Prospect Capital Corp (PSEC) 2014 Q3 法說會逐字稿

Good morning, and welcome to Prospect Capital Corporation's Third Quarter Earnings Release and Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. John Barry, Chairman and CEO. Please go ahead.

Thank you, Jessica. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer and Brian Oswald, our Chief Financial Officer. Brian?

Thanks, John. This call is is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection.

Actual outcomes and results could differ materially from those forecasts due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release, our 10-Q, and our corporate presentation filed previously and available on the Investor Relations tab on our website, prospectstreet.com.

Now I'll turn the call back over to John.

Thank you, Brian. Because we have so many new investors interested in learning more about our Company, we invite such investors to review separate and recently recorded webinars as an introduction to Prospect. Investors can access such webinars through the Investor Relations tab on our website, prospectstreet.com. During those events, we talk through our overview corporate presentation that is also available on our website.

In the same location on our website, investors can also access our archived Analyst and Investor Day that we held on July 10 last year in New York. This is a five-hour webinar that includes senior members of the Prospect team presenting our multiple origination strategies and in-depth case studies to educate investors old and new about Prospect's business.

Now, on to our financial results for the quarter just completed. Our net investment income, or NII, in the March 2014 quarter was $98.5 million, or $0.31 per weighted average share, up 19% on a per-share basis year over year. Our net investment income for the past nine months is $273.1 million, or $0.95 per weighted average share.

Our net income for the March 2014 quarter was $82.1 million, and our net income for the past nine months was $247.4 million. Net income was up 30% on a per-share basis year over year in the March 2014 quarter and was up 21% on a per-share basis year over year for the past nine months.

We just announced more shareholder distribution through December 2014, giving investors seven months of visibility on future dividends. The December 2014 dividend will be our 77th shareholder distribution and the 54th consecutive per-share monthly increase.

Our May 5 closing stock price of $10.81 represents a dividend yield of 12.3%.

Our net investment income has exceeded dividends, demonstrating substantial dividend coverage, for the cumulative history of the Company. For the June 2013 fiscal year, our net investment income exceeded dividends by $53.4 million and $0.26 per share. We utilized 4 pennies of that excess in the past nine months.

Since our IPO ten years ago through our December 2014 distribution at the current share count, we will have paid out $13.26 per share to initial shareholders and $1.3 billion in cumulative distributions to all shareholders.

Our net asset value stood at $10.68 on March 31, down $0.05 from the prior quarter.

We have delivered solid net investment income while keeping leverage prudent. Net of cash and equivalents, our debt-to-equity ratio was 67.9% in March, up from 55.7% in June.

We have substantial liquidity to drive future earnings through prudent levels of matched book funding.

Our Company is locked in a ladder of fixed-rate liabilities extending 30 years into the future while most of our loans float with LIBOR, providing potential upside to shareholders should interest rates rise.

Thank you. I will now turn the call over to Grier Eliasek.

Thank you, John. Our business continues to grow at a solid and prudent pace. As of today, we've now reached over $7 billion of assets and undrawn credit. Our team has increased to approximately 100 professionals, representing one of the largest dedicated middle-market credit groups in the industry.

With our scale, longevity, experience, and deep bench, we continue to focus on a diversified investment strategy that covers third-party private equity sponsor-related lending; direct non-sponsored lending; prospect-sponsored operating buy-outs; prospect-sponsored financial buy-outs; structured credit; real estate yield investing; and club and syndicated lending.

This diversity 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.

Prospect's originations in recent months have been well-diversified across our seven origination strategies.

Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack, with a preference for secured lending and senior loans.

Prospect's approach is one that generates attractive risk-adjusted yields, and our debt investment were generating an annualized yield of 12.5% as of March 31.

We also hold equity positions in many transactions that can act as yield-enhancers or capital gains contributors as such positions generate distributions.

While the market has experienced yield compression in the past year, we've continued to prioritize first-lien, senior, and secured debt with our originations to protect against downside risk while still achieving above-market yields through credit selection discipline and a differentiated origination approach.

Originations in the March quarter were $1.34 billion, a record total. Originations have come in at approximately $3.3 billion in the past 12 months. We also experienced $198 million of repayments in the March quarter as a validation of our capital preservation objective.

As of March 31, we were up to 138 portfolio companies, demonstrating both an increase in diversity as well as a migration toward larger positions and larger portfolio companies. We also continue to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration.

Our originations in the March quarter were 65% weighted toward the last two business days in the quarter, resulting in only a partial quarter positive income benefit from such originations. We expect such originations to generate full-quarter positive benefit in the current June quarter.

Our financial services, controlled investments, and structured credit investments are performing well, with typical annualized cash yields ranging from 15% to 30%.

To date, we've made multiple investments in the real estate arena with our private REITs, largely focused on multi-family stabilized-yield acquisitions with attractive 10-year financing. We hope to increase that activity with more transactions in the months to come.

