Executive Summary / Key Takeaways

• A Yield That Signals Distress, Not Value: Oxford Square Capital's 23% dividend yield reflects market skepticism, not opportunity, as net investment income per share collapsed 30% year-over-year to $0.07, leaving the payout ratio at an unsustainable 150% and suggesting the distribution is living on borrowed time.

• NAV Erosion Undermines the Investment Case: Net asset value per share declined 15% from $2.30 to $1.95 over nine months, driven by realized losses, unrealized depreciation, and a portfolio strategy that prioritizes spread capture over capital preservation in a deteriorating credit environment.

• Management's Leverage Gambit Is the Only Play Left: With asset coverage at 200%—well above the 150% statutory minimum—management openly acknowledges considering increased leverage as "one element worthy of consideration" to boost NII, a move that would amplify risk in an already stressed portfolio.

• Strategic Pivot to Illiquidity: The company is shifting from primary market loans to "opportunistic trades" in less liquid secondary names and has maxed out CLO equity capacity, indicating a portfolio rotation forced by market conditions rather than strategic choice, with future purchases requiring offsetting sales.

• Scale Disadvantage Magnifies Vulnerability: At $151 million market cap and $260 million portfolio, OXSQ competes with multi-billion dollar BDCs like Hercules Capital ($3.4B) and Trinity Capital ($1.15B), leaving it disadvantaged in deal flow, bargaining power, and diversification when credit cycles turn.

Setting the Scene: A Small BDC in a Big Credit Cycle

Oxford Square Capital Corp., founded in 2003 as TICC Capital Corp. and incorporated under Maryland law, operates as a business development company with a straightforward mandate: maximize total return through corporate debt securities and collateralized loan obligation (CLO) equity investments. This simple description masks a fundamental strategic tension that defines the investment case today. As a BDC, OXSQ must distribute at least 90% of its taxable income to maintain its tax-advantaged status, creating a structural imperative for steady cash generation. Yet the company finds itself in a credit environment where that imperative is increasingly at odds with capital preservation.

The BDC sector has ballooned as banks retreated from middle-market lending, but OXSQ occupies a peculiar niche. Unlike tech-focused peers Hercules Capital (HTGC) and Trinity Capital (TRIN) that finance venture-backed growth companies, OXSQ traffics in syndicated loans and CLO equity—assets more sensitive to broad credit cycles than idiosyncratic tech risk. This positioning left it vulnerable when the leveraged loan market weakened materially in early 2025, with prices falling from 97.33% to 96.31% of par in Q1 alone. The company now holds debt in just 19 portfolio companies, a concentration that limits diversification benefits while exposing it to single-name risk.

Management's historical strategic initiatives reveal a pattern of reactive capital management rather than proactive growth. The 2017 SEC order permitting co-investment transactions was meant to broaden opportunities, yet the portfolio saw a minimal decrease from $260.9 million to $260.5 million in nine months. The 2023 establishment of a $150 million at-the-market equity program and subsequent 2024 amendment adding another sales agent demonstrate a continuous need for fresh equity to fund operations, not growth. This is a company that has been treading water while its competitors have been swimming ahead.

Investment Strategy: The Illiquidity Trade-Off

OXSQ's current investment approach represents a tactical retreat disguised as opportunism. In the Q3 2025 call, Kevin Yonon described focusing on "relatively higher-quality credits with lower spreads" while simultaneously pursuing "opportunistic trades, which are somewhat less liquid names, where you're able to capture a bit more spread at prices below par." This bifurcation matters because it signals a portfolio barbell that increases risk in both tails: low-spread credits offer minimal cushion if defaults rise, while less liquid names lock in capital that may be impossible to exit during stress.

The emphasis on secondary market activity is particularly telling. Yonon anticipates "a greater emphasis on less liquid credits in the secondary market to capture more spread, given the slower primary market for higher-quality, lower-spread credits." Translation: the company can't compete for the best new issues, so it's forced to scavenge for bargains in the distressed corners of the market. This is not a strategy of choice but of necessity, and it shows in the numbers. The weighted average yield on debt investments ticked up only 10 basis points to 14.60% despite moving down the credit spectrum, suggesting the spread pickup is inadequate for the risk taken.

On the CLO side, Joseph Kupka's comment about purchasing "a couple of CLO equity pieces" from "long-dated, top-tier managers" sounds prudent until Jonathan Cohen's follow-up: "we have hit the maximum in terms of our ability to add additional CLO equity without rotating the portfolio." This is a critical constraint. CLO equity investments at $113.2 million represent 43% of the portfolio and generate a 9.70% yield—substantially below the debt portfolio's yield. The company cannot grow this exposure further without selling existing positions, creating a ceiling on income generation from what management considers its most defensive asset. Cohen's assertion that "duration is the best hedge" against economic dislocation is theoretically sound but practically irrelevant when you're already maxed out on allocation.

