Oaktree Specialty Lending (NASDAQ:OCSL) held its second-quarter earnings conference call on Tuesday. Below is the complete transcript from the call.

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Access the full call at https://events.q4inc.com/attendee/630715121

Summary

Oaktree Specialty Lending reported a reduction in non-accruals to 2.6% of the total debt portfolio, down from 3.1% last quarter, and increased liquidity to $671 million.

Net asset value per share decreased to $15.69 from $16.30, driven by unrealized mark-to-market write-downs; adjusted net investment income was $33.7 million or $0.38 per share.

The company has sold certain liquid credit positions to build dry powder and maintain leverage, with a focus on investing in private credit deals with wider spreads and improved lender protections.

Management discussed the market environment, emphasizing the current volatility as a recalibration phase and highlighting the company's preparedness to capitalize on future opportunities.

The board declared a total cash dividend of $0.34 per share, with a base dividend adjusted to $0.30 per share and maintaining a supplemental dividend based on excess adjusted net investment income.

Full Transcript

OPERATOR

Welcome and thank you for joining Oaktree Specialty Lending Corporation's second fiscal quarter 2026 conference call. All lines have been placed on mute to prevent any background noise. After the Speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press STAR followed by the number one on your telephone keypad. If you would like to withdraw your question, press Star one again. Today's conference call is being recorded. I'll now turn the call over to Allison Murmy, OCFL's Head of Investor Relations.

Allison Murmy (Head of Investor Relations)

Thank you operator. Our second quarter 2026 earnings release which we issued this morning along with the accompanying slide presentation can be accessed on the Investors section of our website oaktreespecialtylending.com. Before we begin, I want to remind you that the comments on today's call include forward looking statements including reflecting current views with respect to, among other things, future operating results, and financial performance. Actual results could differ materially from those implied or expressed in the forward looking statements. Please refer to the relevant SEC filings for a discussion of these factors in further detail. Oaktree undertakes no duty to update or revise any forward looking statements. I'd 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 an Oaktree fund. Investors and others should note that OCSL uses the Investor section of its corporate website to announce material information. The company encourages investors, the media and others to review information that it shares on its website. Now I'll turn the call over to Matt Pendo, President of OCSL.

Matt Pendo (President)

Matt thank you Allison and good morning everyone. I will begin with an overview of our second quarter fiscal 2026 results, after which Armin Panozian, our CEO and co Chief Investment Officer, will share his perspective on the market environment. Raghav Khanna, our co Chief Investment Officer, will then cover portfolio activity and Chris McCown, our CFO and Treasurer. We'll close with a review of our financial resultss before we open the call for questions. Despite external noise around private credit and BDCs, our team remained focused on reducing non accruals and positioning our balance sheet for flexibility. As of March 31, 2026, non accruals were 2.6% of the total debt portfolio measured at fair value, down from 3.1% last quarter and 4.6% one year ago. As an update post quarter in april we sold 2 legacy non accrual positions, Dominion Diagnostics and all web leads. We expect to make further progress reducing non accruals and realizing cash proceeds that we can deploy into performing assets over the coming months. Managing our balance sheet is a high priority as we position OCSL for a more attractive investment environment. During the quarter, we sold a portion of our liquid credit positions at cost, a strategic decision to build dry powder, maintain leverage below the midpoint of our target range and rotate out of lower yielding public credit. We ended the second quarter with available liquidity of 671 million, up $100 million from last quarter and net leverage of 1.04 times, down from 1.07 times last quarter. Turning to financial highlights, net asset value per share was $15.69 as of March 31, 2026 compared to $16.30 as of December 31, 2025. The decline was driven primarily by unrealized mark to market write downs of software loans. During the quarter, the fair value of our performing software loans declined by approximately 310 basis points, largely consistent with movements in broadly syndicated software loans. Importantly, we believe that these markdowns generally are not indications of deteriorating fundamentals in the underlying portfolio companies, but rather reflecting the repricing of risk in the broader markets. Adjusted net investment income from the quarter was $33.7 million, or $0.38 per share, as compared with $36.1 million or $0.41 per share in the prior quarter. The decrease reflected lower reference rates, lower non recurring income and ending leverage below the midpoint of our target range for the quarter. Our board declared a total cash dividend of $0.34 per share. Due to our conservative use of leverage, we have adjusted our base dividend to $0.30 per share while maintaining our supplemental dividend at 50% of excess adjusted net investment income above our base dividend. The dividends are payable on June 30, 2026. The stockholders are record as of June 15, 2026. With that, I'll turn the call over to Armin to share his perspective on the market environment and what we see ahead.

