Prospect Capital Corp (PSEC) 2016 Q1 法說會逐字稿

Good afternoon and welcome to the Prospect Capital Corporation first fiscal quarter earnings release conference call.

All participants will be in listen-only mode. (Operator Instructions) Please note, this event is being recorded.

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

Thank you, Kate. 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 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 of our website, prospectstreet.com.

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

Thank you, Brian. Our net investment income, or NII, in the September quarter was $91.2 million or $0.26 per share, up $0.01 from the prior quarter. Our recurring interest income mix in the June 2015 quarter was 96% thereby reflecting the high quality of our earnings stream with the lack of dependence on non-recurring 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 $94 million or $0.26 per share. This represents $0.01per share more than our recently declared dividends.

While regulated investment companies may utilize spillback dividends in the 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 November, December and January with the latter representing our 90th shareholder distribution in our Company's history. We plan on announcing our next series of shareholder distributions in February. We've generated cumulative distributable income in excess of cumulative dividends to shareholders since Prospect's IPO 11 years ago. Since our IPO 11 years ago, through our January 2016 distribution at the current share count we will have paid out $14.37 per share to initial continuing shareholders and $1.76 billion in cumulative distributions to all shareholders.

Our NAV stood at $10.17 per share on September 30, down $0.14 from the prior quarter. Our net income was $27.8 million or $0.08 per share. We have delivered solid returns while keeping leverage prudent. Net of cash and equivalents, our debt-to-equity ratio was 76% in September, down from 77.6% in June.

We have substantial liquidity to drive future earnings through prudent levels of matched book funding. We are currently pursuing initiatives to lower our funding cost including refinancing of existing liabilities at lower rate. 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 lean senior secured lending.

In the June 2015 quarter we redeemed our 7% coupon baby bond with the full-quarter benefit of this redemption showing up in the September 2015 quarter.

In the June 2015 quarter, we also sold our first low-yielding asset and such sales continued in the September 2015 quarter 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 as 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 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 September 30, our controlled investments at fair value stood at 31% of our portfolio. 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 multiple origination strategies. Prospect closed 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 September 30, our portfolio at fair value comprised 54.2% first lien, 17.4% second lien, 18.7% structured credit with underlying first lien assets, 0.3% small business whole loan, 1.1% unsecured debt, and 8.3% equity investments resulting in 91% 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 13.0% as of September 2015, an increase of 1.1% over September 2014 and an increase of 0.3% over June 2015. We also hold equity positions and 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 have 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 and reversed recently due to trading valuation discounts for peer companies. As of September 30, we held 131 portfolio companies with a fair value of $6.43 billion. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. The largest is 10.2%.

As of September 30, our asset concentration in the energy industry stood at 3.5%, 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 a percentage of total assets stood at approximately 1.4% at September 30 with nearly all such credits residing in the energy industry. Our weighted average portfolio net leverage stood at 4.36 times EBITDA. And our weighted average EBITDA per portfolio company stood at $44.6 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, self-originated, and anchor investor opportunities compared to the broadly 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 September quarter were $438 million across six new and several follow-on investments. We also experienced $529 million of repayments and exits from several other investments as a validation of our capital preservation objective, resulting in net investment exits of $91 million.

During the September quarter our originations comprised 39% third-party sponsored deals, 28% online lending, 25% syndicated debt, 6% structured credit, 1% non-sponsored direct lending, and 1% real estate. 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 for 2016 boding well for such companies.

To date, we've made multiple investments in the real estate arena with our private RIETs largely focused on multi-family stabilized yield acquisitions 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 scale 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 hope for a significant gain over our initial costs. Over the past two years, we've also entered the online lending industry with a focus on a super-prime, prime and near prime consumer and small business borrowers. We intend on growing this investment strategy, which stands at approximately $261 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 a levered yield of approximately 18% net of all costs and expected losses, which further increases expected. In the past year, we've also 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 September 30, we held $1.2 billion across our 40 non-recourse structured credit investments. Our underlying structured credit portfolio consisted of over 3,150 loans and a total asset base of over $18.8 billion. As of September 30, our CLO portfolio experienced a trailing 12 month default rate of 0.3% or 97 basis points less than the broadly syndicated market default rate of 1.27%. In the June 2015 quarter, this portfolio generated an annualized cash yield -- that's September rather, of 23% and a GAAP yield of 16.5%, up from 20.6% and 15.4% respectively in the June 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 fiscal 2016, we've made three sales of such lower-yielding investments, totaling $74.3 million with a weighted average coupon of 6.0%. 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 in the future as a potential earnings contributor for the June 2016 fiscal year.

