OFS Capital Corp (OFS) 2022 Q1 法說會逐字稿

Good morning, and welcome to the OFS Capital Corporation First Quarter 2022 Earnings 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 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 and filed our Form 10-Q. Each of the 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 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 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 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. We are pleased to report another strong quarter. Some key takeaways. Our net asset value per share increased to $15.52, another historical high for the company. We have increased our quarterly distribution to $0.29 per share for the second quarter, up from $0.28 per share we paid for the first quarter, marking the seventh consecutive increase in our quarterly distribution.

Net investment income was $0.22 per share. Adjusted net investment income was $0.30 per share, which excludes the accrual for the capital gains incentive fee. We had no new loans on nonaccrual in the quarter. In fact, we have not placed any norms on nonaccrual for 7 consecutive quarters. We deployed $55 million in new investments and made $15.1 million in add-on investments with existing portfolio companies.

OFS Capital is approaching its 10th anniversary as a public company. Since our IPO, OFS has paid out $11.77 per share in distributions, and our net asset value per share exceeds our IPO price of $15 per share. We believe this performance puts us in select company among peers. We believe that we are well positioned to benefit from higher interest rates as our loans are largely floating rate and our financing is primarily fixed rate. Our financing continues to provide us operational flexibility.

As of the quarter's end, more than 67% of our debt matures in 2025 or later. And more than half of our debt is unsecured. In addition, our senior loan facility matures in 2024 and is nonrecourse to the BDC. Our corporate line of credit is flexible, with no mark-to-market provisions.

In terms of our investment activity, we are cognizant of macroeconomic and geopolitical uncertainty and continue to remain cautious. We believe that our disciplined approach, along with the strength of our balance sheet, has enabled us to deliver solid performance. We have relied on our long-standing investment process and the dedicated and experienced team of our adviser. Even with several unprecedented events impacting the economy, we continue to believe that we will benefit from this experience, which spans multiple asset classes and industries.

Today, our adviser manages $3.1 billion across the loan and structured credit markets and has worked through multiple credit cycles and global economic disruptions over the past 25-plus years. In this uncertain economic environment, which has been significantly impacted by inflation, rising interest rates and geopolitical conflict, we believe that we continue to be well positioned, both in terms of our portfolio as well as our liabilities. We believe that our portfolio remains defensively positioned, both in terms of seniority in the capital structure and industry selection.

As a percentage of fair value, approximately 97% of our loan portfolio was senior secured at the end of the first quarter and is well diversified across multiple industries. Our largest exposures are in health care, technology, business services and manufacturing, and we continue to avoid highly cyclical industries such as oil and gas, metals and mining.

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. We continue to be encouraged by our overall performance. Last quarter, we generated an increase of more than 2% in our net asset value from the prior quarter to $15.52, which is, once again, a historical high. It is also 24% above our pre-pandemic level at the end of fiscal year 2019.

As Bilal said, our net asset value per share this quarter exceeds our IPO price of $15 per share. And since our IPO, we have made cumulative distributions of $11.77 per share. This quarter, we increased our distribution to $0.29 per share, the seventh consecutive quarterly increase. We posted net investment income of $0.22 per share and excluding the accrual for the capital gains incentive fee, our adjusted net investment income of $0.30 per share was strong and $0.02 above last quarter's distribution.

To get into more specifics, the increase in our net asset value was primarily driven by higher fair value marks on select equity investments as was the case with our equity investment in Pfanstiehl as well as our equity investment in Contract Datascan. Higher valuation marks on the equity portfolio were partially offset by lower marks on our structured finance notes and more liquid senior debt investments due to spread widening in liquid credit markets. Since our IPO, we have invested $45 million in the equity, or received warrants in more than 40 portfolio companies. To date, we have net realized gains of approximately $23 million, which equates to a 1.8x multiple on our invested capital.

As of March 31, our net unrealized gain is just over $70 million on the remaining invested capital of $17.7 million, which equates to an approximately 5x multiple. We believe that these metrics demonstrate the strength of our investment process and are one of the reasons for our record net asset value. Once again, we had no new nonaccruals this quarter. We have not had a new nonaccruals since the second quarter of 2020, at fair value we only have 2.1% of the loan portfolio on nonaccruals.

