Prospect Capital's Dividend And NAV Sustainability Analysis: Part 2

| About: Prospect Capital (PSEC)

Summary

Part 2 of this article discusses three topics/trends impacting PSEC's future dividend and NAV sustainability.

These three topics/trends discuss PSEC's weighted average cash LIBOR floor as of 12/31/2015, a FMV investment rating analysis, and a quarterly FMV percentage analysis on specific portfolio companies.

Due to recent macroeconomic events, performing the three analyzes greatly assists investors make a more informed decision when considering PSEC as a possible equity investment.

My exact PSEC dividend per share projection for May 2016, June 2016, July 2016, and August 2016 are stated in the “Conclusions Drawn” section of the article.

In addition to my BUY, SELL, or HOLD recommendation and price target, this article provides some positive and negative factors to consider when choosing PSEC as a possible equity investment.

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 near-term dividend sustainability of Prospect Capital Corp. (NASDAQ:PSEC). PART 1 helps lead to a better understanding of the topics/trends that will be discussed in PART 2. The link to PART 1's analysis is provided below:

Prospect Capital Corp.'s Dividend and NAV Sustainability Analysis (Pre Fiscal Q3 2016 Earnings) - Part 1

This two-part article is a very detailed look at PSEC's dividend and net asset value ("NAV") sustainability. I have performed this analysis due to the number of readers who have specifically requested such an analysis be periodically performed on PSEC. For readers who just want the summarized conclusions/results, I would suggest to scroll down to the "Conclusions Drawn" section at the bottom of each part of the article.

Focus of PART 2 of Article:

PART 1 of this article mainly analyzed PSEC's past and current performance regarding the company's quarterly NII, cumulative undistributed NII, net ICTI, and cumulative UTI figures (including four tests being performed). PART 2 will transition to a more "forward-looking" dividend sustainability analysis and will discuss some additional topics/trends to consider in a general net rising interest rate environment that may counter (or confirm) the evidence obtained within PART 1. PART 2 will also perform an analysis on PSEC's future NAV sustainability. At the end of this article, I will include the following PSEC projections: 1) next set of dividend declarations (per share rate for May 2016, June 2016, July 2016, and August 2016); and 2) NAV per share range for the next several quarters. In addition to my BUY, SELL, or HOLD recommendation and price target, I will also provide some positive and negative factors to consider when choosing PSEC as a possible equity investment.

Additional Topics/Trends Impacting PSEC's Future Dividend and NAV Sustainability:

In addition to the four tests performed in PART 1 of this article, some recent topics/trends that will affect PSEC's future dividend and NAV sustainability should also be addressed. The following three topics/trends will play an important role regarding PSEC's future dividend and NAV sustainability: 1) an in-depth analysis on how the company's investment portfolio is currently set up for the rise to the "London Interbank Offered Rate" (LIBOR) over the next several years; 2) a fair market value ("FMV") investment rating analysis on the company's debt and equity investments over the past four quarters; and 3) a quarterly FMV percentage analysis on specific portfolio companies for the past six quarters.

Prior to discussing the three topic/trends stated 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"). I believe providing some general examples will be beneficial to most readers.

Through "Generally Accepted Accounting Principles" ("GAAP"), quarterly FMV "write-downs" (also known as capital depreciation) 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. When there is a market "sell-off" within global debt markets (heightened volatility), including certain pockets such as institutional/corporate and high-yield bonds, there is heightened spread/basis risk which negatively affects bids for these types of investments. As such, lower bids typically occur which directly lead to capital depreciation being recorded. In addition, if a portfolio company starts to see slowing operations and/or net losses, a FMV write-down would likely occur on PSEC's debt investment due to a perceived increase in credit risk. As such, the value of PSEC's investment portfolio would be reduced causing an immediate drop to "earnings per share" ("EPS"). This occurs even if the write-down is still "unrealized." 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 portfolio company to be put on "non-accrual" status (non-performance on a loan). When this occurs, interest income would not be accrued as interest payments are not being received. As such, this would cause an immediate drop in PSEC's NII/net ICTI and have a direct impact on PSEC's future dividend sustainability.

