OFS Capital Corp. 10-Q Summary: Period Ended June 30, 2013
Business Context and Reporting Period
OFS Capital Corporation (OFS Capital) is an externally managed, closed-end, non-diversified management investment company that elected to be treated as a Business Development Company (BDC) under the Investment Company Act of 1940. The company focuses on investing primarily in senior secured debt of middle-market U.S. companies. This report covers the quarterly period ended June 30, 2013, and the six months ended June 30, 2013. The company completed its IPO in November 2012.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2013 | Three Months Ended June 30, 2013 |
|---|---|---|
| Total Investment Income | $8.6 million | $4.2 million |
| Net Investment Income | $2.9 million | $1.5 million |
| Net Realized and Unrealized Gain | $3.2 million | $1.8 million |
| Net Increase in Net Assets from Operations | $6.1 million | $3.3 million |
| Total Assets | $242.4 million | $242.4 million |
| Total Investments (Fair Value) | $228.3 million | $228.3 million |
| Cash and Cash Equivalents | $10.0 million | $10.0 million |
| Revolving Line of Credit (Outstanding) | $94.2 million | $94.2 million |
| Net Assets | $142.0 million | $142.0 million |
| Net Asset Value (NAV) per Share | $14.76 | $14.76 |
| Dividends Declared per Share | $0.68 | $0.34 |
Material Changes vs. Prior Period
- Investment Income: Total investment income increased by approximately 67% ($3.4 million) for the six months ended June 30, 2013, compared to the same period in 2012. This increase was primarily driven by six months of interest income from OFS Capital WM (consolidated effective April 1, 2012) versus only three months in the prior year.
- Expenses: Total expenses increased by approximately 49% ($1.9 million) for the six-month period. This was due to increased interest expense and amortization of deferred financing costs (including a $0.3 million write-off related to the termination of the Class B loan facility in January 2013), as well as higher professional and administrative fees associated with public company operations.
- Net Income: Net increase in net assets resulting from operations improved significantly to $6.1 million for the six months ended June 30, 2013, compared to $2.5 million in the prior year period. This was largely due to a $3.2 million net unrealized gain on investments in the current period, contrasting with a $2.1 million net unrealized loss in the prior period.
- Portfolio Composition: The portfolio fair value decreased slightly from $232.2 million at December 31, 2012, to $228.3 million at June 30, 2013. The portfolio consists of 56 senior secured debt investments and an equity investment in Tamarix LP.
Guidance, Outlook, and Risks
- Dividend Policy: The company intends to distribute approximately 90-100% of its taxable income. For the six months ended June 30, 2013, approximately 54% of distributions were characterized as a return of capital.
- Capital Resources: The company utilized $90 million of IPO proceeds to pay down its credit facility in November 2012. As of June 30, 2013, the asset coverage ratio was approximately 242%, well above the 200% requirement for BDCs.
- Tamarix LP Acquisition: OFS Capital intends to acquire the remaining ownership interests in Tamarix LP and Tamarix GP to make Tamarix LP a wholly-owned subsidiary ("drop-down" SBIC). This requires SBA approval, which is pending. Failure to obtain approval could limit the company's ability to leverage Tamarix LP's capacity.
- Regulatory Risks: The company relies on exemptive relief from the SEC to exclude Tamarix LP's SBA-guaranteed debt from its asset coverage test. There is no assurance this relief will be granted.
- Market Risk: All debt investments in the portfolio bear floating interest rates. While interest rate floors effectively convert these to fixed rates in the current environment, a significant increase in rates could increase interest expense more than income due to the company's leverage structure.
Investor Verification Checklist
- Dividend Sustainability: Verify the tax characterization of dividends (ordinary income vs. return of capital) and the company's ability to maintain distributions given the 54% return of capital in the first half of 2013.
- Tamarix LP Status: Monitor the status of the SBA approval for the acquisition of remaining Tamarix LP interests and the SEC exemptive relief request, as these are critical to the company's growth strategy and leverage capacity.
- Credit Facility Terms: Review the terms of the OFS Capital WM Credit Facility, specifically the borrowing base limitations and the maturity date (December 31, 2016), to assess refinancing risks.
- Portfolio Quality: Examine the credit rating distribution of the portfolio. As of June 30, 2013, 93.1% of loans were rated "Average" (Risk 3), 5.3% were "Special Mention" (Risk 4), and 1.6% were "Substandard" (Risk 5). There was one non-accrual loan with a fair value of $3.6 million.
- Valuation Methodology: Confirm the company's reliance on Level 3 inputs (unobservable data) for valuing its portfolio, which involves significant management judgment and could differ from realized values.