Capital Southwest Corporation

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

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 guaranteed the 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 fourth quarter and 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 in the investor relations page on our website at www.capitalsuswest.com. You will also find our quarterly earnings press release issued last evening on our website. Now turning to slide six of the earnings presentation, we will begin with a summary of the key performance highlights for the 2023 fiscal year. During the fiscal year, we grew our total portfolio at fair value by 29% year-over-year to over $1.2 billion, from $937 million in the prior year, while increasing our pre-tax investment income by 21% to $2.30 per share from $1.90 per share in the prior year. We increased our regular dividends paid to $2.03 per share for the fiscal year, representing an increase of 12% compared to the $1.82 per share of regular dividends paid in the prior year. We continue our track record of covering our regular dividend with pre-tax NII with over 113% coverage for the year. In addition to our regular dividend growth, we began a supplemental dividend program in the December 2022 quarter, paying $0.05 per share in each of the December and March quarters. Our board has again declared a $0.05 per share supplemental dividend for the June 2023 quarter. In addition, during the year, we strengthened our balance sheet through a variety of capital markets activities. First, we raised a total of $207 million in gross equity proceeds through our equity ATM program, as well as an underwritten public offering of our common stock, reducing our regulatory leverage to 0.88 to 1 debt to equity as of the end of the fiscal year, compared to 1.16 to 1 debt to equity as of the end of the prior fiscal year. We received $65 million in additional commitments on our revolving credit facility, bringing total credit facility commitments to $400 million. Third, we received approval for $50 million in additional SBA ventures during the year, which we are currently drawing upon. Finally, in March of 2023, based on our performance, balance sheet leverage, and flexibility, we received a BAA3 investment grade rating with a stable outlook. from Moody's Investor Service. Michael will provide further detail on this later in our prepared remarks. Turning to slide seven of the earnings presentation, we have summarized key performance highlights specific to the March quarter. During the quarter, we generated pre-tax net investment income of $0.65 per share, which represented 8% growth over the $0.60 per share generated in the prior quarter, and 30% growth over the $0.50 per share generated a year ago in the March quarter. The $0.65 per share significantly out-earned our 53% per share regular dividend, as well as our total dividends paid during the quarter of $0.58 per share, which includes the $0.05 per share supplemental dividend. As of the end of the quarter, our estimated undistributed taxable income balance was $0.45 per share. As previously announced, our board has declared another $0.01 per share increase to our regular dividends 54 cents per share for the June 2023 quarter. These increases in our regular dividends are a result of the increased fundamental earnings power of our portfolio, given its growth and performance, as well as further improvements in our operating leverage. We have continued to be prudent in increasing our regular dividends, always endeavoring to set the regular dividend at a level that can be maintained even if market base rates return to more historical norms. In addition, due to continued excess earnings being generated by our floating rate debt portfolio in an elevated base rate environment, our Board of Directors has again declared a supplemental dividend of 5 cents per share for the June quarter, bringing total dividends declared for the June quarter to 59 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 continue to distribute quarterly supplemental dividends for the foreseeable future, while base rates are above historical averages and we have meaningful UTI generated by earnings in excess of our dividends and realized gains from our equity co-investment portfolio. During the quarter, deal activity in the low-end market continued to be solid, primarily focused on acquisitions rather than refinancing. The environment during the quarter continued to be a favorable one for a first-ling lender like Capital Southwest. We continued to see average loans pricing spreads on new portfolio company loans that were 50 to 100 basis points higher than a year ago, and leverage levels on new portfolio company loans that were generally lower by around a full turn of EBITDA. At the same time, loan-to-value levels on these new loans, calculated as our first lien loan divided by the enterprise value being paid for an acquisition, were also down meaningfully from a year ago, as private equity firms remained willing to pay full multiples for quality companies. Portfolio growth during the quarter was driven by $67.3 million in new commitments consisting of commitments to five new portfolio companies totaling $49.5 million and add-on commitments to nine existing portfolio companies totaling $17.8 million. This was offset by $16.8 million in proceeds from one debt prepayment during the quarter. On the capitalization front during the quarter, we raised a total of $29.2 million in gross equity proceeds at an weighted average price of $19.15 per share, or 118% of the prevailing NAD per share. Our liquidity remains robust, with approximately $196 million in cash and undrawn capital commitments at the end of the quarter. We have remained diligent in funding a meaningful portion of our investment asset growth with accretive equity issues as we think it is critical that we maintain a conservative mindset to BDC leverage given the current uncertainty in the economy. As we have said many times, we manage our BDC with a full economic cycle mentality. This starts with our underwriting of new opportunities, but it also applies to how we manage the BDC's capitalization. Managing leverage to the lower end of our target range positions us to invest throughout a potential recession. when risk-adjusted returns can be particularly attractive. It also allows us to support our portfolio companies while also opportunistically repurchasing our stock if it were to trade meaningfully below NAD. With this in context, we are very pleased with the strength of our balance sheet as we further reduce regulatory leverage to 0.8821 debt to equity down from 0.9121 debt to equity in the prior quarter. We also maintain our significant liquidity position, and we continue to operate with almost half of our balance sheet liabilities as fixed-rate, unsecured, covenant-free bonds, the earliest of which mature in 2026. On slides eight and nine, 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 quarterly regular dividend pay to shareholders 26 times and have never cut the regular dividend, even in the tumultuous environment we all experienced during the COVID pandemic. Additionally, over the same period, we have paid 19 special or supplemental dividends totaling $3.60 per share generated from excess earnings and realized gains from our investment portfolio. We believe our track record of consistently growing our dividends 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 this strong track record, we believe, is critically important to building long-term shareholder value. Turning to slide 10, we lay out the core tenets of our strategy, which hasn't changed since its launch back in January of 2015. Our core strategy is lending and investing in the low-income market, the vast majority of which is in first lien senior secured loans to private equity-backed companies. In fact, approximately 90% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as the potential for new junior capital support if needed. In the low-income market, we often have the opportunity to invest on a minority basis in the equity carried with the private equity firm. As of the end of the quarter, our equity co-investment portfolio consisted of 53 investments with a total fair value of $117.5 million, which was 155% of our cost, representing $41.6 million in embedded, unrealized appreciation, or $1.15 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 middle market businesses, which will come in the form of NAD per share growth and supplemental dividends over time. Our lower middle market strategy is complemented by core participations in larger companies led by like-minded lenders with whom we have relationships and have gained confidence in their post-closing loan management from working well together across multiple deals. Virtually all of these club deals are also backed by private equity firms. As illustrated on slide 11, our on-balance sheet credit portfolio is at the end of the quarter, excluding our I-45 Senior Loan Fund, grew 31% year-over-year to over $1 billion, compared to $794 million as of the end of the prior year. For the current quarter, 100% of our new portfolio company debt originations were first lien senior security. And as of the end of the quarter, 96% of the total unbalanced sheet credit portfolio was firstly in senior security. Over the past eight years, as we have grown the credit portfolio, we have significantly improved the granularity of loan hold sizes in the portfolio, with the average hold size as a percent of the total loan portfolio falling from 5% to less than 1.5%. On slide 12, we detail the $67.3 million of capital invested in and committed to portfolio companies during the quarter. The capital committed this quarter included $45.7 million in first lien senior secured debt committed to five new portfolio companies, including four in which we invested a total of $3.9 million in equity. We also committed $16 million in first lien senior secured debt and $1.7 million in equity to nine existing portfolio companies. Deal activity continues in the current quarter at a healthy pace, as we have originated over $80 million in new commitments since the March quarter end. Turning to slide 13, during the quarter, we had one loan originated in July 2016 prepaid based on the sale of the portfolio company by the private equity sponsor. This exit generated approximately $16.8 million in proceeds, generating a weighted average IRR of 13%. Since the launch of our credit strategy, we have realized 68 portfolio exits, representing approximately 800 million in proceeds that have generated a cumulative weighted average IRR of 14.5%. Not surprisingly, refinancing activity continues to be slow given the widening spread on new loans in the market. Based on these dynamics, we expect solid net portfolio growth in the coming quarters. We are pleased with the strong market position that our team has established in the lower middle market. is a premier debt and equity capital provider as evidenced by our consistent deal origination activity and the broad array of relationships across the country from which our team is sourcing quality opportunities. In terms of underwriting this market, while our company and portfolio are performing well, we do find underwriting certain industries is more challenging given today's economic uncertainty. An important component of our loan underwriting has always been to run a stress case downside financial model for every new loan, simulating an extreme recession occurring soon after the closing of our loan. So in that respect, our underwriting in the current environment hasn't changed from what we have done in the past, although models today include much higher base rates than we have experienced historically. This modeling analysis attempts 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. Peak to trough recessionary performance volatility across industries, as demonstrated by performance in past recessions, can be very different. So it is critical to assign leverage levels that are appropriate for a given level of potential performance volatility. Specifically, in our stress case financial model, we require the fundamental underwriting standards that the model demonstrates that our loan remains well within the portfolio company's enterprise value and that the portfolio company's cash flow is able to cover our loan interest throughout the simulated recession. On slide 14, 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, this total portfolio at fair value was weighted 86.6% to first-line senior security, 3.1% to second-line senior security, 0.1% to subordinated debt, and 10.2% to equity co-investments. The average hold size for portfolio loans and equity co-investments was $13.3 million and $2.2 million, respectively. The credit portfolio had a weighted average yield of 12.8% and weighted average leverage through our debt security of four times. 515 illustrates the rating migration within our portfolio for the quarter. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating. Is there being the quarter? 95.7% of the portfolio fair value was rated in one of the top two categories, a one or a two. As illustrated on slide 16, our total investment portfolio on this slide now, 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. Again, the portfolio remains heavily weighted towards first-ling senior secured debt with only 3% of the portfolio and secondly in senior secured debt. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter. Thanks, Don.

