Capital Southwest (CSWC) Q1 2027 earnings call transcript

I will now turn the call over to Amy Baker. Thank you. I would like to remind I will remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions, and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see CAPITAL SOUTHWEST's publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances, or any other reason after the date of this press release except as required by law.

I will now hand the call over to our President and Chief Executive Officer, Michael Sarner. Thanks, Amy, and thank you everyone for joining us for our first quarter fiscal year 2027 earnings call. We are pleased to be with you today and look forward to discussing our results for the quarter. Before turning to the quarter, I want to highlight that we are still seeking additional shareholder votes for our proposal to increase CAPITAL SOUTHWEST's authorized shares. The company has received substantial shareholder support for the proposal today. As of today, approximately In addition to the proposal, the proposal is a very important part of the proposal. However, because approval under Texas law requires the affirmative vote of holders of at least two-thirds of all outstanding shares, shareholder participation remains critical to the proposal's approval.

A failure to vote has the same practical effect as a vote against the proposal. The proposal would provide CAPITAL SOUTHWEST with the flexibility to continue executing the strategy that has supported the company's growth and long-term performance. Approval would not, by itself, authorize the issuance of any new shares. Rather, it would ensure that the company has sufficient authorized shares available to issue accretive equity when attractive investment opportunities arise. Additionally, I would like to highlight that ISS and Glass-Lewis have both issued reports recommending that shareholders vote for the proposal. We would encourage all shareholders who have not voted or have voted against the proposal to support the company by casting their affirmative vote prior to the September 1st meeting date.

Turning to the financial results, during the first fiscal quarter, we generated pre-tax net investment income of $0.57 per share, supported by strong recurring earnings across the portfolio. Our undistributed taxable income balance remains robust at $0.87 per share, reflecting consistent realization activity. Although our UTI balance declined this quarter as a result of normal annual corporate activity, we remain confident in our ability to continue growing this balance over time. Chris will provide additional detail later in the call. Our Board of Directors has declared a $0.58 regular dividend for the September quarter, payable monthly in each of July, August, and September 2026, and has also declared a quarterly supplemental dividend of $0.06 per share payable in September, bringing total dividends declared for the September quarter to $0.64 per share.

Turning to originations, deal flow in the lower middle market was strong this quarter. We closed $222 million in total new commitments across 11 new portfolio companies and 16 existing portfolio companies. Add-on financings continue to be an important source of originations for us, as over the last 12 months, add-ons as a percentage of total new commitments have been 25%. These opportunities allow us to deploy capital into businesses we know well with proven management teams and sponsors.

Our investment pipeline of new opportunities continues to meaningfully expand. Over the last 12 months, we have screened approximately 1,300 deals, of which we've closed 19 new platform companies. That is an increase from the 1,200 deals we screened in fiscal year 2025 and 1,000 deals we screened in fiscal year 2024. We have continued to source more deals with each passing year, while our close rate has decreased from 1.7% in fiscal year 2024 to 1.5% today. This highlights both our discipline, underwriting process, and our continued penetration into opportunities in the lower middle market. Demonstrating our continued investment discipline, for new platform fields closed during the Q&A quarter, weighted average senior leverage was 2.8 times debt to EBITDA, and weighted average loan to value was 29%, providing a substantial equity cushion beneath our debt.

Over the past 12 months, new platform originations have averaged 3.1 times senior leverage and 34% loan to value, further underscoring our consistent commitment to conservative underwriting. Additionally, our portfolio continues to benefit from the broad industry diversification with an average position size of 0.8% per company, which helps mitigate company-specific risk. Furthermore, the weighted average yield on our debt portfolio increased to 10.9% during the quarter, up from 10.8% in the previous quarter. The main driver of this increase was an increase in the weighted average spread of our portfolio, which reflects our continued ability to originate high-quality opportunities while maintaining attractive spread economics, even amidst a more competitive and tighter spread credit environment.

