OFS CAPITAL CORPORATION The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this Quarterly Report on Form 10-Q. For additional overview information on the Company, see "Item 1. Business" in our Annual Report on Form 10-K for the year endedDecember 31, 2022 .
Overview
Key performance metrics per common share are presented below:
March 31, 2023 December 31, 2022
Net asset value $ 13.42 $ 13.47
Three Months Ended
March 31, 2023 December 31, 2022
Net investment income $ 0.37 $ 0.35
Net increase in net assets resulting from operations 0.28 0.18
Distributions paid 0.33 0.30
As of
For the quarter endedMarch 31, 2023 , total investment income increased to$14.3 million from$14.0 million in the prior quarter, primarily due to an increase in dividend income. For the quarter endedMarch 31, 2023 , dividend income of$0.8 million was primarily related to a$0.5 million dividend fromPfanstiehl Holdings, Inc. For the quarter endedMarch 31, 2023 , our portfolio's weighted-average performing income yield on debt investments increased to 12.3% from 11.5% in the prior quarter. The increase in our weighted-average performing yield was primarily due to rising interest rates, as 94% of our loan portfolio at fair value consisted of floating rate loans. We continue to believe that our loan portfolio is well positioned and will continue to produce strong net investment income and perform well in the current interest rate environment. For the quarter endedMarch 31, 2023 , our weighted-average debt interest costs increased to 5.8% compared to 5.5% for the quarter endedDecember 31, 2022 , primarily due to an increase in the cost of debt on our BNP Facility resulting from SOFR rate increases. As ofMarch 31, 2023 , approximately 85% of our outstanding debt matures in 2026 and beyond, 68% of our outstanding debt carry fixed interest rates and 54% of our outstanding debt is unsecured.
For the quarter ended
During the quarter endedMarch 31, 2023 , no new loans were placed on non-accrual status. As ofMarch 31, 2023 , our loan portfolio had five non-accrual loans with an aggregate fair value of$11.5 million , or 2.3% of our total investments at fair value. AtMarch 31, 2023 , our asset coverage ratio of 163% exceeded the minimum asset coverage requirement of 150% under the 1940 Act, and we remained in compliance with all applicable covenants under our outstanding debt facilities. As ofMarch 31, 2023 , we had access to$20.0 million under our PWB Credit Facility, as well as$49.0 million under our BNP Facility, each of which are subject to a borrowing base and other covenants. Based on our regulatory asset coverage ratio as ofMarch 31, 2023 , we could access our aggregate unused lines of credit of$69.0 million , subject to the provisions of the borrowing bases as of any borrowing date, and remain in compliance with asset coverage ratio requirements. As ofMarch 31, 2023 , we had unfunded commitments of$21.3 million to 12 portfolio companies. OnMay 2, 2023 , the Board declared a distribution of$0.33 per share for the second quarter of 2023, payable onJune 30, 2023 , to stockholders of record as ofJune 23, 2023 . We are also subject to financial risks, including changes in market interest rates. As ofMarch 31, 2023 , approximately$292.2 million (aggregate fair value), or 94%, of our debt investments bore interest at variable rates, of which 46% are LIBOR-based. We have prepared and planned for the transition away from LIBOR by incorporating alternate reference rates to be used 54 --------------------------------------------------------------------------------
in our credit agreements. As of
Critical Accounting Policies and Significant Estimates
Our critical accounting policies and estimates are those relating to revenue recognition and fair value estimates. Management has discussed the development and selection of each critical accounting policy and estimate with the Audit Committee of the Board. For descriptions of our revenue recognition and fair value policies, see "Item 8. Financial Statements - Notes to Consolidated Financial Statements - Note 2" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Significant Estimates" in our Annual Report on Form 10-K for the year endedDecember 31, 2022 .
The following table illustrates the impact of our fair value measures if we
selected the low or high end of the range of values for all investments at
Fair Value at Range of Fair Value
Investment Type March 31, 2023 Low-end High-end
Debt investments:
Senior secured $ 309,789 $ 303,111 $ 316,651
Subordinated 129 129 129
Structured Finance Securities :
Subordinated notes 52,385 49,686 55,085
Mezzanine debt 26,498 26,155 26,837
Loan accumulation facilities 8,140 7,977 8,303
Equity investments:
Preferred equity 10,221 9,369 11,039
Common equity, warrants and other 92,597 86,678 97,757
$ 499,759 $ 483,105 $ 515,801 Related Party Transactions
We have entered into a number of business relationships with affiliated or related parties, including the following:
•The Investment Advisory Agreement with OFS Advisor to manage our operating and investment activities. Under the Investment Advisory Agreement we have agreed to pay OFS Advisor an annual base management fee based on the average value of our total assets (other than cash but including assets purchased with borrowed amounts and including assets owned by any consolidated entity) as well as an incentive fee based on our investment performance. See "Item 1-Financial Statements-Note 3". •The Administration Agreement with OFS Services, an affiliate of OFS Advisor, to provide us with the office facilities and administrative services necessary to conduct our operations. See "Item 1-Financial Statements-Note 3". •A license agreement with OFSAM, the parent company of OFS Advisor, under which OFSAM has agreed to grant us a non-exclusive, royalty-free license to use the name "OFS." Under this agreement, we have a right to use the "OFS" name for so long as OFS Advisor or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have no legal right to the "OFS" name. This license agreement will remain in effect for so long as the Investment Advisory Agreement with OFS Advisor is in effect. OFS Advisor's services under the Investment Advisory Agreement are not exclusive to us and OFS Advisor is free to furnish similar services to other entities, including other funds affiliated with OFS Advisor, so long as its services to us are not impaired. OFS Advisor also serves as the investment adviser to other funds, including HPCI and OCCI. Additionally, OFS Advisor provides sub-advisory services to (i)CMFT Securities Investments, LLC , a wholly owned subsidiary ofCIM Real Estate Finance Trust, Inc. , a corporation that qualifies as a real estate investment trust and (ii) CIM Real Assets & Credit Fund, an externally managed registered investment company that operates as an interval fund that invests primarily in a combination of real estate, credit and related investments.
