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Summary

  • PSEC had an annualized weighted average yield on the company's debt investments of 12.9% as of 12/31/2013 thus helping maintain its current dividend sustainability.
  • PSEC’s NII per share should begin to increase in the intermediate future due to the cash LIBOR floor threshold ultimately being surpassed thus helping maintain the company’s future dividend sustainability.
  • PSEC’s investment portfolio continues to have several portfolio companies with moderate unrealized FMV losses (capital depreciation) thus raising the risk of the company’s future NAV sustainability.
  • I am projecting the following dividends are declared in May 2014: $0.110550 per share for October 2014; $0.110575 per share for November 2014; and $0.110600 per share for December 2014.
  • I am projecting the following NAV ranges are reported: $10.60 - $10.80 per share as of 3/31/2014; and $10.55 - $10.80 per share as of 6/30/2014 (more ranges in conclusion).

Author's Note: PART 2 of this article is a continuation from PART 1 which was discussed in a previous publication. Please see PART 1 of this article for an initial discussion on the dividend sustainability of Prospect Capital Corp. (NASDAQ:PSEC). PART 1 helps lead to a better understanding of the topics and analysis that will be discussed in PART 2. The link to PART 1's analysis is provided below:

PART 1 - Prospect Capital's Dividend and Net Asset Value Sustainability Analysis (Post Fiscal Q2 2014 Earnings)

This two-part article is a very detailed look at PSEC's dividend and net asset value ('NAV') sustainability. I perform this detailed analysis for readers who anticipate/want such an analysis performed each quarter. For readers who just want the summarized conclusions/results, I would suggest to scroll down to the "Conclusions Drawn" section at the bottom of each part of the article.

Focus of Article:

PART 1 of this article mainly analyzed PSEC's past and current performance regarding the company's quarterly EPS and NII per share figures (including two tests being performed). PART 2 of this article will discuss some current and future topics/trends regarding PSEC's dividend and NAV sustainability. These trends will have a direct impact on PSEC's future dividend and NAV sustainability and therefore should also be addressed. The conclusions derived from PART 2 of this analysis will either help solidify or contradict the results obtained in PART 1 regarding PSEC's dividend sustainability. At the end of this article, there will be a conclusion on my personal opinion about the overall dividend and NAV sustainability of PSEC for several upcoming quarters. This includes specific dividend per share figures and NAV per share ranges.

Additional Topics/Trends Impacting PSEC's Future Dividend and NAV Sustainability:

In addition to TEST 1 and TEST 2 performed in PART 1 of this article, some recent topics/trends that will affect the future dividend and NAV sustainability of PSEC should also be addressed. The following three topics/trends will play a crucial role regarding the future dividend and NAV sustainability of PSEC: 1) an annualized weighted average yield analysis on the company's debt investments; 2) an in-depth look at how the company's investment portfolio is set up for the eventual rise to the London Interbank Offered Rate (LIBOR); and 3) a summarized view of certain portfolio companies within the investment portfolio that have had (and will continue to have) material valuation fluctuations.

Prior to discussing the three topic/trends laid out above, let me provide some general examples of how PSEC's investment portfolio can have income and valuation fluctuations over time. Income fluctuations have a direct impact on PSEC's future dividend sustainability. Valuation fluctuations have a direct impact on PSEC's future NAV sustainability (with some variables "intertwining").

For instance, if a portfolio company starts to see slowing operations and/or net losses, a fair market value ('FMV') "write-down" (also known as capital depreciation) could occur on PSEC's debt investment. As such, the value of PSEC's investment portfolio would be reduced causing an immediate drop to EPS. This occurs even if the write-down is still "unrealized." Through generally accepted accounting principles ('GAAP'), quarterly FMV write-downs or "write-ups" occur (also known as "mark-to-market" adjustments). These FMV fluctuations have an immediate and direct impact on PSEC's future NAV sustainability. Let us now assume this same portfolio company begins to show signs of the inability to pay its loan obligations. This would cause PSEC's debt investment within that company to be put on "non-accrual" status. When this occurs, interest income would not be recognized. As such, this would cause an immediate drop in PSEC's NII. As such, this would have a direct effect on PSEC's future dividend sustainability.

