Q3 2022 Capital Southwest Corp Earnings Call
Speaker 1: Today's conference is scheduled to begin shortly. Please continue to stand by. Thank you for your patience.
Today's conference is scheduled to begin shortly please continue to standby. Thank you for your patience.
[music].
Speaker 2: And.
Speaker 2: Thank you for watching.
Speaker 2: The the.
Thank you for joining today's capital southwest third quarter fiscal year 2022 earnings call.
Speaker 3: Thank you for joining today's Capital Southwest 3rd Quarter Fiscal Year 2022 earnings call. Participating on the call today are Bowen Deal, CEO , Michael Sarner, CFO , and Chris Reberger, VP Finance. I will now turn the call over to Chris Reep.
Participating on the call today are Bowen Diehl, CEO , Michael <unk>, CFO , and Chris Rehberger, VP Finance I will now turn the call over to Chris Rehberger.
Speaker 4: 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. Our subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements.
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.
Speaker 4: For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC.
Speaker 4: 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.
After the date of this press release, except as required by law.
I will now hand, the call off to our President and Chief Executive Officer Bowen Diehl.
Speaker 4: I will now hand the call off to our President and Chief Executive Officer, Bowen Deal.
Thanks, Chris Thank you to everyone for joining us for our earnings call for the quarter ended December 31, 2021, which is the third quarter third quarter of our 2022 fiscal year, which ends March 31 2022 were.
Speaker 5: Thanks Chris, and thank you to everyone for joining us for our earnings call for the quarter-ended December 31, 2021, which is the third quarter of our 2022 fiscal year, which ends March 31, 2022. We're pleased to be with you this morning and look forward to giving you an update on the performance of our company, our portfolio, and our progress on executing our investment strategy as stewards of your capital.
We're pleased to be with you. This morning, and look forward to giving you an update on the performance of our company.
Portfolio on our progress on executing our investment strategy as stewards of your capital.
Speaker 5: Throughout our prepared remarks, we will refer to the various slides in our earnings presentation, which can be found on our website at www.capitalsathwest.com.
Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www Dot capital southwest Dot com.
Speaker 5: Well, again, on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of 51 cents per share, which more than earned our regular dividend paid for the quarter of 47 cents per share. Total dividends for the quarter were 97 cents per share, which consisted of the regular dividend of 47 cents, and the supplemental dividend of 50 cents per share.
Begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter.
During the quarter, we generated pre tax net investment income of 51 per share, which more than earned a regular dividend paid for the quarter up 47 per share.
Total dividends for the quarter were <unk> 97 per share which consisted of a regular dividend of <unk> 47.
In the supplemental dividend of <unk> 50 per share.
We're also pleased to announce that our board has declared an increase in our regular dividend per share $2 48.
Speaker 5: We're also pleased to announce that our board has declared an increase in our regular dividend per share 248 cents for the quarter ended March 31, 2022, an increase of 2.1% from the 47 cents per share paid in the December quarter.
For the quarter ended March 31, 2022, an increase of two 1% from the <unk> 47 per share paid in the December quarter.
Speaker 5: This increase in our recurring regular dividend reflects the increased earnings power of our portfolio, resulting from the growth and performance of our credit portfolio, and the continued reduction reductions in our cost of capital and improvements in our operating leverage.
This increase in our recurring regular dividend reflects the increased earnings power of our portfolio, resulting from the growth and performance of our credit portfolio and the continued reduction reductions in our cost of capital and improvements in our operating leverage.
During the quarter acquisition and financing activity in the lower middle market was very strong resulting in record new originations for capital southwest as.
Speaker 5: During the quarter, acquisition and financing activity in the lower mental market was very strong, resulting in record new originations for capital Southwest. As expected, we also saw record-prepared activity across our portfolio.
As expected, we also saw record prepay activity across our portfolio.
Speaker 5: On a net basis, we were able to grow our investment portfolio by 7.2% to $877 million.
On a net basis, we were able to grow our investment portfolio by seven 2% to $877 million.
Speaker 5: Portfolio growth during the quarter was driven by 268 million in commitments to 14 new portfolio companies and 12 existing portfolio companies, up which 213 million was funded at close.
Portfolio growth during the quarter was driven by $268 million and commitments to 14, new portfolio companies and 12 existing portfolio companies of which $213 million was funded at close.
Speaker 5: This was offset by 158 Nm proceeds from 11 depth prepayments and one equity exit during the quarter.
This was offset by $158 million in proceeds from 11 debt prepayments and one exit one equity exit during the quarter.
Speaker 5: Notivate the equity exit was a very successful outcome as it generated a realized gain of 5.6 million and an IRR of 99.2%.
Notably the X equity exit was a very successful outcome as it generated a realized gain of $5 6 million and an IRR of 99, 2%.
Speaker 5: As we have previously stated, our intention over time is to distribute these realized gains periodically through special dividends to our shareholders.
As we have previously stated our intention over time is to distribute these realized gains periodically through special dividends to our shareholders.
Speaker 5: On a capitalization front, on November 2021, we completed an add-on of $50 million in Addered Principal to our 3 and 3 eighths October 26 note.