For the years ended
55
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(excluding cash) at the end of the two most recently completed calendar
quarters. OFS Advisor's base management fee reduction is renewable on an annual
basis and OFS Advisor is not entitled to recoup the amount of the base
management fee reduced with respect to the OFSCC-FS Assets. OFS Advisor most
recently renewed the agreement for the 2023 calendar year on January 11, 2023 .
The 1940 Act generally prohibits BDCs from making certain negotiated
co-investments with certain affiliates absent an order from the SEC permitting
the BDC to do so. On August 4, 2020 , we received the Order, which superseded a
previous order that we received on October 12, 2016 , and provides us with
greater flexibility to enter into co-investment transactions with certain
Affiliated Funds in a manner consistent with our investment objective,
positions, policies, strategies and restrictions as well as regulatory
requirements and other pertinent factors, subject to compliance with certain
conditions. We are generally permitted to co-invest with Affiliated Funds if,
under the terms of the Order, a "required majority" (as defined in Section 57(o)
of the 1940 Act) of our independent directors make certain conclusions in
connection with a co-investment transaction, including that (1) the terms of the
transaction, including the consideration to be paid, are reasonable and fair to
us and our stockholders and do not involve overreaching in respect of us or our
stockholders on the part of any person concerned and (2) the transaction is
consistent with the interests of our stockholders and is consistent with our
investment objective and strategies.
In addition, we may file an application for an amendment to our existing Order
to permit us to participate in follow-on investments in our existing portfolio
companies with private funds that do not hold any investments in such existing
portfolio companies. However, if filed, there is no guarantee that such
application will be granted.
Conflicts may arise when we make an investment in conjunction with an investment
being made by an Affiliated Account, or in a transaction where an Affiliated
Account has already made an investment. Investment opportunities are, from time
to time, appropriate for more than one account in the same, different or
overlapping securities of a portfolio company's capital structure. Conflicts
arise in determining the terms of investments, particularly where these accounts
may invest in different types of securities in a single portfolio company.
Potential conflicts arise when addressing, among other things, questions as to
whether payment obligations and covenants should be enforced, modified or
waived, or whether debt should be restructured, modified or refinanced. For a
discussion of the risks associated with conflicts of interest, see "Item 1.
Business - Conflicts of Interest", "Item 1A. Risk Factors - Risks Related to OFS
Advisor and its Affiliates -We have potential conflicts of interest related to
the purchases and sales that OFS Advisor makes on our behalf and/or on behalf of
Affiliated Accounts" and "Item 1. Business - Regulation - Conflicts of Interest
- Conflicts Related to Portfolio Investments" in our Annual Report on Form 10-K
for the year ended December 31, 2022 .
Portfolio Composition and Investment Activity
Portfolio Composition
As ofMarch 31, 2023 , the fair value of our debt investment portfolio totaled$309.9 million in 47 portfolio companies, of which approximately 99% were senior secured loans. As ofMarch 31, 2023 , we had equity investments in 17 portfolio companies with a fair value of approximately$102.8 million . As ofMarch 31, 2023 , we also had 23 investments inStructured Finance Securities with a fair value of$87.0 million . We had unfunded commitments of$21.3 million to 12 portfolio companies as ofMarch 31, 2023 . Set forth in the tables and charts below is selected information with respect to our portfolio as ofMarch 31, 2023 andDecember 31, 2022 . The following table presents our investment portfolio by each wholly owned legal entity within the consolidated group as ofMarch 31, 2023 andDecember 31, 2022 (dollar amounts in thousands): March 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value OFS Capital Corporation (Parent)$ 199,759 $ 161,288 $ 195,823 $ 162,308 SBIC I LP 97,331 171,569 97,214 167,211 OFSCC-FS 175,044 163,350 178,460 168,050 OFSCC-MB 2,890 3,552 3,383 3,007 Total investments$ 475,024 $ 499,759 $ 474,880 $ 500,576 56
-------------------------------------------------------------------------------- The following table presents our ten largest debt and equity investments by portfolio company based on fair value as ofMarch 31, 2023 (dollar amounts in thousands): % of Total Portfolio, Portfolio Company Type Amortized Cost Fair Value at Fair Value Pfanstiehl Holdings, Inc. Equity $ 217$ 85,429 17.1 % All Star Auto Lights, Inc. Debt 27,711 27,886 5.6 % Milrose Consultants, LLC Debt 27,554 27,120 5.4 % The Escape Game, LLC Debt 18,173 18,363 3.7 % Inergex Holdings Debt 16,978 17,212 3.4 % Tolemar Acquisition, Inc. Debt 15,838 15,361 3.1 % Kreg LLC Debt 16,635 15,277 3.1 % SSJA Bariatric Management LLC Debt 13,273 13,015 2.6 % Boca Home Care Holdings, Inc. Debt and Equity 12,531 12,218 2.4 % One GI LLC Debt 12,687 11,851 2.4 % Total$ 161,597 $ 243,732 48.8 % As ofMarch 31, 2023 , approximately 4.2% and 11.8% of our total portfolio at fair value and net assets, respectively, were comprised ofStructured Finance Securities managed by a single adviser, and 4.5% and 12.6%, respectively, as ofDecember 31, 2022 . Portfolio Yields
The following table presents weighted-average yield metrics for our portfolio as
of
For the Three Months Ended
March 31, 2023 December 31, 2022
Weighted-average performing income yield(1):
Debt investments 12.3 % 11.5 %
Structured Finance Securities 15.5 % 16.3 %
Interest-bearing investments 13.0 % 12.7 %
Weighted-average realized yield(2):
Interest-bearing investments 11.8 % 11.7 %
(1) Performing income yield is calculated as (a) the actual amount earned on
performing interest-bearing investments, including interest, prepayment fees and
amortization of Net Loan Fees , divided by (b) the weighted-average of total
performing interest-bearing investments at amortized cost.
