OFS Capital Corp (OFS) 2015 Q3 法說會逐字稿

Good morning and welcome to the OFS Capital third quarter 2015 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 Investor Relations. Please go ahead.

Thank you. Good morning, everyone and thank you for joining us. With me today is Bilal Rashid our Chairman and Chief Executive Officer and Jeff Cerny, our Chief Financial Officer and Treasurer.

Please note that we issued a press release this morning announcing our third quarter results. This press release was subsequently filed on Form 8-K with the SEC. We plan on filing our 10-Q this afternoon. Both documents, as well as our most recent investor presentation, can be obtained under the Investor Relations section of our website or OFSCapital.com.

Before we begin please note that statements made on this capital or webcast may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by OFS Capital 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 other factors are, in some ways, 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 could also 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. All forward-looking statements speak only as of the date of this call. Our comments may reference adjusted net investment income, non-GAAP measure. Please refer to our most recent investor presentation for a reconciliation.

With that, I'll turn the call over to our Chairman and Chief Executive Officer Bilal Rashid

Thank you, Steve. Good morning and welcome.

We are happy to report that our third quarter results continue to show improving performance with net investment income of $0.38 per share. This more than covers our $0.34 distribution and it is significant improvement from $0.30 per share in the same period last year.

Our year-to-date performance has been strong as well. We believe that these encouraging results are due to the vision and business plan we have in place at OFS Capital. Our strong performance relies on one, maintaining a strict underwriting standards. This has resulted in low non-acruels and has ensured that we have no portfolio companies in the highly cyclical oil and gas sector.

Two, being responsive to our borrower's needs. This has led to repeat business, a reputation as a reliable partner and good quality deal flow. And lastly, our ability to provide flexible capital solutions to a broad array of industries particularly within the lower middle market. This is where we continue to find the best risk adjusted returns.

We have enough capital to execute on our business plan allowing us to continue to originate quality loans and sustain our distributions. We continue to find attractive risk-adjusted returns in the lower middle market, especially in non-sponsored transactions. Our seasoned team has long-standing sourcing relationships allowing us to see a broad array of potential transactions and to be highly selective in making investments.

OFS Capital's credit intensive culture, thorough due diligence process and expertise in structuring transactions positions us advantageously in this attractive market segment. The credit quality of our portfolio and our track record of underwriting quality loans continues to provide meaningful earnings growth and stability in the value of our portfolio.

At the end of the third quarter, loan accruals represented less than 1% of the fair value of our total assets and 61% of the fair value of our portfolio was in senior secured loans. Our portfolio benefits from our external managers $1.7 billion credit platform which has been in existence since 1994.

Our manager has the size and breadth of expertise across all parts of the leverage loan market, which provides us with considerable economic and capital markets intelligence in addition to expertise across industries. Our portfolio also benefits from the experience of our investment team, which has a long history of working through multiple credit cycles. We place a heavy emphasis on companies with strong management teams, high values to entry and strong free cash flow characteristics.

In addition, we are (inaudible) of highly cyclical and commodity-based industries. Our investment team takes a hands-on approach to managing the portfolio and working with our portfolio companies through the duration of our investment.

Looking ahead, our portfolio is positioned to benefit from a meaningful increase in interest rates. A majority of our loan assets are floating rate while our debt is 100% fixed rate. At the end of September, we had $150 million in fix rate SBA debentures with a weighted average interest rate of 3.18%. We have no maturities until 2022.

In the coming quarters, we will originate loans that meet our strict underwriting criteria. As of September 30, 2015, we had several potential sources of available capital. Number one, we had $42 million in cash, number two, we had $24 million of equity invested in the senior club loan portfolio that can be redeployed in higher yielding investments. Number three, we have the ability to raise additional capital in the bank loan or the bond market.

As a reminder, SBIC debt does not count towards the BDC leverage test so we have not tapped any of our available statutory leverage. Lastly, our second SBIC license was submitted earlier this year. If approved, we would have access to another $75 million in SBA debentures.

