Capital Southwest Corporation Aktie

Thank you for joining today's Capital Southwest Fourth Quarter Fiscal Year 2026 Earnings Call. Participating on today's call are Michael Sarner, Chief Executive Officer; Chris Rehberger, Chief Financial Officer; Josh Weinstein, Chief Investment Officer; and Amy Baker, Executive Vice President, Accounting.

I will now turn the call over to Amy Baker.

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 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 over to our President and Chief Executive Officer, Michael Sarner.

Thanks, Amy, and thank you, everyone, for joining us for our fourth quarter fiscal year 2026 earnings call. We're pleased to be with you today to discuss our fourth fiscal quarter and the 2026 fiscal year.

Overall, 2026 was an outstanding year for Capital Southwest by any measure. During the year, we grew our investment portfolio by approximately $300 million or 17% from $1.8 billion to $2.1 billion. Deal activity was robust with $762 million in new committed investment originations. Additionally, we grew investment income by $28 million or 14% from $204 million to $232 million. And despite a backdrop of pronounced volatility, we preserved the value of our portfolio.

NAV per share closed the year at $16.69, essentially unchanged from $16.70 in the prior year, underscoring the resilience of our platform and the durability of our underwriting. As a result of our consistent investment strategy and strong operating performance, we've delivered an industry-leading 40% return on equity for our shareholders during fiscal year 2026. Despite relentless market disruptions this year from Liberation Day to the private credit contagion to the conflicts in Iran, we continued to execute with consistency. The market has recognized that stability and our stock performance reflects the value of our approach.

The quality of our debt portfolio remains strong, reflected in a weighted average leverage of 3.6x, weighted average interest coverage of 3.5x and nonaccruals of 1.1% at fair value, down from 1.7% in the prior year. During the quarter, we saw improved performance across our watch list with seven companies demonstrating meaningful progress and two removed from the watch list following a return to plan. We attribute much of this improvement to our portfolio operations group, which works closely with our deal teams on credits that require additional support. This team is driving tangible value at the portfolio level, which in turn contributes to stronger overall performance and enhanced long-term shareholder value.

Additionally, our equity portfolio continues to perform well with net unrealized appreciation of $37.8 million or $0.62 per share as of the end of fiscal year 2026. We anticipate that a portion of this appreciation will be harvested as realized gains in fiscal year 2027 and thus will be available in our UTI bucket to support future dividend distributions. With $1.07 per share of undistributed taxable income, we are entering the year from a position of strength.

Over the last 12 months, we have harvested $36.9 million in realized gains from equity exits, driving UTI growth from $0.79 per share in March 2025 to today's level. Our UTI balance highlights both the reliability of our realization engine and our conservative approach to dividend distributions when base rates were elevated, resulting in a meaningful balance of taxable income, which we intend to distribute to our shareholders over time.

Looking ahead, we are confident in our ability to continue generating realized gains that will support and expand our UTI balance. That confidence is grounded in the strength of our investment strategy in the lower middle market. At origination, we typically see three distinct avenues for equity value creation. First, new investments often present low-hanging fruit opportunities, operational or strategic adjustments, the sponsor can implement immediately to drive meaningful EBITDA uplift.

Second, following the change of control, the sponsor and management team activate a set of targeted growth initiatives designed to accelerate both revenue expansion and margin improvement. Third, in many cases, the team has already identified actionable M&A opportunities that can further scale the platform, broaden the capabilities and diversify the business. As EBITDA grows and the business becomes more resilient and diversified, we expect these initiatives to enhance enterprise value and ultimately result in realized gains on our equity investments.

We were also extremely active during the year in diversifying our sources of capital. We raised over $465 million in new debt capital commitments in the form of a $350 million, 5.9% bond issuance, $90 million in approved leverage commitments for our second SBIC fund and an additional $25 million in new secured debt commitments on our corporate credit facility. Additionally, we raised over $160 million in gross equity proceeds on our ATM program during the year at a weighted average price of 1.3x the prevailing NAV per share. Having continual access to the public equity market through the ATM program is a tremendous tool, which we can use in all market environments.

We have also made meaningful progress on CapTrin Partners, our joint venture with Trinity Capital. The JV now holds approximately $85 million in assets, and we expect to continue originating low leverage, high-quality investments within this structure. Subsequent to quarter end, we closed a $150 million revolving credit facility, further expanding the JV's capacity and competitiveness. This facility provides the liquidity to meaningfully increase the scale of our joint venture over time and advance rates that should produce a 13% to 14% return once fully ramped. From a relationship standpoint, we could not be more impressed with Kyle and the entire Trinity team, and we look forward to exploring additional avenues where we can create value for both organizations.

Finally, this year, we continued our long track record of producing steady dividend distributions, consistent dividend coverage and solid value creation. Despite a year in which SOFR shrunk by approximately 60 basis points, we increased our total dividends paid from $2.54 per share in fiscal year 2025 to $2.56 per share in fiscal year 2026. Dividend sustainability, strong credit performance and continued access to capital from multiple capital sources are all core to our overall business strategy. Our track record in all these areas demonstrates consistent performance as well as the absolute alignment of all our decisions with the interest of our fellow shareholders.

Although broader middle market M&A headlines have highlighted a slowdown tied to technology uncertainty, AI-related risks and inflation concerns stemming from the conflict in Iran, our vantage point in the lower middle market tells a very different story. Activity in this segment has historically been and continues to be remarkably steady. Founder-driven catalysts such as retirement, succession planning, estate considerations and the desire to derisk after years of value creation do not fluctuate with macro sentiment or quarterly volatility. As a result, the lower middle market consistently offers a more resilient and predictable transaction environment, a characteristic that remains significantly underappreciated.

From a Capital Southwest perspective, we have seen a meaningful increase in new deals reviewed, advanced and ultimately closed. However, our close rate, which has historically averaged roughly 2%, has moderated to 1.5%. This decline reflects our continued discipline in pricing and structuring transactions based on the risk we underwrite, not simply the terms required to win a deal. We attribute the increase in deal flow to the continued development of our deal leads, the addition of two managing directors and the joint venture, which has enhanced our competitiveness on higher-quality opportunities. Despite this increase in deal flow, we have also seen tightening in leverage levels and loan-to-value ratios, underscoring the importance of maintaining our disciplined approach as the market continues to reprice risk.

In summary, we are extremely proud of our performance throughout fiscal year 2026, and we remain confident in the long-term prospects for our company and the opportunities ahead.

I'll now hand the call over to Josh to review some more specifics of our investment activity.

Thanks, Michael. This quarter, we deployed a total of $158 million of new committed capital, consisting of $112 million in first lien senior secured debt and $2 million of equity across five new portfolio companies. We also completed add-on financings for 12 existing portfolio companies, totaling $43 million in first lien senior secured debt and $650,000 in equity. Add-on financings continue to be an important source of originations for us. As over the last 12 months, add-ons as a percent of total new commitments have been 31%. These opportunities allow us to deploy capital into businesses we know well with proven management teams and sponsors. The weighted average spread on our new commitments this quarter was approximately 6.6%, which we view as extremely attractive given today's competitive spread environment.

Our on-balance sheet credit portfolio ended the quarter at $1.9 billion, representing 19% year-over-year growth from $1.6 billion as of March 2025. Importantly, 100% of our new portfolio company debt originations were first lien senior secured. And as of quarter end, 99% of the credit portfolio remained first lien senior secured with a weighted average exposure per company of only 0.9%. This level of portfolio granularity reflects our disciplined approach to risk management as we continue to scale the balance sheet.

The vast majority of our deal activity continues to be in first lien senior secured loans to private equity-backed companies. Approximately 93% of our credit portfolio is sponsor-backed, which provides strong governance, operational support and when needed, the potential for junior capital. In the lower middle market, we frequently have the opportunity to invest on a minority basis in the equity of our portfolio companies, pari passu with the private equity firm when we believe the equity thesis is compelling.

As of quarter end, our equity co-investment portfolio consisted of 87 investments with a total fair value of $181 million, representing 9% of our total portfolio at fair value. This portfolio was marked at 126% of our cost, representing $37.8 million of embedded unrealized appreciation or $0.62 per share. These equity positions continue to give our shareholders meaningful upside participation in growing lower middle market businesses, driven by both operational improvements and strategic add-on acquisitions.

The lower middle market remains competitive as this segment of the market continues to attract both bank and nonbank lenders. Although this environment has produced tighter loan pricing for higher-quality opportunities, the depth and durability of our sponsor relationships our team has built, combined with the enhanced deal flow generated by our expanded and more seasoned investment staff continue to position us to source and win transactions with compelling risk return profiles. Today, our portfolio includes investments from 88 unique private equity firms. And over the past 12 months, we closed 13 new platform investments with sponsors with which we had not previously partnered. Since launching our credit strategy, we have completed transactions with over 130 private equity firms nationwide, including more than 20% with whom we have completed multiple deals.

Our portfolio now consists of 131 portfolio companies, allocated 90.1% to first lien senior secured debt, 1.2% to second lien senior secured debt and 8.6% to equity co-investments. The credit portfolio generated a weighted average yield of 10.8% with weighted average leverage through our security of 3.6x EBITDA. We remain pleased with the overall performance of the portfolio. At origination, all loans are initially assigned an investment rating of 2 on a 5-point scale, with 1 being the highest rating and 5 being the lowest rating. As of quarter end, 88% of the portfolio at fair value was rated in the top 2 categories.

Cash flow coverage remains strong at 3.5x, reflecting an improvement from the 2.9x low observed during the peak of base rates. This strength is further supported by the fact that our loans represent, on average, only 43% of portfolio company enterprise value. Our portfolio remains broadly diversified across industries and our average exposure per company of less than 1% continues to provide meaningful protection against idiosyncratic risk.

For new platform deals closed during the March quarter, weighted average senior leverage was 2.7x debt-to-EBITDA and weighted average loan-to-value was 33%, providing a substantial equity cushion beneath our debt. Over the past 12 months, new platform originations have averaged 3.1x senior leverage and 35% loan-to-value, underscoring our consistent commitment to conservative underwriting.

I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Josh. Specific to our performance for the quarter, pretax net investment income was $35.2 million or $0.59 per share. For the quarter, total investment income decreased to $57.8 million from $61.4 million in the prior quarter. The decrease was primarily driven by a $2.2 million decrease in interest and dividend income and a decrease of $0.8 million in PIK income. The decrease in interest income was predominantly driven by a 35 basis point decrease in SOFR compared to the prior quarter. As of the end of the quarter, our loans on nonaccrual represented 1.1% of our investment portfolio at fair value, a decrease from 1.5% as of the end of the prior quarter.

During the quarter, we paid a $0.58 per share regular dividend paid monthly and a $0.06 per share supplemental quarterly dividend. For the June 2026 quarter, our Board has again declared a total of $0.58 per share in regular quarterly dividends payable monthly in each of April, May and June 2026 and maintains the $0.06 supplemental quarterly dividend also payable in June, bringing total dividends declared to $0.64 per share. We continue to demonstrate strong dividend coverage with 109% cumulative coverage since launching our credit strategy. With a UTI balance of $1.07 per share and a sizable unrealized appreciation balance in our equity portfolio, we remain confident in our ability to continue distributing quarterly supplemental dividends over time.

LTM operating leverage ended the quarter at 1.4%, a meaningful improvement from 1.7% in the prior quarter. Notably, this reduction occurred despite the addition of six new employees. Going forward, we expect to continue to add resources to our team while maintaining operating leverage in the 1.4% to 1.5% range. Our operating leverage remains significantly better than the BDC industry median of approximately 2.7%, underscoring the inherent efficiency of the internally managed BDC model. This structure has consistently delivered meaningful fixed cost leverage to shareholders while still enabling us to invest in talent and infrastructure as we continue to scale a best-in-class BDC platform.

NAV per share decreased to $16.69 per share, down from $16.75 per share in the prior quarter. The primary drivers of the NAV per share decline for the quarter were net realized and unrealized depreciation on our investment portfolio, offset by accretion from our equity ATM program. We raised approximately $25 million in gross equity proceeds during the quarter through our equity ATM program at a weighted average share price of $23.13 per share or 138% of the prevailing NAV per share, reinforcing our ability to raise capital efficiently and accretively.

