OFS - NASDAQ

Good day, and welcome to the OFS Capital Corporation Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Steve Altebrando. Please go ahead.

Good morning, everyone, and thank you for joining us. Also on the call today are Bilal Rashid, our Chairman and Chief Executive Officer; and Kyle Spina, the company's Chief Financial Officer and Treasurer. Before we begin, please note that the 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 OFS 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 incorrect, 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. OFS 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. With that, I'll turn the call over to Chairman and Chief Executive Officer, Bilal Rashid.

Thank you, Steve. Yesterday, we announced our third quarter earnings. Net investment income was $0.22 per share compared to $0.25 per share in the prior quarter. This decline was primarily due to higher interest costs, which were expected as part of our ongoing initiative to refinance our existing bonds and extend the maturities of our debt. Net asset value at September 30 was $10.17 per share compared to $10.91 per share in the prior quarter. The decrease was largely driven by a markdown on our equity investments, most notably our position in Pfanstiehl Holdings and unrealized depreciation on our CLO equity investments attributable to underlying loan spread tightening. Overall, we believe our credit portfolio is stable. During the quarter, we had one loan placed on nonaccrual status and one loan was taken off of nonaccrual and moved to performing status. While we remain steadfast on preserving capital, we are strategically focused on efforts to improve our net investment income over the long term. This includes ongoing efforts to monetize our minority equity position in Pfanstiehl, our largest position in the portfolio with a fair value of approximately $78.5 million at quarter end. The fundamental performance of the company continued to improve and the long-term outlook remains strong in our view. The reduced valuation mark reflects the challenging market conditions to monetize this asset despite the improved performance. While we remain confident in the portfolio company's long-term potential, a near-term exit could improve our net investment income and reduce concentration risk. However, we recognize this may come at the cost of realizing the investment's full fundamental value. As a reminder, our initial $200,000 investment in Pfanstiehl in 2014 has generated approximately $4.2 million in distributions to date, an approximately 20x return on our cost. Looking forward, the broader economic outlook remains uncertain. On the monetary front, so far this year, the Fed has lowered interest rates by 50 basis points, and there is potential for further reductions in the near term. Given that the vast majority of our loan portfolio is floating rate, continued rate cuts could reduce our net investment income. Despite this backdrop, we remain comfortable with the overall health of our portfolio. We have deliberately constructed our loan portfolio to be resilient by avoiding highly cyclical industries and maintaining our strong diversification. Our loan portfolio is entirely composed of first and second lien senior secured loans, reflecting our commitment to positioning higher in the capital structure. As for new originations, middle market M&A activity this year has remained below expectations. However, we remain actively engaged with our existing portfolio companies and are prepared to deploy additional capital if needed. As we mentioned on our last call, early in the third quarter, we began the process of refinancing our $125 million unsecured notes that were due to mature in February 2026. In July, we completed a $69 million unsecured public bond offering. These new public notes mature in July 2028. In August, we continued the refinancing process by completing a private placement of a $25 million unsecured note. This new private note matures in August 2029. Following the completion of these offerings, we repaid $94 million of the February 2026 notes in August, resulting in a leverage-neutral refinancing. We believe these actions have further strengthened our capital position and enhanced our operational flexibility. In addition, the public bonds have a non-call period of only 1 year, while the private unsecured note is prepayable at any time, providing us additional flexibility in an evolving rate environment. We expect to repay the remaining $31 million on the February 2026 notes ahead of the maturity. Additionally, during the quarter, we elected to reduce the size of our floating rate facility with BNP Paribas from $150 million to $80 million. We took this action as we embark on delevering the balance sheet. We believe our liquidity position remains sufficient, supported by our $25 million Banc of California floating rate corporate line of credit, which was undrawn at the end of the quarter. As we continue to navigate this uncertain environment, we remain confident in the experience and capabilities of our adviser with approximately $4.1 billion in assets under management across the known and structured credit markets, deep expertise across industries and a track record spanning more than 25 years and multiple credit cycles, we believe we are well positioned to manage through this ongoing uncertainty. With that, I'll turn the call over to Kyle Spina, our Chief Financial Officer, to give you more details and color for the quarter.

