Capital Southwest Corporation

Thank you for joining today's Capital Southwest fourth quarter and fiscal year 2024 earnings call. Participating on today's call are Bowen Deal, CEO, Michael Sarner, CFO, Josh Weinstein, CIO, and Chris Rehberger, EVP 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 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, Owen Deal.

Thanks, Chris. And thank you, everyone, for joining us for our fourth quarter and fiscal year-end 2024 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 over the last quarter as well as highlights of our performance over the last year. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found in the investor relations section of our website at www.capitalsouthwest.com. You will also find our quarterly earnings press release, issued last evening, on our website. Before we begin, I would like to take the opportunity to mention two recent promotions which will broaden our executive team here at Capital Southwest. Josh Weinstein, who joined Capital Southwest in 2015 and manages all our deal sourcing and underwriting activity, has been promoted to Chief Investment Officer. And Chris Rehberger, who also joined Capital Southwest in 2015 and manages all our treasury and valuation activities, has been promoted to Executive Vice President, Finance and Treasury. Both of these gentlemen have been integral contributors to Capital Southwest in generating our strong track record over the last nine plus years. Core to our culture is continually cultivating talent up and down our organization, and these additions to our executive team illustrate the deep bench strength that our company has developed over the years. We'll now begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the March 31, 2024 fiscal year. During the fiscal year, we grew our total investment portfolio at fair value by 22% to $1.5 billion, up from $1.2 billion at the end of the prior fiscal year, while increasing our pre-tax net investment income by 18% to $2.72 per share, up from $2.30 per share in the prior fiscal year. We increased our regular dividends paid to shareholders to $2.24 per share for the fiscal year, representing an increase of 10% compared to $2.03 per share of regular dividends paid in the prior fiscal year. We continued our strong track record of covering our regular dividends with pre-tax net investment income, achieving coverage for the year of 121%. In addition to our regular dividend, we paid a total of 23 cents per share in supplemental dividends during the fiscal year, compared to 10 cents per share in supplemental dividends paid in the prior fiscal year. For our March 2024 fiscal year, assuming reinvestment of our quarterly dividends, we generated a total return for our shareholders of 56%, which was among the top-performing public BDCs during this time period. During the year, we strengthened our balance sheet through a variety of capital markets activities, which raised over $500 million in additional capital while reducing our regulatory leverage to 0.82 debt-to-equity as of the end of the fiscal year. Capital raised during the year included $184 million in gross equity proceeds through our equity ATM program, a new senior secured SPV credit facility led by Deutsche Bank, and an increase in commitments on our existing corporate credit facility led by ING. During the fiscal year, we also completed an underwritten baby bond offering. We obtained approval for the final amount of leverage on our first SBIC license, and we began the licensing process for our second SBIC license. Michael will discuss further details around these capital raising activities later in our prepared remarks. Starting in 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 68 cents per share which more than covered both our regular dividend of 50 cents per share and our supplemental dividend of 6 cents per share paid during the quarter. Portfolio earnings continue to be strong, and as of the end of the quarter, we estimate that our undistributed taxable income was 64 cents per share. Net asset value per share ended the fiscal year at $16.77, which was flat compared to the prior quarter, and up 40 cents per share compared to the year-ago quarter. As we look forward to the June quarter, we are pleased to announce today that our Board of Directors has declared a regular dividend of 57 cents per share and a supplemental dividend of 6 cents per share, bringing total dividends declared for the June quarter of 2024 to 63 cents per share. Deal quality and activity in the lower middle market during the March quarter continued at a healthy pace as private equity firms and business owners continued to transact and we continue to source attractive investment opportunities. While we have continued to source and close deals at comfortable loan-to-value levels, averaging approximately 40%, and leverage levels of approximately 3.5 times debt to EBITDA, competition in the low-end of the market has increased, resulting in spreads tightening to levels last seen over 18 months ago. The increased competition for quality deals has come from both non-bank lenders and to some degree, traditional banks. Over the past decade, our team has done an excellent job generating attractive returns for our shareholders in all competitive environments, and I'm highly confident we will continue our track record in the current environment. Portfolio growth during the quarter was driven by $157.5 million in new commitments to six new portfolio companies and five existing portfolio companies. offset by $13.7 million in proceeds from two debt prepayments, which generated a weighted average realized IRR of 16.5%. On the capitalization front during the quarter, in addition to closing the FPV credit facility, we raised nearly $50 million in gross equity proceeds during the quarter through our equity ATM program at a weighted average price of $23.80 per share, or 142% of the prevailing NAV per share. Finally, consistent with our communication on last quarter's conference call, the I-45 Senior Loan Fund was dissolved and the assets were distributed to the joint venture partners in accordance with their respective ownership percentages. We have remained diligent in ensuring we have strong balance sheet liquidity while also funding a meaningful portion of our investment activity with accretive equity issuances. We continue to maintain