On the capitalization front on November 2021, we completed an add on of $50 million in aggregate principal two or three and three eights October 'twenty six notes.
Furthermore, in lockstep with our strong deal pipeline, we raised $16 million of equity through our ATM program at an average price of $25 97 per share representing an average of 159% of the prevailing net asset value per share.
Speaker 5: Furthermore, in lockstep with our strong deal pipeline, we raised 16 million of equity through our ATM program at an average price of $25.97 per share, representing an average of 159 percent of the prevailing net asset value per share.
Speaker 5: On slide seven and eight, we illustrate our continued track record of producing steady, steady dividend growth, consistent dividend coverage and value creation since the launch of our credit strategy.
On slides seven and eight we illustrate our continued track record of producing steady steady dividend growth.
Consistent dividend coverage and value creation since the launch of our credit strategy.
We believe the solid performance of our portfolio and our company's sustained access to the capital markets as demonstrated the strength of our investment and capitalization management strategies.
Speaker 5: We believe the solid, performative, or portfolio and our company's sustained access to the capital markets has demonstrated the strength of our investment in capitalization management strategies.
Maintenance and growth of both both NAV per share and shareholder dividends remain as core tenants of our long term investment objective of creating long term value for our shareholders.
Speaker 5: Maintenance and growth of both NAV push-air and shareholder dividends remain as core tenants of our long-term investment objective of creating long-term value for shareholders.
Turning to slide nine as a refresher our investment strategy has remained consistent since its launch in January of 2015.
Speaker 5: Turning the slide 9 at the refresher, our investment strategy has remained consistent since its launch in January of 2015.
Speaker 5: We continue to focus on our core lower middle market lending strategy while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk adjusted returns exist.
We continue to focus on our core lower middle market lending strategy, while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk adjusted returns exist.
In the lower middle market, we directly originate and lead opportunities consisting primarily of first lien senior secured loans with smaller equity co investments made alongside.
Speaker 5: In the role of the mental market, we directly originate in lead opportunities, consisting primarily of first-leaning senior secured loans with smaller equity current investments made alongside many of our loans.
One side many of our loans.
Speaker 5: We believe that this combination is powerful for BDC as it provides strong security for the vast majority of our invested capital while also providing NAV website from equity investments in many of these growing business.
We believe that this combination is powerful for BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from equity investments in many of these growing businesses.
Speaker 5: Building out a well-performing and granular portfolio of equity co-investments is important to driving growth in NAV per share while aiding in the mitigation of any credit losses over time.
Building out a well performing and granular portfolio of equity co investments is important to driving growth in NAV per share while aiding in the mitigation of any credit losses over time.
Speaker 5: As of the end of the quarter, our equity co-investment portfolio consisted of 39 investments with a total fair value of $74.5 million, which included $17.7 million in embedded unrealized appreciation for approximately $0.74 per share.
As of the end of the quarter, our equity co investment portfolio consisted of 39 investments with a total fair value of $74 5 million, which included $17 $7 million and embedded unrealized depreciation were approximately 74 per share.
Our equity portfolio, which represented approximately 9% of our total portfolio at fair value as of the end of the quarter continues to provide our shareholders attractive upside from growing lower middle market businesses.
Speaker 5: Our equity portfolio, which represented approximately 9% of our total portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from growing lower middle market businesses.
Speaker 5: The successful exit of one of our lower middle market equity co-investments this quarter, which produced a realized gain of $5.6 million, is an example of the benefits of this component of our strategy.
The successful exit of one of our lower middle market equity co investments this quarter, which produced a realized gain of $5 6 million as an example of the benefits of this component of our strategy.
As illustrated on slide 10.
Speaker 5: Is illustrated on flight 10, our on-balance sheet credit portfolio is at the end of the quarter, excluding our I-45 senior loan fund grew 8% to 745 million, as compared to 689 million as of the end of the prior quarter.
On balance sheet credit portfolio as of the end of the quarter, excluding our I 45, senior loan fund grew 8% to $745 million as compared to $689 million as of the end of the prior quarter.
Speaker 5: For the quarter 99% of our new portfolio company debt originations were firstly senior secured and all of the debt originations for the quarter were senior secured.
For the quarter, 99% of our new portfolio company debt originations were first lien senior secured and all of the debt originations for the quarter were senior secured.
Speaker 5: Finally, as of the end of the quarter, 91% of the credit portfolio was FirstLink Senior Securities.
Finally as of the end of the quarter, 91% of the credit portfolio was first lien senior secured.
On slides 11 and 12.
Speaker 5: On slides 11 and 12, we lay out the $268 million of capital invested in and committed to portfolio companies during the quarter.
We lay out the $268 million of capital invested in and committed to portfolio of companies during the quarter.
Capital committed this quarter included $204 million in first lien senior secured debt committed to 14, new portfolio companies, including one in which we also invested $3 $3 million in second lien alongside our first lien debt.
Speaker 5: Capital committed this quarter included $204 million in first lien senior secured debt committed to 14 new portfolio companies, including one in which we also invested $3.3 million in second lien alongside our first lien debt.
