Prospect Capital Corp (PSEC) 2015 Q4 法說會逐字稿

Good morning, and welcome to the Prospect Capital Corporation's fiscal year earnings release 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 Chief Executive Officer. Please go ahead.

Thank you very much, Allison. 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 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 forecast, 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-K and our corporate presentation filed previously and available on the Investor Relations tab of our website, prospectstreet.com.

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

Thank you, Brian. Our net income in the June quarter was $94.8 million, or $0.26 per share, the latter up 24% year over year. Our net investment income, or NII, was $89.5 million, or $0.25 per share. Our recurring interest income mix in the June 2015 quarter was 96%, up from 86% in the June 2014 fiscal year, thereby reflecting the high quality of our earnings stream, with a lack of dependence on nonrecurring fee income.

As a tax-efficient regulated investment company, our shareholder dividend payout requirement is based on taxable distributable income, rather than GAAP net investment income. In the June quarter, we generated distributable income of $96.3 million, or $0.27 per share. This represents $0.02 per share more than our recently declared dividend. Our distributable income for the full June 2015 fiscal year was $0.12 per share greater than our dividends. While regulated investment companies may utilize spill-back dividends in a subsequent tax year to count toward prior-year distribution requirements, distributable income consistently in excess of dividends enhances the possibility of future special dividends in order to maintain regulated investment company status.

We have previously announced monthly cash dividends to shareholders of $0.08333 per share for August, for September, and for October, 2015, with the latter representing our 87th consecutive shareholder distribution in our Company's history. We plan on announcing our next series of shareholder distributions in November. We have generated cumulative distributable income in excess of cumulative dividends to shareholders since Prospect's IPO 11 years ago. From the IPO through June 2015, our taxable income is currently $53.1 million in excess of dividends to shareholders, an excess of $0.15 per share. Since our IPO 11 years ago through our October 2015 distribution at the current share count, we will have paid out $14.12 per share to initial continuing shareholders and $1.67 billion in cumulative distributions to all shareholders.

Our NAV stood at $10.31 per share on June 30, up $0.01 from the prior quarter, demonstrating a stable investment portfolio value and NAV per share during the June 2015 quarter. We've delivered solid returns, while keeping leverage prudent. Net of cash and equivalents, our debt-to-equity ratio was 77.6% in June, down from 79% in March.

We have substantial liquidity to drive future earnings through prudent levels of matched book funding. We are currently pursuing initiatives to lower our funding costs, including refinancing of existing liabilities at lower rates; opportunistically harvest certain controlled investments; optimize our origination strategy mix, including increasing our mix of online loans; repurchase shares at a discount to net asset value; and rotate our portfolio out of lower-yielding assets into higher-yielding assets, while maintaining a significant focus on first lien senior secured lending.

Last quarter, we redeemed our 7% coupon baby bond on May 15, with a full quarter benefit of this redemption showing up in the current September quarter. Last quarter, we also sold our first low-yielding asset and expect sale of such assets to continue in the current September 2015 quarter and beyond, as part of our portfolio optimization initiative.

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

Thank you. I'll now turn the call over to Grier.

Thanks, John. Our business continues to grow at a solid and prudent pace. Prospect has scaled to over $7 billion of assets and undrawn credit. Our team has reached 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 and direct non-sponsor lending; Prospect-sponsored operating and financial buyouts; structured credit; real estate yield investing; and online lending.

At June 30, our controlled investments at fair value stood at 29.9% of our portfolio. This diversity allows us to source a broad range and high volume of opportunity, 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 five primary origination strategies. Prospect originated approximately $2 billion of investments during the June 2015 fiscal year.

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. At June 30, our portfolio at fair value comprised 53.8% first lien; 18.3% second lien; 17.3% structured credit, with underlying first lien assets; 0.8% small business whole loan; 2.2% unsecured debt; and 7.6% equity investments, resulting in 90.2% 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 and our debt investments were generating an annualized yield of 12.7% as of June 2015, an increase of 0.6% over June 2014, and an increase of 0.3% over March 2015. 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 some yield compression in recent years, we have 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. We've also elected to deploy capital in structured credit and online lending to help counteract overall market yield compression. We believe such yield compression may have stabilized recently, due to trading evaluation discounts for peer companies.