The same general risks would occur on PSEC's equity investments. Generally speaking, if a portfolio company (which PSEC has an equity investment in) starts to see slowing operations and/or net losses, PSEC's equity investment would ultimately be deemed less valuable. As such, a FMV equity write-down/capital depreciation would occur. In a worst case scenario, a total write-off would be necessary leaving PSEC's equity investment worthless. Similar to the debt investment example above, this would cause an immediate drop to EPS. As such, this would have an immediate and direct impact on PSEC's future NAV sustainability. If a portfolio company (which PSEC has an equity investment in) begins to show signs of an inability to pay its loan obligations (whether it has a loan arrangement with PSEC or elsewhere), PSEC's equity investment in that company would most likely see a reduction in dividend income. This would occur because the portfolio company's dividend distributions would be reduced or suspended. As such, this would cause an immediate drop to PSEC's NII and have a direct effect on PSEC's future dividend sustainability.

Since several examples have been provided above showing the potential risks to PSEC's investment portfolio when management deems a higher yield is appropriate (hence a higher tolerance for potential risk), let us perform an annualized weighted average yield analysis regarding the company's debt investments.

1) Annualized Weighted Average Yield Analysis on PSEC's Debt Investments:

The first topic/trend to discuss is PSEC's annualized weighted average yield on the company's debt investments. When compared to other companies within the BDC sector, PSEC historically has had an annual dividend yield more towards the higher end of the range. PSEC's above average annual dividend yield is highly correlated to the company's annualized weighted average yield on its debt investments. This basically gets back to the risk versus reward profile. PSEC's higher overall annualized weighted average yield on the company's debt investments comes with a greater risk of losing investment principal if a particular portfolio company has the inability to repay its loan obligations or files for bankruptcy. As highlighted earlier, this risk has direct EPS and NII implications (thus directly impacting future dividend and NAV sustainability). Let us take a look at PSEC's annualized weighted average yield on the company's debt investments for the past six fiscal quarters.

Table 5 - PSEC Annualized Weighted Average Yield Analysis

(click to enlarge)

(Source: Table created entirely by myself, partially using PSEC data obtained from the SEC's EDGAR Database)

Using Table 5 above as a reference, PSEC had an annualized weighted average yield on the company's debt investments of 13.3% at the end of the fiscal first quarter of 2013. However, this annualized weighted average yield percentage increased to 14.7% at the end of the fiscal second quarter of 2013. As such, PSEC took on some added risk to the company's debt investments. Therefore, look what was reported within PSEC's "net realized gain (loss) on investments" and "net unrealized appreciation (depreciation) on investments" accounts. For the fiscal second quarter of 2013, PSEC recorded a combined net realized and unrealized gain (loss) of ($52.7) million. Because of this material combined realized and unrealized loss, I believe management reduced PSEC's risk tolerance and thus lowered the company's annualized weighted average yield on debt investments.

PSEC had an annualized weighted average yield on the company's debt investments of 13.9% and 13.6% during the third and fourth fiscal quarters of 2013, respectively. As such, PSEC lowered the risk to the company's debt investments during these two fiscal quarters. In correlation, look what was reported within PSEC's net realized gain (loss) on investments and net unrealized appreciation (depreciation) on investments accounts. For the fiscal third and fourth quarters of 2013, PSEC recorded a combined net realized and unrealized gain (loss) of ($15.2) and ($9.4) million, respectively. These two minor net losses were materially less than the combined net realized and unrealized gain (loss) of ($52.7) million recorded in the fiscal second quarter of 2013 when PSEC had the higher annualized weighted average yield percentage.

By the end of fiscal first quarter of 2014, PSEC had an annualized weighted average yield on the company's debt investments of only 12.5%. When calculated, this was a (1.1%) decrease from the fiscal fourth quarter of 2013. Again in correlation, look what was reported within PSEC's net realized gain (loss) on investments and net unrealized appreciation (depreciation) on investments accounts. For the fiscal first quarter of 2014, PSEC recorded a combined net realized and unrealized gain (loss) of just ($2.4) million. Once again, PSEC had lowered the company's NII potential (via the lower annualized weighted average yield percentage; thus directly impacting future dividend sustainability) for the sake of EPS preservation (thus directly impacting future NAV sustainability).