Speaker 5: Additionally, we invested $6.4 million in equity alongside eight of our new portfolio companies.
Additionally, we invested $6 4 million in equity alongside eight of our new portfolio of companies.
Speaker 5: Finally, during the quarter, we also committed $54.3 million in first-line senior secured debt to nine existing portfolio companies.
Finally during the quarter, we also committed $54 $3 million in first lien senior secured debt to nine existing portfolio companies.
Speaker 5: Turning to slide 13, we continue our track record of successful.
Turning to slide 13, we continued our track record of successful exits.
Speaker 5: with 11 debt investment exits and one equity exit during the quarter. In total, these exits generated over $158 million in total proceeds, realizing gains of $7.4 million and generating a weighted average IRR of 16.2%.
With 11 debt investment exit and one equity exit during the quarter in total these exits generated over $158 million in total proceeds.
Rising gains of $7 $4 million and generating a weighted average IRR of 16, 2%.
Speaker 5: Since the launch of our credit strategy over seven years ago, we have generated a cumulative wage average IRR of 14.6% on 56 portfolio exits, representing approximately $638 million in proceeds.
Since launch of our credit strategy over seven years ago, we have generated a cumulative weighted average IRR of 14, 6%.
On 56 portfolio exits representing approximately $638 million in proceeds.
Speaker 5: As previously mentioned, the market for acquisition and refinancing capital was very robust during the quarter, resulting in heavy volume in both origination and refinancing activity.
As previously mentioned the market for acquisition and refinancing capital was very robust during the quarter, resulting in heavy volume in both the origination and refinancing activity.
Speaker 5: Our investment pipeline, as we have mentioned on previous earnings calls, has been robust throughout 2021 in both volume and quality of deals, and the December quarter was especially so.
Our investment pipeline as we have mentioned on previous earnings calls has been robust throughout 2021, and both volume and quality of deals.
In the December quarter was especially so.
Speaker 5: I'm very pleased with the strong market position that our team has established in the lower middle market as a premier debt and equity capital partner.
Im very pleased with the strong market position that our team has established in the lower middle market is a premier debt and equity capital partner.
Speaker 5: I'm especially encouraged by the increasing number of deal sources, private equity firms and otherwise, that have been cultivated where we have closed multiple transactions together. We are finding that these firms are willing to be references for us as we prospect for new relationships.
I'm, especially encouraged by the increasing number of deal sources private equity firms and otherwise.
That had been cultivated where we have closed multiple transactions together we.
We are finding these firms are willing to be references for us as we prospect for new relationships.
Additionally, it is exciting to also see the number of new deals coming in from very relevant deal sources that are new to us.
Speaker 5: Additionally, it is exciting to also see the number of new deals coming in from very relevant deal sources that are new to us.
Speaker 5: As we have always contended, this broadening of our sourcing network and deal funnel is a critical proponent of building and maintaining a quality investment portfolio in a competitive market.
As we have always contended this broadening of our sourcing network in deal funnel is a critical component of building and maintaining a quality investment portfolio in a competitive market.
Speaker 5: On slide 14, we illustrate some key stats from our on-balance sheet portfolio as of the end of the quarter, again, excluding our I-45 senior loan fund.
On slide 14, we illustrate some key stats from our on balance sheet portfolio as of the end of the quarter.
Again, excluding I 45 senior loan fund.
Speaker 5: As of the end of the quarter, the total On Balance Sheet portfolio at fair value was weighted 82.9% to first lien investments, 6.5% to second lien investments.
As of the end of the quarter. The total on balance sheet portfolio at fair value was weighted 82, 9% of first lien investments.
Six 5% of second lien investments.
One 5% of subordinated and investments and nine 1% to equity co investments.
Speaker 5: 1.5% to subordinated investments and 9.1% to equity co-investments.
Turning to slide 15.
Speaker 5: We have laid out the rating migration within the portfolio. During the quarter, we had two loans upgraded from a 2 to a 1 and two loans upgraded from a 3 to a 2. We had no loans downgraded this quarter.
We have laid out the rating migration within the portfolio during.
During the quarter, we had two loans upgraded from a two tier one and two loans upgraded from a three tier two we.
We had no loans downgraded this quarter.
Speaker 5: As a reminder, all loans upon origination are initially assigned an investment rating of 2 on a 4-point scale, with 1 being the highest rating and 4 being the lowest rating.
As a reminder, all loans upon origination are initially assigned an investment rating of two on a four point scale with one being the highest rating and four being the lowest rating.
Speaker 5: As of the end of the quarter, we had 68 loans representing approximately 95.4% of our investment portfolio at fair value rated in one of the top two categories, a one or a two.
As of the end of the quarter, we had 68 loans, representing approximately 95, 4% of our investment portfolio at fair value and one of the top two categories one or two.
Speaker 5: We had five loans representing 4.6% of the portfolio, rated a 3, and one loan representing less than 1% of the portfolio, rated a 4.
We had five loans, representing four 6% of the portfolio rated a three.
