Oaktree Specialty Lending Corp (OCSL) 2026 Q1 法說會逐字稿

Welcome, and thank you for joining Oaktree Specialty Lending Corporation's first fiscal quarter 2026 conference call. Today's conference call is being recorded.

I'll now turn the call over to Alison Mermey, OCSL's Head of Investor Relations.

Our first 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 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 a solicitation of an offer to purchase any interest in an Oaktree fund.

Investors and others should note that OCSL uses the Investors 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?

Thanks, Allison, and good morning, everyone. I'll begin the call with an overview of our first quarter results. Armen Panossian, our CEO and Co-CIO, will then share some commentary on the current market environment and Raghav Khanna, our Co-CIO, who will provide details on our portfolio and investment activity. Our CFO and Treasurer, Chris McKown, will then review our financial performance before we open the call for questions.

This year is off to a good start, and we delivered solid results for the first fiscal quarter of 2026. Adjusted net investment income for the quarter was $36.1 million or $0.41 per share up modestly from the prior quarter. Once again, we fully covered our quarterly dividend with earnings. These results reflect our team's disciplined capital deployment into income-generating assets as well as the actions we took last year to optimize the liability side of our balance sheet.

Importantly, this was the first full quarter reflecting the impact of the September rate cut, and despite lower base rates, earnings remain stable. Consistent with our dividend policy and first quarter earnings, our Board declared a quarterly cash dividend of $0.40 per share payable on March 31, 2026, to stockholders of record as of March 16, 2026.

As discussed on our fiscal 2025 year end call, we have several levers to help offset lower base rates and support net investment income. One of the key levers is our ability to prudently deploy capital into attractive investment opportunities.

To that point, new fund investments, including drawdowns from existing commitments totaled $314 million, up from $220 million in the prior quarter. The average spread and yield of new private investments was 525 basis points and 9%, respectively. We have ample financial flexibility to continue deploying capital as we ended the quarter with over $576 million of available liquidity.

We are intensely focused on reducing nonaccruals and equity positions as another key lever for improving earnings power. In the first quarter, nonaccruals relatively stable sequentially and down nearly 85 basis points year-over-year. At quarter end, nonaccruals represented 3.1% total debt portfolio measured at fair value. For several of our nonaccrual positions, we are optimistic about the potential outcomes and are actively working to maximize recovery value.

This quarter, we restructured our investment in Avery and put a portion of the loan back on accrual status, which is consistent with the broader objective of converting nonearning assets into income-producing assets. Abry continues to sell units and it appears to be happening at an increased pace. Any proceeds from monetization of nonaccruals or equity positions will be reinvested into income-generating investments. We will continue to evaluate these levers and their potential contribution to our earnings and dividends.

As always, we remain committed to strong alignment with our shareholders as we navigate an evolving credit landscape. Now I'll turn the call over to Armen for an update on the market environment.

Thanks, Matt. Current trends in private credit mirror the bifurcation we're seeing in the broader economy. Macro factors, including persistent inflation, tariffs and ongoing technology disruption are amplifying structural strength and weaknesses, creating a clear divide between the winners and losers. Companies with scale, profitability and financial stability of ample access to capital and those that are struggling have limited or no access at all.

Over the past two years, sponsors have favored recapitalizations over exits in a muted M&A environment, creating a backlog of transactions waiting to come to market. With the rate pressures easing, sponsors are increasingly turning to the M&A market to deliver much needed liquidity for their LPs.

While large cap activity accelerated in the December quarter, middle market volumes were still below historical averages. That said, we are starting to feel more confident that middle market M&A activity will improve over the course of the year.

Since the Fed rate cut in September, we have seen greater price discipline in the market and believe that spreads in private credit have now bottomed out at SOFR plus 450 basis points to 475 basis points. We think this may be supported by elevated redemptions in the perpetual BDC space, easing the demand for new paper. We are cautiously optimistic that spreads will remain stable in 2026 with the potential to white.

Importantly, direct lending transactions continue to offer an approximate 150 basis points spread premium relative to broadly syndicated loans similar credit quality. PIK interest remains prevalent in direct lending transactions, underscoring sponsors preference for flexible capital structures. We continue to stay extremely disciplined in our use of PIC.

