Q3 2021 OFS Capital Corp Earnings Call
Okay.
Good morning, and welcome to the O F S Capital Corporation third quarter 2021 earnings conference call all participants.
<unk> will be in listen only mode.
Should you need assistance. Please signal conference specialist by pressing the star key followed by zero.
After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad to withdraw your question. Please press Star then two.
Please note. This event is being recorded I would now like to turn the conference over to Steve at the Brando VP of capital markets. Please go ahead.
Morning, everyone and thank you for joining US also on the call today is Bilal Rashid Chairman and Chief Executive Officer of first capital and Jeff Cerny, The company's Chief Financial Officer and Treasurer. Please note that we issued a press release. This morning announcing our third quarter 2021 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 O F S capital Dot com.
Before we begin please note that 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 O F. S 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, the forward looking statements based on those assumptions also can be incorrect you should not place undue reliance on these forward looking statements below first capital undertakes no duty to update any forward looking statements made herein and all forward looking statements speak only as of the date.
On 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 Oh, that's called capital Dot Com.
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, everyone.
We appreciate you joining us today and hope that you and your families continue to be healthy and safe.
We had another solid quarter.
The key takeaways.
Our net asset value increased five 5% from the second quarter to $14.16.
This represents a 14% increase from the fourth quarter of 2019.
The last quarter before the pandemic interrupted U S economic activity.
We increased our quarterly distribution to <unk> 25 per share.
Marking our fifth consecutive quarterly distribution increase.
Net investment income was 24 cents per share in line with the second quarter.
Adjusted net investment income was 25 cents per share an increase of more than 4% compared to the second quarter.
We had no new loans on non accrual in the quarter.
In fact, we have not placed any loans on non accrual since the second quarter of 2020.
In October we closed a $50 million.
Seven year unsecured bond offering with an attractive coupon of 495%.
In fact, so far this year, we have issued $180 million of unsecured long term bonds to refinance existing bonds, which reduces our borrowing costs.
And extends the maturity of our bond debt.
We expect that the bone refinancings will help increase our earnings and further strengthen our balance sheet.
The increase in our net asset value.
Didn't use to be aided by improvements in the performance of our debt investments and strong growth in our equity investments.
As we discussed last quarter one of these equity investments.
<unk>, a global manufacturer of high purity pharmaceutical ingredients continues to perform well.
While we primarily invest in senior secured loans our investment.
<unk> strategy allows us to selectively make equity investments when we identify a strong opportunity.
We believe that our asset selection before and during the pandemic along with the strength of our balance sheet has enabled us to successfully navigate this unprecedented situation.
We also relied on the experience of our adviser, which has worked through multiple credit cycles and global economic disruptions over the last 25 years.
We believe the resiliency of our portfolio through the pandemic is a testament to our longstanding underwriting process.
Since our IPO, we have invested $39 $1 million in the equity all received warrants in more than 38 portfolio companies.
To date, we have.
Net realized gains of approximately $19 $5 million.
On $16 $5 million of invested capital.
This equates to a multiple of invested capital of two two times four realized investments.
As of September 30th the remaining $22.6 million of capital still invested in our portfolio companies as a net unrealized gain of approximately $55 million.
This equates to a multiple of three two times or unrealized investments.
Our fundamental priority is to remain focused on preserving capital while thoughtfully growing our earnings.
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 95% of our loan portfolio was senior secured at the end of the third quarter.
Our portfolio is diversified across multiple industries with significant exposures in healthcare technology business services and manufacturing.
Edition.
We continue to avoid highly cyclical industries.
Such as oil and gas metals and mining.
Our loans are largely floating rate financing is primarily fixed rate.
Therefore, we view our portfolio as being well positioned to benefit from an eventual increase in interest rates.
Looking forward we.
Anticipate that the broader economy will continue to improve overtime due to supportive fiscal and monetary policies for growth.
These steps continued to drive overall M&A activity and the need for debt capital to finance this level of deal, making activity, which should remain robust.
We haven't been actively reviewing potential investments from new borrowers as well as existing borrowers, which consider or first capital interested capital provider.
We made $64 $7 million in investments in the third quarter, which was an increase of 7% from the second quarter.
This brings the total for investments this year to $193 $5 million.
Our origination activities have been increasing steadily since the beginning of this year.
While always highly selective we see the current conditions as a solid backdrop to deploy capital.
Which we anticipate will lead to an increase in our net investment income in the long term.
Our financing continues to provide us operational flexibility.
As of the quarters and more than 92% of our debt matures in 2024 or later.
Nearly two thirds of our debt is unsecured.
In addition, our senior loan facility matures in 2024 and is non recourse to the BDC.
Our corporate line of credit is flexible with no mark to market provisions.
Well first capital continues to benefit from the expertise and scale Opex adviser.
With more than $2 $8 billion in assets under management.
BDC adviser has experience investing across the known and structured credit markets, which helps us to identify relative value credit opportunities across multiple asset classes.
Our team of investment professionals has extensive experience in credit underwriting and restructuring across industry verticals.
