KBRA Affirms Ratings for Prospect Capital Corporation

11 Mar 2024   |   New York


KBRA affirms the issuer and senior unsecured debt ratings of BBB- for Prospect Capital Corporation (NASDAQ: PSEC) (“the company” or "Prospect"). The rating Outlook is revised to Negative from Stable.

Key Credit Considerations

The rating affirmation and Outlook revision to Negative reflect PSEC’s $7.6 billion investment portfolio that is comprised largely of senior secured loans (~59%), although with a disproportionate amount of concentrated positions in sectors that have had greater negative impact in the current economic environment. The three large portfolio company positions comprised approximately 35% of total investments at FV at December 31, 2023, and include debt and equity of National Property REIT Corp. ("NPRC") (real estate and online lending), First Tower (consumer finance), and InterDent (healthcare/dental). With the Federal Reserve's unprecedented pace of base rate increases beginning in March 2022, these industries have been materially impacted and these portfolio companies have a large element of PIK. NPRC (21% of total investments), which holds all of PSEC's real estate investments, is 100% owned and controlled by PSEC, with a FV of ~$1.6 billion comprising 64% debt and 36% equity positions. NPRC is focused on class B/C multifamily properties and student housing and incurred a $145.9 million unrealized loss in the last six months of calendar year 2023 due to rising cap rates and discount rates. Moreover, the REIT at the business level has run negative operating cash flows after debt service for several years. While the REIT has had some financial under performance and valuation declines, KBRA acknowledges that underlying mortgages are all performing as to interest and principal payments and properties are of typical quality for class B/C multifamily and student housing.

At December 31, 2023, PSEC's investment portfolio included 187 portfolio companies across 36 sectors in primarily the upper middle market. The portfolio companies had a weighted average EBITDA of $110 million, were largely sponsor backed with meaningful equity cushions with low LTVs, and had net leverage of 5.4x and interest coverage of 1.9x, based on a trailing 12 month calculation. The ratings are also supported by the company's 20 years of operating history, managing through various economic cycles including the GFC, and its management team’s long tenure with the 12 members of the Investment Committee having an average of more than 30 years of experience. Further supporting the ratings are the diverse funding mix with a high proportion of unsecured debt to total debt at 65% as well as the $1.95 billion bank revolving credit facility with an extensive network of lending relationships developed over 20 years consisting of 53 credit facility lenders, supported by a dedicated team that develops and manages creditor relationships. The company has minimal debt maturities over the next two years and only $27.6 million of unfunded commitments, providing for solid liquidity. As of December 31, 2023, gross leverage was 1.08x with asset coverage of 185.2%, above the regulatory asset coverage of 150%. The company has $1.5 billion of preferred stock which the company views as equity which would lower its leverage to below 1.0x. Portfolio quality has been mixed over the years; however, non-accruals to total investments at cost and fair value of 2.16% and 0.20%, respectively, were low at 4Q23 which largely reflects the 3Q23 restructuring of its $255 million at cost investment in PGX Holdings, Inc.

Further counterbalancing these credit strengths is the investment portfolio’s investments in higher volatility CLO residual interests (7.8% of total investments at FV) and the potential risk related to the company’s illiquid investments, retained earnings constraints as a RIC, and a more uncertain economic environment with high interest rates, geopolitical risks, and the potential of increasing non-accruals.

Formed in 2004, Prospect Capital Corporation is the fifth largest by net assets publicly traded closed-end externally managed BDC regulated under the Investment Company Act of 1940. The company trades on the NASDAQ under the symbol PSEC and has a recent market capitalization of approximately $2.3 billion.

Rating Sensitivities

The Outlook could be revised to Stable if the company's REIT and consumer finance portfolios weather the higher interest rate environment over the medium term, if the REIT at the business level begins to generate positive operating cash flows, and if PIK interest materially reduces as a proportion of total income. Additional positive rating momentum could be achieved if improved credit metrics are sustained over time with an increase in third-party senior secured first lien investments, reduced CLOs as a proportion of the investment portfolio, and should earnings metrics become more stable with no significant negative valuation changes to the REIT moving forward. The ratings could be downgraded if little progress is shown with respect to the former metrics, if performance of underlying assets further impacts earnings, valuations, and credit quality or if there is a further downturn in the U.S. economy with a negative impact on PSEC’s earnings performance and asset quality with increased non-accruals and leverage.

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A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

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