In the first quarter, PIC as a percentage of adjusted total investment income, was 6.3%, which is below the public BDC industry average. Even with tighter than normal spreads and looser terms, we are still seeing compelling investment opportunities as reflected in our strong level of originations this quarter. In the current market environment, we are prioritizing loans to businesses with resilient models, defensible market positions and durable long-term outlooks that align with our bottoms-up value-driven approach to underwriting.

One area we are monitoring closely is the impact of AI on private credit and the broader economy. Software and applications have consistently been the primary secular beneficiaries of major technology shifts. And we believe AI will increase the total addressable market for software. That said, we expect outcomes to be uneven with increasing dispersion between players as success depends heavily on execution and speed of adoption.

For 2026, we see an active backdrop supported by robust hyperscale investment and a more active software M&A environment as incumbents look to consolidate amid public valuation multiples that are at multiyear lows. At the same time, we are mindful that current levels of AI-related spending are a meaningful driver of broader economic growth and that disappointment in realized returns or adoption time line could result in a pullback in the AI investment.

Against this backdrop of increasing dispersion and uncertainty, we believe our scaled global investment platform positions us well. While U.S. middle market direct lending remains the foundation of Oaktree's global private credit platform. Our expertise across multiple strategies and our ability to underwrite complex transactions, expand our opportunity set and allows us to be highly selective.

Specifically, the depth and breadth of our sponsor, corporate and adviser relationships provide access to proprietary deal flow across asset-backed finance, European direct lending, infrastructure lending and capital solutions. We remain constructive from a long-term outlook for private credit. In this environment, disciplined underwriting, selectivity and active portfolio management will remain critical drivers of long-term performance. Raghav will now talk more about our portfolio and new investments. Raghav?

Thanks, Armen. Before turning to our standard discussion of portfolio activity, I want to build on Armen's comments on software and spend a few minutes outlining our approach to investing in the software sector. Our foundational approach to software investing has not changed in light of AI but we have become more selective in the sector.

At its core, our framework focuses on software providers that are deeply embedded in customers' daily workflows and business processes require meaningful buying from multiple stakeholders and have high switching costs. EI has raised the quality bar for software investments. And as a result, we have added incremental criteria to our underwriting for both new investments and existing portfolio companies.

We prioritize software businesses with multiple control points, data gravity, business context, high mission criticality and a coherent and credible AI road map. This has contributed to a higher pass rate on new opportunities relative to prior years.

In addition, over the past 12 months, approximately 18% of our total software positions have been repaid, underscoring the quality of our underwriting decisions. Further details of the software portfolio are shown on page 8 of the earnings presentation. As of December 31, software represented approximately 23% of investments at fair value, across 28 issuers, 94% of our software positions are first lien terminals, and we have only two ARR-based loans, representing approximately 2% of fair value.

Turning to the broader portfolio. As of December 31, 85% of the total portfolio was comprised of first lien senior secured debt and the weighted average yield on debt investments was 9.3%. We remain committed to a diversified portfolio. The average position makes up less than 1% and no position makes up more than 2% of our portfolio at fair value. Portfolio company weighted average leverage and interest coverage remained unchanged at 5.2 times and 2.2 times, respectively.

Our team delivered a meaningful increase in investment activity, which grew our portfolio size by approximately $100 million to $295 billion. Newly funded investment activity totaled $314 million, up 40% sequentially. Paydowns and exits were stable at $179 million, resulting in $135 million of net new investments for the quarter. This increase in deal flow reflects the breadth of Oaktree's private credit platform, combined with recent targeted investments in global sourcing and origination and specialized investment talent, which have meaningfully expanded the top of our funnel despite the lower volume in US middle market direct lending.

We continue to prioritize first-lien senior secured investments in resilient market-leading businesses supported by disciplined underwriting. First lien loans represented 92% of our new originations and the all-in weighted average spread on new originations during the quarter was approximately 500 basis points.

One transaction I want to highlight this quarter is our investment in Premier Inc. a health care services company that operates a large national group purchasing organization for a network of hospitals and health care providers. The company also provides a range of complementary offerings such as health care software supply chain management, data and analytics and consulting services.

In November, Patient Square Capital completed the Take-Private transaction of Premier at a total enterprise value of $2.6 billion. Oaktree has been growing its relationship with the sponsor and was deeply involved through the complex underwriting and negotiation process.

