Capital Southwest Corporation (NASDAQ:CSWC) Q4 2023 Earnings Call Transcript

Capital Southwest Corporation (NASDAQ:CSWC) Q4 2023 Earnings Call Transcript May 23, 2023

Operator: Thank you for joining today’s Capital Southwest Fourth Quarter and Fiscal Year 2023 Earnings Call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, Vice President, Finance. I will now turn the call over to Chris Rehberger.

Chris Rehberger: Thank you. I’d 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.

Bowen Diehl: Thanks Chris, and thank you to everyone for joining us for our fourth quarter and fiscal year 2023 earnings call. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company and our portfolio as we continue to diligently execute our investment strategy as stewards of your capital. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found in the Investor Relations page on our website at www.capitalsouthwest.com. You will also find our quarterly earnings press release issued last evening on our website. Now turning to slide six of the earnings presentation, we will begin with a summary of the key performance highlights for the 2023 fiscal year.

During the fiscal year we grew our total portfolio at fair value by 29% year-over-year to over $1.2 billion, from $937 million in the prior year, while increasing our pretax investment income by 21% to $2.30 per share from $1.90 per share in the prior year. We increased our regular dividends paid to $2.03 per share for the fiscal year, representing an increase of 12% compared to the $1.82 per share regular dividends paid in the prior year. We continued our track record of covering our regular dividends in pre-tax NII with over 113% coverage for the year. In addition to our regular dividend growth, we began a supplemental dividend program in the December 2022 quarter, paying $0.05 per share in each of the December and March quarters. Our Board has again declared a $0.05 per share supplemental dividend for the June 2023 quarter.

In addition, during the year we strengthened our balance sheet through a variety of capital markets activities. First, we raised a total of $207 million in gross equity proceeds through our Equity ATM Program, as well as an underwritten public offering of our common stock, reducing our regulatory leverage to 0.88 to 1 debt-to-equity as of the end of the fiscal year, compared to 1.16 to 1 debt-to-equity as of the end of the prior fiscal year. Second, we received $65 million in additional commitments on our revolving credit facility, bringing total credit facility commitments to $400 million. Third, we received approval for $50 million in additional SBA debentures during the year, which we are currently drawing upon. Finally, in March of 2023, based on our performance, balance sheet leverage and flexibility, we received a Baa3 investment grade rating with a Stable Outlook from Moody’s Investors Service.

Michael will provide further detail on this later in our prepared remarks. Turning to slide seven of the earnings presentation, we have summarized key performance highlights specific to the March quarter. During the quarter we generated pre-tax net investment income of $0.65 per share, which represented an 8% growth over the $0.60 per share generated in the prior quarter, and 30% growth over the $0.50 per share generated a year ago in the March quarter. The $0.65 per share, significantly out earned our 53% per share regular dividend as well our total dividends paid during the quarter of $0.58 per share, which includes the $0.05 per share supplemental dividend. As of the end of the quarter our estimated undistributed taxable income balance was $0.45 per share.

As previously announced, our Board has declared another $0.01 per share increase to our regular dividend to $0.54 per share for the June 2023 quarter. These increases in our regular dividends are a result of the increased fundamental earnings power of our portfolio given its growth and performance, as well as further improvements in our operating leverage. We have continued to be prudent in increasing our regular dividends, always endeavoring to set the regular dividend at a level that can be maintained even if market base rates return to more historical norms. In addition due to continued excess earnings being generated by our floating rate debt portfolio in an elevated base rate environment, our board of directors has again declared a supplemental dividend of $0.05 per share for the June quarter, bringing total dividends declared for the June quarter to $0.59 per share.

While future dividend declarations are at the discretion of our Board of Directors, it is our intent and expectation that Capital Southwest will continue to distribute quarterly supplemental dividends for the foreseeable future, while base rates are above historical averages and we have meaningful UTI generated by earnings in excess of our dividends and realized gains from our equity co-investment portfolio. During the quarter, deal activity in the lower middle market continued to be solid, primarily focused on acquisitions rather than refinancing. The environment during the quarter continues to be a favorable one for a first lien lender like Capital Southwest. We continue to see average loans pricing spreads on new portfolio company loans that were 50 to 100 basis points higher than a year ago and leverage levels on new portfolio company loans that were generally lower by around a full turn of EBITDA.

