Oxford Square Capital Corp. — Q3 2022 Form 10-Q Summary
Business context and reporting period
Oxford Square Capital Corp. is a closed-end investment company regulated as a business development company and taxed as a regulated investment company. Its objective is to maximize total return through investments primarily in corporate debt securities and collateralized loan obligation (CLO) structured finance investments. This filing covers the unaudited three and nine months ended September 30, 2022, compared with the corresponding 2021 periods, and the balance sheet is compared with December 31, 2021.
Financial condition and key metrics
| Metric | September 30, 2022 | Comparable period / prior date |
|---|---|---|
| Total assets | $358.0 million | $433.5 million at December 31, 2021 |
| Total investments at fair value | $340.2 million | $420.8 million at December 31, 2021 |
| Net assets | $166.5 million | $244.6 million at December 31, 2021 |
| NAV per common share | $3.34 | $4.92 at December 31, 2021 |
| Cash and cash equivalents | $14.4 million | $9.0 million at December 31, 2021 |
| Borrowings, carrying value | $186.1 million | $185.4 million at December 31, 2021 |
| Asset coverage for borrowings | 186% | 227% at December 31, 2021 |
| Portfolio weighted average debt yield | 10.41% | 7.49% at September 30, 2021 |
The investment portfolio comprised approximately $230.3 million of senior secured notes, $107.7 million of CLO equity and $2.2 million of other equity investments. Software represented 23.1% of portfolio fair value, business services 18.8%, healthcare 11.6%, and structured finance 31.7%.
Operating results and cash flow
| Metric | Three months ended September 30, 2022 | Three months ended September 30, 2021 | Nine months ended September 30, 2022 | Nine months ended September 30, 2021 |
|---|---|---|---|---|
| Total investment income | $11.4 million | $9.8 million | $31.2 million | $27.0 million |
| Total expenses | $5.8 million | $5.8 million | $17.1 million | $15.4 million |
| Net investment income | $5.6 million | $4.0 million | $14.1 million | $11.6 million |
| Net realized gains/(losses) | $0.1 million | $1.7 million | $(0.4) million | $(11.2) million |
| Net unrealized appreciation/(depreciation) | $(16.8) million | $5.6 million | $(76.5) million | $39.2 million |
| Net change in net assets from operations | $(11.1) million | $11.3 million | $(62.8) million | $39.6 million |
| Net investment income per share | $0.11 | $0.08 | $0.28 | $0.23 |
Net cash provided by operating activities was $18.8 million for the nine months ended September 30, 2022, versus $102.0 million of cash used in operating activities in the prior-year period. The company purchased $78.2 million of investments, received $49.8 million of principal repayments and $14.6 million from investment sales, and paid $15.3 million of distributions net of reinvestment activity. Ending cash and cash equivalents were $14.4 million.
Material changes versus prior comparable periods
- Investment income increased 16.3% for the quarter and 15.6% year to date, driven primarily by higher interest income and higher debt yields.
- Net investment income increased 39.5% for the quarter and 22.2% year to date, despite higher year-to-date interest expense and other operating expenses.
- Results were materially affected by fair-value declines: unrealized depreciation was $16.8 million for the quarter and $76.5 million year to date, compared with unrealized appreciation in the 2021 periods.
- Net assets declined by $78.0 million during the first nine months, primarily because of unrealized depreciation and distributions. NAV per share decreased from $4.92 at year-end 2021 to $3.34.
- The portfolio shifted toward senior secured notes as a percentage of fair value, while CLO equity declined from $155.6 million to $107.7 million.
- Debt principal remained $189.7 million, but the weighted average maturity shortened from 4.6 years to 3.8 years. Interest expense increased year to date because the 5.50% notes were outstanding for a full comparable period in 2022.
- Three debt investments remained on non-accrual status. Their aggregate principal value was approximately $27.8 million, while their aggregate fair value was approximately $0.5 million.
Guidance, outlook, risks and unusual items
- Management did not provide formal earnings or NAV guidance. It stated that results are subject to portfolio activity, interest rates, credit performance, valuation changes and access to capital.
- All debt investments had variable interest rates. Management estimated that a 100-basis-point increase in base rates would increase annualized investment income by approximately 6.0%, while a 100-basis-point decrease would reduce it by approximately 6.0%, before considering changes in portfolio composition or credit quality.
- Management highlighted risks from inflation, higher interest rates, economic weakness, credit losses, market illiquidity, the transition from LIBOR to alternative reference rates, COVID-19-related disruptions, cybersecurity, and the Russia-Ukraine conflict.
- Approximately 69.7% of total assets were qualifying assets under the 1940 Act at September 30, 2022, below the 70% threshold applicable when acquiring additional non-qualifying assets. The company stated that it acquired no additional non-qualifying assets while below the threshold.
- All investments other than cash equivalents were classified as Level 3 fair values, making NAV sensitive to unobservable valuation inputs, market quotes and management judgments.
- CLO equity distributions and income are based partly on estimated future cash flows and may not ultimately be realized. CLO payment levels may decline if collateralization or interest coverage tests fail.
- The company declared monthly distributions of $0.035 per share for October, November and December 2022 and for January, February and March 2023. Distribution tax character remains subject to final year-end determination.
- The replacement revolver investment in Premiere Global Services was amended on September 30, 2022, to extend maturity to December 16, 2022. It had no unfunded commitment and was on non-accrual status.
- The company reported no material legal proceedings, no commitments to purchase additional investments, no defaults upon senior securities and no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Whether the $76.5 million year-to-date unrealized depreciation and the decline in NAV are temporary market effects or reflect lasting deterioration in portfolio credit quality.
- The recoverability and future cash income from the three non-accrual investments, including the approximately $27.8 million of principal exposure.
- The sustainability of CLO equity distributions and the assumptions underlying Level 3 valuations.
- Liquidity and refinancing capacity for the $64.4 million of notes due in 2024 and the $44.8 million of notes due in 2026, given the 186% asset coverage ratio.
- The impact of further interest-rate increases, LIBOR replacement terms and potential changes in CLO collateral performance.
- The final tax character of 2022 distributions and whether any portion is treated as return of capital.