Prospect Capital Corporation (NASDAQ:PSEC)
Q2 2016 Earnings Conference Call
February 10, 2015 10:00 AM ET
John Barry - Chairman and Chief Executive Officer
Grier Eliasek - President and Chief Operating Officer
Brian Oswald - Chief Financial Officer, Chief Compliance Officer, Treasurer and Corporate Secretary
Merrill Ross - Wunderlich Securities
Terry Ma - Barclays Capital
Christopher Nolan - FBR & Company
David Chiaverini - Cantor Fitzgerald L.P.,
Christopher Testa - National Securities Corporation
Gregg Abella - Investment Partners Asset Management
Good morning and welcome to the Prospect Capital Corporation Second Fiscal Quarter Earnings Release and Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. John Barry, Chairman and CEO of Prospect Capital. Please go ahead.
Thank you, Carrie. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer; and Brian Oswald, our Chief Financial Officer. Brian?
Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecasts due to the impact of many factors.
We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release, our 10-Q, and our corporate presentation filed previously and available on the Investor Relations tab of our website, prospectstreet.com.
Now I’ll turn the call back over to John.
Thank you, Brian. Our net investment income or NII in the December quarter was $100.9 million or $0.28 per share, up $0.02 from the prior quarter and $0.03 more than our recently declared dividends. For the first six fiscal months of the year, our net investment income was $192.1 million or $0.54 per share, $0.04 more than our dividend.
While regulated investment companies may utilize spillback dividends in the subsequent tax quarter to count toward prior-year distribution requirements, distributable income consistently in excess of dividends enhances the possibility of future special dividends in order to maintain regulated investment company status.
We have previously announced monthly cash dividends to shareholders of $$0.08333 per share for February, March, and April 2016, with the latter representing our 93rd consecutive shareholder distribution in our Company's history. We plan on announcing our next series of shareholder distribution in May.
We have generated cumulative distributable income in excess of cumulative dividends to shareholders since Prospect’s IPO 12 years ago. Since our IPO 12 years ago through our April 2016 distribution at the current share count, we will fit out over $14.62 per share to initial continuing shareholders and over $1.85 billion in cumulative distributions to all shareholders. We have delivered solid returns while keeping leverage prudent. Net of cash and equivalents our debt-to-equity ratio was 77.9% in December, close to 77.6% in June.
Our NAV stood at $9.65 per share on December 31, down $0.52 from the prior quarter. We estimate approximately 74% of the unrealized write-down we experienced this quarter related to macro changes in the capital markets as opposed to specific portfolio credit issues. We estimate 18% related to energy and the remaining 8% related to specific non-energy individual credit matters. Our energy asset concentration at December 31, stood at 3.2%.
Our objective is to drive future earnings through prudent levels of matched-book funding. We are currently pursuing initiatives to lower our funding costs, including refinancing of existing liabilities at lower rates. Opportunistically harvest certain controlled investments at a gain, optimize our origination strategy mix, including increasing our mix of online loans, repurchase shares at a discount to net asset value, and rotate our portfolio out of lower-yielding assets into higher-yielding assets while maintaining a significant focus on first lien senior secured lending.
Our Company has locked in a ladder of fixed rate liabilities extending nearly 30 years into the future. While the significant majority of our loans float with LIBOR providing potential upside to shareholders should interest rates rise.
As of December 31, all of our portfolios companies are Level 3 assets, meaning such assets are illiquid with a requirement to use estimation techniques. When we went public in 2004, our Board instituted best practice in the BDC industry by employing third party valuation firms to provide - to value 100% of our assets for each fiscal quarter using a positive assurance methodology.
Prior to our leading by example, other companies in the industry used self-valuations, sampling, and other less robust methods for valuations. When determining the fair value of portfolio investments, the Audit Committee and Board, including our independent directors, consider not just recommendations from management but also a range of valuations from three independent valuation firms.
The Board looks at several factors in determining where within the range to value each asset, including recent operating and financial trends for the asset, independent ratings obtained from third parties, comparable multiples for recent sales of companies within the industry, and discounted cash flow models. Final selected valuations have never been outside the range provided by third party valuation firms.
In the past several days, we have seen not only people spreading lies about our company, but also people who should know better, repeating those lies without a shred of evidence, without a single identified source, without any diligent checking or any corroboration at all. We know of no current or pending SEC investigation, inquiries or whatever you want to call it. That is not sell-side research or journalism as each should be practiced in America, but rather fear driven rumormongering without any checking. And it is plain wrong. Plain and simple wrong.
We are amazed how many of the things we have seen written ever passed muster for editorial and quantity control with the management of a Wall Street research department, or a quality publication. This appears to be nothing short of a smear campaign to use lies as a campaign to try to hurt our company, and our shareholders. We are not interested in seeing that campaign succeed. Now we would like to get back to the important business of our Company.
Thank you. I’ll now turn the call over to Grier.
Thank you, John. Our scaled business with over $7 billion of assets and undrawn credit continues to deliver solid performance. Our team has reached approximately 100 professionals representing one of the largest dedicated middle-market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that covers third-party private equity sponsor related and direct non-sponsor lending, Prospect sponsored operating and financial buyouts, structured credit, real estate yield investing and online lending.
At December 31, our controlled investments at fair higher value stood at 33% of our portfolio. This diversity allows us to source a broad range and high volume of opportunities, then select an undisciplined bottom-ups manner, the opportunities we deem to be the most attractive on a risk adjusted basis. Our team typically evaluates thousands of opportunities annually and invest in a disciplined manner in a low single-digit percentage of such opportunities.
Prospect’s originations in recent months have been well diversified across our multiple origination strategies. Prospect closed approximately $1.8 billion of investments during the 2015 calendar year. Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans.
