Oaktree Specialty Lending Corporation — Form 10-Q
Reporting period: Fiscal first quarter, three months ended December 31, 2022. Unless otherwise noted, amounts are in U.S. dollars. Oaktree is an externally managed business development company (BDC) and regulated investment company (RIC) that provides credit and related investments, primarily to middle-market companies.
Key financial results
| Metric | Quarter ended Dec. 31, 2022 | Prior-year quarter / comparison |
|---|---|---|
| Total investment income | $79.2 million | $64.9 million; up 21.9% |
| Net expenses, after fee waivers | $40.3 million | $29.3 million; up 37.3% |
| Net investment income | $38.8 million; $0.63 per share | $32.3 million; $0.54 per share |
| Net realized gains (losses) | $(3.2) million | $9.3 million |
| Net unrealized appreciation (depreciation) | $(23.0) million | $(4.6) million |
| Net increase in net assets from operations | $13.2 million; $0.22 per share | $39.4 million; $0.66 per share |
| Net asset value (NAV) | $19.63 per share; $1.202 billion total net assets | $20.38 per share at Sept. 30, 2022 |
| Cash distributions declared and paid during quarter | $0.96 per share, including a $0.42 special distribution | $0.465 per share in prior-year quarter |
Higher interest income, primarily from rising reference rates, and increased fee income drove revenue growth. Higher borrowing costs and incentive fees offset much of that gain. Net investment income rose, but lower realized results and greater unrealized depreciation reduced the increase in net assets from operations.
Portfolio, cash flow, debt and liquidity
- Investments at fair value were $2.643 billion, compared with $2.494 billion at September 30, 2022. New originations exceeded repayments; the portfolio covered 156 companies. Senior secured debt was 86.3% of portfolio fair value.
- About 87.3% of debt investments at fair value bore floating rates. Interest income therefore benefits from higher rates, while rate increases can also pressure portfolio borrowers and raise funding costs.
- Operating cash flow was $(109.9) million, largely reflecting $261.4 million of investment purchases, partly offset by $108.8 million of sales and repayments. Financing cash flow was $103.3 million, including $160.0 million of net credit-facility borrowings and $56.7 million of cash distributions. Cash and restricted cash ended at $19.2 million.
- Quarter-end credit-facility borrowings were $860 million; unsecured notes had $603.6 million net carrying value. Principal debt outstanding was $1.510 billion. Net debt to equity was 1.24x and asset coverage was 176.3%.
- Reported undrawn credit-facility capacity was $340 million, subject to borrowing-base and other limitations. Unfunded commitments totaled $198.9 million, including $27.1 million to the joint ventures.
- The company reported compliance with its financial covenants. It had no investments on non-accrual at quarter-end.
Material changes, outlook and risks
- Compared with the prior-year quarter, investment income increased $14.2 million, while net expenses increased $11.0 million. Unrealized depreciation worsened to $23.0 million from $4.6 million, and realized results shifted from a $9.3 million gain to a $3.2 million loss.
- Management cited inflation, rising interest rates, recession concerns, financial-market volatility and geopolitical conflict, including the war in Ukraine. It said it was monitoring portfolio-company impacts and described its focus for new investments as situational, select sponsor, stressed-sector and rescue lending. No quantified earnings or distribution guidance was provided.
- Management estimated that a 100-basis-point increase in base rates would increase annualized net assets from operations by approximately $10.9 million, excluding potential incentive-fee effects; a 100-basis-point decrease would reduce them by approximately $10.6 million. These are hypothetical estimates and assume no changes in the investment or capital structure.
- Valuation is a key uncertainty: most investments are privately held or otherwise illiquid, and $2.335 billion of the $2.643 billion portfolio was classified as Level 3. Management cautioned that estimated fair values may differ materially from realizable sale values.
- PIK interest was $6.1 million of the quarter’s investment income. PIK is accrued rather than received in cash and may ultimately prove uncollectible; certain PIK income may nevertheless need to be distributed to shareholders.
- Subsequent events: Oaktree completed its OSI2 merger on January 23, 2023, issuing 15.86 million shares; 77,079,805 shares were outstanding after the merger. The transaction also brought in an OSI2 credit facility with $225 million outstanding at closing. The company completed a 1-for-3 reverse stock split in January; per-share figures in this filing are retrospectively adjusted. A $0.55-per-share quarterly distribution was declared for payment March 31, 2023.
Important facts for investors to verify
- Whether portfolio valuations and realized credit outcomes support reported NAV, particularly for Level 3 holdings and investments marked below cost.
- Whether higher portfolio yields continue to outweigh higher borrowing costs, and how borrower performance responds to rates and weaker economic conditions.
- Cash available after distributions, investment funding and the $198.9 million of unfunded commitments; confirm actual facility availability under borrowing-base limits.
- Leverage, asset-coverage headroom and covenant compliance after the OSI2 merger and its additional debt.
- Distribution coverage by recurring cash income, including the effect of PIK income and the special distribution in the reported quarter.
- Portfolio concentration and credit quality, including exposure to application software, the joint ventures, and investments with reduced fair values.