Oaktree Specialty Lending Corporation — Form 10-Q
Reporting period: Fiscal second quarter and six months ended March 31, 2023. Oaktree is an externally managed business development company investing primarily in loans and other securities of middle-market companies. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and position
- Investment income: Second-quarter investment income was $96.3 million, up 49.8% from $64.3 million a year earlier. Six-month income was $175.5 million, up 35.8% from $129.2 million. Growth reflected the OSI2 merger, new originations and higher floating reference rates.
- Net investment income (NII): Second-quarter NII was $46.0 million, or $0.63 per share, versus $40.1 million, or $0.66 per share, a year earlier. Six-month NII was $84.8 million, or $1.26 per share, versus $72.4 million, or $1.20 per share. NII was below the $0.55 quarterly distribution per share in the reported quarter.
- Net results: Net increase in net assets from operations was $21.5 million ($0.29 per share) for the quarter, compared with $14.4 million ($0.24 per share) in the prior-year quarter. Six-month results were $34.7 million ($0.52 per share), compared with $53.8 million ($0.89 per share). Net realized and unrealized losses after tax were $24.5 million for the quarter and $50.1 million for six months.
- Portfolio valuation and NAV: Investments at fair value were $3.165 billion across 165 portfolio companies, versus $2.494 billion across 149 investments at September 30, 2022; the increase primarily reflects OSI2. NAV was $19.66 per share, down from $20.38 at September 30. Approximately 88% of the debt portfolio at fair value was floating rate, and 88% of the portfolio was senior secured debt.
- Expenses and margins: Net expenses after fee waivers rose to $50.3 million for the quarter from $24.2 million, chiefly due to higher borrowing costs and increased incentive fees. NII as a share of investment income was approximately 47.7%, versus 62.3% a year earlier, reflecting expense growth. Fee waivers were $1.8 million for the quarter.
- Cash flow: Six-month operating cash flow was negative $63.7 million, primarily reflecting investment funding; financing cash flow was positive $90.8 million, including net credit-facility borrowings. Cash and restricted cash totaled $53.0 million at March 31, including $9.3 million restricted.
- Debt and liquidity: Credit-facility borrowings were $1.115 billion and unsecured notes had $608.8 million net carrying value; total debt principal was $1.765 billion. Net debt-to-equity was 1.14x and asset coverage was 183.4%. The company reported $335 million of undrawn credit capacity, subject to borrowing-base and other limitations, and compliance with financial covenants.
Material changes versus comparable periods
- On January 23, 2023, the company completed its acquisition of OSI2, issuing 15.86 million shares. The merger added $592.8 million of investments and $225.0 million of debt, among other acquired assets and liabilities. The share count rose to 77.08 million at quarter-end from 61.13 million at September 30.
- Interest expense increased to $27.8 million in the quarter from $9.9 million a year earlier; six-month expense increased to $48.5 million from $19.3 million. The company attributed the increase to higher rates and borrowings, including debt assumed with OSI2.
- Six-month net unrealized depreciation was $41.3 million, compared with $31.6 million in the prior year. The current period included $20.7 million of depreciation from OSI2 merger-related accounting adjustments. Six-month realized losses were $9.3 million versus realized gains of $10.7 million.
- Two investments were on non-accrual at March 31, representing 2.4% of debt investments at fair value; there were none at September 30, 2022.
Outlook, risks and unusual items
- Management cited inflation, rising interest rates, potential recession, geopolitical conflict and market volatility as uncertainties affecting portfolio companies and investment markets. It said it is monitoring these conditions and believes its resources and experience support sourcing and structuring investments, but provided no specific earnings or distribution guidance.
- The company reported that liquidity and capital resources were sufficient to pursue market opportunities, while noting that borrowing capacity is subject to facility terms. It intends to distribute taxable income as required to maintain regulated investment company status; future distributions are not assured. The board declared a $0.55-per-share quarterly distribution payable June 30, 2023.
- Investment values are substantially judgment-based: $2.794 billion of investments were Level 3 at March 31. The filing cautions that estimated fair values may differ materially from realizable sale values.
- Floating-rate assets support income as rates rise, but higher rates also raise financing costs and may impair borrowers’ ability to pay. Management also highlighted the expected cessation of most U.S. dollar LIBOR publication after June 30, 2023 and the need to address transition language in some loan agreements.
- Unfunded commitments were $264.5 million, up from $224.2 million at September 30, 2022. A $350 million interest-rate swap associated with the 2027 notes had a $35.3 million fair-value liability; foreign-currency forwards had a $2.6 million liability.
- The company completed a 1-for-3 reverse stock split in January 2023; all reported per-share data is adjusted retroactively. It reported no pending material legal proceedings and no material changes to the risk factors in its 2022 Form 10-K.
Key facts for investors to verify
- Whether portfolio-company payment performance and the two non-accrual investments change, and how much of income consists of PIK or other non-cash accruals.
- How OSI2 merger accounting, acquired assets and liabilities, and the larger share count affect future NII per share, NAV and distributions.
- Whether fair-value marks—particularly Level 3 marks and merger-related adjustments—are supported by subsequent borrower results or realizations.
- How higher funding costs, LIBOR transition, facility maturities and covenant headroom affect net investment income and liquidity.
- Whether the $264.5 million of unfunded commitments are drawn and how future distribution coverage compares with NII and taxable income.