We closed our platform acquisition of CP Energy in the September quarter and closed multiple follow-on acquisitions in the December quarter. In March, we closed the Harbortouch acquisition with the simultaneous financing of an add-on acquisition. And on Monday this week, we closed the Arctic Energy acquisition.

We currently have other one-stop acquisitions under LOI or near LOI at attractive multiples of cash flow with both double-digit yield generation and up-side expectations.

In the March quarter, we made three investments in non-controlled third-party sponsor-backed companies that brought our total investment in each company to more than $100 million, demonstrating the competitive differentiation of our scale balance sheet to close one-stop financing opportunities.

With our initial $92.6 million investment in Echelon to finance a diversified airplane asset acquisition, we have now entered the aircraft leasing sector. Echelon focuses on acquiring aviation assets with attractive contractual cash flows, strong lessee credit attributes, and stable residual value characteristics. The Echelon management team has decades of experience in the aircraft leasing industry and expects to generate double-digit yields through a focus on mid-life aircraft.

Over the past few months, we've entered the peer-to-peer online direct lending industry with a focus on prime, near-prime, and subprime consumer and small business borrowers. We expect to grow our investment, which stands at approximately $40 million today, across multiple origination platforms, including potentially our own future controlled origination and underwriting platform.

The majority of our portfolio consists of agented and self-originated middle-market loans. In general, we perceive the risk-adjusted reward in the current environment to be superior for agented and self-originated opportunities compared to the syndicated market, causing us to prioritize our proactive sourcing efforts.

Our differentiated call center initiative continues to drive proprietary deal flow for our business.

As a yield enhancement for our business, we've launched a prospect senior loan strategic initiative called PSEN, in which we would collaborate with third-party investor capital that would acquire lower-yielding loans from our balance sheet while we would retain fee-generating servicing responsibilities on behalf of such investor base.

Once we close PSEN, which we hope to achieve in the coming months, we expect PSEN to help us generate accretive income and to expand our ability to close scale one-stop investment opportunities with efficient pricing.

Our credit quality continues to be stable. Non-accruals as a percentage of total assets continues at 0.3% in March 2014. We have booked $268.2 million across seven originations so far in the current June quarter. Net of $96.5 million of repayments, our net investment amount so far this quarter is $171.7 million.

Our advanced investment platform aggregates more than $500 million in potential opportunities, boding well for the coming months.

Thank you; I will now turn the call over to Brian.

Thanks, Grier. As John discussed, we've grown our business with prudent leverage, which we've recently expanded through two scale unsecured term debt offerings to help drive our earnings.

Net of cash and equivalents, our debt-to-equity ratio stood at 67.9% in March, up from 55.7% in June 2013.

We believe our prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets, and weighting toward unsecured fix-rate debt, demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities.

Our Company has locked in a ladder of fixed-rate liabilities extending 30 years into the future, while most of our loans float with LIBOR, providing potential up side to shareholders as interest rates rise.

We're a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, conduct an APM program, develop a notes program, issue an institutional bond, and acquire a competitor, as we did with Patriot Capital.

Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry which we have taken toward construction of the right hand of our balance sheet.

As of March 2014, we held more than $4.8 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding LLC, which has an AA-rated $792.5 million revolver with 24 banks and with a $1 billion total size accordion feature at our option. The revolver is priced at LIBOR plus 275 basis points and revolves for three years, followed by two years of amortization, with interest distributions continuing to be allowed to us.

We started the June 2012 quarter with a $410 million revolver at 10 banks, so we've seen significant lender interest as we've grown the revolver.

Outside of our revolver, and benefiting from our unencumbered assets, we've issued at Prospect Capital Corporation multiple types of investment-grade unsecured debt, including convertible bonds, baby bonds, institutional 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 a BBB rating from S&P and have recently received a BBB+ rating from Kroll.

We've now topped the unsecured term debt market to extend our liability duration up to 30 years. We have no debt maturities until December 2015, with debt maturities extending through 2043.

With so many banks and debt investors across so many debt tranches, we've substantially reduced our counterparty risk over the years. As of today, we have issued six tranches of convertible bonds with staggered maturities that aggregate approximately $1.25 billion, have interest rates ranging from 4.75% to 6.25%, and have conversion prices ranging from $11.23 to $12.61 per share. In the past, we have repurchased such bonds when we deemed such purchases to be attractive for us.

We have issued $100 million of 6.95% baby bonds due in 2022, which is traded on the New York Stock Exchange with the ticker PRY.

On March 15, 2013, we issued $250 million of 8-7/8% senior secured notes due March 2023. This was the first institutional bond issued in our set during the last seven years.

On April 7, 2014, we issued $300 million of 5% senior unsecured notes due July 2019.

We currently have $789 million of program notes outstanding with staggered maturities between 2016 and 2043, and a weighted average interest rate of 5.38%.

During and since the March 2014 quarter, in addition to our revolver expansion and program notes issuance, we have issued equity at a premium to net asset value and therefore accretive.

From January 1 through May 2, we sold approximately 37.3 million shares of our common stock in our APM program, and raised $414 million of gross proceeds. We do not anticipate filing another after-market equity program for the remainder of the June 2014 quarter.