Thanks, Bilal, and good morning, everyone. As Bilal mentioned, we posted net investment income of $2.9 million or $0.22 per share for the third quarter, which was down $0.03 per share from the second quarter. Top line income increased $75,000 quarter-over-quarter. However, expenses increased by $418,000, leading to the decline in net investment income. As we alluded to on our last call, we announced yesterday that we are reducing the quarterly distribution to $0.17 per share for the fourth quarter of 2025. This adjusted distribution rate represented an implied 8.8% annualized yield based on the market price of our common stock as of September 30. In light of ongoing interest rate cuts, coupled with our increased cost of financing, we determined it an appropriate time to better align our distribution rate with our net investment income. We believe this step will allow us to preserve capital as we focus on deleveraging and strengthening our balance sheet in this uncertain economic environment. Despite this reduction, we remain focused on improving our long-term returns as we continue exploring avenues to monetize our equity investment in Pfanstiehl. Our net asset value per share decreased by approximately 7% or $0.74 this quarter. As Bilal described, the decline in our investment portfolio at fair value was most pronounced in our equity holdings, including $4.5 million of unrealized depreciation on our equity investment in Pfanstiehl. We also observed more meaningful net unrealized depreciation in our CLO equity holdings totaling $4.0 million attributable to spread tightening in the underlying loan collateral. We placed one loan on nonaccrual status during the quarter, representing 1.8% of the total portfolio at fair value. We also placed one loan back on accrual status during the quarter following the completion of a restructuring transaction. Overall, our loan portfolio was relatively stable quarter-over-quarter based on our internal credit ratings. At quarter end, our regulatory asset coverage ratio was 157%, a decrease of 3 percentage points from the prior quarter. As we discussed last quarter, we closed on $94 million of new bond issuances during the quarter between a public and private offering, the proceeds of which were utilized to partially refinance our 4.75% unsecured notes scheduled to mature in February 2026 in leverage-neutral transactions. We are pleased with the execution on these deals, which extended our debt maturities, though obviously, they are priced wider than where our existing notes were issued in early 2021 in a near 0 rate environment. Following the completion of these transactions, we have a more manageable $31 million remaining outstanding on our February 2026 unsecured notes, which we intend to repay in advance of the maturity date. Turning to the income statement. Total investment income increased approximately 1% to $10.6 million this quarter. This was primarily driven by nonrecurring dividend and fee income recognized during the quarter, totaling approximately $0.6 million. Total expenses increased by approximately 6% during the period to $7.6 million. This was primarily due to an approximately $700,000 increase in total interest expense, largely driven by the higher coupon on our new unsecured note issuances. Looking ahead, we anticipate further net interest margin compression attributable to lower reference rates following the Fed's aggregate 50 basis point rate cuts so far this year and the impact of any potential future reductions. We expect this will impact yields on our predominantly floating rate loan portfolio. In addition, we anticipate higher interest costs related to the refinancing of our February 2026 unsecured notes. Turning to our investments. We believe the majority of our loan portfolio remains solid, while we continue to closely monitor certain borrowers performing below our expectations. As mentioned, overall, we were neutral relative to the number of issuers with loans on nonaccrual status quarter-over-quarter with one new loan placed on nonaccrual status and one loan placed back on accrual status during the third quarter. With respect to our loan portfolio, we are committed to being senior in the capital structure and selective in our underwriting, with 88% of our loan holdings being in first lien positions based on fair value. During the quarter, we committed $8.3 million to a new middle-market debt investment. In addition, we continue to focus on add-on opportunities for growth with our existing issuers and as of quarter end, had $18.3 million in unfunded commitments to our portfolio companies. The majority of our investments are in loans and 100% of our loan portfolio was senior secured at quarter end. Based on amortized costs as of quarter end, our investment portfolio was comprised of approximately 69% senior secured loans, 23% structured finance securities and 8% equity securities. At the end of the quarter, we had investments in 57 unique issuers totaling $370.2 million at fair value. On the interest-bearing portion of the portfolio, the weighted average performing investment income yield decreased modestly to 13.3%, which is down about 0.3% quarter-over-quarter. The decrease in yield was primarily due to the impact of net change in nonaccrual positions. This metric includes all interest, prepayment fee and amortization of deferred loan fee income, but excludes syndication fee income if applicable. With that, I'll turn the call back over to Bilal for concluding remarks.

Thank you, Kyle. In today's continued uncertain economic environment, we remain focused on preserving capital and strengthening our balance sheet. In that regard, we have taken meaningful steps to extend the maturities of our debt and secure financing that gives us operational flexibility over the coming years. As we look ahead, we are focused on defensively positioning our balance sheet, which includes our decision to reduce the distribution rate as well as our ongoing plans to reduce our debt. We believe our loan portfolio remains generally stable and well positioned to withstand this market. Its diversification across multiple industries continues to serve us well, and we maintain our focus on investing higher in the capital structure. As with prior quarters, we remain focused on increasing our net investment income over the long term, specifically through our efforts to monetize certain noninterest-earning equity positions, including our investment in Pfanstiehl. Our team's long-standing experience and investment discipline has driven consistent results. Since 2011, the BDC has invested more than $2 billion with an annualized net realized loss of just 0.25%, while continuing to generate attractive risk-adjusted returns on our portfolio. As always, we will continue to rely on the size, experience and reputation of our adviser. With a $4.1 billion corporate credit platform and affiliation with a $30 billion asset management group, our adviser brings deep credit experience and long-standing banking and capital markets relationships. Our corporate credit platform has gone through multiple credit cycles over the last 25-plus years. Our adviser and affiliates are also strongly aligned with shareholders as they maintain an approximately 23% ownership in the company. With that, operator, please open the call for questions.