Our liquidity position remains robust with approximately $394 million in cash and undrawn leverage commitments across our two credit facilities, plus $42 million available on SBA debentures. In total, this represents more than 1.3x coverage of the $329 million in unfunded commitments across the portfolio. Regulatory leverage ended the quarter at 0.9:1 debt to equity. While our target leverage remains in the 0.85 to 0.95x range, we continue to factor in the current macroeconomic backdrop and intend to maintain a prudent leverage cushion to help mitigate capital markets volatility.

We will continue to raise secured and unsecured debt capital as well as equity through our ATM program in a methodical and opportunistic manner to ensure we maintain significant liquidity and a conservatively constructed balance sheet with adequate covenant cushions.

I will now hand the call back to Michael for some final comments.

Thank you, Chris, Josh and Amy and all the employees who help us tell the story on a quarterly basis. And thank you, everyone, for joining us today. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

[Operator Instructions] Our first question comes from the line of Erik Zwick from Lucid Capital Markets.

If I could start, I'm just curious with regard to the unrealized depreciation in the credit portfolio in the quarter. Was that primarily related to changes in kind of market multiples or anything kind of more credit specific. Wondering if you could just expand on that a little bit.

Yes. I think we had one portfolio company that was added to our watch list that had a write-down, which we have confidence in the company, but it had a fairly large write-down. And then the rest, I do think multiples were down quite a bit this quarter, which is sort of an overhang. When we went through our portfolio review, we pretty much identified about 95% of the portfolio was doing exceptionally well, and yet some of those didn't have write-ups because of those multiples. But by and large, it was just one company and then the overall market multiple.

I appreciate that. And just looking at the trajectory of the dividend income that you received in the most recent year, it was up markedly from the prior year from $4.5 million to $12.7 million. So curious how much of that increase is sustainable or how much of that might have been kind of onetime dividends? Just any outlook -- any thoughts on outlook you might have there would be helpful.

Sure. We've had a few companies that have done exceptionally well and have been making large distributions. I think that in the first half of this -- our fiscal year, we'll continue to see strong distributions from these companies. One or both could be in the market for sale at some point. And so maybe that doesn't bleed into fiscal year '28. But for the next few quarters, we should expect to continue to see those dividends.

And last one for me. As I look at the space of publicly traded BDCs, Capital Southwest has one of the lowest concentrations of software in the portfolio, which I guess puts you in a more favorable eye relative to many peers given the current market sentiment. Just curious why over time, have you decided not to have that much exposure to software. And in the instances where you have made some investments, what attracted you to those particular companies?

I think a lot of the software companies, honestly, are generally larger and more venture. So those two together generally wouldn't fit our lens. Same could be said, a lot of these companies also have ARR, which are -- we generally are lending cash flow lenders, and we believe that lending off a multiple of EBITDA is a more conservative and prudent way to underwrite. So I think that's generally been the reason why it's not that we haven't seen the opportunities, we've just never gotten truly comfortable with them. I don't know, Josh, you have?

Yes. To Michael's point, we've seen them over the years, we reviewed them. It's just not something any of us previously had a lot of experience with. And so we just couldn't really get comfortable or as comfortable with doing a lot of ARR deals and stuck to our knitting of cash flow lending for the most part.

I appreciate that. And just looking back across your historical results, you've certainly done very well with that. So it's not like you've needed it. Thanks. I appreciate the insight there.

[Operator Instructions] Our next question comes from the line of Robert Dodd from Raymond James.

On the operating efficiency, to your point, the 1.4 to 1.5 and the advantage of being internally managed. In this quarter, obviously, some expenses seemed pretty low, another advantage, right? That gets adjusted by the Board as you go. But can you give us any color about what was the driver there? Was it not hitting targets on deployment? Was it the fact that NAV was down, which may be temporary? But can you give us any idea like what got factored into why that was low in the fourth quarter? Just trying to get a feel for what didn't meet your expectations exactly.

Sure. And you know what, I wouldn't frame it that way at all. I think the Board and management felt that this was one of our strongest years for a variety of reasons. But we had accrued -- essentially, we had some large fees that came in over the year. We had some over accruals into the bonus pool. And then at the end of the year, the Board gets together to basically determine what they think that the final number would look like. And so we -- from where we had accrued for 3 quarters to where the payout was in the fourth quarter, we had some that was backed out. But we paid over 100% in all cases for our employees. And again, would frame this year as a very successful one.

Yes. Robert, I'll just jump in sort of going forward because it was kind of low in the last quarter, total compensation expense is sort of in the $5.5 million per quarter range. That will vacillate a little bit based on the discussion we just had, but that's sort of what you can expect going forward.

Got it. Then on the other one, I mean, to your point, I mean, you've got a lot of unrealized appreciation in the equity portfolio. Obviously, I don't have the March portfolio, the K is not out yet. But if I look at the fourth quarter, I mean, the net number is -- there's a lot of net unrealized appreciation, but as well. I mean, if you look just at the successes, you've got $100 million in appreciation on assets and then that's offset by some that are down.

Just listening to your comment, it sounds like you're very confident some of that is going to monetize this year. Now it might result in lower dividend income. But what -- are those processes -- are there significant processes already underway to sell assets not by the sponsor, obviously, to sell assets this year that gives you that level of confidence? I mean there's some like ITA Group. I mean that's -- there's a lot of appreciation in that asset, for example, right? So could you give us any incremental -- and I know it's a touchy kind of topic, but any incremental info on where the level of confidence comes from? And is it going to be some of your biggest appreciated assets that are likely to crystallize this year?

Yes. I think that there's two primary sales. I won't get into the details, but I mean one has actually been announced publicly that there's an IPO process, which would result in us -- we have shares in a company, we sold into a company that went public. We have the ability to sell those shares, and we have actually floors on what the equity value would look like. So that is something that we'd expect to see happen in the next 3 months, 4 months. And then we have another company that's in the market. Now it's still in the nascent stages. It is a fairly large position, but we feel pretty confident based on where we are that there should be a sale there.

If you look at the cost basis relative to the fair value, obviously, there's going to be large gains associated that will go into our UTI bucket. It will also allow us to reduce our cost of capital because obviously, this is appreciation that's realized, now becomes the ability to pay down our credit facility and/or raise less shares. So all of that gives us confidence both in these exits and the ability to grow UTI and the ability to continue to support our dividend going forward.

Understood. If I got one more quick one. On the JV, I think you said expected or the target kind of return on capital to you from that vehicle is 13% to 14% when fully ramped, obviously. I mean, is that like -- is the full ramp 18 months? Or yes, I mean, I'm just -- kind of what's the kind of time frame to get to that kind of -- in that vehicle with the partner you have?

Sure. So I think the notion would be it's going to take at least -- I'm looking at Chris, 18 to 24 months before we see the full ramp. I think we're targeting 2x leverage plus. And so I think it's going to take a little bit of time. I would say that we have the capital in-house, the $150 million credit facility in order to achieve that leverage and achieve that returns. But I do think we're looking at originating $30 million to $40 million a quarter in the fund. And so I think it's going to take at least 1.5 years to 2.

Yes. So Robert, we're going to be sort of efficient with the leverage there and try to be mindful of asset diversity and borrowing base. We'll probably try to ramp the leverage fairly -- in the fairly short term here. So as we look ahead, I agree with Michael's comments, it's going to take kind of 18 months to full ramp. But in the next 6 months, this should start producing double-digit returns for Capital Southwest. So call it, 6 months, we're kind of in the 11% range and then we go from there.

And Robert, I'd also like to add that the JV in itself -- so certainly, there's going to be an uplift of $0.01 or $0.02 from this fund by itself. But having this joint venture has been really important to the business in the way of us being able to be more competitive on deals that are priced somewhere in the SOFR plus 5% to 5.75%, which historically we weren't bidding or winning on. And so today, we are -- we have the ability to both bid and win on these deals, maintain tight structures and as well as earning the same type of spreads, the 6% to 7% spread that we're used to through the last-out positions on these credits.

[Operator Instructions] Our next question comes from the line of Sean-Paul Adams from B. Riley Securities.

It looks like you guys have kind of ramped up in terms of the employee count and perhaps the deal team. Any color on how just these changes in the amount of employees and perhaps the amount of deals passing your desk are going to look forward for next fiscal year's origination activity?

Sure. Sure. Look, when we look back around, what, 15, 18 months ago, we had 27 employees. Today, we have -- as of the quarter end, we had 36, and we actually have another 7 coming on. So we're going to actually be up to 43 employees. We built out our operations team over the last 18 months. We've added a new MD, a new Vice President, a new principal, certainly added more support staff on the back office. And the notion here is that with the new MD we have, with the sort of maturation of the deal leads in place and the ability to continue to win new share and new sponsor relationships, we're just seeing enhanced deal flow.

Two years ago, I think we saw 800 deals that we looked at. In 1 year, the run rate now is around 1,400 deals a year. So we are adding staff to support the growth that we're seeing and to strengthen the organization to continue to make great decisions based on having the right people in the right place, having time and experience to review these opportunities.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Michael Sarner for any further remarks.

Thank you, operator, and thank you, everyone, for joining us today. Please feel free to call us anytime with questions or get an update on the business. We look forward to catching up with you next quarter. Goodbye.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

Thank you for joining today's Capital Southwest Third Quarter Fiscal Year 2026 Earnings Call. Participating on the call today are Michael Sarner, Chief Executive Officer; Chris Rehberger, Chief Financial Officer; Josh Weinstein, Chief Investment Officer; and Amy Baker, Executive Vice President, Accounting.

I will now turn the call over to Amy Baker.

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 [ these ] Capital Southwest's 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 over to our President and Chief Executive Officer, Michael Sarner.

Thanks, Amy, and thank you all for joining us for our Third Quarter Fiscal Year 2026 Earnings Call. We are pleased to be with you today and look forward to walking you through our results for the quarter.

During the third fiscal quarter, we generated pretax net investment income of $0.60 per share, supported by strong recurring earnings across the portfolio. Our undistributed taxable income balance remained robust at $1.02 per share, reflecting consistent realization activity. In fact, over the last 12 months, we have harvested $44.5 million in realized gains from equity exits driving UTI growth from $0.68 per share in December of 2024 to today's level.

Subsequent to quarter end, we realized an additional realized gain of $6.8 million from another equity exit which should further support our UTI balance going forward. Our Board of Directors has declared a total of $0.58 in regular dividends for the March quarter, payable monthly in each of January, February and March 2026, and is also declared a quarterly dividend, supplemental dividend of $0.06 per share payable in March, bringing total dividends to clear for the March quarter to $0.64 per share.

Turning to originations. Deal flow in the lower middle market remained healthy this quarter. We closed $244 million in total new commitments across 8 new portfolio companies and 16 existing portfolio companies. Add-on financings continue to be an important source of origination for us as over the last 12 months, add-ons as a percentage of total new commitments have been 29%. These opportunities allow us to deploy capital into businesses we know well with proven management teams and sponsors. The weighted average spread on our new commitments this quarter was approximately 6.4%, which we view as very attractive given today's competitive spread environment.

On the capitalization front, last quarter, we strengthened our balance sheet by issuing $350 million in aggregate principal of 5.95% notes due 2030. This quarter, we used a portion of the proceeds to fully redeem our $105 million notes due 2026 and $71.9 million notes due 2028, extending our maturity profile at an attractive cost of capital. We also raised approximately $53 million in gross equity proceeds through our equity ATM program at a weighted average share price of $21.11 per share or 127% of the prevailing NAV per share, reinforcing our ability to raise capital efficiently and accretively.

Subsequent to quarter end, we announced a first-out senior loan joint venture with a private credit asset manager, which I would like to spend some time discussing. We believe this new JV will enhance our competitiveness in our core lower middle market by enabling us to participate in larger, higher quality deals with tighter spreads while maintaining disciplined hole sizes. The structure also allows us to earn outsized economics due to our role as originator and administrator of the JV and higher relative yields on last out loans, which is extremely important in an environment where [ Sopris ] declining and loan spreads on new deals remain very tight.