a conservative mindset to both BDC leverage and balance sheet liquidity. Managing leverage to the lower end of our target range while ensuring strong balance sheet liquidity affords us the ability to continue to invest in new platform companies and to grow our balance sheet even in periods of volatile capital markets when risk-adjusted returns can be particularly attractive. Additionally, it allows us the ability to support our portfolio companies by either providing growth capital or by financing add-on acquisitions, all while maintaining the ability to opportunistically repurchase our stock if it were to trade meaningfully below NAB. On slides 8 and 9, we illustrate our continued track record of producing steady 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 28 times and have never cut the regular dividend, all while maintaining strong coverage of our regular dividend with pre-tax net investment income. Additionally, over the same time period, we have paid or declared 24 special or supplemental dividends, totaling $3.95 per share, all generated through excess earnings and realized gains from our investment portfolio. Dividend sustainability, strong credit performance, and continued access to capital from multiple capital sources are all core to our overall business strategy. Our track record in all these areas demonstrates the strength of our investment and capitalization management strategies, as well as the absolute alignment of all our decisions with the interest of our shareholders. Prior to slide 10, as a reminder, we lay out our core tenets of our investment strategy. Our core strategy is lending and investing in the lower middle market, the vast majority of which is in first lien senior secured loans to companies backed by private equity firms. In fact, approximately 92% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as a potential source of new junior capital support if needed. In the lower middle market, we often have the opportunity to invest on a minority basis in the portfolio company equity Perry pursued with the private equity firm, when we believe the equity thesis is compelling. As of the end of the quarter, our equity co-investment portfolio consisted of 65 investments with a total fair value of $132 million, which was marked at 141% of our cost, representing $38.5 million in embedded, unrealized depreciation for $0.85 per share. Our equity portfolio, which represented approximately 9% of our total portfolio fair value as of the end of the quarter, continues to provide our shareholders participation in the attractive upside of these growing lower middle market businesses, which will come in the form of NAV per share growth and supplemental dividends over time. As illustrated on slide 11, our on-balance sheet credit portfolio ended the quarter at $1.3 billion, representing year-over-year growth of 30% from $1 billion as of the end of March 23 quarter. By the current quarter, 100% of the new portfolio company debt originations were first lien senior secured, and as of the end of the quarter, 97% of the credit portfolio was first lien senior secured. During the year, we improved the granularity in our portfolio as the average investment exposure per portfolio company ended the fiscal year at 0.9%, compared to 1.3% as of the end of the prior fiscal year. We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet. We expect that this metric will continue to improve as our asset base grows. On slide 12, we detail the $157.5 million in capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $123.5 million in first lien senior secured committed to six new portfolio companies in which we also invested $2.8 million in equity. In addition, we committed a total of $31.1 million in first lien senior secured debt and $143,000 in equity to five existing portfolio companies. We are pleased with the strong market position that our team has established in the lower middle market as a premier debt and equity capital provider, as evidenced by the consistency of our origination activity and the broad array of relationships across the country from which our team is sourcing quality opportunities. As a point of reference, currently there are 70 different private equity firms represented across our investment portfolio. Since the launch of our credit strategy back in January of 2015, we have completed transactions with over 100 private equity firms across the country. including over 25% of which we have completed multiple transactions. Turning to slide 13, we continued our track record of strong returns on our exits, with two debt prepayments during the quarter. In total, these exits generated $13.7 million in total proceeds, generating a weighted IRR of 16.5%. Since the launch of our credit strategy, we have realized 74 company exits, representing 919 million in proceeds that have generated a cumulative weighted average IRR of 14%. On slide 14, we detail key statistics for our portfolios in the end of the quarter. The total portfolio fair value ended the quarter weighted 88.7% to first lien senior secured debt, 2.3% to second lien senior secured debt, 0.1% to sub debt, and 8.9% to equity co-investments. The credit portfolio had a weighted average yield of 13.3% and weighted average leverage through our security of 3.6 times EBITDA. Overall, we are quite pleased with the portfolio company performance across the portfolio. Cash flow coverage of debt obligations across the portfolio remains at a healthy 3.2 times despite the higher base rate environment. And quarter-over-quarter revenue and EBITDA growth on a weighted average basis was 3% and 5% respectively. As seen on slide 15, our total investment portfolio continues to be broadly diversified across industries with an asset mix which provides strong security for our shareholders' capital. On slide 16, we have laid out the ratings migration across our portfolio during 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. We had four loans representing almost $30 million in fair value upgraded this quarter, while having four loans representing about $14 million in fair value downgraded this quarter. The portfolio remains healthy with 94.7% of the portfolio at fair value, rated in one of the top two categories, a one or a two. I will now hand the call over to Michael to review some specifics of our financial performance for the quarter. Thanks, Bowen.

