Prospect Capital Corporation [PSEC] Conference call transcript for 2022 q1
2022-05-10 19:33:08
Fiscal: 2022 q3
Operator: Good afternoon, and welcome to Prospect Capital’s Third Fiscal Quarter Earnings Release and Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to the Chairman and Chief Executive Officer, John Barry. Please go ahead.
John Barry: Thank you, Joe. I hope everyone can hear me. Joining on the call today are Grier Eliasek, our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?
Kristin Van Dask: Thanks, John. This call is the property of Prospect. Unauthorized use is prohibited. This call contains forward-looking statements that are intended to be subject to safe harbor protection. Actual developments and results are highly likely to vary materially, and we do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release and 10-Q filed previously and available on our website, prospectstreet.com. Now, I’ll turn the call back over to John.
John Barry: Thank you, Kristin. Welcome, everyone. In the March quarter, our net investment income, or NII, was $87 million or $0.22 per common share, exceeding our distribution rate per common share by $0.04. Our basic net income attributable to common shareholders was $157.2 million or $0.40 per common share as the overall value of our investment portfolio increased for the eighth consecutive quarter due to a combination of positive company-specific and macro factors. Our NAV stood at $10.81 per common share in March, up $0.21 and 2% from the prior quarter and representing our eighth quarter in a row with NAV growth. Our NAV per common share is now at the highest level since September 2015 over six years ago. Over the eight quarters from the pre-pandemic December 2019 quarter to the December 2021 quarter, Prospect has delivered the highest growth in the business development company industry in net asset value per common share with NAV per common share increasing by 25% over that time period. Since inception in 2004, Prospect has invested $18.7 billion across 394 investments, exiting 270 of those investments. We have outperformed our peers during the past multiple quarters of macro volatility as a direct result of our previous derisking, not chasing leverage as well as other risk management controls. We are staying true to that strategy that has served us well since 1988, controlling and reducing portfolio and balance sheet risk, both to protect the capital entrusted to us and to protect the ability of such capital to generate earnings for our shareholders. In the March quarter, our net debt-to-equity ratio was 53.9%, down 20.2 percentage points from March 2020 and up 2.6 percentage points from the December quarter as we continue to run an underleveraged balance sheet, which has been the case for us for multiple quarters. Over the past four years, other listed BDCs overall have increased leverage with a typical listed BDC now at around 114% debt to total equity or approximately 60 percentage points higher than for Prospect. Running at half the debt leverage of the rest of the industry, Prospect has not increased debt leverage, instead electing lower risk from lower debt leverage with a cautious approach, given macro dynamics. In May 2020, we moved our minimum 1940 Act regulatory asset coverage to 150% equivalent to 200% debt to equity, which not only increased our cushion, but also gave us flexibility to pursue our subsequently announced junior capital perpetual preferred equity issuance, which counts toward ‘40 Act asset coverage, but which gets significant equity treatment by our rating agencies. We have no plans to increase our actual drawn debt leverage beyond our historical target of 0.70 to 0.85 debt to equity, and we are currently significantly below such target range. Prospect’s balance sheet is highly differentiated from peers with 100% of Prospect’s funding coming from unsecured and nonrecourse debt, which has been the case for Prospect for more than 14 years. Unsecured debt was 73.3% of Prospect’s total debt in March 2020, or about 22 percentage points higher than around 50% for the typical listed BDC. Our unsecured and diversified funding profile provides us with significantly lower risk and significantly more investment strategy and balance sheet flexibility than many of our BDC peers. Turning to the cash distribution front, we are pleased to report the Board’s declaration of 4 more steady monthly distributions. We are announcing monthly cash common shareholder distributions of $0.06 per share for each of May, June, July and August. These four months represent the 57th, 58th, 59th and 60th consecutive $0.06 per share distribution, continuing five years of stable monthly cash shareholder distributions. Consistent with past practice, we plan on our next set of shareholder distribution announcement in August. Our goal over the long term is to maintain and ideally grow this steady monthly cash shareholder distribution, as we seek to provide low volatility, stability to our shareholders amidst a macro market backdrop that delivers greater volatility elsewhere. Shareholders participating in our common stock DRIP for the 12 months ended March 31, 2022, received a return 1% greater than non-participating shareholders for a total