Prospect Capital's Net Asset Value Sustainability Analysis (Post Fiscal Q1 2015 Earnings)

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Summary

This article discusses three topics/trends impacting PSEC's future NAV sustainability.

First, PSEC's recent dividend policy change should start having NAV benefits beginning in the fiscal third quarter of 2015 (quarter ending 3/31/2015).

Second, I have classified 94% of PSEC's investment portfolio performing near or above expectations as of 9/30/2014 (6% of portfolio was performing slightly, modestly, or materially below expectations).

Third, PSEC's investment portfolio continues to have several portfolio companies with moderate unrealized FMV losses (capital depreciation) thus modestly raising the risk of the company's future NAV sustainability.

Projections for PSEC's NAV per share ranges for the next three fiscal quarters and my buy, sell, or hold recommendation are stated in the "Conclusions Drawn" section of the article.

Author's Note: This article is a very detailed look at PSEC's NAV sustainability. I perform this detailed analysis for readers who anticipate/want such an analysis performed (which has materially increased from recent reader feedback). For readers who just want the summarized conclusions/results, I would suggest to scroll down to the "Conclusions Drawn" section at the bottom of the article.

Focus of Article:

The focus of this article is to provide a detailed analysis with supporting documentation on Prospect Capital Corp.'s (NASDAQ:PSEC) future NAV sustainability. I believe there are several topics/trends to discuss which allows readers to better understand PSEC's current and future outlook regarding the valuation of the company's investment portfolio. The following three topics/trends will play an important role regarding PSEC's future NAV sustainability: 1) recent change in dividend policy; 2) a cost/fair market value ('FMV') investment rating analysis on the company's debt and equity investments; and 3) a quarterly FMV gain (loss) analysis on the company's debt and equity investments. At the end of this article, I will provide my projected PSEC NAV per share range for the next three fiscal quarters. I will also include my current BUY, SELL, or HOLD recommendation regarding PSEC.

PSEC NAV Sustainability Analysis - Overview:

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 tend to have a direct impact on PSEC's future dividend sustainability whereas valuation fluctuations tend to have a direct impact on PSEC's future NAV sustainability (with some variables "intertwining").

For instance, if a portfolio company starts to see slowing operations and/or net losses, an FMV "write-down" (also known as capital depreciation) could occur on PSEC's debt investment. As such, the value of PSEC's investment portfolio would be reduced causing an immediate drop to EPS. This occurs even if the write-down is still "unrealized". Through Generally Accepted Accounting Principles ('GAAP'), quarterly FMV write-downs 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. 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 with that portfolio company to be put on "non-accrual" status. When this occurs, interest income would not be recognized 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 and NAV sustainability.

The same general risks would 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 inherently be deemed less valuable. As such, an 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 with an independent third party), PSEC's equity investment in that company would most likely see a reduction in dividend income. The probability of a portion or all of the cash distributions received by PSEC from the portfolio company would be deemed as a "return of capital" ('ROC') per GAAP and thus not a component of NII. As such, this would cause an immediate drop to PSEC's NII (and in most cases net ICTI) and have a direct impact on PSEC's future dividend and NAV sustainability.

1) Recent Change in Dividend Policy:

The first topic/trend to discuss is PSEC's recent change in policy regarding the company's monthly dividend per share rate. Over the past several years, PSEC continued to be one of the highest yielding business development companies ("BDC") in the sector. While most BDC peers experienced various levels of dividend reductions, PSEC continued to either increase or maintain (technically, fractionally increase) the company's dividend per share rate. However, some investors/analysts came to the conclusion there was growing pressure for PSEC to reduce the company's dividend based on the "non-coverage" of NII/net ICTI during the fiscal year 2014. During the fiscal year 2014, PSEC used a material portion of the company's cumulative NII and UTI balances to support its monthly dividend distributions. Regarding NII, this trend continued in the fiscal first quarter of 2015.

