Capital Southwest Corporation (CSWC) Q4 2026 Earnings Report, Transcript and Summary

Thanks for joining today's Capital Southwest Fourth Quarter Fiscal Year 26 Earnings Call. Participating on today's call are Michael Scott Sarner, Chief Executive Officer Chris Rehberger, Chief Financial Officer Joshua S. Weinstein, Chief Investment Officer and Amy Baker, Executive Vice President Accounting. I will now turn the call over to Amy Baker.

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

Thanks, Amy. Thank you everyone for joining us for our fourth quarter fiscal year 2020 6 earnings call. We are pleased to be with you today to discuss our fourth fiscal quarter and the 2026 fiscal year. Overall, 2026 was an outstanding year for Capital Southwest by any measure. During the year, we grew our investment portfolio by approximately $300 million or 17% from 1.8 billion to 2.1 billion. Deal activity was robust with 762 million in new committed investment originations, Additionally, we grew investment income by $28 million or 14% from $204 million to $232 million. And despite a backdrop of pronounced volatility, we preserved the value of our portfolio NAV per share closed the year at $16.69 essentially unchanged from $16.70 in the prior year. Underscoring the resilience of our platform and the durability of our underwriting. As a result, of our consistent investment strategy, and strong operating performance, we have delivered an industry leading 40% return on equity for our shareholders during fiscal year 2020 6. Despite relentless market disruptions this year from Liberation Day, to the private credit contagion to the conflict in Ukraine, we continue to execute with consistency. The market has recognized that stability, our stock performance reflects the value of our approach. The quality of our debt portfolio remains strong. Reflected in a weighted average leverage of 3.6x, weighted average interest coverage of 3.5x, and non accruals of 1.1% at fair value. Down from 1.7% in the prior year. During the quarter, we saw improved performance across our watch list with 7 companies demonstrating meaningful progress and 2 removed from the watch list following a return to plan. Attribute much of this improvement to our portfolio operations group, which works closely with our deal teams on credits that require additional support This team is driving tangible value at the portfolio level which in turn contributes to stronger overall performance and enhanced long term shareholder value. Additionally, our equity portfolio continues to perform well with net unrealized appreciation of $37.8 million or $0.62 per share. As of the end of fiscal year 2020 6. We anticipate that a portion of this appreciation will be harvested as realized gains in fiscal year 2020 7 and thus will be available in our UTI bucket to support future dividend distributions. With $1.07 per share of undistributed taxable income, we are entering the year from a position of strength. Over the last 12 months, we have harvested $36.9 million in realized gains from equity exits. Driving UTI growth from $0.79 per share March 2025 to today's level. Our UTI balance highlights both the reliability of our realization engine and our conservative approach to dividend distributions when base rates were elevated. Resulting in a meaningful balance of taxable income, which we intend to distribute to our shareholders over time. Looking ahead, we are confident in our ability to continue generating realized gains that will support and expand our UTI balance. That confidence is grounded in the strength of our investment strategy in the lower middle market. At origination, we typically see 3 distinct avenues for equity value creation. First, new investments often present low hanging fruit opportunities, operational or strategic adjustments that the sponsor can implement immediately to drive meaningful EBITDA uplift. Second, following a change of control, the sponsor and management team activate a set of targeted growth initiatives designed to accelerate both revenue expansion and margin improvement. Third, in many cases, the team has already identified actionable M&A opportunities that can further scale the platform broaden its capabilities, and diversify the business. As EBITDA grows and the business becomes more resilient and diversified, we expect these initiatives to enhance enterprise value, and ultimately result in realized gains on our equity investments. We were also extremely active during the year in diversifying our sources of capital. We raised over $465 million in new debt capital commitments in the form of a $350 million 5.9% bond issuance $90 million in approved leverage commitments for our second SBIC fund, and an additional $25 million in new secured debt commitments on our corporate credit facility. Additionally, we raised over $160 million in gross equity proceeds on our ATM program during the year at a weighted average price of 1.3x the prevailing NAV per share. Having continual access to the public equity market through the ATM program is a tremendous tool which we can use in all market environments. We have also made meaningful progress on cap trend partners our joint venture with Trinity Capital. The JV now holds approximately $85 million in assets, and we expect to continue originating low leverage, high quality investments within this structure. Subsequent to quarter end, we closed $150 million revolving credit facility, further expanding the JV's capacity and competitiveness. This facility provides the liquidity to meaningfully increase the scale of our joint venture over time and advance rates that should produce a 13-14% return once fully ramped. From a relationship standpoint, we could not be more impressed with Kyle and the entire Trinity team and we look forward to exploring additional avenues where we can create value for both organizations. Finally, this year, we continued our long track record of producing steady dividend distributions consistent dividend coverage, and solid value creation. Despite a year in which SOFR shrunk, by approximately 60 basis points, we increased our total dividends paid from $2.54 per share in fiscal year 2020 5 to $2.56 per share in fiscal year 2020 6. 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 consistent performance as well as the absolute alignment of all our decisions with the interest of our fellow shareholders. Although broader middle market M&A headlines have highlighted a slowdown, tied to technology uncertainty, AI related risks, and inflation concerns stemming from the conflict in Ukraine our vantage point in the lower middle market tells a very different story. Activity in this segment has historically been and continues to be remarkably steady. Founder driven catalysts such as retirement, succession planning, estate considerations, and the desire to derisk after years of value creation, do not fluctuate with macro sentiment or quarterly volatility. As a result, the lower middle market consistently offers a more resilient and predictable transaction environment. A characteristic that remains significantly underappreciated. From a Capital Southwest perspective, we have seen a meaningful increase in new deals reviewed, advanced, and ultimately closed. However, our close rate, which has historically averaged roughly 2%, has moderated to 1.5%. This decline reflects our continued discipline in pricing and structuring transactions based on the risk we underwrite not simply the terms required to win a deal. We attribute the increase in deal flow to the continued development of our deal leads, the addition of 2 managing directors, and the joint venture. Which has enhanced our competitiveness on higher quality opportunities. Despite this increase in deal flow, we have also seen tightening in leverage levels and loan to value ratios, underscoring the importance of maintaining our disciplined approach as the market continues to reprice risk. In summary, we are extremely proud of our performance throughout fiscal year 2020 and we remain confident in the long term prospects for our company and the opportunities ahead. I will now hand the call over to Josh to review some more specifics of our investment activity.