(2) Realized yield is calculated as (a) the actual amount earned on
interest-bearing investments, including interest, prepayment fees and
amortization of Net Loan Fees , divided by (b) the weighted-average of total
interest-bearing investments at amortized cost, in each case, including debt
investments on non-accrual status and non-income producing Structured Finance
Securities .
For the quarter ended March 31, 2023 , the weighted average performing income
yield on interest-bearing investments increased primarily due to rising interest
rates as 94% of our loan portfolio at fair value consisted of floating rate
loans.
Weighted-average yields of our investments are not the same as a return on
investment for our stockholders, but rather the gross investment income from our
investment portfolio before the payment of all of our fees and expenses. There
can be no assurance that the weighted average yields will remain at their
current levels.
57
--------------------------------------------------------------------------------Portfolio Company Investments
The following table summarizes the composition of ourPortfolio Company Investments as ofMarch 31, 2023 andDecember 31, 2022 (dollar amounts in thousands): March 31, 2023 December 31, 2022 Amortized Cost Fair Value Amortized Cost Fair Value Senior secured debt investments$ 334,903 $
309,789
13,890 129 13,890 1,226
Preferred equity 10,375 10,221 9,966 8,196
Common equity, warrants and other 12,495 92,597 12,989 91,000
Total Portfolio Company Investments $ 371,663 $
412,736
58 58 63 63
At March 31, 2023 , approximately 99% and 62% of our loan portfolio and total
portfolio, respectively, consisted of senior secured loans, based on fair value.
We believe the seniority of our debt investments in the borrowers' capital
structures may provide greater downside protection against adverse economic
changes, including those caused by the impacts of the ongoing war between Russia
and Ukraine , rising interest and elevated inflation rates, instability in the
U.S. and international banking systems, the risk of recession and of a failure
to increase the U.S. debt ceiling and related market volatility.
As of March 31, 2023 , the three largest industries of our Portfolio Company
Investments by fair value, were (1) Manufacturing (27.5%), (2) Health Care and
Social Assistance (16.5%) and (3) Wholesale Trade (13.1%), totaling an aggregate
of approximately 57.1% of our Portfolio Company Investment portfolio. For a full
summary of our investment portfolio by industry, see "Item 1-Financial
Statements-Note 4."
As of March 31, 2023 , our common equity investment in Pfanstiehl Holdings, Inc. ,
a global manufacturer of high-purity pharmaceutical ingredients, accounted for
17.1% and 47.5% of our total portfolio at fair value and our total net assets,
respectively. The value of this investment is substantially comprised of
unrealized appreciation of $85.2 million . A deterioration in the operating
performance of the company or other factors underlying the valuation of this
investment could have a material impact on our NAV.
58
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The following table summarizes the composition of our
March 31, 2023 December 31, 2022
Amortized Cost Fair Value Amortized Cost Fair Value
Subordinated notes $ 66,695 $
52,385
28,166 26,498 28,107 26,412
Loan accumulation facilities 8,500 8,140 8,500 8,299
Total Structured Finance Securities $ 103,361 $
87,023
23 23 23 23
As of
Investment Activity
The following is a summary of our investment activity for the three months ended
Three Months Ended
March 31, 2023
Investments in debt and equity securities $ 9.9
Investments in Structured Finance Securities -
Total investment purchases and originations $ 9.9
Proceeds from principal payments $ 1.8
Proceeds from investments sold or redeemed 8.9
Proceeds from distributions received from portfolio investments 3.1
Total proceeds from principal payments, sales and distributions from
portfolio investments $ 13.8
59--------------------------------------------------------------------------------
Risk Monitoring
We categorize investments in the debt securities of portfolio companies into seven risk categories based on relevant information about the ability of borrowers to service their debt. For additional information regarding our risk categories, see "Item 1. Business-Portfolio Review/Risk Monitoring" in our Annual Report on Form 10-K for the year endedDecember 31, 2022 , filed onMarch 3, 2023 . The following table shows the classification of our debt securities of portfolio companies, excludingStructured Finance Securities , by credit risk rating as ofMarch 31, 2023 andDecember 31, 2022 (dollar amounts in thousands): Debt Investments, at Fair Value Risk Category March 31, 2023 December 31, 2022 1 (Low Risk) $ - - % $ - - % 2 (Below Average Risk) - - - - 3 (Average) 286,184 92.3 288,170 92.2 4 (Special Mention) 16,284 5.3 17,218 5.5 5 (Substandard) 7,210 2.3 7,352 2.3 6 (Doubtful) 240 0.1 122 - 7 (Loss) - - - -$ 309,918 100.0 %$ 312,862 100.0 % Non-Accrual Loans Management reviews, for placement on non-accrual status, all loans that become past due on principal and interest, and/or when there is reasonable doubt that principal, cash interest, or PIK interest will be collected. When a loan is placed on non-accrual status, unpaid interest is credited to income and reversed. Additionally,Net Loan Fees are no longer accreted to interest income as of the date the loan is placed on non-accrual status. Interest payments subsequently received on non-accrual investments may be recognized as income or applied to principal depending upon management's judgment. Interest accruals andNet Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal and interest payments and, in the judgment of management, the investments are estimated to be fully collectible as to all principal and interest. During the quarter endedMarch 31, 2023 , no new loans were placed on non-accrual status. As ofMarch 31, 2023 , the aggregate amortized cost and fair value of loans on non-accrual status with respect to all interest andNet Loan Fee amortization was$36.5 million and$11.5 million , respectively, and$36.5 million and$11.2 million , respectively, as ofDecember 31, 2022 .