On the capitalization front, we raised $64 million in gross equity proceeds through our ATM program this quarter. Our ability to assess the ATM program continues to be a meaningful competitive advantage for CAPITAL SOUTHWEST. In a market where fewer publicly traded BDCs are trading above book value, our improved price-to-book valuation gives us a differentiated ability to raise growth capital in a way that is accretive to NAD and supportive of long-term shareholder value. We believe our relative position has strengthened significantly over the past few years, and it provides us with the flexibility that many of our peers simply do not have today. In fact, only six BDCs were trading above book on June 30, 2026, down from 17 BDCs on June 30, 2024.

Additionally while the median EDC price to book multiple declined from 0 times to 0 times over that same two year period CSWC has continued to trade well above book value in a range of 1 times to 1 times I will now hand the call over to Josh to review more specifics of our investment activity Thanks, Michael. As previously mentioned, this quarter we deployed a total of $222 million of new committed capital, consisting of $167 million in first lien senior secured debt and $6 million of equity across 11 new portfolio companies. We also completed add-on financings for 16 existing portfolio companies, totaling $49 million in first lien senior secured debt and $285,000 in equity.

Our on-balance sheet credit portfolio ended the quarter at $2 billion, representing 24% year-over-year growth from $1.6 billion as of June 2025. Importantly, 100% of new portfolio company debt originations were first lien senior secured, and as of quarter end, 99% of the credit portfolio remained first lien senior secured, with a weighted average exposure per company of only 0.8%. This level of portfolio granularity reflects our disciplined approach to risk management as we continue to scale the balance. The vast majority of our deal activity continues to be in first-leens senior secured loans to private equity-backed companies.

Approximately 92% of our credit portfolio is sponsor-backed, which provides strong governance, operational support, and, when needed, the potential for junior capital.

In the lower middle market, we frequently have the opportunity to invest, on a minority basis, in the equity of our portfolio companies, Perry pursue with the private equity firm when we believe the equity thesis is compelling. As of quarter end, our equity co-investment portfolio consisted of 95 investments with a total fair value of $202 million, representing 9% of our total portfolio at fair value.

This portfolio was marked at 121% of our costs, representing $34.4 million of embedded, unrealized appreciation, or $0.54 per share. These equity positions continue to give our shareholders meaningful upside participation in growing lower middle market businesses, driven by both operational improvements and strategic add-on acquisitions. The lower middle market remains competitive as this segment of the market continues to attract both bank and non-bank lenders. Although this environment has produced tighter loan pricing for higher quality opportunities, the depth and durability of the sponsor relationships our team has built, combined with the enhanced deal flow generated by our expanded and more seasoned investment staff, continue to position us to source and win transactions with compelling risk-return profiles. Today, our portfolio includes investments from 95 unique private equity firms, and over the past 12 months, we have closed new platform investments with 20 sponsors with which we had not previously partnered.

Since launching our credit strategy, we have completed transactions with over 135 private equity firms nationwide, including more than 20% with whom we have completed multiple deals. Our portfolio now consists of 141 portfolio companies allocated 89.6% to first lien senior secured debt, 1.1% to second lien senior secured debt, and 9.2% to equity co-investments. The credit portfolio generated a weighted average yield of 10.9% with weighted average leverage through our security of 3.7 times EBITDA.

We remain pleased with the overall performance of the portfolio. At origination, all loans are initially assigned an investment rating of two on our five-point scale, with one being the highest rating and five being the lowest rating. As of quarter-end, 89% of the portfolio at fair value was rated in the top two categories. Cash flow coverage remains strong at 3.6 times, reflecting an improvement from the 2.9 times low observed during the peak of base rates. I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Josh. Specific to our performance for the quarter, pre-tax net investment income was $35 million, or 57 cents per share. For the quarter, total investment income increased to $61 million from $57.8 million in the prior quarter. The increase was primarily driven by a $2.6 million increase in cash interest income, coupled with an increase of $1.1 million in PIC interest income. The increase in PIC income was driven by an amendment to one of our portfolio companies, which capitalized two quarters of PIC into the current quarter, half of which will be non-recurring going forward. As of the end of the quarter, our loans on non-accrual represented 1.1% of our investment portfolio at fair value, flat from the end of the prior quarter.