These same general risks could also occur on PSEC's equity investments. 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 generally be deemed less valuable. As such, a 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 to 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. If this were to occur, there would be an increased probability that some or all of the cash distributions received by PSEC from the portfolio company would be a "return of capital" ("ROC") per GAAP/the "Internal Revenue Code" ("IRC") and thus not a component of NII/net ICTI. This would be determined by the "earnings and profit" (E&P; an IRC methodology) of the underlying operating companies. As such, this would cause an immediate drop to PSEC's NII/net ICTI and have a direct impact on PSEC's future dividend sustainability.

With that being said, let us now perform an in-depth analysis on how PSEC's investment portfolio is currently set up for the rise in LIBOR over the next several years.

1) Rise in LIBOR and the Impact on PSEC's Investment Portfolio:

There have been many readers who have continued to ask about this first topic/trend via both private and public correspondence. From these conversations, I have come to the conclusion some readers are having trouble understanding what will occur to PSEC's interest income and expense accounts as the "Federal Open Market Committee" ("FOMC") continues to increase the Federal ("Fed") Funds Rate. In particular, this topic will analyze PSEC's "cash LIBOR floor" associated with most of the company's debt investments. While not having an immediate, "material" impact on PSEC's NII, I still believe a discussion of this topic/trend should be provided since this event will eventually have a direct impact on the company's future dividend sustainability. As the Fed Funds Rate continues to increase in the future, this event will have varying impacts on the BDC sector which is dependent on each company's weighted average cash LIBOR floor and percentage of floating-rate liabilities.

Let us first take a look at the one-, three-, six-, and twelve-month LIBOR percentages during PSEC's fiscal third quarter of 2016 (quarter ending 3/31/2016). This will help put things in better perspective when analyzing PSEC's weighted average cash LIBOR floor later in this section of the article.

Table 3 - LIBOR Percentages for PSEC's Fiscal Third Quarter of 2016

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(Source: Table created entirely by myself, obtaining LIBOR data via private access to a professional resource [Thomson Reuters])

Using Table 3 above as a reference, contrary to the modest-material movements witnessed during the prior quarter, one can see each LIBOR maturity had only minor net movement during PSEC's fiscal third quarter of 2016. As discussed within my mortgage real estate investment trust (mREIT) articles, this is due to the high correlation between the movement of the Fed Funds Rate and LIBOR. Since the FOMC did not increase the Fed Funds Rate during the calendar first quarter of 2016, the effective Fed Funds Rate/LIBOR "followed suit" by basically maintaining rates within each respective maturity. As of 3/31/2016, one-, three-, six-, and twelve-month LIBOR increased 0.01%, 0.02%, 0.05%, and 0.03% during PSEC's fiscal third quarter of 2016, respectively (rounded to the nearest hundredth of a percentage).

Since most industry experts would agree that an increase in LIBOR is a higher probability when compared to a decrease in LIBOR (since the current percentages continue to be near historical lows), this analysis will assume an incremental, gradual rise in LIBOR will occur across all maturities over the next several years. For PSEC (and the BDC sector in general), a gradual rise in LIBOR has two general implications.

First, this would positively impact the sector's new loan originations that would most likely have higher stated interest rates when compared to existing fixed- and floating-rate debt investments. Of course, factors like credit/spread risk come into play regarding this scenario but we will remained focused on specific LIBOR implications. During 2012 - 2014, most new loan originations within similar debt classifications (1st/ 2nd lien senior secured loans, subordinated/unsecured loans, structured securitizations, etc...) continued to experience a gradual decrease in the average interest rate charged on new investments due to falling interest rates across broader markets, general market conditions, and increased competition within the BDC sector and the lower middle market ("LMM"), middle market ("MM") and upper middle market ("UMM"). This is known as "yield compression" and negatively affected most BDC peers during this timeframe, including PSEC. To show the extent of PSEC's yield compression during 2012 - 2014 (technically, the company's weighted average annualized yield on its debt investments), Table 4 is provided below.

Table 4 - PSEC Quarterly Weighted Average Annualized Yield Analysis (Evidence of Prior Yield Compression)

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

Using Table 4 above as a reference, as of 6/30/2012 PSEC had a weighted average annualized yield on the company's debt investments of 13.9%. Through a gradual decline (a few quarters contradicted this notion), PSEC's weighted average annualized yield modestly decreased to 11.9% as of 9/30/2014. PSEC's mounting cumulative quarterly net decrease to the company's weighted average annualized yield percentage basically caused a gradual decrease to its quarterly NII (generally speaking; several quarters had exceptions). However, this general trend reversed course during the calendar year 2015 which has continued through the calendar first quarter of 2016. PSEC's weighted average annualized yield has increased from 11.9% as of 9/30/2014 to 13.3% as of 12/31/2015. While part of this increase was due to portfolio "shifts" per se, a large part of the increase was also a result of spreads widening within the MM/UMM. In addition, the continued gradual increase in LIBOR should continue to reverse the spread compression that occurred during 2012-2014.