By the end of fiscal second quarter of 2014, PSEC had an annualized weighted average yield on the company's debt investments of 12.9%. When calculated, this was a 0.4% increase from the fiscal first quarter of 2014. Once again in correlation, look what was reported within PSEC's net realized gain (loss) on investments and net unrealized appreciation (depreciation) on investments accounts. Even though PSEC's combined net realized and unrealized gain (loss) increased to ($6.9) million, the company seemed willing to slightly increase the company's risk within its debt investments. This past fiscal quarter, PSEC had slightly increased the company's NII potential (via the minor increase in the annualized weighted average yield percentage) for the slight increase in risk of EPS preservation. As stated above, both variables have direct future dividend and NAV sustainability implications.

Currently, a majority of PSEC's debt instruments have an annual weighted average interest rate of 3% - 6.5%. This includes PSEC's credit facility, senior convertible notes, senior unsecured notes, and "InterNotes©." Therefore, the net interest "spread" on PSEC's main source of income (debt investments) is between 6.5% - 9%. As mentioned earlier, PSEC can also achieve a net realized gain (loss) through appreciation (depreciation) regarding sold debt and equity investments. PSEC also obtains certain annual dividend or "one-time" dividend payouts from the company's equity investments. PSEC's net realized gain (loss) and dividend income typically increase PSEC's net interest spread by an additional 1% - 3%. PSEC also receives various structuring, servicing, and prepayment/exit fees regarding the company's investment portfolio (where applicable). When all these variables are combined, it helps identify why PSEC has continued to pay out an annualized dividend yield between 10% - 13% over the past several fiscal quarters.

From the analysis shown above, PSEC's annualized weighted average yield on the company's debt investments has a direct impact on its future dividend and NAV sustainability. As PSEC's annualized weighted average yield from the company's debt investments decreases, the NII potential would generally lower which would have negative ramifications on its future dividend sustainability. However, this scenario would also have an offsetting effect by the reduced risk of valuation losses which would have a beneficial effect on PSEC's future NAV sustainability (inverse relationship). As PSEC's annualized weighted average yield from the company's debt investments increases, the NII potential would generally increase which would have positive impacts on its future dividend sustainability. However, this scenario would also have an offsetting effect by the heightened risk of valuation losses which would have a detrimental effect on PSEC's future NAV sustainability.

Therefore, one should continue to pay attention to PSEC's annualized weighted average yield on the company's debt investments to ensure this percentage stays within a "balanced" range. As examined above, this analysis provides strong evidence on PSEC's future dividend and NAV sustainability. Under the current market environment, I believe an attractive yield percentage on PSEC's debt investments is 12% - 14%. Since PSEC's annualized weighted average yield on the company's debt investments was 12.9% as of 12/31/2013, I currently believe management has appropriately balanced PSEC's risk versus reward profile. PSEC currently has an attractive annualized weighted average yield on the company's debt investments while keeping the risks of potential NAV losses at a "relatively stable" level.

2) Eventual Rise in LIBOR and the Impact on PSEC's Debt Investments:

The second topic/trend to discuss is PSEC's "cash LIBOR floor" associated with some of the company's debt investments. In particular, this trend is associated with the correlation between the Federal ('FED') Funds Rate and LIBOR. This will have a direct impact on the PSEC's future dividend sustainability. While not having a material impact on PSEC's NII until at least 2015, I still believe a discussion of the eventual impacts of a rise in LIBOR should be discussed as readers (even some authors) seem unfamiliar with this topic/trend.

Let us first take a look at the LIBOR percentages during the fiscal third quarter of 2014. This will help put things in perspective when analyzing PSEC's debt investments later on in this section.

Table 6 - LIBOR Percentages for the Fiscal Third Quarter of 2014

(click to enlarge)

(Source: Table created entirely by myself, using privately-assessed LIBOR data from my company's intranet resources [courtesy of Thomson Reuters])

Using Table 6 above as a reference, one can see each LIBOR maturity (1,3,6, and 12-month) had only minor movements during PSEC's fiscal third quarter of 2014. As of 3/31/2014, LIBOR with maturities of 1, 3, 6, and 12-months were 0.15%, 0.23%, 0.33%, and 0.56%, respectively. When compared to historical LIBOR, these percentages have surpassed or are near historical lows. As stated in past articles on other companies I cover, LIBOR continued to slightly decrease over the past several quarters while mortgage interest rates, interest rate swap rates, and U.S. Treasury yields all have materially increased.

