Capital Southwest Corp (CSWC) Q2 2022 Earnings Call Transcript

Thank you for joining today’s 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. You may begin.

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 our publicly available 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.

Thanks, Chris. And thank you, everyone, for joining us for our earnings call for the quarter ended September 30, 2021, which is the second quarter of our 2022 fiscal year, which ends March 31, 2022. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company, our portfolio, and our progress on executing our investment strategy as stewards of your capital. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website. We’ll begin on Slide 6 of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pretax net investment income of $0.45 per share, which more than earned our regular dividend for the quarter of $0.44 per share. Total dividends for the quarter were $0.54 per share, which included a $0.10 per share supplemental dividend. Total dividends paid during the quarter represented an annualized dividend yield on our stock price on the last trading day of the quarter of 8.6% and an annualized yield on net asset value per share of 13.2%. As a reminder, we previously announced that our Board declared an increase in our regular dividend per share to $0.47 for the quarter ended December 2021 from the $0.44 paid in the September quarter. This increase in our regular recurring dividend reflects the increased earnings power of our portfolio, resulting from portfolio growth, continued reductions in our cost of capital, and continued improvements in operating leverage achieved through our internally managed structure. Our Board also declared a supplemental dividend of $0.50 per share to be paid on the December quarter. This supplemental dividend represents an accelerated payout of our prior supplemental dividend program, which had been paying out $0.10 per share per quarter over the past several years. We believe that this accelerated distribution of UTI maximizes value for our shareholders today while also maintaining an adequate UTI balance into the future. Going forward, we expect that shareholders will continue to participate in the successful exits of our investment portfolio through special distributions as we monetize the unrealized appreciation in our portfolio over time. During the quarter, we grew our investment portfolio on a net basis by 2.4% to $818 million. Portfolio growth during the quarter was driven primarily by a total of $112.9 million in commitments to 6 new portfolio companies and 4 existing portfolio companies, of which $77.2 million was funded at close. This was offset by $60.9 million in proceeds from 6 debt prepayments and 2 equity exits during the quarter. The portfolio generated net realized and unrealized gains of $2.8 million during the quarter, driven primarily by unrealized depreciation in our equity co-investment portfolio. On the capitalization front, we completed an amendment to our ING credit facility, extending the maturity to August 2026, and decreasing the interest rate to LIBOR plus 215 basis points, down from LIBOR plus 250 basis points. Additionally, we issued $100 million in aggregate principal of 3.375% notes due October 2026 and repaid in full our 5.375% notes due October 2024. Furthermore, in lockstep with our strong deal pipeline, we raised $30.3 million of equity through our ATM program at an average price of $26.59 per share, representing an average of 160% of the prevailing net asset value per share. On Slide 7 and 8, we illustrate our continued track record of producing steady dividend growth, consistent dividend coverage, and value creation since the launch of our credit strategy. We believe the solid performance of our portfolio and our company’s sustained access to the capital markets has demonstrated the strength of our investment and capitalization management strategies. Maintenance and growth of both NAV per share and shareholder dividends remain as core tenets of our long-term investment objective of creating long-term value for our shareholders. Turning to Slide 9, as a refresher, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on our core lower middle market lending strategy while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk-adjusted returns exist. In the lower middle market, we directly originate and lead opportunities consisting primarily of first lien senior secured loans with smaller equity co-investments made alongside our loans. We believe that this combination is powerful for a BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from equity investments in many of these growing businesses. Building out a well-performing and granular portfolio of equity co-investments is important to driving growth in NAV per share while aiding in the mitigation of any credit losses over time. As of the end of the quarter, our equity co-investment portfolio consisted of 31 investments across approximately half of our portfolio companies. The equity portfolio had