While we have an ongoing dialogue with the SBA, we do not have the an update regarding its timing and status. As you can appreciate, we have several financing options available to us that we can access if and when needed so that we can continue to originate quality loans.

OFS Capital had $32 million in originations in the third quarter and $155 million in originations over the past year. Our new loan pipeline is solid. Going forward, our primary focus remains the same, to grow our earnings while being a conservative steward of our shareholders' capital.

As we have done so far, we will continue to finance the company in a thoughtful manner. We will only raise additional capital if it's creative. As a 30% owner of the company, the interests of our external manager are aligned with those of our shareholders.

At this point, I'll turn the call over to our Chief Financial Officer, Jeff Cerny who will provide more details on the financials.

Thanks, Bilal.

Turning to our results we continue to be excited about the opportunity to enhance our yield and net investment income. We have 30% of our net asset value in cash. This gives us a lot of flexibility.

We are continuing to focus on optimizing our capital base with higher yielding, lower middle market loans as we believe the relative value opportunity is strong in this market. This strategy helped to drive our net investment income above our distribution for the quarter.

This quarter we had 39 companies in our investment portfolio totaling $247.2 million on a fair value basis equating to 100% of cost. As a percentage of fair value, our investments were comprised of approximately 61% in senior secured loans, 29% in subordinated debt and 10% in equity.

Our average investment in each portfolio company was $6.5 million at fair value or 2.6% of the portfolio's total fair value. The overall weighted average yield to fair value on our debt investments continues to move in a positive direction. It increased 32 bases points since last quarter to 11.8%.

This increase reflects the continued redeployment of capital into higher yielding loans. At the end of the quarter, floating rate loans comprised 56% of our loan portfolio.

All of our floating rate loans contain live or floaters. We had one new non-accrual loan this quarter, Phoenix brands which has $1.1 million fair value. We think there's a high likelihood we will collect par on this asset. Our only other non-accrual was Strata Pathology Services and it was resolved on October 2 when the company was sold. It had a fair value of only $84,000 and has been a non-accrual since the first quarter of 2013.

Moving on to deal activity during the third quarter, we closed six transactions with an aggregate principal amount of $31.9 million. This included $5 million of investments in two new portfolio companies and $26.9 million of investments to four existing portfolio companies.

These investments included senior secured loans and subordinated loans. We derived approximately $7.7 million in total investment income in the third quarter compared to $8.1 million last quarter. This quarter over quarter decline was largely due to the loss of income in the third quarter from investments that we sold in our senior loan fund during the second quarter, partially offset by a 32 bases point increase in the weighted average yield to fair value.

Expenses totalled $4.1 million compared to $5.3 million for the prior quarter. The $1.2 million decrease in expenses was largely driven by a write-off of $1.2 million of unamortized deferred financing closing costs in the second quarter that was non-recurring. Net investment income for the third quarter was approximately $3.6 million or $0.38 per share which exceeds our prior quarter net investment income of $0.28 per share and our adjusted net investment income of $0.35 per share.

As Bilal mentioned, we more than fully covered our distribution this quarter with net investment income. We still have the capacity to invest with approximately $42 million of cash as well as $24 million in assets remaining in the lower yielding senior loan fund.

We have made good progress in deploying capital and optimizing our portfolio and we will continue to prudently generate liquidity on a timeline that allows us to maximize our interest income. Only selling lower yielding assets or otherwise raising capital when we believe we can timely redeploy the cash in higher yielding loans.

With that I will turn the call back over to Bilal.

To summarize, we are pleased that our results this quarter have continued to improve, demonstrating the strength of our investment platform. We have a differentiated origination capability that is currently focused on the lower middle market, especially on non-sponsored transactions. This is where we continue to see attractive risk adjusted returns.

Our external managers extensive experience through multiple credit cycles and the strength of our team's underwriting expertise and sourcing relationships has allowed us to construct a quality portfolio. We have attractive long-term fixed rate financing through the SBIC program that positions us well for an expected increase in interest rates.