Specific to our performance for the quarter, as summarized on slide 17, pre-tax net investment income was $29.8 million, or 68 cents per share, as compared to $29.8 million or $0.72 per share in the prior quarter. During the quarter, we paid out a $0.57 per share regular dividend and a $0.06 per share supplemental dividend. As mentioned earlier, our Board has declared a regular dividend of $0.57 per share and a supplemental dividend of $0.06 per share for the June quarter. Maintaining a consistent track record of meaningfully covering our dividend with pre-tax net investment income is important to our investment strategy. We continued our strong track record of regular dividend coverage with 121% coverage for the 12 months ended March 31, 2024, and 111% cumulative coverage since the launch of our credit strategy in January 2015. As a reminder, our intent is to continue to distribute a portion of the excess of our quarterly pre-tax NII over our regular dividend to our shareholders in a quarterly supplemental dividend. We are confident in our ability to continue to distribute quarterly supplemental dividends for the foreseeable future based upon our current UTI balance of 64 cents per share, our 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 85 cents per share in unrealized depreciation on the equity portfolio. For the quarter, Total investment income decreased to $46.4 million from $48.6 million in the prior quarter. The prior quarter's investment income included a significant one-time dividend from one of our portfolio companies. The quarter-over-quarter decrease in dividend income was offset by an increase in interest income from the growth in our credit portfolio. As of the end of the quarter, our loans on non-accrual represented 2.3% of our investment portfolio at fair value, and the weighted average yield in the portfolio on all investments was 12.7%. As seen on slide 18, LTM operating leverage ended the quarter at 1.7%, which compares favorably to the BDC industry average of approximately 3%. We believe this metric speaks to the benefits of the internally managed BDC model and our absolute alignment with shareholders. The internally managed model has, and will continue to, produce real fixed cost leverage while also allowing for significant resources to invest in people and infrastructure as we continue to build a best-in-class BDC. As we look forward, we expect further improvements in operating leverage as we continue to grow our balance sheet over time. Turning to slide 19, the company's NAB per share at the end of the quarter was $16.77, which was flat from the prior quarter, and up 40 cents per share from the year ago March 2023 quarter. Turning to slide 20, we are pleased to report that we have significant balance sheet liquidity with approximately $398 million in cash and undrawn leverage commitments on our two credit facilities and our SBA debenture commitments, which altogether represented 2.8 times the $140 million of unfunded commitments we had across our portfolio as at the end of the quarter. As Bowen mentioned, During the quarter, we raised a new senior secured SDB credit facility led by Deutsche Bank. The facility has $150 million in initial commitments, which will contractually increase to $200 million of total commitments by June 2024. In addition, based on the current borrowing base, we have access to the full $460 million in total commitments for the ING-led corporate credit facility, which has an accordion feature allowing for the further increase in total commitments in this facility up to an aggregate of $750 million, allowing us to continue to grow our revolver capacity in lockstep with the growth of our overall balance sheet. We are actively working to further increase commitments in the corporate credit facility and provide updates on that process in the coming months. In March 2024, we submitted a MAC application to the SBA, which has begun the process towards a second SBIC license. We look forward to providing updates on this process as they become available. Finally, as of the end of the March quarter, 46% of our capital structure liabilities were in unsecured covenant-free bonds with our earliest debt maturity in January, 2026. As Bowen alluded to earlier, during the quarter, the I-45 Board of Managers approved the dissolution of the fund, which included a full repayment of the I-45 credit facility and the distribution of the I-45 assets to the joint venture partners in accordance with their ownership percentages. The assets distributed to Capital Southwest from the I-45 Fund are now included on the schedule of investments in our financial statements. Our regulatory leverage, as seen on slide 21, ended the quarter at a debt-to-equity ratio of 0.82 to 1, down from 0.88 to 1 as of the year-ago March quarter. We will continue to methodically and opportunistically raise secured and unsecured debt cap as well as equity capital through our ATM program to ensure we continue to maintain significant liquidity and conservative leverage with adequate covenant cushions. Despite not having any maturities within our debt structure until 2026, we were always proactively planning our path forward to mitigate the risk of capital markets volatility. Finally, we are very pleased that both Moody's and Fitch have recently affirmed our investment grade rating. I will now hand the call back to Bowen for some final comments.