We consider a broad investment platform and expertise across multiple asset classes and industries too.
To be beneficial in this current market environment.
Where we are seeing increased competition to effectively deploy capital.
In addition, we believe that shareholders benefit from our alignment of interest with the advisor owning 22% of the outstanding shares of the BDC.
You can be assured that we are working diligently every day to protect our investments and drive the business forward for the benefit of all shareholders.
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, Paul Good morning, everyone as Bilal just discussed we continue to be encouraged by the overall performance of our portfolio of companies and the increase in the fair value of our debt and equity investments driving a five 5% increase in our net asset value over the prior quarter.
Our net asset value per share now stands at $14.16, which is more than 14% above our pre pandemic net asset value at the end of fiscal year 2019.
Turning to our results at quarters end, we had approximately $70 million in outstanding SBA debentures compared to approximately $203 million in cash in investments at fair value in our Spi Sea.
We believe this provides a meaningful equity cushion of approximately $133 million compared to our initial investment and he asked me I see of approximately $75 million.
We feel good about the composition of our liabilities since quarter end, we issued approximately $55 million of new lower priced unsecured debt, which we anticipate will result in a reduction in our borrowing costs as Bilal mentioned nine set up our debt matures in 2024, or later and 64% of our hours.
Standing debt at quarter end was unsecured.
Excluding our SP I see that our debt to equity ratio was stable quarter over quarter at approximately one three times.
As we mentioned our net asset value continues to show a strong recovery since the onset of the pandemic.
The increase was primarily driven by higher fair value marks on our debt and equity investments, especially as Bilal discussed the increase in our unrealized gain on our equity investment in fan steel.
We had no new non accruals this quarter, we have not had a new non accruals since the second quarter of 2020 at fair value. We currently have two 1% of our loan portfolio on non accrual.
Turning to the income statement total investment income for the quarter decreased approximately $825000 from the second quarter to $10 $6 million. This was primarily due to a decrease in the weighted average yield on our portfolio lower syndication fees and.
Accounting for prepayment and amendment fees.
Total expenses of seven $4 million were down approximately $800000 from the prior quarter.
This decrease was primarily attributable to lower incentive and administrative fees.
Net investment income of 24 cents per share. It was in line with the second quarter. Adjusted net investment income was 25 per share an increase of more than 4% compared to the second quarter.
Cause Bilal discussed earlier this morning, we announced a distribution for the fourth quarter of 25 cents, an approximate 4% increase in the quarterly rate.
<unk> approved as higher distribution based in part on our increased adjusted net investment income and our earnings expectations. We believe our most recent bond offering we will help improve our overall earnings and better optimize our capital structure.
As always we remain focused on our liquidity and maintaining a healthy balance sheet.
Turning to our investments we are pleased that our portfolio companies have continued to perform and continue to have confidence that our underwriting selectivity will increase the likelihood that the portfolio performs positively in the future.
Several of our portfolio of companies continue to identify opportunities for growth for which we are evaluating incremental funding.
The majority of our investments are in loans, 95% of the fair value of our loans were senior secured 97% of which were floating rate.
He had LIBOR floors on approximately 86% of our floating rate loan portfolio with a weighted average LIBOR floor of 96%.
And the current interest rate environment. This LIBOR floor continues to be a strong contributor to our earnings.
As it favorably compares to the three month LIBOR of just 13 basis points at September 30th.
Our overall investment portfolio as a percentage of cost includes approximately 77% senior secured loans, 2% subordinated debt, 15% structured finance notes and 6% equity of which approximately half of our equity wasn't preferred equity securities.
Our portfolio remains diversified at the end of the quarter the portfolio had investments in 100 companies totaling approximately $526 million on a fair value basis with an average investment in each portfolio company of $5 $3 million or 1% of the portfolio's total fair value.
Overall weighted average yield to cost on our performing debt and structured finance note investments is 964%.
Down by 13 basis points quarter over quarter, primarily as a result of our continued focus on first lien debt to larger companies.
With that I'll turn the call back over to Paul.
Thank you Jeff.
In closing.
We are pleased with our performance in the third quarter.
Net asset value has continued to grow driven by the performance of both our debt and equity investments.
Our net asset value is 14% above its level at the end of 2019 before the pandemic began.
Once again, we increased our distribution, reflecting our view of the improved performance and our expected outlook for the quarters ahead.
Since the beginning of 2011 <unk> has invested approximately $1 6 billion with accumulative net realized loss of principal of only $24 $7 million or.
Or a cumulative loss rate of only one 3%.
While generating attractive yields on our call.
Portfolio.
Over time, we have been steadily increasing our allocation to senior secured loans, which now constitute the majority of our loan portfolio.
Our financing is primarily long term with 90% of our debt maturing in 2024 and beyond.
And 64% of our outstanding debt was unsecured.
We believe that this gives us operational flexibility.
Execute on our business plan.
Lastly.
We believe the size experience and reputation of our adviser has continued to benefit our business.
With a $2 8 billion corporate credit platform within a more than $30 billion of asset management group.
