Earnings Call Transcript - OXSQ Q3 2021

Operator, Operator

Hello, and welcome to the Oxford Square Capital Corp. Third Quarter of 2021 Earnings Conference Call. My name is Elliot, and I will be coordinating your call today. I will now hand over to our host, Jonathan Cohen. Jonathan, please go ahead when you're ready.

Jonathan Cohen, Host

Thanks very much. Good morning, everyone, and welcome to the Oxford Square Capital Corp. third quarter 2021 earnings conference call. I'm joined today by Saul Rosenthal, our President, Bruce Rubin, our Chief Financial Officer, and Kevin Yonon, our Managing Director and Portfolio Manager. Bruce, could you open the call with a disclosure regarding forward-looking statements?

Bruce Rubin, CFO

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 this morning. Please note that this call is the property of Oxford Square Capital Corp., and the 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 could 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. To obtain copies of our latest SEC filings, please visit our website at www.oxfordsquarecapital.com. With that, I'll turn the presentation back to Jonathan.

Jonathan Cohen, Host

Thank you, Bruce. For the quarter ended September 30, Oxford Square’s net investment income was approximately $4 million or $0.08 per share, and our net asset value per share stood at $5.03. This compares to net investment income of approximately $2.8 million or $0.06 per share and our net asset value per share of $4.91 for the prior quarter. That increase in net investment income was principally driven by higher interest in CLO income, partially offset by higher interest expense. For the third quarter, we recorded a total investment income of approximately $9.8 million, as compared to approximately $7.8 million in the prior quarter. In the third quarter, we recorded net unrealized appreciation on investments of approximately $5.6 million or $0.11 per share, compared to net unrealized appreciation on investments of approximately $2.5 million or $0.05 per share for the prior quarter. In the third quarter of 2021, we recorded realized gains on investments of approximately $1.7 million or $0.03 per share, compared to realized gains of $1.2 million or $0.02 per share for the prior quarter. In total, for the third quarter, we had a net increase in net assets from operations of approximately $11.3 million or $0.23 per share, compared to a net increase in net assets from operations of $6.5 million or $0.13 per share for the prior quarter. During the third quarter, our investment activity consisted of purchases of approximately $23.1 million and repayments of approximately $5.7 million. As of September 30, we held cash and cash equivalents of approximately $19.5 million, against which there were unsettled purchases of approximately $6.5 million. On October 22, 2021, our Board of Directors declared monthly distributions of $0.035 per share for each of the months ending January, February, and March of 2022. Additional details regarding record and payment date information can be found in our press release that was issued this morning. With that, I'll turn the call over to our portfolio manager, Kevin Yonon, to discuss the loan market.

Kevin Yonon, Managing Director and Portfolio Manager

Thank you, Jonathan. During the quarter ended September 30, 2021, the U.S. loan market modestly strengthened versus the quarter ended June 30, 2021. U.S. bond prices, as defined by the S&P/LSTA Leveraged Loan Index increased from 98.37% of par as of June 30 to 98.62% of par as of September 30. According to LCD, during the quarter, BB rated loan prices increased 13 basis points. B rated loan prices increased 4 basis points, and CCC rated loan prices increased 26 basis points on average. The 12-month trailing default rate for the S&P/LSTA Leveraged Loan Index increased to 0.35% by principal amount at the end of the quarter after starting the quarter at 1.25%. Note that this rate is just 14 basis points above the post-global financial crisis low. Additionally, the distress ratio, defined as a percentage of loans with a price below 80% of par, ended the quarter at approximately 0.72%, the lowest level in nearly seven years and below levels in June 2020. During the quarter ended September 30, primary market issuance was approximately $161 billion, bringing year-to-date primary market issuance to approximately $485 billion versus $407 billion during all of 2020. This was driven by continued strong refinancing, M&A, and LBO activity. Moreover, U.S. loan fund inflows as measured by Lipper were approximately $5.6 billion for the quarter ended September 30, bringing year-to-date total inflows to approximately $25.9 billion versus total outflows of approximately $19 billion during 2020. We continue to focus on portfolio management strategies designed to maximize our long-term total return. As a permanent capital vehicle, we have historically been able to take a longer-term view towards our investment strategy.

