OFS Capital Corporation 4.95% Notes due 2028 (OFSSH) Q3 2023 Earnings Report, Transcript and Summary

Good morning, and welcome to the OFS Capital Corporation Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Steve Altebrando, Vice President of Capital Markets. Please go ahead.

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. Good morning. This quarter, we are pleased to report a fourth consecutive increase in our net investment income, which rose to $0.40 per share, up by 5% from the second quarter. We believe this increase was a result in part of our balance sheet positioning with the majority of our debt being fixed rate and the vast majority of our loan portfolio being floating rate. Our net asset value declined slightly by 1.5% to $12.74 per share, primarily due to unrealized depreciation on a few assets. This was partially offset by broader net unrealized appreciation across the remainder of the investment portfolio, particularly in our structured finance investments. The overall performance of our portfolio companies remains solid in this uncertain macroeconomic environment. In our view, the vast majority of our portfolio companies remained well positioned to manage the increased cost of borrowing. Yields on the portfolio continued to increase compared to the last quarter, in line with observed increases in benchmark rates. As part of our long-standing investment discipline, we have historically avoided investing in highly cyclical industries. We believe that our well-diversified portfolio is defensively positioned with our largest sector exposures in manufacturing, health care, business services and technology. 99% of our loan portfolio at fair value is senior secured. We believe that being at the top of the capital structure will continue to benefit us in this uncertain economic environment. In terms of new originations, we continue to see subdued M&A activity compared to historical levels due to interest rate and macroeconomic uncertainty. Like many market participants, we are optimistic that we will see increased activity in the first half of next year. In the meantime, we remain deliberate in putting capital to work. Our financing continues to benefit our company. At the end of the third quarter, approximately 89% of our outstanding debt matures in 2026 or later, and 59% of our outstanding debt is unsecured. Our nonrecourse $150 million senior loan facility with BNP Paribas matures in June 2027. Our corporate line of credit is flexible with no mark-to-market provisions. As we have discussed before, we locked in $180 million of fixed rate unsecured debt 2 years ago, and that has a weighted average coupon of 4.8%, which is notably lower than current market pricing. We also anticipate that we will continue to benefit from the experience of our adviser, which manages approximately $4.2 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 $0.40 per share for the third quarter. This compares favorably to our prior quarter's net investment income of $0.38 per share. We also announced that our quarterly distribution remains at $0.34 per share for the fourth quarter, representing a 12.1% annualized yield per share as of the close on September 30. Quarter-over-quarter, our net investment income increased approximately 5%. The increase was primarily due to nonrecurring interest income driven by our CLO warehouse investments that was repaid near the end of the quarter. Our net asset value per share decreased by $0.20 per share or approximately 1.5% to $12.74 per share. As Bilal mentioned, this decline was primarily related to a few downward valuation marks for the quarter and was partially offset by broader unrealized appreciation across the remainder of the investment portfolio, particularly in our structured finance investments. During the quarter, we placed loans with an aggregate fair value of $6.4 million on nonaccrual status. As of September 30, 3.7% of our total investments at fair value were on nonaccrual status, even though a couple of them remain current on their cash interest payments. Turning to the income statement. Total investment income was up approximately [0.2%] to $14.7 million. As I previously mentioned, this was primarily to an increase in interest income driven by a CLO warehouse investment upon payment near the end of the quarter. Total expenses of $9.3 million were down slightly during the period, primarily due to a decrease in our average debt balance and correspondingly our interest expense. As I mentioned, net investment income was $0.40 per share for the third quarter. This is a $0.02 increase compared to last quarter, which continues the trend of quarterly increases over the past year. We continue to believe that net investment income will benefit from our balance sheet positioning, given that 94% of our loan portfolio at fair value is floating rate, while 70% of outstanding debt is fixed rate. It is also worth noting that at quarter-end, 89% of our outstanding debt matures in 2026 or later, and 59% of our outstanding debt was unsecured. Excluding the SBIC debt, our regulatory debt-to-equity ratio was relatively stable quarter-over-quarter at approximately 1.59x, and our regulatory asset coverage ratio was 163%. Turning to our investments. The overall performance of our portfolio companies remains solid in this uncertain macroeconomic environment despite weakness in a few of our investments. We are committed to being senior in the capital structure and selective in our underwriting. We remain cautious with regard to new originations and have continued to see slow M&A activity during the third quarter. We continue to support our portfolio companies as they identify add-on opportunities for growth for which we either funded this quarter or are evaluating incremental funding in the fourth quarter. As of September 30, we had commitments to fund investments under various credit facilities to our portfolio companies totaling $14.1 million. The majority of our investments are in loans and 99% of our portfolio at fair value was senior secured at September 30. As far as our overall investment portfolio, it includes approximately 71% senior secured loans, 1% subordinated debt, 23% structured finance securities and 5% equity securities as a percentage of cost. At the end of the quarter, we had investments in 77 unique issuers totaling approximately $457 million on a fair value basis. For the quarter ended September 30, the weighted average 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 80 basis points to 14.6%. With that, I'll turn the call back over to Bilal.

Thank you, Jeff. To wrap up our call today, we are pleased to report continued growth in net investment income this quarter, which we attribute in large part to our strong balance sheet positioning. The vast majority of our loan portfolio is comprised of floating rate investments and 70% of our outstanding debt is fixed rate. Our focus remains 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 substantially long term with approximately 89% of our outstanding debt maturing in 2026 and beyond. We have relied on our long-standing experience and investment discipline, which has served us well. Since the beginning of 2011, the BDC has invested more than $1.9 billion with a cumulative debt realized loss of just 2.5% over the past 13 years, 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 adviser. With a $4.2 billion corporate credit platform affiliated with a more than $30 billion asset management group, our adviser has broad expertise including long-standing banking and capital markets relationships. Our corporate credit platform has gone through multiple credit cycles over the last 25-plus years. Our adviser is also strongly aligned with shareholders as it maintains an approximately 22% ownership stake in the BDC. With that, operator, please open up the call for questions.

[Operator Instructions] The first question comes from Mitchel Penn with Oppenheimer.

A couple of quick questions. What's the percent of second liens in the portfolio?

Yes, the second lien is 20% of the loan portfolio. As I typically mentioned, this is -- they do tend to be the larger, more liquid loans. We've seen a very modest increase since last quarter and just due to the -- really just the portfolio size, but it really haven't been increasing in the second lien arena.

Got it. And in terms of the portfolio, what percentage of the portfolio has interest coverage below 1x?

Mitch, I don't have that statistic handy. I will say that so far based on current interest rates, we have been able to maintain our covenant coverage ratios, and we have seen some tightening in coverage ratios. But still very manageable given kind of the initial low leverage levels. And with the primarily first lien portfolio, I think the interest rate risk is a bit lessened, but I don't have that statistic handy.

Got it. And last question, are you guys -- we had -- [Gallup] did its middle market report this quarter and showed strong growth in EBITDA and revenue in their portfolio. And TSLX actually talked on their call about seeing similar times in numbers. What are you guys seeing in your portfolio in terms of growth in EBITDA and revenue on a trailing 12-month basis?

Yes, I would say more than a majority of our portfolio has seen growth on both revenues and EBITDA. I would say that we had seen some margin compression, but that has certainly lessened. So yes, more than a majority is definitely continuing to see growth in both revenues and EBITDA.

This concludes our question-and-answer session and the OFS Capital Corporation Third Quarter 2023 Earnings Conference Call. Thank you for attending today's presentation. You may now disconnect.