Q4 2021 OFS Capital Corp Earnings Call
Yeah.
Good morning, and welcome to the OSI Capital Corporation, Q4, and full year 2021 earnings call.
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I would now like to turn the conference over to Steve <unk> VP 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 all the 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 fourth quarter and fiscal year 2021 results Press release was subsequently filed on form 8-K with the SEC.
These documents can be obtained under the Investor Relations section of our website at what best capital Dotcom.
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 all the first 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 could be incorrect.
You should not place undue reliance on these forward looking statements.
<unk> capital undertakes no duty to update any forward looking statements made herein and all forward looking statements speak only as of the date of this call.
Also 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.
I'll turn the call over to chairman and Chief Executive Officer of Al Rashid.
Thank you Steve.
Good morning.
I hope everyone is doing well.
This morning, we are pleased to report an exceptionally strong quarter.
Some key takeaways.
Our net asset value increased seven 2% from the third quarter to $15, an 18 cents a historical high for the company.
This represents a 22% increase in our net asset value compared to its pre pandemic level at the end of 2019.
We increased our quarterly distribution.
98 cents per share, marking the sixth consecutive increase in our quarterly distribution.
Net investment income was 33 cents per share compared to a 24 cents per share for the third quarter.
Adjusted net investment income was 47 cents per share an increase of more than 41% compared to the third quarter.
This also represents a historical high for the company.
We had no new loans on non accrual in the quarter.
In fact, we have not placed any loans on non accrual for six consecutive quarters.
We deployed $61.6 million in new portfolio companies and made $38 million in add on investments with existing portfolio companies.
The increase in our net asset value was primarily driven by improvements in the performance of our debt investments.
Strong gains on our equity investments.
One of our equity investments D. T. G had a gross realized gain of $5.8 million.
Which was over three and a half times, our initial equity investment.
Our senior secured loan and this health care services and equipment company paid off at par as the company was sold in December .
Also on prior calls.
<unk> discussed our equity investment in Penn Steel, a global manufacturer of high purity pharmaceutical ingredients.
That investment continues to perform well and paid a significant cash dividend last quarter.
Well, we primarily invest in senior secured loans being able to make equity investments when we identify a strong opportunity like this.
It helps us to maximize value for our shareholders.
Since our IPO, we have invested $39 million in the equity.
C warrants and.
More than 38 portfolio companies.
To date, we have net realized gains of approximately $23 million.
Which equates to a 195 times multiple on invested capital.
As of December 31.
Net unrealized gain is approximately $55 $4 million.
On the remaining invested capital of $15 $1 million.
Equates to a four seven times multiple.
We believe that these metrics demonstrate the strength of our investment process.
An important factor in the growth of our net investment income is a reduction in cost of our debt.
As you know, we refinanced $178 million of our bond debt last year at considerably lower rates.
Which are locked in until 2026 and beyond.
In terms of originations the fourth quarter was one of our most active quarters ever.
We made $75 $4 million in investments at <unk>.
16, 6% increase from the third quarter.
For all of 2021, we invested a total of $269 million in new and existing portfolio companies.
Which is significantly higher than the $128 million invested in 'twenty, it might be and $222 million invested in 2019 before the pandemic.
Even with this increase in origination activity, we remain highly selective.
We believe that our disciplined approach before and during the pandemic along with the strength of our balance sheet has enabled us to deliver strong performance.
We have relied on our long standing investment process and the dedicated and experienced team of our adviser.
As market conditions change.
Continue to believe that we will benefit from this experience.
Which spans multiple asset classes and industries.
Today, our adviser manages $3 billion across the lawn and structured credit markets and has worked through multiple credit cycles and.
Global economic disruptions over the past 25 years.
In this uncertain economic environment, which has been impacted by the effects of rising interest rates inflation and geopolitics. We believe that we continue to be well positioned both in terms of our portfolio as well as our liabilities.
We have been fundamentally focused on preserving capital while also 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.
The end of the fourth quarter.
Our portfolio is well diversified.
Across multiple industries with significant exposures in healthcare technology business services and manufacturing.
In addition.
We continue to avoid highly cyclical industries.
Oil and gas metals and mining.
We believe that we are well positioned to benefit from increases in interest rates as our loans are largely floating rate and that financing is primarily fixed rate.
Our financing continues to provide us operational flexibility.
As of the quarters and more than 71% of our debt matures in 2025 or later.
And over half 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.
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. We continue to be encouraged by our overall performance last quarter, we generated a significant increase in net asset value from the prior quarter to $15.18, which is an all time high we once again posted strong net investment income per share and our adjusted net investment.
Income per share was above any previous mark the distribution was increased to 28 sets the sixth consecutive quarterly increase.
To get into more specifics, our net asset value per share increased by seven 2% over the prior quarter and is 22% above our pre pandemic level at the end of fiscal year 2019.