The first out loans within the JV are expected to be conservatively levered at approximately 1.5x debt to EBITDA or less. And once fully ramped, we expect the JV to generate a low to mid-teens equity return for Capital Southwest. Finally, our partners in the JV is a highly regarded, well-capitalized asset manager with whom we are extremely excited to build a long-term relationship. We believe this relationship may open up other unique opportunities for co-investment in the future as we continue to expand our platform. Overall, we are pleased with our performance this quarter and enthusiastic about the prospects for this new venture. We look forward to giving further updates on the funds in the coming quarters.

I will now hand the call over to Josh to review more specifics on our investment activity and the market environment.

Thanks, Michael. This quarter, we deployed a total of $199 million of new committed capital consisting of $197 million in first lien senior secured debt in $2 million of equity across 8 new portfolio companies. We also completed add-on financings for 16 existing portfolio companies totaling $44 million in first lien senior secured debt and $405,000 in equity.

Our on-balance sheet credit portfolio ended the quarter at $1.8 billion, representing 19% year-over-year growth from $1.5 billion as of December 2024. Importantly, 100% of new portfolio company debt originations were first-lien senior secured and as of quarter end, 99% of the credit portfolio remained first lien senior secured with a weighted average exposure per company of only 0.9%. This level of portfolio granularity reflects our disciplined approach to risk management as we continue to scale the balance sheet. The vast majority of our deal activity continues to be in first lien senior secured loans to private equity-backed companies.

Approximately 93% of our credit portfolio is sponsor backed, which provides strong governance, operational support and when needed, the potential for junior capital. In the lower middle market, we frequently have the opportunity to invest on a monthly -- on a minority basis in the equity of our portfolio companies [ Paris ] with the private equity firm, where we believe the equity pieces [indiscernible]. As of quarter end, our equity co-investment portfolio consisted of 86 investments with a total fair value of $183 million, representing 9% of our total portfolio at fair value. This portfolio was marked at 133% of our costs, representing $45.2 million of embedded unrealized appreciation or $0.76 per share. These equity positions continue to give our shareholders a meaningful upside participation in growing lower middle market businesses driven by both operational improvements and strategic add-on acquisitions. This is evident from the recent realized gains, which Michael mentioned earlier.

The lower middle market remains highly competitive as this segment of the market continues to attract both bank and nonbank lenders. While this has resulted in tight loan pricing for high-quality opportunities, the depth and strength of our sponsor relationships, the team has cultivated over the years has continued to result in our sourcing and winning opportunities with attractive risk return profiles.

Today, our portfolio includes investments from 90 unique private equity firms. And over the past 12 months, we closed 14 new platform investments with sponsors we had not previously partnered with. Since launching our credit strategy, we have completed transactions with over 129 private equity firms nationwide, including more than 20% with whom we have completed in multiple deals. Our portfolio now consists of 132 portfolio companies, allocated 90% to first lien senior secured debt, 0.8% to second lien senior secured debt and 9.1% to equity co-investment. The credit portfolio generated a weighted average yield of 11.3% with weighted average leverage through our security of 3.6x EBITDA.

We remain pleased with the overall performance of the portfolio. At originations, all loan are initially assigned an investment rating of 2 on a 5-point scale, with one being the highest rating and 5 being the lowest rating. As of quarter end, 90% of the portfolio at fair value was rated in the top 2 categories. Cash flow coverage remained strong at 3.4x reflecting an improvement from the 2.9x low observed during the peak of base rate. This strength is further supported by the fact that our loans represent, on average, only 44% of portfolio company enterprise value. Our portfolio remains broadly diversified across industries and our average exposure per company of less than 1% continues to provide meaningful protection against idiosyncratic risk.

For new platform deals closed during the December quarter, weighted average senior leverage was 3x debt-to-EBITDA and weighted average loan-to-value was 36%, providing a substantial equity pushing to ease our debt. Over the past 12 months, new platform originations have averaged 3.3x year leverage and 37% loan-to-value, underscoring our consistent commitment to conservative underwriting.

I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Josh. Turning to our financial performance for the quarter. Pretax net investment income was $34.6 million or $0.60 per share. Total investment income increased to $61.4 million, up from $56.9 million in the prior quarter. The increase was driven primarily by a $1.8 million increase in PIK income, a $1.1 million increase in fees and other income and a $1 million increase in dividend income. The increase in PIK was driven by an amendment to one of our portfolio companies in which the sponsor provided significant new cash equity support and a debt paydown in exchange for a PIK option.

As of quarter end, non-accruals represented just 1.5% of our investment portfolio at fair value. During the quarter, we paid a $0.58 per share regular dividend and a $0.06 per share supplemental item. For the March 2026 quarter, our Board has again declared a total of $0.58 per share in regular dividends payable monthly in each of January, February and March 2026, and maintained the $0.06 supplemental dividend also payable in March, bringing total dividends declared to $0.64 per share.

We continue to demonstrate strong dividend coverage with 110% cumulative coverage since launching our credit strategy. With UTI of $1.02 per share and a sizable unrealized depreciation balance in our equity portfolio, we remain confident in our ability to continue distributing quarterly supplemental dividends over time. LTM operating leverage ended the quarter at 1.7%, significantly better than BDC industry average of approximately 2.6%. As our asset base continues to grow, our near-term target for operating leverage is 1.5% or below, reflecting the inherent efficiency of the internally managed BDC model. The internally managed model has and will continue to provide meaningful full fixed cost leverage to shareholders, while still allowing us to invest in talent and infrastructure as we continue to scale a best-in-class BDC platform.

NAV per share increased to $16.75 per share, up from $16.62 per share in the prior quarter, driven primarily by our equity ATM program. As Michael noted, last quarter, we issued $350 million of 5.95% unsecured notes due 2030. During the December quarter, we used a portion of the proceeds to fully redeem our $71.9 million August 2028 notes and $150 million October 2026, with no make-whole payments required. We view this refinancing as a highly favorable outcome for shareholders strengthen our balance sheet and positioning us well across a range of market environments.

Our liquidity position remains robust, with approximately $438 million in cash and undrawn leverage commitments across our 2 credit facilities plus $20 million available on SBA debentures. In total, this represents more than 1.5x coverage of the $285 million in unfunded commitments across the portfolio.

Regulatory leverage ended the quarter at 0.89:1 debt to equity, down slightly from 0.91:1 in the prior quarter. While our target leverage remains 0.8 to 0.95 we continue to factor in the macroeconomic backdrop and intend to maintain a prudent leverage pushing to help mitigate capital markets volatility. We will continue to raise secured and unsecured debt capital as well as equity through our ATM program in a methodical and opportunistic manner to ensure we maintain significant liquidity and a conservatively constructed balance sheet with adequate covenant cushion.

I will now hand the call back to Michael for some final comments.

Thank you, Chris, Josh and Amy, and thank you to all of our employees who work tirelessly behind the scenes to help us deliver for our shareholders and communicate our progress each quarter. Your dedication is a critical part of what makes this platform so strong, and it remains a deep source of pride for me. And to everyone joining us today, we appreciate your continued interest, engagement and support. We remain focused on executing our strategy, maintaining disciplined growth and creating long-term value for our shareholders.

That concludes our prepared remarks. Operator, we're ready to open the line for Q&A.

[Operator Instructions] Our first question comes from Doug Harter with UBS.

I was hoping you could just expand a little more talk about the lower middle market. Just how do you view that from a competitive dynamic today what are you seeing in terms of players? Or is anyone kind of moving back into that market, moving out of the market? Just how are you seeing that? And what's the outlook for spreads as a result?

Yes. I don't think it's really changed much over the last probably 6 months. I think over the last 12 to 18 months, we have seen regional banks. I think I've noted this before that have dropped down. Historically, they only [ lended ] to maybe 1.5 turns of leverage in maybe in a senior [ menstructure ]. And we're recently we're seeing regional banks actually underwrite a full unitranche loan may come and go. Certainly, anytime you're seeing headlines of private credit issues, they sort of back off.

But by and large, I think that it's kind of the same players. I mean what we probably have seen in the last I would say, 1 to 2 months that there's -- particularly on the BDC space, there's [ 2742 ] BDCs that have cut their dividends. And I think we're only seeing 5 BDCs trade above book right now. So there's a little less competition from our peers as the sort of like their wounds right now. But other than that, I think that we're in a very strong competitive position. And obviously, we announced this joint venture which we think is going to strengthen our ability to continue to win deals that are in our core competency, the lower middle market.

Great. And I guess just then on the spread outlook, how that kind of those comments would lead to kind of how you think spreads progress over the coming quarters?

Yes. So when we look at it, the spread on debt is actually from 331, 2025, it was 7.35%, today it's 7.24%. So we've held in pretty well from a spread perspective. I think we'd say that we've seen the spread compression has seemed to stop the last 12 months and even the last 3 months, we've seen our spreads on our newly originated deals in the mid-6s, and those are 3x leverage and 36% loan-to-value. So very conservatively structured deals with decent spreads. So I think for us, will continue to be somewhere between 7% and 7.5%, we would expect for the next 12 months.

Our next question comes from Mickey Schleien with Clear Street.

Yes. Michael, could you give us a sense of the breakdown of the portfolio between sponsored and nonsponsored at this time?

I think it's 93% sponsored and 7% nonsponsor. And that's probably on the high side. It's typically been somewhere between 85% and 95% sponsored deals.

And how are those sponsors behaving in terms of their appetite for deals in the current market environment. I mean we go quarter-to-quarter and sometimes it's risk on, sometimes it's risk off or there's so much going on. Can you give us a sense of just the backdrop?

Josh, do you want to take this one?

I think there's still a lot of capital in the private equity lower market private equity funds. So they're still looking for deals. I think that if you ask most private equity sponsors in a low over the market, they would say last year was a pretty weak year from a deployment perspective, and they're hoping 2026, there will be more opportunities for them. But -- but yes, I think that they're looking for deals. They have capital to spend, but they're not -- but last year, they didn't find as many deals available to them.

The other thing I would add is that the lower middle market where we play the $3 million to [ $50 ] million EBITDA. We're not -- the volume you see as typical with what you hear on the headlines of M&A going up and down. New York Founders is an aging population where companies are turning over. There's been a steady drumbeat. I wouldn't say that there's been -- there's clearly not the same peaks and troughs that you see in the upper and middle market. So I think the sponsors that Josh was referring to, they're still seeing plenty of deal flow.

And Michael, with that in mind, I mean, we're certainly reading a lot about pressure from LPs on these sponsors to provide them some liquidity. But I'm getting the sense that the sponsors you work with, which are focused on the lower middle market, is that less of an issue for them?

I think it's -- I mean, I think it can be an issue. It depends on where they are in the life cycle of fund. I mean I think that they're looking for opportunities to exit as well to provide that liquidity to LPs, but probably a little bit less pressure than you'd see in the middle market or upper middle market. But we obviously talk to a lot of sponsors in the country and have deep relationships with them. But speaking specifically about their liquidity situations and all that stuff is a little bit tough for us.

Right. I get it.

And the other thing I would note for you, this is -- when we go through our investment committee process on new deals, we definitely focus on where this investment stands in a fund's life. So if a fund or a sponsor, this is one of the last deals and we know there's only $5 million to $10 million of dry powder that's allocated with the rest of the portfolio. That's certainly going to be a negative and something that we're going to discuss to see whether we still feel good about the credit. So we typically want these deals to be in the beginning or the middle stages of a fund line.

Understood. Michael, given what we've just talked about in terms of sponsors, any sense of how active you expect to be this calendar year? And and maybe even next year in terms of deal flow and repayment risk in the portfolio. And essentially, what's your sort of business plan for net portfolio growth?

No, I feel very bullish for several reasons. One, we've grown our sponsor relationships, I think we started the numbers earlier over time. We've recently added another MD, originating MD, [ Brian Mullins ], who brings his own unique set of sponsors who's going to be covering the country. We recently promoted [ Brand Easton ], one of our principles to MD and he is firing on all cylinders and he's -- so he's another source of origination.

