Prospect Capital's Dividend And NAV Sustainability Analysis (Pre-Fiscal Q4 2016 Earnings) - Part 1

| About: Prospect Capital (PSEC)

Summary

Following continued requests by readers, Part 1 of this article analyzes PSEC's near-term dividend sustainability by performing four tests based on recent quarterly results.

The first two tests analyze PSEC's NII and the company's cumulative undistributed NII which are based on GAAP.

The next two tests analyze PSEC's net ICTI and cumulative UTI which are based on IRC methodologies.

Summarized results from the four tests performed within this analysis, in regards to PSEC's near-term dividend sustainability, are stated within the “Conclusions Drawn” section of the article.

My current buy, sell, or hold recommendation for PSEC and current price target are stated at the end of the article.

Author's Note: This two-part article is a very detailed look at Prospect Capital Corp.'s (NASDAQ:PSEC) 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 Article:

The focus of PART 1 of this article is to provide a detailed analysis with supporting documentation (via four tests) on the near-term dividend sustainability of PSEC. This analysis will be provided after a brief overview of PSEC's regulated investment company ("RIC") classification per the Internal Revenue Code ("IRC"). I will be performing four dividend sustainability tests within PART 1 of this article. The first two tests will focus on PSEC's net investment income ("NII"). These two tests will be termed "TEST 1" and "TEST 2." The next two tests will focus on PSEC's net investment company taxable income ("ICTI"). These two tests will be termed "TEST 3" and "TEST 4." At the end of PART 1 of this article, there will be a conclusion based on the results obtained from TEST 1 - TEST 4 about the near-term dividend sustainability of PSEC. I will also provide my current PSEC price target and BUY, SELL, or HOLD recommendation.

Understanding the tax and dividend payout characteristics of PSEC will provide investors with an overall better understanding of the business development company ("BDC") sector as a whole. From reading this article, investors will better understand how a RIC per the IRC comes up with the company's current dividend per share rate and specific signs when an impending increase or decrease should occur.

PART 2 transitions to a more "forward-looking" dividend sustainability analysis and will discuss some topics/trends to consider in a net rising interest rate environment. PART 2 will also perform an analysis on PSEC's future NAV sustainability. I will also provide my projection regarding PSEC's NAV per share range over the next several fiscal quarters.

Side Note: It should be noted PSEC's fiscal year-end, based on Generally Accepted Accounting Principles ("GAAP"), is June 30th of a given year. However, its tax year-end, based on IRC methodologies, is August 31st of a given year. Readers should understand there is a two-month "gap" per se between PSEC's GAAP fiscal year-end and the company's IRC tax year-end as the analysis is presented below.

Brief Discussion of PSEC's RIC Classification per the IRC:

In prior articles, I have discussed PSEC's RIC classification per the IRC in detail. This included specific provisions that PSEC must adhere by to remain in RIC compliance. There is one specific provision which pertains to PSEC's dividend sustainability that should be mentioned. As a RIC, PSEC is required to distribute to shareholders at least 90% of the company's "ICTI" and "net capital gains" (in excess of its "capital loss carryforward" balance, if applicable) in any given tax year in order to be eligible for the tax benefits allowed in regards to this type of entity (dividends paid deduction at the corporate level). When these two figures are combined, this comprises PSEC's net ICTI which is also known as the company's annual distribution requirement ("ADR"). There is one specific "exclusion" to this rule which is mentioned later in the article (the "spillback provision"). Readers can take a look back at the following Main Street Capital Corp. (NYSE:MAIN) article for a further discussion of this topic:

Main Street Capital Corp.'s Dividend Projection for June - August 2016

Two Main Factors PSEC Considers Regarding Dividend Distributions:

Management continues to either state or imply PSEC's dividend is mainly based on the following two factors:

First Factor: Intend to cover the company's dividend payout level with NII ("minimum expected NII" over the foreseeable future)

Second Factor: Intend to cover the company's annual dividend payout level with net ICTI

The first factor will focus on PSEC's NII and cumulative undistributed NII and be analyzed via TEST 1 and TEST 2, respectively. The second factor will focus on PSEC's net ICTI and cumulative undistributed taxable income ("UTI") and be analyzed via TEST 3 and TEST 4, respectively. Readers should understand these distinctions as the four tests are provided/analyzed below.

