Company Overview
OFS Capital Corporation (NASDAQ:OFS) is a diversified investment management firm that has demonstrated remarkable resilience in the face of ongoing market volatility. With a long-standing track record spanning over a decade, OFS Capital has established itself as a key player in the alternative investment landscape, providing investors with exposure to a dynamic portfolio of debt and equity investments across various sectors.
Incorporated in Delaware in 2011, OFS Capital Corporation commenced operations in November 2012 as a business development company (BDC) regulated under the Investment Company Act of 1940. The company operates as an externally managed, closed-end, non-diversified management investment company, with its primary focus on providing both current income and capital appreciation to stockholders through debt and equity investments in middle-market companies across the United States.
OFS Capital’s day-to-day operations and investment advisory services are managed by OFS Advisor, a wholly-owned subsidiary of Orchard First Source Asset Management (OFSAM). This structure allows the company to leverage the expertise and resources of its management team while maintaining a lean operational model. OFS Advisor manages approximately $3.9 billion across loan and structured credit investments and has over 25 years of experience investing through multiple credit cycles.
Credit Facilities and Liquidity
To support its investment activities and enhance financial flexibility, OFS Capital has secured important credit facilities. In March 2018, the company entered into a senior secured revolving credit facility with Banc of California, which has since been amended to extend the maturity date and adjust certain terms. Additionally, in June 2019, OFS Capital’s wholly-owned subsidiary OFSCC-FS established a secured revolving credit facility with BNP Paribas, further bolstering the company’s liquidity position.
As of September 30, 2024, OFS Capital had $20.28 million in cash and cash equivalents. The company maintains strong liquidity with $25 million available under the Banc of California Credit Facility and $80.9 million under the BNP Facility. The company’s debt-to-equity ratio stood at 1.85, while its current ratio and quick ratio were both 1.12, indicating a solid short-term liquidity position.
Investment Portfolio
One of the hallmarks of OFS Capital’s success has been its ability to maintain a robust and well-diversified investment portfolio. As of September 30, 2024, the company’s investment portfolio was valued at $394.7 million, consisting of investments in 52 portfolio companies. The portfolio composition included 71% senior secured loans, 23% structured finance securities, and 6% equity investments. This balanced approach has allowed OFS Capital to mitigate risks and generate stable returns for its shareholders over time.
Breaking down the portfolio further, OFS Capital had $231.09 million in first lien debt investments and $41.57 million in second lien debt investments, accounting for a total of 69% of its investment portfolio at fair value. These debt investments are diversified across various industries, with the largest exposures in Manufacturing (33.4%), Health Care and Social Assistance (20.5%), and Professional, Scientific, and Technical Services (8.8%) sectors.
The weighted-average performing income yield on interest-bearing debt investments was 13.6% for the third quarter of 2024, up from 13.4% in the prior quarter. However, 5.4% of the debt investments were on non-accrual status as of September 30, 2024, representing a potential credit risk.
Equity investments, including preferred and common equity, were valued at $89.82 million, or 22.8% of the total investment portfolio. These equity investments are primarily in the same industries as the debt investments and provide additional upside potential. The fair value of the equity investments is subject to market volatility and changes in the underlying portfolio companies’ performance.
OFS Capital also held $73.83 million, or 18.7% of its investment portfolio, in Structured Finance Securities, such as collateralized loan obligation (CLO) mezzanine debt and subordinated notes. These investments provide exposure to broader credit markets and diversification but are also subject to market risks.
Financial Performance
The company’s financial performance in recent years has been marked by both successes and challenges. In the fiscal year 2023, OFS Capital reported revenue of $4.79 million and a net income of -$465,000, a decrease from the previous year’s net income of -$7.59 million. Operating cash flow and free cash flow for 2023 both stood at $81.57 million. This decline was largely attributable to a combination of factors, including the ongoing impact of the COVID-19 pandemic, as well as the company’s strategic efforts to reposition its portfolio and align its investments with prevailing market conditions.
For the most recent quarter (Q3 2024), OFS Capital reported revenue of $10.92 million, a 2% decrease from the previous quarter. However, net income increased by 49% to $1.69 million, primarily due to a decrease in general and administrative expenses. Operating cash flow and free cash flow for the quarter were both $41.91 million.
Despite these headwinds, OFS Capital has demonstrated its resilience through its ability to maintain a strong balance sheet and generate consistent cash flows. As of September 30, 2024, the company’s net debt stood at $249.10 million, with a regulatory asset coverage ratio of 161%, well above the minimum requirement of 150% under the Investment Company Act of 1940.
Furthermore, OFS Capital has been proactive in its capital management, actively managing its debt structure to optimize its cost of capital and ensure financial flexibility. In 2021, the company issued $180 million in unsecured notes, locking in a weighted average coupon of 4.8%, which remains significantly lower than current market rates. This strategic move has helped to insulate OFS Capital from the impact of rising interest rates, positioning the company for continued success in the years ahead.
Future Outlook
Looking ahead, OFS Capital’s management remains cautiously optimistic about the company’s prospects, despite the ongoing market volatility. The recent interest rate cuts by the Federal Reserve, combined with the company’s focus on defensive industries and senior secured investments, are expected to provide a tailwind for the business. While these rate cuts may put some pressure on OFS Capital’s net interest margin, they are also expected to have a positive impact on the health of their loan portfolio by decreasing the debt service burden on their borrowers.
The company has announced that its quarterly distribution will remain at $0.34 per share for the fourth quarter. Management is focused on improving net investment income to exceed the distribution rate. OFS Capital expects M&A activity to pick up in the coming quarters, which could lead to higher originations and fee income, potentially having a positive impact on their net investment income.
Additionally, the company’s experienced management team, led by CEO Bilal Rashid, is well-equipped to navigate the challenges of the current environment and capitalize on emerging opportunities. Management has expressed confidence that the overall quality and fundamentals of their portfolio remain stable, despite the uncertain macroeconomic environment.
In conclusion, OFS Capital Corporation is a resilient and adaptable investment firm that has demonstrated its ability to weather the storm of market turbulence. With a diversified portfolio, a strong balance sheet, and a seasoned management team, the company is well-positioned to continue delivering value to its shareholders in the years to come. As a US-focused BDC, OFS Capital’s performance is closely tied to the health of the middle-market companies it invests in, and it will continue to navigate the challenges and opportunities presented by the evolving economic landscape.
Disclaimer: This article is for informational purposes only. It does not constitute financial, legal, or other types of advice. While every effort has been made to ensure the accuracy of the information presented here, the author and the publisher do not make any guarantees about the completeness, reliability, and accuracy of this information.