OFS Capital Corp (OFS) 2018 Q1 法說會逐字稿

Good morning, and welcome to the OFS Capital Corporation 2018 First Quarter 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.

Good morning, everyone. Thank you for joining us. With me 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 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 of 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, forward-looking statements based on those assumptions could also 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. All forward-looking statements speak only as of the date of this call.

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

Thank you, Steve. Good morning, and welcome. The last 4 months have been very productive, and we believe we have set the stage for a strong 2018. As we have noted in our prior calls, our goal is to generate net investment income above our distribution while maintaining the quality of our portfolio.

Our strong pipeline generated $98 million in investments in the first quarter. As a result, we expect to see higher interest income and net investment income beginning in the second quarter.

Our investments were funded with cash on hand as well as our revolving credit facility. In April, we closed a $50 million 7-year bond offering locking in fixed-rate, unsecured long-term financing. We used a portion of the proceeds to fully repay our revolving line of credit.

Our balance sheet continues to be very well positioned. Approximately 76% of our loans were floating rate at the end of the first quarter.

As of today, our outstanding debt is entirely fixed rate at a weighted average all-in cost of just 4.3%. We have no maturities on our fixed-rate debt until 2022, and nearly 70% of our fixed-rate debt matures after 2024. It is important to mention that the overall weighted average yield-to-cost on our debt investments was 12.57% at the end of the quarter.

Our first quarter net investment income of $0.29 per share was in line with our expectations. As we indicated on our call in March, we expected the net investment income per share to be soft for this quarter due to unusually high prepayment activity last year, which resulted in approximately $73 million of cash on hand at the end of 2017.

Our net asset value per share at the end of the first quarter was $13.67, which reflects a stable fair value of our portfolio as the decline was largely related to the $0.37 per share special dividend we paid in the first quarter. So far, we have declared $1.05 per share in distributions in 2018. Since going public in the fourth quarter of 2012, we have paid $7.34 per share in distributions.

Legislation was passed earlier this year allowing BDCs to carry 2:1 leverage. This week, our board approved this increase, which we will be able to implement as early as a year from now. This will give us the flexibility to invest in lower-yielding, high-quality loans.

As you know, the adviser to the BDC manages more than $2 billion of corporate credit assets, and majority of which consists of lower-yielding first-lien loans. We believe that adding these assets to our portfolio will make our pace of investment activity more consistent as we will be able to diversify the sources of our loan origination.

As you may know, the adviser to the BDC is part of a large asset management platform with approximately $30 billion in credit and real assets. We believe this gives us access to attractive bank financing given the size and scale of the overall platform. We anticipate that this will position us well to take advantage of this regulatory change.

Lastly, we remain committed to our top priority, capital preservation. Since the beginning of 2011, we have invested $921 million and posted a cumulative net realized gain on invested capital of $4.7 million while also generating attractive yields on our portfolio. We believe that this is one of the stronger records in the listed BDC sector. With our external manager owning 22% of the common shares outstanding, the alignment of interests between all stakeholders remains strong.

At this point, I'll turn the call over to Jeff Cerny, our Chief Financial Officer.

Thank you. Good morning, everyone. We were able to fund several deals this quarter from the strong pipeline we referenced on our prior calls. We deployed $98 million in the first quarter across 13 investments, primarily in senior secured loans. As a result, we expect to see an increase in investment income starting in the second quarter. We continue to evaluate new deals, and our pipeline still remains strong.

As it was a big quarter for originations, we would like to give you more detail about the investments, which were the result of many months of work, stretching back to the second half of last year. The $98 million consisted of a combination of add-ons and increases to 6 existing portfolio companies, and we also invested in 7 new names. The new names consisted of both sponsored and non-sponsored investments, mostly floating rate with a weighted average coupon of 10.8%, and the vast majority were senior secured.

Early in the second quarter, we closed a 7-year $50 million bond offering, which gives us additional flexibility to fund new deals and continue our goal of generating net investment income above our distribution. With the bond proceeds, we repaid approximately $38 million on our revolving line of credit, leaving it untapped with $50 million of availability.

Our current cash position, inclusive of the excess bond proceeds, is approximately $45 million, of which $34 million is in our SBIC. Given our pipeline, we expect to deploy a significant portion of this cash in the near term.

Our larger capital base gives us the ability to make larger investments. We believe that our deal pipeline has increased as a result, better positioning us with respect to existing and potential clients that seek larger and more flexible mandates, especially in a market where certainty of closing continues to be a key criteria in winning business.

Prepayments have slowed down in 2018. We had approximately $9.6 million in prepayments during the first quarter, and we also proactively sold approximately $27 million in loans to optimize the yields in our portfolio. In 2017, we had $141 million of prepayments and loan sales, which was approximately 4x higher than what we saw in 2016. So it was good to see prepayments slowing down this year.

Our net asset value at the end of the quarter was $13.67 compared to $14.12 at the end of the December quarter. This decline was primarily due to the $0.37 special dividend in the first quarter, which was related to our 2017 realized gain activity.

We believe that we are well positioned in a rising rate environment. 76% of our loan portfolio had floating-rate coupons at quarter's end, while 79% of our debt was long-term fixed-rate. Today, 100% of our outstanding debt is long-term fixed-rate with a weighted average all-in cost of 4.3%. With the asset and liability profile at quarter's end, for each 50 basis points of LIBOR increase, we realize an organic increase of $0.08 per share per annum after the impact of incentive fees or approximately a 7% increase in net investment income.

Turning to the income statement. We derived approximately $9 million in total investment income during the quarter, an increase of $700,000 over the fourth quarter. The increase was due to incremental interest earned on investments made during the quarter as we deployed our idle cash, along with LIBOR increases.

