Oaktree Lending (OCSL) Earnings Call Transcript

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DATE

Tuesday, Nov. 18, 2025 at 11 a.m. ET

CALL PARTICIPANTS

• Chief Executive Officer and Co-Chief Investment Officer — Armen Panossian
• President and Chief Operating Officer — Matt Pendo
• Chief Financial Officer and Treasurer — Christopher McKown
• Co-Chief Investment Officer — Raghav Khanna
• Chief Accounting Officer and Corporate Secretary — Clark Koury

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RISKS

• Nonaccrual loans remain concentrated in the healthcare and life sciences segments, with "a small handful of positions that were put on a few years ago" continuing to weigh on results and not expected to be resolved in the near term.
• Net asset value per share decreased to $16.64 from $16.76 due to unrealized depreciation on certain debt and equity investments.
• Lower base rates, following the September Federal Reserve rate cut, are anticipated to reduce net investment income in December, affecting earnings power.

TAKEAWAYS

• Adjusted Net Investment Income -- $35.4 million, or $0.40 per share, in the fourth fiscal quarter ending September 30, 2025, up from $32.5 million, or $0.37 per share, in the prior quarter, reflecting improved prepayment fees, dividend income, and decreased interest expense.
• Nonaccruals (at Fair Value) -- Reduced to 2.8% of the portfolio, a 20 basis point sequential decline and down 100 basis points year over year, as part of ongoing credit quality initiatives.
• Dividend Declared -- $0.40 per share for the quarter, aligning with reported earnings and dividend policy.
• New Investment Commitments -- $120 million of funded investments, an increase of 54% from the prior quarter, with prepayments and repayments totaling $177 million.
• First Lien Focus -- 83% of the portfolio and 88% of new originations are in first lien senior secured debt, emphasizing risk mitigation.
• Portfolio Markups -- Over 40% of portfolio companies were marked up by an average of 70 basis points, primarily due to improving company fundamentals.
• Weighted Average Spread on Deployments -- New deployments yielded approximately SOFR plus 570 basis points, reflecting portfolio repositioning and transaction mix.
• Yield on Debt Investments -- Portfolio weighted average yield was 9.8%; PIK represented 6.4% of total investment income.
• Leverage Ratio -- Stood at 0.97 times, up from 0.93 times, inside the target range of 0.9–1.25 times and facilitating additional capital flexibility.
• Liquidity Position -- $695 million of available liquidity, including $80 million in cash and $615 million in undrawn credit capacity.
• Cost of Borrowings -- Decreased to 6.5%, reflecting lower underlying rates and refinancing activity.
• Notable Transaction -- Oaktree participated as joint lead arranger for a $2.5 billion FILO first lien term loan supporting Walgreens Boots Alliance's U.S. retail business, priced at SOFR plus 700 basis points with 2.5 points OID.
• Joint Ventures -- JVs held $513 million in assets with a combined ROE of 12.4%; leverage at the JVs rose to 1.7 times from 1.3 times sequentially.
• Mosaic Recovery -- Realized over 70% of original Mosaic loan principal through asset sales and paydowns, achieving positive IRR when accounting for coupon income.
• Unfunded Commitments -- $258.9 million excluding joint ventures, with $246.9 million immediately available, balancing future deployment flexibility.
• Incentive Fee Waiver -- $1.9 million of incentive fees were waived under the total return hurdle.

SUMMARY

Oaktree Specialty Lending Corporation (NASDAQ:OCSL) reported a sequential increase in adjusted net investment income and maintained its dividend payout in alignment with quarterly earnings. Management indicated that the drag from nonaccrual assets, particularly longstanding healthcare and pharmaceuticals exposures, remains a material challenge limiting short-term NAV performance. Market commentary suggested continued selectivity in new loan origination as competition compresses spreads, with large, complex transactions such as the Walgreens FILO highlighting the company’s capacity to capture premium-priced opportunities when available.

• Chief Executive Officer Panossian said, "PIK and looser covenants remain popular tools for private debt managers to win mandates," but reaffirmed a disciplined approach toward their selective use for defined periods on qualifying transactions only.
• Significant liquidity was retained, providing management with multiple "levers at both the corporate and JV levels to help offset lower base rates and support net investment income."
• Weighted average portfolio company leverage increased slightly to 5.2 times, but interest coverage held steady at 2.2 times.
• Management does not anticipate outsized repayments or material deviations from the current pace of deployment or leverage for the December quarter, despite acknowledging the impact of lower reference rates on future income.

INDUSTRY GLOSSARY

• FILO (First In, Last Out): A senior secured loan structure where a lender funds a tranche that is paid after other senior tranches in a liquidation but ranks above junior/equity holders.
• PIK (Payment-in-Kind): A loan feature allowing issuers to pay interest by increasing the principal balance rather than in cash for a period, typically used in complex or transitional financings.
• SOFR (Secured Overnight Financing Rate): A benchmark interest rate for U.S. dollar-denominated derivatives and loans, replacing LIBOR as a market reference.

