Oaktree Specialty Lending - Earnings Call - Q4 2025

Executive Summary

• Q4 FY25 adjusted net investment income (NII) was $35.4 million ($0.40 per share) and GAAP NII was $35.8 million ($0.41 per share), with total investment income (TII) of $77.3 million; sequential NII improvement was driven by higher prepayment fees and dividend income and lower interest expense.
• Results modestly beat Wall Street consensus on EPS ($0.40 vs $0.389*) and revenue ($77.3mm vs $76.5mm*); NAV per share declined to $16.64 from $16.76 QoQ due to unrealized depreciation.
• Dividend held at $0.40 per share for Q4, fully covered by NII; liquidity stood at $695 million ($79.6mm cash and $615mm undrawn revolver) and net debt-to-equity was 0.97x, at the low end of the 0.90x–1.25x target.
• Management emphasized levers to offset expected December-quarter NII headwinds from lower base rates (prudently increasing leverage, optimizing JVs, reducing non-accruals), and noted cautiously improving price discipline as private credit spreads stabilize around SOFR+450.

Note: Values marked with * are retrieved from S&P Global.

What Went Well and What Went Wrong

What Went Well

• “Our fourth quarter results demonstrate progress in stabilizing the investment portfolio … and we fully covered our quarterly dividend with net investment income.” – CEO Armen Panossian.
• Adjusted TII increased by $2.6 million QoQ on higher prepayment fees (+$1.8mm) and dividend income (+$0.9mm); net expenses fell $0.5 million QoQ, aided by lower interest expense and fee waivers.
• Portfolio risk metrics improved: non‑accruals declined to 3.0% of debt investments at fair value (from 3.2% QoQ and 4.0% YoY) and weighted average borrowing cost dipped to 6.5% (from 6.6%).

What Went Wrong

• NAV per share declined to $16.64 (from $16.76 QoQ and $18.09 YoY), reflecting unrealized depreciation on certain debt and equity investments.
• Adjusted net realized and unrealized losses were $10.8 million in Q4, driven by realized and unrealized losses on select positions.
• Life sciences/healthcare non‑accruals remain a drag (e.g., SIO2), with operational workouts ongoing and no near‑term exits anticipated; 10 investments remained on non‑accrual in Q4.

Transcript

Operator (participant)

Welcome, and thank you for joining Oaktree Specialty Lending Corporation's Fourth Fiscal Quarter and Full Year 2025 conference call. Today's conference call is being recorded. I'll now turn the call to Clark Koury, OCSL's Head of Investor Relations.

Clark Koury (Head of Investor Relations)

Thank you, Operator. Our 4th quarter and full year 2025 earnings release, which we issued this morning along with the accompanying slide presentation, can be accessed on the Investor 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 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 will turn the call over to Matt Pendo, President of OCSL. Matt.

Matt Pendo (President and COO)

Thank you, Clark, and thank you all for joining our call today. I'll begin the call with an overview of our results for the fiscal year and fourth quarter. Armen Panossian, our CEO and co-CIO, will then share commentary on the current market environment. Raghav Khanna, our co-CIO, will provide details on our portfolio and investment activity. Chris McKown, our CFO and Treasurer, will then review our financial results before we open the call for questions. The fourth quarter and second half of fiscal 2025 reflected steady improvement for OCSL, even as the macro environment remained choppy. As we will discuss in more detail, our team worked hard to turn around non-income-producing positions, find interesting investment opportunities, and reduce our cost of capital. In the fourth quarter, we achieved adjusted net investment income of $0.40 per share, up from $0.37 in the prior quarter.

This sequential improvement reflects the return to more normalized prepayment fees, higher dividend income, and lower interest expense from our refinancings earlier this year and lower base rates. Additionally, we continue to make progress reducing our non-accruals, a key strategic focus. At year-end, non-accruals were 2.8% of the portfolio measured at fair value, down 20 basis points from the third quarter and down 100 basis points from last year. Last week, the board approved a dividend of $0.40 per share for the quarter, consistent with our dividend policy and 4th quarter earnings. While the Federal Reserve's September rate cut did not affect 4th quarter earnings, lower base rates will impact net investment income in the December quarter. As we've said before, we have several levers at both the corporate and JV levels to help offset lower base rates and support net investment income.