And then the joint venture looking back to it. So the joint venture allows us to compete on the send deals we're looking at today, but we've historically held the line at around 5.75% because that's a moving target. But most recently, 5.75% spread kind of meets our ROE target. And making below that, we didn't view as accretive to the portfolio and helpful to our dividend. By doing this joint venture, we're able to compete and win on deals at 5% or above while still actually incorporating additional arranger fee, profit allocation and enhanced spread that increases the yield on deal by 100 basis points.

So we're going to be able to see the same amount of deals from one perspective, but be winning more of them. And these are typically -- the reason this venture was really important to us is we were focused over the last 12 months say, look, we've seen a lot of really high-quality deals that we would love to put in our portfolio that we thought were "sleep credit", but we weren't getting our DLC and the ability to go below 5.75%. This is giving them another arrow in quiver to actually go out and compete. And again, these are deals that we can consider cleaner and more high quality. And it also allows us to maintain granularity. So we think that's been a huge part of our success is maintaining granularity through the last 10 years and not really getting great staying below that 1% on average.

Michael, did you say in your prepared remarks that the JV would be primarily a last-out fund. Did I hear you correctly?

No. So well, I'd say it's primarily, but there's going to be different types of assets that go into the fund. But the -- probably the best example of what this fund is, is if you look at a $10 million EBITDA company, that's 3.5x with to say, 35% loan to value at a 550 spreads. That's a $35 million total debt check. So in our -- in the example I give you the first out that we go into the joint venture, so probably correct myself. The only thing that's pretty much filling into the joint venture would be first out positioned.

So they would hold $10 million at 3.75% spread, one turn of leverage and 10% loan to value. On our balance sheet, we would hold $25 million of that debt of the debt stack and that we get a 6.25% spread, and it still levered at the same 3.5x and 35% loan to value. So that kind of gets you of what it look like on balance sheet and in the JV.

Understood. And what kind of leverage do you expect the JV's balance sheet to have?

So I'll start the asset level is going to be between one and 1.5 turns of leverage or individually on the asset side. The fund itself will be probably something around 2.5 turns, plus or minus.

Okay. And that gets you to your ROE target. I understand. And lastly, and I appreciate your patience. The portfolio has about 21% at fair value in consumer products and services, restaurants and movies. Those are sort of cyclical segments. Can you discuss your underwriting approach to those segments? And how are those portfolio companies doing given everything we're reading about a K-shaped economy?

So I think Josh, do you want to take this one. I would tell you that when we look at our weighted average leverage for consumer services that fall into the buckets you're referring to, their leverage is slightly elevated at 4.2x. When we look at where other portfolios begin at 5.5 to 6x another middle market, we would say it's still pretty conservatively levered because our entry multiple on many of these companies are going to be somewhere between 1.5 to 3x leverage. We're certainly cognizant of consumer discretionary. So I would say there's a decent amount of that consumer probably the majority of that consumer, we think, are well positioned for consumer pullback or economic pullback.

And on top of that, we do structure our deals, recognizing where we are with the potential consumer pullback.

Our next question comes from Erik Zwick with Lucid Capital Markets.

This is [ Justin Marko ] on for Erik today. Just going back to the spread conversation. I was wondering if you guys could talk about the current state of underwriting conditions and if you're seeing any other signs of pressure on structure terms?

From a performance standpoint, I would tell you that we're not seeing pressure on any particular industry. Any issues in the portfolio continue to be idosyncratic. I think you're asking about the structure of new deals we're doing. I think -- is that your question?

Yes, yes.

Yes. So I think we said this and it stayed consistent that we've definitely seen -- we had seen spread compression over the last 12,18 months considerably. But structurally, in the lower middle market, we have not seen sort of weak credit agreements or asks coming through from our private equity sponsors. It's pretty status quo from a structural perspective over the last [indiscernible] of years. I think where the lower middle market has moved in the last kind of 18 months or so has been on the pricing and the spread, not on the structure. So still seeing good covenants and solid credit documents.

Yes. I mean almost I'd say 100% of our portfolio, we're close to it. I have a fixed charge covenant, we have a leverage covenant, we have a CapEx covenant. And then to the extent that there's a [ DDTL ], you'll see an incurrence covenant as well.

Okay. And last one for me. Any other additional deals on the new JV, whether you have like a targeted size in mind or when you're expecting to be fully ramped up?

Sure. So we've actually -- we've been negotiating that for a bit of time. We've already started ramping. We closed 3 deals that will be contributed closer to deal than the [ 120-month ] than contributed in the coming weeks. And we're close to closing the credit facility. I think how many $150 million -- $150 million credit facility.

I think the answer to the question is each party is contributing its committed $50 million of equity to date. We think it's going to take probably at least a year to get probably up to the full leverage. So it's going to probably it will eventually be a mid-teens return. I think it will be double-digits return by the end of the year.

Our next question comes from [ Dylan Hines ] with B. Riley Securities.

I was just wondering, I know you talked about the spreads in the quarter for the originations. I was wondering do you have -- do you know what the weighted average yield was for your originations in the quarter?

[indiscernible] over to you.

Well, I think I said earlier, so the spread on the new deals this quarter was 6.5% and leverage was 3x and load value is 36%. So are you just -- I mean, with the SOFR, so the weighted average yield is approximately [ 1,050 ].

Yes. And then I was wondering about the ATM issuances. Do you expect to continue doing that as long as the premium is favorable? Do you have a target rate that you generally want to issue at or.

Yes, sure. So if you look past history, we do somewhere between $30 million and $50 million every quarter. That past relates depending on deal flow and repayments and liquidity needs. But certainly, with the premium we're trading at, somewhere in that range is -- would be a good expectation for the coming quarter.

Our next question comes from Robert Dodd with Raymond James.

Hope you can hear me with backgrounds noise. On the JV, but is there any impact -- I mean, you've said you don't need to expand kind of your net currently in terms of being able to stock that up. But is there any intent to expand maybe the stories of the businesses or the type of leverage multiple, anything like that? Maybe once it gets closer to scale? Or is it just it's exactly the same assets, just the lower spread ones going in that JV?

So I say that point, it's pretty much exactly the same as I think these deals that are really targeted for this are going to be deals that are between $5 million and $10 million of EBITDA. So like I said many times, we're very clean deals and at a price between $5 and [ $5.75 ]. I would say it's the extent that we're seeing deals that are slightly larger, so let's call the $35 million to $40 million check, which we don't prefer to hold as our parent granularity this does give us the ability on those deals to put $10 million to $50 million in the JV, while still maintaining $20 million to $30 million hold.

So I think on the margin, it allows us to feel more [indiscernible] field slightly larger, but for the most part, it's just the cleanest deals in our core space.

Got it. One more if I can. It's been topical at the last time a couple of this. How are you evaluating AI disruption risk, both within the assets you already have in the portfolio. But then when you look at new originations and opportunities, how much, if any, is AI risk being factored into your underwriting case?

Honestly, that is something that we started taking up about probably a year ago, we formed an AI committee and then actually created a segment in our investment committee process, which rates the various aspects of a company in terms of the AI risk. Because look, when we look at companies, sometimes AI is going to be helpful. We see sometimes financial services companies they're going to be using AI to basically become more efficient. In other deals, we're seeing AI as a potential. We just saw a deal maybe 2 weeks ago that we couldn't get comfortable with because the advent of AI may not impact the business in the next 2 years, but it would impact the business in 5, and therefore, the concern of how it's going to get sold and at what valuation would that cover the day.

So I think we're looking at -- we're certainly -- it's definitely a heavy segment of our investment committee discussion. And then internally, we're looking to see how we can utilize AI as well to become more efficient as an organization. And that's something that has begun in our list.

That concludes today's question-and-answer session. I'd like to turn the call back to Michael Sarner for closing remarks.

Yes. I want to take one to just pause and reflect our company, our balance sheet, just passed $2 billion in assets. I know growing the balance sheet is not the goal here is creating value. It is a testament to everybody who has worked here and all the value that's created will allow us to continue to grow. My optimism today and I think our optimism as a group has never been higher.

I mean we've mentioned the 2 new MDs that are helping enhance the business. The joint venture, which we spend a lot of time discussing, We talked about it, we've over the last 12 months, we've exited to date, $50 million in equity. And I'd remind everybody that's on $5 million -- a 5% equity portfolio at cost. So we're punching way above our way, which tells you our underwriting, both on our debt and our ability to create equity gains has been strong. That's created $1.02 per share of UTI. We have $0.76 of unrealized depreciation, and we would tell you, a majority of that or in companies that are in the market, some in the first half of 2026 and other in the back half.

Our operating leverage of the company is 1.4% on a run rate basis, excluding the onetime charge from last year, conservative leverage at active corporate level of 0.89, conservative leverage at our portfolio level of 3.6x, significant liquidity. And all of that has brought us to a place where in a 40% plus premium to book on our stock, which reflects, I think, all the strong work we've done in the company.

So as we did this call, I just -- I'm thankful to all of the shareholders in support of the company. I'm extremely proud of all of the employees who have done this great work and as we look forward, we see this optimism and hope you understand it as well. Thanks to everyone, and have a great week.

This concludes today's conference call. Thank you for participating. You may now disconnect.

Thank you for joining today's Capital Southwest Second Quarter Fiscal Year 2026 Earnings Call. Participating on the call today are Michael Sarner, Chief Executive Officer; Chris Rehberger, Chief Financial Officer; Josh Weinstein, Chief Investment Officer; and Amy Baker, Executive Vice President, Accounting. I will now turn the call over to Amy Baker.

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 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 over to our President and Chief Executive Officer, Michael Sarner.

Thanks, Amy. And thank you, everyone, for joining us for our second quarter fiscal year 2026 earnings call. We are pleased to be with you today to discuss our second fiscal quarter as well as share our observations on the current market environment. During the second fiscal quarter, we generated pretax net investment income of $0.61 per share. Additionally, we were able to increase our undistributed taxable income balance to $1.13 per share from $1 per share as of the end of the prior quarter. Over the last 12 months, we've harvested $44.8 million in realized gains from equity exits, which is the main driver of our growth in UTI per share from $0.64 in September 2024 to $1.13 today.

Furthermore, our Board of Directors has declared a total of $0.58 in regular dividends for the quarter, payable monthly in each of October, November and December 2025, and it's also declared a quarterly supplemental dividend of $0.06 per share bringing total dividends to cleared for the December quarter to $0.64 per share. On the capitalization front, we successfully raised $350 million in aggregate principal of 5.95% notes due 2030. Subsequent to quarter end, the proceeds from these notes were partially used to redeem in full our outstanding $150 million notes due October 2026 and our $71.9 million notes due August 2028. Importantly, the redemption of these notes did not require a make-whole premium to be paid in either case. We believe this new capital enhances the strength of our balance sheet and alleviates any concerns surrounding near-term bond maturities with our earliest unsecured maturity now in fiscal year 2030.

Finally, we raised approximately $40 million in gross equity proceeds during the quarter through our equity ATM program at a weighted average share price of $22.81 per share, or 137% of the prevailing NAV per share.

Deal flow in the lower middle market continued to be robust this quarter with $245 million in total new commitments to 7 new portfolio companies and 10 existing portfolio companies. Add-on financings continue to be an important source of originations for us as approximately 32% of the total capital commitments during the quarter were follow-on financings in performing portfolio companies. Over the last 12 months, add-ons as a percentage of total new commitments have been 39%. So this is clearly a strong source of origination volume in deals. We know well and have experience with the management team and sponsor. Additionally, the weighted average spread on our new commitments this quarter was approximately 6.5%, which we view as strong in a tight spread sale environment.

I will now hand the call over to Josh to review more specifics of our investment activity and the market environment.

Thanks, Michael. This quarter, we deployed a total of $166 million of new committed capital including $162 million in the first lien senior secured debt and $3 million of equity across 7 new portfolio companies. In addition, we closed add-on financings for 10 existing portfolio companies, consisting of $79 million in first lien senior secured debt and $1 million in equity. Our on-balance sheet credit portfolio ended the quarter at $1.7 billion, representing a year-over-year growth of 24% from $1.4 billion as of September 2024. For the current quarter, 100% of the new portfolio company debt originations were first lien senior secured and as of the end of the quarter, 99% of the credit portfolio was first lien senior secured with a weighted average exposure per company of only 0.9%. We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet.

