Capital Southwest Corporation

Thank you for joining today's Capital Southwest third quarter fiscal year 2025 earnings call. Participating on the call today are Bowen Diehl, Chief Executive Officer, Michael Sarner, Chief Financial Officer, Josh Weinstein, Chief Investment Officer, and Chris Rehberger, Executive Vice President, Finance. I will now turn the call over to Chris Rehberger.

Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions, and beliefs. They are not guarantees of future results that are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest publicly available filings with the SEC. The company does not undertake any obligation to update and 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 Chief Executive Officer, Bo Engage.

Thanks, Chris. And thank you, everyone, for joining us for our third quarter fiscal year 2025 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 section of our website at www.capitalsouthwest.com. You will also find our quarterly earnings press release issued last evening on our website. We'll now begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of 64 cents per share, which fully covered both our regular dividend of 58 cents per share and our supplemental dividend of 5 cents per share paid during the quarter. Portfolio earnings continued to be strong, and as of the end of the quarter, we estimate that our undistributed taxable income was 68 cents per share, which is up from our prior quarter estimate of 64 cents per share. As we look forward to the March quarter, we are pleased to announce that our Board of Directors has declared a regular dividend of 58 cents per share for the quarter ending March 31, 2025. Additionally, our Board has declared an increase to the supplemental dividend to 6 cents per share from the 5 cents per share in the December quarter, bringing total dividends declared for the March quarter to 64 cents per share. Deal flow in the lower middle market was very strong this quarter, and the competitive environment around quality deals continued at the feverish pace we have seen for the past few quarters. Portfolio activity during the quarter consisted of 317.5 million in new commitments to nine new portfolio companies and 20 existing portfolio companies. Add-on financings continued to be an important component of many private equity firms' investment and a highly attractive source of originations for us. In fact, over 41% of total capital commitments during the quarter were follow on financing and performing companies. The deals we are currently underwriting continue to have loan to value levels ranging from 35% to 50%, resulting in significant equity capital cushion below our debt and reasonable leverage levels of around three and a half times debt to EBITDA. Josh Weinstein will provide additional color on the market, our investment activity, and the performance of our portfolio later in our prepared remarks. On the capitalization front during the quarter, we issued $230 million in aggregate principal of convertible notes with a coupon of 5.125% and an initial conversion price of $25 per share. Net proceeds from these convertible notes were used to redeem in full the $140 million January 2026 notes, as well as pay down our senior secured revolving credit facility. Importantly, there was no make-hold payment associated with the repayment of the January 2026 notes. Michael will walk through some additional important mechanics of the convertible bond offering in a moment. Additionally, we received a green light letter from the FDA, allowing us to submit our final application for our second SBIC license. and we have been informed by the SBA that we will receive final approval any day. We are excited about our continued participation in the SBA program as this program has been and will continue to be a very important component of our capitalization strategy. Finally, we raised approximately $54 million in gross equity proceeds during the quarter through our equity ATM program at a weighted average share price of $22.68 per share or 137% of the prevailing NAV per share. We have remained diligent in ensuring that we have strong balance sheet liquidity while also funding a meaningful portion of our investment activity with both unsecured debt and accretive equity issuances. We continue to maintain a conservative mindset to both BDC leverage and balance sheet liquidity. Balance sheet liquidity at Capital Southwest remains robust. which Michael will provide additional commentary on in a moment. Ensuring strong balance sheet liquidity affords us the ability to continue to invest in new platform companies as well as provide financing for both growth capital and add-on acquisitions for our existing portfolio companies. We believe this strategy allows us to continue to grow our balance sheet through any capital markets environment while also maintaining the flexibility to opportunistically repurchase our stock if it were to trade meaningfully below NAV. On slide seven and eight, 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, we have increased our quarterly regular dividend 29 times and have never cut the regular dividend, all while maintaining strong coverage of our regular dividend with pre-tax net investment income. In addition, over the same period, we have paid or declared 27 special or supplemental dividends totaling $4.12 per share, all generated from 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 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 fellow shareholders. As a reminder, slide nine lays out the core tenets of our investment strategy in lending and investing in the lower middle market. The vast majority of our portfolio and deal activity is in first lien senior secured loans to companies backed by private equity firms. Currently, approximately 94% 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 junior capital support if needed. In the lower middle market, we often have the opportunity to invest on a minority basis in the equity of our portfolio companies. How do you pursue with a 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 77 investments with a total fair value of $159 million, representing 9% of our total portfolio fair value. Our equity portfolio was marked at 143% of our cost, representing 47.9 million in embedded unrealized appreciation, or 96 cents per share. Our equity portfolio continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, often resulting from the institutionalization of the businesses by experienced private equity firms, as well as the significant value accretion potential of strategic add-on acquisitions. Equity co-investments across our portfolio provide our shareholders with the potential for asset value appreciation, as well as equity distributions to Capital Southwest over time. To that end, I would note that we have two equity investments currently in the final stages of sale processes, which should provide meaningful realized gains for Capital Southwest in the March 2025 quarter. Additionally, we are seeing some increased visibility in our portfolio on companies' beginning sales processes in 2025, several of which could result in material realized gains later this year for Capital Southwest. We look forward to providing you updates as appropriate as they develop. As illustrated on slide 10, our on-balance sheet credit portfolio ended the quarter at $1.5 billion, representing year-over-year growth of 31% from $1.2 billion as of December 2023. For the current quarter, 100% of our new portfolio debt originations were first lien senior security, And as of the end of the quarter, 98% of the credit portfolio was first lien senior secured with weighted average exposure per company of only 0.9%. 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. I will now hand the call over to Josh to review more specifics of our investment activity, the market environment, and the performance of our portfolio for the quarter.