First Main Factor - Intend to Cover the Company's Dividend Payout Level with NII:

To test management's first main factor, I believe it is necessary to analyze and discuss PSEC's prior quarterly NII figures to see if the company's dividend distributions were covered. This will lead to a better understanding of the overall trends regarding this particular factor and possible future pitfalls that may arise. This includes PSEC using the company's cumulative undistributed NII balance on any quarterly NII overpayments.

Table 1 below shows PSEC's NII from the fiscal third quarter of 2016 going back to the company's fiscal first quarter of 2015. Table 1 then compares PSEC's quarterly NII figure to the company's dividend distributions figure showing the quarterly underpayment (overpayment). Table 1 below then shows PSEC's quarterly cumulative undistributed NII (deficit) balance for the same time frame.

Table 1 - PSEC NII and Cumulative Undistributed NII (Deficit) Analysis (GAAP Methodologies Based on Fiscal Year-End Time frames)

Click to enlarge

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

Table 1 will be the main source of information as TEST 1 and TEST 2 are analyzed below. Now let us begin PSEC's near-term dividend sustainability analysis.

TEST 1 - Quarterly NII Versus Quarterly Distributions Analysis:

- See Red References "C, D, E, (D / C)" in Table 1 Above Next to the March 31, 2016 Column

Using Table 1 above as a reference, I take PSEC's quarterly "NII" figure (see red reference "C") and subtract this amount by the quarterly "distributions from NII" figure (see red reference "D"). If PSEC's red reference "C" is greater than the company's red reference "D," then PSEC technically had enough quarterly NII to pay out the company's dividend distributions for a particular quarter. Any excess NII left over, after accounting for the dividend distributions, would be added to PSEC's cumulative undistributed NII (deficit) balance. This particular balance will be further discussed within TEST 2 later in the article. If PSEC's red reference "C" is less than the company's red reference "D," then the company technically did not have enough quarterly NII to pay out its dividend distributions for a particular quarter and must use a portion of the remaining cumulative undistributed NII (deficit) balance to help with the overpayment.

TEST 1 - Analysis and Results:

Still using Table 1 above as a reference, PSEC had NII of $94.5, $91.3, $87.4 and $89.5 million for the fiscal first, second, third and fourth quarters of 2015, respectively. In comparison, PSEC had dividend distributions of ($114.3), ($118.2), ($99.4) and ($89.7) million for the fiscal first, second, third and fourth quarters of 2015, respectively. When calculated, PSEC had an overpayment of NII of ($19.8), ($26.9), ($12.0) and ($0.2) million for the fiscal first, second, third and fourth quarters of 2015, respectively (see red reference "E"). This calculates to a dividend distributions payout ratio of 121%, 129%, 114% and 100% for the fiscal first, second, third and fourth quarters of 2015, respectively (see red reference "(D / C)"). As such, I believe it can be determined PSEC materially overpaid the company's NII during the fiscal first, second and third quarters of 2015 while basically matching dividend distributions to NII during the fiscal fourth quarter of 2015. Now let us take a look at what occurred during PSEC's first three fiscal quarters of 2016.

PSEC had NII of $91.2, $100.9 and $87.6 million for the fiscal first, second and third quarters of 2016, respectively. In comparison, PSEC had dividend distributions of ($89.1), ($88.8) and ($89.0) million for the fiscal first, second and third quarters of 2016, respectively. When calculated, PSEC had an underpayment (overpayment) of NII of $2.1, $12.1 and ($1.4) million for the fiscal first, second and third quarters of 2016, respectively. As such, after a minor and modest underpayment of NII during PSEC's fiscal first and second quarters of 2016, the company had a minor overpayment of NII during its fiscal third quarter of 2016.