We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver, and that we are in compliance with all our revolver terms, and taking into account our cash balances on hand, we have over $900 million of new facility-based investment capacity.

Now, I'll turn the call back over to John.

Thank you, Brian. We're ready for questions.

(Operator Instructions) Terry Ma, Barclays.

Thanks for taking my questions. Just looking at your Progression investment, it looks like it's about 7% of your portfolio. Can you just give us some color there on the risk/reward and maybe just talk through the rationale of funding multiple dividend recaps on this company? It looks like it's levered about six or seven times, all in.

Sure. Progression is a company that's performed terrifically well in our portfolio. This is a company that corrects errors in individual credit reports. As folks might be aware, the credit bureau reports can be rife with errors, identity issues, mistakes, etc., that can hamper -- it produces FICO scores erroneously and hampers access to credit for individuals. So this is a subscription-based service that provides tremendous value, which has been recognized with significant growth in the business.

We have recapped the company multiple times against that growth run rate leverage; I think it's substantially lower than some of the numbers you have quoted. And we're very pleased with the performance of that company.

Sir, this is John Barry. I would add that one of the things that we believe is happening in the United States is that people are more alert to their FICO scores, they're more alert to their need to keep track of the availability of credit, the interest rates on their credit cards, erroneous reporting, getting their finances in order, and the like. And that this awareness is what drives the demand for this company's services.

We don't see this pool of people wanting to be smarter about credit reporting and how they're depicted when they get a loan or a credit card or a car loan as falling off; we see it as growing. And given that Progression is either the leader or one of the leaders -- I think it is the leader -- in that marketplace, we believe that the company has a strong future.

Another point I'd make here is that when we loan to a company and sit there with a loan for several years, and it does well, and we get to know the company and we participate as observers in the board meetings, we get to know the management and the team as a sponsor -- in this case, HIG -- we develop, I guess, a level of information about the company, its ongoing operations, its prospects, and its future that is hard to get if you're coming in with a fresh loan.

As a result, we find making additional loans to companies where we know the situation is a good risk-reward for us.

I would also add that it's a granular business with thousands and thousands of customers. So we look at it as a very diversified business.

That's good color; thanks. Can you maybe just give us some color on the credit trends you're seeing in the installment loan space and the auto finance space? Just given we're coming off cyclical lows in net charge-offs and delinquencies.

Sure. We've seen, last year and in 2013, an increase in some of the charge-offs in the consumer and sub-prime space. Not a massive spike, but an increase. And that trend has actually reversed itself over the last several months and we've seen improvement in credit quality.

In general, one of the things we like about the installment space -- and as we've discussed before, we made our first investment in a junior debt instrument in a company that refinanced us many years ago, so this goes back seven years ago, approximately. We did analysis on this industry going back all the way to the 1980s through multiple credit cycles and recessions. And we were quite pleased with the stability, in that charge-offs and delinquencies don't seem to go through super spikes in this market as they do in other markets.

So when you talk about increases and decreases, they tend to be more the modest variety as opposed to the significantly volatile variety. So we're seeing an improvement there.

When we're talking about the installment space, auto finance, we own the company called Nationwide and we've seen -- it really depends upon what each company's doing, but we've got a very disciplined operating management team there that has not been chasing volume and has been very careful about credit quality. So there's significant stability there as well.

Yes, that's great. And can you just talk about fee (inaudible) real quick? What kind of servicing fees are associated with this? And how should we think about that going forward?

We don't have a number yet; this is an initiative we've launched. We're in conversations with strategic investors for this. But we do expect there will be some accretive fee income from this. Primarily what it would be, it would be a capability enhancer that would allow third-party capital to come in and purchase lower-yielding loans as part of a one-stop proposition where we bifurcate. A one-stop solution for private equity firm or some other third-party owner into, say, an A and a B piece, the A amortizing, sweeping out, first before the B. And so having a lower coupon and lower yield attached to the A than the B.

So we would have another investor basically purchase the A and then Prospect would retain the B on our balance sheet. So this would allow us to face the market from a sponsor and owner perspective in a one-stop fashion while offering efficient funding solutions to them and enabling us to rotate out of some of our lower-yielding investments on our balance sheet into higher-yielding ones.

So the two pieces of accretion we would seek to achieve would be (1) through fee income and (2) by rotating to higher-yielding positions.

Alan, this is John Barry. We do need to emphasize, we haven't closed this yet. We're looking forward to closing it with someone. Oh, it's Terry; I'm sorry. Terry, I just want to be clear that we have not closed this yet. We're in discussions with people, we think it would be a significant advance for our business and we hope we can close it.

Okay, great. That's it for me. Thanks a lot.

Thanks, Terry.

Andrew Kerai, National Securities Corporation.

Yes. Good morning, and thank you for taking my questions. If I could just go back to PSEN for a second as well. So is the idea here that you originate loans sort of at the BDC level. You sort of take the fee income, then you basically just sell off those loans to basically PSEN. So you're clipping the 2% or 3% origination fee and then basically just selling off the loans to PSEN. Is that kind of the idea behind the incremental fee revenue that you guys are talking about?

