Capital Southwest - Earnings Call - Q3 2025
February 4, 2025
Executive Summary
- Solid quarter on origination and income: total investment income rose sequentially to $56.9M, pre-tax NII was $34.0M ($0.61/sh), and NII was $32.0M ($0.57/sh) for the quarter ended Sep 30, 2025 (calendar Q3 2025; CSWC FQ2’26). NAV/share ticked up to $16.62 on ATM accretion despite modest portfolio depreciation.
- Balance sheet de-risked: issued $350M 5.950% 2030 notes, then redeemed in full the 2026 and 2028 notes post-quarter with no make‑whole; pro forma regulatory leverage ~0.82x vs reported 0.91x at quarter end.
- Credit quality stable with low non-accruals (1.0% of FV) and strong coverage; weighted average yield eased to 11.5% on compression and mix, but fee income offset PIK declines, keeping total income growing QoQ.
- Dividends maintained: Board declared regular monthly $0.1934 for Oct/Nov/Dec and $0.06 supplemental for December (total $0.64 for the quarter). UTI increased to $1.13/sh, supporting supplemental capacity.
- Near-term catalysts: sustained robust origination pipeline and capital structure extension could support NII resilience; watch spread environment and base rate trajectory per management’s commentary on potential yield pressure.
What Went Well and What Went Wrong
- What Went Well
- Robust origination and fee momentum: “approximately $245 million of originations in seven new and ten existing portfolio companies” with weighted average spread ~6.5% on new commitments; fees helped lift total investment income sequentially.
- Balance sheet actions reduced refinancing risk: $350M of 2030 notes issued; 2026 and 2028 notes redeemed with no make‑whole; CFO noted pro forma leverage back to ~0.82x and liquidity >2x unfunded commitments.
- Dividend sustainability: 104% LTM regular dividend coverage and UTI rose to $1.13/sh, supporting continued supplemental dividends.
- What Went Wrong
- Yield compression and modest portfolio depreciation: weighted average debt yield fell to 11.5% (from 11.83% in prior quarter) due to non-accruals and spread compression; net realized/unrealized losses of $6.4M (primarily on debt).
- Higher interest expense with higher borrowings: interest expense increased to $16.0M QoQ.
- Taxes and deferred tax effects weighed: total tax provision rose to $2.0M, including $0.9M deferred tax expense tied to tax basis changes in a taxable subsidiary.
Transcript
Operator (participant)
Thank you for joining today's Capital Southwest Third Quarter Fiscal Year 2025 earnings call. Participating on the call today are Bowen Diehl, Chief Executive Officer, Michael Sarner, Chief Financial Officer, Josh Weinstein, Chief Investment Officer, and Chris Rehberger, Executive Vice President, Finance. I will now turn the call over to Chris Rehberger.
Chris Rehberger (EVP of Finance)
Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions, and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest 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 off to our Chief Executive Officer, Bowen Diehl.
Bowen Diehl (CEO)
Thanks, Chris, and thank you, everyone, for joining us for our Third Quarter Fiscal Year 2025 earnings call. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company and our portfolio as we continue to diligently execute our investment strategy as stewards of your capital. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found in the Investor Relations section of our website at www.capitalsouthwest.com. You will also find our quarterly earnings press release issued last evening on our website. We'll now begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter.
During the quarter, we generated pre-tax net investment income of $0.64 per share, which fully covered both our regular dividend of $0.58 per share and our supplemental dividend of $0.05 per share paid during the quarter. Portfolio earnings continued to be strong, and as of the end of the quarter, we estimate that our undistributed taxable income was $0.68 per share, which is up from our prior quarter estimate of $0.64 per share. As we look forward to the March quarter, we are pleased to announce that our Board of Directors has declared a regular dividend of $0.58 per share for the quarter ending March 31, 2025. Additionally, our board has declared an increase to the supplemental dividend to $0.06 per share from the $0.05 per share in the December quarter, bringing total dividends declared for the March quarter to $0.64 per share.
Deal flow in the lower middle market was very strong this quarter, and the competitive environment around quality deals continued at the feverish pace we have seen for the past few quarters. Portfolio activity during the quarter consisted of $317.5 million in new commitments to nine new portfolio companies and 20 existing portfolio companies. Add-on financings continued to be an important component of many private equity firms' investment theses and a highly attractive source of originations for us. In fact, over 41% of total capital commitments during the quarter were follow-on financings in performing companies. The deals we are currently underwriting continue to have loan-to-value levels ranging from 35%-50%, resulting in significant equity capital cushion below our debt and reasonable leverage levels of around 3.5x debt-to-EBITDA.
