Fitch Ratings has affirmed
The Rating Outlook is Stable.
The 'A-' Long-Term IDR and Stable Outlook assigned to
Today's rating actions have been taken as part of a broader review of business development companies (BDCs) which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Ratings Completes 2023 BDC Peer Review,' available at www.fitchratings.com.
Key Rating Drivers
The ratings affirmation reflects OCSL's access to investment resources from
Rating constraints include the recent decline in the unsecured funding mix; higher-than-peer exposure to nonqualifying assets; and above-average, albeit declining, exposure to broadly syndicated loans which can result in higher valuation volatility.
Rating constraints for BDCs more broadly include the market impact on leverage, given the need to fair-value the portfolio quarterly, dependence on access to the capital markets to fund growth and a limited ability to retain capital due to distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid higher interest rates and slower growth at portfolio companies.
OCSL's asset quality metrics have been strong in recent years, as demonstrated by the generation of net realized gains on investments in three of the last four fiscal years, including the year ended
OCSL's net investment income (NII) yield, defined as adjusted NII (adjusting for capital gains incentive fee accruals not paid in cash and merger accounting impacts) as a percentage of the average portfolio at cost, was 5% in fiscal 2022, up from 4.5% in fiscal 2021 driven by rising interest rates and continued rotation out of lower-yielding investments. The adjusted NII yield improved to 5.5% (annualized) in fiscal 1Q23. Fitch believes there is additional upside to OCSL's earnings given benefits from higher interest rates and continued rotation out of lower-yielding investments, but funding costs will also increase since 80.1% of OCSL's outstanding debt (adjusted for interest rate swaps) was floating-rate at fiscal 1Q23.
In
The leverage ratio implied a Fitch-calculated asset coverage cushion of 16.5% at fiscal 1Q23, or 18.9% pro forma for the merger, within Fitch's 'bbb' category capitalization and leverage benchmark range of 11%-33%. Fitch expects OCSL to continue to manage the covenant cushion at an appropriate level to account for potential investment valuation volatility and/or future credit losses.
Unsecured debt accounted for 43% of OCSL's outstanding debt at fiscal 1Q23, but declined to 36% pro forma for the OSI II merger, which was at the low end of Fitch's 'bbb' category quantitative benchmark range of 35%-50% for BDCs. OCSL's next unsecured debt maturity is in
After-tax adjusted NII coverage of dividends declared, excluding special dividends, amounted to 108.4% in fiscal 2022 and 112.3% in fiscal 1Q23. Adjusting for non-cash income and expenses, Fitch estimates dividend coverage was 79.8% in fiscal 2022 and 86.5% in fiscal 1Q23. Paid-in-kind (PIK) income represented 8.4% of interest and dividend income in fiscal 2022 and 8.1% in fiscal 1Q23. Fitch believes PIK income could tick up in 2023 as a result of amendment activity and will continue to monitor OCSL's ability to collect PIK in cash over time.
The Stable Outlook reflects Fitch's expectations that OCSL will continue to demonstrate solid asset quality metrics, focus on senior debt investments, manage leverage within the targeted range, maintain unsecured debt-to-total debt of at least 35%, and maintain sufficient liquidity and solid dividend coverage.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A sustained meaningful increase in non-accrual levels and/or realized losses, a sustained increase in leverage above the targeted range, a sustained decline in unsecured debt to below 35% of total debt outstanding and/or weaker cash-based NII coverage of the dividend.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Strong and differentiated credit performance of recent vintages, evaluated in combination with the consistency of OCSL's operating performance, asset quality metrics, investment valuations and underlying portfolio metrics could drive positive rating momentum. Positive rating momentum would also be conditioned upon an increase in unsecured debt to above 40% of total debt outstanding and the maintenance of sufficient liquidity, leverage levels commensurate with the risk profile of the portfolio and solid cash earnings coverage of the dividend.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
The alignment of the unsecured debt rating and secured debt rating with that of the Long-Term IDR reflects solid collateral coverage for all classes of debt given OCSL's funding mix and the fact that is subject to a 150% regulatory asset coverage requirement.
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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