The vast majority of our portfolio [indiscernible] activity is in first lien senior secured loans to companies backed by private equity firms. Currently, approximately 93% of our credit portfolio is backed by private equity firms which provide important guidance and leadership to the portfolio companies as well as the potential for junior capital support is. In the lower middle market, we often have the opportunity to invest on a minority basis in the equity of our portfolio of companies, [indiscernible] the private equity firm when we believe the equity piece is compelling. As of the end of the quarter, our equity co-investment portfolio consisted of 83 investments with a total fair value of $172 million, representing 9% of our total portfolio at fair value.

Our equity portfolio was marked at 126% of our cost, representing $35.8 million in embedded unrealized appreciation or $0.63 per share. Our equity portfolio continues to provide our shareholders' participation in the attractive upside potential of these growing lower middle market businesses often resulting from the institutionalization of the businesses by experienced private equity firms as well as the significant value accretion potential from strategic add-on acquisitions. Equity co-investments across our portfolio provide our shareholders with the potential for asset value appreciation as well as equity distributions to Capital Southwest over time.

Consistent with previous quarters, the lower middle market continues to be quite competitive as this segment of the market is highly attractive to both bank and nonbank lenders. While this has resulted in tight growing pricing for high-quality opportunities that are not exposed to the macroeconomic uncertainty, the depth and strength of the relationships our team have cultivated over the years has continued to result in our existing and winning opportunities with attractive risk-return profiles.

As a point of reference, currently, there are 85 unique private equity firms represented across our investment portfolio. Additionally, in the last 12 months, we closed 17 new platforms with financial sponsors with which we had not previously closed the deal, demonstrating our continued penetration in the market. Since the launch of our credit strategy, we have completed transactions with over 120 different private equity firms across the country, including over 20% with which we have completed multiple transactions.

Our portfolio currently consists of 126 portfolio companies, with 89.9% to first lien senior secured debt, 0.9% to second lien senior secured debt and 9.1% to equity investments. The credit portfolio had a weighted average yield of 11.5% and weighted average leverage through our security of 3.5x EBITDA. We continue to be pleased with the operating performance across our loan portfolio. All our loans upon origination are initially assigned an investment rating of 2 on a 5-point scale, with 1 being the highest rating and 5 being the lowest rating.

Overall, the portfolio remains healthy with approximately 91% of the portfolio at fair value rated in one of the top 2 categories, 1 or 2. Cash flow coverage of debt service obligations has reached 3.6x, the strongest level in the past 3 years, reflecting an improvement from the 2.9x low observed during the peak of base rates. This enhanced coverage underscores the strength of our portfolio with our loan average of approximately 43% of portfolio company enterprise value.

Our portfolio continued to be broadly diversified across industries, and our average exposure for a company is less than 1% of investment assets which gives us great comfort in the overall risk profile of our portfolio. For the new platform deals we closed in the September quarter, the weighted average senior leverage level was 3.6x debt to EBITDA and the weighted average loan-to-value level was 36%, resulting in significant equity capital attrition below our net. Over the past 12 months, new platform originations have average senior leverage of 3.5x debt to EBITDA and 38% loan [indiscernible] which highlights our consistent track record of conservative underwriting on new originations.

As Michael mentioned earlier, we believe our balance sheet is well positioned with low leverage and significant liquidity, which allows us to continue to be active and opportunistic in all economic environments.

I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Josh. Specific to our performance for the quarter, pretax net investment income was $34 million or $0.61 per share. For the quarter, total investment income increased to $56.9 million from $55.9 million in the prior quarter. The increase was driven primarily by a $1.3 million increase in fees and other income, which was offset by a decrease of approximately $500,000 in picking [indiscernible] compared to the prior quarter. Importantly, [ PIC ] as a percentage of our total investment income decreased to 4.9% as compared to 5.8% in the prior quarter. Additionally, as of the end of the quarter, our loans on nonaccrual represented 1% of our investment portfolio at fair value.

During the quarter, we paid out a 58% -- $0.58 per share regular dividend and a $0.06 per share supplemental dividend. For the December 2025 quarter, our Board has declared a total of $0.58 per share in regular dividends payable monthly in each of October, November and December 2025, while also maintaining the supplemental dividend at $0.06 per share, bringing total dividends to $0.64 per share for the December 2025 quarter. We continued our consistent track record of regular dividend coverage with 104% coverage for the 12 months ended September 30, 2025, and 110% cumulative coverage since the launch of our credit strategy. We are confident in our ability to continue to distribute quarterly supplemental dividends based upon our current UTI balance of $1.13 per share and the expectation that we will continue to harvest gains over time from our sizable unrealized depreciation balance on the equity portfolio.

LTM operating leverage ended the quarter at 1.6%, a slight decrease from the prior quarter. Our operating leverage is significantly better than the BDC industry average of approximately 2.7%, and we believe this metric speaks to the benefits of the internally managed BDC model and our absolute alignment with shareholders. The internally managed model has and will continue to produce real fixed cost leverage while also allowing for significant resources to be invested in people and infrastructure as we continue to grow and manage a best-in-class BDC.

The company's NAV per share at the end of the quarter was $16.62 per share, an increase from $16.59 per share in the prior quarter. The primary driver of the NAV per share increase was the accretion from the ATM equity program during the quarter.

As Michael mentioned, during the quarter, we successfully raised $350 million in new 5.95% unsecured notes due September 2030. Subsequent to quarter end, -- the proceeds from these notes were partially used to redeem in full our $71.9 million August 2028 notes and $150 million October 2026 notes with no make-whole payment required on either redemption. The cost of the $350 million notes at 5.95% fixed, was approximately breakeven with the cost of the debt we subsequently paid off, inclusive of the secured credit facilities. We view this capital raise as a highly favorable outcome for both the company and its shareholders as it strengthens our balance sheet and positions us to thrive across a wide range of capital markets environment.

We are pleased to report that our balance sheet liquidity is robust with approximately $719 million in cash and undrawn leverage commitments on our 2 credit facilities, which represents over 2x the $334 million of unfunded commitments we had across our portfolio as of the end of the quarter. Our regulatory leverage ended the quarter at a debt-to-equity ratio of 0.91:1, up from 0.82:1 as of the prior quarter. However, given that the $350 million bond issuance occurred during the September quarter and the bond redemptions occurred subsequent to quarter end, we ended the quarter with significant cash on the balance sheet.

Net leverage, which assumes paying down outstanding debt liabilities with cash on hand as of 9/30 would result in pro forma regulatory leverage of 0.82x. While our optimal target leverage continues to be in the 0.8 to 0.95 range, we continue to weigh the impacts of the current macroeconomic landscape and intend to maintain a regulatory leverage cushion, which will mitigate capital markets volatility. We will continue to methodically and opportunistically raise secured and unsecured debt capital as well as equity capital through our ATM program to ensure we maintain significant liquidity and conservative balance sheet construction with adequate covenant cushions.

I will now hand the call back to Michael for some final comments.

Thank you, Chris, Josh and Amy and all the employees who help us tell the story each and every quarter and thank you, everyone, for joining us today. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

[Operator Instructions] Our first question comes from the line of Brian McKenna of Citizens.

So it's clearly a strong quarter of origination activity. It does feel like industry-wide M&A has picked up pretty meaningfully, even since the last earnings call. So what does the pipeline look like heading into year-end? And then is there a way to think about the size of the pipeline today relative to the last quarter or 2 or even a year ago?

Yes. Look, we definitely have seen, at least in these 4 walls, a significant uptick just in the size of the pipeline, top of the funnel. We did $248 million this past quarter and that 7 platform companies and 10 add-ons. I think the add-ons has been a steady drip. That's been pretty consistent. I think we'll continue to see 8 to 12 transactions a quarter. From the new resonation side, I think this coming quarter, the 12/31 is probably going to look based on what we're seeing today, similar volumes to what we saw in the 9/30 quarter. And then looking ahead, it just feels like the -- our principals, MDs, we've made significant headway with sponsor activity, and we continue to see a lot of their quality deals.

And so we don't really see any reason for the growth to slow down. So where we used to originate $100 million to $125 million a quarter, I think we're doing something closer to $150 million to $200 million on a normal quarter.

Okay. That's helpful. And then just for my follow-up, Michael, you've been CEO for a few quarters now. Can you just remind us of your top priorities for the firm heading into calendar 2026. You've also made some early changes like moving to a monthly regular dividend. But is there anything else you can do that ultimately benefit shareholders?

Yes. We've mentioned on previous calls that we're looking to monetize our investment platform to enhance our competitive position in the market as well as potentially bringing fees and additional economics for what we do. So certainly, that we spent quite a bit of time on the road, we think that -- I think I said in the previous call that we have potential opportunities in front of us that could be closing in the near-er time. So that's something that we're looking at. We since we -- in the last 8 months, we've grown a portfolio operations group internally. That's something that I thought was an important part of the process to scalability. And we continue to look to add originators to the platform. So I think it's just building for growth because couple -- taking these 2 questions together, we've seen really remarkable growth on deal volume, which doesn't always portend to deals that are closed, but getting that funnel larger leads to better quality deals, so we're definitely -- there's a focus internally.

Our operating leverage is quite low in the market, but we are looking to continually add to our staff so that we can be ready for the growth that comes.

Our next question comes from the line of Doug Harter of UBS.

I'm hoping you could just talk a little bit more about credit quality and kind of what you're seeing in the underlying portfolio companies? Any change in kind of their growth or profitability? And just kind of how you're thinking about the credit outlook over the coming quarters.

Yes. I'll give my remarks, and I think Josh, you should well. But we just looked at it over the last 12 months, the growth in EBITDA and revenue of our existing portfolio company has been about 10% growth annually, which is still very healthy. If you look back maybe 18 months, 24 months ago, it might have been something closer to 15%. So it slowed a bit. But when we are looking at our individual portfolio companies, there they're performing extremely well. We're not really seeing any one particular industry that has issues.

The one thing that's gotten more difficult, I think in the boardroom is just the changing environment in terms of what's coming out of the White House and how it impacts potential industries on a go-forward basis, right? Nothing has stayed the same. I feel like we've got our nose buried in the news more today than we ever have to make certain that we understand the impact on our portfolio, but also what's investable going forward.

Josh, do you have anything?

Yes. I mean, look, we have over 100 portfolio companies in the lower middle market. So obviously, not all of them are going to perform really well or as expected, but we have created a very diversified by industry and granular by company portfolio. So I feel pretty comfortable with where we sit today.

And the other thing I'd add is that when we look at the deals we're doing, is competitive as the environment has been, which has led to spread compression, the loan to value and the leverage of these deals is stay very conservative and consistent. I mean let me look at it, I think, over the last 9 months, we've seen, I think it was 36% loan to value and 3.4x leverage. So companies aren't stretching. They're just basically the portfolio -- the borrowers are getting lower spreads for sort of the same amount of debt.

So that's -- for us, that also in a market where there was certainly a feeding frenzy over the last 12 months, the fact that debt discipline maintained is a strong project strong going forward.

Our next question comes from the line of Mickey Schleien of Clear Street.

In your internal ratings, you're showing about 9% of the debt portfolio performing below expectations. It looks like those are names like [ Bradner ], Apple Roofing, Monster [indiscernible], U.S. TelePacific and Everest. How do you describe the trends overall affecting those companies and their outlook?

Well, let me -- I want to say one thing. When we look at our watch list and you compare us to the upper middle market. One thing to note is the leverage levels that we get in that are much lower than others, so they're 2.5x or 3x, and they have covenant cushions of 30%, so when we have a default in our portfolio, these credits are defaulting somewhere between 4x and 6x. So I say that to sort of frame that these companies aren't in dire situations when they show up on our watch list. They are obviously having issues, but they have private equity sponsors that are supporting the deals.

In terms of the individual -- kind of consistent with what I was just talking about, it's obviously a diversified portfolio, and we we obviously keep track on the industry breakout of the underperforming assets, but we don't see any real consistency or correlation. There are a lot of syncratic issues that have happened at some of these lower middle market companies, which candidly is unexpected into which ones we're going to see them, but we know in a big -- a large broad portfolio that we're going to see them. So we monitor them by industry, but we don't see sort of correlations in our underperforming assets.

