Q4 2024 Oaktree Specialty Lending Corp Earnings Call

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Speaker Change: Welcome and thank you for joining Oatree Specialty Lending Corporation's fourth fiscal quarter conference call. Today's conference call is being recorded. If you require operator assistance, please press star then zero. 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.

Speaker Change: Before I pass the call over to the Oaktree team, I want to remind you that comments on today's call may include forward-looking statements reflecting Oaktree's current views with respect to future operating results and financial performance.

Speaker Change: Actual results could differ materially from those implied or expressed in the forward-looking statements.

Speaker Change: Please refer to OCSL's SEC filings for a discussion of these factors in further detail. Oaktree undertakes no duty to update or revise any forward-looking statements.

Speaker Change: I'd also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in any Oaktree fund.

Speaker Change: Now, I would like to introduce Dane Kleven, Head of Investor Relations, who will host today's conference call. Mr. Kleven, you may begin.

Thank you, Operator, and thank you all for listening in.

Speaker Change: We very much appreciate your support of Oak Tree Specialty Lending Corporation.

Speaker Change: I'd like to welcome you to our earnings call for the fourth fiscal quarter of 2024. Our earnings release, which we issued this morning, and the accompanying slide presentation can be accessed on the investor section of our website at oaktreespecialtylending.com. We encourage investors, the media, and others to review the information that is shared on our website.

Speaker Change: Joining us on the call today are Armin Panossian, Chief Executive Officer and Co-Chief Investment Officer, Matt Pendo, President, and Chris McKown, Chief Financial Officer and Treasurer. With that, I would now like to turn the call over to Matt to discuss our results.

Matt Pendo: Thanks, Dane, and welcome, everyone. Our adjusted NAI for the fiscal fourth quarter ended September 30, 2024, with $45 million or 55 cents per share, which was consistent with our third quarter results.

Matt Pendo: NII for the quarter reflected our healthy origination and repayment activity combined with the decrease in net expenses driven by our lower management fees that went into effect on July 1st and interest expense.

Matt Pendo: This was partially upset by a modest decline in adjusted total investment income as certain investments were moved to non-accrual status.

Matt Pendo: Full year fiscal 2024 adjusted NII was $179 million, or $2.23 per share, compared to $178 million, or $2.47 per share, for fiscal year 2023.

Matt Pendo: The dollar increase was driven by higher investment income generated from a larger average investment portfolio following last year's completion of our merger with Oaktree Strategic Income II, Inc. or OSI II

Matt Pendo: impact of higher base rates and an increase in prepayment fees and OID acceleration from successful investment exits.

Matt Pendo: These drivers were offset by an increase in investments placed on non-accrual status and higher interest expense, primarily due to our floating rate liabilities. The year-over-year per share decrease in adjusted NAI reflects a higher share count from the issuance of common shares.

Matt Pendo: During fiscal 2024, we continue to rotate into primarily first-lien loans.

Matt Pendo: Our first lien investments increased to 82% from 76% at fiscal year-end 2023. Concurrently, second lien investments decreased from 10% to 4%.

Matt Pendo: Investments on non-accrual status at quarter end were 4% at fair value and 4.9% at cost compared to 3.7% and 5.7% last quarter.

Matt Pendo: During the quarter, we successfully restructured two investments and removed them from non-accrual. However, we placed three additional investments on non-accrual status and took some further write-downs on certain investments.

Matt Pendo: Our net asset value per share decreased slightly to $18.09 from $18.19 last quarter. We are working closely with each company and using our resources and expertise to achieve successful outcomes for our shareholders.

Matt Pendo: Given that these non-accruals and additional write-downs had an impact on our earnings and net asset value, we waived $1.2 million of Part 1 incentive fees for the quarter.

Matt Pendo: This is in addition to the $3.2 million of Part 1 incentive fees that we waived last quarter and $1.3 million of additional discretionary fees waived since the OSI-2 merger in January of last year.

Matt Pendo: As a reminder, we implemented a permanent reduction in the base management fee from 1.5% to 1.0% of gross assets affected July 1, 2024. We hope these actions reflect our ongoing commitment to our shareholders.

Turning to investment activity.

