Prospect Capital Corporation’s Hunt for Higher Yields

Prospect Capital Corporation (NASDAQ: PSEC  ) has a problem: its investment yields are in decline. 

Now it has a solution: swap low-yielding debt investments for higher-yielding alternatives.

How it works
Prospect Capital announced a new "senior loan initiative" in which the company would sell low-yielding debt to third parties.

Prospect will free up investment capital it can dedicate to new, higher-yielding assets, removing the drag of low-return assets on its balance sheet. In the past year, yields on interest-bearing assets have fallen from 13.9% to 12.5%.

Additionally, the company believes it could generate on-going servicing revenue for managing the investments on behalf of another party.

I went through the company's latest quarterly report to check up on asset yields across the portfolio. Here's what that distribution looks like:

As you can see, the company has a substantial portion of its balance sheet dedicated to largely low-yielding assets. Some $712.5 million of debt investments yield less than 10%, and roughly half of that yields less than 7%. Fully half of the company's asset base yields under 12% per year.

Selling the lowest-yielding securities and reinvesting the proceeds in higher-return investments could be very accretive to total investment income. 

A 2 percentage point improvement in yields on its $712.5 million in sub-10% yielding debt would add $14.25 million in new total investment income, or about 7.5% of total investment income in the third quarter. 

The details of the program are still being worked out, but it's an undeniable reality that reallocating the portfolio could do a lot to reverse the effects of falling yields.

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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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8/28/2015 4:00 PM
PSEC $7.71 Up +0.21 +2.80%
Prospect Capital C… CAPS Rating: ****