Josh Weinstein will provide additional color on the market, our investment activity, and the performance of our portfolio later in our prepared remarks. On the capitalization front, during the quarter, we issued $230 million in aggregate principal of convertible notes with a coupon of 5.125% and an initial conversion price of $25 per share. Net proceeds from these convertible notes were used to redeem in full the $140 million January 2026 notes, as well as pay down our senior secured revolving credit facility. Importantly, there was no make-hole payment associated with the repayment of the January 2026 notes. Michael will walk through some additional important mechanics of the convertible bond offering in a moment.
Additionally, we received a green light letter from the SBA allowing us to submit our final application for our second SBIC license, and we have been informed by the SBA that we will receive final approval any day. We are excited about our continued participation in the SBA program, as this program has been and will continue to be a very important component of our capitalization strategy. Finally, we raised approximately $54 million in gross equity proceeds during the quarter through our Equity ATM Program at a weighted average share price of $22.68 per share, or 137% of the prevailing NAV per share. We have remained diligent in ensuring that we have strong balance sheet liquidity while also funding a meaningful portion of our investment activity with both unsecured debt and accretive equity issuances. We continue to maintain a conservative mindset to both BDC leverage and balance sheet liquidity.
Balance sheet liquidity at Capital Southwest remains robust, which Michael will provide additional commentary on in a moment. Ensuring strong balance sheet liquidity affords us the ability to continue to invest in new platform companies as well as provide financing for both growth capital and add-on acquisitions for our existing portfolio companies. We believe this strategy allows us to continue to grow our balance sheet through any capital markets environment while also maintaining the flexibility to opportunistically repurchase our stock if it were to trade meaningfully below NAV. On slides seven and eight, we illustrate our continued track record of producing steady dividend growth, consistent dividend coverage, and solid value creation. Since the launch of our credit strategy, we have increased our quarterly regular dividend 29x and have never cut the regular dividend, all while maintaining strong coverage of our regular dividend with pre-tax net investment income.
In addition, over the same period, we have paid or declared 27 special or supplemental dividends totaling $4.12 per share, all generated from excess earnings and realized gains from our investment portfolio. Dividend sustainability, strong credit performance, and continued access to capital from multiple capital sources are all core to our overall strategy. Our track record in all these areas demonstrates the strength of our investment and capitalization management strategies, as well as the absolute alignment of all our decisions with the interests of our fellow shareholders. As a reminder, slide nine lays out the core tenets of our investment strategy in lending and investing in the lower middle market. The vast majority of our portfolio and deal activity is in first-lien senior secured loans to companies backed by private equity firms.
Currently, approximately 94% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as the potential for junior capital support if needed. In the lower middle market, we often have the opportunity to invest on a minority basis in the equity of our portfolio companies. Pari passu with the private equity firm when we believe the equity thesis is compelling. As of the end of the quarter, our equity co-investment portfolio consisted of 77 investments with a total fair value of $159 million, representing 9% of our total portfolio fair value. Our equity portfolio was marked at 143% of our cost, representing $47.9 million in embedded unrealized appreciation, or $0.96 per share.
Our equity portfolio continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, often resulting from the institutionalization of the businesses by experienced private equity firms, as well as the significant value accretion potential of strategic add-on acquisitions. Equity co-investments across our portfolio provide our shareholders with the potential for asset value appreciation, as well as equity distributions to Capital Southwest over time. To that end, I would note that we have two equity investments currently in the final stages of sale processes, which should provide meaningful realized gains for Capital Southwest in the March 2025 quarter. Additionally, we are seeing some increased visibility in our portfolio on companies beginning sales processes in 2025, several of which could result in material realized gains later this year for Capital Southwest. We look forward to providing you updates as appropriate as they develop.
As illustrated on slide 10, our on-balance sheet credit portfolio ended the quarter at $1.5 billion, representing year-over-year growth of 31% from $1.2 billion as of December 2023. For the current quarter, 100% of our new portfolio debt originations were first-lien senior secured, and as of the end of the quarter, 98% of the credit portfolio was first-lien senior secured, with weighted average exposure per company of only 0.9%. We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet. I will now hand the call over to Josh to review more specifics of our investment activity, the market environment, and the performance of our portfolio for the quarter.
Josh Weinstein (CIO)
Thanks, Bowen. On slide 11 and 12, we detail the $317.5 million of capital invested in and committed to portfolio companies during the quarter. Capital committed during the quarter included $172.3 million in first-lien senior secured debt across nine new portfolio companies, in which we also invested a total of $3 million in equity. In addition, we closed add-on financings for 20 existing portfolio companies consisting of $141.1 million in first-lien senior secured debt and $1.1 million in equity. We are pleased with the strong market position that our team has established as a premier lender to the lower middle market. This is evidenced by the broad array of relationships across the country from which our team is sourcing quality opportunities. As a point of reference, currently, there are 80 unique private equity firms represented across our investment portfolio.