Thanks, Michael. This quarter, we deployed a total of $158 million of new committed capital, consisting of $112 million in first lien senior secured debt and $2 million of equity across 5 new portfolio companies. We also completed add on financings for 12 existing portfolio companies totaling $43 million in first lien senior secured debt and $650 thousand in equity. Add on financing continued to be an important source of originations for us. As over the last 12 months, add ons as a percent of total new commitments have been 31%. These opportunities allow us to deploy capital into businesses we know well, with proven management teams and sponsors. The weighted average spread on our new commitments this quarter was approximately point 6%. Which we view as extremely attractive given today's competitive spread environment. Our on balance sheet credit portfolio ended the quarter at $1.9 billion representing 19% year over year growth from $1.6 billion as of March 2025. Importantly, 100% of our 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 point 9%. This level of portfolio granularity reflects our disciplined approach to risk management as we continue to scale the balance sheet. The vast majority of our deal activity continues to be in first lien senior secured loans to private equity backed companies. Approximately 93% 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 pari passu with the private equity firm when we believe the equity thesis is compelling. As of quarter end, our equity co investment portfolio consisted of 87 investments with a total fair value $181 million representing 9% of our total portfolio at fair value. This portfolio was marked at 126% of our cost. Representing 37.8 million of embedded unrealized appreciation or 62¢ 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 nonbank lenders. Although this environment has produced tighter loan pricing for higher quality opportunities, the depth and durability of our 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 88 unique private equity firms. And over the past 12 months, we closed 13 new platform investments with sponsors with which we had not previously partnered. Since launching our credit strategy, we have completed transactions with over a 130 private equity firms nationwide. Including more than 20% with whom we have completed multiple deals. Our portfolio now consists of 131 portfolio companies allocated 90.1% to first lien senior secured debt 1.2% to second lien senior secured debt, and 8.6% to equity co invest. The credit portfolio generated a weighted average yield of 10.8% with weighted average leverage through our security of 3.6x EBITDA. We remain pleased with the overall performance of the portfolio. At origination, all loans are initially assigned an investment rating of a 2 on a 5 point scale. With 1 being the highest rating and 5 being the lowest rating. As of quarter end, 88% of the portfolio at fair value was rated in the top 2 categories. Cash flow coverage remains strong at 3.5x, reflecting an improvement from the 2.9x low observed during the peak of base rate. This strength is further supported by the fact that our loans represent on average, only 43% of portfolio company enterprise value. Our portfolio remains broadly diversified across industries, and our average exposure per company of less than 1% continues to provide meaningful protection against idiosyncratic risk. For new platform deals closed during the March, weighted average senior leverage was 2.7x debt to EBITDA and weighted average loan to value was 33%. Providing a substantial equity cushion beneath our debt. Over the past 12 months, new platform originations have averaged 3.1x senior leverage and 35% loan to value. Underscoring our consistent commitment to conservative underwriting. 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, pretax net investment income was $35.2 million or $0.59 per share. For the quarter, total investment income decreased to $57.8 million from $61.4 million in the prior quarter. The decrease was primarily driven by a $2.2 million decrease in interest and dividend income and a decrease of $800 thousand in PIK income. The decrease in interest income was predominantly driven by 35 basis point decrease in SOFR compared to the prior quarter. As of the end of the quarter, our loans on non accrual represented 1.1% of our investment portfolio at fair value. A decrease from 1.5% as of the end of the prior quarter. During the quarter, we paid a $0.58 per share regular dividend paid monthly and a $0.06 per share supplemental quarterly dividend. For the June 2026 quarter, our board has again declared a total of $0.58 per share in regular quarterly dividends payable monthly in each of April, May, and June 2026 and maintains the $0.06 supplemental quarterly dividend also payable in June, bringing total dividends declared to $0.64 per share. We continue to demonstrate strong dividend coverage, with a 109% cumulative coverage since launching our credit strategy. With a UTI balance of $1.07 per share, and a sizable unrealized appreciation balance in our equity portfolio, we remain confident in our ability to continue distributing quarterly supplemental dividends over time. LTM operating leverage ended the quarter at 1.4%, a meaningful improvement from 1.7% in the prior quarter. Notably, this reduction occurred despite the addition of 6 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 2.7%. 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 $16.69 per share down from $16.75 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 offset by accretion from our equity ATM program. We raised approximately $25 million in gross equity proceeds during the quarter, through our equity ATM program, at a weighted average share price of $23.13 per share. Or 138% of the prevailing NAV per share. Reinforcing our ability to raise capital efficiently and accretively. Our liquidity position remains robust, with approximately $394 million in cash and undrawn leverage commitments across our 2 credit facilities. Plus $42 million available on SBA debentures. In total, this represents more than 1.3 times coverage of $329 million in unfunded commitments across the portfolio. Regulatory leverage ended the quarter at 0.9:1 debt to equity. While our target leverage remains in the 0.85 to 0.95 times range, we continue to factor in the current macroeconomic backdrop and intend to maintain a prudent leverage cushion to help mitigate capital markets volatility.