Turning to the income statement. Total investment income was $10.9 million for the quarter, down from $15.3 million in the prior quarter. This was primarily due to a decrease in dividend and fee income, including syndication fees, which were at very high levels in the prior quarter and can fluctuate from quarter-to-quarter depending on portfolio investment activity. Also contributing to the decline in investment income is portfolio rotation out of certain higher-yielding assets and lower amortization of deferred origination fees due to a lower portfolio turnover.

Total expenses of $7.9 million were down $2.9 million from the prior quarter, primarily due to lower income and capital gains and incentive fees. We also benefited from lower interest expense due to the full quarterly benefit of lower weighted average pricing on our unsecured notes, resulting from the November issuances and related reductions. As I just mentioned, net investment income was $0.22 per share for the first quarter. And on an adjusted basis, it was $0.30 per share after adding back our capital gains fee accrual.

As Bilal discussed, earlier this morning, we announced a distribution of $0.29 per share, a 3.6% increase in the quarterly rate and the seventh consecutive increase. We believe the strength of our platform and investment portfolio will continue to help drive healthy earnings. Our bond offerings last year helped to improve our capital structure, and we've been focused on our liquidity and maintaining a healthy balance sheet. In the first quarter, we realized the full benefit of our new lower-priced $55 million of unsecured debt issued in the fourth quarter. It is worth noting that 67% of our debt matures in 2025 or later, and 52% of our standing debt, at quarter's end, is unsecured. Excluding the SBIC debt, our debt-to-equity ratio was stable quarter-over-quarter at approximately 1.4x.

Turning to our investments. We are pleased by the continued strong performance of our portfolio companies, with the majority of them posting positive revenue and EBITDA gains. We continue to have confidence that our underwriting selectivity increases the likelihood that the portfolio performs positively in the future. Several of our portfolio companies continue to identify opportunities for growth, for which we are evaluating incremental funding. These opportunities give us relationship and informational advantages in making investment decisions.

In terms of originations, we deployed $15.1 million in add-on investments to existing portfolio companies and $55 million in new investments in the first quarter, while remaining cautious due to the macroeconomic and geopolitical environment. The majority of our investments are on loans. And as of March 31, 97% of the loan portfolio was senior secured. In addition, over 90% of the loan portfolio is floating rate with variable rates that are subject to a LIBOR floor. As of March 31, the weighted average LIBOR floor was 85 basis points. With 3-month LIBOR now well above 1%, and statements by the Fed and other central banks that rates will continue to rise, we anticipate a positive impact on our net investment income over the coming quarters as we have over 90% of our loan portfolio in floating rate loans and the majority of our debt is fixed rate.

As a percentage of cost, our overall investment portfolio includes approximately 74% senior secured loans, 3% subordinated debt, 19% structured finance notes and 4% equity securities. Our portfolio remains diversified. At the end of the quarter, we had 95 portfolio investments, totaling approximately $557 million on a fair value basis, with an average investment size of $5.9 million or approximately 1% of the portfolio's total fair value. For the quarter ended March 31, the income yield on the investment portfolio, which includes all interest and amortization of deferred loan fees, was 9%.

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

Thank you, Jeff. In closing, we are pleased with our first quarter performance. Our net asset value has continued to grow, driven by the performance of both our debt and equity investments. We increased our distribution for the seventh straight quarter, reflecting our view of our improved performance and our expected outlook for the quarters ahead, even in light of this uncertain economic environment.

Since the beginning of 2011, OFS has invested more than $1.7 billion, with a cumulative net realized loss of just 2% over the last 11 years, while generating attractive yields on our portfolio. Our loan portfolio is almost completely comprised of senior secured loans standing at 97%, and our financing is primarily long term, with 67% of our debt maturing in 2025 and beyond.