Andrew, thank you for your question. We haven't finalized the structure with the investor base here. That's one of the items of discussion on the up-front portion. So that part is unclear. The ongoing servicing would be more clear and that would be incremental fee income from third-party capital that we obviously don't have today. So that's one piece of it.

I think even more, the accretion will potentially come from being able to sell off those, again, lower-yielding loans and then add more higher-yielding ones -- in effect, the [D] pieces of the next one-stop deal that comes along.

Right. No, certainly, thank you; that's helpful color. And then, if I could just ask as well kind of about the SEC assertion that you guys disclosed has kind of received a significant amount of attention this morning.

So is the idea here that basically if you look back and the GAAP earnings would be lower as a results of this restatement, right? Then the idea is that the incentive piece would also be lower. So just trying to understand, from that perspective, given that the fees have already been paid out, would that imply that you would be effectively lowering part of your incentive fees in the future to kind of account for that? I guess, how should we think about that from simply just kind of the taxable income perspective?

If that investment income was lower, the calculation and the management agreement will require that the fees would be recovered. So that would actually be an offset to any decrease in net investment income. And it would also be an increase to taxable earnings and distribution. So from a shareholder standpoint, there's little to no downside to a restatement if it is required by the SEC.

The best disclosure is to look at page 100 of our 10-Q, where we outline that in detail.

Right. I just wanted to, I guess, be clear -- I guess the idea is if historical taxable income would be increasing, then I guess the two sides of that is (1) that benefits your NAV; and secondly, that also increases the amount of, I guess, distributable net -- just taxable income, I guess, if I'm reading that correctly?

Yes.

Net income, NAV, would all increase on an historical basis. And we believe that net investment income would become much less useful of a metric for our taxable earnings and distribution requirements. And as we said in our release, we probably would need to show some sort of adjusted NII to clarify things for investors, which would also be expected to go up through the incentive fee reduction.

And have you done an analysis, I guess, based on if this were to take place -- if you had to apply this guidance historically -- what would your sort of undistributed or spill-over income be at the end of Q1 compared to the roughly -- I think it's about $0.20 or so now?

We're in the process of making that calculation now. We do not have that.

It would be a higher number, but we don't know how much higher.

Got it; certainly, thank you. And then, also just wanted to talk about the CLO investments, if I could, as well. And you guys obviously account for CLO investments on an effective yield method, which can differ pretty considerably from sort of a cash-on-cash return from a CLO equity.

If you were to look at the cash distributions from the CLO investments and kind of compare them to the income you recognize, do you guys have sort of the delta in what lift that would give to the interest income line?

Sure. On a cash basis, our CLOs are yielding in the -- about 22%. And on a GAAP basis, we're recognizing between 15% and 16%. So there's about 700, approximately, basis points there that we use to reduce our cost basis to provide a cushion for the future.

Great.

(Inaudible) out earning on a cash basis what we're recognizing for GAAP income there.

Got it. So I guess if you were to take that in context, then -- if you were to say, well, your taxable or distributable NII, when you look at the cash returns from the CLO equity, would actually be higher than the given CAD if you were to apply what seems to be more than a couple of pennies just from simply the cash versus the GAAP treatment for CLO equity, if I'm interpreting that correctly.

That's correct. Tax matches pretty closely with CLOs' cash. So if you're only recognizing part of the cash as income to basically build an economic reserve against potential future losses, you actually have higher taxable earnings than you do GAAP. That's correct.

Great. Thank you for taking my questions.

Sure.

Thank you, Andrew.

Christopher Knowland, MLV and Company.

Hi, thank you for taking my questions. The dividend coverage deteriorated a little bit in the quarter relative to the last quarter. Given the balance sheet debt leverage is pretty close to 0.7 debt to equity, what's the strategy here, or the options, in terms of trying to improve the dividend coverage, if any?

Thank you, Chris. Recall that leverage stat is a balance sheet stat as of 3/31; and income, of course, covers the entire quarter. A lot of deals -- about two-thirds of our originations last quarter -- actually ended up closing in the last two business days of the quarter. Which is generally outside of our sole control as to when these deals close. Sometimes they seem to get lumped towards the end of a period because it becomes earlier for a change of control to start a new reporting period at quarter end or month end.

So our hope is that those deals would then be full-quarter contributors in the coming quarter. So that's one piece of it.

Second piece is, the PSEN initiative that we talked about earlier, we hope and anticipate could be an earnings driver as well -- again, through both incremental servicing as well as rotating some of the lower-yielding, say, 6% or 7% yielding assets on our balance sheet, into double-digit yielding ones.

And we haven't calculated precisely what that impact would be. We're still in discussions with strategic investors for that.

So because of the late closings in the quarter, it's fair to say that the dividend coverage is likely to improve going forward?