This increase was primarily driven by higher fair value marks on our investments as was the case with our equity investment in fan steel and a realized gain on our investment in T. T G.
Once again, 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 2% of the loan portfolio on non accrual.
Turning to the income statement total investment income increased to $15 $3 million for the quarter up approximately $4 $8 million from the prior quarter.
This was primarily due to an increase in interest income and increase in cash dividends and an increase in fee income, including an increase in syndication fees.
Total expenses of $10 $9 million were up approximately $3.5 million from the prior quarter.
This increase was primarily attributable to higher incentive fees and the accrual of the capital gains fee.
Net investment income of 33 per share exceeded the 24 cents per share posted in the third quarter, an increase of 37% adjusted.
Adjusted net investment income increased by 88% to 47 cents per share in the quarter from 25 per share in the last quarter.
As Bilal discussed earlier this morning, we announced a distribution of 28 cents, a 12% increase in the quarterly rate and the sixth consecutive quarterly increase the board approve this higher distribution based in part on our net investment income as well as our earnings expectations.
We believe the strength of our platform and invest in our portfolio will continue to help drive healthy earnings.
We remain focused on our liquidity and maintaining a healthy balance sheet. Additionally, our most recent bond offering has further optimized our capital structure.
During the quarter, we issued approximately $55 million of new lower priced unsecured debt, which we anticipate will result in a reduction in our borrowing costs, 71% of our debt matures in 2025, or later and 51% of our outstanding debt at quarter end was unsecured.
At quarters end, we had approximately $70 million outstanding SBA debentures.
Compared to approximately $195 million in cash in investments at fair value in our Spic's fund.
The fund started with approximately $75 million of equity, which has grown to $125 million, even after our returns of capital.
Are there more on Monday, we repaid another $19 million in debentures, reducing our balance to just $51 million.
Excluding our SP I see that our debt to equity ratio was stable quarter over quarter at approximately 1.4 times.
Turning to our investments we are pleased by the continued strong performance of our portfolio companies. We continue to have confidence that our underwriting selectivity will increase 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.
The vast majority of our investments are in loans, 95% of the fair value of our debt portfolio was senior secured 92% of our debt portfolio consisted of floating rate loans.
We have LIBOR floors on approximately 90% of our floating rate loan portfolio with a weighted average LIBOR floor of 95 basis points.
Even in the current rising rate environment.
This LIBOR floor continues to be a contributor to our earnings as it favorably compares to three month LIBOR of approximately 21 basis points at quarter end.
And still remains a contributor although lessor with three month LIBOR moving up to approximately 49 basis points earlier this week.
As a percentage of cost our overall investment portfolio includes approximately 74% senior secured loans, 5% subordinated debt, 16% structured finance notes and 5% equity of which approximately half of our equity was in preferred equity securities.
Our portfolio remains diversified at the end of the quarter the portfolio had investments in 87 companies totaling approximately $507 million on a fair value basis with an average investment in each portfolio company of $5 $8 million.
Approximately 1% of the portfolio's total fair value.
At the end of the quarter. The overall weighted average yield to cost on our performing debt and structured finance note investments was approximately nine 6% remaining consistent with the prior quarter with that I'll turn the call back over to Bilal.
Thank you Jeff in closing, we had a great quarter to close out the year in a strong position.
Our net asset value has continued to grow.
Given by the performance of both.
Debt and equity investments.
We increased our distribution for the sixth straight quarter.
Reflecting our view of.
Our improved performance.
Unexpected outlook for the quarters ahead.
Since the beginning of 2011 <unk> has invested approximately $1 7 billion with accumulative net realized loss of principal of only $34 $5 million.
Which is just 2%.
While generating attractive yields on our portfolio.
We continue to increase our allocation to senior secured loans, which now constitute the majority of our loan portfolio.
Our financing is primarily long term with 71% of our debt maturing in 'twenty five and beyond.
And 51% 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.
<unk> continued to benefit our business.
It is 3 billion corporate credit platform with it at 30 billion plus.
Asset management group.
Our adviser has brought resources Inc.
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 22% ownership in the BDC.
Before we go.
I would like to thank all of our employees.
And for their continued hard work and.
And dedication this past year.
With that operator, please open up the call for questions.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad.
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To withdraw your question please call starting to.
At this time, we will pause momentarily to assemble our roster.
Our first question comes from Mickey <unk> with Ladenburg <unk> you May now go ahead.
Yes, good morning, everyone below.
Hello can you give us a sense of how your portfolio.
The companies are doing in terms of their revenues and margins.
And how do you feel about their ability to service their debt down the road with what.
What could be some meaningful rate increases later this year.
Okay, great. Thanks, a lot <unk> those are both very good questions.
