Prospect Capital Corp (PSEC) 2017 Q1 法說會逐字稿

Good day. Welcome to the Prospect Capital Corporation first quarter earnings conference call. All participants will be in listen-only mode. After today's presentation there will be an opportunity to ask questions. (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 Nicole. Joining me on the call today are Grier Eliasek, our President and Chief Operating Office, 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 press release, our 10-Q, and our corporate presentation filed previously, and available on the Investor Relations tab on our website, ProspectStreet.com. Now I will turn the call back over to John.

Thank you Brian. For the September 2016 fiscal quarter our net investment income, or NII, was $78.9 million, $0.22 per share equaling our distributable income. Our net income was $81.4 million, $0.23 per share. Earnings declined from the prior quarter primarily because of a decrease in interest and other income from the sale of Harbor Touch. We used $0.03 of our $0.30 per share of spill back income, to support our $0.25 per share in shareholder distributions paid last quarter. We still have $0.27 per share, or $96.6 million of spill back income to support future dividends, if needed.

With the Harbor Touch sale and other significant repayments, we were under invested during the September quarter, carrying an average cash balance of $161 million, and an average revolver draw of $2 million. If another $460 million of 10% annualized coupon earning assets had been on our books utilizing our uninvested cash and financing the remainder from our revolver, during the September quarter net income would have been $7 million higher. Without accounting for any additional structuring fee or prepayment income that may have been generated in connection with such originations. We are focused on achieving full investment with prudent origination, meeting not only strict diligence standards, but also return and capital preservation requirements.

We previously announced monthly cash dividends to shareholders of $0.0833 per share for November, December, and January. The last being the 102nd consecutive shareholder distribution in our Company's history. We will announce our next series of shareholder distributions in February. Since our IPO 12 years ago through our January distribution at the current share count, we will have paid out $15.37 per share to initial continuing shareholders, exceeding $2.1 billion in cumulative distribution to all shareholders. Our NAV was $9.60 per share in September, down $0.02 from the prior quarter. Our debt to equity ratio was 76.3% down 170 basis points, from 78% in September 2015. Our assets as of September 30 comprised 90% floating rate assets, and 98% fixed rate liabilities, positioning us to benefit from rising interest rates.

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

Thanks John. Our scale business with over $7 billion of assets and undrawn credit, continues to deliver solid performance. Our team consists of approximately 100 professionals, representing one of the largest 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 on-line lending. As of September 2016 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 percentage of such opportunities. Our nonbank structure gives us the flexibility to invest in multiple levels of the corporate capital stack, with a preference for secured lending and senior loans.

As of September 2016 our portfolio at fair value comprised 51.5% first lien, 19.5% second lien, 16.9% structured credit with underlined first lien assets, 22% small business whole loan, 1.1% unsecured debt, and 10.8% equity investments, resulting in 88% 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 12.8% as of September 2016.

We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors, as such positions generate distributions. 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. As of September 2016 we held 123 portfolio companies with a fair value of $6.11 billion. We also continue to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration. The largest is 9.3%. As of September 2016 our asset concentration in the energy industry stood at 2.6%, including our first lien senior secured loans, where third parties bear first loss capital risk. Our credit quality continues to be solid. Nonaccruals as a percentage of total assets stood at approximately 1.6% in September 2016, with approximately 0.5% residing in the energy industry. Our weighted average portfolio and net leverage stood 4.07 times EBITDA, down from 4.18 times in June 2016, and down from 4.36 times in September 2015.

Our weighted average EBITDA per portfolio company stood at $51.7 million in September 2016, up from $48.1 million in June, and up from $44.6 million in September 2015. The majority of our portfolio consists of sole agented and self-originated middle market loans. In recent years, we have perceived the risk adjusted reward to be higher 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 2016 quarter aggregated $347 million. We also experienced $114 million of repayments and exits, as a validation of our capital preservation objective, resulting in net originations of $233 million. During the September 2016 quarter, our originations comprised 36% third party sponsor deals, 20% on-line lending, and 20% structure credit, 14% real estate, 6% syndicated debt, and 4% operating buyouts.

Our financial services controlled investments are performing well with annualized cash yields ranging from 15% to 25%. Because of lower unemployment rates and commodity prices compared to years ago, we believe the outlook for consumer credit continues to be positive for 2016 and 2017. To date we have made multiple investments in the real estate arena through our private REITS, largely focused on multi family stabilized yield acquisitions with attractive 10-year financing. In the June 2016 quarter we consolidated our REITs into NCRC. Our real estate portfolio is benefiting from rising rents and strong occupancies, and our cash yields have increased with each passing quarter. In the past few months we have recapitalized many of our NCRC properties with attractive financing, and exited completely certain properties including Vista and Abbington. So that we can redeploy capital into other return enhancing avenues. We expect both recapitalizations and exits to continue.

