Capital Southwest Corporation

Thank you for joining today's Capital Southwest second quarter fiscal year 2023 earnings call. Participating on the call today are Bowen Deal, CEO Michael Sarner, CFO, and Chris Reberger, VP Finance. I will now turn the call over to Chris Reberger.

Thank you. I'd 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 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 Deagle.

Thanks, Chris, and thank you to everyone for joining us for our second quarter fiscal year 2023 earnings call. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company and our portfolio as we continue to diligently execute 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. You will also find our quarterly earnings press release issued last evening on our website. 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 54 cents per share, which represented 20% growth over the $0.45 per share generated a year ago in the September quarter. The $0.54 per share, Board had earned our regular dividend pay during the quarter of $0.50 per share. As previously announced, our Board had declared a $0.02 per share increase in our regular dividend to $0.52 per share for the quarter ending December 31, 2022. This increase represents 4% growth over the 50 cents per share paid in the September quarter and 11% growth over the 47 cents per share paid a year ago in the December quarter. These increases in our regular dividend are a result of the increased fundamental earnings power of our portfolio given its growth and performance, as well as improvements in our operating leverage. In addition, given the Federal Reserve's aggressive interest rate increases, and the resulting excess earnings being generated by our floating debt portfolio, our Board of Directors has also declared a supplemental dividend of 5 cents per share for the December quarter, bringing total dividends declared for the December quarter to 57 cents per share. While future dividend declarations are at the discretion of our Board of Directors, it is our intent and expectation that Capital Southwest will distribute supplemental dividends for the foreseeable future while base rates remain materially above long-term historical averages. Finally, I should note that as we have done in the past, we intend to also distribute supplemental dividends as we harvest realized gains from our equity co-investment portfolio. During the quarter, acquisition and financing activity in the lower middle market continued to be strong. Portfolio growth during the quarter was driven by 86 million in new commitments consisting of commitments to five new portfolio companies, totaling $67 million, and add-on commitments to five existing portfolio companies, totaling $19 million. This was offset by $14 million in proceeds from two debt prepayments and one debt sale during the quarter. On the capitalization front, we raised $26.9 million in equity through our ATM program at an average price of $19.48 per share, representing an average of 118% of the prevailing net asset value per share. Our liquidity remains robust, with approximately $170 million in cash and undrawn capital commitments as of the end of the quarter. We have remained diligent in funding a meaningful portion of our investment asset growth with accretive equity issuances on our equity ATM program. As we think it is critical that we maintain a conservative mindset to BDC leverage given the uncertainty in the economy, Overall, we are pleased with the strength of our balance sheet, with regulatory leverage of 1.1 to 1, a significant liquidity position, as well as the fact that almost half of our balance sheet liabilities are in fixed-rate, unsecured bonds, and our earliest debt maturity isn't until 2026. On slides 7 and 8, we illustrate our continued track record of producing strong dividend growth, consistent dividend coverage, and solid value creation since the launch of our credit strategy back in January of 2015. Since that time, we have increased our regular dividend pay to shareholders 24 times and have never cut the regular dividend, including during the tumultuous environment we all experienced during the COVID pandemic. Additionally, over the same time period, we have paid or declared 18 special or supplemental dividends totaling $3.61 per share. generated from excess earnings and realized gains from our investment portfolio. We believe our track record of consistently growing our dividend, the solid performance of our portfolio, as well as our company's sustained access to the capital markets, has demonstrated the strength of our investment and capitalization management strategies, as well as the absolute alignment of all our decisions with the interests of our shareholders. Continuing to generate the strong track record is critically important to us as long-term shareholder value creation through the maintenance and growth of both dividends and NAD per share are a top priority for our company. Turning to slide nine, our investment strategy as laid out for our shareholders at its launch back in January of 2015 hasn't changed. The vast majority of our activity has been in our core lower middle market where we are the first lien senior secured lender, most often backing a private equity firm's acquisition of a growing, lower-than-market company. We also often participate on a