Oxford Square Capital Corp. — Fiscal 2022 Form 10-K
Business context and reporting period
Oxford Square Capital Corp. is a non-diversified, closed-end business development company regulated under the Investment Company Act of 1940 and taxed as a regulated investment company. Its objective is to maximize total return through corporate debt securities and collateralized loan obligation investments, primarily CLO equity. This filing covers the year ended December 31, 2022; selected fourth-quarter results are included where relevant.
Financial performance and key metrics
| Metric | 2022 | 2021 | Change |
|---|---|---|---|
| Total investment income | $43.1 million | $37.2 million | +16.0% |
| Net investment income | $20.7 million | $16.1 million | +28.5% |
| Net investment income per share | $0.42 | $0.32 | +$0.10 |
| Net decrease in net assets from operations | $(85.6) million | $39.6 million increase | Driven by unrealized depreciation |
| Net decrease from operations per share | $(1.72) | $0.80 increase | Material deterioration |
| Net asset value per share | $2.78 | $4.92 | Down 43.5% |
| Total investment portfolio fair value | $314.7 million | $420.8 million | Down 25.2% |
| Cash and cash equivalents | $9.0 million | $9.0 million | Essentially unchanged |
- Net investment income represented approximately 48% of total investment income. The filing does not provide a conventional operating-company gross or EBITDA margin.
- Investment income increased primarily because stated interest income rose to $24.0 million from $16.1 million as portfolio yields increased. CLO income declined to $17.1 million from $18.7 million.
- Operating expenses increased to $22.4 million from $21.1 million. Interest expense rose to $12.4 million from $10.5 million, while the base advisory fee declined to $5.9 million from $6.3 million.
- No net investment income incentive fee or capital gains incentive fee was recorded in either 2022 or 2021, principally because of the total-return requirement and portfolio losses.
- Net unrealized depreciation was $105.9 million, versus $38.5 million of net unrealized appreciation in 2021. Net realized investment losses were $0.3 million, versus $15.0 million in 2021.
- The company paid $0.42 per share of distributions during 2022, or $0.105 per quarter. The estimated 2022 distribution source was ordinary income, but final tax characterization had not been determined in the filing.
Portfolio, leverage and liquidity
- At year-end, the portfolio consisted of approximately 67.2% senior secured notes, 31.4% CLO equity and 1.4% equity and other investments, based on fair value.
- The company purchased $84.2 million of investments, including $57.0 million of senior secured notes and $27.2 million of CLO equity. It received $50.0 million of principal repayments and sold $14.6 million of investments.
- All portfolio debt investments were floating-rate. The weighted average annualized yield on debt investments was 11.85%, versus 7.70% in 2021; stated rates ranged from 7.63% to 14.24%.
- Debt investments had principal value of approximately $307.2 million and fair value of $211.4 million. Three debt investments were on non-accrual status.
- Debt portfolio grading deteriorated modestly: Grade 2 investments represented 85.1% of debt fair value in 2022, down from 94.2%; Grade 5 investments represented 0.1% of fair value, with $28.2 million of principal value classified as Grade 5.
- Outstanding unsecured notes totaled $189.7 million principal, consisting of $64.4 million due 2024, $44.8 million due 2026 and $80.5 million due 2028. Carrying value was $186.3 million and fair value was $176.0 million.
- Asset coverage for borrowings declined to approximately 171% from 227%, remaining above the 150% statutory requirement. Weighted average debt cost was 6.02%, with weighted average maturity of 3.6 years.
- The statement of cash flows reported $20.4 million of net cash provided by operating activities and $20.4 million of cash used in financing activities, primarily distributions, resulting in a $3,464 increase in cash. The MD&A narrative contains an inconsistent statement describing operating cash flow as used.
Material changes, outlook and risks
- Market conditions were volatile in 2022. The S&P/LSTA Leveraged Loan Index fell from 98.64% at December 31, 2021 to 92.44% at December 31, 2022; CCC-rated loan prices declined 19.01%, and loan defaults increased to 0.72% from 0.29%.
- Management attributed the portfolio decline primarily to macroeconomic uncertainty, investment outflows from loan and CLO markets, weaker credit quality and broad market repricing. It stated that the environment also created opportunities to purchase performing assets at attractive risk-adjusted returns.
- Interest-rate increases benefited income because most debt investments are floating-rate, but higher rates may pressure portfolio-company borrowers and increase funding costs. Management estimates that a 100-basis-point increase in the underlying base rate would increase investment income by approximately 5.9%, excluding CLO equity.
- The company is transitioning investments and contracts from LIBOR to SOFR and other replacement rates. Remaining LIBOR contracts, operational changes and uncertain rate conventions create transition risk.
- Most investments are Level 3 assets valued using significant unobservable inputs. Fair-value estimates are therefore subject to substantial judgment and may not equal realizable values.
- CLO equity is subordinate, highly leveraged and less transparent than direct ownership of the underlying loans. CLO vehicles had average leverage of 9.1 times, ranging from approximately 2.8 to 12.6 times.
- Key risks include further credit-market deterioration, defaults, illiquidity, leverage and refinancing risk, inability to access capital, distribution constraints, loss of RIC or BDC status, conflicts involving Oxford Square Management and affiliated funds, and potential losses from concentrated or non-accrual investments.
- Subsequent to year-end, the Board declared monthly distributions of $0.035 per share for January through June 2023. The filing provides no earnings or NAV guidance.
- The company reported no pending material legal proceedings, effective disclosure controls and effective internal control over financial reporting. PricewaterhouseCoopers issued an unqualified audit opinion; valuation of Level 3 investments and CLO income were identified as critical audit matters.
Important facts for investors to verify
- Reconcile the reported $105.9 million unrealized depreciation with current portfolio marks, especially the largest declines in ConvergeOne, Quest Software, Sound Point CLO XVI, Octagon Investment Partners 49 and RSA Security.
- Review the three non-accrual debt investments, including Premiere Global Services and other materially impaired positions, and assess expected recovery values and maturity extensions.
- Confirm the company’s ability to refinance or repay the $64.4 million of notes due March 30, 2024 while maintaining the 150% asset-coverage requirement.
- Assess whether the $0.42 per-share annual distribution is supported by recurring cash income rather than CLO cash-flow timing, valuation changes or return of capital.
- Evaluate the sensitivity of NAV and distributions to CLO defaults, collateralization tests, valuation assumptions, interest rates and the LIBOR-to-SOFR transition.
- Investigate the apparent cash-flow presentation inconsistency between the MD&A narrative and the audited statement of cash flows.