Oaktree Specialty Lending - Q3 2023

Transcript

Operator (participant)

Welcome, and thank you for joining Oaktree Specialty Lending Corporation's third fiscal quarter 2023 conference call. Today's conference call is being recorded. At this time, all participants are in a listen-only mode, but will be prompted for a question-and-answer session following the prepared remarks. Now, I would like to introduce Michael Mosticchio, Head of Investor Relations, who will host today's conference call. Mr. Mosticchio, you may begin.

Michael Mosticchio (Head of Investor Relations)

Thank you, operator, and welcome to Oaktree Specialty Lending Corporation's third fiscal quarter conference call. Our earnings release, which we issued this morning, and the accompanying slide presentation, can be accessed on the investor section of our website at oaktreespecialtylending.com. Our speakers today are Armen Panossian, Chief Executive Officer and Chief Investment Officer; Matt Pendo, President; and Chris McKown, Chief Financial Officer and Treasurer. Also joining us on the call for the question-and-answer session is Matt Stewart, our Chief Operating Officer. Before we begin, I want to remind you that comments on today's call include forward-looking statements reflecting our current views with respect to, among other things, the expected synergies and savings associated with the merger with Oaktree Strategic Income II, Inc., the ability to realize the anticipated benefits of the merger, and our future operating results and financial performance.

Our actual results could differ materially from those implied or expressed in the forward-looking statements. Please refer to our SEC filings for a discussion of these factors in further detail. We undertake 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 any Oaktree fund. Investors and others should note that Oaktree Specialty Lending uses the investor section of its corporate website to announce material information. The company encourages investors, the media, and others to review the information that it shares on its website. With that, I would now like to turn the call over to Matt.

Matt Pendo (President)

Thanks, Mike. Welcome everyone. Thank you for your interest and support of OCSL. We appreciate your participation on this call. We produced strong results in our fiscal third quarter, bolstered by robust origination activity and attractive yields and the positive impact of higher base rates on our predominantly floating-rate portfolio. Combined with the cost synergies arising from the recently closed merger with OSI II, we generated strong earnings on behalf of our shareholders. Third quarter adjusted NII was $0.62 per share, in line with the prior quarter. This was supported primarily by higher total investment income and lower operating expenses, partly offset by increased interest expense, as well as higher management and incentive fees. We reported NAV per share of $19.58, down slightly from $19.66 for the prior quarter.

The decrease reflected a modest decline in the value of certain debt investments and was offset by net investment income in excess or a $0.55 per share quarterly dividend. Given the strong overall earnings, our board maintained our quarterly dividend at $0.55 per share. As a reminder, this is nearly double our pre-pandemic quarterly dividend run rate of $0.285. Our investment activity in the third quarter was strong, with $251 million of new investment commitments, more than double the level of the prior quarter. Of the new originations, nearly 90% were private direct lending opportunities and 90% were first-lien loans, reflecting our emphasis on being at the top of the capital structure. The weighted average yield on new originations was attractive at 12.6%.

Paydowns and exits in the quarter were also strong, as we received $261 million of proceeds. While broader market activity has been slower, given higher interest rates and fewer refinancings, we continue to receive steady levels of paydowns and have also been opportunistically selling out of lower-yielding public credit investments. Importantly, the third quarter marked our first full quarter realizing synergies following the merger with OSI II. We are pleased to be on track to achieve $1.4 million worth of operating expense synergies on an annualized basis. We've also been focused on streamlining our capital structure, leveraging OCSL's greater scale to improve our financial flexibility. During the quarter, we increased the size of our syndicated credit facility to $1.2 billion from $1.0 billion and extended the maturity by two years to 2028.

We also consolidated a credit facility acquired from OSI II with our existing Citibank facility and pushed out the maturity by two years to 2027. We appreciate our banking partners' support and their confidence in Oaktree as a manager. These improvements further strengthen our funding options and enhance our ability to capitalize on new investment opportunities. Altogether, our strong balance sheet puts OCSL in excellent shape to continue delivering attractive returns to our shareholders. Before I turn the call over to Armen, on behalf of the team, I wanted to congratulate him on being selected as co-CEO of Oaktree, along with Bob O'Leary, beginning the first quarter of calendar 2024. Well deserved, Armen.

Armen Panossian (CEO and CIO)

Thanks, Matt. Much appreciated, and good day, everyone. The current market environment presents a complex landscape. On one hand, headline inflation has responded to the most aggressive rate hiking cycle in 40 years.