We booked $140 million in originations so far in the current September quarter. Our advanced investment pipeline aggregates more than $300 million and potential opportunities with additions expected boding well for the coming months. We've 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 a pure play earnings multiple expansion, moving strategies into faster growing non-BDC formats with reduced baskets and leverage constraints and freeing up 30% basket in leverage capacity for new originations at Prospect. These investment strategies have grown rapidly for us in recent years and we believe these spin-offs 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 and which existing Prospect shareholders could elect to participate in each offering or sell their rights. The goals of these spin-offs 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-off remain to be determined. But we currently expect the collective size of these dispositions to be 10% or less of our asset base. We seek to complete the first of these spin-offs sometime early in calendar year 2016 and the others in 2016 in a sequential fashion, but the timeline is dependent on regulatory and exchange listing approval, including an exempted release application we file based on regulator guidance in May, 2015 and also depended on market conditions. There can be no guarantee that we will consummate any of these spinoffs.

Prospect Capital will continue as the only multiline BDC in the marketplace with a continued diversified focus on originations, including the businesses being spun-out.

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

Thanks, Grier. We believe that our prudent leverage, diversified access to matchbook funding, substantial majority of unencumbered assets, and weighting toward unsecured fixed 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 liability extending approximately 30 years into the future, while the significant majority of our loans float with LIBOR providing potential upside 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, acquire another BDC and many other lists of firsts.

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 September 2015, we held approximately $4.9 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 followed by one year of amortization with interest distributions continuing to be allowed to us.

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, 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 Kroll and a BBB- rating from S&P. We've tapped the unsecured term 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 bad tranches, we 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 with interest rates ranging from 4.75% to 6.25% and have conversion prices ranging from $11.23 to $12.61 per share.

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 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 $300 million or 5% senior secured -- unsecured notes due in July of 2019. We currently have $875 million of program notes outstanding with staggered maturities between 2016 and 2043 and a weighted average interest rate of 5.19%.

On July 28, 2015 we began repurchasing our shares of common stocks as they were trading at a significant discount to NAV. Since last time we have purchased -- repurchased 4.6 million shares of our common stock at an average price of $7.24 per share. Repurchases totaled approximately $33 million to date.

We currently have drawn $246 million under our revolver. Assuming sufficient 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 have over $599 million of new facility based investment capacity.

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

Thank you very much Brian. We can now answer any questions.

We will now begin the question-and-answer session. (Operator Instructions) Terry Ma, Barclays.

Can you just remind us what your appetite for share buybacks is? It doesn't look you guys bought back any more share since last quarter.

Thanks, Terry. We have a Board authorization for $100 million of share buybacks and since the requisite mailing, I think it was around at the beginning of the summer for that. I think it was included at our annual proxy which allows good for six months until you do another mailing. In the past quarter, we repurchased -- how many shares was it, Brian, about 4 million?

4.5 million.

Approximately in the September quarter. Quarter today has been more modest. There are some black outs as well embedded in that, Terry. But our intention is to selectively utilize that program.

Okay, got it. Can you just give us some color on CP Energy Services, looks you were on non-accrual this quarter, you guys marked the second lien down to zero, and it looks like you guys didn't mark down anything else there?

Sure. I would describe the current credit environment as the same in our book, I think as many other book and reflection of the overall economy is kind of a tale of two cities where you have a lot of industries doing quite fine and the energy sector is going through a depression that rivals what you saw in the 1980s and you've seen significant gap downs in profitability there.

