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Summary

  • PSEC had an annualized weighted average yield on the company's debt investments of 12.5% as of 3/31/2014, thus helping maintain its current dividend sustainability.
  • Using FMV methodologies, I have classified 96% of PSEC's investment portfolio as performing near or above expectations as of 3/31/2014 (4% of portfolio was performing slightly, modestly, or materially below expectations).
  • PSEC's investment portfolio continues to have several portfolio companies with moderate unrealized FMV losses (capital depreciation), thus slightly raising the risk of the company's future NAV sustainability.
  • My PSEC dividend per share projections for January-March 2015 and NAV per share ranges for several upcoming quarters are stated at the end of the article.

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:

Prospect Capital Corp.'s Dividend and Net Asset Value Sustainability Analysis (Post Fiscal Q3 2014 Earnings) - Part 1)

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 the 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 regarding 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 an important role regarding the future dividend and NAV sustainability of PSEC: 1) an annualized weighted average yield analysis on the company's debt investments; 2) a fair market value ("FMV") investment rating analysis on the company's debt and equity investments; and 3) a quarterly FMV gain (loss) analysis on the company's debt and equity investments.

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, an 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" (also known as capital appreciation) occur. Quarterly FMV fluctuations are 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, an 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 in 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 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 in 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 first 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 peers within the BDC sector, PSEC's annual dividend yield continues to be classified as "above-average". 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 a company's risk-versus-reward metric. PSEC's higher 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 PSEC's 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 fiscal five quarters.

Table 5 - PSEC Annualized Weighted Average Yield Analysis

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

For the fiscal fourth quarter of 2012, first quarter of 2013, and second quarter of 2013, PSEC reported a combined "net realized gain (loss) on investments" and "net unrealized appreciation (depreciation) on investments" of ($27.9), ($26.8), and ($52.7) million, respectively. For the fiscal fourth quarter of 2012, first quarter of 2013, and second quarter of 2013, PSEC had an annualized weighted average yield on the company's debt investments of 13.9%, 13.3%, and 14.7%, respectively. Some could argue the amount of PSEC's net realized and unrealized gains (losses) have a general correlation to the company's annualized weighted average yield. It certainly appeared such a correlation existed in the three fiscal quarters referenced above.

Using Table 5 above as a reference, 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. However, this annualized weighted average yield percentage modestly decreased to 12.5% at the end of the third fiscal quarter of 2014. As such, along with minor yield compression within the BDC sector, I believe PSEC modestly reduced the company's risk-tolerance to its debt investments to reduce the amount of net unrealized and realized losses sustained in prior quarters.

Continuing with this general correlation, look what was reported within PSEC's net realized gain (loss) on investments and net unrealized appreciation (depreciation) on investments accounts within the three fiscal quarters of 2014. For the first fiscal quarter of 2014, second quarter of 2014, and third quarter of 2014, PSEC reported a combined net realized and unrealized FMV gain (loss) of ($2.4), ($6.9), and ($16.4) million, respectively. For the first fiscal quarter of 2014, second quarter of 2014, and third quarter of 2014, PSEC had an annualized weighted average yield on the company's debt investments of 12.5%, 12.9%, and 12.5%, respectively. 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).

While there may be a quarter where this general correlation does not apply, when taking a step back and looking at this "general trend", one can see that a lower annualized weighted average yield on PSEC's debt investments will inherently factor into a reduced probability of material valuation losses.

Currently, a majority of PSEC's debt instruments (liabilities) 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 its 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 years.

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 highlighted 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 12.5% as of 3/31/2014, I currently believe management has appropriately balanced PSEC's risk-versus-reward metric. 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. To remain prudent, this metric will be continually monitored in the future.

2) FMV Investment Rating Analysis on PSEC's Debt and Equity Investments:

The second topic/trend to discuss is an FMV investment rating analysis associated with PSEC's debt and equity investments. In particular, this analysis will highlight specific portfolio companies who are currently susceptible to further FMV write-downs over the next several fiscal quarters. Since FMV write-downs are one of the main determinants of whether to put a debt investment on non-accrual status (ceasing to recognize interest income on a particular loan), this analysis has a direct impact on PSEC's future dividend sustainability. Since FMV write-downs (whether unrealized or realized) directly affect PSEC's EPS in the quarter of occurrence, this analysis also has a direct impact on the company's future NAV sustainability.