However, core inflation, which excludes food and energy prices, has proven more challenging to control. Meanwhile, unemployment numbers and consumer spending are both relatively stable. Against the backdrop of rapid rate increases, this economic resilience could be at least partially attributed to the U.S. government's aggressive fiscal policy that has buoyed the economy. In the near term, investors have become exuberant, and the public markets have rallied over the last several weeks. If inflation continues to trend in the right direction and a recession does not occur, the likely scenario would be that rates would remain higher for longer. Such a condition would create elevated default risk among interest rate-sensitive assets, such as real estate and highly levered equities, even if a recession does not materialize first.

Many companies have capital structures put in place during the easy money era of near zero base rates, and we have only recently begun to see the elevated impact of higher rates on levered free cash flow. This might lead borrowers to seek concessions from lenders or additional equity injections from owners. As a result, availability of capital for new deals may become limited at times, benefiting managers like Oaktree, who consider these risks well in advance of them materializing, helping our portfolios withstand volatility and capitalize on opportunities. At OCSL, our timely merger with OSI II provided us with important scale, and as Matt noted, additional financial flexibility.

Combined with our team's long history of opportunistic investing, we believe that we are well positioned to leverage the power of the Oaktree platform and to negotiate and structure deals that provide downside risk protection and generate excellent risk-adjusted returns over the long term. Now, turning to the overall portfolio. At the close of the June quarter, our portfolio was well diversified, with $3.1 billion at fair value across 156 companies. 88% of the portfolio was invested in senior secured loans, with first-lien loans representing 76%, underscoring our emphasis on being at the top of the capital structure. We continue to emphasize investing in larger, more diversified businesses that are better positioned to weather downturns or market turbulence.

To that end, median portfolio company EBITDA as of June 30 was approximately $119 million, and leverage in our portfolio companies was 5.0x, well below overall middle market leverage levels. The portfolio's weighted average interest coverage, based on trailing 12-month performance, was steady at 2.5x. Turning now to our origination activity. Our $251 million of new investment commitments were spread over six new and four existing portfolio companies in the quarter. I'd like to highlight two representative examples from the quarter. First, Oaktree led a direct lending financing for Melissa & Doug, which sells children's toys to retailers in North America and Europe. Known for reimagining classic educational play patterns to promote creativity, imagination, and social connection, the company's toys encourage free play and reduce screen time, an increasingly popular mission.

Oaktree approached the sponsor, who was originally planning to amend and extend its existing broadly syndicated loan in the public market and offered several flexible financing solutions. This resulted in an Oaktree-led transaction consisting of a $260 million first-lien term loan and a $65 million revolving credit facility. OCSL was allocated $51.3 million in total, and the deal was priced at SOFR plus 750. Oaktree originated a $550 million commitment and allocated $50 million to OCSL as part of a larger loan to Vedanta Group, an India-based diversified resources company. Its presence spans across the zinc, aluminum, oil and gas, copper, power, iron ore, and steel industries. The company was looking to raise capital to refinance debt that was set to mature in the near term.

This first-lien loan was priced favorably with a 13% fixed rate and carried strong downside protections. Turning to credit quality, we moved three investments to nonaccrual during the quarter. One involved a very small, immaterial position with a fair value of $325,000. Another, All Web Leads, which provides insurance lead services, is a non-core position we inherited from the prior manager that is maturing later this year. While the company is exploring options, including the possible sale of some or all of its assets, we felt it was prudent to place it on nonaccrual at this time. The other new nonaccrual is an investment that we made in Athenex, a biopharmaceutical company dedicated to the discovery, development, and commercialization of novel therapies for the treatment of cancer and related conditions.

It has many subdivisions and uncorrelated assets that it has been selling over time to pay down our loan. Today, OCSL has been repaid on roughly 90% of its original funded amount of $55 million, and the position totaled $7.5 million fair value as of June 30, 2023. In May, the company filed for Chapter 11 to facilitate an orderly sale and wind down of the remaining assets, which we expect to conclude in the near term. To that end, since quarter end, we received an additional paydown of $2.3 million. Altogether, the new non-accruals represented just 1% and 0.8% of the debt portfolio at cost and fair value, respectively.

