Executive Summary / Key Takeaways

• Strategic Re-Anchoring: Oaktree Specialty Lending (NASDAQ:OCSL) is strategically re-anchoring its investment approach, emphasizing first-lien, senior secured debt in the middle market and leveraging Oaktree's expansive platform for differentiated deal sourcing and underwriting expertise. This shift aims to fortify credit quality and enhance income stability.
• Capital Structure Optimization & Oaktree's Commitment: Recent actions, including a $100 million equity injection from Oaktree at NAV, a permanent reduction in base management fees, and a revised dividend policy (base + supplemental), underscore management's commitment to shareholder value and provide substantial dry powder for growth.
• Improving Portfolio Health & Liquidity: Despite ongoing challenges with certain non-accrual investments, OCSL is actively managing these positions, demonstrating progress in restructurings and exits. The company maintains robust liquidity of approximately $730 million and a low net leverage ratio of 0.93x, positioning it for strategic capital deployment.
• Outlook for Deployment & Earnings: Management anticipates deploying capital into a strong pipeline over the coming quarters, gradually increasing leverage towards the midpoint of its target range (0.9x-1.25x) and optimizing Joint Venture contributions to drive earnings growth and support its $0.40 per share base dividend.
• Competitive Edge in Volatile Markets: OCSL's competitive advantage stems from Oaktree's global platform, which provides access to larger, high-quality transactions and specialized lending opportunities (e.g., asset-backed, life sciences, rescue financing) that are often unavailable to smaller lenders, allowing it to capitalize on market dislocations.

Oaktree Specialty Lending: Forging a Path in Middle-Market Direct Lending

Oaktree Specialty Lending Corporation, established in late 2007, operates as a prominent Business Development Company (BDC) within the specialty finance sector. Its core mandate is to generate current income and capital appreciation by providing flexible and innovative credit solutions to middle-market companies. This involves a diversified investment approach, primarily focusing on first-lien loans, which may include unitranche and last-out first-lien structures, alongside second-lien, unsecured, and mezzanine loans, bonds, preferred equity, and strategic equity co-investments. OCSL's investment philosophy is deeply rooted in Oaktree's renowned credit expertise, targeting companies with resilient business models and strong fundamentals across a broad spectrum of industries, including technology, healthcare, manufacturing, and diversified financial services.

The competitive landscape for OCSL is dynamic, encompassing other large BDCs like Ares Capital Corporation (ARCC), FS KKR Capital Corp. (FSK), Blue Owl Capital Corporation (OBDC), and Hercules Capital, Inc. (HTGC), as well as traditional banks and emerging fintech platforms. OCSL distinguishes itself through its affiliation with Oaktree Capital Management, leveraging a global platform that provides unparalleled access to deal flow and deep analytical capabilities. This proprietary investment platform and extensive network of sponsor relationships serve as OCSL's primary technological differentiator, enabling it to source, diligence, and structure complex transactions that often elude smaller lenders. This operational technology translates into tangible benefits such as a more granular and diversified portfolio, enhanced risk-adjusted returns, and the capacity to lead or participate in larger financings. While OCSL may not possess a "product technology" in the traditional sense, its sophisticated investment management platform and human capital expertise are its core technological moats, allowing it to maintain a competitive edge in a crowded market.

Historically, OCSL's journey has been marked by strategic expansions and capital structure refinements. Key mergers, such as the acquisition of Oaktree Strategic Income Corporation (OCSI) in March 2021 and Oaktree Strategic Income II, Inc. (OSI2) in January 2023, significantly expanded its asset base. A pivotal moment occurred in June 2019 when stockholders approved reduced asset coverage requirements, allowing OCSL to increase its leverage capacity. This strategic flexibility, combined with Oaktree's recent $100 million equity investment in February 2025 at net asset value, provides OCSL with substantial dry powder to capitalize on market opportunities.

Strategic Evolution and Competitive Positioning

OCSL's investment strategy is currently undergoing a deliberate evolution, driven by a commitment to fortify its portfolio and enhance shareholder returns. The company is increasingly emphasizing first-lien, senior secured debt, a move designed to position it at the top of the capital structure for greater downside protection. As of June 30, 2025, first-lien investments constituted 83.40% of the total portfolio at fair value, a notable increase from 76% at fiscal year-end 2023. This strategic pivot is a direct response to market dynamics where, as Co-CIO Raghav Khanna noted in Q3 2025, "All our originations in the quarter were first lien loans, consistent with our strategy of investing at the top of the capital structure to provide greater downside protection."

The company's competitive positioning is significantly bolstered by Oaktree's global platform. This affiliation grants OCSL access to a diverse range of high-quality transactions, including larger financings and specialized lending opportunities that are often inaccessible to smaller competitors. While direct competitors like ARCC and FSK boast larger overall scale, OCSL leverages Oaktree's broad sourcing capabilities—spanning sponsored and non-sponsored deals, stress and rescue lending, high-yield public credit, and asset-backed transactions—to identify opportunities with superior risk-adjusted returns. This breadth allows OCSL to be selective, prioritizing mature, market-leading businesses with solid fundamentals and consistent cash flows, thereby avoiding excessive industry concentration risk and cyclical businesses.

OCSL's focus on middle-market lending, with a median portfolio company EBITDA of approximately $161 million as of June 30, 2025, allows it to achieve attractive spreads. While spreads on newly originated loans have tightened, OCSL's Q3 2025 weighted average yield on new debt investments remained healthy at 9.1%. This is achieved by leaning into opportunities like life sciences and non-U.S. deals (e.g., Draken International, priced at SONIA plus 5.50% with 2 points of upfront fees), where spreads are often wider than in the U.S. core market. The company's ability to lead or co-lead transactions, as demonstrated by its participation in the Draken International and Lyons Magnus financings, further highlights its competitive strength in structuring favorable terms.

