Welcome, thank you for joining Oaktree Specialty Lending Corporation’s first fiscal quarter 2023 conference call. Today’s call is being recorded. All participants are in listen-only mode and will be prompted for a Q&A session following the prepared remarks. I would now like to introduce Michael Mosticchio, Head of Investor Relations, who will host today’s conference call. Mr. Mosticchio, please go ahead.
Thank you, operator, and welcome to Oaktree Specialty Lending Corporation’s first fiscal quarter conference call. Our earnings release, issued this morning, and the accompanying slide presentation can be accessed on the Investors section of our website at oaktreespecialtylending.com. Our speakers today are Armen Panossian, Chief Executive Officer and Chief Investment Officer; Mathew Pendo, President; and Christopher McKown, Chief Financial Officer and Treasurer. Also joining us for the Q&A session is Matthew Stewart, our Chief Operating Officer. Before we begin, I want to remind you that comments on today’s call include forward-looking statements reflecting our current views regarding, among other things, expected synergies and savings from the merger with Oaktree Strategic Income II, Inc., the ability to realize anticipated benefits, and our future operating results and financial performance.
Our actual results could differ materially from those implied or expressed in forward-looking statements. Please refer to our SEC filings for a discussion of these factors in further detail. We undertake no duty to update or revise any forward-looking statements. I’d also like to remind you that nothing on this call constitutes an offer to sell or solicitation to purchase any interest in any Oaktree fund. Investors and others should note that Oaktree Specialty Lending uses the Investors section of its website to announce material information. We encourage investors, the media, and others to review this information. With that, I’ll turn the call over to Matt.
Thanks, Mike. Welcome, everyone, and thank you for your interest in and support of OCSL. Before my remarks, I’d like to note that all per-share amounts referenced on this call have been adjusted for the one-for-three reverse stock split implemented on January 23, 2023. Turning to results, we generated strong outcomes in the fiscal first quarter, identifying compelling investments across both sponsor and non-sponsor deals. Robust origination activity allowed us to capitalize on higher base rates and spreads, driving profitability. First-quarter adjusted NII was $0.61 per share, a 10% increase from $0.55 in the prior quarter. The increase was driven primarily by higher total investment income that more than offset increased interest expense.
Even as we grew, we remained highly selective, maintaining a defensively positioned portfolio with strong credit quality. We had no investments on non-accrual. We are mindful that rising rates can slow overall consumer spending and business investment, creating potential recessionary risks. We are proactively managing risks that may arise should volatility persist. Given our earnings strength, the board increased our quarterly dividend by 2% to $0.55 per share, marking the 11th consecutive quarterly increase and more than 90% growth from the pre-pandemic level at fiscal 2019 close. Looking at first-quarter results, we reported NAV per share of $19.63, down from $20.38 in the prior quarter.
This decrease primarily reflected the $0.42 special distribution paid during the quarter and unrealized appreciation related to price declines on certain public debt investments. In January, our portfolio saw price recoveries, and NAV as of January 31 was estimated at $19.83 per share, up approximately 1%. Turning to portfolio activity, we originated $250 million of new investment commitments, more than double the prior quarter. Of these, 85% were first-lien loans. The weighted average yield on new debt investments was 13.1%, favorably compared to 9.9% in the September quarter, as we capitalized on wider spreads in December.
We received $104 million from paydowns, sales, and exits, selectively reinvesting into better risk-adjusted opportunities. Our pipeline remains robust. We draw on the breadth of the Oaktree platform to source attractive deals with strong downside protections. Looking ahead, we expect substantial benefits from our merger with Oaktree Strategic Income II, Inc. (OSI II), closed in January. Our combined company has more than $3.3 billion in assets on a pro forma basis, increasing first-lien investment to 74%, providing scale and financial flexibility while maintaining our value-driven investment strategy.
We expect the merger to be accretive near- and long-term through cost savings, estimated at $1.6 million annually. Reduced management fees will total $9 million over two years—$6 million in the first year and $3 million in the second. Since closing, our trading liquidity has improved, and we have enhanced our capital structure. We are in excellent financial shape with strong liquidity and capital levels, well-positioned to continue delivering attractive returns to shareholders. I’ll now turn the call over to Armen to provide more color on portfolio activity and the market environment.