a fair value of $69.2 million, which included $17.7 million in embedded unrealized appreciation or approximately $0.76 per share. Our equity portfolio, which represented 8% of our portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from the growing lower middle market businesses. As illustrated on Slide 10, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 senior loan fund, grew 3% to $689 million compared to $671 million as of the end of the prior quarter. For the quarter, all 6 of the new portfolio company debt originations were first lien senior secured. And as of the quarter end, 91% of the credit portfolio was first lien senior secured. On Slide 11, we lay out the $112.9 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $107.8 million in first lien senior secured debt committed to 6 new portfolio companies, one of which we also invested $1 million in equity alongside our debt; $3.8 million in first lien senior secured debt committed to one existing portfolio company and $400,000 in sub-debt and equity follow-on investments in 3 existing companies. Turning to Slide 12, we continued our track record of successful exits with 6 exits during the quarter. These exits generated $60.9 million in total proceeds, realized gains of $3.3 million, and a weighted average IRR of 17.5%. To date, we have generated a cumulative weighted average IRR of 15.2% on 45 portfolio exits, representing approximately $462 million in proceeds. From a macro perspective, the market for acquisition and refinancing capital was robust this quarter and has continued its strong momentum into the December quarter, resulting in heavy volume in both origination and refinancing activity. Our investment pipeline, as we have mentioned on previous earnings calls, has been robust in both volume and the quality of deals. The deal team continues to do an excellent job broadening the top end of our deal funnel, which maximizes the number of deals in the market for which we have the opportunity to review and consider. As we have always contended, this is a critical component of building and maintaining a quality investment portfolio in a competitive market. Finally, we believe that the returns realized on exits over the past several years have proven out the investment acumen of our investment team and the merits of our investment strategy in generating strong risk-adjusted returns over the long term. On Slide 13, we illustrate some key stats for our on-balance sheet portfolio as of the end of the quarter, again, excluding our I-45 senior loan fund. Beginning this quarter, we have decided to consolidate reporting on our on-balance sheet upper middle market and lower middle market loans in order to give shareholders a more concise view of our portfolio makeup in total. As of the end of the quarter, the total on-balance sheet portfolio at fair value was weighted 82.4% to first lien investments, 6.8% to second lien investments, 1.6% to subordinated debt investments, and 9.1% in equity co-investments. Turning to Slide 14, we have laid out the rating migration within our portfolio. During the quarter, we had 2 loans upgraded from a 2 to a 1; 1 loan downgraded from a 2 to a 3; and 1 loan downgraded from a 3 to a 4. As a reminder, all 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. As of the end of the quarter, we had 61 loans, representing approximately 90% of our investment portfolio at fair value, rated in one of the top 2 categories, a 1 or a 2; we had 6 loans, representing 9.7% of the portfolio at fair value, rated a 3; and 1 loan, representing less than 1% of the portfolio, rated at 4. During the quarter, we placed 1 first lien senior secured loan on non-accrual with a fair value of $10.4 million or 1.3% of the total investment portfolio. This company is currently working through a restructuring of its balance sheet, so we have decided to place the loan on nonaccrual pending more clarity on the post-restructure loan terms. Based on conversations with the company to date, we expect a portion of this loan to come off nonaccrual in the near term once the restructuring is finalized, which should be completed in the coming weeks. As illustrated on Slide 15, our total investment portfolio continues to be well diversified across industries with an asset mix that provides strong security for our shareholders’ capital. The portfolio remains heavily weighted towards first lien senior secured debt, with only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in subordinated debt. Turning to Slide 16, the I-45 senior loan fund continues its solid performance. As of the end of the quarter, 95% of the I-45 portfolio was invested in first lien senior secured debt. Weighted average EBITDA and leverage across the companies in the I-45 portfolio was $75 million or 4.7x, respectively, down slightly from the last quarter. The portfolio continues to have diversity among industries at an average hold size of 2.6% of the portfolio. Leverage at the I-45 fund level is currently 1.3x debt to equity. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.

