Capital Southwest Corporation (CSWC) Q2 2027 Earnings Report, Transcript and Summary

Thank you for joining today's Capital Southwest Second Quarter Fiscal Year 27 earnings call. Participating on the call today are Michael Scott Sarner, chief executive officer Chris Rehberger, chief financial officer Joshua S. Weinstein, chief investment officer Amy Baker, executive vice president of accounting and Morgan Stewart. Director of communications. I will now turn the call over to Morgan.

Thank you. I would like to remind everyone that in this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's assumptions, 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 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 Scott Sarner. Thanks, Morgan. And thank you, everyone, for joining us for our second quarter fiscal year 27 earnings call. We are pleased to be with you today and look forward to discussing our results for the quarter. Our portfolio continued to deliver consistent results during the second fiscal quarter. We generated pre tax net investment income of $0.58 per share, which was supported by strong recurring earnings. Our undistributed taxable income balance remains robust. At $0.92 per share, reflecting consistent realization activity. We remain confident in our ability to continue covering both our regular and supplemental dividends throughout the earnings power of the portfolio. Our board of directors has declared a $0.58 per share regular dividend for the December quarter paid out monthly over October, November, and December 2026. They have also declared a quarterly supplemental dividend of $0.06 per share payable in December, bringing total dividends declared for the third fiscal quarter to $0.64 per share. Deal flow in the lower middle market has been robust, The quarter was exceptionally active on the origination front, driven by both the strength of our sponsor relationships and the continued growth of our investment team. We closed a record $391 million in total new commitments across 14 new portfolio companies and 16 existing portfolio companies. Our new portfolio companies this quarter span 11 industries, reflecting our ability to source deals across the lower middle market. For the new deals that closed during the September quarter, weighted average senior leverage was 3.4x debt to EBITDA and weighted average loan to value was 33%. Providing a substantial equity cushion beneath our debt. Our recent origination success has been supported by the sizable growth of our organization. Over the past 18 months, we have expanded our team from 27 to 46 employees, significantly increasing our sourcing and underwriting capacity. CapTrin, our strategic joint venture with Trinity Capital, has also broadened the range of opportunities we can competitively pursue. Together, these efforts have helped us build a substantially larger pipeline. In fact, over the last 12 months, we have screened approximately 1.6 thousand opportunities, up from 1.2 thousand in fiscal year 26 and 1 thousand in fiscal year 25. And while our pipeline has grown, we remain highly selective with a close rate below 2 percent. We believe this reflects both our disciplined underwriting process and the depth of our relationships and sourcing capabilities in the lower middle market. Looking at the current macro lending environment, it seems more likely than not that we are heading back toward a higher for longer rate environment. In a recent article, I discussed how a renewed rise in base rates could affect BDCs. The short answer is that higher rates are not simply good or bad for BDC earnings. Higher rates will certainly increase portfolio yields, but they can also put pressure on borrower cash flows and raise the BDC's own cost of capital. I think if rates move higher, you could see greater separation across the industry. With credit quality, portfolio company leverage, funding costs, and balance sheet liquidity becoming increasingly important differentiators. For Capital Southwest, we believe we are well positioned if rates move higher. Our assets are predominantly floating rate, much of our debt is fixed rate, and our portfolio companies have conservative leverage of approximately 3.7x. We have also gained experience and insight from navigating the previous rate cycle. When SOFR rose above 5.5% and saw firsthand how our lower middle market portfolio performed. While every rate cycle is different, we believe the combination of our asset sensitivity, liability structure, and conservative portfolio leverage positions us well if base rates move higher. Beyond our core balance sheet activity, we continue to broaden the ways we attract investment opportunities. This quarter, we partnered with Trinity Capital to form Desert Star, our second joint venture together with a $25 million equity commitment. Desert Star gives us access to technology lending market. Allowing us to gain exposure through a granular portfolio of investments in an area where we have not historically focused. We expect to deploy our equity commitment over several years as we take a measured approach to investing in this area of the market. Turning to our capital structure, we significantly strengthened our balance sheet during the quarter. We issued $350 million of 5-year unsecured notes and amended, extended, and upsized our corporate credit facility. This amendment meaningfully reduced our cost of capital while providing additional capacity and flexibility to support future growth. Following these transactions, we have no debt maturities until 2029. In connection with the unsecured note issuance, we also entered into our first interest rate swap. Chris will provide more detail on these activities in his remarks. Rounding out a solid quarter, we raised $67 million in gross equity proceeds through our ATM program. Our ability to access this program continues to be a meaningful competitive advantage for Capital Southwest. In a market where fewer publicly traded BDCs are trading above book value, our improved price to book valuation gives us a differentiated ability to raise growth capital that is accretive to NAV and supportive of long term shareholder value. I will now hand the call over to Joshua to review more specifics of our investment activity.