Results of Operations
Our key financial measures are described in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations-Key Financial Measures" in our Annual Report on Form 10-K for the year endedDecember 31, 2022 , filed onMarch 3, 2023 . The following is a discussion of the key financial measures that management employs in reviewing the performance of our operations. We do not believe that our historical operating performance is necessarily indicative of our future results of operations. We are primarily focused on debt investments in middle-market and larger companies inthe United States and, to a lesser extent, equity investments, including warrants and other minority equity securities, andStructured Finance Securities , which differs to some degree from our historical investment concentration in that we now also focus on the debt of largerU.S. companies andStructured Finance Securities . Moreover, as a BDC and a RIC, we are also subject to certain constraints on our operations, including, but not limited to, limitations imposed by the 1940 Act and the Code. In addition,SBIC I LP is subject to regulation and oversight by the SBA. For the reasons described above, the results of operations described below may not necessarily be indicative of the results we expect to report in future periods.
Net increase (decrease) in net assets resulting from operations can vary substantially from period to period for various reasons, including the recognition of realized gains and losses and unrealized appreciation and depreciation. As a result, annual comparisons of net increase (decrease) in net assets resulting from operations may not be meaningful.
The following analysis compares our quarterly results of operations to the
preceding quarter, as well as our year-to-date results of operations to the
corresponding period in the prior year. We believe a comparison of our current
quarterly results to the preceding quarter is more meaningful and transparent
than a comparison to the corresponding prior-year quarter as our results of
operations are not influenced by seasonal factors the latter comparison is
designed to elicit and highlight.
60
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Comparison of the three months ended
Consolidated operating results for the three months ended
Three Months Ended
March 31, 2023 December 31, 2022
Investment income
Interest income:
Cash interest income $ 9,698 $ 9,954
PIK interest income 226 92
Net Loan Fee amortization 409 408
Accretion of interest income on
3,002 3,009
Other interest income 58 56
Total interest income 13,393 13,519
Dividend income:
Cash dividends 549 136
Preferred equity PIK dividends 236 236
Total dividend income 785 372
Fee income:
Syndication fees 36 -
Prepayment and other fees 69 107
Total fee income 105 107
Total investment income 14,283 13,998
Total expenses 9,333 9,272
Net investment income 4,950 4,726
Net loss on investments (1,125) (2,292)
Loss on extinguishment of debt (19) -
Net increase in net assets resulting from operations
$ 2,434 Investment Income For the quarter endedMarch 31, 2023 , total investment income increased to$14.3 million from$14.0 million in the prior quarter, primarily due to an increase in total dividend income of$0.5 million .
Interest income decreased
Prepayment fees and syndication fees generally result from periodic transactions rather than from holding portfolio investments and are considered non-recurring. We receive syndication fees on investments where OFS Advisor sources, structures, and arranges the lending group. For the quarter endedMarch 31, 2023 , total fee income was stable compared to the prior quarter. 61 --------------------------------------------------------------------------------
Expenses
Operating expenses for the three months ended
Three Months Ended
March 31, 2023 December 31, 2022
Interest expense $ 4,874 $ 4,801
Management fee 1,894 1,918
Income Incentive Fee 1,238 1,183
Professional fees 436 453
Administration fee 482 433
Other expenses 409 484
Total expenses $ 9,333 $ 9,272
Comparison of the three months ended
Interest expense for the quarter endedMarch 31, 2023 increased$0.1 million compared to the prior quarter, primarily due to the increase in the effective interest rate on our BNP Facility resulting from SOFR rate increases.
Management fee expense for the quarter ended
The Income Incentive Fee for the quarter ended
For the quarter ended
Net realized and unrealized gain (loss) on investments
Net gain (loss), inclusive of realized and unrealized gains (losses), by
investment type for the three months ended
Three Months Ended
March 31, 2023 December 31, 2022
Senior secured debt $ (1,443) $ (689)
Subordinated debt (1,097) (3,049)
Preferred equity 1,630 483
Common equity, warrants and other 2,498 2,779
Structured Finance Securities (2,383) (1,612)
Income tax expense on net realized investment gains (171) (210)
Deferred tax benefit (expense) (159) 6
Total net loss on investments $ (1,125) $ (2,292)
Net gain (loss) on investments for the three months ended
Three months ended
For the quarter ended
Three months ended
During the three months endedDecember 31, 2022 , our portfolio experienced net losses of$2.3 million , primarily related to unrealized depreciation of$4.0 million on our debt and equity investments in a non-accrual portfolio company. 62 --------------------------------------------------------------------------------
Loss on Extinguishment of Debt
Three months ended
During the three months endedMarch 31, 2023 , we redeemed$5.0 million of SBA debentures and, as a result, we recognized loss on extinguishment of debt of$0.02 million related to the acceleration of unamortized deferred borrowing costs on the redeemed debentures.
Three months ended
During the three months endedMarch 31, 2022 , we redeemed$19.0 million of SBA debentures, and, as a result, we recognized losses on extinguishment of debt of$0.1 million related to the charge-off of unamortized deferred borrowing costs on these instruments.
