Q3 2023 Capital Southwest Corp Earnings Call

Speaker 2: Thanks for watching!

Speaker 3: begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1.

Speaker 4: Thank you for joining today's Capitol Southwest 3rd quarter fiscal year 2023 earnings call. Participating on the call today are Bowendeeel CEO , Michael Scarner, CFO and Chris Reberger.

Speaker 5: VP Finance. I will now turn the call over to Chris Reiberger. 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.

Speaker 6: They are not guaranteed the 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 publicly available filings with the SEC.

Speaker 7: The company does not undertake any obligation to update or revise any forward-looking statement.

Speaker 8: 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 off to our president and chief executive officer, Boen Diel. Thanks Chris.

Speaker 9: And thank you everyone for joining us for our third quarter fiscal year 2023 earnings call.

Speaker 10: We are pleased to be ready this morning and look forward to giving an update on the performance of our company and our portfolio as we continue to diligently execute our investment strategy as storage of your capital.

Speaker 11: Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com.

Speaker 12: You will also find our quarterly earnings press release issued last evening on our website.

Speaker 13: We'll begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. We'll begin on slide seven of the earnings presentation, where we have summarized some of the key performance highlights for the quarter.

Speaker 14: During the quarter, we generated pre-tax net investment income of $0.60 per share, which represented 11% growth over the $0.54 per share generated in the prior quarter and 18% growth over the $0.51 per share generated a year ago in the December quarter.

Speaker 15: The 60 cents per share, more than earned a regular dividend paid during the quarter of 52 cents per share, while also covering the supplemental dividend paid during the December quarter of 5 cents per share.

Speaker 16: We are also pleased to announce today that our Board has declared another 1 cent per share increase in our regular dividend to 53 cents per share for the quarter ending March 31, 2023.

Speaker 17: This increase represents 1.9% growth over the 52 cents per share paid in the December quarter and 10% growth over the 48 cents per share paid a year ago in the March quarter.

Speaker 18: These increases in our regular dividend over salt of the increased fundamental earnings power of our portfolio give it its growth and performance.

Speaker 19: as well as improvements in our operating leverage.

Speaker 20: In addition, these are the continued excess earnings being generated from viral floating rate debt investment portfolio.

Speaker 21: Our board of directors has again declared a supplemental dividend of 5 cents per share for the March quarter.

Speaker 22: Bringing total evidence declared in the March 23 quarter to 58 cents per share.

Speaker 23: While future dividend declarations are at the discretion of our Board of Directors, it is our intent and expectation that Capital South West will continue to distribute quarterly supplemental dividends for the foreseeable future while base rates remain materially above long-term historical averages.

Speaker 24: Finally, I should note that as we have done in the past, we intend to also distribute additional supplemental dividends as we harvest realized gains from our equity co-investment portfolio.

Speaker 25: During the quarter, we saw strong deal activity in the lower middle market, primarily focused on acquisitions rather than recent antics.

Speaker 26: The environment during the quarter was a favorable one for a personally winter like couple's hot west.

Speaker 27: We saw average spreads that were 50 to 100 basis points wider than a year ago, with leverage levels on our new platform deals that were lower by a full turn of EBITDA.

Speaker 28: Interestingly, loan to value levels on New Deals calculated as our first lean loan divided by the enterprise value being paid for in acquisition.

Speaker 29: We're out for Down Knee and Knee.

Speaker 30: This suggests that multiples being paid for strong companies remain robust.

Speaker 31: Corfolio grove during a quarter was driven by 164 million in new commitments.

Speaker 32: consisting of commitments to five new portfolio companies totaling 122.4 million.

and add-on commitments to 12 existing portfolio companies.

totaling 41.69.

This was offset by 12.4 million in prestige for one debt prepayment and warrant equity sailed during the quarter.

On the capitalization front, we raised a total of $104.3 million in gross equity proceeds during the quarter at a weighted average price of $17.99 per share or 109% of the prevailing NAV per share.

This included 53.58.3 million radius to our equity ATM program and 46 million radius to an underwritten public equity offering.

Our liquidity remains robust with approximately $196 million in cash and undrawn capital commitments as of the end of the quarter.

We have remained diligent in funding a meaningful portion of our investment asset group with creative equity issuances, and we think it is critical that we maintain a conservative mindset to BDC leverage given the uncertainty of the economy.

As we have said many times, we manage our VDC with its full economic cycle mentality.

This starts with the underwriting of our new opportunities.

But it also applies to how we manage the BEC's capitalization.

