OFS Capital Corp
NASDAQ:OFS
Earnings Call Analysis
Q4-2023 Analysis
OFS Capital Corp
This quarter, the company reported a net investment income of $0.35 per share, which was a decline from the previous quarter's $0.40 per share. This decrease was largely attributed to nonrecurring investment income that the company earned in the third quarter, not repeating in the fourth quarter. Despite the decline, the net investment income remained above the quarterly distribution rate of $0.34 per share. The company’s net asset value per share decreased by $0.65, from $12.74 to $12.09, mainly due to unrealized depreciation in a select few investments. However, the management is confident in the portfolio's health and its capital preservation strategy, emphasizing that 100% of their loan portfolio at fair value is senior secured.
OFS Capital's financing structure remains robust, with roughly 89% of their debt maturing in 2026 or later. Notably, during the fourth quarter, they retired the remaining $31.9 million of SBIC debt that was previously due to mature in early 2025. The debt-to-equity ratio stands at approximately 1.67x and the asset coverage ratio at 160%, excluding the SBIC debt. The company maintains a strategic focus on fixed-rate debt to hedge against market volatility, with 60% of the outstanding debt being unsecured, which provides financial flexibility.
The company keeps a selective approach towards new originations and underwriting, aiming to hold senior positions in the capital structure while avoiding highly cyclical industries. This strategy is proving advantageous in the current economic climate. They expect to see an uptick in M&A activity later in the year, which may provide new investment opportunities as interest rate clarity improves. Furthermore, the management believes the current portfolio is well-diversified and defensively positioned, with the largest sector exposures in manufacturing, health care, business services, and technology.
While overall investment income took an approximate 8% hit, declining to $13.5 million due to a reduction in investment income yield and some prepayments, the company's portfolio's performance remains solid. They currently have $13.8 million in funding commitments to various credit facilities for their portfolio companies, supporting their growth and allowing for add-on investment opportunities. At the end of the quarter, the investment portfolio included approximately 69% senior secured loans, 1% subordinated debt, 24% structured finance securities, and 6% equity securities, with investments in 76 unique issuers totaling about $420 million on a fair value basis.
The management believes that the experience of their advisor, managing about $4 billion across various credit markets, positions the company to navigate the current market effectively. The advisor group has over a 25-year history of navigating multiple credit cycles, and their significant stake of approximately 23% in the BDC aligns them with shareholder interests. The company’s distribution rate results in an 11.6% annualized yield based on the year-end common stock price, with a continued distribution of $0.34 per share for the quarter.
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Good morning, and welcome to the OFS Capital Corporation Fourth 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. Earlier this morning, we announced our fourth quarter results. Our net investment income in the fourth quarter was $0.35 per share, which was below our net investment income of $0.40 per share in the third quarter.
As you may recall, in the third quarter, we had some nonrecurring investment income, which was the primary driver of the drop in net investment income in the fourth quarter. Even so, our net investment income remains above our distribution of $0.34 per share.
We believe the overall performance of the companies in our portfolio remains solid. We had no new nonaccruals this quarter, and we placed 1 investment back on accrual status. Additionally, we believe that we benefited from 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 in the fourth quarter to $12.09 per share from $12.74 per share at September 30, primarily due to unrealized depreciation in a couple of positions. Looking ahead to 2024, we continue to believe our portfolio is well positioned for the current macroeconomic environment. 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.
100% 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 economic environment. In terms of new originations, we expect to see an increase in M&A activity later in the year as we get more clarity on interest rates. In the meantime, we remain active in supporting our existing portfolio companies.
Our financing continues to benefit our company. At the end of the fourth quarter, approximately 89% of our outstanding debt matures in 2026 or later, and 60% 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 of fixed rate unsecured debt in 2021, and that has a weighted average coupon of 4.8%, which is notably lower than current market pricing.
Since the end of the fourth quarter, we retired our remaining $31.9 million of SBIC debt, which was due to mature in early 2025. Going into the new year, we anticipate that we will continue to benefit from the experience of our adviser, which manages approximately $4 billion across the known 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 $0.35 per share for the fourth quarter, once again covering our $0.34 per share distribution declared during the quarter.
Our current distribution rate represents an 11.6% annualized yield based on the price of our common stock at year-end. We also announced that our quarterly distribution for the quarter remains at $0.34 per share. Our net asset value per share decreased by $0.65 to $12.09. As Bilal mentioned, this decline was primarily due to unrealized depreciation concentrated in a couple of positions.