Non-GAAP Financial Measure - Adjusted Net Investment Income
On a supplemental basis, we disclose adjusted net investment income ("Adjusted
NII") (including on a per share basis), which is a financial measure calculated
and presented on basis other than in accordance with GAAP. Adjusted NII
represents net investment income, excluding the capital gains incentive fee, in
periods in which such expense occurs. GAAP requires recognition of a capital
gains incentive fee in our financial statements when aggregate net realized and
unrealized capital gains, if any, on a cumulative basis is positive from the
date of the election to be a BDC through the reporting date. Such fees are
subject to further conditions specified in the Investment Advisory Agreement,
principally related to the realization of such net gains, before OFS Advisor is
entitled to payment, and such recognized fees are subject to the risk of
reversal should unrealized gains diminish to become losses. Management believes
that Adjusted NII is a useful indicator of operations exclusive of any net
capital gains incentive fee, as net investment income does not include the net
gains, realized or unrealized, associated with the capital gains incentive fee.
Management believes Adjusted NII facilitates the analysis of our results of
operations and provides greater transparency into the determination of incentive
fees. Adjusted NII is not meant as a substitute for net investment income
determined in accordance with GAAP and should be considered in the context of
the entirety of our reported results of operations, financial position and cash
flows determined in accordance with GAAP.
The following table provides a reconciliation from net investment income (the
most comparable GAAP measure) to Adjusted NII for the quarters ended March 31,
2023 and December 31, 2022 and three months ended March 31, 2023 and 2022,
respectively (dollar amounts in thousands, except per share data):
Three Months Ended Three Months Ended March 31,
March 31, 2023 December 31, 2022 2023 2022
(000's) Per Share (000's) Per Share (000's) Per Share (000's) Per Share
Net investment income $ 4,950 $ 0.37 $ 4,726 $ 0.35 $ 4,950 $ 0.37 $ 3,005 $ 0.22
Capital Gains Fee - - - - - - 1,072 0.08
Adjusted NII $ 4,950 $ 0.37 $ 4,726 $ 0.35 $ 4,950 $ 0.37 $ 4,077 $ 0.30
Although these non-GAAP financial measures are intended to enhance investors'
understanding of our business and performance, these non-GAAP financial measures
should not be considered an alternative to GAAP.
Liquidity and Capital Resources
As ofMarch 31, 2023 , we held cash of$10.8 million , which includes$3.1 million held bySBIC I LP , our wholly owned SBIC, and$3.6 million held by OFSCC-FS. Our use of cash held bySBIC I LP may be restricted by SBA regulation, including limitations on the amount of cashSBIC I LP can distribute to the Parent. Any such distributions to the Parent fromSBIC I LP are generally restricted under SBA regulations to a statutory measure of undistributed accumulated earnings ("READ") or regulatory capital ofSBIC I LP . During the three months endedMarch 31, 2023 , the Parent received READ fromSBIC I LP of$2.5 million . Distributions from OFSCC-FS to the Parent are restricted by the terms and conditions of the BNP Facility. During the three months endedMarch 31, 2023 , the Parent received$2.8 million in cash distributions from OFSCC-FS. As ofMarch 31, 2023 , cash available to be distributed fromSBIC I LP and OFSCC-FS were$3.8 million and$-0- million , respectively. As ofMarch 31, 2023 , we had an unused commitment of$20.0 million under our PWB Credit Facility, as well as an unused commitment of$49.0 million under our BNP Facility, both of which are subject to a borrowing base requirements and other covenants. Based on our regulatory asset coverage ratio as ofMarch 31, 2023 , we could access our aggregate unused lines of credit of$69.0 million , subject to the provisions of the borrowing bases as of any borrowing date, and remain in compliance with asset coverage ratio requirements. 63 -------------------------------------------------------------------------------- The Parent may make unsecured loans toSBIC I LP , of which the aggregate cannot exceed$35 million at any given time, and no interest may be charged on the unpaid principal balance. There were no intercompany loans between theParent and SBIC I LP as ofMarch 31, 2023 .
Sources and Uses of Cash
We generate operating cash flows from net investment income and the net liquidation of portfolio investments, and use cash in our operations in the net purchase of portfolio investments and payment of expenses. Significant variations may exist between net investment income and cash from net investment income, primarily due to the recognition of non-cash investment income, including certainNet Loan Fee amortization, PIK interest and PIK dividends, which generally will not be fully realized in cash until we exit the investment, as well as accreted interest income onStructured Finance Securities , which may not coincide with cash distributions from these investments. As discussed in "Item 1.-Financial Statements-Note 3," we pay OFS Advisor a quarterly incentive fee with respect to our pre-incentive fee net investment income, which may include investment income that we have not received in cash. In addition, we must distribute substantially all of our taxable income, which approximates, but will not always equal, the cash we generate from net investment income to maintain our RIC tax treatment. We also obtain cash to fund investments or general corporate activities from the issuance of securities and our revolving line of credit. These principal sources and uses of cash and liquidity are presented below (in thousands): Three Months Ended March 31, 2023 2022 Cash from net investment income(1)$ 3,055 $ 428
Net (purchases and originations)/repayments and sales of portfolio investments(1)
902 (24,812)
Net cash provided by (used in) operating activities 3,957 (24,384)
Distributions paid to stockholders(2) (4,421) (3,719)
Net borrowings under lines of credit 1,300 14,650
Repayments of SBA debentures (5,000) (19,000)
Other financing activities - (122)
Net cash used in financing activities (8,121) (8,191)
Net decrease in cash $ (4,164) $ (32,575)
(1) Net purchases and originations/repayments and sales of portfolio
investments includes the purchase and origination of portfolio investments,
proceeds from principal payments on portfolio investments, proceeds from sale or
redemption of portfolio investments, changes in receivable for investments sold,
payable from investments purchased as reported in our statements of cash flows,
as well as the excess of proceeds from distributions received from Structured
Finance Securities over accretion of interest income on Structured Finance
Securities . Cash from net investment income includes all other cash flows from
operating activities reported in our statements of cash flows.