Managing leverage to the lower end of our target range positions us to invest throughout a potential recession when risk-adjusted returns can be particularly attractive.

It also allows us to support our portfolio companies while also optunistically repurchasing our stock that will betray many good below integrity.

With this as context, we are very pleased with the strength of our balance sheet as we reduced regulatory leverage to 0.91 to 1.

from 1.11 to 1 in the prior quarter.

We maintained our significant liquidity position.

and we continue to operate with almost half of our balance sheet liabilities fixed rate, unsecured, covenant free bonds.

the earliest of which mature in 2026.

On slides 7 and 8, we illustrate our continued track record of producing strong dividend growth.

Consistent dividend coverage and solid value creation since launch of our credit strategy back in January 2015.

Since that time, we have increased our regular dividend paid to shareholders 25 times and have never cut the regular dividend, including during the tumultuous environment we all experienced during the COVID pandemic.

Additionally, over the same time period, we have paid or declared 19 special or supplemental dividends totaling $3.60 per share.

Generating some excess earnings and realized gains from our industrial portfolio.

We believe our top record of consistently growing our dividends

The solid performance of our portfolio, as well as our company's sustained access to the capital markets, has demonstrated the strength of our investment and capitalization management strategies, as well as the absolute alignment of our decisions with the interests of our shareholders.

Continuing to generate this strong track record we believe is critically important to building long-term show overnight.

30 and flood 9, our NEPFL strategy is laid out for our shareholders at its launch back in January 2015.

The vast majority of our activity has been in our core lower middle market, where we are the first lean senior secured lender.

most often backing a private equity firm's acquisition of a growing lower-income market company.

We also often participate on a minority basis in the equity of the company through an equity co-investment made alongside the private equity firm.

In fact, 90% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as the potential for new junior capital support if needed.

Our low-minor market strategy is complemented by close participation in larger companies led by like-minded lenders with whom we have relationships and have gained confidence in their post-closing loan management from working well together across multiple deals.

Virtually all of these plug deals are also backed by side-air creepers.

And so at the end of the quarter, our equity co-investment portfolio consisted of 48 investments with a total fair value of $112.1 million, which was 60% over our cost.

representing 41.8 million.

21 cents per share.

Our equity portfolio, which represented approximately 10% of our total portfolio value at the end of the quarter, continues to provide our shareholders participation in attractive upside potential of these growing lower middle market businesses.

which will come in the form of NAV for share and supplemental dividends over time.

As illustrated on slide 10, our on-down-sheet credit portfolios will be this quarter, excluding our I-45 Senior Lunch Bunch.

Group 10% to 990 million has compared to 903 million as of the end of the part of quarter.

Over the past year, our credit portfolio has grown by 245 million, or 33%, from 745 million as of the end of December 21 quarter.

For the current quarter, 99.7% of our new portfolio company data originations were personally senior secured debt.

And at the end of the quarter, 96% of our total credit portfolio was firstly in senior

On slide 1112, we detail the 164 million capital invested debt and committed to portfolio companies during the quarter.

Capital committed this quarter included $120.4 million in first-lane senior secured debt.

in 1.6 million equity co-investments to five new portfolio companies.

Additionally, we committed 39.7 million in personally and serious care debt and 1.9 million equity co-adabtives to existing portfolio companies during the quarter.

Turning to slide 13.

During the quarter, we had one debt prepayment and one equity sale.

In total, these exits generated approximately $12.4 million in total proceeds.

generating a weighted average IRR of 10.1%.

Since the launch of our credit strategy eight years ago, we have realized 67 portfolio exits, representing 775 million proceeds.

that have generated a cumulative weighted average IRR of 14.6%.

The market for acquisition capital continues to be active, not surprisingly given the widening spreads on new loans in the market. The slowdown in refinancing activity continues.

So on a net basis, we expect solid net portfolio growth in the near term.

We are pleased with the strong market position that our team has established in the lower middle market as a premier debt and equity capital provider.

as evidenced by the broad array of relationships across the country from which our team is sourcing quality opportunities.

In terms of the yellow origination, we find that underwriting certain industries is more challenging given today's economic uncertainty.

However, an important component of our underwriting has always been to run a stress case downside model for every new deal.

simulating an extreme recession occurring soon after closing.

The major steps are underwriting and the cart environment has a change.

Although our models today include much higher base rates than we have experienced in Destroyer ...

Our fundamental analysis attempts to tie the leverage level we are willing to put on a company to the potential performance volatility of a particular business.

industry throughout the economic cycle.

We're forwards and forwards and different industries can be very different to the economic cycle. So getting this right is an important component of the enterprising process.

