Capital Southwest Corporation Q3 FY2026 earnings call

• Generated pretax net investment income of 60¢ per share with strong recurring earnings. Undistributed taxable income balance at $1.02 per share. Harvested $44.5 million in realized gains from equity access over last twelve months and an additional $6.8 million after quarter end. Board declared dividends totaling 64¢ per share for March. - Deal flow in lower middle market healthy, closed $244 million in total new commitments. Add-on financings important, 29% of total new commitment over last twelve months. Weighted average spread on new commitments this quarter ~6.4%. - Strengthened balance sheet by issuing $350 million notes, using proceeds to redeem notes and extending maturity profile. Raised ~$53 million in gross equity proceeds through equity ATM program. Announced first out senior loan joint venture with private credit asset manager to enhance competitiveness in lower middle market. - Credit portfolio on-balance sheet ended quarter at $1.8 billion, 90% first lien senior secured debt, 0.8% second lien, 9.1% equity co-investments. Weighted average yield 11.3%, weighted average leverage 3.6 times EBITDA. 90% of portfolio at fair value rated in top two categories. Cash flow coverage 3.4 times. - Financial performance: pretax net investment income $34.6 million or 60¢ per share, total investment income increased. Dividends declared, strong dividend coverage. LTM operating leverage 1.7% better than BDC industry average. NAV per share increased driven by equity ATM program. Liquidity robust with ~$438 million in cash and undrawn leverage commitments. Regulatory leverage ended quarter at 0.89 to one.

During the third fiscal quarter, pretax net investment income was 60¢ per share. Total investment income increased to $61.4 million. Pretax net investment income was $34.6 million or 60¢ per share. NAV per share increased to $16.75 per share. The credit portfolio generated a weighted average yield of 11.3% with weighted average leverage through our security of 3.6 times EBITDA. The portfolio is 90% to first lien senior secured debt, 0.8% to second lien senior secured debt, and 9.1% to equity co-investments. 93% of the portfolio is sponsored, 7% non-sponsored. The undistributed taxable income balance was $1.02 per share. Originations: closed $244 million in total new commitments across eight new portfolio companies and 16 existing portfolio companies, add-ons as a percentage of total new commitment over last twelve months was 29%, weighted average spread on new commitments this quarter was approximately 6.4%.

• Expect to continue seeing deal flow in lower middle market. Joint venture expected to generate low to mid teens equity return for Capital Southwest once fully ramped. - Intend to continue raising secured and unsecured debt capital, as well as equity through ATM program in a methodical and opportunistic manner. - Expect spreads on newly originated deals to be somewhere between seven percent and seven and a quarter over next twelve months. - Expect to continue with equity ATM issuances if premium favorable, with past history of $30 - $50 million every quarter depending on deal flow, repayments, and liquidity needs.

• Market competition in lower middle market remains high with both bank and nonbank lenders, which could impact loan pricing. - Macroeconomic backdrop could affect leverage and capital markets volatility. - AI risk is being factored into investment committee discussions as it can impact company valuations and business outlooks. - Private equity sponsors' liquidity situations and fund life cycles could impact deal flow and credit quality.

Q: Expand on lower middle market competitive dynamic, players, and spread outlook.

A: Regional banks have changed underwriting, BDC space has fewer competitors, spreads on debt were 7.35% on 03/31/2025, now 7.24%, spreads on newly originated deals mid sixes, expect spreads between seven percent and seven and a quarter over next twelve months.

Q: Breakdown of portfolio between sponsored and non-sponsored.

A: 93% sponsored and 7% non-sponsored.

Q: Sponsors' appetite for deals in current market.

A: Private equity sponsors in lower middle market still looking for deals, last year was weak for deployment, hoping 2026 has more opportunities, focus on deals in beginning or middle stages of fund life.

Q: Activity, deal flow, repayment risk, net portfolio growth.

A: Bullish due to growing sponsor relationships, new MDs, joint venture allowing competition on better deals, expecting to be active, focusing on clean and high-quality deals.

Q: JV details, leverage.

A: JV is for first out position, asset level leverage between one and one and a half turns, fund level around two and a half turns plus or minus.

Q: Underwriting approach to cyclical segments like consumer products and services.

A: Weighted average leverage for such segments is slightly elevated at 4.2 times, still conservatively levered, cognizant of consumer discretionary, structuring deals accordingly.

Q: Underwriting conditions and structure terms.

A: Spread compression seen but structurally in lower middle market, good covenants and credit documents, no weak structure terms observed.

Q: JV ramp-up, targeted size.

A: Already started ramping, closed three deals contributing in coming weeks, close to closing $300 million credit facility, likely take at least a year to full leverage, expected mid teens return.

Q: Weighted average yield on originations and ATM issuances.

A: Weighted average yield on new deals this quarter ~10.5%, expect to continue equity ATM issuances if premium favorable, with past $30 - $50 million every quarter.

Q: JV impact on expanding businesses or leverage multiples.

A: Deals targeted for JV are between 5 and 10 million of EBITDA, allows putting 10 to 15 million in JV on slightly larger deals while maintaining hold.

Q: AI risk evaluation.

A: Formed AI committee and created segment in investment committee process to rate AI risk in companies, discussing how AI impacts business valuations and outlooks, also utilizing AI internally for efficiency.