U.S. Markets close in 2 hrs 37 mins

Edited Transcript of CSWC earnings conference call or presentation 5-Jun-18 3:00pm GMT

Q4 2018 Capital Southwest Corp Earnings Call

Dallas Jun 5, 2018 (Thomson StreetEvents) -- Edited Transcript of Capital Southwest Corp earnings conference call or presentation Tuesday, June 5, 2018 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Chris Rehberger

Capital Southwest Corporation - VP Finance & Treasurer

* Bowen Diehl

Capital Southwest Corporation - President & CEO

* Michael Sarner

Capital Southwest Corporation - CFO

================================================================================

Conference Call Participants

================================================================================

* Mickey Schleien

Ladenburg Thalmann & Co. - Analyst

* Christopher Testa

National Securities Corp. - Analyst

* Troy Ward

Ares Management - Analyst

* Chris McCampbell

Hilltop Securities - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Thank you for joining today's Capital Southwest fourth fiscal quarter 2018 earnings call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP Finance. I will now turn the call over to Chris Rehberger.

--------------------------------------------------------------------------------

Chris Rehberger, Capital Southwest Corporation - VP Finance & Treasurer [2]

--------------------------------------------------------------------------------

Thank you. I would 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 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, Capital Southwest Corporation - President & CEO [3]

--------------------------------------------------------------------------------

Thanks, Chris, and thanks to everyone for joining us for our fourth-quarter fiscal year 2018 earnings call. Throughout our prepared remarks we will refer to various slides in our earnings presentation which can be found on our website at www.CapitalSouthwest.com.

We are pleased to be here with you this morning to announce our quarterly and annual results for the fiscal year 2018. This year our focus remained on building a lower middle market portfolio consisting largely of first-lien senior debt with smaller equity co-investments across the loan portfolio where significant equity upside opportunity exists.

We continue to execute under our shareholder friendly internally managed structure, which at its foundation closely aligns our interest with the interest of our fellow shareholders in generating sustainable long-term value through stable increasing dividends and NAV per share growth.

Laid out on slide 5 are some important summary points on our performance for the fiscal year ending March 31, 2018. During the year we paid $0.99 per share in quarterly dividends, a 25% increase in dividends over the $0.76 per share we paid out during our fiscal year 2017. We were able to accomplish this while growing NAV per share to $19.08 from $17.80 per share as of the end of the fiscal year 2017. As a result our total return on equity for the fiscal year 2018 was 13.7%.

During the year we significantly grew the right side of our balance sheet, increasing our total debt capitalization through increasing commitments on our revolving line of credit from $100 million to $180 million and issuing 57.5 million in unsecured baby bonds, which today trade on the NASDAQ under the ticker CSWCL.

Subsequent to yearend we added an additional $30 million in commitments to our credit facility from both new and existing lenders, bringing our total credit facility commitment to its current level of $210 million. Our increased capital base has been utilized to grow our portfolio over 35% from $287 million at March 31, 2017 to $393 million at March 31, 2018.

During the year we originated $169 million in total commitments in 17 portfolio companies including $10 million invested in equity alongside eight of our loans while exiting 11 companies for $61 million in proceeds generating a weighted average IRR of 12.2%. We are pleased to note that three years into our credit strategy we have a portfolio with no loans on nonaccrual and only one investment on our internal watchlist.

In fact WasteWater Specialties, the company we have mentioned on previous calls as being on our internal watchlist, has now been sold. The transaction closed last Friday resulting in our first lien loan being prepaid in full with contractual prepayment fees. The exit generated an IRR of approximately 17%.

Our current watchlist credit recently added to the list is a distribution and logistics company in which we have a first lien loan and no equity. The company has underperformed and has breached our financial covenants. That said, the company has signed up a large number of new customers that are expected to ramp up in the coming months.

The financial sponsor and other equity investors are very bullish on the company's prospects and are preparing to invest significant equity dollars to fund the necessary growth CapEx to prepare the company to take on this new business.

We feel pretty good about the long-term prospects of this company and very good about the security of our shareholders' capital in this deal. We are also pleased with the support the sponsor is providing the company and think the management team have done an excellent job signing up some interesting new customers.

Specific to the fourth quarter, as seen on slide 6, we experienced strong portfolio performance, growing NAV per share by $0.64 during the quarter to $19.08 per share while earning $0.28 per share in pretax net investment income. During the quarter we achieved net portfolio growth of 7%, increasing the investment portfolio to $393 million from $367 million at the end of the prior quarter.

Our I-45 senior loan fund continued its solid performance providing a 13% annualized cash yield on our capital in the fund for the quarter. Finally this quarter we repurchased 36,000 shares under our share repurchase program. As we have previously said, we are committed to building long-term shareholder value. While the number of shares we can purchase at any given day or week is significantly limited due to the low trading volume of our stock, if the market price presents itself where it makes sense to repurchase shares, then we will repurchase what we can.

As we have illustrated in the past quarterly updates, slide 7 shows our continued progress and track record of increasing shareholder dividends and driving increases in NAV per share through thoughtfully building a portfolio of well performing assets.

For the quarter ending March 31, 2018, we paid out $0.28 per share in quarterly dividend generating a 6.6% annualized dividend yield to our shareholders while increasing NAV significantly. NAV appreciation this quarter was driven largely by appreciation in our equity investment in Titan Liner and in MRI.

