OFS Capital Corporation (OFS) Q3 2024 Earnings Report, Transcript and Summary

Good day, and welcome to the OFS Capital Third Quarter of 2024 Earnings Conference Call. All participants will be in a listen-only mode for the duration of the call. [Operator Instructions] Also, please be aware that today's call is being recorded. I would now like to turn the call over to Steve Altebrando. Please go ahead sir.

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.

Thank you, Steve. Earlier this morning we announced our third quarter earnings. Our net investment income increased by approximately 4.8% to $0.27 per share. Our net asset value per share decreased modestly by 1.9% to $11.29 per share. With respect to net investment income, while we had an improvement this quarter, we remain focused on increasing this metric longer term primarily by rotating certain non-interest earning equity positions into interest earning assets. As we discussed on our last call, we continue to explore potential alternatives for our minority equity investment in Pfanstiehl, our largest equity position. In the meantime, the fair value of the position continued to improve this quarter, appreciating by $2.8 million to $73.7 million at quarter end. The increase in value is primarily attributed to improved fundamental performance of the company. As a reminder, this is a position we invested in more than 10 years ago at a cost of only $200,000. To date, we have received $3.4 million in distributions for approximately 16 times our cost. Our net asset value per share decreased by 1.9% as a result of certain markdowns during the quarter in our loan and structured finance positions, which were offset by an increase in the value of our equity positions notably Pfanstiehl. Our nonaccrual metrics as a percentage of our total portfolio at fair value were relatively stable compared to the prior quarter. We removed one loan, which had previously been on nonaccrual status during the quarter and we placed one loan on nonaccrual this quarter representing only 0.6% of the total portfolio at fair value. Overall, we believe the portfolio continues to be well positioned for the current macroeconomic environment. As part of our longstanding investment discipline, we remain committed to avoiding highly cyclical industries. We believe that our loan portfolio remains well diversified and defensively positioned. At quarter end, our largest sector exposures at fair value are in manufacturing and healthcare. Another key part of our investment discipline is investing higher in the capital structure with 100% of our loan portfolio at fair value in first-lien and second-lien senior secured loans. In our view, our financing continues to benefit our company. At the end of the third quarter 100% of our outstanding debt matures in 2026 or later and 72% of our outstanding debt is unsecured. Our non-recourse $150 million floating rate facility with BNP Paribas matures in June 2027. Our Bank of California floating rate corporate line of credit provides us additional liquidity and flexibility. As we have discussed before, in 2021 we locked in $180 million of fixed rate, unsecured debt bearing a weighted average coupon of 4.8% which remains notably lower than current market pricing. Looking ahead, we believe the recent interest rate cut by the Federal Reserve and potential additional interest rate reductions in the near-to-medium term will put some pressure on our net interest margin. However, we also believe that lower interest rates should have a positive impact on the health of the loan portfolio as it decreases the debt service burden on our borrowers. Additionally, we believe that lower rates reduce the risk of a recession which would bode well for our portfolio. We expect M&A activity to pick-up in the coming quarters, which could lead to higher originations and fee income and a potential positive impact on net investment income. As we navigate this market environment, we have confidence in the experience of our advisor which manages approximately $3.9 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.

Thanks Bilal. Good morning everyone. As Bilal mentioned, we posted net investment income of $0.27 per share for the third quarter, which was up $0.01 per share from the second quarter primarily due to a decrease in G&A expenses which more than offset the modest decline in investment income. Our current distribution rate represents a 16.1% annualized yield based on the market price of our common stock at quarter end. We also announced that our quarterly distribution will remain at $0.34 per share for the fourth quarter. We are focused on improving net investment income so that it exceeds our distribution rate. As Bilal discussed, we are actively exploring potential alternatives to monetize certain non-interest earning equity investments to increase our net investment income, primarily our minority equity stake in Pfanstiehl. Our net asset value per share decreased by approximately 1.9% or $0.22 this quarter. This decrease was primarily the result of certain markdowns during the quarter in our loan and structured finance positions which were offset by an increase in the value of our equity positions, notably Pfanstiehl as Bilal described. Our one new non-accrual loan, JP Intermediate was downgraded this quarter based on our internal credit rating scale, it represents 0.6% of the total portfolio at fair value. In addition, we removed one loan which had previously been on non-accrual status during the quarter. Our non-accrual metrics as a percentage of our total portfolio at fair value were relatively stable compared to the prior quarter. Overall, we believe the portfolio continues to be well positioned for the current macroeconomic environment and we believe the overall quality of the portfolio remains stable. 5.4% of our total investments at fair value were on non-accrual status at quarter end. Turning to the income statement, total investment income was down approximately 2% to $10.9 million this quarter. This was primarily driven by one of our large loan positions being repaid at par, which impacted interest income as we redeployed the proceeds into a handful of new loan positions. Our regulatory asset coverage ratio stands at 161% at quarter end. Total expenses were down 5.3% during the period to $7.3 million primarily due to a decrease in G&A expenses as I mentioned earlier, most notably a reduction in administration fees. Turning to net investment income, it was up $0.01 to $0.27 per share for the third quarter. We described our plans to increase net investment income and it is also worth noting that at quarter end all of our outstanding debt matures in 2026 or later and approximately 72% of our outstanding debt was unsecured. Turning to our investments, we believe the overall performance of our portfolio companies remained relatively stable compared to last quarter despite this uncertain macroeconomic environment. We do believe that the recent interest rate reduction and the expected future reductions will benefit our borrowers overall. We are committed to being senior in the capital structure and selective in our underwriting. As M&A activity has remained subdued, we continue to work with our portfolio companies as they identify add-on opportunities for growth. As of September 30, we had $8.5 million in commitments under various credit facilities to fund investments to our portfolio companies. The majority of our investments are in loans and 100% of our loan portfolio at fair value was senior secured as of September 30 based on amortized cost as of quarter end, our investment portfolio was comprised of approximately 71% senior secured loans, 23% structured finance securities and 6% equity securities. At the end of the quarter we had investments in 69 unique issuers totaling $394.7 million on a fair value basis. The weighted average performing investment income yield on the interest bearing portion of the portfolio improved slightly to 13.6%, which is up about 0.2% quarter-over-quarter. This includes all interest prepayment fees and amortization of deferred loan fees. With that, I'll turn the call back over to Bilal.

Thank you, Jeff. In closing, we remain focused on increasing our net investment income in the coming quarters, specifically by exploring the sale of certain non-interest earning equity positions and redeploying the proceeds into interest earning assets. We continue to focus on capital preservation and we remain confident in the overall quality and fundamentals of our portfolio. We believe our longstanding experience and investment discipline has served us well over the past 13 years. Since the beginning of 2011, the BDC has invested more than $2 billion with a cumulative net realized loss of just 3.2% while generating attractive risk adjusted returns on our portfolio. We believe our business is especially equipped to navigate this market successfully due to the size, experience and reputation of our advisor. With $3.9 billion corporate credit platform affiliated with a $29 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 and affiliates are strongly aligned with the shareholders as they maintain an approximately 23% ownership in the company. With that operator, please open up the call for questions.

We will now begin the question-and-answer session. [Operator Instructions] And this will conclude our question-and-answer session and will also conclude today's conference call. Thank you all for attending today's presentation. You may now disconnect your lines.