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PSEC Cashes In on Its Controlled and Structured Credit Strategy

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Higher controlled investments

Prospect Capital’s (PSEC) controlled investments in fiscal 3Q16 stood at 33.3% of its total portfolio compared to 32.5% in the previous quarter.

The company has selectively monetized its controlled positions when it has found attractive pricing. Subsequently, it has deployed the proceeds into new, attractive opportunities yielding higher returns at lower risks.

Prospect Capital is deploying investments for the online lending industry, with a focus on near-prime, prime, and subprime consumers as well as small business borrowers. The company generated 20% of its origination in the quarter through online lending. Overall originations fell substantially in the quarter.

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During fiscal 2014, the company entered the online lending industry jointly with National Property REIT (or NPRC). Its total business currently stands at ~$700 million across multiple third-party and captive origination and underwriting platforms. In fiscal 3Q16, the company made one follow-on investment in NPRC totaling $2 million.

The business currently delivers an expected leveraged yield of ~17%. In 2015, the company closed four bank credit facilities and one securitization to enhance its returns. It’s also focusing on diversifying origination sources for its online business in order to generate more leads. Its earnings per share growth in the investment management space is as follows:

  • CIT Group (CIT): 78%
  • American Capital (ACAS): 157%
  • United Rentals (URI): 33.8%

Together, these companies form 14.8% of the ProShares Global Listed Private Equity (PEX).

Outperforming structured credit

Prospect has been focusing on the strategy of pursuing majority stakes, working with strong management teams, providing strong collateral underwriting through primary issuance, and targeting attractive risk-adjusted opportunities.

As of March 31, 2016, Prospect has invested in 38 structured credit investments with a fair value of $996 million, with individual standalone non-recourse financing to the company and risk capped at the net investment amount. Its underlying structured credit portfolio comprised over 3,000 loans and a total asset base of over $18.5 billion. The portfolio experienced a trailing-12-month default rate of 1.2%, or 59 basis points less than the broadly syndicated market rate of 1.8%.

In fiscal 3Q16, Prospect’s structured credit equity portfolio generated an annualized cash yield of 27.0% and an annualized GAAP (generally accepted accounting principles) yield of 17.7%. The portfolio has generated $633.7 million in cumulative cash distributions, representing 48.8% of the original investment.

In addition, the company has exited seven structured credit investments totaling $153.6 million, with an average realized internal rate of return of 16.8% and a cash-on-cash multiple of 1.42x.

In the next part of this series, we’ll discuss Prospect’s higher leverage, which allows it to take advantage of low interest rates.

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