As we have mentioned on our past -- our last several quarterly calls, Titan Liner's financial performance has been quite robust as the company has continued to benefit from significant increases in oil and gas drilling activity and from a management team that has done a great job managing the business and generating what we believe are market share gains.

Titan Liner has been in an active sale process for the past several months and is under a letter of intent today for a sale transaction that we expect to close very soon. Regarding MRI, the company continues to perform very well with growth being driven by increased profit margins on its core products and increasing market penetration on several new products.

We also recently announced our capitalization policy following the passage of the Small Business Credit Availability Act. The Act allows for business development companies to decrease the required minimum asset coverage ratio applicable to the company from 200% down to 150%. Stated differently, maximum allowable leverage at the BDC can be increased from the prior limit of 1-to-1 debt-to-equity up to a maximum of 2-to-1 debt to equity.

BBCs can access this additional financing flexibility either immediately through a vote of the shareholders or one year after a resolution of the BDC's Board of Directors that adopts the new leverage limitation.

After careful consideration of the Company's long-term strategy the Board announced two resolutions: first, that it approved the adoption of the new regulatory limitation; and second, that it also adopted a self-imposed more restrictive limitation on leverage of Capital Southwest of only 1.5-to-1 or 166% asset coverage.

While the additional financial flexibility provided by the legislation is certainly a positive for the Company, in that it provides Capital Southwest with the flexibility to manage balance sheet leverage above our previously stated target of 0.8-to-1, our philosophy on leverage at Capital Southwest has not changed.

We remain steadfast in our view that leverage should be prudently applied to an underlying portfolio of assets based on the security and quality of the assets. Specifically, we consider factors such as the portion of the portfolio and first lien assets, the weighted average leverage at the portfolio companies themselves, and the underlying portfolio loan performance.

While we do not view balance sheet leverage at Capital Southwest near 2-to-1 as being appropriate, we do believe that targeting balance sheet leverage at Capital Southwest greater than 0.8-to-1 may be appropriate. Frankly 0.8-to-1 previously stated leverage target was as much a cushion to the 1-to-1 leverage limitation from a regulatory perspective as it was evaluating the optimal leverage level appropriate for a well performing portfolio of largely first lien assets.

We believe that the additional leverage will better enable us to increase the security and quality of our loan portfolio while allowing for additional economics flowing from any increase in leverage levels at Capital Southwest to flow to our shareholders.

The second resolution by our Board implementing a more restrictive leverage limitation specific to Capital Southwest was meant to communicate our intent to be measured and prudent in managing any changes in Capital Southwest's leverage levels.

Since our growth plan does not currently contemplate needing the additional leverage over the next 12 months, our Board of Directors elected to pass the resolution at this time and then utilize the one-year waiting period to obtain feedback from our shareholders and our lenders to take into consideration in our capitalization decisions over the longer term, as all of these decisions will be made in the context of creating attractive risk-adjusted returns and long-term sustainable value for shareholders.

Again, it is important to emphasize that our internally managed structure allows for virtually 100% of the economics earned from any incremental leverage to flow to our shareholders. This is in stark contrast to the externally managed structure where much of the incremental economics flow to the asset manager.

Our investment strategy, as described on slide 8, which focuses on a blend of both lower middle market and upper middle market assets, provides us strategic flexibility as we have built the robust capability to seek attractive risk-adjusted returns in both markets.

In our core market, the lower middle market, we directly originate opportunities consisting of debt investments as well as equity investments made alongside our debt. Building out a high performing and granular portfolio of equity co-investments is important to driving growth in NAV per share while mitigating future credit losses.

On the other hand, our capability and presence in the upper middle market provides us the ability to opportunistically invest in a more liquid market when attractive risk-adjusted returns exist.

This quarter, as seen on slide 9, we committed $27 million to two new portfolio investments and two add-on investments to existing portfolio companies. Three of the investments were in the lower middle market and two included equity co-investments. On a weighted average basis the debt investments made during the quarter had a yield to maturity of 11.2%.

During the quarter, as seen on slide 10, we received $5 million in proceeds from the exit of one upper middle market second lien investment held since December 5, 2015 that generated an IRR over this time of 13%. This continues our track record of generating strong risk-adjusted returns on our shareholders' capital as we have now had 19 exits since the launch of our credit strategy three years ago, representing over 122 million in proceeds and a weighted average IRR on exits of 16.9%.

On slide 11 we break out our on balance sheet credit portfolio, excluding I-45, between the lower middle market and the upper middle market. As of the end of the quarter, the portfolio was approximately 75%/25% weighted on a cost basis between the lower middle market and upper middle market respectively.

We had 19 lower middle market investments comprised of first lien sub debt and equity securities with an average hold size of $10.8 million, a weighted average EBITDA of $8.6 million, a weighted average yield of 11.9%, and leverage measured as debt to EBITDA through our security of 3.3 times. Within our lower middle market portfolio as of the end of the quarter we held equity ownership in approximately 74% of our portfolio companies.

Our upper middle market portfolio consisted of 10 loans including first lien and second lien debt with an average hold size of $6.6 million, a weighted average EBITDA of $86.2 million, a weighted average yield of 10.2%, and leverage through our security of 4.3 times.

On our balance sheet credit portfolio at Capital Southwest, as shown on slide 12, again excluding I-45, this grew 6% to $239 million driven by strong lower middle market first lien activity. As the portfolio has grown the percentage of the credit portfolio represented by the lower middle market has increased by design to now 72%.

