OFS Capital's $60M Notes Offering: A Prudent Play to Hedge Rate Risks and Secure Dividends

OFS Capital (NASDAQ: OFS), a leading middle-market business development company (BDC), has launched a $60 million offering of 7.50% senior notes due 2028. This refinancing move is a strategic response to rising interest rate risks and economic uncertainty, aiming to extend its debt maturity profile while shielding its 15.82% dividend yield—a streak sustained for 13 years. The transaction underscores OFS's focus on balance sheet resilience, positioning it as a defensive play for income investors in turbulent markets.

The Refinancing Rationale: Locking in Costs Amid Volatility

The core of OFS's strategy is to replace $25 million of its existing 4.75% notes due 2026 with the new 2028 notes. While the coupon on the new debt is higher (7.50% vs. 4.75%), this move extends the weighted-average maturity of its debt by nearly two years, reducing exposure to refinancing risks in 2026—a period when rising rates could force higher borrowing costs.

By shifting debt to a longer maturity, OFS mitigates the risk of being forced to refinance a portion of its debt in a potentially tighter credit environment. This aligns with its portfolio's long-term nature, as its investments in senior secured loans and mezzanine debt typically have multi-year durations. The transaction also stabilizes interest cost management, as the new notes' fixed-rate structure insulates the company from near-term rate hikes.

Dividend Sustainability: A Delicate Balancing Act

OFS's dividend yield of 15.82%—among the highest in the BDC sector—is its strongest selling point. However, its net asset value (NAV) per share dipped to between $10.86 and $10.96 in Q2 2025, down from $11.97 in Q1, reflecting broader market headwinds. The refinancing aims to bolster dividend sustainability by reducing near-term liabilities and preserving liquidity.

The company's net investment income (NII) for Q2 2025 is projected at $0.23–$0.27 per share, slightly lower than Q1's $0.26, signaling cautious optimism. While the dividend payout ratio remains manageable, investors must monitor whether OFS can maintain its NII amid rising costs for the new notes. The $10.2 million in cash and $111.6 million in unused credit lines as of June 2025 provide a liquidity buffer, but leverage levels ($243.4 million total debt) remain a risk if economic conditions deteriorate.

Risks and Structural Considerations

The new notes' unsecured status and subordination to existing secured debt introduce some risk, particularly in a liquidity crisis. However, OFS's asset coverage ratio of 160% (above the 150% regulatory minimum) offers a safety margin. The involvement of underwriters like Goldman Sachs and Lucid Capital Markets adds credibility, potentially enhancing market reception and liquidity for the new notes.

Crucially, the transaction's success hinges on the final coupon rate. If the 7.50% rate is competitive with market alternatives, it could reduce refinancing costs over the long term. Conversely, if rates rise further, OFS may face margin compression.

Why This Matters for Income Investors

OFS's move positions it as a defensive play for income-focused investors seeking steady dividends in a volatile environment. The refinancing reduces near-term refinancing risks, aligns debt maturities with its long-duration asset portfolio, and preserves liquidity buffers. While NAV declines and margin pressures warrant caution, the dividend's history of resilience and the company's focus on credit-worthy middle-market borrowers (a sector with structural demand) justify its appeal.

Investment Takeaway

Investors should view OFS as a “buy the dip” opportunity if its stock price continues to lag its NAV. The $60M offering strengthens its balance sheet and underscores management's commitment to dividend discipline. However, monitor the following metrics:
- Final coupon rate of the 2028 notes relative to the 4.75% redeemed bonds.
- Q2 2025 NAV and NII trends.
- Interest rate movements and their impact on OFS's portfolio companies.

While not a growth play, OFS remains a compelling option for income investors prioritizing stability over upside. The dividend yield, coupled with its strategic refinancing, makes it a defensive stalwart in an uncertain market.

In conclusion, OFS's refinancing is a prudent step toward mitigating rate risks and sustaining dividends. While challenges remain, the transaction solidifies its position as a reliable income generator for cautious investors.