As far as the margins are concerned I mean, there is certainly we're certainly seeing some.
Our wage inflation.
Inflation in raw materials.
But so far our companies have been able to make.
Maintaining the margins they've been able to pass on some of those increases to the eventual.
Customer.
So are we.
At least at this point are not seeing any major impact on the margins.
And again.
No.
As we mentioned on the call.
A.
Vast majority of our loan portfolio is senior secured.
And Oh.
Well diversified across industries.
Uh huh.
We have confidence into IFF.
At some point there is some margin erosion I think.
We have structural protections in place.
That would mitigate that risk.
As it relates to the rising interest rate environment.
So.
Obviously.
As it relates to the.
Returns on the portfolio.
Floating rate.
Loans.
No.
We believe that as interest rates rise.
The interest rate.
We'll go up and so from a return standpoint, that's a good thing.
But the point that you mentioned, which is how will the borrowers be able to withstand.
Rising interest rates.
I think a couple of things there one you know when.
We're looking at.
When youre looking at middle market loans.
The benchmark on that loan so, let's say, it's a sofa plus you know 6%, 7%. The benchmark is a smaller percentage of the overall.
Interest that the borrowers paying so even though the benchmark is increasing.
You know on a percentage basis, that's not a very large.
You know.
Increase.
As it relates to the.
The interest overall interest.
So I think that as opposed to someone.
Some of the you know.
Syndicated loans, where you may have a sofa.
Sofa plus three.
3%.
So you.
So interest rate.
Going up significantly.
You know you don't have.
As big of an issue.
But when we underwrite loans.
We make sure that we are.
<unk> the portfolio.
With respect to debt service coverage.
And we you know as we underwrite these loans.
We will.
Look at various scenarios.
And.
In terms of the performance of the company, but also as it relates to interest rates and.
And make sure that the company is able to withstand.
Higher interest rates and Mickey as you may remember.
You know we had this rising interest rate environment, three or four years ago and.
At that point LIBOR was going up.
And we were able to.
Navigate that scenario fairly well so I think.
At this point you know we feel that we have.
You know we feel good about our.
The company's ability to <unk>.
Stand a rising interest rate burden.
Okay.
Hello.
And thinking about this cycle versus the last one perhaps one of the differences is the amount of private capital that's available today guys.
Funds or disintermediation banks do you how do you expect spreads to potentially behave.
As short term rates rise in other words.
Do you think.
Private lenders like yourselves will allow.
Allow spreads to maybe contract a little bit.
And keep.
Keep yields at a certain level or you expect to just pass that on to the to the borrower.
Yeah, that's a good point I mean, I you know it's.
No.
Part of the market that we are.
Navigating in which is what I would call the lower middle market.
You know we.
See less of a competition there.
Some banks are and so.
So I think that Oh.
As we look.
Look to the future and the part of the market that are.
We play in I I would I would I would believe that we'll be able to pass on.
The this rising interest rate.
Rising interest rates too.
Our borrowers as we did last time.
Last time around I think a lot of the capital that has come into the market has been.
Focusing on some of the larger.
Larger part of the middle market larger borrowers so.
I think that's one of the reasons why we play in this part of the market.
There's certainly competition, but somewhat.
Insulated from.
From.
Strong.
Petition.
So.
So as far as.
Part of the market that we're in.
I think that.
I believe that.
We should be able to pass the higher interest rates on to our borrowers.
Mickey This is Jeff.
How are you.
I guess the other thing I would add is that the you know.
Liabilities all of these various funds you need to consider that as well.
And I think a lot of them to the extent, they're applying leverage do have floating rate.
Liabilities, and so I think theyre going to be.
Largely focused on maintaining that that spread to make sure that their margin stay in sync, whereas.
But for our firm we've got about 70% ish of our borrowings that are that are fixed at this point. So I think we're going to benefit in the long run, but I do think funds are also going to be considering the liability side.
Sheet when considering that question.
That's a good point, Jeff I appreciate that.
Thank you My last question is just you know.
I haven't seen the.
Portfolio portfolio, yet for the quarter, but are there any companies with outsized risks related to the sanctions that are being imposed on on Russia.
Just thinking of companies that may be import or export to Russia.
And.
Any companies that have outsized sort of risk related to commodity prices.
Yeah. So.
The answer to that is no.
You know, we don't have any direct exposure to Russia Ukraine.
And as we said in our prepared remarks, I mean, we try to.
Stay away from companies that have exposure.
Exposure to commodity prices and oil and gas metals and mining.
No.
So I think that Uh huh.
We don't have really any outsized exposure to what's happening in Russia and Ukraine.
Well that's good to hear thank you those are all my questions. This morning I appreciate your time as always.
Thank you.
Our next question comes from David Miyazaki with confluence investment management you May now go ahead.
Hi, good morning, and thank you for taking my questions.