Thanks, Michael. As previously mentioned, this quarter, we deployed a total of $391 million across new and existing portfolio companies. This consisted of $314 million first-lien senior secured debt and $13 million of equity across 4 new portfolio companies. Across 16 existing portfolio companies, we invested $63 million in first lien senior secured debt and $1 million in equity this quarter. Additionally, during the quarter, we generated $74 million of proceeds from portfolio company exits at a weighted average IRR of 4.5 percent. Our credit portfolio ended the quarter at $2.2 billion, representing 28 percent year-over-year growth from $1.7 billion as of September 2025. 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 0.8%. 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 continues to be first-lien senior secured loans to private equity backed companies. Approximately 92% 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 in our portfolio company's equity. When the thesis is compelling, we take a minority position, pari passu, alongside the private equity sponsor. As of quarter end, our equity co investment portfolio consisted of 102 investments with a total fair value of $192 million, representing 8% of our total portfolio. This equity portfolio was marked at 120% of our cost, representing $31.6 million of embedded unrealized appreciation or $0.48 per share. These 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. Our market remains competitive with both bank and nonbank lenders continuing to pursue high quality opportunities. While that competition has resulted in tighter pricing over the past several years, we have begun to see spreads widen over the past few quarters. New originations this quarter had a weighted average spread of 6.5 percent. Despite the competitive environment, the depth of our sponsor relationships and the continued growth of our investment team are expanding the opportunities we are able to originate. Since launching our credit strategy in 2015, we have completed transactions with more than 145 private equity firms nationwide. Over the last 12 months alone, we have closed new platform investments with 22 sponsors with whom we had not previously partnered. We believe the breadth and continued expansion of those relationships position us well to source attractive opportunities while remaining highly selective. Our portfolio now consists of 153 companies, comprised of 89.4% to first-lien senior secured debt 1% to second-lien senior secured debt. 8% to equity co investments, and 1.5% to joint ventures. The credit portfolio generated a weighted average yield of 10.9 percent, with a weighted average leverage through our security of 3.7x EBITDA. 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. At quarter end, 89% of the portfolio at fair value was rated a 1 or a 2. Cash flow coverage has also continued to improve, increasing to 3.5x from a low of 2.9x during the peak of base rates. We remain pleased with the overall performance of the portfolio and believe it remains well positioned as we continue to grow. I will now hand the call over to Chris to review the specifics of our financial performance for the quarter.

