Capital Southwest(CSWC) - 2023 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements This section presents the unaudited consolidated financial statements of Capital Southwest Corporation and its subsidiaries, including statements of assets and liabilities, operations, changes in net assets, cash flows, and detailed schedules of investments, along with comprehensive notes explaining the company's organization, accounting policies, and specific financial items Consolidated Statements of Assets and Liabilities The Consolidated Statements of Assets and Liabilities show an increase in total assets and liabilities, and a significant rise in total net assets from March 31, 2022, to December 31, 2022, primarily driven by increased investments and capital contributions Consolidated Statements of Assets and Liabilities (in thousands) | Category | December 31, 2022 | March 31, 2022 | | :--------------------------------- | :------------------ | :----------------- | | Assets: | | | | Total investments (at fair value) | $1,150,046 | $936,614 | | Cash and cash equivalents | $21,686 | $11,431 | | Total assets | $1,202,157 | $973,957 | | Liabilities: | | | | Total liabilities | $640,670 | $553,090 | | Net Assets: | | | | Total net assets | $561,487 | $420,867 | | Net asset value per share | $16.25 | $16.86 | - Total assets increased by $228.2 million (23.4%) from $973.9 million at March 31, 2022, to $1,202.1 million at December 31, 2022, primarily due to an increase in investments at fair value[11] - Total net assets increased by $140.6 million (33.4%) from $420.8 million at March 31, 2022, to $561.4 million at December 31, 2022[11] Consolidated Statements of Operations The Consolidated Statements of Operations show a substantial increase in net investment income for both the three and nine months ended December 31, 2022, compared to the prior year, driven by higher investment income, despite increased operating expenses. However, net realized and unrealized losses on investments significantly impacted the net increase in net assets from operations Consolidated Statements of Operations (in thousands) | Metric | Three Months Ended Dec 31, 2022 | Three Months Ended Dec 31, 2021 | Nine Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2021 | | :--------------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Total investment income | $32,766 | $22,311 | $82,108 | $61,186 | | Total operating expenses | $14,087 | $10,474 | $35,821 | $29,870 | | Net investment income | $19,425 | $11,899 | $46,307 | $30,668 | | Net realized (loss) gain on investments | $(11,086) | $2,715 | $(17,401) | $5,259 | | Net unrealized (depreciation) appreciation | $(5,390) | $(2,054) | $(13,989) | $4,306 | | Net increase (decrease) in net assets from operations | $2,949 | $12,560 | $14,917 | $23,146 | | Net investment income per share | $0.62 | $0.51 | $1.64 | $1.37 | - Total investment income increased by 46.9% for the three months and 34.2% for the nine months ended December 31, 2022, compared to the same periods in 2021[13][302][312] - Net investment income increased by 63.2% for the three months and 51.0% for the nine months ended December 31, 2022, compared to the same periods in 2021[13][307][316] - The company recognized significant net realized and unrealized losses on investments for both the three months ($(16.5) million) and nine months ($(31.4) million) ended December 31, 2022, contrasting with gains in the prior year[13][308][317] Consolidated Statements of Changes in Net Assets The Consolidated Statements of Changes in Net Assets reflect a substantial increase in net assets from March 31, 2022, to December 31, 2022, primarily driven by significant common stock issuances, despite net realized and unrealized losses from operations and dividend distributions Consolidated Statements of Changes in Net Assets (in thousands) | Metric | Nine Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2021 | | :--------------------------------------- | :----------------------------- | :----------------------------- | | Net assets, March 31 | $420,867 | $336,251 | | Net investment income | $46,307 | $30,668 | | Net realized (loss) gain on investments | $(17,401) | $5,259 | | Net unrealized (depreciation) appreciation | $(13,989) | $4,306 | | Dividends to shareholders | $(50,177) | $(46,847) | | Issuance of common stock | $174,169 | $73,346 | | Net assets, December 31 | $561,487 | $387,337 | - Net assets increased from $420.8 million at March 31, 2022, to $561.4 million