Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 ended December 31, 2020.
Overview
Key performance metrics are presented below:
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March 31, 2021
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December 31, 2020
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Net asset value per common share
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$
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11.96
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$
|
11.85
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Three Months Ended March 31,
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2021
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2020
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Net investment income per common share
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$
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0.19
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$
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0.30
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Net increase (decrease) in net assets resulting from operations per common share
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0.31
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(2.41)
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Distributions paid per common share
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|
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|
|
0.20
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|
|
0.34
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|
Net investment income per share declined $0.11 from the corresponding quarter in the prior year primarily due to an approximate $0.15 decline in net interest margin—total interest income less interest expense—per share. Weighted average yield on debt and Structured Finance Notes for the three months ended March 31, 2021, declined to 9.01% from 9.51% in the quarter ended March 31, 2020, due to the decrease in LIBOR and our plans to focus on lower-yielding, first lien senior secured loans to larger borrowers, which we believe will improve our overall risk profile. The decline in net interest margin was partially offset by declines in management and incentive fees of $0.08 per share. For the three months ended March 31, 2021, our weighted-average interest costs increased to 5.57% from 5.33% in the quarter ended March 31, 2020, principally due to borrowings under our Unsecured Notes Due September 2023, offset by repayments of our SBA debentures. As of March 31, 2021, approximately 94% of our debt is fixed rate.
Our portfolio experienced net gains of $3.9 million, or $0.29 per share, during the three months ended March 31, 2021, principally due to a $4.4 million, or 1.6%, improvement in the fair values of our directly originated debt and equity investments. The net appreciation in our directly originated investments was led by a $1.6 million improvement on our debt investment in Wastebuilt Environmental Solutions LLC, which experienced an improvement in fair value as the company continues to proceed with an anticipated acquisition. Our investment in the common equity of Pfanstiehl Holdings, Inc., and NeoSystems Corp., also improved by $1.0 million and $0.9 million, respectively, in both instances driven by improved operating results of the companies. Additionally, we observed spread tightening in middle market loans ranging from zero to 25 basis points, which translated into fair value increases across our portfolio from zero to 1%. These investment valuation increases were partially offset by a decrease of $2.3 million in the fair value of our subordinated debt investment in Online Tech Stores LLC, due to further degradation of performance at that company. We also experienced net depreciation of $0.5 million in our Structured Finance Note investments, due to the decline in value of Apex Credit CLO 2020 Ltd. The fair value of our investments in broadly syndicated loans were relatively unchanged, consistent with major syndicated loan indices.
Since OFS Advisor implemented its business continuity plan in mid-March 2020, OFS Advisor's entire team has effectively transitioned to remote work and we are currently capable of maintaining our normal functionality to complete our operational requirements.
OFS Advisor has actively monitored our portfolio companies throughout this period of economic uncertainty, which has included assessments of our portfolio companies' operational and liquidity outlook. During the three months ended March 31, 2021, we converted cash interest to PIK interest on one subordinated debt investment, rescheduled the due date of one portfolio company's first quarter 2021 interest payment until the second quarter of 2021, and amended two debt investments that resulted in increased all-in interest rates. As of March 31, 2021, we have unfunded commitments of $5.8 million. During the three months ended March 31, 2021, we purchased Structured Finance Notes for an aggregate cost of $6.2 million and $62.3 million in Portfolio Company Investments.
At March 31, 2021, our asset coverage ratio of 171% was within minimum asset coverage requirements under the 1940 Act, and we remained in compliance with all applicable financial thresholds under our outstanding debt. On February 17, 2021, we executed an amendment to our BLA with Pacific Western Bank in order to, among other things, increase the total commitment under the PWB Credit Facility from $20.0 million to $25.0 million. As of March 31, 2021, we had an unused commitment of $25.0 million under our PWB Credit Facility, as well as an unused commitment of $130.5 million under our BNP Facility, both subject to a borrowing base and other covenants. Based our portfolio's fair value and our equity capital at March 31, 2021, we could access these available lines of credit for $97.0 million and remain in compliance with our asset coverage requirements. We continue to believe that we have sufficient levels of liquidity to support our existing portfolio companies and will continue to selectively deploy capital in new investment opportunities in this challenging environment.
On May 7, 2021, the Board declared a distribution of $0.22 per share for the second quarter of 2021, payable on June 30, 2021 to stockholders of record as of June 23, 2021.
We cannot predict the full impact of the COVID-19 pandemic, including its duration in the United States and worldwide, and the magnitude of the economic impact of the outbreak, including the impact of travel restrictions, business closures and other quarantine measures imposed on service providers and other individuals by various local, state, and federal governmental authorities, as well as non-U.S. governmental authorities. As such, we are unable to predict the duration of any business and supply-chain disruptions, the extent to which the COVID-19 pandemic will negatively affect our portfolio companies’ operating results, or the impact that such disruptions may have on our results of operations and financial condition. Depending on the duration and extent of the disruption to the operations of our portfolio companies, we expect that certain portfolio companies will experience financial distress and possibly default on their financial obligations to us and their other capital providers. We also expect that some of our portfolio companies may significantly curtail business operations, furlough or lay-off employees and terminate service providers, and defer capital expenditures if subjected to prolonged and severe financial distress, which would likely impair their business on a permanent basis. These developments would likely result in a decrease in the value of our investment in any such portfolio company.
We are also subject to financial risks, including changes in market interest rates. As of March 31, 2021, approximately $330 million (principal amount) of our debt investments bore interest at variable rates, which are generally LIBOR-based, and many of which are subject to reference-rate floors. In connection with the COVID-19 pandemic, the U.S. Federal Reserve and other central banks have reduced certain interest rates and LIBOR has decreased, primarily in the second quarter of 2020. A prolonged reduction in interest rates will reduce our gross investment income and could result in a decrease in our net investment income if such decreases in LIBOR are not offset by a corresponding increase in the spread over LIBOR that we earn on our portfolio investments, a decrease in our operating expenses, including with respect to our income incentive fee, or a decrease in the interest rate of our floating interest rate liabilities indexed to LIBOR. As of March 31, 2021, the majority of our variable rate debt investments are subject to the base rate floor, partially mitigating the impact of the recent decrease in LIBOR on our gross investment income.
We will continue to monitor the rapidly evolving situation relating to the COVID-19 pandemic and guidance from U.S. and international authorities, including federal, state and local public health authorities, and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our plan of operation. As such, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of the COVID-19 pandemic on our financial condition, results of operations or cash flows in the future. However, to the extent our portfolio companies continue to be adversely impacted by the COVID-19 pandemic, our future net investment income, financial condition, results of operations and the fair value of our portfolio investments may be materially adversely impacted.
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 Financial Statements - Note 2" and "Management's Discussion and Analysis - Critical Accounting Policies and Significant Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2020.
Fair value estimates. Our approach to fair value estimates was significantly adjusted in response to the economic uncertainty associated with the spread of the COVID-19 pandemic, principally through adjustments to the weights given the various methodologies we utilize to estimate discount rates, greater use of pandemic-adjusted forward-looking information, and shortening the evaluation periods used to assess the market depth and liquidity associated with Indicative Prices. These adjustments resulted from observed decreases in the historic correlation between observable inputs utilized on our valuation models. However, as of December 31, 2020, we had reverted all of our methodologies to their pre-pandemic weightings as financial markets stabilized and the correlations between observable market factors returned.