We will continue to raise secured and unsecured debt capital as well as equity through our ATM program. In a methodical and opportunistic manner, to ensure we maintain significant liquidity and a conservatively constructed balance sheet with adequate covenant cushions. I will now hand the call back to Michael for some final comments. Thank you, Chris, Joshua, 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 and A.

Certainly. At this time, please press 1-1 on your telephone. Our first question comes from the line of Erik Zwick from Lucid Capital Markets. Your question please.

Thank you. Good morning. If I could start, I am just curious with regard to the unrealized depreciation in the credit portfolio in the quarter. Was that primarily related to your changes kind of market multiples or anything kind of more credit specific. Wondering if you could, just expand on that a little bit. I think we had 1 portfolio company that was added to our watch list that had a write down, which we have confidence in the company, but it would have a fairly large write down. And then the rest, as you said, multiples were down quite a bit this quarter, which is sort of an overhang. When we went through our portfolio review, we, we pretty much identified, about 95% of the portfolio was doing exceptionally well, and yet some of those did not have write ups. Because of those multiples. But by and large, it is just 1 company, then the overall market multiple. Thank you. I appreciate that. And just looking at the trajectory of the dividend income that you received in the most recent year, it was up, you know, markedly from prior year from $4.5 million to $12.07 million. So curious how much of that increase is sustainable or how much of that might have been kind of onetime dividends? Just any outlook any thoughts on outlook you might have there would be helpful.