As of June 30, we held 131 portfolio companies, with a fair value of $6.61 billion. We also continue to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration. The largest is 10.8%. As of June 30, our asset concentration in the energy industry stood at 3.7%, down from 4.1% on March 31, including our first lien senior secured loans, where third parties bear first loss capital risk.

Our credit quality continues to be strong. Non-accruals as percentage of total assets stood at approximately 0.1% at June 30, down from 0.5% in March. Our weighted-average portfolio net leverage stood at 4.2 times EBITDA, and our weighted-average EBITDA per portfolio company stood at $45 million.

The majority of our portfolio consists of sole 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. Originations in the June quarter were $460 million across 11 new and several follow-on investments. We also experienced $438 million of repayments and exits from several other investments as a validation of our capital preservation objective, resulting in $22 million of investments net of exits.

During the June quarter, our originations comprised 29% third-party sponsored deals; 22% syndicated debt; 19% online lending; 18% structured credit; 10% non-sponsor direct lending; 1% real estate; and 1% operating buyouts. Our financial services controlled investments are performing well, with annualized cash yields ranging from 18% to 30%.

Because of declining unemployment rates and declining commodity prices, we believe the outlook for consumer credit is positive as we proceed through 2015, boding well for such companies. To date, we have made multiple investments in the real estate arena with our private REITs, largely focused on multifamily, stabilized yield acquisition, with attractive 10-year financing. Our real estate portfolio is benefiting from rising rents and strong occupancies, and our cash yields have increased with each passing quarter.

In the June 2014 fiscal year, we made three investments in non-controlled third-party sponsor-backed companies that brought our total investment in each such company to more than $100 million. In the June 2015 fiscal year, we made another three such investments, demonstrating the competitive differentiation of our scaled balance sheet to close one-stop and other financing opportunities. We've also made multiple control investments that each individually aggregate more than $100 million in size. We may look to harvest certain controlled investments in the coming months at a hoped-for significant gain over our initial costs.

Over the past two years, we've also entered the online lending industry with a focus on super prime, prime, and near-prime consumer and small business borrowers. We intend on growing this investment strategy, which stands at approximately $243 million today, not including third-party financing, across multiple third-party and captive origination and underwriting platforms. Our online business, which includes attractive advance rate financing for certain assets is currently delivering an expected levered yield of approximately 18%, net of all costs and expected losses. In the past year, we've closed three bank credit facilities and one securitization to support this business, with more credit facilities and securitizations expected in the future.

Our structured-credit business performance has exceeded our underwriting expectations, demonstrating the benefits of pursuing majority stakes; working with world-class management teams; providing strong collateral underwriting through primary issuance; and focusing on the most attractive risk-adjusted opportunities. Recently, we've utilized our position as a majority holder to optimize our portfolio through improved financing and other terms by refinancing liabilities at lower rates, as well as removing bond baskets for several of our structured-credit investments.

As of June 30, we held $1.15 billion across our fleet of 37 non-recourse structured-credit investments. Our underlying structured-credit portfolio consisted of over 3,250 loans and a total asset base of over $17.2 billion.

As of June 30, our CLO portfolio experienced a trailing 12-month default rate of 0.15%, significantly less than the broadly syndicated market default rate of 1.24%. In the June 2015 quarter, this portfolio generated an annualized cash yield of 22.4% and a GAAP yield of 16.3%, up from 20.6% and 15.4%, respectively, in the March 2015 quarter.

As a yield enhancement for our business, earlier this year we launched an initiative to divest lower-yielding loans from our balance sheet, thereby allowing us to rotate into higher-yielding assets and to expand our ability to close scale one-stop investment opportunities with efficient pricing. So far in 2015, we made six sales of such lower-yielding investments, totalling $167.5 million, with a weighted-average coupon of 6.5%. We receive recurring servicing fees paid by multiple loan purchasers in conjunction with these divested loans. We expect similar sales, with related recurring servicing fees, both this quarter and in the future, as a potential earnings catalyst for the June 2016 fiscal year.

