OFS Capital's 2025 Q2 Earnings: Navigating Credit Resilience and Yield Potential in a High-Rate BDC Landscape

In the second quarter of 2025, OFS Capital Corporation delivered a mixed performance that underscores the challenges and opportunities facing business development companies (BDCs) in a rising interest rate environment. While net investment income (NII) dipped slightly to $0.25 per share from $0.26 in Q1, the company's strategic refinancing, disciplined credit underwriting, and alignment with broader BDC sector trends position it as a resilient player in the middle-market lending space. For investors seeking income and capital preservation, OFS Capital's Q2 results offer both caution and conviction.

Credit Portfolio Resilience: A Defensive Foundation

OFS Capital's loan portfolio remains a cornerstone of its resilience. Composed entirely of senior secured loans—85% first lien and 15% second lien—the portfolio's structure provides robust collateral support, even as macroeconomic uncertainties persist. The weighted average performing income yield rose to 13.6% in Q2, reflecting the company's ability to capitalize on floating-rate loans (90% of the loan portfolio) in a tightening rate environment. This is a critical advantage, as rising rates typically benefit BDCs with floating-rate assets, which adjust upward to reflect higher benchmarks.

However, the portfolio's resilience is not without risks. The net asset value (NAV) declined to $10.91 per share, a 9% drop from March 2025, driven largely by a $7.8 million unrealized depreciation on its equity investment in Pfanstiehl Holdings, Inc. This highlights a key vulnerability: BDCs with significant equity stakes in private companies face valuation volatility, especially when those investments lack active trading markets. OFS Capital's focus on monetizing non-interest-earning equity positions, such as its long-held stake in Fans Steel Holdings, signals a pragmatic shift toward income-generating assets.

Yield Potential: Balancing Income and Cost of Funds

The BDC sector is experiencing a yield renaissance as interest rates climb, but this comes with the challenge of managing higher borrowing costs. OFS Capital's Q2 refinancing of $69 million in 7.5% unsecured notes—replacing 4.75% notes maturing in 2026—exemplifies a proactive approach to aligning liabilities with asset durations. By extending its debt maturity and securing a fixed rate, the company insulates itself from near-term rate hikes while maintaining leverage flexibility.

The yield dynamics, however, are a double-edged sword. While the company's investment income rose to $10.5 million, the cost of its new debt (7.5%) is significantly higher than its previous leverage (4.75%). This margin compression could weigh on NII unless the company's asset yields continue to outpace borrowing costs. For now, the 13.6% yield on interest-bearing investments provides a buffer, but investors must monitor how OFS Capital navigates this trade-off in 2026.

Alignment with BDC Sector Trends: Leverage, Liquidity, and Liquidity

The BDC sector's leverage ratio has climbed to 53% in 2025, up from 40% in 2017, as companies increasingly rely on debt to fund private credit investments. OFS Capital's leverage of 40% (as of June 2025) is conservative by industry standards, and its asset coverage ratio of 160% (well above the 150% regulatory minimum) provides a margin of safety. This disciplined leverage strategy aligns with the sector's broader shift toward risk management, particularly as banks extend $95 billion in credit lines to BDCs in 2024.

The company's liquidity position further reinforces its alignment with sector trends. With $10.2 million in cash and $111.6 million in unused credit facilities, OFS Capital has ample flexibility to weather short-term volatility. Its $150 million floating-rate facility with BNP Paribas and $25 million line with Bank of California offer additional tools to fund new investments or refinance debt. This liquidity buffer is critical in a sector where refinancing risks are rising as short-term debt maturities loom.

Strategic Positioning in a High-Rate Environment

OFS Capital's Q2 results reflect a strategic pivot toward defensive positioning. By avoiding cyclical sectors, prioritizing senior secured loans, and monetizing non-core equity stakes, the company is adapting to a macroeconomic landscape marked by tariffs, inflation, and regulatory scrutiny. CEO Bilal Rashid's emphasis on “capital preservation” and “operational flexibility” resonates with the sector's broader shift toward risk mitigation.

Yet, the company's dividend sustainability remains a question mark. At $0.34 per share, the dividend is supported by NII of $0.25 per share—a thin margin that leaves little room for error. Rising interest rates could further strain this balance, particularly if the company's yield on investments fails to keep pace with debt costs. For now, the dividend appears secure, but investors should watch for signals of strain in Q3.

Investment Implications

OFS Capital's Q2 results highlight both its strengths and vulnerabilities. The company's disciplined credit portfolio, strategic refinancing, and alignment with sector trends position it as a resilient BDC in a rising-rate environment. However, its reliance on equity investments and thin income coverage for the dividend introduce risks that cannot be ignored.

For income-focused investors, OFS Capital offers an attractive 15.82% yield, but this comes with the caveat of high sensitivity to macroeconomic shifts. A diversified portfolio that includes OFS Capital should also incorporate sectors less correlated with interest rates, such as infrastructure or utilities. For those with a longer time horizon, the company's focus on middle-market lending—a $333 billion sector in 2024—suggests growth potential as private credit continues to fill the gap left by traditional banks.

In conclusion, OFS Capital's Q2 earnings underscore the delicate balance BDCs must strike between yield generation and risk management. While the company's strategic refinancing and defensive credit portfolio provide a strong foundation, its future performance will depend on its ability to navigate valuation risks and maintain its dividend in a high-rate environment. For investors who prioritize income and resilience, OFS Capital remains a compelling but cautious bet.