INTRODUCTION

We have taken the Capital Southwest (CSWC) earnings conference call and kept any discussion relating to credit matters and added our own commentary drawing on further analysis undertaken in the BDC’s filings and earlier conference calls. The result is a relatively long article but worth reading for a great deal of detailed information about what happened to the BDC’s portfolio companies that management handles in very general terms on the conference call.

Capital Southwest Corporation, Q4 2025 Earnings Call, May 15, 2025

CREDIT HIGHLIGHTS

Corporate Participants

Amy L. Baker

Chris Rehberger Capital Southwest Corporation – CFO, Treasurer & Secretary

Joshua S. Weinstein Capital Southwest Corporation – Senior MD & Chief Investment Officer

Michael Scott Sarner Capital Southwest Corporation – CEO, President & Director

Conference Call Participants

Erik Edward Zwick Lucid Capital Markets, LLC, Research Division – Research Analyst

Mickey Max Schleien Ladenburg Thalmann & Co. Inc., Research Division – MD of Equity Research & Supervisory Analyst

Robert James Dodd Raymond James & Associates, Inc., Research Division – Director & Research Analyst

Unknown Analyst

Presentation

Michael Scott Sarner Capital Southwest Corporation – CEO, President & Director

FY OVERVIEW

…On the left side of the balance sheet, during the year, we grew our investment portfolio by approximately $300 million or 21% from $1.5 billion to $1.8 billion. The quality of our debt portfolio continued to improve as we further reduced our weighted average leverage in the investment portfolio to 3.5x, maintained a solid 94% cash income as a percentage of total investment income, while decreasing our non-accruals at fair value from 2.3% to 1.7%.

BDC Reporter Adds: As we shall see, there are many other metrics to consider than the ones mentioned above to evaluate the “quality” of any BDC’s portfolio – including CSWC’s.

UPSIDE

Additionally, our equity portfolio performed exceptionally well this year as we grew unrealized appreciation from $38.5 million or $0.85 per share at the end of fiscal year 2024 to $53.2 million or $1 per share as of the end of fiscal year 2025. This is an important metric as we anticipate that a portion of this appreciation will be harvested as realized gains in fiscal year 2026 and thus will be available in our UTI bucket to support future dividend distributions. In fact, subsequent to quarter end, we have harvested realized gains of approximately $20 million on our equity investments in two portfolio companies, which will further grow our UTI balance.

BDC Reporter Adds: We calculate that $14mn of the increase in unrealized appreciation in the equity portfolio comes from NinjaTrader, a preferred  investment of $2mn at cost now sold for $32mn or thereabouts. The deal closed May 1, 2025. Then there’s ITA Holdings Group LLC, whose common stock and warrants have increased by nearly $20mn over the last 12 months. Currently the investment – not including the debt – is worth $30mn on a cost of under $6mn.  This is what we learned about ITA from Perplexity:

ITA Holdings Group LLC, based in Amarillo, Texas, operates as the parent company of Apollo MedFlight, a provider of 24-hour emergency and non-emergency air medical transport services. Through its subsidiaries, the company transports patients by both helicopter and fixed-wing aircraft, primarily moving individuals from rural hospitals to advanced care facilities in larger metropolitan areas. Apollo MedFlight is accredited by the Commission on Accreditation of Medical Transport Systems (CAMTS), underscoring its commitment to operational safety and high standards of patient care. Incorporated in 2018, ITA Holdings Group has expanded its operations across several states, including Texas, Oklahoma, Colorado, New Mexico, and North Carolina. The company has received growth capital from Capital Southwest Corporation, which provided $14.5 million in 2018 through a combination of credit facilities, term loans, and a minority equity investment. With an estimated annual revenue of around $44 million and a workforce of over 150 employees, ITA Holdings Group LLC is a significant player in the air medical transport industry.

Source: Perplexity

We could not identify any other equity investment gaining significantly in value in CSWC’s long list of positions. 

INVESTMENT GRADE RATINGS

Finally, we recently had our BBB- corporate ratings from both Moody’s and Fitch affirmed as well as our secured debt rating from Fitch upgraded from BBB- to BBB flat. 

