On Thursday, Capital Southwest (NASDAQ:CSWC) discussed fourth-quarter financial results during its earnings call. The full transcript is provided below.
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Summary
Capital Southwest experienced a 17% growth in its investment portfolio, increasing from $1.8 billion to $2.1 billion, with $762 million in new committed investment originations.
The company reported a 14% rise in investment income, reaching $232 million, and maintained a stable NAV per share of $16.69.
The company achieved a 40% return on equity for fiscal year 2026, despite market disruptions.
Weighted average leverage was reported at 3.6 times, with non-accruals reduced to 1.1% at fair value.
Capital Southwest raised over $465 million in new debt capital commitments, including a $350 million bond issuance.
The joint venture with Trinity Capital, CapTrend Partners, now holds approximately $85 million in assets, with plans to increase scale.
The company maintained strong dividend distributions, with a total of $2.56 per share for the fiscal year.
The lower middle market remains stable despite broader market slowdowns, with Capital Southwest focusing on disciplined transaction pricing.
Future guidance suggests continued growth in equity co-investments with a focus on conservative underwriting.
Full Transcript
OPERATOR
Thanks for joining Today's Capital Southwest fourth quarter fiscal year 2026 earnings call. Participating on today's call are Michael Zarner, Chief Executive Officer Chris Reberger, Chief Financial Officer Josh Weinstein, Chief Investment Officer and Amy Baker, Executive Vice President, Accounting. I will now turn the call over to Amy Baker.
Amy Baker (Executive Vice President, Accounting)
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.
Michael Zarner
Thanks Amy and thank you everyone for joining us for our fourth quarter fiscal year 2026 earnings call. We're 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've delivered an industry leading 40% return on equity for our shareholders during fiscal year 2026. Despite relentless market disruptions this year, from a major geopolitical event to the private credit contagion to the conflict in Iran, we continue to execute with consistency. The market has recognized that stability and our stock performance reflects the value of our approach. The quality of our debt portfolio remains strong, reflected in a weighted average leverage of 3.6 times, weighted average interest coverage of 3.5 times 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 seven companies demonstrating meaningful progress and two removed from the watch list following a return to plan. We 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 2026. We anticipate that a portion of this appreciation will be harvested as realized gains in fiscal year 2027 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 in March 2025 to today's level. Our UTI balance highlights both the reliability of our realization engineering 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 real life 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 three distinct avenues for equity value creation. First, new investments often present low hanging fruit opportunities, operational or strategic adjustments 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 $350 million 5.9% bond issuance, $90 million in approved leverage commitments for our second Small Business Investment Company 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 AGM program during the year at a weighted average price of 1.3 times the prevailing NAD per share. Having continual access to the public equity market through the at-the-market program is a tremendous tool which we can use in all market environments. We have also made meaningful progress on CapTrend Partners, our joint venture with Trinity Capital. The Joint Venture now holds approximately 85 million in assets and we expect to continue originating low leverage, high quality investments with within this structure. Subsequent to quarter end, we closed a $150 million revolving credit facility, further expanding the Joint Venture'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 to 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 organization. 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 2025 to $2.56 per share in fiscal year 2026. 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 and AI related risks and inflation concerns stemming from the conflict in Iran, 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 de risk 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 under appreciated 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 two Managing directors and the joint venture which has enhanced our competitiveness on higher quality opportunities. Despite this increase in deal flow, we've 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 2026 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.
Josh Weinstein (Chief Investment Officer)
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 five new portfolio companies. We also completed add on financings for 12 existing portfolio companies totaling 43 million in first lien senior secured debt and 650,000 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 6.6%, 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 0.9%. 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 of 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 depreciation or 62 cents 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 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 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 Investments. The credit portfolio generated a weighted average yield of 10.8% with weighted average leverage through our security of 3.6 times 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 five 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 two categories. Cash flow coverage remains strong 3.5 times, reflecting an improvement from the 2.9 times low observed during the peak of base rates. 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 quarter, weighted average Senior leverage was 2.7 times 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 3.1 times 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.
Chris Reberger (Chief Financial Officer)
Thanks, Josh. Specific to our performance for the quarter, pre tax 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 0.8 million in PIK (Payment-in-Kind) income. The decrease in interest income was predominantly driven by a 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 of fair value, a decrease from 1.5% as of the end of the prior quarter. During the quarter we paid a 58 cent per share regular dividend paid monthly and a 6 cent per share supplemental quarterly dividend. For the June 2026 quarter, our board has again declared a total of 58 cents 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 64 cents per share. We continue to demonstrate strong dividend coverage with 109% cumulative coverage since launching our credit stretch. With a UTI balance of $1.07 per share and a sizable unrealized depreciation 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 six 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 Business Development Company industry median of approximately 2.7%. Underscoring the inherent efficiency of the internally managed Business Development Company 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 Business Development Company 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 two credit facilities, plus 42 million available on SBA debentures. In total, this represents more than 1.3 times coverage of the $329 million in unfunded commitments across the portfolio. Regulatory leverage ended the quarter at 0.9 to 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.
