value was $2.37 billion.
The revolving credit facility had $864.0 million outstanding against $1.95 billion of commitments, leaving $861.1 million available for borrowing after borrowing-base adjustments. The facility matures in September 2027, with the revolving period ending in September 2026.
Public Notes had $1.08 billion of principal outstanding, including $81.2 million of 6.375% notes maturing January 2024, $700 million of 2026 notes and $300 million of 2028 notes.
Convertible Notes had $156.2 million outstanding and mature in March 2025. Prospect Capital InterNotes had $391.0 million of principal outstanding, with a $384.1 million carrying value.
The asset coverage ratio was 307.7% for senior debt and 185.2% including preferred stock, compared with 297.0% and 186.2%, respectively, at June 30, 2023. The company reported compliance with revolving facility covenants.
Common stockholders received monthly distributions of $0.06 per share. The filing also reports preferred-stock distributions at stated annual rates of 5.50%, 6.50% and 5.35% for the outstanding series.

Material Changes Versus Prior Comparable Period

Quarterly net investment income declined 9.2% despite slightly higher interest income, primarily because operating expenses increased and other income declined.
Six-month net investment income increased 8.0%, but common-stock net asset value fell by $49.0 million and $0.32 per share from June 30, 2023, reflecting realized investment losses, partially offset by unrealized gains and net investment income.
Six-month realized investment losses were $207.4 million, compared with $6.9 million of losses in the prior-year period. The largest item was a $181.4 million realized loss related to the PGX restructuring, including the write-off of its second-lien term loan.
Six-month unrealized investment gains were $73.9 million, versus unrealized losses of $219.2 million in the prior-year period. Control investments generated $117.2 million of unrealized losses, partially offset by $188.5 million of gains in non-control/non-affiliate investments.
Portfolio cost declined to $7.63 billion from $7.80 billion, while fair value declined modestly to $7.63 billion from $7.72 billion. Second-lien debt, subordinated structured notes and equity fair values decreased, while first-lien debt increased.
The company issued $38.6 million of InterNotes during the six months and repaid $5.7 million net of redemptions. It also issued $5.86 million shares of preferred stock and repurchased or redeemed Series A preferred stock.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide formal earnings or investment guidance. Management describes continued focus on secured lending, controlling investments, real estate and structured credit, but states that future results are subject to market conditions, portfolio-company performance and financing availability.

Credit quality improved on certain measures: loans on non-accrual status represented approximately 0.2% of total assets at fair value, versus 1.1% at June 30, 2023. However, the cost basis of non-accrual loans remained $164.6 million and their fair value was $15.4 million.
Approximately 82.9% of interest-earning investments at fair value bore floating rates. The company estimates that a 100-basis-point increase in rates would increase annual net investment income by approximately $40.1 million before the effect of incentive fees; a 100-basis-point decrease would increase it by approximately $1.1 million because of rate floors and fixed-rate debt.
Approximately $7.58 billion, or nearly all investments, were Level 3 assets valued using significant unobservable inputs. Valuations depend on market yields, discount rates, capitalization rates, enterprise-value multiples and recovery assumptions.
The portfolio is concentrated in real estate, health care and consumer finance; real estate investment trusts represented 17.8% of portfolio fair value and health care providers and services 10.1%. California investments represented 10.7% of fair value.
CLO subordinated structured notes had a fair value of $601.5 million, or 7.9% of net assets. These securities are highly leveraged, subordinate to senior CLO debt and sensitive to defaults, prepayments, credit spreads and SOFR-related funding costs.
Payment-in-kind interest was $62.4 million for the six-month period. PIK income increases reported investment income without providing current cash and can increase exposure to portfolio-company credit risk.
Several portfolio companies had non-accrual, distressed or restructured investments. Strategic Materials was written down to zero following an interest payment default. PGX’s restructuring created new Credit.com investments and a substantial realized loss.
Post-period, the company declared common and preferred dividends and launched an exchange offer involving Series M1, Series M3 and Floating Rate Series M4 preferred stock.
The company reported no material legal proceedings and concluded that disclosure controls were effective as of December 31, 2023.

Important Facts for Investors to Verify

Reconcile the $181.4 million PGX-related realized loss, the new Credit.com positions and any remaining exposure or recovery prospects.
Review the January 2024 maturity of the $81.2 million 6.375% Public Notes and the company’s subsequent refinancing or repayment activity.
Assess whether net investment income covers common and preferred distributions after considering PIK income, recurring versus non-recurring fees and higher funding costs.
Examine valuation sensitivity for the large Level 3 portfolio, particularly NPRC real estate, control investments and CLO residual interests.
Monitor non-accrual exposure, distressed investments and the credit performance of portfolio companies with near-term maturities.
Confirm the effect of preferred-stock issuance, conversions, redemptions and the post-period M1/M3/M4 exchange offer on common-stock dilution, liquidity and asset coverage.
Verify the company’s ability to refinance or fund the $2.49 billion debt maturity profile while maintaining regulatory asset coverage and revolving-facility covenants.