As we have stated on prior calls, we believe the lower middle market to be the market that has demonstrated the most attractive risk-adjusted returns through the economic cycle as debt pricing, terms and leverage are more attractive and we often have the opportunity to invest in equity in companies with very interesting growth prospects.

While we have increased the percentage of the portfolio represented by the lower middle market, we have also continued to heavily emphasize first lien senior loans in our investment strategy. As of the end of the quarter, 82% of our on balance sheet credit portfolio was in first lien senior securities.

As illustrated on slide 13, now including capital invested in I-45, our overall all investment portfolio grew 7% quarter-over-quarter, increasing to $393 million from $367 million at the beginning of the quarter.

We continue to believe we have positioned our invested assets well for any economic environment we may face in the future. We have a well diversified portfolio heavily biased towards first lien and secure debt investments preparing us for a recession, while at the same time 95% of our credit exposure is invested in floating-rate securities, as can be seen on slide 14, so that our shareholders also continue to benefit should interest rates continue to rise.

Specific to our I-45 senior line fund, as seen on slide 15, we saw slight net portfolio growth with fund assets growing to $221 million from $218 million at the beginning of the quarter. During the quarter I-45 committed $24 million in four new and four add-on credit investments while receiving $19 million in proceeds from the exits and sales of credits during the quarter, which generated a weighted average IRR of 8.9% at the fund level.

As of the end of the quarter, the I-45 portfolio was 94% first lien with diversity among industries at an average hold size of 2.3% of the portfolio. The portfolio had a weighted average EBITDA of $74 million and weighted average leverage through the I-45 security of 3.6 times.

In our markets the environment remains robust and highly competitive. While the business and economic environment is highly favorable for our portfolio companies, the quantum of liquidity in both the private equity and leverage finance markets continues to give rise to the valuation and leverage levels that make it more difficult to find and consistently generate attractive risk-adjusted returns.

As most of you know, the upper middle market, or syndicated market, continues to see tight spreads as the market has given back much of the increase in LIBOR in reduced spreads. In addition, in the syndicated upper middle market leverage levels are high and, in many cases, the portion of underwritten EBITDA represented by pro forma adjustments are at elevated levels. This clearly creates an environment that makes it difficult to generate attractive risk-adjusted returns.

We believe being highly selective in our credits in which we invest, taking small positions so that our portfolio is highly granular, diverse, and relatively easy to sell out of, all while investing through an efficiently levered vehicle like a senior loan fund, is the best strategy for generating attractive risk-adjusted returns in this market right now.

In the lower middle market it is also very competitive and it has been for a while, so we don't believe the environment has changed all that much over the past several quarters. Over the past year LIBOR spreads on senior loans have generally tightened by approximately 100 basis points, but increases in leverage levels have been much less pronounced than we have seen in the upper middle market.

Importantly, loan terms such as covenants and LIBOR floors have remained firmly intact. We continue to focus on maximizing our investment pipeline while maintaining the investment discipline we have consistently described to you since the launch of our credit strategy three years ago.

We continue to model each and every investment we underwrite for stress test purposes assuming the great recession repeats itself during our hold period, and insisting that a financial model demonstrate that our loan remains well within enterprise value with our interest being paid through such a cycle.

This methodology will, by definition, bias the portfolio towards first lien senior debt while appropriately matching capital structures at our portfolio companies to the potential volatility specific to the portfolio of companies businesses and industries in which they operate.

We continue to be pleased with the flow of quality lower middle market deals being generated by our investment team. Our close rate has remained less than 3% over the last 12 months, so a robust pipeline of opportunities is key to maintaining our conservative underwriting approach in a competitive market. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [4]

--------------------------------------------------------------------------------

Thanks, Bowen. As seen on slide 16, our investment portfolio produced $9.9 million in investment income this quarter with a weighted average yield on all investments of 10.5%. This represents an increase of $855,000 versus $9 million from the previous quarter, mostly attributable to net portfolio growth.

We incurred $3.4 million in operating expenses this quarter excluding interest expense, which was flat from $3.4 million in the previous quarter. For the quarter we earned pretax net investment income of $4.5 million or $0.28 per share compared to $0.27 per share during the prior quarter. As a result we paid out $0.28 per share in regular dividends for the quarter, an increase of $0.02 per share over the $0.26 per share paid out in the prior quarter. We continue to focus on growing our quarterly dividends in a sustainable manner demonstrated by our last 12 months dividend coverage of 103%.

As seen on slide 17, during the quarter our NAV increased by $9.8 million to $308.3 million or $19.08 per share. The increase in NAV is primarily due to an increase in net realized and unrealized gains during the current quarter generated primarily from, as Bowen mentioned, appreciation in our equity investments in Titan Liner and MRI.

We produced a total annualized return on equity of 20.1% during the quarter. During fiscal year 2018 we produced a 13.7% total return on equity and increased NAV approximately $23.2 million. This compares to a total return on equity of 8.5% during fiscal year 2017.

As illustrated on slide 18, our on balance sheet investment portfolio mix, excluding capital invested in I-45, was 73% debt and 27% equity at quarter end, and 92% of our total portfolio produced income in the form of either interest or dividends. The weighted average yield on our debt portfolio was 11.5% for the quarter, up from 11% the previous quarter. And as of the end of the quarter there were no assets on nonaccrual.