We've booked $310 million in originations so far in the current September quarter. Our advanced investment pipeline aggregates more than $200 million in potential opportunities, with additions expected, boding well for the coming months.

We previously announced a strategy that we've been working on for many months to spin off portions of certain businesses in our portfolio, including our consumer online lending business, real estate business, and structured-credit business. We believe these dispositions have significant potential to unlock shareholder value through pure-play earnings multiple expansion; moving strategies into faster-growing non-BDC formats, with reduced basket and leverage constraints; and freeing up 30% basket and leverage capacity for new originations at Prospect.

These investment strategies have grown rapidly for us in recent years and we believe these dispositions will provide expanded capacity to continue that growth. We anticipate these non-BDC companies will have tax-efficient structures. We would likely seek to divest these businesses in conjunction with rights offering capital raises in which existing Prospect shareholders could elect to participate in each offering or sell their rights.

The goals of these dispositions include leverage and earnings neutrality for Prospect. Our primary objective is to maximize the valuation of each offering, declining to proceed with any offering if we find any valuation not to be attractive. The sizes and likelihood of these dispositions, some of which are expected to be partial rather than complete spin-offs, remain to be determined, but we currently expect the collective size of these three dispositions to be approximately 10% of our asset base.

We seek to complete the first of these dispositions late in calendar year 2015 and the others in 2016 in a sequential fashion. But, this time line is dependent on regulatory and exchange listing approval, including an exemptive relief application we filed based on regulator guidance in May 2015, and dependent on market conditions. There can be no guarantee that we will consummate any of these spin-offs.

Prospect Capital will continue as the only multi-line BDC in the marketplace, with a continued diversified focus on originations, including the businesses being spun out. Thank you. I'll now turn the call over to Brian. Brian?

Thanks, Grier. We believe that prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets, and weighting toward unsecured fixed-rate debt demonstrate both balance [street] strength, as well as substantial liquidity to capitalize on attractive opportunities. Our Company has locked in a ladder of fixed-rate liabilities extending approximately 30 years into the future, while the significant majority of our loans float with LIBOR, providing potential [uptake] 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, develop a notes program, issue an institutional bond, and acquire another BDC. 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 June 2015, we held approximately $5.1 billion of our assets as unencumbered assets, representing approximately 77% of our portfolio. The remaining assets are pledged to Prospect Capital Funding, which has a AA-rated $885-million revolver with 22 banks and with a $1.5 billion total size accordion feature at our option. The revolver is priced at LIBOR plus 225 basis points and revolves until March 2019.

Outside of our revolver and benefiting from our unencumbered assets, we have issued at Prospect Capital Corporation multiple types of investment-grade unsecured debt, including convertible bonds, institutional bonds, and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions, no cross defaults with our revolver. We enjoy a BBB rating from S&P and a BBB+ rating from Kroll.

We've tapped the unsecured debt market to extend our liability duration up to approximately 30 years. Our debt maturities extend through 2043. With so many banks and debt investors across so many debt tranches, we've substantially reduced our counter-party risk over the years.

As of today, we have issued six tranches of convertible bonds with staggering maturities that aggregate approximately $1.25 billion, at interest rates ranging from 4.75% to 6.25% and have conversion prices ranging from $11.23 to $12.61 per share. In January, we repurchased $8 million of such convertible bonds at a significantly accretive discount to par.

On May 15, 2015, we called our $100 million 6.95% baby bond and replaced this bond with lower-cost liabilities. On March 15, 2013, we issued $250 million of a 8.875% senior secured notes due March 2023. This was the first institutional bond issued in our sector in the last seven years. On April 7, 2014, we issued an additional $300 million of 5% senior unsecured notes due July 2019.

We currently have $827 million of program notes outstanding, with staggered maturities between 2016 and 2043, and a weighted-average interest rate of 5.20%. On July 28, 2015, we began repurchasing our shares of common stock, as they were trading at a significant discount to NAV. Since that time, we repurchased 4.16 million shares of our common stock at an average price of $7.22 per share. Repurchases total more than $30 million to date.