Thanks, Michael. And again, thank you, everyone, for joining us today. As always, 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 demonstrate strong performance, and we continue to be impressed by the job our team has done in building a robust asset base, deal origination and portfolio management capability, as well as a flexible capital structure. We believe we have prepared our company well for future growth and performance. The overall health and security of our portfolio is strong. Our credit portfolio is predominantly made up of first lien senior secured loans allocated across a broad array of companies and industries, the vast majority of which are backed by private equity firms. Further, interest coverage on the debt obligations across our portfolio is a strong 3.2 times. with our loans across our portfolio averaging approximately 40% of the portfolio company enterprise value. Additionally, our equity co-investment portfolio gives our shareholders participation in the equity upside of many of these growing lower middle market businesses, providing further enhancement to our long-term shareholder returns. Last but not least, we have a very well capitalized balance sheet with multiple capital sources, strong liquidity, a flexible capital structure, and an exciting runway to continue to grow our company, generating strong shareholder returns for years to come. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

Thank you. As a reminder, if you have a question at this time, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. One moment while we compile our Q&A roster. And our first question is going to come from the line of Mickey Sheelan with Ladenburg. Your line is open. Please go ahead.

Yes, good morning, everyone. Bowen, you mentioned spreads tightening, which is certainly consistent with everything we're hearing across the space. When you look at the vintages of your portfolio, how much refinancing risk do you see going forward?

Yeah, thanks, Nikki. I mean, look, if we think about the strengthening of the market, the liquidity in the market, and if you look at our rated number one, you know, companies rated number one, companies have significantly outperformed. They're clearly, in most all cases, refinancing candidates. All that said, I mean, there's some things you should, you know, most that don't should understand. I mean, there are ways that we can defend against in some respects refinancing risk on outperforming companies. And obviously we can go proactively if the risk is materially changed, we can go proactively and reduce interest rate on our loans to make it less, you know, less incentive to have us refinanced out. Um, you know, we can do dividend recaps, we can add additional debt on the business that's still well underneath, you know, what you'd be comfortable with leveraging a very well performing business that we understand. And in some cases, we've got one case where the leverage is so low and the company's cash flowing so well, we actually have a situation where we let the sponsor take cash dividends out each quarter. We take a little money to pay back the debt. They take a little money to put in their pocket. And it kind of removes the incentive for them to refinance us out in a very, very safe credit. So there's things you can do, us and anyone else in our position, to defend against those refinancing risks. But clearly, when the market strengthens, and you have companies that are outperforming, you definitely have refinancing risk. And so that's kind of just give you a flavor of some of the ways we manage it.

Yeah, also, I mean, just to quantify, so it's about $200 million, we would say, of portfolios loan grade one that would fall in that category, many of which has been originated in the past 18 months. So to them, they still have call protection on many of those loans. And then the other piece to note is, you know, our all-in yield is 8%. spread over SOFR on our portfolio, which is obviously robust. So if we have a portion of that $200 million that we're not able to retain and it comes back, we don't feel like it's a material downdraft to earnings going forward.

Thanks for that. That's very helpful. Could you give us some highlights on what caused the net realized loss this quarter?

So predominantly, it was the I-45 law. So if you think about it, we had depreciation embedded in I-45 that was unrealized as an equity position. And when I-45 dissolved, that became a realized event into retained earnings. So that was about, I think, $16 million of it.

I understand. I also saw that the fair value of your non-accruals went up a little bit. Was that caused by a new non-accrual, or was that valuation different? adjustments of the previous non-accruals?

Yeah, we had two new names. One's a very highly talked about syndicated name, and another one's a small company in the education space where we had fraud involved. And so, yeah, we had two new non-accrual names. Yeah.

Okay. And I think this is a note, Mickey, those are both from the watch list. So, you know, it isn't really a degradation of portfolios. just sort of two names that had some issues. What we'd also say is when you look at our non-accrual, we have our granularity in the total portfolio is about 0.9%, down from 1.3%. So when you look at our portfolio, very granular portfolio, so non-accruals are painful and we don't like seeing them up. We do say that the impact to earnings is quite small. Those two non-accruals accounted for about a penny of earnings for the quarter.