MACRO ENVIRONMENT- IMPACT ON CSWC

From a market perspective, it is impossible to ignore what has transpired in the broader geopolitical arena over the past 1.5 months. The recent trade policy changes as well as government cost reductions have created uncertainty, which has impacted the lower middle market in the short term. This uncertainty has temporarily impacted the volume of underwritable opportunities. Industries such as manufacturing, building products and consumer discretionary products, all are experiencing increased costs for parts and products from China, Mexico and Canada as well as other countries impacted by the trade war. Recent budget cuts within the government sector have created uncertainty in the healthcare space in terms of Medicare and Medicaid reimbursement as well as medical research. …The recent announcement of a 90-day agreement between China and the United States, whereby tariffs on Chinese goods will come down to 30%, and China’s tariff on American goods will likewise decline to 10% has created some optimism that we’ll see a soft-landing relative to the previous rhetoric.

TARIFF IMPACT PORTFOLIO COMPANIES

However, the announced agreement is temporary and thus, we will remain vigilant in our underwriting standards until such time as we have a more permanent solution in place. In terms of potential direct impacts to our existing portfolio, we have undertaken an in-depth review of our portfolio, and the risks associated with these policy uncertainties. We have identified 7% of the debt portfolio at fair value which we would characterize as moderate risk, which means there’s some exposure to tariffs, such as sourcing of components or inventory, generally from China or customers of the portfolio of the company have some level of exposure to these same risks. However, only 1% of the debt portfolio at fair value has both moderate risk tariff exposure and a current loan-to-value above 50%. In summary, our portfolio has limited direct exposure to tariffs and those companies where the exposure is greatest are well positioned from a capital structure perspective. As a company, we will continually monitor any current or prospective policy changes as they develop and on a real-time basis, analyze any impact on both our existing portfolio as well as the lower middle market in general.

BDC Reporter Adds: We take any assessment made by CSWC as very preliminary as the impact of the tariff war may play out in all sorts of ways that we can not yet ascertain. All we’ll say is that the percentage of assets  said to have “moderate risk” – framed in terms of loans outstanding – is very similar to the percentages we’ve heard from other BDCs in very different segments of the market.

PORTFOLIO METRICS/BDC LEVERAGE

Overall, as a predominantly first lien portfolio with a weighted average debt to EBITDA of 3.5x and a balance sheet levered at 0.89:1 with significant liquidity and no maturities until October 2026, we feel confident that our balance sheet is well positioned to endure this market volatility. 

BDC Reporter Adds: We don’t think it’s appropriate for CSWC when discussing its leverage position to quote only its “regulatory” leverage of 0.89:1, ignoring the SBIC debentures on its books which are just as much debt as anything else. “Real” leverage – i.e. GAAP leverage – is 1.1:1. With that said , CSWC is far from highly leveraged by any standard and by comparison with its BDC peers.

Joshua S. Weinstein Capital Southwest Corporation – Senior MD & Chief Investment Officer

PORTFOLIO SIZE/GROWTH

Our on-balance sheet credit portfolio ended the quarter at $1.6 billion, representing year-over-year growth of 19% from $1.3 billion as of March 2024. For the current quarter, 100% of our new portfolio company debt originations were first lien senior secured. 

DIVERSIFICATION

And as of the end of the quarter, 99% of the credit portfolio was first lien senior secured with a weighted average exposure per company of only 0.9%.We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet. The vast majority of our portfolio and deal activity is in first lien senior secured loans to companies backed by private equity firms. Currently, approximately 93% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies as well as the potential for junior capital support if needed. 

EQUITY UPSIDE

In the lower middle market, we often have the opportunity to invest on a minority basis in the equity of our portfolio companies pari passu with the private equity firm when we believe the equity thesis is compelling.As of the end of the quarter, our equity co-investment portfolio consisted of 79 investments with a total fair value of $179 million, representing 10% of our total portfolio at fair value. Our equity portfolio was marked at 142% of our cost, representing $53.2 million in embedded unrealized appreciation or $1 per share. Our equity portfolio continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, often resulting from the institutionalization of the businesses by experienced private equity firms as well as a significant value accretion potential from strategic add-on acquisitions… This is playing out in real time, as we have harvested 4 sizable exits in the past 4 months that produced significant UTI, which is now available for distribution to our shareholders. 

