Prospect Capital (PSEC) Q1 2026 earnings call transcript

I would now like to turn the conference over to John Berry, Chairman and CEO. Please go ahead.

Thank you, Danielle. Joining me on the call this morning are Greer Lysak, our President and Chief Operating Officer, and Kristen Van Dask, our Chief Financial Officer. Kristen?

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 10Q filed previously and available on our website, prospectstreet. com.

Now I'll turn the call back over to John.

Thank you, Kristen. In the September quarter, our net investment income, or NII, was $79.4 million, or $0.17 per common share. Our net asset value was $3 billion, or $6.45 per common share. At September 30, our net debt-to-total assets ratio was 28.2%. Unsecured debt plus unsecured perpetual preferred was 80.8% of total debt plus preferred. We are announcing monthly common shareholder distributions of $0.4.5 per share for each of November, December, and January. Since our IPO 20 years ago through our January 2026 declared distribution, we will have distributed over $4.6 billion or $21.79 per share.

Our preferred shareholder cash distributions continue at their contracted rates. We continue to make progress repositioning our business, including rotation of assets into and increased focus on our core business of first lien senior secured middle market loans. With our first lien mix increasing 701 basis points to 71.1% from June 2024.

We are focusing on new investments in companies with less than $50 million of EBITDA, including companies with smaller funded private equity sponsors, independent sponsors, and no third-party financial sponsors where we see less competition, better returns, and more protection. Reduction in our second lien senior secured middle market loans with our second lien mix decreasing 292 basis points to 13.5% from June 2024.

Exit of our subordinated structure notes with our subordinated structure notes mix decreasing 808 basis points to 0.3% from June 2024.

Exit of targeted equity-linked securities, including real estate, with three additional properties sold since July 1, 2025, and certain corporate investments, including the sale of significant assets within Echelon Transportation in July 2025, with remaining assets expected to be sold in the December 2025 quarter, with other exits targeted.

Enhancement of portfolio company operations and greater utilization of our cost-efficient floating rate revolver, which largely matches our floating rate assets. Thank you. I will now turn the call over to Greer.

Thank you, John. Over the past two decades, Prospect Capital Corporation has invested approximately $13 billion in nearly 400 exited investments out of over $22 billion in nearly 500 total investments that have earned a 12% unlevered investment-level gross cash internal rate of return, or IRR, to Prospect Capital Corporation. This multi-decade time period includes the GFC and has been dominated in general by low prevailing market interest rates. As of September 2025, we held 92 portfolio companies across 32 different industries with an aggregate fair value of $6.5 billion. We primarily focused on senior and secure debt, which was 85% of our portfolio at cost as of September. Our middle market lending strategy is the primary focus of our company, with such strategy as of September 2025 representing 85% of our investments at cost, an increase of 864 basis points from June of 2024.

In our middle market lending strategy, we've continued our focus on first lien, senior secured loans during the quarter, with such investments totaling 81% of originations during the quarter. Investments during the quarter included a new investment in The Ridge also known as Healthcare Venture Partners a provider of healthcare services and other follow investments in existing portfolio companies to support acquisitions working capital needs organic growth initiatives and other objectives We substantially completed the exit of our subordinated Structured Notes portfolio as of September 2025 with such portfolio representing only 0 of our investment portfolio at cost which represents a reduction of 808 basis points from 8 as of June 2024 In our real estate property portfolio at National Property Recorp, or NPRC, which represented 14% of our investments at cost as of September 2025, and which is focused on developed and occupied cash-flowing multifamily investments.

Since the inception of this strategy in 2012 and through October 31, 2025, we have now exited 55 property investments that have earned an unlevered investment level gross cash IRR of 24% and cash on cash multiple of 2.4 times. We exited three property investments since June 2025 for approximately $59 million of net proceeds to Prospect Capital Corp. , and it earned an unlevered investment-level gross cash IRR of 23% and cash-on-cash multiple of 2.3 times. The remaining real estate property portfolio includes 55 properties and paid us an income yield of 5.1% for the September quarter.

Prospect's aggregate investments in NPRC included a $320 million unrealized gain as of September. We expect to continue to redeploy future asset sale proceeds, primarily into more first-leaning senior secured loans with selected equity-linked investments.

Prospects approach is one that generates attractive risk-adjusted yields and are performing interest-bearing investments. We're generating an annualized yield of 11.8% for the quarter ended September. Our interest income in the September quarter was 97% of total investment income, reflecting a strong and high-quality recurring revenue profile for our business. Amen and Kind income for the quarter ended September 2025 was reduced by over 50% when the quarter ended September 2024.