In the past, two of the main factors PSEC considered when declaring future monthly dividend per share rates were NII and net ICTI. However, it was recently announced PSEC would be changing the company's dividend policy beginning in February 2015. On 12/8/2014, PSEC's press release stated the company will be basing its future monthly dividend per share rate from "minimum expected NII". Minimum expected NII excludes dividend and fee income which is normally a part of NII. PSEC's new dividend policy also implied the company will not base its monthly dividend per share rate off of net ICTI. As such, this was the cause for PSEC's material dividend reduction (25%) beginning in February 2015. For "dividend lovers", this was seen as disappointing news. A detailed discussion/analysis of PSEC's change in dividend policy was provided in the following article:

Understanding Prospect Capital Corp.'s Recently Announced Material Dividend Reduction And Change In Policy

Let us now move on to the specific impact this change in dividend policy will have on PSEC's future NAV sustainability. During PSEC's fiscal second quarter of 2015 (quarter ending 12/31/2014), the company will distribute three monthly dividends totaling $0.331725 per share. Due to the material dividend reduction beginning in February 2015, during PSEC's fiscal third quarter of 2015 (quarter ending 3/31/2015), the company will distribute three monthly dividends totaling $0.277225 per share. During PSEC's fiscal fourth quarter of 2015 (quarter ending 6/30/2015 and assuming an unchanged monthly dividend rate of $0.0833 per share), the company will distribute three monthly dividends totaling only $0.24999 per share. When calculated, PSEC will eventually distribute approximately ($0.08) per share less in quarterly dividends when compared to the prior fiscal year. While investors will be receiving less in dividends, PSEC's NAV per share amount will directly benefit from the reduced distribution level.

When excluding the notion of PSEC distributing "special dividends" to remain in compliance with the Internal Revenue Code ("IRC") where distributions are based on net ICTI (taxed as a Regulated Investment Company ("RIC")), the company's NAV will be positively affected by an annual amount of approximately $0.32 per share. This is a positive factor regarding PSEC's future NAV sustainability. Further discussion/analysis of PSEC's NII/net ICTI metrics were covered in the linked article above. As such, further discussion/analysis of this topic is deemed unwarranted.

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

The second topic/trend to discuss is a cost and FMV investment rating analysis associated with PSEC's debt and equity investments. In particular, this analysis will highlight specific portfolio companies who have had FMV write-downs in the past and who are currently susceptible to further FMV write-downs over the next several fiscal quarters. Since FMV write-downs are one of the main determinants of whether to put a debt investment on non-accrual status (ceasing to recognize interest income on a particular loan), this analysis has a direct impact on PSEC's future dividend and NAV sustainability. Furthermore, since FMV write-downs (whether unrealized or realized) directly affect 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 the company's investment portfolio was rated, regarding investment valuations, as of 6/30/2014 and 9/30/2014. To begin this analysis, Table 1 is provided below.

Table 1 - PSEC Investment Rating Analysis (Based on Cost Basis and FMV)

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

Using Table 1 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/affiliate (purple coloring). A "control" investment is where PSEC owns (through an equity investment) more than 25% of a portfolio company's outstanding voting securities. An "affiliate" investment is where PSEC owns (through an equity investment) more 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 cost basis and FMV. I include each portfolio's cost basis to better highlight past FMV unrealized appreciation (depreciation) within each classification.

An investment rating of "1" describes the portion of debt and equity investments that were performing at or above PSEC's 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 1 as a reference, I have classified 89% and 87% of PSEC's investment portfolio having debt and equity investments that were performing at or above expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). As such, PSEC's investment portfolio had a minor percentage decrease regarding debt and equity investments performing at or above expectations during the fiscal first quarter of 2015. In my opinion, this is a somewhat cautionary trend due to the fact most of PSEC's quarterly loan originations funded at close and add-on investments typically begin within this investment rating. During the fiscal first quarter of 2015, PSEC had quarterly loan originations funded at close and add-on investments of $887 million. Therefore, a minor portion of PSEC's existing debt and equity investments were reclassified out of the investment rating 1 classification and into a lower rating during the fiscal first quarter of 2015. As of 9/30/2014, this investment rating had a cost basis of $5.31 billion while having an FMV of $5.46 billion.

I have classified 8% and 7% of PSEC's investment portfolio having debt and equity investments that were performing near expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). As such, PSEC's investment portfolio had a minor percentage decrease regarding debt and equity investments performing near expectations during the fiscal first quarter of 2015. This minor decrease in percentage was mainly attributed to several debt and equity investments being reclassified from an investment rating of 2 to an investment rating of 3. As of 9/30/2014, this investment rating had a cost basis of $459 million while having an FMV of $450 million.

