Capital Southwest Corp (CSWC) 2016 Q4 法說會逐字稿

Thank you for joining today's Capital Southwest fourth-quarter FY16 earnings call. Participating on the call today is Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP Finance. I will now turn the call over to Chris Rehberger.

Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions and beliefs. They are not guarantees of future results, and are subject to numerous risks, uncertainties and assumptions that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC. The Company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances, or any other reason after the date of this press release, except as required by law.

I will now hand the call off to our President and Chief Executive Officer, Bowen Diehl.

Thanks, Chris, and thanks to everyone for joining us for our fourth-quarter FY16 earnings call. FY16 was a transformational year for Capital Southwest, and one in which we were able to unlock significant shareholder value.

We completed the spin-off of CSW Industrial, created a new publicly-traded company which allowed the market to more appropriately value the highly attractive businesses. We launched a middle market credit strategy, with the goal of transforming Capital Southwest from the anomaly of an all equity focused BDC, to a middle market lending firm distributing recurring dividends to our shareholders.

Our transformation began with divesting a majority of our legacy equity assets, rebuilding the investment and finance teams, and creating a thoughtful, balanced credit investment strategy, drawing on the team's decades of cumulative middle market lending experience within the BDC industry. We are pleased with our significant progress to date, and look forward to continuing down the path of driving long-term, sustainable value for our shareholders, through our shareholder-friendly internally-managed BDC structure. Specific to the fourth quarter of our FY16, we are pleased to report that during the quarter, we continued to advance our strategy of building a robust middle market lending firm with a granular loan portfolio, with diversity among asset classes and capital sources, that achieves a balance between upper middle market and lower middle market assets.

During the quarter, we achieved continued growth in our loan portfolio. We enhanced our deal origination capabilities by adding mid and junior level investment professionals to the team.

We continued to grow I-45, the senior loan fund we launched in September 2015 with Main Street Capital. We made significant progress in our capital raising efforts, and we have now begun to pay regular quarterly dividends to our shareholders. We continue our migration from cash and non-yielding equity investments to investments yielding recurring income.

In mid 2014, when our transformation began, only 1% of our total assets were generating recurring income. Today, 59% of our total assets generate recurring income for our shareholders, with only cash and certain legacy equity investments remaining as non-yielding assets in the portfolio.

During the quarter, we originated $33 million in fixed new loans, and $1.5 million of equity co-investment alongside a private equity sponsor. Our new loans included $21 million in four upper middle market first lien credits, $8 million in a lower middle market club deal in which we invested first lien debt with common stock warrants, and $6 million in a lower middle market direct deal, in which we invested in secured subordinated debt with an equity co-investment.

During the quarter, we grew our total invested assets from $135 million to $178 million at fair value. We grew our on-balance sheet loan portfolio from $61 million to $93 million at fair value, 83% of which was senior secured debt. As of the end of the quarter, our balance sheet loan portfolio consisted of 18 credits, all performing, and none on non-accrual.

During the quarter, we funded an additional $8 million of capital into I-45 to support its growth, bringing our funded equity commitment to I-45 to $37 million out of total commitment of $68 million. As of the end of the quarter, I-45 had $100 million in total invested assets consisting of 24 credits, 95% of which are first lien, and all of which are senior secured. Our average loan hold size in I-45 was approximately $4 million. Subsequent to quarter end, we exited one of our first credit investments, Freedom Truck Finance, receiving $6 million in proceeds, and earning a 14.3% IRR on our investment.

With respect to the overall market environment, we have seen terms and spreads in the upper middle market tighten significantly since the end of the quarter. And until recently, primary issuance in the upper middle market was relatively slow. On the lower middle market side, with the lesser transparency of deal terms across the market and longer deal closing cycles, real-time market pricing and structuring trends are less apparent. That said, we do believe we have seen some tightening of risk premiums in the past few months.