During the March quarter the equity markets experienced significant volatility, which presented an excellent opportunity to repurchase shares at an attractive discount to our net asset value. As Bowen mentioned, despite being limited by trading volume and the quantity of shares we can accumulate on any trading day, we were able to repurchase 36,000 shares at a blended price of $16.37 per share representing approximately $600,000.

We believe these purchases provide both immediate and long-term accretion that will benefit all shareholders. The repurchases also further highlight the advantages of our internally managed structure, which incentivizes us to grow shareholder value while maintaining sufficient capital flexibility rather than solely focusing on growing our assets under management.

After these purchases we have approximately $9.4 million remaining on our $10 million Board approved share repurchase program. We will continue to assess opportunities in the market to purchase shares when we believe our stock is undervalued.

At quarter end we had significant liquidity consisting of $140 million of available capacity on our ING led balance sheet credit facility, $22 million in additional capacity on the Deutsche Bank led I-45 credit facility, and $8 million in balance sheet cash.

In April we increased the ING credit facility commitments to $200 million with the addition of a new lender. In May we further increased the ING credit facility commitments to $210 million with a commitment increase from a current lender.

As seen on slide 19, we have significant unused debt capacity and no payment obligations until late 2021, which will enable us to significantly grow our portfolio. I will now hand the call back to Bowen for some final comments.

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [5]

--------------------------------------------------------------------------------

Thanks, Michael, and thank you, everyone, for joining us today. I am extremely proud of what our team has accomplished so far. Capital Southwest as grown and the business and portfolio has developed consistent with the vision and strategy we communicated to our shareholders over three years ago. We continue to work tirelessly to execute our investment strategy and to be good stewards of our shareholders' capital.

Everyone here at Capital Southwest is totally dedicated to our number one goal: the creation of long-term sustainable shareholder value. This concludes our prepared remarks. Operator, we are ready to open the lines up for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions). Mickey Schleien, Ladenburg.

--------------------------------------------------------------------------------

Mickey Schleien, Ladenburg Thalmann & Co. - Analyst [2]

--------------------------------------------------------------------------------

Bowen, I wanted to ask you about dynamics in the lower middle market. I think the market appreciates that it's partially insulated from the volatility in the more liquid markets and that it's harder to originate deals there so you get better terms. But on the other hand, can you give us some insight into how the LMM companies you target performed during downturns in the economy, especially EBITDA declines and default rates?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [3]

--------------------------------------------------------------------------------

Yes, sure. Thanks, Mickey. I would say to your question on how they perform, if you think about across our portfolio, we have companies that EBITDA in the Great Recession went down maybe 30% and others that EBITDA were flat or even up during the Great Recession based on the nuances of their business models. And so it's a fairly big range.

What we try to do is we try to match the capital structure, which may or may not work for the borrower, which is why we'd lose the deal, but we try to match the capital structure with that potential volatility. So as you would imagine, the lower middle market companies that have the higher potential volatility are going to have lower leverage in our portfolio.

--------------------------------------------------------------------------------

Mickey Schleien, Ladenburg Thalmann & Co. - Analyst [4]

--------------------------------------------------------------------------------

That's helpful, thank you. And on the two LMM deals, Prism and ITA, how did you source those two deals? And are they small companies where you did all the financing or did you lead a club of some sort?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [5]

--------------------------------------------------------------------------------

So on Prism we led a club with another lower middle market lender. We led it; it's a small deal initially but it's going to grow as they do acquisitions, and so we brought on a co-lender to join us in that deal. And so, we sourced that just through networking with sponsors.

And then on the ITA, we actually sourced that as a founder owned business. We source it through a small intermediary actually that I had done business with or a couple of us had done business with at our former firm. We just have a relationship in the market with him and we led that. We are the only financing party there.

--------------------------------------------------------------------------------

Mickey Schleien, Ladenburg Thalmann & Co. - Analyst [6]

--------------------------------------------------------------------------------

Okay, and my last question, I haven't seen the proxy yet for the shareholder meeting. Do you expect to potentially add a proposal there for higher leverage to accelerate the clock for that process?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [7]

--------------------------------------------------------------------------------

We haven't gone that route. The Board decided -- as I said in my remarks, the Board decided to approve the leverage change. Also though message prudence in approving our self-imposed limitation and then take the next year because, as we said, we don't need the leverage above our target for the next year.

And so, we've got a lot of time to talk to our shareholders, talk to our lenders and watch the portfolio, watch the market and make that decision over that time period -- in the context of the feedback we've gained over that year. And so, rather than going through the additional expense of turns of the proxy, preliminary things like preliminary proxy issuances and comments from the SEC which generate legal expenses -- which as a smaller BDC like us, that matters -- we decided to take this route.

--------------------------------------------------------------------------------

Mickey Schleien, Ladenburg Thalmann & Co. - Analyst [8]

--------------------------------------------------------------------------------

I appreciate that. Those are all my questions this morning. Thank you.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

(Operator Instructions). Christopher Testa, National Securities Corporation.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [10]

--------------------------------------------------------------------------------

I appreciate all the thoughtfulness that you guys put into describing how you're going to handle the leverage increase. I just have just a couple more questions about that. You guys have mentioned that you see the SLF as one of the better risk-adjusted returns in the market given where spreads are, but at the same time you guys have predominantly on the balance sheet more lower middle market loans.