Additionally, in the last year, we closed 17 new platforms with financial sponsors with which we had not previously closed a deal, demonstrating our continued penetration in the market. Since the launch of our credit strategy, we have completed transactions with over 110 different private equity firms across the country, including over 20% with which we have completed multiple transactions. As Bowen mentioned, the lower middle market continues to be quite competitive, as this segment of the market is highly attractive to both bank and non-bank lenders. While this has resulted in tight loan pricing for high-quality opportunities, the depth and strength of the relationships our team has cultivated over the years has continued to result in our sourcing and winning opportunities with attractive risk-return profiles. On slide 14, we detail key statistics for our portfolio as of the end of the quarter.
The total portfolio consisted of 125 different companies with fair value. As of the end of the quarter, weighted 89.1% to first-lien senior secured debt, 1.5% to second-lien senior secured debt, 0.1% to subordinated debt, and 9.3% to equity co-investments. The credit portfolio had a weighted average yield of 12.1% and a weighted average leverage through our security of 3.6x EBITDA. Overall, we are pleased with the operating performance across our loan portfolio. In fact, as shown on slide 15, the number of portfolio upgrades were meaningfully more than the number of downgrades this quarter. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating.
We had nine loans in five portfolio companies representing $99 million in fair value upgraded during the quarter, while having three loans in three portfolio companies representing approximately $17.4 million in fair value downgraded during the quarter. Overall, the portfolio remains healthy with approximately 95% of the portfolio at fair value rated in one of the top two categories, a 1 or a 2, and approximately 5% of the portfolio in the 3 or 4 category. Cash flow coverage of debt service obligations across the portfolio remains at a healthy 3.5x, with our loans across our portfolio averaging approximately 41% of the portfolio company enterprise value. Quarter-over-quarter revenue and EBITDA growth on a weighted average basis were each approximately 3%. As seen on slide 16, our portfolio continues to be broadly diversified across industries, with an asset mix which provides strong security for our shareholders' capital.
In addition to industry diversification, our average exposure per company is less than 1% of assets, which gives us great comfort in the overall risk profile of our portfolio. Our investment committee members utilize our cumulative experiences navigating through various economic cycles to continually assess risk both on a company-by-company basis as well as on the overall portfolio. In the current environment, that includes being in close contact with our sponsors and portfolio companies to proactively assess any anticipated effects of recent and future policies on tariffs and immigration. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.
Michael Sarner (CFO)
Thanks, Josh. Specific to our performance for the quarter, as summarized on slide 17, pre-tax net investment income was $30.7 million or $0.64 per share, as compared to $30 million or $0.64 per share in the prior quarter. For the quarter, total investment income increased to $52 million from $48.7 million in the prior quarter. The increase was driven primarily by a $3.2 million increase in fees and other income compared to the prior quarter. As of the end of the quarter, our loans on non-accrual represented 2.7% of our investment portfolio at fair value, and the weighted average yield in the portfolio on all investments was 12.1%. During the quarter, we paid out a $0.58 per share regular dividend and a $0.05 per share supplemental dividend.
As mentioned earlier, our board has declared a regular dividend of $0.58 per share while also increasing the supplemental dividend to $0.06 per share for the March quarter. Management and the board have spent significant time contemplating the impact of a lower interest rate environment on future earnings. We have consistently maintained that setting a regular dividend at a level that we believe will never be cut in any foreseeable interest rate environment is key to generating stable, attractive shareholder returns over the long term. We continued our strong track record of regular dividend coverage with 115% coverage for the 12 months ended December 31st, 2024, and 111% cumulative coverage since the launch of our credit strategy.
We are confident in our ability to continue to distribute quarterly supplemental dividends for the foreseeable future based upon our current UTI balance of $0.68 per share and the expectation that we will harvest gains over time from our existing $0.96 per share in unrealized appreciation on the equity portfolio. As Bowen mentioned earlier, we have two equity investments in sale processes, both expected to close within the next two weeks. These realized gains, all else equal, should increase our UTI balance by a further $0.10-$0.15 per share as of the end of the March quarter. As seen on slide 18, LTM operating leverage ended the quarter at 1.6%. Our operating leverage of 1.6% continues to compare favorably to the BDC industry average of approximately 2.8%. We believe this metric speaks to the benefits of the internally managed BDC model and our absolute alignment with shareholders.
The internally managed model has and will continue to produce real fixed cost leverage while also allowing for significant resources to be invested in people and infrastructure as we continue to grow and manage a best-in-class BDC. Turning to slide 19, the company's NAV per share at the end of the quarter was flat at $16.59 per share. The primary drivers of the NAV per share bridge for the quarter were accretion from the issuance of common stock at a premium to NAV per share, offset by the net realized and unrealized appreciation on our investment portfolio.