Second, this would negatively impact the sector's floating-rate credit facilities (which have a low fixed interest rate and LIBOR attachment) and a few other forms of debt financing. The BDC sector has continued to have low costs of capital regarding credit facilities as LIBOR has continued to remain suppressed. However, with a rise in LIBOR, all floating-rate liabilities will also begin to have increased interest rates. With that being said, on a"net" basis, after LIBOR rises above certain "thresholds," each BDC would eventually benefit from this rise. This is due to the fact each BDC's floating-rate debt investments (assets) generally have a greater monetary amount versus each company's floating-rate debt borrowings (liabilities).

For purposes of this analysis, we will focus on the cash LIBOR floor of PSEC's existing floating-rate debt investments as of 12/31/2015. By performing this analysis, readers will begin to better understand some of the general implications a rise in LIBOR will have on PSEC's current investment portfolio (which would directly affect the company's future dividend sustainability).

Table 5 - PSEC Weighted Average Cash LIBOR Floor Analysis (As of 12/31/2015)

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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 4]; table may not "foot" due to rounding to the nearest percentage)

Using Table 5 above as a reference, I have classified all of PSEC's debt investments into the applicable classifications (floating-rate, structured securitizations, fixed-rate/non-accrual) as of 12/31/2015. I have further classified all of PSEC's floating-rate debt investments into the applicable cash LIBOR floors (separates the company's "collateralized loan obligation" [CLO] investments for additional accuracy). All of PSEC's equity investments are excluded from Table 5 due to the fact this topic/trend does not apply to that type of investment. By looking at the data within Table 5 above, one can better understand how a rise in LIBOR would affect PSEC's interest income that would be generated on the company's floating-rate debt investments.

As of 12/31/2015, 34% of PSEC's debt investments had cash LIBOR floors of less than or equal to 1.00%. This means when the corresponding LIBOR percentage rises above 1.00%, 34% of PSEC's debt investments will begin to recognize additional interest income. When compared to 32% as of 6/30/2015, this specific classification increased 2% during the calendar second-half of 2015. However, when compared to most sector peers, this was still a fairly low percentage of debt investments having cash LIBOR floors at or below 1.00%. With that being said, this negative trend is countered by the fact 89%(rounded) of PSEC's debt investments had floating interest rates as of 12/31/2015. In comparison, only 52% and 60% of Apollo Investment Corp.'s (NASDAQ:AINV) and Main Street Capital Corp.'s (NYSE:MAIN) debt investments had floating interest rates as of 12/31/2015, respectively.

As of 12/31/2015, 8%, 4%, and 3% of PSEC's debt investments had cash LIBOR floors of 1.25%, 1.50%, and 1.75%, respectively. Therefore, 49% of PSEC's debt investments had cash LIBOR floors less than 2%. When compared to 46% as of 6/30/2015, this was a minor increase which was mainly attributable to several quarterly repayments of debt investments which had very high cash LIBOR floors. As of 12/31/2015, 19%, of PSEC's debt investments had cash LIBOR floors at or greater than 2.00% while 23% of the company's investment portfolio consisted of structured securitizations which are directly impacted by the "LIBOR forward curve".

Finally, as of 12/31/2015, 10% of PSEC's debt investments had no cash LIBOR floor (fixed-rate in nature) or were on non-accrual status. When compared to the prior quarter, this was a (1%) decrease mainly due to the "debt-to-equity" exchange within CP Energy Services, Inc. (CP Energy) during the fiscal second quarter of 2016.

