Prospect Capital Corp
NASDAQ:PSEC
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Prospect Capital Corp
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Good day, and welcome to the Prospect Capital First Fiscal Quarter Earnings Release and Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to John Barry, CEO. Please go ahead.
Thank you, Dave. Joining me on the call today are Grier Eliasek our President and Chief Operating Officer; and Kristin Van Dask, our Chief Financial Officer. Kristin?
Thanks, John. This call contains forward-looking statements that are intended to be subject to safe harbor protection. Future results are highly likely to vary materially. We do not undertake to update our forward-looking statements. For additional disclosure, see our earnings press release and 10-Q filed previously and available on our website, prospectstreet.com. Now I'll turn the call back over to John. .
Thank you, Kristin. Before we get started, I wanted to apologize to Finian O'Shea for what I said on our last earnings call. When the love of your life tells you after an earnings call, John you shouldn't have said that. You instantly know you shouldn't have said that.
When you've been doing this for 37 years like I have and founded Prospect from scratch, sometimes criticism of our people can feel unfair. But at Prospect we have a saying, blast furnaces temper the best deal. Finnie and I appreciate your tough questions on our business and from other people at Wells and other firms, and we look forward to working with all of you in the years to come.
Now on to official business. In the September quarter, our net investment income or NII was $89.9 million or $0.21 per common share. Our NAV was $3.51 billion or $8.10 per common share. At September 30, our net debt to total assets ratio was 29.7%. Unsecured debt plus preferred is 86% of total debt, plus preferred for Prospect.
Since inception over 20 years ago through our January 2025 declared distribution we will have distributed $4.4 billion or $21.25 per share, representing 2.6x September 2024 common NAV per share and 4.1x our Wednesday stock price closing. We are announcing monthly common shareholder distributions of $0.045 per share for each of November, December and January.
We plan on announcing our next set of shareholder distributions in February. We are rightsizing our common shareholder distribution rate as we continue to execute our long-term income and total return strategies by rotating structured credit, CLO equity and real estate investments into our core business of first lien senior secured middle market loans including sometimes with selected equity co-investments.
Our preferred shareholder cash distributions continue at the contractual rates of such distributions. CLO equity and real estate investments have generated attractive unlevered investment level, gross cash IRRs 12% for CLO equity and 24% for real estate property exited investments, since inception of such strategies in 2011 and 2012, respectively. But with more variability compared to our core business. As we rotate into lower variability middle-market corporate investments, our recurring income, as shown by interest income as a percent of total income has reached 94% an increase of over 800 basis points for the year-over-year quarterly period.
We still perceive CLO equity and real estate investments as attractive risk-adjusted strategies. We intend another fund to be developed and to be managed by an affiliate of Prospect Capital Management to continue to focus on new CLO investments with less targeted Prospect Capital Corporation balance sheet investment in this strategy going forward.
Similarly with real estate. CLO equity has decreased to 6% of our assets versus 18% as of September 30, 2017 as we execute on our rotation strategy to emphasize first lien senior secured lending with such mix growing significantly for us. CLO equity typically generates attractive cash-on-cash yields, but such yields tend to be higher in the initial years while lower in the later years thereby resulting in variability that we seek to reduce by focusing more on our core business at Prospect Capital Corporation.
Real estate investing is a total return strategy that has been a solid fit for Prospect Capital Corporation during periods of low short-term and medium-term interest rates. We have exited dozens of our value-add properties in the past several years after achieving strong rent and net operating income performance. We have also generated substantial exit-related income from real estate property sales over the years with such exit-related income decreasing recently as we have had fewer exits.
While we expect to monetize further real estate property investments, with attractive returns, we are cautious about the pace of future exit-related income. Over the last 7 weeks, the Fed has reversed 75 basis points of prior short-term interest rate increases that hurt our book with market expectations for more reductions going forward, which may lower future shareholder distribution rates across all related credit industries.
We have already factored in the declining forward curve for short-term interest rates for our common shareholder distribution declaration today.
Thank you. I'll now turn the call over to Grier.