BDC Reporter Adds: Management is not providing much in the way of details and the mention of a 4 month time period makes it impossible to deduce which gains are being talked about.  What we do know – from the 10-Q – is that there were $14mn in equity gains in the first calendar quarter of 2025, offset by some losses (including tax payments due) and a much  larger amount of debt credit losses:

Not to be unkind, but net losses were 6x higher than net gains…More on those write-offs later.

SPONSOR RELATIONSHIPS

Currently, there are 79 unique private equity firms represented across our investment portfolio. Additionally, in the last year, we closed 14 new platforms with financial sponsors, which we had not previously closed a deal, demonstrating our continued penetration in the market.Since the launch of our credit strategy, we have completed transactions with over 117 different private equity firms across the country, including over 20% with which we have completed multiple transactions. 

BDC Reporter Adds:  History shows that lending to PE-backed companies can make a substantial difference for a BDC lender. There are countless examples of sponsors injecting new equity or taking other measures when credit conditions turn sour that – directly and indirectly – inure to the benefit of the BDC lenders involved. The presence of a “deep pocketed” sponsor greatly reduces the risk that a BDC will need to step in to take over control of a failing business. With that said, PE sponsors are not philanthropic organizations and tend to know the score where their portfolio companies are concerned. There are occasions – as a result – where the PE sponsor has thrown the creditors the keys – unwilling to provide further financing.  One has to wonder sometimes if BDCs are being wise by taking over control of a business that a PE sponsor – whose job is to make those assessments – has turned its back on. 

Anyway, here is what CSWC’s 10-Q says about its “Control” investments: “Control investments are generally defined by the 1940 Act as investments in which the Company owns more than 25% of the voting securities or has greater than 50% representation on its board. At March 31, 2025, the Company held $56.1 million of control investments, which represented approximately 3.1% of the Company’s investment assets. The fair value of these investments as a percent of net assets is 6.3%.”

One of those “control” companies just added in the IQ 2025 is KMS,Inc. This close-out company was acquired by New State Capital Partners in 2020, in conjunction with management. CSWC, Main Street Capital (MAIN) and MSC Investments (MSIF) provided  first lien financing since 2021, according to Advantage Data. KMS got into financial trouble in 2024 and defaulted on its loans in the IIIQ 2024. Very recently – as written about on June 5, 2025 in the BDC Credit Reporter – the BDC lender converted debt to equity and took control of KMS in a “debt for equity swap”. New State Capital Partners seems to be no longer involved. 

We’ll be interested to see how this plays out in the quarters and years ahead.

NUMBER OF PORTFOLIO COMPANIES/INVESTMENT TYPE MIX

Our portfolio currently consists of 121 different companies weighted 89% to first lien senior secured debt, 1% through second lien senior secured debt and 10% to equity co-investments. 

PORTFOLIO YIELD/LEVERAGE

The credit portfolio had a weighted average yield of 11.7% and a weighted average leverage through our security of 3.5x EBITDA. We continue to be pleased with the operating performance across our loan portfolio.

BDC Reporter Adds: We believe a lender’s yield on its interest bearing investments tells you a lot about the credit risk involved, adjusted for the market segment involved. CSWC operates in the lower middle market (LMM) and there are many other BDCs fishing in the same waters to compare against. The 11.7% suggests a middle of the road risk level for first lien debt, which is reflected in the BDC’s long term credit performance. 

INVESTMENT RATINGS

All our 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. Overall, the portfolio remains exceedingly healthy with approximately 95% of the portfolio at fair value rated in one of the top 2 categories, a 1 or a 2 and approximately 5% of the portfolio in the 3 or 4 categories. 

BDC Reporter Adds: Here is the investment rating table for the most recent quarter:

As you can see, the percentage of assets in the two lowest credit performance categories is very low and much unchanged from the year-end 2024 number of $81mn, before the recent realized losses booked.