We currently have drawn $295 million under our revolver. Assuming significant assets are pledged to the revolver and that we are in compliance with all revolver terms, and taking into account our cash balances on hand, we now have over $423 million of new facility-based investment capacity.

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

Thank you, Brian. We can now answer any questions. Bring them on.

(Operator Instructions)

And our first question comes from Terry Ma from Barclays. Please go ahead.

Hello. Can you maybe just give us a sense of how you're thinking about the planned spins in the event the SEC review drags on or the valuation isn't in line? Have you contemplated any other avenues to generate value for your shareholders?

Sure. And thank you for your questions, Terry.

I'll answer the second one first. On the valuation question, and I want to underscore this, we are not interested in proceeding with spins on a no-matter-what basis, unattractive valuation. And that's why we deliberately added more language to erase any confusion on that subject. So we just simply won't do them if market conditions aren't compelling. And we're happy to be patient.

In the event that market conditions continue for a while and they're not attractive, we could explore other avenues. For example, with the real estate book, which we could potentially sell and then invest into higher yielding assets, that book generates yields slightly below our weighted average yield today. Of course, those yields are growing through rent and occupancy growth. So we have other avenues available to us, for example, with that book.

Pertaining to the regulatory question, we've received positive feedback to date and, in fact, have engaged with a regulator about a year ago pertaining to the spin-offs and the format. But it's just taking some time to go through the mechanics of getting all that approved. And obviously, there's only so much we can do. We're trying to move that along as expeditiously as possible.

I do want to also emphasize, and we added this disclosure as well, that we currently don't anticipate the spins in the aggregate to be more than about 10% of our assets, which would envision only a modest partial spin of our structured credit portfolio, not the entire portfolio. So as folks think about the impact of spins in the light of my valuation comments earlier in our prepared remarks and the size, up to -- obviously, if you complete fewer than three spins, the 10% goes down to a single-digit percentage -- and determine your own impact and what you think would be on the business from there.

Terry, is that helpful to you?

Yes, that's helpful. I just have two more follow-up questions.

Can you just remind us how large your repurchase program is and what your appetite for repurchasing shares are going forward?

I'm sorry, Terry. Could you repeat that question? I apologize. There's a little bit of background noise.

Can you just remind us how large your share buyback program is and what your appetite for share buybacks are going forward?

Absolutely.

We currently have authorization for $100 million. And we elected, given available liquidity, we had some repayments recently and the backdrop of the share price. We elected to avail ourselves of that Board authorization and we repurchased approximately $30 million, 3-0 million worth of stock in the past month before we enter a blackout period for earnings. Does that answer your question, Terry?

Yes. What's your appetite for buybacks going forward?

Sure.

Well, it's certainly part of the potential investment options for the Company that obviously look attractive when you're at certain trading levels. I want folks to realize that we have multiple competing objectives to think about. And one of the most important objectives for us that we are quite focused on is making sure we stay within appropriate leverage constraints of our company, appropriate for an investment grade company that desires, wants, enjoys and needs continuous access to the bond markets, including the investment grade bond markets.

We're the only issuer in our industry that enjoys the benefits of tapping to weekly program notes, which are terrific, just-in-time capital that supplement our secured financing. And we are running at about between 75% to 80% debt to equity. So we have to be very thoughtful about that. But the share repurchases are indeed part of the composite picture.

Okay. Got it. That's helpful.

So I'm just going to indulge in one more question. Can you talk about Harbortouch payments? It looks like to me that you marked up the equity by 100% sequentially quarter over quarter. Can you just talk about that?

Okay.

So that's one tranche of the capital we hold. We hold several tranches against Harbortouch. We're the primary lender to the company. And on a fully diluted basis we own, I think, it's about 53% or 54%, approximately, of the equity.

We entered with a very attractive valuation attachment point when we purchased control of the Company in conjunction with a follow-on investment. Previously, we had just been a lender. And the second stage deal was done in the spring of 2014.

