Business Context and Reporting Period
Company: Oaktree Specialty Lending Corp (formerly Fifth Street Finance Corp.)
Filing Type: Form 10-K (Annual Report)
Period Ended: September 30, 2018
Structure: Closed-end, externally managed, non-diversified Business Development Company (BDC) and Regulated Investment Company (RIC).
Management Change: As of October 17, 2017, the Company is managed by Oaktree Capital Management, L.P. (Oaktree), following the termination of the agreement with Fifth Street Management LLC.
Key Financial Metrics
| Metric | 2018 (Sep 30) | 2017 (Sep 30) |
|---|---|---|
| Total Investment Income | $138.7 million | $178.0 million |
| Net Investment Income | $60.0 million | $72.7 million |
| Net Increase in Net Assets from Operations | $46.8 million | $(197.0) million |
| Net Asset Value (NAV) per Share | $6.09 | $6.16 |
| Market Price per Share (Period End) | $4.96 | $5.47 |
| Total Portfolio Investments (Fair Value) | $1.49 billion | $1.54 billion |
| Total Debt Outstanding | $643.4 million | $680.7 million |
| Debt-to-Equity Ratio | 0.75x | 0.79x (approx.) |
| Weighted Average Yield on Debt | 8.4% | 9.6% |
| Cash and Cash Equivalents | $13.5 million | $60.0 million |
Material Changes vs. Prior Period
- Income Decline: Total investment income decreased by $39.2 million (22.1%) primarily due to a reduction in portfolio size and yield, partially offset by rising LIBOR rates.
- Expense Reduction: Net expenses decreased by $26.6 million (25.3%) driven by lower management fees, reduced interest expense due to lower debt levels, and decreased general and administrative costs.
- Realized Losses: The Company recorded a net realized loss of $115.1 million, primarily associated with exits from Ameritox Ltd., TransTrade Operators, and Traffic Solutions Holdings, Inc. This compares to a $171.8 million loss in 2017.
- Unrealized Appreciation: Net unrealized appreciation on investments was $100.3 million in 2018, a significant turnaround from $97.5 million of depreciation in 2017.
- Portfolio Repositioning: Oaktree has reduced non-core investments by over $500 million since taking over, with approximately $324 million of non-core investments remaining as of period end.
Guidance, Outlook, and Risks
- Strategy: Oaktree intends to continue repositioning the portfolio into investments aligned with its credit investing approach, targeting a mix of 40-60% first lien loans and 35-55% second lien loans.
- Liquidity: The Company had $13.5 million in cash and $52.7 million in unfunded commitments. It maintains a $600 million revolving credit facility (ING Facility) with $241.0 million drawn.
- Distributions: The Company declared a quarterly distribution of $0.095 per share on November 19, 2018. Distributions are intended to cover at least 90% of taxable income to maintain RIC status.
- Risks:
- SEC Investigation: The Company is cooperating with an SEC investigation related to the activities of its Former Adviser (Fifth Street). Management believes obligations regarding this matter are concluded, but uncertainties remain.
- Interest Rate Risk: 83.2% of the debt portfolio bears floating interest rates. Rising rates increase income but also increase the cost of funds and borrower default risk.
- Valuation Risk: A significant portion of the portfolio is illiquid and valued at fair value by the Board, involving management judgment.
Investor Verification Checklist
- SEC Investigation Status: Verify if there have been any new developments or penalties related to the SEC investigation into the Former Adviser.
- Non-Core Portfolio: Monitor the progress of exiting the remaining $324 million in non-core investments identified by Oaktree.
- Non-Accrual Assets: Review the status of the eight investments on non-accrual status (6.97% of debt portfolio at fair value) and potential write-downs.
- Debt Covenants: Confirm continued compliance with the 200% asset coverage ratio and financial covenants under the ING Facility.
- Stock Discount: Assess the widening discount between the market price ($4.96) and NAV ($6.09) and its impact on capital raising capabilities.