at December 31, 2022[15] - Issuance of common stock contributed $174.1 million in the nine months ended December 31, 2022, significantly higher than $73.3 million in the same period of 2021[15] - Dividends to shareholders increased to $50.1 million for the nine months ended December 31, 2022, from $46.8 million in the prior year[15] Consolidated Statements of Cash Flows The Consolidated Statements of Cash Flows indicate a net increase in cash and cash equivalents for the nine months ended December 31, 2022, primarily due to significant cash provided by financing activities, which offset cash used in operating activities Consolidated Statements of Cash Flows (in thousands) | Cash Flow Activity | Nine Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2021 | | :--------------------------------- | :----------------------------- | :----------------------------- | | Net cash used in operating activities | $(193,648) | $(139,103) | | Net cash used in investing activities | $(159) | $0 | | Net cash provided by financing activities | $204,062 | $126,158 | | Net increase (decrease) in cash and cash equivalents | $10,255 | $(12,945) | | Cash and cash equivalents at end of period | $21,686 | $18,668 | - Operating activities used $193.6 million in cash for the nine months ended December 31, 2022, primarily due to $343.4 million in new portfolio investments[17][322] - Financing activities provided $204.1 million in cash, driven by $174.1 million from common stock offerings and $62.4 million from SBA Debentures, partially offset by $50.1 million in dividends[17][322] - The company experienced a net increase of $10.3 million in cash and cash equivalents for the nine months ended December 31, 2022, a reversal from a net decrease of $12.9 million in the prior year[17][322][323] Consolidated Schedule of Investments The Consolidated Schedule of Investments provides a detailed breakdown of the company's portfolio by investment type, industry, and geographic region, showing a significant increase in total investments and a continued focus on first lien loans and diverse industries Investment Portfolio Composition by Type (Fair Value, in thousands) | Investment Type | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :------------------------ | :----------- | :--------- | :----------- | :--------- | | First lien loans | $954,000 | 83.0% | $739,872 | 79.0% | | Second lien loans | $35,446 | 3.1% | $52,645 | 5.6% | | Subordinated debt | $852 | 0.1% | $1,317 | 0.1% | | Preferred equity | $61,283 | 5.3% | $44,663 | 4.8% | | Common equity & warrants | $50,840 | 4.4% | $40,514 | 4.3% | | I-45 SLF LLC | $47,625 | 4.1% | $57,603 | 6.2% | | Total Investments | $1,150,046 | 100.0% | $936,614 | 100.0% | Top 5 Industries by Fair Value (in thousands) | Industry | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :-------------------------- | :----------- | :--------- | :----------- | :--------- | | Media & Marketing | $142,382 | 12.4% | $43,463 | 4.6% | | Business Services | $127,741 | 11.1% | $123,697 | 13.2% | | Healthcare Services | $108,710 | 9.5% | $88,131 | 9.4% | | Consumer Services | $90,019 | 7.8% | $71,730 | 7.7% | | Consumer Products & Retail | $86,771 | 7.5% | $90,457 | 9.7% | Investment Portfolio by Geographic Region (Fair Value, in thousands) | Region | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :------------- | :----------- | :--------- | :----------- | :--------- | | Southeast | $239,539 | 20.8% | $136,588 | 14.6% | | Northeast | $230,643 | 20.1% | $225,578 | 24.1% | | West | $228,254 | 19.8% | $163,924 | 17.5% | | Southwest | $222,872 | 19.4% | $206,057 | 22.0% | | Midwest | $155,675 | 13.6% | $132,308 | 14.1% | | I-45 SLF LLC | $47,625 | 4.1% | $57,603 | 6.1% | | International | $25,438 | 2.2% | $14,556 | 1.6% | - Total investments at fair value increased by $213.4 million (22.8%) from $936.6 million at March 31, 2022, to $1,150.0 million at December 31, 2022[11][128] - First lien loans continue to be the largest component, increasing from 79.0% to 83.0% of the total portfolio by fair value[128] Notes to Consolidated Financial Statements These notes provide essential context and detailed explanations for the consolidated financial statements, covering the company's operational structure, significant accounting policies, investment specifics, valuation methodologies, debt obligations, tax treatment, equity activities, compensation plans, commitments, related party transactions, per share data, and subsidiary information 