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Prospect Capital: To Redeem Public Notes

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NEWS

On June 7, 2018 Prospect Capital (PSEC) announced its intention to undertake a purchase offer for up to $300mn of its senior unsecured notes, due July 15, 2019.

The 8-K filing indicates PSEC offers to pay $1,020 for every $1,000 of notes outstanding, plus accrued interest.

The tender offer expires on June 13, 2018 and may be withdrawn at any time prior to that date.

Furthermore, the Tender Offer is “subject to certain conditions, including the receipt by the Company of net proceeds from one or more debt financings on terms and conditions satisfactory to the Company in an amount sufficient, together with other available sources of cash, to pay for all Notes accepted for payment in the Tender Offer and estimated fees and expenses related to the Tender Offer”.

See the 8-k filing in its entirety attached.


ANALYSIS

PSEC has recently issued $50mn in a new Baby Bond, as reported here.

In addition, the BDC has also raised monies from a bolt-on offering of Convertible Notes for $104mn in mid-May.

Also back in May 2018, PSEC  issued new 2023 and 2025  Inter Notes. See the BDC Fixed Income News Table.

Here is what the latest PSEC 10-Q says about the 2019 debt issue to be redeemed:

“On April 7, 2014, we issued $300,000 aggregate principal amount of unsecured notes that mature on July 15, 2019 (the “5.00% 2019 Notes”). Included in the issuance is $45,000 of Prospect Capital InterNotes® that were exchanged for the 5.00% 2019 Notes. The 5.00% 2019 Notes bear interest at a rate of 5.00% per year, payable semi-annually on January 15 and July 15 of each year, beginning July 15, 2014. Total proceeds from the issuance of the 5.00% 2019 Notes, net of underwriting discounts and offering costs, were $295,998”.


VIEWS

Why We’re Here

The BDC Reporter chose to write about PSEC’s Tender Offer to brief our readers on this latest development.

However, this could have been relegated to one of our briefer posts (colored in blue on the website) or just mentioned in the Fixed Income News Table.

Where possible, though, we like to dive a little deeper and look at issues from a broader perspective in these long form articles.

Hopefully, we can bring to readers attention insights that might not be immediately obvious or covered elsewhere.

After all, a Premium subscription deserves more than just fact telling.

Here’s what came to mind when reviewing the proposed Tender Offer:

One More Shoe To Drop ?

The missing piece of the puzzle here – judging by the conditions precedent – is yet another debt financing  to occur within the next week.

We don’t know how much – if any – of the capital raised from the offerings listed above have been earmarked for the Tender Offer.

Tucked Away

Technically PSEC has all the unused borrowing capacity needed to redeem the 2019 Unsecured Notes from its secured Revolver.

That facility has a limit of $885mn but only $386mn of gross borrowing capacity at March 31, 2018.

(That amount could be increased if PSEC transferred additional investment assets as collateral).

$86mn was draw under the Revolver at the end of the quarter, but that balance may have been repaid from asset sales or from the prior debt raises.

Yet Another

More likely – given the wording of the 8-K – is that PSEC will be floating a new unsecured debt offering.

This will help PSEC manage its debt liabilities by pushing out the maturity of 15% of its debt for a further period.

Not About Saving Money

However, the BDC Reporter does not project PSEC will gain much in terms of interest expense savings.

Let’s look at the economics if PSEC – surprisingly – redeems the 2019 Notes with its secured Revolver:

The Revolver is priced at LIBOR + 2.25%. With 1 month LIBOR currently at  2.02%, the interest rate is 4.27%.

While that rate is lower than the 5.00% Notes, PSEC will also have to absorb – by our calculation – about $1.0mn in accelerated underwriting and offering costs.

Moreover, the BDC is paying a slight premium to attract offers and has professional and placement fees to contend with.

Likewise, if PSEC is willing and able to issue $300mn in new unsecured debt, the likely 5 year rate (to compare apples with apples) is likely to be 4.750%-5.00%.

That’s based on the recent pricing on the 2023 Inter Notes offering.

Again, there are placement and professional fees to contend with.

(Wall Street loves these kind of capital markets activities).

Confused

The BDC Reporter does not understand why PSEC did not just run out the clock on the 2019 debt, which has some of the lowest yields in the BDC’s borrowing universe.

We don’t pretend, though, to have access to all the considerations available to PSEC’s CFO nor the capital markets background to be an incisive critic.

Coming Up

We note that the BDC has nearly $1.5bn in Unsecured Notes coming due in the next 3 years.

That’s nearly 50% of all the unsecured debt outstanding on the BDC’s balance sheet at March 31, 2018.

Any crisis of confidence in the near term may make raising the necessary funds to refinance even more expensive or even impossible.

Defensive

That may explain why PSEC – which relies almost exclusively on unsecured debt for its borrowings – has been so protective of its investment grade debt rating from S&P.

When the ratings group frowned on adoption by BDCs of the new higher leverage rules permitted by the Small Business Credit Availability Act, PSEC caved almost immediately.

Like FS Investment (FSIC), PSEC reversed its initial decision to take advantage of the new leverage limit.

Unlike Apollo Investment (AINV), whose sole public debt issue is now “junk” rated, PSEC remains investment grade.

Eye On The Prize

If the BDC can stay within the good graces of S&P, the challenge of refinancing all that debt seems manageable.

That’s good for existing and new PSEC debt holders, especially as the BDC might grow that portion of its portfolio in traditional leveraged loans rather than dicier (but higher yielding) CLO and control investments.

S&P is presumably keeping an eye on that factor as well.

PSEC debt holders – even if unsecured – want to see the highest quality assets possible on the books to support their investment.

Those Other Stakeholders

Whether the financial discipline required from keeping a perpetual eye on the rating groups will aid or hurt PSEC’s common stock shareholders is a fascinating question.

In the short run, less CLO and Control investments (many of which are booked at yields as high as 20%) will result in lower investment income, as will lower leverage than might be possible under the Act.

On the other hand, a greater proportion of less risky investments may reduce the write-offs that have been quietly eroding PSEC’s capital base.

The Numbers Tell The Story

Three years ago, aggregate Realized Losses reached ($312mn) and Unrealized Depreciation ($11mn).

Roll forward to March 2018 and Realized Losses are ($459mn) and Unrealized Depreciation ($145mn).

That’s ($281mn) of increased losses or an 87% increase in 12 quarters.

Putting that into context, PSEC’s recurring income is about $280mn a year, which suggests that for every $3 of Net Investment Income, $1 is being lost to credit troubles.

That’s the price PSEC – and its enthusiastic shareholders – pay for a higher risk investment portfolio.

It’s A Choice

This capital erosion does not have to happen, but reflects the strategic direction PSEC has chosen for many years.

For example, Golub Capital  (GBDC) -which has elected to pursue  lower risk-lower yield investments (and charge lower fees) – has seen the value of its portfolio INCREASE slightly over the last 3 years.

We double checked for this article. Here are the links to the March 2018 and March 2015 10-Qs.

Shift ?

At some point PSEC will have to reconsider its own approach, as its book value gradually fritters away.

The BDC Reporter, though,  has no idea when that might happen – if at all.

However, this indirect impact of S&P (and to a lesser degree Fitch) and the need to refinance all that debt may be an impetus.

 

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