Thanks, Matt. Hello, everyone. I’ll start with the market environment. The U.S. job market ended calendar 2022 in relatively strong shape with steady job growth. The economy grew at an annual rate of 2.9% in Q4, marking a slowdown likely due to the Federal Reserve’s aggressive rate actions. Futures markets anticipate additional rate increases in the next two Fed meetings but expect a pause by late spring, with rate cuts before year-end. This dovish pivot is driven by expectations that U.S. inflation will continue to decline at a fairly rapid pace.
While U.S. inflation has slowed, China has fully reopened, likely boosting global growth and potentially exerting upward pressure on U.S. prices. The U.S. labor market remains historically tight, with strong job growth and the lowest unemployment in over 50 years. Recent figures show a mixed economic picture: wage growth is leveling, and consumer spending is easing, signaling potential slowing and recession risks. Despite this, the uncertain backdrop creates opportunities for Oaktree. Our experience across cycles, strong capital base, and long-term perspective position us to withstand short-term volatility and continue generating strong returns.
While we remain cautious, we are confident in our team’s ability to identify new investment opportunities while maintaining solid credit quality. We focus on relative value in areas of the market with the best risk-adjusted returns. Leveraging Oaktree’s scale and resources, we invest across sponsor and non-sponsor markets, structuring customized deals with downside protection. We are deploying capital on favorable terms to build our portfolio and deliver strong shareholder returns. At the close of Q1, our portfolio was well-diversified, with $2.6 billion at fair value across 156 companies, up from 140 a year earlier.
Eighty-six percent of the portfolio was in senior secured loans, with 72% as first-lien, emphasizing top-of-capital-structure positioning. We continue to emphasize larger, diversified businesses with lower risk and better downturn navigation. Overall, borrowers navigated inflationary pressures well, maintaining steady performance. Median portfolio company EBITDA was ~$128 million, generally in line with the prior quarter. Leverage remained steady at 5.1x, below middle-market levels. Weighted average interest coverage declined slightly to 2.5x from 2.7x due to rising base rates.
We leveraged the Oaktree platform to originate $250 million in new commitments, with $235 million for new portfolio companies. Examples include a non-sponsored loan to Superior Industries, a public designer and manufacturer of aluminum wheels for auto and light truck OEMs and aftermarket distributors in North America and Europe. The company holds strong market share, low leverage, and high free cash flow. The deal was a $400 million sole Oaktree commitment in a senior secured term loan used to refinance existing debt.
OCSL was allocated $40 million. Another example is LATAM Airlines Group, a leading passenger and cargo provider across Latin America and major North American and European destinations. OCSL previously invested during LATAM’s 2020 restructuring. This deal involved a $1.1 billion Oaktree-led syndicated loan, with Oaktree funding $750 million, priced at SOFR plus 9.5%, with call protection and an 8.5% original issue discount. OCSL was allocated $26 million.OCSL was allocated $40 million. Another example is LATAM Airlines Group, a leading passenger and cargo provider across Latin America and major North American and European destinations. OCSL previously invested during LATAM’s 2020 restructuring. This deal involved a $1.1 billion Oaktree-led syndicated loan, with Oaktree funding $750 million, priced at SOFR plus 9.5%, with call protection and an 8.5% original issue discount. OCSL was allocated $26 million.
Notably, we are continuing to find opportunities in discounted CLO debt and ABS. Our CLO and ABS purchases totaled $20.7 million in the quarter, with an average price of 87% of par. We see significant potential for upside should these return to par over time.
In summary, our strong liquidity position, experience across both periods of growth and contraction, and the sourcing power of the Oaktree platform continue to put OCSL in an excellent position for 2023. I will now turn the call over to Chris to discuss our financial results in more detail.
Thank you, Matt. OCSL delivered another quarter of strong financial performance, beginning fiscal year 2023 with good momentum. For the first quarter, we reported adjusted net investment income of $37.1 million, or $0.61 per share, up 10% from $33.7 million, or $0.55 per share, in the fourth quarter of fiscal year 2022. The increase was primarily driven by higher interest income from rising base rates, partially offset by higher interest expense. Net expenses for the quarter totaled $40.3 million, up $6 million sequentially, mainly due to $5 million of higher interest expense from the impact of rising rates on our floating rate liabilities and modestly higher management and Part One incentive fees due to a larger, strong-performing portfolio.
