KBRA Downgrades Ratings for Prospect Capital Corporation

KBRA downgrades the issuer and senior unsecured debt ratings to BB+ from BBB- for Prospect Capital Corporation (NASDAQ: PSEC) or (“the company”). The rating Outlook remains Negative.

Key Credit Considerations

The rating change reflects PSEC's highly concentrated portfolio of control investments and 6% but declining (including through amortization) CLO portfolio that have exhibited lower recent performance as evidenced by significant realized losses reported of $100 million in FY 1Q25 and $417 million in FY 2024 (the majority of which were already accounted for as unrealized losses) and unrealized losses of $124 million in 1Q25. The expectation is that the portfolio will continue to face challenges amid the current economic environment. About 42% of PSEC’s total investments are concentrated in four key investments, including the largest, National Property REIT Corp. (with 61 properties as of 1Q25), which reports negative operating cash flow after interest payments, including on debt owed to PSEC (the largest loan in PSEC’s portfolio). The CLO portfolio has low single digit GAAP income returns down from earlier double-digit returns, while First Tower, a consumer finance company, has incurred net losses in recent periods and InterDent, a dental practice administrative service provider, has exhibited weakened earnings performance and increased debt in the capital structure.

To more closely match reduced and projected net investment income, PSEC reduced its common equity dividend by 25% in November 2024. Management plans to diversify its portfolio by reducing concentrated REIT and non-strategic investments, with five REIT properties sold in CY 2024; however, the portfolio rotation will take time as the REIT investments are illiquid and the outlook for the real estate market remains uncertain.

PSEC’s investment portfolio comprises 117 portfolio companies across 33 sectors, primarily in the upper middle market and is comprised largely of first lien senior secured loans with a weighted average portfolio company EBITDA of $105 million. Non-accruals to total investments at cost and fair value of 2.8% and 0.5%, respectively, are consistent with rated peers.

PSEC has a high proportion of unsecured debt to total debt (86% with preferred stock viewed as unsecured debt) as well as a bank revolving credit facility, which was recently extended to mature in June 2029 with 48 lenders. As of 1Q25, the company had $974 million in credit line availability on its revolving credit facility and $57 million of cash, set against $544 million of near-term unsecured note maturities, including $388 million of 2026 maturities, and unfunded commitments of $48 million. Gross leverage is 1.11x when including preferred stock as debt (0.45x when including preferred as equity) and asset coverage of 183% remains above the regulatory minimum of 150%. That said, KBRA believes PSEC has a comparatively riskier asset mix given the aforementioned portfolio concentrations in underperforming control investments and has concerns regarding the company's ability to source cost-effective unsecured funding.

Additional concerns include the relatively illiquid investments, high portfolio concentrations in control investments, retained earnings constraints as a regulated investment company (RIC), and the potential for elevated risk of increased non-accruals amid an uncertain economic environment with high base rates, inflation, and geopolitical risk.

Prospect Capital Corporation is a publicly traded closed-end externally managed business development company (BDC) regulated under the Investment Company Act of 1940 as a RIC, which, among other things, must distribute to its shareholders at least 90% of the company’s investment taxable income. Formed in 2004, the company is externally managed by its advisor, Prospect Capital Management L.P. The company trades on the NASDAQ under the symbol PSEC and has a recent market capitalization of approximately $1.9 billion.

Rating Sensitivities

Positive rating momentum may be realized if there is a meaningful decrease in concentrated positions in the near-term, particularly the REIT investment, a significant reduction in PIK interest and if there is successful execution of the strategy to expand its third-party senior secured first-lien investments. Rating pressure could occur if little progress is made in the near-term in diversifying the investment portfolio through the reduction of concentrated positions and/or if there is further deterioration in the company's earnings performance and asset quality, including increased non-accruals and unrealized and realized losses. In addition, weakening credit metrics related to leverage and liquidity could contribute to negative rating migration.

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