return of over 18%. Both returns are greater than the same period returns on the S&P 500 and on more glamorous household technology names that do not pay dividends. Since our IPO nearly 18 years ago, through August ‘22 distribution at the current share count, we will have paid out $19.56 per common share to original shareholders, aggregating approximately $3.7 billion in cumulative distributions to all common shareholders, more than many household name high flyers combined. Since October 2017, our NII per common share has aggregated $3.59 while our common and preferred shareholder distributions per common share have aggregated $3.29, resulting in our NII exceeding distributions during this period by $0.30 per share. Our NII covered distributions to common and preferred shareholders in the June 2021 fiscal year and has exceeded common and preferred shareholder distributions in the 2022 fiscal year-to-date by $0.11 per share. We are also pleased to announce continued preferred shareholder distributions on the heels of successful launches of our $1.25 billion, 5.5% preferred programs and $150 million, 5.35% listed preferred. We have raised approximately $650 million in preferred stock to date with strong support from institutional investors, RIAs and broker-dealers, including the recent addition of 2 top 5 sized independent broker dealer systems as well as top wirehouse and regional broker-dealer systems. We are currently focused on multiple initiatives to enhance our NII, ROE and NAV in accretive fashion, including, first, our $1.25 billion perpetual preferred equity programs, which could potentially be increased in capacity in an accretive fashion. Two, a greater utilization of our cost-efficient revolving credit facility with an incremental cost of approximately 2.19% at today’s one-month LIBOR. Three, retirement of higher cost liabilities, including recent successful tender offers and repurchases. Four, issuing lower-cost notes, including recent 3 to 30-year senior unsecured note issuances with coupons of approximately 2.5% to 4.625%. Fifth, increase of short-term LIBOR rates based on Fed tightening to exceed floors and boost our asset yields. And sixth, increased originations of senior unsecured debt and selected equity investments to deliver targeted risk-adjusted yields and total returns as we deploy available dry powder from our current underleveraged balance sheet. We believe there is no greater alignment between management and shareholders than for management to purchase a significant amount of stock, particularly when management has purchased stock on the same basis as other shareholders in the open market. Prospect’s management is the largest shareholder in Prospect and has never sold a share. Our senior management team and employees eat our own cooking, currently owning approximately 28% of shares outstanding, representing $1.2 billion of our common equity as measured at NAV. Thank you. I will now turn the call over to Grier.
Grier Eliasek: Thank you, John. Our scale platform with over $8 billion of assets and undrawn credit at Prospect Capital Corporation continues to deliver solid performance in the current dynamic environment. Our experienced team consists of over 100 professionals, which represents one of the largest middle market investment groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that spans third-party private equity sponsor-related lending, direct non-sponsor lending, Prospect-sponsored operating and financial buyouts, structured credit, and real estate yield investing. Consistent with past cycles, we expect during the next downturn to see an increase in secondary opportunities, coupled with wider spread primary opportunities with a pullback from other investment groups, particularly highly leveraged one. Unlike many other groups, we have maintained and continued to maintain significant dry powder that we expect will enable us to capitalize on such attractive opportunities as they arise. This diversity of origination approaches allows us to source a broad range and high volume of opportunities, then select in a disciplined bottoms-up manner the opportunities we deem to be the most attractive on a risk-adjusted basis. Our team typically evaluates thousands of opportunities annually and invests in a disciplined manner in a low-single-digit percentage of such opportunities. Our nonbank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans. As of March 2022, our portfolio at fair value comprised 48.4% first lien debt, 18.5% second lien debt, 9.8% subordinated structured notes with underlying secured first lien collateral and 23.3% unsecured debt in equity investments, resulting in 76.7% of our investments being assets with underlying secured debt, benefiting from borrower-pledged collateral. Prospect’s approach is one that generates attractive risk-adjusted yields. In our performing interest-bearing investments, we’re generating an annualized yield of 10.6% as of March 2022, flat with the prior quarter. We also hold equity positions in certain investments, they can act as yield enhancers or capital gains contributors, as such positions generate distributions. We’ve continued to prioritize senior and secured debt with our originations to protect