Oaktree Specialty Lending (OCSL) Dividend Coverage & Risk Profile Update

The following is from the OCSL Quick Update that was previously provided to subscribers of Premium BDC Reports along with revised target prices, dividend coverage and risk profile rankings, potential credit issues, earnings/dividend projections, quality of management, fee agreements, and my personal positions for all business development companies (“BDCs”).

For calendar Q2 2019, Oaktree Specialty Lending (OCSL) reported slightly below base case projections with lower portfolio yield and lower-than-expected portfolio growth partially offset by higher fee income. NAV per share increased by $0.05 or 0.8% (from $6.55 to $6.60) due to overearning the dividend and net unrealized gains. During calendar Q2 2019, OCSL exited $27 million of non-core investments, including one on non-accrual, reducing non-core investments by almost 70% since September 30, 2017.

OCSL has covered its dividend by an average of 128% with average earnings of around $0.12 per share over the last four quarters mostly due to improved portfolio earnings and reduced borrowing rates. Also, OCSL’s dividend is still 47% lower than two years ago and needs to be increased as it is well below the portfolio earnings each quarter likely due to management wanting to retain earnings to improve NAV per share. The company has plenty of growth capital available given its historically low leverage with a current debt-to-equity ratio of 0.58.

As shown below, management has made meaningful progress shifting the portfolio from ‘non-core’ legacy assets that still account for around 21% of the portfolio fair value.

Edgar Lee, Chief Executive Officer and Chief Investment Officer, said, “The third quarter was highlighted by continued strong financial results and portfolio performance. NAV increased for the sixth consecutive quarter to $6.60 per share, an 11% increase over the same period one year ago, and net investment income remained solid at $0.12 per share. We made further progress in reducing risk in the portfolio, successfully exiting $27 million of non-core investments, while adding $67 million of new investments that are consistent with our late-cycle investment approach. Importantly, with leverage of only 0.58x and $330 million of dry powder, we are well capitalized and have ample capacity to invest in new opportunities.”

OCSL intends to rotate out of another $273 million of investments it has identified as non-core investments and redeploy “into proprietary investments with higher yields”.

On June 28, 2019, shareholders approved the reduced asset coverage requirements allowing the company to double the maximum amount of leverage effective as of June 29, 2019. The investment adviser reduced the base management fee to 1.0% on all assets financed using leverage above 1.0x debt-equity. Management mentioned “we have no near-term plans to increase our leverage above our target range of 0.70 to 0.85 times”:

“As you will recall last quarter, we received Board approval to increase our leverage, effective in February 2020, unless we were to receive shareholder approval before then. While we have no near-term plans to increase our leverage above our target range of 0.70 to 0.85 times, this is an opportunity cost efficiently seeks shareholder approval in the events, but in the future, we deem the appropriate to deploy higher leverage. In connection with this, our base management fee will be reduced to 1% on all assets, finance using leverage above 1.0 times debt to equity once the new leverage limits are in effect.”

Management previously amended its revolving credit facility terms including extending the reinvestment period and modifying the asset coverage ratio covenant.

As discussed in previous reports, management is working to increase NII including:

  • Redeploy non-income generating investments comprised of equity, limited partnership interests and loans on non-accrual
  • Operating cost savings from leveraging Oaktree’s platform
  • Rotation out of broadly syndicated loans priced at LIBOR + 400 or below
  • Realization of lower operating costs from credit facility optimization

OCSL Risk Profile Update:

As of June 30, 2019, 54% of the portfolio was first-lien and there were five investments that stopped accruing cash and/or PIK interest or OID income. Non-accruals increased from 6.1% to 6.4% of the portfolio fair value due to modest markups.

Also discussed earlier, NAV per share increased by $0.05 or 0.8% due to overearning the dividend by $0.02 per share and net realized/unrealized gains of $0.03 per share:

This information was previously made available to subscribers of Premium BDC Reports, along with:

  • OCSL target prices and buying points
  • OCSL risk profile, potential credit issues, and overall rankings
  • OCSL dividend coverage projections and worst-case scenarios
  • Real-time changes to my personal portfolio

To be a successful BDC investor:

  • As companies report results, closely monitor dividend coverage potential and portfolio credit quality.
  • Identify BDCs that fit your risk profile.
  • Establish appropriate price targets based on relative risk and returns (mostly from regular and potential special dividends).
  • Diversify your BDC portfolio with at least five companies. There are around 50 publicly traded BDCs; please be selective.