At December 31, our portfolio at fair value comprised 51.9% first lien, 18.8%. second lien, 17.5% structured credit, with underlying first lien assets, 0.5% small business whole loan, 1.1% unsecured debt and 10.2% equity investments resulting in 89% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral.
Prospect’s approach is one that generates attractive risk-adjusted yields and our debt investments were generating an annualized yield of 13.3% as of December 2015, an increase of 1percentage point over December 2014, an increase of 0.6% over June 2015 and an increase of 0.3% over September 2015. We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions. We have continued to prioritize first lien senior and secured debt with our originations to protect against downside risk, while also still achieving above market yields through credit selection discipline and a differentiated origination approach.
We are seeking to enhance our yields by capitalizing on recent higher market spreads compared to prior years. As of December 31, we held 130 portfolio companies with the fair value of $6.18 billion. We also continue to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration, the largest is 9.3%.
As of December 31, our asset concentration in the energy industry stood at 3.2%, including our first lien senior secured loans where third parties bear first loss capital risk. Our credit quality continues to be solid, non-accruals as a percentage of total assets stood at approximately 0.5% at December 31. Our weighted average portfolio net leverage stood at 4.19 times EBITDA down from 4.36 times in September and our weighted average EBITDA for portfolio company stood at $48.6 million up from $44.6 million in September.
The majority of our portfolio consists of sole agented and self-originated middle market loans. In recent years, we perceive the risk-adjusted reward to be superior for agented, self-originated and anchor investor opportunities compared to the broadly syndicated market causing us to prioritize our proactive sourcing efforts. Our differentiated call center initiative continues to drive proprietary deal flow for our business.
Originations in the December quarter were $692 million across five new and several follow-on investments. We also experienced $731 million of repayments and exits from several other investments as a validation of our capital preservation objective resulting in net investment exits of $39 million. During the December quarter, our originations comprised 45% third-party sponsor deals, 40% online lending, 7% syndicated debt, 3% operating buyouts and 5% real estate.
Our financial services controlled investments are performing well with annualized cash yields ranging from 18% to 30%. Because of declining unemployment rates and declining commodity prices, we believe the outlook for consumer credit continues to be positive for 2016 boding well for such companies.
To date, we have made multiple investments in the real estate arena with our private reach, largely focused on multi-family stabilized yield acquisitions with attractive 10-year financing. Our real estate portfolio is benefiting from rising rents and strong occupancies and our cash yields have an increased with each passing quarter.
In December, our APRC rates exited the Vista transaction with a 35% cash realized IRR and 2.1 times cash on cash multiple. Over the past few years we have grown our online lending portfolio directly, as well as within NPRC, with the focus on super prime, prime, and near prime consumer and small business borrowers. This portfolio stands at approximately $694 today, including third-party financing across multiple third-party and captive origination and underwriting platforms.
Our online business, which includes attractive advance rate financing for certain assets is currently delivering a levered yield of approximately 17% net of all costs and expected losses. In past year, we've closed and upsized four bank credit facilities and one securitization to support this business with more credit facilities and securitizations expected in the future.
Our structured credit business performance has exceeded our underwriting expectations demonstrating the benefits of pursuing majority stakes, working with world-class management teams, providing strong collateral underwriting through primary issuance and focusing on the most attractive on a risk-adjusted opportunities.
As of December 31, we held $1.1 billion across 40 non-recourse structured credit investments. Our underlying structured credit portfolio consisted of over 3,179 loans and a total asset base of over $18.8 billion. As of December 31, our structured credit portfolio experienced a trailing 12-month default rate of 60 basis points or 94 basis points less than the broadly syndicated market default rate of 154 basis points.
In the December 2015 quarter, this portfolio generated an annualized cash yield of 25.8% and GAAP yield of 17.8%, up from 20.6% and 15.4% respectively in the June 2015 quarter. Our structured credit portfolio consist entirely of majority owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same tranche.
In many cases we received fee rebates and other special economics because of our majority position. As a majority holder, we control the ability to call a transaction in our sole discretion in the future, and we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion rather than when loan asset valuations might be temporarily low.
We as majority investor can refinance liabilities on more advantageous terms as we have done four times in the past year and negotiate better terms to remove a bond baskets in exchange for better terms from the debt investors in the deal as we have done five times over the past year.
Recently we sold two structured credit positions at 97% and 94% of par, above both our September 30 and December 31, valuations and at a 13% cash realized IRR, which we believe validates the quality of our structured credit portfolio. As a yield enhancement for our business, in the past year we launched an initiative to divest lower yielding loans from our balance sheet, thereby allowing us to rotate into higher yielding assets and to expand our ability to close scale one-stop investment opportunities with efficient pricing.
So far in fiscal 2016, we have made three sales of such lower yielding investments totaling $74 million with a weighted average coupon of 6%. We receive recurring servicing fees paid by multiple loan purchasers in conjunction with many of these divested loans. We expect similar sales in the future as a potential earnings contributor for the June 2016 fiscal year and beyond. We booked $10 million in originations and received exits of $40 million so far in the current March quarter.
Thank you. I will now turn the call over to Brian.
Thanks, Grier. We believe our prudent leverage, diversified access to matchbook funding, substantial majority of unencumbered assets and weighting towards unsecured fixed rate debt demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities.
Our company has locked in a ladder of fixed rate liabilities extending nearly 30 years into the future, while the significant majority of our loans float with LIBOR, providing potential upside to shareholders as interest rates rise. We’re a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, develop a notes program, issue an institutional bond, acquire another BDC and many other firsts.
Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken toward construction on the right-hand of our balance sheet. As of September 2015, we held approximately $4.7 billion of our assets as unencumbered assets, representing approximately 76% of our portfolio.
The remaining assets are pledged to Prospect Capital Funding LLC, which has a AA rated $885 million revolver with 22 banks and with $1.5 billion total size accordion feature at our option. The revolver is priced at LIBOR plus 225 basis points and revolves until March 2019, followed by one year of amortization with interest distributions continuing to be allowed to us.
Outside of our revolver, and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation, multiple types of investment grade unsecured debt including convertible bonds, institutional bonds and program notes, all of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver.
We enjoy an investment grade rating of BBB+ from Kroll and an investment grade BBB- rating from S&P with stable outlooks for each. We now tapped the unsecured debt market on multiple occasions to ladder our maturities and to extend our liability duration up to nearly 30 years with debt maturities extending through 2043.
With so many banks and debt investors across so many debt tranches, we’ve substantially reduced our counterparty risk over the years. We have refinanced two debt maturities in the past year including our $130 million convertible note in December 2015, and our $100 million baby bond in May 2015.
Our only significant maturity during the next 19 months is a $167 million convertible note due in August 2016, which we anticipate refinancing through our lower-cost $885 million revolver that is currently undrawn. If the need should arise to decrease our leverage ratio, we believe we could slow originations and allow repayments and exits to come in during the ordinary course.
In calendar year 2015, we enjoyed over $1.8 billion of repayment which we view as a validation of our strong underwriting and credit processes. On December 10, 2015, we issued $160 million of 6.25% senior unsecured notes through June 2014. As of December 31, 2015, we had $894 million of program notes outstanding with staggered maturities between October 2016 and October 2043 and a weighted average interest rate of 5.19%.
On July 28, 2015, we began repurchasing our shares of common stock as they were trading at a significant discount to NAV. Since that time, we have repurchased 4.7 million shares of common stock at an average price of $7.27 per share. Repurchases totaled approximately $34 million to-date.
We believe there is no greater alignment between management and shareholders than from management to own a significant amount of stock, particularly when such stock is purchased on the open market as with Prospect. Management is the largest shareholder in Prospect and has never sold a share. Management on a combined basis has purchased at cost over $110 million of stock in Prospect, including over $50 million in December 2015 alone.
We currently have no money drawn on our revolver. Assuming significant assets are pledged to the revolver and that we are in compliance with our revolver terms and taking into account our cash balances on hand, we have over $707 million of new facility-based investment capacity.
Now, I will turn the call back over to John.
Thanks Brian. We can now answer any questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Merrill Ross of Wunderlich. Please go ahead.
Thank you. In reading your 10-Q, in the six months ended 12-31, the CLO residuals experienced about 11% unrealized depreciation and the dollar amount was $119 million, which is the highest dollar amount of deterioration by investment type. But given that credit losses as you discussed, remain well below trend, would you characterize this deterioration or depreciation as related mostly, I mean maybe not 100%, but to spread widening and market conditions?
Yes. That’s correct. Obviously its no - thank you for your question Merrill, obviously it’s no secret out there that there is a tremendous amount of volatility. We really started ramping up in the December quarter and continues significantly in the current quarter. And we're seeing a lot of that decoupled from actual credit and fundamental performance in our portfolio, not just within the structured credit book, but really the entire rest of the portfolio.
Hi Merrill. Merrill, excuse me it’s John. I have a couple of things that are perhaps larger issues to point out. While our default rate in the CLOs has ticked up a bit, it’s still below the market average, I'm proud to say, for other CLOs in the industry. When we started building our CLO book we focused very carefully on the concept of investing in the cash flows of the CLO's, doing careful credit analysis, careful choice of managers, because our investment thesis has been that if we do our diligence on the manager, on the portfolio, on the individual credits, and keep our defaults current, past, projected low, the cash flows will come in overtime and our investment thesis will be vindicated. That markets churn in the meantime in our view is not going to be changing the cash flows that form the foundation for our investment thesis.
I hear you. And the follow-up is many times deterioration in market conditions and widening credit spreads is a precursor to a recession or times of stress. In talking with your portfolio companies, as well as your CLO managers, I just want to confirm that they're not seeing fundamental credit deterioration or expectation of facing headwinds in 2016, but that the market and the economy is in fact expanding.
Well, Merrill, when we do our valuations, we have a reality check as we go through carefully the financials of each company and talk to the valuation agents. And I remember the reading was about half of our companies are doing better and about half were doing worse I think slightly more than half were doing better and slightly more than half were doing worse. So less than half Grier says.
So when we here out in the wild blue yonder rumors of an impending recession, we don't see that in our portfolio yet. No one can predict the future. Now with respect to energy it’s a completely different story. The pain in the energy sector is well understood by everyone and we have about 3.2% of our portfolio is in energy.
We are working with those companies hoping to be able to come out the other side of the commodity cycle. We’ve been through these commodity cycles before we’ve come out every time before this one in the energy sector is clearly one of the worse that we've seen. So that's an area of high concern elsewhere in the portfolio as I said more than half are doing better, less than half are doing worse. So we are unable to infer an imminent recession at least in our portfolio.
And just to add that Merrill it really entails two cities as John mentioned energy and non-energy. And you always can have idiosyncratic things going on with credit but in general we’re seeing a solid performance in the non-energy book and even let someone take away from John’s comments about the decline. If the credit goes down by a dollar in EBITDA that’s a decline. That’s not necessarily worrisome from a credit standpoint. We are not in general taking equity risk will certainly in our straight non-controlled lending book and in small declines are not of great concern.