That's certainly what we're targeting, Chris. And again, we'd also emphasize that we have banked excess earnings, [taxable] earnings, in the past two years and that's available for future dividends. We used -- I think we disclosed we had $0.26 banked from the last fiscal year and we've used about $0.04 of that so far in the first nine months of this current fiscal year.

Great. And can you give us an update on Nick Financial, please? And then I'll go back into queue.

Sure. As we disclosed in our Q, we've encountered some regulatory delays for that transaction. We're working with the regulator to try to get that approved. We can't promise if it it would be approved or how long it would take, but we do anticipate a delay.

We also would need to work with the target company and extend the current agreement that expires in mid-June, and currently here it's May 7; there's not enough time to get a transaction done by mid-June, even if we did have regulatory approval. So our objective is to work with that company and seek to extend that time period to enable us to address topics that we disclosed in our Q with the regulator.

And it is our hope and desire to close that transaction, but we cannot promise that a transaction would, in fact, close or close quickly.

Chris, this is John Barry. I would very much like to close that transaction. We've been working on it -- how many months? Two years. We've gotten to know the company and we've gotten to know the management. We really like the management, we like the company, we like what they do. We think it fits well into what we do. We think we can add value to the company, we think the people at the company can add value to Prospect.

So for what it's worth, speaking for myself, personally, I would very much like to be able to close that transaction. And so I'm hopeful that we can work out an extension with the company and that we can get the permissions that we need and that we can go ahead and close this as soon as possible.

So that's hope. Reality is, well, we need permissions. And until we get them, we just don't know whether we can ever close or how long it would take. But it won't be for lack of my trying or my wanting or my hoping to close that.

While it is a transaction, Chris, we would like to close, to put it into context, it's about a $200 million equity value transaction, which compares to the $1.3 billion we put on the books last quarter. So we want to close it but our world won't end if we don't.

Great; thanks for the color.

Greg Mason, KBW.

Great; thanks for taking my questions. First I wanted to talk about -- in the press release, you talked about through the APM program post-quarter end, you've issued 7 million shares but you don't plan on issuing any more. I just wanted to make sure I'm reading that correctly. And is that because of this SEC issue?

Yes, we are not issuing in our APM for the balance of this quarter while we sort through these topics. I think for investors that have looked towards the growth of our Company and the issuance of equity, perhaps will see that as good news.

And what about other registered securities? You've raised a lot of capital through the program notes and other convertible bonds. Are those still options to raise debt capital?

Greg, it's John. These are options to raise capital through the APM redeem capital program. As you know, from time to time we do more or less or zero under those programs, depending on the demand in the marketplace for our capital, depending on credit spreads, depending on refinancing, depending on pay-backs. We're managing, as I think everyone on this call knows, a large incoming and outgoing capital book.

Part of that management includes the availability of the option of the APM and capital, neither of which on any given day or week or month are significantly substantial additions to our capital base. It's nice to have those options, but we feel it's prudent, while we are having discussions with the regulator concerning our appeal, that we suspend those programs. Just prudent. And hopefully we will have the option to employ all of the tools at our disposal at some time in the near future.

But we'd rather be too conservative than not conservative enough.

And as we discussed, and folks know, we tapped the term markets in a significant fashion in the past two months. Having pioneered the convert market for the industry, we priced our sixth convert over a month ago. And having pioneered the institutional bond -- straight institutional bond industry -- as well for the BDC sector, we did our second such deal a month ago as well.

So we raised a significant amount of liquidity that way. Our revolver is currently undrawn so we have a significant amount of liquidity there. And we have over $4.8 billion of our assets, which is -- approximately 80% are unencumbered. So there's potential things we can do on the secured front as well.

I'm not saying we would encumber all those assets right away, but we do have a storehouse of value there that we could utilize for financing for our capital needs. We're at 0.68 debt to equity as of 3/31. And hopefully folks are happy that we've boosted our debt-to-equity ratio, as people have been looking for us to do; in some cases, for years.

But what we have to do is we have to manage the proper balance at our Company. We have to manage our proper balance on leverage, our proper balance on liquidity.

We've other storehouses of liquidity as well. If you look at the sub-10% yielding assets, I think that's approximately $500 million, give or take, on our balance sheet there. That's another storehouse of liquidity we can use to portfolio rotate. So we have lots of liquidity right now.

We don't put out origination targets but I think $1.3 billion we did in the March quarter; that's probably not something you're going to see replicated quarter after quarter, but we have lots of liquidity for future deals.

That's great. And with that ability to still draw on the credit facility now, what leverage level are you comfortable with taking the balance sheet to? At least for a period of time where you can't issue any equity with this SEC issue?

I'd say somewhere in the 0.75 range, as we've talked about in the past. And leverage will move a little bit up and down around some type of a band. But we think, since we pioneered so many of the longer-dated liabilities in the industry, as really the first to open up these possibilities for the industry, whether it's converts or straight bonds or program notes, it allows us to say we run a matchbook funding from a tender standpoint.

And it's given us the confidence now versus, say, five, 10 years ago in the industry, before we prospected pioneer as the term markets for the industry, to run at that type of leverage level. Which we think still gives us quite a healthy cushion compared to the current one-to-one limit.