At the same time, loan to value levels on these new loans calculated as our first lien loan divided by the enterprise value being paid for an acquisition, were also down meaningfully from a year ago as private equity firms remain willing to pay full multiples for quality companies. Portfolio growth during the quarter was driven by $67.3 million in new commitments, consisting of commitments to five new portfolio companies totaling $49.5 million and add-on commitments to nine existing portfolio companies totaling $17.8 million. This was offset by $16.8 million in proceeds from one debt prepayment during the quarter. On the capitalization front during the quarter, we raised a total of $29.2 million in gross equity proceeds at a weighted average price of $19.15 per share or 118% of the prevailing NAV per share.

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 growth with accretive equity issuances, as we think it is critical that we maintain a conservative mindset to BDC leverage given the current uncertainty in the economy. As we have said many times, we manage our BDC with a full economic cycle mentality. This starts with our underwriting of new opportunities, but it also applies to how we manage the BDC’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 opportunistically repurchasing our stock in order to trade meaningfully below NAV. With this as context, we are very pleased with the strength of our balance sheet as we further reduce regulatory leverage to 0.88 to1 debt-to-equity down from 0.91 to 1 debt-to-equity in the prior quarter. We also maintained our significant liquidity position and we continue to operate with almost half of our balance sheet liabilities at fixed rate, unsecured, covenant-free bonds, the earliest of which mature in 2026. On slides eight and nine, we illustrate our continued track record of producing strong dividend growth, consistent dividend coverage, and solid value creation since the launch of our credit strategy back in January of 2015.

Since that time we have increased our quarterly regular dividend paid to shareholders 26 times and have never cut the regular dividend even in the tumultuous environment we all experienced during the COVID pandemic. Additionally, over the same period, we have paid 19 special or supplemental dividends totaling $3.60 per share generated from excess earnings and realized gains from our investment portfolio. We believe our track 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 all our decisions with the interests of our shareholders.

Continuing to generate this strong track record, we believe is critically important to building long term shareholder value. Turning to slide 10, we lay out the core tenet of our strategy, which hasn’t changed since it launched back on January 2015. Our core strategy of lending and investing in the lower middle market, with vast majority of which is in first lien senior secured loans, private equity backed company. In fact approximately 90% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership for the portfolio companies, as well as the potential for new junior capital support if needed. In the lower middle market we often have the opportunity to invest on a minority basis in the equity [inaudible] with a private equity firm.

As of the end of the quarter, our equity co-investment portfolio consisted of 53 investments with a total fair value of $117.5 million, which was a 155% of our cost, representing $41.6 million in embedded unrealized depreciation of $1.15 per share. Our equity portfolio, which represented approximately 10% of our total portfolio fair value as of the end of the quarter, continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, which will come in the form of NAV per share growth and supplemental dividend over time. Our lower middle market strategy is complemented by core participations 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 club deals are also backed by private equity firms. As illustrated on slide 11, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 senior loan funds, grew 31% year-over-year to over $1 billion compared to $794 million as of the end of the prior year. For the current quarter, 100% of our new portfolio company debt originations were first lien senior securities. And as of the end of the quarter, 96% of the total on-balance sheet credit portfolio was first lien senior securities. Over the past eight years, as we have grown the credit portfolio, we have significantly improved the granularity of loan hold sizes in the portfolio. With the average hold size as a percent of the total loan portfolio falling from 5% to less than 1.5%.

On Slide 12, we detail the $67.3 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $45.7 million in the first lien senior secured debt committed to five new portfolio companies, including four in which we invested a total of $3.9 million in equity. We also committed $16 million in first lien senior secured debt and $1.7 million in equity to nine existing portfolio companies. Deal activity continues in the current quarter at a healthy pace, and we have originated over $80 million in new commitments since the March quarter end. Turning to slide 13, during the quarter, we had one loan originated in July 2016, prepaid based on the sale of the portfolio company by the private equity sponsor.