Thanks, Bowen. On slide 11 and 12, we detail the 317.5 million of capital invested in and committed to portfolio companies during the quarter. Capital committed during the quarter included 172.3 million in first lien senior secured debt across nine new portfolio companies in which we also invested a total of 3 million in equity. In addition, we closed add-on financings for 20 existing portfolio companies consisting 141.1 million in first lien senior sector debt and 1.1 million in equity. We are pleased with the strong market position that our team has established as a premier lender to the lower middle market. This is evidenced by the broad array of relationships across the country from which our team is sourcing quality opportunities. As a point of reference, currently there are 80 unique private equity firms represented across our investment portfolio. In the last year, we closed 17 new platforms with financial sponsors with which we had not previously closed the deal, demonstrating our continued penetration in the market. Since the launch of our credit strategy, we have completed transactions with over 110 different private equity firms across the country, including over 20% with which we have completed multiple transactions. As Bowen mentioned, the lower middle market continues to be quite competitive. as this segment of the market is highly attractive to both bank and non-bank lenders. While this has resulted in tight loan pricing for high-quality opportunities, the depth and strength of the relationships our team has cultivated over the years has continued to result in our sourcing and winning opportunities with attractive risk return profiles. On slide 14, we detail key statistics for our portfolio as of the end of the quarter. The total portfolio consisted of 125 different companies with fair value as of the end of the quarter, weighted 89.1% to first lien senior secured debt, 1.5% to second lien senior secured debt, 0.1% to subordinated debt, and 9.3% to equity co-investment. The credit portfolio had a weighted average yield of 12.1% and a weighted average leverage through our security of 3.6 times EBITDA. Overall, we are pleased with the operating performance across our loan portfolio. In fact, as shown on slide 15, the number of portfolio upgrades were meaningfully more than the number of downgrades this quarter. As a reminder, all loans upon origination are initially assigned an investment rating of 2 on a four-point scale with one being the highest rating and four being the lowest rating. We had nine loans in five portfolio companies representing $99 million in fair value upgraded during the quarter, while having three loans in three portfolio companies representing approximately $17.4 million in fair value downgraded during the quarter. Overall, the portfolio remains healthy with approximately 95% of the portfolio at fair value rated in one of the top two categories, a one or a two, and approximately 5% of the portfolio in the three or four category. Cash flow coverage of debt service obligations across the portfolio remains at a healthy 3.5 times with our loans across our portfolio averaging approximately 41% of the portfolio company enterprise value. Quarter over quarter revenue and EBITDA growth on a weighted average basis were each approximately 3%. As seen on slide 16, our portfolio continues to be broadly diversified across industries with an asset mix which provides strong security for our shareholders' capital. In addition to industry diversification, our average exposure per company is less than 1% of assets, which gives us great comfort in the overall risk profile of our portfolio. Our investment committee members utilize our cumulative experiences navigating through various economic cycles to continually assess risk, both on a company-by-company basis as well as on the overall portfolio. In the current environment, that includes being in close contact with our sponsors and portfolio companies to proactively assess any anticipated effects of recent and future policies on tariffs and immigration. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.