And one loan representing less than 1% of the portfolio rate of four.
During the quarter, we had no new loans placed on non accrual and one loan at a fair value of $5 2 million come off of non accrual.
Speaker 5: During the quarter, we had no new loans placed on nonaccrual and one loan at a fair value of $5.2 million come off of nonaccrual.
Speaker 5: As we discussed last quarter, this company successfully completed the restructuring of its balance sheet in December , which allowed us to place a portion of the original loan back on accrual this quarter.
As we discussed last quarter. This company successfully completed a restructuring of its balance sheet in December which allowed us to place a portion of the original loan back on accrual this quarter.
Speaker 5: As illustrated on slide 16, our total investment portfolio continues to be well diversified across industries with an asset mix that provides strong security for our shareholders' capital.
As illustrated on Slide 16, our total investment portfolio continues to be well diversified across industries with an asset mix that provide strong security for our shareholders' capital.
Speaker 5: Portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio in second lien senior secured debt and only 1% of the portfolio in subordinated debt.
Portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio in second lien senior secured debt and only 1% of the portfolio in subordinated debt.
Turning to slide 17, the I 45 senior loan fund continues its solid performance.
Speaker 5: Turning to slide 17, the I-45 Senior Learning Fund continues its solid performance.
Speaker 5: As of the end of the quarter, 95% of the I-45 portfolio was invested in first lane senior secured debt.
As of the end of the quarter, 95% of the <unk>.
45 portfolio was invested in first lien senior secured debt.
Speaker 5: Weighted average EBITDA and leverage across the companies in the I-45 portfolio was $72.8 million and five times, respectively.
Weighted average EBITDA and leverage across the companies and the I 45 portfolio was $72 8 million and five times respectively.
The portfolio continues to have diversity among industries and an average hold size of two 4% of the portfolio.
Speaker 5: The portfolio continues to have diversity among industries and an average hold size of 2.4% of the portfolio.
Speaker 5: Leverage at the I-45 fund level is currently 1.52 times debt to equity.
Leverage at the I 45 fund level is currently 152 times debt to equity.
Speaker 5: I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.
I will now hand, the call over to Michael to review more specifics of our financial performance for the quarter.
Thanks Bowen.
Specific to our performance for the December quarter are summarized on slide 18, we earned pretax net investment income of $11 8 million or.
<unk> <unk> 51 per share.
Speaker 6: We paid out $0.47 per share in regular dividends for the quarter, an increase from the $0.44 regular dividend per share paid out in the September quarter.
Paid out <unk> 47 per share in regular dividends for the quarter, an increase from the 44% regular dividend per share paid out in the September quarter.
Speaker 6: As mentioned earlier, our board has increased the regular dividend, declaring a regular dividend of $0.48 per share for the March quarter.
As mentioned earlier.
Board has increased the regular dividend declaring a regular dividend of <unk> 48 per share for the March quarter, mainly.
Speaker 6: Maintaining a consistent track record of meaningfully covering our dividend with pre-taxed NII is important to our investment strategy.
Maintaining a consistent track record of meaningfully covering our dividend with pre tax NII is important to our investment strategy. We continue.
Speaker 6: We continue to maintain our strong track record of regular dividend coverage, with 105% for the last 12 months ended December 31, 2021, and 107% cumulative since the launch of our credit strategy in January 2015.
To maintain our strong track record of regular dividend coverage with a 105% for the last 12 months ended December 31, 2021, and 107% cumulative since the launch of our credit strategy in January 2015.
Speaker 6: Our investment portfolio continues to perform well, generating $700,000 in net realized and unrealized gains this quarter, bringing the net realized and unrealized gains over the past four quarters to $12.2 million.
Our investment portfolio continues to perform well generating 700000 in net realized and unrealized gains this quarter, bringing the net realized and unrealized gains over the past four quarters to $12 $2 million.
As Bowen mentioned going forward, we intend to periodically distribute special dividends to our shareholders as we monetize the unrealized depreciation in the portfolio.
Speaker 6: As Bowen mentioned, going forward we intend to periodically distribute special dividends to our shareholders as we monetize the unrealized appreciation in the portfolio.
Speaker 6: As of December 31, 2021, our estimated UTI balance was $0.32 per share.
As of December 31, 2021, our estimated UTI balance was 32 per share.
Speaker 6: The end-of-the-year UTI balance excludes the $5.6 million gain on the sale of one of our equity investments this quarter, as this company was held at our taxable subsidiary. Post-quarter end, we distributed taxable income from our taxable subsidiary to CSWC, and these proceeds are now available for distribution to our shareholders.
At the end of the year UTI balance excludes the $5 6 million gain on the sale of one of our equity investments this quarter. As this company was held at our taxable subsidiary post.
Post quarter end, we distribute taxable income from our taxable subsidiary to see Swc and these proceeds are now available for distribution to our shareholders.
Speaker 6: Our investment portfolio produced $22.3 million of investment income this quarter with a weighted average yield on all investments of 9.4%.
Our investment portfolio produced $22 3 million of investment income this quarter with a weighted average yield on all investments of nine 4%.
