Oaktree Specialty Lending Corporation

Welcome and thank you for joining Oak Tree 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 Allison Meermey, OCFL'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 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 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'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. Armin Pinozian, our CEO and co-CIO, will then share some commentary on the current market environment. And Raghav Khanna, our co-CIO, provide details on our portfolio and investment activity. Our CFO and Treasurer, Chris McCown, 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 invested income for the quarter was $36.1 million, or 41 cents 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 remained stable. Consistent with our dividend policy and first quarter earnings, our board declared a quarterly cash dividend of 40 cents per share, payable on March 31, 2026, to stockholders as a 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 all-in 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 enter the quarter with over $576 million available liquidity. We are intensely focused on reducing non-accruals and equity positions as another key lever for improving earnings power. In the first quarter, non-accruals were relatively stable sequentially and down nearly 85 basis points year over year. At quarter end, non-accruals represented 3.1% of the total debt portfolio measured at fair value. For several of our non-accrual 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 non-earning assets into income-producing assets. Avery continues to sell units, and it appears to be happening at an increased pace. Any proceeds from monetization of non-accruals 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 strengths and weaknesses, creating a clear divide between the winners and losers. Companies with scale, profitability, and financial stability have 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 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 and private credit have now bottomed out at SOFR plus 450 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 wipe. Importantly, direct lending transactions continue to offer an approximate 150 basis point spread premium relative to broadly syndicated loans of similar credit quality. PIC 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 multi-year 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 timelines could result in a pullback in 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 advisor relationships provide access to proprietary deal flow across asset-backed finance, European direct lending, infrastructure lending, and capital solutions. We remain constructive in the 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 a standard discussion of portfolio activity, I want to build on Armand'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 buy-in from multiple stakeholders, and have high switching costs. AI 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 roadmap. 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 eight of the earnings presentation. As of December 31st, software represented approximately 23% of investments at fair value across 28 issuers And 94% of our software positions are first lien term loans, and we have only two ARR-based loans representing approximately 2% of their value. Turning to the broader portfolio, as of December 31st, 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 $2.95 billion. Newly funded investment activity totaled $314 million, up 42% 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 Oak Tree'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 still lower volume in U.S. middle market direct lending. We continue to prioritize first lien senior secured investments in resilient market leading businesses supported by discipline 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 healthcare services company that operates a large national group purchasing organization for a network of hospitals and healthcare providers. The company also provides a range of complementary offerings such as healthcare software, supply chain management, data and analytics, and consulting services. In November, PatientSquare 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 joint lead arranger, 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 SOPR plus 650 and has two points of original issue discount. We were attracted to this transaction based on Premier's strong competitive positioning, secular tailwinds for healthcare spending, and high customer switching costs. During the quarter, there was one new addition to our non-accrual list. We placed a second out terminal on approval site on non-accrual. Our prior position was restructured in August of 2024, and this quarter we placed the restructured loan on non-accrual due to the ongoing challenging industry dynamics and the company's softer-than-expected outlook. At quarter end, there were 11 investments on non-accrual, 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 non-earning assets into income-producing investments over time. I'll now turn the call over to Chris to review our financial results. Thank you, Radha.

In our first fiscal quarter ending December 31, 2025, we delivered adjusted net investment income of $36.1 million, or 41 cents per share, as compared to 35.4 million, or 40 cents 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, 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 marked down the second out-term loan to reflect 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 partially 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 I incentives, primarily as a result of our total return hurdle. OCSL continues to be cautious around the usage of payment in kind, with PIC representing 6.3% of adjusted total investment income in the quarter. Approximately two-thirds of our PIC income is related to investments that had the ability to PIC 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 31st, 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 JVs 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.

At this time, if you would like to ask a question, press star followed by the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Finian O'Shea with Wells Fargo.

Hey, everyone. Good morning. On the portfolio, I'm not sure if you guys give 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 sort of where we are in migrating out of the legacy type issues.

