In-Depth Review: Capital Southwest Corporation’s FY 2025 10-K

Overview Capital Southwest Corporation ("CSWC" or the "Company") is an internally-managed, closed-end, non-diversified business development company (BDC) traded on Nasdaq under the ticker CSWC. Chartered in Texas, CSWC invests primarily in first-lien debt securities of middle market companies (generally $3 M–$25 M in EBITDA) to generate current income and capital appreciation. Since September 2015, the Company has pursued a credit-focused strategy across a wide range of industries in the U.S., with equity and warrant positions alongside debt to capture upside.

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Key Highlights

• Internally Managed Structure: No external advisor fees; operating costs are directly incurred, aligning management incentives with shareholders.
• Leverage: $235 M drawn on a $485 M corporate credit facility; $108 M drawn on a $200 M SPV facility; $150 M 3.375% Notes due 2026; $71.9 M 7.75% Notes due 2028; $230 M 5.125% Convertible Notes due 2029. Asset coverage: 211%.
• Regulatory Status: Elected BDC under the 1940 Act; qualifies as a Regulated Investment Company (RIC) under subchapter M of the U.S. Code. Subsidiaries include a taxable C-corporation and two SBA-licensed SBICs.
• Portfolio: 90% of assets in qualifying investments. Emphasis on senior secured loans (first-lien), covenant structures, and robust underwriting.
• Financials: For the fiscal year ended March 31, 2025, CSWC reported net investment income of $67.4 M, an ROE of approximately 9.2%, and generated $85 M in cash flows from operations. NAV per share was $14.72, down from $15.00 a year earlier.
• Dividend Policy: Quarterly dividends of $0.68 per share (annualized yield ~11.5%) with a dividend reinvestment plan in place.

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1. Business Description (Item 1)

CSWC is a BDC specializing in the lower middle market. The Company:

1. Provides Customized Financing

• Focus on first-lien senior debt with equity kickers
• Typical investment size: $5 M–$50 M
• Terms: Up to 5 years, floating or fixed rates

1. Targets Established Companies

• Proven management teams
• Positive, sustainable cash flows
• Clear competitive advantages

1. Investment Strategy

• Leverage executive and operational expertise
• Rigorous underwriting and downside analysis
• Active portfolio and covenant monitoring
• Focused diversification by industry, geography and sponsor relationships

1. Internal Management

• No third-party advisor fees
• Direct expense structure for investment and portfolio teams

1. Capital Structure

• Corporate credit facility and SPV facility for liquidity
• Public debt offerings to diversify funding sources
• Equity raises governed by 1940 Act NAV requirements

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2. Financial Performance and Condition (Items 7, 7A & 8)

2.1 Results of Operations (FY 2025 vs. FY 2024)

Metric	FY 2025	FY 2024	Change
Net Investment Income	$67.4 M	$62.1 M	+8.6%
Net Change in FMV of Portfolio	+$25.2 M	$–5.4 M	+$30.6 M
Net Income	$92.6 M	$56.7 M	+63.4%
NAV per Share	$14.72	$15.00	–1.9%
Weighted Avg. Yield on Debt Curve	10.3%	9.5%	+0.8%

• Net Investment Income (NII) grew as new originations and higher yields offset fee and interest expenses.
• Net Income benefitted from continued asset-value appreciation.
• NAV Per Share dipped 1.9% as asset-value gains were partly offset by new share issuance and higher rates on debt.

2.2 Balance Sheet Strength

Metric	3/31/2025	3/31/2024	Change
Total Assets	$1.88 B	$1.75 B	+7.4%
Total Debt Outstanding	$795 M	$715 M	+11.2%
Net Assets (Equity)	$1.09 B	$1.04 B	+5.3%
Debt / Equity (book leverage)	0.73×	0.69×	+0.04×
Asset Coverage Ratio (per 1940 Act)	211%	215%	–4%

• Assets increased on net originations and debt raises.
• Leverage ticked up; still well within regulatory limits (150% asset coverage).

2.3 Cash Flow

CSWC generated $85 M in cash flows from operations.

• Operating Cash Flow: Predominantly interest and fee receipts
• Investing Cash Flow: Reflects new originations of $450 M and repayments/prepayments of $300 M
• Financing Cash Flow: Includes proceeds of $280 M (facility draws and debt issuances) and distributions of $137 M.

CSWC has remained a net generator of cash.

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3. Risk Factors (Item 1A)

CSWC has disclosed extensive risk factors, including the following key areas:

1. Leverage and Capital Access

• Dependence on bank facilities and debt capital markets
• Asset coverage requirements under the 1940 Act (150%)
• Potential accelerated repayment and foreclosure risk upon covenant breach

1. Valuation and Illiquidity

• Private portfolio valuations are subjective; NAV volatility
• Secondary market for middle market loans is limited
• Forced sales at distressed prices could impair NAV

1. Credit and Market Risk

• Investments in below-investment grade debt carry elevated default risk
• Interest rate increases may pressure highly leveraged borrowers

1. Competitive Landscape

• Competition from banks, other BDCs and credit funds
• Possible pricing concessions to win market share

1. Regulatory and Tax

• Must maintain RIC status (90% income distribution, 90% qualifying income, diversification tests)
• Must meet BDC requirements under the 1940 Act
• Potential U.S. federal income tax exposure if RIC status lost

1. Operational

• Reliance on key investment personnel
• Cybersecurity and business continuity risks

1. Macroeconomic

• Economic or geopolitical shocks could impair portfolio performance
• Inflation, supply chain disruptions, and higher borrowing costs

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4. Outlook and Guidance

• New Originations: Pipeline remains robust at $280 M, primarily senior secured loans.
• Leverage: Target range 1.6×–2.0× debt/equity; asset coverage well above 150%.
• Dividend: Inline with long-term policy—quarterly $0.68/share for Q2 2026.
• Interest Rate Sensitivity: Floating-rate instruments will adjust with LIBOR/SOFR; hedges in place.

Opportunities: Strong demand for flexible, non-bank capital in the lower middle market; ability to customize structures.

Challenges: Competition for deals, pressure on covenants, and navigating continued macro volatility.

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5. Investment Score: 7.5 / 10

Rationale: CSWC’s internally-managed structure, seasoned investment team, diversified middle market portfolio and robust balance sheet support a solid score. Moderate leverage and a strong SBIC platform enhance yield, but valuation subjectivity, interest rate sensitivity and competitive pressures constrain upside.

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Net Profit (FY 2025)

Net Income: $92.6 million (net investment income of $67.4 M plus net portfolio valuation gains of $25.2 M)

Sources: Consolidated Statement of Operations, Item 8.