Like many of our BDC brethren, we too saw a modest slowdown in overall deal volume, and a decrease in the number of quality deals in the lower middle market late in the March quarter and early in the June quarter. In the past several weeks, however, we have experienced a considerable pick up in our pipeline of quality lower middle market deals. Lower middle market closings can be lumpy, and the quality of the deal flow mixed at times, but we have seen some very interesting opportunities, and found ourselves to be competitive in the market.

We continue to believe that lending to the middle market is a very attractive place to invest capital, and remain vigilant in our underwriting and pricing discipline, when investing our shareholder's capital. I will now hand the call over to our Chief Financial Officer, Michael Sarner, to review our financial performance for the quarter.

Thanks, Bowen. For the quarter, our NAV increased from $271 million to $273 million, which was primarily due to $1 million of net portfolio appreciation, and an increase in the deferred tax asset of $800,000. As a reminder, as part of our quarterly internal valuation process, we engage in independent consulting firms specializing in financial due diligence and valuations to provide a third-party valuation review of certain investments. At quarter end, we had $96 million in cash available for investment activity, and no debt outstanding.

As of March 31, 2016, excluding our equity investment in I-45, our investment portfolio mix was 65% debt and 35% equity. Our mix of debt investment assets at March 31, 2016 was 42% first lien, 41% second lien, and 17% subordinated debt, versus 18% first lien, 64% second lien, and 18% subordinated debt at December 31, 2015. The weighted average yield on our debt investments for the quarter was 10.7% versus 10.3% for the previous quarter. Overall, 90% of our portfolio currently generates a recurring cash yield, and 99% of our investment income is paid in cash.

Our investment portfolio produced $3.8 million in investment income, with a weighted average yield on all investments of 9.5%. This represented an increase of $500,000 from the previous quarter's investment income of $3.3 million. We incurred $3.1 million in operating expenses this quarter, a decrease of $800,000 versus $3.9 million in the previous quarter. This reduction was due to spin-off expenses rolling off from the previous quarter.

For the quarter, we earned pretax net investment income of $700,000 or $0.04 per share, compared to a loss of $600,000 or a negative $0.04 per share in the previous period. We paid a $0.04 per share dividend for the quarter ended March 31, and declared a $0.06 per share dividend for the quarter ended June 30.

From a financing perspective, we continued to make progress toward our overall capitalization strategy. We increased our commitments to the Deutsche Bank led credit facility within I-45, growing from $75 million to $100 million, and are currently in the process of raising additional commitments to support the fund's growth. The facility includes an accordion feature allowing for up to 2 times debt to equity, at a cost of funding of LIBOR plus 250.

Additionally, we are currently in negotiations toward originating an on-balance sheet revolving credit facility. We plan to have this facility in place by the end of the summer.

As we discussed during our previous call, we are working through the application process with the SBA, with the goal of being granted an SBIC license that achieves participation in the SBIC debenture program. As we have discussed previously, Capital Southwest has held an SBIC license for the past 50-plus years. The current license does not participate in the SBIC debenture program, and was originally approved based on the legacy equity investment strategy.

Given our new middle market lending strategy, and the newness of the investment team to Capital Southwest, we and the SBA have determined that the most appropriate way for us to achieve our goal of participation in the SBIC debenture program is to apply for a new SBIC license. We plan to submit our formal application to the SBA in the near future. We will continue to provide updates as we progress.

Finally, we put in place a $10 million share repurchase plan during the quarter, and to date have not purchased any shares. I will now hand the call back to Bowen for some final comments.

Thanks, Michael, and thank you to our shareholders for giving us the opportunity to be stewards of your capital, a responsibility we take very seriously. We are pleased with the shareholder value we were able to unlock this year, and we are very excited about the strategy we have put forth, and its potential for creating sustainable, long-term value for our shareholders.

This concludes our prepared remarks. I would now like to turn the call over to the operator to open up the lines for Q&A.

Thank you.

(Operator Instructions)

Seeing no questions, I would like to turn the conference back over to Capital Southwest for any additional comments.

Thank you, operator, and thank you to all of you who are participating on our call today. We look forward to keeping you apprised of our progress on future calls. Shareholder value is our absolute first priority, and we intend to work hard to make that happen. Thanks very much, and have a great week.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day.