1. ORGANIZATION AND BASIS OF PRESENTATION Capital Southwest Corporation is an internally managed Business Development Company (BDC) and Regulated Investment Company (RIC) focused on providing customized financing to lower middle market (LMM) and upper middle market (UMM) companies, with a significant portion of its assets invested in qualifying assets and managed through a wholly-owned SBIC subsidiary - Capital Southwest Corporation (CSWC) is an internally managed BDC, regulated under the 1940 Act, and has elected to be treated as a RIC for U.S. federal income tax purposes[84][85] - The company specializes in customized financing for LMM companies (EBITDA $3.0M-$20.0M, investments $5.0M-$35.0M) and opportunistically targets UMM companies (EBITDA >$20.0M, investments $5.0M-$20.0M)[87] - CSWC operates a wholly-owned SBIC subsidiary (Capital Southwest SBIC I, LP) which has a similar investment strategy and is consolidated for financial reporting[88][100] - As of December 31, 2022, 86.5% of the company's assets were qualifying assets under the 1940 Act, meeting the BDC requirement of at least 70%[91] 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The company accounts for most financial instruments at fair value using Level 3 inputs, recognizes interest and dividend income on an accrual basis, and capitalizes PIK interest. Recent accounting standards related to reference rate reform and fair value measurement of equity securities are being evaluated for potential impact - Substantially all financial instruments are accounted for at fair value in accordance with ASC 820, primarily using Level 3 unobservable inputs due to the private nature of investments[95][136] - Interest and dividend income is recorded on an accrual basis, with investments placed on non-accrual status when collectability is not expected. As of December 31, 2022, 0.3% of the portfolio's fair value was on non-accrual status[102] - Payment-in-Kind (PIK) interest is added to the principal balance and recorded as interest income, representing 4.6% and 4.4% of total investment income for the three and nine months ended December 31, 2022, respectively[104][105] - The company is evaluating ASU 2020-04 (Reference Rate Reform) and ASU 2022-03 (Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions) but does not anticipate a material impact on its financial statements[125][126] 3. INVESTMENTS The investment portfolio significantly grew from March 31, 2022, to December 31, 2022, with a continued concentration in first lien loans and a diversified exposure across various industries and U.S. geographic regions Investment Portfolio Composition by Type (Fair Value, in thousands) | Investment Type | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :------------------------ | :----------- | :--------- | :----------- | :--------- | | First lien loans | $954,000 | 83.0% | $739,872 | 79.0% | | Second lien loans | $35,446 | 3.1% | $52,645 | 5.6% | | Subordinated debt | $852 | 0.1% | $1,317 | 0.1% | | Preferred equity | $61,283 | 5.3% | $44,663 | 4.8% | | Common equity & warrants | $50,840 | 4.4% | $40,514 | 4.3% | | I-45 SLF LLC | $47,625 | 4.1% | $57,603 | 6.2% | | Total Investments | $1,150,046 | 100.0% | $936,614 | 100.0% | Top 5 Industries by Fair Value (in thousands) | Industry | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :-------------------------- | :----------- | :--------- | :----------- | :--------- | | Media & Marketing | $142,382 | 12.4% | $43,463 | 4.6% | | Business Services | $127,741 | 11.1% | $123,697 | 13.2% | | Healthcare Services | $108,710 | 9.5% | $88,131 | 9.4% | | Consumer Services | $90,019 | 7.8% | $71,730 | 7.7% | | Consumer Products & Retail | $86,771 | 7.5% | $90,457 | 9.7% | Investment Portfolio by Geographic Region (Fair Value, in thousands) | Region | Dec 31, 2022 | % of Total | Mar 31, 2022 | % of Total | | :------------- | :----------- | :--------- | :----------- | :--------- | | Southeast | $239,539 | 20.8% | $136,588 | 14.6% | | Northeast | $230,643 | 20.1% | $225,578 | 24.1% | | West | $228,254 | 19.8% | $163,924 | 17.5% | | Southwest | $222,872 | 19.4% | $206,057 | 22.0% | | Midwest | $155,675 | 13.6% | $132,308 | 14.1% | | I-45 SLF LLC | $47,625 | 4.1% | $57,603 | 6.1% | | International | $25,438 | 2.2% | $14,556 | 1.6% | - Total investment portfolio increased from $936.6 million at March 31, 2022, to $1,150.0 million at December 31, 2022[128] - First lien loans constitute the largest portion of the portfolio, increasing from 79.0% to 