Capital Southwest (CSWC) Q2 2022 Earnings Call Transcript

Capital Southwest (CSWC 0.27%)
Q2 2022 Earnings Call
Nov 02, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for joining today's Capital Southwest's second quarter fiscal year 2022 earnings call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP of finance. I will now turn the call over to Chris Rehberger. You may begin.

Chris Rehberger -- Vice President, 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's 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, Bowen Diehl.

Bowen Diehl -- President and Chief Executive Officer

Thanks, Chris. And thank you, everyone, for joining us for our earnings call for the quarter ended September 30, 2021, which is the second quarter of our 2022 fiscal year, which ends March 31, 2022. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company, our portfolio and our progress on executing 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 on our website at www.capitalsouthwest.com.

We'll begin on Slide 6 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 $0.45 per share which more than earned our regular dividend for the quarter of $0.44 per share. Total dividends for the quarter were $0.54 per share, which included a $0.10 per share supplemental dividend. Total dividends paid during the quarter represented an annualized dividend yield on our stock price on the last trading day of the quarter of 8.6% and an annualized yield on net asset value per share of 13.2%.

As a reminder, we previously announced that our board declared an increase in our regular dividend per share to $0.47 per share for the quarter ended December 2021 from the $0.44 per share paid in the September quarter. This increase in our regular recurring dividend reflects the increased earnings power of our portfolio, resulting from portfolio growth, continued reductions in our cost of capital and continued improvements in operating leverage achieved through our internally managed structure. Our board also declared a supplemental dividend of $0.50 per share to be paid on the December quarter. This supplemental dividend represents an accelerated payout of our prior supplemental dividend program, which had been paying out $0.10 per share per quarter over the past several years.

We believe that this accelerated distribution of UTI maximizes value for our shareholders today while also maintaining an adequate UTI balance into the future. Going forward, we expect that shareholders will continue to participate in the successful exits of our investment portfolio through special distributions as we monetize the unrealized appreciation in our portfolio over time. During the quarter, we grew our investment portfolio on a net basis by 2.4% to $818 million. Portfolio growth during the quarter was driven primarily by a total of $112.9 million in commitments to six new portfolio companies and four existing portfolio companies, of which $77.2 million was funded at close.

This was offset by $60.9 million in proceeds from six debt prepayments and two equity exits during the quarter. The portfolio generated net realized and unrealized gains of $2.8 million during the quarter, driven primarily by unrealized depreciation in our equity co-investment portfolio. On the capitalization front, we completed an amendment to our ING credit facility, extending the maturity to August 2026 and decreasing the interest rate to LIBOR plus 215 basis points, down from LIBOR plus 250 basis points. Additionally, we issued $100 million in aggregate principal of 3.375% notes due October 2026 and repaid in full our 5.375% notes due October 2024.

Furthermore, in lockstep with our strong deal pipeline, we raised $30.3 million of equity through our ATM program at an aggregate -- an average price of $26.59 per share, representing an average of 160% of the prevailing net asset value per share. On Slides 7 and 8, we illustrate our continued track record of producing steady dividend growth, consistent dividend coverage and value creation since the launch of our credit strategy. We believe the solid performance of our portfolio and our company's sustained access to the capital markets has demonstrated the strength of our investment and capitalization management strategies. Maintenance and growth of both NAV per share and shareholder dividends remain as core tenets of our long-term investment objective of creating long-term value for our shareholders.

Turning to Slide 9. As a refresher, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on our core lower middle market lending strategy while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk-adjusted returns exist. In the lower-middle market, we directly originate and lead opportunities consisting primarily of first-lien senior secured loans with smaller equity co-investments made alongside our loans.

We believe that this combination is powerful for a BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from equity investments in many of these growing businesses. Building out a well-performing and granular portfolio of equity co-investments is important to driving growth in NAV per share, while aiding in the mitigation of any credit losses over time. As of the end of the quarter, our equity co-investment portfolio consisted of 31 investments across approximately half of our portfolio companies. The equity portfolio had a fair value of $69.2 million which included $17.7 million in embedded unrealized appreciation or approximately $0.76 per share.

