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Summary

  • On Wednesday, debtor New Century Transportation, Inc. filed for Chapter 7 Bankruptcy.
  • This recent investment, representing 2.3% of Net Assets at origination, went from performing (at par) to Chapter 7 in under two quarters.
  • PCM's representations of low "non-accruals" absent concurrent disclosure of investments that end in bankruptcy, distressed sale, or impairment are unlikely to be useful to creditors or shareholders.

On August 3, 2012, Prospect (NASDAQ:PSEC) provided $44mm of financing to New Century Transportation of New Jersey. Terms of the loan were 12% + a 3% PIK. At the time, the investment represented 2.3% of Prospect's Net Asset Value. [1]

During the December 2013 quarter, terms of the loan were modified from a 3% PIK to a 4% PIK, the increased rate presumably reflecting penalty interest imposed subsequent to a covenant violation. [2]

By close of the March quarter, fair value had been reduced to $35.9mm. [3]

On Wednesday, June 11, 2014, according to documents filed with the United States Bankruptcy Court of the District of New Jersey, New Century Transportation, Inc. and affiliates Northwind Logistics and Western Freightways petitioned for Chapter 7 Bankruptcy (liquidation). [4]

Realized capital losses on the $44mm investment should be recognized in the income statement for the June 2014 quarter.

At March quarter's end, carrying value was $35.9mm. A full impairment would be approximately $0.10 adverse to both June's earnings and NAV, in addition to the $0.02 of unrealized losses already incurred in the March quarter, for $0.12 total. Prospect may recover some portion of its New Century investment in the bankruptcy proceeding; the amount and timing of any recovery is currently unknown.

The speed at which this investment, originated less than two years ago, progressed from performing (marked-at-par) to bankruptcy in under two quarters, should serve as a cautionary tale regarding continued investor reliance on Level 3 portfolio marks during an economic contraction.

In light of Prospect's experience with New MEATCO [5], Gulfco Holdings [6], and New Century Transportation [7], PCM's representation of "no non-accruals" on investments initiated since 2008 [8] is of questionable reliance when assessing either inherent or experienced risk of default of Prospect's loan portfolio.

The historical record contains a growing trail of Chapter 7 and 11 Bankruptcy Filings (as well as outright conversion of senior debt into impaired junior equity, such as NMMB Holdings [9] and AJAX [10]).

RESOLUTION OF SEC DISPUTE

Various analysts have failed to carefully read Prospect's 10-Q or its press release of June 10, 2014.

Outcome (2) as described on page 100 of the May 6th filing has apparently occurred - Prospect will have to consolidate its wholly owned holding companies for financial statement purposes going forward. Outcomes (1) - outright Prospect victory and (3) - restatement of prior financials have not. [11]

Prospect has not disclosed enough information to fully assess the effect of this outcome. The underlying financial statements of the controlled entities have not been made public. Investors need to carefully review the extent to which this accounting change might affect Prospect and its stated income flow, for better or worse.

TERMINATION OF NICHOLAS TRANSACTION

On June 12, 2014, the proposed transaction with Nicholas Financial (NASDAQ: NICK) was terminated due to inability of parties to meet contractual conditions to closing. [12]

In its press release, Nicholas management explicitly stated an interest in continuing to explore a transaction with Prospect. ("strategic alternatives for the Company, including, but not limited to, the possible sale of the Company to Prospect")

Men of good faith and reason can surely agree this would not be a desirable outcome for either side.

FOOTNOTES

[1] SEC Form 10-K, 2013, pp. 81-82.

For size of loan as percent of Net Assets, see SEC Form 10-Q, Q1 2013 (Sep. 2012), p. 14.

The accounting disposition of the non-cash structuring fees recognized into income in conjunction with this transaction has not been disclosed (see ibid p. 73 for structuring fees and p. 6 for non-cash treatment).

"We are pleased to have Capital One and Prospect Capital as our new financial partners," stated New Century's CFO, Brian J. Fitzpatrick."

Brian Fitzpatrick is a signatory (Director, CFO) on the June 11th Bankruptcy filing.

[2] See SEC Form 10-Q, Q3 2014 (Mar. 2014), p. 17 for change in PIK. Penalty interest subsequent to covenant violation was a feature of the Gulfco Holdings foreclosure, according to court filings in that case.

[3] Compare [2] supra. to SEC Form 10-Q, Q2 2014 (Dec. 2013), p. 16 and Form 10-Q, Q1 2014 (Sep 2013), p. 17 for successive changes in terms and fair value.

[4] Filed as: U.S. Bankruptcy Court, District of New Jersey (Trenton) Bankruptcy Petition #: 14-22093-MBK.

[5] Press Release, dated April 30, 2013. New Meatco Provisions LLC Ceases Operations and Sells Certain Assets.

[6] Gulfco Holdings Chapter 11.

[7] See also Trucking Firm Shuts Doors on 1500 Employees, Philadelphia Business Journal, dated June 11, 2014 and, also reported by NBC10.com under Bankrupt Trucking Firm....

[8] See Prospect Capital Corporation President M. Grier Eliasek Talks 12% Yields, without credited authorship, dated Feb. 14, 2014. "`We have not originated a new investment in over six years that has experienced a payment default or non-accrual,' said Eliasek."

[9] Prospect Capital: Meet NMMB Holdings.

[10] See Moving the Goalposts I: Ajax Rolled Ring Subordinated Secured 2013's in

Prospect's Growth Hides Bad Underwriting.

[11] SEC Form 10-Q, Q3 2014 (Mar 2014), p. 100. Also Press Release Prospect Capital Announces No Restatement of Historical Financials... dated June 10, 2014.

[12] Nicholas Financial SEC Form 8-K, dated 12 June, 2014.

Source: Prospect: Portfolio Debtor Files For Bankruptcy, Meet New Century Transportation