Oxford Square Capital Corp. 5.50% Notes due 2028 (OXSQG) Q2 2018 Earnings Report, Transcript and Summary

Good morning and welcome to the Oxford Square Capital Corp's Second Quarter 2018 Earnings Release and 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.

Thanks very much. Good morning and welcome everyone to the Oxford Square Capital Corp. Second 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 website at www.oxfordsquarecapital.com. With that, I will return the presentation back to Jonathan.

Thanks very much, Bruce. We generated a positive total return of 2.1% for our shareholders during the second quarter of 2018. That return reflected a decrease in net asset value per share from $7.60 at the end of March 2018, $7.56 per share as of June 30, as well as the effect of the $0.20 distribution. For the quarter ended June 30, 2018, we recorded GAAP net investment income of approximately $7.7 million, or approximately $0.15 per share compared to $8.7 million or $0.17 per share for the quarter ended March 31, 2018. In the second quarter of 2018, we recorded a net increase in appreciation on investments of $300,000 and net realized losses of approximately $1 million. In total, we had a net increase in net assets from operations of approximately $6.9 million or $0.14 per share. Our core net investment income for the quarter ended June 30, was approximately $9.1 million or $0.18 per share compared to $7.6 million or $0.15 per share for the prior quarter. Please see the earnings release we issued today for reconciliation of net investment income with core net investment income. Following the company's results for the second quarter, the company's Board of Directors has declared a $0.20 per share distribution for the quarter ended September 30, 2018, payable to shareholders of record as of September 14, 2018. On February 5, 2018, the Board of Directors authorized the stock repurchase program of $25 million. Since inception of the program through June 30, we repurchased approximately 2.1 million shares of our common stock at a weighted average share price of $6.41 per share, totaling approximately $13.3 million. Through June 30, our stock repurchase program has produced an accretion of approximately $0.05 per share in our net asset value per share. On June 21, 2018, we announced that Oxford Square Funding 2018, LLC, a special purpose vehicle that is a wholly-owned subsidiary of the company entered into a credit facility with Citibank. Pricing under the facility is based on three months LIBOR plus 2.25% per year, 225 basis points. Pursuant to the terms of the credit agreement governing the facility, we have borrowed approximately $95.2 million. The facility will mature on June 21, 2020. The second quarter of 2018 represented a period of continued strength in the markets in which we participate. From March 31, 2018 to June 30, 2018, the LSTA corporate loan index modestly decreased from approximately 98.4% to 98.1% of PAR. At the same time, corporate loan default rates remained at low levels. During the first half of 2018, tighter leverage loan credit spreads generally reduced the weighted average spreads of the loan assets in our CLO investments. We note that we continue to have no investments on non-accrual status as of June 30. We continue to pursue our mandate of maximizing the risk adjusted total return to our shareholders. As such, we have and continued to focus on portfolio managements 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 information about Oxford Square Capital Corps' second quarter performance has been posted to our website at www.oxfordsquarecapital.com. And with that, Operator, we're happy to open the call up for any questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mickey Schleien of Ladenburg. Please go ahead.

Yes. Good morning, Jonathan.

Good morning, Mickey.

Hey, how are you? Jonathan, it still seems unclear at least to me where we're at in terms of the economic cycle when you look at last week's GDP number versus the slope of the yield curve. I think most folks are assuming we're closer to the end than the beginning obviously since the cycle has been so long. So I'd like to ask you how CLOs have performed during previous downturns in the economy to give us some sense of what the future might hold.

Sure, Mickey. Thank you. Our view is that CLO equity as an asset class is reasonably well-positioned to perform during an economic dislocation and there are certain profiles and certain vintages of CLO equity that are positioned to outperform substantially the asset class broadly during an economic dislocation or a market where there's a widening spread environment. We agree with you that we are certainly closer to the end than to the beginning of a credit cycle. I'm not sure we're at the beginning of the end or the end of the beginning, but we are certainly closer to the end and with that in mind, we are continuing to focus on CLO equity profile that have longer reinvestment periods that are in that way and by virtue of their long term relatively low cost leverage facilities, the leverage that they issue in order to fund their investments, we believe well-positioned to perform during an economic dislocation or a widening spread environment. So yes, we agree.

And Jonathan, given the structure of CLOs, I believe they don't themselves use market-to-market accounting. Could volatility in the leverage loan markets provide specific opportunities to CLO managers that might outweigh some near-term downside as the recession takes hold?

Yes, Mickey. That's a very good and I think perceptive question and the answer in our view is certainly yes and we've seen this play out in different cycles. If you look at the mini cycle, though which wasn't much of a credit cycle, but it was certainly an asset value cycle towards the end of 2015 and into early 2016, you saw some moderate dislocation in syndicated corporate loan pricing, but a much more meaningful pricing cycle in terms of CLO equity valuations. That gave us across our broader platform some very interesting opportunities that we were able to take advantage of similarly during the last sort of full correction which was 2008-2009. We certainly saw some fairly compelling investment opportunities in CLO broadly. So yes, we would agree with that.