Due to the recent events that have unfolded in PSEC's fiscal fourth quarter of 2014 (bankruptcy filing within one of its portfolio companies), I believe this analysis will bring some added clarity to readers to better understand how the company's investment portfolio as of 9/30/2013, 12/31/2013, and 3/31/2014 was rated regarding investment valuations. To begin this analysis, Table 6 is provided below.

Table 6 - PSEC Investment Rating Analysis (Based on FMV)

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

Using Table 6 above as a reference, I classify PSEC's debt and equity investments within one of the following three portfolios: 1) control; 2) affiliate; or 3) non-control/affiliate. A "control" investment is where PSEC owns (through an equity investment) more than 25% of a portfolio company's outstanding voting securities. An "affiliate" investment is where PSEC owns (through an equity investment) more than 5%, but less than 25% of a portfolio company's outstanding voting securities. Within these three portfolios, five different "investment ratings" are shown. An investment rating of "1" describes the portion of debt and equity investments that were performing at or above PSEC's expectations. An investment rating of "2" describes the portion of debt and equity investments that were performing near expectations. An investment rating of "3" describes the portion of debt and equity investments that were performing slightly below expectations. An investment rating of "4" describes the portion of debt and equity investments that were performing modestly below expectations. An investment rating of "5" describes the portion of debt and equity investments that were performing materially below expectations.

Investment Rating 1 and 2 (Near or Above Expectations):

Still using Table 6 as a reference, I have classified 83%, 86%, and 84% of PSEC's investment portfolio having debt and equity investments that were performing at or above expectations as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. I have classified 11%, 10%, and 12% of PSEC's investment portfolio having debt and equity investments that were performing near expectations as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. When combined, I have classified 94%, 96%, and 96% of PSEC's investment portfolio as having a 1 or 2 rating as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. I believe these two investment ratings should be construed as a debt/equity investment being "healthy" at each applicable point in time. When calculated, I believe 6%, 4%, and 4% of PSEC's investment portfolio was experiencing varying levels of underperformance or non-performance as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively.

Investment Rating 3 (Slight Below Expectations):

I have classified 2%, 2%, and 1% of PSEC's investment portfolio having debt and equity investments that were performing slightly below expectations as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. All debt and equity investments within this classification should be carefully monitored each quarter to watch for further FMV write-offs and possible non-accruals. This analysis will now focus in detail on the remaining two investment ratings.

Investment Rating 4 (Modestly Below Expectations):

I have classified 2%, 1%, and 1% of PSEC's investment portfolio having debt and equity investments that were performing modestly below expectations as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. This equates to $75.1, $37.5, and $36.7 million of debt and equity investments as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. All debt and equity investments within this classification should be CONSIDERED for non-accruals. Also, within this classification, certain debt and equity investments have a moderate probability of a partial non-recovery of one's remaining principal/cost basis.

As of 9/30/2013, I classified Valley Electric Holdings I, Inc. (Valley) with an investment rating of 4. At the time, Valley's two senior secured notes were performing at or slightly below expectations. However, PSEC's equity investment in Valley had an FMV of only 33% of the company's cost basis. Furthermore, PSEC did not receive ANY dividend income from its equity investment, which, one could argue, would lower the FMV of the equity investment. Through extensive research, usually when an equity investment's FMV is materially less than its cost basis, over time, the debt investments begin to have varying levels of write-offs/depreciation as well. This particular assumption came to fruition the very next quarter. During the fiscal second quarter of 2014, PSEC recognized an unrealized FMV gain (loss) of ($9.5) million in relation to Valley. Part of the write-off/depreciation was the remaining equity investment in Valley. However, more importantly, one of the two senior secured loans was now written down by an additional ($6.2) million. As such, this investment was reclassified to an investment rating of 5 as of 12/31/2013 and 3/31/2014.