Full Conference Call Transcript

Matt Pendo: Thank you, Clark, and thank you all for joining our call today. I'll begin the call with an overview of our results for the fiscal year and fourth quarter. Armen Panossian, our CEO and co-CIO, will then share commentary on the current market environment. And Raghav Khanna, our co-CIO, will provide details on our portfolio and investment activity. Christopher McKown, our CFO and treasurer, will then review our financial results before we open the call for questions. The 2025 reflected steady improvement for OCSL, even as the macro environment remained choppy. As we will discuss in more detail, our team worked hard to turn around non-income producing positions, find interesting investment opportunities, and reduce our cost of capital.

In the fourth quarter, we achieved adjusted net investment income of $0.40 per share, up from $0.37 the prior quarter. This sequential improvement reflects the return to more normalized prepayment fees, higher dividend income, and lower interest expense from our refinancings earlier this year, and lower base rates. Additionally, we continue to make progress reducing our nonaccruals, a key strategic focus. At year-end, nonaccruals were 2.8% of the portfolio measured at fair value, down 20 basis points from the third quarter and down 100 basis points from last year. Last week, the board approved a dividend of $0.40 per share for the quarter, consistent with our dividend policy, and fourth quarter earnings.

While the Federal Reserve September rate cut did not affect fourth quarter earnings, lower base rates will impact net investment income in December. As we've said before, we have several levers at both the corporate and JV levels to help offset lower base rates and support net investment income. First, we can prudently increase balance sheet leverage to enhance earnings power and deploy capital into interesting investment opportunities. Our balance sheet is conservatively levered at 0.97 times and provides us with ample financial flexibility. Second, we can continue to optimize our JV. Finally, reducing nonaccruals and equity positions will improve our earnings power.

We have line of sight into, one, putting a portion of our previously nonaccruing loans onto accrual status, two, monetizing a portion of our nonaccruals, and three, monetizing equity positions. Any proceeds we receive from realizations of nonaccruals and equity will be reinvested into income-generating assets. On an ongoing basis, we will continue to evaluate these levers and their potential contributions to earnings and our dividend. Now I will pass the call over to Armen for an update on the market environment.

Armen Panossian: Thanks, Matt. Turning to the current market environment, we see many conflicting themes. Private credit deal flow showed modest improvement during the quarter, although the overall quality of deals was mixed. We continue to see a steady supply of high-quality opportunities, alongside an increasing number of lower-quality deals coming to market. Sponsors are pursuing dividend recapitalizations more often as exit activity remains subdued compared to historical levels. Momentum in Europe slowed relative to what we observed in our third quarter given ongoing political and economic uncertainty. But we still see some interesting deal flow from that region. Ample liquidity in the broadly syndicated loan and private debt markets has driven sponsors to dual track financings.

We have seen an increasing share of $1 billion plus LBOs opting for the broadly syndicated market and the tightening of the illiquidity premium. However, since the Fed rate cut in September, we have witnessed slightly more price discipline and are cautiously optimistic that private credit spreads have bottomed out at SOFR plus $4.50. PIK and looser covenants remain popular tools for private debt managers to win mandates and allocations, but we remain extremely disciplined in our credit documentation and acceptance of PIK. As a percentage of total investment income, PIK was 6.4% at quarter end.

We prefer to use PIK judiciously and in situations such as financing a high ROE project or carve-out acquisition that requires the PIK option only for a defined period, after which a project or acquisition generates the necessary cash flow to cover the debt's full cash interest payment. Despite a mixed environment, our long-term outlook on private credit remains bullish. Issuers continue to value the speed and assurance of deal execution with a sophisticated partner. For investors, we think private debt will continue to deliver a premium spread relative to other floating rate asset classes and with lower volatility. To talk more about our portfolio and new investments, I will turn it over to Raghav.

Raghav Khanna: Thanks, Armen. I'll start with a review of our investment activity in the fourth quarter. Our pipeline improved during the quarter, yet given heightened competition and tighter spreads, as Armen mentioned, we are taking a highly selective approach to new investments. We continue to prioritize senior secured loans to market-leading businesses with durable fundamentals, reliable cash flow, and strong downside protection. At the same time, we are focused on diversifying the portfolio, avoiding industry concentration risk, and limiting exposure to more cyclical sectors. Turning to origination and repayment activity for the quarter, new funded investment commitments, including drawdowns from existing commitments, amounted to $120 million, up 54% from the prior quarter.