During the quarter, we paid a $0.58 per share regular quarterly dividend, paid monthly, and a $0.06 per share supplemental quarterly dividend. For the September 2026 quarter, our Board has again declared $0.58 per share regular quarterly dividend, payable monthly in each of July, August, and September 2026, and maintained the $0.06 supplemental quarterly dividend, also payable in September, bringing total dividends declared to $0.64 per share. We continue to demonstrate strong dividend coverage, with 109% cumulative coverage since launching our credit strategy.

Our UTI balance declined to $0.87 per share this quarter, primarily due to book-to-tax differences related to annual cash bonus payments and equity award vesting. However, we have visibility on an equity realization expected to close in the near term, which should generate a realized gain and increase our UTI balance as of September 30th. In addition, we continue to hold significant unrealized appreciation across our equity portfolio. As a result, we remain confident in our ability to grow our UTI balance and continue paying quarterly supplemental dividends over time. LTM operating leverage ended the quarter at 1.4%, a meaningful improvement from the 1.7% observed a year ago in June 2025. Notably, this reduction occurred despite the addition of 12 new employees.

Going forward, we expect to continue to add resources to our team while maintaining operating leverage in the 1.4% to 1.5% range. Our operating leverage remains significantly better than the BDC industry median of approximately 2.6%, underscoring the inherent efficiency of the internally managed BDC model. This structure has consistently delivered meaningful fixed cost leverage to shareholders while still enabling us to invest in talent and infrastructure as we continue to scale a best-in-class BDC platform. NAV per share decreased to per share down from per share in the prior quarter The primary drivers of the NAV per share decline for the quarter were net realized and unrealized depreciation on our investment portfolio and our annual equity grant to employees offset by accretion from our equity ATM program We raised approximately $64 million in gross equity proceeds during the quarter through our Equity ATM program at a weighted average share price of $23.47 per share, or 141% of the prevailing NAV per share, reinforcing our ability to raise capital efficiently and accretively.

Our liquidity position remains robust, with approximately $375 million in cash and undrawn leverage commitments across our two credit facilities. In total, this represents more than 1.2 times coverage of the $312 million in unfunded commitments across the portfolio. Currently, we are working on an amendment and maturity extension of our corporate credit facility, which should provide beneficial economic changes to our cost of capital.

We'll share further details regarding the outcome of this process over the next few weeks. Regulatory leverage ends the quarter at 0.91 to 1 debt-to-equity. We will continue to raise secured and unsecured debt capital, as well as equity through our ACM program, in a methodical and opportunistic manner to ensure we maintain significant liquidity and a conservatively constructed balance sheet with adequate covenant cushions.

Finally, we have made meaningful progress with CAPTRIM Partners, our joint venture with Trinity Capital. During the quarter, we closed a $150 million revolving credit facility, which will provide the liquidity to meaningfully increase the scale of our joint venture over time, with advance rates that should produce a 13% to 15% return once fully ramped. The JV currently holds approximately $98 million in first lien securities in 14 portfolio companies, with a weighted average leverage of 1.2 times debt to EBITDA. We expect to continue originating low-leverage, high-quality investments within this structure. I will now hand the call back to Michael for some final comments.

Thank you, Chris, Josh, and Amy, and all the employees who help us tell this story on a quarterly basis. And thank you, everyone, for joining us today. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A. Thank you.

Yeah, I mean, I started with coupons. I think they ranged between 575 and I think as high as 7%. And some of the uplift in our spreads this quarter were due to CAPTRIN starting to take shape, but we've had additional first out, last out positions.

So the yield on our last out position is a little bit higher.

Josh, do you have any thoughts on the industry? I mean, generally speaking, I think it's pretty consistent with our portfolio broadly. I mean, we've not seen any specific industries we've focused on the last couple quarters or seen more volume. It's really, you know, across the board from an industry perspective and continues to remain diversified. I think the other thing to add as well, and we've noted this in the opening comments, is that the add-on investments that we've seen, some of those are for deals that are older deals that maybe started with $5 million EBITDA and they've grown through add-on originations that we've funded.