Professional fees were slightly higher due to seasonality. Turning to credit quality, which remains excellent, as Matt mentioned, we had no investments on non-accrual at quarter-end. Regarding interest rate sensitivity, OCSL continues to benefit from a rising rate environment. As of December 31, 87% of our debt portfolio at fair value was floating rate. Strong earnings in the first quarter were driven by higher base rates, which increased our interest income. If base rates as of December 31 had been in effect for the entire quarter, adjusted net investment income per share would have been about $0.03 higher, resulting in adjusted NII of $0.64 per share.
Now moving to the balance sheet. OCSL's net leverage ratio at quarter-end increased to 1.24 times due to robust originations, lower repayment activity, and a modest decline in NAV. This is toward the higher end of our target range of 0.9x to 1.25x debt to equity. On a pro forma basis with the OSI II merger, leverage would decrease slightly to approximately 1.16x. As of December 31, total debt outstanding was $1.5 billion, with a weighted average interest rate of 5.6%, up from 4.4% at September 30, due to higher base rates. Unsecured debt represented 43% of total debt, modestly down from the prior quarter.
At quarter-end, we had ample liquidity to meet funding needs, with total dry powder of approximately $357 million, including $17 million in cash and $340 million of undrawn capacity on our attractively priced credit facilities. Excluding joint ventures, unfunded commitments were $172 million, with approximately $130 million eligible for immediate draw, while the remainder is subject to milestones by portfolio companies. We now shift to our two joint ventures.
At quarter-end, the Kemper JV had $409 million of assets invested in senior secured loans to 59 companies, up from $385 million last quarter, driven by $25 million of additional contributions from the company and our JV partner, plus new originations, partially offset by declines from market credit spread widening. The JV generated $2.6 million of cash interest income for OCSL, up from $2.2 million in Q4, and we received a $1.1 million dividend, up from $875,000 last quarter.
Leverage at the Kemper JV was 1.4x at quarter-end, unchanged from the prior quarter. The Glick JV had $137 million of assets as of December 31, down from $147 million at September 30, consisting of senior secured loans to 40 companies. Leverage at the Glick JV was 1.3x, and we received $1.9 million of principal and interest repayments on OCSL's subordinated note during the quarter. In summary, we are very pleased with our financial results and continue to believe our portfolio and balance sheet position us well for the remainder of the fiscal year. I will now turn the call back to Matt.
Thank you, Chris. Our strong financial results for the quarter enabled an annualized return on adjusted net investment income of 11.9%, up from 10.7% last quarter. While pleased with our earnings growth over the years, including a strong Q1, OCSL remains well positioned to maintain and build upon our strong ROE. With 87% of the investment portfolio in floating rate assets, we expect to benefit further from expected interest rate increases in the coming months. As discussed on prior calls, higher ROEs are also being generated at our joint ventures.
During the first quarter, both joint ventures delivered ROEs over 14%, benefiting from the rising rate environment and ongoing portfolio rotation efforts. Additionally, cost savings and management fee reductions from the OSI II merger will support returns. In conclusion, we are very pleased with our strong start to the fiscal year. Our portfolio is healthy, and we are well positioned to capitalize on this attractive investment environment with ample dry powder. Thank you for joining today's call. We are now happy to take your questions. Operator, please open the lines.
We will now begin the question-and-answer session. To ask a question, press Star then One on your touchtone phone. If using a speakerphone, pick up your handset before pressing the keys. To withdraw a question at any time, press Star then Two. We will pause momentarily to assemble our roster. Our first question is from Melissa Wedel of J.P. Morgan. Melissa, please go ahead.
Good morning. Thanks for taking my questions. First, thanks for the pro forma information for the combined portfolio on slide 18. Unless I missed it, could you help us understand what the combined pro forma portfolio yield looks like? Was OSI II lower yielding than OCSL?
Hi, Melissa. The pro forma yield is essentially unchanged post-merger. The overlap from OSI II into OCSL was around 97%, so there is no material change in portfolio yield.
I think, Melissa, building on Matt's answer, the portfolios are very similar. We have tailwinds from rising rates, cost synergies of about $1 million in operational savings plus $200,000–$300,000 in interest expense reductions, and the fee waiver. Adding these together supports our expected results for the March quarter.