Congratulations on.
Really making a lot of progress.
What's your net asset value and restoring.
What are your asset level.
Where you are at to a level that is I think your net asset value is the highest that I can recall since you've become public. So I mean, that's really great.
Just kind of thinking about how you're positioned and what youre going to be doing for going forward, obviously the pandemic.
<unk> had a pretty substantial impact on how you Mark your assets as of the end of it.
March in 2020 and in June 2020.
And you know that the.
The dividend was lower by about half.
A half right back then and now bringing it back up to where it's at today, you're still below where you were pre pandemic.
Kind of wondering how how does the earnings power. It look for you going forward with your net asset value now higher than what it was.
Before the pandemic started and your dividend level below that do you think that the earnings power going forward is.
He is going to be better than it was before the pandemic.
I assume that has a lot to do with asset shift in how you manage your liabilities with the floating rates are and spreads are so how do you feel about the earnings power going forward relative to where you were before the pandemic.
Hi.
Yeah. Thanks, David So I think that's a very good question. So as you mentioned you know we've been.
Slowly growing net.
Investment income and commensurate with that increasing the dividend.
And.
I think that.
Our hope and expectation is that we will continue to increase our originations and.
Grow the net investment income.
With the existing portfolio mix that we have right now I think that potentially floating rates.
Rising would help we have been also increasing.
So are you decreasing the cost.
Of that.
Over the last year or so taking advantage of the tight do you know.
You know market.
As it relates to.
Uh huh.
The bond market last year.
So we've been taking.
Taking all of those steps I think that.
We have some assets in our portfolio right now that are not interest earning assets you know.
One of them.
Being fans steel in there.
Few other equity securities.
Securities.
Uh Huh, particularly fan steel, which oh.
Is it a high growth company and you know, we're very happy with its performance, but its not in interest earning assets. So I think the thought would be that in addition to all the things that we've been doing.
Well you know over the last.
A couple of years I think.
Monetizing some of those assets that are not interest earning assets, but actually.
Yeah, you know converting them at the right time.
And.
And using those proceeds to invest in interest, earning assets, thereby increasing the net investment income and then continuing to grow the dividend. So I think thats a that would be the longer term plan.
In the short term as I mentioned, you know, we'll continue to do all the things that we've been doing with the existing portfolio mix, you know reducing costs increasing originations.
You know and.
Hopefully the rising interest rate environment will help as well.
Yeah, I mean, that's that's.
It's kind of a nice pathway for you you have a lot of different levers to push and pull to help.
Hum.
Develop and grow your ROE over time.
I am curious that you know, obviously being able to changeover.
What's a pretty substantial equity exposure and it's something that can be interest, earning as real tailwind for you.
Have you given any thought to.
Moving out of having.
Your structured finance investments on balance sheet, because within the BDC industry.
The exposure to CLO and structured finance oftentimes.
Attaches a discount to the valuation that publicly traded bdcs trade at and so it seems to me like where you're at right now with your income and with the pathway for that is.
Do you have a lot of options that there might be an opportunity for you to come out of that kind.
Kind of investment.
When times are good creates a lot of income for you.
How do you feel about that allocation.
Allocation.
We actually you know that allocation has really helped us a lot but the.
Increasing the investment income.
We.
We are you know we have a long you know.
Long standing expertise.
In CLO management, and also CLO investing and so.
We feel comfortable with.
With the exposure that we have.
As an asset class that has been around for a long time.
And has stood the test of time.
And so I I'm you know.
No.
I think that.
The we have to just balance the impact on the net investment income.
The potential.
Perceived.
The impact on the stock price so.
You know, we like to make investments in things that we are very comfortable with and have long standing expertise in so we are.
You know, we like that asset class and certainly has been a.
Helping a lot with.
The net investment income and has allowed us.
In a big way to increase our dividend as well over the last several quarters.
Right.
And I appreciate that comment and you wanting to utilize resources and capabilities of the manager to.
The benefit of the shareholders I'm just thinking that.
It has a higher return profile, but it has the effect of also increasing the cost of your equity capital.
From the public for the public BDC and so.
You can kind of wind up in a trap there right, where you're earning a lot on the investment, but then your stock trades at a higher cost of capital.
You're kind of stuck with a discounted valuation so it.
It might be just something to consider that although it will lower the return profile coming out of that allocation it might lower the cost of equity capital for the public BDC as well.
Right right Yeah, no I think those are.
The push and pull there but.
I think that that's something that we evaluate.
All the time.
Okay. Thank you very much.
Sure.
Okay.
This concludes our question and answer session I'd like to.
I'll turn the conference back over to the long machine for any closing remarks.
Okay.
Thank you all for joining the call today, and we look forward to speaking with everyone again next quarter.
Operator, you may now end the call.
Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.