Yeah, I appreciate that, and that's certainly something I watch carefully. Lastly, Michael, the new SPV credit facility has a higher spread than the existing corporate credit facility. So notwithstanding that, what are the advantages of putting that into place?

Sure. Well, first I would tell you this. So the spread in and of itself is higher, but the fees and the unused are lower. So they're actually at parity, the two facilities. So the other benefit is, we would tell you, we wanted to expand our diversity of our sources. Some banks, we've been told over the last few years, we're looking for something of an FPV variety because it's better from a capital charge perspective rather than the on-balance sheet credit facility. So that's one of the reasons why we were pursuing an FPV structure. The other thing we would tell you is that the lenders that were involved in I-45 were who, once it was dissolved, were still very interested in doing business with Capital Southwest. So they were looking for a way to get back in. So this was one way. Deutsche took down the $150 million plus the additional $50 that's coming on board in June. But the other lenders in there have some interest as well. So we're looking forward. We're looking at our maturities out in 2026, and we're thinking about it today. So we'd like to build up a secured portfolio dry powder and secured facilities that allow us, if need be, to take down portions of the debt and those maturities if the capital markets were closed. We do anticipate probably paying it down prior to getting within six or 12 months, but having diversity of secured sources that we can draw, especially to refinance, is really helpful in terms of flexibility.

Yeah, I understand, and that makes sense. Those are all my questions this morning. I appreciate your time, as always. Thank you.

Thanks, Vicki.

Thank you, and one moment as we move on to our next question. And our next question comes from the line of Vilas Abraham with UBS. Your line is open. Please go ahead.

Hi, everyone. Thanks for taking the question. I wanted to ask about the mix of originations in the March quarter. It looks like the top three, about $70 million or so in funding for consumer products and consumer services. Can you update us on just how you're feeling about more cyclical industries and, in general, what kind of internal framework you might have on managing industry concentrations across the portfolio?

Yeah, well, first I'll say we look at economic sensitivity the same across all our companies. We look at, you know, past recessions and what that customer base or that, you know, type companies in that industry did from an economic, from an earnings volatility. So that's the same way we look at consumers. And so, you know, so I think, and we lever accordingly. So these consumer companies, I mean, they're kind of interesting names. It's a lower leverage, high fixed, high free cash flow, high variable cost component of their cost structure. In one case as a enthusiast type product, In the other case, it's an incubator for new fragrance lines and things in the industry. So interesting consumer place. And then the consumer services company is a two-man-and-a-truck franchise that basically boasts of their businesses moving renters from apartment to apartment in local markets. And so obviously a segment that may be perhaps less cyclical, but ultimately we look at the businesses as we match leverage to potential economic, So, you know, with respect to your question on sectors, we look at that. I mean, clearly, you know, I'd say, you know, we're, you know, consumer is an area that, you know, is probably close to the top of what we'd be doing from a weighted perspective. But we're constantly, you know, Josh and I and Michael are constantly looking at that from a risk management perspective. We don't want something in the market existential in the market to basically move the credit picture of our portfolio meaningfully.

Okay. And you don't necessarily have any hard ceilings in terms of concentration for particular industries, right?

No, I don't think so. I mean, like, I think, you know, our sectors, you know, we've got some of the larger concentration sectors, you know, around a relative basis. You probably would look at us increasing those meaningfully, but I don't feel, I mean, we don't feel like there's, like, Of course, it's not just the sector. It's the actual companies that are in there and what they do within that sector. But we don't think we're overweighted in any sector.

And to these sectors, certainly consumer is something that has a higher bar. I think Bowen mentioned earlier in his statement just now that our leverage levels on those are really in the two to three times with loan-to-values in sub-40%. So these are companies that we feel like they're the financial profile. and their cash flow history would stand a cycle well.

Obviously, we all have sensitivity to the consumer sectors. It starts with us having sensitivity to that as well. I think it is interesting to point out that all three of these consumer names are with private equity firms that virtually all they do is consumer. They're very deep. What's interesting about a sponsor who has deep expertise in a sector, especially like consumers, is if you look across their portfolio, they have relationships across customers or suppliers or sales channels like retail or whatever across to other companies that they use to leverage to support and enhance the consumer company that they're buying. And so it's interesting. I mean, you really can't say that about a generalist private equity firm necessarily. but one that's deeply rooted in a consumer sector or healthcare sector. But consumer especially, they can really leverage their relationships across their portfolio to enhance, and that's kind of part of their playbook, apparently, to leverage those relationships to enhance each new platform they buy. Got it.

