Capital Southwest Corp 2027 Q1 Earnings Call

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

Thanks, Amy, thank you everyone for joining us for our first quarter fiscal year 2027 earnings call. We're 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 89% of votes cast have been cast in favor 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. 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 disciplined underwriting process and our continued penetration into opportunities in the lower middle market.

Demonstrating our continued investment discipline for new platform deals closed during the June quarter, weighted average senior leverage was 2.8x 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 3.1x 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 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 NAV 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 BDC price-to-book multiple declined from 0.96 times to 0.73 times over that same two-year period, CSWC has continued to trade well above book value in a range of 1.2 times to 1.5 times. I'll 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 sheet.

The vast majority of our deal activity continues to be in first-lien 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, 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 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 cost, 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 2 on our five-point scale, with 1 being the highest rating and 5 being the lowest rating. As of quarter end, 89% of the portfolio at fair value was rated in the top 2 categories.