Got it. That's very helpful. Thanks. I assume the floating rate exposure would be similar as well, given the high degree of portfolio overlap?
Yes.
Got it. Okay. That's my two questions. I'll hop back in the queue. Thanks.
Our next question is coming from Bryce Rowe from B. Riley. Bryce, please go ahead.
Thanks. Good morning. Wanted to maybe start on just the origination activity for the quarter. You know, nice strong quarter from a commitment and funding perspective. Wanted to get a sense from you all if this quarter's activity was more kind of seasonal strength, or would you say the opportunity set was just more attractive here in the December quarter?
Thanks for the question, Bryce. It's Armen. I think that, you know, in the first half of 2022, pricing on the sponsor side of the market was generally not that attractive. We were very cautious about what we were doing on the sponsor side for most of the year. Beginning in August and September, it seemed like there was an air pocket in the market, especially on the sponsor side. Pricing widened, legal terms improved, and we were able to originate some very attractive sponsor and non-sponsored transactions.
It's hard for me to say that it was a seasonal thing, but our activity was faster than what it had been because of the quality of the deal flow, the pricing of it, the lower loan-to-values, and the better legal terms. I wouldn't characterize it necessarily as seasonal, but it certainly was opportunistic. In January, it's been a little bit slower, but we have been building up a decent pipeline for the rest of the first quarter and into the second quarter.
I think there was a little bit of a rush to get deals done in November and December that is now resulting in sort of a pulling forward of deals that would have otherwise occurred in January. I don't know if you would call that seasonal, but these are different sort of timelines. Just in light of the fact that we saw some good deals, we really pushed heavily in the fourth calendar quarter to get those deals done.
That's helpful, Armen. Then, just around pricing of the new commitments, you highlighted a 13% plus weighted average yield. Are you still seeing that level? You mentioned at least two specific investments; it sounded like both of those carry pricing around that level. I'm trying to get a feel for whether that's an anomaly or if you're still seeing that level of pricing on actionable opportunities in the current environment.
Yeah. I would say the frequency of our deal flow, if you line up the pipeline that we have, there is a difference between sponsor-led deal pricing versus non-sponsor. The non-sponsored is certainly in that 13–14% range, sometimes higher. The sponsor deals we're doing these days are pretty much always first lien. The pricing is in the SOFR plus 650–700 range, and with SOFR at 4% and with OIDs of 2–3 points, they sort of solve to about 11.5–12% for sponsor-led deals.
Most of the deals we're seeing are a little shy of 13%, but not a lot—not several hundred basis points lower, maybe 100–150 basis points lower. As long as base rates stay where they are, and market technicals remain balanced between lenders and private equity sponsors, this type of pricing in the 11–14% range is possible.
Okay. Last one for me. In terms of the joint venture, you saw a bit of an uptick in the dividend coming into OCSL from at least one of the joint ventures. Is that more a function of the higher ROEs that the JVs are generating, or is it due to the increased investment you made in the JV in the December quarter?
Hi, it's Matthew Stewart. It's a little bit of both. During the quarter, we drew down about $25 million of additional capital into the JV that we deployed into the market. We benefited from base rates in the portfolio at OCSL as well. It's a little bit of both, and we were able to deploy a decent amount of capital during the December quarter.
Okay, great. Thank you, guys.
Our next question is coming from Kevin Fultz from JMP Securities. Kevin, please go ahead.
Thanks. I wanted to follow up on Bryce's question on the investment landscape. It was a very active quarter of investment activity. I'm curious how you would compare the attractiveness of the current vintage of deals relative to historical periods. If you can, parse out sponsor versus non-sponsor opportunities.
Sure. Let's talk about non-sponsored first. Those deals are always bespoke. It's hard to say what "market pricing" is because every transaction is different. The competitive dynamic is very different between non-sponsored and sponsored. Non-sponsored pricing is maybe 100–200 basis points wider than a year or two ago. Legal terms and protections around non-sponsored transactions are tighter these days, and loan-to-values are a little lower than a year or two ago.
Loan-to-values in non-sponsored transactions are always lower than sponsor deals. Incrementally tighter loan-to-values versus non-sponsored historically. Non-sponsored deals remain difficult to find. On the sponsored side, a typical first lien transaction for a new deal has changed in two key dimensions: pricing and loan-to-values.