Speaker 6: Investment income was $2 million higher this quarter due primarily to an increase in average credit investments outstanding, as well as fees paid on debt prepayment.
Investment income was $2 million higher this quarter due primarily to an increase in average credit investments outstanding as well as fees paid on debt prepayments.
Speaker 6: There were 3 loans on non-accrual with an aggregate fair value of $14 million, or 1.6% of the investment portfolio as of the end of the quarter. Our weighted average yield on our credit portfolio was 9.5% for the quarter.
There were three loans on non accrual with an aggregate fair value of $14 million.
Or one 6% of the investment portfolio as of the end of the quarter.
Our weighted average yield on our credit portfolio was nine 5% for the quarter.
Speaker 6: As seen on slide 19, we maintain LTM operating leverage at 2.3% as of the end of the quarter. We are targeting operating leverage to approach 2% or better in the coming quarter.
On slide 19, we maintain LTM operating leverage at two 3% as at the end of the quarter.
We're targeting operating leverage to approach, 2% or better in the coming quarters.
Speaker 6: Turning to slide 20, the company's NAB per share as of December 31, 2021 was $16.19, as compared to $16.36 at September 30, 2021. The driver of the NAB per share decrease was the 50 cents per share supplemental dividend that was distributed to shareholders this quarter from our UTI balance.
Turning to slide 20, the company's NAV per share as of December 31, 2021 was $16 19 as compared to $16 36 at.
At September 32021 to.
The driver of the NAV <unk> NAV per share decrease was the <unk> 50 per share supplemental dividend that was distributed to shareholders. This quarter from our UTI balance.
As we have discussed on prior calls we continue to originate assets within our <unk> subsidiary, which you will see going forward. As you noted is Spi one.
As a reminder, our initial equity commitment to the fund is $40 million and we have received an initial commitment from the SBA for $40 million of fund leverage which is also referred to as one tier of leverage.
We have funded our initial $40 million of equity capital to the fund and had drawn $29 million of the initial $40 million commitment and debt capital at a weighted average interest rate of 143%.
We have applied for our second $40 million to Euro fund leverage, which we are hopeful will be approved in the coming days.
Overall, we are pleased to report that our balance sheet liquidity continues to be strong with approximately $171 million in cash and undrawn leverage commitments as at the end of the quarter as of December 31, 2021, approximately 57% of our capital structure liabilities were unsecured and our earliest debt maturity is in.
January 2026, our regulatory leverage as seen on slide 22 ended the quarter at a debt to equity ratio of 123 to one I will now hand, the call back to Bowen for some final comments.
Thanks, Michael and thank you everyone for joining us today capital southwest continues to perform well and consistent with our original vision and strategy, we communicated our shareholders. When we began this journey.
Our team has done an outstanding job building a robust asset base.
<unk> origination capability as well as a flexible capital structure that provides us for that prepares us for all environments throughout the economic cycle.
We believe that our performance continues to demonstrate the investment acumen of our team at capital southwest and the merits of our first lien senior secured debt strategy.
We feel very good about the health of our company and portfolio and we are excited to continue to execute our investment strategy going forward.
And everyone here at capital southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long term sustainable value for all our stakeholders.
This concludes our prepared remarks, operator, we are ready to open the lines up for Q&A.
Thank you as a reminder to ask a question you will need to pass Taiwan when your telephone.
Your question. Please press the pound key please standby, while we compile the Q&A roster.
Our first question comes from Mickey Schlein with Ladenburg Thalmann. Your line is now open.
Yes, good morning, everyone.
And this year looking.
Borrowers are probably going to see more inflation in their cost inputs like we saw last year, but they are also probably going to see the cost of their floating rate debt borrowings claim means.
Meaningfully once we get pass through floors.
When you look at your portfolio and stress tested.
Do you see their cash flows performing in 2022, and how concerned are you about the ability to service their debt.
Yes, thanks for the question Mickey I would say.
Kind of starts with our original underwriting these loans and then how we stress test.
Fixed charge coverage across the portfolio from a.
Lenders perspective.
There is a pretty large cushion.
Okay.
I'm getting some feedback.
Yes.
Pretty large cushion from a servicing their debt perspective.
So we're not we're not concerned about that across the portfolio.
With respect to the increased.
Can you hear me Mickey.
I hear you okay.
Okay fine.
As far as the.
The companies themselves, yes, I would say that the two common themes across the portfolio. We hear from companies management teams is the rising cost of inputs.
Being labor being as most folks know from reading on the news labor labor cost inflation is a big piece of it.
Commodity input.
Cost increases are a big part of it and then the other theme is just supply chain cadence and pace.
And so as far as labor and cost inputs Fortunately so far.
These businesses are growing nicely and they are they are able to pass those cost inputs.
Vast majority of that cost on to their customers.
But we think that trend is going to continue this year.
I think from a rising again from a rising interest cost on floating rate borrowings across the portfolio just the level of leverage versus cash flow across our portfolio, we think theirs.
Started from how we originally underwrote the loans.
Theres a lot of cushion there to actually be.
