OCSL

Business Context and Reporting Period

Oaktree Specialty Lending Corp (OCSL) is a closed-end, externally managed Business Development Company (BDC) regulated as a Regulated Investment Company (RIC). The company provides customized credit solutions to middle-market companies. This summary covers the quarterly period ended March 31, 2020, a period significantly impacted by the onset of the COVID-19 pandemic, which caused market volatility and credit spread widening.

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Unrealized Depreciation: The company recorded net unrealized depreciation of $163.5 million for the quarter, compared to appreciation of $21.5 million in the prior year quarter. This was largely driven by increased market volatility and wider credit spreads due to the COVID-19 pandemic.
• Realized Losses: Net realized losses of $26.5 million were recorded, primarily due to exits or restructurings of investments in Cenegenics, LLC and Dominion Diagnostics, LLC. This contrasts with realized gains of $25.2 million in the prior year period.
• Debt Restructuring: The company issued $300 million in 3.500% unsecured notes due 2025 and redeemed all outstanding 2024 Notes ($75 million) and 2028 Notes ($86.3 million). Total debt increased from $476 million at September 30, 2019, to $705 million at March 31, 2020.
• Liquidity Position: Cash and cash equivalents increased significantly from $15.4 million to $89.5 million, bolstered by net cash provided by financing activities of $195.7 million over the six-month period.
• Expense Reduction: Net expenses decreased by $9.2 million compared to the prior year quarter, primarily due to a $6.6 million reversal of previously accrued Part II incentive fees and lower interest expense driven by falling LIBOR rates.

Guidance, Outlook, and Risks

• COVID-19 Impact: Management notes that the pandemic has caused significant market disruption and economic uncertainty. While 90.6% of the debt portfolio is floating rate (benefiting from lower rates), the company faces risks of portfolio company defaults and reduced collateral values.
• Portfolio Strategy: Oaktree intends to opportunistically deploy capital into the market, focusing on resilient business models. The company has reduced non-core investments to approximately $142 million at fair value.
• LIBOR Transition: The company faces uncertainty regarding the phase-out of LIBOR by 2021, which may require renegotiating credit agreements and the Credit Facility.
• Fee Waivers: The two-year contractual fee waiver with Oaktree ended in October 2019. Oaktree voluntarily deferred Part I incentive fees for the quarter ended March 31, 2020.
• Subsequent Events: On May 6, 2020, the company amended its Credit Facility to reduce the minimum shareholders' equity covenant from $700 million to $550 million and adjusted interest rate margins.

Investor Verification Checklist

• Valuation Methodology: Verify the Board's "good faith" valuation process for Level 3 assets, which comprised 64.8% of total investments at fair value, given the lack of active markets.
• Non-Accrual Status: Review the three investments on cash or PIK non-accrual status (0.92% of debt portfolio at cost) and the specific portfolio companies involved (e.g., PLATO Learning Inc.).
• Debt Covenants: Confirm compliance with the amended Credit Facility covenants, specifically the reduced minimum shareholders' equity requirement of $550 million.
• Realized Loss Drivers: Investigate the specific restructuring terms and recovery expectations for the significant realized losses in Cenegenics and Dominion Diagnostics.
• Unfunded Commitments: Assess the $91.6 million in unfunded commitments and the company's ability to fund them given current market conditions.