DBRS Morningstar Affirms Prospect Capital Corporation Ratings at BBB (Low); Stable trend

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Prospect Capital Corporation (PSEC or the Company), including its long-term issuer rating and its senior long-term debt, both at BBB (low).

The company’s intrinsic rating (IA) is BBB (low), while its support rating is SA3, making the final rating in line with the IA. The trend on all ratings is stable.

KEY SCORING CONSIDERATIONS

The ratings reflect the company’s good franchise, underpinned by its long presence in the industry and its strong management team, diversified funding profile and low leverage. Over the past year, PSEC has expanded its investment portfolio through strong acquisition volumes while posting strong profits. The ratings also take into account the degree of risk of the Company’s investment portfolio due to its significant exposure to subordinated investments as well as concentrations in real estate, consumer credit and structured investments.

The stable trend reflects our expectation that PSEC will continue to show strong operating performance accompanied by risk management discipline and prudence in capital management, including maintaining its leverage within its range. target. That said, a significant overflow on the WE the economics of current geopolitical developments Europe or heightened inflationary pressures, present downside risks to our expectations.

DRIVER RATING

Strengthening of the risk profile through a greater proportion of senior loans in Prospect Capital’s investment portfolio, while reducing the share of CLOs, consumer credit and real estate, would result in an improvement in ratings. Conversely, a significant and prolonged deterioration in credit performance indicating an increase in risk appetite and/or a significant decline in the cushion against debt facility covenants or regulatory requirements would result in a downgrade. ratings.

RATING RATIONALE

The firm’s strong franchise is underpinned by its long track record of expertise, scale, broad origination platform and a diverse set of investment strategy capabilities. PSEC is one of the oldest and largest business development companies (BDC) with approximately two decades in business, $7.1 billion of total assets and 127 investments in 39 industries to December 31, 2021 (YE21). PSEC primarily provides secured debt financing to middle market companies, but also invests in a variety of yield-oriented and credit-linked strategies. These investments improve the flexibility of origination and the diversity of the Company’s portfolio, but also increase the risk profile of its balance sheet. Through its longevity and increased scale, PSEC has developed an extensive deal sourcing network of rooted relationships with private equity sponsors, syndicates, intermediaries and holding companies that broaden the optionality of its universe. of investment. PSEC’s franchise is also bolstered by its experienced and long-serving management team who have effectively led the company through challenging economic and investment environments.

The Company has historically demonstrated a consistent and resilient ability to generate earnings. PSEC’s investment portfolio has also generated fairly stable returns (defined as net investment income relative to average investments at cost) over the past five years of around 5%, slightly above the group median from DBRS Morningstar BDC peers. Nevertheless, a notable portion of interest income comes from interest in kind (PIK) and equity investments in CLOs. Specifically, in 1HFY22 (six months ended December 31, 2021) the Company’s interest income from structured credit investments represented 12% of total investment income, while PIK interest represented 10%. After strong operating results for fiscal year 21 (year ended June 30, 2021), as of 1HFY22, PSEC generated a net increase in net assets resulting from $465.7 millioncompared to $473.7 million on 1HFY21, driven by a lower increase in unrealized capital gains even as net investment income increased to $166.9 million, up 20% year-on-year (YoY). In addition, the Company’s net investment income adequately covered the distribution of ordinary and preferred dividends exceeding nearly 11% in FY1HFY22 and 3% in FY21. Over the medium term, PSEC’s net investment income should benefit from rising interest rates given its asset-sensitive balance sheet.

We consider PSEC’s risk profile to be high given its significant exposure to inherently riskier subordinated debt and equity investments. Specifically, as of YE21, of the total investment portfolio (at FV), subordinated secured debt represented 19.5%, subordinated structured notes 10.6%, while equity positions represented 23.1% . Collectively, the portion of these subordinated and equity investments represented nearly 53% of the investment portfolio, essentially unchanged year-over-year, and compared to the DBRS Morningstar BDC peer median of about 20%. Additionally, nearly 38% of PSEC’s debt investments are associated with non-sponsored supported companies. That said, the Company’s portfolio risk exposure is partially mitigated by its well-established risk management processes, integrated into investment opportunity assessment, underwriting, monitoring as well as restructuring capabilities. We also welcome the Company’s engagement with independent valuation firms to determine the FV of each portfolio company on a quarterly basis. The credit performance of the investment portfolio improved slightly over the past year, with defaults as a percentage of the total portfolio at cost at 2.6% in YE21, compared to 3.5% in YE20.

The Company has a strong funding profile from diversified funding sources and a large investor base. PSEC’s funding profile is also supported by a low balance sheet burden and a staggered debt maturity profile that is well aligned with the maturities of the investment portfolio. At YE21, senior unsecured debt of $1.9 billion accounted for 80% of total debt outstanding, consisting primarily of institutional notes, retail notes from weekly programmatic shows as well as convertible notes. In addition, 71% of PSEC’s total assets were unencumbered, despite being mostly comprised of inherently illiquid assets. The Company’s secured debt is associated with a revolving credit facility maturing in 2026 with a total committed capacity of $1.5 billion which encompasses the liabilities of a diverse group of 43 financial institutions. Of the total outstanding unsecured debt of $1.9 billion at YE21, only 3% mature in 2022, while 19% and 48% mature in each of the following two-year periods, respectively. As of year 21, PSEC had ample cash readily available from $790 millionincluding cash and available borrowing capacity based on previously pledged collateral.

The company has a history of disciplined balance sheet management by maintaining leverage near or even below its desired target levels and mostly below the DBRS Morningstar peer median. In YE21, PSEC’s leverage ratio, defined as debt to equity and including preferred shares in total equity, was 0.52x, significantly below its target leverage of 0.70x at 0, 85x (based on net debt and reported as such 0.51x at YE21). In addition, PSEC has a fairly large regulatory capital buffer of approximately $2.7 billion which implies that the total investments at fair value must fall by almost 39% before reaching its regulatory leverage limit. Since the launch of its programmatic issuance of perpetual convertible preferred shares in August 2020 and until March 2022the Company has issued approximately $600 million through multiple distribution channels, including the $150 million of a listed perpetual privileged issue carried out in July 2021. Although preferred stock is considered debt for regulatory leverage requirements, if necessary, PSEC has the option on its preferred convertible to convert it into common stock to increase its capital to meet regulatory limits. imposed.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors in the DBRS Morningstar analytical framework is available in DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Remarks:

All figures are in WE dollars unless otherwise specified.

The main methodology is the Global Rating Methodology for Non-Banking Financial Institutions (September 2, 2021): https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions.

Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and- governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating are Morningstar, Inc. and company documents. DBRS Morningstar considers that the information available to it for the purpose of providing this rating was of satisfactory quality.

The rated entity or its related entities participated in the rating process for this rating metric. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, conditions that lead to a negative or positive trend assignment are resolved within 12 months. DBRS Morningstar’s outlook and ratings are monitored regularly.

For more information on this credit or this industry, visit www.dbrsmorningstar.com.

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Ratings

Date Issued	Debt Rated	Action	Rating	Trend	Attributesi

US = Lead Analyst based in the USA

CA = Lead Analyst based in Canada

EU = Lead Analyst based in EU

UK = Lead Analyst based in UK

E= EU approved

U= UK approved

Unsolicited participation with access

Unsolicited participation without access

Unsolicited Non Participating

21-Apr-22	Long-Term Issuer Rating	Confirmed	BBB (low)	Stb	US

21-Apr-22	Long-Term Senior Debt	Confirmed	BBB (low)	Stb	US