OCSL

Business Context and Reporting Period

Oaktree Specialty Lending Corp (OCSL) is a closed-end, externally managed Business Development Company (BDC) and Regulated Investment Company (RIC) focused on providing customized credit solutions to middle-market companies. This Form 10-Q covers the quarterly period ended June 30, 2021. A significant event during this period was the completion of the merger with Oaktree Strategic Income Corporation (OCSI) on March 19, 2021, which expanded the Company's asset base and share count.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total investment income increased by 90.2% for the three months ended June 30, 2021, compared to the same period in 2020. This was driven by a larger portfolio resulting from the OCSI merger and new originations, as well as higher fee income.
• Expense Increase: Net expenses rose 65.3% year-over-year for the quarter, primarily due to higher incentive fees (Part I and Part II) resulting from increased investment income and capital gains, as well as higher interest expense from increased borrowings.
• Realized Gains: The Company recorded net realized gains of $8.6 million for the quarter, compared to $2.8 million in the prior year quarter. For the nine-month period, net realized gains were $22.7 million, a significant improvement from a net realized loss of $20.4 million in the prior year.
• Unrealized Appreciation: Net unrealized appreciation was $3.9 million for the quarter, a decrease from $100.6 million in the prior year quarter, though the nine-month period showed strong appreciation of $116.6 million compared to depreciation of $60.1 million in the prior year.
• Portfolio Expansion: Total investments at fair value grew from $1.57 billion as of September 30, 2020, to $2.34 billion as of June 30, 2021.

Guidance, Outlook, and Risks

• Merger Impact: The merger with OCSI was accounted for as an asset acquisition, resulting in a purchase discount allocated to the cost basis of acquired investments. This discount will accrete into interest income over the life of the debt investments.
• Interest Rate Risk: Approximately 91.4% of the debt portfolio bears floating interest rates indexed to LIBOR. The Company utilizes interest rate swaps to hedge fixed-rate debt (specifically the 2027 Notes) to align liabilities with the floating-rate asset portfolio.
• Liquidity: The Company maintains significant liquidity with $87.5 million in cash and restricted cash, plus $635.9 million of undrawn capacity on credit facilities. Management believes resources are sufficient to meet obligations and pursue opportunities.
• Legal Proceedings: Merger-related litigation filed by a putative stockholder was voluntarily dismissed with prejudice in May 2021. The Company agreed to pay $0.4 million in legal fees, which was offset by an expected insurance recovery.
• Off-Balance Sheet Commitments: As of June 30, 2021, the Company had $288.0 million in unfunded commitments to portfolio companies and joint ventures.

Investor Verification Checklist

• Merger Accounting: Verify the accretion schedule of the purchase discount from the OCSI merger and its impact on future interest income.
• Debt Covenants: Confirm continued compliance with the Syndicated Facility covenants, specifically the asset coverage ratio (216.01% vs. 150% minimum) and interest coverage ratio.
• LIBOR Transition: Monitor the Company's progress in transitioning loan agreements from LIBOR to alternative reference rates (e.g., SOFR) as LIBOR phase-out approaches.
• Fee Waivers: Review the impact of the $6 million base management fee waiver agreed upon in connection with the merger, which is being amortized over two years.
• Portfolio Concentration: Assess the concentration of the portfolio in specific industries (e.g., Application Software at 14.3% of fair value) and the performance of non-core investments.