These exits generated approximately $16.8 million in proceeds, generating a weighted average IRR of 13%. Since the launch of our credit strategy, we have realized 68 portfolio exits, representing approximately $800 million in proceeds that have generated a cumulative weighted average IRR of 14.5%. Not surprisingly, refinancing activity continues to be slow given the widening spread on new loans in the market. Based on these dynamics, we expect solid net portfolio growth in the coming quarters. 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 our consistent deal origination activity and the broad array of relationships across the country, from which our team is sourcing quality opportunities.

In terms of underwriting this market, while our company and portfolio are performing well, we do find underwriting certain industries is more challenging given today’s economic uncertainty. However, an important component of our loan underwriting has always been to run a stress case downside financial model for every new loan, simulating an extreme recession occurring soon after the closing of our loan. So in that respect, our underwriting in the current environment hasn’t changed from what we have done in the past, although models today include much higher base rates than we have experienced historically. This modeling analysis attempts to tie the leverage level we are willing to put on a company to the potential performance volatility of a particular business and industry throughout the economic cycle.

Peak-to-trough recessionary performance volatility across the industry, as demonstrated by performance in past recessions can be very different. So it is critical to assign leverage levels that are appropriate for a given level of potential performance volatility. Specifically, in our stress case financial model, we require the fundamental underwriting standards, which the model demonstrates that our loan remains well within the portfolio company’s enterprise value and that the portfolio company’s cash flow is able to cover our loan interest throughout the simulated recession. On slide 14, we detail some key stats for our unbalanced sheet portfolio as of the end of the quarter, again excluding our I-45 senior loan fund. As of the end of the quarter, the total portfolio at fair value was weighted at 86.6% to first lien senior secured, 3.1% to the second lien senior secured, 0.1% to subordinated debt, and 10.2% to equity co-investment.

The average hold sizes for portfolio loans and equity co-investments were $13.3 million and $2.2 million respectively. The credit portfolio had a weighted average yield of 12.8% and weighted average leverage through our debt security of 4x. Slide 15 illustrates the rating migration within our portfolio for the quarter. 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 of the end of the quarter, 95.7% of the portfolio at fair value was rated in one of the top two categories, a 1 or a 2. As illustrated on slide 16, our total investment portfolio on this slide now, including our I-45 senior loan fund, continues to be well diversified across industries, with an asset mix which provides strong security for our shareholder capital.

Again, the portfolio remains heavily weighted towards first lien senior secured debt with only 3% of the portfolio in second lien senior secured debt. I will now hand the call over to Michael, to review more specifics about financial performance for the quarter.

Michael Sarner: Thanks, Don. Specific to our performance for the quarter, as summarized on slide 18, we increased pre-tax net investment income of 22% quarter-over-quarter to $22.8 million, compared to $18.7 million in the prior quarter. Pre-tax NII was $0.65 per share for the quarter. During the quarter we paid a $0.53 per share regular dividend and a $0.05 per share of supplemental dividend. As mentioned earlier, our board has approved an increase to the regular dividend for the June quarter to $0.54 per share and declared another $0.05 per share supplemental dividend for the quarter. Maintaining a consistent track record of 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 113% coverage for the last 12 months ended March 31, 2023 and 108% cumulative coverage since the launch of our credit strategy in January of 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 the majority of our loans reset in early April to approximately 5.1%, up from its early January reset at 4.75%. This increase quarter-over-quarter will provide another immediate step up in portfolio income in the June quarter. As such, we expect to thoughtfully increase our regular dividend to a level which can be sustained should base rates return to the neutral level. In addition, while base rates remain elevated, our intent is to distribute a portion of excess pre-tax NII to our shareholders each quarter through supplemental dividends. Based upon our current UTI balance of $0.45 per share, the ability to grow UTI each quarter organically by over-earning our total dividend, and the expectation that we will harvest gains over time from our existing $1.15 per share in 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, 14% quarter-over-quarter to $37.2 million, reducing a weighted average yield on all investments of 12.1%. Total investment income was $4.4 million higher this quarter due to our 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 non-accrual, representing 0.3% of our investment portfolio at fair value, with no new non-accruals added this quarter. Finally, the weighted average yield on our loan portfolio was 12.8% for the quarter. As seen on slide 19, we further improved LTM operating leverage to 1.9% as compared to 2.2% in the prior year.