Armin Panozian (CEO and Co Chief Investment Officer)

Thank you Matt. It was an eventful quarter for private credit. We believe the volatility that we are seeing reflects a period of recalibration rather than a systemic issue. Rising impairments, questions surrounding valuations, the use of leverage, liquidity mismatches, software exposure in an AI, driven world and refinancing risks are all part of the current dialogue surrounding private credit. This may help explain, at least in part, why market sentiment may appear more negative than borrower performance alone would suggest. As the confluence of concerns weigh on investor confidence. The current debate around private credit risks may conflate a range of distinct factors and lead to overly broad conclusions. It is important to differentiate between the fundamentally sound concept of private credit, namely tailored non bank lending, from specific challenges affecting certain segments of the market. Direct lending or making private loans to finance mid sized buyouts isn't inherently flawed. The question for any manager is whether their portfolio assets and liabilities were built to handle a market correction. At Oaktree, we have more than three decades of experience investing in sub investment grade credit and navigating market cycles. This moment is familiar to us. For example, in 2020, OCSL's positioning was the result of deliberate choices we made well before the COVID related market dislocation arrived. By late 2019 we had cleaned up the legacy portfolio that was acquired from the prior advisor, reduced leverage and built liquidity in the fund. When dislocation arrived in March 2020, we had the dry powder and the conviction to go on offense. In 2020 we deployed nearly $1 billion of capital and produced nearly an 11% total economic return in a year when many managers retrenched. Today, OCSL is executing with a similar mindset. We continue to make progress toward turning around underperforming assets, operating below the midpoint of our leverage target, remaining disciplined in deployment and maintaining strong liquidity. We did not predict the current environment, but we prepared to invest into it. Market volatility increased this quarter and AI, related concerns and geopolitical unrest resulted in wider spreads across public liquid credit markets. At the same time, elevated net redemptions in non traded BDCs prompted many managers to reassess their cost of capital and liquidity positions, pushing private credit into a phase of price discovery. Towards quarter end, market conditions stabilized and the private credit deal pipeline began to rebuild. We are encouraged that spreads on new private credit investments have widened to SOFR +500 to 550 basis points, approximately 50 to 100 basis points above the 2025 types and supports improved forward returns. We are also seeing modest improvements in documentation and more lender friendly structures. While markets have rebounded from their lows. We expect continued volatility and increasing dispersion over the coming quarters. Our view is that secondary private transactions, whether through partial or full full portfolio sales, will reshape the private credit landscape as certain market participants look to optimize their asset portfolio or satisfy liquidity demands. We believe Oaktree is well positioned to evaluate and potentially capitalize on all opportunities. Our global platform is a meaningful advantage in this environment. We evaluate private credit alongside liquid credit, distressed debt, asset backed finance and increasingly the Brookfield ecosystem. That ability to compare relative value across credit and now equity informs both our risk management and deployment decisions in ways a single strategy manager can't replicate. Together we will have a fully integrated information network across asset classes, industries, geographies and public and private markets. We are already tracking dozens of emerging opportunities in real time, sharing notes across teams and identifying dislocations. The breadth of our combined relationships with sponsors, companies and advisors will give us access to deal flow that many lenders do not see and allows us to be selective, disciplined underwriting selectivity and active portfolio management will remain the critical drivers of long term performance. Now I will turn the call over to Raghav for a detailed review of our portfolio and investment activity.

Raghav Khanna (Co Chief Investment Officer)

