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The Secret to Prospect Capital’s Successful Leveraging

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Spreads on leverage

Prospect Capital (PSEC) is deploying higher leverage to take advantage of low interest rates. The company’s fiscal 2Q16 (which ended December 31, 2015) net debt-to-equity ratio rose marginally to 77.9% over its 77.6% fiscal 4Q15 and 55.7% in 4Q13. The company still has significant unencumbered assets, matched book funding, access to diversified funding markets, and an unsecured fixed-rate liability focus.

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Reductions in equity

Prospect Capital has suspended its market equity issuances for the indefinite future due to unattractive share price levels. This reduction in equity and asset growth has resulted in lower net origination volumes than in previous quarters, and the company is looking at spin-offs and increasing leverage as sources for raising capital. More leverage should allow Prospect Capital to generate a higher return for its equity holders.

Prospect’s peers generated the following returns on equity:

  • CIT Group (CIT)—12.7%
  • American Capital (ACAS)—7.2%
  • United Rentals (URI)—35.9%

Together, these companies form 2.0% of the PowerShares Global Listed Private Equity ETF (PSP).

Balance sheet expansion

Prospect Capital’s cost of debt is approximately 5.6%, compared to above 6% in one year previously. It achieved this reduction by repaying certain higher-cost debts and by using its revolving credit facility efficiently. The enhanced debt on the company’s balance sheet is supported by the repeat issuance of five-to-30-year unsecured term debt. This has extended its average liability duration.

Prospect Capital has also managed a lower interest rate on its revolving credit facility by choosing LIBOR (Intercontinental Exchange London Interbank Offered Rate) plus 225 basis points, instead of LIBOR plus 275 basis points without the clause of minimum LIBOR. The company’s revolving credit facility continues to carry an investment grade Moody’s rating of Aa3. PSEC’s balance sheet assets fell to $6.3 billion as of December 31, 2015, compared to $6.8 billion on June 30, 2015, and net assets also fell to $3.4 billion as of December 31, 2015, compared to $3.7 billion on June 30, 2015.

Now let’s discuss Prospect Capital’s spin-off strategy for raising capital.

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