Financial Performance and Portfolio Resilience

OCSL's recent financial performance reflects both strategic adjustments and the ongoing challenges within the broader market. For the third fiscal quarter ended June 30, 2025, adjusted net investment income (NII) was $0.37 per share, a decline from $0.45 per share in the prior quarter. This decrease was primarily attributed to nonrecurring and noncash expenses related to refinancing activities, coupled with a lower-than-usual amount of nonrecurring income. CFO Chris McKown clarified that "Our trailing 8-quarter median amount of nonrecurring income has been about $3.8 million or $0.043 per share... Our June quarter nonrecurring income came in around $2.1 million less." This indicates that while the headline NII figure was lower, a significant portion was due to temporary factors.

The company's net asset value (NAV) per share saw a slight increase to $16.76 as of June 30, 2025, up from $16.75 in the prior quarter, signaling a stabilization after earlier declines. This stabilization is partly a result of active portfolio management, including progress in restructuring or exiting challenged names. Non-accrual investments, a key indicator of portfolio health, declined as a percentage of both fair value and cost in Q3 2025. This follows an increase in Q2 2025, where non-accruals reached 4.6% of fair value and 7.6% of cost, driven by additions like Mosaic Companies and SiO2. Management has been proactive in addressing these situations, as evidenced by the successful restructuring of Telestream Holdings, which was removed from non-accrual status in Q3 2025, and the partial cash paydown from Mosaic totaling $25.7 million.

OCSL maintains a robust balance sheet and ample liquidity, crucial for navigating market volatility and seizing new investment opportunities. As of June 30, 2025, the net leverage ratio stood at 0.93x, the lowest in three years and at the low end of its target range of 0.9x to 1.25x. Total debt outstanding was $1.46 billion, with unsecured debt representing a healthy 65% of the total. Liquidity was approximately $730 million, comprising $80 million in cash and $650 million in undrawn capacity on its credit facilities. Unfunded commitments, excluding joint ventures, were $278 million, with approximately $264 million immediately drawable. This strong liquidity profile, bolstered by the $100 million equity investment from Oaktree in February 2025, provides significant dry powder for future deployments.

Capital Structure, Joint Ventures, and Outlook

OCSL has actively optimized its capital structure to reduce interest expense and enhance financial flexibility. The company successfully amended and extended its senior secured revolving facility in Q3 2025, reducing the interest rate from SOFR plus 2% to a range of SOFR plus 1.75% to 1.875%. This move, coupled with the termination of a higher-cost ABL facility (SOFR plus 2.35%), is expected to be accretive to future earnings. The issuance of $300 million in 2030 Notes in February 2025, with an associated interest rate swap translating to a coupon of SOFR plus 2.19%, further diversified its debt profile.

The company's joint ventures (JVs), SLF JV I and OCSI Glick JV LLC, continue to be strategic components of its investment strategy. These JVs primarily invest in broadly syndicated loans, holding $442 million of investments across 54 portfolio companies as of Q3 2025. For the quarter, the JVs generated attractive annualized ROEs of 10.5% in aggregate, with leverage at 1.3x. Management intends to gradually increase leverage in the JVs towards a target of 1.5x, further enhancing OCSL's overall earnings capacity.

Looking ahead, OCSL's outlook is one of cautious optimism, underpinned by a clear strategy for growth and dividend sustainability. Management anticipates that while M&A activity remains muted in the short term due to tariff-related uncertainties, the long-term outlook for direct lending remains favorable. Co-CIO Armen Panossian highlighted that "Yields are compelling on a gross unlevered basis, including at the top of the capital structure. The absence of mark-to-market volatility and the historically tight band of returns across different market environments make this asset class appealing to investors seeking income and capital preservation."

The company expects to deploy its substantial dry powder into a robust pipeline over the next couple of quarters. This deployment, combined with a planned increase in net leverage towards the midpoint of its 0.9x to 1.25x target range, is crucial for driving earnings growth and supporting the dividend. OCSL's dividend policy, amended in March 2025, now features a stable base dividend of $0.40 per share, complemented by a variable supplemental dividend (expected to be 50% of adjusted NII exceeding the base). This structure aims to provide sustainable income through market cycles while allowing for NAV growth.

Key risks include the ongoing uncertainty surrounding tariffs, which could impact portfolio company performance and M&A deal flow. While interest rates have seen some easing, OCSL anticipates they will remain "higher for an extended period," posing challenges for highly levered borrowers. However, Oaktree's expertise in "capital solutions or rescue financing" positions OCSL to capitalize on opportunities arising from such market stress. The company's conservative stance on PIK income, at 6.7% of total income, further reflects its prudent risk management.

Conclusion

Oaktree Specialty Lending is strategically re-anchoring its business to deliver sustainable income and long-term growth for its shareholders. Through a disciplined focus on senior secured, first-lien debt in the middle market, backed by Oaktree's formidable global platform and proprietary investment expertise, OCSL is building a resilient portfolio designed to withstand market fluctuations. The recent capital structure enhancements, including the significant equity investment from Oaktree and a refined dividend policy, underscore a clear commitment to shareholder value and provide the necessary dry powder for strategic deployment.

While challenges such as non-accrual investments and macroeconomic uncertainties persist, OCSL's proactive management of its portfolio and robust liquidity position it favorably. The company's technological edge, manifested in its sophisticated investment platform and deep analytical capabilities, enables it to identify and execute compelling opportunities, particularly in specialized sectors and during periods of market dislocation. As OCSL continues to deploy capital and optimize its balance sheet, its strategic re-anchoring is poised to drive enhanced earnings, support its base dividend, and foster NAV growth, making it a compelling consideration for income-focused investors seeking exposure to the dynamic direct lending market.