Specific to our performance for the quarter, as summarized on slide 18, we increased pre-tax net investment income 22% quarter over quarter to $22.8 million compared to $18.7 million in the prior quarter. Pre-tax NII was $0.65 per share for the quarter. During the quarter, we paid a $0.53 per share of regular dividend and a $0.05 per share of supplemental dividend. As mentioned earlier, our board has approved an increase to the regular dividend for the June quarter to $0.54 per share and declared another $0.05 per share supplemental dividend for the quarter. Maintaining a consistent track record of meaningfully covering our dividend with pre-tax NII is important to our investment strategy. We continue our strong track record of regular dividend coverage with 113% coverage for the last 12 months ended March 31, 2023, and 108% cumulative coverage since the launch of our credit strategy in January of 2015. Given the floating rate nature of our credit portfolio, elevated interest rates continue to be a significant tailwind to our net investment income. The base rate index used to calculate interest on the majority of our loans reset in early April to approximately 5.1%, up from its early January reset at 4.75%. This increase, quarter over quarter, will provide another immediate step up in portfolio income in the June quarter. As such, we expect to thoughtfully increase our regular dividend to a level which can be sustained should base rates return to a neutral level. In addition, while base rates remain elevated, our intent is to distribute a portion of excess pre-tax NII to our shareholders each quarter through supplemental dividends. Based upon our current UTI balance of 45 cents per share, the ability to grow UTI each quarter organically by over-earning our total dividend, and the expectation that we will harvest gains over time from our existing $1.15 per share and unrealized appreciation on the equity portfolio, we are confident in our ability to continue to distribute quarterly supplemental dividends for the foreseeable future. For the quarter, we increased total investment income from our portfolio 14% quarter over quarter to $37.2 million, reducing a weighted average yield on all investments of 12.1%. Total investment income was $4.4 million higher this quarter due to our higher average balance of credit investments outstanding, in addition to the tailwind provided from increases in LIBOR and SOFR base rates. As at the end of the quarter, We had approximately $4 million of our investments on non-accrual, representing 0.3% of our investment portfolio at fair value, with no new non-accruals added this quarter. Finally, the weighted average yield on our loan portfolio was 12.8% for the quarter. As seen on slide 19, we further improved LTM operating leverage to 1.9% as compared to 2.2% in the prior year. Achieving 2% or lower operating leverage was one of our initial long-term goals when we relaunched Capital Southwest as a middle market lender back in 2015. Though we are pleased to have reached this milestone, looking ahead, we expect our internally managed structure to produce incremental improvements in operating leverage over time. We believe our willingness and ability to operate our business efficiently as an internally managed vehicle provide shareholders significant upside in terms of dividend sustainability and growth in the future. Turning to slide 20, the company's NAV per share at the end of the quarter increased by $0.12 per share to $16.37, representing an increase of 0.7%. The primary drivers of the NAV per share increase for the quarter were earnings in excess of our dividends for the quarter, as well as accretion from the issuance of common stock at a premium to NAV per share. Turning to slide 21, as Bowen mentioned earlier, we are pleased to report that our balance sheet liquidity remains strong, with approximately $196 million in cash and undrawn leverage commitments as of the end of the quarter. Based on our credit facility borrowing basis at the end of the quarter, we have full access to our incremental revolver capacity and will look to opportunistically increase commitments to the facility in the near future. Our bank syndicate continues to support our growth, and we are pleased with the flexibility the revolving credit facility provides to our capital structure. We also have $10 million in committed but unfunded SBA debentures to be used to fund future SBIC eligible investments, as well as $45 million in uncommitted capacity on our current SBIC license to draw from in the future. As of March 31, 2023, approximately 45% of our capital structure liabilities and our earliest debt maturity is in January 2026. One of our initiatives for the current year will be to both increase and extend our revolver capacity in order to be well-prepared to effectively manage maturities in the future. As Bowen mentioned earlier, we received a BAA3 investment grade rating from Moody's Investor Service in March of this year. This rating is further validation of our first lien-focused investment strategy our strong credit underwriting track record, and our prudent balance sheet management throughout a variety of capital markets environments. We believe this rating will help immensely in future capital raises as we look to expand our investor base and complete larger capital markets transactions. Our regulatory leverage, as seen on slide 22, ended the quarter at a debt-to-equity ratio of 0.88 to 1. down significantly from 1.16 to 1 as of the March 2022 quarter. Over the past several quarters, we've made a concerted effort to strengthen our balance sheet to ensure we are prepared for any macroeconomic headwinds that we may encounter in the future. These efforts have included our opportunistic unsecured bond issuances at record lower rates in the late calendar of 2021, our receipt of an SBA license in April 2021, which gave us access to long-term fixed debt at attractive rates, our continued support from banking relationships, which have allowed for steady growth in our revolver facility commitments, and our continued diligence in moderating leverage through accretive equity issuances utilizing both our ATM program as well as the secondary equity market. We will continue to work toward strengthening the balance sheet, ensuring adequate liquidity, and maintaining conservative leverage in covenant cushions throughout the economic cycle. I'll now hand the call back to Bowen for some final comments.