When combined, I have classified 97% and 94% of PSEC's investment portfolio having debt and equity investments that were performing near, at, or above expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). When calculated, these two combined investment ratings had an increase (decrease) of (3%) during the fiscal first quarter of 2015. Again, this should be viewed as a somewhat cautionary trend regarding PSEC's future NAV sustainability.

When calculated, I believe 3% and 6% of PSEC's investment portfolio was experiencing varying levels of underperformance/nonperformance as of 6/30/2014 and 9/30/2014, respectively (based on FMV). When based on the investment portfolio's cost basis, these percentages inherently increase to 7% and 9% as of 6/30/2014 and 9/30/2014, respectively. When compared to several larger BDC peers (based on market capitalizations), PSEC had a larger percentage of debt and equity investments performing either slightly, modestly, or materially below expectations as of 9/30/2014.

Investment Rating 3 (Performing Slightly Below Expectations):

I have classified 2% and 3% of PSEC's investment portfolio having debt and equity investments that were performing slightly below expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). All debt and equity investments within this classification should be carefully monitored each quarter to watch for further FMV write-offs and possible non-accruals. As of 6/30/2014, this investment rating had a cost basis of $134 million while having an FMV of $125 million. As of 9/30/2014, this investment rating had a cost basis of $188 million while having an FMV of $174 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $49 million regarding the company's debt and equity investments performing slightly below expectations. As stated earlier, this should be seen as a cautionary trend due to the fact a majority of the increased FMV balance was attributed to several debt and equity investments being downgraded from an investment rating of 2 to an investment rating of 3.

Investment Rating 4 (Performing Modestly Below Expectations):

I have classified 1% and 2% of PSEC's investment portfolio having debt and equity investments that were performing modestly below expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). All debt investments within this classification should be CONSIDERED for non-accruals. 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 6/30/2014, this investment rating had a cost basis of $85 million while having an FMV of $73 million. As of 9/30/2014, this investment rating had a cost basis of $138 million while having an FMV of $119 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $46 million regarding the company's debt and equity investments performing modestly below expectations. The fiscal first quarter of 2015 was the second consecutive quarter where a modest increase to this investing rating occurred. I will briefly discuss a few of the portfolio companies who had this investment rating as of 9/30/2014.

As of 6/30/2014, I classified Atlantis Healthcare Group (Atlantis) with an investment rating of 4. PSEC's senior secured loan with Atlantis recognized a minor to modest unrealized FMV loss during the fiscal first and second quarters of 2014. As such, this specific investment went from a classification of 2 to 4 within several quarters. This debt investment's FMV remained fairly consistent over the fiscal third and fourth quarters of 2014. This general consistency continued into the fiscal first quarter of 2015. As such, Atlantis continued to be classified with an investment rating of 4 and should still be monitored for possible additional unrealized FMV losses (or gains) and a possible non-accrual in the future.

As of 6/30/2014, I classified Focus Products Group International, LLC (Focus) with an investment rating of 2. PSEC's senior secured term loan with Focus recognized a modest unrealized FMV loss during the fiscal first quarter of 2015. As such, this specific investment went from a classification of 2 to 4 within one quarter. As such, Focus should now have a heightened level of monitoring for possible additional unrealized FMV losses (or gains) and a possible non-accrual in the future.

As of 6/30/2014, I classified United States Environmental Services, LLC (U.S. Environmental) with an investment rating of 1. However, both of PSEC's senior secured term loans with U.S. Environmental recognized material unrealized FMV losses during the fiscal first quarter of 2015. As such, these specific investments went from a classification of 1 to 4 within just one quarter. It should also be noted U.S. Environmental was a fairly new portfolio company with funded loan originations beginning in the fiscal third quarter of 2014 (quarter ending 3/31/2014). Within just three quarters, PSEC's debt investments in U.S. Environmental went from performing as expected to performing modestly below expectations. Due to the fact both senior secured term loans mature in 2019, this particular portfolio company should now have a heightened level of monitoring for possible additional unrealized FMV losses (or gains) and possible non-accruals in the future.