Importantly, our overall portfolio is in solid shape. With each of these non-accruals, we expect to arrive at successful outcomes on behalf of our shareholders. In summary, our increased scale and experience across various cycles, paired with the power of the Oaktree platform, places OCSL in great shape to close out fiscal 2023 and move into the next year. Now, I will turn the call over to Chris to discuss our financial results in more detail.

Chris McKown (CFO and Treasurer)

Thank you, Armen. OCSL continues to deliver consistently strong financial performance. We demonstrated that again this quarter. For the third quarter, we reported adjusted net investment income of $47.6 million, or $0.62 per share, up from $45.4 million and consistent with $0.62 per share in the second quarter due to the higher share count as a result of the merger with OSI II. The increase on a dollar basis was primarily driven by the first full quarter of interest income earned on the assets acquired in the merger, the impact of higher base rates on the company's floating-rate debt portfolio, and lower operating expenses, which were partially offset by higher interest expense, management fees, and incentive fees. Net expenses for the third quarter totaled $53.5 million, up $3.2 million sequentially.

The increase was mainly driven by $3.0 million of higher interest expense due to the impact of rising interest rates on the company's floating-rate liabilities and an increase in the average borrowings outstanding. Further contributing to the increase was a $0.8 million increase in base management fees, primarily resulting from the first full quarter of the assets acquired in the OSI II merger, as well as $0.6 million of higher Part One incentive fees, resulting from the higher adjusted net investment income during the quarter. These were partially offset by $1.2 million of lower professional fees and general and administrative expenses, including realized synergies from the OSI II merger. With respect to interest rate sensitivity, OCSL remains well situated to further benefit from the increasing rate environment.

As of quarter end, 86% of our debt portfolio at fair value was in floating-rate investments. Our strong earnings in the third quarter were again driven by the higher base rates, as Matt noted. Moving to our balance sheet. OCSL's net leverage ratio at quarter end was 1.14x, consistent with the end of the March quarter, and it continues to be within our targeted range of 0.9x-1.25x. As of June 30, total debt outstanding was $1.8 billion and had a weighted average interest rate of 6.6%, including the effect of our interest rate swap agreement, up from 6.2% at March 31 due to the impact of higher interest rates. Unsecured debt represented 36% of total debt at quarter end, down modestly from the prior quarter.

At quarter end, we had ample liquidity to meet our funding needs with total dry powder of approximately $542 million, including $60 million of cash and $483 million of undrawn capacity on our credit facilities. Unfunded commitments, excluding unfunded commitments to the joint ventures, were $247 million, with approximately $185 million eligible to be drawn immediately, whereas the remaining amount is subject to certain milestones that must be met by portfolio companies before funds can be drawn. With respect to our credit facilities, during the quarter, we entered into an amendment to our syndicated credit facility that, among other things, increased the size of the facility from $1.0 billion-$1.2 billion and extended its maturity by two years to June 2028, with no change in the margin.

There are now 20 lenders in the syndicate. During the quarter, we consolidated the OCSL and OSI II SPV facilities with Citibank, entering into a new $400 million facility that matures in 2027. Shifting to our two joint ventures. At quarter end, the Kemper JV had $370 million of assets invested in senior secured loans to 52 companies, down from $393 million last quarter, primarily as a result of exits exceeding new originations. The JV generated $3.4 million of cash interest income for OCSL in the quarter, up from $3.2 million in the second quarter as a result of the portfolio's continued strong performance and the impact of rising interest rates on floating-rate investments. We also received a $1.1 million dividend, consistent with the second quarter dividend.

Leverage at the JV was 1.2x at quarter end, down from 1.4x in the prior quarter. The GLIC JV had $127 million of assets as of June 30th, down from $131 million at March 31st. These consisted of senior secured loans to 38 companies. Leverage at the JV was 1.2x at quarter end, and we received $1.7 million of principal and interest payments on OCSL's subordinated note in the Glick JV during the quarter. In summary, we are very pleased with our financial results, and we continue to believe that our strong balance sheet positions us well through the remainder of the fiscal year. Now I will turn the call back to Matt for some closing remarks.

Matt Pendo (President)

Thank you, Chris. Our strong financial results for the quarter enable us to generate an annualized return on adjusted net investment income of 12.6%, consistent with the prior quarter. We are very pleased with the growth in our earnings over the past several years and believe that OCSL remains well positioned to continue delivering strong ROE going forward. First, we believe we are well situated for the prevailing higher interest rate environment. As Chris noted earlier, with 86% of our investment portfolio in floating-rate assets, we expect that the July rate hike and future potential increases in base rates will positively impact our net interest margin.

