Q3 2022 OFS Capital Corp Earnings Call

And welcome to the U S Capital Corporation third quarter 2022 earnings call.

All participants will be in listen only mode.

Any assistance please signal conference back towards by pressing the star key followed by zero.

Today's presentation will be opportunity to ask Washington.

We felt that this event being recorded.

Now I'll turn the call over to Mr. Steve.

Please go ahead Sir.

Yeah.

Good morning, everyone and thank you for joining US also on the call today are Bilal Rashid Chairman and Chief Executive Officer of <unk> 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 results and filed our Form 10-Q each of the documents can be obtained under the Investor Relations section of our website at IR best capital back up.

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 <unk> 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.

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.

In the third quarter, we began to see the greater benefits of our balance sheet positioning in this rising interest rate environment.

Our portfolio is mostly comprised of floating rate senior secured loans and our balance sheet is primarily financed with long term fixed rate debt.

With the fed continuing to increase interest rates, we expect this tailwind to continue.

Adjusted net investment income increased to 33 cents per share in the third quarter up from 24 per share in the second quarter.

This increase was primarily due to rising interest rate coupons on our loan portfolio.

As a result of this solid performance the board increased the distribution to <unk> 30 per share eight.

Three 4% increase.

The prior quarter, and a 20% increase over last year's fourth quarter distribution.

We believe our portfolio remains well positioned.

At the end of the third quarter as a percentage of fair value approximately 99% of our loan portfolio was senior secured and is well diversified across multiple industries.

There were no new non accruals this quarter.

Our largest sector exposures are in healthcare technology business services and manufacturing.

Equally important is our longstanding avoidance of highly cyclical industries.

Additionally, we recognized that while interest rates have increased compared to the historically low levels since the great financial crisis, we believe that the cost of corporate borrowing for our portfolio companies remains manageable.

We continue to manage our portfolio conservatively as we have done through multiple credit cycles.

Our financing continues to provide us operational flexibility.

At the end of the third quarter, 99% of our outstanding debt matures in 2025, or later and approximately half of our debt is unsecured.

As we noted on last quarter's call in June we extended the maturity date of our $150 million senior loan facility with BNP Paribas.

By three years to June 2027.

This facility is nonrecourse to the BDC.

Our corporate line of credit is flexible with no mark to market provisions.

Lastly, as you may recall last year, we locked in $180 million of fixed rate unsecured debt at historically low rates, which we believe has also enhanced our strong positioning in this rising interest rate environment.

Turning to our net asset value per share at quarters end it stood at $13 and 58.

Down from $14 and 57.

Last quarter.

We would like to note that despite the decline our third quarter net asset value represents a 9% increase compared to its pre pandemic level at the end of 2019.

The decrease last quarter was primarily due to unrealized depreciation as the.

As a result of markdowns on the equity portion of the portfolio, especially.

Especially one equity investment in particular.

Jeff will discuss this in more detail.

While we primarily invest in senior secured loans, we continue to believe that selectively making equity investments help us create additional value for our shareholders over the long term.

Since our IPO, we have invested $45 million in the equity, including warrants of more than 40 portfolio companies.

To date, we have net realized gains of approximately $23 million, which equates to one eight times multiple on invested capital.

As of September 30.

Net unrealized gain is approximately $77 million on the remaining invested capital power.

Approximately $18 million, which equates to a five four times multiple.

We remain disciplined in making investments and utilizing the strength of our balance sheet in this uncertain economic environment.

In addition, we also expect to benefit from the experience of our adviser, which manages approximately $3 8 billion.

Across the loan and structured credit markets has expertise in multiple asset classes and industries and has a 25 plus year track record.

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 mentioned for the quarter, we posted net investment income and adjusted net investment income of 33 per share.

This compares to our prior quarter net investment income of 47 per share and adjusted net investment income of 24 cents per share.

Comparing adjusted net investment income quarter over quarter were up more than 37%.

Not only did the rising rate environment contribute to our strong results, we saw improvements quarter over quarter in all categories of investment income, including higher interest income dividend income and fee income we continue to take a cautious approach to originations given the uncertainty and overall state of the economy, we believe the positioning of our balance sheet.

We'll increase the likelihood that our performance will remain strong in this rising rate environment.

Our net asset value per share decreased to $13 58 from $14 57 last quarter.

As Bob noted despite the decline our third quarter net asset value remains approximately 9% above its pre pandemic level at the end of 2019.

The decline this quarter was primarily related to some company specific unrealized depreciation in particular in the equity portfolio.

We had one investment in the post secondary for profit education sector that experienced a decline in fair value due to a decision by the U S Department of education. It is worth noting that the investment was made nearly eight years ago and that is the only investment and our portfolio in the post secondary for profit education sector.

We view this as a one off situation and the investment was an equity appreciation right with a cost basis of zero, we are not accruing any investment income on this position.