A typical first lien sponsor deal with 4.5–5 turns of leverage was usually done at roughly 55–60% loan-to-value and pricing of SOFR plus 500–550 in 2019–2021 and early 2022. Since August/September 2022, loan-to-values have declined to 40–50%, and pricing has widened to SOFR plus 650–675.
If leverage is higher, pricing could reach SOFR plus 700 for a sponsored transaction. These are for businesses that are not tech or software LBOs. Tech/software LBOs are typically SOFR plus 725–800. Pricing goes wider 125–150 basis points, and loan-to-values are 10–20 points lower.
The third dimension is covenants. Middle market sponsor deals have maintenance covenants. Large-cap deals ebbed and flowed. In Q4, covenants returned for large-cap sponsor deals, especially for companies with $100M+ EBITDA, as banks had stepped back from broadly syndicated loans.
Effectively, that sponsor was able to syndicate the deal to a group of direct lenders—probably 10 to 20 lenders—for a roughly $800 million transaction. In doing so, that competitive dynamic allowed them to remove the maintenance covenant and essentially execute a covenant-lite deal. We passed on that transaction once we saw the covenant falling away because we believed the company had cyclicality, and we were not inclined to do a covenant-lite deal for that type of business. That dimension—maintenance covenants—is very important to us. I think in the fourth quarter and into the first calendar quarter, the environment looked really good.
That could change quickly depending on competitive dynamics in the sponsor space.
Helpful color there. I'll leave it there. Congratulations on a really nice quarter and on completing the merger.
Thanks, Kevin.
The next question is from Kyle Joseph of Jefferies. Kyle, please go ahead.
Good morning, guys. Thanks for taking my questions. I'm curious to get your take on expectations for credit this year. Obviously, rate increases haven't yet broadly impacted company credit performance, including within your portfolio. Is that just a timing issue? How long can companies continue to perform in this higher-rate environment? And how do you expect credit performance for the industry this year? Do you see any opportunities resulting from that?
Thanks, Kyle. This is Armen again. Credit quality really has two components: the unlevered performance of companies and the elevated cost of borrowing. In terms of unlevered performance, if a company has not been a beneficiary of inflation—such as an energy or commodity company—most borrowers in the U.S. have generally raised prices, and revenues were up in 2022 year over year. However, inflation in the cost structure has generally outpaced those revenue increases.
While revenues are up, gross profit dollars or EBITDA dollars have not materially changed, and in some cases may have declined. EBITDA margins or gross margins for many businesses are flat to down even though revenues are higher. That’s a general observation, and there are obviously exceptions. The unlevered performance in an inflationary environment is somewhat concerning because we may be approaching the point where price increases begin to create demand destruction in certain industries, slowing growth in volumes sold.
I wouldn’t describe the outlook for unlevered company performance as particularly strong. Few businesses are truly thriving despite inflation. When you look at levered free cash flow—cash flow after the higher borrowing costs—that becomes more challenging as base rates remain elevated throughout the quarter. Base rates have been rising for the last nine to twelve months, and there is a lagged effect as SOFR or LIBOR contracts reset.
Our portfolio yield would have been higher if base rates at the end of the quarter had been the same as at the beginning of the quarter. There is still some catch-up happening in company performance because the cost of borrowing rises with a lag across quarters. That’s positive for portfolio yields for managers like us, but for borrowers it represents a meaningful change in levered performance.
For example, direct lending was generally priced at LIBOR plus 500–550 for the past three to five years. With LIBOR around 25 basis points and a 1% floor, the cost of debt at issuance was about 6–7%. Now SOFR is roughly 300 basis points above that floor, which represents about a 50% increase in borrowing costs for unhedged borrowers. That’s significant, particularly when underlying corporate performance is already under pressure.
I expect elevated risk across portfolios in general and higher default rates, particularly in broadly syndicated loans.
In direct lending, it’s harder to say whether that risk will translate into defaults because lenders and borrowers work more directly together. Defaults may remain muted, but there will likely be stress in portfolios that lenders will need to manage—especially those that financed highly leveraged LBOs at LIBOR plus 500 in recent years.
Got it. One quick follow-up. Regarding your repayment or prepayment pipeline—given the overlap from the merger, it sounds like that shouldn’t materially affect things. But how are you thinking about repayments more broadly in 2023 considering the macro environment?