Finally, in a sector that has seen other participants struggling to maintain growth, we have the capital available to continue our growth. OFS Capital remains committed to providing value to all our stakeholders, including both shareholders and borrowers.

As part of an investment platform with a 30% stake in OFS Capital, shareholders can be reassured that our interests are strongly aligned. We remain focused on being responsive to the needs of our borrowers and providing them flexible capital solutions.

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

Thank you. We will now begin the question-and-answer session. (Operator Instructions). At this time we will pause momentarily to assemble our roster. Our first question is from Terry Ma of Barclay's. Please go ahead

Hi, you guys. I may have missed it but what was the $400,000 in fee income that you guys had this quarter and how should we think about that going forward?

How you doing, Terry? This is Jeff. You know, it was combination of closing fees on new facilities as well as some prepayment fees, and we would expect that to be, you know, recurring plus or minus. It all depends on the, you know, the size of the origination that we do but typically with a closing fee, we take about half of that into income at close and we amortize the rest over the life of (inaudible).

I think in addition to that, you also have, you know, prepayment penalties, so I think part and parcel of what we're doing is originating loans and then loans pay off and so you have origination fees and you have prepayment penalties so we believe that we will be recurring item.

Okay. And how much of the $400,000 was repayment penalties this quarter?

That was about I think a little bit less than half.

Okay. Can you guys just tell us a little bit more about the investments you made this quarter. It looks like it was more skewed toward the existing portfolio companies.

Sure. You know, if we have portfolio companies in our portfolio that we like, you know, our preference is that we continue to support those portfolio companies. That's to be honest one of the best sources of new (inaudible) flow for us.

And so that is, you know, continuing as we move forward, I think, what we will try to do is as it relates to a company that we like, we will continue to support them either in their growth or if there's a potential add-on facility with respect to an acquisition that they're doing, so it's slightly unusual from the last quarter but we will try to be involved in the existing companies as much as we can

Okay. And in a sense, was that committed capital already that they just drew on on the quarter, or was that they needed incremental for whatever reason and you guys just added on?

I think, yes, most of it was really incremental capital. I mean, you know, they're investing in companies and luckily these companies are growing and when they grow, they need more capital and they an option to refinance us out but what we tried do is stay in the deal because we've been involved in the transaction and we want to continue to support a business that we know and like. So, you know, I think that a lot of that activity was related to companies growing and needing more capital.

Okay. And I think your percentage is subordinate, that last quarter was 25% and I think it's close to 30% this quarter so it's ticking up a little bit. Do you have any long-term view on where that may shake out in the steady state?

I think as we have migrated the portfolio from a, you know, senior secured kind of club portfolio out of the WM subsidiary, we naturally would expect that to tick up. You know, I think that as we look forward, we're always trying to chew up the balance sheet and get a first lien on the assets or a second lien on the assets. So, you know, I think that, I wouldn't expect it to differ materially from where it is today.

Okay. Great. And can you maybe just talk about what the actual yield differential between your senior secured portion in the portfolio versus the subordinate debt portion?

You know, we don't have that handy right now so it's something we would have to get back to you on

Okay. Great. That's for me. Thanks.

Our next question is from Christopher Testa of National Securities. Please go ahead

Hi, good morning. Thanks for taking my questions, guys. Just wondering, kind of piggybacking off the previous question about the subordinated portion of the portfolio, are you seeing just generally more opportunities in the subordinated loans given the back-up in high yield and second lead markets or was there anything to you that kind of taking up the portfolio composition this quarter.

Yes, I think, you know, as Jeff was saying earlier on, some of this is just related to us, you know, slowly getting out of the lower yielding, senior secured portfolio that we had in the past. And one point of clarification here is that, you know, when we, you know, we certainly have a large portion of our portfolio in senior secured loans but even the subordinated debt in many cases subordinated that we have, at the leverage that we have in those companies, it's still at a very reasonable level.

So in many of the cases as we're dealing with some of the lower middle market or traditional middle market companies, you know, we may call it subordinated debt but it's behind a very low level of leverage and so it could be a situation where we only have one term of leverage ahead of us and then we have, you know, we're all in three terms of leverage.