The payment space, which Harbortouch is a significant size company, is a diversified, highly recurring cash flow and growth business, benefiting from technology trends, including mobile payments, including improving information technology and tools available for local merchants that Harbortouch addresses. So Harbortouch is seeing strong recurring cash flow and strong growth against a comp set of public and private companies, and M&A comps that are double digit in nature.

So as a result, that business was written up through our robust valuation process, that some may know on this call and some may have forgotten, that our company, Prospect, when we went public 11 years ago, brought best practice valuation to the industry by having every company and every security fair valued on a positive assurance basis. So we don't do valuations around here. Third parties do them, and that's what goes in, with the concurrence of our independent directors, into our Q's and K's.

Got it. I'm just a little bit surprised at how aggressive the actual markup in evaluation was. We can take that offline, though, in the interest of other questions.

And Terry, those marks are not -- they are technically marks of the company, but this is done on a third party basis. And I'm sure if you check with Fin Tech Multiples out there, you'll discover in the payment space, and you look at some of the M&A comps, like Mercury comes to mind, with what Vantiv paid for them in the past year is one comp, and there are others out there, you'll see there's some fairly quantitatively robust comps that support that.

And before we leave your questions, let's just see if John has anything to add to your excellent list of questions. John?

Yes. Terry, thank you very much. Those are great questions. So I do have a couple of comments. Let me take them in reverse order.

We have Lincoln International do our valuations. I think many people on this call are familiar with Lincoln as a respected valuation firm; and their job is not to be high or low, but to be as exact as they can be. We cannot influence the valuations that Lincoln comes up with. Those go directly to our audit committee and directly to -- excuse me, they go first to BDO, which has to sign off on them.

BDO, from time to time, retains its own valuation consultants to five spec and pressure test valuations that are produced by Lincoln. The ultimate -- and so if the BDO valuation experts don't like -- or if BDO or its valuation experts, or both -- I'm not saying I don't believe BDO has an independent valuation expert check every single one of our, whatever it is, 140 positions.

But whenever BDO has reason to want a second opinion, they have on retainer their own valuation firm, which, as I said, can five spec and push back and pressure test. So that's step one, Lincoln. Step two goes to BDO. Step three goes to the audit committee of our Board. And step four is the full Board.

We cannot assign a valuation outside of the range provided by Lincoln and keep BDO happy. They are not interested in signing off on financial statements where any valuation comes outside of the range given by the independent valuation expert.

I wanted to share this with you, so you understand that this is coming to us from third parties that we do not control, who also have no financial incentives. In fact, they have no financial incentive to puff anything. If anything, their incentive is to be as close as possible.

Now, that isn't to say that every valuation is an exact 100% accurate prediction of what we would get if we were to sell any particular position tomorrow. It is more of an art form than a science, like physics. I hope you find that helpful with respect to at least the methodology of our valuations, even if you or another person, or even we as managers, don't agree with the valuations that go out. We have to abide by the process. Okay.

Next I would go to the buybacks. You may have noticed that our buyback program is not ballyhooed. It's not on every bill board along 95 or the West Side Highway. It's not on the radio. It's not press released.

Why is that? We want to buy shares at prices that are significantly accretive to the net asset value of the Company and that help shareholder value, not by propping it up with advertising and jaw boning, but by buying when we see prices that are attractive.

And in my case, rather than predict what's going to happen tomorrow or commit I'm going to do this or I'm going to do that, I prefer to say to people the best guide is to see how we've managed this company the last 11 years and let that be your guide. We got excellent prices for the $30 million of stock that we bought back and we're very happy to be able to buy on such an accretive basis.

Tomorrow's a new day. Obviously, someone who buys $30 million of stock may have a wallet to buy more. And as Grier said, we have authority for $100 million. That's on the buybacks.

Lastly, on the spins, I think one way to look at it, the way I look at it is, we initiated the process of the spins because, number one, we would like to demonstrate the value of the pure play strategies that we've built up inside of PSEC. And we see when they are pure play, they trade at higher multiples than does the BDC industry as a whole. And I think we can all ask ourselves why the BDC as an industry as a whole is under such valuation stress; that would be a very long earnings call now, wouldn't it?