We feel quite fortunate in that our energy exposure heading into this dislocation was quite modest. We only have about 3.5% energy exposure. We did take a hit this quarter putting the bulk of our energy exposure on a non-income basis and taking a -- and that his as well this quarter. So we think that that is now, from an income perspective, in the rearview mirror with only potential upside from here from an income perspective, choosing instead to prioritize for the companies we control cash flow for operations and potentially selective acquisitions. We've been saying I think in the last couple of calls that we thought things would get worse before they got better in the energy patch going back to earlier in the 2015. That has proved to be correct.

It's hard to ever call a bottom on a market, but 2016 could be quite interesting for activity on a cautious basis where we have the proverbial margin of safety for new deal activity. But right now with the existing book, you want to protect customer relationships, aggressively cut costs, seek to expand volume, and in large part wait for the market environment to get better.

Got it. But specifically for CP Energy, for the senior secured, you're pretty confident you'll get full recovery value there even through it's on non-accrual?

Yes, I mean, we're in a cyclical -- this is a mark to market change in value, right. So when you mark to market just used to look at the current environment. That doesn't mean that we would be a seller or want to crystallize any current market I think in the energy patch on the contrary the smart capital. And we like to think of ourselves as such waits for a better environment to not only see a recovery but also potentially makes some money in other deals. So, we'll see.

Okay, got it. And what about Arctic Energy Services? It looks like you guys converted both the debt pieces to equity this quarter, can you talk about what's going on there?

Yes, I think if you could just take the comments I made on energy and Xerox them I repeat them. So I won't do that pertaining to Arctic because they are an energy services company and largely the same sector, some are different basins, but you're seeing the big downtick in activity across lots of different basins.

From a capital structure perspective, we think that it's unhealthy for a business to be carrying an unsustainable debt burden. And having a recapitalization so the more the capital structures equity when you go through a downturn like that is just plain common sense as opposed to pretending like a debt service burden can be serviced for the foreseeable future.

So we think that's just smart again diverting capital not towards debt service, but rather towards operations and potential accretive acquisitions and we're looking at some for each of these companies. But this I want to emphasize energy for us is a small percentage of the portfolio. We did take a hit this quarter, but we've a lesser exposure than the rest of our peers.

Okay, thanks. That's it for me.

Merrill Ross, Wunderlich Securities.

I have two questions. This spin-co concept appears to be sold by the lack of regulatory response and less attractive markets multiples for the potential entities and I'm wondering if the process is just getting too gleaning at this time and maybe should be mothballed?

Well, it's a fair question, Merrill. Thank you for asking it. We didn't anticipate that the process would take as long as it has. It's obviously outside of our control. We were told initially that we will be able to proceed without making exempt to release application. And then that changed and then we had to make that application in May. We did receive comments back around 120 days thereafter, and we responded to that and that's publicly available. And now will -- we're awaiting comments to our second filing. The spin that we're prioritizing first is the online spend.

And I would submit that rather than mothballing that project just because it's been longer we're trying our regulatory approval that the merits pursuing a spend are still very much in place. When you look at marketplace lending companies of different sub-segments within that market, you see valuations that are far more robust than what you see in the BDC sector. We have a structure that we think is pretty interesting and helpful and relevant for a consumer finance focused portfolio. You see a financing market that is only gotten better, not worse than that segment through additional banks having interest in lending and now bond securitizations heating up as well.

So the premise is still there. But again, we're not going to proceed unless we get both of those objectives, obviously, regulatory approval, but also robust valuations. And if we don't see it, we want proceeds, so I guess, you'd say, you would mothball if you're not seeing the valuations you like. Right now, we see it as a positive option for the Company that we're looking to create.

Okay, fair enough. The other question probably follows up on the earlier questions, but do you have any update to provide on Gulf Coast machine? Obviously, you've been supplying the Company with liquidity and converging your evaluation methodology to a liquidation analysis and they didn't know if that meant that the Company was going to liquidate or if that was just more fair methodology.

More of the latter, Merrill, as opposed to the former methodology. And I can repeat all the comments about the energy sector for Gulf Co, which is part of that 3.5% of the portfolio. Thus far, we have provided additional capital to improve the infrastructure in place as compared to the prior ownership and -- to see the equipment. And we think we're making investments with an attractive return profile to pay out in the future.