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 March 31, 2021 (dollar amounts in thousands):
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Investment Type
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Fair Value at March 31, 2021
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Range of Fair Value
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Low-end
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High-end
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Debt investments:
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Senior secured
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$
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307,216
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$
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303,443
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|
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$
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311,156
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Senior secured (valued at Transaction Prices)
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16,934
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16,934
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16,934
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Subordinated
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13,742
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12,599
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14,885
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Structured Finance Notes:
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Subordinated notes
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58,833
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$
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57,076
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60,588
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Mezzanine debt
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2,797
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2,748
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|
2,845
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Equity investments:
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Preferred equity
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12,311
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10,829
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13,775
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Common equity, warrants and other
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54,266
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50,155
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|
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58,146
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$
|
466,099
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$
|
453,784
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|
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$
|
478,329
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|
The SEC issued a final rule in 2020 modifying Rule 2a-5 under the 1940 Act to establish requirements for determining fair value in good faith for purposes of the 1940 Act. We are evaluating the impact of adopting Rule 2a-5 on the consolidated financial statements and intend to comply with the new rule’s requirements on or before the compliance date in September 2022.
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 CLO funds and other assets, including HPCI and OCCI. Additionally, OFS Advisor provides sub-advisory services to CMFT Securities Investments, LLC, a wholly owned subsidiary of CIM Real Estate Finance Trust, Inc., a corporation that qualifies as a real estate investment trust. Additionally, OFS Advisor serves as sub-adviser to 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.
Effective January 1, 2020, OFS Advisor agreed to reduce a portion of its base management fee by reducing the portion of such fee from 0.4375% per quarter (1.75% annualized) to 0.25% per quarter (1.00% annualized) of the average value of the portion of the OFSCC-FS Assets at the end of the two most recently completed calendar quarters. The base management fee reduction by OFS Advisor is renewable on an annual basis and the amount of the base management fee reduced with respect to the OFSCC-FS Assets shall not be subject to recoupment by OFS Advisor; On February 16, 2021, OFS Advisor renewed the waiver through December 31, 2021.
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 we received on October 12, 2016 and provides us with greater flexibility to enter into co-investment transactions with Affiliated Funds. We are generally permitted to co-invest with Affiliated Funds if 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 transactions, 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, pursuant to an exemptive order issued by the SEC on April 8, 2020 and applicable to all BDCs, through December 31, 2020, we were permitted, subject to the satisfaction of certain conditions, to co-invest in our existing portfolio companies with certain affiliates, even if such other funds had not previously invested in such existing portfolio company. Without this order, affiliated funds would not be able to participate in such co-investments with us unless the affiliated funds had previously acquired securities of the portfolio company in a co-investment transaction with us. Although the conditional exemptive order expired on December 31, 2020, the SEC’s Division of Investment Management has indicated that until March 31, 2022, it will not recommend enforcement action, to the extent that any BDC with an existing co-investment order continues to engage in certain transactions described in the conditional exemptive order, pursuant to the same terms and conditions described therein.
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 1A. 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 1A. Risk Factors — Regulations — Conflicts of Interest - Conflicts Related to Portfolio Investments" in our Annual Report on Form 10-K for the year ended December 31, 2020.
Portfolio Composition and Investment Activity
Portfolio Composition
As of March 31, 2021, the fair value of our debt investment portfolio totaled $337.9 million in 59 portfolio companies, of which 96% and 4% were senior secured loans and subordinated loans, respectively. As of March 31, 2021, we had equity investments in 23 portfolio companies with a fair value of approximately $66.6 million. We also have fifteen investments in Structured Finance Notes with a fair value of $61.6 million. We had unfunded commitments of $5.8 million to four portfolio companies at March 31, 2021. Set forth in the tables and charts below is selected information with respect to our portfolio as of March 31, 2021 and December 31, 2020.
The following table presents our investment portfolio by each wholly owned legal entity within the consolidated group as of March 31, 2021, and December 31, 2020 (dollar amounts in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2021
|
|
December 31, 2020
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
OFS Capital Corporation (Parent)
|
$
|
181,644
|
|
|
$
|
164,001
|
|
|
$
|
190,627
|
|
|
$
|
172,249
|
|
SBIC I LP
|
192,881
|
|
|
196,466
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|
|
191,192
|
|
|
190,573
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|
OFSCC-FS
|
95,168
|
|
|
94,629
|
|
|
67,781
|
|
|
68,037
|
|
OFSCC-MB
|
11,209
|
|
|
11,003
|
|
|
11,423
|
|
|
11,464
|
|
Total investments
|
$
|
480,902
|
|
|
$
|
466,099
|
|
|
$
|
461,023
|
|
|
$
|
442,323
|
|
Portfolio Yields
The weighted average yield on total investments(1) was 8.41% and 8.56% at March 31, 2021 and December 31, 2020, respectively. The following table displays the composition of our performing debt investment and Structured Finance Note portfolio by yield range and its weighted average yields as of March 31, 2021, and December 31, 2020:
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|
|
|
|
|
|
|
|
|
|
March 31, 2021
|
|
December 31, 2020
|
Yield Range
|
|
Senior
Secured
|
|
Subordinated
|
|
Structured Finance
|
|
|
|
Senior
Secured
|
|
Subordinated
|
|
Structured Finance
|
|
|
|
Debt
|
|
Debt
|
|
Notes
|
|
Total
|
|
Debt
|
|
Debt
|
|
Notes
|
|
Total
|
Less than 8%
|
|
35.0
|
%
|
|
—
|
%
|
|
2.7
|
%
|
|
28.6
|
%
|
|
29.5
|
%
|
|
—
|
%
|
|
1.4
|
%
|
|
24.0
|
%
|
8% - 10%
|
|
49.0
|
|
|
—
|
|
|
1.5
|
|
|
39.6
|
|
|
52.0
|
|
|
—
|
|
|
1.4
|
|
|
42.2
|
|
10% - 12%
|
|
11.5
|
|
|
—
|
|
|
—
|
|
|
9.2
|
|
|
13.5
|
|
|
—
|
|
|
—
|
|
|
10.9
|
|
12% - 14%
|
|
3.0
|
|
|
53.2
|
|
|
12.9
|
|
|
6.7
|
|
|
3.4
|
|
|
53.6
|
|
|
12.5
|
|
|
7.0
|
|
Greater than 14%
|
|
1.5
|
|
|
46.8
|
|
|
82.9
|
|
|
15.9
|
|
|
1.6
|
|
|
46.4
|
|
|
84.7
|
|
|
15.9
|
|
Total
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Weighted average yield - performing debt and Structured Finance Note investments (2)
|
|
8.52
|
%
|
|
14.05
|
%
|
|
16.88
|
%
|
|
10.04
|
%
|
|
8.92
|
%
|
|
14.88
|
%
|
|
16.56
|
%
|
|
10.27
|
%
|
Weighted average yield - total debt and Structured Finance Note investments (3)
|
|
8.09
|
%
|
|
5.24
|
%
|
|
16.88
|
%
|
|
9.01
|
%
|
|
8.38
|
%
|
|
5.53
|
%
|
|
16.56
|
%
|
|
9.15
|
%
|
(1) Weighted average yield on total investments is computed as (a) the sum of (i) the annual stated accruing interest on our debt investments at the balance sheet date plus the annualized accretion of Net Loan Fees, (ii) the effective yield on our performing preferred equity investments, and (iii) the annual effective yield on Structured Finance Notes, divided by (b) amortized cost of our total investment portfolio, including assets in non-accrual status as of the balance sheet date.