Investment Rating 5 (Performing Materially Below Expectations):

Finally, I have classified under 1% and 1% of PSEC's investment portfolio having debt and equity investments that were performing materially below expectations as of 6/30/2014 and 9/30/2014, respectively (based on FMV). All debt investments within this classification should be on non-accrual status (unless there is a specific reason otherwise). 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 6/30/2014, this investment rating had a cost basis of $246 million while having a FMV of $17 million. As of 9/30/2014, this investment rating had a cost basis of $260 million while having an FMV of $47 million. When calculated, this analysis shows PSEC's investment portfolio had an increased FMV balance of $30 million regarding the company's debt and equity investments performing modestly below expectations. It is never a positive sign when a company has any part of its investments within this rating classification. From an FMV perspective, the monetary amount of PSEC's investments with a rating classification of 5 modestly increased during the fiscal first quarter of 2015. Instead of $17 million subject to a high probability of continued FMV write-downs as of 6/30/2014, I now have classified $47 million subject to a high probability of continued FMV write-downs as of 9/30/2014. Readers should also consider the cost basis within this classification. As of 9/30/2014, PSEC's debt and equity investments within this classification had a cost basis of $260 million while only having an FMV of $47 million. Hypothetically speaking, if all the debt and equity investments within this classification eventually were deemed worthless (FMV of $0), this would currently increase (decrease) PSEC's NAV by approximately ($0.13) per share.

As of 9/30/2014, I have classified numerous portfolio companies with at least one debt or equity investment having a rating classification of 5. The following portfolio companies had at least one debt or equity investment that was materially underperforming expectations (excludes investments with a FMV balance of $0): 1) Ajax Rolled Ring & Machine Services, Inc. ("Ajax"); 2) Freedom Marine Solutions, LLC (Freedom); 3) Gulf Coast Machine and Supply Co. ("Gulf"); 4) NMMB Holdings, Inc. ("NMMB"); 5) Valley Electric Holding Company I Inc. (Valley); 6) Wolf Energy, LLC ("Wolf"); and 7) Maverick Healthcare, LLC (Maverick). It should be noted several of these portfolio companies only had minor FMV equity interests remaining. Again, I am not saying the ENTIRE investment in each of these portfolio companies had an investment rating of 5. However, at least one debt or equity investment within each of the portfolio companies listed above had this classification.

The following companies listed above had debt investments on non-accrual status as of 9/30/2014 (which still had FMV balances): 1) Wolf. Out of the remaining portfolio companies which still had debt investments with an FMV as of 9/30/2014, I believe Valley had the most susceptible loans being put on non-accrual status in the near future. I will be paying particular attention to the debt investments of Valley for a possible non-accrual within the next several fiscal quarters. Readers should understand a non-accrual 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 94% of PSEC's investment portfolio as of 9/30/2014 was relatively stable and in "good health" (performing loans and equity investments; based on FMV). When calculated, 6% of PSEC's investment portfolio showed signs of slight, moderate, or material underperformance. These debt and equity investments will continue to be the portfolio companies I pay particular attention to as they are the most susceptible to continued FMV write-downs, nonperformance (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 NAV sustainability. When compared to the calculated percentages from the prior quarter (97% and 3%), I believe PSEC's investment portfolio, from an FMV versus cost perspective, appeared to be less attractive.

3) Quarterly FMV Gain (Loss) Analysis on PSEC's Debt and Equity Investments:

The last topic/trend to discuss is a quarterly FMV gain (loss) analysis associated with PSEC's debt and equity investments. This is somewhat different than the cost/FMV investment ratings analysis performed above. This quarterly FMV gain (loss) analysis specifically analyzes all material unrealized FMV gains (losses) regardless of what investment rating a portfolio company is in. This analysis helps detect unrealized FMV gains (losses) that recently occurred and identifies potential struggling investments that were once (or still are) performing at or above expectations. This analysis also helps identify which debt and equity investments that were once troubled now show recent signs of modest to material improvement.

When PSEC reported results in regards to the company's fiscal first quarter of 2015, multiple portfolio companies caught my attention regarding a material unrealized FMV gain (loss). This will have a direct impact on PSEC's future NAV sustainability.