Non-accruals as a percentage of total assets as of September stood approximately 0.7% based on fair market value. Investment originations in the September quarter aggregated $92 million and were comprised of 72% middle market investments with a significant majority of first lien senior secured loans. We also experienced $235 million of repayments and exits as a validation of our capital preservation objective, resulting in net repayments of $143 million. Thank you, and I'll now turn the call over to Kristen. Kristen?

Thanks, Greer. We believe our prudent leverage, diversified access to matched book funding, substantial majority of unencumbered assets, waiting toward unsecured fixed rate debt, and avoidance of unfunded asset commitments all demonstrate balance sheet strength, as well as substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of liabilities extending 26 years into the future. On October 30, 2025, we successfully completed the institutional issuance of approximately $168 million in aggregate principal amount of senior unsecured 5.5% notes due 2030, which mature on December 31, 2030. We expect to use the net proceeds of the offering primarily for the refinancing of existing indebtedness. Our unfunded eligible commitments to portfolio companies total approximately $36 million, of which $15 million are considered at our sole discretion, representing approximately 0.5% and 0.2% of our total assets as of September, respectively.

Our combined balance sheet cash and undrawn revolving credit facility commitments stood at 1.5 billion as of September, and we held 4.2 billion of our assets as unencumbered assets, representing approximately 63% of our portfolio. The remaining assets are pledged to prospect capital funding, a non-recourse SPV. We currently have 2.12 billion of commitments from 48 banks, demonstrating strong support of our company from the lender community, with a diversity unmatched by any other company in our industry. The facility does not mature until June 2029 and revolves until June 2028. Our drawn pricing continues to be SOFR plus 2.05%.

Outside of our revolver, we have access to diversified funding sources across multiple investor types and have successfully issued securities in an array of markets. Prospect has issued multiple types of unsecured debt institutional non-convertible bonds institutional convertible bonds retail baby bonds and retail program notes all of these types of unsecured debt have no financial covenants no asset restrictions and no cross defaults with our revolver we have tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration out 26 years with our debt maturities extending through 2052 with so many banks and debt investors across so many unsecured and non-recourse debt tranches we have substantially reduced our counterparty risk at september 30th 2025 our weighted average cost of unsecured debt financing was 4.54 percent now i'll turn the call back over over to John.

John S. : Thank you, Kristen. We can take questions now.

Sure, I'll take that. Go ahead, John.

No, no, please take it, Greg.

Okay. So, Finney, yes, we do like to make first lien and senior and secured loans to companies. And we do, really, an increasing percentage of time, like to have some portion of our paper as equity linked, ideally without a trade-off involved. The best type, of course, is penny warrants, the free type.

And then the next best is convertible debt that is still senior and secured, has a cash pay coupon, pledgable to our facility, but then has ups as well. And then various types of convertible preferred that have coupons and liquidation preferences on top of third-party capital, all the way to some heads-up capital. So our strategy is one of evaluating each investment in the book and looking at it on a foregone yield and foregone IRR, including giving effect to accretion through our roughly S200 secured credit facility for those foregone returns at a price that we think is actionable with a third-party purchaser in the market. That's the guidepost we use to make decisions to optimize the portfolio.

And what that leads us to is to look to divest over time generally when you've had appreciated equity-linked assets and we're looking forward and maybe there's upside in the future but not quite as much, and we're not foregoing as much. And we're also paying careful attention to foregone yield as well, wanting to rotate and drive and optimize increased revenue, increased income for our business. The best candidate for that in our portfolio is real estate. I mentioned we've sold 55 properties. We have another 50 or so to go.

Returns on recent exits, sort of backward-looking, are fairly similar to the overall returns we've generated on the other 50 or so exits with IRRs in the low 20s and a multiple of invested capital generally above two times cash on cash. But the extant book, after giving effect within real estate to appreciation of value, is generating about a 5% income yield.

That, of course, is much lower than what we can achieve in the market for new originations. We are focused on smaller companies increasingly sub-50 million EBITDA and really sub-25 to 35 million because there's so much competition in the upper middle market that is bid-away spreads, that is bid-away floors, that is bid-away covenants, that is bid-away earnings quality, that is bid-away strong documents. So many problems there that we intensely dislike. And so we're focused on the harder to originate, but well worth it when you do, smaller end. Our last dozen or so deals closed have had an average spread in the 700s compared to the upper middle market, which is decidedly with a four handle by comparison.

We're getting much higher floors, generally above 300 basis points on those deals. And look at what's happening with short-term rates. We're down to about 375, and folks are cutting distributions out there, experiencing lower yields. What went up can and almost certainly will go down again from a floating rate perspective. So we can put money out at 10% to 12% unlevered in the lower middle market. Then we lever that in our S200 facility at a 50%, 60% advance rate. And we're talking about a 15% plus income yield return before giving effect to any equity-linked benefit. That 15, of course, is vastly superior on an income yield perspective to the 5% I was quoting on real estate.