For the BDC sector, the "non-movement" of LIBOR has two implications. First, this has been positive regarding the sector's credit facilities (which have a low fixed interest rate and LIBOR attachment) and other forms of debt instruments. The BDC sector has continued to have low costs of capital on credit facilities and secured and unsecured notes that have been issued over the past several years. Second, this has been negative regarding the sector's new loan originations and existing debt investments already on a company's investment portfolio. Over the past several years, new loan originations within the same general debt classifications (senior secured, subordinated secured, subordinated unsecured, CLO, etc.), have continued to see a gradual decrease in the average interest rate charged on these new investments due to general market conditions and increased competition within the BDC sector. For certain BDC companies who maintained the same level of risk versus reward profile, this has caused several minor to moderate dividend cuts over the past several years.

For purposes of this analysis, we will be focusing on the cash LIBOR floor of all of PSEC's existing debt investments. As the FED announced the "tapering" of its third round of Quantitative Easing ('QE3') back in May 2013 most market interest rates materially increased in anticipation of this eventual action. One of the lone exceptions to this trend was LIBOR. LIBOR has an extremely high correlation to the FED Funds Rate. Currently, the consensus estimate for the FED Funds Rate being raised is approximately the summer of 2015. As the FED Funds Rate begins to increase for the first time in over a decade (last increase was the summer of 2004), LIBOR will generally follow suit. So let us see how an eventual increase in LIBOR will affect PSEC's NII. Yes, it should be noted PSEC's investment portfolio will be different between 12/31/2013 and the summer of 2015. However, by performing this analysis now, we will begin to see some of the general implications an eventual rise to LIBOR will have on PSEC's future NII (hence the company's future dividend sustainability).

Table 7 - Cash LIBOR Floor Threshold on PSEC's Debt Investments (As of 12/31/2013)

(click to enlarge)

(Source: Table created entirely by myself, partially using PSEC data obtained from the SEC's EDGAR Database [link provided below Tables 5])

Using Table 7 above as a reference, I have classified PSEC's debt investments into the appropriate cash LIBOR floor thresholds as of 12/31/2013. Keep in mind this EXCLUDES all equity investments since this topic/trend does not apply to those types of investments. By looking at the data within Table 7, we will be able to see how an eventual rise in LIBOR would affect PSEC's NII.

As of 12/31/2013, PSEC had $197.1 million of debt investments that had cash LIBOR floors of less than or equal to 1.00%. This calculates to 4% of PSEC's debt investments. This means when the corresponding LIBOR percentage rises above 1.00%, approximately 4% of PSEC's debt investments will begin to recognize additional interest income. This will ultimately trickle down to a corresponding minor increase in NII. PSEC had $427.9, $813.5, and $454.0 million of debt investments that had cash LIBOR floors of 1.25%, 1.50%, and 1.75%, respectively. This calculates to 9%, 17%, and 9% of PSEC's debt investments. Therefore, $1.89 billion (or 39%) of PSEC's debt investments had cash LIBOR floors below 2%. PSEC had $1.1 billion, $10.0 million, and $574.1 million of debt investments that had cash LIBOR floors of 2.00%, 2.25%, and greater than or equal to 2.50%, respectively. This calculates to 23%, < 1%, and 12% of PSEC's debt investments. Therefore, $1.67 billion (or 35%) of PSEC's debt investment had cash LIBOR floors greater than or equal to 2%. When combined, $3.56 billion (or 74%) of PSEC's debt investments had cash LIBOR floors.

Still using Table 7 as a reference, PSEC had $1.27 billion of debt investments that had no cash LIBOR floor associated with them (or the specific debt investment was on non-accrual status). This calculates to the remaining 26% of PSEC's debt investments. A majority of this balance was collateralized loan obligations ('CLO') (discussed within the third topic/trend later in the article).

Therefore, as the FED Funds Rate begins to increase (current indications are mid-2015) LIBOR will also rise. Eventually, as each cash LIBOR floor threshold is surpassed, PSEC will begin to recognize increased interest income. This bodes well for PSEC's NII in future years. NII will increase because PSEC has aggressively "locked into" the following fixed-rate debt instruments as of 12/31/2013: 1) senior convertible notes of $847.5 million with a weighted average of 5.76% (weighted average current conversion price of $12.09 per share); 2) senior unsecured notes of $347.8 million with a weighted average of 6.18%; and 3) Prospect Capital InterNotes© of $600.9 million with a weighted average of 5.49%. PSEC's senior convertible notes have maturities ranging from 12/15/2015 - 1/15/2019. PSEC's senior unsecured notes have maturities ranging from 11/15/2022 - 3/15/2023. PSEC's InterNotes© have maturities ranging from 10/15/2016 - 10/15/2042. Since PSEC has locked in relatively low fixed interest rates (compared to historical rates) over an extended period of time, the eventual rise in LIBOR (and market interest rates in general) should be deemed as a positive sign in the future.