1st, we can prudently increase balance sheet leverage to enhance earnings power and deploy capital into interesting investment opportunities. Our balance sheet is conservatively levered at 0.97 times and provides us with ample financial flexibility. 2nd, we can continue to optimize our JVs. Finally, reducing non-accruals in equity positions will improve our earnings power. We have line of sight into: one, putting a portion of our previously non-accruing loans onto accrual status; two, monetizing a portion of our non-accruals; and three, monetizing equity positions. Any proceeds we receive from realizations of non-accruals in equity will be reinvested into income-generating assets. On an ongoing basis, we will continue to evaluate these levers and their potential contributions to earnings and our dividend. Now, I will pass the call over to Armen for an update on the market environment.

Armen Panossian (CEO and CIO)

Thanks, Matt. Turning to the current market environment, we see many conflicting themes. Private credit deal flows showed modest improvement during the quarter, although the overall quality of deals was mixed. We continue to see a steady supply of high-quality opportunities alongside an increasing number of lower-quality deals coming to market. Sponsors are pursuing dividend recapitalizations more often as exit activity remains subdued compared to historical levels. Momentum in Europe slowed relative to what we observed in our 3rd quarter given ongoing political and economic uncertainty, but we still see some interesting deal flow from that region. Ample liquidity in the broadly syndicated loan and private debt markets has driven sponsors to dual-track financings. We have seen an increasing share of $1 billion-plus LBOs opting for the broadly syndicated market and a tightening of the illiquidity premium.

However, since the Fed rate cut in September, we have witnessed slightly more price discipline and are cautiously optimistic that private credit spreads have bottomed out at SOFR plus 450. PIC and LUCIR covenants remain popular tools for private debt managers to win mandates and allocations, but we remain extremely disciplined in our credit documentation and acceptance of PIC. As a percentage of total investment income, PIC was 6.4% at quarter end. We prefer to use PIC judiciously and in situations such as financing a high ROE project or carve-out acquisition that requires the PIC option only for a defined period, after which a project or acquisition generates the necessary cash flow to cover the debt's full cash interest payment. Despite a mixed environment, our long-term outlook on private credit remains bullish. Issuers continue to value the speed and assurance of deal execution with a sophisticated partner.

For investors, we think private debt will continue to deliver a premium spread relative to other floating-rate asset classes and with lower volatility. To talk more about our portfolio and new investments, I will turn it over to Raghav.

Raghav Khanna (Co-CIO)

Thanks, Armen. I'll start with a review of our investment activity in the fourth quarter. Our pipeline improved during the quarter, yet given heightened competition and tighter spreads, as Armen mentioned, we're taking a highly selective approach to new investments. We continue to prioritize senior-secured loans to market-leading businesses with durable fundamentals, reliable cash flow, and strong downside protection. At the same time, we're focused on diversifying the portfolio, avoiding industry concentration risk, and limiting exposure to more cyclical sectors. Turning to origination and repayment activity for the quarter, new-funded investment commitments, including drawdowns from existing commitments, amounted to $220 million, up 54% from the prior quarter. Prepayments from exits, other paydowns, and sales were $177 million, and the weighted average spread on deployments during the quarter was approximately SOFR plus 570. First-lien loans represented 88% of our new originations.

One notable investment during the quarter was Walgreens Boots Alliance, an integrated healthcare, pharmacy, and retailer with a 170-year heritage. The company was taken private by Sycamore Partners for over $20 billion, and the sponsor subsequently split the conglomerate into four operating businesses. Each segment required its own bespoke lending solution, and the sponsor sought lenders who could move quickly to underwrite the distinct challenges and transformation opportunities of the retail and pharmaceutical businesses. Oaktree Strategies worked collaboratively to consider various capital structures. Ultimately, Oaktree Funds acted as joint lead arranger for the $2.5 billion 1st-in, last-out, 1st-lien term loan to support the U.S. retail business. The loan was priced at SOFR plus 700 with 2.5 points of OIB, which is attractive for the industry risk and complexity of the deal.

