Oxford Square Capital Corp. (OXSQ) recently released their Q1 2024 earnings transcript, presenting a narrative of stable performance and a promising future. At first glance, the numbers seem to support this claim: net investment income remains decent, the U.S. loan market is exhibiting signs of recovery, and the company persists in distributing regular dividends.

However, concealed within the seemingly ordinary details of the transcript lies a potential warning sign, a subtle inconsistency that hints at an impending crisis: the stark difference between the overall default rate in the U.S. loan market and the default rate observed by Oxford Square within their specific investment focus.

Kevin Yonon, Portfolio Manager at Oxford Square, points out in the transcript that the '12-month trailing default rate for the Morningstar LSTA US Leveraged Loan Index decreased to 1.14% by principal amount at the end of the quarter.' This seemingly favorable trend, however, is immediately followed by a critical caveat: 'We note that we have seen higher default rates amongst issuers of the type we invest in.'

This seemingly casual observation should raise alarm bells for even the most experienced investors. It reveals a fundamental disconnect between the wider market trends and the particular circumstances of Oxford Square's investment portfolio. While the broader market experiences a period of relative stability, the niche where Oxford Square operates is witnessing a disproportionately high number of defaults.

Why is this discrepancy so concerning? It indicates a potentially dangerous mismatch in risk assessment. If the company's investment niche is demonstrably riskier than the broader market, their internal risk models may be undervaluing the actual likelihood of defaults. This could result in a sudden and significant drop in net asset value if a wave of defaults were to occur.

Default Rate Discrepancy: A Cause for Concern

Let's delve further into the figures. While the exact default rate encountered by Oxford Square isn't explicitly mentioned, the fact that it's 'higher' than the 1.14% market average is a reason for worry. For illustrative purposes, let's assume their actual default rate is double the market average, standing at 2.28%.

Now, consider the potential impact of this elevated default rate on their portfolio. A 2.28% default rate on a portfolio of, for instance, $250 million (a rough estimate based on their 'long-term investments' figure in the balance sheet) translates to a possible loss of $5.7 million. This is a significant amount, representing almost 90% of their net investment income for the quarter.

Naturally, this is just a hypothetical scenario. However, it highlights the potential fragility of Oxford Square's portfolio to even a minor increase in default rates within their niche.

Unveiling the Ghost: Lack of Transparency

The transcript doesn't furnish further information about the specific issuers or sectors driving this elevated default rate. This absence of transparency raises further questions. What industries are contributing to this risk? Is the company excessively exposed to a particular sector experiencing instability? Are there systemic factors in play within their investment niche that the broader market isn't facing?

These are questions that necessitate further exploration. While the general market might be basking in a period of calm, the storm clouds could be accumulating over Oxford Square's specialized corner of the investment world. The company's vague language and the scarcity of specific details concerning their heightened default rate should serve as a warning to investors, prompting them to seek greater clarity and reassess their personal risk tolerance when considering Oxford Square Capital Corp.

"Fun Fact: Oxford Square Capital Corp. was originally known as TICC Capital Corp., changing its name in 2018. This rebranding could be seen as an attempt to distance itself from previous performance or to signal a new direction for the company. Does this rebranding mask deeper issues within the company's investment strategy?"