Matt Pendo: We continue to identify compelling investment opportunities across sponsored and non-sponsored companies, as well as in undervalued publicly traded credits, while maintaining our disciplined and selective investment approach in a competitive environment.

Matt Pendo: Paydowns and exits in the quarter generated $338 million in proceeds, up from $186 million in the third quarter.

Matt Pendo: With refinancing activity increasing across the broader market, we have experienced higher levels of paydowns. We believe this speaks to the strength of our overall portfolio as well as our due diligence and investment process.

Matt Pendo: These paydowns demonstrate the ability of our portfolio companies to successfully execute their business plans, positioning them to refinance debt at more attractive prices, reduce leverage, or sell their businesses.

Matt Pendo: Turning to the liability side of our balance sheet, at fiscal year-end, we had substantial liquidity to fund our investment commitments and future investment opportunities. This included $908 million of undirected capacity under our credit facilities and unrestricted cash and cash equivalents of $64 million.

Matt Pendo: Total debt-to-equity was 1.12 times and net debt-to-equity was 1.07 times after adjusting for cash and cash equivalents.

Matt Pendo: With respect to the dividend, our board approved a quarterly dividend of 55 cents per share consistent with prior quarterly distributions.

Speaker Change: This dividend is payable in cash on December 31st, 2024. The stock holds a record on December 16th, 2024. With that, I will turn the call over to Armin to provide more details on our portfolio and the market environment.

Armin Panossian: Thank you Matt and hello everyone. Before I review our portfolio activity, I'd like to provide a quick update on our leadership team. I'm excited to announce the appointment of Raghav Khanna as Co-Chief Investment Officer for OCSL.

Armin Panossian: Raghav joined Oaktree in 2012 as a member of our Global Opportunities Group before becoming a founding member of the Strategic Credit Strategy in 2014, where he now serves as a co-portfolio manager and an Investment Committee member.

Armin Panossian: With that, I will now turn to our portfolio activity for the quarter and conclude with observations in the current market environment. Our portfolio remained well-diversified across 144 companies with a fair market value of over $3 billion at the end of the fourth quarter.

Armin Panossian: in line with our objective to lend to the at the top of the capital structure.

Armin Panossian: To mitigate risk in the current environment, we are pursuing and investing in a diverse group of industries and larger companies. In the fourth quarter, the median EBITDA for our portfolio companies was $140 million and the median leverage was 5.2 times.

Armin Panossian: This leverage ratio is roughly in line with the prior quarter, yet notably below the average for middle market companies. Our portfolio companies continue to perform well with a weighted average interest coverage ratio using current base rates at 2.3 times.

Armin Panossian: During the fourth quarter, we invested $259 million into a diverse set of nine new and 10 existing portfolio companies. Now I will provide details of a few key investments.

Armin Panossian: I will begin with Legends Hospitality, a premium experience company that delivers holistic solutions to sports and entertainment organizations and venues. Legends was founded in 2008 by the ownership groups of the New York Yankees and Dallas Cowboys to manage concessions for two new stadiums.

Armin Panossian: In August, Oaktree co-led a new $2 billion credit facility to support Legends' acquisition of ASM Global Parent, which provides venue management services to a global portfolio of over 350 stadiums, arenas, convention centers, and theaters.

Armin Panossian: Next, Integrity Marketing is a leading independent marketing organization and omni-channel insurance technology company that focuses on life, health, and wealth products, with an emphasis on the senior market.

Armin Panossian: In the fiscal fourth quarter, Oaktree participated in a new $6.5 billion credit facility to support Integrity's debt refinancing, future M&A pipeline, and working capital.

Armin Panossian: Oakshree provided $194 million of the term loan, $25.6 million of the revolver, and $137 million of the delayed draw term loan.

Armin Panossian: The term loan has a coupon of SOFR plus 5% and one point of OID. OCSL participated in 36 million dollars of this deal.

Armin Panossian: We made another significant investment in Everbridge, a global software company that provides critical event management solutions to global corporations, government agencies, and non-profit institutions.

Armin Panossian: with security management solutions that help with incident preparedness, risk monitoring, and service reliability. In September, Oaktree co-led a new $1.35 billion credit facility to fund a sponsors acquisition of Everbridge.

