Prospect Capital (PSEC) has always been one of my more stable investments. As a BDC, the company pays out essentially all of its taxable income via dividends, which ensures a consistently high yield, but also limits the potential upside for the stock. However, some of the recent moves from the company have left me quite puzzled. As I noted in my previous articles, Prospect Capital has recently invested into both rental properties and auto lending. While neither of these investments are odd on an individual basis, the size of these investments does have me wondering if Prospect Capital may taking on elevated risk to maintain its NII, or net interest income, levels.
However, what has me really concerned are Prospect Capital's loan originations for Q4 2013. During any given quarter, Prospect Capital has tons of capital coming in via its various portfolio companies. When loans get paid off or otherwise exited, the company needs to reinvest the proceeds into new income producing assets or risk hurting its cash flow. For Prospect Capital, this situation is exacerbated by its frequent ATM share issuances, which has increased its share count by about 60% over the past 12 months.
Below is a breakdown of Prospect Capital's loan originations over the past 3 quarters ending September 30. Do note that I will be referring to calendar quarters rather than to Prospect Capital's fiscal quarters.
23 new and follow-on investments for $784.4 million
Repayments of $102.5 million (sold four investments, received repayment on one)
Investments net of repayments: $681.9 million
20 new and follow-on investments for $798.8 million
Repayments of $321.6 million (sold four investments, received repayment on seven)
Investments net of repayments: $477.1 million
- 18 new and follow-on investments for $556.8 million
- Repayments of $164.2 million (sold two investments, received repayment on seven)
- Investments net of repayments: $392.7 million
As shown, the pace of Prospect Capital's loan originations really slowed down during Q3 2013. This slowdown may have been an attempt by the company to improve the credit quality of its portfolio companies.
However, being too selective can cause trouble if it takes a bite out of NII per share. At the end of Q3, Prospect Capital still had quite bit of liquidity (or slack) available and thus saw its quarterly NII per share level fall, resulting in a payout ratio of above 100% for the quarter. Luckily for Prospect Capital, it still had a decent chunk of undistributed income from prior gains available and hence its NAV was not impacted much.
Fortunately, Q4 2013 is likely to be very good for Prospect Capital's in terms of originations. I have gathered Prospect Capital's total loan originations and repayments for the entire quarter. This information can be found in several of the company's SEC filings (I, II).
Below is a breakdown of my estimates for Prospect Capital's Q4 originations. Do note that this estimate includes Prospect Capital's $199 million buyout of Nicholas Financial, Inc. (NICK) and the earlier $144.5 million investment into multifamily residential properties.
34 new and follow-on investments for $834.4 million
Repayments of $138.2 million
- Investments net of repayments: $696.2 million
As can be seen, Prospect Capital is likely to post its strongest quarter in terms of total net investments since Q1 2013. I would however caution that many of these loans were short-term in nature, often being repaid during the same quarter. Also, the most important metric in terms of Prospect Capital and its profitability is clearly the yield on these new investments. Unfortunately, this metric will is not yet available for the new loans. As of September 30, Prospect Capital's portfolio annualized yield stood at 12.5% while its debt to equity ratio was about 53.7%.
Final Thoughts and Conclusion
Few stocks offer the combination of both high current yield and share price stability as Prospect Capital. While the company is engaged in a high-risk business, its level of loans on non-accrual status remains top-notch at 0.3% of total assets.
Short-term, Prospect Capital's dividend seems to be safe. In fact, the company has already declared its monthly dividends through June 2014. However, investors should always keep a close eye on the pace of Prospect Capital's loan originations and the yield on new investments as these are often leading indicators to the sustainability of the dividend.
Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.