As of 9/30/2013, I also classified ICON Health & Fitness, Inc. ("Icon") with an investment rating of 4. During the previous two fiscal quarters, Icon had a combined unrealized FMV gain (loss) of ($7.9) million. I saw this as a troubling sign for PSEC's debt investment (senior secured loan) with Icon. However, an unrealized FMV gain (loss) of $3.6 million during the fiscal second quarter of 2014 raised Icon's investment rating back to a 3. During the fiscal third quarter of 2014, PSEC partially sold a portion of the company's debt investment in Icon and recorded a realized FMV gain (loss) of ($1.6) million. This was a slight loss of principal, which is partially why I continue to rate the remaining portion of PSEC's debt investment in Icon as a 3. This particular investment should continue to be monitored accordingly.

As of 12/31/2013, I classified Atlantis Healthcare Group ("Atlantis") with an investment rating of 4. PSEC's senior secured note with Atlantis continued to recognize minor unrealized FMV losses over the past several quarters. As such, this specific investment went from a classification of 2 to 4 within several quarters. As of 3/31/2014, this loan was still only 87% of its cost basis. As such, Atlantis continued to be classified with an investment rating of 4, and should be heavily monitored for possible additional unrealized losses and a possible non-accrual in the future.

Investment Rating 5 (Materially Below Expectations):

Finally, I have classified 2%, 1%, and 2% of PSEC's investment portfolio having debt and equity investments that were performing materially below expectations as of 9/30/2013, 12/31/2013, and 3/31/2014, respectively. All debt investments within this classification should be on non-accrual status (unless there is a specific reason otherwise). Also, within this classification, certain debt and equity investments have a moderate-to-high probability of a partial non-recovery of one's remaining principal/cost basis (including a possible total write-off).

As of 9/30/2013, I classified various portfolio companies with an investment rating of 5. As such, part or all of the following debt and equity investments within these portfolio companies were materially underperforming expectations (only includes investments with an FMV balance): 1) Ajax Rolled Ring & Machine, Inc. ("Ajax"); 2) Borga Inc. ("Borga"); 3) Energy Solutions Holdings, Inc. ("Energy Solutions"); 4) Manx Energy, Inc. ("Manx"); 5) NMMB Holdings, Inc. (NMMB); 6) Wolf Energy Holdings, Inc. ("Wolf"); 7) Boxercraft Inc. ("Boxercraft"); 8) Gulf Coast Machine and Supply Co. ("Gulf"); 9) Maverick Healthcare, LLC ("Maverick"); and 10) National Bankruptcy Services, LLC. ("National"). It should be noted, several of these portfolio companies only had minor FMV equity interests remaining.

As of 12/31/2013, the list above remained the same, except for the following changes: 1) Manx's equity investment was reduced to an FMV of $0; 2) Valley was added to this investment rating (discussed earlier); and 3) National's debt investment was sold for a realized FMV gain (loss) of ($7.9) million.

As of 3/31/2014, the list as of 12/31/2013 remained the same, except for the following change: 1) New Century Transportation, Inc. ("New Century") was added to this investment rating. Regarding New Century, this was a senior subordinated term loan which was originated during PSEC's fiscal first quarter of 2013. Beginning in the fiscal fourth quarter of 2013, New Century's loan began to experience some gradual unrealized FMV losses. During the fiscal first quarter of 2014, I downgraded the investment rating on New Century from a 2 to a 3. After three consecutive minor-to-moderate unrealized FMV losses, PSEC recorded a material unrealized FMV gain (loss) of ($7.9) million during the fiscal third quarter of 2014. This changed New Century's investment rating from a 3 to a 5 as of 3/31/2014. Clearly, the loan was underperforming PSEC's expectations, and a case could be made this debt investment should be put on non-accrual status as of 3/31/2014. During the second week of June 2014, New Century voluntarily filed for Chapter 7 bankruptcy, as the portfolio company's lenders declined to continue funding regular business operations. Again, I believe the analysis performed above showed the "warning signs" regarding this specific debt investment. With that being said, within five quarters, this debt investment went from performing as expected to performing materially below expectations (non-performance). This was a relatively quick depreciation in value.

The following companies listed above had debt investments on non-accrual status as of 3/31/2014 (which still had FMV balances): 1) Borga; 2) Boxercraft; 3) Energy Solutions (2 of 4 loans); and 4) Wolf. Out of the remaining portfolio companies which still had debt investments with an FMV as of 3/31/2014, I believe Gulf, Valley, and New Century had the most susceptible loans to be put on non-accrual status in the near future. Since New Century declared bankruptcy in June 2014 (discussed above), I will be paying particular attention to the debt investments of Gulf and Valley for a possible non-accrual as early as the fiscal fourth quarter of 2014. Readers should understand this brings the potential risk of a slight decrease in accrued interest and the potential risk of a further decrease in NAV from further FMV write-offs.