One of our steps is to look at the option of spinning off pure play strategies where other valuation metrics can come into play. So we have three, online lending, real estate, and our CLO business. Well, number one, we have to get exemptive relief. That's not guaranteed. Anyone who's sought exemptive relief, I think, understands that could be a very long process, as it already has been for us.

Number two, if we do get exemptive relief and we take the next economic steps towards consummating these spins, I think we can all predict of the three, one will have the most attractive impact on our Company and on our shareholders, and one of the three will have the least positive economic impact on our Company and our shareholders. And then there will be a third spin that will be in the middle.

So anyone thinking we are automatically going to do three, we're desperate to do three, we must do three, I've heard these things. Oh, they absolutely have to do it. Nothing could be farther from the truth. We can keep all of these assets right on our books, just as they have been. We are limited by the 30% basket. We're limited by leverage constraints. We're limited by diversification and other things. We won't be able to grow these businesses as quickly as we can grow them in a pure form.

Secondly, where we believe more attractive multiples apply to these pure play businesses than Prospect is currently enjoying, we won't be able to take advantage of that price discovery if the spins do not work out. But we want these to be a positive experience for us as individual shareholders and for all of our shareholders and for the Company as a whole. Because we know that our shareholders have suffered with this huge downdraft in the BDC space, which no one has been able to explain to me why it's an industry-wide phenomenon or how long it will last. No one can predict the future.

So we have to do our best to look at options like the pure play. Now, it may be that at the end of the day, we don't do any or we do all three, or we do one or two. We're looking only at, as Grier said, at less than 10% of our assets, were we to do all three. So people who think that this could -- these spins could somehow be, how would I put it, change the financial position of Prospect are reading way too much into what it means to look at spinning up to less than 10% of your assets.

And I underline that it's a small enough amount that it's not going to change the world. It can help us with price discovery, upward price discovery. That would be good. But that benefit has to be weighed against other costs and, of course, other benefits. And that's the direction we're going.

As well, we've said before that we intend for these spins to be NAV-neutral and net investment income neutral per share, and distributable income per share neutral, and therefore neutral to PSEC and PSEC shareholders even after the spin, even after should one or more spins be consummated. That is our objective.

And we will see what's possible. Of course, we can't do anything until we hear from the government; and meanwhile, as long as we do not get permission from the government, we're continuing with business as usual.

Is that helpful, Terry?

Yes, thank you.

I hope so. We're trying to be as helpful as we can, because we appreciate your interest in our Company. Thank you very much. Let's get the next question.

Our next question comes from David Chiaverini from Cantor Fitzgerald. Please go ahead.

Thanks a lot. Good morning.

So you mentioned that you plan to increase the amount of online loans in the portfolio. Could you talk about to what extent you've hired professionals with expertise in consumer credit to run and manage the online lending business?

Well, I'm going to go first and then Grier's going to pick this up. We have had a dedicated online lending team at Prospect since before the time I ever heard of the word online lending. So we have four -- let's see, at least four professionals who are full-time engaged in online lending. And it's a managing director and it is three associates and support staff. And I would say maybe -- I'm guessing, Brian, how many of our accountants are specializing in online lending? It's a very--

We have four accountants just doing online.

Four accountants just doing online. So you can think of our online, and then we have at least one and a half lawyers spending their time. So you might think of our online lending as based on an employee basis, a dedicated team of 8 to 10 people. On the deal side, those people do almost nothing else. When a friend of theirs sends a deal to us, it's not online lending, they send it elsewhere inside the firm.

The areas of expertise that we have developed are our own software, our own valuations, method of valuing these things, so we know which loans which to buy and which not. We purchase portfolios from multiple providers, On Deck, Prosper, Lending Club, Marlette. We can go right down the line.

And we have purchased from I think -- I've lost count -- probably eight or more originators of online loans. We're able to compare how On Deck does it, how Lending Club does it, how Prosper, how Marlette does it. Marlette's run by a very old friend of mine, Bob Conrad.

