5 Things Prospect Capital Corporation's Management Wants You to Know

Tough questions were asked of Prospect Capital's management following disappointing earnings. Here are the five most important takeaways.

Aug 28, 2014 at 11:10AM


Tough questions followed Prospect Capital (NASDAQ:PSEC) into Monday's conference call after the business development company reported disappointing fourth-quarter earnings.

Here are some of the most important takeaways from the call.

1. This quarter's results could be equally poor

It may seem too soon to think about earnings for the current quarter, which ends just a little over one month from today. But it seems like the quarter will be difficult, too.

On the conference call, President and COO Grier Eliasek said new investments were running lower than normal: "We have booked $239.1 million in originations so far in the current September quarter. Net of $322.3 million of repayments, our net repayment so far this quarter is $83.2 million."

Fewer originations underlied lackluster performance in the fourth quarter. Lower originations mean lower origination- and structuring-fee income, which were a vital portion of Prospect's historical earnings sources.

In the fourth quarter, Prospect Capital missed earnings expectations on $444 million in new investments. This quarter, Prospect Capital is on track to complete even fewer deals.

2. The company wants out of lower-yielding assets

Prospect Capital shares currently yield a little over 12%. Naturally, the low-yielding assets on its balance sheet are doing very little to support that dividend yield.

According to Eliasek, "We have some first-lien, senior secured assets yielding in the range of 6% to 7% which acts as an overall drag on our weighted-average yield and we are looking to potentially exit those while retaining administrative control and stewardship of the same credits."

Later, he provided some more detail into how Prospect would seek to shift these assets off the balance sheet: "We would actually do so in a way so that our assets would be primarily qualifying at least as one of the key strategies we're looking at."

What does this mean for shareholders? First, selling loans yielding 6%-7% to buy double-digit-yielding assets would clearly help support the current dividend. Selling them in a way that allows Prospect Capital Corporation to collect a management fee on the assets would be even better. This is nothing new; it's been the company's plan for two quarters.

Alas, Eliasek's second comment about making sure the assets are qualifying rules out a senior secured lending program -- a strategy employed by competitors including Golub Capital (NASDAQ:GBDC) and Ares Capital (NASDAQ:ARCC).

Admittedly, I'm perplexed as to how Prospect Capital plans on managing these assets in a way that makes them qualifying assets for a business development company structure. At any rate, it's certain that rotating out of lower-yielding investments to higher-yielding investments should help ongoing net investment income.

3. The dividend is at risk

Prospect Capital earned less than it paid out in dividends in every quarter of 2014. Now, with spillover income (retained earnings) in decline, the company will either need to start earning its dividend, cut its dividend, or maintain its dividend by making return of capital distributions.

When asked if Prospect Capital would maintain the dividend, even if it meant returning capital to shareholders, Eliasek explained the company's viewpoint: "Our policy strategy is to focus on paying out dividends out of taxable earnings and to avoid return of capital distributions over the long term, and we do have a spillback available to us to support that. But we also have catalysts which we hope will drive our earnings going forward."

Catalysts mentioned were rotating out of lower-yielding investments, reducing Prospect Capital's borrowing costs, and selling non-income-producing control investments to buy yielding assets.

Analysts further peppered management with questions about the sustainability of the dividend, but the answer remained that Prospect Capital would address dividends at a later time.

4. New at-the-market stock sales appear unlikely

Growing the balance sheet by selling new shares to the public has been one of Prospect Capital's most important sources for driving income. New stock sales mean more capital, which brings new investments, along with their accompanying origination and structuring fees.

When asked if there was any time frame for initiating at-the-market stock sales, Grier Eliasek answered plainly that, "No, we haven't made any final determinations yet on that ... and it will be against an opportunity set that we see in the market."

5. Dividend income might displace interest income

The annual earnings report revealed that Prospect Capital lowered interest rates on loans made to its control companies. This would obviously result in lower interest income, but Eliasek noted that it could be offset by larger dividends.

"[L]est you think that some others going to be a -- some downtick in income from those companies," he said, "remember these are companies where we own a significant portion of the equity as well and have the ability to take recurring distributions and do so for many of those."

The message here is that what is lost in interest income might flow through as dividend income. This will be something to watch carefully in future quarters. 

All in all, it was an interesting, if perplexing, conference call. On one hand, Prospect Capital has paid the largest dividend of any BDC for quite some time. On the other, it seems as though the yield may come into question in January 2015 -- the next month for which the company hasn't yet declared a dividend.

Top dividend stocks with yields that grow over time
The smartest investors know that dividend stocks simply crush their nondividend-paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information

Compare Brokers