Oaktree's deep expertise in inventory appraisal and long track record of investing in filos made us comfortable with the collateral coverage of the loan. This transaction is a great example of how Oaktree is positioned to capitalize on complicated yet compelling investment opportunities. Turning to our portfolio, over 40% of our portfolio companies were marked up during the quarter by about 70 basis points on a weighted average basis, reflecting improving fundamentals in several portfolio companies. As of September 30th, 83% of our portfolio was comprised of first-lien senior-secured debt, and the weighted average yield on debt investments was 9.8%. The median EBITDA of our portfolio companies was approximately $150 million, an $11 million decrease from the prior quarter. Portfolio company weighted average leverage increased slightly to 5.2 times from 5.1 times, and weighted average interest coverage remained unchanged at 2.2 times.

As Matt mentioned, we have made tangible progress reducing non-accruals and resolving challenged investments, which contributed to a decline in non-accruals this quarter. I'll cover those now, starting with an update on Mosaic Companies. We have been working closely with Mosaic to realize value for the separation of its three business segments. Two of these segments were sold, and the third is in a liquidation process. As you may recall, these efforts resulted in a significant cash paydown during the June quarter, and we received additional cash paydowns in the September quarter and after quarter end. Inception to date, the paydowns we received amount to a little over 70% of our original invested cost, and when combined with coupon payments, have resulted in generating positive IRR over the life of this loan.

We believe the proactive actions we took following Mosaic's tariff-related headwinds earlier this year helped maximize our recovery in a challenging situation. We also made progress in monetizing our investment in Oven Therapeutics, whose loan is secured by certain royalty rights and public shares of ADC Therapeutics. Following an increase in ADC's share price, we sold a portion of our ADC shares and used the proceeds to reduce the outstanding loan amount. Our remaining position in Oven Therapeutics continues to be marked at 99.5, reflecting our view that we will continue monetizing the collateral supporting this loan and recover substantially all of the remaining loan balance. While the issuer is not new to our non-accrual list, we added Baymar's first-lien loan to non-accrual status. The company's second-lien loan was put on non-accrual in the third quarter. We are working closely with other lenders and the company to maximize value.

I'll now turn the call over to Chris to review our financial results.

Chris McKown (CFO and Treasurer)

Thank you, Raghav. In our 4th fiscal quarter ending September 30, 2025, we delivered adjusted net investment income of $35.4 million or $0.40 per share as compared to $32.5 million or $0.37 per share in the prior quarter. The increase for the quarter reflects the return to normalized levels of fee income and interest expense following the one-time items that impacted the results in the 3rd quarter. NAV per share was $16.64, down from $16.76 in the 3rd quarter due to unrealized depreciation on certain debt and equity investments. Adjusted total investment income increased to $76.9 million compared to $74.3 million in the 3rd quarter, primarily driven by higher prepayment fees and dividend income. Net expenses declined modestly compared to the 3rd quarter. Interest expense decreased due to the refinancing of our syndicated credit facility completed earlier this year and lower reference rates.

Additionally, as you may recall, our June quarter results were impacted by non-cash and non-recurring interest expense related to the acceleration of deferred financing costs, primarily in connection with the termination of the Citibank SPV facility. Our weighted average cost of borrowings was 6.5% at September 30, down from 6.6% in the third quarter. Further, we waived approximately $1.9 million in incentive fees as a result of our total return hurdle. Our leverage ratio at quarter end was 0.97 times, up slightly from 0.93 times last quarter, and total debt outstanding was $1.5 billion. Our target leverage range of 0.9 times-1.25 times remains unchanged, and driven by our disciplined pace of capital deployment, we remain at the low end of the range. Unsecured debt represented 64% of total debt at quarter end, down slightly from prior quarter.

