Oxford Square Capital's Debt Strategy: Balancing Growth and Risk in the BDC Sector

Oxford Square Capital Corp. (OXSQ) has long operated as a leveraged business development company (BDC) specializing in high-yield debt and collateralized loan obligation (CLO) investments. Its recent $70 million unsecured note offering, announced in July 2025, underscores a strategic pivot to optimize its capital structure while funding growth in a challenging market environment. This move raises critical questions: Does the new debt issuance align with OXSQ's long-term objectives, or does it expose the company to heightened risks in a sector already grappling with economic uncertainty?

Debt Issuance: A Strategic Refinancing Tool

The $70 million offering of 5.50% unsecured notes due 2028 provides OXSQ with flexibility to refinance higher-cost debt and fund new investments. With a maturity of seven years and quarterly interest payments, the notes offer a longer duration than many of the company's existing obligations, which include 6.25% and 5.50% unsecured notes maturing in 2026 and 2028, respectively. By locking in a fixed rate of 5.50%—a slight discount to its current average borrowing cost—OXSQ reduces refinancing risk in a rising interest rate environment.

The proceeds will also be used to acquire investments aligned with its core strategy: syndicated bank loans and CLO tranches. This is a calculated move. BDCs like OXSQ thrive by leveraging debt to amplify returns on high-yield assets. However, the company's debt-to-asset ratio of 46.4% (as of December 2024) already places it in the moderate-risk category for the sector. Adding $70 million in new debt could push this ratio closer to 50%, a level that might concern investors wary of over-leveraging.

Leverage Trends and Risk Mitigation

OXSQ's leverage ratios tell a nuanced story. As of March 2025, its debt-to-equity ratio stood at 0.92, down from a peak of 1.40 in early 2023. The recent offering, which includes a 30-day over-allotment option for an additional $10.5 million, could temporarily increase this metric. However, the company's management has historically maintained conservative leverage levels, and the new notes' 7-year maturity provides a buffer against short-term refinancing pressures.

The BDC sector as a whole has faced scrutiny over leverage in 2025, with some firms struggling to balance aggressive growth with credit quality. OXSQ's focus on syndicated bank loans—a more liquid and diversified asset class than private debt—helps mitigate default risk. Its weighted average credit rating of 2.3 (based on fair value) further suggests a disciplined approach to underwriting.

Net Investment Income and Investor Confidence

OXSQ's net investment income (NII) remains a key barometer of its health. In Q1 2025, the company reported $6.1 million in NII, or $0.09 per share, despite $14.2 million in combined realized and unrealized losses. This resilience is partly due to its high-yield portfolio, which generated a 15.8% weighted average yield as of December 2024. However, the recent market volatility has exposed vulnerabilities: OXSQ's shares fell 3.71% in Q2 2025, reflecting broader BDC sector jitters.

The new debt issuance could stabilize NII by reducing interest expenses. If the company uses the proceeds to repay its 6.25% notes (which mature in 2026), it would save approximately $1.77 million annually in interest payments. This would bolster its ability to maintain its $0.105 per share dividend, a critical draw for income-focused investors.

Risks and Opportunities

The primary risk lies in the cost-benefit analysis of leverage. While OXSQ's 5.50% notes offer a lower cost than its existing debt, the company's net asset value (NAV) has declined slightly, from $2.35 per share in September 2024 to $2.30 in December 2024. A further increase in leverage could amplify NAV volatility, particularly if interest rates continue to climb.

Conversely, the offering provides a lifeline for growth. By deploying the proceeds into new CLO tranches or warehouse facilities, OXSQ can capitalize on its expertise in structuring and managing collateralized debt. The BDC sector is expected to see increased CLO activity in 2025, and OXSQ's experience in this area positions it to outperform peers.

Investment Thesis

For investors considering OXSQ, the debt offering represents a double-edged sword. On one hand, it provides a clear path to reducing short-term liabilities and funding high-conviction opportunities. On the other, it tests the company's ability to maintain disciplined leverage management.

Key considerations for investors:
1. Monitor leverage ratios: Track OXSQ's debt-to-asset and debt-to-equity ratios over the next 12 months. A move above 50% would signal increased risk.
2. Assess portfolio quality: The company's focus on syndicated loans and CLOs with strong credit profiles is a positive, but rising defaults in the high-yield market could strain returns.
3. Evaluate dividend sustainability: The dividend payout ratio has remained stable at ~100%, but this could shift if NII declines.

Conclusion

Oxford Square Capital's debt issuance is a strategic, if cautious, step toward balancing growth and risk. By extending its debt maturity and lowering borrowing costs, the company strengthens its capital structure while retaining flexibility to invest. For BDC investors, this aligns with the sector's long-term trend of prioritizing liquidity and credit quality. However, the offering's success will depend on OXSQ's ability to deploy capital profitably and navigate the ongoing interest rate cycle.

In a sector where leverage is both a tool and a trap, OXSQ's approach offers a blueprint for measured growth. Investors who can stomach the short-term volatility may find the company's disciplined strategy rewarding in the long run.