(2) The weighted average yield on our performing debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated accruing interest on debt investments plus the annualized accretion of Net Loan Fees; and (ii) the annual effective yield on Structured Finance Notes divided by (b) amortized cost of our debt and Structured Finance Note investments, excluding debt investments in non-accrual status as of the balance sheet date.
(3) The weighted average yield on our total debt and Structured Finance Note investments is computed as (a) the sum of (i) the annual stated accruing interest plus the annualized accretion of Net Loan Fees and (ii) plus the annual effective yield on Structured Finance Notes divided by (b) amortized cost of our debt and Structured Finance Note investments, including debt investments in non-accrual status as of the balance sheet date.
The weighted average yield on performing portfolio company debt securities, including Structured Finance Notes, decreased to 10.04% at March 31, 2021 from 10.27% at December 31, 2020, primarily due to the 7.4% weighted average yield on new debt investments and Structured Finance Notes. We purchased approximately $40.9 million in debt securities, primarily in lower-yielding, first lien senior secured loans to larger borrowers, with a weighted average yield of 6.5%. The weighted average yield on total debt, including Structured Finance Notes, decreased to 9.01% at March 31, 2021 from 9.15% at December 31, 2020.
As of March 31, 2021, and December 31, 2020, floating rate loans at fair value were 93% and 96% of our debt portfolio, excluding Structured Finance Notes, respectively, and fixed rate loans at fair value were 7% and 4% of this portfolio, respectively.
The weighted average yield of our investments is 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 yield will remain at its current level.
Portfolio Company Investments
The following table summarizes the composition of our Portfolio Company Investments as of March 31, 2021 and December 31, 2020 (dollar amounts in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2021
|
|
December 31, 2020
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
Senior secured debt investments (1)
|
$
|
339,615
|
|
|
$
|
324,150
|
|
|
$
|
325,647
|
|
|
$
|
306,304
|
|
Subordinated debt investments
|
45,526
|
|
|
13,742
|
|
|
45,409
|
|
|
15,067
|
|
Preferred equity
|
18,695
|
|
|
12,311
|
|
|
18,648
|
|
|
11,543
|
|
Common equity, warrants and other
|
15,459
|
|
|
54,266
|
|
|
15,459
|
|
|
52,984
|
|
Total Portfolio Company Investments
|
$
|
419,295
|
|
|
$
|
404,469
|
|
|
$
|
405,163
|
|
|
$
|
385,898
|
|
Total number of portfolio companies
|
72
|
|
|
72
|
|
|
62
|
|
|
62
|
|
(1) Includes debt investments in which we have entered into contractual arrangements with co‑lenders whereby, subject to certain conditions, we have agreed to receive our principal payments after the repayment of certain co‑lenders pursuant to a payment waterfall. The aggregate amortized cost and fair value of these investments was $55,767 and $57,029, respectively, at March 31, 2021, and $55,776 and $56,217, respectively, at December 31, 2020.
At March 31, 2021, 96% and 70% of our loan portfolio and total portfolio, respectively, consisted of senior secured loans, based on fair value. Approximately 80% of our Portfolio Company Investments at fair value are senior securities of the borrower, rather than in the subordinated securities, preferred equity or common equity. 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 COVID-19 pandemic.
As of March 31, 2021, the three largest industries of our Portfolio Company Investments by fair value, were (1) Manufacturing (23.1%), (2) Professional, Scientific, and Technical Services (17.3%), and (3) Wholesale Trade (14.2%), totaling approximately 54.5% of the investment portfolio. We have limited exposure to the Retail Trade industry (4.3%), which has been significantly impacted by the COVID-19 pandemic. For a full summary of our investment portfolio by industry, see “Item 1–Financial Statements–Note 4.”
The following table presents our debt investment portfolio by investment size as of March 31, 2021 and December 31, 2020 (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized Cost
|
|
Fair Value
|
|
March 31, 2021
|
|
December 31, 2020
|
|
March 31, 2021
|
|
December 31, 2020
|
Up to $4,000
|
$
|
52,017
|
|
|
13.5
|
%
|
|
$
|
30,427
|
|
|
8.2
|
%
|
|
$
|
52,405
|
|
|
15.5
|
%
|
|
$
|
33,149
|
|
|
10.3
|
%
|
$4,001 to $7,000
|
55,388
|
|
|
14.4
|
|
|
72,030
|
|
|
19.4
|
|
|
61,476
|
|
|
18.2
|
|
|
68,939
|
|
|
21.5
|
|
$7,001 to $10,000
|
59,965
|
|
|
15.6
|
|
|
51,874
|
|
|
14.0
|
|
|
43,023
|
|
|
12.7
|
|
|
43,735
|
|
|
13.6
|
|
$10,001 to $13,000
|
23,297
|
|
|
6.0
|
|
|
21,013
|
|
|
5.7
|
|
|
35,956
|
|
|
10.6
|
|
|
33,470
|
|
|
10.4
|
|
Greater than $13,000
|
194,474
|
|
|
50.5
|
|
|
195,711
|
|
|
52.7
|
|
|
145,032
|
|
|
43.0
|
|
|
142,078
|
|
|
44.2
|
|
Total
|
$
|
385,141
|
|
|
100.0
|
%
|
|
$
|
371,055
|
|
|
100.0
|
%
|
|
$
|
337,892
|
|
|
100.0
|
%
|
|
$
|
321,371
|
|
|
100.0
|
%
|
Investment Activity
The following is a summary of our Portfolio Company Investment activity for the three months ended March 31, 2021 (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2021
|
|
|
|
|
|
|
Debt
Investments
|
|
Equity
Investments
|
Investments in new portfolio companies
|
|
|
|
|
|
$
|
36.2
|
|
|
$
|
—
|
|
Investments in existing portfolio companies
|
|
|
|
|
|
|
|
|
Follow-on investments
|
|
|
|
|
|
26.1
|
|
|
—
|
|
Restructured investments
|
|
|
|
|
|
—
|
|
|
—
|
|
Delayed draw and revolver funding
|
|
|
|
|
|
—
|
|
|
—
|
|
Total investments in existing portfolio companies
|
|
|
|
|
|
26.1
|
|
|
—
|
|
Total investments in new and existing portfolio
companies
|
|
|
|
|
|
$
|
62.3
|
|
|
$
|
—
|
|
Number of new portfolio company investments
|
|
|
|
|
|
18
|
|
|
—
|
|
Number of existing portfolio company
investments
|
|
|
|
|
|
16
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Proceeds/redemptions from principal payments/
equity investments
|
|
|
|
|
|
48.6
|
|
|
—
|
|
Proceeds from investments sold or redeemed
|
|
|
|
|
|
0.6
|
|
|
—
|
|
Total proceeds from principal payments, equity
distributions and investments sold
|
|
|
|
|
|
$
|
49.2
|
|
|
$
|
—
|
|
Notable investments in new portfolio companies during the three months ended March 31, 2021, include Allen Media, LLC ($2.9 million senior secured loan), Confie Seguros Holding II Co. ($2.9 million senior secured loan), Innovacare, Inc. ($3.0 million senior secured loan), Ivanti Software, Inc. ($3.0 million senior secured loan) and JP Intermediate B, LLC ($3.8 million senior secured loan).
The weighted-average yield of new debt in Portfolio Company Investment companies during the three months ended March 31, 2021 was 6.5%.
We also invested $6.2 million in Structured Finance Notes with a weighted average annual effective yield of 14.9% during the three months ended March 31, 2021.
