Overview

OFS Capital Corporation is a business development company (BDC) that provides debt and equity financing to middle-market companies in the United States. The company’s key financial metrics show a mixed performance in the first half of 2024.

On the positive side, OFS Capital’s net asset value (NAV) per share increased from $11.08 at the end of March 2024 to $11.51 at the end of June 2024, due to net gains on investments. However, the company’s net investment income per share decreased from $0.42 in the first quarter to $0.26 in the second quarter, leading to a lower quarterly distribution of $0.34 per share.

Financial Performance

For the three months ended June 30, 2024, OFS Capital’s total investment income decreased to $11.2 million from $14.2 million in the prior quarter. This was primarily due to a $2.4 million decrease in dividend income, as well as a $0.5 million decrease in interest income. The decrease in interest income was mainly due to a smaller average investment portfolio size as the company used proceeds from portfolio sales and repayments to pay down debt.

On the expense side, OFS Capital’s total expenses decreased to $7.7 million in the second quarter from $8.6 million in the first quarter. This was primarily driven by a $0.5 million decrease in interest expense and a $0.5 million decrease in incentive fees.

For the six months ended June 30, 2024, OFS Capital’s total investment income decreased by $3.4 million compared to the same period in the prior year. This was mainly due to a $5.2 million decrease in total interest income, partially offset by a $1.9 million increase in total dividend income.

Portfolio Performance

As of June 30, 2024, OFS Capital’s investment portfolio had a fair value of $398.2 million, consisting of 40 debt investments, 16 equity investments, and 18 investments in Structured Finance Securities. The company’s top 10 investments accounted for 50.8% of the total portfolio at fair value.

The company’s common equity investment in Pfanstiehl Holdings, Inc. was the largest holding, accounting for 17.8% of the total portfolio and 45.9% of net assets. This investment has experienced substantial unrealized appreciation, contributing to the increase in OFS Capital’s NAV.

OFS Capital’s portfolio also included $18.3 million in non-accrual loans, representing 4.6% of the total investment portfolio at fair value. The company recognized a net realized loss of $2.4 million during the second quarter related to the write-off of a non-accrual second lien debt investment.

Liquidity and Capital Resources

As of June 30, 2024, OFS Capital had $5.6 million in cash and cash equivalents, as well as $105.9 million in unused commitments under its Banc of California Credit Facility and BNP Facility. The company’s asset coverage ratio of 162% exceeded the minimum requirement of 150% under the Investment Company Act of 1940.

During the six months ended June 30, 2024, OFS Capital generated $6.2 million in cash from net investment income and received $16.5 million in net proceeds from portfolio investment repayments and sales. The company used this cash to pay $9.1 million in distributions to shareholders, repay $21.4 million on its revolving credit facilities, and fully repay $31.9 million in outstanding SBA debentures.

Strengths and Weaknesses

One of OFS Capital’s key strengths is the seniority of its debt investments, with approximately 100% of the loan portfolio and 59% of the total portfolio consisting of first lien and second lien loans as of June 30, 2024. This senior positioning in the capital structure may provide greater downside protection in the event of adverse economic conditions.

Another strength is the company’s diversified portfolio, with investments across various industries, including manufacturing, healthcare, and wholesale trade. This diversification helps mitigate concentration risk.

However, OFS Capital’s reliance on dividend income, which can be more volatile than interest income, is a potential weakness. The significant decline in dividend income during the second quarter contributed to the decrease in the company’s net investment income.

Additionally, the company’s portfolio includes a notable concentration in its common equity investment in Pfanstiehl Holdings, Inc., which accounted for 45.9% of net assets as of June 30, 2024. While this investment has generated substantial unrealized appreciation, a decline in its value could have a material impact on OFS Capital’s NAV.

Outlook and Conclusion

Looking ahead, OFS Capital’s ability to maintain its investment income and manage its non-accrual loans will be crucial to its future performance. The company’s focus on senior secured debt investments and diversified portfolio may help mitigate risks, but it will need to navigate the current economic environment and any potential market volatility.

Overall, OFS Capital’s mixed financial results in the first half of 2024 highlight the challenges faced by BDCs in the current market conditions. While the company’s NAV growth and strong liquidity position are positive signs, the decline in net investment income and the concentration risk in its Pfanstiehl Holdings investment are areas that warrant close monitoring. Investors should carefully consider OFS Capital’s performance and outlook before making investment decisions.