Thanks, Joshua. Specific to our performance for the quarter, pretax net investment income $37.2 million, or $0.58 per share. For the quarter, total investment income increased to $67.2 million from $61 million in the prior quarter. The increase was primarily driven by a $4.6 million increase in cash interest income coupled with an increase of $1 million in fees and other income. The increase in fee income was driven by increased arranger fees due to larger origination volumes than in the prior quarter. Importantly, PIC as a percentage of total investment income decreased to 7.4% from 8.0% in the prior quarter. On the expense side, G&A increased by approximately $400 thousand from the prior quarter. This increase was driven entirely by proxy solicitation expenses related to our shareholder vote on increasing our authorized shares. Which is a nonrecurring item. As of the end of the quarter, our loans on nonaccrual represented 1.4 percent of our investment portfolio at fair value compared to 1.1 percent at the end of the prior quarter, continue to demonstrate strong dividend coverage with 109 percent cumulative coverage since launching our credit strategy. Our UTI balance increased to $0.92 per share this quarter from $0.87 per share in the June quarter. In addition, we continue to hold significant unrealized appreciation across our equity portfolio. As a result, we remain confident in our ability to grow our UTI balance and continue paying quarterly supplemental dividends over time. LTM operating leverage ended the quarter at 1.4 percent, a meaningful improvement from the 1.6 percent observed a year ago in September 2025. Notably, this improvement occurred despite adding 14 employees over the last 12 months. 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 2.5%. Underscoring the inherent efficiency of the internally managed BDC model. NAV per share increased to $16.64 per share. Up from $16.61 per share in the prior quarter. The primary driver of the increase in NAV per share was accretion from our equity ATM program, partially offset by net realized and unrealized depreciation on the investment portfolio. As Michael mentioned earlier, during the quarter, we amended our corporate credit facility. Which increased total commitments to $595 million from $510 million reduced our borrowing applicable margin to 2.0% from 2.15%, remove the incremental SOFR adjustment of 10 to 15 basis points, and extended the maturity to September 2031 from August 2028. As a result, our earliest debt maturity is now in 2029, providing us with greater long term funding certainty. Additionally, we raised $350 million in new unsecured bonds bearing 6.75 percent fixed interest and maturing in September 2031. In conjunction with the unsecured bond offering, we entered into an interest rate hedge, which effectively swaps the September 2031 notes to SOFR plus a 2.16 percent spread. Finally, we raised approximately 67 million in gross equity proceeds during the quarter through our equity ATM program. At a weighted average share price of $24.50 per share. Or 148% of the prevailing NAV per share reinforcing our ability to raise capital efficiently and accretively. Our liquidity position remains robust with approximately $647 million in cash and undrawn commitments across our 2 credit facilities. In total, this represents more than 1.6x coverage of the $394 million unfunded commitments across the portfolio. During the quarter, we also received approval to increase our applicable or, excuse me, our available leverage in the SBIC 2 fund to $250 million. Providing additional flexibility beyond our current $175 million. The SBA program continues to be an attractive source of capital for us. Offering both a competitive cost of funds and reliable long term liquidity to support portfolio growth. Regulatory leverage ended the quarter at 1-to-1 debt to equity. 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 conservative. Conservatively constructed balance sheet with adequate covenant cushions. Finally, we continue to make meaningful progress with capturing Partners, 1 of our joint ventures with Trinity Capital. The JV currently holds approximately a $127 million in first lien securities in 14 portfolio companies, with a weighted average leverage of 1.3x debt to EBITDA. We expect to continue originating low leverage high quality investments within this structure. I will now hand the call back to Michael for some final comments.

Thank you, Chris, Joshua, Amy, and Morgan, 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.

Thank you. To ask a question, you will need to press 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press 1-1 again. Our first question comes from Mickey Schleien of Clear Street.

Yes. Good morning, everyone, and thank you for taking my questions. Michael, you recorded about $15 million of unrealized appreciation on debt investments, if I am not if I am not mistaken. Which individual investments, you know, were the main drivers? And was that primarily borrower specific or indicative of some broader credit deterioration?

Yeah. there is. Thanks for the question, Mickey. there is essentially 3 companies that are on our watch list that had significant depreciation during the quarter. 1 is a car wash business that you are probably familiar with that had gone through bankruptcy. Come out of bankruptcy, and I think cyclicality related to inflation is still harming that business. Probably the balance sheet is probably still a little over leveraged to where it is. So we will see how that lands. there is a roofing business that was a roll strategy. I think the execution on that has had some hiccups, and they are trying to course correct that. And then the other 1 is a. Is an older name that is been on nonaccrual for a while, and post production CGI for the entertainment industry. And that is sort of a 2021 deal that had basically COVID issues. Based on elevated EBITDA at it coming out of COVID. And so I think they are all fairly idiosyncratic from 1 another. Those 3, I think, had about $10 million of the depreciation for the quarter, and the rest of it was really immaterial.