We also continue to benefit from higher ROEs generated at our joint ventures. During the third quarter, both joint ventures delivered ROEs of over 14.5% due to strong credit quality and positive impacts from the rising rate environment. As noted earlier, we expect that the synergies resulting from the OSI II merger will support our returns and generate substantial long-term value for our shareholders. In conclusion, we are very pleased with the continued strength in our results and our ongoing momentum. Our portfolio is diverse and healthy, and we are in excellent financial shape to capitalize on this volatile but attractive investment environment with our robust liquidity, extensive relationships, and disciplined underwriting expertise. We believe that our solid portfolio and strong balance sheet position us favorably for the remainder of the fiscal year.

As always, we thank you for joining us on the call today and for your continued interest in OCSL. With that, we're happy to take your questions. Operator, please open the lines.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press Star then One on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press Star Two. At this time, we will pause momentarily to assemble our roster. Again, I remind you to ask a question, Star One. Our first question comes from Erik Zwick from Hovde Group. Erik, please go ahead.

Erik Zwick (Director of Equity Research)

Good morning. Thank you. I wanted to first just start, you had a, you know, very strong quarter in terms of new commitments. Curious what that might mean for the pipeline going forward, you know, and in the next quarter or so, if you are seeing similar strong opportunities at this point?

Armen Panossian (CEO and CIO)

Hi, Erik, it's Armen. Yeah, it, it has been a strong quarter in terms of originations. You know, what you do see in the quarter represents originations that have been, in the pipeline now for, you know, at least a quarter, if not two or three. There is a little bit of a lag in terms of, the actual originations that you see in any particular quarter.

I would say that generally speaking, the next quarter, the September quarter ended September 30, will probably be a little bit lighter, just given the fact that the elevated cost of borrowing as base rates have risen, so much and spreads have widened, has caused a bit of a decline in M&A volume, as well as a little bit of a pause button being hit by non-sponsored transactions or non-sponsored investment opportunities that we're considering as well. So I would expect it to be a little bit lighter, over the, over the next quarter or so.

Erik Zwick (Director of Equity Research)

Thanks. That's helpful. Then, Armen Panossian, in your prepared comments, you mentioned that, you know, the higher for longer rate environment can create elevated default risk. You know, I know you typically try and focus on, you know, kind of more conservative, and, I guess kind of a, a defensive portfolio, but you have the opportunity to, to look across a, a broad number of sectors. I'm curious, you know, at this point, are, are you seeing any signs of weakness or concern in any particular sectors? Or is it still kind of too early at this point to, you know, see how that might play out?

Armen Panossian (CEO and CIO)

Yeah, it's a good question. We are... I wouldn't say that we are seeing huge alarm bells at the moment, but certainly the stresses, the early signs of stress, I would say, are most acute in companies that didn't benefit from COVID and have experienced some inflationary impact in their costs. Healthcare services, transactions of an older vintage that are in healthcare services, I, I would say are showing a little bit more stress than the average borrower. You know, some technology companies are, I think seeing some stress, and they are, they are working on their cash flow generation potential.

I think a lot of technology companies are, are actually focusing on generating cash flow or becoming cash flow neutral because the assumption of having access to the capital markets has, has gone away a bit. You are probably more likely to see stress in some technology-oriented companies versus the average borrower as well. Net-net, I think it is a bit early to, to really tease out an industry or sector-specific trend.

Erik Zwick (Director of Equity Research)

That's great, color. Thanks for taking my questions today.

Operator (participant)

We now have a question from Melissa Wedel, from JP Morgan. Melissa, please go ahead.

Melissa Wedel (VP of U.S. Equities Research)

Good morning. Thanks for taking my questions today. Following up on the new activity in the portfolio, I was just curious, was there anything kind of idiosyncratic around timing of new deployments versus repayments during the quarter? I guess, more specifically, did you see repayments earlier in the quarter and put capital to work later?

Armen Panossian (CEO and CIO)

... Hi, Melissa, it's Armen again. I, I don't think that there was any, any discernible, trend that way in terms of timing. I, I think we were fairly active in, in originating throughout the quarter. We had a couple, you know, specialty loans that, were done in partnership with our opportunistic credit group that, you know, it's hard to predict if they close in, you know, a certain week or a certain month. They just take longer to, to document. I, I wouldn't say that there was any sort of trend in that regard.