When looking at PSEC's dividend distributions payout ratio from the fiscal first quarter of 2015 through the fiscal third quarter of 2015, one can see this ratio remained "elevated." In my opinion, considering TEST 1 on a "standalone basis," this evidence helps support PSEC's material monthly dividend per share rate decrease which began in February 2015. With that being said, it should also be noted PSEC's dividend distributions payout ratio decreased from 129% during the fiscal second quarter of 2015 to 100% during the fiscal fourth quarter of 2015. This positive trend continued into the fiscal first and second quarters of 2016 when PSEC's dividend distributions payout ratio decreased to 98% and 88%, respectively. This gradual reduction to this ratio is mainly due to the fact PSEC materially reduced the company's monthly dividend rate from $0.110625 per share in January 2015 to $0.0833 per share beginning in February 2015. Even though PSEC had a minor overpayment of NII during the company's fiscal third quarter of 2015, I would note this overpayment was minor and less of an overpayment than experienced during most of fiscal year 2015. When combining the first three fiscal quarters of 2016, PSEC still had a modest net underpayment of NII for fiscal year 2016. I believe this should be seen as a positive trend. Now let us take this analysis a step further and perform TEST 2.

TEST 2 - Cumulative Undistributed NII Coverage of Quarterly Dividend Distributions Ratio Analysis:

- See Red References "D, F, (F / D)" in Table 1 Above Next to the March 31, 2016, Column

Once again using Table 1 above as a reference, I take PSEC's "cumulative undistributed NII (deficit)" figure (see red reference "F") and divide this amount by the quarterly "distributions from NII" figure (see red reference "D"). From this calculation, PSEC's "cumulative undistributed NII coverage of quarterly dividend distributions ratio" is obtained (see red reference "(F / D)"). The higher this ratio is, the more positive the results regarding PSEC's near-term dividend sustainability. Basically, this ratio shows the amount of cumulative undistributed NII covering the current quarter's dividend distributions.

TEST 2 - Analysis and Results:

Continuing to use Table 1 above as a reference, PSEC had a cumulative undistributed NII (deficit) balance of $18.0, ($8.9), ($20.9) and ($21.1) million at the end of the fiscal first, second, third and fourth quarters of 2015, respectively. This considers the fact PSEC had disclosed prior period adjustments to the company's cumulative undistributed NII of ($4.3) million during the fiscal first quarter of 2015. This type of prior period adjustment generally occurs when PSEC performs the company's annual tax return (initial misclassifications by the company).

Having an inverse correlation to the quarterly overpayments of NII shown in TEST 1, PSEC had a cumulative undistributed NII coverage of quarterly dividend distributions ratio of 0.16, (0.08), (0.21), and (0.23) as of 9/30/2014, 12/31/2014, 3/31/2015 and 6/30/2015, respectively. As such, this ratio continued to be negatively impacted during the fiscal first, second, third and fourth quarters of 2015. When looking at the cumulative undistributed NII (deficit) balance from the fiscal first quarter of 2015 to the fiscal fourth quarter of 2015, one can see that this balance materially decreased. PSEC had a cumulative undistributed NII balance of $42.1 million at the end of the fiscal first quarter of 2014. As stated earlier, as of 6/30/2015 PSEC's cumulative undistributed NII (deficit) balance was ($21.1) million. As such, this balance decreased ($63.2) million over a span of four fiscal quarters. When calculated, PSEC had a cumulative undistributed NII coverage of quarterly dividend distributions ratio of 0.37 as of 6/30/2014. As stated earlier, this ratio decreased to (0.23) as of 6/30/2015. When calculated, this ratio decreased (0.60) over a span of four fiscal quarters.

In my opinion, considering TEST 2 on a standalone basis, this evidence helps support PSEC's material monthly dividend per share rate decrease which began in February 2015. However, due in part to PSEC's quarterly NII "break-even" materially decreasing in February 2015 (due to the dividend reduction), the company's new monthly dividend distributions rate of $0.0833 per share appeared to be sustainable during the fiscal year 2015.

An even more positive trend occurred during the fiscal first, second and third quarters of 2016. PSEC had a cumulative undistributed NII (deficit) balance of ($16.5), ($4.4) and ($5.8) million at the end of the fiscal first, second and third quarters of 2016, respectively. This considers the fact PSEC had disclosed prior period adjustments to the company's cumulative undistributed NII of $2.4 million during the fiscal first quarter of 2016. This prior period adjustment was recorded when PSEC performed the company's annual tax return for 2015 (initial misclassifications by the company). The following quote from PSEC's 10-Q for the fiscal quarter ending 9/30/2015 supports this fact:

"...During the tax year ended August 31, 2015, we decreased accumulated overdistributed net investment income by $2,436, increased accumulated net realized loss on investments by $8,541, and increased capital in excess of par value by $6,105..."