83.0% of total fair value[128] 4. FAIR VALUE MEASUREMENTS The company's investment valuation process relies heavily on Level 3 unobservable inputs for its privately held debt and equity instruments, utilizing various valuation techniques such as the Income Approach and Enterprise Value Waterfall Approach, with no transfers between fair value levels during the reported periods - 100% of the investment portfolio consisted of privately held debt and equity instruments valued using Level 3 inputs as of December 31, 2022, and March 31, 2022[136] - Valuation techniques include the Market Approach, Income Approach (using Required Market Yield), Enterprise Value Waterfall Approach (using EBITDA multiples and discount rates), and NAV Valuation Method[138][139][140][144][147] Significant Level 3 Inputs (Weighted Average) for Debt and Equity Securities (Dec 31, 2022) | Type | Valuation Technique | Significant Unobservable Inputs | Weighted Average | | :---------------- | :------------------------ | :------------------------------ | :--------------- | | First lien loans | Income Approach | Discount Rate | 13.2% | | | Market Approach | Cost | 98.2 | | Second lien loans | Income Approach | Discount Rate | 21.9% | | Preferred equity | Enterprise Value Waterfall Approach | EBITDA Multiple | 10.1x | | | | Discount Rate | 18.6% | | Common equity & warrants | Enterprise Value Waterfall Approach | EBITDA Multiple | 9.3x | | | | Discount Rate | 16.8% | - No transfers between fair value levels occurred during the three and nine months ended December 31, 2022 and 2021[153] 5. BORROWINGS The company's borrowings increased significantly from March 31, 2022, to December 31, 2022, primarily through the Credit Facility and SBA Debentures, while maintaining a strong asset coverage ratio of 229% and complying with all financial covenants - As of December 31, 2022, the company's asset coverage ratio was 229%, exceeding the 150% regulatory requirement[157] Outstanding Borrowings (in thousands) | Borrowing Type | Dec 31, 2022 Outstanding Balance | Mar 31, 2022 Outstanding Balance | | :--------------- | :------------------------------- | :------------------------------- | | SBA Debentures | $104,000 | $40,000 | | Credit Facility | $225,000 | $205,000 | | January 2026 Notes | $140,000 | $140,000 | | October 2026 Notes | $150,000 | $150,000 | | Total | $619,000 | $535,000 | - The Credit Facility's total commitments increased to $400 million as of November 16, 2022, with $225 million outstanding at December 31, 2022, and a weighted average interest rate of 6.02% for the three months ended December 31, 2022[164][168] - SBA Debentures increased to $104.0 million outstanding at December 31, 2022, with a weighted average interest rate of 3.70% for the three months ended December 31, 2022[185][186] 6. INCOME TAXES The company maintains its RIC tax treatment by distributing at least 90% of its taxable income, utilizes a Taxable Subsidiary to manage certain portfolio investments, and recorded a net income tax benefit for the three and nine months ended December 31, 2022 - CSWC qualifies for RIC tax treatment by distributing at least 90% of its investment company taxable income annually[188][189] - The Taxable Subsidiary, a wholly-owned subsidiary, helps CSWC satisfy RIC requirements by holding certain pass-through entity interests and is taxed at corporate rates[196][198] Tax Character of Distributions Paid (in thousands) | Category | Twelve Months Ended Dec 31, 2022 | Twelve Months Ended Dec 31, 2021 | | :--------------- | :------------------------------- | :------------------------------- | | Ordinary income | $60,960 | $56,633 | | Capital gains | $0 | $0 | Total Net Deferred Tax (Liabilities) Assets (in thousands) | Category | Dec 31, 2022 | Mar 31, 2022 | | :--------------------------------- | :----------- | :----------- | | Total net deferred tax (liabilities) assets | $(11,427) | $(5,747) | - The company recognized a net income tax benefit of $0.7 million for the three months and $20.6 thousand for the nine months ended December 31, 2022[202] 7. SHAREHOLDERS' EQUITY The company raised significant capital through a public equity offering and its expanded Equity ATM Program, while also conducting share repurchases related to restricted stock vesting - A public equity offering on November 17, 2022, raised $44.1 million in net proceeds from 2,534,436 shares[206] - The Equity ATM Program's maximum offering price was increased to $650 million on August 2, 