Armin Panossian: The facility consists of a $1 billion Ursling term loan, a $100 million revolving credit facility, and a $250 million delayed drop term loan.

Armin Panossian: Oakree provided $159 million of the term loan, $16 million of the revolver, and $40 million of the delayed draw term. The term loan has a coupon of SOFR plus 5% and a half a point of OID.

OCSL participated in 27 million dollars of this deal.

Armin Panossian: These investments demonstrate the power of the Oaktree platform, which is a key competitive advantage that gives us access to compelling investment opportunities, as well as the ability to invest in larger transactions.

Armin Panossian: Now, let's take a closer look at the credit quality of the portfolio.

Speaker Change: As Matt noted, we experienced an increase in the net number of non-accrual loans during the fourth quarter. While our team successfully restructured two investments that were previously on non-accrual status, we added Telestream Holdings and the second out tranches of Astra Acquisition Corp. and Enthrive to non-accrual status during the quarter.

Speaker Change: Looking at the new additions, I'll begin with Astra Acquisition Corporation.

Speaker Change: Astra Acquisition Corporation is a provider of cloud-based software solutions for higher educational institutions.

Speaker Change: Our original investment in Astra was a first-line term loan that was exchanged into a Term Loan A and Term Loan B through a restructuring that closed in April of 2024. Recently, bookings have trended lower, negatively impacting the company's EBITDA and the price at which these loans are quoted in the secondary market.

Speaker Change: These events caused us to put the Term Loan B, which is a second out tranche, on non-accrual. We are working closely with management and the lender group to address ASTRA's declining revenue with the goal of maximizing value of our debt position.

Speaker Change: Now, I will discuss Enthrive, a software company that helps healthcare clients manage their revenue and cash flow.

Speaker Change: in which we hold both a first lien and second lien term loan position. The second lien term loan was placed on non-accrual as a result of declining bookings and lower retention rates. We continue to closely monitor this name.

Next.

Speaker Change: Telestream Holdings is a video software platform that provides on-demand digital video tools and workflow solutions to a diversified customer base.

Speaker Change: Our investment in Telestream includes a first lane term loan and a small revolver. Although there was no valuation change at quarter end, we proactively placed both loans on non-accrual due to liquidity constraints at the company and concerns about collecting coupon interest.

Speaker Change: Finally, as Matt mentioned, we restructured two names previously on our non-accrual list, chlorophyte and impel.

Speaker Change: For Pluralsight, in August, along with other lenders, OAKS re-completed a recapitalization of the company, equitizing part of our former position, receiving some take-back debt, and providing additional capital to the company in the form of a delay-draw term loan and a revolving credit facility.

Speaker Change: We are working with management and the other lenders post reorganization and are confident in our ability to work through situations like these.

Speaker Change: In the case of Impel, the company's primary product, TruDessa, was acquired by a third party who will be seeking to monetize the drug through a reinvigorated sales effort.

Speaker Change: In connection with the acquisition, OCSL and other debtors received a cash payment and the right to receive future payments if the acquirer achieves certain sales milestones.

Speaker Change: Now turning to our view of the market environment. Although the fixed income markets have recently benefited from lower short-term interest rates, we remain in an elevated interest rate environment, which has materially increased the cost of debt capital, especially for highly levered companies.

Speaker Change: Against this backdrop, we are in constant communication with our portfolio companies to evaluate their businesses and markets and ability to navigate the current interest rate environment. Our goal is to identify any potential issues as early as possible and to work collaboratively with our borrowers to resolve them.

Speaker Change: During the fiscal fourth quarter, credit markets continued to rally as the Fed initiated its easing cycle with a 50-basis point cut to the Fed Fund's target rate in September and another 25-basis point cut earlier this month.

Speaker Change: Base rates declined from the prior quarter, and credit spends continued to tighten.

Speaker Change: The more active, broadly syndicated loan market, in combination with large amounts of capital, is driving lenders to aggressively compete for new opportunities, which is also improving deal terms for borrowers. This has driven an increase in repricings and refinancing for many issuers in the private credit space.

Speaker Change: M&A activity has continued to trend higher, and the industry continues to be optimistic regarding future volume, anticipating increased activity in early 2025. Private market borrowers generally remain healthy, demonstrating stable revenues and EBITDA growth.