Our equity portfolio, which represented 8% of our portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from the growing lower-middle market businesses. As illustrated on Slide 10, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 senior loan fund, grew 3% to $689 million as compared to $671 million as of the end of the prior quarter. For the quarter, all six of the new portfolio company debt originations were first-lien senior secured. And as of the quarter end, 91% of the credit portfolio was first-lien senior secured.

On Slide 11, we lay out the $112.9 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $107.8 million in first-lien senior secured debt committed to six new portfolio companies, one of which we also invested $1 million in equity alongside our debt; $3.8 million in first-lien senior secured debt committed to one existing portfolio company and $400,000 in sub-debt and equity follow-on investments in three existing companies. Turning to Slide 12. We continued our track record of successful exits with six exits during the quarter.

These exits generated $60.9 million in total proceeds, realized gains of $3.3 million and a weighted average IRR of 17.5%. To date, we have generated a cumulative weighted average IRR of 15.2% on 45 portfolio exits, representing approximately $462 million in proceeds. From a macro perspective, the market for acquisition and refinancing capital was robust this quarter, and has continued its strong momentum into the December quarter, resulting in heavy volume in both origination and refinancing activity. Our investment pipeline, as we have mentioned on previous earnings calls, has been robust in both volume and the quality of deals.

The deal team continues to do an excellent job broadening the top end of our deal funnel which maximizes the number of deals in the market for which we have the opportunity to review and consider. As we have always contended, this is a critical component of building and maintaining a quality investment portfolio in a competitive market. Finally, we believe that the returns realized on exits over the past several years has proven out the investment acumen of our investment team and the merits of our investment strategy in generating strong risk-adjusted returns over the long term. On Slide 13, we illustrate some key stats for our on-balance sheet portfolio as of the end of the quarter, again, excluding our I-45 senior loan fund.

Beginning this quarter, we have decided to consolidate reporting on our on-balance sheet upper middle market and lower middle market loans in order to give shareholders a more concise view of our portfolio makeup in total. As of the end of the quarter, the total on-balance sheet portfolio at fair value was weighted 82.4% to first-lien investments, 6.8% to second-lien investments, 1.6% to subordinated debt investments and 9.1% in equity co-investments. Turning to Slide 14. We have laid out the rating migration within our portfolio.

During the quarter, we had two loans upgraded from a two to a one; one loan downgraded from a two to a three; and one loan downgraded from a three to a four. As a reminder, all loans upon origination are initially signed an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating. As of the end of the quarter, we had 61 loans, representing approximately 90% of our investment portfolio at fair value, rated in one of the top two categories, a one or a two; we had six loans, representing 9.7% of the portfolio at fair value, rated a three; and one loan, representing less than 1% of the portfolio, rated at four. During the quarter, we placed one first-lien senior secured loan on nonaccrual with a fair value of $10.4 million or 1.3% of the total investment portfolio.

This company is currently working through a restructuring of its balance sheet, so we have decided to place the loan on nonaccrual pending more clarity on the post-restructure loan terms. Based on conversations with the company to date, we expect a portion of this loan to come off nonaccrual in the near term, once the restructuring is finalized, which should be completed in the coming weeks. As illustrated on Slide 15, our total investment portfolio continues to be well diversified across industries with an asset mix which provides strong security for our shareholders' capital. Portfolio remains heavily weighted toward first-lien senior secured debt, with only 6% of the portfolio in second-lien senior secured debt and only 2% of the portfolio in subordinated debt.

Turning to Slide 16. The I-45 senior loan fund continues its solid performance. As of the end of the quarter, 95% of the I-45 portfolio was invested in first-lien senior secured debt. Weighted average EBITDA and leverage across the companies in the I-45 portfolio was $75 million or 4.7 times, respectively, down slightly from the last quarter.