against downside risk, while also achieving above-market yields through credit selection discipline and a differentiated origination approach. As of March 2022, we held 127 portfolio companies, the same as the prior quarter with a fair value of $7.4 billion, an increase of $427 million from the prior quarter. We also continued to invest in a diversified fashion across many different portfolio company industries with a preference for avoiding cyclicality and with no significant industry concentration. The largest is 18.2%. As of March 2022, our asset concentration in the energy industry stood at 1.8%. Our concentration in the hotel, restaurant and leisure sector stood at 0.3% and our concentration in the retail industry stood at 0%. Nonaccruals as a percentage of total assets stood at approximately 0.4% in March 2022, remaining static from the prior quarter and down 0.5% from June of 2020. Our weighted average middle market portfolio net leverage stood at 5.3 times EBITDA, substantially below our reporting peers. Our weighted average EBITDA per portfolio company stood at $101.1 million in March of 2022, an increase of $4.6 million and 2% from December 2021 as we continue to achieve solid profit growth with our portfolio companies. Originations in the March 2022 quarter aggregated $565 million. We also experienced $185 million of repayments and exits as a validation of our capital preservation objective, resulting in net originations of $380 million. During the March quarter, our originations comprised 56.3% middle market lending, 19.5% real estate, 14.5% middle market lending and buyouts, 5.7% subordinated structured notes and 4% other. To date, we’ve deployed significant capital in the real estate arena through our private REIT strategy, largely focused on multifamily, workforce, stabilized yield acquisitions with attractive 7- to 12-year financing. NPRC, our private REIT, has real estate properties that have benefited over the last several years and more recently, from rising rents showing the inflation hedge nature of this business segment, strong occupancies, high collections, suburban work-from-home dynamics, high-returning value-added renovation programs and attractive financing recapitalizations, resulting in an increase in cash yields as a validation of this income growth business alongside our corporate credit businesses. NPRC, as of March, has exited completely 45 properties at an average IRR of 25.1% and average realized cash multiple of invested capital of 2.5 times with an objective to redeploy capital into new property acquisitions, including with repeat property manager relationships. Our structured credit business has delivered attractive cash yields, demonstrating the benefits of pursuing majority stakes, working with world-class management teams, providing strong collateral underwriting through primary issuance and focusing on favorable risk-adjusted opportunities. As of March, we held $729 million across 37 nonrecourse subordinated structured notes investments. We’ve maintained a static size for our subordinated structured notes portfolio on a dollar basis, electing to grow our other investment strategies and resulting in the structured notes portfolio now comprising less than 10% of our investment portfolio. These underlying structured credit portfolios comprised around 1,700 loans and a total asset base of around $16 billion. As of March, the structured credit portfolio experienced a trailing 12-month default rate of 8 basis points, down 11 basis points from the prior quarter and representing 11 basis points less than the broadly syndicated market default rate of 19 basis points. In the March quarter, this portfolio generated an annualized cash yield of 20.7% and GAAP yield of 9.7% with the difference representing a significant amortization of our cost basis. As of March, our subordinated structured credit portfolio has generated $1.42 billion in cumulative cash distributions to us, representing around 102% of our original investment. Through March, we’ve also realized 29 investments, totaling $1.003 billion with an average realized IRR of 13.9% and cash-on-cash multiple of 1.62 times. Our subordinated structured credit portfolio consists entirely of majority-owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same tranche. In many cases, we receive fee rebates because of our majority position. As a majority holder, we control the ability to call a transaction in our sole discretion in the future, and we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion rather than when loan asset valuations might be temporarily low. We, as a majority investor, can refinance liabilities on more advantageous terms, remove bond baskets in exchange for better terms than from debt investors in the deal and extend or reset the investment period to enhance value. We completed 32 refis and resets since December of 2017. So far in the current June 2020 quarter, we have booked $124 million in originations and experienced $115 million of repayments for $9 million of net originations. Our originations have consisted of 82.8% middle market lending, 11.6% real estate, 4.8% middle market lending and buyouts, and 0.8% Other. Thank you. I will now turn the call over to Kristin. Kristin?