Michael Zarner
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 and A.
OPERATOR
Certainly. And as a reminder, ladies and gentlemen, if you do have a question at this time, please press star 11 on your telephone. Our first question comes from the line of Eric Zwick from Lucid Capital Markets. Your question please.
Eric Zwick
Thank you. Good morning. If I could start. I'm just curious with regard to unrealized depreciation in the credit portfolio in the quarter, was that primarily related to changes kind of market multiples or anything kind of more credit specific? Wonder if you could just expand on that a little bit.
Josh Weinstein (Chief Investment Officer)
Yeah, I think we had one portfolio company that was added to our watch list that had a write down which we have confidence in the company, but it had a fairly large write down and then the rest. I do think multiples were down quite a bit this quarter, which is sort of an overhang. When we went through our portfolio review, we pretty much identified about 95% of the portfolio was doing exceptionally well and yet some of those didn't have write ups because of those multiples. But by and large it was just one company and then the overall market multiple.
Eric Zwick
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 markedly from the prior year from $4.5 million to $12.7 million. So curious how much of that increase is sustainable or how much that might have been kind of one time dividends. Just any outlook, any thoughts on outlook you might have there would be helpful.
Josh Weinstein (Chief Investment Officer)
Sure. Yeah. We've had a few companies that have done exceptionally well and have been making large distributions. I think that when the first half of this, our fiscal year, we'll continue to see strong distributions from these companies. One or both could be in the market for for sale at some point. And so maybe that doesn't bleed into fiscal year 28, but for the next few quarters we should expect to continue to see those dividends.
Eric Zwick
Thanks. And last one for me, I look at the space of publicly traded BDCs capital. Southwest has one of the lowest concentrations of software in the portfolio, which I guess puts you in a more favorable eye relative to many peers given the current market sentiment. Just curious, why over time have you decided not to have that much exposure to software? And then the instances where you have made some investments, what attracted you to those particular companies?
Michael Zarner
I think a lot of the software companies honestly are generally larger and more venture. So those two together generally wouldn't fit our lens. Same could be said a lot of these companies also have ARR, which are generally used. We generally are lending cash flow lenders and we believe that lending off a multiple of EBITDA is a more conservative and prudent way to underwrite. So I think that's generally been the reasons why. It's not that we haven't seen the opportunities, we just never gotten truly comfortable with them. I don't know, Josh.
Josh Weinstein (Chief Investment Officer)
Yeah. To Michael's point, we've seen them over the years, we reviewed them. It's just not something any of us really have had a lot of experience with. And so we just couldn't 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.
Eric Zwick
I appreciate that. And just, you know, looking at back across your historical results, you've certainly done very well without it. So it's not like you've needed it. So thanks. I appreciate the insight there.
Josh Weinstein (Chief Investment Officer)
I appreciate it.
OPERATOR
Thank you. And as a reminder, ladies and gentlemen, if you do have a question at this time, please press star 11 on your telephone. Our next question comes from the line of Robert Dodd from Raymond James, your question please.
Robert Dodd
Hi guys. On the operating efficiency to Your point, the 1.4 to 1.5, the advantage of being internally managed in this quarter, obviously some expenses seemed pretty low. Another advantage that gets adjusted by the board as you Go. But can you give us any color about what was the driver there? Was it not hitting targets on deployment? Was it the fact that NAV was down, which may be temporary, but could you give us any idea, like what got factored into why that was low in the fourth quarter? Just trying to get a feel for what didn't meet your expectations.
Michael Zarner
Exactly. Sure. You know what? I wouldn't frame it that way at all. I think the board and management felt that this was one of our strongest years for a variety of reasons. But we had accrued, essentially, we had some large fees 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 3/4 to where the payout was in the fourth quarter, we had some that was backed out, but we paid over 100% in all cases for our employees and again would frame this quarter, this year as a very successful one.
Chris Reberger (Chief Financial Officer)
Yeah, Robert, I'll just jump in sort of going forward because it was kind of low in the last quarter. You know, total compensation expense is sort of in the 5.5 million per quarter range. You know, that'll vacillate a little bit based on the discussion we just had, but that's sort of what you can expect going forward.
