OFS Capital Corp. 10-Q Summary: Period Ended June 30, 2020
Business Context and Reporting Period
OFS Capital Corporation (OFS) is an externally managed, closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). The company invests primarily in debt and, to a lesser extent, equity of middle-market and larger U.S. companies. This report covers the quarterly period ended June 30, 2020, a period significantly impacted by the global COVID-19 pandemic, which caused market volatility and economic disruption.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 |
|---|---|---|
| Net Asset Value (NAV) per Share | $10.10 | $12.95 |
| Net Investment Income | $6.58 million | $9.69 million |
| Net Investment Income per Share | $0.49 | $0.73 |
| Total Investment Income | $23.85 million | $25.25 million |
| Total Expenses (Net of Waiver) | $17.27 million | $15.56 million |
| Net Realized and Unrealized Gain (Loss) | $(31.08) million | $(2.60) million |
| Net Increase (Decrease) in Net Assets | $(24.50) million | $7.09 million |
| Cash and Cash Equivalents | $31.78 million | $9.40 million |
| Total Debt Outstanding | $332.40 million | $352.48 million |
| Asset Coverage Ratio | 166% | N/A |
Material Changes vs. Prior Period
- Portfolio Valuation Decline: The portfolio experienced a net unrealized depreciation of $20.9 million for the six months ended June 30, 2020, compared to $1.7 million in the prior year period. This was driven by adverse economic effects of the pandemic and declines in quoted loan prices.
- Realized Losses: The company recognized a net realized loss of $10.0 million, primarily due to a $9.1 million loss on the restructuring of its debt investment in Constellis Holdings, LLC, which was converted to equity.
- Non-Accrual Status: Investments in Online Tech Stores, LLC and 3rd Rock Gaming Holding, LLC were placed on non-accrual status. Total loans on non-accrual status increased to $49.5 million (amortized cost) from $12.4 million at year-end 2019.
- Yield Compression: The weighted average yield on total debt and Structured Finance Notes decreased to 9.01% from 9.94% at December 31, 2019, due to the shift to lower-yielding senior secured loans and the placement of assets on non-accrual.
- Fee Waiver: The investment advisor waived $0.44 million in income incentive fees for the first quarter of 2020.
Guidance, Outlook, and Risks
Management Commentary: Management noted that while the portfolio saw a recovery in the second quarter (net gain of $5.1 million) driven by improved fair values in Structured Finance Notes and specific equity investments (Pfanstiehl Holdings, Inc.), the six-month period remains challenging. Origination activity has slowed significantly, with no direct originations since March 16, 2020. The company has extended maturities and rescheduled interest payments for certain borrowers to support liquidity.
Liquidity and Capital: As of June 30, 2020, the company held $31.8 million in cash. It has $78.9 million of unused commitment under its PWB Credit Facility and $119.4 million under its BNP Facility. On July 29, 2020, the PWB facility commitment was reduced from $100 million to $50 million to reduce fees.
Risks and Contingencies:
- COVID-19 Impact: Significant uncertainty remains regarding the duration and severity of the pandemic's impact on portfolio companies, potentially leading to defaults or further valuation declines.
- LIBOR Transition: The company faces risks associated with the phase-out of LIBOR by the end of 2021, which may require renegotiation of credit agreements.
- Asset Coverage: The company remains compliant with the 150% asset coverage requirement under the 1940 Act, with a ratio of 166%.
Investor Verification Checklist
- Non-Accrual Exposure: Verify the specific terms and recovery prospects for the $49.5 million in loans placed on non-accrual status, particularly Online Tech Stores and 3rd Rock Gaming.
- Valuation Methodology: Review the shift in weighting for Level 3 fair value models (increased reliance on reunderwriting analysis) and the sensitivity of portfolio values to changes in discount rates and EBITDA multiples.
- Debt Covenants: Confirm ongoing compliance with the amended covenants of the PWB Credit Facility, specifically the new net loss restriction and reduced minimum tangible net asset value.
- Origination Pipeline: Assess the impact of the halt in direct originations since mid-March on future revenue growth and portfolio yield.
- Dividend Sustainability: Evaluate the ability to maintain the declared distribution of $0.17 per share given the decline in net investment income and the potential for distributions to exceed taxable income (return of capital).