Side Note: It should be noted the cash LIBOR floor balances in Table 7 above change each quarter. On top of new debt investments that tend to have lower cash LIBOR floors (when compared to older debt investments), certain existing debt investments also are "restructured" or "renewed" with new interest rates and cash LIBOR floors associated with them. Over the past several fiscal quarters a majority of PSEC's restructured or renewed debt investments have had lower cash LIBOR floors established. Readers should understand this bodes well for PSEC's NII for future quarters as events unfold. Ultimately, this will have a direct positive effect on PSEC's future dividend sustainability going several years out on the time horizon.

3) Recent FMV Fluctuations within PSEC's Investment Portfolio:

The last topic/trend to discuss is the recent FMV fluctuations on PSEC's investment portfolio. When PSEC reported results in regards to the company's fiscal second quarter of 2014, multiple portfolio companies caught my attention regarding a material unrealized FMV gain (loss). This will have a direct impact on the PSEC's future NAV sustainability. Let us take a look at the material unrealized FMV changes during the fiscal second quarter of 2014.

Table 8 - PSEC Material Unrealized FMV Gain (Loss) Analysis

(click to enlarge)

(Source: Table created entirely by myself, partially using PSEC data obtained from the SEC's EDGAR Database [link provided below Tables 5])

Using Table 8 above as a reference, various portfolio companies had a material unrealized FMV gain (loss) for the fiscal second quarter of 2014. One particular portfolio company which I highlighted and "flagged" in my previous dividend sustainability analysis was Gulf Coast Machine & Supply Company (Gulf Coast). This particular investment was only added to PSEC's investment portfolio in the fiscal second quarter of 2013. As such, this is a relatively new investment with a loan maturity of 10/12/2017. The total principal balance on this senior secured term loan was originally $41.7 million. While not one of PSEC's largest principal balances, this is not considered a smaller balance either. Up until the fiscal fourth quarter of 2013, the FMV of this investment was basically the same as the remaining principal balance owed (positive sign). However, a ($9.2) million unrealized FMV gain (loss) occurred in the fiscal fourth quarter of 2013. As such, this particular loan was only valued at $32.0 million as of 6/30/2013. This was somewhat troubling because the investment was still under a year old. I stated it would be wise to monitor the FMV of this portfolio company in future quarters.

During the fiscal first quarter of 2014, PSEC had recognized an additional ($19.0) million unrealized FMV gain (loss) on Gulf Coast. As of 9/30/2013, this company had a principal remaining balance of $41.2 million with a FMV of only $13.0 million. At the time, I felt PSEC should have put this investment on non-accrual status due to the fact the loan's FMV was only 32% of the loan's 9/30/2013 cost basis.

Instead of Gulf Coast going on non-accrual status, PSEC took a controlling interest in this particular portfolio company. PSEC restructured the investment within this company and basically exchanged debt for an equity percentage. As of 12/31/2013, PSEC had a cost basis of $17.5 million of senior secured debt and $26.0 million of convertible preferred stock. As of 12/31/2013, the debt investment had a FMV of $12.4 million and the equity was deemed worthless. Whenever a particular "non-control/non-affiliate" company becomes a "control/affiliate" company, one should monitor this investment closely. More often than not, these investments continue to perform poorly when compared to the rest of the investment portfolio. I anticipate an eventual material loss on Gulf Coast's debt investment along with a fairly low probability the equity investment will ever have a material FMV gain. The eventual write-off on the debt (even though immaterial when compared to the rest of PSEC's investment portfolio) will have direct NAV implications.

Still using Table 8 above as a reference, there were several additional material unrealized FMV gains (losses) worth paying attention to in the fiscal second quarter of 2014. Several material unrealized FMV gain were in relation to the following PSEC investments: 1) CCPI Holdings, Inc.; 2) CP Holdings of Delaware LLC.; 3) CIFC Funding 2011-I, Ltd. (a CLO); and 4) Halcyon Loan Advisors Funding 2013-I, Ltd. (another CLO). Various material unrealized FMV losses were in relation to the following PSEC investments: 1) AIRMALL USA, Inc.; 2) Ajax Rolled Ring and Machine, Incorporated; 3) Credit Central Holdings of Delaware, LLC.; 4) Energy Solutions Holdings, Inc.; 5) Gulf Coast Machine & Supply Company (discussed above); 6) Valley Electric Company of Mt. Vernon, Incorporated; 7) Atlantis Healthcare Group, Inc. and 8) Galaxy XII CLO, Ltd. (a CLO). Out of the eight companies who had material unrealized FMV losses for the fiscal second quarter of 2014, six were control investments. For future quarters, the companies shown in Table 8 will be the first companies I pay attention to regarding FMV fluctuations.

