Scott Kennedy’s BDC And mREIT Earnings Series: Assessing Oaktree Specialty Lending’s And PennyMac Mortgage’s Performance For Q4 2023
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Article section by Scott Kennedy.
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Disclosures
Related to the stocks in this article:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
Scott Kennedy is long: RITM, RC, SLRC, GPMT, ARCC, GBDC, RITM-D, MITT-B, MITT-C, GAINL, ECCC.
The rest of this post is from Scott Kennedy.
Summary
This 7th earnings assessment article reviews OCSL’s and PMT’s NAV/BV and adjusted NII/net interest spreads/margins performance during Q4 2023.
OCSL’s NAV was a modest underperformance while its adjusted NII was a minor-modest underperformance.
OCSL received a 2.5% recommendation range “downgrade” due to the spike in non-accruals (4 this quarter; 2 more than I projected for the calendar Q4 2023).
No change in OCSL’s risk rating though (remains at a 3.5 but edges closer to a 4). OCSL is currently deemed slightly overvalued (SELL).
PMT reported a good quarter regarding BV + net spreads but forward guidance was weaker. No change in PMT’s percentage recommendation ranges/risk rating. PMT is currently appropriately valued (HOLD).
Introduction:
Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.
This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.
I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.
1) OCSL’s NAV and Adjusted NII Calendar Q4 2023 Performance (Projected Versus Actual Results):
On 2/1/2024, Oaktree Specialty Lending Corp. (OCSL) reported the company’s earnings results for the calendar fourth quarter of 2023 (fiscal first quarter of 2024). Table 1 below provides OCSL’s NAV and earnings summary.
Table 1 – OCSL Calendar Q4 2023 NAV and Earnings Summary
Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data
I provided the following commentary in regards to OCSL’s results for the calendar fourth quarter of 2023:
“Hi subscribers. I was able to review OCSL’s calendar Q4 2023 (fiscal Q1 2024) earnings results. OCSL's calendar Q4 2023 adjusted net investment income (“NII”) of $0.568 per share was a minor - modest underperformance versus my projection of $0.605 per share (range $0.565 - $0.645 per share). OCSL’s calendar Q3 2023 adjusted NII was $0.619 per share. As such, I projected an adjusted NII decrease of ($0.014) per share. In actuality, OCSL reported an adjusted NII decrease of ($0.051) per share during the calendar fourth quarter of 2023. In comparison, the institutional analysts’ consensus average was adjusted NII of $0.610 per share. Due to the fact OCSL continually accrues for GAAP capital gains incentive fees (or reversals) and discount accretion in relation to the OCSI and/or OSI2 merger, I continue to believe the company’s adjusted NII is the best metric to track regarding operational performance (not NII; more indicative of net investment company taxable income [net ICTI]). Let us reconcile OCSL’s quarterly adjusted NII underperformance when compared to my expectations.
First, I typically review OCSL’s change in investment portfolio size. OCSL had quarterly loan originations funded at close and add-on investments of $368 million during the calendar fourth quarter of 2023. In comparison, I projected quarterly loan originations funded at close and add-on investments of $300 - $350 million (mean of $325 million). OCSL recorded loan prepayments/repayments/restructurings of ($214) million during the calendar fourth quarter of 2023. In comparison, I projected quarterly prepayments/repayments/restructurings of ($150) – ($200) million (mean of ($175) million). When calculated, excluding fair market value (“FMV”) fluctuations, OCSL increased the company’s investment portfolio size by $154 million during the calendar fourth quarter of 2023. In comparison, I projected OCSL would increase the company’s investment portfolio size by a mean of $150 million. As such, a very similar investment portfolio increase in size when compared to my expectations. As such, this was not the reason for the company’s quarterly NII underperformance this quarter.
Second, unlike the generalized pattern that developed during 2022 – 2023, OCSL experienced a decrease in the company’s weighted average annualized yield during the calendar fourth quarter of 2023 when compared to the prior quarter. Simply put, this was mainly due to the recent “plateauing/leveling off” in LIBOR/SOFR/PRIME and a quarterly “spike” in OCSL’s non-accruals (more on this later). OCSL reported a weighted average annualized yield of 12.30%, 12.70%, and 12.20% for the calendar second, third, and fourth quarter of 2023, respectively. When calculated, this was a quarterly increase of 0.4% and decrease of (0.5%), respectively. This past quarter, this was a (0.2%) underperformance when compared to my expectations which was a bit of a disappointment. As correctly stated last quarter, this metric began to plateau towards the end of 2023. In addition, it should be noted the higher LIBOR/SOFR/PRIME rose (over 500 basis points [bps] in 1.5 years), the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2024 as well.
