OFS Capital Corporation (NASDAQ:OFS) Q1 2023 Earnings Call Transcript May 5, 2023

Operator: Good morning, and welcome to the OFS Capital Corporation First Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Steve Altebrando. Please go ahead.

Steve Altebrando: Good morning, everyone, and thank you for joining us. Also on the call today are Bilal Rashid, our Chairman and Chief Executive Officer; and Jeff Cerny, the company’s Chief Financial Officer and Treasurer. Before we begin, please note that the statements made on this call and webcast may constitute forward-looking statements as defined under applicable securities laws. Such statements reflect various assumptions, expectations and opinions by OFS Capital management concerning anticipated results are not guarantees of future performance and are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from such statements. The uncertainties and other factors are in some way beyond management’s control, including the risk factors described from time to time in our filings with the SEC.

Although, we believe these assumptions are reasonable, any of those assumptions could prove inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance on these forward-looking statements. OFS Capital undertakes no duty to update any forward-looking statements made herein, and all forward-looking statements speak only as of the date of this call. With that, I’ll turn the call over to Chairman and Chief Executive Officer, Bilal Rashid.

Bilal Rashid: Thank you, Steve. Good morning. Since our last call just two months ago, we are pleased to report another increase in our quarterly net investment income. We continue to see the benefits of our balance sheet positioning in this rising interest rate environment with the vast majority of our loan portfolio being floating rate and the majority of our debt being fixed rate. Earlier this morning, we announced a quarterly distribution of $0.33 per share. Our net investment income increased to $0.37 per share in the first quarter up from $0.35 per share in the fourth quarter of last year. This increase was largely due to a dividend payment from our investment in Pfanstiehl. Such payments are at the discretion of the company and are not expected to be received on a recurring quarterly basis.

Our net asset value remained relatively flat decreasing by less than 0.5% to $13.42 per share. This slight decline from last quarter was primarily due to unrealized depreciation on investments. We believe that the overall credit quality of our portfolio companies remain solid. As you would expect, we maintain regular contact with our portfolio companies and we continue to believe that the cost of borrowing remains manageable in this slow growth and rising interest rate environment. As part of our longstanding investment discipline, we limit investing in highly cyclical industries. Our well diversified portfolio is defensively positioned with our largest sector exposures and manufacturing, healthcare, business services, and technology. Although M&A activity remains subdued, we expected to pick up in the second half of the year.

In the meantime, we remain deliberate in putting capital to work. Our financing continues to provide us with operational flexibility. At the end of the first quarter, approximately 85% of our outstanding debt matures in 2026 or later and more than half of our debt is by three years to June 2027. This facility is non-recourse to the BDC. Our corporate line of credit is flexible with no mark-to-market provisions. And in 2021, we locked in $180 million of fixed rate unsecured debt at rates that are notably lower than current market pricing carrying a weighted average coupon of 4.8%. This combination of financings has enabled us to benefit from rising interest rates. Totally after our call in March, the banking industry began experiencing a period of turmoil with the collapse of certain banks.

As you know, we have no direct exposure to venture debt or commercial real estate. In fact, we believe that the weakness in the banking sector will help strengthen our competitive positioning as a lender. As it relates to the impact of rising interest rates and inflation, we believe that being at the top of the capital structure with the majority of our loan portfolio being senior secured helps us in this uncertain economic environment. We also anticipate that we will continue to benefit from the experience of our advisor, which manages approximately $4.1 billion across the loan and structured credit markets has expertise in multiple asset classes and industries and has a more than 25-year track record through multiple credit cycles. At this point, I’ll turn the call over to Jeff Cerny, our Chief Financial Officer to give you more details and color for the quarter.

Jeff Cerny: Thanks, Bilal. Good morning, everyone. As Bilal mentioned, we posted net investment income of $0.37 per share for the quarter. This compares favorably to our prior quarter’s net investment income of $0.35 per share. We also announced a quarterly distribution of $0.33 per share. Comparing net investment income quarter-over-quarter, we are up almost 6% with stable interest income and higher dividend income. This increase was largely due to a $546,000 dividend payment from our investment in Pfanstiehl. As Bilal noted, such payments are at the discretion of the company and are not expected to be received on a recurring quarterly basis. Our net asset value per share decreased by less than 0.5% to $13.42. Despite the modest decline, our March 31 net asset value remains approximately 8% above its pre-pandemic level at the end of 2019.