We also have predominately a first lien secured debt portfolio and a first lien book has scheduled amortization and excess cash flow sweeps that typically start at 50% in many cases and some cases are greater than that. So they’re really deleveraging structures as well. But so far this seems to be a lot more fear than reality, but will of course continue to monitor that very closely as we do in the coming weeks and months in our portfolio.
Say, Brian since you spend so much time on the valuations in the individual companies at valuation time. Do you have any additional color to add?
The one other components that I don’t think it’s really indicative of the actual results for the companies is our consumer debt companies and the multiples on the comparables have driven down and that has driven the values of our - that our valuation is in support on those assets which is not indicative of the operating results of those companies which are doing fantastic, but other than that I think the portfolio remains stable.
Our next question comes from Terry Ma of Barclays. Please go ahead.
Hey guys, can you just talk about what happened with CP Energy Services, it looks like you guys converted both the term loans into convertible preferred stock this quarter and only marked it down a couple of points?
I’ll comment on the - what’s happened to CP and then ask Brian to comment on the valuation component question. This is energy services company, part of the 3.2% energy exposure within our portfolio and like virtually all companies in the oil patch whether E&P companies [or oil field] services company as the case with the CP.
Even the best management teams and the best basins with the best equipment and customer relationships and people have challenges overcoming, a sharp precipitous decline demand such as what we’ve seen in the last year or so. That’s the simple backdrop. We are all aware of what's going on there.
As I think we put in our press release, we think it's a mistake to have a company unable to service its debt with a large debt balance sort of outstanding and highly unrealistic and also demotivating to the existing management team that we want focused on operations. So equitizing that deal is plain old common sense as far as we’re concerned and disclosed fully. It does mean lesser income for that asset, but I think right if I'm not mistaken that was already the case in the September quarter, so…
And it had already been written down in the September quarter substantially.
But also from an income standpoint, so that’s kind of old news from an income standpoint, you’ve got to reach all the way back to June and we already were impacted in September and no change really in December from an income standpoint. And Brian, do you want to comment on the valuation part of Terry’s question.
Yes. That’s what I was talking about. Most of the hurdle in this was taken in the September quarter and already been written down. This is a Company that’s valued at a relatively low multiple of earnings and as written down about almost $40 million from our cost basis. So like I said the pain was taken in September and the Company continues to stay poised as the energy cycles turnaround.
Got it. Where those loans cash loans?
They were serviced until the middle part of 2015 a bit later. I thought we already had them on nonaccrual as of September 30, if I’m not mistaken. They might have added interest payments in the middle of the quarter, but I think as of September 30, CP was on nonaccrual
Non-accrual means in case it means that you’ve only recognized as income when the interest payment has made and you don't accrue for accounting purposes into a period.
Got it. And then with Freedom Marine that’s a same story there?
Yes. Pretty much it’s again part of the 3.2%. This is a Company that has offshore supply vessels that service drilling and also maintenance environmental activities in the Gulf of Mexico and strong operators, strong team demands has been like crickets in that business widely reported elsewhere for a long period of time.
We’ve got pretty nice collateral there in the ships that we own and this is a cyclical industry and much like folks make a mistake in saying higher for longer or higher forever when prices are high. And then sometimes you can see the opposite effect to occur when depression sets in, where you say lower for longer, lower forever either the statement is probably an overstatement and incorrect and we subscribe more to reversion to the mean.
Okay got it. This is just an observation that I’m just surprised those converted positions were marked down a little more a lot of BDC's that reported so far similar non-accruals and energy investments have been markdown a lot more than what you guys marked in your book?
Well, as Brian just mentioned we took some pretty significant write-downs in September in our energy book. One difference might be substantial collateral that we hold I don't - it’s hard to compare to the vagueness of others, but if others are holding term loans that I don't have a first lien on accounts receivables, don’t have our first lien on the equipment and they don’t have our first lien on vessels as we do perhaps the recoveries would be substantially less. We have no bank revolver ABL ahead of us in this deal.
I think it bears repeating as well that the valuation agent is independent as no self-interest to be anything other than accurate and we start with the valuation agents estimate of value sometimes there is a range. We can talk about where in the range we think we should come out. Many times there is a single point so we just have to take that. As managers we are recipients of the workflow from the valuation agent as is our Board of Directors. Brian, do you have anything to add to that.
Not really. The valuations are all within the range that’s provided by our valuation agent and have been since 2004.
Okay, great. That’s it for me. Thanks.
Our next question comes from Christopher Nolan of FBR & Company. Please go ahead.
Hey guys. Could you give a little detail in terms of what’s driving the dividends from the control book this quarter?
I'm guessing Brian APRC and the Vista sale where I mentioned before we - NPRC one of our controlled investments REIT sold the multifamily property and we booked, so we made over two times cash and cash and 35% IRR as I said in the prepared remarks. And they allowed for substantial build-up in tax-based earnings and profits and a distribution as dividend income up to PSEC.
So we are happy with that monetization. There are parts of the economy doing quite well and multifamily residential we think stands out as somewhat of a shining star there with continued period after period increases in net operating income. We are going through a process right now, looking at recapitalizing some of those investments with advantageous financing, in general that industry the most advantageous as GSE financing, which we hope and expect will add to our yields and distributions in the weeks and months to come as well. It’s a great time to rate lock on a recap when you look at 10-year treasuries now well below 2%.
Well from time-to-time people complain about the complexity of our book, the complexity of nine business lines, the complexity of understanding how these things are valued and accounted for. We believe they’re running nine somewhat less than 100% correlated investment strategies allows our Company to move steadily, more steadily than otherwise through the ups and downs of the credit, the economic, the energy cycle.