Going forward as you guys are able to move towards 1-to-1 given that you now have a much higher cushion at 1.5 times, should we expect maybe more -- a higher composition of upper middle market loans on the balance sheet? Are you still seeing that as a better risk-adjusted return on balance sheet as well as the SLF?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [11]

--------------------------------------------------------------------------------

So let me correct part of what you said, Chris, and thanks for the question by the way. You said that we said that one of the more attractive returns in the market is in the upper middle market. That's actually not correct.

What I meant to convey is every market is very competitive. Like I said spreads tight, leverage level high, lots of add backs. And so the way to play in that market is to take small pieces of a lot of loans within the universe of loans that we find attractive in basically good fundamental businesses, take small pieces so that you have a very granular portfolio so if any one of them doesn't do well it doesn't move the needle.

So granularity is key. Then efficiently levering it in a senior loan fund, which is, as you know, a very low leveraged CLO kind of entity. It's not 10-to-1 leverage, it's 2-to-1 leverage or less. And so just take little bites of a bunch of loans. And so, that looks like a senior loan fund.

So we think the senior loan fund -- we still -- we think that's a nice vehicle for us but, as you can see, the assets really aren't growing all that much because we are not driving growth in that fund because we're not really seeing the value to drive growth in the upper middle market on our portfolio.

So, if the environment stays like it is today and the leverage were to increase we would look at our portfolio and say, okay, we see more value in the lower middle market now, that's fact one. Fact two then is what is the optimal leverage on a portfolio that is in fact largely lower middle market and of course largely first lien. And so, we think that leverage could be above the 0.8.

We don't think that's 2-to-1 leverage, even though some BDCs are effectively getting 2-to-1 levers through SBICs. We do think the lower middle market first lien asset class -- certainly a performing asset class could handle more leverage than the 0.8-to-1. But I wouldn't assume that in our leverage calculation that we are going to turbocharge our positions in the upper middle market.

Because if you think about the number of deals that we see that we like and the size holds that we want to take in those deals in the upper middle market, they kind of fit nicely in the senior loan fund. So we are putting new deals in the senior loan fund at the same time we're getting recapped out of deals in the senior loan funds with senior loan funds hanging out at the 2.20, 2.25 asset size. Maybe it grows a little bit from there.

But I wouldn't assume that because we are adjusting leverage that we are going to all of a sudden put a whole lot more money to work in the middle-market, at least in the environment we are in right now.

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [12]

--------------------------------------------------------------------------------

And also, Chris, the I-45 credit facility is a lower cost of capital sale plus 2.40 and slightly higher advance rates, so we are able to get decent returns even with lower yields in the upper middle market (multiple speakers) in I-45.

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [13]

--------------------------------------------------------------------------------

But again, small bites, very granular is kind of how I would see it play in this market.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [14]

--------------------------------------------------------------------------------

Got it. Okay, that's great detail. Thank you for that. And just, you had Media Recovery continues to perform well, and obviously that's been a really great investment for you guys. I'm just curious, as you look in your crystal ball, what do you think the timeline on monetization of this is?

Is the thinking behind this somewhat that you actually want to take on more leverage on the revolver before you actually monetize this so you don't have to deploy so much capital and risk creating a drag on earnings? Or is that just totally out of the question and you guys are simply looking to wait until you think you're going to get the best value for this?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [15]

--------------------------------------------------------------------------------

Well, first and foremost we are looking at the investment, the company's strategy, the company's growth and working with the management team that we put in place three years ago is doing an excellent job managing that business but trying to think, okay, when is the right time to sell against the backdrop of a couple of things.

We are in a very white-hot M&A market; we need not lose context of that. We are -- ultimately if it continues to grow and it continues to appreciate it's just going to become a larger and larger asset on our books. And the strategy that we laid out three years ago was not to become an MRI strategy.

So, at some point it gets large and it probably needs to be sold and we're in a nice market. So you put all those variables together, you can't really turn the dial up and down by days or weeks of course. But if you think about general timing of all of those variables, I think it's fair to say that this is an asset that will be sold in the next 12 months.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [16]

--------------------------------------------------------------------------------

Got it.

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [17]

--------------------------------------------------------------------------------

And Chris, to your question, I think also we tell you with the dry powder we have, we anticipate putting that capital to work and levering up over the next 12 to 15 months. So it actually might be around the same timing of when we lever up and when we see this exit occur.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [18]

--------------------------------------------------------------------------------

Got it, okay, yes, that makes sense. Great. Cov light obviously has been a problem in the upper middle market with over three quarters of the loans being cov light there. Just wondering how much has that dipped down into the sub $40 million $50 million EBITDA market?

I mean I would assume it's not in the $8 million to $10 million EBITDA market where you have a lot of your lower middle market loans at that level. But if you could just give us a sense of how much you've seen covenants and deterioration in terms kind of dip down from the upper middle market that would be appreciated.

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [19]

--------------------------------------------------------------------------------

Given we are kind of in the upper middle market, which is large and you just described it and we've been talking about the competitiveness and the term deterioration and stuff in the upper middle market. In the lower middle market where we play actively, as you also said, it's certainly -- as we said, we certainly are getting robust terms in those deals.

It the middle zone of larger not quite upper middle market, larger not quite lower middle market world, we don't do a lot of deals in that area, but we do do a handful a year of -- a handful or half a handful of club deals where we are partnering with maybe two other lenders or so that they lead and that we're taking a $10 million-ish position in.

