OFS Capital (NASDAQ:OFS) reported second-quarter net investment income of $1 million, or $0.08 per share, down from $0.18 per share in the first quarter, as lower investment income and continued deleveraging outweighed reduced expenses.
Chairman and Chief Executive Officer Bilal Rashid said the prior quarter had benefited from a large, non-recurring dividend from the company’s equity investment in Pfanstiehl. The second quarter also reflected net interest margin compression following the final redemption of OFS Capital’s 4.75% February 2026 unsecured notes during the prior quarter, as well as the effects of reducing leverage and one loan moving to non-accrual status.
Investment Income Declines as Portfolio Deleveraging Continues
Total investment income fell approximately 23% sequentially to $6.8 million, according to Chief Financial Officer and Treasurer Kyle Spina. The decline included the absence of an $874,000 Pfanstiehl dividend received in the first quarter, a smaller interest-bearing portfolio resulting from deleveraging, and the impact of the newly non-accruing loan.
Total expenses declined approximately 9% to $5.8 million. Spina attributed the reduction primarily to a $408,000 decline in incentive fees and lower interest expense from reduced debt balances.
OFS Capital made $16.7 million in aggregate debt repayments during the quarter. Rashid said the company has reduced total debt by $57.6 million over the past 12 months and has extended its debt maturity profile, with remaining maturities now ranging from 2028 through 2031.
At quarter-end, OFS Capital’s regulatory asset coverage ratio stood at 161%, up 7 percentage points from the prior quarter. Management said its balance-sheet initiatives have increased operating flexibility and will allow the company to focus more on deploying capital into income-producing investments.
The company maintained its quarterly distribution at $0.17 per share for the third quarter. As of June 30, that distribution represented an annualized yield of 19.2% based on OFS Capital’s common stock market price, Spina said.
Pfanstiehl Appreciation Lifts Net Asset Value
OFS Capital recorded $14.1 million of unrealized appreciation on its equity investment in Pfanstiehl during the quarter. The investment had a fair value of $94.6 million at quarter-end and represented approximately 32% of the total portfolio at fair value.
Rashid said the company remains aware of the investment’s concentration within the portfolio but is continuing to evaluate monetization opportunities while seeking to optimize overall returns. Since OFS Capital’s initial $200,000 investment in Pfanstiehl in 2014, the position has generated approximately $5.1 million in distributions, or roughly 23 times the company’s cost, he said.
The appreciation in Pfanstiehl was partially offset by net realized and unrealized losses in the credit portfolio, including $6.5 million of losses in CLO equity holdings. Spina said CLO equity valuations continued to face pressure from tighter spreads on underlying loan collateral and challenging market sentiment.
New Non-Accrual Loan Adds Pressure
During the second quarter, OFS Capital placed one loan on non-accrual status. The loan was marked at 79% of par at quarter-end and accounted for 3.5% of the total portfolio at fair value.
Rashid said OFS Capital is working with the borrower and other stakeholders to support a return to accrual status. He said management believes the underlying business value can support recovery of its principal investment over time and that the company has liquidity to make debt-service payments, though it is preserving cash while implementing initiatives intended to strengthen the business.
Spina said non-accrual investments as a percentage of portfolio fair value increased 3.7% quarter over quarter, primarily due to the new non-accrual. The weighted average performing investment income yield on the interest-bearing portfolio fell 0.4 percentage points to 12.1%, reflecting the new non-accrual and lower yields on CLO equity securities.
Management Targets New Deployments
At quarter-end, OFS Capital held investments in 51 issuers with a total fair value of $297.8 million. Based on amortized cost, the portfolio consisted of approximately 66% senior secured loans, 22% structured finance securities and 12% equity securities.
The company said 97% of its loan holdings by fair value were first-lien positions, while its loan portfolio was entirely composed of first- and second-lien senior secured loans. Management also cited limited direct enterprise software exposure and said the portfolio has no reliance on annual recurring revenue-based lending.
OFS Capital had $6 million of unfunded commitments at quarter-end. While middle-market merger and acquisition activity has remained low, management said it is pursuing add-on acquisition and growth-financing opportunities with existing portfolio companies while selectively reviewing new investments.
Rashid said the company’s focus is shifting toward prudently deploying capital into attractive interest-earning investments to improve net investment income, while maintaining its underwriting discipline amid uncertainty related to interest rates, inflation and geopolitical events.
About OFS Capital (NASDAQ:OFS)
OFS Capital Corporation (NASDAQ: OFS) is a business development company (BDC) that provides customized debt and equity financing solutions to U.S. middle-market companies. As an externally managed BDC, OFS Capital focuses on sponsoring capital structures that support growth initiatives, recapitalizations, acquisitions and other strategic transactions. The firm targets companies that demonstrate strong cash flow potential and scalable business models across a range of industries.
The company’s investment portfolio typically includes senior secured loans, unitranche facilities, mezzanine debt and equity co-investments.