Thanks, Michael. And again, thank you, everyone, for joining us today.

We appreciate the opportunity to provide you with an update on our business, our portfolio, and the market environment. Our company and portfolio continue to perform well, and I continue to be impressed by the job our team has done in building a robust asset-based deal origination capability as well as a flexible capital structure. As to the uncertainty in the economy, again, we have been underwriting with a full economic cycle mentality since day one, which we believe has positioned us well for any economic environment presented to us in the future. In summary, we have a floating rate credit portfolio heavily weighted to first-lane senior secured debt allocated across a broad array of companies and industries, 90% of which is backed by private equity firms. We have a well-capitalized balance sheet with diverse capital sources, strong liquidity, and flexible capital, much of which is fixed rate and covenant-like. We believe our First Lane Senior Secured Investment focus and our capitalization strategy provide us complete confidence in the health and positioning of our company and our portfolio as we look ahead. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

Thank you, ladies and gentlemen. If you have a question or a comment at this time, please press star 11 on your telephone. If your question has been answered, you wish to move yourself from the queue, please press star 1-1 again. We'll pause for a moment while we compile our Q&A roster.

Our first question comes from Mickey Sleeman with Leidenberg Daumann.

Your line is open.

Yes, good morning, everyone. I wanted to ask you about the portfolio activity during the quarter. you know, what were the catalysts that allowed you to be so active in what is usually a seasonally slow quarter and with overall M&A volumes, you know, down pretty meaningfully?

You know, it's an interesting question. I mean, if I look down the originations, I mean, they were just sponsor relationships that were active in the market. You know, the lower middle market, I mean, activity was, you know, 60 million or so for the quarter is an okay quarter from a region's perspective. So obviously as we referenced on the prepared remarks, we've done over 80 million in this quarter. So the activity in our world with the sponsors that we have relationships with across the country, it just continues to be nicely active. So we also, leverage levels are down, spreads are up, loan to value

percentages are down from like a year ago. So it, you know, I don't know that we were doing anything as a firm differently other than just, you know, continuing to underwrite to a coming recession. So, you know, it just, our sponsors are, have been, you know, reasonably active.

Yeah. And I'd also add, you know, as we've grown our balance sheet, you'll see, you know, our add on investments with our existing portfolio has grown as well. I mean, there's obviously a lot of these companies that are doing well. They're doing M&A transactions themselves. So that supplements new platforms as well.

I'd say one thing, as I look down the originations, given some of these leverage levels, asset coverage on some of these deals, I would say that the banks have been less aggressive in the market. As I look at that, I see lower leverage levels in a couple of situations have nice asset coverage. A year ago, they would be bank deals. that we've been able to compete for. That's one thing, and that has to be probably due to the bank's mentality looking at the market and pulling back, as we all know that's kind of going on in the economy. And then, you know, we see, you know, less competition from, you know, a bank-mez alternative. You know, mez guys usually attach to a bank loan, and we're seeing, you know, my sense is we're seeing less competition from that, probably driven by, again, the bank's level of agreement.

So I think those two things in our world, in our lower middle world, would be a positive uplift all else equal to our activity.

And the activity that we mentioned earlier, Mickey, in terms of early originations in the June quarter, a lot of those were deals that we've been working on for the last two to four months. So they're not just coming on our plate today, so a longer table.

I understand. Yeah, I was actually going to ask about the bank competition. So I'm glad you addressed that. A couple more questions for me. Clearly, the market's concerned about the outlook for credit. That's no secret. But you noted that the portfolio is performing well, which is really good to hear. But I do see that the portfolio's average EBITDA declined. So could you just walk us through how much of that decline was due to any portfolio company performance issues versus just movements in the portfolio due to the size of the new investments that you made?

Yeah. I mean, like if we looked across our whole portfolio this quarter, as we do each quarter, you know, it's kind of on a weighted average basis, kind of flat, you know, revenues flat, even though the whole portfolio is basically flat. You know, so definitely, you know, I would say that the trajectory of the EBITDA and revenue, it's not really negative, but it's, it's not, it's slowing. So, you know, from a portfolio comment, you know, the trajectory is flattening out, I guess, is the best way to say it.

You're looking at the average EBITDA on the portfolio?

Yeah, I think it's because some of the new originations we put in place actually had lower EBITDA, and so to Bo's point, the existing portfolio is flat, but the new originations were less than that EBITDA, and therefore that's why you saw the reduction.

So it's not about

Yeah, my comment's more on a portfolio static basis. But yes, that's right. The new deals are slightly smaller, for sure. Yeah.

Okay, that's what I suspected. So is that because you see the lower middle market is offering a better risk-adjusted return, or is it just idiosyncratic to the deal pipeline and the pace at which deals are closing? I'm asking because certain other BDCs have indicated that they're seeing better terms further up into the middle market or into the upper middle market, but historically that's not the case.

And we're seeing attractive terms in the lower middle market. I think also the other thing that's going on is we do a new origination. It's got a less EBITDA, smaller company. And we back a lot of buy and build. So we're doing add-ons with our sponsors.

And so the EBITDA of the portfolio company grows through acquisitions. And so you can see new originations are going to have most of the time less EBITDA than a portfolio would because we're just getting started. That's the first platform. We'll do several acquisitions and three or four quarters from now, that EBITDA on that particular company could be much larger.

I understand. Just one housekeeping question. You mentioned, and I think in the press release it says you got $16.8 million from Amware Fulfillment, but I looked at the previous SOI and it showed a principal outstanding from them at $17.1 million. So I'm just trying to reconcile that to the IRR that you mentioned. Did you actually take a loss on that investment apart from the interest that you collected over time?

No, we definitely didn't take a loss. There was a principal prepayment that happened.

So that exit is the actual proceeds on the exit. So we had gotten a principal prepayment prior to the exit. So we got full par back.

Okay. That's it for me this morning. I appreciate your time as always. Thank you.

Thanks, Mickey.

One moment for our next question. Our next question comes from Eric Zwick with Havli Group. Your line is open.

Thank you.

Good morning. I wanted to first just start as I looked at the trends. in the income statement noticed that both the dollar amount and the percentage contribution from PIC interest has increased. Wondering if you could just talk about that trend a little bit, what's driving that?

