OFS Capital Corporation: Navigating NAV Declines for Near-Term Value Recovery

OFS Capital Corporation (NASDAQ: OFS) has released its preliminary Q2 2025 financial results, revealing a challenging quarter marked by a notable decline in net asset value (NAV) but also strategic moves to fortify its balance sheet. Investors must weigh these mixed signals to assess whether the business development company (BDC) presents a compelling opportunity for near-term value recovery.

NAV Declines: Cause for Caution or a Buying Opportunity?

The most striking figure in OFS's Q2 results is the NAV per share drop to $10.86–$10.96, a 8.4% decline from $11.97 at the end of Q1 2025. This contraction reflects broader market pressures, including markdowns in private credit valuations and macroeconomic uncertainty. However, the NAV range remains above the $10.00 threshold critical for maintaining investor confidence.

While the NAV drop is concerning, two factors mitigate immediate pessimism:
1. Stable Loan Performance: No new loans were placed on non-accrual status, underscoring the resilience of OFS's portfolio.
2. Dividend Sustainability: The 15.8% dividend yield (based on the Q2 NAV midpoint) remains among the highest in the BDC sector. Management has maintained distributions for 13 consecutive years, a streak investors will scrutinize closely.

Debt Management: A Strategic Redemption Play

OFS's proactive approach to debt reduction stands out. The company plans to redeem $25 million of its 4.75% unsecured notes due February 2026, reducing outstanding principal to $100 million. This move reduces near-term refinancing risks and aligns with its focus on optimizing capital structure.

Total debt fell to $243.4 million as of June 30, down from $248.1 million in March. Key liquidity sources include $10.2 million in cash and $111.6 million in unused credit facilities, which provide a buffer against market volatility.

Investors should note that debt levels remain manageable at 34.7% leverage (preferred stock to assets), a figure within regulatory limits for BDCs. The redemption of higher-cost debt and the use of revolving credit lines signal a disciplined approach to interest rate risk.

Liquidity and Market Risks: A Delicate Balance

OFS's liquidity profile appears robust on paper, but challenges lurk beneath the surface. The company's reliance on borrowing base requirements for its credit facilities introduces operational risk. If portfolio valuations continue to decline, borrowing capacity could shrink, limiting flexibility.

Additionally, the preliminary results lack final audit validation. KPMG's upcoming review of fair value determinations could alter NAV estimates, creating uncertainty for investors.

The Case for Near-Term Value Recovery

OFS's value recovery hinges on two catalysts:
1. Portfolio Valuation Stabilization: If private credit markets rebound—potentially as the Federal Reserve signals rate cuts—the fair value of OFS's investments could appreciate, lifting NAV.
2. Debt Management Efficiency: The redemption of $25 million in notes reduces interest expenses, potentially boosting net investment income (NII). The Q2 NII per share estimate of $0.23–$0.27, while slightly below Q1's $0.26, remains consistent with long-term trends.

Risks to Consider

• NAV Volatility: Continued markdowns in private credit valuations could prolong the decline.
• Dividend Pressure: If NII fails to recover, the dividend could face cuts, eroding investor confidence.
• Liquidity Constraints: A worsening credit environment might limit access to revolving credit facilities.

Investment Thesis: A Selectively Bullish Outlook

For income-focused investors willing to tolerate volatility, OFS presents a compelling entry point. The 15.8% dividend yield offers a high return relative to its peers, and the debt-reduction strategy addresses liquidity risks. However, this is not a “set-and-forget” investment.

Actionable Advice:
- Buy on dips: Consider accumulating shares if the stock price falls below $10.00, provided the dividend remains intact.
- Set a stop-loss: A stop at $9.00 would protect against further NAV declines.
- Monitor NII trends: A rebound in Q3 NII toward $0.30 per share would validate management's strategy.

Conclusion

OFS Capital's Q2 results highlight a BDC in transition—struggling with NAV headwinds but demonstrating discipline in debt management. While risks remain, the dividend yield and strategic actions position OFS as a speculative buy for investors seeking high income with a horizon of 12–18 months. The next quarter's 10-Q filing and market conditions will be critical in determining whether this near-term value recovery plays out as hoped.