When analyzing PSEC's cash LIBOR floor over the recent past, when excluding CLO investments, the company had a weighted average of 1.54% as of 12/31/2014. In contrast, PSEC was able to lower the company's weighted average cash LIBOR floor to 1.36% as of 12/31/2015. When calculated, this was a weighted average cash LIBOR floor decrease of (18) "basis points" ("bps") during the calendar year 2015 which I consider to be a positive trend. A recent weighted average cash LIBOR floor comparison between PSEC and several other BDC peers was provided in the following article:

Prospect Capital Corp.'s NAV, Dividend, And Valuation Compared To 9 BDC Peers (Post Calendar Q3 2015 Earnings) - Part 2

Eventually, as each cash LIBOR floor is surpassed, PSEC will begin to recognize increased interest income on the company's floating-rate debt investments. This will directly have a positive impact on PSEC's future dividend sustainability. NII will also begin to increase because, as of 12/31/2015, PSEC had 98% of the company's outstanding borrowings in the following fixed-rate liabilities (based on FMV): 1) senior convertible notes of $1.09 billion; 2) senior unsecured notes of $708 million; and 3) Prospect Capital InterNotes of $894 million. Since PSEC has "locked in" relatively low fixed-rate debt financing over an extended period of time (when compared to historical averages), the rise in the Fed Funds Rate/LIBOR should be seen as a positive catalyst for the company. I continue to believe the increase in interest income would "trump" the increased risk of non-performance/non-accruals as LIBOR increases (credit risk would lower accrued interest income). Again, I state as such because I am projecting an incremental, gradual rise in the Fed Funds Rate/LIBOR. In my opinion, this scenario is actually more beneficial to PSEC in the "long run" because it puts less "stress" on the underlying portfolio companies regarding rapidly increasing interest payments.

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

The second topic/trend to discuss is a FMV investment rating analysis associated with PSEC's debt and equity investments. Since FMV write-downs are one of the main determinants of whether to put a debt investment on non-accrual status (through heightened credit risk; ceasing to recognize interest income on a particular loan), this analysis has a direct impact on PSEC's future dividend sustainability. Furthermore, since FMV write-downs (whether unrealized or realized) directly impact PSEC's EPS in the quarter of occurrence, this analysis also has a direct impact on the company's future NAV sustainability.

I believe this analysis will bring some added clarity to readers to better understand how PSEC's investment portfolio was rated, regarding investment valuations, as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015. To begin this analysis, Table 6 is provided below.

Table 6 - PSEC Investment Rating Analysis as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015 (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 4])

Using Table 6 above as a reference, I classify PSEC's debt and equity investments within one of the following three portfolios: 1) control (dark blue coloring); 2) affiliate (olive green coloring); or 3) non-control/non-affiliate (purple coloring). A "control" investment is where PSEC owns (through an equity investment) at or greater than 25% of a portfolio company's outstanding voting securities. An "affiliate" investment is where PSEC owns (through an equity investment) at or greater than 5% but less than 25% of a portfolio company's outstanding voting securities. Within these three classifications, five different "investment ratings" are shown based on each portfolio's recent FMV. I am including four separate points in time to better highlight past unrealized appreciation (depreciation) within each classification. In my professional opinion, spotting certain past/recent trends within a BDC's investment portfolio provides additional insight regarding projecting accurate, reliable projections in the future.

An investment rating of "1" describes the portion of PSEC's debt and equity investments that were performing at or above expectations. An investment rating of "2" describes the portion of investments that were performing near expectations. An investment rating of "3" describes the portion of investments that were performing slightly below expectations. An investment rating of "4" describes the portion of investments that were performing modestly below expectations. Finally, an investment rating of "5" describes the portion of investments that were performing materially below expectations.

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

Still using Table 6 as a reference, I have classified 79%, 80%, 68%, and 57% of PSEC's investment portfolio performing at or above expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively (based on FMV). As such, PSEC's investment portfolio had a notable percentage decrease regarding debt and equity investments performing at or above expectations during the fiscal first and second quarters of 2016. In my opinion, this is a "cautionary"/negative trend. As of 12/31/2015, this investment rating had a cost basis of $3.38 billion while having a FMV of $3.55 billion.

I have classified 14%, 9%, 18%, and 20% of PSEC's investment portfolio performing near expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. As such, PSEC's investment portfolio had a modest percentage increase regarding debt and equity investments performing near expectations during the fiscal first quarter of 2016. This modest percentage increase was mainly attributable to various debt and equity investments being reclassified from an investment rating of 1 to an investment rating of 2. As of 12/31/2015, this investment rating had a cost basis of $1.27 billion while having a FMV of $1.24 billion.

