OXLC - NASDAQ

Good morning, and welcome to the Oxford Lane Capital Corp. Third Fiscal Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Now let me turn the call over to Jonathan Cohen, CEO to begin. So Jonathan, you may begin.

Thanks very much. Good morning, everyone, and welcome to the Oxford Lane Capital Corp. third fiscal quarter 2023 earnings conference call. I'm joined today by Saul Rosenthal, our President; Bruce Rubin, our Chief Financial Officer; and Joe Kupka, our Managing Director. 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 over to Jonathan.

Thank you, Bruce. On December 31, 2022, our net asset value per share stood at $4.63 compared to a net asset value per share of $4.93 as of September 30. For the quarter ended December 31, we recorded GAAP total investment income of approximately $67.6 million, representing an increase of approximately $2.9 million from the prior quarter. The quarter's GAAP total investment income from our portfolio consisted of approximately $64.3 million from our CLO equity and CLO warehouse investments and approximately $3.3 million from our CLO debt investments and from other income. Oxford Lane recorded GAAP net investment income of approximately $41.4 million or $0.26 per share for the quarter ended December 31 compared to approximately $36 million or $0.23 per share for the quarter ended September 30. Our core net investment income was approximately $50.1 million or $0.31 per share for the quarter ended December 31 compared with approximately $51.1 million or $0.33 per share for the quarter ended September 30. For the quarter ended December 31, we recorded net realized losses of approximately $1.5 million in net unrealized depreciation on investments of approximately $54.7 million or $0.35 per share in total. We had a net decrease in net assets resulting from operations of approximately $14.8 million or $0.09 per share for the third fiscal quarter. As of December 31, 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 16.6%, up from 15.1% as of September 30. The weighted average effective yield of our CLO equity investments at current cost was 15.7%, down from 16.1% as of September 30. The weighted average cash distribution yield of our CLO equity investments at current cost was 18.6%, down from 22.1% as of September 30. 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 December 31, we issued a total of approximately 7.2 million shares of our common stock pursuant to an at-the-market offering, resulting in net proceeds of approximately $37.2 million. During the quarter ended December 31, we made additional CLO investments of approximately $82.8 million, and we received approximately $49.5 million from sales and repayments. On January 26, our Board of Directors declared monthly common stock distributions of $0.075 per share for each of the months ending April, May and June of 2023. And with that, I'd like to turn the call over to our Managing Director, Joe Kupka. Joe?

Thanks, Jonathan. During the quarter ended December 31, 2022, the U.S. loan market was volatile. U.S. loan prices, as defined by the Morningstar LSTA U.S. Leveraged Loan Index increased from 91.92% of par as of September 30 to 93.06% of par as of November 16 before dropping to 92.44% of par as of December 30. During the quarter, there was significant pricing dispersion related to credit quality with BB-rated loan prices increasing 195 basis points single B-rated loan prices increasing 94 basis points and CCC-rated loan prices decreasing 603 basis points on average. The 12-month trailing default rate for the loan index decreased to 72 basis points by principal amount at the end of the quarter from 90 basis points at the end of September 2022. Additionally, the distressed ratio defined as a percentage of loans with a price below 80% of par, ended the quarter at 7.4% compared to approximately 6% at the end of September 2022. The increase in U.S. loan prices led to an approximate 7% increase in median U.S. CLO equity net asset values. Median junior over-collateralization cushions remained flat at approximately 4.7%. Additionally, we observed loan pools within CLO portfolios, modestly increased our weighted average spreads to 354 basis points compared to 351 basis points last quarter. Oxford Lane continues to be active in the secondary market during the quarter. While most of our activity took place in the secondary market, we added two new issued CLO equity investments during the quarter. Our investment strategy during the quarter was to engage in relative value trading and lengthened the weighted average reinvestment period of Oxford Lane's CLO equity portfolio. 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 continue to 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'll turn the call back over to Jonathan.

Thanks very much, Joe. Additional information about Oxford Lane's third quarter performance has been uploaded to our website at www.oxfordlanecapital.com. And with that, operator, we are happy to open the call up to any questions.

Thank you. [Operator Instructions] We have our first question from Mickey Schleien of Ladenburg. Your line is now open.

Yes. Good morning, everyone. Jonathan, it appears we're in a more normal economic cycle, which we actually haven't experienced in quite a while with inflation and interest rates climbing and GDP slowing down, et cetera. In that context and considering your firm's long experience in these markets, broadly speaking, what is your outlook for the CLO market this year?