And being Switzerland to all of these online originators, we are able, we believe, to separate the wheat from the chaff. We're able to say, we will take these loans, we will not take these. We would like to securitize these loans. We're not going to securitize these. We like these FICO scores. We don't want those. We want this maturity. We don't want those. We'll pay this, and we won't pay that.

So the question I would ask is do I see any other company out there with as expertised and dedicated an online trading group as Prospect? Let me think about that. I suppose I would throw out Lending Club and On Deck. They've been doing this a little, somewhat longer than we have. But I'm struggling to add other names to that list.

When you're Switzerland, by the way, again, you're not taking out the billboards. You're not putting the ads in the paper. You're not on the radio with the megaphone, we are doing this, we are doing that. You're quietly working behind the scenes to aggregate a very large portfolio of online loans.

To my knowledge, we are the largest owner of online loans on our books. Grier, I'm struggling, who has a bigger asset base and experience with online loans than we do? I'm turning this over to Grier now.

Sure. I would say we're one of the top. We think we're one of the top three institutions in the online lending space.

And I would add to the expertise, David, that we have a substantial portfolio of bricks and mortar businesses focused on consumer finance, where there's obviously a lot of similar analyses relating to APRs, delinquencies, charge-offs, different origination profile, but similar in terms of risk assessment and underwriting. We have been a lender and/or owner to companies such as Regional Management, First Tower, Credit Central, Nationwide, Acceptance on the auto side, the latter spanning the vast bulk of the past decade. So we've got deep expertise, including seeing how these businesses perform across recessions.

I remember when we did our first underwriting as a lender to Regional Management, which is now a public company, they've since repaid our junior debt investment from many years back. I remember we looked at recessions going back to the 1980s and how delinquencies and charge-offs performed for consumer credit, specifically installment.

I would also add, David, that we're in the process of building specialized software within this part of our business to give us additional edge with our underwriting, with our reporting. This is a logistically and operationally complex business to run, because it's so granular in nature. Our corporate lending business, outside of structured credit, has approximately 100 or so loans.

In the consumer, and add small business to that online space, we have tens of thousands of loans. And they're operationally intense, where we need a small army of accountants and lawyers and tax people and deal professionals to address it. So technology becomes an important solution alongside our people and we've got a continuous improvement mindset.

And also, there's complexity that comes in through multiple credit facilities. I mentioned we've got three bank facilities and one securitization under our belts. And we're working on a number of other deals, as well, each of which has to be separately maintained and run from a financing standpoint. Has this been helpful to you, David?

Yes, that's great. Thank you very much.

One thing you could add, Grier, would be -- when did we do the RMC deal, our first investment in this space? How many years ago?

2007, which is why I said spans back almost a decade.

That's great. Thanks for the color on that.

And then following up on your comment of rotating your portfolio out of lower yielding assets into higher yielding assets while maintaining a focus on first lien, can you frame the opportunity and give a magnitude as to how many loans are considered lower yielding?

Sure. You can think about it as if you look at our balance sheet and you see a weighted average yield on one of our agented positions as in the range of, say, 9% or lower, 8 to 9%, we really haven't done anything lower than that. What we do is we split those underwritings into an A and a B piece, each of which is a first lien. And we've generally done that at about a 50/50 demarcation point.

And our objective is to divest some or all of the A piece, while still retaining important control rights through our enter creditor, vis-a-vis the new lender or lenders we bring in. Also, maintaining relationship ball control as the administrative agent and lead arranger for these deals.

So in general, we're bringing in more passive players into these deals. Think more upstream banks and insurance companies, maybe you'll see some sovereigns and pension plans, as well. Not too keen on bringing direct origination competitors into these deals, not without strong contractual protection. So we're fiercely protective of our relationships.

And what's great is we've also been successful in charging servicing fees. They're in the range of about 100 basis points or so to those players coming in. So we're not only getting the benefit of selling off assets. And the magnitude is we have about -- before we did these divestitures, I'm going to say close to, not quite, $0.75 billion of assets in that term loan A, lower yielding, 5.5% to 6.5% type of paper. And we've sold about $170 million approximately. Today we've got a lot of other processes ongoing right now.

