OFS Capital Corporation 4.95% Notes due 2028 (OFSSH) Q1 2021 Earnings Report, Transcript and Summary

Good morning and welcome to the OFS Capital Corporation's First Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I'd now like to turn the conference over to Steve Altebrando. Please go ahead.

Good morning everyone and thank you for joining us. Also on the call today is Bilal Rashid, Chairman and Chief Executive Officer of OFS Capital; and Jeff Cerny, the company's Chief Financial Officer and Treasurer. Please note that we issued a press release this morning announcing our first quarter 2021 results. This press release was subsequently filed on Form 8-K with the SEC. Both documents can be obtained under the Investor Relations section of our website at ofscapital.com. 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 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 those 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. During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the Investor Relations' section of our website at ofccapital.com under the heading Tax and non-GAAP Information. With that, I'll turn the call over to Chairman and Chief Executive Officer, Bilal Rashid.

Thank you, Steve. Good morning and welcome. I hope that you and your families continue to be safe and healthy. I would like to thank everyone for joining us today to discuss all OFS Capital's performance in the first quarter of 2021. During which OFS Capital performed well. Here are the key takeaways from the quarter. Adjusted net investment income of $0.23 per share, up 5% from the last quarter, an increase of approximately 1% in our NAV, which stood at $11.96 per share as of March 31. This number includes $0.21 per share in right-off of costs and expenses tied to the refinancing of our bonds, a meaningful reduction in our weighted average cost of debt from 5.49% to 5.16% as a result of our capital raising activities in the quarter. We had no new loans or non-accrual, which we believe demonstrates the resilience of our portfolio companies. Lastly, we increase our quarterly distribution by 10% compared to last quarter from $0.20 per share to $0.22 per share, marking our third straight quarterly distribution increase. Our new priorities have always been to preserve capital, while thoughtfully growing our earnings. These two long standing principles position as well as the broader economic outlook continues to improve for middle market companies. We remain focused on increasing our earnings by growing our origination activities and reducing our cost of debt. We continue to originate loans to new companies as well as increasing our loans to existing portfolio companies as they grow organically or through acquisitions. As you know, conditions in the debt capital markets have been strong over the last several months. We were able to capitalize on these conditions and issued $125 million of unsecured bonds at attractive costs. The majority of the proceeds from these offerings were used to repay higher cost existing debt. This resulted in a projected annual interest expense savings on the repaid debt of approximately $1.4 million. Our portfolio remains defensively positioned, both in terms of seniority in the capital structure and industry selection. As a percentage of fair value, approximately 96% of our loan portfolio was senior secured at the end of the first quarter. Our portfolio is diversified across multiple industries, such as healthcare, technology, business services, and manufacturing. However, we continue to avoid highly cyclical industries, such as oil and gas and metals and mining. Looking forward, we expect that the economy will continue to improve due to favorable fiscal and monetary policies. Although interest rates remain historically low, we believe that we are well-positioned to benefit from an eventual increase in interest rates since our assets are largely floating and our financing is primarily fixed rate. These factors provide a solid backdrop for increasing the pace of our originations, which we believe could lead to an increase in net investment income over time. In this regard, we are encouraged by our increased pipeline activity through new borrowers and existing borrowers as we help them with their growth plans. Be assured, we are committed to consistently adhering to our longstanding underwriting standards, which have been in place since the inception of our adviser in 1994. Our financing provides us operational flexibility. As of the quarter's end, more than 90% of our debt matures in 2024 or later, and nearly two-thirds of our debt is unsecured. In addition, our senior loan facility matures in 2024 and is non-recourse to the BDC. And our corporate line of credit is taxable as well, with no mark-to-market provisions. OFS Capital continues to benefit from the expertise and skill of its adviser. With more than $2.5 billion in assets under management, the BDC adviser has experience investing across the loan and structured credit markets, which we believe gives us the ability to identify relative value credit opportunities across multiple asset classes. Our team of investment professionals have extensive experience in credit underwriting and restructuring across industry verticals. In addition, we also believe that shareholders benefit from our alignment of interests with the adviser owning 22% of the outstanding shares of the BDC. You can be assured that we are working hard every day to protect our investments and drive the business forward for the benefit of all of our shareholders. 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 just discussed, we continue to be encouraged by the performance of our portfolio companies, as well as the add-on investment activity and the increase in our deal pipeline. We are optimistic about the future of both the economy and the pickup in investment activity. However, we remain cautious moving forward. Turning to our financial results, starting with our balance sheet, we had approximately $41.6 million of cash at the end of the quarter. Only $4.5 million of that cash was in our SBIC as the BDC received a $19.1 million return of capital distribution from our SBIC. In addition, we repaid $9.8 million of SBA debentures during the quarter. At quarter's end, we had only $95.5 million left in outstanding SBA debentures. As Bilal mentioned, 90% of our debt matures in 2024 or later and 64% of our outstanding debt at quarter end was unsecured. Therefore, we feel good about the composition of our liabilities. Our debt to equity ratio of approximately 1.4 times at the end of the quarter, excluding our SBIC debt compares to 1.3 times at year end. Our net asset value per share at the end of the quarter was $11.96, up $0.11 from the prior quarter. The increase was primarily driven by higher fair value marks on our investments. This was offset by a non-cash loss on extinguishment of debt, primarily related to our successful refinancing of approximately $99 million in higher priced unsecured notes and to a lesser extent the prepayment of $9.8 million in SBA debentures I mentioned earlier. In addition, we had higher than normal interest expense due to this unsecured note refinancing, because of the timing difference between when we issued the new unsecured notes and the repayment of certain of our existing notes. Our NAV per share increased quarter-over-quarter and has made a strong recovery since the onset of the pandemic. This quarter's increase includes a $0.21 per share offset for losses and expenses tied to the refinancing I just mentioned. As Bilal mentioned, we had no new non-accruals this quarter. We have not had a new non-accrual since the second quarter of 2020. We currently have 2.3% of the loan portfolio on non-accrual at fair value. Turning to the income statement, total investment income for the quarter decreased approximately $600,000 to $10.5 million. This decrease was primarily due to a decline in prepayment and other fees and lower common equity dividends. Total expenses of $7.9 million were down approximately $200,000. This decrease was due to lower incentive fees, partly offset by increases in interest expense. As Bilal discussed, earlier this morning, we declared a distribution for the second quarter of $0.22 and approximately 10% increase in the quarterly rate. The Board approved this higher distribution based on our increased earnings on an adjusted basis for the unsecured bond refinancing, as well as lower interest costs of approximately $1.4 million annually. We believe that this bond offering improves our overall capital structure. As always, we remain focused on our liquidity and maintaining a healthy balance sheet. Turning to the portfolio, we are pleased that our portfolio companies have continued to perform and believe that our underwriting selectivity will continue to positively impact how the portfolio performs in the future. Several of our portfolio companies identified opportunities for growth for which we are evaluating incremental funding. At the end of the quarter, the portfolio had 87 companies, totaling approximately $466 million on a fair value basis. The overwhelming majority of our investments are in loans, 96% of the fair value of our loan investments were in senior secured loans, up 1% from the prior quarter. 93% of our loan investments were floating rate. We had LIBOR floors on approximately 88% of our floating rate loan portfolio with a weighted average LIBOR floor of 1.17%. In the current interest rate environment, this LIBOR floor is a strong contributor as it favorably compares to the three months LIBOR of just 19 basis points at March 31st. Our overall investment portfolio as a percentage of cost includes approximately 71% senior secured loans, 10% subordinated debt, 12% structured finance notes, and 7% equity, of which approximately 55% of our equity was in preferred equity securities. Our portfolio remains diversified, with an average investment in each portfolio company of approximately $6 million or approximately 1.4% of the portfolio's total fair value. The overall weighted average yield to cost on our performing debt and structured finance note investments remains above 10%, though down by 23 basis points quarter-over-quarter, primarily as a result of overall tightening in the credit markets. With that, I'll turn the call back over to Bilal.