Prepayments from exits, other paydowns, and sales were $177 million. And the weighted average spread on deployments during the quarter was approximately SOFR plus 570. First lien loans represented 88% of our new originations. One notable investment during the quarter was Walgreens Boots Alliance, an integrated healthcare pharmacy, and retailer with a 170-year heritage. The company was taken private by Sycamore Partners for over $20 billion, and the sponsor subsequently split the conglomerate into four operating businesses. Each segment required its own bespoke lending solution, and the sponsor got lenders who could move quickly to underwrite the distinct challenges and transformation opportunities of the retail and pharmaceutical businesses. Oaktree strategies worked collaboratively to consider various capital structures.

Ultimately, Oaktree funds acted as joint lead arranger for the $2.5 billion first in, last out, first lien term loan to support the US retail business. The FILO was priced at SOFR Plus 700 with 2.5 points of OID, which is attractive for the industry risk and complexity of the deal. Oaktree's deep expertise in inventory appraisal and long track record of investing in FILOs made us comfortable with the collateral coverage of the loan. This transaction is a great example of how Oaktree is positioned to capitalize on complicated yet compelling investment opportunities.

Turning to our portfolio, over 40% of our portfolio companies were marked up during the quarter, by about 70 basis points on a weighted average basis, reflecting improving fundamentals in several portfolio companies. As of September 30, 83% of our portfolio was comprised of first lien senior secured debt, and the weighted average yield on debt investments was 9.8%. The median EBITDA of our portfolio companies was approximately $150 million, an $11 million decrease from the prior quarter. Portfolio company weighted average leverage increased slightly to 5.2 times from 5.1 times, and weighted average interest coverage remained unchanged at 2.2 times.

As Matt mentioned, we have made tangible progress reducing nonaccruals and resolving challenged investments, which contributed to a decline in nonaccruals this quarter. I'll cover those now starting with an update on Mosaic companies. We have been working closely with Mosaic to realize value for the separation of its three business segments. Two of these segments were sold, and the third is in a liquidation process. As you may recall, these efforts resulted in a significant cash paydown during June, and we received additional cash paydowns in September and after quarter end.

Inception to date, the paydowns we received amount to a little over 70% of our original invested cost, and when combined with coupon payments, have resulted in generating positive IRR over the life of this loan. We believe the proactive actions we took following Mosaic's tariff-related headwinds earlier this year helped maximize our recovery in a challenging situation. We also made progress in monetizing our Inopen Therapeutics, whose loan is secured by certain royalty rights and public shares of ADC Therapeutics. Following an increase in ADC's share price, we sold a portion of our ADC shares and used the proceeds to reduce the outstanding loan amount.

Our remaining position in Inopen Therapeutics continues to be marked at 99.5, reflecting our view that we will continue monetizing the collateral supporting this loan and recover substantially all of the remaining loan balance. While the issuer is not new to our nonaccrual list, we added Baymark's first lien loan to nonaccrual status. The company's second lien loan was put on nonaccrual in the third quarter. We are working closely with other lenders and the company to maximize value. I'll now turn the call over to Chris to review our financial results.

Christopher McKown: Thank you, Raghav. In our fourth fiscal quarter ending September 30, 2025, we delivered adjusted net investment income of $35.4 million or $0.40 per share as compared to $32.5 million or $0.37 per share in the prior quarter. The increase for the quarter reflects the return to normalized levels of fee income and interest expense following the one-time items that impacted the results in the third quarter. NAV per share was $16.64, down from $16.76 in the third quarter due to unrealized depreciation on certain debt and equity investments. Adjusted total investment income increased to $76.9 million compared to $74.3 million in the third quarter, primarily driven by higher prepayment fees and dividend income.

Net expenses declined modestly compared to the third quarter. Interest expense decreased due to the refinancing of our syndicated credit facility completed earlier this year and lower reference rates. Additionally, as you may recall, our June results were impacted by noncash and nonrecurring interest expense related to the acceleration of deferred financing costs primarily in connection with the termination of the Citibank SPV facility. The weighted average cost of borrowings was 6.5% at September 30, down from 6.6% in the third quarter. Further, we waived approximately $1.9 million in incentive fees as a result of our total return hurdle.

Our leverage ratio at quarter end was 0.97 times, up slightly from 0.93 times last quarter, and total debt outstanding was $1.5 billion. Our target leverage range of 0.9 times to 1.25 remains unchanged. Driven by our disciplined pace of capital deployment, we remain at the low end of the range. Unsecured debt represented 64% of total debt at quarter end, down slightly from the prior quarter. We have ample dry powder to fund commitments with liquidity of approximately $695 million, including $80 million of cash and $615 million of undrawn capacity on our credit facility.