However, CSWC does not tell us which companies or assets are in which of these buckets. In this regard, we look to the BDC Credit Reporter which undertakes its own independent analysis of the entire portfolio, identifying the BDC’s “Important Underperformers”. As of the IQ 2025, there were 7 companies identified, with an investment cost – both debt and equity – of $115mn and an FMV of $69mn.

Even more importantly, the BDC Credit Reporter estimates CSWC may need to book ($18mn) in further losses on these names, and ultimately recognize ($64mn) in realized losses. The ($18mn) of potential loss  amounts to only (2%) of the BDC’s net assets at the moment. 

For the identity of  the Important Underperformers and Company Files on each, please consider subscribing to the BDC Credit Reporter and follow the ever evolving stories of these businesses.

DEBT SERVICE METRICS

Cash flow coverage of debt service obligations across the portfolio remains robust at 3.4x with our loans across the portfolio averaging approximately 43% of portfolio company enterprise value. 

AMENDMENT ACTIVITY

To date, we have not seen an increase in revolver draws or amendment requests, which would serve as an early warning of portfolio company stress. While certain credits may experience an impact from these policies in the future, conversations with management teams and sponsors for the company is most at risk, believe there are mitigants to navigate the tariff environment, including pivoting to countries with less exposure, price increases to customers, sharing the tariff burden with the suppliers, and the potential for cheaper freight costs on imported items, assuming freight volume slows meaningfully, which we have observed in the past few weeks.Additionally, many of our companies have maintained elevated inventory levels heading into this uncertain time, thus enabling them to defer purchasing goods in the hopes of an improved outcome between the U.S. and China. With the recent news of a temporary agreement, these actions seem to have been prudent. 

BDC Reporter Adds: We saw how nimble BDC portfolio companies were during Covid in responding to unexpected conditions, and expect most businesses to be just as flexible and creative in the new tariff environment. 

Chris Rehberger Capital Southwest Corporation – CFO, Treasurer & Secretary

NON ACCRUALS

…As of the end of the quarter, our loans on nonaccrual represented 1.7% of our investment portfolio at fair value– a decrease from 2.7% as of the end of the prior quarter. The reduction this quarter was a result of two portfolio companies being restructured and one portfolio company being sold. We placed one new company on nonaccrual, which post quarter end, completed a bankruptcy process and will likely be removed from nonaccrual in the June 30 quarter. 

BDC REPORTER ADDS: One of the restructured companies was American Nuts, aka Gauge American Nuts, which is held by multiple BDCs. Here is a free-to-all article from the BDC Credit Reporter which explains the restructuring. We estimate CSWC’s realized loss at ($12mn-$13mn). We can’t say exactly because management is evasive about specifics in its filings.The loss of income is significant. Previously CSWS had $25mn in debt paying interest, now there is only $11mn. All income being recognized is in PIK form. We estimate at least ($2mn) of annual interest income is being forgone. CSWC – and other BDC lenders – are now owners but the BDC Credit Reporter is “not convinced American Nuts has yet been “saved”.

The other restructured company was KMS, Inc., discussed earlier. We have not yet determined which company was sold. 

The new non-accrual is Zips Car Wash, a company held by multiple BDCs that famously went from being valued close to par to filing for bankruptcy in a New York Minute. The good news is that – as CSWC mentions – the company has already exited bankruptcy, as discussed in the BDC Credit Reporter. A debt-for-equity restructuring has occurred for which CSWC has been tapped for some Debtor In Possession funding already in the most recent quarter. The BDC Credit Reporter expects the likely realized loss on CSWC’s $20.0mn of loans advanced  to be about (20%)-(25%) of the total. Given the recapitalization, the loss of income may be greater, but we won’t know till next quarter. However, it’s likely that income derived from Zips will increase next quarter and beyond as the company comes back on line and starts paying interest again after a quarter on non-accrual. One final note: As always the BDC Credit Reporter is not yet convinced enough has been done, musing  that Zips “is not out of the woods yet. We wonder if enough debt has been forgiven”.

