OXLC - NASDAQ

Hello, everyone, and welcome to the Oxford Lane Capital Corporation First Fiscal Quarter 2023 Call. My name is Victoria, and I will be coordinating your call today. [Operator Instructions]. I'll now pass over to Jonathan Cohen, CEO, to begin. Please go ahead.

Thanks very much. Good morning, everyone. Welcome to the Oxford Lane Capital Corp. First Fiscal Quarter 2023 Earnings Conference Call. I'm joined today by Saul Rosenthal, our President; Bruce Rubin, our Chief Financial Officer; and Deep Maji, our Senior Managing Director and Portfolio Manager. Bruce, could you open the call with a disclosure regarding forward-looking statements.

Sure, Jonathan. Today's conference call is being recorded. An audio replay of the call will be available for 30 days. Replay information is included in our press release that was issued earlier this morning. Please note that this call is the property of Oxford Lane Capital Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited. At this point, please direct your attention to the customary disclosure in this morning's press release regarding forward-looking information. Today's conference call includes forward-looking statements and projections that reflect the company's current views with respect to, among other things, future events and financial performance. We ask that you refer to our most recent filings with the SEC for important factors that can cause actual results to differ materially from those indicated in these projections. We do not undertake to update our forward-looking statements unless required to do so by law. During this call, we will use terms defined in the earnings release and also refer to non-GAAP measures. For definitions and reconciliations to GAAP, please refer to our earnings release posted on our website at www.oxfordlanecapital.com. With that, I'll turn the presentation back to Jonathan.

Thanks, Bruce. On June 30, 2022, our net asset value per share stood at $5.07 compared to a net asset value per share of $6.56 as of March 31, 2022. For the quarter ended June 30, we recorded GAAP total investment income of approximately $63.5 million representing an increase of approximately $8.4 million from the prior quarter. The quarter's GAAP total investment income from our portfolio consisted of approximately $61 million from our CLO equity and CLO warehouse investments and approximately $2.4 million from our CLO debt investments and from other income. Oxford Lane also recorded GAAP net investment income of approximately $38.7 million or $0.26 per share for the quarter ended June 30 when compared to approximately $32.4 million or $0.24 per share for the quarter ended March 31. Our core net investment income was approximately $82.1 million or $0.55 per share for the quarter ended June 30 compared with approximately $57.9 million or $0.43 per share for the quarter ended March 31. During the quarter ended June 30, we issued a total of approximately 4.6 million shares of our common stock pursuant to an at-the-market offering, resulting in net proceeds of approximately $30.9 million. For the quarter ended June, we recorded net realized losses of approximately $7.5 million. We reported net unrealized depreciation on investments of approximately $220.6 million or $1.49 per share. We had a net decrease in net assets resulting from operations of approximately $189.4 million or $1.28 per share for the first fiscal quarter. As of June 30, the following metrics applied. We note that none of these metrics represented a total return to shareholders. The weighted average yield of our CLO debt investments at current cost was 13.1%, up from 12.5% as of March 31. The weighted average effective yield of our CLO equity investments at current cost was 15.9%, down from 16.2% as of March 31. The weighted average cash distribution yield of our CLO equity investments at current cost was 29.4%, down from 29.7% as of March 31. We note that the cash distribution yields calculated on our CLO equity investments are based on the cash distributions we received or which we were entitled to receive at each respective period end. During the quarter ended June 30, we made additional CLO investments of approximately $237.8 million, and we received approximately $119.3 million from sales and repayments. On June 28, our Board of Directors declared monthly common stock distributions of $0.075 per share for each of the months ending October, November and December of 2022. And with that, I'll turn the call over to our portfolio manager, Deep Maji.

Thank you, Jonathan. During the quarter ended June 30, 2022, the U.S. loan market exhibited weakness versus the quarter ended March 31, 2022. U.S. loan prices, as defined by the S&P/LSTA Leveraged Loan Index, decreased from 97.6% of par as of March 31 to 92.16% of par as of June 30. According to LCD, during the quarter, there was pricing dispersion related to credit quality with BB-rated loan prices decreasing 399 basis points or 4.06%, single B-rated loan prices decreasing 596 basis points or 6.08% and CCC-rated loan prices decreasing 744 basis points or 8.37% on average. The 12-month trailing default rate for the S&P/LSTA Leveraged Loan Index increased to 28 basis points by principal amount at the end of the quarter from 19 basis points at the end of March 2022. Additionally, the distress ratio, defined as the percentage of loans with a price below 80% of par, ended the quarter at approximately 3.65% compared to 1.55% at the end of March 2022. The drop in U.S. loan prices led to a decrease in U.S. CLO net asset values. During the quarter, we observed the median U.S. broadly syndicated loan CLO equity NAV declined from approximately 52% of par to approximately 2% of par. However, median junior over-collateralizations cushions rose to approximately 4.68% compared to 4.42% last quarter. Additionally, we observed loan pools within CLO portfolios modestly increased their weighted average spreads to 349 basis points compared to 345 basis points last quarter. The CLO primary market continues to be challenged with AAAs continuing to widen out past SOFR plus 200 basis points. Driven by existing warehouses need to price, U.S. CLO new issuance still reached approximately $80 billion compared to approximately $90 billion over the same period last year. However, given widening liabilities and a challenging new issue arbitrage, issuance during the second half of this year is expected to slow down and full year estimates for U.S. CLO issuance are now expected to come in well below last year's issuance of approximately $180 billion. Oxford Lane continued to be active in the secondary market during the quarter, trading over $200 million notional of CLO equity and junior debt. We are also active in the primary market, adding 4 new issued CLO equity investments and 2 new issued CLO debt investments during the quarter. As a function of our overall activity in both markets this quarter, we were able to lengthen the weighted average reinvestment period of Oxford Lane CLO equity portfolio from February of 2025 to July of 2025. In the current market environment, we intend to continue to utilize an opportunistic and unconstrained CLO investment strategy across U.S. CLO equity, debt and warehouses as we look to maximize our long-term total return. And as a permanent capital vehicle, we have historically been able to take a longer-term view towards our investment strategy. With that, I will turn the call back over to Jonathan.

