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What to Expect for Prospect Capital’s Yield Expansion in 2018

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Yields to remain under pressure

The rise in interest rates has led to higher cost of capital for closed-end funds (PEX) and other leveraged companies. Spread compression has crept in across the industry, resulting in lower net interest income for a given size of portfolio. Prospect Capital (PSEC) has seen a decline in yields in recent quarters to 9.9% compared to a high of 13% in 2016. They’re expected to stabilize by mid-2018. However, yield curve reversal might be as early as the December quarter of 2018.

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Prospect Capital stock is currently trading at $6.70, which is lower than its NAV (net asset value) of $9.12 as of September 30, 2017. The company is going the convertible debenture route for raising further capital rather than equity dilution due to its discounted valuations. Ares Capital (ARCC), Apollo Investment (AINV), and BlackRock Capital (BKCC) are targeting mezzanine to senior secured debt, resulting in a slightly lower risk profile for its overall portfolio.

Net interest income

Prospect Capital posted total interest income of $158.6 million in fiscal 1Q18 compared with $179.8 million in the prior year’s quarter. Its income fell, mainly due to lower interest income and dividend income, partially offset by higher other income consisting of non-control and affiliate investments. Interest income declined to $148 million due to lower originations and spread compression.

The company’s operating expenses declined on a year-over-year basis. They fell to $94.8 million, mainly due to lower income incentive fees and other general expenses. The company is focusing on a new investment pipeline in order to boost its loan book. It currently has an entry-level investment grade rating of BBB- from the S&P 500.

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