Thank you, Josh. Specific to our performance for the quarter, as summarized on slide 17, pre-tax net investment income was $30.7 million, or 64 cents per share, as compared to $30 million, or 64 cents per share, in the prior quarter. For the quarter, Total investment income increased to $52 million from $48.7 million in the prior quarter. The increase was driven primarily by a $3.2 million increase in fees and other income compared to the prior quarter. As of the end of the quarter, our loans on non-accrual represented 2.7% of our investment portfolio at fair value. And the weighted average yield in the portfolio on all investments was 12.1%. During the quarter, we paid out a $0.58 per share regular dividend and a $0.05 per share supplemental dividend. As mentioned earlier, our board has declared a regular dividend of $0.58 per share while also increasing the supplemental dividend to $0.06 per share for the March quarter. Management and the board have spent significant time contemplating the impact of a lower interest rate environment on future earnings. We have consistently maintained that setting a regular dividend at a level that we believe will never be cut in any foreseeable interest rate environment is key to generating stable, attractive shareholder returns over the long term. We continued our strong track record of regular dividend coverage with 115% coverage for the 12 months ended December 31st, 2024, and 111% cumulative coverage since the launch of our credit strategy. We are confident in our ability to continue to distribute quarterly supplemental dividends for the foreseeable future based upon our current UTI balance of 68 cents per share and the expectation that we will harvest gains over time from our existing 96 cents per share and unrealized appreciation on the equity portfolio. As Bowen mentioned earlier, we have two equity investments in sale processes, both expected to close within the next two weeks. These realized gains, all else equal, should increase our UTI balance by a further 10 to 15 cents per share as of the end of the March quarter. As seen on slide 18, LTM operating leverage ended the quarter at 1.6%. Our operating leverage of 1.6% continues to compare favorably to the BDC industry average of approximately 2.8%. 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 be invested in people and infrastructure as we continue to grow and manage a best-in-class PDC. Turning to slide 19, the company's NAB per share at the end of the quarter was flat at $16.59 per share. The primary drivers of the NAB per share bridge for the quarter or accretion from the issuance of common stock at a premium to NAV per share offset by the net realized and unrealized depreciation on our investment portfolio. Turning to slide 20, we are pleased to report that our balance sheet liquidity is robust with approximately 412 million in cash and undrawn leverage commitments on our two credit facilities, which altogether represented 2.1 times the 193 million of unfunded commitments we had across our portfolio as of the end of the quarter. As Bowen mentioned earlier, in the December quarter, we issued $230 million in aggregate principal of 5.125% convertible notes due to 2029 with an initial conversion price of $25 per share. These net proceeds were used to redeem in full the $140 million January 2026 bonds, as well as pay down our revolving credit facility. As of the end of the December quarter, 48% of our capital structural liabilities were in unsecured covenant-free bonds with our earliest debt maturity in October of 2026. Delving a bit deeper into the conferrable bond issuance, we believe there's been some confusion in the market regarding the issuance, which I would like to address. First, we did not incur any make-hole premium in the takeout of the January 2026 bonds. Second, we have always stressed the importance of balance sheet flexibility and staying well ahead of our debt maturities. Using this convertible issuance to redeem our January 2026 bonds, as well as to pay down our credit facility, gives us further dry powder to continue to originate attractive investment opportunities in all market environments. Moreover, based on today's five-year treasury rate, the rate on the convertible note is approximately 200 basis points cheaper than the current market for a traditional unsecured bond, resulting in significant interest expense savings which flows directly to pre-tax NII. Additionally, the convertible nodes have a flex settlement mechanism. This means that to the extent our stock trades significantly above the conversion price and certain holders of the nodes select to convert, Capital Southwest would have the option to redeem the nodes in cash, shares, or any combination thereof. This gives us the ability to actively manage balance sheet leverage, the impact of any dilution, and the opportunity in this instance to issue equity at share prices, which would be significantly above net asset value and thus be highly accretive to our shareholders. Turning to our SBIC program, in early 2024, we submitted a MAC application to the SBA, which began the process towards a second SBIC license. In December 2024, received a green light letter from the SBA, allowing us to submit our final application, which we completed in January, 2025. We expect to receive final approval A regulatory leverage, as seen on slide 21, ended the quarter at a debt-to-equity ratio of 0.9 to 1, up from 0.8 to 1 as of the prior quarter. While our optimal target leverage continues to be in the 0.8 to 0.95 range, we are weighing the impacts of future base rate reductions and maintaining adequate cushion levels to allow us the flexibility to potentially increase leverage to support future earnings and dividend growth. We will continue to methodically and opportunistically raise secured and unsecured debt capital as well as equity capital through our ATM program to ensure we maintain significant liquidity and conservative balance sheet leverage with adequate covenant cushions. I will now hand the call back to Bowen for some final comments.