Specifically, in a stress case financial model, we require a fundamental underwriting standard that we see our loan remain well within the portfolio of companies' enterprise value and the portfolio of companies' cash flow able to cover our loan interest throughout the cycle.

We detailed some key stats for our unbalanced sheet portfolio as of the end of the quarter. Again, excluding our I-45 senior lunch.

And at the end of the quarter.

The total portfolio at fair value was weighted approximately 87% to first-learn senior secured debt.

3.2% to second lane senior secured debt.

0.1% is subordinated debt and 10.2% to equity co-investment.

Credit portfolio had a weighted average yield of 12%.

weighted average leveraged through our security of 3.6 times.

The weighted average leverages quarter was down from 4.1 times in a prior quarter, doing part to 67.3 million of funded data originations.

to five new portfolio companies and a weighted average leverage through our security of 1.9 times in.

30 to 4515 we have laid out the rating migration with an aqua foliar.

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.

We feel very good about the performance of our portfolio, with 95% of the portfolio at fair value rated in one of the top two categories, a 1 or a 2.

As illustrated on slide 16, our total investment portfolio, including our I-45 Senior Loan Fund, is a

continues to be well-diverse by the prep industries with an asset mix which provides strong security for our shareholders' capital.

The portfolio remains heavily weighted towards first lien senior secured debt with only 3% of the total portfolio and secondly senior secured debt.

I will now hand the call over to Michael to review some specifics of our financial performance for the quarter.

Thanks, Bowen. Specific tour performance for the December quarter has summarized on slide 18. We increased pre-tax net investment income 25% quarter over quarter to $18.7 million compared to $15 million less quarter. Pre-tax and II was 60 cents per share for the quarter.

During the quarter, we paid out a 52-cent per share regular dividend and a 5-cent per share supplemental dividend.

As mentioned earlier, our board has approved an increase to the regular dividend for the March quarter to 53 cents per share and declared another 5 cents per share supplemental dividend for the quarter.

Maintain a consistent track record. Meaningfully covering our dividend with pre-tax NII is important to our investment strategy.

We continue our strong track record of regular dividend coverage with 108% of the last 12 months ended December 31st, 2022, and 107% cumulative since the launch of our credit strategy in January 2015.

Given the floating rate nature of our credit portfolio, elevated interest rates continue to be a significant tailwind to our net investment income.

The base rate index used to calculate interest on a majority of our loans reset in early January to 4.75% up from its early October reset at 3.75%.

This significant increase, quarter over quarter, will provide another immediate step up in portfolio income in the March quarter.

With that as context, we will continue to execute our policy of having regular dividends follow the trajectory of recurring pre-tech NII per share.

As such, we expect to thoughtfully increase our regular dividend to a level which can be sustained should base rates return to a neutral level.

In addition, while base rates remain elevated, our intent is to distribute a portion of excess pre-tax NIIs to our shareholders each quarter through supplemental dividends.

Based upon our current UTI balance of 34 cents per share, the abilities that grow UTI each quarter organically by over earning our dividend and harvesting gains from our existing $1.21 cents per share in your unrealized appreciation on the equity portfolio. We are confident in our ability to continue to distribute quarterly supplemental dividends.

for the foreseeable future. For the quarter, we increased total investment income from our portfolio 22% quarter over quarter to $32.8 million, producing a weighted average yield on all investments of 11.7%.

Total investment income was $6 million higher this quarter due to a higher average balance of credit investments outstanding.

In addition to the tailwind provided from increases in LIBOR and SOFR base rates.

As of the end of the quarter, we had approximately $4 million of our investments on Nonaccrual, which is only 0.3% of our investment portfolio at Sharebally.

Finally, the weighted average yield on our loan portfolio was 12% to the quarter.

As seen on slide 19, we further improved LTM operating leverage to 1.9% as of the end of the quarter. Achieving 2% or lower operating leverage was one of our initial long-term goals when we relaunched Capital Southwest as a middle market lender back in 2015.

So we're pleased to have reached this milestone looking ahead. We expect our internally managed structure to produce additional improvements in operating leverage.

Turning to slide 20, the company's NAD per share at the end of the December quarter decreased by 28 cents per share to $16.25, representing a decrease of 1.4% before giving effect to the supplemental dividend paid for the quarter.

The primary drivers of the NAV per share decrease for the quarter included $8.5 million of net unrealized depreciation on the on-balance sheet debt portfolio, $1.2 million unrealized depreciation on the equity portfolio, and $3.3 million of unrealized depreciation on the I-45 portfolio.

the vast majority of which was mark-to-market quote activity in the syndicated market.

