OFS Capital's Strategic Debt Refinancing: Navigating Rate Risks in Uncertain Markets

July 14, 2025 — OFS Capital Corporation's recent $60 million notes offering, priced at a 7.50% coupon due 2028, marks a pivotal move in its debt restructuring strategy. By refinancing a portion of its cheaper 4.75% notes due 2026, the company is proactively addressing rising interest rate risks while extending its debt maturity profile. This decision underscores a calculated trade-off: accepting higher borrowing costs today to avoid refinancing uncertainty in 2026, when rates could be even higher. Let's unpack the implications for investors.

The Trade-Off: Higher Costs Now, Lower Risk Later

OFS is refinancing $25 million of its 4.75% notes due 2026 with the new 7.50% notes due 2028. The math here is straightforward: the company is replacing low-cost debt with higher-cost debt. But this isn't a misstep—it's a strategic hedge against macroeconomic uncertainty.

By locking in a 7.50% rate now, OFS avoids the risk of refinancing $100 million of the 2026 notes at potentially higher rates in 2026. With the Federal Reserve's path unclear—though many anticipate further hikes—this move reduces refinancing exposure. The trade-off is clear: paying an extra 275 basis points today to avoid a larger rate shock tomorrow.

Credit Quality and Liquidity: Strengthening the Foundation

The refinancing strengthens OFS's balance sheet in two key ways:
1. Extended Maturity Profile: Pushing $25 million of debt from 2026 to 2028 eases near-term repayment pressure. As of June 2025, OFS had $243 million in total debt, including $180 million in unsecured notes. The new offering reduces the 2026 debt bucket, creating a smoother maturity ladder.
2. Liquidity Buffer: Proceeds from the offering will directly fund the August 2025 redemption of the cheaper 2026 notes. This maintains cash reserves ($10.2 million as of June) and keeps $111.6 million in unused credit lines intact.

Critics might argue that the higher coupon could squeeze net investment income (NII). However, OFS's asset coverage ratio of 160% (vs. the 150% regulatory minimum) provides a cushion, and the company's Q2 2025 NAV decline (to $10.86–$10.96 from $11.97 in Q1) appears isolated to broader market conditions, not operational failure.

Interest Rate Risk Mitigation: A Resilient Play

The real value of this move lies in interest rate risk mitigation. OFS's portfolio is heavily weighted in senior loans (which typically float with rates), meaning rising rates could boost income. However, its debt is fixed-rate, creating an asymmetry: rising rates help NII but increase refinancing costs. By refinancing now, OFS fixes a portion of its borrowing costs at 7.50%, capping downside risk if rates spike further.

This strategy positions OFS as a resilient play in the senior loan market. Its dividend yield of 15.82%—sustained for 13 years—depends on steady NII. While the new notes' higher coupon may compress margins slightly, avoiding a refinancing cliff in 2026 is a critical hedge.

Investment Implications: A Defensive Bet

For income-focused investors, OFS remains compelling, but with caveats:
- Upside: If rates stabilize or decline, OFS's locked-in 7.50% costs become advantageous. Its senior loan portfolio could also benefit from borrowers' stronger cash flows in a stable environment.
- Downside: Should rates rise sharply beyond 2028, OFS's fixed-rate debt becomes a drag, though its floating-rate assets would offset some pressure.

The key metric to watch is the spread between borrowing costs and portfolio yields. OFS's Q2 NII guidance ($0.23–$0.27) is below Q1's $0.26, but this may reflect temporary market headwinds. Investors should monitor whether the new notes' terms (including the 30-day over-allotment option) attract demand, as weak pricing could signal market skepticism.

Conclusion: A Prudent Move for Uncertain Times

OFS's decision to issue higher-cost notes now is a prudent trade-off between short-term costs and long-term stability. By reducing refinancing risk and extending maturities, it's fortifying its balance sheet against macroeconomic headwinds. While the move isn't without drawbacks—such as the immediate hit to margins—the strategic upside outweighs the risks.

For investors seeking exposure to senior loans, OFS remains a viable option, particularly if they believe rate volatility will persist. The company's dividend resilience and active debt management make it a defensive bet in an uncertain interest rate environment.

Investment Takeaway: OFS's refinancing is a disciplined move that prioritizes stability over near-term cost savings. It's a play for investors willing to accept modest margin compression today for reduced refinancing risk tomorrow. Monitor NII trends and the company's ability to grow its portfolio in a rising rate environment.