2022[207][355] Equity ATM Program Sales (in thousands, except shares) | Metric | Three Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2022 | | :------------------------ | :------------------------------ | :----------------------------- | | Number of shares sold | 3,264,878 | 6,909,446 | | Net proceeds received | $57,449 | $130,010 | | Weighted average price per share | $17.86 | $19.10 | - Cumulative to date, $310.3 million in net proceeds have been raised through the Equity ATM Program, with $334.5 million remaining available[208][357] - Share repurchases were conducted in connection with restricted stock vesting, with 19,917 shares repurchased for $380 thousand in the three months ended December 31, 2022[211] 8. STOCK BASED COMPENSATION PLANS The company operates restricted stock award plans for employees and non-employee directors, with awards vesting over four-year and one-year periods, respectively, and recognized $1.0 million in share-based compensation expense for the three months ended December 31, 2022 - The 2021 Employee Plan and Non-Employee Director Plan grant restricted stock awards with full voting and dividend rights, subject to forfeiture if employment/service terminates early[212][215] - Employee awards generally vest in equal annual installments over four years, while non-employee director awards vest one year from the grant date[212][215] - Total share-based compensation expense recognized was $1.0 million for the three months and $2.9 million for the nine months ended December 31, 2022[217] - As of December 31, 2022, $8.0 million in unrecognized compensation expense remains, to be amortized over a weighted-average vesting period of approximately 2.6 years[219] 9. OTHER EMPLOYEE COMPENSATION The company maintains a 401(k) plan for its full-time employees, making matching contributions that are immediately fully vested - The company made matching contributions to its 401(k) plan of approximately $28.6 thousand for the three months and $158.1 thousand for the nine months ended December 31, 2022[220] - All matching contributions to the 401(k) plan are fully vested immediately[220] 10. COMMITMENTS AND CONTINGENCIES The company has significant unused commitments to extend financing to portfolio companies, including revolving and delayed draw term loans, and has operating lease obligations for its office space, while reporting no material legal proceedings - Total unused commitments to extend financing were $159.7 million as of December 31, 2022, up from $134.3 million at March 31, 2022[225][365] - As of December 31, 2022, $0.9 million in letters of credit were issued and outstanding on behalf of portfolio companies[225][365] - The company has an operating lease for new office space expiring September 30, 2032, with a ROU asset of $1.9 million and a lease liability of $2.9 million as of December 31, 2022[226][228] Future Minimum Operating Lease Payments (in thousands) | Year ending March 31, | Rent Commitment | | :---------------------- | :-------------- | | 2023 | $92 | | 2024 | $406 | | 2025 | $416 | | 2026 | $426 | | 2027 | $436 | | Thereafter | $2,578 | | Total | $4,354 | - There are no currently pending material legal proceedings to which the company is a party[231][382] 11. RELATED PARTY TRANSACTIONS The company provides significant managerial assistance to its portfolio companies and engages in financial transactions with its joint venture, I-45 SLF LLC, including receiving dividends and administrative fees - The company provides significant managerial assistance to its portfolio companies as required by the 1940 Act[232] - As of December 31, 2022, the company had $1.9 million in dividends receivable from I-45 SLF LLC[233] - Administrative fee income from I-45 SLF LLC was $25.0 thousand for the three months and $75.0 thousand for the nine months ended December 31, 2022[233] 12. SUMMARY OF PER SHARE INFORMATION Per share data shows an increase in net investment income per share for both the three and nine months ended December 31, 2022, compared to the prior year, despite a decrease in net asset value per share over the nine-month period Per Share Data Summary | Metric | Three Months Ended Dec 31, 2022 | Three Months Ended Dec 31, 2021 | Nine Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2021 | | :--------------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Investment income | $1.04 | $0.95 | $2.90 | $2.73 | | Net investment income | $0.62 | $0.51 | $1.64 | $1.37 | | Net realized (loss) gain, net of