Well, that. that is really helpful. I think in your prepared remarks, you talked about the potential for interest rate increases. I agree that you know, every cycle is different. But could you give us a sense of how concerned you are about borrowers at the tail end of your portfolio? I mean, averages and medians are interesting, but the problems are at the tail end. If the forward curve turns out to be correct.

The Fed tightens several more times, I mean, I think I have answered the question just kind of going back to where we were when rates were 5.5%. Our interest coverage across the portfolio, I understand we are talking about sort of on detailed perspective. You have got down to 2.9 times, where it is 3.5x today. But I also think the strength of the portfolio today where it was then we have lower non accruals we did going into that cycle. I think our portfolio loan-to-values are lower. You look at the deals we just did this quarter, is almost $400 million that were at 3.4x and 33% loan to value. I would just tell you, think our portfolio. On top of that, the granularity that resides in the portfolio at about 70-6 basis points I think we are better prepared for a higher rate cycle than we were going into the last cycle. And we came out of that pretty clean, I would say.

Okay. Thank you for that. A couple more if I can. You had record originations in balance sheet leverage is now 1.5x on a debt-to-equity basis. So given your current pipeline and available liquidity, you know, how should we think about investment activity going forward and where do what is your target debt-to-equity ratio on the on the balance sheet?

So, hey, from on the origination activity, I think we are, you know, historically, before the growth in our investment team, which I think we cited on the call has grown 40% over the last 24 months. A lot of those are senior individuals. So I think our total originations quarter was going to move from where it was $150 million-ish a quarter to something closer to $250 million a quarter? The other question was how much on the equity rate.

So maybe I will take the second question. So leverage, we typically look at on a regulatory basis. And so we have said in the past, our target is 0.9 to 1.0 times regulatory. So we are certainly at the top end of that range. I would not expect it to go above that. Part of the reason for that this quarter is, obviously, we were, seeking shareholder approval for our authorized shares. Did not get that until September. So, actually, I think we did a really good job raising 67 million of equity in about a month. The other thing I would say is we are expecting a repayment cycle in this December quarter, which we have not seen in a few quarters. And so, you should think about leverage kind of moderating in the 0.9 to 1.0 times range, regulatory leverage going forward.

Yeah. I mean, over the last 3 quarters, I think we saw maybe $100 million in repayments, and we would expect that number to be maybe twice as much just in the December 31 quarter alone.

Okay. And lastly, and I appreciate your patience, So with CapTrin continued to grow and now the large. The launch of Desert Star, how meaningful could these JVs become to earnings over the next, you know, maybe year? And what returns are you targeting on your invested equity in those ventures And how should we think about the timing of dividend income from them?

Sure. You know, I may just start by maybe framing. So these 2 different JVs probably for 2 different purposes. Obviously, CapTrin is really a strategic venture, which allows us to be more competitive in deals that are sub 6%. That fund, we think since it is originating our core assets is going to grow over time. I think that the. We expect probably a mid turn. Mid teens return as the manager in that fund. I think the fund itself is about 13 percent, but we are getting scraped and some fees associated with it. Desert Star, on the other hand, so whereas we are the sourcing and originating and managing the assets for CapTrin, The inverse is true for Desert Star where Trinity is, you know, they are in that seat of originating the assets. We have committed $25 million, which will be funded over the next 3 years, and we expect a return of somewhere in the same 14% to 16% return once that facility is fully, fully ramped.

Yeah. For the earnings power, Mickey, what I would say is it is going to take-- you know, we have got $50 million in equity committed to the funds, alongside Trinity's $50 million, so $100 million total. it is probably gonna take us 12 to 15 months to get that fully funded. So we will ramp from what we have funded today, which is around $25 million up to $50 million over the next 12 months. Generating, as Michael said, sort of a 13% to 14% return.

that is really helpful.