Oaktree funds acted as jointly to Ranger, providing nearly 40% of the first lien term loan and 30% of the revolving credit facility. The term loan carries an all-cash coupon of SOFR plus 650 and has 2 points of original issue discount. We were attracted to this transaction based on Premier's strong competitive positioning, secular tailwinds for health care spending and high customer switching costs.

During the quarter, there was one new addition to our nonaccrual list. We placed a second how terminal approval side on nonaccrual. Our prior position was restructured in August of 2024 and this quarter, we placed a restructured loan on nonaccrual due to the ongoing challenging industry dynamics and the company's softer-than-expected outlook.

At quarter end, there were 11 investments on nonaccrual, and as Matt noted, they represented 3.1% of the total debt portfolio measured at fair value. We continue to actively manage these positions with a goal of converting nonearning assets into income-producing investments over time. I will now turn the call over to Chris to review our financial results.

Thank you, Raghav. In our first fiscal quarter ending December 31, 2025, we delivered adjusted net investment income of $36.1 million or $0.41 per share as compared to $35.4 million or $0.40 per share in the prior quarter. This increase reflects lower levels of part 1 incentive fee expense which offset lower total investment income quarter-over-quarter.

NAV per share was $16.30 and down from $16.64 in the fourth quarter due to unrealized depreciation on certain debt and equity investments. The largest detractor in our portfolio was Pluralsight, which Raghav discussed in his remarks. We marked the equity position down to zero and mark down the second out term loan reflects this challenged position.

Adjusted total investment income decreased to $74.5 million. This compares to $76.9 million in the fourth quarter and was primarily driven by lower interest income due to lower reference rates and lower original issue discount acceleration which was partly offset by higher fee income, largely from higher prepayment and exit fees.

Net expenses declined modestly compared to the fourth quarter primarily reflecting a $4 million reduction in part 1 incentive fees, primarily as a result of our total return hurdle. OCSL continues to be cautious around the usage of payment and guidance with PIC representing 6.3% of adjusted total investment income in the quarter. Approximately two-third of our PIK income is related to investments that had the ability to pick at origination.

Our net leverage ratio at quarter end was 1.07 times, up from 0.97 times last quarter, and total debt outstanding was $1.6 billion. The increased leverage mirrored our strong deployments during the quarter, our long-term target leverage ratio of 0.9 times to 1.25 times remains unchanged.

As of December 31, the weighted average interest rate on debt outstanding was 6.1%, down from 6.5% from the prior quarter, primarily driven by lower reference rates. Unsecured debt represented 59% of total debt at quarter end, down slightly from the prior quarter. We have ample dry powder to fund investment commitments with liquidity of approximately $576 million, including $81 million of cash and $495 million of undrawn capacity on our credit facility. Unfunded commitments excluding those related to the joint ventures were $247 million.

Turning to our two joint ventures. Together, the JVs currently hold $511 million of investments primarily in broadly syndicated loans spread across 135 portfolio companies. During the first fiscal quarter, the JVs generated ROEs of 12% in aggregate. Leverage at the JV was 1.7 times, unchanged from 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 for Q&A.

(Operator Instructions)

Finian O'Shea, Wells Fargo.

On the portfolio, I'm not sure if you guys gave one of those performance one through five kind of category breakdowns. But in any case, can you give us the picture of the portion of the portfolio at this point that is sort of underperforming its current security or underwrite and where -- sort of where we are in migrating out of the legacy type issues.

Hi, Fin, it's Raghav. So I'd point you to page 13 -- sorry, it's not in there. So the way we think about our underperforming assets are, you obviously have the nonaccruals, which you can see the restructured equities. And then the third thing we monitor are positions that are trading or have been marked well below par, and that's obviously an indicator of stress.

And in that portion, most of the loans and positions we have that are under considerably below par are actually public positions, some of which we actually bought around in the high 80s to 90s and have traded down a few points below that. Most of them we expect to rebound. There are a couple of names which are in the technology space that are -- as I'm sure you can see in the market that are facing a little bit of pressure.

Just on that point, by the way, when we speak to our trading desk, a lot of those technology names are trading down on like $2 million and $3 million trades, mostly from CLO sellers who are trying to manage their wharf tests and rating tests. We're not seeing huge selling in those positions. So we're watching those names in particular, the technology names that are broadly syndicated loans and have freighted down. But there's not a lot of trading actually happening. There's not a lot of selling. It's mostly small selling from CLO sellers.

