Capital Southwest(CSWC) - 2020 Q4 - Annual Report

PART I Item 1. Business CSWC is an internally managed BDC and RIC providing debt and equity financing for U.S. middle-market companies - CSWC is an internally managed BDC and RIC, focusing on debt and equity financing for U.S. middle-market companies[17][18][27] - The company's investment strategy targets Lower Middle Market (LMM) companies with EBITDA between $3.0 million and $15.0 million, and Upper Middle Market (UMM) companies with EBITDA greater than $50.0 million[28][339] - As an internally managed firm, CSWC does not pay external advisory fees, which it considers a structural advantage for managing operating expenses[33] - CSWC must comply with BDC regulations, including maintaining an asset coverage ratio of at least 150% (with a board-imposed floor of 166%) and investing at least 70% of assets in qualifying U.S. companies[17][79][91] - To maintain its RIC status for tax purposes, the company must distribute at least 90% of its annual taxable income to shareholders[18][76] Item 1A. Risk Factors The company faces significant risks from business operations, illiquid investments, market disruptions, and interest rate fluctuations - The company's financial performance is dependent on its ability to effectively manage capital, and unrealized losses on its portfolio could indicate future realized losses, reducing income available for distributions[139][142][143] - All company assets are pledged as collateral under its secured Credit Facility. A default could lead to foreclosure and forced sale of assets at distressed prices[146][147] - The use of leverage magnifies both potential gains and losses. The asset coverage requirement was reduced from 200% to 150% effective April 25, 2019, which could increase investment risk[154][204] - Economic uncertainty and market disruptions, such as the COVID-19 pandemic, can adversely affect the company's portfolio valuations, funding costs, and access to capital markets[178][179][186] - The company's investments are primarily in illiquid, privately held companies, which involves risks such as dependence on key management, limited financial resources, and lack of publicly available information[235][239] - The company faces significant interest rate risk, particularly with the planned cessation of LIBOR after 2021, as approximately 96.8% of its debt portfolio was indexed to LIBOR as of March 31, 2020[253][256] - The December 2022 and October 2024 Notes are unsecured and effectively subordinated to the company's secured debt, including the Credit Facility, offering limited protection to noteholders[269][270][271] Item 1B. Unresolved Staff Comments The company has no unresolved staff comments from the SEC - None[296] Item 2. Properties The company leases approximately 9,261 square feet of office space in Dallas, Texas, with no owned real estate - The company leases its principal executive offices at 5400 Lyndon B. Johnson Freeway, Suite 1300, Dallas, Texas 75240[297] Item 3. Legal Proceedings The company and its subsidiaries are not party to any material pending legal proceedings - The company is not currently a party to any material legal proceedings[298] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[300] PART II Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities This section details senior securities, common stock market performance, dividend history, and share repurchase activities | Senior Security | Outstanding (in thousands) as of Mar 31, 2020 | Asset Coverage per Unit | |---|---|---| | Credit Facility | $154,000 | 1.89 | | December 2022 Notes | $77,136 | 1.89 | | October 2024 Notes | $75,000 | 1.89 | | Fiscal Year 2020 | Q4 | Q3 | Q2 | Q1 | |---|---|---|---|---| | NAV per Share | $15.13 | $16.74 | $18.30 | $18.58 | | High Price | $21.71 | $22.56 | $22.90 | $22.49 | | Low Price | $7.39 | $20.60 | $20.57 | $20.86 | | Fiscal Year | Total Dividends per Share | |---|---| | 2020 | $2.75 | | 2019 | $2.27 | | 2018 | $0.99 | - The company has a share repurchase program authorizing up to $10 million in buybacks. In March 2020, the company repurchased 794,180 shares at an average price of $11.57[323][326] Item 6. Selected Financial Data Selected financial data for the five years ended March 31, 2020, indicates growth in investment income and assets, with a net decrease in net assets from operations in fiscal year 2020 | (in thousands, except per share data) | 2020 | 2019 | 2018 | |---|---|---|---|\n| Total investment income (in thousands) | $62,039 | $51,881 | $35,126 | | Net investment income (in thousands) | $28,232 | $23,710 | $16,233 | | Net increase (decrease) in net assets from operations (in thousands) | ($22,351) | $33,058 | $39,307 | | Net asset value per common share | $15.13 | $18.62 | $19.08 | | Total dividends declared per common share | $2.75 | $2.27 | $0.99 | | Total assets (in thousands) | $584,959 | $551,843 | $417,490 | | Total liabilities (in thousands) | $312,737 | $225,880 | $109,202 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Fiscal year 2020 saw 19.6% growth in total investment income, but a net decrease in net assets from operations due to unrealized depreciation, with liquidity maintained | (in thousands) | Year ended Mar 31, 2020 | Year ended Mar 31, 2019 | % Change | |---|---|---|---|\n| Total investment income (in thousands) | $62,039 | $51,881 | 19.6% | | Net investment income (in thousands) | $28,232 | $23,710 | 19.1% | | Net realized gain on investments (in thousands) | $42,231 | $20,854 | 102.5% | | Net unrealized (depreciation) (in thousands) | ($92,814) | ($11,506) | 706.7% | | Net (decrease) in net assets (in thousands) | ($22,351) | $33,058 | (167.6)% | - The investment portfolio grew to $553.1 million at fair value as of March 31, 2020, up from $524.1 million a year prior. The portfolio consisted of investments in 46 companies[360] - As of March 31, 2020, 96.8% of the debt portfolio bore interest at floating rates. The weighted average yield on debt investments was 10.50%[361][335] - Due to the COVID-19 pandemic's impact, the percentage of debt investments rated 3 or 4 (indicating underperformance or substantial risk) increased from 5.9% of the portfolio at fair value in 2019 to 15.5% in 2020[371][372][373] - The company increased its Credit Facility commitments to $325 million and had $154.0 million outstanding as of March 31, 2020. It also issued $75.0 million of 5.375% Notes due 2024[408][411][420] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate fluctuations, affecting earnings and portfolio value, with 96.8% of its debt portfolio at floating rates - The company's primary market risk is interest rate risk, which affects its earnings, cash flows, and portfolio value[440][441] - As of March 31, 2020, 96.8% of the debt investment portfolio at fair value bore floating interest rates, with 97.6% of those subject to contractual minimum interest rates[442] - A hypothetical 100 basis point increase in interest rates could increase annual net investment income by up to $2.8 million ($0.15 per share), while a 100 basis point decrease could increase it by up to $0.4 million ($0.02 per share)[442] Item 8. Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for fiscal year 2020, reflecting a decrease in total net assets and a net decrease in net assets from operations | (in thousands) | March 31, 2020 | March 31, 2019 | |---|---|---|\n| Total Investments (at fair value, in thousands) | $553,072 | $524,071 | | Total Assets (in thousands) | $584,959 | $551,843 | | Total Liabilities (in thousands) | $312,737 | $225,880 | | Total Net Assets (in thousands) | $272,222 | $325,963 | | (in thousands) | Year Ended Mar 31, 2020 | Year Ended Mar 31, 2019 | |---|---|---|\n| Total Investment Income (in thousands) | $62,039 | $51,881 | | Total Operating Expenses (in thousands) | $31,745 | $27,123 | | Net Investment Income (in thousands) | $28,232 | $23,710 | | Net (Decrease) Increase in Net Assets from Operations (in thousands) | ($22,351) | $33,058 | Notes to Consolidated Financial Statements The notes detail accounting policies, investment valuation, borrowings, income tax, and shareholder equity, providing comprehensive financial context - As of March 31, 2020, 100% of the investment portfolio was valued using significant unobservable (Level 3) inputs, as quoted prices are not available for its privately held securities[649] - The company's borrowings as of March 31, 2020, consisted of $154.0 million under its Credit Facility, $77.1 million in December 2022 Notes, and $75.0 million in October 2024 Notes[676] - For the tax year ended December 31, 2019, the company elected to retain $16.5 million of net long-term capital gains and designated it as a 'deemed distribution' to shareholders, incurring $3.5 million in federal taxes on their behalf[716][717] - The company had approximately $15.2 million in unfunded commitments to its portfolio companies as of March 31, 2020[432][763] Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes or disagreements with its accountants on accounting and financial disclosure - None[813] Item 9A. Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of March 31, 2020, with no material changes - Management concluded that disclosure controls and procedures were effective as of March 31, 2020[815] - Management concluded that internal control over financial reporting was effective as of March 31, 2020[816] Item 9B. Other Information This section details estimated shareholder transaction and annual expenses, with total annual expenses for fiscal year 2020 at 15.24% of net assets | Annual Expenses (as a % of net assets for FY ended Mar 31, 2020) | Percentage | |---|---| | Operating expenses | 5.15% | | Interest payments on borrowed funds | 6.72% | | Income tax expense | 0.60% | | Acquired fund fees and expenses | 2.77% | | Total annual expenses | 15.24% | PART III Item 10. Directors, Executive Officers and Corporate Governance Information for this item is incorporated by reference from the company's 2020 definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[826] Item 11. Executive Compensation Information for this item is incorporated by reference from the company's 2020 definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[827] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters Information for this item is incorporated by reference from the company's 2020 definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[828] Item 13. Certain Relationships and Related Transactions, and Director Independence Information for this item is incorporated by reference from the company's 2020 definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[829] Item 14. Principal Accountant Fees and Services Information for this item is incorporated by reference from the company's 2020 definitive proxy statement - Information is incorporated by reference from the definitive proxy statement[830] PART IV Item 15. Exhibits, Financial Statement Schedules This section lists all documents filed as part of the Annual Report, including financial statements, schedules, and various exhibits - This item contains the index of financial statements, schedules, and exhibits filed with the Form 10-K[834] Item 16. Form 10-K Summary The company indicates that there is no Form 10-K summary - None[843]