And do you have any thoughts on the timeline for this SEC dialog and when this could be resolved? Is this a month time frame? Are we talking six to 12 months? I just don't have a concept.

We believe that the process will be about a month.

Okay, great. And then --

But we have to emphasize, we really don't know. We don't control these processes. So we can estimate, we can guess, we can hope, but this is not something that we control at all. We're better able to talk about things within our control than things that are not within our control.

Okay, great. And then, on the structuring -- on Arctic Energy that you closed post-quarter end, do you have any sense of what the potential structuring key impact could be for net positive benefit next quarter? Do you know off hand?

It's probably in the 200-[bf] level, consistent with other deals. We don't have the number at our fingertips, so that would be consistent with our average structuring fee on deals.

Okay, great; and then, one last question.

It's generally between 150 and 300 bfs at our structuring fee.

Perfect; that's great. And then, one last thing just to be sure I'm thinking of the math correctly. You talked about the spillover -- it was $0.26 last year. You used $0.04 of it this year. In the press release, you put the dollar basis in there. So if I take $53.4 million spillover and you've used $16.8 million of it, it gives you $36.6 million left. If I take that over the current shares outstanding, I get, like, an $0.11 spillover currently.

I just want to make sure I'm thinking about that correctly as we're modeling going forward. On a today basis, it's, like $0.11. Is my thought process right there?

Yes. The answer is that probably at the June 30 quarter, or year end, we will have an update to what those numbers are. As we discussed earlier, the CLO effect -- what is additional taxable income from that is significant. It probably doubles the number that you just discussed. I feel confident that we're closer to that $0.22 that we discussed earlier.

Great; great color. Thank you.

Thanks, Greg.

Jon Bock, Wells Fargo.

Good afternoon, and thank you for taking my questions. John, Grier, just to go back real quick as it relates to the SEC restatement topic for a moment. And this is just to enhance my understanding because I believe you put in your Q an expected effect if there was a restatement, if that was to occur.

In I think Point 3, it mentioned that your historical NII will decrease by the amount of interest in structured income paid by those wholly owned subs in excess of the amount of income that can be reported as dividend income based on taxable earnings and profits.

Now, please correct me if I'm wrong, but does that mean that you booked more income into NII, or more income to you, than the actual amount of earnings and profits that were being generated by those individual businesses?

Jon, the answer there is yes, and that's absolutely the case with almost every company we have, whether it's wholly owned or it's a straight-debt investment. The answer is that these companies are paying their interest costs out of cash flow. Cash flow is the determining factor as to whether they can make their payments or not.

So these payments were all made out of cash flow. Now, a lot of these companies are going to have significant amortization and depreciation, which will change what their taxable income is as opposed to their cash flow. And those are the differences that are creating the changes.

Jon, to add to that, we actually looked at a number of deals -- I think several dozen, actually -- of syndicated transactions we've done in the past. So these are companies not only we don't control but are more kind of widely known, larger sponsor owned, many lenders, etc. And we've seen that in the vast bulk of those situations, that tax earnings is far below the interest payments.

That doesn't mean the companies are unable to service the debt; it just shows a significant decoupling between economic ability and what's happening on a tax front. Obviously, there are many businesses that have non-cash deductions available to them which they want to avail themselves of for proper and prudent tax planning.

So if you suddenly held those same companies to the standard of saying that you can't recognize interest income beyond tax earnings, you'd see many, many lenders across the field wake up and discover that instead of having interest income, they'd be, I don't know, returning capital distributions.

That's a very simple example of what we have going on here, where if the debt had been placed at the opp co, income recognition. If, instead, it's placed at a hold co, then some of the interest suddenly becomes a return of capital distribution. No economic change whatsoever, no change from a tax standpoint. The change is entirely from a GAAP standpoint.

And that's why we say if that's how the accounting must be done going forward, net investment income, NII, which other companies sometimes call NOI, will, in our opinion, be far less useful for analysts, for shareholders, for ourselves to assess the business. And we'll have to come up with other metrics we think will be more useful that adjust GAAP.

Okay. The only question is, we follow a number BDCs -- have followed you for a long time. And this issue, obviously, doesn't materialize with any of them. And so are you saying it should in the future, or are you doing things that are unique relative to your competition?

Well, I'm not sure it's an accurate statement to say that no other BDCs do controlled investments, including wholly owned investments. I think there are some out there elsewhere in the industry. And we can't speak for other companies, but we'll see what happens in the industry between the regulator and other companies.

Okay, fair enough.

But we do have a differentiated business model which we think history has shown outperforms by having a more diversified business that allows us to do controlled deals and to capture attractive returns.

And remember, when we do controlled deals, in many cases -- not always -- in many cases, the only third-party debt against these companies is an ABL revolver. In fact, I think that is the only third-party debt; in some cases, that's a trivial amount of debt. In some cases, there's zero third-party debt.

So that's why I like to call many of these less-leveraged buyouts because we're putting out own debt against these companies and seeking to acquire them at an attractive purchase multiple.