And on those deals we've had covenants. I think the covenants are a little bit certainly higher cushions than the lower middle market and terms are a little bit looser. But it hasn't been near as much -- it's not near as loose as in the upper middle market. So it's kind of somewhere in between, Chris, I guess is the best way to put it.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [20]

--------------------------------------------------------------------------------

Okay. All right, that's fair. And last one for me, just -- what caused the increase in income from your affiliate investments this quarter?

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [21]

--------------------------------------------------------------------------------

Sure. There's actually a few factors there. We re-classed two portfolio companies from nonaccrual to affiliate -- non-controlled to affiliate to the voting security percentage being greater than 5%. That was about $35 million. We had two originations during the quarter that were in the affiliate category and that was about $15 million. And then we had one prepayment during the quarter that was the non-controlled category, about $5 million.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [22]

--------------------------------------------------------------------------------

Got it, okay. So the current quarterly run rate we should, for modeling purposes, kind of use that going forward as a base.

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [23]

--------------------------------------------------------------------------------

That's correct.

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [24]

--------------------------------------------------------------------------------

The affiliate hurdle, as you know, is a 5% ownership, so it's pretty low. So, as you move forward you will see a lot of our investments when we make a co-investment it's -- very often times we are in the 5% to 10% ownership, which would be affiliate.

--------------------------------------------------------------------------------

Christopher Testa, National Securities Corp. - Analyst [25]

--------------------------------------------------------------------------------

Right. Okay, that makes sense. Thanks for taking my questions today, guys.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

Troy Ward, Ares.

--------------------------------------------------------------------------------

Troy Ward, Ares Management - Analyst [27]

--------------------------------------------------------------------------------

Great, thanks, guys. Thanks for taking my question. I actually had a question on the current liability stack. So on slide 19 you showed the facility and the 2022 senior notes, the baby bonds. Can you just talk about if any of these liabilities have covenants tied to the 200% asset coverage?

And I know you did some -- you had conversations with your lenders post quarter end, some changes, some increases. Can you just talk about how the lenders are thinking about lower asset coverage or higher debt-to-equity going forward?

--------------------------------------------------------------------------------

Michael Sarner, Capital Southwest Corporation - CFO [28]

--------------------------------------------------------------------------------

Sure. The revolver, as other BDCs have, has a 1-to-1 covenant. The notes do not. They just require you to stay compliant within the BDC. But obviously the governor being the revolver. We have had conversations; I think for our lender particularly I think they're still putting together white papers and considering how they are going to handle it.

Generally what they've discussed is they are looking at companies that have performed well over the last 6, 12, 18 months to see what kind of levels they are going to allow in terms of overall leverage.

I think body language has been positive, but for us we have 12 months before we're going to be up against a 1-to-1 leverage so we have some time to work with them on an amendment and are going to obviously see how they interact with other BDCs and where they reset those levels. We are hopeful that it's going to be consistent with our policy that we've set if not better.

--------------------------------------------------------------------------------

Troy Ward, Ares Management - Analyst [29]

--------------------------------------------------------------------------------

Okay, great. That's great color. Thanks, guys.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

Chris McCampbell, Hilltop Securities.

--------------------------------------------------------------------------------

Chris McCampbell, Hilltop Securities - Analyst [31]

--------------------------------------------------------------------------------

In regards to dividend policy, your rate of change in dividend growth is slowing. Should our expectations be that we've gotten to a point where increases are going to be less frequent?

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [32]

--------------------------------------------------------------------------------

I don't think that's the case. I think what you saw this quarter was that we did raise a significant amount of capital, the baby bonds that were raised at the very end of December and therefore it was a bit of an overhang this quarter.

We also have unused fees on our revolver. So therefore when you when you use those proceeds to pay it down we are going to incur additional costs there. I'd also say we had some late stage originations. So I think there will be a bit of a J curve as we move forward and we still expect to see dividend growth over the next really 6 to 12 months.

--------------------------------------------------------------------------------

Chris McCampbell, Hilltop Securities - Analyst [33]

--------------------------------------------------------------------------------

Okay, great. Thanks.

--------------------------------------------------------------------------------

Operator [34]

--------------------------------------------------------------------------------

And I'm showing no further questions at this time. I would now like to turn the conference back over to Bowen Diehl for any closing remarks.

--------------------------------------------------------------------------------

Bowen Diehl, Capital Southwest Corporation - President & CEO [35]

--------------------------------------------------------------------------------

Thanks, operator, and thanks, everybody, for joining us today, we really appreciate it. And we look forward to keeping you apprised of our progress on future calls. Have a great week.

--------------------------------------------------------------------------------

Operator [36]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.

  • This Refining Giant Is the Latest Energy Company to Give Up on Its MLP
    Business
    Motley Fool

    This Refining Giant Is the Latest Energy Company to Give Up on Its MLP

    The energy sector continues to experience a gigantic consolidation wave, which is causing master limited partnerships (MLPs) to drop like flies. Valero Energy (NYSE: VLO) is behind the latest disappearing act in the space after it agreed to buy out its MLP Valero Energy Partners (NYSE: VLP). Valero Energy launched Valero Energy Partners in late 2013, joining its refining rivals in creating an income-producing vehicle that would steadily buy its parent's midstream assets.

  • Tesla slides after Elon Musk announced lower-cost Model 3 (TSLA)
    Business
    Business Insider

    Tesla slides after Elon Musk announced lower-cost Model 3 (TSLA)

    Tesla CEO Elon Musk announced on Twitter on Thursday that a lower-cost Model 3 was immediately available for order on the company's website. The electric car will have a base price of $45,000 and is eligible for federal and state tax rebates. Tesla shares were down more than 3% Friday after — they gained as much as 2.2% earlier in the session.

