Published October 24, 2013
NEW YORK, Oct 24 (RLPC) - Prospect Capital Corp , the second-largest actively managed business development company (BDC), is banking on its heft and diverse strategy in an increasingly competitive middle market lending business.
With nearly $5 billion in assets and seven distinct origination tactics, compared with most other much smaller BDCs that concentrate on sponsor-driven private equity deals, Prospect's winners are overshadowing the laggards.
Two of them - structured credit featuring collateralized loan obligations (CLOs) and financial services buyouts - now represent about one-quarter of portfolio assets and are pulling in high double-digit yields.
"It's nice to have these Clydesdales pulling the wagon," Grier Eliasek, Prospect Capital Corp's president and chief operating officer, told Thomson Reuters LPC in an interview at Prospect's New York office.
Clydesdales are "handsome, weighty and powerful, but with a gaiety of carriage and outlook, so that the impression is given of quality and weight, rather than grossness and bulk," says the Clydesdale Horse Society.
The other buckets are private equity sponsored deals, direct lending, real estate, operating business buyouts and syndicated debt investing.
The sponsor business is one pressure source. "It is a good business, but probably down a couple hundred basis points over the last 18 months and maybe it will keep marching downward in spread," said Eliasek.
"Our assets yield in the 13.5 percent range, which is several hundred basis points above our peers, and that's precisely because we are in other origination strategies relative to others," he added.
Scale gives Prospect access to deals and controls that may elude competitors. Its market capitalization tops $3 billion. "This is a $30 billion industry and we have 10 percent of it," said Eliasek. "We can hold larger transaction sizes. A $200 million deal? No problem."
BDCs are also among alternative funding sources expected to gather steam if regulations lead banks to pull back.
Prospect doubled its assets in 2012 and has grown by about 30 percent this year. The portfolio houses more than 120 private middle market companies in a wide range of industries such as financial services, chemicals, electronics, food and healthcare.
"We try not to redline industries," Eliasek said.
With direct lending, often to family-owned companies, Prospect said it is the only BDC maintaining a call center. The center reaches out to intermediaries, such as business brokers, regional accounting firms and estate lawyers, to generate deals.
As a CLO investor, Prospect partners with about a dozen collateral managers to create what he calls "clean baskets from inception." Prospect seeks a controlling equity stake, giving it power to call the deal and redeploy assets.
Among Prospect's 2013 deals: a $70 million secured term loan to support the recapitalization of Cinedigm Digital Cinema Corp units; a $197 million first-lien senior secured credit facility to support a Capstone Logistics refinancing; and $80 million of first-lien senior secured loans and a revolver to recapitalize Matrixx Initiatives , owner of cold remedy maker Zicam.
Prospect keeps the same team on each deal from start to exit to minimize risks.
"My mother taught me that if I made a mess I had to clean it up," Eliasek said. "Being responsible for cleaning up the mess is a powerful disincentive for creating future messes."
Prospect has gone six years without a new loan experiencing non-accrual, meaning going 60 days without a borrower payment.
Registered with the Securities and Exchange Commission and publicly traded under the symbol PSEC , Prospect also has diverse capital access.
Investors are about 30 percent institutional and 70 percent retail.
Prospect is the only BDC with a medium-term note program, for just-in-time funding, Eliasek said. Weekly issues mature in three to 30 years, depending on need and interest rates.
Prospect regularly issues stock, of which $30 million to $40 million trades daily; tapped the market in March for $250 million 5.875 percent senior unsecured bonds due 2023 and has a $650 million revolver backed by 20 banks.
Almost 90 percent of Prospect's assets are floating-rate, while 93 percent of its liabilities are fixed as of the end of June. The vast majority of portfolio investments are secured first- and second-lien loans.
"If we go through another 2008-2009 dislocation, we'll have all these assets continuing to generate cash flow that's available to pay bondholders and our equity investors," Elisek said. "That's quite different from others who capitalize themselves by putting all of their assets encumbered by one bank group and then unsecured holders behind them and equity behind them."
Investment grade corporate ratings are BBB by S&P and BBB+ by Kroll. Moody's rates the credit facility Aa3.
National Securities, citing the relatively high-yielding secured portfolio and low mix of non-accruals, on October 21 wrote "the Street's been asleep at the wheel on this stock - buy shares at current levels before it wakes up."
(Editing By Jon Methven)