Financial Performance: The Deterioration Is Accelerating

The numbers tell a story of accelerating decline masked by technical factors. Net investment income for the nine months ended September 30, 2025, fell 16% to $17.16 million, or $0.23 per share, down from $0.33 in the prior year. The quarterly trend is worse: Q3 NII of $0.07 per share represents a 30% drop from $0.10 a year earlier. This matters because OXSQ's monthly distribution is $0.035 per share, or $0.105 quarterly. The company is paying out 150% of its quarterly earnings, funding the shortfall through a combination of return of capital, leverage, and hope.

Total investment income declined 8% year-over-year to $29.92 million despite a stable portfolio size, driven by "a decrease in interest income" that management attributes to lower yields on new investments. Meanwhile, total expenses increased "primarily due to an increase in interest expense" as the company refinanced debt—issuing $74.8 million of 7.75% notes due 2030 while redeeming older 6.25% notes. The weighted average interest rate on debt jumped from 5.77% to 6.58% in nine months, squeezing the net interest margin at the worst possible time.

The balance sheet reveals a company managing liquidity through equity dilution rather than operational cash generation. Cash increased from $34.9 million to $50.8 million, but this was principally timing as a result of the ATM issuances, not retained earnings. Net cash from financing activities of $31.5 million was driven by $27.4 million in ATM proceeds and $74.8 million in new debt, offsetting $22.7 million in distributions and $44.8 million in note redemptions. The company is essentially borrowing and issuing equity to pay dividends—a Ponzi-like dynamic that cannot persist.

Asset coverage of 200% provides $50 million of additional borrowing capacity before hitting the 150% statutory floor, but using it would be playing with fire. The portfolio's credit quality is already deteriorating: the 12-month trailing default rate rose to 1.47% by principal amount, while the "default rate including various forms of liability management exercises" remained elevated at 4.32%. The distress ratio —loans trading below 80% of par—ended Q3 at 2.88%, down slightly from 3.06% but still elevated. These metrics matter because they indicate stress in the very secondary market where OXSQ is increasing its presence.

Competitive Position: The Scale Problem

OXSQ's $151 million market cap and $260 million portfolio place it at a severe disadvantage against direct competitors. Hercules Capital (HTGC), with $3.4 billion market cap and $5.6 billion enterprise value, can fund larger deals, negotiate better terms, and diversify across hundreds of portfolio companies. Trinity Capital (TRIN)'s $1.15 billion market cap and $2.32 billion enterprise value give it similar scale advantages. Horizon Technology Finance (HRZN), though smaller at $294 million market cap, maintains a specialized niche in venture debt that commands premium yields.

The scale disparity manifests in every meaningful metric. HTGC's return on equity of 15.36% and profit margin of 60% dwarf OXSQ's -1.61% ROE and -6.39% profit margin. TRIN's 16.18% ROE and 52.93% profit margin reflect operational efficiency that OXSQ cannot match. Even HRZN, with negative margins due to its life sciences focus, maintains higher asset quality and lower leverage. OXSQ's debt-to-equity ratio of 0.95 is comparable to peers, but its absolute debt burden of $95 million represents 63% of market cap—creating refinancing risk that larger BDCs can amortize across multiple funding sources.

The company's competitive moats are weak. Its BDC status provides access to public markets, but that access is a double-edged sword: the ATM program enables continuous dilution, with shares issued below net asset value eroding existing shareholders' equity. The "proprietary tech sector network" is a fiction; OXSQ holds debt in just 19 companies, hardly a network effect. Its focus on "relatively higher-quality credits" is belied by the 4.32% default rate and the strategic pivot to less liquid names. Unlike HTGC's Silicon Valley relationships or TRIN's AI-focused pipeline, OXSQ lacks a differentiated sourcing advantage.

Valuation Context: The Value Trap Springs

At $1.85 per share, OXSQ trades at 0.95x book value of $1.95—a seemingly attractive discount in the BDC world where many peers trade at premiums. But this discount is warranted. Book value declined 15% in nine months, and the pace of erosion may accelerate if credit conditions worsen. The 23% dividend yield is not a sign of undervaluation but a market signal that the distribution is unsustainable. With a payout ratio of 150%, every dividend payment destroys value unless the company can magically restore NII.