The following is a summary of our Portfolio Company Investment activity for the three months ended March 31, 2020 (dollar amounts in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31, 2020
|
|
|
|
|
|
|
Debt
Investments
|
|
Equity
Investments
|
Investments in new portfolio companies
|
|
|
|
|
|
$
|
39.8
|
|
|
$
|
—
|
|
Investments in existing portfolio companies
|
|
|
|
|
|
|
|
|
Follow-on investments
|
|
|
|
|
|
9.6
|
|
|
0.1
|
|
Restructured investments
|
|
|
|
|
|
—
|
|
|
0.7
|
|
Delayed draw and revolver funding
|
|
|
|
|
|
1.4
|
|
|
—
|
|
Total investments in existing portfolio companies
|
|
|
|
|
|
11.0
|
|
|
0.8
|
|
Total investments in new and existing portfolio
companies
|
|
|
|
|
|
$
|
5.8
|
|
|
$
|
0.8
|
|
Number of new portfolio company investments
|
|
|
|
|
|
5
|
|
|
—
|
|
Number of existing portfolio company
investments
|
|
|
|
|
|
11
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
Proceeds/distributions from principal payments/
equity investments
|
|
|
|
|
|
37.2
|
|
|
—
|
|
Proceeds from investments sold or redeemed
|
|
|
|
|
|
38.5
|
|
|
3.6
|
|
Total proceeds from principal payments, equity
distributions and investments sold
|
|
|
|
|
|
$
|
75.7
|
|
|
$
|
3.6
|
|
Notable investments in new portfolio companies during the three months ended March 31, 2020, include A&A Transfer, LLC ($23.7 million senior secured loan and $1.6 million revolver) and SourceHOV Tax, Inc. ($12.8 million senior secured loan).
The weighted-average yield of direct debt investments in new portfolio companies during the three months ended March 31, 2020 was 8.8%.
We also invested $12.0 million in Structure Finance Notes with a weighted average annual effective yield of 17.3% during the three months ended March 31, 2020.
Non-cash investment activity
On March 27, 2020, our debt investment in Constellis Holdings, LLC was restructured. We converted our non-accrual debt investment into 20,628 shares of common equity. The cost and fair value of the 20,628 shares of common equity received was $0.7 million and $0.7 million, respectively, which we recognized as the investment's cost.
Risk Monitoring
We categorize direct 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 ended December 31, 2020. The following table shows the classification of our debt securities of portfolio companies, excluding Structured Finance Notes, by credit risk rating as of March 31, 2021, and December 31, 2020 (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt Investments, at Fair Value
|
Risk Category
|
|
March 31, 2021
|
|
December 31, 2020
|
1 (Low Risk)
|
|
$
|
—
|
|
|
—
|
%
|
|
$
|
—
|
|
|
—
|
%
|
2 (Below Average Risk)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
3 (Average)
|
|
282,739
|
|
|
83.7
|
|
|
263,934
|
|
|
82.2
|
|
4 (Special Mention)
|
|
47,297
|
|
|
14.0
|
|
|
45,302
|
|
|
14.1
|
|
5 (Substandard)
|
|
7,094
|
|
|
2.1
|
|
|
11,684
|
|
|
3.6
|
|
6 (Doubtful)
|
|
762
|
|
|
0.2
|
|
|
451
|
|
|
0.1
|
|
7 (Loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
$
|
337,892
|
|
|
100.0
|
%
|
|
$
|
321,371
|
|
|
100.0
|
%
|
Changes in the distribution of our debt investments across risk categories were a result of new debt investments, the receipt of amortization payments on existing debt investments, repayment of certain debt investments in full, changes in the fair value of our existing debt investments, realized gains on the sale of investments, as well as changes in risk categories. A debt investment with a cost and fair value of $4,712 and $4,731, respectively, had a risk rating upgrade from risk category 4 to risk category 3 during the three months ended March 31, 2021.
Non-Accrual Loans
When there is reasonable doubt that principal, cash interest, or PIK interest will be collected, loan investments are placed on non-accrual status and the Company will generally cease recognizing cash interest, PIK interest, or Net Loan Fee amortization, as applicable. Interest accruals and Net Loan Fee amortization are resumed on non-accrual investments only when they are brought current with respect to principal, interest and when, in the judgment of management, the investments are estimated to be fully collectible as to all principal. No new loans were placed on non-accrual status during the three months ended March 31, 2021. The aggregate amortized cost and fair value of loans on non-accrual status with respect to all interest and Net Loan Fee amortization was $45,878 and $7,856, respectively, at March 31, 2021, and $48,102 and $12,135, respectively, at December 31, 2020.
Structured Finance Notes
The following table summarizes the composition of our Structured Finance Notes as of March 31, 2021, and December 31, 2020 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2021
|
|
December 31, 2020
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
Subordinated notes
|
$
|
58,992
|
|
|
$
|
58,833
|
|
|
$
|
54,280
|
|
|
$
|
54,724
|
|
Mezzanine bonds
|
2,616
|
|
|
2,797
|
|
|
1,580
|
|
|
1,701
|
|
Total Structured Finance Notes
|
$
|
61,608
|
|
|
$
|
61,630
|
|
|
$
|
55,860
|
|
|
$
|
56,425
|
|
The weighted average yield on Structured Finance Notes increased to 16.88% at March 31, 2021, from 16.56% at December 31, 2020, primarily due to an increase in the effective yields of our subordinated notes.
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 ended December 31, 2020. 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 in the United States and, to a lesser
extent, equity investments, including warrants and other minority equity securities and Structured Finance Notes, which differs to some degree from our historical investment concentration, in that we now also focus on the debt of larger U.S. companies and Structured Finance Notes. Moreover, as a BDC and a RIC, we will also be 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 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.
Comparison of the three months ended March 31, 2021 and December 31, 2020
Consolidated operating results for the three months ended March 31, 2021 and December 31, 2020 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2021
|
|
December 31, 2020
|
|
|
|
|
Investment income
|
|
|
|
|
|
|
|
Interest income:
|
|
|
|
|
|
|
|
Cash interest income
|
$
|
6,837
|
|
|
$
|
7,423
|
|
|
|
|
|
Net Loan Fee amortization
|
573
|
|
|
625
|
|
|
|
|
|
Accretion of interest income on Structured Finance Notes
|
2,278
|
|
|
1,735
|
|
|
|
|
|
Other interest income
|
12
|
|
|
15
|
|
|
|
|
|
Total interest income
|
9,700
|
|
|
9,798
|
|
|
|
|
|
PIK income:
|
|
|
|
|
|
|
|
PIK interest income
|
440
|
|
|
306
|
|
|
|
|
|
Preferred equity PIK dividends
|
47
|
|
|
116
|
|
|
|
|
|
Total PIK income
|
487
|
|
|
422
|
|
|
|
|
|
Dividend income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common and preferred equity cash dividends
|
—
|
|
|
350
|
|
|
|
|
|
Total dividend income
|
—
|
|
|
350
|
|
|
|
|
|
Fee income:
|
|
|
|
|
|
|
|
Syndication fees
|
217
|
|
|
278
|
|
|
|
|
|
Prepayment and other fees
|
86
|
|
|
289
|
|
|
|
|
|
Total fee income
|
304
|
|
|
567
|
|
|
|
|
|
Total investment income
|
10,491
|
|
|
11,137
|
|
|
|
|
|
Total expenses
|
7,941
|
|
|
8,133
|
|
|
|
|
|
Net investment income
|
2,550
|
|
|
3,004
|
|
|
|
|
|
Net gain on investments
|
3,923
|
|
|
8,915
|
|
|
|
|
|
Loss on extinguishment of debt
|
(2,299)
|
|
|
(484)
|
|
|
|
|
|
Net increase in net assets resulting from operations
|
$
|
4,174
|
|
|
$
|
3,694
|
|
|
|
|
|
Interest and PIK income by debt investment type for the three months ended March 31, 2021 and December 31, 2020, is summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Interest income and PIK interest income:
|
|
|
|
|
|
|
|
Senior secured debt investments
|
$
|
7,202
|
|
|
$
|
7,464
|
|
|
|
|
|
Subordinated debt investments
|
660
|
|
|
863
|
|
|
|
|
|
Structured Finance Notes
|
2,278
|
|
|
1,777
|
|
|
|
|
|
Total interest income and PIK interest income
|
10,140
|
|
|
10,104
|
|
|
|
|
|
Plus purchased premiums (less Net Loan Fees) accelerations
|
(342)
|
|
|
(333)
|
|
|
|
|
|
Recurring interest income and PIK interest income
|
$
|
9,798
|
|
|
$
|
9,771
|
|
|
|
|
|
Investment Income
We consider our interest income on direct debt investments to portfolio companies—other than acceleration of Net Loan Fees recognized upon the repayment of a loan—PIK interest income, and the accretable yield on Structured Finance Notes to be recurring in nature. Such recurring interest income and PIK interest income was essentially unchanged during the three months ended March 31, 2021 compared to the three months ended December 31, 2020.