So here we have an example real estate was not pulling the sled as the strongest force two years ago. And in this last quarter where we see rents don't decline when economic activity declines, when interest rates go down, rents are not declining, but in fact our book rents continue to increase and I know people who are renters are very unhappy about that, but in our book as investors that means, as Grier says, the real estate portfolio can stand up and take its turn to move us forward and here we have earned $0.03 more than our dividend. If we didn't have nine differentiated less than 100% correlated investment strategies. We probably wouldn't be here with $0.28.
John as a follow-up to that given that your investment strategy is a little bit more sophisticated and I think a lot of people in the BDC industry in general do, any thoughts in terms of how transparency particularly for the CLO book to be improved. My thought being is that the CLO asset quality performance has been strong better than I think pierce and just trying to get some clarification in terms of what's driving that and how I think would be helpful in terms of investors better understand the story?
Okay. Let me comment first by - with the truism, unfortunately. When something is obvious to everybody it's probably when an investment thesis is obvious and available and transparent and easily understood by everyone is less not more likely that we can earn alpha investing in that strategy. And I mean that’s a truism right.
So when I look at aircraft leasing, which we have a book of and I have done very well with. When I look at real estate, which we’ve done well with. When I look at CLO's where we have done very well and I noticed that people don't understand the complexity it's too complicated I don't get it. I'm not sure what’s happening here.
What that does is it removes competition from the playing field for us. And here in the case of CLO's we take a majority stake, meaning we have more influence over the course of the CLO when it will be called, when it will be [indiscernible] than your average hedge fund its buying small pieces.
So while we endeavor to be transparent we’re required to be transparent by law. I think for one of the most transparent companies that I can think of. The fact that there is some level of how would I call it irreducible complexity in our book we think is the source of strength and the reason why our portfolio has outperformed that of other BDCs I am sure you have seen slides on our website. All audited numbers showing that outperformance.
Chris, I think couple of things. One we haven’t benchmarked the pagination of 10-Qs, 10-Ks ourselves versus our peers, but we got to have some of the thickest disclosure package is already out there. Having said that if you got specific ideas off-line on additional information and tables and other information you think would be helpful for us to publish in the future to the investor community, we would more than welcome that feedback and we’re happy to disclose as much as is reasonable and feasible. Anything you add to that Brian.
No, I we’re - there is various ways to get at every one of these - one of these CLO's they are all on in text. So any firm that has in text can see the cash flows on these at any time this is not something we’re trying to hide and I look forward to hearing your feedback on what you think we could add to the disclosures.
Great. Thanks for taking my questions guys.
Our next question comes from David Chiaverini of Cantor Fitzgerald. Please go ahead.
Thanks I just wanted to follow-up on the CLO discussion. So as of December 31 you had 32 million of CLO debt and over a 1 billion of CLO equity. Now the 32 million of CLO debt that's what you sold and you get a great price for it. So I was happy to see that, but given that over a 1 billion of CLO equity could you comment on market conditions for CLO equity and if there's any transactions that you’ve seen post quarter end of similar securities that which you own?
Sure. David, while this is limited liquidity and I think it’s important to point out. These are Level 3 assets. These are not Level 2 assets; these are not Level 1 assets certainly and Level 3 assets where you have to use estimation of value. But in general because of the volatility of the capital markets, the equity markets, the credit markets you’ve seen not surprisingly a significant slowdown in primary issuance and any type of secondary activity not surprising it at all, if you see a drop in equity markets or credit markets people sometimes pause and then say well, let me wait another day maybe it will be a little cheaper, so this is a typical dynamic.
We have not typically grown our portfolio to where it is today and the structured credit business on a secondary basis it's always been a highly illiquid even during different market conditions. And we also have insisted almost all the time to be in a control seat because of the many benefits that we talked about during our prepared remarks and have talked about for quite some time now. And you don't see that much transaction activity in general especially for larger control stakes that have the benefits that we talked about. So I hope that helps to answer your question David.
Well, I have something to add David as well. And that is investing in Level 3 assets is only prudent for well-capitalized companies in my judgment, because if you are hedge fund suffering redemptions through a third avenue or the analog to third avenue in the hedge funds are perhaps other mutual fund space. And you must sell, you will be deemed to be selling from some type of desperation.
In illiquid markets the smart people step aside and they wait for the volume and the liquidity to return. We are in the fortunate position of not needing to sell anything. When we do sell, we can wait for the price that we want, and that's why we were able to sell these two debt pieces above our most recent marks. People will say those were debt pieces, those were not equity pieces.
One of the discussions we have here is that CLO people often talk about all pieces being bonds or being notes or being debt, because the absolute last penny in the waterfall is typically a piece of equity held by a came in charitable trust or some other entity like that.
So the entire CLO structure is a waterfall of debt and accordingly while the notes that we sold above our most recent marks, mind you, in a horrible market, mind you, were debt they were no more debt and the equity that we hold except that they are higher up in the ladder. And so they're not 100% all fours with what we call equity and we think we are proper calling them equity positions.
They are not a 100% all fours, but we believe they are indicative. And they are also indicative of the propriety of a strategy where we don't sell things unless we believe we are going to get a good price ideally above our marks as we just did. We’re not under any compulsion to sell and nor are we under any compulsion to buy. So we’re waiting for how would I say common sense to return to these markets.
Thanks for that. And then shifting gears to your online lending and now that its north of 10%, the gross exposure of roughly $700 million is north of 10% of the portfolio. I was curious how much of that portfolio is near-prime versus the super-prime and prime?