Speaker Change: Interest coverage ratios continue to be a focus in the market, and with spreads tightening and SOFR rates declining, the average interest coverage ratio is expected to increase.

Speaker Change: Additionally, the fair value of direct lending investments increased from last quarter due to tighter credit spreads and overall solid fundamental company performance.

Speaker Change: Turning to the impact of the U.S. election, President-elect Trump is widely regarded as a pro-business leader. He has committed to lowering corporate taxes, reducing regulation, and easing restrictions on energy production.

Speaker Change: These measures are generally favorable for corporate profitability. Moreover, we anticipate a surge in M&A and IPO activity under Trump's administration. This uptick in deal-making is likely to create a strong pipeline of deals in 2025.

Speaker Change: As I said earlier, we remain focused on the inherent risks of the current market. While the emergency inflation rate hike cycle is over, and short-term rates have declined recently,

Speaker Change: We do not believe the Fed will take rates back to the ultra-low levels of the last decade.

Speaker Change: In other words, rates are likely to remain higher for an extended period, and this could be challenging for companies with elevated debt levels.

Speaker Change: While inflation has recently subsided, high costs remain a challenge for companies and consumers.

Speaker Change: The environment appears to be improving, however, we believe it is prudent to remain cautious. We are closely watching market conditions and lenders' appetite to refinance companies with maturing debt as we believe companies with refinancing needs may have difficulty obtaining cost-effective capital if credit becomes less available.

Speaker Change: Now, I will turn the call over to Chris to discuss our financial results in more detail.

Chris McKown: Thank you, Armin. As Matt noted, for our fourth fiscal quarter, we reported adjusted net investment income of $45.2 million, or $0.55 per share, which was consistent with the prior quarter ending June 30, 2024.

Chris McKown: Adjusted total investment income for the quarter declined 0.6 million dollars or about one cent from the prior quarter.

Chris McKown: This was driven by a 2.7 million dollar decrease in interest income resulting from placing certain investments on non-accrual status, smaller average portfolio size, and the impact of spread compression.

Chris McKown: These factors were partially offset by increased OID acceleration in connection with repayments.

Chris McKown: We also had a $0.3 million decline in dividend income from the Kemper JV.

Chris McKown: These decreases were offset by a $2.4 million increase in fee income, which was primarily driven by prepayment and exit fees.

Chris McKown: Non-recurring income generated in connection with successful investment exits did have a larger than usual impact on our results this quarter. To give you a sense of magnitude, our non-recurring income in the September quarter was about $0.09, whereas we generally see non-recurring income in the neighborhood of about $0.03 to $0.05 per share per quarter.

Chris McKown: Net expenses declined $0.6 million from the prior quarter, driven by a $2.5 million decrease in management fees, net of fees waived.

Chris McKown: $0.5 million of lower interest expense from lower average borrowings and $0.2 million of lower professional fees, partially offset by $2.6 million of higher Part 1 incentive fees, net of fees waived.

Now, moving to our balance sheet.

Chris McKown: OCSL's net leverage ratio at quarter end was 1.07 times, down from 1.10 times at the end of the third quarter.

Chris McKown: Repayments and sales of $338 million outpaced our newly funded investments of $233 million.

Chris McKown: This, in combination with the markdowns this quarter, resulted in a slight decline in the size of our portfolio.

Chris McKown: Our net leverage remained within our targeted range of 0.9 times to 1.25 times.

Chris McKown: As of September 30th, total debt outstanding was $1.66 billion and, including the effect of our interest rate swap agreements, had a weighted average interest rate of 6.7%, which is slightly down from last quarter.

Chris McKown: Unsecured debt represented 57% of total debt at quarter end, up marginally from the prior quarter. Our liquidity remained strong, including $64 million of cash and $908 million of undrawn capacity on our credit facilities.

Chris McKown: Unfunded commitments, excluding those related to the joint ventures, were $284 million with approximately $248 million eligible to be drawn immediately. The remaining $36 million is subject to certain milestones that must be met by portfolio companies before the funds can be drawn.

Chris McKown: Now, turning to our two joint ventures, together, the JVs currently hold $454 million of investments, primarily in broadly syndicated loans, spread across 49 portfolio companies.