Total PIK income on debt securities was $0.4 million and $0.3 million for the three months ended March 31, 2021 and December 31, 2020, respectively. During the three months ended March 31, 2021, we amended two loans to increase the PIK rate and amended a non-accrual loan to convert first quarter cash interest due to PIK interest; however, such income remained unrecognized in accordance with our non-accrual policy.
Syndication fees, prepayment fees and the acceleration of Net Loan Fees generally result from periodic transactions rather than from holding portfolio investments and are considered non-recurring. Syndication fees, which are recognized when OFS Advisor sources, structures, and arranges the lending group, and for which we are additionally compensated, declined to $0.2 million for the three months ended March 31, 2021 compared to $0.3 million for the three months ended December 31, 2020. Total fee income for the three months ended March 31, 2021 compared to December 31, 2020, decreased from $0.6 million to $0.3 million due to decreases in syndication fees and prepayment fees.
Expenses
Operating expenses for the three months ended March 31, 2021 and December 31, 2020, are presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Interest expense
|
$
|
4,825
|
|
|
$
|
4,507
|
|
|
|
|
|
Management fee
|
1,834
|
|
|
1,846
|
|
|
|
|
|
Incentive fee
|
—
|
|
|
693
|
|
|
|
|
|
Professional fees
|
387
|
|
|
464
|
|
|
|
|
|
Administration fee
|
568
|
|
|
399
|
|
|
|
|
|
General and administrative expenses
|
327
|
|
|
224
|
|
|
|
|
|
Total expenses
|
$
|
7,941
|
|
|
$
|
8,133
|
|
|
|
|
|
Interest expense for the three months ended March 31, 2021, increased $0.3 million compared to the three months ended December 31, 2020, primarily due to us paying interest on both the Unsecured Notes Due February 2026, issued in March of 2021, and the Unsecured Notes Due April 2025 and the Unsecured Notes Due October 2025. After the 30-day notice period expired, we used the proceeds from the Unsecured Notes Due February 2026 to redeem both the Unsecured Notes Due April 2025 and the Unsecured Notes Due October 2025.
Management fee expense for the three months ended March 31, 2021 remained stable compared to the prior quarter.
Incentive fee expense for the three months ended March 31, 2021 decreased $0.7 million compared to the prior quarter due to a decline in net interest margin and lower fee income.
Professional fees for the three months ended March 31, 2021 decreased $0.1 million compared to the prior quarter due to reduced valuation and accounting costs.
Administration fee expense for the three months ended March 31, 2021 increased $0.2 million over the prior quarter due to allocations related to year-end administrative services, including audit support.
General and administrative expenses for the three months ended March 31, 2021 increased $0.1 million over the prior quarter primarily due to the realization of tax benefits in the fourth quarter of 2020.
Net realized and unrealized gain (loss) on investments
Net gain (loss) by investment type for the three months ended March 31, 2021 and December 31, 2020, were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Senior secured debt
|
$
|
3,880
|
|
|
$
|
148
|
|
|
|
|
|
Subordinated debt
|
(1,442)
|
|
|
(4,803)
|
|
|
|
|
|
Preferred equity, net of taxes
|
655
|
|
|
(71)
|
|
|
|
|
|
Common equity, warrants and other
|
1,373
|
|
|
9,347
|
|
|
|
|
|
Structured Finance Notes
|
(543)
|
|
|
4,294
|
|
|
|
|
|
Total net gain on investments
|
$
|
3,923
|
|
|
$
|
8,915
|
|
|
|
|
|
Net gain on investments for the three months ended March 31, 2021 and March 31, 2020
Our portfolio experienced net gains of $3.9 million in the first quarter of 2021, primarily as a result of performance improvements in our directly originated debt and equity investments, resulting in net unrealized appreciation. During the first quarter of 2020, the fair value of the portfolio declined $27.4 million primarily as a result of the adverse economic effects of the COVID-19 pandemic on market conditions and the overall economy and the related declines in quoted loan prices, increases in underlying market credit spreads and company-specific negative impacts on past and expected future operating performance. Additionally, we incurred realized losses of $9.1 million primarily due to the restructuring of our debt investment in Constellis Holdings, LLC, which was fully recognized as an unrealized loss as of December 31, 2019.
The net appreciation on our senior secured debt investments in the first quarter of 2021 was primarily attributable to a $1.5 million improvement on our debt investment in Wastebuilt Environmental Solutions LLC, which experienced an improvement in fair value as the company continues to proceed with an anticipated acquisition. We also experienced general appreciation in our senior secured investments as a result of credit spread tightening observed in the market, leading to a 31 basis point reduction in the weighted averge discount rates utilized in our discounted cash flow fair value models. We recognized net losses of $18.7 million on senior secured debt during the three months ended March 31, 2020, primarily as a result of the net unrealized depreciation of $19.0 million on our senior secured debt. We also recognized a net realized loss of $9.1 million, primarily due to a $9.1 million realized loss from the restructuring of our debt investment in Constellis Holdings, LLC, which had unrealized depreciation of $9.3 million as of December 31, 2019, and therefore positively impacted the first quarter of 2020 net loss by $0.2 million.
First quarter 2021 net losses in our subordinated debt investments was principally due to a decrease of $2.3 million in the fair value of our subordinated debt investment in Online Tech Stores LLC, due to further degradation of performance at that company. We recognized net losses of $7.5 million on subordinated debt during the three months ended March 31, 2020, primarily as a result of unrealized depreciation of $7.2 million on Online Tech Stores, LLC, which was the only loan placed on non-accrual during the quarter. We also recognized net unrealized depreciation of $0.3 million on our remaining subordinated debt securities, primarily due to net negative impact of portfolio company-specific performance factors.