Yeah, so from the previous quarter to this quarter, that's actually one company that had around $300,000 in PIC. Now, that company had a PIC toggle through a previous amendment that ended at the end of March 31 when we had another amendment where there was an equity infusion in cash. So that company is delevered and performing and back on cash.

So we would expect that to come back down in the subsequent quarter.

Okay. That's helpful. Thank you.

And then I noted that for the I-45 SOF, that credit facility was amended to reduce the available total commitment from 150 to 100. Curious, you know, kind of maybe the tenor of that discussion or what kind of drove that reduction?

Yeah, we probably tell you over the last two and three years, our investments in the syndicated space has been opportunistic at best. So what we've seen are the credit facility come down from probably $135 million drawn to $80 million drawn today. And so we were incurring significant unused fees at the $150 million in commitment size. So it made sense, without us seeing a runway where we'd be relevering that facility, it made a lot of sense to do a permanent reduction to the level that's more appropriate for our current utilization.

And just to be clear, 100% driven by us.

Okay, great. I appreciate the commentary there, and I guess Maybe a quick follow-up on that one. Does that mean, as you mentioned, you don't have any ability to or don't have any desire at this point to kind of utilize that and leverage that facility back up? Is that just what you choose to hold on your balance sheet outside of that? The opportunities are more attractive today in terms of spread and what you're seeing?

I mean, I would tell you yes. I mean, if you look at a levered return – You know, our leverage on our balance sheet is about commensurate with the leverage in the credit facility for I-45, and the yields tend to be wider on the lower middle market than they do in the upper middle market. So the all-in return is more attractive. We also have more control as a first lien lender with Covenant than you might see on the syndicated space.

Yeah, as we've kind of said the last several quarters, I mean, from what I've heard from other earnings calls, I think it's probably similar across the industry. I mean, the syndicated markets, hasn't been that interesting with sandbox especially for us given how robust our lower middle market asset class and platform is being and that senior loan fund is really designed around the syndicated market kind of product um and so you know the decrease in the facility reflects kind of the you know the less investing in that asset class and you know we'll see where it goes going forward you know we could if we could always grow it and expand it in the future if we

saw the opportunity to but we don't we don't really we're very focused on the direct lending to the lower market where we lead the deals and to the point earlier i mean there was there's plenty of appetite from db who leads that facility to grow as well as some of the lenders underneath it in the syndicate got it that's helpful thank you one last one for me and then i'll step aside and um i appreciate the interest rate sensitivity table you included on page 26 and

I guess I'm just curious if the Fed is done hiking here. I guess there's still some debate whether they do one more in June. But if we start to see Libra and so forth kind of level out, maybe hold at this level for a little while, is there still a little bit of lag benefit that you would see in terms of your portfolio yields and NII as it kind of catches up to the final Fed or increase in kind of the base rates and so forth in Libra? And then as we move forward, would you still potentially feel a little bit of creep as you put on new investments would seem to be coming on with maybe with higher spreads, just trying to get a sense of, you know, the direction of NII from here.

Sure. Yeah, we would tell you that, you know, if rates do flatten out at five and a quarter or thereabouts for a period of time, I mean, we would expect that our NII would be somewhere in the 65 to 70 cents range for a period of time. It's hard to see. You know, we've I think we put our balance sheet in a pretty strong position. You know, we've got, you know, inexpensive fixed rate debt. We've got the SBIC, which is low rate that we're funding off of and, you know, floating rate assets.

So, certainly, you know, we can see expansion in NII in the near term.

Thanks for taking my questions today.

Thank you.

One moment for our next question. Our next question comes from Robert Dodd with Brayman James.

Your line is open.

Hi, guys. On the leverage, you know, obviously it's come down. It's slightly below, I think, the historic target range. Now, can you give us any – is that – you see the pipeline building, obviously, $80 million since the end of the quarter, and so you took the leverage down to rebuild it that way, or was there any connection to – you know, was there any feedback from Moody's that – Maybe they've got a different target in mind.

Well, I'll tell you, Moody's is actually part of their analysis in providing us an investment grade was our strategy to de-lever going into what could be a cycle and being at the lower end of our range certainly was important to them. It just happened to dovetail. Their view dovetailed with our strategy, so that's positive. Going forward, I mean, I think we tell you, Bo and I would tell you that if we think we're going into a tumultuous time or even they're going kind of sideways, we think we should start out at a lower leverage. And so being at 0.88, 0.9 is where we'd like to be. We still see the ability to raise equity off the ATM, which we started off this quarter with the ability to do that as well. So we feel like Staying at that bottom end is not going to be an issue for us in the short term, and it's certainly where we are. If and when there's sort of an all clear in the market, you could see us picking up, maybe raising slightly less equity and trending closer to one times regulatory leverage.

But that's where we are now.

Got it. Got it. I appreciate that. Now, one more question if I can. Maybe I'm reading too much into this. Okay. So on page 15 of your presentation, obviously, there were three investments that were downgraded, but small, right? This quarter, but last quarter you had nine, category three, category four. This quarter you've still got nine. So three downgrades, presumably three others that were already rated at the lower end of the curve were exited. If I look at footnote five on page 14, right, last quarter you're excluding six portfolio companies because of, I guess, negative EBITDA. And this quarter, you're excluding nine, right? So there's three again. So are there really portfolio companies that are showing meaningful EBITDA deterioration? Or is there, I mean, obviously, you talked about the average, right? The average portfolio revenue EBITDA is kind of flat. But is at the margin, are there three that are showing material weakness at the moment, or am I reading too much into a couple of tiny details?

Yeah, we'll break that apart in a couple of pieces.

The new downgrade to a four was the last small loan in one of the prior, not four-oriented companies. So it's further deterioration in an already very tough situation we've been writing, it was written down for a while. So that's not a new portfolio company story. The two that were, the two downgraded to a three, you know, both underperforming. One of them underperforming very temporarily because of some inventory adjustments at its customers. The other one's underperforming, and so it deserves going down to a three.

And so that's, I mean, to add to that, Michael, that's the... Yes, and then the color behind those... Yes, and then if you turn to slide 14, the increase from 3.6 times to 4.0 was actually we included a company back in these metrics because it now has positive EBITDA where it had negative EBITDA in the previous quarter. And therefore, the metric shifted up just by its inclusion because it is a highly leveraged business. I think if you excluded that company, the weighted average leverage would actually have been pretty consistent with the previous quarter.

Got it. Got it. I appreciate that. Thank you. Sure. Thanks, Robert.

And I'm not showing any further questions this time. I'd like to turn the call back over to Bowen.

Great. Thank you, Operator. Thanks, everybody, for joining us. We always love giving you an update on our company and how we're performing, and we look forward to speaking to you next quarter. Thank you.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day. you Bye. Thank you. music music Thank you. Thank you for joining today's Capital Southwest fourth quarter and fiscal year 2023 earnings call. Participating on the call today are Bowen Deal, CEO, Michael Sarner, CFO, and Chris Reberger, Vice President of Finance. I will now turn the call over to Chris Reberger.

