Decoding OFS Credit's High-Yield Dividend: A Sustainable Income Play in the CLO Equity Market?

In the ever-shifting landscape of income investing, few assets combine high yields with the veneer of stability as effectively as collateralized loan obligation (CLO) equity. For income-focused investors, OFS Credit Company, Inc. (NASDAQ: OCCI) has emerged as a key player, offering a monthly dividend of $0.115 per share—a yield of 20.7% annualized as of April 30, 2025. But in a market where “too good to be true” often precedes a reckoning, the critical question remains: Is this payout sustainable?

The Allure of High Yield, the Risks of Thin Margins

OFS Credit's dividend strategy hinges on its portfolio of CLO equity and debt securities, which generate recurring waterfall payments. In Q2 2025, the company reported Core Net Investment Income (Core NII) of $0.37 per share, driven by $13.0 million in waterfall payments from CLO equities. This outperformed Net Investment Income (NII) of $0.21 per share, a gap that reflects the company's reliance on non-GAAP metrics to smooth volatility. However, the same quarter saw a 12% drop in NAV per share, from $7.00 to $6.17, due to $16.8 million in unrealized depreciation on CLO equities.

The disconnect between NII and Core NII underscores a critical risk: OFS Credit's ability to maintain its dividend depends not just on current income but on the fair value of its portfolio. With CLO equities sensitive to interest rate movements and collateral loan prices, any further widening of debt spreads could erode capital, as seen in Q2 2025.

Capital Raising as a Buffer, Not a Cure

To offset portfolio headwinds, OFS Credit has raised $40.4 million in Q2 2025 alone—$16.2 million via common stock and $24.3 million via Series G preferred stock. These funds were deployed into new CLO investments, extending the weighted-average reinvestment period to 3.4 years and boosting the portfolio's effective yield to 14.07%. While this suggests disciplined capital allocation, it also highlights a dependency on continuous fundraising.

The company's At-the-Market (ATM) program and preferred stock offerings provide a lifeline, but they come with trade-offs. For example, issuing preferred stock dilutes equity and increases fixed obligations, which could pressure future dividends if earnings falter. As of April 30, 2025, OFS Credit had $115.9 million in preferred stock outstanding, a significant portion of its capital structure.

The Dividend Reinvestment Plan: A Double-Edged Sword

OFS Credit's 5% discount DRIP for common stockholders is a tactical advantage. By allowing investors to reinvest dividends at a discount, the company enhances compounding potential while reducing the need for external capital. However, this benefit is contingent on the company's ability to maintain its dividend. If earnings decline, the DRIP could become a liability, as reinvested shares would trade at a discount to a falling NAV.

For income investors, the DRIP's 5% discount is attractive but must be weighed against the 20.7% yield. A yield this high is often a red flag—it suggests the market is pricing in a high probability of a cut. Historical data shows that companies with yields above 20% have a 40% chance of reducing dividends within a year, per S&P Global data.

The CLO Equity Market: A Gold Mine or a Time Bomb?

The CLO equity market remains a double-edged sword. OFS Credit's focus on CLOs—structured pools of leveraged loans—offers high yields but exposes it to collateral performance and refinancing risks. With the Fed's rate hikes still fresh, CLOs face a liquidity crunch as refinancing costs rise. This could delay waterfall payments, reducing Core NII and forcing OFS Credit to rely more on capital raising to fund dividends.

Moreover, the company's non-diversified structure (holding 85 issuers as of April 2025) amplifies sector-specific risks. A downturn in a key industry within its portfolio could trigger mark-to-market losses, further pressuring NAV.

A Calculated Bet for Income Investors

For income-focused investors, OFS Credit's dividend is a tantalizing offer, but it requires a nuanced risk assessment. The company's ability to sustain its $0.115 payout hinges on three factors:
1. Portfolio Resilience: Can OFS Credit's CLO equities withstand further rate hikes without triggering large unrealized losses?
2. Capital Access: Will the ATM program and preferred stock offerings remain viable in a tightening credit market?
3. Earnings Stability: Can Core NII outpace NII volatility to fund dividends?

The answer to all three is “maybe.” While Q2 2025 results suggest OFS Credit is navigating the current environment, the path forward is fraught. Investors should monitor the company's N-PORT-P filings for real-time portfolio updates and its N-CSR reports for NAV trends. A declining NAV paired with stable Core NII could signal a temporary setback, but a sustained drop would raise red flags.

Final Verdict: High Yield, High Stakes

OFS Credit's $0.115 monthly dividend is a compelling proposition for income investors willing to tolerate volatility. However, the 20.7% yield is a warning sign rather than a feature. Investors should treat this stock as a high-risk, high-reward play—suitable for those with a strong stomach for market swings and a diversified portfolio. For conservative investors, the dividend's sustainability is an open question. As always, the key is to balance yield with resilience.