Kristin Van Dask: Thanks, Grier. We believe our prudent leverage, diversified access to matched-book funding, substantial majority of unencumbered assets, weighting toward unsecured fixed rate debt, avoidance of unfunded asset commitments and lack of near-term maturities demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. Our Company has locked in a ladder of liabilities extending 30 years into the future. Today, our sole maturity of $60.5 million is our only debt maturing for all of calendar year 2022. Our total unfunded eligible commitments to non-controlled portfolio companies totaled approximately $42 million, representing approximately 0.6% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at approximately $850 million. We’re a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop a notes program, issue under a bond and equity ATM, acquire another BDC and many other lists of firsts. In 2020, we also added our programmatic perpetual preferred issuance to that list of firsts followed in 2021 by our listed perpetual preferred as another first in the industry. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken toward construction of the right-hand side of our balance sheet. As of March 2022, we held approximately $4.92 billion of our assets as unencumbered assets, representing approximately 66% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, a nonrecourse SPV, where in April 2021, we completed an upsizing and extension of our revolver to a refreshed 5-year maturity. We currently have $1.5 billion of commitments from 43 banks, an increase of 13 lenders from March 2021 and demonstrating strong support of our company from the lender community with a diversity unmatched by any other company in our industry. The facility revolves until April 2025, followed by a year of amortization with interest distributions continuing to be allowed to us. Our drawn pricing is now LIBOR plus 2.05%, a decrease of 15 basis points from before. Our undrawn pricing between 35% and 60% utilization has been reduced by 30 basis points. We also now have an improvement in our borrowing base due to a change in concentration baskets, which we estimate increased our borrowing base by approximately $150 million. Of our floating rate assets, 93.9% have LIBOR floors with a weighted average floor of 1.34%. Short-term rates are now beginning to exceed these floors, giving us visibility for increased asset yields from Fed rate hikes. Outside of our revolver and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation, including in the past few years, multiple types of investment-grade unsecured debt, including convertible bonds, institutional bonds, baby bonds and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We enjoy an investment grade BBB negative rating from S&P, an investment-grade Baa3 rating from Moody’s, an investment-grade BBB rating from Kroll and investment-grade BBB rating from Egan-Jones and an investment-grade BBB low rating from DBRS. In 2021, we received the latter investment-grade rating, taking us to five investment-grade ratings, more than any other company in our industry. All of these ratings have stable outlooks. We have now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 30 years. Our debt maturities extend through 2052. With so many banks and debt investors across so many debt tranches, we have substantially reduced our counterparty risk over the years. In the March 2022 quarter, we completed successful redemptions, tender offerings and repayments, retiring $36 million of our InterNotes. In the March 2022 quarter, we have continued to substitute more expensive term debt with significantly lower cost revolving credit with an incremental 2.19% cost. We also have continued with our weekly programmatic InterNotes issuance on an efficient funding basis. To date, we have raised approximately $650 million in aggregate issuance of our perpetual preferred stock across our preferred programs and listed preferred with the ability potentially to upsize such programs based on significant balance sheet capacity. We now have seven separate unsecured debt issuances aggregating $1.6 billion, not including our program notes, with maturities extending through October 2028. As of March 2022, we had $341 million of program notes outstanding with staggered maturities through 2052. At March 31, 2022, our weighted average cost of unsecured debt financing was 4.35%, a decrease of 0.04% from December 31st, and a decrease of 0.87% from March 31st. Including usage of our revolving credit facility at March 31, 2022, our weighted average cost of all debt financing was 3.77%, a decrease of 0.18% from December 31, 2021, and a decrease of 0.99% from March 31, 2021. In 2020, we added a shareholder loyalty benefit to our dividend reinvestment plan or DRIP that allows for a 5% discount to the market price for DRIP participants. As many brokerage firms either do not make DRIPs automatic or they have their own synthetic DRIPs with no such 5% discount, we encourage any shareholder interested in DRIP participation to contact your broker. Make sure to specify you wish to participate in the Prospect Capital Corporation DRIP plan through DTC and at a 5% discount and obtain confirmation of same from your broker. Our preferred holders can also elect to DRIP at a price per share of $25. Now, I’ll turn the call back over to John.
John Barry: Okay. Thank you very much, Kristin. We can now answer any questions.
Operator: Our first question comes from Matt Tjaden with Raymond James. Please go ahead.
Matt Tjaden: Hey, all. Good afternoon, and I appreciate you taking my questions. I wanted to start off on the preferred. With base rates on the rise the last couple of months, can you talk about any changes you’ve seen in demand for your fixed rate preferreds?