NAVPS

The company’s NAV per share at the end of the quarter was $16.70 per share, an increase from $16.59 per share in the prior quarter. The primary drivers of NAV per share growth for the quarter or accretion from the issuance of common stock at a premium to NAV per share, offset by net realized and unrealized depreciation on our investment portfolio. 

BDC Reporter Adds: CSWC’s strategic positioning as a BDC involved both in lending and investing kept net losses on the low side. Despite booking a relatively high ($26mn) in realized credit losses, the net loss on both a  realized and unrealized basis amounted to just ($10mn). Here’s the break-down:

Net Realized and Unrealized Depreciation: $10.3 million, or 0.6% of total investments at fair value

◦$19.3 million of net appreciation related to the equity portfolio

◦$25.7 million of net depreciation related to the credit portfolio

◦$3.9 million realized and unrealized income tax provision

LEVERAGE- GAAP AND REGULATORY

Our regulatory leverage ended the quarter at a debt-to-equity ratio of 0.89:1, down slightly from 0.9:1 as of the prior quarter. While our optimal target leverage continues to be in the 0.8 to 0.95 range, we are weighing the impacts of the current macroeconomic landscape and intend to maintain a regulatory leverage cushion, which will mitigate capital markets volatility. 

BDC Reporter Adds: CSWC is one of the few BDCs in the most recent earnings season that announced its intention to restrain its investment activities in light of the uncertain environment. On the one hand, investors should appreciate the “conservative” approach. On the other hand, we wonder if management is more nervous than they have been letting on in this transcript.

Questions and Answers

REALIZED LOSSES DETAIL

Mickey Max Schleien Ladenburg Thalmann & Co. Inc., Research Division – MD of Equity Research & Supervisory Analyst

At a high level  could you just break out what were the main drivers of the net realized loss and the markdown in the credit portfolio?

Chris Rehberger Capital Southwest Corporation – CFO, Treasurer & Secretary

Yes. So the couple of companies that really drove the realized and unrealized losses this quarter were related to the restructurings, and we noted in our remarks, two of those were on non-accrual that were restructured during the quarter. And so it’s really those two companies that drove most of the depreciation — net depreciation for the quarter, it wasn’t really across the broad credit portfolio.

BDC Reporter Adds: As discussed above: these were KMS and American Nuts. 

Michael Scott Sarner Capital Southwest Corporation – CEO, President & Director

… There were a few companies that sort of — that were on our watch list that had restructurings where we had to take write-downs that from an accounting perspective are realized losses. And so that’s the net impact of the quarter.

PIK TOGGLE

Unknown Analyst

 I’ve seen that the PIK income has increased a bit over the last few quarters. Are there any trends that you’re seeing there? Any particular type of companies? Or what are your thoughts in regard to how that may trend over in regard to credit quality over the next few quarters.

Michael Scott Sarner Capital Southwest Corporation – CEO, President & Director

Sure, sure. So we saw a few companies that had a PIK toggle that elected in this quarter that they hadn’t in previous quarters. And those — honestly, those are like short lived in nature, so they’ll come back off in time. We do know that for the June quarter that we expect to see a few companies that their PIK toggle expired and they are able to cash pay, so at the moment, I can probably say we expect that PIK percentage to come down in the 5% to 6% range for reoccurring PIK.

BDC Reporter Adds: One of those companies toggling to PIK this quarter is Gains Intermediate LLC. Here is what Preplexity tells about the company:

Gains Intermediate LLC, based in Carrollton, Texas, is a private equity-backed company specializing in the health and wellness coaching space. Its business is focused on helping gym owners and fitness professionals grow their businesses through a combination of coaching programs, business training solutions, and industry-leading nutrition and supplement products. Gains Intermediate operates three main business units: Gym Launch, which provides coaching and business support for gym owners; Prestige Labs, a supplement brand tailored for gym owners and their clients; and Gymowners.com, a software platform designed to help gym owners track business metrics and streamline payment processing. The company serves the health and wellness industry and is classified under SIC code 7299, which covers miscellaneous personal services not elsewhere classified, including health and fitness coaching. Gains Intermediate is notable for being the first private equity-backed portfolio specializing in this niche, though the specific private equity sponsor is not publicly disclosed.

