OFS Capital Corporation (NASDAQ:OFS) Q1 2020 Earnings Conference Call May 8, 2020 1:00 PM ET
Steve Altebrando – Vice President, Investor Relations
Bilal Rashid – Chairman & Chief Executive Officer
Jeff Cerny – Chief Financial Officer & Treasurer
Conference Call Participants
Mickey Schleien – Ladenburg
Good day, and welcome to the OFS Capital Corporation First Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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 afternoon, 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. 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 by OFS capital management’s 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 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.
With that, I’ll turn the call over to Chairman and Chief Executive Officer, Bilal Rashid.
Thank you, Steve. Good afternoon, and welcome. These are very challenging times for everyone, and we hope that you and your loved ones are safe and healthy. We also offer our thoughts and best wishes to those who have been affected by the COVID-19 pandemic and our deepest gratitude for those on the frontlines working hard every day to help us through this difficult time.
For today’s call, I want to primarily focus on three topics: our performance in the first quarter, how we have positioned our balance sheet for this unprecedented time, and how we have been working with our portfolio companies to navigate the impact of the COVID-19 pandemic.
First, our performance for the quarter. Our net investment income per share was $0.30 for the first quarter. The decline in net investment income was primarily due to a decrease in the yield of our portfolio as we continue to position it more defensively into lower-yielding assets. In addition, we paused our origination activities towards the end of the quarter due to uncertainty related to COVID-19. We also had one new loan on non-accrual in the quarter.
Our net asset value per share at the end of the quarter was $9.71 compared to $12.46 in the prior quarter. The quarterly decline in NAV was largely due to unrealized losses related to fair values determined at the end of the quarter. The fair value mark on our portfolio declined by 7.2% in the quarter.
Second, with regard to our balance sheet, we are focused on maintaining liquidity and compliance with both the regulatory asset coverage tests and our debt covenants. As of today, we believe we have ample cash on hand with approximately $47.2 million in cash and additional capacity to draw on our two lines of credit.
With respect to our portfolio, we had just $9 million in revolving debt commitments, all of which were fully drawn last month. It has been our long-standing practice to keep our revolving debt exposure to a minimum, which we believe has helped us with our current liquidity position. We believe that our liquidity position will help us navigate the current economic situation, allow us to support portfolio companies and use the capital opportunistically as the broader economic picture becomes more clear.
With regard to our financings, we believe that we have been thoughtful in order to increase the likelihood of withstanding periods of market dislocation. In that regard, as of March 31, over 93% of our debt had stated maturities in 2024 or later. Our long-term unsecured debt makes up 44% of our debt outstanding as of March 31, which should give us operational flexibility in the current environment.
Our senior loan facility matures in 2024 and is non-recourse to the BDC. And our corporate line of credit is flexible as well with no mark-to-market provisions. As we announced earlier this morning, we declared a $0.17 per share distribution for the quarter. Given the unprecedented uncertainty related to the COVID-19 situation, we took a cautious approach to our distribution. We believe that this rate will enhance our liquidity and strengthen our balance sheet, so that we can continue to support our borrowers and capitalize on new potential opportunities.
Lastly, I want to discuss our portfolio itself. We have maintained close contact with our portfolio companies and have been encouraged by the steps they are taking to manage their businesses during this time. We are focused today on helping our borrowers get through this challenging period. Following the passage of the CARES Act, which, among other things, provided eligible companies with up to $10 million and 100% SBA-guaranteed Paycheck Protection Program loans, more than 25 of our portfolio companies have collectively secured approximately $78 million in PPP loans from the SBA.
We believe this is a significant number to support these businesses where we have investment exposure totaling approximately $240 million at costs.
It is hard to predict the full impact of the pandemic on our portfolio. However, we believe that we have been positioning our loan portfolio defensively for some time now. As a percentage of fair value, approximately 91% of our loan portfolio was senior secured at the end of the first quarter compared to 76% two years ago. Our view is that this seniority in the capital structure will provide greater downside protection.
We have been concentrating on non-cyclical sectors with minimal direct exposure to oil and gas, metals, mining, restaurants and airlines. We believe that the BDC’s adviser has expertise to invest across the loan market and structured credit markets with more than $2.1 billion in assets under management. As such, in an environment like this, we believe that we are able to identify relative value credit opportunities across multiple markets.