  • Now is a ‘once-in-a-lifetime’ chance to invest in US pot companies, investor says
    Finance
    Yahoo Finance

    Now is a ‘once-in-a-lifetime’ chance to invest in US pot companies, investor says

    With some Canadian pot stocks posting triple-digit return rates this year, many retail investors have looked north to pour cash into cannabis. U.S. cannabis companies are worth a lot more than their current valuations suggest since federal illegality has put undue pressure on the industry, said David Wenger, a New York attorney and senior editor of the Cannabis Law Digest.

  • Business
    Motley Fool

    Why IBM’s Brief Growth Streak Just Stalled

    Unfortunately for its shareholders, there was a speed bump on the road to rebound last quarter: The company reported this week that revenue shrank, and growth in its vital "strategic imperatives" businesses slowed. Seriously, when IBM's legacy mainframe business is the strongest performer in a given quarter, one has to see that as a problem.

  • Business
    Benzinga

    Jim Cramer Shares His Thoughts On Amarin, AT&T, McDonald's And More

    On CNBC's "Mad Money Lightning Round", Jim Cramer said Arrowhead Pharmaceuticals Inc (NASDAQ: ARWR) is a great speculative stock. Cramer is willing to endorse AT&T Inc. (NYSE: T), but he thinks Verizon Communications Inc. (NYSE: VZ) offers more safety

  • Here’s why you shouldn’t retire super early — even if you can
    Business
    MarketWatch

    Here’s why you shouldn’t retire super early — even if you can

    Despite the many perks of early retirement — waking up whenever you want, for example — it wasn’t the easiest decision. Earnings tend to peak around 48 for men and about 39 for women, according to an analysis by PayScale.

  • Why Is Ford Stock Tanking before Its Q3 2018 Earnings Event?
    Finance
    Market Realist

    Why Is Ford Stock Tanking before Its Q3 2018 Earnings Event?

    Why Analysts Are Pessimistic about Ford’s Q3 2018 Earnings  Ford’s Q3 2018 earnings Ford Motor Company (F), the second-largest US automaker by 2017 vehicle sales volume, is set to release its third quarter of 2018 earnings report on October 24. But before

  • Goldman Sachs Adds Nvidia To 'Conviction Buy' List
    Business
    Yahoo Finance Video

    Goldman Sachs Adds Nvidia To 'Conviction Buy' List

    Goldman Sachs analyst Toshiya Hari reiterated his 'Buy' rating for Nvidia and added the chip-maker to Goldman’s 'Conviction Buy' list.

  • What happens if you win Mega Millions' $970M jackpot?
    News
    Associated Press

    What happens if you win Mega Millions' $970M jackpot?

    Despite the terrible odds — one in 302.5 million for those keeping score at home — someone will eventually match all six numbers and win the Mega Millions jackpot, which now stands at $970 million. Here are some answers for someone holding that prized lottery ticket for what would be the second-largest lottery jackpot in U.S. history. Lottery officials recommend winners take a deep breath, put their winning ticket in a safe spot and consult with a reputable financial planner before popping over to the lottery headquarters.

  • Business
    Barrons.com

    How High Can Apple Stock Go? This Analyst Says the Sky’s the Limit

    The sky’s the limit for (AAPL) (AAPL), Wedbush Securities analyst Daniel Ives said in a note late Thursday that gave the company the highest price target on Wall Street. In his Overweight recommendation, Ives, managing director of equity research, initiated coverage with a $310 target on the stock, a 43.5% upside from Thursday’s closing price. Insatiable demand for Apple’s new crop of iPhones, including its highest-priced model yet (the $1,099 iPhone XS Max), will lead the charge in 2019 and beyond, Ives told Barron’s.

  • Suddenly Toxic, Saudi Prince Is Shunned by Investors He Courted
    World
    Bloomberg

    Suddenly Toxic, Saudi Prince Is Shunned by Investors He Courted

    Now Crown Prince Mohammed bin Salman could become the biggest risk to his own project. Everything changed when Jamal Khashoggi walked into the Saudi consulate in Istanbul on Oct. 2 and didn’t come out. Prince Mohammed, who’s denied any knowledge of Khashoggi’s fate, still has his defenders -– notably Donald Trump.

  • Why Yandex N.V. Stock Plunged Today
    Business
    Motley Fool

    Why Yandex N.V. Stock Plunged Today

    What happened Shares of Yandex N.V. (NASDAQ: YNDX) dropped 17.8% on Thursday following reports that Russia's state-owned Sberbank may take a controlling stake in the country's leading internet search company. More specifically, according to sources speaking

  • The only positive in autos is Tesla, says Jim Cramer
    F
    CNBC Videos

    The only positive in autos is Tesla, says Jim Cramer

    CNBC's 'Squawk on the Street' discusses Tesla after Tesla CEO Elon Musk announced the low-cost Model 3 vehicle.

  • Home Depot vs. Lowe’s: Both Stocks Are Slumping, So Which One Should You Buy?
    Finance
    GoBankingRates

    Home Depot vs. Lowe’s: Both Stocks Are Slumping, So Which One Should You Buy?