Melissa Wedel (VP of U.S. Equities Research)

Okay. Appreciate that. I, I do appreciate the detail that you provided on the three new non-accruals in the portfolio. I was hoping to circle back to the previous two companies that you talked about last quarter. I believe, as I recall, with regard to both of those companies, that were already on non-accrual headed into the June quarter, you'd indicated that you expected somewhat near-term resolutions on those as well. Just curious if that's still your outlook or if things have evolved. Thank you.

Armen Panossian (CEO and CIO)

Thanks. The other two, one was called the Avery, one is SIO2. Avery is a real estate asset in the San Francisco market. We continue to work with the sponsor there, the developer. They are a very skilled developer and marketer of all types of real estate assets. We think their highest and best use is to have that developer continue to sell the units. The good news is that the units are continuing to sell at accretive prices relative to our attachment point on our loan. It's just gonna take a little bit longer.

I don't think we're gonna do a bulk sale of the, of the, remaining units anytime soon. I think it's kind of steady as it goes, and it will take a little bit of time to get all of the capital back. I, I wouldn't be surprised if they did a bulk sale, but that's certainly not- we're not, we're not putting the pressure on to get the capital back quickly. We'd rather do an orderly liquidation. In the case of SIO2, the company had its confirmation hearing for emergence from bankruptcy. That is an ongoing situation. It is going to exit bankruptcy very soon, and we will have more to report, probably, at the end of the fiscal year, at the end of the next quarter as to an update.

We have been very heavily involved with operational changes for the business during the pendency of the case. We are also engaging with strategic partners and investors, as well as financial investors, to help in terms of the equity infusions that the company would like to engage in to grow. There is a lot of interest in the intellectual property and the capabilities of this business. We at Oaktree are not really of the mindset to grow our equity exposure to the company, but we're happy to have especially strategic investors join in and help grow that business. We are cautiously optimistic about that situation, but it is not, I would say, a complete resolution of the position over the course of the next few weeks.

I think it will take at least a few quarters to, to have a clear path here. We are, I think, in the thick of the bankruptcy and the operational changes to the business, as well as engaging with, with many investors on the equity side to help kind of take the business to the next level as it emerges from bankruptcy in the coming weeks. I think the only update there is that it is gonna emerge from bankruptcy quickly. It's a very quick bankruptcy. We are in control of the business and we are really setting it up for, for success, but that success is not at hand at the, at the moment or in the near term.

Melissa Wedel (VP of U.S. Equities Research)

Got it. Thank you, Armen.

Operator (participant)

At this time, I would like to remind you, if you would like to enter the question queue, press star one. We have a question coming from Bryce Rowe from B. Riley. Bryce, please go ahead.

Bryce Rowe (Senior Equity Research Analyst)

Thank you so much. Good, good morning. Wanted to maybe start on some of the repayment activity and then also on the portfolios of the JVs. You know, somewhat elevated repayment activity here this quarter, and then, you know, the portfolios of the JVs, you know, fell, in, in terms of, in terms of the, of, of their outstanding. Kind of curious if it's more, if, if that's intentional, both, you know, with the on-balance sheet and the JV portfolios in terms of trying to exit, you know, with, with a, with a market that might be, you know, more active than not?

Matthew Stewart (COO)

Yeah. Hi, it's Matthew Stewart. I would say across both the on-balance sheet and the JVs, we were better sellers as the syndicated loan market rallied during the quarter. If you look at our repayment activity on balance sheet, about a third of that was us actively selling. Some of the positions that we purchased in the secondary market, at the end of last year, or that came along with the OSI II merger, we were better sellers of. We were- we're selling out of those positions, and then we, we did some more themes in the JV as well, just given the strength in the loan market. We continue to monitor the primary market for all these syndicated loans for the JVs.

On balance sheet, again, we've been rotating out of some of the liquid positions in anticipation of our private pipeline....

Bryce Rowe (Senior Equity Research Analyst)

Okay. Matt, are there maybe continued opportunities to, to, to do that, or, you know, pretty well exhausted at this point?

Matthew Stewart (COO)

We worked through most of our liquid positions from the OSI II merger and the, and obviously, the balance of our OCSL merger a few years back. There's still some rotation opportunities in the portfolio, just not as plentiful as it was previously.