We also recently closed our first portfolio investment in student housing, an attractive segments similar to multi-family residential, where we have analyzed many opportunities for several years. Over the past few years we have grown our online lending portfolio directly, as well as within NPRC, with a focus on super prime, prime and near prime consumer and small business borrowers. This portfolio stands at approximately $577 million today, of loans and securitization interests across multiple origination and underwriting platforms.

Our online business which includes attractive advance rate financing for certain assets, is currently delivering a mid-teens levered yield, net of all costs and expected losses. In the past two years we have closed the five bank credit facilities and two securitizations, including recently a first consumer securitization, to support our online 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 and working with world class management teams, providing strong collateral underwriting through primary issuance, and focusing on attractive risk adjustment opportunities. As of September 2016 we held $1.0 billion across 70 nonresource structured credit investments. Our underlying structure credit portfolio consisted of 2,900 loans, and a total asset base of over $19.6 billion. As of September 2016 our structured credit portfolio experienced a trailing 12-month default rate of 1.39%, or 56 basis points less than the broadly syndicated default rate of 1.95%.

In the September 2016 quarter this portfolio generated an annualized cash yield of 26.1%. And a GAAP yield of 16.1%. As of September 2016 our existing structured credit portfolio has generated $759 million in cumulative cash distributions, representing 58% of our original investment. We have also exited seven investments totalling $154 million, with an average realized IRR of 16.8%, and cash on cash multiple of 1.42 times. Our structured credit portfolio consists entirely of majority owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same traunch. In many cases we receive fee rebates an average of a 14-point discount to the industry average, because of our majority position.

As a majority holder, we control the ability to call a transaction in our sole discretion in the future, and we believe such options add substantial value to the portfolio. We have the option of waiting years to call a transaction in an optimal fashion, rather than when loan asset valuations might be temporarily low. We as majority investor can refinance liabilities on more advantageous terms, as we have done six times since the beginning of 2015, with more possible. Remove bond baskets in exchange for better terms from debt investors in the deal, as we have done five times since the beginning of 2015, with more possible. And extend or reset the investment period to enhance value, as we have done three times so far in calendar 2016, with more possible.

Our structured credit equity portfolio has paid us an average 26.5% cash yield in the 12-months ended September 30th, 2016. We booked $135 million in originations, and received exits of $378 million, resulting in net exits of $243 million so far in the current December 2016 quarter. Thank you. I will now turn the call over to Brian.

Thanks Grier. We believe our prudent leverage, diversified access to match book fundings, 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 is locked in a ladder of fixed rate liabilities extending nearly 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 are 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 BBC, and many other lists of firsts. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken towards construction of the right hand side of our balance sheet.

As of September 2016 we held approximately $4.8 billion of our assets as unencumbered assets, representing approximately 76% of our portfolio. The remaining assets are pledged to Prospect Capital Funding LLC, which has a AA-rated $885 million revolver with 21 banks, and with a $1.5 billion total size accordion feature at our option. The revolver is priced at LIBOR at 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 have issued at Prospect Capital Corporation multiple types of investment grade unsecured debt, including convertible bonds, institutional bonds, baby bonds, and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We enjoy an investment grade with BBB+ rating with Crowell and investment BBB- from S&P, each recently reaffirmed. We have now tapped the unsecured debt market on multiple occasions to ladder our maturities, and extend our liability duration up to nearly 30 years. Our debt maturities extends through 2043. With so many banks and debt investors across so many debt traunches, we have substantially reduced our counter party risk over the years. We have refinanced three debt maturities in the past 1.5 years, including our $100 million baby bond in May 2015, our $150 million convertible note in December 2015, and our $167.5 million convertible note in August 2016.

We have no liability maturities exceeding $10 million in the fiscal year 2017. Our $885 million revolver is currently undrawn. If the need should arise to decrease our leverage ratio, we believe we could slow originations and allow repayments and exits to come in during the ordinary course, as we have demonstrated in the first half of calendar year 2016. During the September 2016 quarter, we received $114 million of repayments, which we view as a validation of our strong underwriting and credit processes. On December 10th 2015 we issued $160 million of 6.25% senior secured notes due June 2024. We have increased that bond by $39 million under an ATM program from June to August 2016.