Thanks Armin As Matt and Arman mentioned, investment activity was measured in the second quarter as we kept our focus on controlling risk and maintaining balance sheet flexibility. During the quarter, we sold certain liquid credit positions at cost to build dry powder. We also saw a healthy pace of private portfolio prepayments, proceeds from prepayments, exits and other paydowns and sales were 334 million, up from 179 million in the previous quarter and 279 million last year. A notable prepayment was Mindbody, an ARR software loan. Despite the challenging market backdrop for Software, we exited MindBody at par through a refinancing to a competitor. This leaves us with only one ARR loan in the portfolio representing 76 basis points of fair value, down from total ARR exposure of, 214 basis points last quarter. Our limited exposure to ARR structures is an example of how we deliberately stayed underinvested in an area of private credit where we believed press could emerge. New investment commitments in the quarter totaled $204 million, down 36% from the prior quarter. Deal activity slowed due to software sector volatility and escalating geopolitical tensions. As Armin mentioned, our deal pipeline began to rebuild towards the end of March and into early April. We are encouraged that new private credit deals are pricing with wider spreads and structured with better lender protections. The weighted average yield on new debt investments was 9.2%, 50 basis points higher than the December quarter. An example of a new private deal from the second quarter is Jonah Energy, a highly structured loan to a heavy asset, low obsolescence or halo company. The company is a Denver based independent oil and gas developer with producing assets in six states. In January, Jonah signed a purchase agreement to acquire Grit Oil and Gas, an upstream oil and gas operator located in the Eagle Ford Basin in Texas. While the deal was originally contemplated by the asset backed finance market, Jonah prioritized speed of execution to capitalize on oil price appreciation driven by the conflict in Iran. As a result, the company shifted to direct lending and partnered with Oaktree to leverage our flexibility and ability to move quickly. Oaktree funds participated in approximately $200 million or 1/3 of the first lien term loan to support the acquisition. The first lien term loan was priced at SOFR 600 with mandatory amortization, favorable excess cash flow sweeps and multiple maintenance covenants. This transaction reflects the strength of Oaktree's broader platform, deep advisor relationships, the ability to partner across strategy and to be opportunistic in a volatile market environment. Turning to our software exposure based on GICS, industry group classification software represents 21% of the portfolio at fair value across 29 issuers, that is down approximately 140 basis points from last quarter, primarily reflecting the exit of mindbody. Taking a broad and conservative classification for software and technology, we estimate exposure is approximately 26% of the portfolio, including certain investments in healthcare technology, interactive media and services. As outlined on page 8 of the earnings presentation, we apply a seven factor business resilience framework supplemented by operating KPIs and financial metrics. Each investment is scored and categorized into high, medium and low AI risk buckets within a performing debt portfolio. Two investments representing 2.9% of fair value are classified as having high AI risk. These companies have a weighted average LTM ebitda of approximately $96 million, which was generally stable from the prior quarter. LTVs increased to high 50%, up from low 40% last quarter, reflecting multiple compression in public market comparables for issuers in the medium and low AI risk categories. Weighted average LTM EBITDA is approximately 385 million. LTVs are around high 40s to low 50s percentage, which we view as reasonable despite recent multiple compression for many of these companies, we see AI as a potential tailwind with management teams and sponsors actively exploring ways to leverage the technology to enhance margins and strengthen competitive positioning. Excluding non accruals, the weighted average mark on Our software portfolio was 96 as of March 31, 2026, down approximately 310 basis points from last quarter. These markdowns largely reflect the repricing of risk and corresponding spread widening across liquid credit. Our private credit software marks were consistent with levels seen in the broadly syndicated loan market. In most cases, these markdowns do not suggest deterioration in underlying company performance. Moving to our non accruals at quarter end and investments were on non accrual, representing 2.6% of the total debt portfolio at fair value, down 50 basis points from December 2025 and down 200 basis points from March 2025. In March, we restructured Astra after it emerged from Chapter 11 and exited the position shortly after quarter end, modestly below our mark. The decision was driven by our preference for reallocating our resources and capital toward better risk adjusted opportunities. We also continue to make progress on Avery, where we have seen an uptick in condo sales and units under escrow. During the quarter, 12 units were sold or placed under contract compared to a full year underwriting assumption of six unit sales. Avery's March 31 valuation assumes only a portion of the units under contract close although we are cautiously optimistic that we will close more units in the future. After quarter end we sold Dominion and All web Leads two legacy non accrual positions acquired from the prior BDC manager. On Dominion, we received 7 million of cash proceeds versus a mark of 5 million as of December 31st. For the March quarter, we moved the first out to accrual status mark the first out to par and wrote up the second out modestly. All web leads sold to a strategic buyer with an AI focused value creation angle at a price in line with our March 31st mark. We received approximately 20% of the March 31st mark in cash at close, with the remainder of the consideration coming via a seller note and equity positioning us to potentially recover more than the March 31 mark over time as legacy non accrual investments, Dominion and all web Leads demonstrate our patient, disciplined and active approach to portfolio management. We continue to work on realizing proceeds from other non accruals and equity positions in a way that optimizes outcomes for OCSL shareholders. Looking at total portfolio Metrics as of March 31, 84% of total portfolio investments at fair value were first lien senior secured debt and the weighted average yield on debt investments was 9.3%. Even quarter over quarter, the portfolio remains well diversified with the average position representing 0.7% of our debt portfolio at fair value and no single position exceeding 2% of fair value. The median EBITDA of our portfolio companies was approximately $182 million, a slight decrease from the prior quarter due to exits on large cap deals. Portfolio company weighted average leverage and interest coverage ratios were 5.2 times and 2.1 times respectively. Consistent with the last quarter, we remain focused on managing our existing portfolio and resolving challenged credits while maintaining flexibility to capitalize on new investment opportunities ahead. And with that, I'll turn the call over to Chris to review our financial results.