Thanks very much, Deep. I'd like to note that additional information about Oxford Lane's first fiscal quarter performance has been uploaded to our website at www.oxfordlanecapital.com. And with that, operator, we're happy to open the discussion for any questions.

[Operator Instructions]. Our first question comes from Mickey Schleien at Ladenburg.

Jonathan, I'd like to start by asking how you would describe secondary trading and CLO equity in terms of the volumes and bid-ask spreads during the quarter and perhaps how they look today and now that we're well into the next quarter?

Sure, Mickey. Deep will take that question.

Sure. CLO trading volumes were definitely a little weaker towards the end of last quarter. That being said, with the rebound in the LSTA from 92.16% at the end of June to 93.68% as of yesterday, we've definitely seen liquidity improve, trading volumes improve, especially after the July distributions.

And you mentioned that -- I think I heard you say the AAAs in the primary market are above 200 basis points. Is that right?

That's correct.

So at that level, does the -- who's buying in the primary market, I guess, is my question? Does the arbitrage even work with AAAs at that level, given that spreads are relatively stable?

Spreads are relatively stable, but the loan prices are clearly more depressed being kind of around -- between 92% and 93% over the last handful of 2 months or so. I think it's more challenging. And the AAA buyers are some historic buyers, including Japanese banks, but we've seen a range of buyers.

Okay. So there's this enormous imbalance between the CLO equity portfolio's cash flows at cost, which, as you mentioned, are almost 30%. And that's about as high as I can remember for all the years that I've been following Oxford Lane compared to what those yields would be at fair value, which is extremely high. So it seems that the market is implying that we're either going to see a very high default cycle and the distress ratio doesn't seem to be implying that now? Or someone could argue that the fair values are just too conservative. And I'm not picking on your valuation process, I'm just talking about the market, in general. So which track do you believe is more likely? And -- how are you positioning Oxford Lane to take advantage of that outlook?

Sure, Mickey. I think what you've seen historically is that we've taken an opportunistic approach to the markets that we face. So we'll see you've been covering the company -- the fund for a very long time. You've seen long periods where we've been very, very active in the primary market. We participated in warehouses, where we've put substantial amounts of capital to work in the new issue market. Similarly, you've also seen extended periods where we've not done very much at all in the primary market, where we've been extremely active trading in secondary markets. And we feel like our approach and our investment philosophy lends itself, we think, to an ability to migrate between those strategies in different parts of those strategies. So we'll continue to be opportunistic. The other part of your question, I think, related to our fair value marks and...

Not yours specifically, Jonathan. I'm just saying, in general, they look -- either the fair values are too low or the cash flows are going to come down, one or the other, right?

We'll see. We don't have a defined position on that issue.

Okay. Jonathan, the fund's leverage is around 0.6 when you measure by debt to equity. How does that level compare to sort of your comfort level, your target range in the current market environment?

It's probably at the higher end of the range right now, Mickey. So you're unlikely to see us increase our leverage in the intermediate term, absent raising additional equity first.

Okay. And my last question. In 2021, about a quarter of the funds' distributions were a return of capital. But looking at this year, the core NII is running way above the distribution. So can you give us any sense of where UTI stands and the potential for special distributions to manage that liability?

Sure, Mickey. Just one small correction, the 2021 return of capital was, I think, as you mentioned, that was on a tax basis, that was a tax...

Yes, I'm talking about tax.

Yes. And no, we're not really able to give any forward guidance with respect to tax character of our distribution. Those really are manifested in the PFIC statements, the passive foreign investment company tax reporting statements that we received in the subsequent calendar year. So all -- our most recent information so far as tax character is concerned is the information that would be up on our website.

Our next question comes from Matthew Howlett at B. Riley.

Just looking at the improvement and the spread and the junior OC level. Your investments are doing a good job taking advantage of the discounted market. And going forward, I mean, given where leverage loan prices are, I mean, do you -- and I know there's been some shift in downgrades beginning, do you still feel good about the ability for your portfolio to continue building the OC level?