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 fourth quarter and 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 presentations which can be found in the investor relations page on our website at www.capitalsuswest.com. You will also find our quarterly earnings press release issued last evening on our website. Now turning to slide six of the earnings presentation, we will begin with a summary of the key performance highlights for the 2023 fiscal year. During the fiscal year, we grew our total portfolio at fair value by 29% year-over-year to over $1.2 billion, from $937 million in the prior year, while increasing our pre-tax investment income by 21% to $2.30 per share from $1.90 per share in the prior year. We increased our regular dividends paid to $2.03 per share for the fiscal year, representing an increase of 12% compared to the $1.82 per share of regular dividends paid in the prior year. We continued our track record of covering our regular dividend with pre-tax NII with over 113% coverage for the year. In addition to our regular dividend growth, we began a supplemental dividend program in the December 2022 quarter, paying $0.05 per share in each of the December and March quarters. Our board has again declared a $0.05 per share supplemental dividend for the June 2023 quarter. In addition, during the year, we strengthened our balance sheet through a variety of capital markets activities. First, we raised a total of $207 million in gross equity proceeds through our equity ATM program, as well as an underwritten public offering of our common stock, reducing our regulatory leverage to 0.88 to 1 debt to equity as of the end of the fiscal year, compared to 1.16 to 1 debt to equity as of the end of the prior fiscal year. We received $65 million in additional commitments on our revolving credit facility, bringing total credit facility commitments to $400 million. Third, we received approval for $50 million in additional SBA debentures during the year, which we are currently drawing upon. Finally, in March of 2023, based on our performance, balance sheet leverage, and flexibility, we received a BAA3 investment grade rating with a stable outlook from Moody's Investor Service. Michael will provide further detail on this later in our prepared remarks. Turning to slide seven of the earnings presentation, we have summarized key performance highlights specific to the March quarter. During the quarter, we generated pre-tax net investment income of $0.65 per share, which represented 8% growth over the $0.60 per share generated in the prior quarter, and 30% growth over the $0.50 per share generated a year ago in the March quarter. The $0.65 per share significantly out-earned our 53% share per share regular dividend, as well as our total dividends paid during the quarter of $0.58 per share, which includes the $0.05 per share supplemental dividend. As of the end of the quarter, our estimated undistributed taxable income balance was $0.45 per share. As previously announced, our board has declared another $0.01 per share increase to our regular dividends 54 cents per share for the June 2023 quarter. These increases in our regular dividends are a result of the increased fundamental earnings power of our portfolio, given its growth and performance, as well as further improvements in our operating leverage. We have continued to be prudent in increasing our regular dividends, always endeavoring to set the regular dividend at a level that can be maintained even if market base rates return to more historical norms. In addition, due to continued excess earnings being generated by our floating rate debt portfolio in an elevated base rate environment, our Board of Directors has again declared a supplemental dividend of 5 cents per share for the June quarter, bringing total dividends declared for the June quarter to 59 cents per share. While future dividend declarations are at the discretion of our Board of Directors, it is our intent and expectation that Capital Tough West will continue to distribute quarterly supplemental dividends for the foreseeable future, while base rates are above historical averages and we have meaningful UTI generated by earnings in excess of our dividends and realized gains from our equity co-investment portfolio. During the quarter, deal activity in the low-end market continued to be solid, primarily focused on acquisitions rather than refinancing. The environment during the quarter continued to be a favorable one for a first-ling lender like Capital Southwest. We continued to see average loans pricing spreads on new portfolio company loans that were 50 to 100 basis points higher than a year ago, and leverage levels on new portfolio company loans that were generally lower by around a full turn of EBITDA. At the same time, loan-to-value levels on these new loans, calculated as our first lien loan divided by the enterprise value being paid for an acquisition, were also down meaningfully from a year ago, as private equity firms remained willing to pay full multiples for quality companies. Portfolio growth during the quarter was driven by 67.3 million in new commitments, consisting of commitments to five new portfolio companies, totaling 49.5 million, and add-on commitments to nine existing portfolio companies, totaling 17.8 million. This was offset by 16.8 million in proceeds from one debt prepayment during the quarter. On the capitalization front during the quarter, we raised a total of $29.2 million in gross equity proceeds at an weighted average price of $19.15 per share, or 118% of the prevailing NAD per share. Our liquidity remains robust, with approximately $196 million in cash and undrawn capital commitments at the end of the quarter. We have remained diligent in funding a meaningful portion of our investment asset growth with accretive equity issues as we think it is critical that we maintain a conservative mindset to BDC leverage given the current uncertainty in the economy. As we have said many times, we manage our BDC with a full economic cycle mentality. This starts with our underwriting of new opportunities, but it also applies to how we manage the BDC's capitalization. Managing leverage to the lower end of our target range positions us to invest throughout a potential recession. when risk-adjusted returns can be particularly attractive. It also allows us to support our portfolio companies while also opportunistically repurchasing our stock if it were to trade meaningfully below NME. With this in context, we are very pleased with the strength of our balance sheet as we further reduced regulatory leverage to 0.8821 debt-to-equity down from 0.9121 debt-to-equity in the prior quarter. We also maintain our significant liquidity position, and we continue to operate with almost half of our balance sheet liabilities as fixed-rate, unsecured, covenant-free bonds, the earliest of which mature in 2026. On slides eight and nine, 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 quarterly regular dividend pay to shareholders 26 times and have never cut the regular dividend, even in the tumultuous environment we all experienced during the COVID pandemic. Additionally, over the same period, we have paid 19 special or supplemental dividends totaling $3.60 per share generated from excess earnings and realized gains from our industrial portfolio. We believe our track record of consistently growing our dividends 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 this strong track record, we believe, is critically important to building long-term shareholder value. Turning to slide 10, we lay out the core tenets of our strategy, which hasn't changed since its launch back in January of 2015. Our core strategy is lending and investing in the low-income market, the vast majority of which is in first lien senior secured loans to private equity-backed companies. In fact, approximately 90% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as the potential for new junior capital support if needed. In the low-income market, we often have the opportunity to invest on a minority basis in the equity carried with the private equity firm. As of the end of the quarter, our equity co-investment portfolio consisted of 53 investments with a total fair value of $117.5 million, which was 155% of our cost, representing $41.6 million in embedded, unrealized appreciation, or $1.15 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 middle market businesses, which will come in the form of NAD per share growth and supplemental dividends over time. Our lower middle market strategy is complemented by club participations in larger companies led by like-minded lenders with whom we have relationships and have gained confidence in their post-closing loan management from working well together across multiple deals. Virtually all of these club deals are also backed by private equity firms. As illustrated on slide 11, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 Senior Loan Fund, grew 31% year-over-year to over $1 billion, compared to $794 million as of the end of the prior year. For the current quarter, 100% of our new portfolio company debt originations were first lien senior securities. And as of the end of the quarter, 96% of the total unbalanced sheet credit portfolio was firstly in senior security. Over the past eight years, as we have grown the credit portfolio, we have significantly improved the granularity of loan hold sizes in the portfolio, with the average hold size as a percent of the total loan portfolio falling from 5% to less than 1.5%. On slide 12, we detailed the $67.3 million of capital invested in and committed to portfolio companies during the quarter. The capital committed this quarter included $45.7 million in first lien senior secured debt committed to five new portfolio companies, including four in which we invested a total of $3.9 million in equity. We also committed $16 million in first lien senior secured debt and $1.7 million in equity to nine existing portfolio companies. Deal activity continues in the current quarter at a healthy pace, as we have originated over $80 million in new commitments since the March quarter end. Turning to slide 13, during the quarter, we had one loan originated in July 2016 prepaid based on the sale of the portfolio company by the private equity sponsor. This exit generated approximately $16.8 million in proceeds, generating a weighted average IRR of 13%. Since the launch of our credit strategy, we have realized 68 portfolio exits, representing approximately 800 million in proceeds, that have generated a cumulative weighted average IRR of 14.5%. Not surprisingly, refinancing activity continues to be slow given the widening spread on new loans in the market. Based on these dynamics, we expect solid net portfolio growth in the coming quarters. We are pleased with the strong market position that our team has established in the lower middle market. is a premier debt and equity capital provider as evidenced by our consistent deal origination activity and the broad array of relationships across the country from which our team is sourcing quality opportunities. In terms of underwriting this market, while our company and portfolio are performing well, we do find underwriting certain industries is more challenging given today's economic uncertainty. An important component of our loan underwriting has always been to run a stress case downside financial model for every new loan, simulating an extreme recession occurring soon after the closing of our loan. So in that respect, our underwriting in the current environment hasn't changed from what we have done in the past, although models today include much higher base rates than we have experienced historically. This modeling analysis attempts 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. Peak to trough recessionary performance volatility across industries, as demonstrated by performance in past recessions, can be very different. So it is critical to assign leverage levels that are appropriate for a given level of potential performance volatility. Specifically, in our stress case financial model, we require the fundamental underwriting standards that the model demonstrates that our loan remains well within the portfolio company's enterprise value and that the portfolio company's cash flow is able to cover our loan interest throughout the simulated recession. On slide 14, 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 fair value was weighted 86.6% to first-line senior security, 3.1% to second-line senior security, 0.1% to subordinated debt, and 10.2% to equity co-investments. The average hold size for portfolio loans and equity co-investments was $13.3 million and $2.2 million, respectively. The credit portfolio had a weighted average yield of 12.8% and weighted average leverage through our debt security of four times. 515 illustrates the rating migration within our portfolio for the quarter. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating. Is that the end of the quarter? 95.7% of the portfolio fair value was rated in one of the top two categories, a one or a two. As illustrated on slide 16, our total investment portfolio on this slide now, 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. Again, the portfolio remains heavily weighted towards first-ling senior secured debt with only 3% of the portfolio and secondly in senior secured debt. I will now hand the call over to Michael to review more specifics about financial performance for the quarter. Thanks, Don.

