Oaktree Specialty Lending Corp Q2 FY2025 earnings call

• Performance: Adjusted net investment income decreased due to lower total investment income, partially offset by reduced interest expense and Part 1 incentive fees. Non-accrual investments increased, but progress was made in resolving some, like exiting SVP-Singer. Sales activity in Avery picked up.
• Capital structure: Issued new unsecured bonds and amended the senior secured revolving credit facility, reducing interest rate. Unsecured debt increased as a percentage of total debt.
• Dividend: Board approved base and supplemental dividends as per new policy.
• Joint ventures: Hold $440 million of investments, generated attractive ROEs.
• Investment activity: Committed $407 million of capital across 32 investments, weighted average yield on new debt investments was 9.5%. Focus on portfolio diversification, prioritizing larger diversified businesses. Highlighted loans to Vantive and Barracuda.
• Exit and repayment: Investment exits slowed to $279 million in the second quarter, primarily due to fewer sales in liquid portfolio.

Adjusted net investment income was $39 million or $0.45 per share in the second quarter, compared to $45 million or $0.54 per share in the first quarter. Net asset value was $16.75 per share versus $17.63 in the prior quarter. Investments on non-accrual status increased to 4.6% and 7.6% of fair market value and cost respectively, up from 3.9% and 5.1% in the first quarter. We exited our loan position in SVP-Singer, receiving $5.7 million. Sales activity in Avery, a luxury mixed use building in San Francisco, picked up. We received nearly $100 million from repayments on debt investments in April. The board approved a base dividend of $0.40 per share and a variable supplemental dividend of $0.02 per share for the second quarter. Successfully issued new unsecured bonds to refinance existing ones and amended the senior secured revolving credit facility, reducing the interest rate. Joint ventures currently hold $440 million of investments, generating approximately 10.6% annualized ROEs in the second fiscal quarter.

• Target leverage range remains 0.9 times to 1.25 times, currently at the low end due to successful exits, equity investment, and prudent capital deployment.
• Will be patient around deploying capital but mindful of potentially lowering leverage range over time.
• Look to increase leverage in joint ventures and find good investment opportunities there.

• Market volatility: Significant volatility in public markets since the end of the second quarter, similar to pandemic levels in 2020.
• Trade environment uncertainty: Uncertainty around tariffs, including potential new tariffs, retaliatory measures, and their impact on investment portfolio companies, M&A activity, and corporate behavior like inventory building and CapEx spending.
• Non-accrual investment risks: Some portfolio company investments on non-accrual status, and challenges in resolving them, with SiO2 and Dialyze still posing issues though representing less than 1% of the portfolio at fair value.

Q: Did you lean into any liquid market, structured finance or syndicated loans in April?

A: We were a little active but not very because we were and continue to be concerned that the tariff situation is not resolved. There was a sell-off in high yield bonds, senior loans, to a lesser extent in structured credit in April, but there's been a rebound in the back half of April and we've taken a more measured approach given that recovery.

Q: Armen, you mentioned remaining focused on the larger and diversified businesses. Can you hit on like high level how successfully you've been effectuating that? Are you out there finding adequate issuers that fit within your box on a credit and structure perspective for direct lending or is this a challenge? And then sort of part B there, the losses experienced are – what's the sort of overlap? Are they generally smaller EBITDA or do they overlap with that sort of core focus?

A: The market ebbs and flows. Late last year, larger borrowers could get better pricing and looser legal terms from broadly syndicated loan market vs direct lending. With market volatility, there's a pullback in new issuance activity from banks, and some larger borrowers are returning to direct lending. M&A deal volume is slow due to tariff announcements and private equity sponsors being reticent. Markdowns are not in large cap sponsored lendings, mostly idiosyncratic situations where businesses didn't execute as expected, not related to large vs small business theme.

Q: Really trying to discern sort of run rate NII, given the markdowns on the portfolio and the additions – changes in non-accruals. It seems like with some stabilizing base rates this could be sort of what we could expect in that given no changes in base rates this could be a run rate level NII. Is that fair to say or are you seeing other things happening in the portfolio that could impact that?

A: A couple of factors. Average portfolio was lower vs prior quarters. We're patient around deployment but mindful of lowering leverage range. Working through non-accruals to turn them into cash producing assets is a focus. Also, JVs can be a place to deploy assets with relatively easier deployment than some private assets.

Q: And to that point on leverage and then deploying within the joint ventures. I mean, obviously, this quarter seems very different from even the March quarter. When we look at sort of the repayment levels that you've seen in the portfolio and exits – repayments and exits over the last three quarters, they've been pretty sizable. Should we be expecting any slowing of repayment activity during this period of volatility? Or would you expect that to remain pretty elevated?

A: In terms of liquid credit, we delevered JVs in the back half of last year. Given current market volatility and tariff backdrop, we expect to find opportunities to deploy into JVs and increase their leverage again, but not yet as markets haven't reached ideal levels. Repayments won't be immaterial but may slow down over coming quarters as markets are volatile.

Q: Just on the kind of run rate question of income, just looking at the portfolio yield this quarter, think it was down 50 basis points or so. But if I take a quick average of just kind of the debt portfolio yield quarter-over-quarter, it looks like it's down a little over 100 basis points. So I'm just curious, is there any kind of one-time stuff that's flowing through there that would – is this yield, I guess, that we have today reflective of kind of what you think the portfolio should generate going forward?

A: Part of the quarter-on-quarter decline in interest income is due to reference rate declines and new non-accruals. Majority of the 30 bps worth of decline from last quarter's 10.7% to this quarter's 10.2% was due to new non-accruals. Also some spread compression. We think where we're at now is a decent run rate on the book.

Q: And on the JV, the 10.6% ROE, is that a net ROE as opposed to like an operating ROE on the JV? And then with leverage I guess what do you think you could potentially get the JV to in terms of an ROE over time?

A: The 10.6% ROE is looking at the NII of the JV plus coupon interest on the subordinated note. It would depend on the opportunity set, but certainly getting back up into the 11%-12% context is achievable depending on opportunities.