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This article provides an analysis of Prospect Capital's (PSEC) 4th quarter 2011 earnings report. PSEC is a business development company that lends to and invests in private and microcap public businesses. A large majority of their holdings are in industries related to the Energy Sector.

A few of the portfolio companies noted below should be monitored closely, as write-downs could result in future book value decreases. However, with that said, the overall portfolio of PSEC appears to be healthy as evidenced by its valuation above cost. For the quarter, PSEC delivered solid numbers, and appears to be well-situated to continue its trend of gradually increasing its dividend and growing book value.

Highlights

  • Net income of $0.59 per share, which more than covers the quarter's dividend by a factor of 1.9
  • PSEC's net asset value (NAV) in the last five quarters is as follows (from oldest to newest): 10.25, 10.30, 10.36, 10.41, 10.69
  • During the last 5 quarters, PSEC has increased book value by 4% while paying out $1.52 in dividends
  • Per the earnings report:

We have generated cumulative NII in excess of cumulative distributions to shareholders for both the current August 2012 tax year as well as since Prospect's initial public offering almost eight years ago. Depending on future distributions to shareholders, spillback dividend classification, and other factors, we may retain significantly all or a portion of recent realizations and reinvest them in additional income-producing investments.

Portfolio

  • Per the earnings report:

We are pleased with the overall credit quality of our portfolio, with many of our companies generating year-over-year and sequential growth in top-line revenues and bottom-line profits. None of our loans originated in over four years has gone on non-accrual status. The fair market value of our loan assets on non-accrual as a percentage of total assets stood at approximately 3.1% on December 31, 2011, down from 3.5% on June 30, 2011.

  • Portfolio fair value: $1.04 on the dollar. The fact that the PSEC portfolio is valued above par demonstrates its ability for capital appreciation. To put this $1.04 in perspective, another business development company that I follow, Gladstone Capital (GLAD), currently values its portfolio at $0.79 on the dollar.
  • No new loans were placed on non-accrual. The following statement was also made:

On December 29, 2011, Iron Horse Coiled Tubing, Inc. ("Iron Horse") repaid our $11.3 million loan. Iron Horse had previously been a non-accruing loan experiencing significant stress in 2009. Due to our supervision and the turnaround efforts of a new management team that we recruited, this loan returned to accrual status and was repaid in full, representing a 1.2 times cash on cash multiple and a 10% realized cash internal rate of return on our investment.

An important factor to future net investment income (and dividends) are the overall health of the portfolio. Any loans placed on non-accrual status mean the loan is no longer providing income. These loans could negatively impact future distribution levels. As such, I went through the most recent 10-Q and flagged any loan that is valued at less than $0.80 on the dollar and not listed as on non-accrual status. $0.80 was selected because values below this level suggest an increased likelihood for non-accrual status.
Only 1 item was returned from this query - PSEC provides a senior subordinated loan to New Meatco, which is currently valued at $0.77 on the dollar. The cost of this investment was 13.4 million. To put this number in perspective, given PSEC's float of 110 million shares, writing down this investment to 0 would result in a book value decrease of $0.09 per share from where New Meatco is currently valued. Besides this investment, the remainder of PSEC's portfolio appears to be quite healthy.

While loans on non-accrual status are not producing income, these loans may be currently valued above 0.00, and could consequently result in a book value decrease when further written down. The table below lists all loans on non-accrual, their cost, and their current value (cents on the dollar) as of 12/31/2011.

Company

Description

Cost (million)

Value (cents on dollar)

Borga

Senior secured term loan B

1.6

0.11

Integrated Contract

Secured promissory notes

2.6

0.43

Senior Demand Note

1.2

0.00

Senior secured note

0.7

0.00

Junior secured note

13.1

0.00

Manx Energy

Senior secured first lien note

2.0

0.00

Senior secured note

6.0

0.00

Senior secured note

3.6

0.12

H&M Oil & Gas

Senior secured note

60.0

0.65

Stryker Energy

Subordinated secured revolving credit facility

32.7

0.17

Wind River Resource

Senior secured note

15.0

0.38

The loan with the largest cost is to H & M Oil & Gas, with a cost of $60 million. A write-down of this loan to zero would result in a net decrease of $39 million. In terms of book value, the worst case scenario of a write-down to 0 would cause a book value decrease of $0.35. The status of this loan should be monitored closely going forward.

A write-down to zero of Wind River Resource and Stryker Energy would result in a net decrease of 5.7 million and 5.6 million, respectively. These investments should be monitored as well.

Source: Prospect Capital Q4 2011 Earnings Analysis

Additional disclosure: Short GLAD