As such, PSEC's cumulative undistributed NII coverage of quarterly dividend distributions ratio reversed a two-year negative trend and increased from (0.23) to (0.07) during the first three fiscal quarters of 2016. Compared to what occurred over the prior two fiscal years in regards to this specific metric (material decrease each year), I believe this should be seen as a positive trend.

When looking at the results from TEST 1 and TEST 2, PSEC's recent NII figures appear to support the current monthly dividend distributions rate of $0.0833 per share. However, with that being said, PSEC's margin of safety regarding NII matching quarterly dividend distributions still remains relatively narrow. In addition, TEST 1 and TEST 2 do not specifically account for PSEC's net ICTI figures. As such, TEST 3 and TEST 4 will now be performed to gain further clarity on PSEC's near-term dividend sustainability.

Second Main Factor - Intend to Cover the Company's Annual Dividend Payout Level with Net ICTI:

To "fully" understand and accurately project a BDC's dividend sustainability, one must understand the subtle differences between a company's NII and net ICTI figures/cumulative balances. NII is a GAAP figure which is based on the accrual method of accounting. ICTI and net ICTI are IRC figures which are "generally" based on the cash method of accounting (some exceptions to this notion but I am keeping it simple for this discussion).

In order for PSEC to come up with a proper ICTI figure, there are specific GAAP to IRC adjustments (reversals) that need to be performed each quarter. Income and expense recognition of certain accounting transactions differ between GAAP and the IRC (book versus tax accounting treatments). A majority of PSEC's book to tax differences (either temporary or permanent in nature) consist of the following: 1) deferred financing fees on loans and deferred offering costs in relation to equity offerings; 2) amortization (accretion) of loan/investment premiums (discounts); and 3) timing recognition of interest income on certain loans/investments. There are several additional book to tax adjustments that PSEC periodically recognizes. However, for purposes of this article, further discussion of these additional adjustments is unwarranted.

Once PSEC's ICTI is known, one adds all net capital gains to this figure (if a capital loss carryforward balance does not exist). Net capital gains consist of realized short-term net capital gains in excess of realized long-term net capital losses for each tax year. However, PSEC had a material capital loss carryforward balance as of 8/31/2015 to offset any net capital gains that might arise in the future. As such, this balance will continue to remain $0 over the foreseeable future, even if PSEC realizes material net capital gains on the company's debt/equity investments. After this calculation, PSEC's net ICTI figure is known.

To test management's second main factor, I believe it is necessary to analyze and discuss PSEC's prior quarterly net ICTI figures to see if the company's quarterly dividend distributions were covered. This will lead to a better understanding of the overall trends regarding this particular factor and possible future pitfalls that may arise. This includes PSEC using the company's cumulative UTI balance on any quarterly net ICTI overpayments.

Table 2 below shows PSEC's net ICTI from the fiscal third quarter of 2016 going back to the company's fiscal first quarter of 2015. Table 2 then compares PSEC's quarterly net ICTI figure to the company's dividend distributions figure showing the quarterly underpayment (overpayment). Table 2 below then shows PSEC's cumulative UTI balance for the same time frame.

Side Note: Table 2 is providing IRC information based on GAAP fiscal year-end time frames to better compare and contrast cumulative undistributed NII (discussed within TEST 2 above) and cumulative UTI (discussed within TEST 4 below).

Table 2 - PSEC Net ICTI and Cumulative UTI Analysis (IRC Methodologies Based on GAAP Fiscal Year-End Time frames)

Click to enlarge

(Source: Table created entirely by myself, partially using PSEC data obtained from the SEC's EDGAR Database [link provided below Table 1])

Table 2 will be the main source of information as TEST 3 and TEST 4 are analyzed below. Now let us begin the next phase of PSEC's near-term dividend sustainability analysis.

