2023-07-06 13:59:31 ET
Summary
- Oxford Square Capital's shares have lost significant value over the last 1 year, with an annualized forward dividend yield that's grown to 15.33%.
- The business development company's allocation to CLOs has introduced more significant volatility than if it was purely focused on lending to established US companies.
- NAV under a sustained decline makes it hard to recommend the BDC as a buy, even with its dividend payout ratio improving markedly against its most recent net investment income.
Oxford Square Capital's ( OXSQ ) common shares have been turbulent. They've lost 12% since the start of 2023, down 25% over the last 1 year, and have shed around 60% of their value over the last 5 years. The Greenwich, Connecticut-based business development company did last declare a monthly cash dividend of $0.035 per share, in line with its prior payout and for a 15.33% annualized forward yield. This has helped cushion the sustained loss of value, with total returns over the last 5 years coming in at a loss of 25%. OXSQ provides debt capital to established businesses, invests in syndicated bank loans, and purchases both the debt and equity tranches of collateralized loan obligations.
Crucially, its allocation to CLOs and syndicated bank loans has blurred the lines between a BDC and credit-focused fund. This has perhaps introduced more significant volatility than it otherwise would have been subjected to if it was purely focused on just lending to established US companies. OXSQ's portfolio was valued at $319.7 million as of the end of its last reported fiscal 2023 first quarter, with around 30% of this allocated to the equity tranche of CLOs.
CLOs are investment vehicles created from different types of pooled corporate loans, with the equity tranche of CLOs broadly constituted of unrated and low credit-rated loans. It is the highest risk, comes with the highest yield, and sits at the bottom of the CLO structure. The aggregate valuation of these equity CLOs was $94.6 million as of the end of the first quarter and was spread across 21 positions with a weighted average portfolio life of 4.4 years.
Dual Beats As Dividend Coverage Improves
OXSQ reported first-quarter total investment income of $12.94 million , a 31.1% increase over its year-ago comp and a beat by $740,000 on consensus estimates. Growth was driven by a $3.04 million increase in interest income from loans provided to established businesses. Income from CLOs at $4.38 million was a marginal 1.4% drop over its year-ago comp. Net investment income of $6.49 million , around $0.13 per share, grew from $4.25 million or around $0.09 per share in the year-ago quarter. This was also a beat by $0.02 on consensus estimates.
I like that the BDC's weighted average shares outstanding have stayed flat year-over-year and that NII against the 3-month aggregate of the dividend formed an 80.76% payout ratio. The dividend yield at 15.3% has moved to its highest level since early 2021 and is now more secure than it was a year ago when the BDC's payout ratio stood at 116%. OXSQ portfolio is also heavy on senior secured debt to reduce inherent portfolio volatility in the event of a US recession. Pimco recently came out saying that they expect a harder landing for the global economy as central banks stay hawkish to battle inflation. Around 68.4% of OXSQ is in senior secured debt, however, only around 28% of OXSQ's portfolio is in first lien debt with around 40.4% being second lien debt.
Possible Total Returns For 2023
OSXQ held three debt investments on non-accrual status as of the end of the first quarter with a combined fair value of just $123,000 . There was another $5.1 million of preferred equity investments on non-accrual. This was as OXSQ made around $8.2 million in investments during the quarter against $330,000 in repayments.
Net asset value per share at $2.80 as of the end of the first quarter was a $0.02 sequential drop over the fourth quarter to maintain what's been a pertinent trend of NAV, as defined by tangible book value, being under a sustained decline. Tangible book value of $139.84 million declined by 39.54% from $231.3 million in the year-ago comp to remain at its lows. The protection of NAV forms one of the most important factors in deciding which BDC to invest in, as market cap tracks NAV closely. Hence, it's hard to recommend OXSQ as a buy against this trendline.
The CLO allocation is broadly inversely correlated to rising interest rates, and the NAV decline definitely became sustained at the start of 2022 when the Fed ramped up what would become ten consecutive rate hikes up until its June 2023 FOMC meeting. Hence, even though the Fed funds rate currently sits at its highest level since 2008 at 5% to 5.25%, further pauses should contribute to a stabilization of OXSQ. I would expect the BDC to possibly eke out a positive return if NAV stays flat from here and the dividend is maintained through to the end of 2023.
For further details see:
Oxford Square Capital: Trading Close To NAV With A 15.3% Yield Paid Monthly