Net gain on investments for the three months ended December 31, 2020
Our portfolio experienced net gains of $8.9 million in the fourth quarter of 2020 primarily as a result of performance improvements in our equity investments. During the three months ended December 31, 2020, we recognized net gains of $9.3 million on our equity investments, primarily due to unrealized appreciation of $4.3 million on our investment in Pfanstiehl Holdings, Inc., as well as unrealized appreciation of $2.5 million on our investment in MTE Holding Corp. We recognized net losses of $4.8 million on our subordinated debt investments, primarily due to unrealized depreciation of $4.7 million on our investment in Online Tech Stores, LLC.
Loss on Extinguishment of Debt
During the three months ended March 31, 2021, we prepaid $9.8 million of SBA debentures and redeemed $98.5 million of unsecured notes, and, as a result, we recognized losses on extinguishment of debt of $2.3 million related to the charge-off of deferred borrowing costs on these instruments.
During the three months ended December 31, 2020, we prepaid $23.5 million of SBA debentures and the BLA was amended to reduce the total commitment from $50.0 million to $20.0 million, and, as a result, recognized losses on extinguishment of debt of $0.5 million related to the charge-off of deferred borrowing costs on these instruments.
Comparison of the three months ended March 31, 2021 and 2020
Consolidated operating results for the three months ended March 31, 2021 and 2020 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Investment income
|
|
|
|
|
|
|
|
Interest income:
|
|
|
|
|
|
|
|
Cash interest income
|
$
|
6,837
|
|
|
$
|
9,988
|
|
|
|
|
|
Net Loan Fee amortization
|
573
|
|
|
414
|
|
|
|
|
|
Accretion of interest income on Structured Finance Notes
|
2,278
|
|
|
1,223
|
|
|
|
|
|
Other interest income
|
12
|
|
|
37
|
|
|
|
|
|
Total interest income
|
9,700
|
|
|
11,662
|
|
|
|
|
|
PIK income:
|
|
|
|
|
|
|
|
PIK interest income
|
440
|
|
|
436
|
|
|
|
|
|
Preferred equity PIK dividends
|
47
|
|
|
179
|
|
|
|
|
|
Total PIK income
|
487
|
|
|
615
|
|
|
|
|
|
Dividend income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common and preferred equity cash dividends
|
—
|
|
|
100
|
|
|
|
|
|
Total dividend income
|
—
|
|
|
100
|
|
|
|
|
|
Fee income:
|
|
|
|
|
|
|
|
Management and syndication
|
217
|
|
|
378
|
|
|
|
|
|
Prepayment and other fees
|
86
|
|
|
115
|
|
|
|
|
|
Total fee income
|
304
|
|
|
493
|
|
|
|
|
|
Total investment income
|
10,491
|
|
|
12,870
|
|
|
|
|
|
Total expenses, net incentive fee waiver
|
7,941
|
|
|
8,898
|
|
|
|
|
|
Net investment income
|
2,550
|
|
|
3,972
|
|
|
|
|
|
Net gain (loss) on investments
|
3,923
|
|
|
(35,983)
|
|
|
|
|
|
Loss on extinguishment of debt
|
(2,299)
|
|
|
(149)
|
|
|
|
|
|
Net increase (decrease) in net assets resulting from operations
|
$
|
4,174
|
|
|
$
|
(32,160)
|
|
|
|
|
|
Interest and PIK income by debt investment type for the three months ended March 31, 2021 and 2020, is summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Interest income and PIK interest income:
|
|
|
|
|
|
|
|
Senior secured debt investments
|
$
|
7,202
|
|
|
$
|
9,918
|
|
|
|
|
|
Subordinated debt investments
|
660
|
|
|
958
|
|
|
|
|
|
Structured Finance Notes
|
2,278
|
|
|
1,223
|
|
|
|
|
|
Total interest income and PIK interest income
|
10,140
|
|
|
12,099
|
|
|
|
|
|
Plus purchased premiums (less Net Loan Fees) accelerations
|
(342)
|
|
|
(103)
|
|
|
|
|
|
Recurring interest income and PIK interest income
|
$
|
9,798
|
|
|
$
|
11,996
|
|
|
|
|
|
Investment Income
We consider our interest income on direct debt investments to portfolio companies—other than acceleration of Net Loan Fees recognized upon the repayment of a loan—PIK interest income, and the accretable yield on Structured Finance Notes to be recurring in nature. Such recurring interest income and PIK interest income decreased by $2.2 million for the three months ended March 31, 2021, compared to the three months ended March 31, 2020, primarily due to $2.0 million from a $85 million decrease in the average outstanding performing loan balance, and a $0.2 million decrease resulting from a 6 basis point reduction in the recurring earned yield on our portfolio primarily due to lower yielding senior secured investments.
Expenses
Operating expenses for the three months ended March 31, 2021 and 2020, are presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Interest expense
|
$
|
4,825
|
|
|
$
|
4,922
|
|
|
|
|
|
Management fee
|
1,834
|
|
|
2,019
|
|
|
|
|
|
Incentive fee
|
—
|
|
|
883
|
|
|
|
|
|
Professional fees
|
387
|
|
|
648
|
|
|
|
|
|
Administration fee
|
568
|
|
|
520
|
|
|
|
|
|
Other expenses
|
327
|
|
|
347
|
|
|
|
|
|
Total expenses before incentive fee waiver
|
$
|
7,941
|
|
|
$
|
9,339
|
|
|
|
|
|
Incentive fee waiver
|
—
|
|
|
(441)
|
|
|
|
|
|
Total expenses, net of incentive fee waiver
|
$
|
7,941
|
|
|
$
|
8,898
|
|
|
|
|
|
Interest expense for the three months ended March 31, 2021 decreased $0.1 million over the corresponding prior year period primarily due to a decrease in the average dollar borrowings.
Management fee expense for the three months ended March 31, 2021 decreased $0.2 million over the corresponding prior year period due to a decrease in the size of our portfolio.
The $0.9 million decrease in incentive fee expense during the three months ended March 31, 2021 was attributable to a decrease in net investment income resulting from a decline in net interest margin. On May 4, 2020, OFS Advisor agreed to irrevocably waive the receipt of $0.4 million in Income Incentive Fees (based on net investment income) related to net investment income, that it would otherwise be entitled to receive under the Investment Advisory Agreement for the three months ended March 31, 2020. As a result of the voluntary fee waiver, we incurred Income Incentive Fee expense of $0.4 million for the three months ended March 31, 2020, which is equal to half the Income Incentive Fee expense we would have incurred for such period.
The $0.3 million decrease in professional fees for the three months ended March 31, 2021, compared to the corresponding prior year period was attributable to reduced valuation and accounting costs.
Administration fee expense for the three months ended March 31, 2021, remained stable compared to the corresponding prior year period.
Other expenses for the three months ended March 31, 2021 remained stable compared to the corresponding prior year period.
Net realized and unrealized gain (loss) on investments
Net gain (loss) by investment type for the three months ended March 31, 2021 and 2020, were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2021
|
|
2020
|
|
|
|
|
Senior secured debt
|
$
|
3,880
|
|
|
$
|
(18,731)
|
|
|
|
|
|
Subordinated debt
|
(1,442)
|
|
|
(7,465)
|
|
|
|
|
|
Preferred equity, net of taxes
|
655
|
|
|
(1,237)
|
|
|
|
|
|
Common equity, warrants and other
|
1,373
|
|
|
(344)
|
|
|
|
|
|
Structured Finance Notes
|
(543)
|
|
|
(8,206)
|
|
|
|
|
|
Total net gain (loss) on investments
|
$
|
3,923
|
|
|
$
|
(35,983)
|
|
|
|
|
|
Net gains on investments for the three months ended March 31, 2020.