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. Though we were pleased to have reached this milestone, looking ahead we expect our internally managed structure to produce incremental improvements in operating leverage over time. We believe our willingness and ability to operate our business efficiently as an internally managed vehicle provides shareholders significant upside in terms of dividend sustainability and growth in the future. Turning to slide 20, the company’s NAV per share at the end of the quarter increased by $0.12 per share to $16.37, representing an increase of 0.7%. The primary drivers of the NAV per share increase for the quarter were earnings in excess of our dividends for the quarter, as well as accretion from the issuance of common stock at a premium to NAV 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 undrawn leverage commitments as of the end of the quarter. Based on our credit facility borrowing base as of the end of the quarter, we have full access to our incremental revolver capacity and will look to opportunistically increase commitments to the facility in the near future. Our bank syndicate continues to support our growth and we are pleased with the flexibility the revolving credit facility provides to our capital structure. We also have $10 million in committed, but unfunded SBA debentures to be used to fund future SBIT-eligible investments, as well as $45 million in uncommitted capacity on our current SBIT license to draw from in the future.

As of March 31, 2023, approximately 45% of our capital structure liabilities were unsecured and our earliest debt maturity is in January 2026. One of our initiatives for the current year will be to both increase and extend our revolver capacity in order to be well prepared to effectively manage maturities in the future. As Bowen mentioned earlier, we received a Baa3 investment grade rating from Moody’s Investor Service in March of this year. This rating is further validation of our first lien focused investment strategy, our strong credit underwriting track record, and our prudent balance sheet management throughout a variety of capital market environments. We believe this rating will help immensely in future capital ratings as we look to expand our investor base and complete larger capital markets transactions.

Our regulatory leverage as seen on slide 22, ended the quarter at a debt-to-equity ratio of 0.88 to 1, down significantly from 1.16 to 1 as of the March 2022 quarter. Over the past several quarters, we’ve made a concerted effort to strengthen our balance sheet to ensure we are prepared for any macroeconomic headwinds that we may encounter in the future. These efforts have included our opportunistic unsecured bond issuances at a record lower rate in the late calendar 2021, our receipt of an SBA license in April 2021, which gave us access to long-term fixed debt at attractive rates, our continued support from banking relationships, which have allowed for steady growth in our revolver facility commitments, and our continued diligence in moderating leverage through accretive equity issuances, 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.

Bowen Diehl: Thanks, Michael, and again, thank you everyone for joining us today. We appreciate the opportunity to provide you with 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-based, deal origination capability, as well as a flexible capital structure. As 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 any economic environment presented to us in the future. In summary, we have a floating-rate credit portfolio heavily weighted to first-line senior secured debt, allocated across a broad 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 covenant-like. We believe our first lien senior secured investment focus and our capital relation strategy provide us complete confidence in the health and positioning of our company and our portfolio as we look ahead. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Mickey Schleien with Ladenburg Thalmann. Your line is open.

Mickey Schleien: Yes, good morning, everyone. Bowen, I wanted to ask you about the portfolio activity during the quarter. What were the catalysts that allowed you to be so active in what is usually a seasonally slow quarter and with overall M&A volumes down pretty meaningfully?

Bowen Diehl: That’s an interesting question. I mean, if I look down the originations, I mean they were just sponsor relationships. They were active in the market. The lower middle market – I mean activity was $60 million or so for the quarter. It was an okay quarter from an originations perspective. So obviously as we referenced on the prepared remarks, we’ve done over $80 million in this quarter. So the activity in our world with the sponsors that we have relationships with across the country, it just continues to be nicely active. So we also – the leverage levels are down, spreads are up, loan to value percentages are down from like a year ago. So, I don’t know that we were doing anything as a firm differently other than just continuing to underwrite to a coming recession. So it just – our sponsors have been reasonably active.