Thanks, Bowen. Specific to our performance for the September quarter, as summarized on Slide 17, we earned pretax net investment income of $10 million or $0.45 per share. We paid out $0.44 per share in regular dividends for the quarter, an increase from the $0.43 regular dividend per share paid out in the June quarter. As mentioned earlier, our Board has again, this quarter, increased the regular dividend, declaring a quarterly dividend of $0.47 per share for the December quarter. Additionally, our Board previously declared a final supplemental dividend of $0.50 per share, which will also be paid out during the December quarter. Our investment portfolio continues to perform very well, generating $2.8 million in net realized and unrealized gains this quarter, bringing the net realized and unrealized gains over the past 4 quarters to $18.7 million. Though we are accelerating the current supplemental dividend program as of December 31, 2021, going forward, we will continue to distribute special dividends as we monetize the unrealized appreciation in the portfolio. As of September 30, 2021, our estimated UTI balance was $0.69 per share. Maintaining a consistent track record of meaningfully covering our regular dividend with pretax net investment income is important to our investment strategy. We continue to maintain our strong track record of regular dividend coverage with 109% for the last 12 months ended September 30, 2021, and 107% cumulative since the launch of our credit strategy in January 2015. Our investment portfolio produced $20.3 million of investment income this quarter with a weighted average yield on all investments of 9.6%. Investment income was $1.7 million higher this quarter due primarily to an increase in average credit investments outstanding and prepayment fees. There were 3 loans on non-accrual with an aggregate fair value of $24.2 million or 3% of the investment portfolio as of the end of the quarter. Our weighted average yield on our credit portfolio was 9.7% for the quarter. As seen on Slide 18, we maintained LTM operating leverage at 2.3% as of the end of the quarter. We are targeting operating leverage to approach 2% or better in the coming quarters. Turning to Slide 19, the company’s NAV per share as of September 30, 2021, was $16.36 compared to $16.58 at June 30, 2021, representing a quarter-over-quarter decrease of 1.3%. The main driver of the NAV per share decrease was $17.1 million in realized losses on the extinguishment of debt on the full prepayment of our 5.375% note due October 2024. The realized loss consists of a make-whole premium payment of $15.2 million as well as the write-off of related unamortized debt issuance costs of $1.9 million. The refinancing of these notes with a new 5-year 3.375% issuance significantly reduces our cost of capital and increases our annual net investment income run rate by approximately $0.10 per share on a risk-free basis. This was the primary catalyst for our decision to increase the regular dividend by $0.03 this quarter from $0.44 per share to $0.47 per share. We believe this considerable increase in earnings power enhances our market capitalization on a dividend yield basis and allows us to pass the cost of capital savings directly to our shareholders in the form of increased dividends. This transaction also pushes out our nearest debt maturity to 2026, providing significant balance sheet flexibility going forward. On Slide 20, we lay out our multiple pockets of capital. As we have mentioned on our prior calls, a strategic priority for our company is to continually evaluate approaches to derisk our liability structure while ensuring that we have adequate investable capital throughout the economic cycle. Our debt capitalization today includes a $335 million on-balance sheet revolving line of credit with 10 syndicate banks maturing in August 2026; a $140 million institutional bond maturing in January 2026; the newly issued $100 million institutional bond maturing in October 2026; a $150 million revolving line of credit at I-45 maturing in March 2026; and an initial $40 million leverage commitment from the SBA, which is $22.5 million left to be drawn upon. Although the majority of our outstanding debt is currently due in 2026, we will look to opportunistically amend and extend our credit facilities well before maturity consistent with past practice. Finally, as we’ve discussed on prior calls, we have now begun operations within our SBIC subsidiary, which you will see going forward denoted as SBIC-1. As a reminder, our initial equity commitment to the fund is $40 million, and we have received an additional commitment from the SBA for $40 million of fund leverage, which is also referred to as one tier of leverage. We expect to fully invest this initial $80 million of capital over the next 6 months, at which point we will apply for a second tier of leverage. Over the life of the fund, we plan to draw the full $175 million in SBIC debentures alongside $87.5 million in capital from Capital Southwest. We’re excited to be part of this program and believe it is a natural fit with our investment strategy. Overall, we are pleased to report that our balance sheet liquidity continues to be strong with approximately $166 million in cash and undrawn leverage commitments as of the end of the quarter. As of September 30, 2021, approximately 50% of our capital structure liabilities were unsecured and our earliest debt maturity is in January 2026. Our regulatory leverage, as seen on Slide 21, ended the quarter at a debt-to-equity ratio of 1.18:1. I will now hand the call back to Bowen for some final comments.