And so some of those have been on the higher end of the yield as well.

Yeah, so I think when we're looking ahead, we're, you know, just into August. We've already closed about $125 million in originations this quarter. In a continued granular sense, we're still originating somewhere between $15 and $20 million on each origination. We would tell you, based on the pipeline of deals that we've actually signed up, that we expect to close over the next 60 days. I mean, we could be in the $250 to $300 million range, and that's going to include probably about 75% of that are new platform companies. And the other 25% are add-ons to existing companies.

And we've continued to ramp our origination staff that's helped drive continued pipeline strength. So that coupled with CAPTRIN, again, where we're able to originate deals with slightly lower yields on the phase. I think those two things together, yeah, really. I think we noted also just the amount of deals that we've looked at on an annual basis. It's growing. And we fully expect that to continue to grow because it feels like momentum is real and sustainable.

Yeah, Eric, they're all – it's a mix. So we did a secondary transaction to sort of seed the portfolio, and then we've originated some new first outs into that fund, as Michael mentioned. So there's overlap. There's nothing that's solely in CAPTREN. And there's overlap on every asset between CAPITAL SOUTHWEST and CAPTREN in some form or fashion, whether it's a pair pursuit, debt piece, or a first out last out.

And you expect that will that be consistent over the life of the fund Yeah that will be I will also say that we have looked at opportunities that are first out only loans that would go only into the JV I think we looking at one today But I don think today we haven closed any But we are open to deals that are one one and a half turns of leverage to support a deal Thank you for taking my questions today.

You know, the answer to your question is it's certainly possible, and if I'm being optimistic, I would probably say yes, but I think we'd probably stick to that timeline because we're not trying to reach. I think this quarter we'll probably see, and maybe typically we're going to see like two to four deals a quarter that fit into the pipeline, but if we are originating in excess of the 250 to 300 million I noted earlier, certainly this could be 12 to 15 months.

I think the answer is possibly, but I actually think this fund is set up to have one to one and a quarter terms leverage and have lower risk because we're planning to lever the entity three turns, which is significantly higher than we would lever our balance sheet. Obviously, from that perspective, I think having a non-sponsored deal, which on the margin is higher risk than a sponsored deal. So I probably would shy away from that. But there are instances where we see a deal that we like a lot and perhaps it's levered lowly enough and there's some comfort there. But I wouldn't think that's going to be the bread and butter. But most of our non-sponsored deals, we consider them to be usually higher risk and have higher spreads versus lower spreads.

I don't think that we're increasing our sort of DOA type of deals that we're getting in over the last six or 12 months. In fact, as a percentage of total deals, I would say there's a chance it's even lower. I mean, the other thing to add is, keep going back to CAPTRIN, but, you know, the reason we set up that fund was so we could originate deals that were below, you know, 575, because that's sort of the bogey that we'd like to stay above in terms of minimum yield. And so I think Josh and his team is working with sponsors, and where deals were priced in the fives, we probably weren't relevant or weren't being shown as many of those deals.

And today, that's sort of, you know, that's opened up. And so, you know, I think we're just negotiating on, I mean, if you think about it, I've said this a few times on other calls, these deals are higher quality deals. These are going to tend to be, you know, $8 to $10 million EBITDA companies that are low levered, but, you know, lower spread, but kind of more sleep at night credits if that is actually a thing. And so we're just seeing more of those.

Thank you, operator, and thank you again to everyone for joining us today. Before we end the call, I want to reiterate the importance of shareholder approval of the proposal to increase CAPITAL SOUTHWEST's authorized shares. We encourage all shareholders who have not yet voted or who have voted against the proposal to support the company by casting an affirmative vote prior to the September 1st meeting. Everyone at CAPITAL SOUTHWEST works each day to serve our shareholders in a transparent, disciplined, and shareholder-friendly manner. We are now asking for your support so we can continue building on the success we have achieved for our shareholders, employees, board of directors, and all stakeholders. Thank you in advance for your support, and we look forward to speaking with you again next quarter.