CREDIT REVIEW

March 2018

SUMMARY

At March 30, 2018 CSWC had 30 portfolio companies, including the I-45 SLF Joint Venture with Main Street Capital (MAIN), with a total value of $393.095mn.  28 companies – including the JV – are Performing. There are only two Watch List companies: one new (Amware Fulfillment) and one long standing (Deepwater Corrosion Services). Wastewater Specialties, still on the books at quarter end, has been written up from a slight discount to a premium and repaid in the second quarter 2018. Both the current Watch List companies are rated CCR 3 and do not immediately threaten current Investment Income. However, Amware is generating an above average $1.9mn a year thanks to default interest and $14.8mn balance. Deepwater Corrosion is non income producing and has been since first booked in 2013. No loans were on non accrual.

CSWC INTERNAL RATING

At March 31, 2018, CSWC rated $12.9mn in Category 3 of their 4 point debt investment rating system, or 5.4% of the Debt Portfolio. There was nothing rated 4 out of 4. Based on comments made on the Conference Call we know that the $12.9mn refers to Amware Fulfillment, which is carried at $12.939mn in the portfolio, but has a cost of $13.284mn. That’s a new Watch List company.

PORTFOLIO RISK PROFILE

The investment portfolio Risk Profile remains HIGH, with only 58% of investment assets in first lien secured loans, valued at cost. 13% are in Second Lien/Subordinated, 5% in Preferred, 5.1% in common and 19.3% invested in equity of the highly leveraged JV. However, the proportion of First Lien loans is increasing and Second Lien/Subordinated has dropped substantially in absolute and percentage terms. However common equity and JV positions have increased.

The weighted average yield on debt investments is at 11.5%, also in the HIGH category. Many of the new loans and equity co-investments have been made in the last two years, which makes credible credit assessment difficult. However, reviewing loan pricing and terms, a positive is that only 5 of 29 borrowers are paying rates of 12.00% or higher and/or paying material amounts in kind. One of the five is since repaid Wastewater Specialties, and Watch List name Amware Fulfillment (boosted by 2.5% default interest).  Also modestly encouraging is that the still small portfolio is split between lower middle market and upper middle market names. Even more important is that 5 portfolio companies include equity stakes trading at a premium to cost. Of those 4 are material (over $1mn) and two are reportedly worth over $65mn. One of those (Titanliner) was just sold off, leaving only Media Recovery ($43.1mn) as a major offsetting potential gain to any losses.

INVESTMENT INCOME RISK

With no loans rated CCR 4, there is no immediate threat to CSWC’s recurring earnings from bad debts. However, we will need to keep an eye on Amware Fulfillment, which represents 2.9% of the latest Net Investment Income. Moreover, one-third of Investment Income is derived from Control investments. More specifically that income comes from i) the I-45 JV, which is structurally at risk of being cut-off if a default should occur at the vehicle; ii) dividends paid out at Media Recovery, which could be switched off at any time. The former paid $9.0mn out in FY 2018 and the latter $3.2mn. Both the JV and Media Recovery – which we have a modicum of information about – have seen performance improve in the past 12 months and no red flag has been waved as yet, but requires to be monitored.

BALANCE SHEET RISK

Compared to its peers CSWC remains lower risk from a balance sheet standpoint. Debt to Equity is at 0.31. If we look at Debt to equity at par (which eliminates the value of the Unrealized Gain in Media Recovery) the number is a not much worse 0.35. Moreover, the BDC reports $6.1mn of undistributed Net Investment Income to support distribution payments.

What debt CSWC does have is neatly split between unsecured notes ($55mn) and a secured Credit Facility ($40mn). The former is not due for several years and has no material covenants. The latter – which all portfolio assets are pledged to – has a nominal limit of $210mn. We don’t know what the current gross borrowing base might be, but is likely to be two to three times larger than current outstandings, allowing plenty of room for borrowing.