(2) The determination of the tax attributes of our distributions is made
annually as of the end of our fiscal year based upon our ICTI for the full year
and distributions paid for the full year. Therefore, a determination made on a
quarterly basis may not be representative of the actual tax attributes of our
distributions for a full year.
Cash from net investment income
Cash from net investment income increased
Net (purchases and originations)/repayments and sales of portfolio investments
During the three months endedMarch 31, 2023 , net purchases and originations of portfolio investments of$0.9 million were primarily due to$9.9 million of cash we used to purchase portfolio investments, offset by$10.8 million of cash we received from amortized cost repayments, sales on our portfolio investments and the net proceeds from distributions received fromStructured Finance Securities and accretion of interest income onStructured Finance Securities . During the three months endedMarch 31, 2022 , net purchases and originations of portfolio investments of$24.8 million were primarily due to$65.9 million of cash we used to purchase portfolio investments, offset by$41.1 million of cash we received from amortized cost repayments, sales on our portfolio investments and the net proceeds from distributions received fromStructured Finance Securities and accretion of interest income onStructured Finance Securities . See "-Portfolio Composition and Investment Activity-Investment Activity." 64 --------------------------------------------------------------------------------
Borrowings
SBA Debentures
SBIC I LP's SBIC license allowed it to obtain leverage by issuing SBA-guaranteed debentures, subject to issuance of a capital commitment by the SBA and customary procedures. These debentures are non-recourse to us, and bear interest payable semi-annually, and each debenture has a maturity date that is ten years following issuance. The interest rate was fixed at the first pooling date after issuance, which was March and September of each year, at a market-driven spread overU.S. Treasury Notes with ten-year maturities. As ofMarch 31, 2023 andDecember 31, 2022 ,SBIC I LP had outstanding debentures of$45.9 million and$50.9 million , respectively. On a stand-alone basis, atMarch 31, 2023 andDecember 31, 2022 ,SBIC I LP held$175.3 million and$176.5 million in total assets, respectively, which accounted for approximately 34% and 34% of the Company's total consolidated assets, respectively. As part of our plans to focus on providing first lien senior secured loans to larger borrowers, which we believe will improve our overall risk profile,SBIC I LP is repaying over time its outstanding SBA debentures prior to their scheduled maturity dates. Under a plan approved by the SBA, we will only make follow-on investments in current portfolio companies held bySBIC I LP . During the three months endedMarch 31, 2023 ,SBIC I LP redeemed$5.0 million of SBA debentures that were contractually dueMarch 1, 2025 .SBIC I LP is periodically examined and audited by the SBA's staff to determine its compliance with SBA regulations. IfSBIC I LP fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibitSBIC I LP's use of debentures, declare outstanding debentures immediately due and payable, and/or limitSBIC I LP from making distributions. We have received exemptive relief from theSEC effectiveNovember 26, 2013 , which permits us to exclude SBA guaranteed debentures from the definition of senior securities in the statutory 150% asset coverage ratio under the 1940 Act.
PWB Credit Facility
We are party to a BLA withPacific Western Bank , as lender, to provide us with a senior secured revolving credit facility, or the PWB Credit Facility, which is available for general corporate purposes including investment funding. The maximum availability of the PWB Credit Facility is equal to 50% of the aggregate outstanding principal amount of eligible loans included in the borrowing base, which excludes subordinated loan investments (as defined in the BLA) and as otherwise specified in the BLA. The PWB Credit Facility is guaranteed byOFSCC-MB, Inc. and secured by all of our current and future assets, excluding assets held bySBIC I LP , OFSCC-FS and the Company's partnership interests inSBIC I LP and OFS SBIC I, GP. OnApril 22, 2022 , we amended the BLA to: (i) increase the maximum amount available under the PWB Credit Facility from$25.0 million to$35.0 million ; and (ii) extend the maturity date of the PWB Credit Facility fromFebruary 28, 2023 toFebruary 28, 2024 . OnDecember 15, 2022 , we amended the PWB Credit Facility to: (i) reduce the maximum amount available under the PWB Credit Facility from$35.0 million to$25.0 million ; and (ii) eliminate the No Net Losses covenant, which restricted net losses (defined as income after adjustments to the investment portfolio for gains and losses, realized and unrealized, also shown as net increase (decrease) in net assets resulting from operations) in more than two quarters during the prior four quarters then ended. As ofMarch 31, 2023 , we had$5.0 million outstanding and an unused commitment of$20.0 million under the PWB Credit Facility, subject to a borrowing base and other covenants. As ofMarch 31, 2023 , the effective interest rate on the PWB Credit Facility was 8.55%. The BLA contains customary terms and conditions, including, without limitation, affirmative and negative covenants, such as information reporting requirements, a minimum tangible net asset value, a minimum quarterly net investment income after incentive fees, a debt/worth ratio and a net loss restriction. The BLA also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change in investment advisor, and the occurrence of a material adverse change in our financial condition. As ofMarch 31, 2023 , we were in compliance in all material respects with the applicable covenants under the PWB Credit Facility.