When combined, I have classified 93%, 89%, 86%, and 77% of PSEC's investment portfolio performing near, at, or above expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. When calculated, these two combined investment ratings had a decrease of (4%), (3%), and (9%) during the fiscal fourth quarter of 2015, fiscal first quarter of 2016, and fiscal second quarter of 2016, respectively. I believe a majority of PSEC's investment portfolio continued to be performing near, at, or above expectations. However, it would also appear there has been a gradual decrease in the percentage of investments performing within an investment rating of 1 or 2 over the past three quarters. As such, there was a growing proportion of investments that exhibited varying levels of underperformance/non-performance.

When calculated, I have determined 7%, 11%, 14%, and 23% of PSEC's investment portfolio was experiencing varying levels of underperformance/non-performance as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. While the most recent percentage may initially seems a bit alarming, when compared to most BDC peers I currently cover (ten other companies), PSEC had an average percentage of debt and equity investments performing either slightly, modestly, or materially below expectations as of 12/31/2015.

To put things in better perspective, as was discussed in a prior BDC comparison article, the following were the FMV versus cost ratios for PSEC and nine other BDC peers as of 12/31/2015 (in order of highest to lowest ratio): 1) MAIN 1.0800x; 2) Golub Capital BDC Inc. (NASDAQ:GBDC) 1.0087x; 3) Ares Capital Corp. (NASDAQ:ARCC) 0.9899x; 4) Solar Capital Ltd. (NASDAQ:SLRC) 0.9761x; 5) PSEC: 0.9684x; 6) Fifth Street Senior Floating Rate Corp. (NASDAQ:FSFR) 0.9525x; 7) Apollo Investment Corp. 0.9418x; 8) Fifth Street Finance Corp. (NASDAQ:FSC) 0.9351x; 9) Medley Capital Corp. (NYSE:MCC) 0.9054x; and 10) American Capital Senior Floating Ltd. (NASDAQ:ACSF) 0.8747x.

Investment Rating 3 (Performing Slightly Below Expectations):

I have classified 4%, 7%, 6%, and 7% of PSEC's investment portfolio performing slightly below expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. All debt and equity investments within this classification should be carefully monitored each quarter to watch for future FMV write-downs and possible eventual non-accruals. As of 3/31/2015, this investment rating had a cost basis of $249 million while having a FMV of $231 million. As of 12/31/2015, this investment rating had a cost basis of $449 million while having a FMV of $415 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $185 million (rounded) regarding the company's debt and equity investments performing slightly below expectations between the end of the fiscal third quarter of 2015 and fiscal second quarter of 2016. This should be seen as a cautionary/negative trend regarding future NAV sustainability.

Investment Rating 4 (Performing Modestly Below Expectations):

I have classified 1%, 4%, 5%, and 11% of PSEC's investment portfolio performing modestly below expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. All debt investments within this classification should be CONSIDERED for non-accruals. In other words, heightened monitoring should occur. Also, debt and equity investments within this classification have a moderate probability of a partial non-recovery of one's remaining principal/cost basis. As of 3/31/2015, this investment rating had a cost basis of $104 million while having a FMV of $92 million. As of 12/31/2015, this investment rating had a cost basis of $750 million while having a FMV of $658 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $566 million regarding the company's debt and equity investments performing modestly below expectations between the end of the fiscal third quarter of 2015 and fiscal second quarter of 2016. I believe this should be seen as a negative trend due to the fact a majority of this increase was attributable to several sizable debt and equity investments being reclassified from a higher investment rating (1,2, or 3) to an investment rating of 4.

Investment Rating 5 (Performing Materially Below Expectations):

Finally, I have classified 2%, less than 1%, 3%, and 5% of PSEC's investment portfolio performing materially below expectations as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. All debt investments within this classification should be on non-accrual status unless there is a specific reason otherwise (which can [and does] occur). Also, certain debt and equity investments within this classification 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 3/31/2015, this investment rating had a cost basis of $243 million while having a FMV of $95 million. As of 12/31/2015, this investment rating had a cost basis of $538 million while having a FMV of $313 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $218 million regarding the company's debt and equity investments performing materially below expectations between the end of the fiscal third quarter of 2015 and fiscal second quarter of 2016. It is never a positive trend when a company has any part of its investment portfolio within this rating classification. From a FMV perspective, the monetary amount of PSEC's investments with a rating classification of 5 more than doubled in the matter of three fiscal quarters. Again, I believe this should be seen as a negative trend due to the fact a majority of this increase was attributable to several sizable debt and equity investments being reclassified from a higher investment rating (1, 2, 3, or 4) to an investment rating of 5. Hypothetically speaking, under a"worst case" scenario where all debt and equity investments within this classification were eventually deemed worthless (FMV of $0; fairly low probability of actually occurring), this would currently decrease PSEC's NAV by ($0.88) per share. With that being said, to remain non-bias, it appears PSEC's stock price of $7.19 per share as of 4/6/2016 has already "priced-in" this worst case scenario.