A – Michael Sarner: And I’d also add, as we’ve grown our balance sheet, you’ll see our add-on investments with our existing portfolio has grown as well. I mean there’s obviously a lot of these companies that are doing well, they are doing M&A transactions themselves. So that supplements new platforms as well.

Bowen Diehl: And I’d say one thing, as I look down the originations, given some of these leverage levels, asset coverage on some of these deals, I would say that the banks have been less aggressive in the market. As I look at that, I see lower leverage levels in a couple of situations have nice asset coverage. A year ago there would be bank deals that we’ve been able to compete for, that’s one thing and that has to be probably due to the banks mentality looking at the market and pulling back as we all know, that’s kind of going on in the economy. And then we see less competition from a bank mez alternative. Mez guys usually attach to a bank loan and we’re seeing – my sense is, we’re seeing less competition from that, probably driven by again, the bank’s level of aggressiveness in the market. So I think those two things in our world, in our lower middle market world, would be a positive uplift, all else equal to our activity.

A – Bowen Diehl: And the activity that we mentioned earlier Mickey, in terms of early originations in the June quarter, a lot of those were deals that we’ve been working on for the last two to four months. So they are not just coming on our plate today, so a longer, longer table.

Mickey Schleien: I understand. Yeah, I was actually going to ask about the bank competition, so I’m glad you addressed that. A couple more questions for me. Clearly, the market’s concerned about the outlook for credit, that’s no secret, but you noted that the portfolio is performing well, which is really good to hear, but I do see that the portfolio’s average EBITDA declined. So could you just walk us through how much of that decline was due to any portfolio company performance issues versus just movements in the portfolio due to the size of the new investments that you made?

A – Bowen Diehl: Yeah, I mean, like if we looked across our whole portfolio this quarter, as we do each quarter, it’s kind of on a weighted average basis kind of flat. Revenue is flat, EBITDA over the whole portfolio is basically flat. So definitely, I would say that the trajectory of the EBITDA and revenue, it’s not really negative, but it’s slowing. So from a portfolio comment, the trajectory is flattening out I guess is the best way to say it. You’re just looking at the average EBITDA on the portfolio.

Michael Sarner: Yeah, I think it’s because some of the new originations we put in place actually had lower EBITDA. And so to Bow points, the existing portfolio is flat, but the new originations were less than that EBITDA and therefore that’s why you saw the reduction. So it’s not about [Multiple Speakers]

Bowen Diehl: Yeah, my comment is more on a portfolio static basis. But yes, that’s right. The new deals are slightly smaller EBITDA for sure, yeah.

Mickey Schleien: Okay, that’s what I suspected. So is that because you see the lower middle market is offering a better risk adjusted return or is it just idiosyncratic to the deal pipeline and the pace at which deals are closing? I’m asking, because certain other BDCs have indicated that they are seeing better terms in the, further up into the middle market or in the upper middle market, but historically that’s not the case.

Bowen Diehl: Yeah, no, we’re seeing attractive terms in the lower-middle market. I think you also, the other thing that’s going on is, we do a new origination, it’s got less EBITDA, smaller company and we back a lot of buy and builds, so we’re doing add-ons with our sponsors and so the EBITDA of the portfolio company grows through acquisitions. And so you can see, new originations are going to have most of the time, less EBITDA than a portfolio would because we’re just getting started. That’s the first platform. We’ll do several acquisitions and three or four quarters from now that EBITDA on that particular company could be much larger.

Mickey Schleien: I understand. Just one housekeeping question. You mentioned, and I think in the press release it says you got $16.8 million from Amware Fulfillment. But I looked at the previous SOI and it showed a principal outstanding from them at $17.1 million. So I’m just trying to reconcile that to the IRR that you mentioned. Did you actually take a loss on that investment, apart from the interest that you collected over time?