What would have to happen before they can service their debt.
Right.
I appreciate that that's good to hear.
My follow up question regards spreads there is an enormous amount of capital being injected into the upper middle market private debt market. As these lenders continue to disintermediation the syndicated loan market and obviously thats driving down spreads in that market, how do you feel about.
That trend.
Potentially trickling down into the middle market and even into the lower middle market over time and impacting.
The economics in the business.
Yes, so I mean, that's definitely a dynamic that.
Could continue to happen and it's happening a little bit.
We don't see the big syndicated funds moving down into the to the middle market and drove that we'd see it we do see it and we certainly see a lot of capital being raised.
In the middle market.
And so look at the end of the day, we generate earnings off of our net interest margin.
So that's obviously our asset yield.
And different from your asset yield and our operating and financing costs and so we also take advantage of the quantum of capital being being wanting to invest in the middle market and lower middle market through our capital providers on the leverage side and so as long as we can keep that net interest margin maintained which we feel very good.
About that.
That ultimately.
What really drives our earnings and our business model at the end of the day.
I understand I appreciate that.
Thank you for your time.
We'll follow up if I have any more questions and have a good morning.
Thank you.
Our next question comes from Kevin <unk> with JMP Securities. Your line is open.
Good morning, and thank you for taking my questions.
Clearly Q3 was a very strong quarter for origination activity and repayment activity, which led to solid portfolio growth can you give us a sense how originations are tracking so far this quarter relative to last quarter as well as the repayment activity.
Yes.
General comment I mean, clearly and Youll, probably hear this across the industry as earnings cannot.
The December quarter was very robust and just transaction activity.
Both from an M&A for us primarily from an M&A perspective.
Which drove.
In answering activity and then obviously.
If we have a portfolio company that is doing a large funded debt funded acquisition. Then we have a chance to fund that or we have it if the leverage market provides a leverage package for that acquisition.
Thats more leverage or and lower yield than we're comfortable with we.
In many cases in many cases across our repayments, we had the opportunity to stay in the deal.
And we chose to let it go and let it be refinanced just from a risk adjusted return perspective so.
That was a.
Big flurry of activity in the December quarter. So I would tell you that activity in the March and June quarter, we would expect to be down from where it was in the December quarter, but our origination activity right now it's still from a long term average deal flow perspective, it's still strong, but it's down from a very few.
<unk> takes.
In the fourth in the December quarter last year, I think from a run rate perspective, I think the point is right I think we assume we're going to originate somewhere in the $60 million to $75 million per quarter.
Of new investments.
I've seen uptick in our <unk>, our delayed draw term loans, so that we see maybe $5 million to $10 million being funded off of those <unk> each quarter and a repayment activities somewhere in the $20 million to $30 million.
Each quarter. So net we look to see somewhere in the $30 million to $50 million of net growth per quarter as a general run rate, yes, so our repayment activity is down.
Well, so and so.
So I think Michael's comments Youre right.
Okay. That's really helpful. And then a question relating to interest rate sensitivity could you provide the weighted average LIBOR floor for floating rate investments and also what percent of floating rate investments contain interest rate floors.
Yes. So the floor is about one one on a weighted basis.
And I would say, it's close to 100% have a floor in them.
Okay.
The range of between 75 basis points, and 2%, but again almost all of them is weighted towards one at this point. So one is really the bogey.
Got it. Thank you for taking my questions and congrats on a strong quarter.
Thank you thanks.
Thank you. Our next question comes from Bryce Rowe of the group.
Your line is now open.
Great. Thanks.
Maybe just.
Just wanted to follow up on some of the comments you just you just made about.
Having the ability to possibly participate in deals.
And refinancings and choosing not to do that.
Can you speak to kind of maybe what's driving the decision to not participate in and some of the some of the some of the opportunities.
Yes, let's just I'll just throw out a hypothetical example, right. So we do our original we lend to a company.
Let's say three times EBITDA.
And a year later year and a half later companies grown performed well theyre going to a large acquisition.
We lend at like 700 basis points over LIBOR LIBOR plus.
Mike This is <unk>.
Example, year later, they do a large acquisition and because its more diverse and a bunch of reasons.
Market.
It's one of the Wyndham.
Five times EBITDA.
LIBOR plus 600.
That's a different yes. So we haven't at that point, we can decide whether five times leverage on admittedly a better business.
At LIBOR 600 is is a risk adjusted return.
Well.
And sometimes you'll note that the company has a bad company, but it got risks.
Loved it scene.
Kind of play out.
At three times leverage.
That's fine at five times leveraged and LIBOR 600.
Up to not participate so that would be an example of and there is and again most of the time that's happening in a doing an acquisition, where they are going out to the market with a larger credit facility higher leverage.
An admittedly a better company, but but the leverage is higher and the pricing is lower than we would think is appropriate for the.
The risk of that situation, so that would be a tip that would be a situation, where we would just say you know what.
Candidly in most of these situations, we had equity in the investment too. So therefore on the equity we love it but we think the credit risk we can find risk adjusted returns in the lower middle market on a credit book somewhere else and so that's a decision we have to make.