Turning to slide 20, we are pleased to report that our balance sheet liquidity is robust with approximately $412 million in cash and undrawn leverage commitments on our two credit facilities, which altogether represented 2.1x the $193 million of unfunded commitments we had across our portfolio as of the end of the quarter. As Bowen mentioned earlier, in the December quarter, we issued $230 million in aggregate principal of 5.125% convertible notes due 2029, with an initial conversion price of $25 per share. These net proceeds were used to redeem, in full, the $140 million January 2026 bonds, as well as pay down our revolving credit facility. As of the end of the December quarter, 48% of our capital structure liabilities were in unsecured covenant-free bonds with our earliest debt maturity in October 2026.
Delving a bit deeper into the convertible bond issuance, we believe there has been some confusion in the market regarding the issuance, which I would like to address. First, we did not incur any make-whole premium in the takeout of the January 2026 bonds. Second, we have always stressed the importance of balance sheet flexibility and staying well ahead of our debt maturities. Using this convertible issuance to redeem our January 2026 bonds, as well as to pay down our credit facility, gives a further dry powder to continue to originate attractive investment opportunities in all market environments. Moreover, based on today's five-year treasury rate, the rate on the convertible note was approximately 200 basis points cheaper than the current market for a traditional unsecured bond, resulting in significant interest expense savings, which flow directly to pre-tax NII. Additionally, the convertible notes have a flex settlement mechanism.
This means that to the extent our stock trades significantly above the conversion price and certain holders of the notes elect to convert, Capital Southwest would have the option to redeem the notes in cash, shares, or any combination thereof. This gives us the ability to actively manage balance sheet leverage, the impact of any dilution, and the opportunity, in this instance, to issue equity at share prices which would be significantly above net asset value and thus be highly accretive to our shareholders. Turning to our SBIC program, in early 2024, we submitted a MAQ application to the SBA, which began the process towards a second SBIC license. In December 2024, we received a green light letter from the SBA, allowing us to submit our final application, which we completed in January 2025. We expect to receive final approval for SBIC II imminently.
Our regulatory leverage, as seen on slide 21, ended the quarter at a debt-to-equity ratio of 0.9-1, up from 0.8-1 as of the prior quarter. While our optimal target leverage continues to be in the 0.8-0.95 range, we are weighing the impacts of future base rate reductions and maintaining adequate cushion levels to allow us the flexibility to potentially increase leverage to support future earnings and dividend growth. We will continue to methodically and opportunistically raise secured and unsecured debt capital, as well as equity capital through our ATM Program, to ensure we maintain significant liquidity and conservative balance sheet leverage with adequate covenant cushions. I will now hand the call back to Bowen for some final comments.
Bowen Diehl (CEO)
Thank you, Michael, and thank you, Josh. And again, thank you, everyone, for joining us today. As always, we appreciate the opportunity to provide you with an update on our business, our portfolio, and the market environment. Our company and portfolio continue to perform well, and we are pleased with the company's robust asset base, deal origination, and portfolio management capability, as well as flexible capital structure. The overall health and security of our portfolio is strong. Our portfolio is predominantly made up of first-lien senior secured loans allocated across a broader array of companies and industries, with weighted average exposure per company under 1%. The vast majority of our portfolio is backed by private equity firms. Interest coverage on the debt obligations across our portfolio is a solid 3.5x, with strong equity value cushion and support below our debt investments.
Additionally, our equity co-investment portfolio gives our shareholders participation in the equity upside of many of these growing lower middle market businesses, providing further enhancement to our long-term shareholder returns. Last but not least, we have a very well-capitalized balance sheet with multiple capital sources and significant balance sheet liquidity, all of which provides our company an exciting runway to continue to grow and generate strong shareholder returns. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.
Operator (participant)
Thank you, sir. As a reminder, to ask a question, you would need to press star one one on your telephone. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster, and I show our first question comes from the line of Mickey Schleien from Ladenburg. Please go ahead.
Mickey Schleien (Analyst)
Yes. Good morning, everyone. Bowen, you mentioned that follow-on investments were an important part of your investment activity this quarter, but could you also give us some insight into the trends you're seeing in terms of new investment M&A activity in your market, considering that the election's behind us now and maybe there's a little bit more certainty in the direction of interest rates?
Bowen Diehl (CEO)
Yeah. I mean, so obviously, the M&A market was, in our market, active in the fourth quarter. We've seen that activity continue into the first quarter. Generally speaking, as we referenced, we're seeing some visibility on some exits in our portfolio for the calendar 2025, some immediate ones, and then we think some future ones. So the M&A market, as we've all heard in the industry, people talk about hoping that it increases in 2025. I think we're seeing some early signs that that actually might be the case as we look forward. I don't know, Josh, if you have anything to add to that.
Josh Weinstein (CIO)
Yeah. I mean, I think you covered most of it, but I think we've obviously worked really hard over the last 10 years or so to create and cultivate relationships in that lower middle market, and we feel like while it remains competitive, we're continuing to be well-positioned to participate in that M&A activity in 2025.
