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Oaktree Specialty Lending Corporation (OCSL) Q1 2024 Earnings Call Transcript

Oaktree Specialty Lending Corporation (OCSL)

Q1 2024 Earnings Conference Call

Company Participants

Michael Mosticchio - Head of Investor Relations

Armen Panossian - Chief Executive Officer and Chief Investments Officer

Matt Pendo - President

Chris McKown - Chief Financial Officer and Treasurer

Matt Stewart - Chief Operating Officer

Conference Call Participants

Kyle Joseph - Jefferies

Bryce Rowe - B. Riley

Finian O'Shea - Wells Fargo

Erik Zwick - The Hovde Group

Paul Johnson - KBW

Melissa Wedel - JPMorgan

Presentation

Operator

Hello and welcome. Thank you for joining Oaktree Specialty Lending Corporation's First Fiscal Quarter Conference Call. Today's conference call is being recorded. At this time, all participants are in a listen-only mode. But will be prompted for a question-and-answer session following the prepared remarks.

Now, I would like to introduce Michael Mosticchio, Head of Investor Relations, who will host today's conference call. Mr. Mosticchio, please begin.

Michael Mosticchio

Thank you, Operator, and welcome to Oaktree Specialty Lending Corporation's first fiscal quarter conference call. Our earnings release, which we issued this morning and the accompanying slide presentation, can be accessed on the Investors section of our website at oaktreespecialtylending.com.

Joining us on the call today are Armen Panossian, Chief Executive Officer and Chief Investment Officer; Matt Pendo, President; Chris McKown, Chief Financial Officer and Treasurer; and Matt Stewart, our Chief Operating Officer.

Before we begin, I want to remind you that comments on today's call include forward-looking statements reflecting our current views with respect to, among other things, the expected synergies and savings associated with the merger with Oaktree Strategic Income II, Inc., the ability to realize the anticipated benefits of the merger, and our future operating results and financial performance. Our actual results could differ materially from those implied or expressed in the forward-looking statements. Please refer to our SEC filings for a discussion of these factors in further detail. We undertake no duty to update or revise any forward-looking statements.

I would also like to remind you that nothing on this call constitutes an offer to sell or solicitation of an offer to purchase any interest in any Oaktree Fund. Investors and others should note that Oaktree Specialty Lending uses the Investors section of its corporate website to announce material information. The company encourages investors, the media and others to review the information that it shares on its website.

With that, I would now like to turn the call over to Matt.

Matt Pendo

Thanks, Mike, and welcome everyone. Thank you for joining us today and for your interest in and support of OCSL. We identified a diverse set of attractive investment opportunities in our first quarter, driving strong origination activity and solid earnings. Adjusted NII was $0.57 per share, down from $0.62 for the prior quarter. These results reflect higher interest income from our predominantly floating rate portfolio and benefits of the scale we built with OSI2 merger. However, our results were impacted by idiosyncratic performance challenges at four portfolio companies. Armen will provide more specifics, but we experienced an uptick in non-accruals during the quarter as a result.

We are engaged in working with each company to address their specific situations. We are drawing upon our long history and proven expertise in turning around challenged investments, as well as the deep resources of Oaktree to maximize outcomes for our shareholders. Investments on non-accrual status at quarter-end represented 4.2% and 5.9% of the debt portfolio at fair value and cost, respectively. That was up from 1.8% of the debt portfolio at fair value, and 2.4% of the portfolio at cost last quarter.

We reported NAV per share $19.14, down from $19.63 per share for the prior quarter. The decline reflected realized and unrealized losses on certain debt and equity investments, including the markdowns on the aforementioned four portfolio investments, as well as the $0.07 per share special distribution that was paid in December. This was partially offset by broader credit spread tightening across the portfolio.

Our investment activity for the first quarter was strong, with $370 million of new investment commitments, up substantially from $87 million in the prior quarter. We continue to find attractive opportunities across sponsor, non-sponsor, and discounted publicly traded credit investments, generating net portfolio growth for the quarter, even as we maintain our highly selective approach to investing amid the uncertain current economic environment. Importantly, our new originations were made during an attractive environment for private credit, highlighted by higher interest rates and lender-friendly deal structure and terms, including lower leverage and loan-to-values. The weighted average yield on new debt investments was 11.6%.