That’s a good question. It’s hard to predict. Our non-sponsored borrowers typically take on leverage to achieve strategic goals rather than to financially engineer equity returns. When those strategic goals are achieved, we tend to get repaid. We saw several repayments in 2022 under that framework, and we expect some additional repayments over the next several months in that segment.
The cost of debt in non-sponsored lending is generally higher than in sponsored lending. As a result, once those companies achieve their objectives, our financing can look expensive, which leads them to refinance or repay us. We expect that to happen in some cases this year. On the sponsored side, however, it’s harder to see much repayment activity. LBO transaction volume is declining due to higher borrowing costs, which means fewer exits or sponsor-to-sponsor transactions.
That’s our expectation. With that said, we also have a publicly traded portion of the portfolio. January was very strong there, and over time that could be a source of liquidity as well. You may see some repayments driven by trading activity, with the proceeds redeployed into higher-yielding structured private debt.
Just picking up on that—this is Ryan Lynch. The OSI II portfolio has a similar liquid asset composition as OCSL. So it essentially adds more assets that we can rotate out of over time.
Yep. Got it. Thanks a lot for answering my questions.
Thanks, Kyle.
We will now take a question from Erik Zwick of The Hovde Group. Erik, please go ahead.
Good morning. Thank you. I wanted to start with a question on portfolio leverage. You indicated you're currently at the top of your target range, and pro forma for the OSI II closing you’ll move down to about 1.16x. Given that over the past 12 months you moved from the bottom of the range to the top, and investment opportunities still appear plentiful, how are you thinking about managing leverage while continuing to grow the portfolio in the near term?
Yeah, thanks, Eric. A couple of things. One is that we have seen some of the best opportunities in direct lending over the last several months, better than what we've seen over the last several years. That's why we felt the conviction to increase our leverage and take advantage of those opportunities. We also bought publicly traded debt when that market went through significant volatility in 2022. I would say that the public book is a source of cash to fund new private deals without increasing leverage. We don't intend to increase leverage from current levels. We're always looking at potential market opportunities where we can increase the size of our portfolio as well.
I think we can grow, but we don't want to grow through leverage at this point. We're going to work within the portfolio and take advantage of capital markets opportunities when appropriate. That's all I can say about that.
Yeah. One of the things to consider as you look at the December quarter is that the balance sheet was pre-merger. However, we were already working on the merger and had announced it, with the vote scheduled for January. We were anticipating the merger would be completed, so we were managing the portfolio with that assumption in mind. That's why I view the 1.16 number as being more representative than the 1.24
That's helpful. Thank you. Just a follow-up on the secondary market opportunities you mentioned. Activity has certainly been a little slower in the last two quarters, but according to slide six, the pricing you saw in the most recent quarter was the most attractive you've seen. I'm curious whether that was a one-off opportunity or if you expect to continue seeing similar opportunities over the next quarter or two at those attractive pricing levels.
I think the pricing is relatively consistent in terms of the opportunities we're evaluating now. Sponsor-led private credit is around SOFR plus 650 to 675 for a typical non-software transaction. Software deals are around SOFR plus 750 or so. That's pretty consistent with what we saw last quarter and the quarter before. On the non-sponsored side, pricing is generally higher than that. What's harder to predict at this point is the pace of deal flow. On the non-sponsor side especially, there are periods where we do a lot in one quarter, and that just happens from time to time.
Because it's opportunistic and bespoke, it's difficult for us to predict the pace at which we originate deals on the non-sponsored side. Pricing-wise, I would say it's holding steady year-to-date compared with last year and the back half of last year.
Got it. Thank you. One last question, if I can squeeze it in. Looking at the press release, there are 42 equity investments currently, 30 of which also include a debt investment. For the 12 where you don't currently hold debt, are these situations where the debt has been repaid and you still retain the equity investment, or are there times when you make a purely equity investment in companies?
We generally don't make equity-only investments. In a small handful of cases, the legacy portfolio we acquired from Fifth Street had restructured positions where we ended up owning equity. Alternatively, it could be an equity position that remained after a debt investment was repaid. But as a matter of policy, we don't buy straight equity without a debt component attached to it.
That's what I figured. Thanks for confirming. That's all for me today. Thank you.
Our next question comes from Ryan Lynch from KBW. Ryan, please go ahead.
