Capital Southwest Corp (CSWC) 2017 Q2 法說會逐字稿

Good morning, welcome to Capital Southwest second fiscal quarter 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, everyone, for joining us for our second-quarter FY17 earnings call. 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.

This quarter we continued executing on our strategy of building a premier, middle-market lending firm. As seen on slide 6, the evolution of our investment portfolio continues, as 75% of our investable assets are now in securities generating recurring cash income, compared to 1% when we started the transformation in mid-2014.

Our two-pronged strategy, as seen on slide 7, with investing capability in both the upper middle-market and the lower middle-market continues to play out as designed, allowing us two markets in which to evaluate investments for our portfolio. We grew our investment portfolio by 35% during the quarter to $238 million from $176 million at the end of the prior quarter, including our investment in I-45 senior loan fund. We also experienced $5.6 million in unrealized appreciation in the portfolio during the quarter, driven by strong financial performance in our equity investments, as well as appreciation in our upper middle-market loan portfolio at I-45 and at Capital Southwest.

During the quarter we experienced robust origination volume in both the upper and lower middle-markets. As seen on slide 10, we closed on $55 million in nine loans during the quarter to six new and three existing portfolio companies, and $8 million in one lower middle-market portfolio company where closing slipped past quarter end. All but one of the loans we funded this quarter were first lien senior secured, and together they had a weighted average yield to maturity of approximately 10%.

We continue to close on approximately 2% of the opportunities we review, as we remain vigilant in our underwriting discipline. As illustrated on slides 11 and 12, our portfolio is performing well, with attractive risk-adjusted returns and high levels of recurring cash income, while maintaining granularity and diversity among asset classes.

Subsequent to quarter end, we had an upper middle-market first lien senior loan participation to Vivid Seats repay. We received $7 million in proceeds and realized an IRR of 21.5% on our investment.

During the quarter we continued to see robust credit markets. In the upper middle-market, deal volume increased substantially after Labor Day, and we continue to see elevated leverage levels with no financial covenant on many deals. We have continued to be biased towards first lien credits and generally avoid covenant-lite deals.

In the lower middle-market, our pipeline remains strong, and we have seen some level of discipline among lending firms with respect to pricing and terms. However, for A+ businesses with demonstrated growth, and with business models and in industries proven to be non-cyclical, private equity firms are showing a willingness to stretch on valuation. And along with their stretch, lenders are pushing the envelope on leverage. This dynamic is especially true in robust auction situations.

To mitigate risk in times like these, we must aggressively broaden our deal pipeline, but we must be conservative in our underwriting approach, maintaining the highest level of investment discipline. In every deal we structure and underwrite, we stress test the capital structure by modeling a recession during our hold period equivalent to the great recession. As a result, we focus on situations where we can understand how the businesses and industries performed during the great recession, apply capital structures to these businesses that are appropriate for their potential volatility, and invest our shareholders' capital in securities that will remain inside enterprise value with interest being paid during such tough times. While this discipline sometimes causes us to pass on opportunities or lose opportunities that we like, we are pleased with the credits we have added to our portfolio and believe this discipline will pay off in the long run.

During this quarter we placed one legacy portfolio company on nonaccrual. We hold $2.5 million in subordinated notes in TitanLiner, a company in the oil field services industry, an investment made back in 2012. The oil field service industry has gone through very tough times over the past 1.5 years, and TitanLiner's financial performance has suffered as a result. We are currently in the process of negotiating a restructuring, which will result in Capital Southwest taking a controlling interest in the equity and voting control of Titan's Board of Directors.

Despite the difficult environment in the oil field services industry over the past 1.5 years, Titan is beginning to show some signs of recovery in recent months. We believe the proposed restructured capital structure will better position the company in its recovery while more appropriately compensating Capital Southwest for the risk position it has in the capital structure today.

As seen on slide 13, our I-45 senior loan fund experienced solid net portfolio growth during the quarter, increasing portfolio assets to $173 million from $134 million at the beginning of the quarter. I-45 originated $48 million in seven new portfolio companies and nine existing portfolio companies, while receiving $9 million in proceeds from the prepayment of two credits during the quarter.

