It has been a wild couple of days for the BDC Prospect Capital (NASDAQ:PSEC). The company got dinged to the tune of 13% over two trading days after a fairly speculative piece came out alleging that the company may facing a potential SEC inquiry. The timing of this report, just before Prospect Capital was to report its Q4 numbers, was questionable at best. Though, the company was quick to silence its critics posting a solid quarterly numbers.
Dividends reaffirmed for three more month, NII coverage improved
For starters, it appears Prospect Capital's dividend is not going to be cut anytime soon. The company declared $0.08333 per share dividends for the months of February, March, and April 2016, inline with prior levels.
Prospect Capital was able to maintain its dividend given that its NII came in at $0.28 per share for the quarter, implying a coverage ratio of ~1.12x. Since reducing its dividend in late 2014, Prospect Capital has generated NII of $1.03 per share versus dividends of $1.00 per share, good for 1.03x coverage.
The company is also covering its dividend via other metrics such as distributable income with coverage of ~1.05x. Given its tax status, the company is required to pay 90% of this income in dividends which makes the case for no change in the dividend policy.
NAV declined, but less than feared
As for Prospect Capital's net asset value "NAV", this key metric fell by $0.52 to $9.65 per share, compared to $10.17 per share as of last quarter. This is 5% q/q decline, quite significant. Though, this is much less than feared, especially when factoring in the price action in the stock with the discount to NAV approaching 50% at one point.
However, most of this decline came from Prospect Capital marking down the value of some of its assets due to the recent market volatility, not fundamental credit factors. The company noted that a full 74% of this was due to writedowns from "macro changes in the capital markets" versus "specific portfolio credit issues", with most of the remainder coming from energy investments and non-energy investments.
Keep in mind that these are mostly unrealized losses in the mark to market value of Prospect Capital's portfolio assets. If the current environment for interest rates and energy were to improve, its stands to reason that these losses could be reversed.
CLO portfolio may be more valuable than the market thinks
As has been widely expected, Prospect Capital has started to mark down the value of its CLO portfolio, reducing their fair value by ~$120 million, putting these investments at ~76% of par, versus 85% last quarter. This was a large hit, but was already priced into the stock.
Though, given the following note from the press release, it appears that at least some of Prospect Capital's CLO assets are more viable than others.
"Subsequent to quarter end we sold two structured credit positions at 97.25% and 93.75% of par, above our September 30 and December 31, 2015 valuations, which we believe validates the quality of our structured credit portfolio".
It is still unclear what valuation Prospect Capital's CLO assets merit. Many other BDCs have been more aggressive in marking down the value of these assets. Though, Prospect Capital has frequently noted that its position as 'majority owner" gives its an advantage and hence deserves a stronger valuation.
Nevertheless, selling some of these assets at 94-97% of par has to be a slam dunk for the company. Though, we need more details regarding these sales before reading too much into them.
Overall, I am pleased with Prospect Capital's quarterly report. The dividend seems stable for at least a couple more months while the company is taking steps in addressing the black box that are the CLO investments which has undoubtedly caused tremendous uncertainty given the current interest rate environment.
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: I am/we are long PSEC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.