Table 2 - PSEC Quarterly Material FMV Gain (Loss) Analysis

(Source: Table created entirely by myself, partially using PSEC data obtained from the SEC's EDGAR Database [link provided below Tables 3])

Using Table 2 above as a reference, the following portfolio companies had a material unrealized FMV gain during the fiscal first quarter of 2015: 1) Ajax.; 2) First Tower Holdings of Delaware, LLC (First Tower); 3) Harbortouch Holdings of Delaware Inc. (Harbortouch); 4) MITY, Inc. ("Mity"); 5) National Property REIT Corp. (National Property); 6) Matrixx Initiatives, Inc. (Matrixx); and 7) Sudbury Mill CLO, Ltd. (Sudbury). The following portfolio companies had a material unrealized FMV loss during the fiscal first quarter of 2015: 1) American Property REIT Corp. (American Property); 2) Echelon Aviation, LLC (Echelon); 3) Gulf; 4) Valley; 5) Babson CLO, Ltd. 2011-I (Babson); and 6) U.S. Environmental. Out of the six portfolio companies who had a material unrealized FMV loss for the fiscal first quarter of 2015, four were control investments.

For future quarters, the companies shown in Table 2 above will be one of the first groups of investments I will pay attention to regarding quarterly FMV gains (losses). The various quarterly FMV fluctuations within Table 2 are one reason why PSEC's NAV net decreased during the fiscal first quarter of 2015. Regarding the material decrease in Echelon's FMV, this equity write-down was mainly attributed due to the "monetization event" that occurred in September 2014. This event was covered, in detail, within the following prior PSEC article:

Update: Prospect Capital Declares January 2015 Dividend In Line With My Projection And Discloses A Material 'Monetization Event'

It should also be noted while PSEC's collateralized loan obligation ("CLO") portfolio continued to perform materially above the company's expectations, one specific investment began to show signs of "stress" during the fiscal first quarter of 2015. As noted above, this was the CLO investment with Babson. A CLO is a form of securitization where debt investments are pooled together and passed on to different classes of owners in various tranches. Instead of receiving a fixed interest amount, a CLO investment distributes interest (per a "waterfall" calculation) based on which particular "level" a company is situated within the tranche structure. Depending on which tranche a company is classified within, each class of owners is entitled to more/less of the interest payments than the next. However, with this added potential interest income is the heightened risk of being allocating a greater proportion of principal losses in the case of non-performance of a portion (or all) of the CLO. One main point readers should take from a CLO is these types of investments inherently have a higher level of risk (potential principal loss) but also inherently have a higher level of return (potential yield). Again, this all gets back to the risk versus reward metric.

Along with the potential "high risk/high reward" profile of a CLO investment (dependent on each company's tranche), there are complex methods to value these types of securitizations at regular intervals. These valuation techniques are based on modeled projections using a high degree of "management judgment". Below is a quoted text from PSEC's most recent 10-K SEC filing:

"…Our investments in CLOs are classified as ASC 820 Level 3 securities and are valued using a discounted cash flow model. The valuations have been accomplished through the analysis of the CLO deal structures to identify the risk exposures from the modeling point of view. For each CLO security, the most appropriate valuation approach has been chosen from alternative approaches to ensure the most accurate valuation for such security. To value a CLO, both the assets and the liabilities of the CLO capital structure are modeled. We use a waterfall engine to store the collateral data, generate collateral cash flows from the assets based on various assumptions for the risk factors, and distribute the cash flows to the liability structure based on the payment priorities, and discount them back using current market discount rates. The main risk factors are: default risk, interest rate risk, downgrade risk, and credit spread risk...."

In other words, these securities are extremely difficult to precisely value, and PSEC, along with an independent valuation company, uses various models/assumptions to create an estimated FMV at a given point in time. Each securitization is made up of numerous debt investments either domestically, globally, or a combination of both. Also, the loans held within these securitizations are usually comprised of numerous sectors. As such, readers should understand the inherent assumption that a CLO investment will generally have material unrealized FMV gains (losses) as market environments change. Again, this will have a direct impact on PSEC's future NAV sustainability.

