Capital Southwest Corporation

Thank you for joining today's Capital Southwest Third Quarter Fiscal Year 2022 Earnings Call. Participating on the call today are Bowen Deal, CEO, Michael Sarner, CFO, and Chris Rehberger, VP Finance. I will now turn the call over to Chris Rehberger.

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 Deal.

Thanks, Chris, and thank you to everyone for joining us for our earnings call for the quarter ended December 31, 2021, which is the third quarter of our 2022 fiscal year, which ends March 31, 2022. We are 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 the 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 51 cents per share, which more than earned our regular dividend paid for the quarter of 47 cents per share. Total dividends for the quarter were 97 cents per share, which consisted of a regular dividend of 47 cents and a supplemental dividend of 50 cents per share. We are also pleased to announce that our board has declared an increase in our regular dividend per share to 48 cents for the quarter ended January. March 31, 2022, an increase of 2.1% from the 47 cents per share paid in the December quarter. This increase in our recurring regular dividend reflects the increased earnings power of our portfolio, resulting from the growth and performance of our credit portfolio and the continued reductions in our cost of capital and improvements in our operating leverage. During the quarter, acquisition and financing activity in the lower middle market was very strong, resulting in record new originations for Capital Southwest. As expected, we also saw record prepayment activity across our portfolio. On a net basis, we were able to grow our investment portfolio by 7.2% to $877 million. Portfolio growth during the quarter was driven by $268 million in commitments to 14 new portfolio companies and 12 existing portfolio companies, of which $213 million was funded at close. This was offset by $158 million in proceeds from 11 debt prepayments and one equity exit during the quarter. Notably, the equity exit was a very successful outcome as it generated a realized gain of $5.6 million and an IRR of 99.2%. As we have previously stated, our intention over time is to distribute these realized gains periodically through special dividends to our shareholders. On the capitalization front, on November 2021, we completed an add-on of $50 million in aggregate principal to our three and three-eighths October 26 notes. Furthermore, in lockstep with our strong deal pipeline, we raised $16 million of equity through our ATM program at an average price of $25.97 per share, representing an average of 159% of the prevailing net asset value per share. On slides 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 NAV 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 of 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 many of our loans. We believe that this combination is powerful for BDC as it provides strong security for the vast majority of our invested capital while also providing NAB 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 NAV per share while aiding in the mitigation of any credit losses over time. As of the end of the quarter, our equity co-investment portfolio consisted of 39 investments with a total fair value of $74.5 million, which included $17.7 million in embedded unrealized appreciation for approximately $0.74 per share. Our equity portfolio, which represented approximately 9% of our total portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from growing lower middle market businesses. The successful exit of one of our lower middle market equity co-investments this quarter, which produced a realized gain of $5.6 million, is an example of the benefits of this component of our strategy. 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 8% to $745 million, as compared to $689 million as of the end of the prior quarter. For the quarter, 99% of our new portfolio company debt originations were first lien senior secured, and all of the debt originations for the quarter were senior secured. Finally, as of the end of the quarter, 91% of the credit portfolio was first lien senior secured. On slides 11 and 12, we lay out the $268 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $204 million in first lien senior secured debt committed to 14 new portfolio companies, including one in which we also invested $3.3 million in second lien alongside our first lien debt. Additionally, We invested $6.4 million in equity alongside eight of our new portfolio companies. Finally, during the quarter, we also committed $54.3 million in first lien senior secured debt to nine existing portfolio companies. Turning to slide 13, we continue our track record of successful exits, with 11 debt investment exits and one equity exit during the quarter. In total, these exits generated over $158 million in total proceeds, realizing gains of 7.4 million and generating a weighted average IRR of 16.2 percent. Since the launch of our credit strategy over seven years ago, we have generated a cumulative weighted average IRR of 14.6 percent on 56 portfolio exits, representing approximately 638 million in proceeds. As previously mentioned, the market for acquisition and refinancing capital was very robust during the 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 throughout 2021 in both volume and quality of deals, and the December quarter was especially so. I'm very pleased with the strong market position that our team has established in the lower middle market as a premier debt and equity capital partner. I'm especially encouraged by the increasing number of deal sources, private equity firms and otherwise, that have been cultivated where we have closed multiple transactions together. We are finding these firms are willing to be references for us as we prospect for new relationships. Additionally, it is exciting to also see the number of new deals coming in from very relevant deal sources that are new to us. As we have always contended, this broadening of our sourcing network and deal funnel is a critical component of building and maintaining a quality investment portfolio in a competitive market. On slide 14, we illustrate some key stats from our on-balance sheet portfolio as of the end of the quarter, again excluding our I-45 Senior Loan Fund. As of the end of the quarter, the total on-balance sheet portfolio at fair value was weighted 82.9% to first lien investments, 6.5% to second lien investments, 1.5% to subordinated investments, and 9.1% to equity co-investments. Turning to slide 15, we have laid out the rating migration within the portfolio. During the quarter, we had two loans upgraded from a 2 to a 1 and two loans upgraded from a 3 to a 2. We had no loans downgraded this quarter. 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 68 loans representing approximately 95.4% of our investment portfolio at fair value rated in one of the top two categories, a one or a two. We had five loans representing 4.6% of the portfolio rated a three, and one loan representing less than 1% of the portfolio rated a four. During the quarter, we had no new loans placed on non-accrual. and one loan at a fair value of $5.2 million come off of non-accrual. As we discussed last quarter, this company successfully completed a restructuring of its balance sheet in December, which allowed us to place a portion of the original loan back on accrual this quarter. As illustrated on slide 16, our total investment portfolio continues to be well diversified across industries with an asset mix that provides strong security for our shareholders' capital. Portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio in second lien senior secured debt and only 1% of the portfolio in subordinated debt. Turning to slide 17, 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 $72.8 million and five times respectively. The portfolio continues to have diversity among industries and an average hold size of 2.4 percent of the portfolio. Leverage at the I-45 fund level is currently 1.52 times debt-to-equity. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.