So although we're technically subordinated in that situation, we're always monitoring the total leverage that we have in that company and also how much leverage we have ahead of us. So when you view the subordinated debt, you know, you should also keep in mind that in most of those situations, you know, we're monitoring the leverage levels as well and so it's not in a very traditional manner a standard sort of mezzanine type of leverage level that people see.

Right. That's helpful. And do you by any chance offhand have the weighted average attachment point leverage for the portfolio for the quarter?

Yes, I think in the past we've, you know, told people that it's in the sort of mid crease right now and, you know, it continues to be in that range, slightly above sort of mid crease.

Okay, great. And let me see. And just on the non-accruals, I missed, what was the previous non-accrual was not resolved?

A company called Strata Pathology.

And was that recovered at par?

No, no, that's been our non-accrual for several years and it's been carrying a fair value well below par

Okay, got it and the other non-accrual that you mentioned, Phoenix Brands, was that a new one for this quarter?

Correct.

Okay. And can you just, you know, give us some color on that, you know, basically what the company does and, you know, why you're expecting the high likelihood of a par recovery, like, how much capital is junior queue.

Sure. We typically don't comment too extensively on companies but this is a company that into consumer brands, mostly in the laundry segment. So laundry detergents, fabric softeners, starch and things of that nature and it has brands and, you know, we expect that the company is undergoing a sale process as we speak. So there's some indications that we're expecting that we will recover par.

And also I should mention here that it's less than $1.2 million principal balance, and it used to be slightly higher than that and over time it's been paying off. So it's a very small loan and as Jeff said, you know, we expect to receive par on that.

Okay. And just, you know, I know you guys are very much concentrated in non-sponsored but are you starting to see more sponsor opportunities as kind of more and more people seem to be backing out of that market, or is that something where the volume has just become so abysmal that non-sponsor is still going to be a major portion of the originations over the next quarter or so.

You know, I would say that, you know, we're focusing on the non-sponsored market because that's the market where we find the best risk adjusted returns. We find the best pricing there. We get, you know, good covenants, good fee structures in terms of origination fees and prepayment penalties.

So we will continue to focus on that sector, but from time-to-time when we find opportunities in the sponsored market which are attractive, you know, we will certainly take advantage of those opportunities as well. So if you look at our portfolio, it does have sponsored transactions and so, you know, I don't see us changing our, you know, tactics on that front and I think to the extent that we find opportunities in the sponsored market as I said, you know, we will look at those certainly.

But, you know, our focus certainly the main on the non-sponsored market because compared to the sponsored market, we're still finding better risk adjusted characteristics there.

Okay, great. And the $24 million of the low yielding senior loan fund assets, do you have a timeline for when, you know, you think that will be totally run off?

Are those liquid enough that you are actively able to sell those or do you just kind of wait for those to repay?

No, it's going to be a combination. I think that, you know, we have some cash as we indicated and we don't want to sell those assets and give up the interest income, because they're good assets, too quickly so we are just kind of, you know, we'll sell those on a prudent timeline based on liquidity needs but there are some, a certain of those companies that are in the midst of a sale process so we would expect to realize on some of those and sell others.

Great. And last one for me would just be, you know, was there any portion of the interest income this quarter that was, you know, I guess what you would consider non-can core and the acceleration of interest income from a prepayment or anything?

Yes, there was. Certain of our new originations were loans that had previously, you know, on our books and they actually paid off and maybe the capital structure was redone so the short answer is yes.

Okay. Do you have an idea of, you know, how much that accounted for this quarter, Jeff?

So you're talking about, just so I know, acceleration of OID, right?

Right, yes.

I think it was less than $0.02.

Oh, okay, great. That's all for me. Thanks for taking my questions, guys.

(Operator Instructions). I'm showing no additional questions at this time. This will conclude our question-and-answer session. I would like to turn the call over to Bilal Rashid for any closing remarks

Thank you all for joining our call today and for your questions. We look forward to speaking with everyone again on our next call. Operator, you may end the call.

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