Yes, that's what I was getting at, actually. And on the flip side, you have about 20% of the portfolio performing above expectations, which is great. But that could imply meaningful prepayment risk. What is your gauge of that risk? And how much could that impact the portfolio's yield obviously, excluding the fees that you could collect on those prepayments?

So I think this goes back to our discipline on granularity. When we were $500 million fund of assets, we were originating $12 million to $13 million per asset. Today, we're $2 billion, and we're still originating around $15, $16 per hold. So really, we're -- I don't -- I think that cuts from both prepayment risk as well as nonaccrual risk. The portfolio is granular enough that no one credit is going to have a material impact. In fact, 6/3 in the quarter we had -- I can't remember what company it was, but we got repaid. I think it was the tune of, what, $50 million came back and we still posted $0.61 this quarter. So we don't live in fear of that. Our top 5 is not significantly larger than the rest of the portfolio, and that supply design. That's helpful.

Yes, Mickey, if you look back in history, the other thing I would add is we've sort of had over the past 2 to 3 years, consistently 15% to 20% of the portfolio in that investment rating one bucket for outperformance and that has not correlated directly to sort of 20% of prepayment per year. Our prepayment will more 10% to 12% per year as a percentage of the portfolio. So it's an indication of performance but it doesn't necessarily indicate that all of those are going to prepay in the near term.

No, I understand. It's just that you also mentioned the tight spread environment, which I clearly agree with, and we're seeing that across not only our -- the lower middle market, but as well in the middle market and the upper middle market. So I was trying to gauge if that was a consideration.

Well kind of given the breakdown, by the way. So over the last 6 months, our spread has actually stayed pretty constant and give you an indication for this quarter, we had new -- 7 new portfolio companies the range of yield or spread was $5.50 at the lowest and $7.25 at the highest -- the add-on activity was at 6.7%, so blended 6.5%. So I don't think it's meaningfully off of part of our pace. The other point I would notice that, so one of our probably our top performing portfolio company, our largest hold is due to its equity appreciation. So if that exit the debt hold is small, the equity is nonyielding for the most part, right? So you'll redeploy that capital into gene -- so that could actually be an uptick and as well as an increase to our UTI bucket.

I understand. And in terms of the change of the portfolio's weighted average yield during the quarter, which fell about 30 basis points in a quarter where SOFR was stable. Was that due to the spread environment that you're talking about? Or was it due to maybe going up market a little bit toward higher-quality names with lower spreads? Or could you give us some insight into that?

Sure. Sure. I actually would go back in time. If you look at the 3/31 quarter, our spread was -- our total yield was [ 1168 ] it went up to [ 1183 ] in the 6/30 quarter, primarily because we had one large exit that I just mentioned that had 16 basis points of accelerated OID. So it was actually a bit used. So this quarter, it came back to the same [ 1158 ], but then we did see 8 basis points reduction due to nonaccruals and just 5 basis points based on compression.

Okay. And lastly for me, could you give us some guidance on stock-based compensation and salary expense for the fourth calendar quarter, the quarter we're in right now, given that there's some seasonality, that would be helpful for us.

So there won't be seasonality on the RSU expense. So that should be consistent with the current quarter. For the cash compensation, that is really going to be dependent on our performance during the quarter. I would say that it's somewhere between flat with 9/30 and maybe slightly elevated based on some of tapping initiatives that Michael laid out. So that's -- it's really dependent on where we -- how we performed for the quarter and how much bonus are we end up taking.

Our next question comes from the line of Erik Zwick of Lucid Capital Markets.

Wanted to follow up with the kind of a question on the credit outlook you provided. And just curious, you mentioned that the top of the funnel for originations has continues to expand. And there are maybe a couple of pockets of the economy that are showing some weakness now. So as you evaluate these new opportunities, are there any industries or segments that you're maybe kind of looking at a little bit more kind of discerning eye or staying away from that maybe you weren't 12 months ago?

Well, I'd start off by saying the area that -- and it's a very diverse is health care that there's just -- with the big beautiful build that came out before, not quite understanding where Medicare and Medicare mitigate reimbursement might come. that is something that historically we like quite a bit. And now it's not that it's I'm a no file, but it requires a deep dive to understand how that's going to play out. I'm not sure there's any other like industries that we're just staying away from completely.

I mean government-funded companies, sponsored companies. Those are tough for us right now. But we're -- Look, I mean, we're generalists. That being said, when we look at dynamic industries like health care or government, we like to partner with private equity groups that have a lot of expertise so we can piggyback off that expertise. And so when we do deals in more dynamic industries, typically, we're doing them with guys that we're investing in that space for years, given our generalist tilt that -- and then we also structure around those types of risks. We may -- like you talked about being more discerning we'll do that with -- in regards to adding spread and then also probably more importantly, reducing leverage and tightening up structure on deals to do deals in industries that we're a little bit more concerned about.

Another thing to note is related to that with our operating leverage has come down, obviously, we've grown our portfolio and our funnel has gotten larger. So we can be just generally speaking, more discerning. We've started -- we have the ability now with our cost of capital to originate deals that are 550, 575, and I always say to these guys, like 4 years ago, our deals need to be 750 and above, then it was 650. So today, we can see sort of the whole gamut of investments in our space. And we can opt out of the ones that have hair on and originate the ones that -- when we're forced ranking deals that are in the same industry that we feel have the most competitive advantages.

I appreciate the color. And just one more for me. Mike, when you're talking about building for growth and continuing to add new originators. Can you just kind of remind me about your kind of strategy for bringing in new originators. Do you typically look for some people that have multiple years of experience or you prefer to bring people fresh out of maybe college and train them yourself kind of to fit in with Capital Southwest lease? Or how do you approach that?

So we've told it both ways. I would tell you right now, we are sort of aim to do all of the above. We're certainly looking on the originator side to bring in another resource to cover one of the costs that we don't cover quite as strongly as we'd like to. We're bringing in several people on the analyst side to start supporting the pyramid. And we're also looking for another Operations VP. I kind of noticed earlier that's a department that we feel like adds a lot of value. And when we say that, these -- the operations group works alongside our deal team. So we get basically 2 opinions when we come into the boardroom to make better decisions before we put good money after bad. So I actually think it's sort of up and down the organization. I think what we're seeing today, we have enough staff to support it, but where we're going is going to require just a more scalable infrastructure.

Our next question comes from the line of John Hecht of Jefferies.

The first one is you guys have on the margin made some -- you've added the bond, you've used your ATM, you've got your SBIC, so you've got a diverse set of sourcing. Anything we should think about kind of as we go into 2020 -- well, this calendar year 2026 about the mix of your capital structure and about how that might be influenced by interest rate changes?

So I don't think so. If you look at -- we obviously, as you mentioned, we did the $350 million unsecured. We redeemed those prior 2 bonds. We're in a really good situation from a liquidity perspective. I think we'll continue to use the SBIC that will be a main source of sort of new capital for calendar year 2026 and continue to create flexibility under our secured credit facilities to make sure that we have adequate liquidity. But I don't think that you'll see a major shift from sort of where we sit today in our philosophy on the mix of unsecured debt, secured debt and SBIC.

And then final question. You guys mentioned at the beginning of the call that seeing a lot of competition from both banks and nonbanks. I'm wondering, has that changed just in light of some of these give idiosyncratic events in the bond market over the last few weeks?

It's hard to tell in real time because we propose on deals consistently. But like -- yes, I mean, there's been a little bit of firming up in the market, but I don't think -- it's a little early to say it's widespread.

Our next question comes from the line of Robert Dodd of Raymond James.

On -- I think in your prepared remarks, I think obviously looking to monetize investment platform on asset management. Correct me if I'm wrong, it seems like you're indicating that could be something on the table on that front within the next 12 months or something like that. So maybe I was reading too much into your wording, but if you could give us any more color there? And I mean, obviously, that would be an excellent low capital miss given you just be using the predominant staffing you already have. And you -- Would there be any -- yes, sorry, go ahead.

Look, yes, these processes tend to take a lot longer than you hoped or you think going in. Yes, definitely the answer is like we have a direction. I think backing up, we've been seeking out partners to help grow and I said, monetize on our investment platform that we've built over the last 10 years. And I think it's been on the road 3 years doing it, I think we finally started to hone on the right structure and found potentially a partner that is someone that's like-minded. I don't have anything to announce right now, but we're hopeful as we keep pushing along that, that will be something that we can make an announcement. And it would be net helpful to this organization going forward.

Got it. Got it. Then just another there been any changes in on -- you mentioned the equity co-invest where you've got a really good track record for an unrealized appreciation in the portfolio I mean at the margin spreads come in a little bit within your end market. Is there any appetite to maybe tweak the amount that goes into equity up a little bit? I mean if the spreads tighter and it's a good equity story, does it make sense to allocate a little bit more to that side of the book to kind of improve the total return or IRR over the life of an asset, if you're giving up a little bit of a spread for the business?

It's a good question. It's something that we grapple with internally as our hold sizes get larger, but we're still playing in the same bailiwick. Our debt check will probably be a larger percentage of the total investment capital, the equity is still being in the usually $0.5 million to $1.5 million.

We do have interest in doing so. I think that the way you get that accomplished is potentially seeing more non-sponsored deals, which we do see a pipeline of non-sponsored deals, which require usually it's a smaller debt check and a larger equity check. But a lot of those deals have a lot of hair. And so I think the old saying we got to kiss a lot of frogs there. So I think we -- that is -- when I talked about scalability, that is an area we may add some more resources to be able to do so. It does fit nicely in our business strategy because we are our SBA, right? Those are usually going to be the small and smaller businesses. And so the answer is yes, we're around 9% equity today. I would like to see it grow. I don't think that's going to happen in the next 6 to 12 months. But I think over the next 24 to 36 months, that's something we are geared towards working towards.

Our next question comes from the line of Dylan Heinz of Riley Securities.

I was just wondering, so while rate cuts are slowing, if your commitment growth maintains moving forward, do you expect the yield dilution to be roughly the same quarter-over-quarter as it was for last quarter or this quarter?

It's a tough question to answer. I mean, we are -- over the last 3 quarters, as we noted, we haven't seen that degradation. The deals that we are seeing in our pipeline for this quarter and maybe we're working on for the subsequent quarter, probably similar yield profiles. So I don't see the yields coming down. I think also some of the activity we're working on might allow us to continue to either hold or improve our spreads going forward, some of the kind of the other activities we're working on.

So I don't think -- I'm not expecting over the -- from a spread perspective. On the base rate, right, obviously, with SOFR, that's coming down. That's out of our control. But we built a portfolio and an income statement, we think that's positioned well both with our regular dividend as well as our UTI bucket.

Thank you I'm showing no further questions at this time. I would now like to turn it back to Michael Sarner for closing remarks.

Well, we appreciate everybody joining us today. We look forward to speaking to you in 3 months. Have a good weekend.

All right. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

Thank you for joining today's Capital Southwest First Quarter Fiscal Year 2026 Earnings Call. Participating on today's call are Michael Sarner, Chief Executive Officer; Chris Rehberger, Chief Financial Officer; Josh Weinstein, Chief Investment Officer; and Amy Baker, Executive Vice President, Accounting. I will now turn the call over to Amy Baker.

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 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 over to our President and Chief Executive Officer, Michael Sarner.

Thanks, Amy, and thank you, everyone, for joining us for our first quarter fiscal year 2026 earnings call. We are pleased to be with you today to discuss our first fiscal quarter. The June quarter was another productive quarter for the company as we continued to strengthen both sides of our balance sheet. During the quarter, we reduced the investment portfolio weighted average debt to EBITDA from 3.5x to 3.4x. The investment revenue PIK rate from 7.6% to 5.8% and our nonaccrual rate from 1.7% to 0.8% of the investment portfolio at fair value. These metrics, coupled with corporate leverage of 0.82x and a weighted average yield on debt investments of 11.8% provide shareholders with an attractive risk return profile to support both our regular and supplemental dividend looking forward to the future. During the first fiscal quarter, we generated pretax net investment income of $0.61 per share.