Specific to our performance for the quarter, as summarized on slide 18, we increased pre-tax net investment income 22% quarter over quarter to $22.8 million compared to $18.7 million in the prior quarter. Pre-tax NII was $0.65 per share for the quarter. During the quarter, we paid a $0.53 per share of regular dividend and a $0.05 per share of supplemental dividend. As mentioned earlier, our board has approved an increase to the regular dividend for the June quarter to $0.54 per share and declared another $0.05 per share supplemental dividend for the quarter. Maintaining a consistent track record of meaningfully covering our dividend with pre-tax NII is important to our investment strategy. We continue our strong track record of regular dividend coverage with 113% coverage for the last 12 months ended March 31, 2023, and 108% cumulative coverage since the launch of our credit strategy in January of 2015. Given the floating rate nature of our credit portfolio, elevated interest rates continue to be a significant tailwind to our net investment income. The base rate index used to calculate interest on the majority of our loans reset in early April to approximately 5.1%, up from its early January reset at 4.75%. This increase, quarter over quarter, will provide another immediate step-up in portfolio income in the June quarter. As such, we expect to thoughtfully increase our regular dividend to a level which can be sustained should base rates return to a neutral level. In addition, while base rates remain elevated, our intent is to distribute a portion of excess pre-tax NII to our shareholders each quarter through supplemental dividends. Based upon our current UTI balance of $0.45 per share, the ability to grow UTI each quarter organically by over-earning our total dividend, and the expectation that we will harvest gains over time from our existing $1.15 per share and unrealized appreciation on the equity portfolio, we are confident in our ability to continue to distribute quarterly supplemental dividends for the foreseeable future. For the quarter, we increased total investment income from our portfolio 14% quarter over quarter to $37.2 million, reducing a weighted average yield on all investments of 12.1%. Total investment income was $4.4 million higher this quarter due to our higher average balance of credit investments outstanding, in addition to the tailwind provided from increases in LIBOR and SOFR base rates. As at the end of the quarter, we had approximately $4 million of our investments on non-accrual, representing 0.3% of our investment portfolio at fair value, with no new non-accruals added this quarter. Finally, the weighted average yield on our loan portfolio was 12.8% for the quarter. As seen on slide 19, we further improved LTM operating leverage to 1.9% as compared to 2.2% in the prior year. Achieving 2% or lower operating leverage was one of our initial long-term goals when we relaunched Capital Southwest as a middle market lender back in 2015. Though we are pleased to have reached this milestone, looking ahead, we expect our internally managed structure to produce incremental improvements in operating leverage over time. We believe our willingness and ability to operate our business efficiently as an internally managed vehicle provide shareholders significant upside in terms of dividend sustainability and growth in the future. Turning to slide 20, the company's NAV per share at the end of the quarter increased by $0.12 per share to $16.37, representing an increase of 0.7%. The primary drivers of the NAV per share increase for the quarter were earnings in excess of our dividends for the quarter, as well as accretion from the issuance of common stock at a premium to NAV per share. Turning to slide 21, as Bowen mentioned earlier, we are pleased to report that our balance sheet liquidity remains strong, with approximately $196 million in cash and undrawn leverage commitments as of the end of the quarter. Based on our credit facility borrowing basis at the end of the quarter, we have full access to our incremental revolver capacity and will look to opportunistically increase commitments to the facility in the near future. Our bank syndicate continues to support our growth, and we are pleased with the flexibility the revolving credit facility provides to our capital structure. We also have $10 million in committed but unfunded SBA ventures to be used to fund future SBIC-eligible investments, as well as $45 million in uncommitted capacity on our current SBIC license to draw from in the future. As of March 31, 2023, approximately 45% of our capital structure liabilities unsecured, and our earliest debt maturity is in January of 2026. One of our initiatives for the current year will be to both increase and extend our revolver capacity in order to be well prepared to effectively manage maturities in the future. As Bowen mentioned earlier, we received a BAA3 investment grade rating from Moody's Investor Service in March of this year. This rating is further validation of our first lien-focused investment strategy, our strong credit underwriting track record, and our prudent balance sheet management throughout a variety of capital markets environments. We believe this rating will help immensely in future capital raises as we look to expand our investor base and complete larger capital markets transactions. Our regulatory leverage, as seen on slide 22, ended the quarter at a debt-to-equity ratio of 0.88 to 1. down significantly from 1.16 to 1 as of the March 2022 quarter. Over the past several quarters, we've made a concerted effort to strengthen our balance sheet to ensure we are prepared for any macroeconomic headwinds that we may encounter in the future. These efforts have included our opportunistic unsecured bond issuances at record lower rates in the late calendar 2021, our receipt of an SBA license in April 2021, which gave us access to long-term fixed debt at attractive rates, our continued support from banking relationships, which have allowed for steady growth in our revolver facility commitments, and our continued diligence in moderating leverage through creative equity issues utilizing both our ATM program as well as the secondary equity market. We will continue to work toward strengthening the balance sheet, ensuring adequate liquidity, and maintaining conservative leverage in covenant cushions throughout the economic cycle. I'll now hand the call back to Bowen for some final comments.