Thank you, Michael, and thank you, Josh. 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 perform well, and we are pleased with the company's robust asset base, deal origination, and portfolio management capability, as well as flexible capital structure. 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 broader array of companies and industries. with weighted average exposure per company under 1%. The vast majority of our portfolio is backed by private equity firms. Interest coverage of the debt obligations across our portfolio is a solid three and a half times with strong equity value cushion and support below our debt investments. 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 and significant balance sheet liquidity, all of which provides our company an exciting runway to continue to grow and generate strong shareholder returns. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

Thank you, sir. As a reminder, to ask a question, you will need to press star 11 on your telephone. To re-draw your question, please press star 11 again. Please stand by while we compile the Q&A roster. And I'm sure our first question comes from the line of Mickey Schlein from Leidenberg. Please go ahead.

Yes, good morning, everyone. Bowen, you mentioned that follow-on investments, or important part of your investment activity this quarter, but could you also give us some insight into the trends you're seeing in terms of new investment M&A activity in your market, you know, considering that the election is behind us now and maybe there's a little bit more certainty in the direction of interest rates?

Yeah, I mean, so obviously the M&A market was, and our market was active in the fourth quarter. We've seen that activity, you know, go, you know, continues in the first quarter. You know, generally speaking, you know, as we referenced, we're seeing some visibility on some exits in our portfolio for the calendar 25, some immediate ones, and then we think some future ones. So the M&A market, as we've all heard in the industry, people talk about, you know, hoping that it increases in 2025. I think we're seeing some, you know, early signs that that actually might be the case as we look forward.

I don't know, Josh, you got anything to add to that?

I mean, I think you covered most of it, but I think, you know, we've obviously worked really hard over the last 10 years or so to, you know, create and cultivate relationships in that environmental market. And we feel like we're, while it remains competitive, we're continuing to be well-positioned to participate in that M&A activity in 2025.

And we did, you know, $320 million of funded, or I should say committed investments in the 1231 quarter. And that had, I think we had 11 new platform companies and 20-something add-ons. But this current quarter, we're also seeing the continuation of that thing, a lot of granularity in the deals we're seeing and the expectation that we're able to put on additional platform companies. So, it's definitely something where, you know, you expect our baseline originations in the near term to be higher than the previous.

Even though this tends to be a seasonally slower quarter, Mike?

Yeah. No, this quarter for certain, I think, you know, We would tell you our normal quarter probably would be somewhere between maybe 125 and 150. But I would also say to Josh's point, we've added on a lot of sponsors. I mean, we've seen a lot of traction in the market. So I would expect our number to be something closer to 150 to 200 million in originations for this coming quarter.

We had a number of deals that were targeting closing by the end of the fourth quarter that leaked into the first quarter that I think will help mitigate some of that seasonality this year.

I understand. You also had really low repayment activity. To what extent did call protection keep repayments low, and how much refinancing risk do you see in the portfolio given all the pressure there is on spreads?