Additionally, as a result of harvesting $27.2 million in realized gains from 2 equity investment exits during the quarter, we were able to increase our undistributed taxable income balance to $1 per share from $0.79 per share as of the end of the prior quarter. Furthermore, as previously announced, we transitioned our regular dividend payment frequency from quarterly to monthly. We believe that transitioning to a monthly regular dividend is a shareholder-friendly initiative that will benefit all stakeholders of Capital Southwest. Our Board of Directors has declared a total of $0.58 in regular dividends for the quarter, payable monthly in each of July, August and September 2025 and has also declared a quarterly supplemental dividend of $0.06 per share, bringing total dividends declared for the September quarter to $0.64 per share. On the capitalization front, we received final approval from the SBA for our second SBIC license during the quarter, which allows us to access up to $175 million in additional SBA debentures over time.

Additionally, we increased our existing ING-led corporate credit facility by $25 million, bringing total commitments to $510 million. Finally, we raised $42 million in gross equity proceeds during the quarter through our equity ATM program at a weighted average share price of $20.50 per share or 123% of the prevailing NAV per share. We are pleased with the progress we have made on the capitalization front, and we'll continue to take measures to further improve our balance sheet as we look ahead. From an originations perspective, we took a conservative approach to underwriting this quarter due to the noise and uncertainty related to tariffs and government policies impacting health care and government services. Despite this noise, deal flow in the lower middle market remained solid this quarter with $115 million in total new commitments to 3 new portfolio companies and 12 existing portfolio companies.

Add-on financings continue to be an important source of originations for us as approximately 55% of the total capital commitments during the quarter were follow-on offerings in performing portfolio companies. Over the last 12 months, add-ons as a percentage of total new commitments have been 38%. So clearly, a strong source of origination volume in deals we know well and have experience with the management team and sponsor. Looking ahead, we have seen a distinct pickup in the volume and quality of deals in the past 6 weeks. As such, we are anticipating significant activity in terms of new platform company originations as well as add-on activity in the existing portfolio. Finally, from a BDC perspective, there's been some long-awaited progress on the AFFE rule or affiliated fund fees and expenses.

On June 23, 2025, there was a unanimous house passage of the Access to Small Business Investor Capital Act, which corrects the misleading SEC disclosure requirement that overstates the actual cost of investment in BDCs. The bill will exempt funds that invest in BDCs from including the acquired fund fees and expenses calculation in the prospectus fee table, providing more accurate information for investors. If BDCs are exempt from the AFFE rule, it could significantly increase trading volumes in the sector, especially through mutual funds and ETFs. If you recall, the onset of this rule in 2014 precipitated the Russell and S&P to remove BDCs from their indices. So we believe the impact of this corrective legislation could be meaningful. I will now hand the call over to Josh to review more specifics of our investment activity and the market environment.

Thanks, Michael. This quarter, we deployed a total of $51 million of new committed capital, including $50 million in first lien senior secured debt and $1 million of equity across 3 new portfolio companies. In addition, we closed add-on financings for 12 existing portfolio companies, consisting of $64 million in first lien senior secured debt and $1 million in equity. Our on-balance sheet credit portfolio ended the quarter at $1.6 billion, representing year-over-year growth of 21% from $1.3 billion as of June 2024. For the current quarter, 100% of our -- of the new portfolio company debt originations were first lien senior secured. And as of the end of the quarter, 99% of the credit portfolio was first lien senior secured with a weighted average exposure per company of only 0.9%. We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet.

The vast majority of our portfolio and deal activity is in first lien senior secured loans to companies backed by private equity firms. Currently, approximately 93% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies as well as the potential for junior capital support if needed. In the lower middle market, we often have the opportunity to invest on a minority basis in the equity of our portfolio companies' paired pursuit with the private equity firm when we believe the equity thesis is compelling. As of the end of the quarter, our equity co-investment portfolio consisted of 80 investments with a total fair value of $166 million, representing 9% of our total portfolio at fair value. Our equity portfolio was marked at 125% of our cost, representing $33.2 million in embedded unrealized appreciation or $0.60 per share.

Our equity portfolio continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, often resulting from the institutionalization of the businesses by experienced private equity firms as well as the significant value accretion potential from strategic add-on acquisitions. Equity co-investments across our portfolio provide our shareholders with the potential for asset value appreciation as well as equity distributions to Capital Southwest over time. This is playing out in real time as this quarter, we harvested 2 sizable equity exits, which generated $27.2 million in realized gains. Over the past 2 quarters, our equity portfolio has produced $41.3 million in total realized gains. As noted earlier, these realized gains grow our UTI balance and thus support both regular and supplemental dividends going forward.

Consistent with previous quarters, the lower middle market continues to be quite competitive as this segment of the market is highly attractive to both bank and nonbank lenders. While this has resulted in tight loan pricing for high-quality opportunities that are not exposed to the macroeconomic uncertainty, the depth and strength of the relationships our team has cultivated over the years has continued to result in our sourcing and winning opportunities with attractive risk return profiles. As a point of reference, currently, there are 80 unique private equity firms represented across our investment portfolio. Additionally, in the last 12 months, we closed 13 new platforms with financial sponsors with which we had not previously closed the deal, demonstrating our continued penetration in the market.

Since the launch of our credit strategy, we have completed transactions with over 119 different private equity firms across the country, including over 20% with which we have completed multiple transactions. Our portfolio currently consists of 122 different companies weighted 89.6% to first lien senior secured debt, 1% to second lien senior secured debt and 9.3% to equity co-investments. The credit portfolio had a weighted average yield of 11.8% and a weighted average leverage through our security of 3.4x EBITDA. We continue to be pleased with the operating performance across our loan portfolio. We have recently changed our loan grade structure from a 4-point scale to a 5-point scale. We have made this change in order to provide additional transparency for our shareholders. All of our loans upon origination are initially assigned an investment rating of 2 on a 5-point scale, with 1 being the highest and 5 being the lowest rating.

Overall, the portfolio remains healthy with approximately 92% of the portfolio at fair value rated in 1 of the top 2 categories, a 1 or a 2. Cash flow coverage of debt service obligations across the portfolio remains robust at 3.5x with our loans across the portfolio averaging approximately 42% of portfolio company enterprise value. We believe these performance metrics are indicative of a well-performing and conservatively structured portfolio. Our portfolio continues to be broadly diversified across industries, and our average exposure per company is less than 1% of investment assets, which gives us great comfort in the overall risk profile of our portfolio.

For the deals we are currently underwriting, they continue to have tight covenant packages, loan-to-value levels ranging from 35% to 50%, resulting in significant equity capital cushion below our debt and reasonable leverage levels of 2.5x to 4x debt to EBITDA. As Michael mentioned earlier, we believe our balance sheet is well positioned with low leverage and significant liquidity, which should allow us to be opportunistic should the market become less competitive, resulting in more attractive risk return profile deals. I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Josh. Specific to our performance for the quarter, pretax net investment income was $32.7 million or $0.61 per share. For the quarter, total investment income increased to $55.9 million from $52.4 million in the prior quarter. The increase was driven by a $5.2 million increase in cash interest and dividend income, offset by a decrease of $900,000 in fees and a decrease of $700,000 in PIK income compared to the prior quarter. Importantly, PIK as a percentage of our total investment revenue decreased to 5.8% compared to 7.6% in the prior quarter. Additionally, as of the end of the quarter, our loans on nonaccrual represented 0.8% of our investment portfolio at fair value, a decrease from 1.7% as of the end of the prior quarter. During the quarter, we paid out a $0.58 per share regular dividend and a $0.06 per share supplemental dividend.

As mentioned earlier, we have transitioned the frequency of our regular dividend payment to monthly with our Board declaring a total of $0.58 per share in regular dividends for the quarter, payable monthly in each of July, August and September 2025, while also maintaining a quarterly supplemental dividend at $0.06 per share, bringing total dividend to $0.64 per share for the September 2025 quarter. We continued our strong track record of regular dividend coverage with 106% coverage for the 12 months ended June 30, 2025, and 110% cumulative coverage since the launch of our credit strategy. We are confident in our ability to continue to distribute quarterly supplemental dividends based upon our current UTI balance of $1 per share and the expectation that we will continue to harvest gains over time from our sizable unrealized appreciation balance on the equity portfolio. LTM operating leverage ended the quarter at 1.7%. Looking ahead, we anticipate our run rate operating leverage to be in the 1.4% to 1.5% range by the end of our current fiscal year.

Our operating leverage is significantly better than the BDC industry average of approximately 2.7%, and we believe this metric speaks to the benefits of the internally managed BDC model and our absolute alignment with shareholders. The internally managed model has and will continue to produce real fixed cost leverage while also allowing for significant resources to be invested in people and infrastructure as we continue to grow and manage a best-in-class BDC. The company's NAV per share at the end of the quarter was $16.59 per share, a decrease from $16.70 per share in the prior quarter. The primary driver of the NAV per share decline was the annual issuance of restricted stock compensation to employees during the quarter.

We are pleased to report that our balance sheet liquidity is robust with approximately $444 million in cash and undrawn leverage commitments on our 2 credit facilities, which represents 2x the $223 million of unfunded commitments we had across our portfolio as of the end of the quarter. During the June quarter, we increased our corporate credit facility by $25 million, bringing total commitments on the facility to $510 million. Additionally, as of the end of the June quarter, 48% of our capital structure liabilities were in unsecured covenant-free bonds with our earliest debt maturity in October 2026. As previously mentioned, during the June quarter, we received final approval from the SBA for our second SBIC license.

This license allows us to access up to $175 million in additional SBA debentures over time, which is a cost-effective way to finance our lower middle market investment strategy. Our regulatory leverage ended the quarter at a debt-to-equity ratio of 0.82:1, down from 0.89:1 as of the prior quarter. While our optimal target leverage continues to be in the 0.8 to 0.95 range, we are weighing the impact of the current macroeconomic landscape and intend to maintain a regulatory leverage cushion, which will mitigate capital markets volatility. We will continue to methodically and opportunistically raise secured and unsecured debt capital as well as equity capital through our ATM program to ensure we maintain significant liquidity and conservative balance sheet construction with adequate covenant cushions. I will now hand the call back to Michael for some final comments.

Thank you, Chris, Josh and Amy, and all the employees who help us tell the story on a quarterly basis. And thank you, everyone, for joining us today. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

[Operator Instructions] Our first question will come from the line of Doug Harter from UBS.

Can you just talk a little bit more about the competitive landscape right now? And kind of how do you see that sort of playing out over the coming quarters?

Yes. I mean, look, there's a bit of a supply-demand dynamic here. And if you think about the supply, there's -- private equity sponsors have turned their attention away from consumer discretionary businesses a little bit as well as companies with international supply chain. So there's a little bit of a scarcity of quality assets out there. So -- and there's a bit of a pullback in the supply a little bit. And then on the demand side, you have banks and nonbank lenders continue to be aggressive and incentivized to deploy capital. So we've seen spread compression over the last 6 months or so. While we have seen that spread compression, the structures, which is something we focus on heavily on loan-to-value leverage quality credit agreements, those kinds of things have we stayed prudent on structuring. So we've been able to continue to deploy capital and leverage the relationships to continue to find opportunities. So yes, it's continued to be competitive. It always has been competitive, but we've been able to compete candidly. And so we've got a lot of good traction in this upcoming quarter as well.

I mean our overall weighted average spread has been -- 2 years ago, it was 8.50%. Currently, it's around 7.50%. The deals that we saw in this previous quarter were around 7% over and the deals that we're looking at in a very robust September quarter are around 7%, a little north of 7% as well. So to Josh's point, as -- even though things are compressed, we still are able to find our marks.

Got it. I mean, I guess, how do you think about is -- whether there is actually a floor on that around -- do you think that's going to be able to hold 7% if kind of that supply-demand imbalance kind of continues? Just how do you think about kind of any floor on the spreads?

It feels like it has settled to some degree. What we've seen is lower middle market credits that are extremely tight have been as low as 5.25%, which is 125 to 150 basis points tighter than what we're used to. But there still are plenty of deals that are still somewhere between the 5.25% and 7.50% to 8%. We have a pretty wide group of sponsors that we work with. We're also willing to be originating deals on the smaller side. So $3 million to $6 million EBITDA companies that are probably garnering closer to 6.50% over. So again, still being able to find our marks. And I do think that as SOFR comes down, history would tell us that the spreads will probably widen out. And so we might be at that -- kind of at the trough right now.