Fair enough. I guess the one thing I also wanted to jump into and make sure I got it correct -- you mentioned that you, yourself, felt it prudent not to issue equity or securities at this time. And that maybe as this gets worked out -- maybe I'll pose a different question. Are you deemed defective by the SEC to issue such securities?

We don't know. No one's said we're not effective. We just decided last week that we didn't think it was a good idea. I would be very surprised if the SEC doesn't agree with that. But they haven't called us and -- they haven't called me -- how about that? Maybe they've spoken to someone else.

We feel, Jon, that when you have a disagreement with a regulator, the prudent course is to just stop doing anything that could attract attention and create controversy. And so issuing securities while there is this discussion just doesn't seem prudent to us.

I'd like to get back to something that I'd like to be sure is not lost in the discussion. I'm not an accountant, but I do feel I know a little bit about the leveraged buyout business, having lived in that business for a few years. In my experience, leveraged buyout firms -- not just us, other leveraged buyout firms -- typically buy companies using a holding company structure.

Why is that? Well, because there's sureties at the opp co. There are counterparties at the opp co. There's a desire for a less-leveraged situation at the opp co on behalf of management. It's very common for a leveraged buyout firm to buy a company and put the equity in a hold co and put it down as equity into the opp co.

So we've done that. Now we understand, had we simply not used a hold co but had used -- this is my understanding -- had we not used a hold co, but had simply put all the debt at the operating company, my understanding is there would not be an issue.

In other words, because we used a holding company there's an issue that would not exist without a holding company. The economics of the transaction are exactly the same, from what I can tell. The cash flow-generating power of the business to our company is exactly the same, from what I can tell. But apparently if you make the mistake of using a holding company, as so many of our competitors do -- not necessarily public traded, and we haven't done the analysis of publicly traded people -- there's a difference.

So we understand that, that that's a viewpoint that some people may have. I can tell you that going forward in the future, we now know we have to put the debt that is in these buyouts, we have to put it at the operating company.

John, because the only reason -- when you mentioned the use of hold cos, like for example if a large [bolts bracket P] firm is to purchase somebody, it makes total sense to have the hold co then own the opp co because of protections and assurity, etc. But the major difference here is, when they raise capital, they often will bring third-party debt as part of the hold co. You provide both the equity and the debt yourself.

So if it was all equity, fine. Superior amounts of debt with equity, I guess that's the major difference I see relative to the number of hold cos that purchase operating companies in the future.

So it does sound like there'll be a change, and I appreciate your candor in discussing all this.

Well, it think it depends; what I was saying. So we've been using a method that's common in the energy industry, common -- by the way, let's just start with the larger picture. You loan money to a cable company, they're not paying you interest out of earnings and profits. You loan money to a real estate company, they're not paying you interest out of earnings and profits. You loan money to any capital-intensive business, they are typically not paying interest out of earnings and profits.

No. 2, if you look at leveraged buyout debt across the country extended by all kinds of financial actors through leveraged buyouts, I would be surprised if there's very many that anyone can find where the total interest is supported by earnings and profits.

In fact --

Tax earnings and profits.

Tax earnings and profits. In fact, I'm going to make a huge confession here on this call -- I never even heard of the concept of tax earnings and profits until about a year ago. So this was all brand new to me. Because I think people in the leveraged buyout business are focused on cash flow. That's the whole genesis of the industry -- cash flow. What is the cash flow-generating ability of the company to pay its obligations? This is what we've always focused on.

By the way, I'd like to point out, I think that's one of the reasons that our nonaccrual rate is low. We focus very hard on that. Now we understand that when we loan into these industries or do buyouts in these industries, we have to be extra careful for reasons that were not apparent to us in the past.

No. 2, you will often see in the energy industry and in the buyout industry investors using structural subordination. What does that mean? That means that the ABL lender says, I see that there's other debt underneath me. I don't want it in this company; I want it in a holding company. It's a very common position of ABL lenders.

If you would like to have ABL lenders in your buyouts, if you would like to have cheap debt that drives good returns for your shareholders, putting your debt into the operating company, which other buyout firms do not do, will not enhance your ability to drive good terms with sureties, ABL lenders, revolving credit, counterparties, Dun & Bradstreet -- it's a long list.

But we now recognize that what we've done historically we may not be able to do in the future as far as where we put the debt. We don't see it making any change in the cash flow-generating ability of the companies that we invest in.

Okay, that makes sense. Then I guess if we're going to turn to Harbortouch for a moment, and we talked about lending out of cash flow there, we see that that $100-some-odd million loan was an L plus 8 with a 2% floor plus 6% PIK. So would you assume that -- the question is, if it's coming all out of cash flow, why add the PIK component, which is non-cash but then still flows into income?

The management team likes to see a PIK component there just so they feel like if there's ever a soft month or soft quarter or seasonality piece there's a cushion there.