Sure. Yeah. We have had a few companies that had done exceptionally well and had been making large distributions. I think that in the first half of this, our fiscal year, we will continue to see strong distributions from these companies. 1 or both could be in the market for sale at some point. And so maybe that does not bleed into fiscal year 2020 8. But for the next few quarters, we should expect to continue to see those dividends. Thanks. And last 1 for me.

You know, I look at the you know, space of publicly traded BDCs, Capital Southwest, has 1 of the lowest concentrations of software in the portfolio, which I guess puts you in a more, you know, favorable eye relative to many peers. Given the current market sentiment. Just curious why over time have you decided not to have, you know, that much exposure to software and in the instances where you have made some investments, what attracted you to those, particular companies?

I think a lot of the software companies, honestly, are generally larger and more venture. So those 2 together generally would not fit our lens. Same could be said. A lot of these companies also have ARR. Which are you know, we generally are lending cash flow lenders. And we believe that, you know, lending off a multiple of EBITDA is a more conservative and prudent way to underwrite. So I think that is generally been the reasons why not that we have not seen the opportunities. We just never gotten truly comfortable with them. I do not know, Josh.

Yeah. To Michael's point, we have seen them over the years. We have reviewed them. it is just not something any of us have had a lot of experience with, and so we just could not really get comfortable or as comfortable with you know, doing a lot of ARR deals and stuck to our knitting of cash flow lending for the most part.

I appreciate that. And just, you know, looking at back across your historical results, you would certainly done very well without it. So it is not like you have needed it. So thanks. I appreciate the insight there.

I appreciate it.

Thank you. And as a reminder, ladies and gentlemen, if you do have a question at Our next question comes from the line of Robert Dodd from Raymond James. Your question please.

Hi guys. On the operating efficiency, to your point, you know, 1.4% to 1.5%, the advantage of being internally managed. In this quarter, obviously, some expenses seemed pretty low. Another advantage, right, that gets that gets adjusted by the board as you go. But can you give us any color about what was the driver there? Was it was it not hitting targets on the deployment? Was it the fact that NAV was down, which may be temporary, but you know, can you give us any idea, like, what got factored into to why that was low in the fourth quarter Just trying to get a feel for what did not meet your expectations, exactly.

Sure. And I you know what? I would not frame it that way at all. I think the board and management felt that this was 1 of our strongest years for a variety of reasons. But we had accrued essentially, we had some large fees that came in over the year. We had some over accruals into the bonus. Pool. And then at the end of the year, you know, the board gets together to basically determine what they think that the final number would look like. And so we, you know, from where we had accrued through 3 quarters to where the payout was in the fourth quarter, we had some that was backed out. But we paid over a 100% in all cases for our employees. And, again, would frame this quarter this year as a very successful 1.

Yeah, Robert. I will just jump in sort of going forward because it was kinda low in the last quarter. You know, total compensation expense is sort of in the $5.5 million per quarter range. You know, that is that will vacillate a little bit based on the discussion we just had. that is sort of what you can expect going forward.

Got it. Thank you. Then on the other 1, I mean, to your point, I mean, you have got a lot of unrealized appreciation in the equity portfolio. Obviously, I do not have the, the March portfolio. The case is not out yet. But if I look at App, at the fourth quarter, I mean, the net number is there is a lot of net unrealized appreciation. But as well, I mean, if you look just at the successes, you know, you have got $100 million in appreciation on assets, and then that is offset by some that are down. Just listening to the economy, it sounds like you are very confident some of that is gonna monetize this year. Now it might result in lower dividend income, but, you know, at the--yeah. What are those processes are there significant processes already underway to sell assets? there is not you know, by the sponsor, obviously. To sell assets this year that gives you that level of confidence. I mean, there is some, like, ITA Group. I mean, that is that is there is a lot of appreciation in the asset. For example, Right? So could you give us any incremental? And I know it is a per kind of topic, but any incremental info on where the level of confidence comes from, and is it gonna be some of your biggest appreciated assets that are likely to crystallize?