Chris McKown: For the quarter, the JVs again generated attractive annualized ROEs, which when combined were approximately 11.2%.

Chris McKown: Leverage at the JVs was 1.4 times in aggregate at quarter end, flat with the last quarter due to a slight increase in unrealized depreciation in the underlying portfolios, partially offset by repayments received from portfolio companies during the quarter.

Chris McKown: With that, we appreciate your participation on the call today and for your interest in OCSL. We are happy to take your questions now. Operator, please open the lines.

We will now begin the question and answer session.

Speaker Change: To ask a question, you may press star then 1 on your telephone keypad.

Speaker Change: If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster.

Paul Johnson, Paul Johnson, Paul Johnson, Paul Johnson

Speaker Change: Our first question today is from Paul Johnston with KBW. Please go ahead.

Speaker Change: Yeah, thanks. Good morning. Thanks for taking my questions. Just on the incentive fee waiver this quarter, just trying to understand if this is going to be something that the advisor is committed to on a go-forward basis to the extent that NII trends below the $0.55 dividend.

Speaker Change: Hey Paul, it's Matt Pendo. Thanks for the question. So, this quarter we announced a

Speaker Change: the quarter prior to that there was a another discretionary fee waiver of you know 3.2 million

Speaker Change: You know, we view those as discretionary, you know, not permanent.

Speaker Change: So, you know, that's kind of how we're looking at it, kind of quarter to quarter.

Yes, yes.

Speaker Change: The July, you know, starting July 1 is when the management fee was reduced to 1%. That, that was permanent.

Speaker Change: So, that's kind of how, you know, we've approached the incentive fee waiver and then, obviously, the 1% managed fee is permanent.

Speaker Change: Got it. Thanks for that. And then just on a few credits in the portfolio, the Thin Thrive, obviously going on non-accrual this quarter, but it looked like it was just marked incrementally higher in the quarter. Thrasio also on non-accrual.

It's still had a fairly strong mark, quarter over quarter.

Speaker Change: Yeah, how do you feel I guess you know and in terms of you know, how comfortable are you with where? You know either those loans are adding give you especially Frazier which has been on a crawl a little bit longer I mean are we is that investment approaching?

Speaker Change: point of resolution anytime soon? Is there any sort of update there?

Thanks for the question, this is Armin.

Speaker Change: On Thrasio, I think this is an execution story that's going to take another few quarters. I wouldn't say that it is.

close to a resolution that we would think is value-maximizing.

Speaker Change: For Finthrive, or Anthrive as it's known, there is public information out there, a press release that was disclosed yesterday, which we think is actually positive for the company and its stability, and we think that that business is well positioned, but certainly

Speaker Change: has some execution to do and it's and has a lot of engagement from its sponsor. We are watching it closely but I think Finthrive and Nthrive and Thrive are in very different positions.

Speaker Change: I was wondering if you could tell us, I mean, within the delayed draw or the revolver, I should say, is there the loan is still on pick at this point. I mean, is there anything that restricts the borrower from.

Speaker Change: borrowing on the revolver to pay the interest on the restructured loan.

Speaker Change: I'll give you a more detailed answer with a legal read, but that isn't the intention to draw on the revolver to pay the coupon. The revolver is meant...

Speaker Change: to support the business as it repositions itself and strengthens its position. It's not meant to pay coupon interest.

Got it. And last one for me.

Speaker Change: If 2025 next year ends up being, you know, a good year and we have a very good wave of activity in the market, I mean, how do you feel about kind of terms and covenants in the market? Do you think that direct lenders are going to be able to hold the line on kind of further covenant and term erosion and, you know, kind of where do you think, you know, we stand in terms of

You know how documents hurt.

are going to be holding up in the market.

Speaker Change: Sure, I think in the lower middle market and the core middle market, so lower middle market between being companies with 20 million of EBITDA or lower, core middle market being 20 to 70 million of EBITDA, I think in those two categories we should expect to see reasonably good covenants.

Speaker Change: tested quarterly, reasonably good protections in terms of stripping collateral away from lenders.

Speaker Change: I think as you get larger, as you get to 100 million, 150, 200 million of EBITDA, you know, those businesses or those borrowers...