We recognized net losses of $1.2 million on preferred equity investments for the three months ended March 31, 2020, primarily as a result of unrealized depreciation of $2.0 million on Contract Datascan Series A units, offset by unrealized appreciation of $0.8 million on TTG Healthcare, LLC Class B preferred shares.
Net appreciation in our common equity, warrants and other during the three months ended March 31, 2021, was led by net gains on our investments in the common equity of Pfanstiehl Holdings, Inc., and NeoSystems Corp., which improved by $1.0 million and $0.9 million, respectively, in both instances driven by improved operating results of the companies. We
recognized net losses of $0.3 million on common equity and warrant investments for the three months ended March 31, 2020, primarily as a result of negative portfolio company-specific performance factors.
We recognized unrealized depreciation of $8.2 million on Structured Finance Notes for the three months ended March 31, 2020, primarily as a result of the negative impact of assumptions that reflect more stress on the underlying portfolios due to widening credit spreads.
Liquidity and Capital Resources
At March 31, 2021, we held cash of $41.6 million, which includes $4.5 million held by SBIC I LP, our wholly owned SBIC, and $4.4 million held by OFSCC-FS. Our use of cash held by SBIC I LP may be restricted by SBA regulation, including limitations on the amount of cash SBIC I LP can distribute to the Parent. Any such distributions to the Parent from SBIC I LP are generally restricted under SBA regulations to a statutory measure of undistributed accumulated earnings or regulatory capital of SBIC I LP, and require the prior approval of the SBA. During the three months ended March 31, 2021, the Parent received a return of capital distribution of $19.1 million from SBIC I LP. Distributions from OFSCC-FS to the Parent are restricted by the terms and conditions of the BNP Facility. During the three months ended March 31, 2021, the Parent received $0.7 million in cash distributions from OFSCC-FS. As of March 31, 2021, cash available to be distributed from SBIC I LP and OFSCC-FS were $8.9 million and $-0-, respectively.
At March 31, 2021, we had an unused commitment of $25.0 million under our PWB Credit Facility, as well as an unused commitment of $130.5 million under our BNP Facility, both subject to a borrowing base requirements and other covenants. The Parent may make unsecured loans to SBIC I LP, the aggregate which 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 the Parent and SBIC I LP as of March 31, 2021.
Based on fair values and equity capital at March 31, 2021, we could access available lines of credit for $97 million and remain in compliance with our asset coverage requirements. As of May 7, 2021, we had cash on hand of approximately $28.5 million. We continue to believe that we have sufficient levels of liquidity to support our existing portfolio companies and selectively deploy capital in new investment opportunities in this challenging environment.
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 certain Net Loan Fee amortization, PIK interest, and PIK dividends, which generally will not be fully realized in cash until we exit the investment. 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. Historically, our distributions have been in excess of taxable income, and we have limited history of net taxable gains. 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,
|
|
|
2021
|
|
2020
|
Cash from net investment income
|
|
$
|
(1,517)
|
|
|
$
|
886
|
|
Net (purchases and originations)/repayments and sales of portfolio investments
|
|
7,340
|
|
|
6,831
|
|
Net cash provided by operating activities
|
|
5,823
|
|
|
7,717
|
|
|
|
|
|
|
Distributions paid to stockholders(1)
|
|
(2,655)
|
|
|
(4,484)
|
|
Net (borrowings) repayments under lines of credit
|
|
(12,500)
|
|
|
1,600
|
|
Repayment of SBA debentures
|
|
(9,765)
|
|
|
(16,110)
|
|
Proceeds from unsecured notes offering, net of discounts
|
|
121,791
|
|
|
—
|
|
Redemption of unsecured notes
|
|
(98,525)
|
|
|
—
|
|
Other financing activities
|
|
(236)
|
|
|
—
|
|
Net cash used in financing activities
|
|
(1,890)
|
|
|
(18,994)
|
|
Increase (decrease) in cash
|
|
$
|
3,933
|
|
|
$
|
(11,277)
|
|
(1) 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. See "Item 1–Financial Statements–Note 9. "
Cash from net investment income
Cash from net investment income decreased $2.4 million for the three months ended March 31, 2021, compared to the three months ended March 31, 2020, principally due to an decrease in collected net interest, dividend, and fee income of $3.1 million and an increase in operating expenses paid of $0.5 million, offset by an decrease in fees paid to OFS Advisor and affiliates of $1.4 million.
Net (purchases and originations)/repayments and sales of portfolio investments
During the three months ended March 31, 2021, net purchases and originations of portfolio investments of $7.3 million were primarily due to $44.0 million of cash we used to purchase portfolio investments, offset by $51.3 million of cash we received from amortized cost repayments and sales on our portfolio investments. During the three months ended March 31, 2020, net purchases and originations of portfolio investments consisted of $71.9 million of cash we used to purchase portfolio investments, offset by $78.7 million of cash we received from amortized cost repayments and sales on our portfolio investments. See "—Portfolio Composition and Investment Activity–Investment Activity."
Borrowings
SBA Debentures
SBIC I LP has a SBIC license that 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 over U.S. Treasury Notes with ten-year maturities. As of March 31, 2021 and 2020, SBIC I LP had outstanding debentures of $95.5 million and $133.8 million, respectively.
On a stand-alone basis, SBIC I LP held $201.5 million, and $223.8 million in total assets at March 31, 2021 and December 31, 2020, respectively, which accounted for approximately 39% and 46% of the Company’s total consolidated assets, respectively.
As part of our plans to focus on lower-yielding, 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 the scheduled maturity dates of its debentures. Under a plan approved by the SBA, we will only make follow-on investments in current portfolio companies held by SBIC I LP. We believe that investing in more senior loans to larger borrowers is consistent with our view of the private loan market and will reduce our overall leverage on a consolidated basis. During the three months ended March 31, 2021, SBIC I LP prepaid $9.8 million of SBA debentures that were contractually due September 1, 2022 and September 1, 2024. We recognized a loss on extinguishment of debt of $0.1 million related to the charge-off of deferred borrowing costs on the prepaid debentures.
SBIC I LP is periodically examined and audited by the SBA’s staff to determine its compliance with SBA regulations. If SBIC I LP fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit SBIC I LP’s use of debentures, declare outstanding debentures immediately due and payable, and/or limit SBIC I LP from making distributions.
We have received exemptive relief from the SEC effective November 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 with Pacific 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 by OFSCC-MB, Inc. and secured by all of our current and future assets, excluding assets held by SBIC I LP, OFSCC-FS and the Company’s partnership interests in SBIC I LP and OFS SBIC I, GP.
On February 17, 2021, we amended the BLA to among other things: (i) increase the maximum amount available from $20.0 million to $25.0 million; (ii) decrease the interest rate floor from 5.25% per annum to 5.00% per annum; (iii) modify certain financial performance covenants; and (iv) extend the maturity date from February 28, 2021 to February 28, 2023.
As of March 31, 2021, we had no outstanding balance and an unused commitment of $25.0 million under the PWB Credit Facility, subject to a borrowing base and other covenants.
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 of March 31, 2021, we were in compliance with the applicable covenants under the PWB Credit Facility.