So we not only get the benefit of selling off, say, a 6%, 6.5%-er and reinvesting into a much higher yielding position. Our weighted average yield as a business is about 12.7%. So if we reinvested at the same weighted average, that would be significant expansion. And then we get the servicing revenue on top of that.

So we're in the early stages of that now with a lot more term loan A sales to complete, but we think we've made nice progress, strengthened and built our capital markets and syndication capability. We have a team that is dedicated and focused on that effort and we're looking at potentially supplementing that. And that's a capability set that we may look to harness more on the front end to arrange and take down scale deals and sell off pieces at the front end as opposed to after the fact utilizing the benefit of our scaled balance sheet. So that's a potential earnings driver in several ways.

Thanks very much.

Thanks, David.

Our next question comes from Leslie Vandegrift from Raymond James. Please go ahead.

Hello. Good morning. I just had a quick question.

You talked about purchasing some of the portfolio assets from On Deck. Could you give me some color on that number for the quarter?

We purchased about $60 million of loans from On Deck, I think, since December, and probably the vast bulk of that was during the last quarter.

And we securitized approximately half of those assets, give or take, by teaming up with another purchaser of those assets to get more scale benefits. And that's the securitization that I referenced, and we completed that just in the past month. And I think we're getting over a, what, 200% return on equity off of that residual tranche.

So we're keen on growing our small business lending initiative. And that is not currently part of the spin-off, due to the regulatory format of a publicly traded partnership. Consumer loans fit a lot easier into those, into that advantageous format. And small business loans unlevered are 70% basket loans. So it's a long way of saying right now our intention is to keep those small business loans and the related securitizations here on Prospect's balance sheet.

Okay. Perfect.

And then another question. You talked about rising interest rates. You've got it in the presentation, about a 5% increase due to net investment income. At what point do you start getting the positive impact?

At around 100 -- I think it's 115 basis points.

Perfect. All right. Thank you. That's all.

And I want to add something else related to interest rates, because we get a lot of questions about interest rate sensitivity, not only in our main business, but our structured credit business. That business generates a lot of questions. It's 17% of our assets, but you would think it would be 71% of our assets sometimes, based on the number of questions.

What occurs there is this question on what happens with rising rates pertaining to valuations and income, and the way our cash flows work in that business is we assume the LIBOR forward curve. And the LIBOR forward curve is an amalgamation of everybody's expectations out there, from all global market participants. So if interest rates follow the path of the forward curve, we would expect de minimus impact on valuation and income.

If rates should increase to a lesser extent than the forward curve and perhaps that will be the case if the Fed decides to defer, all those things being equal, because there's a lot of variables at play here, including credit risk, of course, we would expect to see a benefit in our book. The same token, if rates went up faster than the forward curve, we would expect to see some compression, not some giant amount, but some compression related to getting to the 100-basis point LIBOR floor on the asset side while the liabilities are going up.

But the important bottom line is this is already factored in to the cash flows of the forward curve, which already has rates going up. And we get a lot of questions about that, a lot of confusion. I saw your excellent question as an opportunity to address that. John, do you have anything you want to add to that?

No, I do not. We're going to stick with you, Grier. This is going well with you.

Brian has something to add. Go ahead, Brian.

I just wanted to talk about, yes, it takes 115 basis points till we see a positive effect. But the downside effect is virtually immaterial because of the limited amount of floating rate liabilities that we have. We have $300 million outstanding on our credit facility. That is the only floating rate debt that we have.

So even if it went right to the verge, and it went just below 1%, we're talking about an annualized difference of $3 million. So the effects of minor increases in interest rates are not going to have any effects on Prospect on a quarterly basis.

And $0.01 or $0.02 per share, it's de minimus.

Yes.

Perfect. Thank you for that color.

Thanks, Leslie.

This will conclude our question-and-answer session. I would like to turn the conference back over to Management for any closing remarks.

Well, thank you very much, Allison.

We appreciate the time that you and everyone who has joined our call has taken, and I wish everyone a pleasant and enjoyable lunch and afternoon and the rest of August. Thank you all very much for joining our call.

Bye now.

Thank you all.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.