Comparing valuation multiples to peers reveals the scale of underperformance. HTGC trades at 1.54x book and 10.82x earnings, reflecting its profitability and growth. TRIN trades at 1.14x book and 6.87x earnings, supported by 22% revenue growth. HRZN trades at 0.93x book, similar to OXSQ, but its 19.88% dividend yield is backed by positive NII and a more stable portfolio. OXSQ's negative earnings and declining book value place it in a different category entirely—more akin to a distressed credit fund than a stable BDC.

The bond market provides clearer insight. OXSQ's 7.75% notes due 2030 trade with a 7.75% coupon, while HTGC's comparable debt yields less, reflecting its superior credit profile. The company's own debt costs have risen 81 basis points in nine months, indicating creditors view it as increasingly risky. When your cost of capital rises while your asset yields fall, the business model is broken.

Outlook and Execution Risk: The Leverage Temptation

Management's commentary reveals a team searching for answers. When asked about improving NII coverage, Jonathan Cohen's response—"we're running a relatively lightly levered portfolio at the moment relative to our statutory limitation"—is a tacit admission that increasing leverage is the only clear path to maintaining the dividend. This matters because it transforms OXSQ from a credit picker into a leveraged credit vehicle, amplifying both upside and downside. In a benign credit environment, 1.5x leverage could boost ROE to competitive levels. In a deteriorating environment, it could wipe out equity quickly.

The strategic focus on secondary loans and long-dated CLO equity suggests a barbell approach that is difficult to execute successfully. Secondary loans offer spread but sacrifice liquidity precisely when liquidity matters most. Long-dated CLO equity provides duration-matched income but caps allocation at 43% of the portfolio. The company is essentially telling investors: "We can't grow the good stuff, so we're buying more of the risky stuff." This is not a strategy that inspires confidence.

Credit metrics provide little comfort. The loan market's stability in Q3—prices falling just 1 basis point to 97.06% of par—masks significant dispersion. BB-rated loans fell 11 basis points, B-rated rose 37 basis points, and CCC-rated plunged 227 basis points. OXSQ's increasing allocation to "less liquid names" likely means more CCC exposure, explaining why the portfolio's unrealized depreciation accelerated. The 12-month trailing default rate of 1.47% may seem low, but the 4.32% rate including liability management exercises captures the true stress in the market. These out-of-court restructurings, exchanges, and subpar buybacks are precisely the "opportunistic trades" OXSQ is pursuing—meaning the company is buying into credits that are already distressed.

Risks and Asymmetries: The Downside Scenarios

The primary risk is a credit cycle downturn. If default rates rise from 4.32% to 6-8%, OXSQ's concentrated portfolio of 19 names could experience multiple defaults, wiping out NII and forcing a dividend cut. The company's 200% asset coverage provides a buffer, but increasing leverage to 150% would eliminate that cushion. In a severe downturn, the stock could trade to 0.7x book or lower, implying approximately 26% downside from current levels.

A secondary risk is interest rate volatility. While OXSQ's variable-rate loans benefit from higher base rates, they also expose the company to refinancing risk. If the Fed cuts rates aggressively, loan spreads could compress, further reducing NII. If rates spike, distressed borrowers could default. The 6.58% weighted average cost of debt is already elevated; any increase would pressure margins further.

The most likely scenario is a slow grind. OXSQ continues paying dividends from capital, NAV erodes 10-15% annually, and the stock trades sideways as yield-hungry investors are lured by the 23% payout. Eventually, the board will be forced to cut the distribution, triggering a 20-30% price decline as income investors flee. The October 2025 authorization of a $25 million share repurchase program is a modest positive but represents only 16% of market cap—insufficient to move the needle.

Conclusion: The Thesis Hinges on Leverage and Luck

Oxford Square Capital is not a misunderstood value play but a small BDC facing fundamental headwinds. The 23% dividend yield is a siren song, funded by a 150% payout ratio and eroding book value. Management's strategic pivot to secondary loans and maxed-out CLO equity allocation reflects a portfolio constrained by its own size and market conditions. The only clear path to dividend sustainability is increasing leverage from 200% to 150% asset coverage—a move that would boost NII but transform the risk profile.

The investment thesis boils down to two variables: whether management can execute a leveraged credit strategy without catastrophic losses, and whether credit markets remain stable long enough for the company to grow its way out of its current predicament. Given the elevated default rates, deteriorating loan quality, and OXSQ's scale disadvantage, the probability of success appears low. For investors, the 0.95x book value multiple offers insufficient margin of safety for a business with negative earnings momentum and a dividend that is mathematically unsustainable. The high yield is not an opportunity; it's a warning.