The BDC adviser has a team of investment professionals organized by industry verticals. Our advisers’ credit platform has been in existence since 1994 and has gone through multiple credit cycles, navigating recessionary environments to maximize potential recoveries.
As we have mentioned to you many times on these calls, the adviser owns 22% of the outstanding shares of the BDC. In our view, this key alignment of interest is always important, but in this environment, we believe it is critical. You can be assured that we are working hard every day to protect our investments and drive the business forward for the benefit of all of our shareholders.
At this point, I’ll turn the call over to Jeff Cerny, our Chief Financial Officer to give you more color and details for the quarter.
Thanks, and good afternoon, everyone. Like Bilal said, we recognize these are trying times, and we are grateful for the health of our families and employees. We appreciate you joining us today and hope you are doing well and staying safe and healthy.
Turning to our financial results. Starting with our balance sheet, we had approximately $2.1 million of cash at the end of the quarter. As Bilal noted, as of today, we believe we have ample cash on hand with approximately $47.2 million in cash and additional capacity to draw on our two lines of credit. The cash buildup after quarter end was largely related to $31.5 million of proceeds from the payoff and sale of assets, which were greater than the aggregate fair value as of March 31 and approximated their cost. We also had net draws of approximately $15 million on our lines of credit.
Our debt-to-equity ratio at the end of the quarter, excluding our SBIC debt, was approximately 1.6 times. At the end of the quarter, our regulatory asset coverage ratio was 162%, which was above the required ratio of 150%. Please note that the SBIC leverage does not count towards the regulatory asset coverage ratio.
At the onset of the market impact from COVID-19 during the first quarter, we sold $35.5 million of loans at approximately cost to lower our leverage. These sales occurred prior to the broader dislocation in the loan market, which we believe turned out to be a prudent decision. Our net asset value per share at the end of the quarter was $9.71 compared to $12.46 in the prior quarter. The decline was driven by a 7.2% decline in fair value mark on our investments during the quarter.
We added one new non-accrual in the quarter. Online tech is a subordinated debt investment with a cost of $16.1 million and a coupon of 13.5%. Performance has suffered. It missed its March 31 interest payment, and the fair value was taken down to 45% this quarter. We currently have 1.6% of the portfolio on non-accrual at fair value. At cost, we currently have 5.5% of the portfolio on non-accrual.
Turning to the income statement. Total investment income for the quarter was approximately $12.9 million, a decrease from $13.4 million in the fourth quarter. This decrease was driven by lower interest income during the quarter due to declining LIBOR rates and, as I just mentioned, one new non-accrual as well as proactively selling $35.5 million of loans at approximately cost at the onset of the COVID-19 market disruption.
Total expenses net of incentive fee waiver were in line with the prior quarter at $8.9 million. The adviser waived 50% of its incentive fee this quarter to support the earnings in this, particularly challenging environment.
Resulting net investment income per share was $0.30 for the quarter. As Bilal discussed, we declared a distribution of $0.17. We believe that this rate will enhance our liquidity and strengthen our balance sheet, so that we can continue to support our borrowers and capitalize on new potential opportunities.
Turning to the portfolio. We are actively working with our portfolio companies to help them get through this challenging time. And as Bilal mentioned, our portfolio companies were able to secure approximately $78 million through the Paycheck Protection Program. Clearly, we, like all lenders, expect to see an impact from COVID-19. However, at this point, we are still not sure how the length and depth of this virus will play out and how it will fully impact our borrowers. We believe that our highly selective investment process and focus on capital preservation may positively impact how our portfolio performs through this initial period of disruption as well as the long term.
As far as investments, at the end of the quarter, we had investments in 77 companies totaling approximately $465.7 million on a fair value basis. 88% of our loan commitments were in floating rate loans. We have LIBOR floors of approximately 87% of our floating rate loan portfolio, with an average LIBOR floor of 1.15%. As a percentage of cost, our investments were approximately 75% senior secured loans, 11% subordinated debt, 7% structured finance notes and 7% equity, of which 54% of our equity was in preferred equity securities.