I guess, these investors liquidating at the bottom doesn't tend to make sense to us as an alternative. And sometimes putting of capital -- additional capital can be a tough decision to make, but one which can be, no guarantees, rewarded nicely when you have a reversion to the mean which we think is a pretty powerful concept in any market including energy.

Christopher Nolan, FBR & Company.

Grier, on CP Energy again, are they still servicing the senior secured term loans to you guys?

I believe [Brian could have] mistaken that we're not having any income from that asset either just like Arctic.

They are on non-accrual.

That was a non-accrual as well.

Okay. And then do these guys have some sort of bank facility which stands in front of your position there?

I think the answer is, yes, but very, very small.

Okay. And then a follow-up question is on what was the driver for the write-up for the national property REIT?

I thought national actually was written down by about $11 million.

The value may have gone up because we made investments in that.

Okay, I was looking at it on an apples-to-apples basis -- making additional investments. That's the division which houses our online business. And as we said on our prepared remarks, that's an area in which we are actually allocating more capital at some pretty attractive returns.

Got you. No, I misread my table here. Okay. Thanks for taking my questions.

Robert Dodd, Raymond James.

You'll be glad to know I'm not going to ask you about energy. I am going to ask you -- start on the structured products side, but on the new avenue. You took some of these small business loans and moved those into a structured vehicle, and you took a modest realized loss on that. So can you walk us through the process? So you're getting very attractive rates of return on the loans you purchased from On Deck and kept on balance sheet and you've decided to shift those -- take a loss, and structure them differently. So can you give us some color on the process on that decision and exactly what the trust certificate represents? I mean, is that an equity tranche vehicle which should obviously boost your returns, but maybe increase the risk, or more color on that would be great. Thanks.

Sure. Yes, there is an equity tranche of the securitization. What we did was we took our assets, Robert, and we pulled them with a major investment bank that holds similar assets and we thought that by joining forces and combining our assets in the securitization we could amortize the fixed cost of issuance over a larger pool. So that made sense to us. This is a highly economic transaction, and I want to make sure folks realize that it does -- you do book an accounting loss at time zero merely because these are assets that are purchased from our origination counterparty, in this case On Deck at a premium.

So from an accounting standpoint we sell them into a separate pool then that's you basically instead of amortizing the premium over a longer period you amortize over a shorter period. So you take a small loss at time zero but because you've got so much of your capital back through the securitization the returns are very high. I think we estimated something like an 80% IRR and we get our capital back in a matter of months. Very, very rapid payback and very high returns and we'd actually like to grow that part of our portfolio.

We've had more success growing our consumer book in the online space than in the small business arena in part -- in significant part because the consumer loans have a duration of more like two years whereas the small business loans have a duration of more like six months.

So you have to work four times harder on the origination front to build a small business book because the money comes back to you so quickly from these short-term loans compared to consumer book. So I think that that's the big reason why. But we do expect to increase our investments in the small business arena which are nice ones to hold as 70% basket good BDC assets as well.

Hey, Robert, it's John. I think, Brian, am I right in believing that it's not just the amortization in premium, but it's also the legal fees and expenses associated with the origination, those all get instantly amortized, Robert, when we sell into the securitization.

Okay, got it. Just sticking with structured products if I can, I mean, earlier you said when you mark assets to market you have to pay attention to what's going on out in the marketplace and I guess you probably knew this is coming on the CLO equity side, I know you don't really mark these based on a waterfall approach of looking at the underlying collateral and what loans have traded down by and just flowing that through, so that's one consideration because the market is clearly saying loan values are weaker today and that in principal should flow through to a mark on your CLO equity. But your default method as we know is cash flow valuation of your CLO equity.

When you took out the GAAP yield in the quarter at the level of your analysis so either you lowered the yield curve expectations or you lowered your default rate expectations or your prepayment rate expectations since June and the market since June has basically been telling us all of those are moving in the opposite direction. So can you reconcile that for us?

