Business context and reporting period
Capital Southwest Corporation (Nasdaq: CSWC) is an internally managed business development company that provides debt and equity financing to lower- and upper-middle-market companies, primarily in the United States. This Form 10-Q covers the fiscal third quarter and nine months ended December 31, 2023; the quarterly results are compared with the three months ended December 31, 2022.
Financial and portfolio highlights
| Metric | Three months ended Dec. 31, 2023 | Nine months ended Dec. 31, 2023 |
|---|---|---|
| Investment income | $48.6 million, up 48.2% year over year | $131.7 million, up 60.4% |
| Net investment income | $28.9 million; $0.70 per share | $80.6 million; $2.04 per share |
| Net increase in net assets from operations | $23.5 million; $0.57 per share | $69.9 million; $1.77 per share |
| Net realized investment losses, after tax | $7.8 million | $20.2 million |
| Net unrealized investment appreciation, after tax | $2.5 million | $9.9 million |
- Portfolio and NAV: Investments at fair value were $1.365 billion at December 31, 2023, compared with $1.206 billion at March 31, 2023. The portfolio included 96 companies. NAV per share was $16.77, up from $16.37 at March 31.
- Portfolio mix and credit: Approximately 84% of investments were first-lien loans. Healthcare services, media and marketing, and business services were the largest industry exposures. Debt investments rated 3 accounted for 5.0% of debt portfolio fair value; none were rated 4. Non-accrual investments were 2.2% of portfolio fair value, versus 0.3% at March 31, 2023.
- Cash flow: Operating activities used $86.4 million in the nine-month period, mainly reflecting $317.9 million of investment purchases and originations, partly offset by repayments and sales. Financing activities provided $88.4 million; cash increased $2.0 million to $23.6 million. These operating cash flows include portfolio investment activity and should not be read as ordinary operating-company free cash flow.
- Debt and liquidity: Gross borrowings were $686.9 million, with a carrying value of $677.8 million. Debt included $195.0 million drawn on the credit facility, $130.0 million of SBA debentures, and $361.9 million principal amount of unsecured notes. Reported asset coverage was 253%; the company said it was in compliance with credit-facility covenants. It reported $264.4 million of available credit-facility borrowings and stated that liquidity was adequate for the next 12 months.
- Distributions and share issuance: The December-quarter dividend was $0.63 per share, comprising $0.57 regular and $0.06 supplemental; the same amount was declared for the quarter ending March 31, 2024. The company raised $132.9 million net through its at-the-market equity program during the nine months, issuing 6.66 million shares. Shares outstanding rose to 43.0 million from 36.1 million at March 31.
Material changes and management commentary
- Quarterly and year-to-date investment income and net investment income grew substantially, which management attributed chiefly to a larger debt-investment cost base and higher yields amid rising benchmark rates; higher portfolio-company dividends also contributed.
- Interest expense rose 44.6% for the quarter and 57.8% for the nine months, reflecting higher average borrowings and rates. The weighted-average rate on total debt increased to 5.60% for the quarter and 5.40% for the nine months.
- The company issued $71.9 million principal amount of 7.75% notes due 2028 during the period. Its revolving credit facility commitments increased to $460 million, with maturity extended to August 2028 and the revolving period to August 2027.
- Management cited continuing economic, inflation, labor, supply-chain, geopolitical, and interest-rate uncertainty, and said it was increasing oversight of credits in vulnerable industries. It provided no formal earnings guidance.
- Most portfolio investments are privately held and valued using significant unobservable Level 3 inputs. Management cautions that realized outcomes may differ materially from recorded valuations. PIK interest represented 8.4% of quarterly investment income and 5.5% for the nine months; it is recognized as income without current cash receipt. The company also noted non-accrual exposure had increased.
- Subsequent event: I-45 SLF LLC approved liquidation and distribution of its assets to its owners; CSWC’s additional capital commitment approved in connection with the process was $37.6 million. The JV repaid and terminated its credit facility on January 24, 2024.
Important facts for investors to verify
- Whether portfolio-company performance, non-accrual exposure, and realized credit losses continue to develop as indicated by the ratings and valuation disclosures.
- How much reported investment income is collected in cash, particularly PIK and other non-cash income, and how that affects dividend coverage.
- Whether investment yields continue to exceed borrowing costs as rates change; the filing estimates an annualized $10.1 million NII decline for a 100-basis-point rate decrease, assuming no changes in portfolio or borrowings.
- How additional ATM share issuance affects per-share earnings and NAV, and whether future distributions remain supported by taxable income and cash generation.
- Execution and proceeds from the I-45 SLF LLC liquidation, and the availability of committed credit and SBA leverage when needed.