Capital Southwest Corporation

Thank you for joining today's Capital Southwest Second Quarter Fiscal Year 2022 Earnings Call. Participating on the call today are Boyne Deal, CEO, Michael Saunders, CFO, and Chris Reberger, VP, Finance. I will now turn the call over to Chris Reberger. You may begin.

Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions, and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances, or any other reason after the date of this press release, except as required by law. I will now hand the call off to our President and Chief Executive Officer, Bowen Diehl.

Thanks, Chris. And thank you, everyone, for joining us for our earnings call for the quarter-ended September 30, 2021 season. which is the second quarter of our 2022 fiscal year, which ends March 31, 2022. We're pleased to be with you this morning and look forward to giving you an update on the performance of our company, our portfolio, and our progress on executing our investment strategy as stewards of your capital. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We'll begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of 45 cents per share, which more than earned our regular dividend for the quarter of 44 cents per share. Total dividends for the quarter were 54 cents per share, which included a 10 cent per share supplemental dividend. Total dividends paid during the quarter represented an annualized dividend yield on our stock price on the last trading day of the quarter, of 8.6% and an annualized yield on net asset value per share of 13.2%. As a reminder, we previously announced that our Board declared an increase in our regular dividend per share to 47 cents per share for the quarter ended December 2021 from the 44 cents per share paid in the September quarter. This increase in our regular recurring dividend reflects the increased earnings power of our portfolio resulting from portfolio growth continued reductions in our cost of capital, and continued improvements in operating leverage achieved through our internally managed structure. Our Board also declared a supplemental dividend of 50 cents per share to be paid out in the December quarter. This supplemental dividend represents an accelerated payout of our prior supplemental dividend program, which had been paying out 10 cents per share per quarter over the past several years. We believe that this accelerated distribution of UTI maximizes value for our shareholders today while also maintaining an adequate UTI balance into the future. Going forward, we expect that shareholders will continue to participate in the successful exits of our investment portfolio through special distributions as we monetize the unrealized appreciation in our portfolio over time. During the quarter, we grew our investment portfolio on a net basis by 2.4%. to $818 million. Portfolio growth during the quarter was driven primarily by a total of $112.9 million in commitments to six new portfolio companies and four existing portfolio companies, of which $77.2 million was funded at close. This was offset by $60.9 million in proceeds from six debt prepayments and two equity exits during the quarter. The portfolio generated net realized and unrealized gains of $2.8 million during the quarter, driven primarily by unrealized depreciation in our equity co-investment portfolio. On the capitalization front, we completed an amendment to our ING credit facility, extending the maturity to August 2026 and decreasing the interest rate to LIBOR plus 215 basis points down from LIBOR plus 250 basis points. Additionally, we issued $100 million in aggregate principal of 3 3⁄8 notes due October 2026 and repaid in full our 5 3⁄8 percent notes due October 2024. Furthermore, in lockstep with our strong deal pipeline, we raised $30.3 million of equity through our ATM program at an average price of $26.59 per share, representing an average of 160% of the prevailing net asset value per share. On slide 7 and 8, we illustrate our continued track record of producing steady dividend growth, consistent dividend coverage, and value creation since the launch of our credit strategy. We believe the solid performance of our portfolio and our company's sustained access to the capital markets has demonstrated the strength of our investment and capitalization management strategies. Maintenance and growth of both NAD per share and shareholder dividends remain as core tenants of our long-term investment objective of creating long-term value for our shareholders. Turning to slide nine, as a refresher, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on our core lower middle market lending strategy while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk-adjusted returns exist. In the lower middle market, we directly originate and lead opportunities consisting primarily of first lien senior secured loans with smaller equity co-investments made alongside our loans. We believe that this combination is powerful for our BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from equity investments in many of these growing businesses. Building out a well-performing and granular portfolio of equity co-investments is important to driving growth in NAB per share, while aiding in the mitigation of any credit losses over time. At the end of