Sure. And this bears some longer explanation. I think it's important. First of all, when you hold equity in a CLO particularly in a majority sense what you hold is significant long-term option value for reinvestment. You don't just hold a pile of assets with a quote-unquote NAV from a liquidation standpoint. That option has significant value. That option value is in the range of four to six years for us in our book which is the time periods in expected call date. And any option also increases in value when volatility increases.

So sometimes people evaluate CLOs they say ah, volatility went up, it must be a terrible thing for CLOs, it's actually the opposite. Volatility is your friend and history -- historical results show that when you're able to reinvest and purchased asset at more volatile times at discount to par that's hugely beneficial to you as the equity because your cost of financing doesn't change, no one reprices that risk on you. But every dollar of discount on the reinvest accretes to you fully into your pockets as the equity holder.

So we have benefited from market volatility by picking up loans at discounted prices and that includes deals, new deals that we priced earlier in the quarter and then we're still in the final stages of ramping late in the quarter, September for example, when you had a lot of volatility going on in the market. We've also benefitted because we had significantly exceeded our underwriting expectations. Our collateral and cash flow collectively are about $157 million ahead of our underwriting case in this book, which is a combination of defaults being far less than expected or far less than underwritten. We're running only 30 basis points of defaults, which is less than a quarter of the overall market. It's a function of being able to purchase at a discount. It's a function of working with world-class top quartile management teams who will get significant allocations on primary issuance and make money from that as well as through other opportunistic trading and it's a function of the LIBOR forward curve being moved back compared to an underwriting case where we've benefited from the Fed being slow to move up rates. This doesn't mean we don't anticipate rates going up, but rather we've benefited from the curve continuing to be pushed back. So you combine all of those things and is valued by third party valuation agents and auditors -- oh, I also left out low energy exposure. We're about 60 basis points less than the overall market for energy.

We also refinanced forward deals with lower liabilities a few months ago and reaped significant benefits -- are reaping significant benefits from that right now. And that's a direct function of being a majority holder where we have the ability to refinance. If you're just a bit player, you don't have that control. So all of these things add up and mean there is substantial alpha generation in this business, it's not a beta trade, it's an alpha one where Prospect continuously outperformed three other, or whatever the number is, public BDC that maybe don't have the same profile to their structured credit book. Everybody does not rise and fall in walk step as one another.

I appreciate that color. perhaps I can clarify the question. Since most of your comment revolved around outperformance since origination, I'm asking about since June. So between the end of June and the end of September, how did your expectation for loss slates? You have outperformed, no question, but for the GAAP yield to go up, you need to be outperforming by more when the market is telling you to expect less. So how can you -- again not since you've underwritten them where your performance has been very, very good, clearly. Your cash flow performance had been very good. From GAAP yield perspective, over the last three months just in the third quarter what has changed to allow you to take the GAAP yield up?

Sure. First of all, we're closer to the call period from an IRR perspective by one more quarter. Secondly --

If I can bud in right there because two quarters ago we had an issue where you exited some CLO equity and told us that you didn't call them even though you had the right because the call would have resulted in lower proceeds. So you just exited that loss. So it's hard to see, you changed on the call side there that the calls are now worth more rather than less.

Okay.

I don't think we said that, Robert. We don't remember -- this is John, Robert. What I remember about that sale was not that we felt selling would be more advantageous than calling, but that there was a feeling that in order to buy a new half a dozen transaction that people felt was very attractive on a longer duration than in shortening durations of what we had, we should go ahead and do that. But we should sell something simultaneously to maintain our particular level of exposure and not get into a situation where we purchase something on day one, and sell something to fund it on day two, and the market moves around. So we had a rigorous internal discussion since I wasn't so sure that one or two or three or five or 10 or 15 days was so key.

Robert, may I complete my answer?

Absolutely. I apologize.

That's okay. So the first piece was being closer to your expected call day, I'm talking about five years from now, okay. The second piece is, we expected higher defaults than what actually came in the quarter. We underwrite more conservatively and we've vastly exceeded our underwriting case, and that has continued. The third piece is our reinvestment spreads have widened. So again, our liabilities are what they are. We don't have to pay more for those. But when reinvestment spreads widened and our defaults don't go up, that's going to net accrue to our benefit.