Okay, that's helpful. And my next question is, yeah, so I appreciate your remarks on... competition and spread tightening. Has there been any impact to structure that you're seeing at this point? And is it any harder now to get the equity co-invest than in the past?

So on the structure, I would tell you, any time the market increases in competition, you have some erosion of structure. But the good news is we always talk about, and I know you know this, but like in the lower middle markets, I mean, our documents are tight, our covenants are tight, reasonable, you know, the EBITDA ad-bats, we're very sensitive to that. You know, so sometimes credit performance, obviously credit, I mean, it's wrong to say it doesn't change at all when the market gets more competitive, but in our market, I mean, it's already well within what one would be comfortable with, and so it doesn't really deteriorate that much, but it's not zero. And then what was the other part of the question? So equity co-investment. Yeah, equity co-investment is usually a function of that private equity firm's, you know, the size of their check versus the size of their fund, where they are in their fund life, and that type of thing. It's not necessarily a function of how competitive the market is. It's more of a function of the individual private equity firm and where they are on their liquidity profile.

And you will see, though, as, you know, our checks – We haven't really grown our hold size that much. Obviously, we talked about the granularity. But to the extent we have, or maybe our debt goes up from $12 to $15 million or maybe $18 million, you're not seeing the equity check. It's still difficult to get a large equity investment, equity co-investment from all these sponsors to where Bowen's indicated. And in other cases, obviously, places where we get the debt story, we don't get the equity story. So with that all being said, I mean, we'd expect our equity hold as a portfolio would probably be in the 8% to 10%. Probably not going to be able to grow up beyond 10%. Okay.

We'll hop back in the queue. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Bryce Rowe with B. Reilly. Your line is open. Please go ahead.

Thanks. Good morning. Maybe we wanted to start with a couple more questions about I-45. I'm just curious, what was the impact on the debt portfolio from that resolution or dissolution in just trying to understand the quarter-over-quarter increase in the debt portfolio? What percentage of that or what dollar amount was coming from the I-45 asset?

Sure. So there were 17 portfolio companies that came over for approximately $80 million. And just the yield on those were about S plus 650. So not materially lower than our portfolio, but obviously the $80 million is a very small percentage. So it had a very little impact. And I've mentioned on other calls that The impact to earnings is net positive because we're getting rid of a lot of frictional costs associated with trustees and audits, et cetera. So you could consider this a net impact to earnings to CSWC.

Okay. And, Michael, I mean, what's the inclination to hold those or just to be opportunistic if you see an opportunity to get out? I assume you're not in control of the situation, so to speak. So you're more along for the ride. Is that the right way to think about it?

That would be the right way to look at it. That's right. We just ride the story out. Okay.

Okay. And then, Bowen or Michael, you mentioned the dividend income for the quarter and it being, you know, more one-time in nature. Can any color around, you know, the source of that dividend and then, you know, help us quantify, you know, how much it in fact was? Yep.

So actually, what I was indicating was last quarter, we had a $2.4 million one-time dividend. So that's for the 1231 quarter. And then this quarter, we had some dividends, but we certainly didn't have anything of that materiality. So I think dividend income came down about $2 million quarter over quarter. But at the same time, our interest income, one, because you had assets coming over from I-45 into the portfolio, as we just noted, there was additional interest income there, plus we had net portfolio growth during the quarter. Okay.

And so was there any I-45 dividend income in the quarter? I assume there's not, but maybe there was.

Yeah, there was a bit of it. I think it was around $500,000. It wasn't significant for the quarter. Okay.

Okay. Last one for me. the comp line down a bit. It sounds like from the press release, there was just a difference in bonus accrual quarter over quarter. Any thoughts on kind of what a good run rate might be from a comp perspective?

Sure, sure. So cash comp, I would expect for this coming quarter, fiscal year to be on a quarterly basis around $2.8 million for cash comp. Probably the RSU expense around $1.5 million. and gna is about two and a half million a quarter so the total you'd expect about 6.8 million dollars as a run rate quarterly that'll obviously vacillate up and down but that's what you should expect maybe on a that times four would be your annualized amount okay and and what what was the reason for the you know the the lower bonus bonus accrual in the quarter Sure. So in that previous quarter, they indicated that we had that $2.4 million dividend. And so at that point, we accrued additional bonus accrual above the target. And then in the fourth quarter, we had accrued probably above where we decided to pay out for the company. And so there was a back out of some accrual for the bonus.