Thanks, Michael, and thank you, everyone, for joining us today. Capital Southwest continues to perform well and consistent with our original vision and strategy we communicated to our shareholders when we began this journey. Our team has done an excellent job building a robust asset base, deal origination capability, as well as a flexible capital structure that prepares us for all environments throughout the economic cycle. We believe that our performance continues to demonstrate the investment acumen of our team at Capital Southwest and the merits of our first lien senior secured debt strategy. We feel very good about the health of our company and portfolio, and we are excited to continue to execute our investment strategy going forward. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders’ capital by continuing to deliver strong performance and creating long-term sustainable value for all our stakeholders. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

Our first question comes from Devin Ryan with JMP Securities.

This is Kevin on for Devin. First question. Just looking at non-accruals, can you provide the name of the new company that was added to nonaccrual? And then separately, can you share any developments in the 2 existing nonaccrual investments?

Yes. So I’d rather not say the name of the non-accrual on a public call like this because it will wind up in a transcript, but there will be an announcement later tonight. It’s a company that’s been affected by the supply chain challenges that we’ve all heard about, and we certainly hope this is temporary. The company’s sales cycle as a result of that in its market has extended. So restructuring this quarter. We think about one-third of it or so will come back on accrual, and we’ll own equity in the business going forward as it recovers.

What about the other 2? If you can...

Yes. One of them is a large syndicated deal. It’s currently still working on its restructuring. So really, no update on that.

It’s definite?

Yes. And then the other one continues to actually improve within the pharmaceutical services space. It’s kind of the same report as last quarter; the pipeline continues to build, and we’re starting to convert the increased pipeline quite encouragingly. We think that one’s going to be fine.

Yes, we have accumulated some PEC with that company. As the recovery takes place and our enterprise value surpasses the debt value, that will be reflected in the accrual as well.

Okay. That information is helpful. And then just touching on quarter-to-date investment activity. Can you give us a sense of how originations are tracking so far and then also repayment activity as well?

Yes. Originations this quarter are strong and are expected to remain strong until the end of the quarter. With the current market activity, prepayments will also be significant this quarter. We anticipate net portfolio growth for the quarter, which is typical with a robust portfolio like ours, as we will see refinancings from several deals. Our deal team has done an excellent job expanding our opportunities in the market, and we believe we will achieve net portfolio growth this quarter.

And our next question comes from the line of Mickey Schleien with Ladenburg.

Bowen, there is a significant demand for yield, which is attracting more capital to private debt and appears to be increasing both payment and prepayment risk across the sector. This can lead to immediate fees, which is positive. Could you elaborate on what your organization is doing to maintain its market share as we move forward?

Yes. I mean defending your market share really is a function of covering the market being good partners with your deal sources, sponsors mainly, and really the track record you develop over a lot of years. We have every market across the country covered with a primary and secondary coverage person. It’s pretty interesting; to me anyway, the number of sponsors that we’ve been doing business with or we have deals from that I had yet to hear of before. Usually, that’s junior partners at PE funds that spin off into their own PE funds, start their own funds, and we’ve been able to really broaden the number of deal sources that we get deals from. And we’ve really seen that, which has been super encouraging. Going through a pandemic and having stress in the portfolio while being a first lien lender gives you the freedom to make good business decisions that balance your shareholders’ capital interest with the interest of that company and sponsor to make reasonable fair decisions on how you deal with stress. We had stress in the portfolio during the pandemic; fortunately, everything recovered nicely. We extracted extra economics here and there where it was fair, and the sponsors supported the companies where necessary. Going through something like that really gives us street credibility that we might not have necessarily had 3 years ago. So that’s a big deal. More and more sponsors that are new to us are asking us for references from other sponsors that we’ve been doing business with and actually calling those sponsors. How you act, how you make decisions, and how you operate in the market is becoming increasingly important among the sponsors and other deal sources. Those are all ways you defend your market share at the end of the day.

Yes. Over the past few years, we have lowered our cost of capital from 5.5% to around 3.5%. Our operating leverage has also decreased from 5% to 2.3%, which enhances our competitiveness. This does not mean we are pursuing deals with lower yields for riskier businesses, but we can now consider deals at L plus 600 or 650, which we would not have looked at 2 or 3 years ago. This improvement assists us when defending our position. There are certain deals that are refinanced; historically, we didn't stay in a deal just based on yield if it was an L 850 deal that dropped to L 650. Today, we can evaluate specialty credits we know well and maintain our involvement in the deal based on our net interest margin.

Of course, the reason that happens, as most people on the call know, is that as these companies grow, leverage comes down, clearly spreads or their cost of capital is going to come down. The question really is how long can we stay in that credit from a net interest margin perspective. As we drop our cost of capital and increase our operating leverage, it allows us to extend the tail on growing businesses and lend to companies at lower loan to value, tighter spreads, that kind of thing.