Michael Sarner (CFO)
Yeah. And as an anecdote, we did $320 million of funded, or I should say committed investments in the 12/31 quarter. And that had, I think we had 11 new platform companies and 20-something add-ons. For this current quarter, we are also seeing a continuation of that, seeing a lot of granularity in the deals we're seeing and the expectation that we're able to put on additional platform companies. So it's definitely something where you expect our baseline originations in the near term to be higher than the previous.
Mickey Schleien (Analyst)
Even though this tends to be a seasonally slower quarter, Mike?
Michael Sarner (CFO)
Yeah. No, this quarter for certain, I think we would tell you our normal quarter probably would be somewhere between maybe 125 and 150. But I would also say, to Josh's point, we've added on a lot of sponsors. I mean, we've seen a lot of traction in the market. So I would expect our number to be something closer to 150 million-200 million in originations for this coming quarter.
Josh Weinstein (CIO)
We had a number of deals that were targeting closing by the end of the fourth quarter that leaked into the first quarter. I think it'll help mitigate some of that seasonality this year.
Mickey Schleien (Analyst)
I understand. You also had really low repayment activity. To what extent did call protection keep repayments low, and how much refinancing risk do you see in the portfolio given all the pressure there is on spreads?
Michael Sarner (CFO)
I mean, looking ahead, I would tell you that we have had calls. I mean, I think we do expect to see some level of prepayments into the future. To your point on call protection, we had one repayment of size in the previous quarter that had call protection where we generated, I think, approximately $600,000 in fees. But some of the deals we're looking at are probably 2022 and 2023 where you have some of that call protection either winding down or maybe it's only 1%, and they're willing to pay that and get out of the credit. So I mean, I think rule of thumb for us, I mean, we're expecting probably maybe to see 10%-15% of the portfolio rotate in the 2025 calendar year.
Josh Weinstein (CIO)
Based on the risk that we've created over the years, we usually get the call before there's a repricing where we have the opportunity to lower our pricing and stay in the deal. And we obviously assess that on a situation-by-situation basis to see if we want to stay in the deal at the lower pricing. So we would expect some pressure just given potential competitive factors, but we feel like we're pretty well-positioned to continue to stay in the deals and not get repriced out.
Bowen Diehl (CEO)
I would add, Mickey, that as we referenced the UTI increase and the potential exits this year, those are obviously well-performing companies, but oftentimes they also have debt in them if we haven't already been recapped out. So I think it's probably fair to expect that a meaningful portion of our prepayments will be driven by M&A activity, which is not really a function of prepayment penalties. I mean, private equity firms selling the business because it's time to sell the business, not because of the prepayment, so.
Mickey Schleien (Analyst)
Yeah. No, I understand. That's helpful. Last question, then I'll get back in the queue. You have investments in sectors like food and consumer machinery. How do you see tariffs, which I know are a moving target, but we seem to be moving in the direction of tariffs? How do you see those tariffs impacting these companies or the portfolio in general?
Josh Weinstein (CIO)
Yeah. I mean, you mentioned it. We have 120, 125 portfolio companies, so clearly we're going to have some exposure. Based on our preliminary analysis, it looks like around 10% of our portfolio could see some impact. That being said, we are first-lien senior secured lenders, so we think that positioning in the capital structure will mute the impact to our portfolio. And obviously, information is real-time, and we're continuing to monitor it and analyze it as it comes through. But the diverse portfolio with the first-lien position feels like we're in a good position to mitigate that risk.
Michael Sarner (CFO)
The other point I'd make, too, is that during the 2016 Trump administration, they did increase tariffs as well then, particularly with China, and so we saw that impact with some of our portfolio companies, and honestly, they were still able to thrive under the environment. Obviously, it's a moving target, as you said, Mickey, so we'll have to see where those go on a go-forward basis, but I think Josh points a good one. We're also in the boardroom during investment committee meetings. We're certainly discussing the impacts to make certain any deals we're looking at on a prospective basis, we're taking into account on a downside scenario.
Bowen Diehl (CEO)
I mean, it's all happening kind of real-time, obviously, as we all know. The goalposts are moving around, but there's a lot of communication gathering, as we referenced, Josh referenced, from our sponsors and our portfolio companies. But like Josh referenced, that was kind of our initial take over the weekend.
Mickey Schleien (Analyst)
Understand. I have some more questions, but I'll get back in the queue and let some other folks take the microphone. Thanks.
Michael Sarner (CFO)
Thanks, Mickey.
Operator (participant)
Thank you. And I show our next question comes from the line of Doug Harter from UBS. Please go ahead.
Doug Harter (Analyst)
Thanks. I was hoping to get a little bit more on the SBIC license. I guess, how do you think about how long it might take to fill that up and what type of funding cost do you anticipate that being?