TEST 3 - Quarterly Net ICTI Versus Quarterly Distributions Analysis:

- See Red References "K, D, L, (D / K)" in Table 2 Above Next to the March 31, 2016, Column

Using Table 2 above as a reference, I take PSEC's quarterly "net ICTI" figure (see red reference "K") and subtract this amount by the quarterly "distributions from net ICTI" figure (see red reference "D"). If PSEC's red reference "K" is greater than the company's red reference "D," then PSEC technically had enough quarterly net ICTI to pay out the company's dividend distributions for a particular quarter. Any excess net ICTI left over, after accounting for the dividend distributions, would be added to PSEC's cumulative UTI balance. This particular balance will be further discussed within TEST 4 later in the article. If PSEC's red reference "K" is less than the company's red reference "D," then the company technically did not have enough quarterly net ICTI to pay out its dividend distributions for a particular quarter and must use a portion of the remaining cumulative UTI balance to help with the overpayment.

TEST 3 - Analysis and Results:

Still using Table 2 above as a reference, PSEC had net ICTI of $151.3, $107.8, $93.7 and $96.3 million for the fiscal first, second, third and fourth quarters of 2015, respectively. In comparison, PSEC had dividend distributions of ($114.3), ($118.2), ($99.4) and ($89.7) million for the fiscal first, second, third and fourth quarters of 2015, respectively. When calculated, PSEC had an underpayment (overpayment) of net ICTI of $37.0, ($10.4), ($5.7) and $6.5 million for the fiscal first, second, third and fourth quarters of 2015, respectively (see red reference "L"). This calculates to a dividend distributions payout ratio of 76%, 110%, 106% and 93% for the fiscal first, second, third and fourth quarters of 2015, respectively (see red reference "(D / K)"). PSEC had a combined net ICTI underpayment of $27.4 million for the fiscal year 2015. This calculates to an annual dividend distributions payout ratio of 94%. However, this underpayment is a bit deceiving. PSEC's original net ICTI figures for the fiscal first, second, third and fourth quarters of 2015 were amended by the company via several prior period adjustments in subsequent quarters. When including PSEC's two prior period "true-down" adjustments of ($4.3) and ($20.9) million, one minor prior period "true-up" adjustment of $0.6 million and one material true-up adjustment of $12.5 million (which were discussed/reconciled in a prior article), PSEC's adjusted net ICTI underpayment was $15.3 million for the fiscal year 2015. This calculates to an annual dividend distributions payout ratio of 97%. While this does not calculate to a material difference in annual payout ratios, to remain "technically precise," I believe both percentages should be provided to readers.

However, it should also be noted PSEC's dividend distributions payout ratio decreased from 106% during the fiscal third quarter of 2015 to 93% during the fiscal fourth quarter of 2015 (a greater decrease if one considers the prior period adjustments that were accounted for in each respective fiscal quarter). This reduced payout ratio was directly attributable to the new monthly dividend rate of $0.0833 per share (new quarterly dividend rate totaling $0.25 per share). Now let us take a look at what occurred during PSEC's first three fiscal quarters of 2016.

PSEC had net ICTI of $94.3, $99.9 and $86.6 million for the fiscal first, second and third quarters of 2016, respectively. In comparison, PSEC had dividend distributions of ($89.1), ($88.8) and ($89.0) million for the fiscal first, second and third quarters of 2016, respectively. When calculated, PSEC had an underpayment (overpayment) of net ICTI of $5.2, $11.0 and ($2.4) million for the fiscal first, second and third quarters of 2016, respectively. This calculates to a dividend distributions payout ratio of 94%, 89% and 103% for the fiscal first, second and third quarters of 2016, respectively. Now let us take this analysis a step further and perform TEST 4.

TEST 4 - Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio Analysis:

- See Red References "D, N, (N / D)" in Table 2 Above Next to the March 31, 2016, Column

Once again using Table 2 above as a reference, I take PSEC's "cumulative undistributed UTI" figure (see red reference "N") and divide this amount by the quarterly "distributions from net ICTI" figure (see red reference "D"). From this calculation, PSEC's "cumulative UTI coverage of quarterly dividend distributions ratio" is obtained (see red reference "(N / D)"). The higher this ratio is, the more positive the results regarding PSEC's near-term dividend sustainability. Basically, this ratio shows the amount of cumulative UTI covering the current quarter's dividend distributions.

