OFS

OFS Capital Corp. 10-Q Summary: Period Ended September 30, 2019

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) 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. This report covers the quarterly period ended September 30, 2019, and the nine months ended on that date.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income Growth: Total investment income increased to $39.10 million for the nine months ended September 30, 2019, compared to $30.26 million in the prior year period. This was driven by a larger portfolio balance and the addition of Structured Finance Notes.
• Expense Increase: Total expenses rose to $24.56 million (nine months 2019) from $17.20 million (nine months 2018). Interest expense increased significantly to $11.56 million due to new borrowings under the BNP Facility and Unsecured Notes, alongside higher management fees due to increased asset levels.
• Net Realized/Unrealized Losses: The company reported a net loss on investments of $5.69 million for the nine months ended September 30, 2019, compared to a net gain of $0.60 million in the prior year. This was primarily due to unrealized depreciation on senior secured debt (notably Constellis Holdings and MAI Holdings) and Structured Finance Notes.
• Portfolio Expansion: Total investments at fair value grew from $396.80 million at December 31, 2018, to $502.16 million at September 30, 2019. The portfolio now includes $22.2 million in Structured Finance Notes (CLO subordinated debt), a new asset class for the company.

Guidance, Outlook, and Risks

• Capital Markets Activity: In October and November 2019 (subsequent to the reporting period), the company closed a public offering of $54.3 million in 5.95% Notes due 2026, netting approximately $52.3 million.
• Liquidity and Leverage: The company established a new $150 million revolving credit facility (BNP Facility) in June 2019, with $46.65 million drawn as of September 30, 2019. The company also amended its PWB Credit Facility, increasing capacity to $100 million.
• Dividend Policy: The Board declared a distribution of $0.34 per share for the fourth quarter of 2019. The company aims to distribute substantially all of its taxable income to maintain Regulated Investment Company (RIC) status.
• Risks: Key risks include the impact of interest rate fluctuations (90% of debt portfolio is floating rate), credit risk in the portfolio (including non-accrual loans totaling $12.4 million amortized cost), and the ability to maintain RIC tax status given non-cash income recognition (PIK interest).

Investor Verification Checklist

• Non-Accrual Status: Verify the status and fair value of loans on non-accrual, specifically Community Intervention Services, Inc. and Master Cutlery, LLC, which have significant fair value impairments.
• Structured Finance Notes: Review the valuation methodology and yield assumptions for the new $22.2 million CLO subordinated debt portfolio, which is subject to significant unobservable inputs (Level 3).
• Debt Covenants: Confirm continued compliance with the 150% asset coverage ratio requirement under the 1940 Act and specific covenants in the BNP and PWB credit facilities.
• Related Party Fees: Monitor the impact of the base management fee waiver on OFSCC-FS assets and the calculation of the incentive fee based on pre-incentive net investment income.
• Subsequent Debt Offering: Assess the impact of the $54.3 million 5.95% Notes due 2026 issued in late 2019 on future interest expense and leverage ratios.