Oaktree Specialty Lending Corporation Q2 FY2026 earnings call

The team remained focused on reducing non-accruals and positioning the balance sheet for flexibility. Sold a portion of liquid credit positions to build dry powder, ended Q2 with available liquidity of $671 million and net leverage of 1.04 times. Software loan fair value declined due to market repricing. Investment activity included selling liquid credit positions, healthy private portfolio prepayments, new investment commitments of $204 million, and progress on non-accruals like selling Dominion and All Web Leads

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. The fair value of performing software loans declined by approximately 310 basis points. Adjusted net investment income was $33.7 million, or 38 cents per share, down from $36.1 million, or 41 cents per share, in the prior quarter. Net asset value per share was $15.69 as of March 31, 2026, compared to $16.30 as of December 31, 2025

Expect to make further progress reducing non-accruals and realizing cash proceeds to deploy into performing assets. Have dry powder to take advantage of market opportunities

External noise around private credit and BDCs, market volatility, AI-related concerns, geopolitical unrest, elevated net redemptions in non-traded BDCs prompting reassessment of cost of capital and liquidity positions

Q: 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% a book, that equates to about a 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.

A: Hey, it's Raghav. I can start and then, you know, Chris and Brett can chime in. 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 dropped out in December at in the mid to maybe high 400s. 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 lien 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 dropped out pre the Middle East situation. So that's number two. Away from sponsor deals, I would say, We do a mix of obviously both sponsor and non-sponsor deals. We do corporate lending as well as asset-backed deals, U.S., Europe. On a blended basis, I would say that when you mix it all together, low 500s for sponsor deals, low 600s to 700s in some of the more interesting areas of lending that we're seeing, which are less commoditized. Our pipeline is in the high 500s on a spread basis and just under 600, call it, including OIDs. So you put it all together on a forward basis. Obviously, the portfolio and 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 SOFR curve is certainly helping on the asset side. And then the third piece is leverage. 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 over time, I do suspect that we will maybe gradually increase leverage if this pipeline opportunity continues and hopefully expands. So Both on the unlevered asset yield side, I think that is getting better. And then second, to finance that pipeline, I do expect leverage will go up slowly, and both of those should help ROE.

Q: And then one quick follow-up. 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 we can think about that?

A: Yeah. I mean, the big picture technical in the market is if you look at just the unlisted and perpetual BDC space, that part of the asset class, you know, really became the marginal dollar that was setting price and risk. That space raised $110 billion in 2025. And, you know, I'm 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. from a from a stock perspective they're not huge from a flow perspective they were very large and uh you know we suspect that that's that's the one change that is driving both pricing uh uh improvements in 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 uh is going away uh second is Again, you're right, hard to see, but I'm sure you're familiar with the concept of adjusted EBITDA, which 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 LME protection, which is, you know, there's always been like a push and pull between borrowers and lenders. I would say, you know, 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 the, I wouldn't say the maintenance covenant is coming back, especially for larger deals in any kind of a meaningful way. But, you know, 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.