Unfunded commitments, excluding those related to the joint ventures, were $258.9 million, approximately $246.9 million of which can be drawn immediately as the remaining amount is subject to portfolio companies meeting certain milestones before the funds can be drawn. Turning to our two joint ventures, together, the JVs currently hold $513 million of investment primarily in broadly syndicated loans spread across 73 portfolio companies. During the fourth fiscal quarter, the JVs generated ROEs of 12.4% in aggregate. Leverage at the JVs was 1.7 times, compared to 1.3 times last quarter. In addition, we received a $525,000 dividend from the Kemper JV. With that, I'll turn the call back to the operator to open the call for questions.

Operator: Thank you. We will now begin the question and answer session. At this time, I would like to remind everyone in order to ask a question, press 1 on your telephone keypad. And your first question comes from the line of Melissa Wedel with JPMorgan.

Melissa Wedel: Good morning. Thanks for taking my questions today. Definitely noted the turnaround in the level of new net funding activity this quarter. I know that typically December is a seasonally busy quarter, but I'm just curious if you have any early insight into sort of expectations around investment activity in the December quarter this year? And any outsized repayments that should be thinking about?

Armen Panossian: Thanks, Melissa. It's Armen. In terms of outsized repayments, we don't expect any at this time for the quarter, December. As far as deployment, nothing really stands out either direction, either on the heavy side or the light side relative to past December quarters. You know, we certainly have seen some tightening in the spreads, and so we're judicious about how we're deploying. But I don't see us materially deviating from past quarters in terms of deployment or leverage levels for the quarter.

Melissa Wedel: Okay. I appreciate that. One of the other things related to your comment about spreads tightening, I did notice that the yield on new investments this quarter was a step higher, about 60 bps higher, compared to last quarter. I'm assuming that relates to sort of the complexity of the Walgreens deal, the complexity and size of the Walgreens deal. I guess, one, is that right? And then two, what's your view on sort of a pipeline for transactions like that where there might be more complexity and pricing involved? Thanks very much.

Christopher McKown: Hey, Melissa. It's Chris. Thanks for the question. I'll start and maybe Armen can add a little bit in terms of pipeline. In terms of the quarter-on-quarter change, I mean, you're right in noting Walgreens. I think the other thing I would just note about June is that on balance, we had a little bit higher originations into your LIBOR indexed loans. So when you're looking at the absolute coupons, you know, June was a little bit lower as a result of that. You know, we do hedge all of that back to US dollars.

There is a little bit of a pickup when you take into account that hedging impact, but that does create a little bit of noise, you know, kind of quarter to quarter. Armen, do you have anything?

Armen Panossian: Yeah. You know, we do have a very active origination function in non-sponsored direct lending. I think Walgreens stands out as a pretty high spread loan. I don't see anything that we would be originating in the December quarter that's quite that high in spread. But we do have a few things that we're working on that might be sort of higher than the 450 to 500 spread that's typical sponsor lending, but I think it's too early at this point to provide forward guidance. I just don't think that the Walgreens deal is not repeatable, I don't think, in the fourth quarter. Oh, sorry. The fourth calendar quarter.

Melissa Wedel: Yep. Understood. Thanks. Our next question comes from the line of Sean Paul Adams with B. Riley Securities.

Sean Paul Adams: Hey, guys. Good morning. On the nonaccruals still on the books, it seems like there's still a heavy skew towards healthcare and pharma. Can you just share a little bit more color about what's going on in those particular segments?

Armen Panossian: Sure. This is Armen. You know, we have or we had a couple of sort of chunky positions in the life sciences space. It's not many in number, but there were unfortunately some larger positions that continue to be the subject of workouts. FIO2 being the, I would say, the most material of them, which is a name that we've talked about on past calls. But that's really what it is. We continue to sort of work out situations that at this point have been in the portfolio for several years. They're all sort of stable to maybe slightly improving, but still not at the position where we're either going to exit or move them into accrual status, unfortunately.

We're not adding. We haven't added other kind of life sciences or healthcare names that have created problems in the recent quarters. But again, these handfuls, a small handful of positions that were put on a few years ago continue to sort of weigh on the nonaccrual bucket.

Sean Paul Adams: Got it. And as a quick follow-up, is there any workout strategies going on with those long-standing nonaccruals?

Armen Panossian: They were operational workouts. They have already been, from a capital structure perspective, restructured. But operational improvements are being made. We're working closely with management teams to drive that performance. And when possible, we are working with the management to sell assets and either fund cash burn or repay, or make distributions to our position. But there's nothing significant or monumental that would be happening in the near term with respect to those positions. It's just kind of blocking and tackling with an operational turnaround.

Sean Paul Adams: Appreciate the color. Thank you.

Operator: Again, if you would like to ask a question, press 1 on your telephone keypad. Thank you. I'm not showing any further questions in the queue. I would now like to turn it back to Clark Koury for closing remarks.

Clark Koury: Great. Thank you, operator, and thanks to everybody for joining. Please reach out with any questions. We're happy to jump on the phone. Have a great day.

Operator: And that concludes our today's conference call. Thank you all for joining. You may now disconnect.

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