On the repayment front, we received $214 million from paydowns and exits in the first quarter. While market activity has eased overall given higher interest rates and fewer M&A transactions, we continue to receive steady levels of repayments. We have also been opportunistically selling out of certain liquid securities, including several junior capital positions. As we noted previously, about 30% of our portfolio turned over in fiscal year 2023, and that trend continued into the first quarter. We believe this amplifies the strength in the overall portfolio and our underwriting and selection process.

As we see portfolio exits, it is largely because of these companies' achievements of their respective financial goals, enabling them to pay down debt, refinance at lower rates or sell at attractive prices to larger competitors. In short, these outcomes effectively validate our initial investment decisions. Importantly, our portfolio turnover continues to drive a positive shift in our investment composition. Our first lien investments increased from 71% as of September 30, 2022, to 78% as of December 31, 2023. At the same time, second lien investments decreased from 16% to 8%. This shift underscores our emphasis on improving the risk profile of our portfolio.

Turning to the right-hand side of our balance sheet, as always, we maintained ample liquidity to meet funding needs. At quarter-end, our net leverage ratio was 1x, consistent with the prior quarter. We had $908 million available on our credit facility, and $112 million of cash. Our Board approved the quarterly dividend of $0.55 per share, consistent with the prior quarterly distribution. Importantly, our dividend continues to be covered by our earnings despite the headwinds caused by the increase in non-accruals.

With that, I would like to turn the call over to Armen to provide more color on our portfolio activity and the market environment.

Armen Panossian

Thanks, Matt, and hello everyone. I'll begin with comments on our portfolio activity, and then conclude with observations regarding the market environment. Our portfolio was well-diversified with $3 billion of fair value across 146 companies at the close of the quarter. We continue to prioritize investing at the top of the capital structure, with 86% of the portfolio invested in senior secured loans, and first lien loans representing 78% of the portfolio at fair value. The further minimize risk; we are focused on larger, more diversified businesses. Median portfolio company EBITDA, as of December, was approximately $133 million, and leverage in our portfolio companies was approximately 5.3x, we below overall middle-market leverage levels.

Our portfolio companies have been performing well despite the higher interest rate environment. The portfolios weighted average interest coverage based on current base rates was in line with the prior quarter at 1.9x. In the December quarter, we originated $370 million of new investment commitments across 14 new and 10 existing portfolio companies. Nearly all of these originations were first lien loans.

The diversity of our originations is evident in key examples from the quarter. AmSpec, one of the world's largest testing and certification services providers specializing in energy commodities and fuels, Oaktree was presented with an opportunity to be the lead underwriter to fund the purchase of the company by a sponsor and provided $301 million of a $710 million financing package for the company, which came with a 2.5% original issue discount and a SOFR plus 5.75% coupon. OCSL was allocated $43 million of this transaction.

PetVet, an operator of veterinary hospitals, as joint lead arranger and one of the largest lenders in the deal, Oaktree made a $673 million total commitment with the company, with OCSL allocated $71 million. ProFrac, an oil field services business with fracturing fleets and sand mines. This is a non-sponsored name that Oaktree has been invested in for several years. And as part of a refinancing package, Oaktree made a $150 million commitment in the $520 million refinancing. OCSL was allocated $29 million. We also made $68 million of secondary market purchases, including discounted first lien bonds at an average price of 90. As we move further into the new year, our origination activity is healthy, and we have a strong pipeline of opportunities.

Turning to credit quality, as Matt noted, we experienced an increase in non-accruals during the quarter, driven by the additions of Thrasio, Impel Pharmaceuticals, OTG Management, and Stitch Acquisition, also known as Singer. Another name, CIG Logistics, which had been on non-accrual, was restructured and thus removed from non-accrual status.

Looking closer at the new additions, I'll begin with Thrasio, an Amazon marketplace aggregator. This is a company that capitalized on elevated demand during the pandemic, which required growing its operations and increasing leverage. Recently, it has faced operational challenges related to supply chain delays and inventory, as well as reduced Amazon traffic. The company entered forbearance on our loan during the first quarter, and we are engaged with the management team and other lenders to develop a new path and the best possible outcome, potentially including a restructuring.

Regarding OTG management, this company operates an airport concession business across several airports throughout the U.S. We made this investment alongside our opportunity's funds in 2021 as the company was emerging from the pandemic travel slowdown. While the company's performance has been solid as air travel has rebounded, it has faced a higher interest expense burden from the increase in interest rates, pressuring cash flow generation....

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