I think we feel generally constructive, Matt. But obviously, as you note, a great deal depends on what happens to the ticketed corporate loan market, what happens to default rates going forward, how all of these kind of macroeconomic fundamentals are distilled in the markets that we participate in. But as a general thought, I feel like we are constructive at this moment.

Yes. Matt, one thing I would just add is, if you look at over the last 2, 3 months, CLO managers have definitely been able to take any sort of prepayment and also make kind of relative trading assessment and build hundreds -- many basis points of par kind of month-over-month and quarter-over-quarter because of the depressed loan market. So again, we are constructive on it.

Yes. That's right. I'm sort of getting that this could be sort of a Goldilocks environment where if we do get a recession, it's going to be mild and it's going to take time. And meanwhile, the portfolio can really take advantage of these deep discounts. And I guess that's -- the question is on the core number that jumped up a lot, sequentially, and I noticed that you don't have any CLOs diverting cash flow, you had a small amount, but now it's 0. First, what explained the big pickup in the core number?

Sure. I think the biggest driver of that was quarter-over-quarter we had a lot of first-time payers come on board. So some of the investments that we had put into the ground in the calendar quarter, fourth quarter or the quarter ending 12/31, those made those first distributions in April.

And that's going to continue, right? I mean, you are sure there's been a few still in their kind of ramp space, right?

Yes.

Absent diversion or the sales of those positions, yes, the cash flow should -- are expected to continue.

Yes, that puts you into just a tremendous position in the portfolio. Look, you're well covering the dividend on a GAAP basis and you're even 2x on a core basis. I want to ask -- I'll spare the dividend questions. I think you covered that. You guys have been around the longest in the space. You were the first mover in this asset class during the Great Recession. When you look at secondary acquisitions going forward, I mean you've always said sort of it's all about sort of pricing. Do you feel -- do you want to -- I mean do you feel like getting defensive to being just a top-tier, most defensive buyer secondary paper? Would you want to look at this deeper value elsewhere, whether it could be deals that could be failing OCs that could come back? I mean, how do you look at value in the space today, entering into what could be softer economic conditions?

Sure, Matt. We look at value very broadly. So the direct answer to your question is both. We would look and we continue to look every day at top-tier manager deals that have plenty of reinvestment period left in them and are very, very tightly structured with respect to their liability stack. But at the same time, we look at deals that may have more challenged collateral pools are managed by second or third tier collateral managers that are even outside of their reinvestment period. For us, the ultimate reflection of value is the relationship between the cash flows that we expect to receive and the price that we're forced to pay for those cash flows. And to the extent that we can take a better risk-adjusted position, at one end of the continuum versus the other, we're generally fairly comfortable doing that.

Includes CLO debt, CLO equity, everything that you sort of look at?

Very much on that, yes.

And then last question just on the -- great job extending the reinvestment period. I mean, I think it's so critical that you keep that window open. I mean do you expect -- I mean, is the goal still to kind of continue pushing that out? Or would you look at -- would you sacrifice shorter reinvestment or just deeper value?

Sure. This is Deep, Matt. I think our goal is always to try to extend the weighted average reinvestment period. Clearly with the primary market being even more challenged now than it was in the past quarter and the past 6 to 12 months, that becomes a little bit more difficult from a primary creation point of view. But that being said, we can, of course, go into the secondary market, and we have been adding longer-dated reinvestment period equity in the secondary market. But as Jonathan mentioned, we're happy to look at shorter-dated equity, especially majority positions at the right price. And if there's value there, we're going to take advantage of it.

Exactly right, Matt. I mean we place as Deep said, a very high value on duration and the optionality embedded with that duration in some cases. That said, there tends to be a price for everything, including that duration.

Absolutely. And I guess, my last comment is sort of NAV went down because of mark-to-market issues, but the cash flows and the core number went up, and you have this disconnect which probably have been a very great environment to be a top CLO investor like you are, how do you explain to the investors that disconnect that NAV doesn't really capture really forward cash flows in your model?

I mean, at the end of the day, Matt, we are an investor at least on a derivative basis in the syndicated corporate loan market. And syndicated corporate loans, as reflected by the LSTA Index, fell about 550 basis points during the quarter, which is a fairly substantial drop. Now they've regained about 150 basis points of that drop since the end of the quarter, which is a generally positive development. But in terms of reflecting this to the investor community and relating that to the move in our NAV, at the end of the day, it really is mostly, in many ways, about the change in the loan market.

Right. Just on the other end, I just think the cash flow is -- you could make that up longer term with these dividends and cash flow. So it's just for analysts and for investors, sometimes it's tough to really be able to convey that to the market given the complexity of CLO?

Sure. Absolutely, Matt. And we'll be announcing our July month end NAV. It should be in a few days from now. So we'll be able to update the market.

The syndicate is a little bit more better [indiscernible] check with 93-something?

93 spot 6-8 as of last night, up from 92.16% as of June 30.

Thank you so much for your questions. At this time, there are no further questions. I now would like to pass back over to Jonathan Cohen for any final remarks.

Thank you very much. I'd like to thank everybody on the call and listening to the replay for their interest in Oxford Lane Capital Corp., and we look forward to speaking to you again soon. Thank you.