Total expenses of $5.2 million increased compared to $4.5 million in the prior quarter. The increase was primarily driven by the cost of capital-raising activities in the first quarter. For the first quarter, net investment income was $3.8 million or $0.29 per share, which was flat compared to the fourth quarter, primarily related to the additional costs I just noted.

Turning to our portfolio. At the end of the quarter, we had investments in 39 companies totaling $335.5 million on a fair value basis. As a percentage of cost, our investments were approximately 67% senior secured loans; 23% subordinated debt; and 10% equity, 8% of which is in preferred securities.

Our portfolio remains diversified with an average investment in each portfolio company of $8.6 million or 2.6% of the portfolio's fair value. The overall weighted average yield-to-cost on our debt investments increased 46 basis points to 12.57%. This improvement was primarily driven by an increase in LIBOR during the quarter. We currently have 2 loans on nonaccrual: Community Intervention Services and Southern Tech, which we have marked to a fair value of 0.

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

Thank you, Jeff. We are happy with the significant investments we made last quarter and believe that our continued strong pipeline will lead to an increase in investment income beginning in the second quarter. We believe that we are on our way to achieving our long-stated goal of net investment income exceeding our distribution, all while maintaining the quality of our portfolio.

We believe that we are well positioned for rising interest rates given our attractive long-term fixed-rate financing through the SBIC program and our recently completed 7-year fixed-rate debt offering.

As you know, approximately 76% of our loan portfolio is floating rate. This positions us very well for increasing our earnings in a rising interest rate environment. In addition, we believe that that the added flexibility provided through recently passed BDC legislation will allow us to diversify our sources of loan origination and enable us to more fully meet the flexible capital needs of middle-market borrowers. We expect that our thorough underwriting process will continue to produce no losses as focusing on capital preservation remains our top priority.

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

(Operator Instructions) The first question today comes from Christopher Testa with National Securities.

Just wondering if you could provide some more color on Southern Technical Institute, just what's going on there, what your discussions with the company have been would be greatly appreciated.

This is Jeff. Yes, I guess when it comes to specific assets, it's sometimes a little difficult to get into too much detail. But this company's in the for-profit education sector. It's been a bit of a tough sector over the last few years. I would say that the performance overall continues to be relatively flat. We did take that asset down from a fair value perspective, so all that's been reflected in our net asset value. We do -- we did get some reasonably good news on that credit more recently. And we hope that, over time, we can see some benefit from that.

Got it. Okay. And to the extent that you can disclose, how much, if any, debt is in front of you in that investment?

I'd have to get back to you on that, those specifics, to be honest with you.

Okay. No, that's fine. And what drove the roughly $1.1 million of realized losses during the quarter?

I'm sorry. Can you repeat that?

What drove the realized losses during the quarter?

Sorry, the question was what drove the $1.1 million realized losses?

Yes, that's correct, Bilal, yes.

The big driver of the unrealized losses was Southern Tech.

Oh, okay. I'm sorry. I had that mixed up. My mistake.

In the aggregate, it was not $1 million of net loss.

Got it. Okay. My mistake on that. And just obviously, this was a very strong quarter of originations for you guys. Just could you give me just somewhat of a ballpark estimate on the timing of when those commitments closed during the quarter?

Yes. They were actually pretty well spread out through the quarter. We closed some in Jan, some in Feb and some in March. And we did have a few that closed in kind of mid- to latter March, but it wasn't -- it was not, by any means, back-end-loaded. It was fairly balanced.

Okay, got it. That's fair. And one of the things -- I mean, as you guys look at your stock price, I mean, your performance hasn't been horrible. Your asset quality has been all right. It's been nothing major, yet you guys are persistently trading between 75%, 80% of NAV, call it. Does this give you guys any more kind of motivation to potentially put in a repurchase program, to put in a total return hurdle on the fee structure and things like that? It just seems like those are the things -- the kind of low-hanging fruit that you could be taking in order to get the stock up and -- especially on the repurchases given where you're trading and given that you guys have such low regulatory leverage, which has now been increased by your board. Just wondering how you're thinking about those things.

Yes. I would say we're always reviewing those things and thinking them through. And in light of the recent regulatory changes, we'll continue to. I think right now, we've elected not to do so. We -- from a stock buyback perspective, we want to make sure that we maintain scale, keep -- reduce our concentration risk, improve our overall origination capability. And I think, as you've seen, the scale of business increased starting with the offering last year, in '17, the stock offering and the addition of the bonds this year. You're starting to see a larger scale. And you'll see -- as you see in the first quarter, we saw the benefits of that scale. We're able to -- one of the important things, as we talked about, when you're seeking to win new transactions is the ability to speak for the transaction. And we've been able to do that, and it's really helped us win business. So we're reluctant to shrink the scale of the business right now.

Okay. But I mean, if you're -- I understand what you're saying, Jeff, but if you were looking at where your regulatory leverage is and you just increase the ability to take on even more leverage, and you have so much in the SBA that your regulatory leverage is really de minimis, I don't see how, if you put in a 10b5-1, it's really going to harm your ability to scale OFS.

Yes. I think the point that Jeff was making is that from the standpoint of concentration risk and the ability to do bigger transactions and the ability to speak for the whole tranche of debt which makes us competitive, I think from that standpoint, I think the equity really matters more. And in fact, I think if you're increasing leverage, that having a smaller equity base, I think, increases that risk further. So I think the point that Jeff was making, from a scale standpoint and doing bigger transactions and being more competitive in the market to be able to speak for bigger transactions and speaking for the whole tranche, I think from that standpoint, having an equity base is more important -- a bigger equity base is more important and more relevant than the overall asset base, so...

This concludes our question-and-answer session. I would like to turn the conference back over to Bilal Rashid for any closing remarks.

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

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