I continue to anticipate various investments having both a minor to moderate unrealized FMV gain (loss). I project the probability associated with future unrealized FMV losses currently are greater than the probability associated with future unrealized FMV gains. This includes the fact that, as of 12/31/2013, 17% of PSEC's portfolio was in CLO investments (based on the portfolio's cost basis). A CLO investment is basically a pool of investments in debt, equity, or a mix of securities (also known as tranches) where holders of these vehicles receive regular interest from a "waterfall" calculation. The amount of interest typically depends on the seniority within the payment structure. One main point readers should take from a CLO investment is this investment has an inherently higher level of risk (potential principal loss) but also has an inherently higher level of return (potential yield). Along with the potential "high risk/high reward" profile of a CLO investment, there are complex methods to value these types of investments at regular intervals. These valuation techniques are based on modeled projections using a high degree of "management's judgment". Below is the quoted text from PSEC's second fiscal quarter of 2014:

"…Our investments in CLOs are classified as ASC 820 Level 3 securities, and are valued using a dynamic discounted cash flow model, where the projected future cash flow is estimated using Monte Carlo simulation techniques. The valuations have been accomplished through the analysis of the CLO deal structures to identify the risk exposures from the modeling point of view. For each CLO security, the most appropriate valuation approach has been chosen from alternative approaches to ensure the most accurate valuation for such security..."

In other words, these securities are extremely difficult to precisely value and PSEC, along with an independent valuation company, uses various models/assumptions to create an estimated FMV at a given point in time. As such, readers should understand the fact these investments will have a material unrealized FMV gain (loss) as market environments change. Again, this will have a direct impact on PSEC's future NAV sustainability.

Conclusions Drawn From PART 1 and PART 2:

To reiterate what was performed in PART 1 of this article, two dividend sustainability tests were performed on PSEC. The first test focused on PSEC's EPS - basic component while a second test focused on PSEC's NII per share - basic component.

TEST 1 seemed to point out PSEC's cumulative running EPS - basic overpayment at the end of the fiscal second quarter of 2014 showed some signs the future dividend could be vulnerable if this were the only factor the company looked at. Even though PSEC considers EPS as a factor when considering the company's dividend declarations, management has stated NII is a more important factor. As such, I make the assumption that TEST 1's results should be considered less important when compared to TEST 2's results.

TEST 2 seemed to point out PSEC's cumulative running NII per share - basic underpayment at the end of the fiscal second quarter of 2014 still showed little signs the future dividend will be cut over the next several fiscal quarters. Actually, TEST 2 showed there still is strong evidence fractionally higher dividend increases will continue to occur. As such, TEST 2 concluded a dividend cut is a fairly low probability through at least the fiscal first-half of 2015 (through December 2014). TEST 2's results also show TEST 1's results should be less alarming regarding possible vulnerabilities of PSEC's future dividend sustainability.

Based on the mixed results shown in TEST 1 and TEST 2 in PART 1 of this article, I felt it was only prudent to include additional analysis regarding PSEC's future dividend sustainability. Since PART 1 of this article mainly covered PSEC's past performance, PART 2 above discussed several topics/trends that would affect the company's future dividend and NAV sustainability.

To reiterate what was performed in PART 2 of this article, the following three topic/trends were discussed which have a direct impact on the future dividend and NAV sustainability of PSEC: 1) an annualized weighted average yield analysis on the company's debt investments; 2) an in-depth look at how the company's investment portfolio is set up for the eventual rise to the London Interbank Offered Rate (LIBOR); and 3) a summarized view of certain portfolio companies within the investment portfolio that have had (and will continue to have) material valuation fluctuations.