Okay. I guess, helpful I guess a follow-up, sticking with that topic. You gave some helpful views or color on AI risk to software. Are you let's say, to the extent there is volume, are there interesting names on the screen. It looked like you had a good amount of liquid this quarter. Should we expect that to continue?

Yes. So one of the benefits we have is we obviously have a large public markets business in our high-yield business and in our senior notes business. So we're actually triaging all of the software names and technology in addition to obviously, very closely monitoring our private positions by developing AS or cards and other types of score cars to, again, triage. Because I think your sentiment is right that there is a bit of a baby out with the backwater situation. And that's something we are looking at.

Again, when we look at what is the right point to step in, it doesn't feel like that right now just because, again, the trading volume we've seen is either small ticket sales from CLOs or dealers trying to make a market. And these like $2 million, $3 million order trades are basically being used to mark positions down 2 points, 3 points. So it looks very attractive when you look on a screen, at least for some of these names where the air risk is low, but there isn't enough volume to actually want to step in and try to be a buyer.

Ethan Kaye, Lucid Capital Markets.

So you disclosed media -- portfolio EBITDA increasing from $150 million to $190 million sequentially. I feels like a pretty big change for one quarter. You did talk about there being maybe some more activity in the upper middle market as compared to the core middle market. But wondering really kind of what drove that? Was it strategic result or more so a byproduct of the deal environment and company growth?

Yes. So it's -- you're right. So it was really driven by our new originations that we funded in the fourth quarter, which were pretty large companies. They were all large cap Mostly on the sponsor side, mostly in the US, there were a couple of non-sponsor situations a couple of non-US, really just European situations that we funded in the fourth quarter but they were typically much larger EBITDA. So most of the growth in the median EBITDA, I would say, was a mix shift from those originations in the fourth quarter.

But the overall portfolio EBITDA has also been growing that, I would say, was a smaller portion of the increase you're seeing in the median EBITDA.

Got it. Great. And then one other. So I'm hoping you can kind of walk through the $32 million or so of unrealized depreciation. We talked about purse, which appears to be about one-third of that net number, but can you kind of talk through whether there was maybe any other themes or drivers of kind of the markdowns in the quarter.

It's Chris. I'll make a few comments and add any color. So you're right, our site was the single largest driver, accounting for about 38% of the total mark. Beyond that, we did take some smaller markets and a few other private positions. And then we did see some of the quoted names trade down, which impacted the name going balance sheet as well as in the JV.

Paul Johnson with KBW.

I mean just a little bit more in terms of the -- your sort of perspective on software. I guess, how would you kind of characterize at this point, top line growth and EBITDA trends sort of broadly have you noticed any sort of change in the growth rates there back up in any sort of new activity for deals. I mean, how has that impacted the market, I guess, beyond kind of the weakness in some of the secondary loan prices.

Thanks for the question. This is Armen. Look, I think big picture, I would say that it's too early to actually see performance degradation in any software name, and it's probably going to take a fair bit of time to actually see any sort of dispersion in performance due to AI or disruption in performance in AI. There have been a lot of splashy headlines, but it has not translated big picture into a widespread issue across the names. The reason for the concern isn't necessarily near-term weakness in performance.

It's more that the concern around the long run calls into question the refinanceability of these loans when they mature. And that's why everybody should be looking at their software exposure because to the extent that a subset of software names, whether they're in your private equity book or in your private credit book to the extent some of them are more susceptible to long-term dislocation due to AI the more likely it is that the private equity sponsor fails to support them when in maturity occurs even in advance of a real issue in performance.

The other thing I would say is if some number of these software businesses are eventually disrupted by it may turn out to be that they are binary in their outcomes. What I mean by that is if the business appears to be at risk of an AI. A meaningful AI competitor, you could see, depending on the nature of the contracts and the nature of the business, you could see a pretty rapid degradation of performance in those businesses over time.

And therefore, from an equity perspective and from a credit perspective, the recoveries could be quite problematic. So it is a significant reason to be concerned about in the medium to long term, but it's not going to really emerge in the short run.

And on this point, I think it's worth mentioning real quick, the concept of covenants in software deals. Covenants and software deals mirror the same sort of mirror the same sort of condition as just large cap versus core or small-cap private credit.

And what I mean by that is this, there are software deals that have covenants, EBITDA covenants, and they tend to be smaller or midsized companies. But as businesses become large cap and as they are possibly financeable in the broadly syndicated loan market, those software loans do not have any covenants. So it's like cov-light, as you'd imagine, in another industry outside of software in a large-cap deal, you don't see covenants in a small or midsize deal, you do see covenants typically.

