How Prospect Capital Corporation Can Cover Its Dividend

It seems earnings season never ends. With about one month to go before business development companies report earnings, I wanted to take a look at Prospect Capital Corporation (NASDAQ: PSEC  ) and its dividend.

As shareholders know, Prospect Capital has failed to cover dividends for several quarters. However, there's a quick fix to its inability to earn more than its dividend: use cheaper leverage.

Prospect's funding costs
Prospect Capital has one of the highest funding costs of the BDC industry as a result of its reliance on more expensive, long-term debt financing. Most of its funding comes from higher-cost, fixed-rate debt obligations.

Its high funding costs are partly to blame for its inability to cover the dividend.

Last quarter, Prospect Capital earned $0.32 in net investment income per share, failing to cover the more than $0.33 in dividends it pays shareholders each quarter.

I modeled a few different scenarios in which Prospect Capital uses more of its credit facility to make new investments at its average portfolio yield of 12.9%. Here are the results:

  • 20% of the facility: $0.035 in additional annual income per share
  • 30% of the facility: $0.053 in additional annual income per share
  • 51% of the facility: $0.096 in additional annual income per share

Two of these scenarios (30% and 51% utilization) would allow Prospect to more than cover its dividend.

Interestingly, the more Prospect Capital borrows under its credit facility, the cheaper its borrowings become. This is because Prospect pays fees equal to as much as 1% of all unused credit each year. If you were to graph Prospect Capital's credit facility costs as a percentage of the total amount borrowed, it'd look like this:

The more it borrows, the less impact unused credit facility fees have on its income statement. 

Will it cover the dividend this quarter?
On the March 18 webcast, Prospect Capital COO Grier Eliasek noted that the company was not currently raising new capital by issuing new shares. The company's stock traded too close to its net asset value, and selling pressure from index funds would prohibit Prospect from using its at-the-market program to raise new capital.

If Prospect reveals a higher balance on its credit facilities, and the desire to keep a balance, it could easily cover its dividend. It's not a question of if, but when.

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Read/Post Comments (3) | Recommend This Article (3)

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  • Report this Comment On April 08, 2014, at 9:52 AM, firozshroff wrote:

    My 2 cents on future of Prospect

    Among Business Development Corporation BDC space - Certainly I like Prospect - I am investing.


    Has good management - why - when the senior management has no ego issue they write direct to prospect.- email from Grier Eliasek - Keep it up. I like your marketing approach.....

    I like their territory USA and Canada - safest place in the world.- As their ecosystem matures and the integrative power is diagnosis and recognized ( I see it) they can franchise the process in most countries for with a local partner.for fees and piece of pie for

    Also like the size of investment $ 10 mill to $ 250 mill.

    The hidden jewel is various sectors - These sectors are directly giving them to integrative powers to develop an ecosystem for comparison to measure return and opportunities sectors and industries and how to migrate and them into new space.

    Prospect could become Amazon of BDC...

    Wait and see when Prospects one morning like Amazon learns to combine Wellness/Healthcare- Real Estate - Technology - Food - Education - Business Services into one powerful piece. Their highest return will come from their Intellectual Assets i.e system,process, people, know how, ecosystem and integrative approach.

    Don't watch for divided - watch their business model they will make humongous wealth for the shareholders

  • Report this Comment On April 14, 2014, at 2:25 PM, OffTheCharts wrote:

    Hi Jordan, Thanks for the insights. This article left me with one large question: why? Why does Prospect choose to not utilize its credit facility, where does it prefer to rely on its alternative means of financing and leave its facility for a "rainy day" or for the potential for large acquisitions (Patriot Capital 2009). It just seems to me that a management group like those at Prospect must have a valid reason for not utilizing the facility (and continuing to amend/grow it from time to time). Any explanation on the matter would be extremely helpful.

  • Report this Comment On April 14, 2014, at 3:56 PM, TMFValueMagnet wrote:

    OffTheCharts, I wish I had an answer. Prospect's management seems to think it'll have the opportunity to deploy the credit line in the next cycle, presumably to buy cheap assets other players need/want to sell.

    Why that precludes them from making use of at least some of its massive credit facility is beyond me. Either way, it's becoming clear that Prospect Capital's management sees an unused credit facility as a small opportunity cost to pay to keep it open for bargains.

    As for whether they're right or wrong won't be proven until we reach a turn in the credit cycle.

    But it is important to point out that with a 2% management fee on all assets (including borrowed amounts), their notes program leaves a pretty small spread between the all-in borrowing cost, and investment yields. The credit facility is much cheaper in that respect, even after accounting for the 2% management fee.

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Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

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