Michael Sarner (CFO)
First of all, I mean, I'll start by saying look, we're expecting that license to come in any day now. However, what's going on with the government right now, we understand that there's sort of a freeze for the next week or two, or actually, they don't really have a good timing on it before they come back to us. Let's just assume that we do see that license in the next few weeks. We'd expect to be able to ramp that fairly quickly. I mean, the majority of our deals, when we break it down, 80%+ of our deals are lower middle market that fit the SBIC perfectly. So I think our previous license we got in April of 2021, and it took us, what, two and a half, three years to fill it up.
I assume the same cadence, maybe slightly quicker, just because of the amount of sponsors we've won and the deals we're doing. In terms of an expectation on pricing, I would expect somewhere, and this is a big range, but I would imagine that we'd be borrowing somewhere between 4%-5%, which if you compare that, obviously, to what our credit facility or what the bond market is, that's exceptional. I mean, it's certainly not the 2% or 1% that you saw five years ago, but it's still net accretive to our shareholders.
Doug Harter (Analyst)
Great. And I appreciate the details you gave around the convert. Just wondering how you think about kind of the option cost of the convert when you're kind of factoring that into it and maybe any sort of short-term impact it has on kind of the trading of the stock into the calculus of the decision to do convert or forms of capital?
Michael Sarner (CFO)
I mean, I think if you look at the convertible, over the long term, what we've been seeing is, first of all, it's very unlikely most bond traders are going to actually convert into equity or, in our situation, actually just put it to us and give us the option for cash or shares. So what we're looking at is if it's $25 on a conversion price, we're trading at $22.50 or $23. The expectation is, first of all, there's a lot of cushion between now and then. The convertible holders would have to see significant accretion above the $25 before they would actually call and ask for the conversion, and at that point, they're taking the risk that we are going to just redeem their bonds and they lose any option value, so from our perspective, it seems to be a low risk.
And when we compared that 12 months ago and six months ago to what we saw in the market, which is a lot of uncertainty with the change in administration, whatever's going on in the macroeconomy, it's kind of played itself out where if you look at the risk premium and the five-year Treasuries, if we were to go to market today, it would look like something in the 7.5%-8% range, either through a baby bond and maybe it's slightly better for an institutional bond. When you look at that and you compare it to a 5 and an 8, knowing all along that SOFR over the last nine months has come in over 100 basis points, this felt like this was, from an accretion perspective, we're giving our shareholders a reduction in interest expense, therefore an increase in their dividend.
If the risk is in two or three years, we see some additional dilution. It's at a $26 or $27 share price, which is accretive to shareholders. Therefore, we think that they're winning along the way, and they'll win if and when a conversion takes place.
Operator (participant)
Thank you.
Doug Harter (Analyst)
Great. Appreciate it.
Operator (participant)
Thank you, and I show our next question comes from the line of Erik Zwick from Lucid Capital Markets. Please go ahead.
Erik Zwick (Analyst)
Thank you. Good morning, everyone. Wanted to start with, you mentioned we've been hearing it from others as well, just that the competition in the market is certainly driving some spread compression. Wondering if you could quantify that a little bit. If you take a look at what's in pipeline today and what the average spread is, how that compares to maybe six months ago.
Josh Weinstein (CIO)
I mean, I would say from our perspective, the market moved about nine months ago, and it probably flexed 50-100 basis points.
Bowen Diehl (CEO)
But generally, pretty flat this quarter to last quarter. I mean, it was a six to nine months ago event that's kind of been kind of more of the same.
Erik Zwick (Analyst)
Thanks for the color there, and maybe just, is the competition spreading into structure at all as you go out and potentially compete with others in the market? Are you seeing some bending there, and if so, how are you dealing with that?
Josh Weinstein (CIO)
We have not seen as much pressure on the structure. Loan-to-value still remain pretty consistent from where they've been the last year or two, and it's mostly been focused on the pricing.
Erik Zwick (Analyst)
That's good to hear, and if I just switch gears a little bit, could you provide an update on the relationships that are currently on non-accrual? Have there been any changes over the past three months in terms of anything maybe getting closer to a resolution or any companies improving performance that could potentially move them off non-accrual in the next quarter or two?
Bowen Diehl (CEO)
Yeah. We had a non-accrual. One of our non-accruals restructured in the December quarter. One of the other non-accruals has now restructured in this quarter that's in non-accrual as of the end of December. So it's now restructured. The non-accrual group is the vast majority of the depreciation this quarter. That depreciation is not okay with us. It's very frustrating. At the same time, though, the main depreciation is coming from companies that aren't in NII. So it's more of a NAV effect on us as opposed to earnings effect. But that's hopefully helpful general color on what's happening.