This year? Yeah. I think that there is 2 primary sales. I will not get into details, but I mean, 1 is actually been announced publicly that there is an IPO process which would result in us we have shares in a company We sold into company that went public. We would have the ability to sell those shares and we have, actually floors on what the equity value would look like. So that is something that we would expect to see happen in the next you know, 3 months, 4 months. And then we have another company that is in the market. Now it is still in the nascent stages. It is a fairly large position, but we feel pretty confident. Based on where we are that there should be a sale there. If you look at the cost basis relative to the fair value, you know, obviously, there is gonna be a large gains associated that will go into our UTI It will also allow us to, you know, reduce our cost of capital because, obviously, this is you know, appreciation that is realized now becomes the ability to pay down our credit facility and or, you know, raise less shares. So all of that gives us confidence both in these exits and the ability to grow UTI and the ability to continue to support our dividend going forward.

Understood. Understood. Thank you. If I have 1 more quick 1. On the JV, I think you said expected or the target kind of return on capital to you from that is 13-14% when fully ramped, obviously. I mean, is that, like and is the full ramp 18 months? Or, you know yeah. I mean, I am just you know, kind of what is the kind of time frame to get to that kind of in that vehicle with the partner you have? Michael Scott Sarner: Sure. So I think the notion would be it is gonna take at least, I am looking at Chris, 18 to 24 months before we see the full ramp I think we are targeting, you know, 2x leverage plus. And so I think it is gonna take a little bit of time. I would say that we have the capital house, the $150 million credit facility. In order to achieve that leverage and achieve those returns. But I do think you know, we are looking at originating $30 million to $40 million a quarter in the fund. And so I think it is gonna take at least a year and a half to 2. Yeah. So, Robert, we are gonna be sort of efficient with the leverage there and try to, you know, being mindful of asset diversity and borrowing base. We will probably try to ramp the leverage fairly in the short term here. So as we look ahead, agree with Michael's comment, it is going to take kind of 18 months to full ramp. But in the next 6 months, this should start producing double digit returns for Capital Southwest. So call it, you know, 6 months, we are kinda in the 11% range, then we go from there. Got it. Thank you.

Yep. And Robert, I would also like to add that the JV itself so the certainly, there is gonna be an uplift of a penny or 2 from this fund by itself. But having this joint venture has been really important to the business in the way of us being able to be more competitive on deals that are priced you know, somewhere in the, you know, SOFR plus 5% to 5.75%. Which historically, we were not bidding or winning on. Mhmm. And so today we are--we have the ability to both bid and win on these deals, maintain tight structures, and as well as, you know, earning the same type of spreads, the 6% to 7% spread that we are used to, through the left out positions. On these credits.

Got it. Thank you.

Thank you. And as a reminder, ladies and gentlemen, if you Our next question comes from the line of Sean-Paul Aaron Adams from B.

Riley Securities. Your question please. Hey, guys. Good morning. It looks like you guys have kind of ramped up on terms of the employee count and perhaps the deal team. Any color on how just these changes in the amount of employees and perhaps the amount of deals passing your desk are going to, you know, look forward for you know, next fiscal year's origination activity. Thanks.

Sure. Sure. Look. When we look back around, what, 15, 18 months ago, we had 27 employees. Today, we have you know, as of the quarter end, we had 36 and we actually have another 7 coming on. We are gonna actually be up to 43 employees. We built out our operations team over the last 18 months. We have added a new MD. A new vice president. A new principal, certainly added more support staff on the back office. And the notion here is that you know, with the new MD we have, with the maturation of the deal leads in place and the ability to continue to win new share and new, sponsor relationships. We are just seeing enhanced deal flow. 2 years ago, I think we saw 800 deals that we looked at in 1 year. The run rate now is around 1.4 thousand deals a year. So we are adding staff to support the growth that we are seeing. And to strengthen the organization to continue to make great decisions based on having the right people in the right place, you know, having time experience to review these opportunities.

Perfect. Thank you for the color.

Thank you. This does conclude the question and answer of today's program. I would like to hand the program back to Michael Scott Sarner for any further remarks.

Thank you, operator, and thank you, everyone, for joining us today. Please feel free to call us anytime with questions or get an update on the business. We look forward to catching up with you next quarter. Goodbye.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.