In addition, more than half of our outstanding debt was unsecured. We believe that this gives us operational flexibility to execute on our business plan. Lastly, we believe the size, experience and replication of our adviser has continued to benefit our business. With a $3.1 billion corporate credit platform within a more than $30 billion asset management group, our adviser has broad resources, including long-standing banking and capital markets relationships. It has gone through multiple credit cycles over the past 25 years, and has a strong alignment of interest with a 22% ownership of the BDC.

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

(Operator Instructions) The first question comes from Mickey Schleien with Ladenburg.

Bilal, with all this volatility in the private markets for much of this year, are you seeing more deal flow migrating to direct lenders like OFS? And what kind of quality are you seeing in the pipeline?

Yes. So, Mickey, I think that we're not seeing yet -- because of the volatility in the public markets, I mean, we're not seeing a lot of deal flow coming in from that market to the private markets, certainly in the lower middle market, where we play, but I think that it's still early as it relates to the volatility in the public market, so that may happen over time.

And with respect to the quality of the deal flow, I think the quality still remains fairly good. We are not seeing any major changes in the quality of the deal flow compared to before this whole volatility began. So again, I think it's still early in this high volatility environment. But so far, we are seeing relative stability in the private lending market.

Bilal, that volatility in the public markets is obviously reflecting all these headwinds, whether it's inflation or the political unrest in Europe or Fed tightening. And you and the rest of your team have a lot of experience in the credit market. So we have defaults at record lows and all this volatility, what's your view on the trajectory for defaults over the next couple of years?

Yes. No, I think that's a very good question. And we -- Mickey, we think about that all the time. I think that as you just pointed out, I think there are too big risks, and you have the inflation risk and you have a potential recession risk and both of them happening at the same time, obviously, poses some challenges to the economy. And the way we have dealt with it in the past, I think we're -- our plan is to deal with it in the same way; one, staying senior secured in the capital structure. So as you see, a vast majority of our loan portfolio is senior secured. So I think that helps mitigate some of that risk. And I think that, clearly, if you have an environment where you have inflation and you have potential for recession in the next couple of years, you would likely see default rates across the industry creeping up.

But what I would say there is that, I think senior in the capital structure certainly mitigate that risk? And then, clearly, the underwriting experience that the team has really through multiple credit cycles at this point, I think we'll -- we expect that, that will certainly help us as we navigate through this uncertain environment.

Thanks for that explanation, Bilal. That's helpful. But if I can ask in terms of the senior secured portion of the portfolio, how does that break down between first lien unitranche and second lien?

Yes, Mickey, Thanks for the question. This is Jeff. So about 16% -- 15% to 16% in the second lien and the remainder is first lien. I don't have a split out at my fingertips as I would consider unitranche, but I would say that most of our unitranche loans are still at relatively low leverage points. And I would say that our second lien book tends to be a little larger, a little more liquid-type names, and it's a pretty granular portfolio.

So most of the names there tend to be smaller than the average size. So we feel really good about the quality of our book. And quarter-over-quarter, we've continued to see revenue and EBITDA growth with the vast majority of the businesses. And so we -- very limited companies on the watch list. So we feel very, very good about the portfolio.

That's helpful. My last question. So obviously, the forward LIBOR and SOFR curves are steep and nominal rates on your debt investments could go up fairly sharply over the near term. And I think you talked about that in your prepared remarks. But that's going to make us that a lot more expensive for borrowers over time. How much of that increase in nominal rates you think the private lenders like OFS will keep versus maybe seeing some spread compression due to competition or just to help support your portfolio companies?

Because the LIBOR and SOFR tend to be a relatively small portion of the overall coupon. I think that we will -- look, we've seen this before, where LIBOR has spiked up. I think it was maybe in 2019. And the portfolio performed well. 3-month LIBOR, I think, went from 30 basis points to well over 2%, and it did not have a meaningful impact on the portfolio.

So when you look at the coupons on our book, I think that we feel that as floating rates continue to increase that the companies will see some strain, but we've modeled that in, as Bilal said, into our downside for these investments. We always include a sensitivity of interest rates to ensure there's adequate cushion, and we don't expect that to be a major issue in our book.

This concludes our question-and-answer session, and today's OFS Capital Corporation First Quarter 2022 Earnings Call. Thank you for attending today's presentation. You may now disconnect.