We also generated a total of 17 cents per share of accretion from the issuance of common stock at a premium to NAD per share.

Turning to slide 21, as Bowen mentioned earlier, we are pleased to report that our balance sheet liquidity remains strong, with approximately $196 million in cash and under-run leverage commitment.

on our revolving credit facility at the end of the quarter.

Based on our credit facility borrowing base at the end of the quarter, we have full access to the incremental revolver capacity and will look to opportunistically increase commitments to the facility in the future.

Our bank syndicate continues to support our growth and we're pleased with the flexibility the revolving credit facility provides.

syndicate continues to support our growth and we're pleased with the flexibility and revolving credit facility provides for capital structure.

In addition, we have 26 million in committed but unfunded SBA debentures.

to be used to fund future SBIC-eligible investments.

As of December 31, 2022, approximately 47% of our capital structure liabilities were unsecured and our earliest debt maturity is in January 2026.

A regulatory leverage, as seen on slide 21, ended the quarter at a debt-to-equity ratio of 0.91 to 1, down significantly from 1.23 to 1 as of December 2021 quarter.

Over the past couple of years, we've made a concerted effort to strengthen our balance sheet to ensure we are prepared for any macroeconomic headwinds that we may encounter.

These efforts have included our opportunistic unsecured bond issuances at record low rates in the late calendar 2021.

our continued support from banking relationships which have allowed for steady growth in our revolving facility commitments, and our continued diligence in moderating leverage through a creative equity issuance of our funds.

and utilizing both our ATM program as well as the secondary equity market.

We will continue to work towards strengthening the balance sheet, ensuring adequate liquidity, and maintaining conservative leverage in covenant cushions throughout the economic cycle.

I will now hand the call back to Bowen for some final comments.

Thanks Michael, and again thank you everyone for joining us today. We appreciate the opportunity to provide you an update on our business, our portfolio, and the market environment.

Our company and portfolio continue to perform well and I continue to be impressed by the job our team has done in building a robust asset base.

the original nation capability as well as a flexible capital structure.

And to the uncertainty in the economy, again, we have been underwriting with a full economic cycle mentality since day one, which we believe has positioned us well for the potential economic volatility in the coming months and years.

In summary, we have a floating rate credit portfolio heavily weighted to first-leaning your secure debt.

Allocated across a broad and rough array of companies and industries.

90% of which is backed by private equity firms.

We have a well-capitalized balance sheet with diverse capital sources, strong liquidity, and flexible capital, much of which is fixed rate and come in light.

We believe our first senior security investment focus and our capitalization strategy provide us complete confidence in health and positioning of our company and our portfolio as we look to your Cover posts.

This concludes our prepared remarks. Out later, we are ready to open the lines up for Q&A.

Thank you.

And if you would like to ask a question at this time, please press star 11 on your telephone and wait for your name to be announced. To let's draw your question, please press star 11 again.

And our first question comes from the line of Mickey Schoon with Lattenberg. Your line is open. Please go ahead.

Yes, good morning everyone. Bowen, in the fourth quarter we continue to see spreads in the middle market widen a little bit more, which is obviously helpful for your company's financial performance. So I'd like to ask you, what's your outlook on how private lenders will behave?

going forward this year in terms of spread, when we think about the fact that Libor and SOFR have already climbed a lot and that stresses borrowers and what types of floors are you getting nowadays?

Yeah, thanks Mickey. I'll answer them in reverse order. So we're pretty regularly getting 2% floors.

other ones

And as far as what the market will do, spreads could widen, we address that in our...

prepared remarks and leverage level will come down that we're seeing which is which is attractive at a nice time to be at first lean lenders.

As far as what the market does with spread going forward, it's an interesting question. I mean, in past cycles, candidly, the lending market can tend to, you know,

basically enjoy the increased index and

by a small amount, 25 basis points or so, 50 basis points. I don't know whether they'll do that this time or not. You know, it seems to be that there's a lot of liquidity in the private equity market, and you know, the pipeline seems to be solid. So, you know, we'll have to see. I don't know, I mean, you know.

In past cycles, there has been trade-offs between spread and index.

But it's hard to tell. We don't see that right now, for sure.

I appreciate that. And Bowen, the portfolio's average debt to EBITD declined quite a bit this quarter. I think you mentioned that some of that was due to new investments at lower multiples. But we've also seen data that somewhat surprisingly middle market company EBITD growth on average rebounded.

pretty nicely in the fourth quarter. So could you give us a sense of how your portfolio's companies are performing in terms of their revenues and margins?