We now have seven separate unsecured debt issuances aggregating $1.67 billion, not including our notes program, with maturities ranging from October 2017 to June 2024. As of September 30th 2016, we had $946 million of program notes outstanding, with staggered maturities through October 2043, and a weighted average interest rate of 5.2%. On July 28th, 2015, we began repurchasing our common shares of stock as they have been trading at a discount to NAV. Since that time, we have repurchased 4.71 million shares of common stock, at an average price of $7.27 per share.

Repurchases total approximately $34 million to date. We currently have no money drawn under our revolver. Assuming sufficient assets our pledge to the revolver, and that we are in compliance with all revolver terms, we have $640 million of new facility-based investment capacity, not including cash at the Prospect level. In the September 2016 quarter we completed amendments to our credit facility, to enhance the eligibility of loan asset collateral that we can pledge to the facility. Now I will turn the call back over to John.

Thanks Brian. We can now answer any questions.

Thank you. We will now begin the question and answer session. (Operator Instructions). Our first question comes from Christopher Nolan of FBR and Company. Please go ahead.

Hi. Thanks for taking my questions. Online loans seem to have declined since the last quarter if I understand correctly. What is leading to this, Grier?

Sure. They haven't actually declined in terms of our invested capital. What's happened is we securitized our near prime consumer portfolio, so the number that I quoted doesn't include the financing of that securitization. It includes the financing securitization we have actually increased our online book a bit versus the prior quarter.

Thank you. And then also in your comments for the real estate, it sounds like you guys are shying away from multi family and looking at students. What are you the yields that you should see in students versus multi-family?

We are actually not shying away from multi-family. What we are doing is harvesting assets after we've executed on a substantial amount of our renovation upgrade program. Our strategy is to buy Class B, Class C properties and upgrade them with rent expansion, and then to sell to another owner at an attractive price. It is a good time to sell assets given where cap rates are, given the plentiful availability of financing, and the deep buyer base out there. You have seen us monetize assets, and expect to see us do that in the future as well. But at the same time we continue to deploy capital in new deals as well. It is more challenging to put capital to work, really in a lot of parts of the private market, not just real estate, but our core plurality corporate lending business as well, because there is a lot more capital out there than a couple of years ago.

But we pick our spots, and having a large team is very helpful. As it pertains to student housing there are a lot of similarities with multi family. There is a high premium on mantra team, executional talent, when you are talking about turning around virtually your entire tenant base in a couple of month period. So certain nuances of that are highly management team specific. We expect similar yields in that segment, and similar returns as to what we have got in multi-family. I am not sure how much we will do there. It is all on a bottoms-up basis. Deal by deal, and the real estate go up just like the rest of our origination process.

And final question, given the surprising election result, do you have any thoughts in terms of the potential impact on the BDC in general, and Prospect in particular?

Sure. I think it is pretty soon, extremely soon and somewhat speculative at this stage to talk about the impact. I mean, there are so many aspects where the government interrelates with business in our lives, right, from regulation, to drivers of the economy, et cetera. We would not deem ourselves to have some view beyond speculation at this point, versus a lot of pundits out there, many of which were not always obviously correct in their projections.

Thanks for taking my questions.

Thanks, Chris.

Our next question comes from Christopher Testa of National Securities Corporation. Please go ahead.

Good morning. Thanks for taking my questions. Just touching more on the multi-family. Just wondering if you can discuss the differential in cap rates between what you are able to sell the Bs and Cs at, and what you are investing into?

Sure. It is less of a significant delta in cap rates, and more just boosting net operating income at the individual property level, stabilized yield cap rates, in non-gateway cities for Class B properties, are generally in the 6% to 7% range out there, give or take, plus or minus. We obviously are trying to buy to the maximum extent possible off market properties, properties where we think we have an edge in conjunction with our co-investing management team partners that put up capital alongside us in each deal. It is more of an NOI expansion, generally through rent increases and a rehabilitation program.

Got it. And just with the CLL equity, so the cash yields were up nicely quarter over quarter, the loan market volatility has obviously subsided, which hinders the reinvestment opportunities. So with the cash yield equity boost mostly from debt refinances on those?