Hey, Finn, it's Raghav. So I pointed to page 13. Sorry, it's not on there. So the way we think about our underperforming assets are You obviously have the non-accruals, 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, you know, 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, you know, when we speak to our trading desk, a lot of those technology names are trading down on like $2 and $3 million trades, mostly from CLO sellers who are trying to manage their work 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 traded 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 that's helpful in a, I guess, follow-up sticking with that topic. You gave some helpful views or color on AI risk to software. Are you, you know, let's say to the extent there is volume, are there interesting names on the screen that looked like you had a good amount of liquid this quarter? Should we expect that to continue?

Yeah, 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 nodes 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 AI scorecards and other types of scorecards to, again, triage. Because I think your sentiment is right that there is a bit of a baby out with a backwater situation. And that's something we are looking at. Again, you know, when we look at what is the right point to step in, it doesn't feel like that right now, just because again, you know, the trading volume we've seen is either small ticket sales from CLOs or dealers trying to make a market. And these like two, $3 million trades are basically being used to mark positions down, you know, two, three points. So it looks very attractive when you look on a screen, at least for some of these names where the AI risk is low, but there isn't enough volume to actually want to step in and try to be a buyer.

Awesome. Thanks, everyone.

Your next question comes from Ethan K. with Lucid Capital Markets.

Hey, guys. Thanks for taking the question here. You disclose median portfolio EBITDA increasing from $150 million to $190 million sequentially. It 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 a strategic result or more so a byproduct of the deal environment and company growth?

Yeah, so 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 and 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 mixed 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 unrealized appreciation. You know, we talked about Pluralsight, which appears to be about a third of that net number. But can you kind of talk through whether there was, you know, maybe any other themes or drivers of kind of the markdowns in the quarter?

Yeah, hey, it's Chris. I'll make a few comments. So you're right, you know, Pluralsight was the single largest driver, accounting for about 38% of the total mark. Beyond that, you know, we did take some smaller marks and a few other private positions. And then we did see some of the quoted names trade down, you know, which impacted, you know, some of the names that go along balance sheet, you know, as well as in the JVs.

Okay, great. Thank you, guys.

Your next question comes from Paul Johnson with KBW.

Hey guys, thanks for taking my questions. I mean, just a little bit more in terms of the, you know, your sort of perspective on software. You know, I guess how would you kind of characterize at this point, you know, top line growth and EBITDA trends sort of broadly, you know, have you, you know, noticed any sort of change in the growth rates there, you know, 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 Armin. 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 due to 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 a 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 AI, it may turn out to be that they are binary in their outcomes. What I mean by that is if a 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 in software deals 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 mid-sized 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 CovLight, as you would imagine in another industry outside of software. In a large cap deal, you don't see covenants. In a smaller mid-sized deal, you do see covenants typically. And the covenants in 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 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 cap. 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 deal. with a very large private equity sponsor. We think it's pretty well insulated from AI competition, but 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've wanted to avoid those situations now for several years, and And so that's not really an issue in our portfolio.

I think, Paul and Matt, we put a new page in the deck, page eight, that breaks out our software exposure in OCSL. But I think it's... Give us any comments if you have on it. But when we lay out there, kind of your question on kind of performing in the business. So if you look at the EBITDA growth since we funded... 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 hopefully successful underwriting. So we laid all this out on page 8, which is what we posted. Hopefully that's helpful as well.

It is, yeah, thank you for that. It's, you know, very good color there, and Arvind, appreciate, you know, the helpful answer 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, an underwriter, or is that a more, you know, 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. You know, how much of a valuation sort of reset do you think that, you know, broadly the software space can absorb in the equity multiples before we do start to see, you know, 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 at underwrite. And I'll hand it off there.

Thanks. Yeah, this is Armin. 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 a 1231, the current one. It's the current one at 1231? Okay. So 1231, it would, so that is our estimate of the LTV as of 1231. And then in terms of the amount of degradation and 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 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 timeframe 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 a fund cannot call 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 You know, those straggler businesses that need additional capital to kind of punch through a refinancing or a maturity. And so the sponsor is less likely to support the business in that event. So there's a lot of economic and non-economic factors that come into play to judge a sponsor's willingness to support a business if and when the LTV of the loan exceeds, again, probably that 55% or 60% LTV threshold level.

Appreciate it. That's all for me. Thank you very much, guys.

Again, if you would like to ask a question, press star 1 on your telephone keypad. There are no further questions at this time. I'll now turn the call back over to Allison Mierme 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.