The decline this quarter was primarily due to some unrealized depreciation on our investment portfolio. Credit trends in our portfolio remained relatively stable. At fair value, we currently have just 2.3% of our total investments on non-accrual status. Turning to the income statement, total investment income was up 2% to $14.3 million. As I previously mentioned, this was primarily due to an increase in dividend income. Total expenses of $9.3 million were up slightly primarily due to an increase in the variable interest rate on our BNP credit facility. As I mentioned earlier, net investment income was $0.37 per share for the first quarter. This is a meaningful increase compared to last quarter’s net investment income of $0.35 per share. The increase was largely related to a dividend payment from Pfanstiehl, we continue to believe that net investment income will remain solid given the vast majority of our loan portfolios floating rate while 68% of our liabilities are fixed rate, which are at rates lower than current market levels for similar debt.

It is also worth noting that at quarter end, approximately 85% of our outstanding debt matures in 2026 or later and approximately 54% of our outstanding debt was unsecured. Excluding the SBIC debt, our regulatory debt-to-equity ratio was relatively stable quarter-over-quarter at approximately 1.59 times and our regulatory asset coverage ratio remained stable at 163%. Turning to our investments. We are pleased by the continued performance of our portfolio companies in this uncertain macroeconomic environment. We remain committed to being senior in the capital structure and selective in our underwriting. While we remain cautious with regard to new originations, several of our portfolio companies continue to identify add-on opportunities for growth, for which we either funded in the first quarter or are evaluating incremental funding in the second quarter.

The majority of our investments are in loans. And as of March 31, nearly 100% of the loan portfolio at fair value was senior secured. In addition at quarter’s end, 94% of the loan portfolio was floating rate, which is naturally advantageous in a rising rate environment. However, we are now seeing a slowing in the increase of benchmark interest rates. For instance, during the fourth quarter, three-month LIBOR increased by approximately 100 basis points compared to 42 basis points in the first quarter and 11 basis points for the month of April. As a percentage of cost, our overall investment portfolio includes approximately 70% senior secured loans, 3% subordinated debt, 22% structured finance notes, and 5% equity securities. Our portfolio remains diversified.

At the end of the quarter, we had 87 portfolio companies totaling approximately $500 million on a fair value basis. For the quarter that ended March 31, the performing investment income yield on the interest-bearing portion of the portfolio, which includes all interest, prepayment fees, and amortization of deferred loan fees was up 30 basis points to 13%. This reflects the benefits of the floating rate nature of our portfolio in this rising rate environment. We should note that this 30 basis point increase is lower than the 110 basis point increase reported in the fourth quarter as a result of the deceleration of rate increases. With that, I’ll turn the call back over to Bilal.

Bilal Rashid: Thank you, Jeff. In closing, we are proud to have continued to grow net investment income once again this quarter. Our balance sheet positioning has served us well, but the vast majority of our known portfolio being floating rate and 68% of our outstanding debt being fixed rate. We believe we will continue to benefit from our focus on capital preservation with nearly 100% of our loan portfolio at fair value being senior secured and we remain confident in the overall quality and fundamentals of our portfolio. Our financing is primarily long-term with approximately 85% of our outstanding debt maturing in 2026 and beyond. We will continue to rely upon our longstanding experience and investment discipline to guide us through this period of economic uncertainty.

Our track record illustrates that since the beginning of 2011, OFS has invested more than $1.9 billion with accumulative net realized loss of just 1.9% over the last 12 years while generating attractive risk adjusted returns on our portfolio. Lastly, we believe our business is especially equipped to navigate this market successfully due to the size, experience, and reputation of our advisor. With a $4.1 billion corporate credit platform affiliated with a more than $30 billion asset management group, our advisor has broad expertise including longstanding banking and capital markets relationships. Our corporate credit platform has gone through multiple credit cycles over the last 25-plus years. Our advisor is also strongly aligned with shareholders as it maintains a 22% ownership stake in the BDC.

With that, operator, please open up the call for questions.

Operator: Thank you. We will now begin our question-and-answer session. Ladies and gentlemen, as I’m showing no questions at this time. This concludes our question-and-answer session and thus concludes today’s call. We thank you for joining OFS Capital Corporation’s first quarter 2023 earnings call and at this time you may now disconnect. Take care.