Advisor has broad resources, including long standing banking and capital markets relationships.
It has gone through multiple credit cycles over the past 25 years and it has a strong alignment of interest with a large ownership interest in the BDC.
Before we go I want to make sure to thank all our employees for their continued hard work, especially through this evolving pandemic.
Their dedication and diligence has been invaluable to our ability to navigate this challenging time.
With that operator, please open up the call for questions.
We will now begin the question and answer session.
Ask a question you May press Star then one on your telephone keypad.
If you're using a speakerphone please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question comes from Mickey Schlein with Ladenburg you May go ahead.
Yes, good morning, everyone based on the second quarter's Q, we obviously haven't seen the third quarter yet.
You had about 10% of the portfolio and loan and loans with <unk>.
Spreads below 500 basis points, which are relatively low yields and some of those were added relatively recently could could you give us the investment thesis for holding those lower yielding assets in the BDC.
Sure.
So Mickey as you know we are.
Set up this a senior loan facility a little while ago.
And those assets are those lower yielding assets are in that senior loan facility on which we're charging a lower.
Management fee as well.
Are those assets you know our expectation is that.
Over time, we have.
Going to rotate.
Our plan is to rotate out of those lower yielding assets.
And replace them with the.
With higher yielding assets. So we didn't want to sit on cash or have.
That facility to be.
Not utilized so our expectation is that we would overtime rotate out of them and replace them with.
Hi, good evening.
Assets.
Thank you for that I do understand your explanation. Thank you bill.
Hello over what period of time do you expect to unwind the S. P. I C and where do you see your overall leverage ending up in current market conditions when that unwinding is complete.
Sure Mickey So I think it's.
Hard to predict.
How long it will take for the S. P. A C to unwind I can give you a sense that over the last 18 months or so we have paid down.
Approximately.
$80 million.
After $150 million of debt our debt outstanding. So are you now so that's sort of the history there.
And so I think the wind down really will depend.
On how quickly you know, we get prepayments et cetera, which is hard to predict.
At this point, but we are you can certainly look at the history.
After the pay down and how long it took us to.
Pay down $80 million.
And we have approximately $70 million.
Now left on.
On that so so I think Oh, Oh I'm sorry.
And then I think in terms of the <unk>.
Ill get leverage I mean, I you know unexpected shouldn't is that you know the yes.
The regulatory leverage.
And you know the overall GAAP leverage are going to converge over time as you know as we pay down the SBA T and the target there you know sort of a long term target from a regulatory.
And you know GAAP leverage.
Once the two converge would be in the 1314.
<unk>.
Debt to equity.
Thank you for that below and.
What sort of deal flow do you expect to focus on S. D. S. P. I C N warrants.
And as you rotate those lower yielding assets in terms of the sourcing channels and the size of the borrower that youre pursuing going forward.
Sure. So the deal flow a lot of the deal flow.
It's coming.
For us these days to the private equity channel.
We have relationships with the lower middle market.
Private equity firms, we do also have the ability to oh, and a sourcing capability to do.
Do non sponsored transactions as well and we have relationships to source those deals as.
As well.
Directly.
From the borrowers and in many cases through financial intermediaries.
And you know the focus for.
Is.
No.
Not the you know the really lower part of the middle market, which was where we had a lot of the S. E T.
Types of assets are you know, we're generally looking at 10.
230 million EBITDA.
Companies and are generally focusing on.
You know.
Senior secured loans.
And the.
So I think that's a kind of the target.
For us.
Companies with let's say between 10, and 30 million of EBITDA and senior secured loans.
Mostly.
Private equity backed companies, but also looking at our non sponsored deals as well.
If it if it makes sense.
Below in that situation are you talking about let's say L plus 600 to perhaps L. Plus 800 on first lien deals.
That's sort of the range I.
I would say.
Okay.
Alright.
You know the floors as.
As well and you know and points upfront.
Sure sure.
Last question you had you had another strong quarter of unrealized appreciation as you mentioned in the remarks in the portfolio's valuation if I'm not mistaken when you look at fair value over cost is at a record level.
Thank you said most of that is being driven by by company performance as opposed to evaluations.
Looking forward do you think theres more upside in the portfolio's valuation or when we look at the <unk>.
Economic cycle in the credit cycle do you think we're sort of achieving full valuation on these investments.
Alright.
This is Jeff how are you yeah.
Jeff.
Hello, Good morning, and yes, as you know.
That investment is kind of <unk>.
Generally move up and down in a fairly tight band we do think there's continued additional upside.
Within our within our equity portfolio and you're right the fair value of our investments.
A day exceed the exceed the amortized cost so we're quite happy with the performance of the portfolio and the.
The gains have largely been driven by.
Strong performance in the overall portfolio.
Thank you for that trip. That's helpful. Those are all my questions. This morning I appreciate your time as always.
Thanks, Mike.
Okay.
This concludes our question and answer session I would like to turn the conference back over to Bill Al 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. Thanks.
The conference has now concluded. Thank you for today's presentation you may now disconnect.