We are careful users of PIK and we know that if a company doesn't pay every last penny back of PIK down the road, you get the privilege of reversing in full. And that PIK interest is actually paid in cash. So it's paid in cash. It's not like these other PIK deals where you have some [mes] blender that does 12 plus 2. And (2) you know one thing -- it's never going to be paid in cash and you're hoping to wait to the end.

So you've built in some felicity. If it's not paid in cash, then you do it through a reversal at the end. Ours is paid in cash for our control deals so we don't have an issue there of the potential of a reversal.

Okay, great; thank you.

It's John Berry again. I'd like to take this moment to point out as well that anyone looking at the companies that we buy I think could observe that we pay low multiples. And that's our discipline. That's what's helped us manage our Company here.

Paying low multiples means that the company is better able to generate the cash flow to service all of its obligations. Now, some of the people we compete with pay higher multiples, make loans that companies can't service out of cash flow. And these people use PIKs.

If you look at our portfolio -- I haven't compared us to every other company -- but I believe that our use of so-called paying time securities, where we merely accrue money that we're not getting, is very low. It's not that we couldn't have done that; it's not that we weren't offered opportunities; it's not that there weren't companies to go buy where we could have bridged the gap from cash flow to some future hope through a PIK.

We've declined to invest in such companies. We've said if the company can't generate cash flow to service its obligations on a current basis, then that's type of an investment is of way less interest to us.

Now, this Harbortouch thing is an unusual situation where we're in effect joint owners with the management team that specifically requested that. We'd like to be a good partner with Jared there -- who's a wonderful person, by the way.

Elsewhere in our portfolio -- look around -- you will not see [paying time], which is -- what would I say? If somebody wanted to be recognizing income where it's a question whether it's there, you would think that that would be a place to look, right?

Well, we don't do that.

And Jon, also I think some folks write from time to time, oh, that controls -- that must make Prospect so much riskier than a straight debt book. We look at it from a [cashier] point standpoint. You're seeing leverage creeping up there across the board. You're seeing spreads compress in the middle market.

It's actually a little bit worse in the middle market right now in the last month and a half than the broader syndicated market, where spreads actually have come back a bit because of outflows on the open-end stocks. Whereas the middle market has to keep getting vested there.

Would you rather buy a company for 5.5 times cash flow, or lend money to a company for 5.5 times cash flow, as an example? Which is riskier to do -- and it's the same company?

Well, obviously, it's riskier to end money at 5.5 than to own the whole company at 5.5, and you have the up side to boot from being the owner here.

So that's what our disciplined strategy has been on the control side. Not to chase multiples into the stratosphere but to focus on buying companies that can generate cash flow, as John emphasized before, that then goes out to our shareholders to make distributions.

So I think it's very important to set that in context.

Controlled companies are not the majority of our companies. They can't be, under our regulatory and tax structure. They're a minority of our companies, but an important differentiated contributor that we think has higher barriers to entry than many aspects of the straight lending business.

To sponsor a business right now -- if you go to a lender meeting, especially a smaller sponsored deal, a company with, say, $5 million to $15 million in EBITDA, which the vast bulk of our peers focus on financing on the long-tail smaller end of our industry, you might see 20 seats around the table filled with lenders all bidding aggressively against one another in an eBay-like fashion, driving down spread, each offering a little more leverage.

We are uninterested in that game. And you've seen us emphasize some of our larger transactions last quarter, where we have scale, where there's more differentiation available by writing a larger check size, and just fewer lenders that can do that.

So we like to be in businesses, like any business organization, where we detect higher barriers to entry where we can differentiate ourselves. We don't like to be commoditized. And there are folks that are allowing themselves to be commoditized because they're monoline. All they do is sponsor finance; all they do is smaller deals. And if that letter doesn't close, there are 10 folks that can replace them.

I'm thinking back to the beginning of the leveraged buyout business, and it got started in part because standard accounting conventions would present a picture of a company that wasn't generating a ton of cash. Because there's a lot of depreciation, for example, or amortization of intangibles.

So there was no buyout business until the early 1980s, when people said, wait a minute; wait a minute. The coin of the realm is cash; it's cash flow. And so look at this cable company, look at this real estate company, look at this Snapple company, look at this and that company. They have huge cash flows that enable them to service huge amounts of debt and other obligations.

So in our business, that's what we've always measured -- cash flow. In fact, our terms are CAD -- what does CAD stand for? Cash available for debt service. What is another one? Cash available for distribution to owner. That's what we measure. That's the economic value of what we buy.

If we buy something that has a lot of net income -- well, you see these companies. They have a huge net income. But they're eating cash. We don't want to own those companies. Maybe they look great to someone else, but what we know is investing in a company like that means we're going to be writing checks.

So we'd rather invest in a company with no net income that is generating a ton of cash. Because we believe that we've been hired to produce cash flow for our investors.

Thank you very much for that long and very diligent response. Thank you.

Thank you, Jon.

This now concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Okay. Well, I'd like to wish everyone a wonderful spring day and a nice lunch. Thank you very much.

Thank you.

The conference is now concluded. Thank you for attending today's presentation; you may now disconnect.