Thank you, John. Over the past 2 decades, Prospect Capital Corporation has invested $11.4 billion and over 300 exited investments that have earned a 13% unlevered investment level gross cash IRR to Prospect Capital Corporation. This 2-decade time period includes the GFC and has been dominated in general by low reference interest rates. The majority of peer BDCs have not been battle-tested by such general economic downturn in other headwinds. Our core business of directly originated non-syndicated first lien senior secured loans to U.S. middle-market companies, sometimes with selected equity co-investments offers multiple compelling attributes.
First lien loans as a percentage of total investments have now reached 65%, an increase of over 700 basis points for the year-over-year quarterly period. Such core business with proprietary opportunity flow offers higher spreads than lending to much larger companies which loans are experiencing significant spread compression for other lenders focused on that more competitive and commoditized larger end of the market.
Middle market loans by comparison, offer higher interest rate floors, often 250 to 400 basis points versus loans to larger companies which often have only 0 to 100 basis point floors, thereby providing better protection for yield and income when short-term interest rates decline. Such higher floors benefited Prospect Capital Corporation greatly when the Fed last sharply reduced such rates during the GFC.
First lien senior secured middle market loans, different from CLO equity and real estate investments also are eligible for favorable financing with our efficient cost revolving credit facility, helping to further enhance our net investment income. With such core business middle market investments, we also sometimes have an opportunity to structure investments with equity upside, including through warrants, convertible debt and 2x liquidation preferences. With an objective to maximize current yields and total returns in a prudent and risk-adjusted fashion.
Many such investments that we are currently underwriting have targeted unlevered double-digit current yields and unlevered total returns of 12% to 15% or more. With such yields and total returns further enhanced by our credit facility to lift targeted levered returns to 18% to 20% or more.
Recent investments like RK Logistics, Discovery Point and Druid City, illustrate such nonsyndicated middle-market focus where we also capture equity upside. Our middle market portfolio companies also have the potential to drive substantial synergistic value creation with add-on acquisitions. With examples, including Valley purchasing Comet and R-V Industries making multiple acquisitions.
With such middle market investments, we have a greater ability to add value to management teams that benefit from our experienced prospect team of over 130 professionals in areas like Board supervision, operational assistance, strategic planning, executive recruiting, add-on acquisition sourcing in other important areas. Our pipeline continues to build with additional non-syndicated first lien senior secured middle market loans with selected equity co-investments, which we expect to deliver substantial benefits to Prospect Capital Corporation and its shareholders going forward.
For the September quarter, our portfolio at fair value comprised 64.9% first lien debt -- that's up 7.6% from the prior year, 11.1% second lien debt. That's down 4.8% from the prior year. 6.2% subordinated structured notes with underlying secured first lien collateral, that's down 1.9% from the prior year and 17.8% unsecured debt and equity investments, that's down 0.9% from the prior year, resulting in 82.2% of our investments being assets with underlying secured debt benefiting from borrower-pledged collateral. We're pleased with our continued success in executing our plan to increase our first lien mix while reducing our second lien and subordinated structured notes exposure, thereby reducing portfolio risk.
Prospect's approach is one that generates attractive risk-adjusted yields, and our performing interest-bearing investments, we're generating an annualized yield of 11.8% as of September. Our interest income in the September quarter was 94% of total investment income, reflecting a strong recurring revenue profile to our business.
As of September, we held 117 portfolio companies with a fair value of $7.5 billion. We also continue to invest in a diversified fashion across many different portfolio company industries with a preference for avoiding cyclicality and industry concentration. As of September, our asset concentration in the energy industry stood at only 1.5% in hotel, restaurant and leisure sector stood at only 0.3%.
And in the retail industry stood at only 0.1% as examples of cyclical industries where we have low exposure. Nonaccruals as a percentage of total assets stood at approximately 0.5% in September. Weighted average middle market portfolio net leverage stood at 5.7x EBITDA. Our weighted average EBITDA per portfolio company stood at $105 million. Originations in the September quarter aggregated $291 million.
We also experienced $282 million of repayments and exits as a validation of our capital preservation objective, resulting in net originations of $8 million. During the September quarter, our originations comprised 85.8% middle market lending, 7.8%; real estate and 6.1% middle market lending and buyouts. So far in the current December quarter, we booked $42 million in originations and experienced $163 million of repayments.
Thank you. I'll now turn the call over to Kristin. Kristin?
Thanks, Grier. We believe our prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets weighting toward unsecured fixed rate debt, avoidance of unfunded asset commitments and lack of near-term maturities demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. .