TEST 4 - Analysis and Results:

Continuing to use Table 2 above as a reference, PSEC had a cumulative UTI balance of $70.5, $39.2, $34.1 and $53.1 million at the end of the fiscal first, second, third and fourth quarters of 2015, respectively. One should note PSEC's cumulative UTI balance has been (and continues to be) materially higher when compared to the company's cumulative undistributed NII (deficit) balance which was analyzed back in TEST 2. As such, this is why I believe net ICTI figures should also be analyzed in any BDC's dividend sustainability analysis. I believe IRC metrics provide evidence/support for any potential "special periodic" dividends being declared (when the spillback provision is not utilized).

Having an inverse correlation to the quarterly underpayments (overpayments) of net ICTI shown in TEST 3, PSEC had a cumulative UTI coverage of quarterly dividend distributions ratio of 0.62, 0.33, 0.34 and 0.59 as of 9/30/2014, 12/31/2014, 3/31/2015 and 6/30/2015 respectively. In my opinion, considering TEST 4 on a standalone basis, this provides further evidence supporting PSEC's monthly dividend per share rate decrease which began in February 2015. However, it should also be noted PSEC's cumulative UTI coverage of quarterly dividend distributions ratio increased from 0.34 as of 3/31/2015 to 0.59 as of 6/30/2015 (immediately after the reduced dividend; direct correlation). Now let us take a look at what occurred during PSEC's first three fiscal quarters of 2016.

PSEC had a cumulative UTI balance of $57.7, $66.2 and $70.6 million at the end of the fiscal first, second and third quarters of 2016, respectively. These balances include prior period adjustments of ($0.6), ($2.6), $6.9 million during the fiscal first, second and third quarters of 2016, respectively. These adjustments, performed by PSEC in subsequent quarters, pertained to minor changes to figures for tax years 2012-2015 and adjustments in the current tax year. Since cumulative UTI is a "running balance," this figure is always impacted by any prior period adjustments being recorded in the current quarter. PSEC had a cumulative UTI coverage of quarterly dividend distributions ratio of 0.65, 0.75 and 0.79 as of 9/30/2015, 12/31/2015 and 3/31/2016, respectively. As such, PSEC has been able to gradually increase this ratio over the last five fiscal quarters. I believe this should be seen as a positive trend.

As important, I also project PSEC's net ICTI for the fiscal fourth quarter of 2016 (quarter ending 6/30/2016) will be near, at, or above the company's dividend distributions for the same time frame. For the fiscal fourth quarter of 2016, I am projecting PSEC will have dividend distributions of approximately $89 million. When looking at the results from TEST 3 and TEST 4, I believe the probability of PSEC being able to maintain the company's monthly dividend distributions rate of $0.0833 remains unchanged when compared to the prior quarter.

Conclusions Drawn - PART 1:

To sum up the information in PART 1 of this article, four dividend sustainability tests were performed on PSEC. The first two tests were based on PSEC's NII figures which are based on GAAP. The next two tests were based on PSEC's net ICTI figures which are based on IRC methodologies. TEST 1 provided the following information in regards to PSEC's NII for the prior three fiscal quarters:

PSEC's NII Payout Ratio for Fiscal Q1 2016, Q2 2016 and Q3 2016, Respectively: 98%, 88% and 102%

TEST 2 provided the following information in regards to PSEC's cumulative undistributed NII coverage of quarterly dividend distributions ratio at the end of the prior three fiscal quarters:

PSEC's Cumulative Undistributed NII Coverage of Quarterly Dividend Distributions Ratio as of 9/30/2015, 12/31/2015 and 3/31/2016, Respectively: (0.19), (0.05), and (0.07)

When looking at the results from TEST 1 and TEST 2 (based on GAAP), PSEC's recent NII figures appear to support the current monthly dividend distributions rate of $0.0833 per share. However, with that being said, PSEC's margin of safety regarding NII matching quarterly dividend distributions still remains relatively narrow.