Looking ahead, I would tell you that we have had calls. I mean, I think we do expect to see some level of prepayments into the future. To your point on call protection, You know, we had one repayment of size in the previous quarter that had call protection where we generated, I think, approximately $600,000 in fees. But, you know, some of the deals we're looking at are probably 22 and 23 where you have some of that call protection either winding down or maybe it's only 1% and they're willing to pay that and get out of the credit. So I think rule of thumb for us, I mean, we're expecting probably maybe to see, you know, 10 to 15% of the portfolio rotate in the 2025 calendar year.

Based on the gifts we've created over the years, you know, we usually get the call before there's a repricing where we have the opportunity to lower our pricing and stay in the deal. And we obviously assess that, you know, on a situation-by-situation basis to see if we want to stay in the deal at the lower pricing. So, you know, we would expect, You know, we would expect some pressure just given, you know, potential competitive factors, but we feel like we're pretty well positioned to continue to stay in the deals and not get repressed out.

I would add, Mickey, that as we, you know, as we referenced the UTI increase and the potential exits this year, you know, those are obviously well-performing companies, but oftentimes they also have debt in them if we haven't already been recapped out. So I think it's probably fair to expect that a meaningful portion of our prepayments will be driven by M&A activity, which is not really a function of prepayment penalties. I mean, private equity firms selling the business for this time to sell the business, not because of the prepayment, so.

Yeah, I understand. That's helpful. Last question, then I'll get back in the queue. You have investments in sectors like food and consumer machinery. How do you see tariffs, which I know are a moving target, but we seem to be moving in the direction of tariffs, how do you see those tariffs

impacting you know these companies or or the portfolio in general yeah i mean you mentioned it we have 120 125 portfolio companies so clearly we're going to have some exposure um based on our preliminary analysis it looks like around 10 of our portfolio could see some impact now that being said we are firstly continue secured lenders so we think that positioning in the capital structure will mute the impact um to our portfolio and you know obviously we're you know, information is real time and we're continuing to monitor it and analyze it as it comes through. But, you know, the diverse portfolio with the first name position feels like, you know, we're in a good position to mitigate that risk.

The other point I'd make, too, is during the 2020 2016, you know, Trump administration, they did increase tariffs as well then, particularly with China. And so we saw that impact with some of our portfolio companies. And honestly, they were still able to thrive under the environment. You know, obviously, it's a moving target, as you said, Mickey. So we'll have to see where those go on a go-forward basis. But I think Josh points a good one. We're also in the boardroom during investment committee meetings. We're certainly discussing the impact to make certain any deals we're looking at on a prospective basis, you know, we're taking into that into account on a downside scenario.

I mean, it's all happening kind of real time. Obviously, as we all know, goalposts are moving around, but there's a lot of communication gathering as we referenced. Josh referenced from our sponsors and our portfolio companies, but like Josh referenced, that was kind of our initial take over the weekend.

I understand. I have some more questions, but I'll get back in the queue and let some of the folks take the microphone. Thanks. Thanks, Nicky.

Thank you. And I'm sure our next question comes from the line of Doug Harter from UBS. Please go ahead.

Thanks. I was hoping to get a little bit more on the SBA license. You know, I guess, how do you think about how long it might take to fill that up and what type of funding costs do you anticipate that being?

Well, first of all, I mean, I start by saying that we were expecting that license to come in any day now. However, what's going on with the government right now? You know, we understand that there's sort of a freeze for the next week or two, or actually, they don't really have a good timing on it before they come back to us. Let's just assume that we do see that license in the next few weeks. We'd expect to be able to ramp that fairly quickly in the majority of our deals. And when we break it down, you know, 80 plus percent of our deals are lower middle market that fit the FDIC perfectly. You know, I think our previous license we got in April of 2021, and we took us, what, two and a half, three years to fill it up. I assume the same cadence, maybe slightly quicker, just because the amount of sponsors we've won and the deals we're doing. In terms of an expectation on pricing, I would expect somewhere, you know, this is a big range, but I would imagine that we'd be borrowing somewhere between 4% and 5%, which if you compare that, obviously, to what our credit facility or what the bond market is, that's exceptional. I mean, it's certainly not the 2% or 1% that you saw five years ago, but it's still, you know, net accretive to our shareholders.