So we view that as an earnings powerhouse that we're unleashing through that rotation that we're pursuing. That doesn't mean we're going to dispose of the real estate portfolio lickety split. We're doing so on a thoughtful, value-maximizing basis on a bottoms-up look at different geographies, different properties. We've concluded you maximize value by selling individual assets or smaller groups of assets as opposed to the whole. There's just a lot more buyers who can transact with individual assets as opposed to cut a multibillion-dollar check. check. Usually those guys look for significant bargains that we're not too interested in parting with. So that's what's going on with real estate. We're seeing solid NOI growth. We've had about 7% NOI growth, and we're seeing tailwinds there as supply has diminished and look for us to continue to monetize assets in coming quarters.

Then you have other assets on the corporate side. I'll divide that into non-financials and financials that you mentioned. We have a number of very successful non-financial deals. We have some equity-linked positions that have appreciated significantly. And again when you look at it on a foregone yield and IRR basis we say okay we think it could make sense at the right price You know the deal business is dynamic and you never know exactly what the outcome will be But at the right price there a potential transaction there So we've got various processes that are ongoing there, and we'll disclose that at the appropriate point should we find interesting exit points. And again, an unleashing of earnings power by rotating those appreciated assets into more and a diversified way of income-producing properties.

In the financial book that you talked about, those are really, for the most part, long-term holds for multiple reasons. I mean, that doesn't mean we would say no if some huge outlier bid came along. But we have substantial tax advantages that aren't enjoyed by other public companies because we're a BDC, we're a RIC, we pay no corporate taxes as long as, of course, we meet the regulatory requirements, which we have for our 20-plus year history and intend on continuing to do. And we hold these financials as tax partnerships. so there's no taxes at the underlying portfolio company level. If these companies, say First Tower, for example, were to become its own public company and it's large enough business that perhaps it could or could someday, it would need to be a corporate taxpayer under the regs, and that would be an erosion of value.

Any potential buyer would keep that in mind for their eventual exit. So we enjoy very low cost of capital as the natural resting ground for financials. And just more important than that, we've had terrific success focusing on areas that are highly recurring and recession resilient. I'm talking about installment lending, which is what First Tower and Credit Central and our latest deal, which is QCHI, are all transact in. We do have a small auto book, very small. That's been a tougher business. That's a scale business. It's less of a customer loyalty recurring cash flow business because an automobile purchase is episodic. But for these installment lenders, they're doing 50% to 75% plus of their business with current customers, and there's a substantial loyalty element that grounds the business and really creates low volatility.

And as short-term rates are starting now to subside, that's a further tailwind for those businesses that utilize third-party ABL that's floating rate in nature. I think with TOWER, something like every 100 basis point reduction in SOFR increases pre-tax net income by somewhere in the range of $5 to $10 million. and then of course there's a valuation benefit from that as well. So that's what we're after. We've made a lot of progress in the last year of Finian.

Exiting our structured credit book was a big part of that process. That book had become low yielding on a gap basis as well. And we're rotating and having great success with deals like The Ridge, deals like verified diagnostics, deals like Druid City and Discovery Point, Taos and QC as Equalink deals have had substantial write-ups year-to-date since we closed each of them. So the strategy is working well, and we're going to continue to execute on that game plan.

Sure. It's a new channel. It's not a one-off. It's something we've evaluated for a very long time, and we thought the timing made sense for us. We've been utilizing our revolver to retire liabilities. We utilized our 48-bank-strong $2.1 billion revolver a few months ago to take out our first half of 2026 original issue $400 million bond and could utilize that as well for our next maturity, which isn't until the tail end of 2026.

but thought this was an interesting and strategic place to issue. We have strong relationships there. We've had institutional support from that market on other types of issuance and prospect. And so it just made a lot of sense. And something like 40-plus institutional investors come into that bond. And that's a decent-sized market, and I think you'll see us on a softball basis continue to expand our presence there.

But that doesn't mean that's going to be our only source of financing. We're big, big believers in diversified financing. The fact that we have almost 50 banks in our facility shows we're not taking substantial counterparty risk. which can be problematic, especially in downturns. We saw that happen in the GFC with folks. Well, that's a big reason why we were able to buy Patriot Capital, for example, and what happened to that business when we did the first BDC acquisition in history.

But Prospect, of course, created the bond market for BDCs. We were the first to issue convertible bonds going back to 2010 and then straight institutional bonds in 2012, and first and only to issue medium-term notes. So we've been doing this for a very long time and are big believers in diversified access to funding, and we think that creates a strong credit profile for all, including, of course, equity investors that benefit from that diversified funding.

Thank you, Finian.

Okay. Thank you, everyone. Have a wonderful day. Bye now. Thanks, all.