Oaktree to focus on reducing Fifth Street non-accruals

The alternative lending titan told analysts and shareholders the reasoning behind its purchase of two business development companies’ books and said it wouldn’t shy away from future such buys.

Executives at Oaktree Capital Management laid out their near-term plan to manage Fifth Street Asset Management’s business development companies on the firm’s Thursday second-quarter earnings call, a strategy that includes taking several steps to stabilise the targeted mid-market lenders’ portfolios. 

Los Angeles-based Oaktree’s chief executive officer, Jay Wintrob, said the firm plans to emphasise reducing the level of credits on non-accrual, and to post more consistent results as it begins managing the two BDCs, Fifth Street Finance Corp. and Fifth Street Floating Rate Corp.

The deal, announced on 14 July, would see Oaktree pay Fifth Street $320 million in cash and become the investment advisor to both the BDCs. FSF would be renamed Oaktree Specialty Lending Corp., and FSFR would become Oaktree Strategic Income Corp.

The deal is expected to close in the fourth quarter of this year.

Chris Harris, an analyst at Wells Fargo, asked Wintrob what gave the firm confidence the portfolios for the Fifth Street BDCs, which have been plagued by falling net asset value per share figures for years, would play out in their favour.

The Oaktree head noted one of the benefits of auctioned deals is the breadth of due diligence afforded to prospective buyers, noting Oaktree was “realistic” about the BDCs’ assets. “Overtime I think we’ll be proven right,” he said. “We got into this with our eyes wide open, and there’s going to be things we need to do. There’s going to be some workout situations.”

Wintrob said Oaktree’s expertise in distressed debt will be beneficial as the firm sorts through the BDCs’ non-accrual credits. FSC had 11.33 percent of its debt portfolio on non-accrual, as of 31 March, while FSFR reported a much lower number of 2.65 percent at the end of the first quarter.

He later added that the firm hoped the NAV per share figures for both FSC and FSFR up so they are trading at or above that price, which would allow Oaktree to issue new equity. He also noted that the credit investing behemoth wouldn’t rule out the opportunity to purchase other existing BDC portfolios down the road.

The firm raised $1.4 billion in the second quarter and had multiple closed-end funds in market, including Real Estate Debt Fund II and Middle-Market Direct Lending Fund, the senior debt-focused fund that will have both levered and unlevered sleeves.

Oaktree has continued to be a net seller out of its closed-end funds, chief financial officer Dan Levin said on the call. As a result, management fee income in the second quarter had a year-on-year decrease of $11.2 million, or 5.7 percent, from the same time last year to $186.31 million.

Incentive income increased by $369.8 million to $457.4 million from the same time last year. The large jump was attributed to its sale of AdvancePierre Foods, which generated $427.8 million from Oaktree Principal Opportunities Fund IV, a special situations vehicle that began investing in October 2006 and started generating incentive income this past quarter.

Oaktree’s funds use a European-style incentive fee payment structure, meaning the firm will receive incentive income only after investors have made back their principal and preferred return. As a result, the firm receives incentive income for their funds much later than under a US-style incentive fee payment structure, which pays on a deal-by-deal basis.

Economic net income, a non-GAAP measure to operate the firm’s performance, stood at $179.28 million for the second quarter, an increase from $165.52 million at the same time last year. Assets under management stood at $99.3 billion, down 1 percent from the previous quarter and a 1 percent increase since the second quarter of 2016.