All right. That's it for me. Appreciate it. Thanks, Bryce. Thanks, Bryce.

And one moment as we move on to our next question. And our next question is going to come from the line of Eric Zwick with Hovde Group. Your line is open. Please go ahead.

Thank you. Good morning, everyone. Just one question for me today. One, it was nice to see that the dollar value of investment upgrades was a little bit more than twice what was downgraded in a quarter. And I guess my question is more towards those downgrades, those three relationships you have there. If you could just talk maybe about the circumstances or characteristics that led to those downgrades in terms of company performance or whether they're facing some industry challenges or anything you could provide there would be interesting.

Yeah, no, I mean, I'm just looking at the list here. I mean, they were all pretty idiosyncratic. You know, two of them were our non-accruals One of them is another company that's relatively anti-Socratic. It's hard to really put a point on the economy that we see. One of them was broad. One of them is a large syndicated deal. It seems to be over levered. There are not really any trends in those names that I can point to.

That's helpful. I appreciate it. Maybe then Kind of one quick follow-up on that point, Sal. If we look at the interest rate futures curve, it seems that we're likely to be in this higher for longer interest rate environment for a while. And I guess, how are your companies coping with this? Were there any that were holding out, hoping that we would see a decline in interest rates, or most managed well and have continued to be able to grow EBITDA and hopefully deliver over time? How are they handling this interest rate environment?

Yeah, a couple of comments I'll make on that. on the last 12 months of, or 12, 18 months of this kind of interest rate cycle, we kind of commented on some of the things we've seen these private equity firms do and, you know, cutting operational costs, you know, because their interest burden is going up. And they've been doing that. And if you look at our, and then we're also, you know, leverage levels that we're leveraging companies up and, you know, fixed charge coverage is a very important metric, right? Obviously. And so as rates increase, come up, leverage on new loans can come down. And so if you look at, ultimately if you zone out and say, okay, what's the health of the engine that's generating earnings and dividends for our shareholders? Things like, you know, EBITDA to interest coverage metrics on a weighted average basis of 3.2 times, pretty healthy, especially in the current interest rate environment. And then average loan-to-values, which is not necessarily a fixed charge issue, but it's just an absolute leverage issue. You know, 40% is pretty healthy. So We feel like as a portfolio, you know, we look at, you know, narratively, we look at what the private equity firms are doing in the portfolio to manage the business in a higher interest rate environment. And we look at the, you know, kind of portfolio level test metrics, and you feel pretty good. I mean, there's, you know, there's small problems here and there, a small handful of companies that we talk about. But overall, the portfolio looks pretty good from an engine creating earnings for our shareholders perspective. And then, you know, the longer we go into this, the longer the industries, companies, private equity firms have kind of gotten their sea legs, if you will, in the higher interest rate environment and they've managed the business. So the longer we're in this environment, the less you kind of wake up in the middle of the night thinking something's going to blow up, you know, kind of thing. Does that mean you're going to have, you know, the one thing I will say is interest rates are higher. It brings problems to the table faster and our deal teams can get in front of the private equity firms and insist that they put money in the businesses and support anything from liquidity, but also they want to continue to increase their capex budgets, maybe higher than what we have in our credit agreement. We have sponsors that have put equity in, so they can continue to focus on their growth, those types of things. And so when the system gets tighter because the interest burden is going up, it tightens the whole system and brings conversations to the table faster before there's kind of a material change. problem or shift in the thesis of the business, if that makes sense.

I think the lever that's available probably to all BDCs is the PIC, a PIC toggle. We haven't seen that across the portfolio, but certainly there's probably one or two where that has come into play. We saw that our PIC number came down significantly from the previous quarter, so we're still at a very low level. But again, that's a lever you can utilize if companies have a short-term issue with interest coverage.

Yeah, I can't really, you know, I think some of the analysts have asked us questions about that early on, like 18 months ago. Like, what do we expect? And I can't really would have expected more pit toggles in a rising interest rate environment than we've seen. And I think some of that's the profitability of our companies. But, you know, or in the sponsor's willingness to support the businesses rather than take on additional, you know, kind of interest burden on the business. But Michael's right. But also, you know, it's

A lot of the deals, I would say the majority of the deals that we originate, the interest coverage is well above three. It's three to five times that close. So the fact that ours is 3.2 right now, and that's had degradation because of base rates. But you compare that to the syndicated market where those guys are living at two times in a normal environment. And so they're going to get crunched a lot harder and a lot sooner than our lower middle market portfolio has or will.