Next, TEST 3 provided the following information in regards to PSEC's net ICTI for the prior three fiscal quarters:

PSEC's Net ICTI Payout Ratio for Fiscal Q1 2016, Q2 2016 and Q3 2016, Respectively: 94%, 89% and 103%

Finally, TEST 4 provided the following information in regards to PSEC's cumulative UTI coverage of quarterly dividend distributions ratio at the end of the prior three fiscal quarters:

PSEC's Cumulative UTI Coverage of Quarterly Dividend Distributions Ratio as of 9/30/2015, 12/31/2015, and 3/31/2016, Respectively: 0.65, 0.75, and 0.79

When looking at the results from TEST 3 and TEST 4 (based on IRC methodologies), I believe the probability of PSEC being able to maintain the company's recent monthly dividend distributions rate of $0.0833 per share over the foreseeable future remains high (80%).

Due to the reduced distribution level which began in February 2015, including the fact PSEC had an additional "cushion" per se regarding the company's cumulative UTI balance of $70.6 million as of 3/31/2016, I believe the probability of the company declaring a minor, special periodic dividend during 2016 is still a valid consideration but only has a fairly low (30%) probability of occurring at this point in time. I believe PSEC wants to remain cautious regarding the use of the company's cumulative UTI balance just in case quarterly net ICTI shortfalls arise in the future (hence the utilization of the spillback provision).

My BUY, SELL or HOLD Recommendation:

PSEC recently closed at $7.71 per share as of 6/8/2016. This was a ($1.90) per share discount to PSEC's NAV of $9.61 per share as of 3/31/2016. This calculates to a price to NAV ratio of 0.8021 or a discount of (19.79%).

From the analysis provided above, including additional factors not analyzed within this article, I currently rate PSEC as a SELL when the company's stock price is trading at less than a (18%) discount to NAV as of 3/31/2016, a HOLD when trading at or greater than an (18%) but less than a (25%) discount to NAV as of 3/31/2016, and a BUY when trading at or greater than a (25%) discount to NAV as of 3/31/2016. These ranges are unchanged when compared to my last PSEC article.

As such, I currently rate PSEC as a HOLD. My current price target for PSEC is approximately $7.90 per share. This is currently the price where my HOLD recommendation would change to a SELL. This price target is unchanged when compared to my last PSEC article. My current re-entry price for PSEC is approximately $7.20 per share. This is currently the price where my HOLD recommendation would change to a BUY.

For support on my current BUY, SELL or HOLD recommendation, I recently discussed some of PSEC's positive and negative trends to consider in the following prior article (read the Conclusions Drawn section for quick access):

Prospect Capital Corp.'s Results for Fiscal Q3 2016 - My Assessment (Including Current Price Target)

In addition, I recently wrote a comparison article which provided various metrics between PSEC and ten other BDC peers. The information provided within the following article provided additional support on my current BUY, SELL or HOLD recommendation (including prior/recent trading disclosures):

Prospect Capital's Valuation, NAV, and Dividend Compared To 10 BDC Peers (Post Calendar Q1 2016 Earnings) - Part 1

Final Note: The four tests provided within PART 1 do not "completely" consider certain future events that could occur over the next several fiscal years. Such events could have a direct impact on PSEC's "longer-term" dividend sustainability. As such, I believe it is only prudent to include additional analysis regarding PSEC's dividend sustainability for the next several fiscal years. As such, PART 1 of this article is only a PARTIAL analysis. A "full" conclusion regarding PSEC's future dividend sustainability will not be provided yet. PART 2 of this article will just pick up where PART 1's analysis ends. Since PART 1 of this article mainly covered PSEC's past and current performance, PART 2 will transition to a more forward-looking dividend sustainability analysis and will discuss some additional topics/trends to consider in a 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 PART 2 of this article, I will include the following PSEC projections: 1) next set of dividend declarations (dividend per share rate for September 2016 and October 2016); and 2) general NAV per share range for the next several fiscal quarters. PART 2 of this article will be available to readers in the near future.

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. The factual information provided within this article is intended to help assist readers when it comes to investing strategies/decisions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.