The other thing I wanted to add too is. Desert Star you know, it is mostly gonna be software deals. And the question is like, why are we doing that today? If you look at what those deals look like in the market over the last 2 years, these are deals that were negative cash flow, negative EBITDA, They are being funded off a 2x to 4x ARR. And so not cash flow loans and it is not assets that we would frequent. That market has changed. I think there is. Since, you know, all the headline noise coming out of the last fall. there is a lot less lenders in the market. Deals today are all cash flow. I would say all of the deals that we have seen are positive cash flow, positive EBITDA. They are 1x ARR. Full set of covenants. And when we are thinking about the partnership, you know, we believe we are pretty good at what we do in the sponsored finance floor of in a market, but we do not frequent with scale in software technology. And you know, as underwriters, the more deals you look at, the better decisions you will make. And so our viewpoint is partnering with an expert in the field, we consider Trinity an expert in the venture side. Getting involved with them and having a small investment of granular size is a measured approach to investing in that industry, without taking excess risk.

If I could just follow-up, you said those deals are gonna be primarily cash flow positive. You know, there is been a lot of talk about you know, the impact of AI on these companies and that, you know, small software companies are particularly at risk because it is just so hard for them to build a moat. Can you give us a sense at least as to the scale of these businesses in terms of the EBITDA you are targeting?

Well, we are-- it is really across the board in the lower middle market to the middle market. So Trinity typically, in those deals are businesses that are in the $5 million to $25 million of the EBITDA.

So these software technology deals would still fall into that range?

Yeah. They are direct. Most of the deals will be directly originated by Trinity and not bigger club deals and syndicated deals.

Okay. I appreciate your time. Thanks for taking my questions.

Thanks, Mickey.

Thank you. Our next question is from Melissa Weidl from UBS. Your line is open.

Good morning. Thanks for taking my questions today. When I listened to what you have talked about with regard to the second JV, it really seems like, just sort of reading between the lines, you really wanna keep those 2 groups of assets separate, and that is the rationale for 2 separate JVs rather than combining into 1. Is that fair?

Yeah. Absolutely. I mean, like I said, capturing is a very strategic vehicle. It is adding value to this organization. You know, I will-- maybe I will reframe it again is that between $5 million and $8 million of EBITDA in the lower middle market is where we have real specialty. But when deals get slightly larger, and these are safer companies, they tend to price sub-6 percent. And those deals do not fit perfectly into our target ROE. And so having this JV allows us to compete and win on deals where we think that the spread should be below 6 percent and we are able to create a structure of first out last out structure. That provides the necessary yield. So that in and of itself is a strategic venture that we are focused on with growth.

As you said, the $25 million investment into Desert Star is really just that. Consider it a single investment. Which had granular risk relative to the number of companies that have been embedded within it and maybe more directly. Generally speaking, there is not gonna be any crossover between the 2 joint ventures. I mean, today, there actually is 1 asset, but going forward, we do expect them to be separate strategies and separate asset allocations.

Okay. Thanks for clarifying that. I also had a follow-up on the comment that you made about expecting more of a repayment cycle in the fourth quarter. I was hoping you could elaborate on that in terms of what is driving sort of elevated repayments that you expect in the quarter, and is that something that might be matched on the origination side?

I will say this. We have seen 2 large originations come back large to us is $30 million to $40 million and we are expecting a third of the same size towards the end of the quarter. Originations are gonna be closer, I would imagine, to what I stated earlier. Like, a normal quarter for the amount of professionals we have scouring the nation, which is probably $250 million.

I probably asked Joshua if you wanted to chime in on that. Yeah. I think the lower middle market M&A activity is actually pretty good right now. I know that the middle market and upper middle market has been a lot less activity. And so some of that is just timing of some of the sale processes of portfolio companies of ours.

Thank you.

Thank you. The next question is from Chris Mueller with Citizens. Your line is open.

Hey, guys. Thanks for taking the questions. I guess, on the growth of the investment team, is there more hiring that you guys expect to do there? And when you guys bring new people onto the platform, how long does it typically take for them to fully ramp up?

