August 19, 2022
Capital Southwest (CSWC) reported much unchanged calendar IIQ 2022 results FY IQ 2023) and raised its regular distribution to $0.50 for the quarter ended September 30, 2022. The BDC Reporter annotated the BDC's latest conference call transcript, 10-Q, earnings press release, etc. Overall, this was a ho-hum, business as usual quarter.
Here's the rub. Without getting too specific, management made clear that they expect the third quarter 2022 - and by implication the quarters beyond - to see substantially higher earnings. If true, that would also mean the BDC's regular distribution should be headed higher, the just announced increase notwithstanding.
The main cause - maybe the only one - of the higher earnings going forward are higher rates. CSWC didn't really benefit from the initial rise in short term rates during the IIQ 2022 given how long it takes for borrowers loan agreements to reset to the higher levels. However, from July that is happening and CSWC shared that if those rates had been in place through the entire second quarter it's EPS would have been $0.53, rather than $0.50.
As we all know, rates have risen further since the end of June and more increases are on the way. As they say, it's not a matter of if the Fed will raise rates but how much and for how long. CSWC should be a beneficiary. In its latest 10-Q, the BDC - whose annualized EPS is running at $2.00, claims that 100 basis point increase in the reference rate could increase net investment income per share by $0.25. Rates could readily increase by twice that level to $2.5000.
How long that might take and what offsets might occur - like income lost to credit defaults or a shrinking portfolio to keep leverage at more modest levels than in the past - is hard to say. We take the analyst consensus of $2.13 for FY 2024 with a pinch of salt because nobody can know for sure and there's another known unknown: possible net realized gains CSWC might distribute as a "special" dividend.
What we do know - almost certainly - is that CSWC's earnings and regular distribution are going up - and soon. In our model, we've upped the 2022 projection from $2.11 to $2.13 - most of which is already in the bag. In 2023, we're now projecting the payout will go to $2.2200, mostly due to rate increases. Only in 2024 do we envisage CSWC's distributions might shrink down as the Fed starts to reduce rates. We're predicting - very roughly - $2.08 in 2024, dropping to $2.04 ($0.51 a quarter) in 2025 and 2026. That's pretty much where we were before for the latter years.
Still, the higher payout in 2022-2024 has boosted the 5 year total return prospects for CSWC, which compelled us to undertake this update. At the close on