Yeah, we had kind of two factors that brought that ratio down. One is what I referenced. The other one is we had a couple of names.

that had very low EBITDA.

So very high leverage ratios and that EBITDA went from slightly positive to slightly negative. So not really a significant move from a credit picture perspective. But you know a very high multiple of a positive EBITDA, if EBITDA goes to slightly negative then there's not really a way to calculate that in the average. So basically we had a couple of very high level

or high leverage names move out of the average, so brought the average down. But organically, if you look without that, leverage went from 4.1 times down to 3.9 times, to give you an idea. So across the portfolio, I would say our weighted average EBITDA across the portfolio revenue was up, and EBITDA was basically flat.

So weighted average basis, we had some nice winners and some flat. But basically, EBITDA was basically flat for the quarter. Revenues we saw, Mickey, were still increasing but at a slower clip than in previous quarters.

And we think maybe.

potentially we're peaking on inflationary impacts in terms of costs. That remains to be seen, but that kind of resulted in it still being high and us having you know flat EBIT it ish with even though revenue is up.

Okay, I understand and that's a nice segue into my next question. You have several investments in the consumer sector, at least if we look at the SOI, the word consumer shows up. And we're seeing data that the consumer's really starting to retrench now. So could you give us some insight into how...

your specifically your consumer related investments are performing and what you think their outlook is this year.

Yeah, I mean, across our consumer, I'm just thinking about the names. We have had a couple of cases where revenue has kind of slowed. In one case, you saw retailers resetting inventory levels.

to an anticipated throughput. And so basically, kind of in the short term, if you're selling into the retailers, your revenue goes down. But if you kind of look at the sell-through, you get comfortable with revenue. It's not going to stay down and not really be down all that much yet. The first lien lender, I'm not sure it gives you credit worries. But as far as economic, you're right, you're right.

Sign posts for the US economy or the US consumer.

Yeah, I mean that was I would put that in the category of you know what you're saying about the US consumer

But not really in those cases, most of them we don't have equity investments in, but in those cases, not a lot of.

Not credit concern, but definitely those signals.

Okay, I appreciate and understand. One last question, if I can. With this quarter's deleveraging of the balance sheet, I'd like to ask whether you've adjusted your leverage targets, and if not, where do they stand, both on a total and regulatory basis?

Historically, I think we said we expected once the SBA got ramped that our regulatory leverage would be somewhere in the 0.9 to 1.1 range. And that's obviously we sit right now at the very bottom of that range. I think our perspective is

going into a potential cycle, we would like to de-lever and that you'd expect the expectations that, you know, if there are concerns and you'll see us lever back up to some degree based upon depreciation. So we got ahead of the curve from that perspective, but from a go-for basis, you'd expect to see us continue to stay within that.

0.9 to 1.1 range. On an economic basis, we're at 1.1, which is also within the 1.1 to 1.3 percent range we've discussed. We think we'll follow suit, we'll vacillate inside that range.

You know, it would be obviously as I try to address in the prepared remarks, I mean, through a cycle, you kind of want to be at the lower end of your range going into a recession. If we don't have a recession for some natural reasons, then that's great. We're fine. But if we do, you want to maintain the ability to invest throughout the recession because risk-adjustive returns, especially in the second half of the recession.

can become really interesting based on path cycles. And then obviously we mentioned the stock biodex as well. So we want to just be able to manage as we've always had for full cycle mentality. We want to be able to position the ship, if you will, to really perform and do well for the shareholders throughout the cycle.

Yeah, I appreciate that. Those are all my questions this morning. I appreciate your time as always. Thank you. Thanks, Becky. Thank you. And one moment for our next question.

And our next question comes in the line of Kevin Flutz with J&P Securities. Your line is open. Please go ahead.

Hi, good morning and thank you for taking my question. You know, my first question is on credit. I'm just curious if you've seen an increase in amendment requests and if you can discuss your exhortation for that to potentially pick up in the near term.

Yeah, we had two for the quarter.

I would say...

I would say it's increased slightly, but not really a lot. It's not zero, but it's kind of, you know, they've been, you know, request canally when a first-ling lender gets a request for an amendment. We get a fee. He shows a nice, nice dynamic of a first-ling lender book.

So it's part of our business to have those amendments. But I wouldn't say there has definitely not been a flood of increase of amendments. But there's been some increase.

Okay, that's helpful. And then just in regards to portfolio positioning, are there any pockets or industries that you find particularly attractive in the current environment? And if you can, maybe parsing out lower metal market and upper metal market opportunities? Yeah. I premiums. Female Gentleman Nee chatter and cheers.

