Oxford Square Capital Corp. (OXSQ) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Oxford Square Capital Corp's First Quarter 2018 Earnings Release Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jonathan Cohen, CEO. Please go ahead, sir.

Thanks very much. Good morning and welcome everyone to the Oxford Square Capital Corp. First Quarter 2018 Earnings Conference Call. I'm joined today by Saul Rosenthal, our President; and Bruce Rubin, our Chief Financial Officer. Bruce, could you open the call today with the discussion regarding forward-looking statements?

Sure, Jonathan. Today's call is being recorded. An audio replay of the conference call will be available for 30 days. Replay information is included in our press release that was released earlier this morning. Please note that this call is the property of Oxford Square Capital Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited. I would also like to call your attention to the customary disclosure in our press release this morning regarding forward-looking information. Today's conference call includes forward-looking statements and projections, and we ask that you refer to our most recent filings at the SEC for important factors that could cause actual results to differ materially from 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 Web site at www.oxfordsquarecapital.com. With that, I will return the presentation back to Jonathan.

Thanks very much, Bruce. We are pleased to report that we generated a positive total return of 3.31% for our shareholders during the first quarter of 2018. That return reflects the increase in net asset value per share from $7.55 at the end of December 2017 to $7.60 per share as of March 31 as well the effect of a $0.20 distribution. For the quarter ended March 31, we recorded GAAP net investment income of approximately $8.7 million or approximately $0.17 per share compared to $7.6 million or $0.15 per share for the quarter ended December 31, 2017. In the first quarter of 2018, we recorded a net change in unrealized appreciation on investments of $2.5 million and realized gains of approximately $300,000. In total, we had a net increase in net assets from operations of approximately $11.5 million or $0.22 per share. Our core net investment income for the quarter ended March 31 was approximately $7.6 million or approximately $0.15 per share compared with $9 million or 17% -- $0.17 per share for the prior quarter. Please see the earnings release we issued today for a reconciliation of net investment income with core net investment income. Following the company's results for the first quarter, the company's Board of Directors has declared a $0.20 per share distribution for the quarter ended June 30, 2018 payable to shareholders of record as of June 15, 2018. On February 5, 2018, the Board of Directors authorized the stock repurchase program of $25 million up to $25 million. During the quarter, we repurchased 990,260 shares of our common stock at a weighted average price of $6.01 per share using book value accretion of approximately $0.03 per share over our net asset value per share as of December 31. The first quarter of 2018 represent a period of continued strength in the markets in which we participate. From January 1, 2018 to March 31, the LSTA corporate loan index modestly increased, trading at approximately 98.4% at par at the end of the quarter. At the same time, corporate loan default rates remained at low levels providing investors with a generally lower risk, lower return corporate debt environment. During the first quarter of 2018, tighter leverage loan credit spreads reduced the weighted average spreads of the loan assets within various CLO investments. The current market environment has also resulted in tighter CLO liability spreads presenting us with ongoing refinancing as well as resetting opportunities, which we have and continued to take advantage of. As we executed our strategy of rotating out of more broadly syndicated corporate loans into a combination of clubbed deals and narrowly syndicated loans through purchases in both the primary and secondary markets, we remain mindful of maintaining overall portfolio liquidity. We believe this strategy allowed us to maintain corporate debt investments, which have sufficient liquidity to be sold, if necessary, in order to take advantage of market opportunities. We know that we continue to have no investments on nonaccrual status as of March 31. We continue to pursue our mandate of maximizing the risk-adjusted total return to our shareholders. As such, we haven't continue to focus on portfolio management strategies designed to maximize our total return as opposed to generating a certain level of income over a particular time frame. We view the market opportunity currently available to us as strong and as a permanent capital vehicle, we have historically been able to take a longer-term view towards our investments. Additional investment about Oxford Square Capital Corp's first quarter performance has been posted to our Web site at www.oxfordsquarecapital.com. And operator, with that we're happy to open the line up for any questions.

Thank you. [Operator Instructions] Our first question comes from Mickey Schleien of Ladenburg.

