Oaktree Specialty Lending Corporation 2026 Q3 Earnings Call

Our third quarter 2026 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 statement. Please refer to the relevant SEC filing for a discussion of these factors in further detail. Oaktree undertakes no duty to update or revise any forward-looking statement. 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. On today's call, Matt Pendo, President of OCSL, will begin with a progress report on objectives we set out for fiscal 2026 and an overview of our third quarter results. Armen Panossian, our CEO and Co-Chief Investment Officer, will then provide a market update. Raghav Khanna, our Co-Chief Investment Officer, will cover portfolio activity, and Chris McKown, our CFO and Treasurer, will close with a review of our financial results before we open the call for questions. I will turn the call over to Matt Pendo, President of OCSL.

Matt? Thank you, Alison, good morning, everyone.

With three quarters of fiscal 2026 complete, we want to assess our progress against two of our primary objectives. First, reducing non-accruals through exits and monetization events, and second, maintaining a flexible balance sheet. Starting with the first objective, reducing non-accruals. As of June 30, 2026, non-accruals were approximately 1.8% of the total debt portfolio at fair value, down 80 basis points sequentially and down 140 basis points year-over-year. In the last two quarters alone, we exited five non-accrual positions, leaving six investments on non-accrual. More than 85% of the decline in non-accrual dollars over the past year is due to proceeds received and investments returning to accrual status. The most significant portfolio development this quarter was Thrasio.

Through a series of asset sales, Thrasio repaid approximately $25 million, or a little over 80% of our loans, including paying off the entire first out-term loan and about 75% of the second out-term loan. The remaining second out position was returned to accrual status, and we expect it to be repaid in the next few months. Raghav will discuss Thrasio in more detail in his remarks. Turning to the second objective, maintaining a flexible balance sheet. We ended the quarter with net leverage of approximately 1.02 times, compared to 1.04 times at the end of March, and below the midpoint of our 0.9 times-1.25 times target range. Available liquidity was nearly $700 million at quarter end, up about $30 million from last quarter. We believe this combination of conservative leverage and ample liquidity positions us well to invest into an evolving private credit market.

Furthermore, we plan to address the $350 million of unsecured notes that mature in January 2027 over the next several quarters. Turning to our third fiscal quarter financial highlights. Adjusted net investment income was $32.2 million, or approximately $0.37 per share, down slightly from $33.7 million, or $0.38 per share in the prior quarter. This slight decrease primarily reflected our lower use of leverage, the lighter than average quarter of non-recurring income, and the payment of a partial income-based incentive fee, which Chris will walk through in more detail. For the quarter, our board declared a total cash dividend of $0.33 per share. The dividend is composed of a base cash dividend of $0.30 per share and a supplemental dividend of $0.03 per share.

This is consistent with our policy of paying a supplemental dividend equal to 50% of adjusted net investment income in excess of the base dividend. The dividends are payable in cash on September 30, 2026. The stock goes of record on September 15, 2026. With that, I'll turn the call over to Armen to discuss the market environment.

Thank you, Matt. On our last call, I described the volatility in direct lending as more a period of recalibration than a systemic issue. I also walked through specific investor concerns around direct lending, including rising impairments, the use of leverage, liquidity mismatches, software exposure in an AI-driven world, and refinancing risk. On today's call, I want to provide a brief market update, take stock of how these concerns are evolving, and explain how they inform our approach at Oaktree. First, the market backdrop. The June quarter was less volatile than the March quarter. Credit and equity markets stabilized, and the general tone was less bearish, although dispersion continued to be a dominant theme. For example, the broadly syndicated loans market showed a bifurcated recovery.

Spreads for single B and single B-plus loans retraced most of the widening experience during the March quarter, and ended June close to December 2025 levels. New issuance in the broadly syndicated loan market also resumed, and many transactions priced at or through the tight end of initial price talk. However, the recovery has not been uniform. Spreads on traded B-minus credits remain wider than they were in late 2025, and new issuance among lower-rated borrowers remains limited. The direct lending market was also more subdued. Spreads remained wider than 2025 levels, while direct lending deal value declined to a two-and-a-half year low. The decline in deal flow largely reflected the slowdown in private equity activity, with quarterly deal value also declining to a multi-year low.

Sponsors continue to face a difficult exit environment amid a wide bid-ask spread between sellers and buyers, geopolitical uncertainty, a less predictable macroeconomic outlook, and the possibility of slower growth alongside persistent inflation. In this environment, the balance between private credit borrowers and lenders has improved. Competition has generally been more rational, and underwriting standards have strengthened. On average, loans issued in calendar 2026 offer more attractive terms than transactions completed in 2024 and 2025. During the June quarter, new sponsor-backed first-lien direct loans were pricing in the range of SOFR plus 500 to 550 basis points, consistent with the March quarter and above the 2025 types of SOFR plus 450 to 475. However, competition for new deals, especially in middle-market first-lien direct lending, increased towards the end of June and compressed average spreads closer to 500 basis points.

Now I'll turn to the specific concerns we highlighted last quarter, beginning with impairment risk. Across the direct lending industry, credit issues have continued to arise. While industry data for non-accruals has been mixed in recent quarters, OCSL's non-accruals are down approximately 280 basis points from its peak in March of 2025. Our work is not complete, yet our progress reflects an active, hands-on approach to challenged credits. We have successfully pursued monetizations, restructured investments, and, when necessary, made difficult decisions to exit positions to avoid tying up capital and to minimize losses. The second concern is the use of leverage. The statutory debt-to-equity limit for BDCs is 2 to 1, and essentially, all BDCs operate under that limit today. Our concern is not the level of leverage at BDCs, which by historical standards and compared to other levered vehicles is relatively modest, but how leverage is used.

At Oaktree, we view leverage as an output of the investment environment, not as a way to achieve a particular earnings or dividend target. When we find compelling investments with appropriate downside protection, we are prepared to deploy capital and allow leverage to increase. When the opportunity set is less attractive, we are comfortable maintaining greater liquidity and operating at lower leverage. At quarter end, OCSL's net leverage was 1.02 times, positioning us below the midpoint of our target range and preserving capacity to invest as opportunities emerge. The next risk, and the source of continued headlines this quarter, is liquidity or asset-liability mismatches in non-traded BDCs. Redemption requests of several large non-traded vehicles remained elevated during the June quarter, in some cases reaching the mid-to-high teens as a percentage of equity.

This highlights the potential mismatch between the liquidity expectations of investors in non-traded BDCs and the less liquid profiles of the underlying private credit assets. We expect it may take several quarters for existing redemption queues to normalize and for net flows in non-traded BDCs to inflect positive. As a reminder, OCSL is a permanent capital vehicle and does not face redemption risk. Against this backdrop, we view headwinds to the non-traded BDC market as a net positive for permanent capital public BDCs with dry powder. Net outflows from non-traded BDCs reduce competition for new investments, and it may create opportunities in the form of secondary portfolio purchases and industry consolidation, which we are positioned to evaluate. The final, and perhaps most debated risk, is software exposure and related refinancing risk. Investors across credit and equity markets have spent considerable time analyzing software and potential AI disruption.