That's really helpful. Just a couple more, if I may. The CLO equity portfolio has seen the weighted average spread decline. I think you mentioned in your prepared remarks, it's been going down about 5 basis points a quarter. Looking at the remaining opportunity for CLO managers to refinance or reset their liabilities, how much more downside do you see in the weighted average spread of your portfolio?

Our view, Mickey, is not a great deal. We have seen some moderate spread widening over the course of the last few months for four selected profiles. I do think that we are again much closer to a bottom in terms of spread tightening than the middle or the top. And given our portfolio profile which is a focus on longer reinvestment periods had a focus as well on refinancing and reset opportunities, we think we're reasonably well-positioned.

Okay. My last question for now is if you could give us some sense of what drove the $0.03 per share quarter-to-quarter increase in the adjustment to calculate core NII. I know you don't break it out per se, but if you could give us at a high level what caused the change from March to June. That would be very helpful.

Sure, Mickey. Thank you. It's primarily as you mentioned earlier, refinancings and resets on CLO equity tranches that have flowed through our P&L in the second quarter.

So the pace of refis and resets was slower in the second calendar quarter and therefore core NII was higher? Is that the correct interpretation?

Sure, yes. It's principally, Mickey, with respect to the second quarter, first quarter refinancings and resets where we received the full benefit of those activities in the second quarter.

All right. Thank you. Appreciate it. Thanks for your time this morning.

Thank you very much. Thank you.

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

Hey. Good morning, Jonathan. Thanks for taking my questions.

Thanks, Chris.

Following up a little bit on what Mickey was asking about the CLO equity yields. We obviously saw a nice jump in the cash yield which is great and your refi and resets were pulling through, but the GAAP yields were down. Could you walk us through why the GAAP yields were down when you positively recalibrated some things in your holdings with lower borrowing costs?

Sure, Chris. Absolutely. Generally speaking what you saw in the second quarter was just a manifestation of a tightening spread environment. So spreads tightened, we at the CLO equity level are affected by that until and unless we see refinancings and resets start to flow through, which we generally have been, but the timing of those things is not perfectly linear.

Got it. Okay, now that makes sense. And I know you have roughly $4.5 million of inaugural distributions that should be coming through in the third quarter. How do you balance this against potentially having probably the most high opting refis from 2016 and the upfront cost dealing with that? What I'm getting at is, should the shake out into higher core NII and higher estimated taxable income for the third quarter? Or do you think that potentially more refi and more reset costs will offset the inaugural distributions for the cash flow coming in?

It's difficult to say, Chris, because again, now that we've taken this leverage through the Citibank facility, we have the benefit of being able to rotate our CLO book in a way that we weren't able to in the last several quarters. So long as we were above the 30% statutory limit under the BDC rules, we certainly had the ability to sell assets, but we didn't have the ability to take the capital from those sold assets and redeploy it in new purchases either in the primary market or in the secondary market. Now that we have dropped below the 30% statutory tax by virtue of taking in the $95 million under the Citibank facility, we now have the ability to again rotate the portfolio. So to your point, I'm not certain whether initial refi and reset upfront cost will or won't offset inaugural distributions from those activities. Certainly, we are only engaging in refis and resets where we see meaningful positive economic benefits. Whether those benefits accrue through the initial distributions or over a longer period of time by virtue of having longer reinvestment periods and the ability to take advantage of widening spread opportunities over time, that's difficult to say right now.

Okay, that's fair. And what's the capacity on the Citi facility? Excuse me.

$95 million is essentially the capacity which is what we have taken down.

Got it. And have you given thought to using the available reduced asset coverage to the BDCs?

We have and we had our board of directors took action, I believe last November, to put that in motion, but we haven't taken any steps or given serious thought to actually changing our balance sheet to take advantage of that new statutory limit. No.

Okay. Just last one for me if I may. You guys have obviously moved more from the broadly syndicated loan side obviously into these more lightly syndicated or club deals that are more predominantly second lien. Jonathan, and so far as you do decide to use higher balance sheet leverage or maybe even not use that but enter into a joint venture, would you consider potentially using more economic or balance sheet leverage on more first lien broadly syndicated loans again and kind of shift away from second lien as we get later in the cycle? It just seems like that's something where you could get the similar or potentially higher ROE and a better-risk adjusted one at that.

Yes, Chris, that's exactly the right question. One of the benefits of the lower cost of capital that we're the beneficiaries of now under the Citi facility is that we do have the ability to move higher up the capital stack if we think it's appropriate to take on more first-lien debt, lower risk, lower spread debt, but paper that has the benefit of a positive arbitrage against our lower cost in capital. So the answer is yes.

Okay, that's all for me. Thanks for taking my questions.

And Chris, one last thing.

Sure.

It was more recently than last November, was within the last several months and we put out a press release at the time that the board took that action.

Got it. Okay, thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Jonathan Cohen for any closing remarks.

Great. I'd like to thank everyone on the call and who's listening to the replay for their interest and their participation. We look forward to speaking to many of you during the quarter and certainly at next quarter's call. So thanks all very much.

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