CLO equity stress test reveals the danger behind 22% yields

ByAmeliaApril 10, 20263 Mins read8

Oxford Square Capital Corp. (OXSQ) — 22% yield masks NAV erosion as half of distributions come from returned capital.
Oxford Square’s CLO equity yields compressed from 9.7% to 8.6% in one quarter due to Fed rate cuts.
Distribution covers only 46% of payout through net investment income; another cut is likely.
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Oxford Square Capital Corp. (NASDAQ:OXSQ) carries a yield around 22%, but that number rests on two income streams, one of which is visibly cracking. Understanding what drives that yield, and what threatens it, is the only way to judge whether the payout is real income or a slow-motion return of your own capital.

A close-up view of a finger pressing a bright green key on a white computer keyboard. The green key is prominently labeled 'CLO Collateralized Loan Obligation' in white text. Surrounding white keys display various symbols and letters like 'ctrl', 'alt', 'Ç', '{', '}', '*', '+', and '-'. — Momius13 / Shutterstock.com

A finger presses a green key labeled ‘CLO Collateralized Loan Obligation’ on a computer keyboard, symbolizing a key financial concept.

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Oxford Square is a Business Development Company (BDC) that lends to mid-sized businesses and passes income directly to shareholders. Its yield comes from floating-rate loans to middle-market companies and equity stakes in collateralized loan obligations (CLOs). A CLO pools leveraged corporate loans into tranches by risk. The equity tranche, where Oxford Square invests, sits at the bottom and absorbs losses first. In return, it receives residual cash flows after senior tranches are paid, which can be generous in healthy credit markets and painful otherwise.

In Q4 2025, debt investments generated $5.3 million and CLO equity generated $4.3 million, making them roughly equal contributors. The debt side has held steady, with weighted average yields around 14.5%. The CLO equity side tells a different story.

The effective yield on Oxford Square’s CLO equity fell from 9.7% in Q3 2025 to 8.6% in Q4 2025, and the cash distribution yield dropped from 16.0% in Q1 2025 to 13.8% by Q2. The Fed’s rate cuts of 75 basis points between October and December 2025 compressed spreads on underlying leveraged loans, directly squeezing what CLO equity tranches can distribute.

Management acknowledged the pressure directly. On the Q4 earnings call, an executive confirmed the CLO equity book faced a “very challenging year-end quarter, primarily resulting from a markdown of the CLO equity portion of the book.” CEO Jonathan Cohen added that losses were “principally unrealized.” The distress ratio on underlying loans rose to 4.34% in Q4 from 2.88% the prior quarter. Cohen also flagged “real concern” in the software private credit market as a driver of wider loan spreads.

Oxford Square paid $0.105 per share in distributions during Q4 2025 while generating only $0.07 per share in net investment income (NII). That works out to a payout ratio of 150%, meaning the fund paid out half again what it earned. The gap was filled by returning capital to shareholders, directly causing NAV erosion.

NAV declined every quarter of fiscal 2025, falling from $2.30 at year-end 2024 to $1.69 by Q4 2025. Full-year realized losses totaled approximately $17 million, and Q4 alone saw $18.3 million in combined unrealized and realized losses. The distribution was already cut once, from $0.067 per month to $0.035, roughly half, in October 2025.

Total liabilities grew 16% year-over-year while shareholders’ equity shrank 9.5%. Oxford Square issued $72.1 million in 7.75% unsecured notes in Q4, locking in fixed borrowing costs even as floating-rate asset income declines with the Fed’s easing cycle. The fund simultaneously sold shares via an at-the-market offering while running a $25 million share repurchase program, a contradictory capital allocation posture.

The full-year 2025 total return based on market value was -11.92%, and Q3 alone delivered a -24.74% market value return. Shares are up about 10% year-to-date in 2026, but down roughly 5% over the past year. A yield approaching 22% on a vehicle whose NAV is eroded by distributions amounts to scheduled liquidation dressed as income, not genuine income generation.

The distribution at Oxford Square faces meaningful risk of another cut. NII covers only about two-thirds of quarterly payouts, CLO equity yields are compressing, and NAV has declined every quarter for a full year. The fund already cut its payout once and is funding the remainder through capital erosion. Investors needing stable income should treat this yield with caution. Those drawn to the headline number should understand they are likely receiving a portion of their own principal with each payment.

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