Thanks, Michael. And again, thank you, everyone, for joining us today.

We appreciate the opportunity to provide you with an update on our business, our portfolio, and the market environment. Our company and portfolio continue to perform well, and I continue to be impressed by the job our team has done in building a robust asset-based deal origination capability as well as a flexible capital structure. As to the uncertainty in the economy, again, we have been underwriting with a full economic cycle mentality since day one, which we believe has positioned us well for any economic environment presented to us in the future. In summary, we have a floating rate credit portfolio heavily weighted to first-lane senior secure debt allocated across a broad array of companies and industries, 90% of which is backed by private equity firms. We have a well-capitalized balance sheet with diverse capital sources, strong liquidity, and flexible capital, much of which is fixed rate and covenant-like. We believe our First Lane Senior Secured Investment focus and our capitalization strategy provide us complete confidence in the health and positioning of our company and our portfolio as we look ahead. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

Thank you, ladies and gentlemen. If you have a question or a comment at this time, please press star 11 on your telephone. If your question has been answered, you wish to move yourself from the queue, please press star 1-1 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Mickey Sleeman with Leidenberg Daumann. Your line is open.

Yes, good morning, everyone. I wanted to ask you about the portfolio activity during the quarter. what were the catalysts that allowed you to be so active in what is usually a seasonally slow quarter and with overall M&A volumes, you know, down pretty meaningfully?

You know, it's an interesting question. I mean, if I look down the originations, I mean, they were just sponsor relationships that were active in the market. You know, the lower middle market, I mean, activity was, you know, $60 million or so for the quarter is an okay quarter from Origination's perspective. So, you know, obviously as we referenced on the prepared remarks, we've done over $80 million in this quarter.

So the activity in our world with the sponsors that we have relationships with across the country, you know, it just continues to be, you know, nicely active.

So, you know, we also, leverage levels are down, spreads are up, loan to value increases.

percentages are down from like a year ago. So it, you know, I don't know that we were doing anything as a firm differently other than just, you know, continuing to underwrite to a coming recession. So, you know, it just, our sponsors are, have been, you know, reasonably active. Yeah.

And I'd also add, you know, as we've grown our balance sheet, you'll see, you know, our add on investments with our existing portfolio has grown as well. I mean, there's obviously a lot of these companies are doing well. They're doing M&A transactions themselves. So that supplements new platforms as well.

I'd say one thing, as I look down the originations, given some of these leverage levels, asset coverage on some of these deals, I would say that the banks have been less aggressive in the market. As I look at that, I see lower leverage levels in a couple of situations have nice asset coverage. A year ago, they would be bank deals. that we've been able to compete for. That's one thing.

And that has to be probably due to the bank's mentality looking at the market and pulling back, as we all know that's kind of going on in the economy.

And then, you know, we see, you know, less competition from, you know, a bank-mez alternative. You know, mez guys usually attach to a bank loan. And we're seeing, you know, my sense is we're seeing less competition from that, probably driven by, again, the bank's level of agreement.

So I think those two things in our world, in our lower middle world, would be a positive uplift all else equal to our activity.

And the activity that we mentioned earlier, Mickey, in terms of early originations in the June quarter, a lot of those were deals that we've been working on for the last two to four months. So they're not just coming on our plate today, so a longer table.

I understand. Yeah, I was actually going to ask about the bank competition. So I'm glad you addressed that. A couple more questions for me. Clearly, the market's concerned about the outlook for credit. That's no secret. But you noted that the portfolio is performing well, which is really good to hear. But I do see that the portfolio's average EBITDA declined. So could you just walk us through how much of that decline was due to any portfolio company performance issues versus just movements in the portfolio due to the size of the new investments that you made?

Yeah. I mean, like if we looked across our whole portfolio this quarter, as we do each quarter, you know, it's kind of on a weighted average basis, kind of flat, you know, revenues flat, even though the whole portfolio is basically flat. You know, so definitely, you know, I would say that the trajectory of the even time revenue, it's not really negative, but it's, it's not, it's slowing.

So, you know, from a portfolio comment, you know, the trajectory is flattening out, I guess, is the best way to say it. You're looking at the average EBITDA on the portfolio?

Yeah, I think it's because some of the new originations we put in place actually had lower EBITDA, and so to Bo's point, the existing portfolio is flat, but the new originations were less than that EBITDA, and therefore that's why you saw the reduction.

So it's not about

Yeah, my comment's more on a portfolio static basis. But yes, that's right. The new deals are slightly smaller, for sure.

Yeah.

Okay, that's what I suspected. So is that because you see the lower middle market is offering a better risk-adjusted return, or is it just idiosyncratic to the deal pipeline and the pace at which deals are closing? I'm asking because certain other BDCs have indicated that they're seeing better terms further up into the middle market or into the upper middle market, but historically that's not the case.

And we're seeing attractive terms in the lower middle market. I think also the other thing that's going on is we do a new origination. It's got a less EBITDA, smaller company. And we back a lot of buy and build. So we're doing add-ons with our sponsors.

And so the EBITDA of the portfolio company grows through acquisitions. And so you can see new originations are going to have most of the time less EBITDA than a portfolio would because we're just getting started. That's the first platform. We'll do several acquisitions and three or four quarters from now that EBITDA on that particular company could be much larger.

I understand. Just one housekeeping question. You mentioned, and I think in the press release it says you got $16.8 million from Amware Fulfillment, but I looked at the previous SOI and it showed a principal outstanding from them at $17.1 million. So I'm just trying to reconcile that to the IRR that you mentioned. Did you actually take a loss on that investment apart from the interest that you collected over time?

No, we definitely didn't take a loss. There was a principal prepayment that happened.

So that exit is the actual proceeds on the exit. So we had gotten a principal prepayment prior to the exit. So we got full power back.

Okay. That's it for me this morning. I appreciate your time as always. Thank you.

Thanks, Mickey. One moment for our next question.