The cash yield equity boost is quoted on a fair value basis, and we had a slight reduction in fair value. On a dollars basis, I think the delta was actually down about $1.2 million from quarter to quarter in our book, which was primarily driven by the methodology for GAAP income recognition based on projected defaults, which I will a lot of time mirror our recent experience, and more numbers going into an NLTM period, or a more recent run rate period. So I guess the flip side of that is if you have a GAAP income recognition that is a tad less, is you reduce your cost basis. We had about a 10 percentage point differential between our cash yield and GAAP yield, which went to reduce our cost basis. And that is obviously a cushion for the future.

Got it. And how much of the CLL book do you think you will be able to refinance with that traunch over the next coming quarters?

It is difficult to project because refinancing windows can open and close, and sometimes that can happen quickly with changes in capital markets conditions. We have actually had a decent runway in the last few weeks to refinance deals, and that's a runway that will continue post risk retention for certain deals of I think 2014 and before, you can still refinance under the rules.

So it is difficult to tell. I would say we are actually working on another handful of opportunities. The markets can only digest so much at a given point in time. That is the liability purchasers who are getting pitched refinancing deals, that are getting pitched extension deals, and we have been active doing that, to expand our reinvestment options to the maximum extent possible, and as economically prudent to do so before risk retention kicks in, and before the year ends. And then of course there is new deal formation for primary issuance. So you have a times three deal type right now ,compared to a typical environment in the CLO market, which makes things extremely busy for arrangers, for collateral managers, for ourselves and our teams, and the liability holders. We'll see how much we can get done, but we are obviously trying to move forward expeditiously when it is economically prudent to do so.

Got it. And your remarks on the consumer, and looking at the online lending and peer-to-peer lending has obviously been sort of troublesome with the trends in that lately, just wondering what you are seeing, and what your thoughts are there, and maybe if you are thinking of potentially scaling back that part of the business?

Well I would say we are not interested in scaling back that part of the business, but optimizing it with new data streams that come at us. One of the great things about this business is as you are purchasing an average of $10,000 loans on a fairly continuous basis, on the consumer book call it $50,000 average loans in the small and medium enterprise, SME small business lending book, and so you have got the ability to adjust course, tweak underwriting standards, et cetera, based on data streams that are coming at us. I would say that in general we have been pleased with our near prime consumer book performance, and less pleased with our prime book performance, and having a higher APR turns out is an essentially positive cushion against defaults coming in other than as expected. So near prime has been pretty much on par with expectation, prime a little bit less so. At least with the relationship that we have been purchasing.

I think you will see us emphasizing more of the near prime. I would say also the liability side of that business has really recovered nicely, from some of the issues that surrounded one of the leaders in the marketplace in the June quarter, almost remarkably so. We were able to get our first consumer securitization done in the last few weeks. We were quite pleased with that. We think that should enable more access to credit, and more future securitizations. They are great match book funding, and profitable business. We see a return on equity through those near prime securitizations as high-teens. and approaching 20%. We would like to grow that business, we do have capacity constraints as to how much we can do. We are trying to optimize that complicated compliance aspect as well.

Got it. And can you just remind us if there is any existing paths with the repurchase program in place, and what your appetite is for that, versus new investments given the discount on the stocks?

Yes we have an authorization for the Board for $100 million of share repurchases to date. We have utilized about $34 million of that. We hit the pause button on that at the beginning of 2016, when we saw a significant amount of volatility coming to the market, with growth concerns, and China concerns, et cetera.

We were concerned about the impact that could have on valuations and on leverage ratios, et cetera. That is obviously a ratings negative with share repurchases, so you have got to balance out amidst everything else going on in the system, and having ready access to the debt capital markets is very important to us, and we have continued to enjoy access in a number of different markets there. We'll evaluate that going forward. I would say when you look at the returns we generated, and some of these real estate investments, some of the returns I have indicated and the online book where we have been deploying capital more recently, it does look pretty attractive as well.

Got it. That's all from me. Thanks for taking my questions.

Thank you.

Our next question comes from Merrill Ross of Wunderlich.

Good morning. I noticed recurring income as a percentage of investment incomes have increased over the past few years. It was in the high-70 or 80 percentile two years ago, and now it was 95% in this most recent quarter. How did you accomplish that? Did it reflect an intentional shift in the way you do business, or more was it a function of lower turnover?

Thanks for your question, Merrill. It is really a function of the maturation of our business, and the fact that we have achieved scale, and have not been in growth mode for a little while. And when you think about two significant revenue streams for companies like ours, there is recurring interest and then there is up front structuring fee less recurring-type of income. And for a smaller lending credit book that is growing, you can enjoy higher earnings during growth mode, because you are booking all of those fees up front. But the nature of those fees is less recurring, and arguably lower quality in nature, than the interest types of fees. So a more mature business with a high 95% recurring revenue mixes we have, is arguably a much higher earnings quality stream business. That doesn't mean we don't like fee income as well. We of course are interested in that.