From time to time.
Okay.
We're also looking down the road.
We talked about net interest margin I think Brian mentioned earlier, we really monitor to make certain that tracking towards an NII Roe.
<unk>, 5% so when we're looking at individual investments we're also.
Looking to see what it is we are in terms of portfolio turnover. This quarter 12, 31, we saw 20% of our portfolio turnover and so some of those were higher yielding assets.
We originated some slightly lower yield.
Our portfolio leverage went from four one down to $3 nine so to some extent these are safer credits, but when we're looking to see making certain that we're able to produce a growing dividend over time, we are monitoring that yield on an asset by asset basis to make sure it fits into.
Our strategy going forward and so some of these credits to Boeing's point will fall below a threshold and if the risk reward doesn't make sense, we'll move on from it.
Understood and then a follow up to that topic.
Any any kind of rush to exit the standalone equity investments now or.
Is it just going to be kind of opportunistic in terms of how that how that business.
And that sponsor relationship kind of plays out.
Yes, so I mean keep in mind I mean, the vast majority of those equity co investments alongside an institutional private equity firm, that's managing their own liquidity and so they buy a company that grow it and they sell the company and so.
So we ride sidesaddle with that that dynamic and so those obviously those p/e firms don't get their carry payments until they sell a company and so they need to grow all that they need to exit them. So we feel pretty good about that portfolio over the next.
Small number of years monetizing.
Alongside that liquidity curve, if you will of those private equity firms.
Okay, and then Michael kind of quest.
Question for you on the comp line just any help you can give us obviously went up I assume that's a function of.
The performance accrual getting getting baked in here for the December quarter, but but any any kind of thoughts around that would be helpful. Sure.
Sure sure. So for this quarter I would tell you looking at it Holistically, we had about $2 million in revenue this quarter that was essentially one time in nature and.
And our bonus accrual for the quarter was about $1 four above our normal run rate.
Essentially it's about 600000 of one time income or net income or <unk>.
So I think when we look at our performance to date for the year and where we're tracking for.
For the full fiscal year 2022.
We did accrue a bonus above the target commensurate with the performance so far of our staff.
Okay. Okay.
Shape.
The answers.
Sure. Thanks, Chris.
Thank you. Our next question comes from Sarkis <unk> with B Riley Securities. Your line is open.
Hey, good morning, and thank you for taking my question here.
Just wanted to start off with.
A question regarding the <unk>.
Opportunities are the field of opportunities.
If it's changed.
So far in the first month of January given the potential acceleration in the shift in the interest rate regime. If you can comment on that please.
I don't know that.
Yes by your question.
Can you hear me sorry, Keith I can hear you can you can you guys hear me.
Yes, we can.
So as far as the opportunity set the deals we're looking at I.
I don't know that I would say they've changed.
With as it relates to the interest rate scheme.
Which I think is your question.
I think that I mean honestly the drivers of the business sales and investment opportunities that we're seeing in the market is.
A really kind of very similar themes as they were in the December quarter.
Just the quantum of activity is lower than the December quarter, but but the themes are the same.
And so how can I answer your question I don't why have we haven't seen the interest rate.
Regime change narrative from the fed affecting our deal activity.
Got it that's helpful.
And I guess, if we can kind of touch on the spic's side of the business.
Yes.
Obviously, a very attractive cost of capital proposition for you any.
Ideas or any help on the glide path to filling that capacity that you have on the SBA side.
Yes sure.
I would tell you.
Looking ahead.
We would expect to see probably.
Maybe two thirds of the deals get funded through the FDIC any of the third through IMG and an equity <unk> being our revolving credit facility.
Today, we have as a top 31, I think we had drawn $29 million of debt.
Going to receive our leverage application for the following 40 likely this week.
And we would probably expect to have drawn somewhere in the $75 million to $100 million in the next 12 to 15 months is probably where I would place it.
Great. Thanks for that and just one final one from me clearly the earnings power of the business is starting to March higher and you're raising.
Raising the dividend it seems like reflect that I think as we kind of look at the earnings power kind of going forward and based on the commentary you provided for net originations continuing is it reasonable to think that you would continue to kind of block the dividend at the same pace you've demonstrated.
So to answer the question is we will we do anticipate increasing the dividend I would say as LIBOR slash sofa increases with the fed announcing three to four price hikes rate hikes in the next year.
That will there will be some level of compression still NII and the dividend should grow I think once we get beyond those the next 75 basis points of hikes, then youll see significant expansion.
So maybe.
From here, maybe as much as two dividend increases potentially for the year. So we're not saying that segment in stone, but that would be the hope, yes, I would say that I would say the rate increases are a headwind, but the tailwind has to do with improved operating leverage.
As well as cost of capital effect of layering in the SPX. So.
So you had some gives and takes so it's not all negative we got some tailwind as well so we're kind of managing the balance between those two dynamics. We currently we have 60% of our liabilities are fixed and we think that will grow as the FDIC gets drawn.
And so absolutely comment is correct.
Fantastic Thats all for me. Thank you.
Thanks, Okay. Thank you.
