Prospect Capital Shares Volatile Following Negative Report From SIRF's Roddy Boyd

The report initially sent shares tumbling to an intra-day low of $8.08, but shares since rebounded and traded as high as $8.37.

Boyd pointed out that Prospect bought advertising space in Barron's back in June 2015, which touted its 12.4 percent dividend yield. After the ad, the stock began to drop and the stock was even called "The most hated stock on Wall Street" and was on the receiving end of critical reports by both The Wall Street Journal and the New York Times.

Related Link: National Securities Downgrades Prospect Capital To Sell

With a valuation of less than $3 billion, it is odd that Prospect would be on the receiving end of so many scathing reports. Boyd suggested one reason for the "intense feelings" is the fact that the company operates as a business development company (BDC), which pays a 12 percent yield. However, this is of great concern as the company is holding $1.1 billion of collateralized loan obligation (CLO) investments.

Prospect, and other BDCs, find CLOs attractive given its diversified mix of loans. The problem in this case is that many of Prospect's peers have "shown little hesitation" in slashing the value of their own similar CLO portfolio.

Boyd highlighted a research report by Wells Fargo's analyst Jonathan Bock who compared Prospect's CLO portfolio to Eagle Point Credit's portfolio. The analyst found that Eagle Point's CLO book was valued at 55.6 percent of its estimated fair value, while Prospect valued its book at 76.3 percent.

Related Link: Yield-Is-High Squad: 3 BDCs Paying Monthly Dividends

"While an imperfect comparison, that 20.7 percent percentage point differential between the two portfolios illustrated the point that the stakes are very real, representing a notional $230 million hit to Prospect's equity value and the loss of millions of dollars in fee income for its management," Boyd wrote.

A BDC also faces limits on their ability to disburse cash to investors if their debt-to-equity ratio exceeds 100 percent. Based on Boyd's calculations, Prospect's ratio as of the end of March stood at 73.8 percent. After all, a BDC that doesn't pay dividends "would be hard pressed to retain many investors."

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