How Prospect Capital Corporation Can Cover Its Dividend

Here's how Prospect Capital can cover its dividend with a little financial engineering.

Apr 8, 2014 at 7:00AM

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:

Credit Facility

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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Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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