Also, the ATM issuance we’re doing at 1.6x or 1.7x is obviously a lot less dilutive than raising equity at 1x or 1.2x where we would have done so 2 years ago.

I concur. Bowen, you mentioned earlier that while Zoom meetings are beneficial, nothing beats the importance of sitting face to face to establish a new relationship. Are you engaging in more of that now, or is travel still a challenge for the origination team?

The industry has definitely adapted to working over Zoom. However, we are traveling again, and in-person management meetings are much better than Zoom calls. From a deal professional's perspective, traveling to see manufacturing plants and operations adds an interesting dynamic to the job. This change in the rhythm of work is very important, especially for someone who has been a deal professional. Fortunately, we are traveling again, and I’m very pleased about that.

One other high-level question, Bowen. Apart from repayments this year, which is a trend across the sector, BDCs have certainly had a lot of wind at their back in terms of very strong economic growth and a very low default environment. But I’m starting to think next year will be more challenging with potential Fed tightening, probably lower economic growth, and volatility around the election. How are you thinking about those risks in terms of new originations that you’re seeking and your own balance sheet leverage?

Yes. First of all, for new deals, we’re maintaining our usual approach by assessing potential risks in the system, such as recessions, pandemics, and unforeseen events. We incorporate these factors into our stress tests before finalizing deals. We genuinely believe this method helps us prepare our asset base to handle various situations. With rising interest rates, the majority of our capital is in floating rate loans. We are focused on securing the rate on our liabilities, which is why we successfully issued our recent 3.375% bond on an unsecured basis. These are our strategies as we look ahead; we’ve consistently been cautious about the possibility of a recession in the next year or two. If we avoid a recession, that would be excellent, but we must always keep that scenario in mind. Regarding the election year, it may introduce volatility, but ultimately, it’s about the underlying economic fluctuations. The election could trigger some volatility, but other factors might also contribute to it.

Right. By pushing out our maturities as far as we did. That’s essentially taking a lot of that risk off the table, allowing us to draw additional debt off the SBA, which will have some interest rate volatility, but not nearly what you’d expect in the broader market.

I got you. Just one small housekeeping question for Michael. Did you reverse any previous income accruals for the new NPL?

No, we didn’t accrue anything this quarter for that asset.

And you didn’t reverse anything for previous accruals?

No, no. We just reversed out whatever was reserved for this quarter.

And our next question comes from the line of Bryce Rowe with Hovde.

I wanted to ask about the level of commitments here over the last couple of quarters relative to funded debt investments. You’ve seen an uptick in unfunded commitments within the new investment activity. Bowen and Michael, can you speak to whether you expect that structure to continue? Any feel for the pace of those unfunded commitments converting to some level of funding here in the near future?

Yes, sure. We’re clearly managing our unfunded commitments as a first lien lender. Revolvers are often funded, and not all the revolvers are that interesting to banks. We can offer the revolver, get ticking fees, and the rate on the revolver is the same as the rate on the term loan. It ends up being nice security for us, but we have to manage our balance sheet liquidity. In the pandemic, for example, I think we had 35% of our revolver capital drawn, which is lower than I might have thought. We have to have liquidity on our balance sheet to fund that. Our unfunded commitments this quarter are about half revolver, half delayed draw term loans. Delayed draw term loans are usually a function of a specific acquisition strategy based on buying similar businesses, maybe funding an earn-out on a purchase. Most of the delayed draw term loans that we have in our financials, we would expect to fund.

On a normal quarterly basis, we see about maybe 10% of the revolvers get drawn, but we also see 10% of them repaid. So on a quarterly basis, we have net funding of 0 on the revolvers. During COVID, the 35% that was funded was funded really soon after the COVID hit. And then those were all repaid as well. From a planning perspective, the DDTLs are all scheduled out. We’re monitoring that, and it will impact how much equity we raised on an ATM or for our planning purposes for raising additional debt.

Okay. That’s helpful. So, regarding the pace of investment activity, it seems that this quarter you continued to experience strong engagement in both origination and repayment. Do you think that net growth was modest compared to previous quarters?