Unsecured Notes
The Unsecured Notes are direct unsecured obligations and rank equal in right
of payment with all of our current and future unsecured indebtedness. Because
the Unsecured Notes are not secured by any of our assets, they are effectively
subordinated to all existing and future secured unsubordinated indebtedness (or
any indebtedness that is initially unsecured as to
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which we subsequently grant a security interest), to the extent of the value of
the assets securing such indebtedness, including, without limitation, borrowings
under the PWB Credit Facility. As of March 31, 2023 and December 31, 2022 , we
had $180.0 million in Unsecured Notes.
In order to, among other things, reduce future cash interest payments, as well
as future amounts due at maturity or upon redemption, we may, from time to time,
purchase the Unsecured Notes for cash in open market purchases and/or privately
negotiated transactions. We will evaluate any such transactions in light of
then-existing market conditions, taking into account our current liquidity,
prospects for future access to capital, contractual restrictions and other
factors. The amounts involved in any such transactions, individually or in the
aggregate, may be material.
BNP Facility
On June 20, 2019 , OFSCC-FS entered into the BNP Facility, as amended, which
provides for borrowings in an aggregate principal amount up to $150.0 million ,
of which $101.0 million was drawn as of March 31, 2023 . Borrowings under the BNP
Facility bear interest based on SOFR for the relevant interest period, plus an
applicable spread (subject to an effective floor of 2.65%). The BNP Facility
will mature on the earlier of June 20, 2027 or upon certain other events defined
in the credit agreement which may result in accelerated maturity. Borrowings
under the BNP Facility are secured by substantially all of the assets held by
OFSCC-FS. As of March 31, 2023 , we were in compliance in all material respects
with the applicable covenants under the BNP Facility.
On June 24, 2022 , we amended the BNP Facility to, among other things: (i) extend
the reinvestment period under the BNP Facility for three years from June 20,
2022 to June 20, 2025 ; (ii) extend the maturity date under the BNP Facility from
June 20, 2024 to June 20, 2027 ; (iii) convert the benchmark interest rate from
LIBOR to SOFR; (iv) increase the top two Moody's Industry concentrations from
15% to 17.5% and 20%; (v) increase the applicable margin by 0.40% on all classes
of loans; and (vi) increase the applicable margin floor from 1.925% to 2.65%.
As of March 31, 2023 , the effective interest rate on the BNP Facility was 8.00%
and the unused commitment under the was $49.0 million . On a stand-alone basis,
at March 31, 2023 and December 31, 2022 , OFSCC-FS held approximately $168.9
million and $173.7 million in total assets, respectively, which accounted for
approximately 33% and 33% of our total consolidated assets, respectively.
Other Liquidity Matters
We expect to fund the growth of our investment portfolio utilizing our current borrowings, follow-on equity offerings, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act. We cannot assure stockholders that our plans to raise capital will be successful. In addition, we intend to distribute to our stockholders substantially all of our taxable income in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments or make additional investments in our portfolio companies. The illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value. As a BDC, we must not acquire any assets other than "qualifying assets" specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our assets, as defined by the 1940 Act, are qualifying assets (with certain limited exceptions). Qualifying assets include investments in "eligible portfolio companies." Under the relevantSEC rules, the term "eligible portfolio company" includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than$250 million , in each case organized inthe United States . Conversely, we may invest up to 30% of our portfolio in opportunistic investments not otherwise eligible under BDC regulations. Specifically, as part of this 30% basket, we may consider investments in investment funds that are operating pursuant to certain exceptions to the 1940 Act and in advisers to similar investment funds, as well as in debt or equity of middle-market portfolio companies located outside ofthe United States and debt and equity of public companies that do not meet the definition of eligible portfolio companies because their market capitalization of publicly traded equity securities exceeds the levels provided for in the 1940 Act. We have, and may continue to, make opportunistic investments inStructured Finance Securities and other non-qualifying assets, consistent with our investment strategy. As ofMarch 31, 2023 , approximately 81% of our investments were qualifying assets. BDCs are generally required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities to total senior securities. We received an exemptive order from theSEC to permit us to exclude the debt ofSBIC I LP guaranteed by the SBA from the definition ofSenior Securities in the statutory asset coverage ratio under the 1940 Act, which limits the amount that we may borrow. To fund growth in our investment portfolio in the future, we anticipate the need to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all. 66 -------------------------------------------------------------------------------- OnMay 3, 2018 , our Board, including a required majority (as such term is defined in Section 57(o) of the 1940 Act) thereof, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, our minimum required asset coverage ratio decreased from 200% to 150%, effectiveMay 3, 2019 . OnMay 22, 2018 , the Board authorized the Stock Repurchase Program under which we could acquire up to$10.0 million of our outstanding common stock through the two-year period endingMay 22, 2020 . OnMay 4, 2020 andMay 3, 2022 , the Board extended the Stock Repurchase Program for additional two-year periods. Under the extended Stock Repurchase Program, we are authorized to repurchase shares in open-market transactions, including through block purchases, depending on prevailing market conditions and other factors. We expect the Stock Repurchase Program to be in place throughMay 22, 2024 , or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The Stock Repurchase Program may be extended, modified or discontinued at any time for any reason. We have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements. We retire all shares of common stock that we purchased in connection with the Stock Repurchase Program. During the three months endedMarch 31, 2023 , we did not make any repurchases of common stock on the open market under the Stock Repurchase Program. As ofMarch 31, 2023 , the approximate dollar value of shares remaining that may be purchased under the program was$9.64 million . As ofMarch 31, 2023 , the aggregate amount outstanding of the senior securities issued by us was$331.9 million , for which our asset coverage was 163%.The Small Business Administration debentures are not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by theSEC effectiveNovember 26, 2013 . The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our consolidated total assets, less all liabilities and indebtedness not represented by senior securities, divided by total senior securities representing indebtedness. As a BDC, we are generally not permitted to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of our common stock if the Board determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve such sale. OnJuly 13, 2022 , our stockholders approved a proposal to authorize us, with approval of our Board, to sell or otherwise issue shares of our common stock (during a twelve-month period) at a price below our then-current net asset value per share in one or more offerings, subject to certain limitations (including that the cumulative number of shares sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale). We have not sold any shares below net asset value pursuant to the proposal approved by our stockholders. We continue to monitor the instability in the current banking environment arising from recent bank failures. If the banks and financial institutions with whom we have credit facilities enter into receivership or become insolvent in the future, our liquidity may be reduced significantly. At various times, our cash balances at third-party financial institutions exceed the federally insured limit. Our cash balances are retained in custodian accounts withU.S. Bank N.A andCitibank N.A ., and we do not believe they are exposed to any significant credit risk. We continue to monitor our portfolio and believe the deposit risk and counterparty risk to be minimal.