Great. And I appreciate the details you gave around the convert. You know, just wondering how you think about, you know, kind of the option cost of the convert when you're, you know, kind of factoring that into it and, you know, maybe any sort of short-term impact it has on kind of the trading of the stock when into the calculus of, you know, the decision to do convert or form to capital.

I mean, I think if you look at the convertibles, Over the long term, what we've been seeing is, first of all, it's very unlikely most bond traders are going to actually convert into equity or, in our situation, actually just put it to us and give us the option for cash or shares. So what we're looking at is if it's $25 on the conversion price, we're trading at $22.50 or $23. The expectation is, first of all, there's a lot of cushion between now and then. the convertible holders would have to see significant accretion above the $25 before they would actually call and ask for the conversion. And at that point, they're taking the risk that we are going to just redeem their bonds and they lose any option value. So, from our perspective, it seems to be a low risk. And when we compared that, you know, 12 months ago and six months ago to what we saw in the market, which is, you know, A lot of uncertainty with the change administration, you know, whatever's going on in the macro economy, it's kind of played itself out where if you look at the risk premium and the five-year treasuries, if we were to go to market today, it would look like something in the 7.5% to 8% range, even through a baby bond, and maybe it's slightly better for an institutional bond. When you look at that, you compare it to a 5 and an 8, knowing all along that SOFR over the last, you know, nine months has come in over 100 basis points. This felt like this was, from an accretion perspective, we're giving our shareholders a reduction in interest expense, therefore an increase in their dividend. And if the risk is in two or three years, we see some additional dilution, it's at a $26 or $27 share price, which is accretive to shareholders. And therefore, we think that they're winning along the way, and they'll win if and when a conversion takes place.

Thank you. Great. Appreciate it.

Thank you. And I show our next question comes from the line of Eric Zwick from Lucid Capital Markets. Please go ahead.

Thank you. Good morning, everyone. I wanted to start with, you mentioned, and we've been hearing it from others as well, just that the competition in the market is certainly driving some spread compression. I'm wondering if you could quantify that a little bit, if you take a look at the, you know, what's in pipeline today and what the average spread is, how that compares to maybe six months ago.

I mean, I would say the market move, from our perspective, the market moved about nine months ago, and it probably would flex 50 to 100 basis points.

But generally pretty flat this quarter to last quarter. I mean, like it was a nine months ago, six, nine months ago event that's kind of been kind of more of the same.

Thanks for the comment there. And maybe just... Is the competition spreading into structure at all as you go out and potentially compete with others in the market? Are you seeing some bending there? And if so, how are you dealing with that?

We have not seen as much pressure on the structure. Loan to value still remain pretty consistent from where they've been the last year or two. And it's mostly been focused on the pricing.

That's good to hear. If I just switch gears a little bit, could you provide an update on the relationships that are currently on non-accrual? Have there been any changes over the past three months in terms of anything maybe getting closer to a resolution or any companies improving performance that could potentially move them off non-accrual in the next quarter or two?

Yeah. We had a non-accrual. One of our non-accruals can restructure in the December quarter. One of the other non-accruals is now restructured in this quarter that's in non-accrual at the end of December. So it's now restructured. You know, the non-accrual group is in the vast majority of the depreciation this quarter. That's depreciation is not okay with us. It's very frustrating. At the same time, though, the main depreciation is coming from companies that aren't in NII. So it's more of an NAV effect on us as opposed to earnings.

But that's hopefully helpful, general color on what's happening.

And for those that did restructure, are they currently, have they moved back to accrual? And then do you have any equity positions or how did those play out?

Yeah, so we restructured into, you know, varying levels of debt and the remainder of the debt is equity. So we have the ability as the company recovers to retain, you know, recoup our NAD.

Great. Thank you for all the answers today. That's all for me.

Thank you. And I show our next question comes from the line of Robert Dodd from Raymond James. Please go ahead.