Erik Zwick (Analyst)
And for those that did restructure, are they currently? Have they moved back to accrual? And then do you have any equity positions, or how did those play out?
Bowen Diehl (CEO)
Yeah. So we restructured into varying levels of debt, and the remainder of the debt is equity. So we have the ability, as the company recovers, to recoup our NAV.
Erik Zwick (Analyst)
Great. Thank you for all the answers today. That's all for me.
Operator (participant)
Thank you. And I show our next question comes from the line of Robert Dodd from Raymond James. Please go ahead.
Robert Dodd (Analyst)
Morning. Congrats on the quarter. A couple of questions. First, I mean, very, very busy. I mean, somewhere around, I think, 30 deals between follow-ons and new platforms this quarter. How do you feel about the staffing levels with expanding the number of sponsors you're working with, the number of add-ons? I mean, you're incredibly active. Is the staffing of a sufficient level to keep going at that kind of pace? Because it sounds like Q1's pretty active as well. I mean, can you give us any color about needs there? Do you need more increases in staffing? Could that, in the short term, impact the expense ratio?
Bowen Diehl (CEO)
Yeah. I'll just make a comment generally. I mean, we feel like where we sit, we're, that's a good question, and we're constantly thinking about that. I mean, staffing is super important. I mean, one of the reasons we didn't mention that our deal flow has been up, it's a factor. I mean, it's all the things we've talked about. But it's also our net across the country has expanded, too, as Josh has done a great job training up some of his folks. With new people in the market over the last couple of years and them gaining traction has resulted in a wider net in the market. But I would say, and Josh and Michael can comment, I don't know that we're way off base, but it's something that we definitely are constantly looking at, and we would probably expand as we grow, so.
Michael Sarner (CFO)
Yeah. I mean, I'm going to tell you, just on a run rate basis, we typically add, let's say, on the deal side, three professionals minimum a year that usually are on the junior side. And then I would say probably every other year, we'll add someone at the senior associate or VP level. On the accounting back office side, we probably also add around one to two people based on volume as well. So I don't think that there's a point where we say, "Ooh, volume has caught up to a place where we can't accommodate it." I think that we're continually assessing, as Bowen said, but we continually add to it. If you look back, I think when we started this venture, we had six or eight employees, and now we have, I think, 36 employees today.
So the answer to your question is, I think the asset base might be growing slightly quicker than the employee base, which is why our operating leverage is going down. But it's not because we are either A, not hiring people, or B, not paying our people. Because we also make it a point to promote from within, which has worked wonderfully, honestly, over the last decade, which has allowed us to be able to add the people at the lower levels and be trained up by the people that have been through the system and understand our underwriting process.
Bowen Diehl (CEO)
Yeah. Michael touched on it. I mean, it's not all part of it is activity, as you referenced, Robert, but it's also just us constantly looking at the size of the portfolio and specifically the number of portfolio companies. As Josh's team and we think about who's monitoring those companies and managing those loans, do we have enough people? Then Michael on the back office side, as he referenced, I mean, do we have the infrastructure to manage that portfolio of 125 companies, which is gross. Some get prepaid, some new ones come on. But that's how we're looking at that.
Robert Dodd (Analyst)
Got it. Thank you. I appreciate that color. Another one I think I've got. I mean, you mentioned obviously tariffs and immigration. I mean, what percentage of your portfolio has exposure as kind of federal contractors? Because it looks like there's efforts there to cut some payments. How sticky those cuts are is a wild card. But do you have any portfolio companies with any material exposure to more federal contracting than government contracting in general?
Bowen Diehl (CEO)
Yeah. So I'm sitting here on the fly thinking about that, looking at my colleagues here. I mean, just imagining of the 125 companies, I can come up in my head three of them, two definitely do business with contracting with the federal, I guess, government. The other one indirectly. So I mean.
Michael Sarner (CFO)
Most of those are subcontractors. So they're actually not federal government workers. So I think Bowen's point's a good point. It's very small. And even within those three, I'm not sure if it's going to have a direct impact.
Bowen Diehl (CEO)
If I'm at the C-level thinking about the portfolio at risk to the company, I think that is not the first thing we're worried about. But it's a good question. It's definitely one you should ask.
Robert Dodd (Analyst)
Yeah. Got it. Thank you. One last one, if I can. I mean, obviously, spillovers go back up $0.68. Sounds like that's going to go up again in the March quarter. In the past, you did run that up, and then you distributed it. I was going to say, like maybe 2021. I didn't want to use yours, but to keep the absolute level of spillover down and reduce your excise tax, et cetera. So have you changed your mind, and now you're going to build it back up? Or is there some level where you'd want to distribute that again to keep the spillover level down? And does the existence of the convert now change any dynamics there? That's obviously extra dividends impact.