Unsecured Notes
On February 10, 2021, we closed the public offering of $100.0 million aggregate principal amount of our 4.75% notes due 2026, and on March 18, 2021, we closed an additional public offering of $25.0 million aggregate principal amount of our 4.75% notes due 2026 (the "Unsecured Notes Due February 2026"). The total net proceeds to us from the Unsecured Notes Due February 2026, after deducting underwriting fees of $3.2 million and estimated offering expenses of $0.3 million, was approximately $121.5 million. The Unsecured Notes Due February 2026 bear an effective interest rate, including amortization of deferred debt issuance costs, of 5.30%. The Unsecured Notes Due February 2026 will mature on February 10, 2026, and we may redeem the Unsecured Notes Due February 2026 in whole or in part at any time, or from time to time, at our option at par plus a "make-whole" premium, if applicable. The Unsecured Notes Due February 2026 bear interest at a rate of 4.75% per year payable semi-annually in arrears on February 10 and August 10 of each year, commencing on August 10, 2021.
In connection with, and using the proceeds from, the issuance of the Unsecured Notes Due February 2026, on March 12, 2021, we redeemed all $50.0 million in aggregate principal amount of the Unsecured Notes Due April 2025 and all $48.5 million in aggregate principal amount of the Unsecured Notes Due October 2025. The Unsecured Notes Due April 2025 and the Unsecured Notes Due October 2025 were redeemed at 100% of their principal amount ($25 per Note), plus the accrued and unpaid interest thereon from January 31, 2021, through, but excluding, March 12, 2021. We recognized a loss on extinguishment of debt of $2.2 million related to the charge-off of deferred borrowing costs on the redemption of the 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 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.
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, which provides for borrowings in an aggregate principal amount up to $150.0 million, of which $19.6 million was drawn as of March 31, 2021. Borrowings under the BNP Facility bear interest based on LIBOR for the relevant interest period, plus an applicable spread. The effective interest rate on the BNP Facility was 7.36% at March 31, 2021. The BNP Facility will mature on the earlier of June 20, 2024 or upon certain other events defined in the credit agreement which result in accelerated maturity. Borrowings under the BNP Facility are secured by substantially all of the assets held by OFSCC-FS. The unused commitment under the BNP Facility was $130.5 million as of March 31, 2021. As of March 31, 2021, we were in compliance with the applicable covenants.
On a stand-alone basis, OFSCC-FS held approximately $100.9 million and $72.4 million in total assets at March 31, 2021 and December 31, 2020, respectively, which accounted for approximately 19.7% and 15% 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 relevant SEC 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 in the 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 of the 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. As of March 31, 2021, approximately 86% of our investments were qualifying assets.
BDCs generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200% (150% if certain requirements are met). We received an exemptive order from the SEC to permit us to exclude the debt of SBIC I LP guaranteed by the SBA from the definition of Senior Securities in the statutory asset coverage ratio under the 1940 Act. This requirement 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.
On May 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%, effective May 3, 2019.
On May 22, 2018, the Board authorized the Stock Repurchase Program under which we could acquire up to $10.0 million of our outstanding common stock through the two-year period ending May 22, 2020. On May 4, 2020, the Board extended the Stock Repurchase Program for an additional two-year period. Under the extended Stock Repurchase Program, we are authorized to repurchase shares in open-market transactions, including through block purchases, depending on prevailing market conditions and other factors. We expect the Stock Repurchase Program to be in place through May 22, 2022, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. The Stock Repurchase Program may be extended, modified or discontinued at any time for any reason. We have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements. We retire all shares of common stock that we purchased in connection with the Stock Repurchase Program.
The following table summarizes shares of common stock repurchased under the Stock Repurchase Program during the three months ended March 31, 2021.
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Period
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Total Number
of Shares Purchased
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Cost of Shares Purchased
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Average Price Paid Per Share
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January 1, 2021 through March 31, 2021
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700
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$
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4,690
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$
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6.70
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As of March 31, 2021, the aggregate amount outstanding of the senior securities issued by us was $223.9 million, for which our asset coverage was 171%. 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 the SEC effective November 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. On June 23, 2020, 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).
Contractual Obligations and Off-Balance Sheet Arrangements
The following table shows our contractual obligations as of March 31, 2021 (in thousands):
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Payments due by period
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Contractual Obligation (1)
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Total
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Less than
year
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1-3 years (2)
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4-5 years (2)
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After 5
years (2)
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PWB Credit Facility
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$
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—
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$
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—
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$
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—
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$
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—
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$
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—
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Unsecured Notes
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204,325
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—
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25,000
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125,000
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54,325
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SBA Debentures
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95,505
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—
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7,000
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88,505
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—
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BNP Facility
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19,550
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—
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—
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19,550
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—
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Total(3)
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$
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319,380
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$
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—
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$
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32,000
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$
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233,055
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$
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54,325
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(1)Excludes commitments to extend credit to our portfolio companies.
(2)The PWB Credit Facility is scheduled to mature on February 28, 2023. The SBA debentures are scheduled to mature between September 2022 and September 2025. SBIC I LP is repaying over time its outstanding SBA debentures prior to the scheduled maturity dates of its debentures. The Unsecured Notes are scheduled to mature between October 2023 and October 2026. The BNP Facility is scheduled to mature on June 20, 2024.
(3)64% of the outstanding debt is unsecured.
We continue to believe our long-dated financing, with approximately 90% of our total debt contractually maturing in 2024 and beyond, affords us operational flexibility.
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.
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. At March 31, 2021, we had $5.8 million in unfunded commitments to four portfolio companies. 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.
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 four 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, at the end of the year, we may also pay an additional special dividend, or fifth 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. Each year, a statement on Form 1099-DIV identifying the source of the distribution is mailed to the Company’s stockholders. 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.
Recent Developments
On May 7, 2021, our Board declared a distribution of $0.22 per share for the second quarter of 2021, payable on June 30, 2021 to stockholders of record as of June, 23, 2021.
We evaluated events subsequent to March 31, 2021 through May 10, 2021. We are continuing to closely monitor the impact of the outbreak of COVID-19 on all aspects of our business, including how it impacts our portfolio companies, employees, due diligence and underwriting processes, and financial markets. The U.S. capital markets experienced extreme volatility and disruption following the COVID-19 pandemic, which appear to have subsided and returned to pre-COVID-19 levels. Nonetheless, certain economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a prolonged period of world-wide economic downturn.
On March 27, 2020, the U.S. government enacted the CARES Act, which contains provisions intended to mitigate the adverse economic effects of the coronavirus pandemic. On December 27, 2020, the U.S. government enacted the December 2020 COVID Relief Package. Additionally, on March 11, 2021, the U.S. government enacted the American Rescue Plan, which included additional funding to mitigate the adverse economic effects of the COVID-19 pandemic. It is uncertain whether, or to what extent, our portfolio companies will be able to benefit from the CARES Act, the December 2020 COVID Relief Package, the American Rescue Plan, or any other subsequent legislation intended to provide financial relief or assistance. As a result of this disruption and the pressures on their liquidity, certain of our portfolio companies have been, or may continue to be, incentivized to draw on most, if not all, of the unfunded portion of any revolving or delayed draw term loans made by us, subject to availability under the terms of such loans.
The extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our business strategies and initiatives in the expected time frame, will depend to a large extent on future developments regarding the duration and severity of the coronavirus, effectiveness of vaccination deployment and the actions taken by governments (including stimulus measures or the lack thereof) and their citizens to contain the coronavirus or treat its impact, all of which are beyond our control. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition. Given the fluidity of the situation, we cannot estimate the long-term impact of COVID-19 on our business, future results of operations, financial position, or cash flows at this time.