Speaker Change: comp their leverage terms to what could be available in the broadly syndicated loan markets, which are much weaker covenants.

Speaker Change: And therefore, I think there has been covenant erosion in that very large end of the market.

Speaker Change: And I would think, though, that as deal flow picks up, that some of those covenants will come back on the large cap end and on the core middle market and on the lower middle market end. I think they will continue.

to...

I think over the last 12 months or so,

Speaker Change: There's been a condition where there haven't been that many deals and there's there has been a substantial amount of capital chasing those deals

So we have seen a tightening of spreads.

Speaker Change: in the last 12 to 24 months, and we have generally seen a little bit of a loosening of covenants, especially in that large cap end of the market. And I think more deal flow will help to counter some of that, but I don't think it will completely undo what has happened in terms of legal protections or spread compression in the market.

Thanks for that. It's very helpful.

Speaker Change: Again, if you have a question, please press star then 1. The next question is from Melissa Waddell with JPMorgan. Please go ahead.

Speaker Change: Good morning. If I'm reading between the lines a little bit regarding your comments on the investment environment right now, it sounds like you're not necessarily expecting a normally large December quarter like we typically see on a seasonal basis and you're sort of expecting that activity to pick up in early 25.

Am I interpreting that right?

Armin Panossian: Yeah, this is Armin and Melissa. We don't want to make forward-looking statements, and I would say that it's very hard to predict, sort of,

Armin Panossian: fourth quarter and first quarter sometimes, because deals that are slotted to happen in the fourth quarter sometimes slip into the first quarter. Sometimes they're accelerated into the fourth quarter, which is more rare. I would just say that over an extended period of time, over the next 12 to 24 months with lower rates,

Armin Panossian: and with the decline and spread that we've seen over the last 12 to 24 months.

Armin Panossian: the expectation and some of the conversations that we've been having with sponsors and with non-sponsored companies has certainly picked up. The velocity of those conversations has picked up. It's hard to predict one quarter of the next though.

Speaker Change: Okay, fair enough. I also wanted to go back to the JVs. I'm wondering, we've seen that, you know, slip a little bit in terms of portfolio allocation year-over-year. I'm wondering if you see an opportunity, particularly in a more compressed spread environment, to sort of further optimize those JVs and maybe generate some incremental income and how...

how that might be sized.

Appreciate your thoughts

Sure, this is Armin again.

Speaker Change: We're always looking at optimizing the JVs. There are ways that we think we could do that. So I do think that there are some ways to get a little bit more return out of them. We have JV partners, however, and we are in constant dialogue with them, but expansion of those JVs really is a partnership.

Speaker Change: at this time about expanding those JVs, but we are constantly looking at the portfolio allocation there, the nature of the portfolio, public versus private positions, as well as the quantum and cost of the leverage.

Speaker Change: So we will always look to optimize those for the JVs and for OCSL.

Speaker Change: A quick follow-up there. In terms of the level of leverage in each of the JVs right now, can you give us just an update on how you're thinking about the current leverage and whether within the existing framework that's there, if there's an opportunity to increase the capacity just through higher leverage? Thanks.

Speaker Change: Sure, I mean the leverage levels there are in the above one times And we we think sorry now on a combined basis between the two JVs. It's about 1.4 times

Speaker Change: We are looking to take it up over time. It's not going to be a significant and sudden increase.

Speaker Change: But we do think that there's a little bit of leverage capacity there to increase given the nature of those portfolios on the the performing names in those portfolios are largely publicly traded debt that you can get a much higher than 1.4 times leverage multiple on

Speaker Change: And we do have some legacy positions in those JVs that existed prior to Oak Tree's assumption of the management of OCSL that we're consistently or constantly looking to restructure and turn into performing credit assets for those JVs.

Speaker Change: and we will look to rotate out of the privates in there and make it a largely a broadly syndicated loan portfolio with some increases in leverage beyond the 1.4 times that there is currently there.

Thank you.

Welcome.

Speaker Change: This concludes our question and answer session. I would like to turn the conference back over to Dane Kleven for any closing remarks.

Dane Kleven: Thank you all for joining today's call and for your continued interest in OCSL. Please reach out if you have any additional questions. We appreciate your time today.

Speaker Change: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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