Morning. Congrats on the quarter. A couple of questions. First, I mean, very, very busy, right? I mean, somewhere around, I think, 30 deals between follow-ons and new platforms this quarter. How do you feel about the staffing levels with expanding the number of sponsors you're working with, you know, the number of add-ons? I mean, you're incredibly active. And is the staffing... of a sufficient level to keep going on at that kind of pace. It sounds like Q1 is pretty active as well. So, I mean, you know, can you give us any code about needs there? Do you need more increases in staffing? Could that, in the short term, impact the expense ratio?

Yeah, I'll just make a comment generally. I mean, we feel like when we sit, we're, you know, that's a good question, and we're constantly, I mean, staffing is super important. I mean, one of the reasons we didn't mention that our deal flow has been up, you know, it's a factor. I mean, it's all the things we've talked about. But it's also, you know, we've in our net across the country has expanded to this. Josh has done a great job training up some of his folks with new people in the market over the last couple of years and then gaining traction has resulted in, you know, a wider net in the market. But, you know, I would say, and Josh and Michael can comment, I don't know that we're, like, way off base, but it's something that we definitely are constantly looking at. We would probably, you know, expand, you know, as we grow.

Yeah, I mean, I'm going to tell you, just on a run-right basis, we typically add, let's say, on the deal side, you know, three professionals minimum a year that usually are on the junior side. And then, you know, I would say probably every other year we'll add a, someone at the, you know, senior associate or VP level. On the accounting back office side, we probably also add around one to two people based on volume as well. So, I don't think that there's a point where we say, oh, you know, volume is caught up to a place where we can't accommodate it. I think that we're continually assessing, as Bowen said, but we continually add to it. If you look back, you know, I think when we started this venture, we had, you know, six or eight employees, and now we have, I think, 36 employees today. So, the answer to your question is, I think the asset base might be growing slightly, you know, quicker than the employee base, which is why our operating leverage is going down, but it's not because we're either A, not hiring people, or B, not paying our people. But we also make it a point to promote from within, which has worked wonderfully, honestly, over the last decade, which has allowed us to be able to add the people at the local levels and be trained up by the people that have been through the system and understand our underwriting process.

Yeah, Michael touched on it. I mean, it's not all, part of it is activity, as you referenced, Robert. But it's also just us constantly looking at the size of the portfolio and specifically the number of portfolio companies. And as Josh's team, and we think about who's monitoring those companies and managing those loans, do we have enough people and Michael on the back office side, as he referenced, I mean, do we have the structure to manage that portfolio 125 companies, which is gross, some get prepaid, some new ones come on. But that's how we're looking at that.

Got it. Thank you. I appreciate that, Colin. Another one, you mentioned obviously tariffs and immigration. What percentage of your portfolio has exposure as kind of federal contractors? Because it looks like there's efforts there to cut some payments. How sticky those cuts are is a wild card, but do you have any significant, any portfolio companies with any material exposure to more federal contracting than government contracting in general?

Yeah, so I'm sitting here on the fly thinking about that, looking at my colleagues here. I mean, just imagine, you know, the 125 companies I can come up in my head. Three of them, two definitely have, you know, do business with federal, with contracting with the federal, you know, I guess government. The other one indirectly, so, you know.

Most of those are subcontractors, so they're actually not federal government workers, so I I think it's very small, and even within those three, I'm not sure if it's going to have a direct impact.

So if I'm at the C-level thinking about the portfolio at risk to the company, I think that is not the first thing we're worried about. But it's a good question. It's definitely what you should have.

Got it. Thank you. One last one, if I can. I mean, obviously, still over, still back up, 68 cents. Sounds like that's going to go up again in Q2. Oh, well. in the March quarter. In the past, you did run that up, and then you distributed it, maybe 2021. I didn't want to get your chance, but to keep the absolute level of spillover down and reduce your excise tax, et cetera. So, have you changed your mind, and now you're going to build it back up, or is there some level where you'd want to distribute that again to keep the spillover level down. And does the existence of the convert now change any dynamics there? Because obviously extra dividends impact that.