tax | $(0.36) | $0.12 | $(0.62) | $0.23 | | Net unrealized appreciation (depreciation), net of tax | $(0.17) | $(0.09) | $(0.49) | $0.19 | | Net asset value, end of period | $16.25 | $16.19 | $16.25 | $16.19 | | Weighted-average basic and diluted shares outstanding | 31,381 | 23,433 | 28,304 | 22,394 | - Net investment income per share increased to $0.62 (Q3 2022) and $1.64 (9M 2022) from $0.51 and $1.37 in the respective prior periods[236] - Net asset value per share decreased from $16.86 at the beginning of the nine-month period to $16.25 at December 31, 2022[11][236] - Total investment return was 4.31% for the three months ended December 31, 2022, but (20.95)% for the nine months ended December 31, 2022[236] 13. SIGNIFICANT SUBSIDIARIES I-45 SLF LLC, a joint venture with Main Street Capital Corporation, primarily invests in UMM syndicated senior secured loans, with CSWC holding an 80% ownership and 78.25% current profits interest. The subsidiary's financial performance showed a net decrease in members' equity from operations for the nine months ended December 31, 2022 - CSWC owns 80% of I-45 SLF LLC and has a current profits interest of 78.25%[240] - I-45 SLF LLC had total assets of $166.2 million and total investments at fair value of $161.0 million as of December 31, 2022[241][244] - I-45 SLF LLC had $104.0 million drawn under its senior secured credit facility as of December 31, 2022[242][244] I-45 SLF LLC Selected Statement of Operations Information (in thousands) | Metric | Three Months Ended Dec 31, 2022 | Nine Months Ended Dec 31, 2022 | | :--------------------------------------- | :------------------------------ | :----------------------------- | | Total revenues | $4,648 | $12,217 | | Net investment income | $2,453 | $6,964 | | Net (decrease) increase in members' equity resulting from operations | $(1,607) | $(5,516) | 14. SUBSEQUENT EVENTS The Board of Directors declared a total dividend of $0.58 per share for the quarter ending March 31, 2023, comprising a regular dividend of $0.53 and a supplemental dividend of $0.05 - On January 25, 2023, the Board declared a total dividend of $0.58 per share for the quarter ending March 31, 2023[256][367] - The dividend consists of a regular dividend of $0.53 and a supplemental dividend of $0.05[256][367] Consolidated Schedule of Investments in and Advances to Affiliates This schedule details the company's investments in control and affiliate entities, showing the principal amounts, interest/dividends credited, fair value changes, and realized/unrealized gains or losses for the nine months ended December 31, 2022 Control and Affiliate Investments Summary (in thousands) | Category | Fair Value at Mar 31, 2022 | Gross Additions | Gross Reductions | Realized Gain/(Loss) | Unrealized Gain/(Loss) | Fair Value at Dec 31, 2022 | | :-------------------------- | :------------------------- | :-------------- | :--------------- | :------------------- | :--------------------- | :------------------------- | | Control Investments | $57,603 | $0 | $0 | $0 | $(9,978) | $47,625 | | Affiliate Investments | $131,879 | $83,675 | $(37,784) | $(10,625) | $6,187 | $173,332 | | Total | $189,482 | $83,675 | $(37,784) | $(10,625) | $(3,791) | $220,957 | - Fair value of Control Investments (I-45 SLF LLC) decreased by $9.9 million due to unrealized depreciation[259] - Affiliate Investments saw significant gross additions of $83.7 million and gross reductions of $37.8 million, resulting in a net increase in fair value[263] - Total Control & Affiliate Investments increased in fair value from $189.5 million to $221.0 million over the nine months[263] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides an overview of the company's business as an internally managed BDC focusing on LMM and UMM financing, discusses critical accounting policies for investment valuation and revenue recognition, details the growth and composition of its investment portfolio, and analyzes the financial results for the three and nine months ended December 31, 2022, highlighting increased investment income and net realized/unrealized losses - CSWC is an internally managed BDC specializing in customized debt and equity financing for LMM companies (EBITDA $3.0M-$20.0M) and UMM companies (EBITDA >$20.0M)[270][271] - The total value of the investment portfolio increased to $1,150.0 million as of December 31, 2022, from $936.6 million as of March 31, 2022, across 82 portfolio companies[283] - Approximately 96.7% of the debt investment