Yeah, I mean, the vast majority of what we've been doing is in the..................

lower than the market.

You know, I would say businesses, first and foremost, that we can underwrite a full cycle. You know, we've been looking at certain situations of high asset coverage.

Basically, the industries that have higher pre-cashable margins, recurring revenue, subscription type businesses that have shown to be low-chirn in past cycles, I mean, those are the sectors that...

that certainly we like and hope to in this market. Okay, that makes sense. And I'll leave it there. Congratulations on the quarter.

Thanks. Thank you. Thank you.

And our next question comes in line of Bryce Rowe with B Riley. Your line is open. Please go ahead.

Thanks a bunch. Good morning. Wanted to maybe start on the dividend. Great, great to see another quarter of increase here. And based on your comments, sounds like you're approaching these regular dividend increases pretty methodically.

You noted in the prepared remarks, you know, some inclination to, you know, be careful about, you know, where the dividend or where earnings could be when rates get back to kind of a neutral level. So, you know, any thoughts on, you know, what that neutral level might look like?

and how it kind of translates into a kind of a neutral and III type of generation model.

Yeah, Bryce, looking specifically at this quarter, for example, we posted at $0.60.

If rates were neutral, let's say neutral was 3%, the run rate on the portfolio would look more like $0.56 per share.

So when you look at that relative to the dividend that we paid this quarter of 52 cents, still 4 cents of cushion. As we move forward and grow the portfolio, and you see, we mentioned earlier, operating leverage. We expect operating leverage to continue to decline. That 56 cents bogey will grow. And that's why.

Well, as you stated, we're going to methodically grow that dividend, but we do feel between now and high 50s, there's safety on the regular dividend.

Got it. That's helpful, Michael. You mentioned the kind of the majority of your loans kind of resetting it in January , maybe a hundred basis points higher, you know, based on what we've seen in base rates.

is your expectation that we'll see, you know, give or take 100 basis points of weighted average yield expansion in the portfolio as we kind of get to the, into April or into May when you report earnings next.

Yes, we want to expect that on the revenue side. I would just say that there is one overhang you'll also see is you know obviously raised a lot of capital in the prior quarter and much of that was late stage and so there will be some level of dilution that will offset that increase on the top line revenue.

So we will expect to see NII grow, and meaningfully, next quarter, but there will be a little bit of an overhang.

Okay, that's helpful. Maybe a question around quarterly marks, you obviously highlighted the more kind of broader credit market driven marks on the I-45 portfolio. In terms of the 1.2 million of unrealized depreciation on the...

Yeah, if I look down the equity marks, you know, we had.

one, two companies that were downgraded, that were the majority of the decrease.

Really, taking those out, I mean, looking down there, there's several very large winters and then a bunch of slight positives and a bunch of flats.

and a few kind of downs. And so I think the equity portfolio, we had those two kind of underperformed. Other than that, the portfolio was.

I think the equity portfolio, we had those two kind of underperformed. Other than that, the portfolio was, you know.

kind of net up.

So, I guess that answers your question.

That's helpful.

I appreciate that, Bill. And maybe last one for me, from a pacing perspective, just kind of curious kind of how the pipeline is shaking up. It looks like it sounds like repayment activity is going to continue to be muted. So just thoughts on how to think about pacing.

within our models would be great. Thanks. Okay, go ahead. Yeah, so our originates, so we took pretty robust pipeline this quarter, probably not to the same extent as last quarter for sure. But, you know, numerically, we'd expect to be somewhere in the, you know, 90 to $110 million of new originations this quarter.

I think 75 to 100 million for the next few quarters. I think that's right. I think that's right. We have definitely that kind of repayment activity. We do have some disability on some cell processes that are going on.

that based on the company's health, you would expect the companies to in fact sell. So we'll see some repayment activity, but it won't be a refinancing, but it'll be someone acquiring that company and resulting in us getting refinanced out. So our refinancings won't be zero, but they're definitely like Michael's, so it'd be lower. I agree with that.

General comment on the pipeline. That's great. Appreciate the color, guys.

Take care, Bryce.

Thank you and one moment for our next question.

And our next question comes from the line of Eric Zwick with Hovde Group. Your line is open, please go ahead.

Thank you. Good morning. First question, within the prepared comments you mentioned that underwriting certain industries is more challenging today. And I'm curious how you approach that. Does that mean there are certain industries that you are not willing to underwrite in today or does it just mean you need to adapt and maybe change your underwriting?

standards and structures for those particular industries. And maybe if you can get another one, the industries are as well.