That was a great commentary and insight. Thanks for taking my questions today.

Thanks, Eric. Thanks, Eric.

Thank you. One moment for our next question. And our next question is going to come from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Hi, guys. Good morning. This is Sean Paul Adams on the line for Robert Dodd. On the downgrades and the risk ratings, and the portfolio, it looks like it was primarily driven by the non-accruals. I'm just asking for a little bit more color on the non-accruals. It seems like the education-based one could be related to the Student Resource Center. Is that just an accreditation issue or is there, you know, a path forward for getting that back on accrual?

So I would summarize the challenges there as, you know, the education partner, one of the education partners that they do work with and place students in. And there was some fraud involved as well in that deal. And so it's a little bit idiosyncratic to that particular company and situation.

Got you.

And the other one was Research Now, which was obviously broadly held in BDC portfolios across the board. That one we have limited information because the first lien lenders are negotiating. It doesn't look like it's going to be a great outcome for the second lien lenders.

But we'll end up with a small equity ownership in the business. Probably the way most of these situations work out.

To your question, I also tell you, we just had our watch list meeting literally two days ago, and we went through all the lists of companies on that watch list. What we actually saw is that a lot of those companies were either stable, which is slightly positive, and there is a hope, and I wouldn't say it's in the next one or two quarters, but where some of the non-accrual names might actually turn around. To go back on accrual. To go back on accrual, rather than seeing any of those watch list names in the near future going on non-accrual. That's not a prediction or a projection, but that's just an observation based upon the information we reviewed the other day.

Got it, got it. That's perfect. And on the outlook for the next fiscal year, have there been any shifts in the long-term target range concerning leverage given like changes in the forward curve? It seems like you guys just tapped the lower end of the short-term target you guys were talking about last quarter for leverage.

Yeah, I mean, I wouldn't say it's a change. I think what I would tell you is leverage is going to be probably as low as 0.8 on a regulatory basis or as high as 0.95. that's probably where our comfort level is. We're at 0.82 at the moment. I would anticipate, based on how we feel about our portfolio, that we might lever that up closer to the middle of the range. But as we've shown during the course of the last few years, we're mindful of where the economy is and going to make certain that we vacillate it in the same rhythm of the economy itself.

Got it. Thank you for the call. That's perfect. Thank you. Sure. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is a follow-up question with Belis Abraham with UBS. Your line is open. Please go ahead.

Hey, just one more follow-up here. More of a high-level question. And, you know, we've talked about this a little bit before in the past, but as you guys think about the internal management structure and the flexibility it provides. Can you give us any thoughts on how you might be thinking about any potential partnerships, sidecar vehicles, that kind of thing?

That's obviously something that we've been thinking about and honestly probably working on behind the scenes. As our portfolio has grown, our hold side can grow as well. There's a lot of deals that we share with other partners where that we could be putting, maybe having a separate account, separately managed account, where they would be, we'd manage that capital. It'd be a portion of what of origination we hold. That obviously would earn a fee and an incentive carry. So it would be, honestly, it would be strategic, but it'd also be, it would work well within what we're already doing today. So it wouldn't require us to go up balance sheet. So that is something we're considering. I think that that's kind of a, you know, I hear people say, you know, you have to test a lot of frogs in those ventures in order to actually, you know, meet and kind of close on a partnership. So I don't think that's a calendar year 2024 event, but we would definitely expect that that'd be something in the future that we were able to be able to incorporate into the balance sheet.

Yeah, it's an interesting opportunity for us. There's definitely institutions out there interested in investing in our track record, our asset class, that don't want to pay above net asset value. So if they could partner with us in a fund concept and invest in some of our deals directly, it's interesting. But those types of things are always for us. I mean, we're all about the long-term shareholder returns. And, you know, candidly, there's a lot of opportunity just organically doing what we're doing and continuing to, you know, basically slightly higher hold sizes by sharing less of deals. And as our guys get even our mid-level, as they're growing up in the industry and, you know, increasing their franchise personally of relationships, it's really broadening the top end of our funnel of deals we look at. There's a lot of organic growth really in front of us. And we don't want to distract ourselves from that. But it's absolutely, you know, it's actually an opportunity we think exists.

Great. Thank you.

Thank you. And I would like to hand the conference back over to Bowen Deal for closing remarks.

Thanks, operator, and thanks for all the questions today, and we appreciate the opportunity to update you on the business. So we look forward to continuing to execute and talking to you all next quarter. Thank you.

This concludes today's conference call. Thank you for participating, and you may now disconnect.