During the quarter, we had no new nonaccruals and 1 loan was placed back on accrual status following an amendment, which included an equity infusion from the private equity sponsor and an improvement in the loan's fair value. This loan had a fair value of $4.2 million as of December 31. 2.9% of our total investments at fair value were on nonaccrual status at year-end.
Turning to the income statement. Total investment income was down by approximately 8% to $13.5 million. This was partly due to a 50 basis point decline in our investment income yield, largely related to nonrecurring investment income realized in the third quarter as well as some prepayments in the fourth quarter. This resulted in a lower overall investment balance in the fourth quarter.
We did not reinvest certain of the proceeds from repaid investments as we were preparing to redeem our remaining $31.9 million of SBIC debentures, which were due to mature in early 2025. On March 1, we completed this redemption.
Total expenses of $8.8 million were down approximately 5% during the period, primarily due to a decrease in interest expense related to the lower average outstanding debt balances during the quarter as well as lower management and incentive fees due to the declines in our investment portfolio and net investment income.
As I mentioned, net investment income was $0.35 per share for the fourth quarter. Net investment income covered our $0.34 distribution for the fourth quarter, and we believe that net investment income has benefited from our balance sheet positioning, given that 92% of our loan portfolio at fair value is floating rate, while 70% of our 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 60% of our outstanding debt was unsecured.
Excluding the SBIC debt, our regulatory debt-to-equity ratio was approximately 1.67x and our regulatory asset coverage ratio was 160%.
Turning to our investments. The overall performance of our portfolio companies remain solid in this uncertain macroeconomic environment despite weaknesses 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 continue to see slow M&A activity during the fourth quarter.
As I mentioned, we saw some heavier prepayments in the fourth quarter, and we're sitting on a much larger cash position at year-end than is typical as we prepare to retire the remaining $31.9 million in SBA debentures. We continue to support our portfolio companies as they identify add-on opportunities for growth, and we also funded a few new middle market investments in the fourth quarter.
As of December 31, we had $13.8 million in commitments to fund investments under various credit facilities 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 December 31.
Based on amortized cost as of quarter end, our investment portfolio was comprised of approximately 69% senior secured loans, 1% subordinated debt, 24% structured finance securities and 6% equity securities. At the end of the quarter, we had investments in 76 unique issuers totaling approximately $420 million on a fair value basis.
For the quarter ended December 31, the weighted average performing investment income yield on the interest-bearing portion of the portfolio was down about 50 basis points to 14.1%. This includes all interest, prepayment fees and amortization of deferred loan fees. The decline was largely due to certain nonrecurring income in our structured finance investments that occurred in the third quarter as well as some prepayments in the fourth quarter.
With that, I'll turn the call back over to Bilal.
Thank you, Jeff. In closing, we believe our portfolio remains in good shape with no new nonaccruals in the quarter and with 1 investment being placed back on accrual status. Our focus remains on capital preservation with 100% of our loan portfolio at fair value being senior secured, and we remain confident in the overall quality and fundamentals of our portfolio.
We have relied on our long-standing experience and investment discipline which we believe has served us well. Since the beginning of 2011, the BDC has invested more than $1.9 billion with a cumulative net realized loss of just 2.5% in 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 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 past 25-plus years. Our adviser and affiliates are also strongly aligned with shareholders as they maintain an approximately 23% ownership stake in the BDC.
With that, operator, please open up the call for questions.
[Operator Instructions] Our first question is from Mitchel Penn with Oppenheimer.
A couple of quick questions, just housekeeping. Your -- what percent of your loans are second liens?
Mitchell, this is Jeff. About 19% of our loan portfolio are second liens, and you'll notice we did start to break that out on our [indiscernible] happy to address that, but just for your...
Okay. Great. Great. And the affiliate pick income, was there a catch-up there for the quarter? Or because -- or is that -- it doesn't appear to be the run rate going forward, but I'm curious if there was some sort of adjustment.
Yes, there was a pickup of a loan, as I mentioned, the loan that we put back on accrual status, we had an equity infusion. And recognized some previously reserved past due interest in the form of PIK.
Got it. Got it. And one last question. the audit opinion sort of talked about valuation. Do you guys -- I always thought you guys employees like a third-party valuation service that periodically looks at the portfolio. Is that correct?
So For all of our Level 3 investments we have them valued by a third party, all of them, all the Level 3s every quarter. So it's not a...
Got it. And anything else you guys have value? Is that where the market values it?
That's right. If it's a Level 2. .
Got it. That's all for me.
This concludes our question-and-answer session, and the conference has also now concluded. Thank you for attending today's presentation. You may now disconnect.