As of 12/31/2015, the following portfolio companies had at least one debt or equity investment that was materially underperforming expectations (excludes investments with a FMV of $0 or an escrow receivable balance): 1) CP Energy; 2) Freedom Marine Solutions, LLC (Freedom); 3) Gulf Coast Machine and Supply Co. ("Gulf"); 4) NMMB, Inc. ("NMMB"); 5) Valley Electric Company, Inc. (Valley); 6) Wolf Energy, LLC ("Wolf"); 7) Ark-La-Tex Wireline Services, LLC (Ark-La-Tex); 8) Lasership, Inc. (Lasership); 9) Prince Mineral Holding Corp. (Prince); 10) Speedy Group Holdings Corp. (Speedy); 11) Targus Group International, Inc. (Targus); and 12) Venio LLC (Venio). Again, I am not saying the ENTIRE investment in each of these portfolio companies had an investment rating of 5 (where multiple investments exist). However, at least one debt or equity investment within each of the portfolio companies listed above had a rating classification of 5.

The following portfolio companies listed above had debt investments on non-accrual status as of 12/31/2015: 1) Gulf; 2) Wolf; 3) Targus; and 4) Venio. Readers should understand any future non-accruals would bring the risk of a slight decrease in interest income per GAAP and the risk of further decreases in NAV from future FMV write-offs.

Simply put, this analysis shows 93%, 89%, 86%, and 77% of PSEC's investment portfolio as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015 was relatively stable and in "good health", respectively (performing loans and equity investments; based on FMV). However, 7%, 11%, 14%, and 23% of PSEC's investment portfolio showed signs of slight, moderate, or material underperformance as of 3/31/2015, 6/30/2015, 9/30/2015, and 12/31/2015, respectively. When taking a look at the percentages, I believe PSEC's investment portfolio had a gradual increase in risk for further FMV decreases in future quarters (especially regarding several portfolio companies). This should be seen as a negative trend due to the fact this was attributable to several sizable debt and equity investments being reclassified from a higher investment rating (1 or 2) to a lower investment rating (3, 4 or 5).

I believe the debt and equity investments within these lower classifications should continue to be monitored to a greater degree as they are the most susceptible to continued FMV write-downs, non-performance (which would lead to non-accruals), and ultimately a probable partial (in some cases total) loss of principal/cost basis. This would negatively impact PSEC's future dividend and NAV sustainability.

3) Quarterly FMV Percentage Analysis on PSEC's Portfolio Companies for the Past Six Quarters:

The last topic/trend to discuss is a quarterly FMV percentage analysis associated with PSEC's portfolio companies for the past six quarters (9/30/2014 - 12/31/2015). This is somewhat different than the FMV investment ratings analysis performed in the previous section of the article. This quarterly FMV percentage analysis shows specific portfolio companies where noticeable unrealized FMV fluctuations occurred over a greater period of time. This analysis helps detect unrealized FMV fluctuations that have recently occurred and identifies struggling investments that were once (or still are) performing near, at, or above expectations. This analysis also identifies certain prior troubled debt and equity investments that are now beginning to show signs of improvement. Spotting these trends will lead to a more accurate portrayal of PSEC's future NAV sustainability. To begin this analysis, Table 7 is provided below.

Table 7 - PSEC Portfolio Company FMV Analysis (Investment Ratings 9/30/2014 - 12/31/2015)

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(Source: Table created entirely by myself, including all calculated figures and ratios)