Yeah, no, I don't really want to say there was a change. I think like if you go back to the first program we put in place, we had an extremely large gain that we couldn't even hold all of it just from rec and BDC restriction. And so we distributed what we had to upfront, and then we paid over time. And when we no longer thought we had the pathway to continue the program, we decided to distribute it back to shareholders. So that was sort of the natural evolution. I would tell you now, like, you know, we're at 68, we see ourselves climbing into the 80 cent range by next quarter. And we do anticipate distributing probably a little more than our run rate today. Walking, you know, we've gone down to five, we went up to six. We anticipate walking that up slowly. And then I think the point that we've all made today that there's a pathway to some sizable gains towards the end of the year. And if that was the case, we'd be back in sort of the same territory where we have a significant UTI bucket, which we would intend to increase the supplemental and continue to pay our shareholders on a quarterly basis, and that would be a larger percentage of the total distribution. So that's sort of the plan going forward. Thank you for that.

That's it for me. Thank you. And I show our next question comes from the line of Mickey Schlein from Leidenberg. Please go ahead.

Yes, to follow up, I wanted to get a sense of what drove the increase in fee income this quarter.

Sure. So there's a number of things on it. First, we had, I know I mentioned earlier, we had a prepayment penalty for approximately $600,000. We also had, if you recall, the bonds that we raised, so we brought that, you know, $230 million in. Most of that was used to pay down, redeem the 2026 bonds, but there was a 30-day redemption period. So we essentially held cash on the balance sheet for, you know, 30 days, which came out to about $1.2 million in income. So that's 1.8 between those. And then on top of that, there was some, a few member, amendment fees, waiver fees, and some arranger fees as well on some directly led deals.

Okay. And my other, another follow-up is what were the main drivers of the realized loss this quarter?

The realized loss was a restructured deal. Okay, that was 12, I think it was $12.7 million. So most of that was just to be clear, was in depreciation was reversed. And a portion of that was new depreciation that was taken during the quarter.

Understand. And so you had this diversion in portfolio company performance, which was a nice increase in companies performing above expectations. But you also had some below expectations. You know, are there some Can you help us understand what are the trends that drove that movement?

So as I look down the list here, I mean, it's a bit idiosyncratic, honestly, the upgrades and downgrades. There's one that's in the shipping space where spot rates have moved and to the company's detriment. So that was a negative to that. Another company is, you know, a little bit weather related, you know, probably cover some based on the And then the other downgrade was just one of our non-accruals that's, you know, this continued struggle.

Okay. And lastly, I think Michael gave us guidance on regulatory leverage targets. Could you also give us an idea of where you're expecting your economic leverage or your total leverage to, what is your target in the current market environment?

Sure. So I think we've been between 1.0 and 1.1 for economic leverage. And, you know, we've been on a regulatory basis. We've been between really 0.8 and 0.9 or even lower. I would tell you we're at 0.9 on the regulatory. We'll start there. And We tell you, you know, we're going to keep an eye on what's going on, obviously, in the macro economy, you know, geopolitical scene to determine whether there's more or less risk. But we feel comfortable right now that the 0.9 leverage that we have right now and the 1.08, that's about a decent place to be. And, you know, we're looking down the road. We would tell you as we look back, you know, when we did the convertible bond offering, you know, with seeing all the things that are happening in the world, you know, that was one reason why we took risk off the table you know, bring bonds into the to on our balance sheet earlier. And then we can make decisions in terms of leverage going forward. So we feel like we're in a really good place, especially with trades, definitely book. And so we are active in the ATM market to manage that metric going forward.

Okay, and just to make sure I understand the income on idle count on your cash, some of that's accruing into fee income as opposed to other income.

No, I think the line you're looking at says fee and other income. And so the other income, because it's not portfolio interest income, it's actually money market income, interest income, it falls into other. And I would probably tell you I wouldn't anticipate seeing that happen ever again, right? This is a one-off. So that's why it fits into the other rather than interest income.

Okay. Those are all my follow-ups. I appreciate your time. Thanks so much.

Thanks, Mickey. Thank you. And I show no further questions in the queue. At this time, I'd like to turn the call back to Bowen Deal for closing remarks. Thank you, operator.

Thank you everybody for joining us. We appreciate it. Appreciate your time and look forward to giving you further updates in the future. Have a great rest of the week.

Thank you. This concludes today's conference call. Thank you for participating. You may all disconnect.