Our company has locked in a ladder of liabilities extending 28 years into the future. Our total unfunded eligible commitments to portfolio companies totals approximately $48 million representing approximately 0.6% of our assets. Our combined balance sheet cash and undrawn revolving credit facility commitments currently stand at $1.5 billion. As of September, we held $4.9 billion of our assets as unencumbered assets, representing approximately 64% of our portfolio. .
The remaining assets are pledged to Prospect Capital funding, a nonrecourse SPV. In June, we successfully completed an amended and extended credit facility with a new 5-year maturity. We currently have $2.12 billion of commitments from 48 banks, demonstrating strong support of our company from the lender community with the diversity unmatched by any other company in our industry.
The facility revolves until June 2028, followed by a year of amortization with interest distributions continuing to be allowed to us. Our drawn pricing continues to be SOFR plus 2.05%. Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect Capital Corporation, including in the past few years, multiple types of investment-grade unsecured debt, including convertible bonds, institutional bonds, baby bonds and program notes.
All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We currently have 5 investment-grade ratings more than any other company in our industry. We've now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 28 years with our debt maturities extending through 2052.
With so many banks and debt investors across so many unsecured and nonrecourse debt tranches, we have substantially reduced our counterparty risk. At September 30, 2024, our weighted average cost of unsecured debt financing was 4.42%.
Now I'll turn the call back over to John. .
Thank you, Kristin. I think it's time for us to take questions if we have any. Thank you very much.
[Operator Instructions] Our first question comes from Finian O'Shea with Wells Fargo Securities.
I appreciate the opening remarks, John.
Welcome back. We're delighted to hear your voice.
Likewise, I know we both always like to have a good time when talking about BDC. So just one this quarter on the dividend. So it feels more rightsized now, but it's still a comparatively low yield on book. And of course, that weighs on valuation for a BDC, which isn't ideal. So you touched on some things, I think, CLO rotation. But can you help outline or quantify like how much you can rotate where those pockets are and what you can -- what you sort of strive for on driving an improved book return.
I'd love to, but I'm not allowed to answer any questions. Actually, I gave my little [indiscernible] at the beginning. Grier, why do we hear from Grier because I'm sure he will have a slightly different perspective.
Sure. Fannie, thank you for your question. So in the CLO segment, we talked about how income and yield tends to be front-end weighted during the life of the deal. And while we're enjoying a reasonably robust cash flows, we're actually not recognizing much income from a GAAP standpoint. And that book is, therefore, amortizing significantly. I think we're getting somewhere along 2% or 3% GAAP yield off of CLOs, which obviously is well below the double-digit yields plus equity upside in many cases that we can earn on our core business of middle market lending, which has been quite robust with successful recent investments.
So by continuing to amortize that book and you see every quarter it continues to amortize and drop as a percentage of the portfolio. We're now at about 6% of the book in CLOs. That should provide in earnings boost. That's area #1. Area #2, which we also highlighted is real estate, which is a terrific total return strategy, but a lot of the return is more exit driven as opposed to on a current basis.
When SOFR was near 0 and maybe we'll return to that at some point, depending upon the pacing of Fed cuts. We've obviously had 75 bps and only 7 weeks here, getting a sort of high single-digit yield on real estate was competitive with middle market lending, plus we had upside beyond that.
And in the current environment, that's not as competitive and we think monetizing our real estate as we've continued to do and expect to do in a prudent and orderly fashion to again, rotate into our core business of middle market lending with equity upside is prudent and much of that real estate has appreciated through our successful investing in value-add workforce housing.
So that's area number #2, area #3 would be exiting again in a prudent fashion successful middle market deals where we also hold equity, and we think that it's the right time to exit was often appreciated equity and rotate once again into a slate of new deals to produce a higher current income and total return running a permanent capital business, what we do from a capital efficiency and discipline standpoint is to examine our foregone return where we to potentially hold particular investments.
And if we've concluded foregone IRR to foregone yield we examined both are below our hurdle rates then we'd rather sell to a third party and then rotate. So we think this provides significant upside to our business going forward to boost our return on equity, which we're relentlessly focused on. Thank you.
This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.
Okay. Well, thank you, everyone. Have a wonderful morning, and we'll see you in a quarter. Thanks so much. Bye now.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.