    An analyst downgrade based on housing market outlooks has sent stocks from Lowe’s and Home Depot down over the last two days. Both Home Depot and Lowe’s are in downtrends dating back to September. On Wednesday, shares in Lowe’s and The Home Depot were slumping after disappointing housing market data led a key analyst to downgrade his ratings and slash price targets, and both stocks continued the slump into a second day on Thursday.

  • Palo Alto Networks Stock Upgraded: What You Need to Know
    Business
    Motley Fool

    Palo Alto Networks Stock Upgraded: What You Need to Know

    Cybersecurity company Palo Alto Networks (NYSE: PANW) won a big upgrade today when analysts at R.W. Baird announced they're assuming coverage of the stock and raising their price target to $250 a share. If they're right about that, Palo Alto Networks is worth more than 23% more than it currently costs. Many companies offer cybersecurity services, but which one is the best to invest in?

  • Don't Be Fooled -- Intuitive Surgical Had Another Huge Quarter
    Business
    Motley Fool

    Don't Be Fooled -- Intuitive Surgical Had Another Huge Quarter

    One look at the headline numbers might have had Intuitive Surgical (NASDAQ: ISRG) investors worried. Revenue grew a modest 14%, but earnings were only up 2%? This is, after all, a company that trades for over 50 times earnings.  But worry not. The devil

  • Business
    CNBC

    Trump-approved boycott appears to be hitting Harley-Davidson amid rising trade-ins for rival Indian brand

    Harley-Davidson sales continue to falter after a rough first half in which it lost share to Indian, its main U.S.-based competitor, according to BMO Capital Markets. Harley engaged in a public spat with Trump a few months ago when it said it was shifting some production overseas in response to retaliatory tariffs from abroad. "It should be disconcerting to HOG investors that most Indian dealers we speak with are seeing an uptick in Harley trade-ins for whatever the reason may be," BMO says.

  • Is CenturyLink, Inc. a Buy?
    Business
    Motley Fool

    Is CenturyLink, Inc. a Buy?

    Legacy landline telecom CenturyLink, Inc. (NYSE: CTL) gets plenty of grief. And understandably so, considering that its legacy business, copper wire landline and internet connections is a steadily declining business while fiber and wireless technologies

  • What’s Pfizer’s Current Valuation?
    Finance
    Market Realist

    What’s Pfizer’s Current Valuation?

    Pfizer's Stock Performance and Estimates in October (Continued from Prior Part) Pfizer’s valuation In this part, we’ll compare Pfizer’s (PFE) valuation with its peers including Merck (MRK), Johnson & Johnson (JNJ), Eli Lilly (LLY), and Bristol-Myers

  • Why This Hedge Fund Manager Loves PayPal
    Business
    Motley Fool

    Why This Hedge Fund Manager Loves PayPal

    One of the biggest hedge fund managers is Dan Loeb, manager of the sometimes-activist Third Point Capital. Third Point's Offshore Fund has returned an impressive 15.1% annualized vs. 8.1% for the S&P 500 since 1996. When a manager like Loeb makes a large bet, it's probably a good idea to listen.

  • 5 U.S. Marijuana Stocks to Buy Before the Market Lights Up
    Finance
    InvestorPlace

    5 U.S. Marijuana Stocks to Buy Before the Market Lights Up

    As such, the full range of recreational products offered by Tilray (NASDAQ:TLRY), Canopy Growth (NYSE:CGC) and their peers can now be sold throughout Canada. One question for American investors is how that affects U.S. marijuana stocks? What happened in Canada changes little in the U.S. The federal ban on marijuana remains in place.

  • Why ServiceSource International Is Imploding Today
    Business
    Motley Fool

    Why ServiceSource International Is Imploding Today

    Shares of ServiceSource (NASDAQ: SREV), a provider of outsourced inside sales and customer service solutions, are being obliterated today. The stock is down 46% as of 11:07 a.m. EDT on Friday after the company shared preliminary third-quarter results and revised its full-year guidance.

  • Love Dividends? 3 Stocks You Might Want to Buy
    Business
    Motley Fool

    Love Dividends? 3 Stocks You Might Want to Buy

    It's even better when you know that the dividend is a big one! You'll get more of those good feelings if you add high-yielding Magellan Midstream Partners, L.P. (NYSE: MMP), General Mills, Inc. (NYSE: GIS), and Tanger Factory Outlet Centers, Inc. (NYSE: SKT) to your income portfolio. It has also been reworking older brands, notably with new yogurt and ice cream products.

  • Caterpillar, Boeing Sell Off After Honeywell's Tariff Pessimism
    Business
    Bloomberg

    Caterpillar, Boeing Sell Off After Honeywell's Tariff Pessimism

    The company’s executives are bracing for “hundreds of millions of dollars” in earnings pressure next year from the expanded tariff lists. Caterpillar and Boeing dropped more than 1 percent while the Dow rose 0.5 percent.

  • Why Activision Blizzard, United Rentals, and Gap Slumped Today
    Business
    Motley Fool

    Why Activision Blizzard, United Rentals, and Gap Slumped Today

    The stock market had a tough session on Thursday, with the Dow Jones Industrial Average finishing down over 300 points. Investors continued to worry about rising interest rates in the U.S., but they also turned their attention to the global macroeconomic picture, where new concerns about the prospects for growth in areas like Europe and China weighed on sentiment. Company-specific news hurt certain stocks, and Activision Blizzard (NASDAQ: ATVI), United Rentals (NYSE: URI), and Gap (NYSE: GPS) were among the worst performers on the day.