Michael Sarner (CFO)
Yeah. No, I don't really want to say there was a change. I think if you go back to the first program we put in place, we had an extremely large gain that we couldn't even hold all of it just from RIC and BDC restrictions. And so we distributed what we had to upfront, and then we paid over time. And when we no longer thought we had a pathway to continue the program, we decided to distribute it back to shareholders. So that was sort of the natural evolution. I would tell you now, we're at $0.68. We see ourselves climbing into the $0.80 range by next quarter. And we do anticipate distributing probably a little more than our run rate today. We've gone down to $0.05. We went up to $0.06. We're anticipating walking that up slowly.
And then I think the point that we've all made today that there's a pathway to some sizable gains towards the end of the year. And if that was the case, we'd be back in sort of the same territory where we have a significant UTI bucket, which we would intend to increase the supplemental and continue to pay our shareholders on a quarterly basis. And that would be a larger percentage of the total distribution. So that's sort of the plan going forward.
Robert Dodd (Analyst)
Thank you for that. That's it for me.
Operator (participant)
Thank you.
Thank you.
And I show our next question comes from the line of Mickey Schleien from Ladenburg. Please go ahead.
Mickey Schleien (Analyst)
Yeah. To follow up, I wanted to get a sense of what drove the increase in fee income this quarter.
Michael Sarner (CFO)
Sure. So there's a number of things on it. First, I know it mentioned earlier, we had a prepayment penalty for approximately $600,000. We also had, if you recall, the bonds that we raised. So we brought that $230 million in. Most of that was used to pay down and redeem the 2026 bonds, but there was a 30-day redemption period. So we essentially held cash on the balance sheet for 30 days, which came out to about $1.2 million in income. So that's $1.8 million between those. And then on top of that, there were some few amendment fees, waiver fees, and some arranger fees as well on some directly-led deals.
Mickey Schleien (Analyst)
Okay. And another follow-up is, what were the main drivers of the realized loss this quarter?
Michael Sarner (CFO)
The realized loss was a restructured deal. It was a deal that was, I think, it was $12.7 million. So most of that was, just to be clear, was in depreciation was reversed, and a portion of that was new depreciation that was taken during the quarter.
Mickey Schleien (Analyst)
Understand. You had this divergence in portfolio company performance, which was a nice increase in companies performing above expectations, but you also had some below expectations. Can you help us understand what are the trends that drove that movement?
Bowen Diehl (CEO)
As I look down the list here, I mean, it's a bit idiosyncratic, honestly, the upgrades and downgrades. There's one that's in the shipping space where spot rates have moved to the company's detriment. That was a negative to that. Another company is a little bit weather-related, probably covers some based on the snow of recent. Then the other downgrade was just one of our non-accruals that's this continuing struggle.
Mickey Schleien (Analyst)
Okay, and lastly, I think Michael gave us guidance on regulatory leverage targets. Could you also give us an idea of where you're expecting your economic leverage or your total leverage to what is your target in the current market environment?
Bowen Diehl (CEO)
Sure. So I think we've been between 1.0 and 1.1 for economic leverage. And we've been on a regulatory basis. We've been between really 0.8 and 0.9 or even lower. I would tell you we're at 0.9 on the regulatory. We'll start there. And we tell you we're going to keep an eye on what's going on, obviously, in the macroeconomy, geopolitical scene to determine whether there's more or less risk. But we feel comfortable right now that the 0.9 leverage that we have right now in the 1.08, that's about a decent place to be. And we're looking down the road. We would tell you as we look back, when we did the convertible bond offering, with seeing all the things that are happening in the world, that was one reason why we took risk off the table by bringing bonds on our balance sheet earlier.
Then we can make decisions in terms of leverage going forward. We feel like we're in a really good place, especially with trades significantly above book. We are active in the ATM market to manage that metric going forward.
Mickey Schleien (Analyst)
Okay. And just to make sure I understand, the income on your cash, some of that's accruing into fee income as opposed to other income? Is that?
Bowen Diehl (CEO)
I think the line item you're looking at says fee and other income. The other income, because it's not portfolio interest income, it's actually money market income, interest income, it falls into other. I would probably tell you I wouldn't anticipate seeing that happen ever again, right? This is a one-off. That's why it fits into the other rather than interest income.
Mickey Schleien (Analyst)
Okay. Those are all my follow-ups. I appreciate your time. Thanks so much.
Bowen Diehl (CEO)
Thanks, Mickey.
Operator (participant)
Thank you, and I show no further questions in the queue. At this time, I'd like to turn the call back to Bowen Diehl for closing remarks.
Bowen Diehl (CEO)
Thank you, operator. Thanks, everybody, for joining us. We appreciate it. Appreciate your time, and look forward to giving you further updates in the future. Have a great rest of the week.
Operator (participant)
Thank you. This concludes today's conference call. Thank you for participating. You may all disconnect.