Prospect Capital Increases Revolver, Improves Terms

| About: Prospect Capital (PSEC)

Prospect Capital (NASDAQ:PSEC) announced the expansion of its Revolver from $250mn to $300mn. Like many Business Development Companies (“BDCs”), Prospect has arranged a Revolver which has a so-called “accordion” feature, which means that the company can add new lenders (if they can find them) up to a pre-determined dollar lending limit.

Yesterday’s announcement was about the increase in that theoretical outer limit. However, to date Prospect has commitments of only $210mn from a variety of lenders, and will have to find new institutions to take full advantage of the full “accordion” capability. The Revolver has an investment grade rating. That’s helpful in attracting possible lenders who might otherwise be wary of participating in a loan facility to a relatively small lender with a high level of non-accruing loans.

The BDC Reporter was mildly encouraged to see that the Revolver has a two year regular maturity when funds can be borrowed and repaid. If not renewed, though, the Revolver amortizes over an additional year, starting in June 2012. Two years is better than 1 year, and the one year amortization period is really just giving Prospect the opportunity to arrange refinancing from normal pre-payments, equity raising and other debt financing should the Revolver lenders fail to renew.

The press release indicates distributions can continue during the amortization period, which is a good concession for the shareholders to have. Several BDC borrowing agreements did not have that concession during the Great Recession and that puts management and shareholders under considerable stress (but it’s great for the lenders who get paid back faster).

However, the biggest news in yesterday’s press release was the lower pricing negotiated. PSEC is now paying LIBOR + 3.25% versus LIBOR + 4%. Moreover, the lenders have agreed to a 1% LIBOR floor as opposed to a 2% floor. That’s an all-in “savings” of 1.75%, which is not chump change. Very theoretically, we calculate that if PSEC ends up borrowing $200mn under the new Revolver pricing, the Company would have $3.5mn lower interest expense than would have been the case previously, or over 5 cents a year.

Not shabby, and a good sign that PSEC’s cost of capital (which was on the high side) is coming into line with most of its peers. We’d like to see no floor and LIBOR + 2% (or less), but this is a good step forward.

This brings PSEC a little closer to its goal of earnings eventually catching up with its distribution. We still believe that’s a Pyrrhic goal, but the lower debt pricing will narrow what is still a very big gap (9 cents a share per quarter last quarter, and earnings were boosted by a couple of unusual items).

Disclosure: Author holds a long position in PSEC