Yeah, I would say generally business, I would say what I'm trying to communicate is that really the way we look at the world hasn't changed. And so there's underwriting certain industries.

has always been tricky. Industries where there's higher fixed costs, lower margins, and then when you look at an economic backdrop or economic effect on the customers, maybe the customers are making a capital investment decision which results in your revenue at your portfolio company. You know capital has become more expensive.

CEOs across you know you hear it on the news or whatever you know CEOs are being more judicious or careful about capital investment decisions are making and if you have a portfolio company that's got you know that Whose customers are making capital investment decisions that would drive revenue.

that would be an industry that we would shy away from, as an example. And then you throw on top of that industry, if you look at the margins on a portfolio company.

the split between fixed cost and variable cost is really, really important.

to look at. So, industry you have.

manufacturing for example. Obviously if you have a manufacturing plant you naturally have higher fixed costs. Those are tight industries that we can't shy away from but also are the ones that are tricky to underwrite.

So, but at the same time when I'm trying to communicate it really the way we look at the world haven't changed.

We've been saying that since day one, that we look at an extreme recession right after our loans made and try to spell out for everyone what that means in a financial model.

And so we've been thinking about the possibility of a recession for the last eight years because you could have always along the way made the argument that we're pretty long in the tooth on this expansion. And then each year it didn't come. Now we're facing it potentially, but certainly a very advertised recession.

for good reason. And so in one sense, our underwriting hasn't changed at all, except for higher base rates going into that model. The other thing I'd add as well is, I think everybody probably has to deal with this, the COVID hangover. So looking at financials and seeing...

how far that, you know, the bounce back from 21 and 22 related to, you know, coming off the bottom of 2020 with COVID. As well as now, if you look at healthcare, sometimes you're seeing flare-ups in COVID in various places in the country. And so sometimes it's difficult to underwrite what the run rate was before and whether the run rate is current.

makes looking at kind of 2018 and 19's bookmarks.

and getting a sense as to what the pre-COVID level of performance was for a particular company. That's a little bit different than we were doing four years ago, for example.

That's a great color. I really appreciate that. And then my other question was just.

In your conversations with the PE sponsors that you work with, I'm curious if you've noticed any change in sentiment. Certainly the industry data I look at indicates there's still a lot of dry powder. Are they sensing potential recession and keeping some dry powder on hand in the event that they'd have to?

commit extra equity to initial investments? Are they still out there looking for, I'm sorry, to existing investments, or are they still out there looking for new opportunities to the same level that they were 12, 18, 24 months ago?

So, yes, there's liquidity out there in the private equity market, and yes, they're out looking for acquisition. And hopefully in the next 12 months, there's much more to think about other nice opportunities as in very creative acquisition.

So that's definitely the case. I would also say that that you know probably every firm They're smart right and they're they're actively managing these companies You know their spreads are widening on their or not spread the index and so the cost of their debts going up

And they're thinking about recession, like all of us on the call, all of these people listening to this call are thinking about that. And so what are the private equity firms doing? I mean, they're cost of debt is going up and they're thinking about recession. So they're leaning in and really actively looking at cost structures.

And, candidly, I think that's really imposing really good discipline on these companies. And so, I think that's going to benefit the companies in the long run. The increased index or cost debt going up imposed discipline on the cost structure of a business. And so, I think that's really a good discipline on the cost structure of a business.

That's one thing. And then as they think about recessions and all that, they're imposing discipline also on the cost structures as well. And so we'll see. I mean, we'll see whether that results in layoffs or what have you. But I do think the dynamic, you know, the answer to your question, probably equity firms are kind of doing and signaling.

Yes, liquidity, yes, acquisitions, but also an enhanced discipline on looking at their cost structures, which I think is healthy.

Yeah, and we also see the company that have come to us

with amendments or waivers or companies that might be having a little bit of trouble, they've been willing and able to fund into these companies. Those negotiations have gone well. There's no signs that they're thinking there's a dooming recession coming and that they're kind of tossing the keys to us. They've been pretty productive in conversations.

across the board. Yeah, that's a good point and very transparent on what they want to do with the business as well.

Yeah, that's great commentary. I appreciate it. Thank you for taking my questions today.

Thank you. Thank you and one moment for our next question.

And our next question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead. it's closed.

Hi guys and congratulations on the quarter. Kind of a follow up, but the leverage question, in the very beginning you talked about leverage being a full-term low in some cases on new originations and that's driving the risky portfolio leverage down a little bit.