Well, thank you, Mickey. Good morning. As you know, we don't take macro-based positions. We're not really a firm which forecasts macro fundamentals and makes large directional investments based on that macro forecast. That said, I think we are looking broadly for a continuation of current macroeconomic trends, which means hopefully, inflation comes under control. But we certainly have the potentials to see an additional rise in rates. We have the potential to see additional syndicated corporate loan spread widening. But I think there's a fair amount of uncertainty right now. So in terms of having a high degree of conviction around a specific macro outlook, I can say we are trying to remain flexible in our approach. We're trying to remain opportunistic in our investment decisions, but those things are not generally predicated on a specific macro outlook.

I understand. And following up on that question, Jonathan. Broadly speaking, how is the primary market behaving? And how do you see the supply – the equilibrium in the market developing in terms of supply of loans and demand for loans within the CLO market this year?

Sure, Mickey. The principal driver we see for the primary market is liability pricing which has been a bit volatile over the course of the last year or so. But let me turn it over to Joe to discuss that a little bit more broadly.

Sure. So towards the end of last year, we definitely see [indiscernible] pretty wide liability prices with AAAs pricing wide of silver plus 200. Since the beginning of the year, we've seen some banks start to come into the space and have seen some price stock in deals starting to get done as tight as silver plus 175. So that's obviously a good sign. In terms of just the supply equilibrium, we continue to see a decent amount of warehouses outstanding. And so as those look to price, that will – could have potentially a range bound effect on the price of liabilities. So that might bump up against the force of just continued banks coming in. So we'll kind of see how that equilibrium plays out in the next couple of quarters.

Yes, I understand. And I noticed – I can't recall a time when yields on CLO debt investments were higher than CLO equity estimated yields, which is the case currently in your portfolio. Can you expand on what's driving that deviation and how you can take advantage of it?

Well, CLO debt tranches, Mickey, have fundamentally different properties from CLO equity tranches. And we're looking in the context of making these various investments at obviously, the current yield, but we're also looking at the interest-only component. We're looking at the principle – return of principle prospect, we're looking at the operation of the waterfall with respect to the equity tranches, specifically the structure of the indenture, which in turn, informs and provides a framework for the operation of that waterfall. We've always invested with a focus or we've generally invested with a focus on CLO equity tranches is against debt. But we are certainly looking actively at CLO debt tranche investments in this environment.

But Jonathan, what's driving the difference? I mean you would expect the CLO equity estimated yields to be higher than debt given their risk profile, but the inverse is happening right now, at least on average, what's driving that?

Sure. I think you're referring to the weighted average GAAP effective yields. So I would just point that that's a GAAP measure of our current portfolio. Not necessarily a reflection of the current state of the market. And obviously, our purchase prices for those various tranches is going to drive that calculation pretty dramatically. We may have purchased an equity tranche or a debt tranche at different moments in time when the market was providing us with a different opportunity set.

Okay. Jonathan, the average price of the collateral in the portfolio actually increased about 75 basis points during the quarter, but the fund reported $0.34 per share of unrealized depreciation. I understand that it was a very volatile quarter and that the relationship is not linear, but what were the main factors driving down fair values during the three months ending December?

It's essentially market prices, Mickey, supply and demand characteristics for the CLO equity tranches that we hold as of December 31, which during some periods may or may not, as you say, be particularly well correlated to the pricing of the various collateral pools that reside within those CLO structures. These are simply market factors.

Okay. And Jonathan, to what extent did the spread between one-month and three-month LIBOR or SOFR and the pace of rate increases, which have been dramatic impact cash flows in the [fourth] calendar quarter? And how do you see that dynamic affecting cash flows this year?

Sure. It had a pretty meaningful effect this quarter. We see it tightening in a bit for the next quarter, but I see that stabilizing going forward, for sure. That's obviously a projection based just on the publicly available forward curves, but that's what we're seeing.

Okay. And my last question. I noticed that almost $1 million of cash flows were diverted this quarter which we haven't seen for a while. So I'd like to understand how large the portfolio's average CCC bucket is? And how much risk do you see in managers tripping their CCC limits this year with the rating agencies potentially continue to downgrade?

Sorry. Let me go ahead and answer that question for Mickey. We are – as Mickey referred to – as Mickey referenced, we don't have a specific projection for the speed of downgrades or the speed of CCC downgrades by the rating agencies for the remainder of 2023. That said, we're obviously sensitive to the issue of cash flow diversions and we continue to monitor market dynamics closely. Operator, happy to go ahead with the other question now.

Our next question comes from the line of Matthew Howlett of B. Riley. Your line is open.

Thanks for taking my question. Good morning, everybody. Just to follow on that note, I mean the – what I was really impressed with was the junior OC, over-collateralization was up and stable 459. I mean, given – the downgrades are outweighing, the upgrades we see that, what's going on in the portfolio that's allowing the CLO junior OC tranches to be stable in that environment? Is it just reinvestment, good portfolio management? Can you just elaborate on how that's – why that's staying stable in a higher downgrade market?