Regarding the first topic/trend, an annualized weighted average yield analysis on PSEC's debt investments, in order to maintain or slightly increase the company's dividend in the future management needs to carefully balance its risk verses reward profile. Under the current market environment, I believe an attractive yield percentage on PSEC's debt investments is 12% - 14%. Since PSEC's annualized weighted average yield on the company's debt investments was 12.9% as of 12/31/2013, I currently believe management has appropriately balanced PSEC's risk versus reward profile. PSEC currently has an attractive annualized weighted average yield on the company's debt investments while keeping the risks of potential NAV losses at a "relatively stable" level.

Regarding the second topic/trend, as the FED Funds Rate begins to increase (current indications are mid-2015) LIBOR will also rise. Eventually, as each cash LIBOR floor threshold is surpassed, PSEC will begin to recognize increased interest income. This bodes well for PSEC's NII in future years. NII will increase because PSEC has aggressively entered into various debt agreements at relatively attractive historical fixed interest rates. Some of these debt agreements have maturities extending out over 30 years. While not having a material impact on PSEC's NII until at least 2015, I still believed a discussion of the eventual impacts of a rise in LIBOR should have be discussed as this will have a direct impact on the PSEC's future dividend sustainability going several years out on the time horizon.

Regarding the third topic/trend, the recent FMV fluctuations on PSEC's investment portfolio, there were various portfolio companies that had a material unrealized FMV gain (loss) for the fiscal second quarter of 2014. While there were several portfolio companies with a material unrealized FMV gain, there were even more portfolio companies with material unrealized FMV losses. These specific portfolio companies will be the first companies I pay attention to regarding FMV fluctuations. I continue to anticipate various investments having both a minor to moderate unrealized FMV gain (loss). I project the probability associated with future unrealized FMV losses currently are greater than the probability associated with future unrealized FMV gains. This includes the fact that, as of 12/31/2013, 17% of PSEC's portfolio was in CLO investments (based on the portfolio's cost basis).

When all the information from both parts of the article are taken into consideration (TEST 1 and TEST 2 from PART 1 and the three topics/trends from PART 2), I believe there is moderate (some could argue strong) evidence PSEC's dividend should continue to be stable through the foreseeable future. As such, when PSEC announces the company's next set of dividends (for the fiscal second quarter of 2015), I am projecting the following dividends to be declared:

Dividend for October 2014 (Paid in November 2014): $0.110550 per share

Dividend for November 2014 (Paid in December 2014): $0.110575 per share

Dividend for December 2014 (Paid in January 2015): $0.110600 per share

Therefore, I anticipate a continued fractionally higher dividend declared through December 2014 (no material increases though).

When all the information from both parts of the article are taken into consideration (TEST 1 and TEST 2 from PART 1 and the three topics/trends from PART 2), I believe there is relatively strong evidence some of PSEC's portfolio investments are at risk for moderate to material net realized and unrealized FMV losses (especially certain control investments). However, the amount of these potential losses would only have a minor NAV impact when compared to PSEC's growing investment portfolio. As such, I am projecting the following quarterly NAV ranges over the next twelve months:

NAV as of 3/31/2014 (Fiscal Third Quarter of 2014): $10.60 - $10.80 per share

NAV as of 6/30/2014 (Fiscal Fourth Quarter of 2014): $10.55 - $10.80 per share

NAV as of 9/30/2014 (Fiscal First Quarter of 2015): $10.50 - $10.80 per share

NAV as of 12/31/2014 (Fiscal Second Quarter of 2015): $10.45 - $10.75 per share

Therefore, I am projecting a flat to slight decrease in PSEC's NAV over the next four fiscal quarters. When considering I am projecting the company will pay a dividend of $1.32 per share for the calendar year 2014, I personally believe the projected flat to slight decrease in NAV should be seen as only a minor deterrent. The company's "net economic return" (dividends paid and NAV change) should continue to provide a modest positive return for the calendar year 2014.

Final Note: It should be noted I initiated a position in PSEC in October 2013 at prices ranging from $10.80 - $10.85 per share. Prior to these acquisitions, I did not own PSEC as an investment. I believe the current risk versus reward profile continues to be moderately (some could argue highly) attractive. Personally, I would look to increase my position in PSEC if the stock price decreased below the company's 12/31/2013 NAV of $10.73 per share. Each investor's buy, sell, or hold decision should be based on one's risk tolerance, time horizon, and dividend income goals.

Source: Prospect Capital's Dividend And Net Asset Value Sustainability Analysis (Post Fiscal Q2 2014 Earnings) - Part 2