minority basis in the equity of the company through an equity co-investment made alongside the private equity firm. In fact, 90% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership of the portfolio companies, as well as the potential new capital support if needed. Our low-email market strategy is complemented by club participation in slightly larger companies led by like-minded lenders with which we have worked well across multiple deals. Virtually all of these club deals are also backed by private equity firms. As of the end of the quarter, our equity co-investment portfolio consisted of 46 investments with a total fair value of $102.6 million. which included $38.6 million in embedded unrealized appreciation, or approximately $1.34 per share. Our equity portfolio, which represented approximately 10% of our total portfolio fair value as of the end of the quarter, continues to provide our shareholders participation in the attractive upside potential of these growing lower-rental market businesses, which will come in the form of NAD per share growth and supplemental dividends paid over time. As illustrated on slide 10, our on-balance sheet credit portfolios at the end of the quarter, excluding our I-45 Senior Loan Fund, grew 4% to $903 million as compared to $865 million as of the end of the prior quarter. Over the past year, our credit portfolio has grown by $214 million, or 31%, from $689 million as of the end of the September 2021 quarter. For the current quarter, 95% of of new portfolio company debt originations were first lien senior secured debt. And as of the end of the quarter, 94% of our total credit portfolio was first lien senior secured. On slide 11, we detailed the 86 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter includes 64 million in first lien senior secured debt and 3 million in second lien senior secured debt to five new portfolio companies. Additionally, we committed $18 million in first lien senior secured debt to five existing portfolio companies and $816,000 in equity co-investments to two existing portfolio companies. Turning to slide 12, we continued our track record of successful exits with two debt prepayments and one debt sale during the quarter. In total, these exits generated approximately $14 million in total proceeds. generating a weighted average IRR of 10.1%. Since the launch of our credit strategy, we have realized 66 portfolio exits representing $763 million in proceeds that have generated a cumulative weighted average IRR of 14.7%. The market for acquisition capital continues to be active. Not surprisingly, we have also seen a slowdown in refinancing activity. As a result, we would expect continued solid net portfolio growth in the near term. The activity in our investment pipeline is strong in terms of both volume and breadth of deal sources. We are pleased with the strong market position our team has established in the lower middle market as a premier debt and equity capital partner, as evidenced by the broad array of relationships across the country from which our team is sourcing quality opportunities. In terms of deal origination, we find that underwriting certain industries is more challenging given today's economic uncertainty. However, for eight years now, an important component of our underwriting has always been to run a stress case downside model for every new deal, simulating an extreme recession occurring soon after closing. So in many respects, our underwriting in the current environment hasn't changed. Although our models today include much higher base rates than we have in We continue to tie the leverage level we are willing to put on a company to the potential performance volatility of a particular business and industry throughout the economic cycle. Performance across different industries can be very different through the economic cycle, so getting this right is an important component of the underwriting process. Specifically, we require a fundamental underwriting standard that we see our loan remain well within the portfolio company's enterprise value and our interest being paid through the cycle in a stress case financial model. On slide 13, we detail some key stats for 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 portfolio at fair value was weighted approximately 85% first lien senior secured debt, 5% to second lien senior secured debt, and 10% to equity co-investment. The credit portfolio had a weighted average yield of 10.6% and weighted average leverage through our security of 4.1 times. Turning to slide 14, we have laid out the rating migration within our portfolio for the quarter. During the quarter, we upgraded six loans with a total fair value of $37.9 million, and downgraded three loans with a total fair value of $18.39. As a reminder, all loans upon origination are initially signed at an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating. We feel very good about the performance of our portfolio with 97% of the portfolio at fair value rated in one of the top two categories, a one or a two. As illustrated on slide 15, our total investment portfolio, including our I-45 Senior Loan Fund, 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-lane senior secured debt with only 5% of the portfolio in second-lane senior secured debt. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.