And the covenants and software deals are usually one of two types. One is an EBITDA-based covenant, as you would see in a normal business that is financed off of a leverage multiple. And the other would be ARR or annual recurring revenue.

And those transactions that are recurring revenue based, again, if they're middle market or lower middle market, they will have typically an ARR covenant whereby they have a total debt to ARR cap, and that covenant usually falls away in about three years, and it converts into a more traditional leverage-based covenant.

So the covenants are -- can become a problem for ARR deals as they approach that three-year anniversary typically and those deals that have such a covenant again, large cap is less likely to have it than small caps. But it is yet sort of an additional factor that may ring the alarm bell a little bit sooner or earlier than the maturity.

And in our case, by the way, in terms of OCSL, we really only have two ARR deals in our portfolio period. And one of them is already free cash flow positive and expected to repay imminently. The other is a very large transaction, a very large company with a very large private equity sponsor.

We think it's pretty well insulated from AI competition, but we think we've done we think we've been pretty forward-looking on the ARR side at least to avoid those situations that do not cash flow and therefore, need some sort of access to the public markets or some sort of availability in the financing markets. We wanted to avoid those situations now for several years. And so that's not really an issue in our portfolio.

I think, Paul, it's Matt. We put a new page in the deck, page 8 that breaks out our software exposure in OCSL, which I think -- give us any comments if you have on it. But we're really out there, kind of your question on kind of performing in the business. So if you look at kind of the EBITDA growth since we funded the deals, it's up about 20%. So it gives you a sense of we've had growth there.

The EBITDA margin is around 40%. So these are EBITDA positive companies. And about 18% almost 20% of our software loans have repaid over the last 12 months. So a reflection of thoughtful and successful underwriting. But we did lose out on page 8, which what we posted. Hopefully, that's helpful as well.

It's very good color there, and Armen. I appreciate the help points are there as well. One more bigger question, bigger picture question, if I may, kind of on this topic. Sort of two part. But on that slide, you mentioned there's a 47% weighted average LTV ratio. I'm just curious, is that an LTV ratio and underwrite -- or is that more a current LTV ratio, obviously, based on valuations and leverage today. That's the first part of the question.

And then the other part of the question is bigger picture. How much of valuation sort of reset do you think that broadly the software space can absorb in the equity multiples before we do start to see widespread sort of restructurings and losses. And bigger trouble within the software industry, just given that, obviously, these are companies that are typically financed with lower LTV ratios underwrite. And I'll hand it off there.

This is Armen. I'll answer that, Paul. I mean -- so first of all, on that slide, that is the LTV at underwrite, not a current estimate.

It's at 12/31, the current one.

It's the current, 12/31?.

Yes.

Okay. So at 12/31, it would -- so that is our estimate of the LTV as of 12/31. And then in terms of the amount of degradation in the equity multiple that it could sustain. I would say, generally speaking, if you do see LTVs rise to 60%. That's getting to the point where they -- it calls into question the refinanceability of the loan.

Generally speaking, today, outside of software when there is an LBO, you're seeing something like 50% to 55% LTV at the MAX you're not seeing 70% or 65% LTV deals generally. So what would happen, theoretically, assuming these businesses aren't burning a terrible amount of cash and they get to within a reasonable time frame of maturity.

Once the sponsor calls up the market and says, Hey, I want to refinance. And the response is going to be, well, you're going to need to put in more equity to kind of make this closer to a 50-50 LTV again. And the sponsors will then have to judge whether it makes sense to do that or not based on the future sort of risk factors and earnings potential of the business, but also the stage of deployment of the fund that those investments are in.

If we fund it cannot all capital, well, then that sponsor can't support the business. if the fund is already a winner and has already returned a lot of capital, then it's more likely to let go of those straggler businesses that needed capital to kind of punch through a refinancing or a maturity.

And so there -- the sponsor is less likely to support the business in that event. So there's a lot of economic and noneconomic factors that come into play to judge the sponsor's willingness to support a business, if and when the of the loan exceeds again, probably that -- 55% or 60% LTV threshold level.

(Operator Instructions) There are no further questions at this time. I'll now turn the call back over to Allison Mary for any closing remarks.

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.

Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect.