Prospect Capital Corporation Q4 FY2025 earnings call

• Repositioning business: Rotation into first lien senior secured middle market loans, reduction in second lien and subordinated structured notes, prudent exits of equity-linked assets, enhancement of portfolio company operations, greater utilization of floating-rate revolver.
• Financials: Net investment income $79 million, $0.17 per share; NAV $3 billion, $6.56 per share; net debt to total assets ratio 30.4%; monthly common shareholder distributions of $0.045 per share for September and October.
• Real estate: 58 properties in NPRC with 4.5% income yield in June, exited 52 properties with 24% unlevered IRR and 2.4x cash-on-cash multiple, $378 million unrealized gain.
• Yields and accruals: Performing interest-bearing investments annualized yield 12.2%; interest income 95% of total investment income; non-accruals reduced from prior quarter.

In the June quarter, Prospect Capital's net investment income was $79 million, $0.17 per common share. NAV was $3 billion, $6.56 per common share. The first lien senior secured middle market loans mix increased 642 basis points to 70.5% from last year. Second lien senior secured middle market loans mix decreased 202 basis points to 14.4% from last year and further to 13.7% after repayments. Subordinated structured notes mix decreased 781 basis points to 0.6% from last year. Real estate (NPRC) represented 14% of investments at cost, had 58 properties with 4.5% income yield in June, and an unrealized gain of $378 million. Middle market lending strategy was 85% of investments at cost, with originations in June quarter totaling $271 million, 91% being middle market investment with majority first lien senior secured loans.

• Plan to redeploy asset sale proceeds into first lien senior secured middle market loans.
• Expect to selectively exit real estate and equity-linked assets to maximize value.
• Anticipate accelerating same property net operating income growth in real estate to double-digit.

• Industry challenges in multifamily: Inflation hitting OpEx and difficulty raising rents.
• Counterparty risk related to diversified funding sources and debt tranches.
• Market risks from interest rate changes affecting real estate and lending.

Q: We wanted to ask about the REIT. You've seen industry challenges in multifamily both on inflation hitting OpEx, and it's also been hard to raise rents to our understanding. Where do you think we are in terms of getting through those headwinds and seeing if you could give some outlook for the income trajectory if it should improve sooner or later or if today's income rate is sort of appropriate to model out.

A: Thank you, Finian. I think you articulated many of the prior headwinds within multifamily, but we're seeing a substantial turning the corner occur in our portfolio, and I'll take each of those in turn. First, it's widely diversified from a geographic standpoint. Many of our assets are located in areas in the Midwest and Mid-Atlantic or more sort of tertiary areas of the Sun Belt which weren't as targeted for development and actually have some fairly healthy rent growth. For certain assets in larger cities in the Sun Belt where there were supply additions in the market in the last few years. That is now abating substantially. There's a lag effect for new development. So developments that were started prior to 2022 when rates shot up didn't get completed until 2023, 2024, even a little bit at the beginning of 2025. Now much of that new supply has ground to a halt because of higher interest rates and higher development costs. which is very good for incumbent landlords like in our portfolio. That's on the revenue, rents and occupancy side. In terms of the cost equation, we've seen a significant slowdown in inflation, property taxes, insurance and payroll and all of that is quite favorable. Our book has had a like-for-like sort of same property net operating income increase of 7% in the last year. And we anticipate that accelerating to double- digit growth going forward. We are strategically focused as a middle market first lien senior secured lender. Real estate is substantially lower yielding than our middle market book. We are selectively exiting investments at a value maximizing price over time in a careful and prudent way. Of course, if we expect substantial NOI growth in certain properties, it may make sense to exit in a year or 2 as opposed to this second. It also makes sense to exit in a methodical bottoms-up singular asset or mini portfolio way to maximize buyer interest. There are a lot fewer buyers that can stroke a $1 billion check plus for the entire portfolio compared to ones that can buy individual assets or mini portfolio. So we're very pleased with the direction of our real estate business. We view the rotation from that 4.5% yielding a part of our book into middle market senior secured loans as a huge value driver for our business. Our last 10 or so deals in the middle market, which have been focused, as John mentioned, on sub-$50 million EBITDA companies have had an average spread of around 750 and an average floor of 300 basis points. So we're talking about double-digit yields in an all-weather fashion, even if rates get cut to are near 0, where they were only 3.5 years ago. So we've been resisting the upper middle market urge to jump into deals with tight spreads, with loose covenants with lender liability, liability management exercises low to no floors, no maintenance covenants, significant problems, and we're staying away from those Wall Street ask or larger club deals where so much capital has been focused. There's maybe 230,000 middle-market companies between $5 million and $150 million of EBITDA. The upper middle market, where there are so many problems in the $50 million to $150 million range, has only about 10,000 of those companies and the other 220,000 are sub-$50 million. That's where we're focused. They're harder deals to originate to underwrite, to close, but we originate thousands of deals per annum and have a low 0.5% book-to- look ratio with our 150-person strong team. So we're well equipped to do that. We've already unlocked value and streamlined and simplified our business by exiting our CLO book, you are not seeing this company message itself as we have in the past as a multiline player, we are focused on middle market lending first lien, senior secured with a portion of our assets from time to time purchasing selected equity that in many cases is highly synergistic with our debt and helps to command better debt terms, plus, of course, give us upside in many cases, without trade-offs through warrants through convertible debt and other types of liquidation preference security attached to our position. So that's what we're doing strategically and as it relates to real estate, Finian.