Simply put, this analysis shows a majority (96%) of PSEC's investment portfolio as of 3/31/2014 was stable and in relatively good health (performing loans and stable equity investments). When calculated, 4% of PSEC's investment portfolio showed signs of slight, moderate, and material underperformance. These debt and equity investments will continue to be the portfolio companies I pay particular attention to, as they are the most susceptible to continued FMV write-downs, non-performance (which would lead to non-accruals), and ultimately, a probable partial loss of principal/cost basis. This would negatively impact PSEC's future dividend and NAV sustainability.

3) Quarterly FMV Gain (Loss) Analysis on PSEC's Debt and Equity Investments:

The last topic/trend to discuss is a quarterly FMV gain (loss) analysis associated with PSEC's debt and equity investments. This is somewhat different than the FMV investment ratings analysis performed in the previous section of the article. This quarterly FMV gain (loss) analysis includes ALL investment ratings, and specifically analyzes all material unrealized FMV gains (losses), regardless of what investment rating a portfolio company is in. This analysis helps detect unrealized FMV gains (losses) that recently occurred, and helps identify potential struggling investments that were once (or still are) performing at or above expectations. This analysis also helps identify which debt and equity investments that were once troubled have recently showed signs of material improvement.

When PSEC reported results in regards to the company's fiscal third 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 quarterly FMV gains (losses) during the fiscal third quarter of 2014.

Table 7 - PSEC Quarterly Material FMV Gain (Loss) Analysis

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(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, various portfolio companies had a material unrealized FMV gain (loss) for the fiscal third quarter of 2014. There were various material unrealized FMV gains (losses) worth paying attention to in the fiscal third quarter of 2014. Various material unrealized FMV gains were in relation to the following portfolio companies: 1) APH Property Holdings, Inc.; 2) Energy Solutions Holdings, Inc.; 3) First Tower Holdings of Delaware, LLC; 4) R-V Industries, Inc.; 5) UPH Property Holdings, LLC; 6) Halcyon Loan Advisors Funding 2013-I, Ltd.; and 7) ICON Health & Fitness, Incorporated. Various material unrealized FMV losses were in relation to the following portfolio companies: 1) Ajax; 2) Boxercraft; 3) CCPI Holdings, Inc.; 4) Credit Central Holdings of Delaware, LLC; 5) NMMB; 6) Valley; and 7) New Century. Out of the seven portfolio companies who had material unrealized FMV losses for the fiscal third quarter of 2014, six were control investments.

For future quarters, the companies shown in Table 7 will be the first companies I pay attention to regarding quarterly FMV gains (losses). 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 3/31/2014, 16% of PSEC's portfolio was in collateralized loan obligation ("CLO") investments (based on the portfolio's cost basis).

A CLO is a form of securitization where debt investments are pooled together and passed on to different classes of owners in various tranches. Instead of receiving a fixed interest amount, a CLO investment combines multiple loans together and distributes interest according to the level a particular company is on within the tranche structure (per a "waterfall" calculation). Depending on which tranche level a company is classified within, each class of owners is entitled to more/less of the interest payments than the next. However, with this added potential interest income is the heightened risk of being allocating a greater proportion of principal loss in the case of non-performance of a portion of the CLO.

One main point readers should take from a CLO is these types of investments have an inherently higher level of risk (potential principal loss), but also have an inherently higher level of return (potential yield). Again, this all gets back to the risk-versus-reward metric. Along with the potential "high risk/high reward" profile of a CLO investment (dependent on which tranche one is classified within), 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 third fiscal quarter of 2014:

"…Our investments in CLOs are classified as ASC 820 Level 3 securities, and are valued using a discounted cash flow model. 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. To value a CLO, both the assets and the liabilities of the CLO capital structure are modeled. We use a waterfall engine to store the collateral data, generate collateral cash flows from the assets based on various assumptions for the risk factors, and distribute the cash flows to the liability structure based on the payment priorities, and discount them back using current market discount rates. The main risk factors are: default risk, interest rate risk, downgrade risk, and credit spread risk...."