Contractual Obligations and Off-Balance Sheet Arrangements
AtMarch 31, 2023 , we had$10.8 million of cash and cash equivalents, as well as$20.0 million and$49.0 million of unfunded commitments under our PWB Credit Facility and BNP Facility, respectively, to meet our short-term contractual obligations. AtMarch 31, 2023 , we had$21.3 million in outstanding commitments to fund portfolio investments under various undrawn revolvers and other credit facilities. Long-term contractual obligations, such as our BNP Facility that matures in 2027 and has$101.0 million outstanding atMarch 31, 2023 , can be repaid by selling OFSCC-FS portfolio investments that have a fair value of$163.4 million atMarch 31, 2023 . The OFSCC-FS portfolio is primarily comprised of broadly syndicated loans that can be sold over a relatively short period to generate cash. We cannot, however, be certain that this source of funds will be available and upon terms acceptable to us in sufficient amounts in the future.
At
As of
We have entered into contracts with third parties under which we have material
future commitments-the Investment Advisory Agreement, pursuant to which OFS
Advisor has agreed to serve as our investment adviser, and the Administration
Agreement, pursuant to which OFS Services has agreed to furnish us with the
facilities and administrative services necessary to conduct our day-to-day
operations.
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We may become a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financial needs of our portfolio
companies. These instruments may include commitments to extend credit and
involve, to varying degrees, elements of liquidity and credit risk in excess of
the amount recognized in the balance sheet. There is no guarantee that these
amounts will be funded to the borrowing party now or in the future. We continue
to believe that we have sufficient levels of liquidity to support our existing
portfolio companies and will meet these unfunded commitments by using our cash
on hand or utilizing our available borrowings under the PWB Credit Facility and
BNP Facility. In addition, we generally hold broadly syndicated loans in larger
portfolio companies that can be sold over a relatively short period to generate
cash.
Distributions
We are taxed as a RIC under the Code. In order to maintain our tax treatment as
a RIC, we are required to distribute annually to our stockholders at least 90%
of our ICTI, as defined by the Code. Additionally, to avoid a 4% excise tax on
undistributed earnings we are required to distribute each calendar year the sum
of: (i) 98% of our ordinary income for such calendar year; (ii) 98.2% of our net
capital gains for the one-year period ending October 31 of that calendar year;
and (iii) any income recognized, but not distributed, in preceding years and on
which we paid no federal income tax. Maintenance of our RIC status requires
adherence to certain source of income and asset diversification requirements.
Generally, a RIC is entitled to deduct dividends it pays to its stockholders
from its income to determine "taxable income." Taxable income includes our
taxable interest, dividend and fee income, and taxable net capital gains.
Taxable income generally differs from net income for financial reporting
purposes due to temporary and permanent differences in the recognition of income
and expenses, and generally excludes net unrealized appreciation or
depreciation, as gains or losses are not included in taxable income until they
are realized. In addition, gains realized for financial reporting purposes may
differ from gains included in taxable income as a result of our election to
recognize gains using installment sale treatment, which generally results in the
deferment of gains for tax purposes until notes or other amounts, including
amounts held in escrow received as consideration from the sale of investments,
are collected in cash. Taxable income includes non-cash income, such as changes
in accrued and reinvested interest and dividends, which includes contractual PIK
interest, and the amortization of discounts and fees. Cash collections of income
resulting from contractual PIK interest and dividends or the amortization of
discounts and fees generally occur upon the repayment of the loans or debt
securities that include such items. Non-cash taxable income is reduced by
non-cash expenses, such as realized losses and depreciation, and amortization
expense.
Our Board maintains a variable dividend policy with the objective of
distributing quarterly distributions in an amount not less than 90-100% of our
taxable quarterly income or potential annual income for a particular year. In
addition, during the year, we may pay a special dividend, such that we may
distribute approximately all of our annual taxable income in the year it was
earned, while maintaining the option to spill over our excess taxable income to
a following year. We may choose to retain a portion of our taxable income in any
year and pay the 4% U.S. federal excise tax on the retained amounts. Each year,
a statement on Form 1099-DIV identifying the source of the distribution is
mailed to the Company's stockholders.
Recent Developments
OnMay 2, 2023 , our Board declared a distribution of$0.33 per share for the second quarter of 2023, payable onJune 30, 2023 to stockholders of record as ofJune 23, 2023 . OnApril 10, 2023 ,Ross Teune notified our Board of his intention to resign.Mr. Teune's resignation as Chief Accounting Officer was effective onApril 21, 2023 . The resignation was not in any way related to a disagreement with the Company on any matter relating to the Company's operations, policies, practices or otherwise.
On
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