Using Table 7 above as a reference, the following portfolio companies had a notable fluctuation in one's investment valuation over the past six quarters (9/30/2014 - 12/31/2015): 1) Arctic Energy Services, LLC (Arctic); 2) CP Energy; 3) Freedom; 4) Apidos CLO XI, Ltd (Apidos XI); 5) Apidos CLO XII, Ltd (Apidos XII); 6) Apidos CLO XV, Ltd (Apidos XV); 7) Apidos CLO XXII, Ltd (Apidos XXII); 8) Ark-La-Tex; 9) Cent 20 CLO Limited (Cent 20); 10) Cent 21 CLO Limited (Cent 21); 11) CIFC Funds 2013-III Ltd. (CIFC 2013-III); 12) Galaxy XVII CLO, Ltd. (Galaxy XVII); 13) Jefferson Mill CLO Ltd. (Jefferson Mill); 14) Lasership; 15) Nixon, Inc. (Nixon); 16) Pacific World Corp. (Pacific World); 17) Prince; 18) Spartan Energy Services, Inc. (Spartan); 19) Speedy; 20) Symphony CLO, XIV Ltd. (Symphony XIV); 21) Symphony CLO XV, Ltd. (Symphony XV); 22) Targus; 23) United Sporting Companies, Inc. (United Sporting); 24) United States Environment Services, LLC (U.S. Environmental); 25) Venio; and 26) Washington Mill CLO Ltd (Washington Mill).

Some of these fluctuations were due to spread/basis risk. This includes most CLO investments which were affected by lower pricing (due to heightened volatility within debt markets; a slight "uptick" in defaults) and the net movement across the forward LIBOR curve (discussed earlier). Other fluctuations, mostly negative over time, pertained more to credit risk. This includes several oil and gas portfolio companies such as Arctic, CP Energy, Ark-La-Tex, and Spartan Energy. Other portfolio companies such as Lasership, Prince, Speedy, Targus, and Venio have also experienced heightened credit risk. A gradual net decrease in FMV occurred within these portfolio companies over the past six quarters. Most portfolio companies listed above started out as performing at or above expectations but then gradually began to perform slightly, modestly, or in several cases materially below expectations. I believe this should be seen as a negative trend. As of 12/31/2015, Targus and Venio were on non-accrual status. Over the next several quarters, I believe PSEC's oil and gas portfolio companies, Lasership and Speedy are at the greatest risk regarding non-performance (hence non-accruals on applicable debt investments).

In future quarters, the portfolio companies shown in Table 7 above will be one of the first groups of investments I pay particular attention to regarding quarterly FMV fluctuations. The performance of these portfolio companies will have a direct impact on PSEC's future dividend and NAV sustainability.

Conclusions Drawn- PART 2:

To summarize what was performed in PART 2 of this article, the following three topic/trends were discussed which have a direct impact on PSEC's future dividend and NAV sustainability: 1) an in-depth analysis on how the company's investment portfolio is currently set up for the rise to LIBOR over the next several years; 2) a FMV investment rating analysis on the company's debt and equity investments over the past four quarters; and 3) a quarterly FMV percentage analysis on specific portfolio companies for the past six quarters.

When all the information from both parts of this article ( four tests from PART 1 and the three topics/trends from PART 2) are taken into consideration, I believe the probability of PSEC being able to maintain the company's current monthly dividend of $0.0833 per share over the foreseeable future is modest to high (70%).

As such, I am projecting PSEC declares the following monthly dividends for May 2016, June 2016, July 2016, and August 2016

Dividend for May 2016 (Paid in June 2016): $0.0833 per share

Dividend for June 2016 (Paid in July 2016): $0.0833 per share

Dividend for July 2016 (Paid in August 2016): $0.0833 per share

Dividend for August 2016 (Paid in September 2016): $0.0833 per share

When considering PSEC's dividend over the next several years, I believe investors will need to continue monitoring the correlation between the positive impacts of a continued increase in the Fed Funds Rate/LIBOR (which would increase the company's interest income) offset by the heightened risk of investment depreciation/non-accruals (which would eventually decrease the company's interest income).

When the three topics/trends from PART 2 of this article are taken into consideration, including other factors not specifically analyzed in this article, I believe there is relatively strong evidence some of PSEC's debt and equity investments are at heightened risk for varying levels of net realized and unrealized FMV depreciation (especially several oil and gas portfolio companies) in future quarters. However, there are also a few debt and equity investments that should continue to perform above expectations including (but not limited to) several consumer finance and real estate investment trust ("REIT") portfolio companies.

As concluded in the analysis above, I project the probability associated with future net unrealized FMV depreciation is currently greater than the probability associated with future net unrealized FMV appreciation.