We had no new non accruals during the third quarter and at fair value. We currently have just two 4% of our total investments on non accrual.

Turning to the income statement total investment income was $13 4 million for the quarter up from $10 4 million in the prior quarter.

As I previously mentioned this was primarily due to an increase in investment income, reflecting a rising interest rate environment as well as increases in both dividend and fee income.

Total expenses of $9 million were up from last quarter's $4 2 million.

Primarily due to the accounting for a noncash reversal of a portion of our capital gains from the last quarter.

As I mentioned earlier adjusted net investment income was 33 per share for the third quarter. This is a significant increase compared to last quarter's adjusted net investment income of 24 cents per share after adding back the reversal of the non cash capital gains fee accrual I just discussed.

Earlier. This morning, we announced a distribution of <unk> 30 per share an increase from the <unk> 29 per share from the prior quarter due to a stronger adjusted net investment income.

Compared to the fourth quarter distribution last year, the distribution has increased by 20% we.

We believe earnings tailwind from higher interest rates benefited us in the third quarter with our loan portfolio being largely floating rate and our outstanding debt being primarily a fixed rate.

It is worth noting that at quarter's end approximately 99% of our outstanding debt matures in 2025, or later and 51% of our outstanding debt at quarter end was unsecured.

Excluding the <unk> debt, our debt to equity ratio increased modestly quarter over quarter to approximately $1 six six times much of this was attributable to unrealized depreciation on our investments.

Our debt balances were lower this quarter.

We continue to target our long term debt to equity ratio of approximately one three to one four times.

Turning to our investments we are pleased by the continued performance of our portfolio companies in a tough macroeconomic environment.

We believe that our underwriting selectivity and seniority in the capital structure will benefit our portfolio in the future.

While we remain cautious with regard to new originations.

Several of our portfolio of companies continue to identify opportunities for growth.

Which we are evaluating incremental funding.

In our opinion, knowing the company and its management team, especially in today's macro environment gives us relationship and informational advantages in making these investments.

The majority of our investments are in loans and as of September 30, 99% of the loan portfolio is senior secured.

In addition, 94% of the loan portfolio is floating rate and there has been a meaningful increase in benchmark interest rates.

For instance over the last quarter three month LIBOR increased by almost one 5% to 375% on September 30.

And just this week.

Increased rates again by an additional 75 basis points, which continues to impact this quarter as LIBOR.

Given this meaningful run up in interest rates and the fact that 65% of our outstanding debt is fixed rate. We anticipate continued tailwind on our net investment income for the fourth quarter and beyond.

As a percentage of cost our overall investment portfolio includes approximately 73% senior secured loans, 5% subordinated debt, 17% structured finance notes and 5% equity securities.

Our portfolio remains diversified at the end of the quarter, we had 92 portfolio investments totaling approximately $517 million on a fair value basis.

With an average investment size of $5 $6 million.

Approximately 1% of the portfolio's total fair value.

For the quarter ended September 30, the income yield on the investment portfolio was 11, 1%.

Which includes all interest and the amortization of deferred loan fees.

This meaningful increase of 250 basis points from the last quarter is substantial and is reflective of the floating rate nature of our portfolio in this rising rate environment.

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

Thank you Jim in closing we are pleased to see that in this rising interest rate environment, our balance sheet positioning has served us well.

With the vast majority of our loan portfolio being floating rate and 65% of our outstanding debt being fixed rate.

We expect to continue to benefit from our focus on capital preservation with 99% of our loan portfolio at fair value being senior secured.

We believe the overall quality and fundamentals of our portfolio remains solid.

Our financing is primarily long term with all of our outstanding debt maturing in 2025 and beyond.

In addition, approximately half of our outstanding debt is unsecured.

We believe that this gives us operational flexibility to execute on our business plan.

Through this uncertain economic environment, we believe our long standing experience will continue to guide us.

Since the beginning of 2011 <unk> has invested more than $1 9 billion with the.

Relative net realized loss of just.

One 9% over the last 11, and a half years, while generating attractive yields on our portfolio.

Our net asset value has increased approximately 9% from pre pandemic levels.

And lastly, we believe the size experience and reputation of our advisor will continue to benefit our business.

With the $3 8 billion corporate credit platform within the 30 plus billion asset management group.

Advisor has broad expertise, including long standing banking and capital markets relationships.

Our corporate credit platform has gone through multiple credit cycles over the last 25 years.

It is also important to reiterate that Oss capitals adviser has a strong alignment of interest with shareholders.

Holding a 22% ownership stake in the BDC.

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

Thank you.

Ill begin the question and answer session. Patrick a question you May Press Star then one on you touched on phone.

Using a speaker phone please collect their handset before pressing the keys.

So probably your question. Please press Star then two.

At this time, we'll pause momentarily to assemble the roster.

We don't have any questions at this time.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.