Yes, good morning, Jonathan.

Good morning, Mickey.

Jonathan, in 2017, about 18% of your distributions were a return of capital. What caused distributions to exceed taxable income last year? And what are your plans to generate sufficient taxable income this year to cover the distribution?

Sure. I don't think it's our goal, Mickey, to generate sufficient taxable income to cover any particular distribution. The tax treatment of our income and of our distribution is essentially determined after-the-fact by virtue of the PFIC income, the passive foreign investment company income that we received from our CLO equity investments. So to the extent that our taxable income is lower than our GAAP NII and/or our actual economic return for any particular period, that -- that's not something we view as negative. If we have income, cash and economic returns sufficient to cover a particular distribution, but the tax treatment of that distribution is ultimately more favorable to our shareholders we regard that as a positive outcome.

Okay. I understand. Jonathan, the Board has approved higher leverage, can you describe what type of investment strategy the company will follow or would follow with a larger balance sheet?

We're really not in a position yet, Mickey, to talk about that. We've talked internally and with our Board about various strategies, but those really remain hypothetical at this point because we have no near-term opportunity or no turn -- no near-term strategy, I should say, or probably any near-term opportunity as well to exceed the historic statutory leverage limit.

And with regard to that timing, Jonathan, what limitations to your existing unsecured notes have in preventing you from getting higher leverage?

None to my knowledge, Mickey. I think the notes simply require us to comply with the -- fully at leverage test.

Okay. And then as you mentioned, spreads in the fourth quarter began to stabilize, but now they’re compressed, a lot of CLOs have already refinanced or reset their liabilities. So I would like to understand what your outlook is for the ability of the CLOs in the portfolio now to continue to manage their balance sheet against that trend?

Sure, Mickey. That's a good question. So we consummated a number of refis and resets during the first quarter and we're working on more. Some of these refi and reset opportunities are seem to be in a sense of recurring. In a sense that deals have refied or reset and then they would be looking to refi or reset yet again as liability spreads on CLO structures continue to grind lower.

The next question comes from Jonathan Bock of Wells Fargo.

Good morning, Jonathan, and thank you for taking my questions. Maybe first question just as it relates to leverage. Have you tried to procure or are in the process of procuring any additional source of borrowings beyond what we already have outstanding via credit line etcetera?

Yes, Jon. Thank you for the question. We are looking at several opportunities to up lever the balance sheet, although none that would take us even close to the historic statutory limit of one to one.

Okay. And then, maybe a questions as it relates to CLO equity. Could you just explain how GAAP yields go up quarter-over-quarter, but cash yields actually go down, specifically what changed in the outlook for effective yield?

Sure, Jon. Absolutely. It's principally a function or completely a function of two different dynamics. The first element are called deals, deals that we or we and the other equity holders have called for liquidation. Those deals may be producing significant GAAP effective yield income for us, but they may not be producing the sort of cash that they had historically. The total return, the total IRR, the total cash on cash return is what we’re ultimately focused on. The second and probably more relevant dynamic relates to what we’ve just talked about with respect to the refi and reset transactions. So when we refi or reset a deal, the economic value of that deal generally increases, our book value increases as a result of that refi or reset, the ultimate economic profitability will generally increase. But the cash income may decline for a quarter, a single quarter typically by virtue of the front-end loaded refi or reset expenses associated with that transaction.

The next question comes from Christopher Testa of National Securities Corporation.

Good morning, Jonathan. Thank you for taking my questions. Just following up a little on what you were just going over with Jon Bock, just wondering if you could quantify the impact per share from the refinance and reset cluster in the first quarter?

Sure. We don't have a number immediately to hand, but it was certainly the vast majority or essentially all of that delta in the core NII. We had, for example, the effect of three club [ph] deals during the quarter to some greater or lesser extent, and six refi or reset transactions that had some effect or that were at least relevant, some portion of that anyways was relevant with respect to that number. So was a significant delta.

