OFS

OFS Capital Corp. Q1 2019 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2019. OFS Capital Corp. is an externally managed, closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The Company invests primarily in debt and, to a lesser extent, equity of middle-market U.S. companies. It also operates through a wholly-owned Small Business Investment Company (SBIC) subsidiary, SBIC I LP.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased by $3.34 million (37%) compared to Q1 2018. This was driven by a $3.15 million increase in interest income and a $0.52 million increase in fee income, primarily due to a larger portfolio balance and higher syndication fees.
• Expense Increase: Total expenses rose to $7.52 million from $5.19 million. Interest expense more than doubled to $3.46 million due to the issuance of $98.5 million in Unsecured Notes in late 2018. Management and incentive fees also increased due to higher average assets and net investment income.
• Portfolio Valuation: The portfolio experienced a net loss on investments of $1.10 million, compared to a net loss of $0.32 million in the prior year. This included unrealized depreciation on preferred equity and senior secured debt, partially offset by unrealized appreciation on common equity and new Structured Finance Notes.
• Liquidity: Cash balances decreased by $23.0 million, primarily due to net purchases of portfolio investments ($63.6 million) exceeding proceeds from repayments and sales ($22.3 million).

Outlook, Risks, and Management Commentary

• Debt Facility Amendment: On April 10, 2019, the Company amended its revolving credit facility with Pacific Western Bank, increasing the maximum availability from $50.0 million to $100.0 million and extending the maturity to February 28, 2021. The interest rate margin was reduced, and the statutory asset coverage ratio test was lowered to 150% (effective May 3, 2019).
• Asset Coverage: As of March 31, 2019, the Company's asset coverage ratio was 227%, well above the required 200% (and the upcoming 150% threshold).
• Non-Accrual Status: Loans on non-accrual status totaled $12.4 million in amortized cost with a fair value of $0.73 million. Notable non-performing assets include Community Intervention Services, Inc. and Master Cutlery, LLC.
• Regulatory Risks: The Company faces risks related to maintaining its RIC tax status, which requires distributing at least 90% of taxable income. Non-cash income (PIK interest, accretion) may create a cash shortfall for distributions. Additionally, SBIC I LP is subject to SBA regulations limiting leverage and distributions.
• Market Risk: 88% of the debt portfolio bears floating interest rates. A 100 basis point increase in rates would increase net income by approximately $3.46 million annually, while a 100 basis point decrease would reduce it by $3.10 million.

Investor Verification Checklist

• Debt Servicing: Verify the Company's ability to service the new Unsecured Notes ($98.5 million principal) and the increased interest expense relative to cash flow from operations.
• Non-Accrual Assets: Review the specific status and recovery prospects of the $12.4 million in non-accrual loans, particularly Community Intervention Services and Master Cutlery.
• Structured Finance Notes: Assess the valuation methodology and liquidity of the new $15.7 million Structured Finance Notes (CLO subordinated debt) added to the portfolio.
• Asset Coverage Ratio: Monitor the impact of the new 150% asset coverage ratio requirement effective May 3, 2019, on future borrowing capacity.
• Distribution Sustainability: Confirm that cash collections from the portfolio are sufficient to cover the $0.34 per share quarterly distribution, given the presence of non-cash PIK income.