Chris McCown (CFO and Treasurer)

Thank you, Raghav in our second fiscal quarter ended March 31, 2026, adjusted total investment income was $69.7 million, a decrease compared to $74.5 million in the prior quarter. The decrease was primarily due to lower reference rates and lower non recurring income attributable to lower prepayment and exit fees. Net expenses decreased by 6% compared to the prior quarter, primarily reflecting a reduction in Part 1 incentive fees as a result of our total return hurdle. We delivered adjusted net investment income of $33.7 million or $0.38 per share, compared to $36.1 million or $0.41 per share in the prior quarter. These results reflected lower total investment income partially offset by lower interest expense and lower Part 1 incentive fees. NAV per share was $15.69, down from $16.30 last quarter. The drivers of NAV were about evenly split between write downs and certain non accruals mark to market volatility in quoted names and spread widening on private credit marks. OCSL continues to be prudent around the use of payment in kind income with PIK representing approximately 5.5% of adjusted total investment income during the quarter. This is down from 6.3% last quarter due to the sale of Athenahealth PIK preferred at our mark. Approximately two thirds of our PIK income relates to investments that were structured with the option to PIKk at origination. Our net leverage ratio at quarter end was 1.04 times, down from 1.07 times last quarter and total debt outstanding was $1.5 billion. The decreased leverage mirrors portfolio rotation and asset sales during the period. Our long term target leverage ratio of 0.9 times to 1.25 times remains unchanged, although our plan is to run leverage towards the mid to low end of that range. As of March 31, the weighted average interest rate on debt outstanding was 5.9%, down from 6.1% in the prior quarter, primarily driven by lower reference rates. Unsecured debt represented 64% of total debt at quarter end up from the prior quarter. We have ample dry powder to take advantage of market opportunities with liquidity of approximately $671 million including $51 million of cash on hand and $620 million of fund drawn capacity under our credit facility, up from $576 million of total liquidity at the end of December. Unfunded commitments, including those related to joint ventures were approximately $250 million. Turning to our joint ventures, together the JVs held approximately $521 million of investments across 130 portfolio companies and generated aggregate returns on equity of approximately 10%. During the quarter, leverage at the JVs was 1.9 times up modestly from last quarter. With that, I'll turn the call back to the operator for Q and A

OPERATOR

At this time, if you would like to ask a question, press Star then the number one on your telephone keypad and your first question comes from the line of Rick Shane with JP Morgan. Please go ahead.

Rick Shane (Equity Analyst)

Hey guys, thanks for taking my question this morning. Look, when we sort of calculate the implied return to the dividend of about 8.6% of book, that equates to about 5% spread to three month base rates. As we think about your business model over the long term, where would you put that return? You know, base rate plus 5% in sort of your cycle? Is that a trough in the cycle? Is that a realistic long term objective? Help us understand sort of what the return profile as a function of base rate should be.

Raghav Khanna (Co Chief Investment Officer)