As such, I am projecting the following quarterly NAV ranges over the next several fiscal quarters:

NAV as of 3/31/2016: $9.20 - $9.60 per share

NAV as of 6/30/2016: $9.05 - $9.55 per share

NAV as of 9/30/2016: $8.95 - $9.55 per share

Therefore, I am currently projecting a slight - modest decrease in PSEC's NAV over the next three fiscal quarters. Within PSEC's heightened "at-risk" portfolio companies, continued FMV depreciation during the fiscal second quarter of 2016 resulted in this specific portion of the investment portfolio looking less "appealing" when compared to the end of the prior quarter. This also considers the increase in several risk factors over the past several fiscal quarters including PSEC's oil and gas exposure, credit risk on several other portfolio companies, and the continued widening of spreads within the high yield debt market. On the other hand, PSEC's "economic return" (dividends received and change in NAV) should provide a minor positive return over the next three combined fiscal quarters. In other words, as long as PSEC's NAV does not decrease by ($0.75) per share over the next three fiscal quarters, the company's economic return will be positive.

My BUY, SELL, or HOLD Recommendation:

In my opinion, the following positive trends should be highlighted for existing and potential PSEC shareholders: 1) quarterly economic returns being generated in most quarters; 2) separation of CLO, online lending, and real estate investments through spin-offs; 3) recent quarterly net ICTI figures continue to be in excess of quarterly dividend distributions; 4) continued strong cumulative performance regarding several control investments; 5) continued "modest" exposure to the oil and gas sector when compared to its peers; 6) continued high percentage of floating-rate debt investments; and 7) notable insider purchases of common stock by the company's Chief Executive Officer ("CEO") John Barry (since 12/9/2015 has purchased 14.7 million outstanding shares of common stock [excludes all reinvestments] for a total purchase price of $98.0 million).

However, the following cautionary/negative trends should cause heightened awareness for existing and potential PSEC shareholders: 1) continued suppressed dividend and structuring/fee income; 2) projected low loan originations for the fiscal third quarter of 2016 (negatively impacts NII); 3) continued modest - material depreciation on several control/non-control investments (including most oil and gas portfolio companies); 4) "non-amendment" of the company's Investment Advisory Agreement with Prospect Capital Management L.P. (regarding the "2%/20%" fee structure); 5) recent notable net unrealized depreciation within the company's CLO portfolio (has to be continually monitored going forward); 6) continued delays regarding the company's three proposed spin-offs (first spin-off is now "pushed back" to the second calendar quarter of 2016 at the earliest); 7) fairly high weighted average cash LIBOR floor when compared to sector peers; and 8) lack of share repurchases initiated by PSEC (the company itself; not insider purchases which do not affect the amount of dividend distributions accrued for/paid).

When combining the analysis above with various other factors/analytical metrics not discussed within this specific article (some factors were covered in PART 1), I currently rate PSEC as a SELL when the company's stock price is trading at less than a (20%) discount to my projected NAV as of 3/31/2016 (see range provided above), a HOLD when trading at or greater than a (20%) but less than a (30%) discount to my projected NAV as of 3/31/2016, and a BUY when trading at or greater than a (30%) discount to my projected NAV as of 3/31/2016.

As such, I currently rate PSEC as a HOLD. My current price target for PSEC is $7.50 per share. This price target is unchanged when compared to my last PSEC article.

Final Note: I first initiated a position in PSEC in October 2013 at prices ranging from $10.80-$10.85 per share. On 7/28/2014, I sold 50% of my position in PSEC at a weighted average sales price of $11.00 per share. On 8/26/2014, I sold my remaining position in PSEC at a weighted average sales price of $10.69. At the time, this disclosure was provided to readers, within subsequent PSEC articles, over the next several months. On 8/27/2015, I once again initiated a position in PSEC at a weighted average purchase price of $7.325 per share. I made a subsequent purchase in PSEC on 2/8/2016 at a weighted average price of $5.445 per share. My second purchase was approximately double the monetary amount of my initial purchase. When calculated, the weighted average purchase price on my PSEC position was $6.072 per share. This weighted average per share price excluded all dividends received/reinvested. I sold my entire PSEC position on 3/2/2016 at a weighted average sales price of $7.495 per share as my price target was met. All 2015 - 2016 trades were disclosed to readers, in"real time", via the"StockTalks" feature of Seeking Alpha (and in prior PSEC articles).

Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader's current investing strategy.

Disclosure: I am/we are long FSFR, GBDC.

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.

Additional disclosure: I currently have no position (long or short) in PSEC, ACSF, AINV, ARCC, FSC, MAIN, MCC, or SLRC.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.