Our next question comes from Eric Zwick with Havde Group.

Your line is open.

Thank you. Good morning. I wanted to first just start as I looked at the trends. in the income statement noticed that both the dollar amount and the percentage contribution from PIC interest has increased. Wondering if you could just talk about that trend a little bit, what's driving that?

Yeah, so from the previous quarter to this quarter, that's actually one company that had around $300,000 in PIC. Now, that company had a PIC toggle through a previous amendment that ended at the end of March 31 when we had another amendment where there was an equity infusion in cash. So that company is delevered and performing and back on cash.

So we would expect that to come back down in the subsequent quarter.

Okay. That's helpful. Thank you.

And then I noted that for the I-45 SOF, that credit facility was amended to reduce the available total commitment from 150 to 100. Curious, you know, kind of maybe the tenor of that discussion or what kind of drove that reduction?

Yeah, we probably tell you over the last two and three years, our investments in the syndicated space has been opportunistic at best. So what we've seen are the credit facility come down from probably $135 million drawn to $80 million drawn today. And so we were incurring significant unused fees at the $150 million in commitment size. So it made sense, without us seeing a runway where we'd be re-levering that facility, it made a lot of sense to do a permanent reduction to the level that's more appropriate for our current utilization.

And just to be clear, 100% driven by us.

Okay, great. I appreciate the commentary there, and I guess Maybe a quick follow-up on that one. Does that mean, as you mentioned, you don't have any ability to or don't have any desire at this point to kind of utilize that and leverage that facility back up? Is that just what you choose to hold on your balance sheet outside of that? The opportunities are more attractive today in terms of spread and what you're seeing?

I mean, I would tell you yes. I mean, if you look at a levered return – our leverage on our balance sheet is about commensurate with the leverage in the credit facility for I-45, and the yields tend to be wider on the lower middle market than they do in the upper middle market. So the all-in return is more attractive. We also have more control as a first lien lender with Covenant than you might see on the syndicated space.

Yeah, as we've kind of said the last several quarters, I mean, from what I've heard from other earnings calls, I think it's probably similar across the industry. I mean, the syndicated markets, It hasn't been that interesting with Sandbox, especially for us, given how robust our lower middle market asset class and platform is being. And that senior loan fund is really designed around a syndicated market kind of product.

And so, you know, the decrease in the facility reflects kind of the, you know, the less investing in that asset class. And, you know, we'll see where it goes going forward. You know, we could always grow it and expand it in the future if we could.

saw the opportunity to but we don't we don't really we're very focused on the direct lending to the lower market where we lead the deals and to the point earlier i mean there was there's plenty of appetite from db who leads that facility to grow as well as some of the lenders underneath it in the syndicate got it that's helpful thank you one last one for me and then i'll step aside and um i appreciate the interest rate sensitivity table you included on page 26 and

I guess I'm just curious if the Fed is done hiking here. I guess there's still some debate whether they do one more in June. But if we start to see LIBOR and so forth kind of level out, maybe hold at this level for a little while, is there still a little bit of lag benefit that you would see in terms of your portfolio yields and NII as it kind of catches up to the final Fed or increase in kind of the base rates and so forth in LIBOR? And then as we move forward, would you still potentially feel a little bit of creep as you put on new investments would seem to be coming on with maybe with higher spreads, just trying to get a sense of, you know, the direction of NII from here.

Sure. Yeah, we would tell you that, you know, if rates do flatten out at five and a quarter or thereabouts for a period of time, I mean, we would expect that our NII would be somewhere in the 65 to 70 cents range for a period of time. It's hard to see. You know, we've I think we put our balance sheet in a pretty strong position. You know, we've got, you know, inexpensive fixed rate debt. We've got the SBIC, which is low rate that we're funding off of and, you know, floating rate assets.

So, certainly, you know, we can see expansion in NII in the near term.

Thanks for taking my questions today. Thank you. One moment for our next question. Our next question comes from Robert Dodd with Brayman James.

Your line is open.

Hi, guys. On the leverage, you know, obviously it's come down. It's slightly below, I think, the historic target range. Now, can you give us any – is that – you see the pipeline building, obviously, $80 million since the end of the quarter, and so you took the leverage down to rebuild it that way, or was there any connection to – you know, was there any feedback from Moody's that –

maybe they've got a different target in mind well i'll tell you from moody's is actually part of their analysis in providing us an investment grade was our strategy to deliver going into what could be a cycle and being at the low level the lower end of our range meant you know certainly was important to them um i mean that's it just happened to dovetail their view with dovetail with our strategy so that's positive Going forward, I mean, I think we tell you, Bo and I would tell you that if we think we're going into a tumultuous time or even they're going kind of sideways, we think we should start out at a lower leverage. And so being at 0.88, 0.9 is where we'd like to be. We still see the ability to raise equity off the ATM, which we started off this quarter with the ability to do that as well. So we feel like staying at that bottom end is not going to be an issue for us in the short term, and it's certainly where we are. If and when there's sort of an all clear in the market, you could see us, you know, picking up, maybe raising slightly less equity and trending closer to one times regulatory leverage, but that's where we are now.

Got it, got it. I appreciate that. Now, one more question if I can. Maybe I'm reading too much into this. Okay, so on page 15 of your presentation, obviously there were three investments that were downgraded, but small, right? This quarter, but last quarter you had nine, category three, category four. This quarter you've still got nine. So three downgrades, presumably three others that were already rated at the lower end of the curve were exited. If I look at footnote five on page 14, right, last quarter you're excluding six portfolio companies, right? because of uh i guess negative ebitda um and this quarter is you're excluding nine right so there's three again so is it does it is are there really portfolio companies that are showing meaningful ebitda deterioration or or is there i mean obviously you talked about the average right the average portfolio revenue if it does kind of flat um But is at the margin, are there three that are showing material weakness at the moment, or am I reading too much into a couple of tiny details?

Yeah, we'll break that apart in a couple of pieces.

The new downgrade to a four was the last small loan in one of the prior, not four-oriented companies. So it's further deterioration in an already very tough situation we've been writing it was written down for a while so so that's that's not a new portfolio company story um the two that that were the two downgraded to a three you know both underperforming one of them underperforming very temporarily because of some inventory adjustments that is customers um the other ones that you know underperforming um and so it deserves going down to a three um

And so that's, I mean, to add to that, Michael, that's the... Yes, and then the color behind those... Yes, and then if you turn to slide 14, the increase from 3.6 times to 4.0 was actually we included a company back in these metrics because it now has positive EBITDA where it had negative EBITDA in the previous quarter. And therefore, the metric shifted up just by its inclusion because it is a highly leveraged business.

I think if you excluded that company, the weighted average leverage would actually have been pretty consistent with the previous quarter.

Got it. Got it. I appreciate that. Thank you. Sure. Thanks, Robert.

And I'm not showing any further questions this time. I'd like to turn the call back over to Bowen.

Great. Thank you, Operator. Thanks, everybody, for joining us. We always love giving you an update on our company and how we're performing, and we look forward to speaking to you next quarter. Thank you.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.