Good morning. My first question is about your liability structure post-merger with OSI II. It looks like your total unsecured borrowings decline to about 36% from 43%. Are you comfortable operating at that level post-merger, or should we expect you to access the capital markets to bring that number closer to where you've historically operated?
Ryan, it's Matt. Good question. Are we comfortable at this level? The answer is yes, we are comfortable. The liability structure in OSI II was something we created, and we knew the assets well. That was one of the advantages of the transaction. It simply carries over, and we're able to reprice some of it more attractively. That said, we're always looking at the unsecured market. We've had good success with our previous unsecured deals. They were priced well and have traded well, and we have a strong base of fixed-income investors. We'll continue to look at that market as it performs or reopens. For now, though, we're comfortable with where we are.
We obviously like to maintain a very balanced liability structure and capital structure overall.
Okay, understood. Armen, you gave fairly downbeat commentary on the outlook for credit quality, at least in the private credit markets broadly. Fundamentally, it sounds like unlevered business performance is not great given tightening EBITDA margins, and there's obviously pressure on levered cash flow given higher rates. If inflation continues to show signs of easing, though it's still pretty high, would you expect any sort of reversal in 2023 in terms of margin pressure, or is inflation still too high?
Then a separate question on that. You mentioned pressure on EBIT or levered cash flow. You provided an estimated range of interest coverage of 2.5 times, which declined slightly from the prior quarter. In this marketplace, the real risk is the tail end risk from borrowers that are running closer to that lower leverage point given higher rates. Have you done any analysis looking at your current portfolio based on where rates are today or where the forward LIBOR curve is?
What percentage of your current portfolio would fall below that 1x interest coverage?
Good question. We are always looking at our portfolio in terms of assessing the risk profile, either on a fundamental basis or on a levered free cash flow basis. I don't have the percentage of our portfolio that would be less than 1 times fixed charges, but it wouldn't be much, if any, of the portfolio. You're right that tail risk is the part of the market, or the portfolio, to focus on rather than the average. Generally speaking, our portfolio is pretty lightly levered. We do look at the fixed charge ratio and leverage profile across sponsored, non-sponsored, and publicly traded investments.
We've done a good job managing the leverage profile and fixed charge coverage to a point where we don't really have meaningful watchlist names, which is evidenced by the fact that we don't have anything on non-accrual. We're watching things closely, but I don't have anything to report that would say a specific percentage of our portfolio would fall below 1 times coverage if base rates stayed here for 12 months. We don't have that analysis to report at this time. In the first part of your question, whether inflation moderates and some of this reverses, that's a great question.
Generally speaking, companies have increased prices, but at a slower rate than the increase in the cost of goods sold. For a reversal to occur, prices on the cost side would need to decline while the revenue side remains flat. There may be a period where that is possible, where price increases happen on a delayed basis while cost of goods sold stabilizes. However, generally speaking, you don't see a material reduction in cost of goods sold after an inflationary period. Inflation slows, but it typically doesn't go negative. In some industries it could.
Sometimes building product inputs such as timber, steel, or concrete prices may decline for a period if demand declines. But broadly speaking, we wouldn't expect a meaningful decline in cost of goods sold that would create an outsized profit opportunity. It's hard to predict what will happen in 2023 with inflation and rates. I do think the pace of inflation is showing signs of slowing, which is a good thing and may point to a pivot at some point. However, the market seems to believe that pivot will happen in 2023, and I think that's probably a little too rosy.
I think the downside surprise with the Fed is that they may leave rates higher for longer than people expect to ensure the inflation picture is under control. I wouldn't bet on an outsized profit opportunity in 2023, though it could happen. Stability is possible in late 2023 or more likely in 2024, with a more balanced supply-demand environment and more stable borrowing costs for most companies. It's coming, but I don't think it's this year.
Okay. That's helpful. That's all for me today. Appreciate the time.
Thank you.
This concludes our Q&A session. I would like to turn the conference back over to Mr. Musticchio. Please go ahead.
Thank you, Marlise, and thank you all for joining us on today's earnings conference call. A replay of this call will be available for 30 days on OCSL's website in the Investors section, or by dialing 877-344-7529 for U.S. callers or 1-412-317-0088 for non-U.S. callers, with replay access code 6846351, beginning approximately one hour after this broadcast.
Thank you for attending today's presentation. You may now disconnect.