As shown in Table 2 above, Babson had an unrealized FMV gain (loss) of ($3.3) million during the fiscal first quarter of 2015. When I first noticed this unrealized FMV loss, I made a note to myself to begin monitoring this CLO investment in future quarters. Furthermore, I also wanted to begin monitoring the two other Babson CLO investments as well. Within one of PSEC's recent SEC filings, the following disclosures were provided regarding several CLO investments during the fiscal second quarter of 2015 (quarter ending 12/31/2014):

"…On October 3, 2014, we sold our $35,000 investment in Babson CLO Ltd. 2011-I. and realized a loss on the sale…On October 20, 2014, we sold our $22,000 investment in Galaxy XII CLO, Ltd. and realized a loss on the sale… On December 4, 2014, we sold our $29.1 million investment in Babson CLO Ltd. 2012-I and realized a loss on the sale… On December 4, 2014, we sold our $27.8 million investment in Babson CLO Ltd. 2012-II and realized a loss on the sale..."

While an eventual net realized loss was "expected" regarding one of PSEC's CLO investments (Babson CLO Ltd. 2011-I; investment rating 3 as of 9/30/2014), the company also disclosed three other CLO investments recently incurred net realized losses. In my professional opinion, this was fairly disturbing due to the fact these three other CLO investments were performing at or above expectations as of 9/30/2014. Again, this gets back to the nature of level 3 assets per GAAP (no quoted prices available; FMV ultimately based on management's judgment). As such, actual FMV prices could be materially different when sold versus what was recently determined.

From the analysis performed above, PSEC's investment portfolio continues to have several portfolio companies with moderate unrealized FMV losses (capital depreciation) thus modestly raising the risk of the company's future NAV sustainability. The recent disclosures regarding several of PSEC's CLO investments incurring net realized losses also raises the risk of the company's future NAV sustainability.

Conclusions Drawn:

To reiterate what was performed in this article, the following three topic/trends were discussed which will have a direct impact on the PSEC's future NAV sustainability: 1) recent change in dividend policy; 2) a cost/FMV investment rating analysis on the company's debt and equity investments; and 3) a quarterly FMV gain (loss) analysis on the company's debt and equity investments.

When the three topic/trends are taken into consideration, I believe there is relatively strong evidence several of PSEC's debt and equity investments are at risk for varying levels of net realized and unrealized FMV losses (especially certain control investments) in future quarters. However, there are a few of PSEC's debt and equity investments that should continue to perform at or above expectations in future quarters. I currently project the probability associated with future net unrealized FMV losses are slightly greater than the probability associated with future net unrealized FMV gains. In my opinion, the recent CLO investment net realized losses help solidify this projection. However, beginning in February 2015, a positive NAV impact will start taking shape when PSEC's newly reduced dividend per share rate occurs. As such, I am projecting the following quarterly NAV ranges over the next three fiscal quarters:

NAV as of 12/31/2014 (Fiscal Second Quarter of 2015): $10.30 - $10.50 per share

NAV as of 3/31/2015 (Fiscal Third Quarter of 2015): $10.25 - $10.50 per share

NAV as of 6/30/2015 (Fiscal Fourth Quarter of 2015): $10.25 - $10.55 per share

Therefore, I am projecting an average flat to slight decrease in PSEC's NAV over the next three fiscal quarters. On the other hand, PSEC's "economic return" (dividends received and change in NAV) should continue to provide a slight to modest positive return over the next three fiscal quarters. In other words, as long as PSEC's NAV does not increase (decrease) by approximately ($0.86) per share over the next three fiscal quarters, the company's economic return will still be positive. I also believe PSEC's stock price has already been discounted for the upcoming dividend reduction.

PSEC recently closed at $8.51 per share as of 12/26/2014. This was a ($1.96) per share premium (discount) to PSEC's NAV of $10.47 per share as of 9/30/2014. This calculates to a price-to-NAV ratio of 0.813 or a premium (discount) of (18.70%). I currently rate PSEC as a HOLD when trading at a material (at or over 10%) discount to CURRENT NAV. This recommendation would change to a BUY when I believe PSEC's stock price is trading at an excessively material (at or over 15%) discount to CURRENT NAV.

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

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.