the quarter, our equity co-investment portfolio consisted of 31 investments across approximately half of our portfolio companies. The equity portfolio had a fair value of $69.2 million. which included $17.7 million in embedded unrealized appreciation, or approximately $0.76 per share. Our equity portfolio, which represented 8 percent of our portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from the growing lower middle market businesses. As illustrated on slide 10, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 Senior Loan Fund, grew 3 percent to $689 million, as compared to $671 million as of the end of the prior quarter. For the quarter, all six of the new portfolio company debt originations were first lien senior secured, and as of the quarter end, 91 percent of the credit portfolio was first lien senior secured. On slide 11, we lay out the $112.9 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $107.8 million in first lien senior secured debt committed to six new portfolio companies, one of which we also invested $1 million in equity alongside our debt, $3.8 million in first lien senior secured debt committed to one existing portfolio company, and $400,000 in sub-debt and equity follow-on investments in three existing companies. Turning to slide 12, we continued our track record of successful exits with six exits during the quarter. These exits generated $60.9 million in total proceeds, realized gains of $3.3 million, and a weighted average IRR of 17.5%. To date, we have generated a cumulative weighted average IRR of 15.2% on 45 portfolio exits, representing approximately $462 million in proceeds. From a macro perspective, the market for acquisition and refinancing capital was robust this quarter and has continued its strong momentum into the December quarter, resulting in heavy volume in both origination and refinancing activity. Our investment pipeline, as we have mentioned on previous earnings calls, has been robust in both volume and quality of deals. The deal team continues to do an excellent job broadening the top end of our deal funnel and which maximizes the number of deals in the market for which we have the opportunity to review and consider. As we have always contended, this is a critical component of building and maintaining a quality investment portfolio in a competitive market. Finally, we believe that the returns realized on exits over the past several years has proven out the investment acumen of our investment team and the merits of our investment strategy in generating strong risk-adjusted returns over the long term. On slide 13, we illustrate some key stats for our on-balance sheet portfolio as of the end of the quarter, again, excluding our I-45 Senior Loan Fund. Beginning this quarter, we have decided to consolidate reporting on our on-balance sheet upper middle market and lower middle market loans in order to give shareholders a more concise view of our portfolio makeup in total. At the end of the quarter, the total on-balance sheet portfolio at fair value was weighted 82.4% to first lien investments, 6.8% to second lien investments, 1.6% to subordinated debt investments, and 9.1% in equity co-investments. Turning to slide 14, we have laid out the rating migration within our portfolio. During the quarter, we had two loans upgraded from a 2 to a 1, one loan downgraded from a 2 to a 3, and one loan downgraded from a 3 to a 4. As a reminder, all loans upon origination are initially assigned an investment rating of 2 on a 4-point scale, with 1 being the highest rating and 4 being the lowest rating. As of the end of the quarter, we had 61 loans representing approximately 90% of our investment portfolio at fair value rated in one of the top two categories, a 1 or a 2. We had six loans representing 9.7% of the portfolio at fair value rated a 3, and one loan representing less than 1% of the portfolio rated a 4. During the quarter, we placed one first lien senior secured loan on non-accrual with a fair value of $10.4 million, or 1.3% of the total investment portfolio. This company is currently working through a restructuring of its balance sheet, so we have decided to place the loan on non-accrual pending more clarity on the post-restructure loan terms. Based on conversations with the company to date, we expect a portion of this loan to come off non-accrual in the near term once the restructuring is finalized, which should be completed in the coming weeks. As illustrated on slide 15, our total investment portfolio continues to be well diversified across industries with an asset mix which provides strong security for our shareholders' capital. The portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in subordinated debt. Turning to slide 16, the I-45 Senior Loan Fund continues its solid performance. As of the end of the quarter, 95% of the I-45 portfolio was invested in first lien senior secured debt. Weighted average EBITDA and leverage across the companies in the I-45 portfolio was $75 million, or 4.7 times, respectively, down slightly from last quarter. Portfolio continues to have diversity among industries and an average hold size of 2.6% of the portfolio. Leverage at the I-45 fund level is currently 1.3 times debt to equity. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.