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 inherent assumption that a CLO investment will generally have material unrealized FMV gains (losses) as market environments change. Again, this will have a direct impact on PSEC's future NAV sustainability.

Conclusions Drawn - PART 2:

To reiterate what was performed in PART 2 of this article, the following three topic/trends were discussed, which will 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 FMV investment rating analysis on the company's debt and equity investments; and 3) a quarterly FMV gain (loss) analysis on the company's debt and equity investments.

Regarding the first topic/trend, an annualized weighted average yield analysis associated with PSEC's debt investments was performed. In order to maintain or slightly increase PSEC's dividend in the future, the company needs to carefully balance its risk-versus-reward metric. 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 12.5% as of 3/31/2014, I currently believe management has appropriately balanced PSEC's risk-versus-reward metric. 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. To remain prudent, this metric will be continually monitored in the future.

Regarding the second topic/trend, an FMV investment rating analysis associated with PSEC's debt and equity investments was performed. In particular, this analysis highlighted which specific portfolio companies are currently susceptible to further FMV write-downs or interest non-accruals over the next several fiscal quarters. This analysis showed a majority (96%) of PSEC's investment portfolio as of 3/31/2014 was stable and in relatively good health (performing loans and stable equity investments). When calculated, 4% of PSEC's investment portfolio showed signs of slight, moderate, and material underperformance. These debt and equity investments will continue to be the portfolio companies I pay particular attention to, as they are the most susceptible to continued FMV write-downs, non-performance (which would lead to non-accruals), and ultimately, a probable partial loss of principal/cost basis. This would negatively impact PSEC's future dividend and NAV sustainability.

Regarding the third topic/trend, a quarterly FMV gain (loss) analysis associated with PSEC's debt and equity investments was performed. There were various portfolio companies with a material unrealized FMV gain (loss) during the fiscal third quarter of 2014. These specific portfolio companies will be the first companies I pay attention to regarding future quarterly FMV gains (losses). These future quarterly FMV gains (losses) will have a direct impact on PSEC's NAV sustainability.

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 third quarter of 2015), I am projecting the following dividends will be declared in August 2014:

Dividend for January 2015 (Paid in February 2015): $0.110625 per share

Dividend for February 2015 (Paid in March 2015): $0.110650 per share

Dividend for March 2015 (Paid in April 2015): $0.110675 per share

Therefore, I anticipate a continued fractionally higher dividend declared through March 2015 (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 debt and equity investments are at risk for varying levels of net realized and unrealized FMV losses (especially certain control investments). However, the amount of these potential losses should only have a minor NAV impact when compared to PSEC's total investment portfolio. As such, I am projecting the following quarterly NAV ranges over the next four fiscal quarters:

NAV as of 6/30/2014 (Fiscal Fourth Quarter of 2014): $10.50 - $10.70 per share

NAV as of 9/30/2014 (Fiscal First Quarter of 2015): $10.45 - $10.65 per share

NAV as of 12/31/2014 (Fiscal Second Quarter of 2015): $10.40 - $10.65 per share

NAV as of 3/31/2015 (Fiscal Third Quarter of 2015): $10.40 - $10.70 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 slight decrease in NAV should be seen as only a MINOR deterrent. PSEC's "economic return" (dividends received and change in NAV) should continue to provide a modest positive return for the calendar year 2014. In other words, as long as PSEC's NAV does not increase (decrease) by ($1.32) per share during the next four fiscal quarters, the company's economic return will still be positive.

I currently rate PSEC as a SOLID HOLD when the company's stock price is trading at a minor discount (up to a 5% discount) to NAV as of 3/31/2014, which was $10.68 per share. I will continue to increase my PSEC holdings (rate the company as a BUY) when the company's stock price is trading a modest discount (over a 5% discount) to NAV as of 3/31/2014.

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 have reinvested most monthly dividends. The decision to reinvest dividends was mainly dependent on PSEC's stock price at the time of distribution (in comparison to NAV). Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation may not fit each investor's current investing strategy.

Disclosure: The author is long PSEC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Prospect Capital Corp.'s Dividend And Net Asset Value Sustainability Analysis (Post Fiscal Q3 2014 Earnings) - Part 2