Robert Dodd
Got it, thank you. Then on the other one, to your point, you've got a lot of unrealized appreciation in the equity portfolio. Obviously, I don't have the March portfolio, the case not out yet, but if I look at the fourth quarter, the net number, there's a lot of net unrealized appreciation. But as well, I mean, if you look just at the, the success is you've got 100 million in appreciation on assets and then that's offset by some that are down. Just listening to your comment, it sounds like you're very confident some of that is going to monetize this year. Now, it might result in lower dividend income, but those processes, other significant processes already underway to sell assets, there's not by the sponsor, obviously to sell assets this year that gives you that level of confidence. I mean, there's some like ICA Group, I mean, there's a lot of appreciation in that asset, for example. Right. So could you give us any incremental. And I know it's a touchy kind of topic, but any incremental info on where the level of confidence comes from and is it going to be some of your biggest appreciated assets that are likely to crystallize this year?
Michael Zarner
Yeah, I think that there's two primary sales. I won't get into details, but one has actually been announced publicly that there's an IPO process which would result in us, we have shares in a company we sold into, a company that went public, we'd have the ability to sell those shares and we have actually floors on what the equity value would look like. So that is something we'd expect to see happen in the next three months, four months. And then we have another company that's in the market now. It's 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, obviously there's going to be large gains associated that will go into our Undistributed Taxable Income bucket. It'll also allow us to reduce our cost of capital because obviously this is appreciation. It's realized now becomes the ability to pay down our credit facility and or raise less shares. So all of that gives us confidence both in these exits, in the ability to grow Undistributed Taxable Income and the ability to continue to support our dividend going forward.
Robert Dodd
Understood. Understood. Thank you. If I got one more quick one on the jv, I think you said expected or the target kind of return on capital to you from that vehicle, 13 to 14% when fully, fully ramped, obviously. I mean, is that like, is the full ramp 18 months or, you know. Yeah, I mean, I'm just, you know, kind of what's, what's the kind of time frame to get to that kind of in that vehicle with, with the partner you have.
Chris Reberger (Chief Financial Officer)
Sure. So I think the notion would be it's going to take at least, I'm looking at, Chris, 18 to 24 months before we see the full ramp. I think we're targeting, you know, two times leverage plus. And so I think it's going to take a little bit of time. I would say that we have the capital in house, $150 million credit facility in order to achieve that leverage and achieve that returns. But I do think we're looking at originating 30 to 40 million a quarter in the fund. And so I think it's going to take at least a year and a half to two. Yeah. So, Robert, we're going to be sort of efficient with the leverage there and try to be mindful of asset diversity and borrowing base. We'll probably try to ramp the leverage in the short term here. So as we look ahead, agree with Michael's comments, it's going to take kind of 18 months to full ramp. But in the next six months this should start producing double digit returns for Capital Southwest. So call it six months. We're kind of in the 11% range. Then we go from there.
Robert Dodd
Got it. Thank you. And Robert, I'd also like to add that the JV itself, so certainly there's going to be an uplift of a penny or two 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 somewhere in the sofa plus 5 to 575, which historically we weren't bidding or winning on. And so today we have the ability to both bid and win on these deals, maintain tight structures and as well as earning the same type of spreads, the 6 to 7% spreads that we're used to through the left out positions on these credits. Thank you.
OPERATOR
Thank you. And as a reminder, ladies and gentlemen, if you have a question at this time, please press star 11 on your telephone. Our next question comes to the line of Sean Paul Adams from B. Riley Securities. Your question please.
Sean Paul Adams
Hey guys. Good morning. It looks like you guys have kind of ramped up on terms of the employee count and perhaps a 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 look forward for next fiscal year's origination activity? Thanks.
Michael Zarner
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 have 36 and we actually have another seven coming on. So we're going to actually be up to 43 employees. We built out our operations team over the last 18 months. We've 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're just seeing enhanced deal flow. Two years ago, I think we saw 800 deals that we looked at in one year. The run rate now is around 1,400 to 1,500 deals a year. So we are adding staff to support the growth that we're seeing and to strengthen the organization, to continue to make great decisions based on having the right people in the right place, having time and experience to review these opportunities. Perfect. Thank you for the color.
OPERATOR
Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Michael Zerner for any further remarks.
Michael Zarner
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.
Disclaimer: This transcript is provided for informational purposes only. While we strive for accuracy, there may be errors or omissions in this automated transcription. For official company statements and financial information, please refer to the company's SEC filings and official press releases. Corporate participants' and analysts' statements reflect their views as of the date of this call and are subject to change without notice.
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