Our next question will come from the line of Mickey Schleien from Clear Street.

Michael, we received sort of mixed signals on the M&A market. Most folks are claiming it's still pretty muted relative to where it was a couple of years ago. But you're pretty optimistic it sounds like on your third calendar quarter and the fourth calendar quarter tends to be the busiest. So I'm assuming the second half looks pretty good. Well, what's underpinning that optimism in a market that seems to be sort of trudging along?

So I would say some of the deals that were in the June quarter bled over into the September quarter. I mean I can tell you right now, we've closed $110 million of originations through this morning. And we have another $40 million in deals that are signed up and that would be pending close later this month. So we already know we're probably at $150 million, and then there's a number of deals that we're in the mix for. So I think where we live in the lower middle market, we've seen plenty of deal activity. And I'd let Josh chime in as well, it feels like quality deals.

Yes. I think when I talk to other lower middle market lenders, they are very surprised at how full our pipeline is. And I really do think that speaks to the efforts we put forth in the last 3 years, 4 years, 5 years in cultivating private equity relationships to put us in a position to see all their deal flow and/or the majority of their deal flow. And so I do think that, that's paying dividends now and will continue to in the future.

And on the flip side, do you have any insight into prepayment or repayment activity in the third and fourth quarter?

So we just saw -- we had $80-plus million of repayments in this quarter, so it was obviously a heavy quarter. We do have a few companies that we know are going to market though for some larger holds. So that's probably closer in the -- to December quarter. Aside from that, I mean, I don't think we have a beat -- on the September quarter, we really don't have much of anything in the pipeline at this point.

Well, that's good news. My last question relates to your operating leverage. I looked at the page in the presentation, and it looks like it's sort of bottomed out at 1.7%. Is that where we can expect it to stay? Or do you think there's some more leverage there that can be extracted as you continue to grow?

This is definitely coming down. So the metric for the quarter based on actuals for the LTM was 1.7%. The run rate was 1.6% trending down to 1.5%. And we would tell you, we sometimes accrue additional bonus during the year before our final decision at the end of the year where the Board makes a decision on bonus. So maybe we have an over accrual. But we would tell you the run rate when it all settles for this year should be 1.4% or 1.5%, and we still think there'll be room to continue to reduce that over time. While we're -- and I would say this as well, that while still reducing -- increasing our staff and paying our people, we think that there's -- obviously, this internally managed structure has a lot of benefits from that perspective, and we expect that to continue to be a strong point for us, especially with rates coming back in. That's going to be a big differentiator for our business model relative to certainly the externals as rates come in.

Yes, I agree with that. And I just want to make sure I understood what you said 1.4% to 1.5% run rate in the fourth calendar quarter. So that's the fourth quarter annualized rate?

So for the March 31 quarter, the LTM number, we believe, will be 1.4% or 1.5%.

Okay.

So -- and Mickey, just to give you a sense for the current quarter, for the 6/30 quarter, the quarterized was 1.5%. So we're just -- if the LTM has some overhang from some of the onetime expenses incurred in the prior quarter. So we're already running sort of at 1.5%, which we expect to continue to come down on an LTM basis, as Michael described.

Okay. And in terms of leverage, Michael, you've tapped into the ATM, but the balance sheet leverage is not particularly high. Can we expect you to continue to issue common equity at sort of the pace that you've been at? Or do you prefer to lever up the balance sheet a little bit and maybe optimize your returns?

Yes, well, so leverage came down this quarter, probably mainly because we had so much in repayments during the quarter and that sort of -- that happened late stage. I think that I think Chris has said in the past, we're raising about $40 million to $60 million on a given quarter. And I think that you should expect that each quarter will look like that. I think we'd like to be closer to 0.85 leverage. And I could also say that it wouldn't bother me if our portfolio is in as good a shape as it is today with our debt-to-EBITDA and our fixed charge covenants, we could maybe move closer to 0.9. So we're certainly at a low point for leverage at the moment.

Yes. And part of it, we try to be consistent, Mickey, and as Michael said, we're raising, if you look at the last kind of 5 or 6 quarters. It's about exactly an average of $40 million a quarter. So we try to be consistently in the market. Some of the deals, as Michael described, pushed into July, which optically made the June leverage a little bit low. I would expect we'll be in the 0.85 to 0.9 range sort of in the September and December quarters. That seems about right.

And philosophically, most BDCs or many BDCs sort of run at more like 1.1. Obviously, you're in the lower middle market and maybe that causes you to be a little bit more conservative. But conceptually, why not run the balance sheet with a little bit more leverage than you've been doing recently?

Yes. I think the fact of the matter is that we're able to find yield kind of the way Josh described earlier and meet or exceed analyst expectations, have operating leverage where it needs to be. We don't really feel like the need to reach additional leverage necessarily. All of these metrics can move around over time. But generally speaking, we're going to take a more conservative bend. Especially, we're a smaller BDC, right? We -- I think we earned our credibility in the market, but we still believe having a conservative infrastructure, having conservative leverage communicates to the market sort of the way we do business here, and we think that could probably help our price to book in the end.

Our next question will come from the line of Robert Dodd from Raymond James.

If I can go back to kind of the competitive environment for a moment. And to your point, with the leverage you're doing 2.5 to 4, I mean, banks can kind of play in that market and keep those loans on balance sheet. And you mentioned, I mean, obviously, that it can be attractive to them. Where would -- the banks tend to be boom and bust, whether they're actually targeting the market. So where would you say the competitive pressure from banks is right now in terms of how it flows through a cycle. I mean, are they being pretty pushy right now? And is that one of the factors driving down the spreads? Or are they more moderate placed as to where you view the level of aggression, if I can put it that way?

Yes, you're spot on there, boom or bust. And right now, they're boom, they're risk on and from what I'm seeing -- and they're competing with us because you're right, the leverage profile that we generally are seeing banks can be competitive there. We have other ways to compete with banks. But candidly, it's tough for sponsors to turn down 150 or 200 basis points lower pricing when they have the opportunity to do it. So right now, banks are being competitive. It definitely is one of the factors driving the lower spreads. But you're right, they will derisk off at some point. It's pretty tough for me to predict when that will be, but they will be and that might be a factor for spreads to widen out a little bit.

Got it. Got it. Yes, on the -- and then one of the other advantages of being an internally managed BDC as we see from some of your internally managed peers is you can run an asset manager. And you've talked about that. And that -- and fees from the asset manager accrue to shareholders' benefit rather than some external manager's benefit. You've talked about that before. Are there any updates on efforts in that -- on that front about adding an asset manager kind of vehicle within the BDC to benefit ROE, lower your effective efficiency ratio, et cetera? Any updates there?

Yes. So yes, we're continuing to pursue those type of options. We're probably also looking at a strategic initiative to maybe look to enhance earnings and origination capabilities on some of the larger deals, which I don't -- nothing I want to formally state now. But certainly, that would help capture additional yield while winning deals in our -- within our same bailiwick. So lower middle market deals maybe between $8 million and $15 million, which we typically having to share those companies out with no economics, finding ways to structure those assets with other partners to basically maintain the assets and maybe bring in scrape and the management team. I think that's...

You might not want to formally articulate it, but that's formally enough for me. So thank you on that one. And then last one because I'm not going to touch AFFE because I don't want to jinx it. On -- to your point on like deployments, it seemed like you were saying you likely -- you could be $150 million plus in September with moderate repayments. The indication from leverage maybe not going up that much, the 0.8 to 0.9 would tend to imply that you might be running the ATM at like the high end of the range this quarter rather than the average, which is more the low end of the range. I mean, am I doing my math right there?

Yes, I think that's right. I think this quarter, if we say $40 million to $60 million and we've sort of been running at $40 million, you're probably looking at more like 50%. But obviously, we'll make that judgment as the knock on wood as some of these deals look like they're going to close. But yes, it's probably more in the $50 million range this quarter, that's right.

Our next question comes from the line of Erik Zwick from Lucid Capital Markets.

Just curious, you mentioned the strong pace of originations so far this quarter. I'm curious if you could maybe provide a little color in terms of the breakout between that from new versus add-on opportunities?

This quarter feels like it's fairly robust on the new. So the last quarter, it was like, what, 65-35. This quarter, again, the 9/30 numbers look like what, 75% new versus 25% add-ons?

Got it. No, it's an interesting change. I think as I look across your -- some of your competitors in the rest of the industry, it's been fairly heavy on the add-ons recently. So a switch back to new would indicate maybe kind of more market activity and a little more confidence there. So interesting to hear that. And then going, I think it was Chris speaking about your confidence in maintaining the dividend, both the regular and the supplemental, given the spillover of $1 plus the expectation for continued ability to harvest gains from the equity portfolio. Within that expectation, does that also include, I guess, the futures curve and just looking at Slide 24 in your deck, would indicate if the futures curve, Silver Futures curve is right, we do get about 100 basis points of reduction. There would be maybe a $0.06 or so per quarter headwind to the run rate of NII. So is that incorporated in kind of those dividend comments earlier?

Yes, I'll answer the question. So I mean, when we're looking ahead, we're anticipating, to your point, 100 basis point drop between -- in the next 15 months. We've kind of talked about where we expect our spreads to be 7-plus percent and seeing -- receiving some of these operational efficiencies. We believe that we're going to be able to maintain a $0.58 NII to cover our regular dividend. Looking ahead, the biggest risk I see is if this year turns over in the spring of next year and rates instead of troughing at 3.50% end up troughing at 1.5%. Now that's a different story altogether.

We have to rethink our regular dividend policy. But short of that, we feel that we'll be able to maintain that balance, plus we're at $1 UTI now. We would anticipate that to grow sizably in the next 6 to 9 months as well.which would be a support for both the supplemental and the regular. Our viewpoint is, if we're performing well and even if in the draconian scenario, we were at -- woke-up at $0.56 or $0.57 but we -- it wasn't because of nonaccruals, it wasn't because of portfolio performance, but rather about macroeconomic issues that we felt we could grow out of, we may use our UTI bucket to support that $0.58 regulator dividend, not grow it.

The other thing I would say, Erik, is Michael sort of touched on the operational efficiencies, which is an advantage as you look at that slide, but compared to sort of the reality of the ROE with operating leverage coming down. The other thing is we still have the full $175 million of debentures to drawn on, which obviously I can't predict where the 10 year is going to be, but right now, that would be sort of 5% type fixed paper. So as we're deploying assets with spreads that we are today at 7%, 7.50% range with a 5% sort of fixed debentures being our main source of growth on the liability side. We think that's going to also enhance those NIIs that we show on the table.

Our next question comes from the line of Sean-Paul Adams from B. Riley Securities.

On nonrural, it seemed that the nonaccruals decreased quarter-over-quarter, though on the investment rating schedule, it seemed that it was pretty much flat with risk rating of 5 at $3.8 million fair value. Generally, there was a general improvement in the risk rating. So there was a slight convergence towards the 2 to 3 mark. Was there a specific reason towards some of that change? And where are we at with the remaining nonaccrual runoff?

Sure, so this quarter, we had Zips -- I'm sorry, came back on accrual, which was a large position. I think that was around $25 million. And then we had a small second lien piece, which I think was like $3 million that actually went on nonaccrual. So the net, we picked up $22 million, although the numbers stayed flat. What was your second question, I apologize, Sean?

Correct. The migration towards the 2 from the top rating of 1, was there any general degradation in the top credit quality portfolio? And was there any idiosyncratic or just thematic themes towards that?

I don't think so. I mean I think there might have been a credit where it was a -- typically, when a company ends up looking towards an exit, it may be upgraded to a 1. And it might -- just might not have gone forward and it's moved back to a 2%, but it was performing in either case. That might be what you're referring to.

And I'm not showing any further questions in the queue. I would now like to turn it back over to Michael Sarner, President and CEO, for closing remarks.

Well, I appreciate everybody joining us. We look forward to speaking to you next quarter. Have a good day.

Thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.