OFS Capital Corporation — Q1 2023 Form 10-Q Summary
Business context and reporting period
OFS Capital Corporation is an externally managed, non-diversified business development company and regulated investment company. It invests primarily in senior secured loans to middle-market and larger U.S. companies, with additional equity investments and structured finance securities. This filing covers the unaudited three months ended March 31, 2023, compared primarily with the three months ended March 31, 2022 and the quarter ended December 31, 2022.
Key financial metrics
| Metric | Q1 2023 | Comparable period |
|---|---|---|
| Total investment income | $14.3 million | $10.9 million in Q1 2022; $14.0 million in Q4 2022 |
| Net investment income | $5.0 million, or $0.37 per share | $3.0 million, or $0.22, in Q1 2022; $4.7 million, or $0.35, in Q4 2022 |
| Net increase in net assets from operations | $3.8 million, or $0.28 per share | $8.4 million, or $0.62, in Q1 2022; $2.4 million, or $0.18, in Q4 2022 |
| Distributions declared | $0.33 per share; $4.4 million total | $0.28 per share in Q1 2022; $0.30 per share paid in Q4 2022 |
| Net asset value | $179.8 million; $13.42 per share | $180.4 million; $13.47 per share at December 31, 2022 |
| Cash at period end | $10.8 million | $14.9 million at December 31, 2022; $10.5 million at March 31, 2022 |
| Total investments at fair value | $499.8 million | $500.6 million at December 31, 2022 |
| Total debt carrying value | $328.4 million | $331.8 million at December 31, 2022 |
| Asset coverage ratio | 163% | Above the 150% statutory minimum |
Investment income increased year over year primarily because of higher interest income and, to a lesser extent, dividends. Interest expense increased to $4.9 million from $3.6 million in Q1 2022, reflecting higher borrowing costs, particularly on the BNP Facility. Annualized total expenses were 20.7% of average net assets and annualized net investment income was 11.0% of average net assets.
Cash flow from operating activities was $4.0 million, compared with cash used in operating activities of $24.4 million in Q1 2022. The Company purchased or originated $9.9 million of investments and received $1.8 million of principal repayments, $8.9 million from sales or redemptions, and $3.1 million of distributions. Financing activities used $8.1 million, including $4.4 million of distributions and $5.0 million of SBA debenture repayments.
Portfolio, leverage and liquidity
- The portfolio included 47 companies with debt investments, 17 companies with equity investments, and 23 structured finance securities.
- Debt investments had a fair value of approximately $309.9 million, of which approximately 99% were senior secured loans.
- Structured finance securities had a fair value of $87.0 million; equity investments had a fair value of approximately $102.8 million.
- Approximately 94% of debt investments at fair value bore floating rates. Management reported a weighted-average performing debt yield of 12.3%, up from 11.5% in the prior quarter.
- Outstanding principal borrowings totaled approximately $331.9 million: $180.0 million of unsecured notes, $101.0 million under the BNP Facility, $45.9 million of SBA debentures and $5.0 million under the PWB Credit Facility.
- Unused borrowing capacity was $20.0 million under the PWB Credit Facility and $49.0 million under the BNP Facility, subject to borrowing-base and covenant requirements.
- Unfunded investment commitments totaled $21.3 million to 12 portfolio companies.
- Approximately 85% of outstanding debt matures in 2026 or later, 68% bears fixed interest rates, and 54% is unsecured.
Material changes versus prior periods
- Net investment income rose 65% from Q1 2022, while total investment income increased 31%. Higher interest income reflected the higher-rate environment and the portfolio’s floating-rate exposure.
- Net investment income increased from $4.7 million in Q4 2022 to $5.0 million, while net investment income per share increased from $0.35 to $0.37.
- Net investment gains declined to a $1.1 million loss from a $5.5 million gain in Q1 2022, primarily because of issuer-specific declines in debt investments and structured finance securities. Equity appreciation partially offset these losses.
- Net asset value per share declined modestly from $13.47 to $13.42 during the quarter after the $0.33 per-share distribution.
- Investment fair value was broadly stable, but portfolio composition shifted: structured finance securities declined to $87.0 million from $88.5 million, while affiliate investments increased to $99.3 million from $96.7 million.
- SBIC I LP repaid $5.0 million of debentures on March 1, 2023. The Company recognized a $19,000 loss on extinguishment of debt.
- The Company reported no new non-accrual loans during the quarter. Five loans remained on non-accrual status, with fair value of $11.5 million, or 2.3% of total investments.
Guidance, outlook, risks and unusual items
Management stated that the loan portfolio remains well positioned in the current interest-rate environment and expects it to continue producing strong net investment income. The Company has not provided formal earnings or investment guidance in the filing.
- The largest portfolio exposure was Pfanstiehl Holdings, Inc., an equity investment with fair value of $85.4 million, equal to 17.1% of the total portfolio and 47.5% of net assets. Approximately $85.2 million of this value represented unrealized appreciation, creating significant NAV concentration risk.
- Approximately 92.3% of debt investments were rated in the Company’s average-risk category, while 5.3% were special mention, 2.3% substandard and 0.1% doubtful.
- Most investments are valued using Level 3 inputs, including discounted cash flows, multiples and other unobservable assumptions. Forced-sale values could be materially below recorded fair values.
- Higher interest rates increase income on floating-rate assets but also increase borrowing costs. The BNP Facility’s effective rate was approximately 8.00% and the PWB Facility’s effective rate was approximately 8.55% at March 31, 2023.
- The Company continued its transition from LIBOR to SOFR; management reported that 54% of variable-rate loans at fair value had transitioned to SOFR with minimal impact.
- Risks include recession, inflation, credit-market illiquidity, banking-system instability, refinancing and counterparty risk, portfolio-company defaults, valuation uncertainty, leverage, regulatory compliance, conflicts with affiliates and the ongoing Russia-Ukraine war.
- The Company held cash at financial institutions in amounts exceeding FDIC insurance limits, although management did not believe significant credit risk existed.
- On May 2, 2023, the Board declared a $0.33-per-share distribution payable June 30, 2023. The Chief Accounting Officer resigned effective April 21, 2023, and a successor was appointed the same day.
Important facts for investors to verify
- Reconcile the $85.4 million Pfanstiehl fair value and assess the sensitivity of NAV to changes in that valuation.
- Review the five non-accrual loans, including their $36.5 million amortized cost and $11.5 million fair value, and any expected recoveries.
- Confirm borrowing-base availability, covenants and maturity/refinancing requirements for the BNP Facility, PWB Facility and SBA debentures.
- Evaluate whether the $0.33 quarterly distribution is supported by recurring cash investment income, given PIK income, fee amortization and structured-finance accretion.
- Assess the impact of higher SOFR and any remaining LIBOR exposure on both portfolio income and borrowing costs.
- Review the concentration of investments in manufacturing, health care, wholesale trade and the largest individual borrowers.
- Consider the limitations and uncertainty of Level 3 fair-value estimates and the potential effect of adverse credit-market conditions on NAV.