Hey it's Raghav. I can start and then you know Chris and Brett can chime in. So. So you know as I'm sure you know there's really two levers that we're playing with. The first is what is the unlevered asset yield? Again probably no surprise given the enormous amounts of capital that's been raised in direct lending in perpetual BDC vehicles. In particular I would say that market direct lending spreads probably troughed out in December at the mid to maybe high four hundreds. Since then we have seen, I wouldn't call it a dramatic yet repricing but certainly a significant enough repricing of risk where regular way direct lending deals. So probably the lowest returning deals that we see in our pipeline. These are first link deals to private equity sponsors are in the low to mid-500s so certainly have improved by 50 to 75 basis points. I would say more on a forward basis. If you look at the SOFR, curve thanks to the war in the Middle East and the ensuing inflation expectations going up, the SOFR, curve is probably 50 to 60 basis points higher than where it troughed out pre the Middle east situation. So that's number two away from sponsored deals. I would say we do a mix of obviously both sponsor and non sponsored deals. We do corporate lending as well as asset backed deals. U.S. and Europe on a blended basis. I would say that when you mix it all together, low 500 for sponsored deals, low 600 to 700. In some of the more interesting areas of lending that we're seeing, which are less commoditized. Our pipeline is in the high five hundreds on a spread basis and you know, just under 600, call it including OID. So you put it all together on a forward basis, obviously the portfolio in the ground will churn over time, but on a forward basis, I would say that spreads on new deals are far more attractive, at least 100 basis points more attractive than they were even three months ago. Second, the silver curve is certainly helping on the asset side. And then the third piece is leverage. You know, we took the decision to sell a number of names out of a public book. That has a near term cost, obviously, as you can imagine, which is you have less income producing assets, your ROE declines as a result. That's the cost. The benefit is that as we're seeing our private pipeline reprice higher, we actually have a lot of liquidity to invest in that pipeline. So for us the opportunity is not theoretical. And so, you know, over time I do suspect that we will maybe gradually increase leverage if this pipeline opportunity continues and you know, hopefully expand. So both on the unlevered asset yield side, I think that is getting better. And then second, you know, to finance that pipeline, I do expect leverage will go up slowly and both of those should help roe.

Rick Shane (Equity Analyst)

Got it. And then one quick follow up. You know, there's been a lot of conversation about the markets improving since December,. And the empirical thing that we all want to run through our model is the widening of spreads. But what's interesting is every time a company makes that comment, they follow it with better protections, better covenants. Obviously that's not something that we can plug into a model, but it's also something I'm not necessarily sure we fully understand. Can you just give us a couple of examples of how deal protections are improving so, you know, we can think about that.

Raghav Khanna (Co Chief Investment Officer)

Yeah, I mean, you know, like the big picture, you know, technical in the market is if you look at just the unlisted and perpetual BDC space, you know, that part of the asset class, you know, really became the marginal dollar of that was setting price and risk. That space raised $110 billion in 2025 and you know, not sure what the numbers are going to be, but they're more likely to be negative this year with net outflows than positive. So that's a pretty, you know, it's not a huge part of the market like BDCs, together, you know, public and private are about 25% of the private credit market, not huge. But from a, from a stock perspective, they're not huge. From a flow perspective, they were very large. And you know, we suspect that that's, that's the one change that is driving both pricing improvements and new deals, but also the non economic terms you talked about. So what are those improvements we're seeing? So one is, you know, pick requests on new deals have declined to, I don't want to say zero, but let's say close to zero. So that's just going, is going away. Second is again, you're right, hard to see. But I'm sure you're familiar with the concept of adjusted ebitda, which you know, I would say in the go go days leading up to 4Q 2025, adjusted EBITDA was getting more and more unrealistic versus what we call cash EBITDA and the true cash earnings profile of the borrowers. That is getting better. Now again, so that's two, three is LMA protection, which is there's always been like a push and pull between borrowers and lenders. I would say certainly borrowers had probably more leverage in 2025 than lenders did. Those are also getting better. And then the fourth thing I would say is I wouldn't say the maintenance covenant is coming back, especially for larger deals in any kind of a meaningful way, but the direction of travel is the right direction, which is even in some large cap deals that we have in our pipeline, which we Describe as over 100 million of EBITDA, we are starting to see the maintenance covenant come back. So all of those are like marginal improvements, but they're all going the right direction.

Rick Shane (Equity Analyst)

Got it. I appreciate the answers to both questions. Very helpful. Thank you guys.

OPERATOR

Again, if you would like to ask a question, press star followed by the number one on your telephone keypad. And there are no further questions at this time. I will now turn the call back over to Allison Murmy for closing remarks.

Allison Murmy (Head of Investor Relations)

Thank you all for joining us on today's call. Please feel free to reach out to me and the team with any questions you may have. Have a great day.

Disclaimer: This transcript is provided for informational purposes only. While we strive for accuracy, there may be errors or omissions in this automated transcription. For official company statements and financial information, please refer to the company's SEC filings and official press releases. Corporate participants' and analysts' statements reflect their views as of the date of this call and are subject to change without notice.