PROSPECT CAPITAL CORPORATION The trend on all credit ratings has been revised to Positive from Stable. The Company's Intrinsic Assessment (IA) is BBB (low), while its Support Assessment is SA3, resulting in the final rating being positioned in line with the IA.
KEY CREDIT RATING CONSIDERATIONS
The Positive trend reflects the Company's notable progress over the past two years to reduce its risk profile. PSEC has increased the proportion of its first lien exposure from 47% of its total investment portfolio at fair value (FV) at YE21 to approximately 59% at
The confirmation of the credit ratings reflects the Company's solid franchise that is underpinned by its expertise and longevity in the industry, diverse funding profile and appropriate capitalization. The credit ratings also consider the Company's portfolio riskiness given the still elevated portion of subordinated investments and key asset class concentrations in real estate, consumer finance and structured investments. That said, key downside risks to our expectations is a contraction in
CREDIT RATING DRIVERS
If the Company continues to increase the proportion of its secured first lien portfolio at a similar pace seen each of the past two years while generating improved operating results, the credit ratings would be upgraded. Conversely, if the proportion of the Company's secured first lien portfolio does not increase as expected and/or there is a weakening in operating results, the trend could revert back to Stable. Furthermore, a prolonged and material deterioration in credit fundamentals would result in a credit ratings downgrade.
CREDIT RATING RATIONALE
Franchise
The Company's franchise is supported by its long presence, scale, broad origination platform and diversified investment capabilities. Having operated for two decades, PSEC is one of the oldest and largest business development companies (BDCs) with an investment portfolio of
Earnings
The Company has historically generated a solid level of earnings. The net investment yield (net investment income-to-average investments at cost) has improved over the past two years, as PSEC continues to benefit from higher market rates given that 83% of its interest earning investment portfolio is comprised of floating rate assets. Net investment income grew a solid 8% year-over-year (YoY) in 1HFY24, following 22% growth YoY in FY23, which have comfortably covered common and preferred dividend distributions in excess of 15% and 17%, respectively. Nonetheless, in FY23, bottom-line results were adversely impacted by unrealized losses due to fair value marks driven by the higher rate environment, while 1HFY24 results included a large one off realized loss because of a portfolio company restructuring. Overall in 1HFY24, the Company generated a net increase in net assets resulting from operations (net income) of
Risk
PSEC's risk profile is viewed as elevated given its sizeable exposure to inherently riskier subordinated debt and equity investments. At YE23, second lien debt accounted for 15.5% of the total investment portfolio at FV, subordinated structured notes accounted for 7.9%, and equity investments accounted for 17.8%. Nonetheless, PSEC's risk profile has improved over the past few years by gradually expanding the portion of first lien loans in its investment portfolio at FV, reaching 58.7% at YE23, up from 53.0% at YE22 and 47.3% at YE20, but remains lower relative to the Morningstar DBRS BDC peer group (with a median of 83%). PSEC's portfolio risk exposure is partially mitigated by its well-established risk management processes embedded in its underwriting, monitoring and restructuring capabilities. Further, we view favorably PSEC's assignment to third-party independent valuation firms to determine each portfolio company's FV on a quarterly basis. The non-accruals as a percent of total portfolio at cost were 2.2% at YE23, flat from the prior quarter and down from 2.6% at YE22. We expect credit performance to slightly weaken over the coming quarters but to remain manageable for the Company.
Funding and Liquidity
The Company has a solid and diversified funding profile given its access to multiple funding channels, an diverse investor base, and low balance sheet encumbrance. At YE23, senior unsecured debt of
Capitalization
The Company has a track record of disciplined balance sheet management by maintaining regulatory leverage at a solid 1.1x at YE23. We estimate that the Company's cushion to regulatory leverage limits to be approximately
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.
Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.
Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (
Notes:
All figures are in US Dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The primary sources of information used for these credit ratings include Morningstar, Inc. and company documents. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.
The credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
Morningstar DBRS did not have access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.
For more information on this credit or on this industry, visit dbrs.morningstar.com.
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