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Oaktree Specialty Lending: New Dividend Outlook

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NEWS

 

The former Fifth Street Finance – now Oaktree Specialty Lending (OCSL) and advised by an affiliate of Oaktree Capital – announced IVQ 2017 results and a reduction in the quarterly distribution from $0.125 to $0.0875.

 

DIVIDEND RATING

 

The BDC Reporter had rated OCSL’s Dividend Outlook as DECREASE for several months. Back on November 30, 2017, we wrote:

 

“We will guess that the distribution will annualize somewhere around $0.32-$0.35”

 

The new annualized distribution, which begins in the first quarter of 2018, annualizes at $0.35, the high end of our projected rating.

 

This is the first of the 6 BDcs that we’ve rated DECREASE for 2018 to cut their pay-outs. Moreover, there are another 15 BDC names which we rate AT RISK.

 

NEW RATING

 

To date, the BDC Reporter has only reviewed OCSL’s IVQ 2017 earnings release. Coming up will be the Conference Call transcript and a full review of the 10-Q.  With that caveat, the BDC reporter already has doubts about how dependable the new $0.875 quarterly distribution may be.

 

SUSTAINABILITY

 

Of course, one would expect that an experienced group like Oaktree Capital would have been careful to set its dividend at a level that would not require yet another cut in the foreseeable future. FSC/OCSL shareholders have already had to contend with multiple cuts over the last few years.

At first blush, we can’t help noting , though, that the distribution is only half a cent (!) lower than the BDC’s IVQ 2017 Net Investment Income.

 

Nor does the Investment Advisor have much flexibility to boost earnings by growing the balance sheet. As the press release shows,  Debt To Equity is already at 0.77 to 1.00. Oaktree has promised – for what that’s worth – to be more conservative in its leverage policies than Fifth Street Management was- so the current level must be close to the top of what OCSL can borrow to grow its portfolio.

 

Then there’s the fact that the BDC Reporter likes to point out at every turn: a decent portion of the BDC’s income is not even in cash form but effectively an IOU to pay when the loan gets repaid. We’re talking about Pay-In-Kind income. Of $13.3mn of Net Investment Income for the quarter, $4mn was in non-cash form. It’s the optimistic lender who assumes that non-cash income is as good as cash over the full life of a loan. In fact, many BDC disclosures explicitly warn readers that PIK income comes with higher risk on non-collectibility than “normal” loans.

 

Plus, there’s the still uncertain credit status of the portfolio that Oaktree has inherited. This quarter the BDC booked ($43.5mn) in Unrealized Depreciation on three portfolio companies. That brought the number of non-performing companies to 8 – out of 75 borrowers -which account for a still huge 14.5% of the debt portfolio at cost. Who can say – given the poor underwriting that accumulated so many poor performing borrowers – that OCSL won’t be saddled with new non-performers or that losses may not increase among the 8 existing borrowers ?

 

Even the new Investment Advisor is not promising that the BDC has been “turned around” as yet. Based on comments made on the prior Conference Call and in the current press release, it’s clear that the re-positioning of the BDC’s portfolio; the sale or restructure of its under-performing entities and various other changes envisaged will be going on well into 2018. We’ve used the analogy of  turning around a super-tanker before where OCSL is concerned and that still holds true.

As a result – and before we look at the borrower by borrower risks in the current portfolio – the BDC Reporter cannot say with any sense of certainty that OCSL may not be making yet another  dividend reduction announcement by the first quarter of 2019. As a result, our new rating for OCSL is AT RISK.

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