Prospect Capital Corporation (PSEC +0.00%) is the first major BDC to report earnings, and its second quarter was a good one.
The company earned $0.32 per share in net investment income, which puts it very close to covering its monthly dividends, which sit at roughly $0.011 per month, or $0.33 per quarter. Here are the three most important (and interesting) tidbits from the company's earnings report.
1. Leverage is coming in light
Prospect Capital reported that it's light on leverage -- the company's debt-to-equity ratio fell to 0.48 after subtracting cash on the balance sheet, meaning it had $0.48 of debt for every $1 in shareholder's equity. As a business development company, Prospect Capital is limited to $1 of debt for each $1 in equity, so it's safe to say Prospect is probably underleveraged.
This is good news for the dividend. Though Prospect Capital hasn't covered its dividend with net investment income in the last two quarters, increasing the company's portfolio leverage would likely propel net investment income above distributions paid to shareholders.
2. A new consumer-lending strategy
Prospect Capital announced a new "online direct consumer loan initiative" in its earnings press release. Given that Prospect Capital is heavily invested in consumer loans already, I couldn't help but immediately worry it was getting into the online payday loan game.
Those concerns were fleshed out in the quarterly filing with the SEC. Through one of its controlled REITs, Prospect Capital has set aside $19 million to invest in peer-to-peer loans, presumably through an exchange like Prosper or LendingClub. It's an interesting strategy, one that Prospect Capital is clearly ramping up (the SEC filing shows a series of $2-5 million investments to fund new peer-to-peer loans in a matter of two months).
I'd like to see Prospect Capital provide more information about its peer-to-peer lending goals. The biggest question is whether a 2-and-20 fee structure is really fitting for peer-to-peer loan investments. The average investor can make peer-to-peer loans on their own, so I'd like to see Prospect Capital do something the average person can't do.
It's possible Prospect Capital can add value with cheaper or greater leverage in the portfolio than the average investor can achieve, which would allow it to earn returns consistent with the yields it needs to earn its dividend.
3. Some new investments and sales
During the quarter, Prospect Capital sold one loan to National Bankruptcy Services at a loss, receiving $7.9 million for a loan worth $18.8 million at face value. No other loans were sold at a loss, and the company hasn't recorded any new loans on non-accrual, so loss rates are still quite low.
Additionally, the company stepped up its investment in First Tower, its largest consumer loans business, by $10 million on December 31. This is interesting, since First Tower tends to see greater demand in the fourth quarter of the calendar year, ahead of the holiday shopping season. It now appears that First Tower lending volumes may be even higher in 2014, which is great for Prospect. Remember, loans to First Tower are yielding 20% per year -- much higher than the 12.9% average for its performing loans.
All in all, this was just another quarter for Prospect Capital. The company nearly earned its dividend, suffered only small losses on one sold loan, and made total net investments of $352.4 million. In the land of volatile, middle-market investments, business as usual is as good as it gets.