Thank you, Jeff. In closing, we are pleased with our performance in the first quarter. Additionally, once again, we increased our distribution in the second quarter of 2021, reflecting both the improved performance and our outlook for the quarters ahead. We believe that our solid liquidity positions will help us in the current economic environment as we seek to take advantage of potential new investment opportunities and support our existing portfolio companies. Since the beginning of 2011, OFS has invested approximately $1.5 billion with a cumulative net realized loss of principle of only $13.8 million or an annualized loss percentage of approximately 0.1%, while generating attractive yields on our portfolio. We have been steadily increasing our allocation to senior secured loans and our loan portfolio consists primarily of such loans. We have also been increasing our exposure to larger borrowers. Our financing is primarily long-term. As of March 31, 90% of our debt matures in 2024 and beyond. We believe that this gives us operational flexibility to execute on our business plan. Lastly, we benefit from the experience of our adviser, which manages a $2.5 billion corporate credit platform. Our adviser is a part of an asset management group, with over $30 billion in assets with broad resources, including longstanding banking relationships. Our adviser has gone through multiple credit cycles over the past 25 years and we believe it has a strong alignment of interest with all shareholders with a 22% interest in the BDC. I want to acknowledge the continued dedication and hard work of our employees. OFS continues to work diligently to adapt to the evolving impact of the pandemic, especially by supporting our portfolio companies, employees, and other stakeholders. With that, operator, please open up the call for questions.

Thank you all for joining our call today and we look forward to speaking with everyone again next quarter. Operator, you may now end the call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.