So I think the answer to the question in terms of. I do expect us to continue to hire people. I think 1 of the areas of growth that we have had over the last 18 months is in, you know, hiring and building an operations team. So to work on deals that end up in our watch list, and that is been huge value add within the organization. So that is been a number of people I think Joshua mentioned, I believe, is that we hired 2 senior people. there is originators, and there is others that have come up through our system that are now firing on all cylinders, if you will. So I would expect this to continue to hire in the. Maybe the mid to the lower end. We probably stepped up our infrastructure on the back office fully, and that will probably grow at a slower clip at the moment.

Joshua, how long would you-- Yeah. I would say. Obviously, commenting on the time to ramp. It depends on the on the on the position. We had, you know, we hired an originator, a direct-- dedicated originator earlier this year. Who had been lower middle market for the last 5 to 10 years. So the ramp up period was pretty short. And then on the deal team front, the underwriting front, sort of depends on the position, but we hired a level and a VP level underwriter who both of whom had lower middle market direct lending experience. So the ramp-up period is very, very short. When we hire, you know, a junior underwriter from, you know, either an underwriter or from investment banking, it is a little bit longer, but it is still within a few months. They can get up to speed and significantly add value.

Got it. that is helpful. And then, I guess, given the focus on tech in the Desert Star JV, will we see some positions in there, or is it going to all just be debt investments?

So Desert Star is all tech. it is all debt inside the fund. I also wanna kinda react to that, again, this is a $25 million check over 3 years. I would. I do not wanna overemphasize this is a you know, a change in strategy or, you know, over allocation to technology and software. This is, you know, an opportunity to invest alongside someone that we respect in the industry and make a nice 15 percent return.

Got it. that is fair. Appreciate you guys taking the questions today. Thanks.

Thank you. Our next question is from Robert Dodd with Raymond James. Your line is open.

Hi, guys, and congratulations on another good quarter. A couple of questions. I mean, first, on the ramp, obviously, you have just talked about it and the amount of incremental pipeline you are seeing. I mean, when I look at pipeline, can you characterize it? How much of it is now coming from. And the deal closing is coming from kind of newer relationships versus more established. I mean, I just think the risk profile is different. Right? If you have known a sponsor for decades, you know how they think. You know how they invest. If it is somebody. If it is a sponsor that is a new relationship over the last 18 months, it might not be more risky, but there is more uncertainty. So, I mean, is there a different approach in terms of how you assess deal flow and pipeline that is coming from those newer relationships versus those longer standing ones? And are those new relationships the factor that is driving the increase in originations right now? And how should we think about the relative uncertainty of long standing relationships versus newer ones?

Yep. Yep. The first thing I would answer on that is our close rate has come down from 22% closer to, I think, 1.7%. So by and large, your question is true. We originate. We are accepting a lot less deals because the people that join us do have to go through a process of learning us and us learning them.

I think Joshua, you want to get some more detail on-- Yeah. I think. Look, I mean, I think it takes years to cultivate a relationship where you sort of touched on this, where. You create that trust level and you know, you kind of. You know each other very well. What I would say is, you know, the way that this generally plays is that you know, you meet a new relationship or you get a new relationship, and, you know, you may not see a deal from them for a few months or you see a deal and then, you know, you get to see how each other think, what kinds of deals they are looking at, how we how we think about the deal. You likely do not win a deal from a relationship that you that you create for a year or 2, maybe even 3 years. that is 1 of the reasons why our pipeline is growing because we had a couple of we have 1 new originator who is driving a lot of growth. We also have a couple of originators who have been doing it for 3 or 4 years. And some of those were relationships that they created 3, 4 years ago, are coming to the forefront now. You start to see, okay, maybe they saw zero or 1 deal in the first year. They sort of created that relationship, but then taking multiple trips to that specific city or seeing them at conferences and getting to know people better. You know, year 3 and 4 is when you start to see all of their deal flow, that kind of thing. And so that is 1 of the real reasons why we are driving a lot more pipeline and a lot more deal flow right now from relationships that we started in, you know, 3 or 4 years ago and have cultivated over that time period.

Got it. Thank you for that.