And as we indicated in our prepared remarks we are very focused on deploying capital, but doing so thoughtfully and candidly in the current environment right now, there are a lot of irrational deals being done by others in the marketplace. There has been an uptick in capital that has entered primarily from the private marketplace, with institutional funds raised, et cetera, that seems to need a home almost on a no matter what basis. So we are maintaining discipline, we are in it for the long haul, have been around for the long haul. We are not going to chase deals at imprudent leverage periods. We are also mindful of the macro cycle and the fact that it has been nine years since the last recession, and we generally underwrite to a recession occurring some time in the next two to three years. The numbers have to pencil out accordingly with the loans that we make. I suspect others are not putting that into their base case expectations for underwriting.

It would seem that you have sufficient spill over income, that you don't need to chase deals. Are you completely willing to continue draw down that income? Would you readjust the dividends if you weren't able to get fully invested to your satisfaction?

Sure, well we obviously use part of our spill back in the prior quarter to support the dividend, and we view that as an attractive store house of value. We used about $0.03 out of the $0.30 we have approximately stored up in spill back. That gives us a reasonably long period of protection for us potentially, but we are focused on deploying capital, and we expect to get more fully invested, but these things are not always on a perfect conveyor belt as it pertains to deals. The ones that we are chasing versus what gets over the goal line at the end of the day. Our team is very focused on this, and we expect to get fully invested.

Thank you.

I would say right now, Merrill, looking at our pipeline it shows about $300 million of what we call Category A originations between now and December 31st. Those are deals where we have been mandated by a counter party, either under work letter or some other type of higher confidence level. That is not a guarantee that those deals will come to fruition, but it is an indication that we have got some pretty decent flow right now.

Merrill, this is John. I appreciate your question, because it reminds me of prior cycles, when we have obviously been involve with your company for a very long time, going back to our IPO in 2004, and please say hello to Gary for me.

Thank you.

Since then we have lived through a number of cycles, the energy bubble, the syndicated loan bubble, the sponsor finance bubble, and at each time we backed away a bit from what we thought was an overheated market, and have been happy to have done so. So we are in business for the long haul, not the short haul. And as a result we have not been able to get reinvested as quickly as we would have liked, but then again we have maintained our underwriting standards, our diligence standards, and our hurdle rates. It will take a little longer, but we think we will benefit over the long-term by being careful and prudent.

Thank you.

Yes, say hi to Gary, please.

Thank you very much.

Our next question comes from Casey Alexander of Compass Point Research. Please go ahead.

Hi, good morning.

Good morning, Casey.

I'm sure I'm going to ask this badly, but were your originations in the September quarter sort of back ended, and if so, coming out of the quarter what was sort of your natural NII run rate? And understanding that in the absence of Harbor Touch there has been, in this quarter some shortage of NII to the dividend. Do you need to run a little bit higher target leverage ratio, in order to naturally cover the dividend with net investment income? I'm sorry to chop it up that way, but I think you get the idea?

I think we got this.

I think it is a great question, if you ask me. I will take the second piece first. Net of cash we are somewhere in the low 70s, which is on the 70% debt to equity as of 9/30, so we are on the lower end, and we need to be higher in that range from a coverage standpoint. I think that's fairly plain to see. Our originations were somewhat back ended at the end of the quarter. That sometimes happens closings oftentimes are clustered, either at month end or quarter end, for the change of control, convenience purposes, and moving over for new buyer accounting, et cetera, as an action forcing an event for some of these deals.

We have had some repayments, however, at the beginning of the current quarter as we have announced, so in the quarter to date we have actually had net repayments rather than originations. So we've got a decent amount of dry powder to put to work right now. It would be hard to take all of this moving parts for end of the quarter and since the quarter, and quote something run rate right now. It is better for us to just deploy this capital.

Thank you. Recently I think it was announced that you set up, that the advisor set up a private partnership for a portfolio of online lending loans. Is that correct?

No, that's not ringing a bell to me.

Okay, thinking of something else. My bad. Thank you for take my questions. I appreciate it.

Very nice questions. Thank you.

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

Thank you everyone for joining our conference call. We greatly appreciate your interest in Prospect. I think it is time we all got back to work. What do you say, Grier? Okay. Thanks, all. Bye.

Alright. Thanks all, bye now.

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