Michael Sarner: No, we definitely didn’t take a loss. There was a principal prepayment that happened. So that that exit is the actual, is the proceeds on the exit. So we had gotten a principal prepayment prior to the exit, so we got full par back.

Mickey Schleien: Okay. All right, that’s it for me this morning. I appreciate your time as always. Thank you.

Michael Sarner: Thanks, Mickey.

Operator: One moment for our next question. Our next question comes from Erik Zwick with Hovde Group. Your line is open.

Erik Zwick: Thank you. Good morning. I wanted to first just start, as I looked at the trend in the income statement, I noticed that the dollar amount and the percentage contribution from PIK interest has increased. Wondering if you could just talk about that trend a little bit, what’s driving that?

Michael Sarner: Yes. So from the previous quarter to this quarter, that’s actually one company. That had around 300,000 in PIK. That company had a PIK toggle through a previous amendment that ended at the end of March 31 when we had another amendment where there was an equity infusion in cash. So that company is delevered and performing and back-on-cash. So we would expect that to come back down in the subsequent quarter.

Erik Zwick: Okay, that’s helpful. Thank you. And then I noted that for the I-45, so that credit facility was amended to reduce the available total commitment from 150 to 100. Curious, kind of maybe that the tenor of that discussion or what kind of drove that reduction?

Michael Sarner: Yeah. We probably tell you over the last two and three years, our investments in the syndicated space has been opportunistic at best. So what we’ve seen are the credit facility come down from probably $135 million drawn to $80 million drawn today. And so we were incurring significant unused fees at the $150 million in commitment size, so it made sense. Without us seeing a runway where we’d be re-levering that facility, it made a lot of sense just to have a permanent reduction to the level that’s more appropriate for our current utilization.

Bowen Diehl: And just to be clear, 100% driven by us.

Erik Zwick: Okay, great. I appreciate the commentary there. And I guess maybe a quick follow-up on that one. Does that mean, as you mentioned, you don’t have any ability to – or don’t have any desire at this point to kind of utilize that and lever that facility back up? Is that just what you choose to hold on your balance sheet outside of that? The opportunities are more attractive today in terms of spread and what you’re seeing?

Bowen Diehl: I mean, I would tell you yes, and maybe if you look at a levered return, our leverage on our balance sheet is about commensurate with the leverage in the credit facility for I-45, and the yields tend to be wider on the lower-middle market than they do in the upper-middle market. So the all-in return is more attractive. We also have more control of the first lien lender with covenants than you might see on the syndicated space, so.

Michael Sarner: And as we kind of said the last several quarters, I mean and from what I’ve heard from other earnings calls, I think it’s probably similar across the industry, I mean the syndicated market just hasn’t been that interesting with sandbox, especially for us, given how robust our lower middle market asset class and platform is being, and that senior loan fund is really designed around syndicated market kind of product. And so the decrease in the facility reflects kind of the, you know the less investing in that asset class, and we’ll see where it goes going forward. We can always grow it and expand it in the future if we saw the opportunity to, but we don’t really. We’re very focused on the direct lending to the lower middle market where we lead the deals.

Bowen Diehl: Yeah, and to Bowen’s point earlier, I mean there’s plenty of appetite from DB who leads that facility to grow, as well as some of the lenders underneath it in the syndicate.

Erik Zwick: Got it, that’s helpful, thank you. One last one for me, and then I’ll step aside, and I appreciate the interest rate sensitivity table you included on page 26. I guess I’m just curious, if the Fed is done hiking here, I guess there’s still some debate of whether they do one more in June. But if we start to see LIBOR and SOFR kind of level out, maybe hold at this level for a little while, is there still a little bit of lag benefit that you would see in terms of your portfolio yields and NII, as it kind of catches up to the final Fed or increase in kind of the base rates and SOFR and LIBOR. And then as we move forward, would you still potentially feel a little bit of creep as you put on new investments which seem to be coming on with maybe with higher spreads, just trying to get a sense of the direction of NII from here?