Bryce Rowe (Senior Equity Research Analyst)

Okay. All right. maybe shifting to, to capital structure, obviously active with, you know, some of the amendments, with, with the credit facilities. Just kind of curious how you're, how you're thinking about the unsecured opportunity, at, at this point to maybe layer in some more unsecured notes. Then, you know, a, a follow-up to that, you know, any, any appetite to, to use the ATM, now that your, your stock price is, is over NAV?

Matthew Stewart (COO)

We're, we're still watching the unsecured market. We feel comfortable where our capital structure is today. As you mentioned, we pushed out both our secured facilities by a little over two years, so our near-term maturities of 25 and 26 are now 27 and 28. We're about 36% unsecured at this point, so we're gonna continue to watch that market. It's tightened about 100 basis points if you look at some of the recent prints in the market versus where we were a few quarters ago. We do feel comfortable about where we are today. Our next maturity is February of 2025, so we have significant runway. We'll continue to evaluate that market, and see if there's any opportunities.

On the ATM side, we've had the ATM in place for about a year and a half now. We've accessed it, you know, very little last year. We'll continue to watch that, and, you know, we'll see how the stock trades and what our pipeline looks like and if there's any opportunities for ROE in the future there.

Bryce Rowe (Senior Equity Research Analyst)

Got it. Okay, thanks, thanks for taking the questions.

Operator (participant)

We have a question from Ryan Lynch from KBW. Ryan, please proceed.

Ryan Lynch (Managing Director)

Hey, good morning. First question I had was just, you had about $2.6 million of non-interest operating expenses this quarter. That was a little bit lower than we were expecting. I know there was expected to be some synergies. Is that a pretty good run rate that we should expect going forward, or is there anything that, that, that kind of lowered that, or, or is there anything in other quarters that expected to, to kind of make that a little bit higher?

Chris McKown (CFO and Treasurer)

Yeah. Hey, Ryan, Chris McKown here. Thanks for the question. Yeah, we, we were very happy to realize some of the synergies from the OSI II merger. You know, we're always gonna have some puts and takes quarter in and quarter out with respect to the operating expenses. You know, I, I do think that where we landed this quarter is a, you know, is a, is a decent run rate, again, taking into account some puts and takes, you know. In addition to the synergies, we did have some, some items that were kind of a nonrecurring nature last quarter that also contributed to, to the decline.

Ryan Lynch (Managing Director)

Outside of the, maybe the nonaccruals that you guys have had, put on this quarter, have you guys been receiving many amendment activity requests from borrowers in your portfolio relative to, you know, call it, you know, requests you would have received, you know, on a, on a normal basis like a year ago?

Armen Panossian (CEO and CIO)

Yeah, I, I think it's been pretty light so far. It's been, I would say, consistent to -- with what it's been -- it was in 2022 or 2021, so not really an uptick. I would expect some of those conversations to happen at some point in the markets broadly. For now, you know, it's, it's really been pretty, pretty quiet on that front.

Ryan Lynch (Managing Director)

Then just one final question that I had, you know, kind of a higher level question, but you guys have, have really good insights on the credit markets. You mentioned, you know, higher base rates, that are, that are-- borrowers are just now starting to feel the effect of higher base rates kind of on their, on their financials. I'm just curious, we've heard in the past that, that higher base rates alone are probably not going to, you know, put a lot of borrowers into default. It's probably gonna take some sort of weakness, in the business, in combination with, with higher base rates.

I'm just curious, do you expect sort of broadly, and then maybe with your portfolio specifically, because the economy has been so resilient now, it's been uneven in certain areas, but it's been pretty resilient. Are you expecting sort of a meaningful increase in defaults, if the economy does stay this strong, and base rates stay this high? Do you think base rates alone are effective enough to kind of meaningfully increase the defaults going forward?

Armen Panossian (CEO and CIO)

Yeah, I mean, it's, it's obviously very hard to predict, but, you know, you're right that base rates on their own are probably not gonna result in a wave of defaults. It should result in an increase in the default rate by a couple hundred basis points from historical averages and over a period of time, over an extended period of time. I think that you won't see the big spike in defaults until you get to, you know, closer to a maturity wall, which in the public market, you start seeing more heavy maturities in 2025 or 2026. You don't really see a very heavy maturity wall in 2024. You know, the, the comment about base rates being problematic is that-

If base rates remain this elevated for an extended period of time, then what you will find is a maturity wall issue, potentially. You will find some number of companies, albeit maybe not a big distressed cycle, but you will see defaults growing. You will see just asset bubble deflation as companies then- companies and asset owners need to decide, are they going to invest additional equity into these businesses if they are underwater from a capital structure perspective? You will see a combination of factors that don't bode well, you know, underinvestment in assets, some level of defaults, some requests for picking interest, some requests for amendments and waivers.