Our portfolio remains diversified with an average investment in each portfolio company of approximately $6 million or 1.3% of the portfolio’s total fair value. The overall weighted average yield to cost on our performing debt and structured finance note investments was approximately 10.1% at March 31 compared to 10.4% at December 31.
With that, I’ll turn the call back over to Bilal.
Thank you, Jeff. In closing, we believe that our liquidity position remains solid, which should help us weather the current economic situation and take advantage of potential investment opportunities due to this dislocation. We remain focused on strengthening our balance sheet. We continue to proactively manage our portfolio and help our borrowers to navigate this difficult and uncertain economic environment.
Since the beginning of 2011, OFS has invested $1.4 billion with a cumulative net realized loss of principal of only $12.9 million or just 0.9% while generating attractive yields on our portfolio. We have been steadily increasing our allocation to senior secured loans, and our portfolio consists primarily of such loans. We have also been increasing our exposure to larger borrowers. Our financing is primarily long term. As of March 31, 93% of our debt matures in 2024 and beyond. We believe that this gives us operational flexibility in the current market environment.
Lastly, we benefit from the experience of our adviser, which manages a $2.1 billion corporate credit platform. Our adviser is part of an asset management platform with over $30 billion of assets with broad resources, including longstanding banking relationships. Our adviser has gone through multiple credit cycles over the past 25 years. It has a strong alignment of interest with all shareholders with a 22% ownership interest in the BDC. We also believe that we have a strong team of investment professionals with industry expertise and portfolio management experience to help us through this period.
And finally, I would like to say thank you to our employees who have worked extremely hard over the last two months. We remain committed to their safety and well-being. OFS continues to be fully operational, and we are working diligently to respond to the evolving situation, especially by supporting our portfolio companies.
With that, operator, please open up the call for questions.
We will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Mickey Schleien from Ladenburg. Please go ahead.
Yes, good afternoon, everyone. I hope everyone’s okay. Today, I just have a series of relatively straightforward sort of housekeeping questions. Do the Pacific Western and Paribas facilities measure collateral at fair value or at cost?
Hey, Mickey. Good afternoon, Mickey, this is Jeff. Both of those facilities have a borrowing base that measures it at par or cost in certain circumstances.
Okay. And the covenants in those facilities for net worth, I assume those are measured at fair value, correct?
That is correct. There is a tangible net worth covenant in the PacWest documentation, and that is measured at GAAP or fair value.
Okay. And do they also have covenants for you requiring you to continue to meet the minimum regulatory asset coverage ratio?
The PacWest credit facility does have that, yes.
PacWest; and in terms of portfolio risk, could you give us at least a sense of what the portfolio’s average EBITDA is and debt-to-EBITDA?
So as you know, we have been moving — we’ve been moving upmarket. So the loans in our BNP financing have an average EBITDA well in excess of $100 million, in many cases, several hundred million dollars. And then the more middle-market and PacWest portfolios have the — have an average EBITDA in the kind of $20-ish million range. And we do have some lower middle-market companies in our SBIC as well. So depending on the bucket of assets, it varies. But generally, as you know, we have been moving upmarket.
Yes. And in terms of going upmarket, where do you stand now in terms of the breakdown on senior secured between first and second liens?
About 25% of the portfolio of the senior secured portfolio is second liens, and those do tend to be larger, larger borrowers.
Okay. And lastly, since we haven’t seen the 10-Q yet, could you at least directionally describe how the portfolio grading — your internal grading looked as of March? I noticed the K for December, about 10% was in the 4 category, which is special mention and nothing really meaningful below that. How did it look in March?
Yes. So as you know, we do have an internal portfolio management tool where we do risk rate. The four-rated credits have increased a bit. This was probably one of the larger quarters for risk rating changes. We have internal risk ratings that we look at every single month. And we did have a slightly higher-than-normal move from 3 rating to 4, and now we had one credit that moved into the 5-rating category, which was a non-accrual.
Okay. And are we going to see the Q tonight?
Yes. That is the expectation that we’re going to file tonight.
Okay. Those are all my questions. I appreciate your time.
And this will conclude our question-and-answer session. I’d 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 now end the call.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines at this time, and have a great day.