Jonathan Cohen, Host

Thanks very much, Kevin. We know that additional information about Oxford Square Capital Corp. third quarter performance has been posted to our website at www.oxfordsquarecapital.com. With that, operator, we're happy to open the call up for any questions.

Operator, Operator

Thank you. Our first question comes from Mickey Schleien from Ladenburg. Mickey, your line is now open.

Mickey Schleien, Analyst

Yes, good morning, everyone. Jonathan, we're experiencing inflation rates not seen in a generation. And as we all know, the loan and CLO markets have grown dramatically over that time. So, I think it would be helpful for us to understand what is your thesis on how these assets should perform during inflation periods, such as now?

Jonathan Cohen, Host

Sure, Mickey. Thank you for the question. We don't have a single answer. Obviously, inflation manifests itself in myriad ways throughout the economy, across different sectors of the economy, and within the operations of the businesses that we are invested in, as well as within the CLO structures we are invested in. So there's no single answer that would be adequate for the purpose of answering this question. As you know, all of our loans are floating rate, expressed as LIBOR plus, and our CLO equity exposure is also constructively borrowing on a LIBOR plus basis. The underlying collateral pools, the assets within these collateral pools of the CLOs that we invest in, are also denominated on a LIBOR plus basis. We have strategies that may provide us some element of protection. However, that protection, to the extent it exists at all, depends on numerous factors concerning how inflation affects businesses operationally, and ultimately, the effect on these assets in a more inflationary environment. We are mindful of inflationary trends and take them into account when we invest, but I don't think there is a specific solution for inflationary trends in the sector we invest in or in most other sectors.

Mickey Schleien, Analyst

Thank you for that, Jonathan. I wanted to move on; I noticed that the effect of yield in your CLO equity portfolio declined, even as the cash yields in that portfolio increased. Could you help us understand that dynamic?

Jonathan Cohen, Host

Sure, Mickey. As you know, effective yield essentially captures the total returns we expect from holding these assets. In most cases, across this portfolio, the effective yield has been and continues to be significantly lower than the actual cash we are receiving from these investments. Regarding the specific reasons for why effective yield may have trended down somewhat this quarter, I don't have a specific reason for that as it varies across each position.

Mickey Schleien, Analyst

Jonathan, under the current market conditions, what's your target leverage ratio in the form of debt to equity for the fund?

Jonathan Cohen, Host

At the moment, Mickey, after raising debt capital several months back, we are at a debt to equity ratio of 0.76. The general consensus is that within this moderate range, we are comfortable given the assets we hold, the economic environment we operate in, and, most importantly, the cost, availability, and duration of leverage we can obtain in the marketplace.

Mickey Schleien, Analyst

Thank you, Jonathan. My last question: could you describe your plans, if any, to reduce the fund's non-qualified asset ratio back down to the statutory limit?

Jonathan Cohen, Host

Sure, Mickey. As you know, all of our non-qualified assets within Oxford Square are CLO tranche positions. CLO tranche investing is an integral part of our current strategy at Oxford Square. Also, these investments roll off over time; they are repaid, deals are called, reset, refinanced, etc. This is probably the largest part of that strategy. However, we have and will continue to make sales when we think it's opportunistic and appropriate.

Mickey Schleien, Analyst

So, over time, as those investments reach maturity, you expect them to roll off and eventually get down to the 30% limit.

Jonathan Cohen, Host

That is our most current thinking, although we’re certainly not opposed to making opportunistic sales when we think it's suitable.

Mickey Schleien, Analyst

I understand. Those are all my questions for this morning. Thank you for your time.

Jonathan Cohen, Host

Thank you very much, Mickey.

Operator, Operator

I show no further questions. I will now turn the call back over to Mr. Cohen.

Jonathan Cohen, Host

Alright, operator, thank you very much. I'd like to thank everyone who listened to this call for their interest and participation. We certainly look forward to seeing you and speaking to you soon. Thanks very much.

Operator, Operator

This concludes today's call. You may now disconnect your lines, and we thank you for joining.