And the fourth thing is the LIBOR forward curve got pushed back again. And we expected that to go up which hurts you a little bit during the period between where we are and the floor. And the fifth thing is, we built par through the dynamic of having world-class management team, co-investment partners with us on these deals who put up their own capital and there is the ability to grow par through some smart advantageous buy in the marketplace. So that's at least five different explanations that I hope helps all of which occurred in this quarter and actually have occurred through multiple quarters now.

I appreciate it and they do help. Thanks.

Fin O'Shea, Wells Fargo Securities.

A quick question first on First Tower, does the $251 million loan on the balance sheet, does that reflect 80.1% of the tranche -- of that subordinate 22% loan?

Yes.

Okay. So if I look at the exhibit down in any of the filings really, do you want the other 20% into notes payable or is that a downsized proportional balance sheet reflecting your exposure?

When you say other 20%, Fin, are you referring to our equity ownership?

Yes. What I was asking if that equity ownership also applies to the sub-term loan, the major piece of the holding. As in is that $250 million sub-term loan, that's 22%, is there a number more like, say, $300 million on First Tower?

I'm sorry, Fin, can you repeat the last part of your question?

Does the 20% member that you own First Tower with, do they also hold 20% of the sub term loan?

Yes.

Okay. So that $251 million on the investment schedule that's just your piece of it?

Yes. We only show on our scheduled investments what we own.

Okay. So, if you look down the exhibit, would there a piece be in other notes people?

I think you're talking about the summarized financial information for First Tower that's in the financials. I will have to go back and check, but I believe that this is just our percentages.

Yes. Yes. We can circle back on First, I mean, I am sorry, on Harbortouch, we saw bit of a mark on the equity there. Is that something company specific or is there kind of an industry downturn in those multiples?

The Harbortouch is doing well. They are growing their trailing 12 months EBITDA. It's a wonderful recurring cash flow and merchant acquirer. The valuation got updated this quarter over last based on the usual array of discounted cash flows, comps and other methods. And that's probably all I want to say about Harbortouch right now.

Okay, very well. And just on -- sorry I'm a bit less familiar than some of the other folks with the rights offering, would those be at, say, Prospect's market price a multiple today or would they be a NAV of the offerings you do in REITs and loans, et cetera?

Well, it's pretty premature since we're not embarking on these, but we would look at the actual assets being spun. Wherever Prospect's stock is trading relative to NAV would be arguably a modest interest and if you [weren't interested to] buy it, it would not be of interest to us most likely at this point from a valuation standpoint. We're looking to protect value and that's why we've emphasized both on this call as well as the last one that we would only do the expense when market conditions are ripe and we think the valuations are appropriate. These are not spin-offs to be done on a no matter what they.

Hey, Fin, this is John. We look at where these assets trade when they are owned by other companies, REITs, online companies and the like, and we see the valuations are more rewarding to companies that are not BDCs. And so that's one of the reasons to do this. We believe that we have that when we spin these assets, we will get much more attractive valuations for them. And then of course the belief, the hope is that people looking at where these pure players are valued, we'll then take a second look at where the BDC is valued, which owns the same asset and conclude that the discount is not warranted.

I mean, your average non-bank financial trades at as you know,

it might even be in your coverage universe, Fin or your colleagues that around two times book and that's rare there for our sector.

So Fin that's the thesis and that's why we're sticking with the program and patiently very patiently extremely patiently waiting for the exemptive relief, that yes, we believe we would have had it long time ago once you start that process patience is a virtue.

Okay. Very well and I guess one final question, just for fun. As you guys have become a pretty big player in the online loan space, I'm sure you have developed a good amount of expertise there. How is that market today with, say, a lot of new players coming in? A lot of people -- you hear a lot about aggressive underwriting and just kind of what you're seeing on the ground there? And potentially as you become -- as this becomes a bigger part of your balance sheet, would you consider sort of launching your own platform to on board these loans and effectively make more money?