Can you give us any cut on you know, what's what's the driving the driver that is it the sponsors with lower tasks?

or is it lenders kind of holding the line? Because obviously if leverage is a turn lower, even with rates up 200 and 50 basis points, you might be underwriting an interest coverage where it was a year ago. So, very different with that leverage in the rate dynamic that both work together.

But is it really the sponsors that are asking less, to your point being disciplined, or is it the lenders holding the line?

Yes, that's a good question. I have some interesting questions. So it's kind of both of those things. So from the sponsor perspective.

I mean, it's indescribable. If you're buying a company, the cash cost of that debt.

has gone up, right? Dollar for dollar. And so, you know, naturally the way you solve for that is you if you want a certain amount of free cash flow to support the business and grow the business, you bring leverage down. That's why my comment on loan to value not really, if loan to value also coming down, it's interesting because I would suggest certainly in the universe we're looking at that multiple for good strong companies hasn't really come down.

win some deals. And so, you know, I would interpret that as the lending market being, you know, being, you know, maybe more cautious. Also some dynamics. I mean, many lenders are backed by insurance companies and they're investing capital and it's their access of their appetite for illiquid credit versus some of the more liquid credit.

and they're investing their books. And so they kind of come and go. So there's a dynamic of that in the market as well.

So it's kind of robert all of those things.

It's all about a long term. They rather look sponsors. We've been working with sponsors now that, probably in conversations with for the last three to six years, we probably haven't found a way to be useful to them. And right now it's sort of left lenders playing in the market.

we are able to be helpful to them and we think long term this is going to enhance our origination platform.

I really appreciate the color. Are you seeing in the pipeline in the early stage or whatever? Are you seeing any changes in quality of companies? Obviously that can be in tough environments. Obviously the average.

quality tends to go up and vice versa and things like that. So are you seeing a mixed shift on who's coming to market versus where it was, say, a year ago?

Yeah, I would definitely say there's some aspect of that that's true because really companies that are in the market right now for sale are ones that are, you know,

Cantily not super cyclical, right? Because they wouldn't be able to raise the financing to do the deal, et cetera. So in many respects, higher quality companies, higher margins, all the aspects of a company that make it higher quality credit, I think is definitely the case. Because anything that's e F

even remotely off-center in a fairway, it would be very hard to sell in a compartment.

So I get where I would get. I would definitely agree to that. Being a factor. And just if I can, this is maybe a non-pay question. In your experience over the years, where's the young impression of what, where do you think the, what is given always dynamics? Where do you think?

the 2023 vintage in terms of quality could shake out as a, you know, ranked against previous origination vintages.

Yeah, I think 23 if it plays out, or any kind of recession.

Yeah, I think I think 23 if it plays out of any kind of recession

That I think the 23 vintage could end up being an outstanding vintage. I mean, you know, and that's what and that would be Consistent with past cycles, right? And so especially you know We you know in kind of the theoretical second half of the recession right where kind of the laundry bin the dirty laundry bin aired

And sponsors have liquidity that can negotiate relatively interesting valuations from a cycle perspective, sellers are a little bit more flexible in structure or what have you, and really end up structuring deals at valuation multiple and leverage multiples, you know, because you're at a top either, right? So.

from a cycle perspective. So people even dog goes up, which drives value, the levers, and so all those factors go in and make a recession year when you look back at path cycles. In my experience, it ended up being very attractive in the system. And the only downside to that is these assets make end.

to be less sticky, right? We've had to negotiate call protection and that's really extremely important on these companies where the leverage is so low in the LTV as well. So, you know, we'd expect if things, if this recession is mild and or if it passes, you know, 2024 could be a high.

refinance a year. And that's consistent with past cycles too. That's a term that we're pretty aggressive on holding the line on, but that's a push back term from sponsors. They want some relief or some lower prepandent penalties and that kind of thing.

So it's a term that's heavily negotiated on deals right now, and that will be the case through the recession. And then clearly, coming out of the recession, the Michael's point is Dr. Guth leverage comes down.

you know things normalize and then you want to kind of normalize the capital structure. So that ends up being less sticky debt and that's what's really interesting on the equity piece.

Got it, got it. Yeah, I appreciate the color. Thank you guys.

Got it. I appreciate the color. Thanks, Robert.

Thank you, and I would like to turn the conference back to Bo and Deal for any closing remarks.

Well, thank you everyone for joining us and we always appreciate giving an update on the company. And thanks for all the questions and we look forward to talking to you next quarter.

This concludes the conference call. Thank you for participating. You may now disconnect.

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