Oaktree Specialty Lending Corporation — Form 10-Q
Reporting period: Fiscal third quarter and nine months ended June 30, 2023. Oaktree Specialty Lending is an externally managed business development company (BDC) and regulated investment company (RIC) providing credit to middle-market companies. Amounts are in U.S. dollars unless stated otherwise.
Key financial metrics
| Metric | Three months ended June 30, 2023 | Comparable 2022 period | Nine months ended June 30, 2023 | Comparable 2022 period |
|---|---|---|---|---|
| Total investment income | $101.9 million | $63.1 million | $277.4 million | $192.4 million |
| Net investment income | $48.4 million; $0.63/share | $40.4 million; $0.66/share | $133.2 million; $1.89/share | $112.8 million; $1.86/share |
| Net realized and unrealized gains (losses), net of taxes | $(11.7) million | $(78.2) million | $(61.8) million | $(96.7) million |
| Change in net assets from operations | $36.7 million; $0.48/share | $(37.8) million; $(0.62)/share | $71.4 million; $1.01/share | $16.0 million; $0.26/share |
Quarterly net investment income increased 20% year over year, while investment income increased 61%. Higher interest income—reflecting the OSI2 merger, new originations and higher floating reference rates—was partly offset by higher borrowing costs and other expenses. Net expenses after fee waivers rose to $53.5 million from $22.8 million in the quarter. The company reported net unrealized depreciation of $1.0 million and realized losses of $10.6 million for the quarter.
Balance sheet, portfolio and liquidity
- At June 30, 2023, investments at fair value were $3.136 billion, versus $2.494 billion at September 30, 2022; the increase primarily reflected the OSI2 merger. Investment cost was $3.296 billion. The portfolio comprised 156 companies, and 88.5% of its fair value consisted of senior secured debt.
- Net assets were $1.509 billion, or $19.58 per share, compared with $1.246 billion and $20.38 per share at September 30, 2022. The change in share count largely reflects the merger; the company issued 15.86 million shares to OSI2 holders. A 1-for-3 reverse stock split was effective January 2023, and historical per-share figures were adjusted retrospectively.
- Cash and restricted cash totaled $72.7 million, including $13.0 million restricted under a facility. The company reported $482.5 million of undrawn credit-facility capacity, subject to borrowing-base and other limits. Nine-month operating cash flow was negative $15.0 million; financing cash flow was positive $61.0 million.
- Credit-facility borrowings were $1.135 billion and unsecured notes payable, net of specified costs and adjustments, were $605.1 million. Total senior securities were $1.785 billion. Net debt to equity was 1.14x and asset coverage was 182.0%. The company reported compliance with its financial covenants.
- Unfunded commitments totaled $274.4 million, including $247.3 million to portfolio companies and $27.1 million to the joint ventures.
Material changes and unusual items
- The January 2023 OSI2 merger added assets and shares. It was accounted for as an asset acquisition; allocation of the purchase premium and subsequent fair-value marking produced a one-time $20.7 million unrealized loss in the nine-month results.
- Nine-month investment income rose 44% year over year, but net expenses rose 89%, principally because of higher interest expense, larger borrowings, and increased incentive fees. Nine-month net investment income per share increased modestly, from $1.86 to $1.89.
- Fair-value unrealized depreciation was $42.3 million for the nine months, compared with $118.4 million in 2022. Net realized results shifted to a $19.9 million loss from a $19.9 million gain.
- Five investments were on non-accrual at June 30, representing 3.6% of debt investments at cost and 3.1% at fair value; there were none at September 30, 2022. PIK interest income was $4.0 million for the quarter and $14.2 million year to date; PIK is accrued income, not necessarily cash received.
Outlook, risks and contingencies
The filing gives no specific earnings or distribution guidance. Management says it is monitoring inflation, higher interest rates, recession risk, market volatility and geopolitical events, and sees potential for risk-adjusted returns in middle-market lending. Its stated focus for new opportunities includes situational lending, select sponsor lending, and stressed-sector and rescue lending. It also intends to continue rotating out of non-core positions; these were approximately $67 million at fair value at June 30.
- About 86% of debt investments at fair value were floating rate. Rate increases can support asset income but also raise funding costs and stress borrowers. The filing’s hypothetical sensitivity estimates annual net operating-asset increases of $11.7 million for a 100-basis-point rate rise and decreases of $11.7 million for a 100-basis-point fall, excluding potential incentive fees and assuming no changes in portfolio or capital structure.
- Most investments are privately held and valued using estimates; $2.826 billion of investments were Level 3 at quarter-end. Management warns estimated fair values may differ materially from amounts ultimately realized.
- The company identified LIBOR transition as a consideration for affected loan agreements. The 2027 notes’ interest-rate swap exposes the company to floating-rate costs; its fair value was a $39.6 million liability, with $40.0 million posted as collateral and recorded as due from broker.
- Oaktree waived $1.5 million of fees for the quarter and $4.0 million year to date under merger-related arrangements. The company declared a $0.55-per-share quarterly distribution for September 29, 2023 after quarter-end; it had paid $2.06 per share during the first nine months.
- The filing reports no pending material legal proceedings, no material risk-factor changes from the 2022 Form 10-K, and no subsequent event requiring recognition other than the declared distribution.
Important facts for investors to verify
- Current performance, payment status and recovery prospects of the five non-accrual investments, and any further movement into non-accrual.
- Fair-value assumptions and valuation support for the largely Level 3 portfolio, including the effect of the OSI2 purchase premium and the $20.7 million merger-related adjustment.
- Borrowing costs, available facility capacity, covenant headroom and refinancing plans, particularly as floating-rate liabilities and interest expense have increased.
- Whether recurring cash income supports distributions, considering PIK income, unfunded commitments, leverage and RIC distribution requirements.
- Progress in realizing OSI2 merger benefits and rotating out of the remaining non-core portfolio.