Grier Eliasek: Sure. We have seen an increase in demand for our preferreds. We’ve seen volumes steadily grow since we launched our preferreds roughly 1.5-year ago, including in recent weeks. And I think the reason for that is a combination of factors. One factor is that when volatility picks up in the market, and we’ve seen that surge out there. We’ve seen it in the bond market, another fixed rate largely market. We’ve seen that, of course, in the stock market, in many markets. The aspect of the preferred -- significant positive aspect of having no volatility by its design, but still having uncapped liquidity comes through in shines. It really showcases those significant benefits. Another reason, which is just starting now and we think we’ll continue to build in coming weeks that there are a number of liquidity events occurring in the marketplace, particularly the private wealth management marketplace where holders and their representatives and advisers for same of a number of non-traded preferred programs as well as other types of programs are receiving significant cash from M&A, particularly in the REIT space. And we expect and anticipate to benefit from recycling of that capital into our preferred, which market research shows in the month just completed, had about 80% market share. Prospect at about 80% market share of the nontrade data preferred market. So, we’re the logical place to go, especially after investors have enjoyed a very positive worked as advertised experience with other programs out there. And this is a great news for us with the significant demand because we think, yes, there’s been a ton of capital raised in the private credit space folks have. They continue to have plenty of capital, but their ability to leverage that capital is slowing dramatically. You’ve seen about a 300 basis-point increase in unsecured bond financing costs in our sector over the past 4 to 6 months. We were very proactive in 2021 about going out and availing ourselves of attractive financing, completing no fewer than three institutional bond deals in that year plus our program notes plus the first of its kind perpetual traded preferred program or offering rather as well. So, we obtained plenty of inexpensive capital in 2021. We also refreshed, extended and upsized our revolving credit facility, which, as Kristin mentioned, with 43 banks is more diversified than any other facility of its kind in our industry. So, we’ve loaded up on inexpensive capital and access to same, and we’re really in a universe of one of enjoying this access to capital on an attractive funding basis for our preferred program. And we’re seeing nice looks in the market. We had a positive uptick in originations in the March quarter. We’re seeing our pipeline continue to build. None of us know if there’s going to be a significant recessionary downturn, and massive gapping out and floating rate asset spreads that tends to accompany same. But, should that occur, we’re ready and have plenty of capital to pounce on those opportunities, which we really haven’t seen in quite some time, the 2020 pandemic-related sort of financial downturn was quite short-lived, and there wasn’t a lot to buy because of federal stimulus. The next general recessionary downturn, we expect will be quite different, and there will be lots of bargains to scoop up for those that are well capitalized, those that have significant access to capital as we do and scale and also have a low leverage profile. So others will likely be playing defense and scrambling, and we’ll be able to go aggressively on offense and benefit. So, that preferred program has been a terrific strategic driver for us in the past year, and we expect that to continue going forward.
Matt Tjaden: Got it. That’s helpful. One more for me, if I could, again, on base rates. Can you talk about any rate reset mismatch between your portfolio assets and your liabilities, and if we should expect a modest interest drag from any mismatch?
Grier Eliasek: We don’t anticipate much of a mismatch because we really have already gone through the quarter just completed of burning through in a significant fashion LIBOR floors. So, we’re now starting to exceed those floors. They tend to be three-month LIBOR driven, and three -month LIBOR is about 140 basis points right now. And so, you’re seeing a reset of our floating rate contracts burning through a significant number of floors already in benefiting us. So, there’s no mismatch there. And then while our asset side of the ledger is dominated by floating rate, on the liability side, it’s inverted. We’re more dominated by fixed rate and again, are reaping the benefits of locking in and locking down inexpensive, cheap financing of issuance over the course of 2021, and that continues. As we disclosed in the quarter just ended, and I expect this is quite different from many of our peers, our financing cost dropped. It dropped on an unsecured basis on its own and it dropped on a mix effect basis as we continued the previously articulated approach of prudently using a little bit more of our secured revolving credit facility, which we expanded to $1.5 billion in diversified with more banks in the early part of the quarter just completed. So, our weighted average cost of all debt financings, we disclosed, went down, not up, 18 basis points in the past quarter. Again, I suspect that is quite different from our peers and not an accident by a direct reflection of what we’ve been doing to lay the groundwork to drive profit growth for our business.
Operator: There are no further questions at this time. And with that, we will conclude our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.
John Barry: Well, thank you, everyone. Have a wonderful afternoon, and we’ll see you in three months. Thanks so much. Bye now.
Grier Eliasek: Thank you, all
Operator: This concludes the conference. Thank you for attending today’s presentation. You may now disconnect.