Anecdotal too, Robert, is that if we hired a business development professional MD in January. So I guess, you know, we are here in November now. And he is brought in sizable amount of traffic on deals. And we closed 2 deals with him over this you know, 10 months. So obviously, you know, that deal flow is there, but, you know, his win rate will increase once again when we get more comfortable with his deal flow and vice versa as well.

Got it. Thank you. On 1, I got. I have to go back to Desert Star. Yeah. I mean, it is it is small. You are only allocating $25 million. But what is your edge on reviewing those software deals? Obviously, Trinity is 1, long-established lender in that segment of the market. But what do you bring to the table other than capital? Right? Because, obviously, it is your capital that is been put. Or shareholders' capital that has been put at risk in principle. I mean, what is the value add that you bring on rejecting a deal if it is inappropriate when it is tech specific I mean, you could have just bought $25 million of Trinity stock, so to speak. I am not saying we are recommending that, but why this approach if it is not your area of expertise?

So I would probably agree with that phrase. I think first of all, yes, we bring cash to the deal. But in both joint ventures, we have 50/50 voting rights. Right? At the end of the day, these businesses are still lower middle market small businesses that our guys are experts in the field in underwriting. The reason why we do not focus on doing software deals ourselves is kind of what I said earlier. If we see a 100 deals, and close 2, you would like to think that you, you know, force ranked the best deals, and those are gonna be the best deals that you could have invested in. In our pipeline, we may only see 10 deals in-- on software in a given year And if we are investing 2 out of 10, now that is 20%. You have to assume those deals may not have been the best deal. So I think in this circumstance, we still bring the underwriting to the table. We certainly bring the cash. And we have all of the input similar that they have with us. On any particular deal to veto the deal if we if we do not get comfortable.

And Josh, do you want to enter-- Yeah. I mean, like, the way that we think about it is just a very. it is a it is a good way for us to deploy a small amount of capital into a strategy that we have not focused on in a very granular way. And so we get to approve the amounts and the deals, and we have, you know, we seek and see a deal and say, we do not really like that 1. I do not wanna put it in. So we get to kinda handpick the deals. Right? They have a lot more expertise in tech investment than we do, and we wanna leverage that. We want to-- and we want to leverage their relationships and sponsors. Without taking, you know, a big bet in sort of software and tech-- in tech lending.

Got it. Got it. Thank you. If I can, 1 more. Your spillover, our UTI, is approaching a dollar again. I mean, it is it is a good problem to have to support the dividend. Is there any conceptual, you know, rule of thumb? Right? I mean, how much you would be willing to accept? If that keeps building, eventually, something has to be done about it, which obviously the special dividends or supplemental dividends is the way to deal with that. it is just-- is there a way we should think about that in terms of, like, how much you would you would like to keep as a as a max or a minimum on that side of the you know, the-- Yeah. Because obviously, it is embedded in NEV as well. I mean, how-- what should we be thinking about on how much UTI is acceptable in your view?

Yep. So I would tell you that rule of thumb, we think a dollar of UTI is a strong balance. On the inverse side, we would tell you that anything at $0.50 and below, you know, at $0.06 per quarter would be too small. The other thing I would add kind of where you are going with the question is, that we have been talking over the last probably 18 months about some sizable exits that were gonna occur, and we saw, you know, the UTI was gonna jump considerably. Those actually. Those companies are performing, but they pushed their sale processes. So we have grown our UTI organically through under distributing the dividend, We have grown it through small granular equity exits. And we still do expect probably 1 of those in 2027 and maybe the other 1 either 2020, you know, 2027 at the end or 2028. So we could see that balance grow sizably. What does that mean? I would tell you that, you know, we would look to increase the supplemental over time once we get comfort where that UTI balance is. And, you know, you did not ask, but it will be. I would say on the regular dividend, I would say, look, we have done what we believe is a pretty strong job of managing NII down through a rate cycle that came down to, you know, 3.5 percent and maintained our dividend at 100%. With the strength of our deal team, with the strength of the originations this quarter, and with the likelihood rates increasing, we are fairly bullish it is possible that either or both the supplemental and the regular dividends will be growing. probably in, you know, 2027.

Thank you.