It's really hard to see in the, I would say, the medium term, a very positive outlook in the case of a higher for longer scenario. For those businesses that are able to grow nominal profitability or nominal dollars of profit over the medium to long term, then, you know, they may be better off if they're able to survive this capital crunch that is probably going to occur over the next, you know, 6-18 months, is the guess that I would have as to when the impact of the base rates and the access to the capital markets for highly levered capital structures put in place before the pandemic.

I think that this next, you know, year or two is gonna be when we see, some pretty key decisions about asset owners' support for those businesses.

Ryan Lynch (Managing Director)

Okay. Understood. That's all for me. Thanks.

Operator (participant)

We have a question from Kyle Joseph, from Jefferies. Kyle, please go ahead.

Kyle Joseph (SVP)

Hey, good morning, guys. Thanks for taking my questions. Apologies if I missed this. Been too many earnings this morning. It was an active quarter of, of both appointments and, and repayments, and then it looked to me like fee income was, was a little lighter than I was expecting. You know, anything you'd highlight there? Was it just kind of the nature of, of some of the repayments there or, or anything, any other nuance?

Matthew Stewart (COO)

Hi, it's Matt Stewart. Not too much to report there. I mean, we got some of our repayments for older vintage loans that didn't have significant call protection, or the call protection had run out. So there's really not much to report there. To Armen's point around amendment activity, the amendment fees during the quarter weren't significant either. Not much to report on that line item.

Kyle Joseph (SVP)

Got it. Then, you know, stepping back, Armen or Matt Pendo, just wanna get your thoughts in terms of kinda the potential fallout from what's going on with regional banks and, and, you know, rumors and, and headlines about increasing capital requirements at banks and, and, you know, how big of an opportunity you think that is for the sector and, and OCSL in particular?

Armen Panossian (CEO and CIO)

Yeah, it is Armen. I mean, I'll, I'll jump in, and Matt, feel free to add. I do think that it's going to present a very attractive opportunity. In some ways, it, it gives us the opportunity to partner with those banks, and in others, in other situations, it gives us the opportunity to buy portfolios. Finally, you know, I think generally speaking, whether there is an increase in required equity capital or not, I think the higher, the, the higher level of scrutiny from the regulators, we are already seeing it kind of play through with an expansion in the aperture of the possible deals that we may, that we may do, you know, with or without partnership with the bank.

We're just, you know, I, I think, beginning to see an increase in deal flow, but I think there's also opportunities to work with the banks as a, as an off-taker of some of their assets, at a price or as a partner with them, going forward through origination. I think it's early days in terms of figuring that out.

Matt Pendo (President)

Yeah, it's Matt. It's Matthew Pendo, Kyle. You know, I think, just to echo Armen's comments, I, I do think it's early days. That being said, I do think it will be a big opportunity. You know, there's no question that from the bank's perspective, you know, the regulatory oversight, capital charges are, are increasing and only gonna continue to increase. We can really partner well with banks. You know, there's a lot of services and products they offer that, that we don't offer and we're not interested in. You know, we have, we have a lot of capital. We can structure, execute transactions very quickly and, and thoughtfully. You know, I think, I think this trend has been, you know, it's been going on for a while, and I think it's, it's only gonna, gonna increase.

You know, the discussions around kind of partnering with banks and, and, doing things together, combining our capital and kind of their, you know, sales force and footprint, while it'll take a while to play out, I think it's, it's gonna be a positive.

Kyle Joseph (SVP)

Got it. Thanks very much for answering my questions.

Operator (participant)

We have no further questions at this time, so I will turn the word back to Mr. Mosticchio.

Michael Mosticchio (Head of Investor Relations)

Thanks, Marlice, and thank you all for joining us on today's earnings conference call. A replay of this call will be available for 30 days on OCSL's website in the Investor section, or by dialing 877-344-7529 for U.S. callers, or 1-412-317-0088 for non-U.S. callers, with the replay access code 1958224, beginning approximately 1 hour after this broadcast. We hope you enjoy the rest of the summer. Thank you.

Operator (participant)

This concludes this conference. Thank you for attending today's presentation. You may now disconnect.