Well, first, online is not 10% of our portfolio, our investment is about I think $360 million or so of our capital which compared to our total portfolio of just over $6 billion talking about the 5% to 6% range. And then pertained your question about wristbands, what - we've not focused on is the sub-prime area, they kind of a sub-600 FICO arena and have really focused on super-prime, prime and near-prime. Most of our - I think the vast bulk of our Prospect book is super-prime and prime and our lending club book is prime and near-prime.
So I don’t know what the precise percentages in each category in the cycle bands in my fingertips David, but the lending club look I think is about 60% of our book and the Prospect book about 40%. I’m talking about our consumer book which is the vast bulk of our investments to date small businesses is relatively small in part because it's more difficult to ramp our portfolio there because the loans payoff so quickly, there is a lot of earnest activity to get assets on the books and then they repay quickly, which of course is a big credit plus as well, but I mean it’s harder to grow.
David, back to your point about transparency I'm surprised I left out of the equation this online book. If you talk to Brian, I think he will tell you half of our accounting staff working on the online business. We have eight people as a dedicated team. We to our knowledge are one of the largest purchasers of these online assets and they are also a very difficult to analyze, to understand and to diligence, but we've been happy to see that our results have been - as to certain metrics I hesitate to say every single metric, but as to certain metrics the results have been coming in above our expectations yet.
When we talk to other investors they are often deterred from investing in this space, because what we don't understand it and we don't have the back office, this is a new asset class. And as a result that is another area of our business where we think we can generate alpha and again that was a big contributor to the $0.03 of our dividend this quarter.
Our next question comes from Christopher Testa of National Securities Corporation. Please go ahead.
Hi good morning. Thanks for taking my questions. Just with regard to the lower yielding assets that you are disposing off, how much more of those you have disposed and then what’s the liquidity there and what should we see is the yield differential between those in your proprietary investments?
Sure. Average yield is in the range of 6% to 7%, call at 6.5%. These are Level III assets that are associated with agented one-stop lending positions that we own. We've got - some of those assets pledged our facility which we may not be interested in selling, but other assets that are unpledged. I want to say it’s in the $400 million range approximately of those assets and we are very, very careful and are taking our time there, we don’t need to sell, we would sell only opportunistically as part of a yield enhancement approach.
So if market conditions slow that from time-to-time, fine, and we will wait for buyers that are interested at the appropriate time. There are pretty attractive positions for someone to purchase as a part of a one-stop if you figure we do and overall loan at 4 to 5 turns of EBITDA really on the lower side of that.
We are one of the lowest debt to EBITDA positions of any BDC that reports that stat that we've seen; others are much closer to 5 or 5.5 that report out there but you figure it takes a 4.5 and you have NAPs and BPs and the APs is that 2.25 and that the BPs is the remaining 2.25. That’s a pretty attractive piece of paper to earn 6% or 7% on for some bank or insurance company or some other type of investor.
So we think that’s nicely added and we've also been successful in charging servicing fees and revenue as an additional yield enhancement and selling to certain investors as well. So we like to do more of that. We also like to do more to look at potentially boosting syndication revenue for our business.
We have to see interface with a lot of folks in the industry have been in this industry for long time with a lot of relationships to leverage and I think owners of businesses are looking for more and more help given the volatility of the markets and given the pullbacks, job cutting, et cetera many of the Wall Street banks in this arena. It creates an opportunity for companies like ours.
Okay. That’s good color. And just as you’re rotating out of these loans with higher-yielding, are these simply lower yielding because they are larger borrowers or would you be taking on more I guess structural risks per se when you're going into the higher-yielding loans?
We don't think we’d taking on structural risk because our bias is towards first lien secured lending anyway and I mentioned where our leverage point tends to attach. So we’re on the lower end anyway and so it’s going to - you’re talking about rotating into some type of first lien position potentially. I think it’s unlikely to see us grow our structure credit book from where it is given 30% basket and another constraints. You didn’t see us add to that position in the quarter.
You may see us look to continue to grow our online business. We think we can enhance our returns there through appropriate securitizations at the right point in time maybe the second the markets are little bit volatile but as they settle down that'll be a very nice to approach for us as well. And which in many cases we recap and get a substantial portion of our capital back quickly in the front end.
So we’re not looking in general to increase our risk in the portfolio and for new originations for some time now we've been including in our base cases the assumption of recession hitting as opposed to many lenders that will kind of extrapolate some type of flat line and run their underwriting off of that. So we’ve been careful on the origination front and are not looking to enhance structural risk.
Okay. Got it that’s helpful. And just with you know I know the multifamily REIT had a great disposition, great return, are there plans for more of these dispositions going forward given that multifamily cap rates are historically very low right now. Is that something where you see an opportunity to harvest more gains like the one you just had?
Potentially, but in many cases we see additional upside ahead of us with these assets and so the best way to harvest partial gains is to recapitalize those businesses which I talked about a few minutes ago with financing from the GSEs and financing costs are quite attractive. Right now given their peg to treasuries and treasuries have dropped pretty sharply. So actually we rate locked on some deals in recent days and feel quite happy about those financing costs.
Okay and just with the commentary on consumer credit I just want to hear your thoughts on consumer credit given a lot of the issues that kind of companies like Santander Consumer [indiscernible] I know Lending Club recently had a pretty big uptick with their write-off. Could you comment on that and how that impacts your outlook on that sector?
Sure, our consumer credit book has exceeded our underwriting expectations we’re very happy we’re not seeing in uptick in losses or expected cumulative losses. In fact the opposite, the consumer wallet, which is what we’re talking about from a macro standpoint looks relatively healthy right now when you look at deleveraging this consumer wallet in the last few years you look at declining unemployment even seen massive wage growth you’ve seen a little bit, you’ve seen a huge gasoline dividend with lower fuel prices.
So we’re very happy overall with the consumer picture and have the exposure on the consumer side has been a net plus and the economy or for any credit book arguably in the last quarter and year compared to say energy which has been on the extreme opposite end.
Okay. And are there any specific industries where you're seeing backup and yields were you could get an attractive underwriting things that have fallen out of favor just kind of baby with a backwater with energy and metals and mining. Is there another industry that seems to be quite seen an unnecessary risk where you are seeing an opportunity?
Well, you mentioned energy, metals and mining that’s the giant space right now where some capital has been raised to take advantage of the opportunity, but mainly earmarked towards secondary trading and these types of distress situations for private middle-market companies that need capital to pursue various things. There's not a lot of capital available, in some cases it’s warranted and justified.
Oilfield services for example it’s hard to see a business case for a lot of new capital coming into that sector until you see some type of uptick in demand. E&P companies are little bit different because you are talking about financing, existing assets and it’s all about the price deck that you select. We’ve got feet on the ground in Houston to help with that. This has been a small percentage of our book about 3.2%, but we’ve got a lot of expertise in-house. We’ve said I think in this format in prior calls that we said things would get worse in energy before they get better and that’s been proven to be correct.
As we sit here right now, things would get a little bit worse, but you start to approach the cash costs of producers for new drilling and so it seems difficult to imagine just mathematically the commodity going significantly south from here and staying there for a sustained period of time. So we’re not prognosticators of commodity and macro markets and saying this is when the bottom will occur. But I think there will be some interesting opportunities to emerge in the coming months in that sector. I’m not sure today, but in the coming months.
Outside of that I mean the underwriting is it’s the same processes that we’ve well-honed and have done over almost 30-year history as an asset manager and the fundamentals of credit don't change and we focused on diligent underwriting. I’m not sure there's anything macro industry by industry to point out this point beyond energy.
Okay. And how do you - how are weighing I guess doing the new origination versus buybacks given that your harvesting gains, you have these lower yields and loans are rotating out of - your stock is at such a significant discount to net asset value right now even with a bounce today. How are you looking at the buybacks and just your thoughts on that in the asset type or your Company doing that in the coming quarter or so?
Sure, I think the first priority for us is to be very prudent with our leverage ratio vis-à-vis showing a strong and disciplined credit profile to the debt community, to the bond community, to the rating agency community. This is a very high priority for our business. And we saw on the past quarter with us and many others I’m sure we’ll continue to report in the coming days and weeks, some nontrivial changes in the market valuations and you have volatility in the quarter today.
So we’re being cautious on the new capital deployment front for that reason. We mentioned that quarter to date we’re about five or six weeks into the quarter that we would then put up about $10 million in the past $40 million of repayments. Last quarter, we had net repayment situation as well so we’re very cautious about that and we’re going to protect our credit profile first and you do want to make universal decisions that could erode that or either way at it in any fashion.
So it’s cautious on the buyback front for that reason in December when volatility started to pick up and but we are interested in buybacks and have bought back a pretty significant amount of stock $34 million, $35 million or so to date. We have authorization of $200 million. We are interested in that in the future, but for right now protecting the leveraging credit profile is the most responsible thing that a non-bank financial services company can do.
We feel very fortunate to have a very well laddered maturity profile. There are others out there that have pretty significant maturities coming due, we do not. We only have about $167 million of kind of discrete term debt coming due in the next 19 months and then we’ve got a laddered with no more than one maturity in any given year.
But you see that withdrawal of confidence and you’ve seen it on the debt side as well as on the equity side. So ours is a business that has developed many of the liability structures you see in the industry. We pioneered the first convertible bond. We pioneered one of the first institutional bonds. We are the only Company that issues program notes out there. We issued a baby bond. We saw that excellent timing in December and many of these markets are currently closed to folks.
So we are very cautious about that and we are going to take your job number one which is the credit profile and liquidity and defending the business. And then once you’ve played a good defense you then consider the next step of going on offense for some of the areas we mentioned in looking at risk reward of primary originations and share repurchase balance fashion. So hopefully that helps Chris to see some of the things that we contemplate on a daily basis.
Well Chris, this is John. I just have a couple of points here to add. Measured by aggregate dollar purchases Prospect Capital Corporation has purchased more stock than any other BDC. Measured by aggregate dollar purchases Prospect management has purchased more stock than any other BDC management team. All such purchases were made in the market at market prices from each manager or employees after-tax savings without the benefit of stock option grants. No Prospect manager or employee has ever sold a single share of Prospect stock and that’s alignment.
Yes. I absolutely respect that and I’ve seen the insider purchases, obviously I was just asking in terms of doing the repurchases from the Company itself would lower share counts significantly and help to get a share a significant boost and be very accretive on an per share basis, but yes, John I do appreciate, you guys always putting your money where your mouth is and believing in your own company it’s of course respected and definitely noticed.
And just a last question for me, just on the CLO equity, again I know it’s an excellent asset class you guys have had one of the best most lowest default rates in the market. I completely respect the asset class. However, it seems to be kind of a recurring theme that the BDC that have a significant amount with CLO equity as part of the 30% bucket are always hit with the substantial NAV discount and whatever anybody like we saw credit announced that they were just going to get out of there even though it was some portion of their portfolio and the stock immediately reacted to that.
What would be your thoughts on potentially letting the CLO equity portfolio just one-off and using the great cash proceeds and just reinvesting into making proprietary origination? I know that you had mentioned that the market doesn’t understand and I agree it’s very frustrating because it is a great asset class, but it just seems to be the case that the market just does not want 30% basket, so any of your thoughts on that would be appreciated?