When combining these 2 factors, OCSL reported total investment income that was slightly - modestly below my expectations. OCSL reported total investment (which includes interest, payment-in-kind (“PIK”)/deferred, fee, and dividend) income of $98 million during the calendar fourth quarter of 2023. In comparison, I projected OCSL would report total investment income of $102 million. When calculated, including the incentive fee offset from lower pre-incentive fee income, this ($4) million variance directly resulted in an adjusted NII underperformance of ($0.041) per share when compared to my expectations.
When the variance above is combined with a remaining $0.004 per share operational expense net outperformance (mainly lower-than-anticipated base management fees due to more severe quarterly fair market value [FMV] decreases), this fully reconciles back to OCSL’s adjusted NII underperformance of ($0.037) per share when compared to my expectations for the calendar fourth quarter of 2023.
Moving on, OCSL reported a NAV as of 12/31/2023 of $19.14 per share (2.5% decrease) versus my projection of $19.80 per share (0.9% increase). I consider this a modest (at or greater than a 2.5% but less than a 5.0%) underperformance and was slightly OUTSIDE my $19.30 - $20.30 per share range (1st BDC to be outside my NAV range this quarterly cycle). This performance was disappointing.
Within OCSL’s entire investment portfolio, which contained 145 portfolio companies as of 12/31/2023, the company reported a combined net realized loss and net unrealized depreciation (including foreign currency FMV fluctuations) of ($33) million during the calendar fourth quarter of 2023. In comparison, I projected a combined net realized loss and unrealized appreciation (including foreign currency FMV fluctuations) of $15 million. When calculated, this ($48) million variance directly led to a NAV underperformance of ($0.62) per share when compared to my expectations. Contrary to what some subscribers may initially conclude, the vast majority of OCSL’s quarterly NAV underperformance was concentrated within only a handful of underlying portfolio companies. This will be explained when reviewing OCSL’s credit metrics shortly.
When the variance noted above is combined with the adjusted NII underperformance of ($0.037) per share discussed earlier, this directly calculates to OCSL’s quarterly NAV underperformance of ($0.66) per share when compared to my expectations.
Regarding credit risk, a very busy quarter for OCSL. Management put 4 new portfolio companies, Impel Pharmaceuticals Inc. (Impel), OTG Management, LLC (“OTG”), SVP-Singer Holdings Inc. (SVP-Singer), and Thrasio, LLC (Thrasio) on non-accrual status during the calendar fourth quarter of 2023. The total principal balance of Impel’s, OTG’s, SVP-Singer’s and Thrasio’s non accrual loans was $32, $33, $26, and $47 million as of 12/31/2023, respectively. As such, all portfolio companies had larger-sized loans. As correctly highlighted in our recent weekly mREIT and BDC newsletters/articles, I was anticipating some non-accruals during OCSL’s calendar fourth quarter of 2023. Specifically, I correctly identified SVP-Singer and Thrasio would be placed on non-accrual status during the quarter. While my research also correctly identified Impel and OTG as starting to have heightened credit risk, I did not project these 2 portfolio companies would be placed on non-accrual status during the calendar fourth quarter of 2023. I previously assumed these non-accruals would occur during the calendar year 2024. As such, disappointment with Impel and OTG being placed on non-accrual status earlier-than-anticipated which directly led to both OCSL’s quarterly adjusted NII underperformance and a good portion of the company’s quarterly NAV underperformance. OCSL also took 1 portfolio company, Continental Intermodal Group (Continental), off non-accrual status during the quarter. Continental had a debt-to-equity restructuring during the quarter whereas the existing debt investment was partially written-off for a realized loss of ($7) million.
As a reminder, OCSL had 0 portfolio companies on non-accrual status as of 12/31/2022. OCSL had 7 portfolio companies on non-accrual status as of 12/31/2023 (with 3 other non-accrual portfolio companies being sold/disposed of/written-off during 2023 as well). This should be considered a large/quick increase in non-accruals for this BDC and an “eye sore”. As of 12/31/2023, OCSL’s non-accrual percentage, based on amortized cost basis and FMV, was 5.5% and 4.0%, respectively. This was an increase from 2.2% and 1.7% as of 9/30/2023, respectively. OCSL’s non-accrual percentages will now be above sector averages as of 12/31/2023 (a negative catalyst/trend). As first stated 4 quarters ago, I correctly anticipated a handful of new non-accruals within OCSL’s investment portfolio as we proceeded through calendar year 2023. That said, 2 additional portfolio companies “crept onto” the non-accrual list during the calendar fourth quarter of 2023 which was disappointing.