OCSL

Business Context and Reporting Period

Oaktree Specialty Lending Corp (OSLE) is a closed-end, externally managed business development company (BDC) regulated under the Investment Company Act of 1940. The company is managed by Oaktree Capital Management, L.P., following a transition from Fifth Street Management LLC in October 2017. This Form 10-Q covers the quarterly period ended June 30, 2018, and the nine months ended June 30, 2018.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total investment income decreased by 29.1% ($13.1 million) for the three months ended June 30, 2018, compared to the same period in 2017. This was primarily driven by a $13.3 million decrease in interest income due to a smaller portfolio size and lower yields.
• Expense Reduction: Net expenses decreased by 31.8% ($8.1 million) for the quarter, largely due to lower management fees, incentive fees, and interest expense resulting from reduced debt levels.
• Realized Losses: The company recorded a net realized loss of $89.4 million for the quarter, primarily driven by exits from Traffic Solutions Holdings, Inc. and Ameritox Ltd. This contrasts with a $12.3 million loss in the prior year quarter.
• Unrealized Gains: Net unrealized appreciation of $98.9 million for the quarter was significantly higher than the $13.3 million depreciation in the prior year, largely due to $97.2 million in reclassifications to realized losses.
• Portfolio Composition: As of June 30, 2018, 76.0% of the portfolio at fair value consisted of senior secured debt, while 19.4% consisted of subordinated notes. The portfolio size at fair value was $1.52 billion, representing 181.4% of net assets.

Guidance, Outlook, and Risks

• Management Strategy: Oaktree intends to reposition the portfolio into investments aligned with its credit investing approach, targeting middle-market companies with enterprise values between $100 million and $750 million. The target mix includes 40-60% first lien loans, 35-55% second lien loans, and 0-10% preferred equity.
• Portfolio Rotation: Management plans to rotate out approximately $357 million of non-core investments and redeploy capital into higher-yielding, Oaktree-originated investments.
• Liquidity and Capital: The company maintains a $600 million senior secured revolving credit facility (ING Facility) with $211 million outstanding as of June 30, 2018. It also has $386.1 million in unsecured notes payable. The company targets a debt-to-equity ratio of 0.70x to 0.85x.
• Risks and Contingencies:
  • SEC Investigation: The company is cooperating with an SEC investigation regarding the activities of its former adviser (Fifth Street Management), including valuation practices and expense allocations. Oaktree is not subject to these subpoenas.
  • Non-Accrual Status: As of June 30, 2018, eight investments were on cash or PIK non-accrual status, representing 12.34% of the debt portfolio at cost.
  • Interest Rate Risk: 82.9% of the debt portfolio at fair value bears floating interest rates, exposing the company to interest rate fluctuations.

Key Facts for Investor Verification

• Realized Loss Drivers: Verify the specific terms and recovery rates of the exits from Traffic Solutions Holdings, Inc. and Ameritox Ltd., which drove the majority of the $89.4 million realized loss in Q2 2018.
• Non-Accrual Portfolio: Review the status and potential recovery values of the eight investments on non-accrual status, which represent a significant portion of the portfolio's cost basis.
• Fee Waivers: Confirm the impact of the two-year contractual fee waiver agreement between Oaktree and the company, which limits fees to amounts that would have been paid to the former adviser.
• Debt Maturities: Note the maturity of the $228.8 million in 2019 Notes due March 1, 2019, and the company's ability to refinance or repay this obligation.
• SEC Investigation Outcome: Monitor updates regarding the SEC investigation into the former adviser to assess potential financial or reputational impacts on the company.