Well, Fin, thank you for that question. Maybe modestly. We are very proud of the team we have in online and you may remember we were asked similar question in August and at the time, I mentioned that I think we had 10 or 12 people full-time equivalents doing online lending for what 2.5 years now, Brian and these are people that are experienced, expertised in quite battle, hardened in origination, in structuring, in diligence, in accounting and in tax, and in legal.

And so we believe our Managing Director, Chris Johnson, who has been building that business with the help of several other people can be toe to toe with anyone else in the industry in terms of experience and expertise and sophistication. I asked on the earnings call last time around, I guess in August if anyone could think of a team with more experience, and someone mentioned Lending Club. Well, maybe we need to go toe to toe with those people. We do so much business with them. We really benefit from what I would call a symbiotic relationship.

Right now, we are very happy with the business model that we've been pursuing. We are Switzerland to all these originators, where the demand selling shovels and pics to the gold rush and we have a fine business here in San Francisco. And when those gold people come back in and they need more capital, our store is open. Right, Grier?

Absolutely. And Fin, I want to respond to the comment about aggressive underwriting. I'm not sure where that comes from. Oftentimes when you see a market that's growing at a significant pace, a journalist will throw out aggressive underwriting about any facts attached to that. I don't think there is any data that actually supports an assertion like that. We've seen the exact opposite and the best analog is in our bricks and mortar consumer business and these are businesses that have been around for the case of First Tower, three decades with the same underwriting model since the 1970s.

And we are seeing a consistent march down in delinquencies in the specialty charge-off and 2015 has been the year of the consumer, and I think 2016 will as well. And we talked about issues in the corporate side, especially with energy and a lot of that wealth and values have been transferred right into consumer packets to benefit them along with rest of the economic recovery and expansion they granted isn't the most robust we've ever seen, but it's still expansion with declining unemployment and other favorable trends.

So, consumer credit has been a terrific place to be, it's been a real bright spot in the economy and in our portfolio. We've been very thoughtful and careful about how we purchase. We spent five, almost six years before starting, doing research on this space before spending dollar one on investments. We've been focusing on super prime, prime and near prime assets, we've shied away from sub-prime they might have more regulatory risks and other credit risk factors attached to it.

We've been embarking on a process of building out our own highly proprietary software around selection, accounting, dashboard and other systems that Will own and it's been a selective expansion. I think we've done diligence on several dozen I think over 40 origination platforms. We've only teamed up with three today. We're looking at maybe a fourth in the not too distant future. We've said no far more than we said yes to platform and we've been thoughtful about our program with each partner as well, not just credit, but the overall economic picture of how we work with that player.

We are early to the market, we form deep relationships and we benefited from that knowledge, expertise and relationships as well. So I just wanted to add to the aggressive underwriting comment because I disagree.

No, no. That's why I asked for your perspective. I just started with kind of an interesting subject and one more boring question, in the press release can help it I noticed for I think several quarters now, we've seen under strategic initiatives to lower funding costs, but the trend in the credit facility, presumably, the cheaper part of your funding cost has been going down while even issuing more and more inter nodes. So how should we think of, if you want to -- kind of want to detail what's the plan there to lower the debt cost in your capital structure?

Thank you for that. We've already past tense called the 7% baby bond that was called halfway through the June quarter. So we reaped the full quarter benefit this past quarter, and expect to do so going forward.

Our credit facility is [Lplus 225], so cost us about 2.5% right now, but there is about 1% unfunded cost, so incremental cost is only 1.5%, so that's pretty nice accretion, if you can call it 70%. The converts that we are going to pay off next month and we've got plenty of dry powder to do so is a 6.25% yield on a [piece of paper]. And whether you're looking at the InterNotes which are lower costs for a revolver, which is much lower cost, we are looking at reducing our funding costs either way.

So that's a potentially positive earnings contributor. If you punch on the math and $150 million convert and utilize the revolver to pay that off, it ends up with just under $0.05 per share of net investment income benefit per quarter per quarter.

There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for closing remarks.

Okay, well, I want to thank everyone for taking interest in our Company and have a wonderful afternoon.

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