Sure. Well, it has been a terrific asset class and we didn’t read in prepare remarks, but you can look at our press release and we put in some information about the asset class which I'm guessing a lot of folks reading it didn't know about including how the asset classes delivered 22% annualized return since 2003.
How it significantly exceed high yield bond index, significantly exceed the S&P in pre-dislocation time periods to today and how less than 2% of deals and lifetime of the industry have had a negative return. That’s not a wipeout that's just the negative IRR. Imagine yourself buying 100 stocks a decade ago and how many at a negative total return of more than 2% I would wager.
So we let the data guide us as rational actors and we make intelligent decisions. There are capacity limits based on regulatory and ratings driven and other baskets for our company, which we manage on a constant basis and as I said a few minutes ago you’re unlikely to see us grow the portfolio from where it is today because of those capacity limits. In terms of valuations and relative valuations I mean finishing argument do you have folks that are pure CLO equity focused companies that trade higher than average BDC.
So go figure, kind of eats away a little bit at that argument and one reason we look to potentially spending off those assets we have looked at that. And of course right now is a time which our whole industry is trading I think on average of more than 30% discount. So it’s I guess folks can talk about how you become a slightly less - how you could go from X% to Y% but still - it’s still might be sharp.
We just have to make intelligent capital allocation decisions based on investments we think prudent. The Street might cheer some company on the go heck vent into energy two years ago I remember reading things about that with some of our peers. You don’t read that now anymore. So you got to stick to your true North analytics I think sometimes as opposed to fairly fleeting sentiment Chris.
Chris, it’s John again. One of the reasons I mentioned how much dollar value of personal after-tax savings is invested by the managers and the employees in Prospect stock is to make sure that people understand the people that work here are hyper-focused on the stock price where it trades, the net investment income and the dividend and everything else that falls under the umbrella of shareholder value.
We've a lot to gain and a lot to lose here in that stock price. So we’re not distracted. Now it's something I too have wondered about looking at other companies that had CLO books, other BDC's with CLO books, how do they trade? Is there evidence that having a CLO book impairs the trading of your stock? Well there is some, but there is also evidence going the other way. So there is a 100% CLO company out there trading at a big premium.
So I think if that occurs. I’m sorry to interrupt, but I think that more so occurs because if you look at kind of an Oxford or Eagle Point, they are all CLO equity with a tiny bit of debt and the market knows when say there is a NAV per share decline they pretty much know that there is no cash flow impairment. This is just from spreads widening, these things shouldn’t be trading off now.
Whereas with the BDC, the market is kind of I guess we could say that most investors are too lazy to differentiate between which NAV decline is coming from spreads widening which your CLO equity book took a hit just because of spreads widening and what’s actually occurring from deterioration in the underlying portfolio companies. So I think that’s why there is kind of [indiscernible] that exists between the pure play CLO players and the BDC that invested in some of it.
Chris, what I was leading up to is I encourage people to look at the slides on our website that show the performance of our portfolio that is something that we are paid to manage and cause to perform. We believe over long periods of time the stock price will follow the portfolio performance. So as focused as we are in the stock price, we have to remember the true north, which is to run a portfolio that steadily we get to week, month after month quarter after quarter churns out Alpha generating portfolio returns. So I want you to know we have both in mind, okay, but thank you very much for your questions.
All right. Thank you for taking my questions guys.
Our next question comes from Gregg Abella of Investment Partners Asset Management. Please go ahead.
Good morning gentlemen, and thanks for taking my question.
Good morning Gregg.
So first to comment, John I'm very happy to hear you in your opening remarks attempt at least to stem some of the negative narrative out there because it's been distressing for those of us who are long-term holders and have been supportive and I don't know whether what you said is enough to turn the tide, but at least it's a step to address some of the things that are out there.
And along those lines it certainly seems to has an impact on the share price. In terms of operationally I hope it hasn't had an impact on the debt side of your balance sheet and attempting to refi it, because we’re running at $42 million a quarter apparently of interest expense and if you can refi it every dollar you can save that flows to the bottom line is always $0.90 in extra dividend to us. So maybe you can comment on how you see that and whether or not you can still in this environment get a Christmas savings from reifying your debt load at potentially lower rates?
Absolutely Greg and thank you for your comments as well. It's a great question because there may be some nice opportunities to retire debt attractively given the volatility of the market and you may see it’s examining some of those possibilities and we have a $885 million revolving credit facility is completely undrawn. The incremental costs above the commitment fee we already paid that shows up in the cost you are referencing is only about 1.75% based on a today's LIBOR. I know we are expecting surging LIBOR given recent comments from the Fed including today.
And that's pretty attractive relative to some of the term debt that’s out there on a coupon basis especially if week holders choose to sell at a discount. So that could be a nice opportunity for us to kill two birds with one stone. One to improve income and profitability and two get a more than kind of one-for-one benefit on the leverage side as well as a partial mitigate potentially compared to the volatility on the asset side ledger, which of course is impacting the whole industry. So we are spending an untrue amount of time on just that Greg and that’s a terrific question.
Roughly, if you're successful how much do you think you can save on an annual basis in interest expense?
It's hard to estimate right now and you got to look at each deal and where it’s trading and how much you can repurchase, how much you have to go to the tender root for et cetera. We would have to evaluate that and it's hard to put out an estimate at this point.
Okay. Fair enough. Well guys we wish you a lot of luck and I'm hoping that it’s downward and upward term here.
Thank you Greg.
Hey Greg, thanks very much. When we appreciate the luck what we find is the harder we work to luckier we get. That’s all the time we have for questions. As always if you wish to follow-up, please don't hesitate to contact us directly. Now we are getting back to work. Thanks all.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your line. Have a great day.
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