Oxford Square Capital's Strategic Debt Issuance: Balancing Leverage and Yield in a High-Rate Era

In a rising interest rate environment, business development companies (BDCs) face a dual challenge: managing borrowing costs while maintaining attractive risk-adjusted returns for shareholders. Oxford Square Capital Corp. (OXSQ) has navigated this landscape with a pair of 2025 unsecured debt offerings—most notably a $65 million issuance of 7.75% notes due 2030—that reflect a calculated balance between capital structure optimization and long-term growth. For income-focused investors, the strategic implications of these moves warrant a closer look.

Locking in Rates for Stability, With a Redemption Option

The 7.75% notes, priced in August 2025, offer a compelling case study in proactive debt management. With a maturity of five years and quarterly interest payments starting October 31, 2025, the offering locks in a favorable rate for a BDC operating in a tightening credit environment. At first glance, 7.75% may seem elevated, but in the context of OXSQ's broader refinancing strategy, it represents a prudent hedge against further rate hikes.

The notes also include a redemption feature exercisable after July 31, 2027, providing management flexibility to refinance if market conditions improve. This structure mirrors the company's earlier $70 million 5.50% offering due 2028, which similarly aims to reduce reliance on higher-cost debt. By diversifying maturity timelines and leveraging current rate environments, Oxford Square mitigates refinancing risks while maintaining liquidity.

Strengthening Capital Structure, Managing Leverage

As of March 2025, Oxford Square's debt-to-equity ratio stood at 0.92, down from a peak of 1.40 in early 2023. This decline underscores a disciplined approach to leverage, particularly for a BDC with a focus on high-yield assets like syndicated bank loans and CLO tranches. The 7.75% notes, while adding to the company's debt load, are structured to extend its maturity profile and reduce short-term refinancing pressures.

Critically, the proceeds will be used to repay existing indebtedness, fund new investments, and support general corporate purposes. This alignment with core investment strategies—prioritizing liquid, diversified assets—reinforces the company's ability to generate consistent net investment income (NII). For investors, the key question is whether the incremental leverage is justified by the potential returns from new investments. Given Oxford Square's weighted average yield of 15.8% on debt investments and 8.8% on CLO equity tranches, the answer appears affirmative.

Risk-Adjusted Returns in a High-Rate World

The 7.75% notes' strategic value lies in their ability to enhance risk-adjusted returns. By refinancing higher-cost debt (such as its 6.25% notes maturing in 2026), the company is projected to save approximately $1.77 million annually in interest expenses. These savings directly support the $0.105 per share dividend, a critical draw for income investors. Meanwhile, the long-term nature of the 7.75% notes insulates the company from near-term rate volatility, allowing it to focus on its core mandate.

However, the higher interest rate does come at a cost. With proceeds allocated to new investments, Oxford Square must ensure that its portfolio generates returns exceeding the 7.75% hurdle rate. This is where the company's underwriting discipline—evidenced by a weighted average credit rating of 2.3—becomes a differentiator. By targeting investment-grade assets, it minimizes the risk of defaults that could erode returns.

A Dual-Pronged Strategy for BDC Investors

For investors evaluating BDCs in a high-rate environment, Oxford Square's dual-pronged approach offers a blueprint for balancing growth and risk. The 5.50% and 7.75% offerings reflect complementary strategies: the former optimizes cost efficiency, while the latter provides long-term capital for growth. Together, they demonstrate how a BDC can navigate a challenging macroeconomic backdrop by extending maturities, reducing refinancing risks, and maintaining a high-yield portfolio.

That said, investors should monitor leverage ratios closely. While Oxford Square's current debt-to-asset ratio of 46.4% is moderate, the $65 million in new debt could push it closer to 50%, a threshold that may warrant caution. The company's conservative historical leverage management and focus on liquid assets mitigate this risk, but vigilance remains essential.

Final Take for Income Investors

Oxford Square Capital's 7.75% notes offering is a testament to the company's strategic agility in a rising rate environment. By locking in long-term financing at a competitive rate and extending its maturity ladder, it positions itself to deliver stable returns while maintaining its dividend. For income investors seeking a BDC with a disciplined capital structure and a focus on high-quality assets, OXSQ's approach offers a compelling case for inclusion in a diversified portfolio.

The key takeaway: In a world of elevated rates, the ability to balance leverage, cost of capital, and yield is what separates top-performing BDCs from the rest. Oxford Square's 2025 offerings suggest it has mastered this art.