Thank you. Our next question is from Sean-Paul Adams with B. Riley Securities. Your line is open.

Hi. Good morning. Was actually the second mention of car wash businesses. This morning in the context of consumer facing businesses feeling a pullback in spending. With wash and wax and Apple Roofing getting added to non-accrual this quarter, I think Company X Roof is also marked below par. You guys now have 2 roofing businesses and a car wash kind of facing consumer pressure. Beyond those, which other parts of the portfolio are you guys seeing exposed to a slowdown in low end consumer spending?

You know, it is interesting. I think that the consumer spending on car washes that we are in is part of the story. But a big part of it also is some of the execution and also an overbuild in car wash centers specifically. And so it is specific to the geographies that we. That this company is focused in. So you know, it is there. Certainly, spending has been. it has attributed to the underperformance, but it is a little bit of it. Well, a lot of it was capital structure overbuild in specific geographies, And so you know, that is. That was a big part of the story as well. On the roofing side, you know, I think it is pretty much across the board that roofing, you had a couple of bad storm years. So 1 of our businesses is heavily focused on storm. And so you have had a couple of bad storm years. Which happens, and that is driven some of the weakness there. And then it is also just been. A lot of it is been execution too. I mean, like, a lot of it is been execution on roll up strategies across the board. From what I have heard across the industry, outside our portfolio companies. So less than consumer spending, particularly on the roofing side. You know, a lot of the roofing example, 1 of our businesses it is specifically an insurance driven business. So that is not gonna be there may be a little bit of consumer spending in there, but it will not be a lot.

Got it. Appreciate the color. Thank you.

Thank you. Our next call is from Erik Zwick with Lucid Capital Markets. Your line is open.

Thanks. Good morning, everyone. I appreciate all the commentary on the new originations of the quarter in terms of average spreads and leverage. I guess 1 thing I had not heard you mention, unless I missed it was just any commentary you have on structure and covenants whether there is been any changes there, in the most recent quarter relative to maybe the past year or so.

Yeah. I mean, honestly, the 1 thing you have to understand on every origination we do, they are gonna have full set of covenants. Mean, you are gonna be in the lower middle market, our big advantage is the fact that we can get full covenants, that we can have low leverage in LTV and so we are. We take advantage of that in each and every case.

Joshua, would you have anything to add to that? Yeah. The structure has stayed really, really firm. I mean, that is the bottom line. it is. And part of that is driven by our discipline. And part of that is driven by the market discipline in the lower middle market. So the combination of both, I think, is driven by, you know, us to have really strong credit agreements really for a long time. And so the more fluid dynamic in the lower middle market is pricing. And structures have not wavered all that much.

that is good to hear. Thanks. And curious just in terms of the increased SBA capacity, what percentage of the pipeline today would be SBA eligible?

Yeah. So we have been pretty consistent on this point. You know, I think roughly 75% of the deals that we see or that come in for serious consideration are SBIC eligible. And so SBIC 2 continues to ramp You know, I think we are not quite at the point to take the additional $75 million of leverage just yet. But that will probably happen in the next quarter or so.

And then, last 1 for me. You mentioned, you know, potential repayment cycle in calendar 4Q. Curious on the equity realization side it is sometimes a little bit harder to have an outlook out past more than a quarter or so there, but just any potential equity realizations towards the end of the year?

So the capital that is coming back this quarter is primarily debt only. I cannot think of any names. We have 1 small equity gain that we expect to come back later in the quarter. Obviously, that is subject to the sale process. But looking forward, early, it could be as soon as the March quarter., We do have 1 of the again, 1 of the assets that we kind of discussed over time. Might have an exit that could be, you know, fairly sizable between $10 million and $15 million.

Thank you for taking my questions today.

Thank you. I am showing no further questions at this time. I would now like to turn it back to Michael Scott Sarner, CEO, for closing remarks.

We appreciate everybody taking the time today to listen in, and I appreciate all the questions. I know that was pretty spirited conversation and I appreciate it. We look forward to telling the story again next quarter and I hope everybody has a good rest of the week.