portfolio bore interest at floating rates (100% with contractual minimums) as of December 31, 2022[285] Investment Portfolio Metrics (excluding I-45 SLF LLC) | Metric | Dec 31, 2022 | Mar 31, 2022 | | :--------------------------------------- | :----------- | :----------- | | Number of portfolio companies | 81 | 72 | | Fair value | $1,102,421 | $879,011 | | % of portfolio at fair value - debt | 89.8% | 90.3% | | % of investments at fair value secured by first lien | 86.5% | 84.2% | | Weighted average annual effective yield on debt investments | 12.0% | 9.3% | | Weighted average leverage through CSWC security | 3.6x | 4.0x | - The company's internal investment rating system shows 83.2% of debt investments rated 2 (performing as expected) and 4.8% rated 3 (performing below expectations) as of December 31, 2022[292] - Net investment income increased by 63.2% to $19.4 million for the three months and 51.0% to $46.3 million for the nine months ended December 31, 2022, compared to the prior year periods[307][316] - Net realized and unrealized losses totaled $16.5 million for the three months and $31.4 million for the nine months ended December 31, 2022, primarily from debt and I-45 SLF LLC investments[308][317] Item 3. Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risk, particularly interest rate risk, due to its portfolio of floating-rate investments and borrowings. Rising interest rates could increase the cost of funds, potentially reducing net investment income, although a hypothetical 100 basis point increase is estimated to increase net investment income by $8.2 million annually - The company is subject to market risk, including interest rate risk, which affects net interest income and investment portfolio value[369][370] - Approximately 96.7% of the debt investment portfolio (at fair value) bore interest at floating rates as of December 31, 2022, with 100% subject to contractual minimum interest rates[373] - A hypothetical 100 basis point increase in interest rates could increase net investment income by a maximum of $8.2 million, or $0.22 per share, on an annual basis[373] - The company was not a party to any hedging arrangements as of December 31, 2022[372] Item 4. Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2022, and reported no material changes in internal control over financial reporting during the quarter - Disclosure controls and procedures were evaluated and deemed effective as of December 31, 2022[378] - No material changes in internal control over financial reporting occurred during the three months ended December 31, 2022[379] PART II. OTHER INFORMATION Item 1. Legal Proceedings The company is not currently involved in any pending material legal proceedings - The company has no currently pending material legal proceedings[382] Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K for the fiscal year ended March 31, 2022 - No material changes to risk factors since the Annual Report on Form 10-K filed on May 24, 2022[383] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company reported no unregistered sales of equity securities and no repurchases under its share repurchase program during the three months ended December 31, 2022 - No unregistered sales of equity securities occurred during the period[384] - No shares were repurchased under the $20 million share repurchase program during the three months ended December 31, 2022[385] Item 3. Defaults Upon Senior Securities The company reported no defaults upon senior securities during the period - No defaults upon senior securities were reported[386] Item 4. Mine Safety Disclosures This item is not applicable to the company - This item is not applicable[388] Item 5. Other Information The company reported no other information for this period - No other information to report[389] Item 6. Exhibits This section lists all exhibits filed as part of the Form 10-Q, including corporate governance documents, debt indentures, and certifications - Exhibits include Articles of Incorporation, Bylaws, Indentures for various notes (4.50% Notes due 2026, 3.375% Notes due 2026), and certifications by the President/CEO and CFO[391] Signatures The report is duly signed by the President and Chief Executive Officer, and the Chief Financial Officer, Secretary and Treasurer, certifying its submission - The report was signed by Bowen S. Diehl, President and Chief Executive Officer, and Michael S. Sarner, Chief Financial Officer, Secretary and Treasurer, on January 31, 2023[395]