OFS Capital Corporation 2022 Form 10-K Summary
Business context and reporting period
OFS Capital Corporation is an externally managed, non-diversified business development company and regulated investment company focused primarily on senior secured loans, subordinated debt, equity investments and structured finance securities issued by U.S. middle-market companies. The filing covers the fiscal year ended December 31, 2022, including fourth-quarter results. The report was filed March 3, 2023.
- At December 31, 2022, the portfolio included debt investments in 52 companies, equity investments in 16 companies and 23 structured finance securities.
- Portfolio fair value was $500.6 million, compared with $507.1 million at December 31, 2021.
- Debt investments were 99.6% senior secured and 0.4% subordinated at fair value.
- Approximately 80% of assets were qualifying assets under the 1940 Act, compared with 85% in 2021.
Financial performance and key metrics
| Metric | 2022 | 2021 |
|---|---|---|
| Total investment income | $48.7 million | $47.8 million |
| Total expenses, net of waivers | $30.4 million | $34.3 million |
| Net investment income | $18.4 million | $13.5 million |
| Net investment income per share | $1.37 | $1.00 |
| Net gain (loss) on investments | $(25.8) million | $48.0 million |
| Net increase (decrease) in net assets from operations | $(7.6) million | $56.9 million |
| Net asset value per share | $13.47 | $15.18 |
| Distributions per share | $1.16 | $0.91 |
- Net investment income rose 37%, primarily because total investment income increased and incentive fee expense declined following reversal of a previously accrued $1.9 million capital gains fee.
- Weighted-average realized yield on interest-bearing investments increased to 10.0% from 9.7%. Approximately 94% of the loan portfolio at fair value was floating rate.
- Net portfolio losses were driven mainly by $23.0 million of unrealized depreciation on loan investments and $14.2 million on structured finance securities, partly offset by $13.1 million of unrealized appreciation on equity investments.
- Net investment income was $4.7 million, or $0.35 per share, in the fourth quarter, compared with $4.4 million, or $0.33 per share, in the third quarter. Fourth-quarter net investment gains and losses were a net loss of $2.3 million, versus a $13.9 million loss in the third quarter.
- The ratio of net investment income to average net assets was 9.5%, compared with 7.5% in 2021. The ratio of total expenses, net, to average net assets was 15.7%, compared with 19.2%.
Cash flow, debt and liquidity
- Cash and cash equivalents were $14.9 million at year-end, down from $43.0 million.
- Operating activities generated $2.9 million of cash, compared with $12.0 million used in 2021.
- Financing activities used $31.1 million, principally reflecting $19.0 million of SBA debenture repayments and $15.4 million of stockholder distributions.
- Outstanding senior securities totaled $335.6 million, compared with $349.9 million in 2021. The statutory asset coverage ratio was 163%, above the applicable 150% minimum.
- Debt consisted principally of $104.7 million under the BNP Facility, $50.9 million of SBA debentures and $180.0 million of unsecured notes. No amounts were outstanding under the $25.0 million PWB Credit Facility.
- Unused commitments were $25.0 million under the PWB Credit Facility and $45.3 million under the BNP Facility, subject to borrowing-base and covenant requirements.
- Unfunded portfolio investment commitments were $32.2 million at year-end.
- The BNP Facility was amended to extend its reinvestment period to June 20, 2025, maturity to June 20, 2027, and transition its benchmark from LIBOR to SOFR. The facility had $104.7 million drawn at year-end at SOFR plus 2.65%.
- Debt maturities include $50.9 million of SBA debentures in 2025, $125.0 million of unsecured notes in 2026, $104.7 million under the BNP Facility in 2027 and $55.0 million of unsecured notes in 2028.
Material changes versus the prior comparable period
- NAV per share declined 11%, from $15.18 to $13.47, as investment losses more than offset higher net investment income and distributions.
- Portfolio fair value declined modestly, but portfolio composition shifted toward structured finance securities, whose fair value increased to $88.5 million from $75.2 million. The company increased mezzanine CLO debt holdings, which management views as more senior and less risky than CLO subordinated notes.
- Debt and equity investment fair value decreased to $412.1 million from $431.9 million. Senior secured debt fair value declined to $311.6 million from $326.7 million.
- Non-accrual loans increased to five with aggregate fair value of $11.2 million, or 3.6% of the loan portfolio, from two loans with fair value of $7.7 million, or 2.2%.
- Risk ratings deteriorated modestly: investments rated 3 declined to 92.2% of debt investments from 94.2%, while ratings 4 and 5 increased to 5.5% and 2.3%, respectively.
- Investment activity slowed substantially: purchases of debt, equity and structured finance securities totaled $154.2 million, compared with $268.9 million in 2021.
- OFS repurchased 42,254 shares during 2022 at an average price of $8.30, leaving $9.6 million available under the repurchase program.
Guidance, outlook, management commentary and risks
- Management intends to focus on first-lien senior secured loans to larger borrowers and is winding down new SBIC investments other than follow-ons. The company believes this should improve its overall risk profile.
- Management expects the loan portfolio to continue benefiting from higher base rates because most loans are floating rate, but higher rates can also increase borrower defaults, funding costs and CLO financing costs.
- Management stated that liquidity is sufficient to support existing commitments and selectively deploy capital. The Board declared a first-quarter 2023 distribution of $0.33 per share, payable March 31, 2023.
- The company expects to distribute substantially all taxable income, but distributions may be reduced, deferred or partly paid in stock to preserve liquidity. It accrued $0.1 million of federal excise tax for 2022.
- Pfanstiehl Holdings represented 17% of the total portfolio and 47% of net assets at fair value. Its $85.5 million valuation included $85.2 million of unrealized appreciation, creating significant concentration and valuation risk.
- Approximately 94% of investments were classified as Level 3 fair value measurements. Valuations depend on unobservable discount rates, EBITDA multiples, default assumptions and recovery rates; the filing states that actual realizable values may differ materially.
- Key risks include economic recession, inflation, rising interest rates, credit-market spread widening, portfolio company defaults, illiquidity, leverage, CLO losses, LIBOR-to-SOFR transition risk, RIC qualification requirements and conflicts with affiliated funds and the external investment adviser.
- On March 1, 2023, SBIC I LP prepaid an additional $5.0 million of SBA debentures.
Most important facts for investors to verify
- Whether the increase in non-accrual loans and lower credit ratings leads to additional realized or unrealized losses.
- The sustainability of the $1.37 per-share annual net investment income and $0.33 quarterly distribution in a changing interest-rate environment.
- The valuation and operating performance of Pfanstiehl Holdings, including the substantial unrealized appreciation embedded in its fair value.
- Compliance with the 150% asset coverage requirement and all BNP Facility, PWB Credit Facility and unsecured note covenants.
- Refinancing and repayment plans for 2025–2028 debt maturities and the availability of credit facilities after borrowing-base adjustments.
- The performance and cash distributions of CLO and other structured finance investments, particularly following the 2022 market-value declines.
- The final tax characterization of 2022 distributions and the company’s continued qualification as a RIC and BDC.