Our next question comes from Robert Dodd with Raymond James Your line is now open.
Hi, guys and congratulations on the quarter by earnings and capital net capital deployed.
First.
A question on <unk>.
Credit.
Your credits in really good shape, but last quarter non accruals of $24 million this quarter that 14.
It's the same number you said 5 million came off because some of the restructuring.
Another $2 million was category for the asset.
Which one matters.
That leaves you with the other $9 million.
Write downs on non accruals.
Can I assume that came from the affiliate investment which is the only other non accrual.
The affiliate investment in health care.
Or was there anything else going on with that.
Blackstone.
Of course, you'd called out alright, yes.
It was reduction in one of the companies that are on non accrual, but so the two of the companies on non accrual had.
A significant depreciation in and the other Ben but you mentioned on the core coming off of non accrual.
Yes got it.
Yes.
Going back to kind of the pricing power.
Question in this environment.
Commodities out labor costs up.
But some of your.
Industry sector segments, I think clearly.
A lot of pricing power, I mean transportation and logistics of 4% of your portfolio, It's probably got a lot of pricing.
In this environment given the constraints.
Things like that or are there any.
Sectors in within the portfolio and you don't have a lot of concentration, but any sectors in the portfolio, where you are incrementally more worried about.
Whether they can exercise the pricing power versus others I guess.
Transportation and logistics, where I'd be less walid.
But maybe I'm wrong.
Yeah.
Yes interesting question I think there is a range of pricing power.
Across the different industries I would say.
No.
Good news I guess the slight good news as.
Missouri deserves company in the sense that when this when these inputs are happening to all of your competitors.
Certain sector.
It's easier to.
To pass those costs onto your <unk>.
Customers if all of your competitors also have to do the same thing. So so I think that that's been a major I guess call it benefit certainly.
Our benefit in defending these portfolio of companies against margin deterioration at the end of the day.
But certainly transportation logistics would be one health care might have a different dynamic.
Consumer products retail have another dynamic right.
So varying levels, but I think.
Again, when it's across taking any of the industry sectors when that inflation is across the entire sector.
Then, it's obviously easier to pass pass those costs on to your customer right.
Yes, yes understood.
Understood and then one more if I can I think Michael you mentioned that.
Delayed draw term loans are being.
Accessed.
At a.
Great great.
Right.
Obviously.
Companies, you've got our borrowers are going to hit milestones et cetera, or whatever before they could do that but can you identify or.
Qualitatively maybe tenants.
How much of that the <unk> draws off for add on acquisitions can you tell us is are they using them grow score.
To support working capital can you go.
Give us any color on.
On kind of what's driving that if you have the data.
Yes.
Robert the strong majority of details or for acquisition strategies.
With.
A minority, but a significant minority of them being for earn out payments.
Where our companies bought and the founder the sponsors negotiate it might be slightly lower purchase price, but the founders are willing to take risk on the upside and get paid for increased performance and so.
So obviously, we want them to hit those earn outs right because that means by definition of the business is doing well.
If the economy falters or whatever those earn outs.
Vast majority of the cases won't fund rate so we.
We want those to fund.
We do have very specific restrictions on leverage levels et cetera.
On how that earn out is going to be paid $10 million earn out might be paid.
$5 million delayed draw of $5 million equity contribution from the equity owners. So we have those restrictions on a company by company basis.
But the vast.
<unk> majority of the time its acquisition strategy.
Yes.
Got it.
Just I guess also from the capital side look we monitor we have I think a $158 million in <unk> and revolvers and we've done well.
How closely the utilization of these facilities and what we've seen our revolvers of $6 million of revolvers. Historically revolvers are net draws of zero the only time that we've seen.
<unk> during the first wave of Covid, which had been March and April of 2020, where we saw about a third of our portfolio draw their revolvers and then pay it back down and then on the <unk> side.
From that balance those are all.
We have exploration dates in 2022 and 2023.
We've seen historical maybe 50% of these get drawn and so we monitor that and make certain that we're planning for capital capital planning to assume for this level of draws on our portfolio.
So just to clarify then the last one for me.
Your.
Assuming currently in the capital planning et cetera, and you've got plenty of capital.
Right.
The historic average amount of Pls will be drawn.
Our lives for given.
Thanks.
So many assets seem to be doing quite well, which we're seeing with equity appreciation et cetera, which can trigger more.
No more.
Announced for example are you assuming.
Later than average a portion of details within the category.
We're assuming that half of these details get drawn less for earn assets Bowen noted more for acquisition growth Yeah, Yeah got it and then.
Right understood.
Thank you.
Thanks, Jeff.
This concludes the Q&A portion I'd like to hand, the conference back over to Doug.
Bowen Diehl for closing comments.
Thanks, operator, thanks, everybody for joining the call I appreciate the good questions as always.
And we look forward to continuing to give you updates quarterly as we move forward and have a great rest of the week.
Ladies and gentlemen, thank you for your participation. This concludes the conference call. You may now disconnect everyone have a wonderful day.
Okay.
Okay.
Okay.
Yes.
Sure.
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