Bowen Diehl: Sure, yeah. We would tell you that if rates do flatten out at 5.25 or thereabouts for a period of time, I mean we would expect that our NII would be somewhere in the $0.65 to $0.70 range for a period of time. It’s hard to see. I think we put our balance sheet in a pretty strong position. We’ve got inexpensive fixed rate debt and we’ve got the SBIC, which is low rate that we’re funding off of, and floating rate assets, so certainly we can see expansion in NII in the near term.

Erik Zwick: Thanks for taking my questions today.

Bowen Diehl: Thank you.

Operator: One moment for our next question. Our next question comes from Robert Dodd with Raymond James. Your line is open.

Robert Dodd: Hi, guys! On the leverage, obviously, it’s come down, it’s slightly below, I think the start target range. Now, can you give us any kind – is that – you see the pipeline building, obviously $80 million since the end of the quarter, and so you took the leverage down to rebuild it that way or is there any connection to – you know was there any feedback from Moody’s that maybe they’ve got a different target in mind?

Michael Sarner: Well, I’ll tell you, Moody’s is actually a part of their analysis and providing us an investment grade was our strategy to delever going into what could be a cycle and staying at the low level, the lower end of our range meant certainly it was important to them. I mean, that – it just happened to dovetail. Their view dovetailed with our strategy, so that’s positive. Going forward, I mean I think you tell – maybe tell you, Bowen and I would tell you that if we think we’re going into a tumultuous time or even we’re going kind of sideways, we think we should start out at a lower leverage. And so being at 0.88, 0.9 is where we’d like to be. We still see the ability to raise equity off the ATM, which we started off this quarter with some ability to do that as well.

So, we don’t – we feel like staying at that bottom end is not going to be an issue for us in the short term, and it’s certainly where we are. If and when there’s sort of an all clear in the market and you could see us picking up, maybe raising slightly less equity and trending closer to 1 times regulatory leverage, that’s where we are now.

Robert Dodd: Got it, got it. I appreciate that. Now, one more question if I can, and maybe I’m reading too much into this. Okay, so on page 15 of your presentation, obviously, there were three investments that were downgraded, but small right, this quarter, but last quarter you had nine category three, category four. This quarter you’ve still got nine. So three downgrades presumably, three others that were already rated at the low end of the curve where exited. If I look at footnote five on page 14, right, last quarter you’re excluding six portfolio companies because of I guess negative EBITDA, and this quarter you’re excluding nine, right, so three again. So are there three portfolio companies that are showing meaningful EBITDA deterioration or is there – I mean obviously you talked about the average, right, the average portfolio revenue EBITDA is kind of flat.

But is – at the margin, are there three that are showing material weakness at the moment or am I reading too much into a couple of party details?

Bowen Diehl: Yeah, let me break that apart in a couple of pieces. The new downgrade to a four was the last small loan in one of the prior, not four rated companies, so it’s not – its further deterioration in an already very tough situation we’ve been writing, it was written down for a while. So that’s not a new portfolio company story. The two that were, the two downgraded to a three, both underperforming, one of them underperforming very temporarily because of some inventory adjustments at its customers, the other ones are underperforming, and so it just started going down to a three. And so that’s, I mean, add to that Michael, but that’s the, that’s the – yes, and then the color behind those could be… [Cross Talk]

Michael Sarner: Yeah, and then if you turned on slide 14, the increase from 3.6x to 4.0x was actually we included a company back in these metrics, because it now has positive EBITDA or it had negative EBITDA in the previous quarter. And therefore, the metric shifted up just by its inclusion, because it is a highly leveraged business. I think if you excluded that company, the weighted average leverage would actually have been pretty consistent with the previous quarter.

Robert Dodd: Got it. Got it. I appreciate that. Thank you.

Bowen Diehl: Yeah, thanks Robert.

Operator: And I’m not showing any further questions at this time. I’d like to turn the call back over to Bowen.

Bowen Diehl : Great! Thank you, operator. Thanks everybody for joining us. We always love giving you an update on our company and how we’re performing and we look forward to speaking to you next quarter. Thank you.

Operator: Well, ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day!