We note that the company – a borrower since 2022 – has seen its debt discounted by the highest percentage yet by CSWC – (13%). The BDC Credit Reporter has just added the company to its Watch List.

Something unusual is happening at National Credit Care. In the IQ 2025, $24mn in loans previously maturing in 2026 and priced at SOFR + 650 or 750 saw their maturity extended to 2030 and are now paying a 45.% PIK. CSWC was granted some warrants in the interim and now calls this a “Control” company. The BDC Credit Reporter has National Credit on its Watch List as well, given the (18%) discount on one of its first lien Term B loan.

Also electing PIK is the now-BDC owned KMS Inc. , which is rated 4 by the BDC Credit Reporter.

CONSUMER PRODUCTS COMPANIES EXPOSURE

Erik Edward Zwick Lucid Capital Markets, LLC, Research Division – Research Analyst

That’s helpful. And then two, just kind of looking at the industry diversification of your portfolio, your second largest concentration based on your pie chart is 9% in consumer products. And given that there is some concern in the market today regarding the lower end consumer. I’m wondering if you could just kind of remind me kind of the companies that you have there that you qualify or characterize as consumer what segment of the consumer market are they delivering their product to?

Michael Scott Sarner Capital Southwest Corporation – CEO, President & Director

I mean, honestly, it’s kind of a tough question to ask because it’s very granular and diversified. I don’t think there’s any one industry within consumer products. We just did a deep dive as part of the tariff exposure; we also did a deep dive just on the whole portfolio. And we really identify very few, if any, sub industries that we feel like we’re overweighted towards in which we were — have a concern on it from a recessionary perspective. Now that doesn’t say that in a recession and a deep recession that all companies will struggle to some point, but I don’t believe it’s anything that will be lumpy and therefore, kind of be moving in the same direction.One of the things we’ve done since the inception of our credit platform is downside case modeling on all of our deals as it relates to the Great Recession. So we’ve taken the posture of being a little bit less aggressive on deals that cycled really hard, or industry cycled really hard in the Great Recession. So generally speaking, at a very high level, I think a lot of our consumer products businesses would be focused more on the lower end with more value end of the spectrum. So give us some insulation to that.

BDC Reporter Adds: For what it’s worth, the BDC Credit Reporter rates all 7 consumer products companies in the portfolio as performing as expected.

VIEWS

Confusing

As we said at the top, there are a multitude of factors to take into consideration when assessing a BDC’s credit performance and the “quality” of its portfolio.

In this case, there are both pluses and minuses. Let’s start with the latter:

In the calendar IQ 2025, CSWC did need to book a material amount of realized losses given the setbacks at KMS and American Nuts and more losses are coming now Zips Car Wash is exiting bankruptcy.

Moreover, the PIK toggling at Gains Intermediate and National Credit Care are – at the very least – worth keeping an eye on.

As to the macro environment, one gets the impression that – not surprisingly – tensions are higher than has been the case of late, even after the full scale review of the portfolio companies.

Sunnier

There are an abundance of pluses though:

Notwithstanding the permanent losses incurred the restructurings of KMS, American Nuts and Zips Car Wash are a step forward and will both generate some interest income for the BDC going forward and create the opportunity to recoup some of the capital lost.

Moreover, both realized equity gains already booked and those on their way will go a long way to offset the credit write-offs incurred recently and over the last several years.

Also encouraging is that leverage remains at a sensible level and the portfolio is becoming ever more diversified by company and sponsor and that essentially all new loans are in a first lien position.

Outlook

Over the last 5 years CSWC has managed to increase its Net Asset Value Per Share by 10% but has stumbled around over recent quarters making little in the way of advances due to a series of credit reverses.

On the evidence here, though, there seems tro be a good chance that CSWC can get back to its winning ways, even in this uncertain environment.

At the very least, the metrics do not suggest the BDC will be suffering any serious drop in value or earnings in 2025.