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OFS Capital: Issues New Baby Bond

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NEWS

On September 15, 2020 OFS Capital (OFS) announced the final terms of a new Baby Bond offering.

The BDC will issue $25.0 of new unsecured with a maturity of September 30, 2023.

There is a $3.750mn over-allotment option for the underwriters.

The yield on the new debt will be 6.25% per annum, and interest will be paid quarterly.

The debt will trade on NASDAQ under the ticker OFSSG.

OFS has the option to redeem the Baby Bonds from September 2021.

The new debt is rated BBB- by Egan-Jones.

OFS intends to use the proceeds for general purposes, including the repayment of its outstanding debt with Pacific Western Bank (“PWB”) of $15.0mn.

The BDC Reporter first noted OFS’s intention to issue new unsecured debt in the BDC News Feed on September 14, 2020.

Attached are the OFS press release and Term Sheet.


ANALYSIS

Highlights

This is an unusual Baby Bond issue in multiple ways, reflecting the difficult position the BDC is in.

First, the amount raised is small, half the size of debt issues launched previously.

Second, the BDC already has three existing Baby Bonds outstanding.

Now with four,  OFS is one of the most prolific public unsecured debt issuers, yet remains a smaller BDC.

OFS has under half a billion dollars in portfolio assets at fair market value.

Third, the maturity is very short by Baby Bond standards: three years to maturity and two years to optional redemption.

Most Baby Bond issues have – at least 5 years maturity, or even longer.

As discussed on the BDC News Feed, Gladstone Investment (GAIN) is currently placing debt that lasts through to 2040.

Cutting In Line

We believe the short term maturity is to indicate to would-be debt investors that the new issue will be repaid in advance of the three existing OFS bonds.

A look at the BDC Fixed Income Table will remind readers that OFSSI, OFSSL and OFSSZ mature in 2025 and 2026.

Educated Guess

We also surmise that the BDC is raising this debt capital to pay-off – not just temporarily repay – its PWB secured debt facility.

In recent months OFS has negotiated significant changes to its secured Revolver with PWB, as spelled out in the 10-Q:

“On June 26, 2020, the BLA was amended to, among other things: (i) reduce the Minimum Tangible Net Asset Value (as defined in the Secured Revolver Amendment) covenant from $125.0 million to $100.0 million; (ii) reduce the Minimum Quarterly Net Investment Income (as defined in the Secured Revolver Amendment) covenant from $3.0 million to $2.0 million; (iii) increase the Debt/Worth Ratio (as defined in the Secured Revolver Amendment) covenant from 300% to 350%; and (iv) add a new covenant commencing on June 30, 2020 restricting net losses (defined as income after adjustments to the investment portfolio for gains and losses, realized and unrealized, also shown as net increase (decrease) in net assets resulting from operations) in more than two quarters during the prior four quarters then ended.
On July 29, 2020, the Company executed an amendment to its BLA with Pacific Western Bank in order to reduce the total commitment under the PWB Credit Facility from $100,000 to $50,000″.
History
The BDC Reporter noted previously that the two quarters of net losses covenant was onerous from the BDC’s point of view and raised the possibility of a loan default in the near to medium term.
OFS has been managing down its exposure to PWB for some time.
At the end of the IIQ 2019, PWB outstandings were close to $40mn, but dropped to $21.5mn as of June 2020 and are now at $15.0mn.
As a result, 60% of the proceeds will be applied to the pay-off of PWB, as called out in its filing.
Unsaid
No word on the BDC’s other secured facility with BNP.
Technically OFS has a $150mn line commitment with the bank, but that’s subject to a borrowing base.
As of June – as the 10-Q shows – zero dollars were available for distribution from the special purpose vehicle that borrows from BNP.
Cash Pile
We’d guess the remaining $10mn from the debt raise will be added to the BDC’s cash stash.
At June 30, 2020 OFS nominally had $31.8mn in cash.
However, after we net out cash held at the SBIC subsidiary of $22.7mn – which is not available for use by the BDC itself – the cash position was already low at mid-year: under $10mn.
The new liquidity may have to be used to pay costs and any distributions, given that both the SBIC and BNP vehicles do not currently allow any amounts to be paid up to the parent.
Pay Off
Also pressing on the liquidity of OFS are principal repayments being made to the SBIC.
In March OFS prepaid  $16mn that was due in 2023-2024.
The BDC’s 10-Q suggests further repayments are planned:
management currently anticipates a portion of cash held by SBIC I LP at June 30, 2020, will be used in the third quarter of 2020 for the early repayment of SBA debentures.
Ergo…
The amounts in play are not given, but the need to pay down debt both at the SBIC and PWB, with no extra availability from BNP, must be straining the BDC’s liquidity position.
This $25mn infusion should provide a short term respite.
However, OFS remains very highly leveraged from a GAAP standpoint, and swapping debt for debt will do little to alleviate the situation.
In fact, leverage may increase slightly once the transaction and the subsequent use of funds is consummated.
At June 30, 2020 net debt to equity was 2.2x .
Regulatory debt to equity (not including a deduction of cash) was 1.48x. 

VIEWS
Never Ending Story
The debt capital raise by OFS is no great surprise to the BDC Reporter.
This is a continuation of a liquidity challenge the BDC has faced for months, accelerated by the strains of the current crisis.
The BDC Reporter rates the BDC’s Liquidity as POOR and has done since we started the BDC Data Table to track performance in the post-Covid period.
Not Enough
This latest move may provide OFS some short term relief but does not alter our rating.
As we all know, tackling debt problems with more debt is a band-aid over the long term.
Or to use another favored cliche: a case of kicking the can down the road.
In the short term OFS may be able to dispose of or place in deep freeze its problematic relationship with PWB.
However, with SBIC debentures to repay and a great deal of leverage to contend with challenges remain.
Sweet And Sour 
We’re impressed that the BDC was able to access the unsecured debt market at all, and at a relatively decent rate, given its troubles.
As we’ve seen, though, this required making the new debt the first to be repaid ahead of the three existing Baby Bonds and even the BNP facility.
That’s worrying news for the holders of OFSSZ, who will have to hope OFS has enough resources to pay off their debt when the Baby Bond matures in 2026.
Key
Much will hang in the next many quarters on how the OFS investment portfolio performs.
The BDC has made much of its positioning its investments in larger sized, lower risk loans which should experience relatively modest losses.
However, if losses continue to mount that could cause the SBA to require pre-payment of its debentures and squeeze availability under the BNP facility.
As the BDC Data Table shows, OFS saw a 4.0% increase in NAV Per Share in the most recent quarter but has recorded (29%) in losses overall since IVQ 2017.
The future of OFS may depend largely on whether we see red ink or black in the next few quarters where NAV is concerned. 
The BDC Reporter promises to have an updated look at the BDC’s credit portfolio in the days ahead to ascertain what is the most likely outcome.
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