Okay. That’s fair. And just looking obviously, AAA notably spreads has continued to come in, I think the average response to something like 98 basis points. Where do you see the shaking out? In other words, are you looking to just refinance everything that you’re able to refinance now, or are you still trying to kind of straggle that a little bit in the event that AAA spreads kind of come in even more?

Sure. Thanks, Chris. We're being very opportunistic that our refis and our resets it have to make sense for the deal, for the transaction for us. Economically it needs to be an accretive transaction. So we have as you know a significant practice in the CLO market last year, I believe, across the entire platform we traded approximately $2 billion of notional CLO equity. And I'm not sure if there are any other market participants who traded that sort of volume. So we think we're in a strong position to participate not only in the warehousing market and the primary markets going forward, but also in the secondary market. So to the extent that I sort of interpret your question as is there more room to go in terms of tightening of CLO liability spread? The answer is we are not sure, but we've been able to be very opportunistic and generate strong returns over the last several years in this asset class partially and recently as a function of these refi and reset opportunities.

Got it. And given the ability of you to do some primary originations here, obviously, these very favorable financing costs, are you expecting -- your GAAP effective yields to kind of be north of where the weighted average yield on the book is right now?

I mean, our GAAP effective yield, Chris, has been stable, maybe trending slightly higher. I mean, part of this is a function of our ability to relever the balance sheet, which we are looking to do opportunistically and only on the right terms and at the right price. If we're able to do that, we then gain the ability to rotate the CLO book, which we don't have the ability to do currently by virtue of being in excess of the 30% limitation for nonqualified assets. That I believe would allow us to generate not only potentially higher GAAP effective yield numbers which are interesting, but much more importantly actual economic returns which are much more relevant to us.

The next question is a follow-up from Mickey Schleien of Ladenburg.

Yes, Jonathan, just a couple of questions. We don't have the queue obviously, so can you give us some color on what drove the unrealized appreciation during the quarter?

Thank you, Mickey. It principally due to appreciation on the CLO equity portfolio, and also but to a lesser extent on the leverage loan book.

Okay. Was that driven by any meaningful changes in assumptions when you were valuating the CLO equity or was that …?

No, we've been very consistent now for a long period of time about our core assumptions. The refi and reset certainly help the valuations because it makes these fields typically more valuable.

I understand. And my last question, there was a pretty meaningful decline in professional fees quarter-to-quarter. Can you tell us what caused that and what sort of trend we might expect for the balance of the year?

Sure, Mickey. That was principally due to a decline in our audit expenses. We had over accrued modestly into calendar 2017 and we have the benefit of that in the first quarter. Our expectation is that audit fees going forward will be more consistent with those reduced levels.

And next we’ve a follow-up from Jonathan Bock of Wells Fargo.

Thank you and apologies I was cut off unexpectedly when I was trying to ask my next set of questions, so I ask the operator respectively hold off once we’re done. So one quick question is, I understand, Jonathan, that you have the Board, majority of independent directors approve leverage, yet we found that there are a certain subset of BDCs that will and are taking votes to increase leverage to allow for shareholders to participate in that discussion. So, Jon, can you talk about your unique situation as to why you're choosing not to ask shareholders when compared and contracted to those that are?

Sure. Jon, I’m not sure the situation is unique as you referenced I think quite a few other BDCs have taken the position of having a Board approval. From the Board's perspective and from management's perspective, this is optionality. It's not an option that we have any immediate or intermediate-term expectation of taking advantage of, but to the extent that dislocated market or if opportunity presents itself, we want to be in a position to take advantage of this new higher statutory limitation.

And then, the next question just relates to the share buyback. Just in terms of timing, I also understand that there were meaningful management purchases of shares as well. Was this buyback done before or after those management purchases were affected?

They were affected, Jon, at the same time on a pari-passu [ph] basis.

Great. Okay. Thank you so much.

Thank you, Jon.

And this concludes our question-and-answer session. I’d like to turn the conference back over to Jonathan Cohen for any closing remarks.

All right. I'd like to thank everybody for their interest and for their participation in the Oxford Square first quarter release. We look forward to speaking to you all again hopefully in the near future. Thank -- thanks very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.