Prospect Capital: How Secure Is The 12% Dividend Yield?

Aug.26.14 | About: Prospect Capital (PSEC)


Prospect Capital reports its Q2 results.

NII comes in weaker than expected.

The NAV also sees a small decline.

At current prices, Prospect Capital yields north of 12%.

Prospect Capital (NASDAQ:PSEC) had quite the eventful quarter. The company was faced with several major challenges, including now resolved issues with the SEC, a "flash crash" in its stock price, the bankruptcy of one of its portfolio companies, the termination of its purchase of Nicholas Financial (NASDAQ:NICK), and selling pressure related to ETF indices dumping BDCs.

Prospect Capital seems to have come out of all this smelling like roses. Indeed, shares of the stock have been drifting higher, closing in at $11, near multi-month highs. However, the most recent quarterly results seem to have disappointed the market, with shares down over 5% in early trading.

Q2 2014 (Fiscal Q4) Overview

On August 25, Prospect Capital reported its Q2 2014 (fiscal Q4) results. For the quarter, the company posted net investment income, or NII, of $84.1 million, or $0.25 per share. This is a decrease compared to NII of $92.1 million, or $0.38 per share posted last year.

Prospect Capital did see a 10% increase to its total investment income to around $182.8 million, compared to $166.4 million last year. However, this was more than offset by a 32% increase in total operating expenses to $98.7 million, compared to $74.3 million last year.

The increase in expenses was largely due to higher interest expenses, up 63% to $41.6 million, and higher advisory fees, up 20% to $53.1 million. However, on the bright side, advisory fees were down slightly compared to last quarter.

Speaking of last quarter, a weak spot once again for Prospect Capital was its net asset value, or NAV. As of quarter end, Prospect Capital's NAV was around $10.56 per share, down 12 cents, or 1.1%, from $10.73 per share reported last quarter, and down 16 cents from last year's $10.72 per share.

Breaking down this decline, much of the change in the NAV has to do with NII of $0.25 not fully covering the dividend of $0.33 per quarter, an 8 cent deficit. Furthermore, the company saw a net depreciation on investments totaling 4 cents per share.

As of Monday's close, Prospect Capital trades at a 4% premium to NAV. However, this premium will likely evaporate given the declines seen in early trading.

Prospect Capital typically aims to pay out nearly all of its net interest income via dividends. Based on NII of $0.25 per share and dividends paid of $0.33, Prospect Capital's dividend coverage ratio for the quarter was very slightly below 0.76x, down from 0.94x last quarter. For the fiscal year, the company generated NII of $1.19 and paid dividends of $1.32, resulting in a coverage ratio of 0.90x.

As noted above, it appears as if the company did not generate enough NII to cover its dividend, falling short by 8 cents for the quarter and 13 cents for the year, in effect making a portion of the dividend a return of capital.

As I have noted previously, Prospect Capital has declared monthly dividends, with very small fractional monthly increases of around 11 cents per share through the end of the year. This locks in the yield at over 12%. However, unless NII rebounds, I do not feel that confident about the dividend for 2015.

Loan originations were weaker than expected

I am sure my readers are all asking the same question - what happened with Prospect Capital this quarter? To be honest, I think the company was impacted by all the hassles that it went through.

The stock price was in the gutter for much of the quarter, making issuing shares via the ATM program no longer feasible. This dried up a major source of capital.

In addition, originations, the lifeblood of any BDC, were down significantly, with only $444 million of new investments, compared to a record total of $1.3 billion last quarter, a 66% sequential decline.

On a net basis, this decline is even worse. The company saw repayments totaling $169.6 million, resulting in investments net of repayments of $274.5 million, down 77% from $1.15 billion last quarter.


Overall, Prospect Capital reported a pretty poor quarter. NII per share declined and fell way short of the dividend. This is a very worrying trend that the company has yet to rectify. Furthermore, I am worried about the erosion in the NAV. Hopefully the conference call on Tuesday can provide some insight as to how the current quarter is shaping up.

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.

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.