Yes. So September's originations and repayments were both above what we would have anticipated, but the net growth was modest, but fine. In the coming quarter, we’re expecting to see net portfolio growth, informed by anticipated significant repayments as well as originations. Some of the market activity is theorized to be pulled forward into the December quarter. It may make it a little harder to anticipate how many deals will be left in the March quarter, but we do expect this quarter to be busy.

Yes. I mean that’s more of a theory. Many in the market have that idea that with potential tax regime changes, founders may seek to monetize a portion of their earnings. After living through the pandemic, it would be a good year to do it. We’ll see. But theoretically, I believe that a lot of the market activity could be influenced in the dynamics we mentioned.

On the P&L, to your question, we would expect to see inflated prepayment penalties in the December quarter. Significant exits have already occurred, and more are anticipated in November and December. You’ll get some level of interest off those assets, but also prepayment penalties.

Got it. And maybe one last one from me. You’ve cleaned up your liability structure; do you expect the same pace of ATM activity to continue?

It’s a lot of variables. Certainly, one of the metrics we look at is leverage. We talked about our target leverage range, but that’s a function of originations and prepayments. It’s mainly about net portfolio growth and portfolio leverage. It’s not just tied to stock price. Our business model is an organic growth story with respect to developing an excellent track record and consistently executing what we know how to do.

This quarter, before a specific context, we know there’s a lot of repayments and are expecting a lot of originations. If some of the originations don’t occur, we will pull back on ATM usage. We are aware of the dilution the ATM brings to future quarters. We’re not going to raise equity for the sake of raising equity.

The other metric we monitor is balance sheet liquidity, i.e., availability on the credit facility. That’s also another crucial metric we watch and manage.

And our next question comes from the line of Robert Dodd with Raymond James.

Congratulations on the quarter. Just a couple of market questions more than anything else. You have a high level of activity in this quarter, with $112 million, but only about 1% of that was equity co-invest. Is there anything to read into that? Is it the market is great for equity valuations within your equity portfolio, but is that making it less appealing for co-invest right now?

Yes, it’s a good question. I wouldn’t read too much into the percentage of equity co-investments this quarter or past quarters. Most of the time, if we have the relationship with the sponsor and like the equity story, we’ll have an opportunity to invest in some amount. It’s more about the types of deals and the sponsor’s preferences influenced by capital circumstances.

Understood. Since the credit strategy, the IRR on recoup capital is about 15%. Is this sustainable or did that benefit from a couple of large wins while you were a smaller business?

I think that comes down a little based on the fact that our yields have decreased. Our yield was closer to 5.5% and now it’s around 3.5%. There’s a possibility the IRR might reduce from 15% down to maybe 13.5 or 14%.

That’s a completely fair question. I think the IRR on that lumpy gain you referred to is something like 12%. It’s a fair question to ask regarding asset performance and IRR, but it remains a pretty wide track record.

We also have $18 million in unrealized depreciation in the portfolio, which could give us a glide path of exits over the next 24 months.

Congrats on the quarter. Can you give an update on pricing or spreads? Given any potential shifts in the interest rate environment?

So from an asset and liability perspective, we are seeing competition in the market, but spreads have remained relatively flat. We’re able to compete in tighter pricing, but the market is competitive.

Market dynamics are influenced by numerous lenders being quite busy right now. If lenders are tied up with numerous deals as we approach the end of the year, they may not be aggressive on pricing new deals.

We're locking in competitive debt for assets, and we expect to maintain a competitive edge in future issues given our economic conditions.

Potentially, if there’s dislocation in the market and we’ve established strong capital reserves, we might see our asset yields expand based on the net interest margins we’ve established.

We would look opportunistically to raise additional debt as we see the market volumes presenting themselves at favorable rates.

If you can maybe describe some key factors on some of the deal quality you’re seeing real-time. Are covenants getting looser and is this impacting how you’re underwriting?

In the lower middle market, we haven’t seen much deterioration on covenant cushions. It’s a market with smart sponsors that have strong financing relationships.

This concludes our question-and-answer session, and I would like to turn the conference back over to Bowen Diehl for any further remarks.

Thank you, everybody. Thanks for joining us and for all the questions. We like answering the questions. Thank you for allowing us to update you on our business, and I look forward to giving everyone further updates as we go forward.

This concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.