I-45's fund assets are now approximately 70% of the way toward our target fund size of $250 million. As it has grown, the I-45 loan portfolio has maintained a weighted average asset yield in excess of our original business plan, and an increasing ROE to Capital Southwest, currently at a run rate of 11.5%. The portfolio is virtually all first lien, with diversity among industries and an average hold size of less than 3% of the portfolio. The portfolio has a weighted average EBITDA of $100 million and a weighted average leverage through the I-45 security of 3.6 times.

On the right side of the balance sheet, we achieved a major milestone during the quarter by closing our initial on-balance-sheet revolving credit facility secured by our middle-market loan portfolio. ING, a lender with a long track record financing the BDC industry, led the financing. We have been very pleased with our working relationship with ING and are excited about the partnership going forward. Michael Sarner will further expand on the details of the facility in a moment.

In addition to the origination of our on-balance-sheet credit facility, we also expanded the bank group in our Deutsche Bank-led credit facility at I-45, increasing availability from $100 million up to $145 million during the quarter. With our new $100 million ING-led balance sheet credit facility, the additional $45 million in capacity on our I-45 credit facility, and our $58 million in cash on hand, we are well positioned to continue to thoughtfully grow our credit portfolio. I will now hand the call over to Michael Sarner to review the specifics of our financial performance for the quarter.

Thanks. As Bowen mentioned, during the quarter we finalized and closed the Company's first on-balance-sheet revolving credit facility. The facility is led by a preeminent lender to the middle-market space in ING Capital and with size at close at $100 million with an accordion up to $150 million. We are extremely pleased with the bank participation in the syndicate, which includes five banks in total.

The facility has a four-year maturity and is priced at LIBOR plus 325. This facility has been structured to grow with our Business in regards to both upper and lower middle-market origination. This credit facility will provide capitalization flexibility as we execute our business plan. As of the end of the quarter, we have yet to draw on the facility.

Additionally, as Bowen mentioned, during the quarter, we increased our commitment to the Deutsche Bank-led credit facility within the I-45 senior loan fund, increasing commitments from $100 million to $145 million. As of September 30, we had $88 million outstanding on the credit facility 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.

For the quarter, our NAV increased by $5.6 million to $279 million, which was mainly due to net portfolio appreciation. At quarter end, we had $58 million in cash available for investment activity, and no debt outstanding.

As of September 30, 2016, excluding our equity investment in I-45, our investment portfolio mix was 73% debts and 27% equities. Our current mix of debt investment assets at September 30, 2016, was 63% first lien, 26% second lien, and 11% secured subordinated debt. The weighted average yield on our debt investments for the quarter was 10% versus 10.1% for the previous quarter.

Overall, 94% of our investment portfolio currently generates a recurring cash yield, and 98% of our investment income is paid in cash. Our investment portfolio produced $4.7 million in investment income, with a weighted average yield on all investments of 9.1%. This represented an increase of $570,000 or 14% from the previous quarter's investment income of $4.2 million.

We incurred $2.9 million in operating expenses this quarter, a decrease of $290,000 or 9% versus $3.2 million in the previous quarter. For the quarter, we earned pre-tax net investment income of $1.8 million or $0.11 per share compared to $918,000 or $0.06 per share in the previous period. We paid a $0.11 per share dividend on October 3 for the quarter ended September 30.

Additionally, we continue to work toward our goal of receiving approval from the SBA for a new SBIC license with participation in the SBIC debenture program. During the quarter, we submitted our management assessment questionnaire, or MAC, with the SBA, formally requesting participation in the debenture program. We look forward to working collaboratively with the SBA as they consider our participation in the program. Out of respect for the SBA and their licensing process, we will only be providing updates on major milestones going forward.

Finally, in regards to the share repurchase program currently in place, we did not repurchase any shares during the quarter ended September 30, 2016. 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 continue to thoughtfully and carefully execute our investment strategy, with the creation of long-term, sustainable shareholder value as our most important goal.

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.

(Operator Instructions)

And I'm not showing any questions in the queue, so at this time, I will turn the call back to Mr. Diehl.

Thank you operator and thank you to all participating in our call today. We look forward to keeping you apprised of our progress on future quarterly calls. Again, shareholder value creation is our absolute first priority and we intend to work hard to make that happen. Thank you very much and we hope everyone has a great week.

(Operator Instructions)

And ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.