We have ample dry powder to fund investment commitments with liquidity of approximately $695 million, including $80 million of cash and $615 million of undrawn capacity on our credit facility. Unfunded commitments, excluding those related to the joint ventures, were $258.9 million, approximately $246.9 million of which can be drawn immediately, as the remaining amount is subject to portfolio companies meeting certain milestones before the funds can be drawn. Turning to our two joint ventures, together, the JVs currently hold $513 million of investments, primarily in broadly syndicated loans spread across 73 portfolio companies. During the fourth fiscal quarter, the JVs generated ROEs of 12.4% in aggregate. Leverage at the JVs was 1.7 times compared to 1.3 times last quarter. In addition, we received a $525,000 dividend from the Kemper JV. With that, I'll turn the call back to the operator to open the call for questions.

Operator (participant)

Thank you. We will now begin the question and answer session. At this time, I would like to remind everyone, in order to ask a question, press star one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your 1st question comes from the line of Melissa Waddell with JPMorgan. Your line is open.

Melissa Waddell (Research Analyst)

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

Armen Panossian (CEO and CIO)

Thanks, Melissa. This is Armen. In terms of outsized repayments, we do not expect any at this time for the quarter end of December. As far as deployment, nothing really stands out either direction, either on the heavy side or the light side relative to past December quarters. We certainly have seen some tightening in the spreads, and so we are judicious about how we are deploying, but I do not see us materially deviating from past quarters in terms of deployment or leverage levels for the quarter.

Melissa Waddell (Research Analyst)

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

Chris McKown (CFO and Treasurer)

Hey, Melissa. It's Chris. Thanks for the question. I'll start. Maybe Armen can add a little bit in terms of pipeline. Yeah, in terms of the quarter-on-quarter change, I mean, you're right in noting Walgreens. I think the other thing I would just note about the June quarter is that on balance, we had a little bit higher originations into your IBOR indexed loans. So when you're looking at the absolute coupons, June was a little bit lower as a result of that. We do hedge all of that back to U.S. dollars. There is a little bit of a pickup when you take into account that hedging impact, but that does create a little bit of noise kind of quarter to quarter. Armen, are you going to add anything?

Armen Panossian (CEO and CIO)

Yeah. We do have a very active origination function in non-sponsored direct lending. I think Walgreens stands out as a pretty high spread loan. I do not see anything that we would be originating in the December quarter that is quite that high in spread. We do have a few things that we are working on that might be sort of higher than the 450-500 spread that is typical of sponsor lending, but I think it is too early at this point to provide forward guidance. I just do not think that the Walgreens deal is repeatable, I do not think, in the fourth quarter. Sorry, the fourth [crosstalk] calendar quarter.

Melissa Waddell (Research Analyst)

Yep. Understood. Thanks.

Operator (participant)

Our next question comes from the line of Sean Paul Adams with B Riley Securities. Your line is open.

Sean Paul Adams (Research Analyst)

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

Armen Panossian (CEO and CIO)

Sure. This is Armen. We have or we had a couple of sort of chunky positions in the life sciences space. It's not many in number, but they were, unfortunately, some larger positions that continue to be the subject of workouts, SIO2 being, I would say, the most material of them, which is a name that we've talked about on past calls. That is really what it is. We continue to sort of work out situations that, at this point, are several years, have been in the portfolio for several years. They're all sort of stable to maybe slightly improving, but still not at the position where we're either going to exit or whether we're going to move them into accrual status, unfortunately. We haven't added other kind of life sciences or healthcare names that have created problems in the recent quarters.

Again, there's a small handful of positions that were put on a few years ago continue to sort of weigh on the non-accrual bucket.

Sean Paul Adams (Research Analyst)

Got it. As a quick follow-up, is there any workout strategies going on with those long-standing non-accruals?

Armen Panossian (CEO and CIO)

They're more operational workouts. They have already been, from a capital structure perspective, restructured, but operational improvements are being made. We're working closely with management teams to drive that performance. When possible, we are working with the management to sell assets and either fund cash burn or repay or make distributions to our position. I wouldn't say that there's anything significant or monumental that would be happening in the near term with respect to those positions. It's just kind of blocking and tackling with an operational turnaround.

Sean Paul Adams (Research Analyst)

Appreciate the color. Thank you.

Operator (participant)

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

Clark Koury (Head of Investor Relations)

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

Operator (participant)

That concludes our today's conference call. Thank you all for joining. You may now disconnect.