Sure. So even though we are starting to see downgrades, the CCCs are still within their allowable 7.5% basket. So even if you see an increase in CCCs as long as it stays under 7.5%, you won’t see that impact the OC ratio. Additionally, just given this environment with a healthy discount in the leveraged loan market, CLO managers are able to build par just by going out and purchasing loans at 95%, 96%, 97%, and that's a good way to just build par and build those OC ratios.

Yes, right. And I noticed you've extended the – you keep extending that reinvestment period. Is that something that – I mean, sort of when you look at buying – you said – I think you said [bought] two new issues in the quarter. I mean you really set on improving – continuing to lengthen that reinvestment period? You've done a great job in the last year just pushing it way out?

Sure, Matt. As you know, we are partial to longer reinvestment periods is, I think that's sort of a fundamental part of a lot of the thesis that we invest around. That said, we seek to be as purely opportunistic and investor as we can be, which means if there are discrete opportunities with shorter reinvestment periods or even transactions that are structures that are outside of the reinvestment periods, we will look very broadly across the asset class.

Certainly been an opportunistic in that time and time again [indiscernible] are today given the equity market rally, year-to-date. Two, there's been a lot of press reports on these leverage loans hung on these investment bank balance sheets and JPMorgan’s asked about it on their call and they said, no issue. Do you foresee any issue with the banks going forward with some of the stuff on their balance sheet, does that create an opportunity for Oxford Lane, if they need to securitize and get them out? And then three, did I hear you that the credit curve is steepening. Is that good for Oxford Lane? Do you like to see the credit curve steepener or does it – are you indifferent to it?

Sure, Matt. I think the first question – the first part of your question was a little bit garbled. Do you mind repeating that?

On just leveraged loan price today?

Oh, sure. So since year-end, the LSTA syndicated corporate U.S. loan index is up roughly 160 basis points. We're just a little bit over 94 in the index right now, which is obviously generally good news for collateral pools that was within U.S. CLO structures. In terms of – yes, so I think your other question was about the pressure on some of these investment banks who have these warehouses. Now, individual loans. So I mean, Matt, our view is that to the extent that those loans or significant numbers of those loans begin to see their way into U.S. CLO collateral pools, they're going to enter those collateral pools at prices that reflect the current risk reward of both that particular loan, that corporate obligors, risk return characteristics as well as the current state of the market. So it's not anything that we've sort of worried about broadly as a market trend.

Got you. And then the last on the credit curve. I mean is that steepening? Am I hearing you correctly that there's been some widening been AAAs and single Bs, CCCs and single Bs?

Are you – so are you referring to the higher rated loans catching a bit while the CCCs saw decrease this quarter?

Yes.

Yes. So that's definitely a challenge for CLOs just because they are somewhat constrained in terms of ability to add on to these CCCs. So it's definitely something we're keeping a close eye on and are in discussions with our manager, but as long as they're still able to, in this environment, still move up in quality and still build par, we think they'll be able to manage it. Right, obviously, Matt as you know, any CLO structures ability to harvest opportunity in the CCC marketplaces is going to be structurally limited.

Right. Got you. And I guess, just the last question is first, great job covering the dividend with the NII. I mean it was really very pleased to see that improvement and the coverage and given where your stock is trading is just really impressive on the yield. It's really impressive that you're covering it. There's nothing on the balance sheet, there's just really nothing you really need to do. We don't really have any near-term debt and even in the fixed rate long-term. So there's really no need to open any of those series up. And in terms of balance sheet management, you feel like you are just in really good shape and just keep on moving along.

Sure, Matt. I think, look, it's always a challenge striking the right balance between raising incremental equity capital, raising additional indebtedness, the cost of that indebtedness, the duration, maturities of those various pieces of indebtedness that we have on our balance sheet, and striking the right balance between the liability side of our balance sheet and the asset side of our balance sheet. So that for us is an ongoing process. It's something that we need to think about all the time. But in that regard, we're reasonably comfortable with the current state of our balance sheet, yes.

Yes. I would just point, I mean you managed for the [indiscernible] and asset price [is very well with leveraging], you are starting to see the other side of it. So I would just obviously commend you on a great job of managing the balance sheet and look forward to the company. Thanks for taking my questions.

Thank you, Matt, very much.

Thank you. We have no further questions. So I'd now like to hand the call back to our CEO, Jonathan Cohen for some final remarks.

Thank you very much, operator. I'd like to thank everyone on the call today, everyone listening to the call on replay for their interest in Oxford Lane Capital Corp. We look forward to speaking to you again soon. Thanks very much.