Portfolio continues to have diversity among industries at an average hold size of 2.6% of the portfolio. Leverage at the I-45 fund level is currently 1.3 times debt to equity. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.

Michael Sarner -- Chief Financial Officer

Thanks, Bowen. Specific to our performance for the September quarter, as summarized on Slide 17, we earned pre-tax net investment income of $10 million or $0.45 per share. We paid out $0.44 per share in regular dividends for the quarter, an increase from the $0.43 regular dividend per share paid out in the June quarter. As mentioned earlier, our board has again, this quarter, increased the regular dividend, declaring a quarterly dividend of $0.47 per share for the December quarter.

Additionally, our board previously declared a final supplemental dividend of $0.50 per share, which will also be paid out during the December quarter. Our investment portfolio continues to perform very well, generating $2.8 million in net realized and unrealized gains this quarter, bringing the net realized and unrealized gains over the past four quarters to $18.7 million. Though we are accelerating the current supplemental dividend program as of December 31, 2021, going forward, we will continue to distribute special dividends as we monetize the unrealized appreciation in the portfolio. As of September 30, 2021, our estimated UTI balance was $0.69 per share.

Maintaining a consistent track record of meaningfully covering our regular dividend with pre-tax net investment income is important to our investment strategy. We continue to maintain our strong track record of regular dividend coverage with 109% for the last 12 months ended September 30, 2021, and 107% cumulative since the launch of our credit strategy in January 2015. Our investment portfolio produced $20.3 million of investment income this quarter with a weighted average yield on all investments of 9.6%. Investment income was $1.7 million higher this quarter due primarily to an increase in average credit investments outstanding and prepayment fees.

There were three loans on nonaccrual with an aggregate fair value of $24.2 million or 3% of the investment portfolio as of the end of the quarter. Our weighted average yield on our credit portfolio was 9.7% for the quarter. As seen on Slide 18, we maintained LTM operating leverage at 2.3% as of the end of the quarter. We are targeting operating leverage to approach 2% or better in the coming quarters.

Turning to Slide 19. The company's NAV per share as of September 30, 2021, was $16.36 as compared to $16.58 at June 30, 2021, representing a quarter-over-quarter decrease of 1.3%. The main driver of the NAV per share decrease was $17.1 million in realized losses on the extinguishment of debt on the full prepayment of our 5.375% note due October 2024. The realized loss consists of a make-whole premium payment of $15.2 million, as well as the write-off of related unamortized debt issuance costs of $1.9 million.

The refinancing of these notes with a new five-year 3.375% issuance significantly reduces our cost of capital and increases our annual net investment income run rate by approximately $0.10 per share on a risk-free basis. This was the primary catalyst for our decision to increase the regular dividend by $0.03 this quarter from $0.44 per share to $0.47 per share. We believe this considerable increase in earnings power enhances our market capitalization on a dividend-yield basis and allows us to pass the cost of capital savings directly to our shareholders in the form of increased dividends. This transaction also pushes out our nearest debt maturity to 2026, providing significant balance sheet flexibility going forward.

On Slide 20, we lay out our multiple pockets of capital. As we have mentioned on our prior calls, a strategic priority for our company is to continually evaluate approaches to derisk our liability structure while ensuring that we have adequate investable capital throughout the economic cycle. Our debt capitalization today includes a $335 million on-balance sheet revolving line of credit with 10 syndicate banks maturing in August 2026; a $140 million institutional bond maturing in January 2026; the newly issued $100 million institutional bond maturing in October 2026; a $150 million revolving line of credit at I-45 maturing in March 2026; and an initial $40 million leverage commitment from the SBA, which is $22.5 million left to be drawn upon. Although the majority of our outstanding debt is currently due in 2026, we will look to opportunistically amend and extend our credit facilities well before maturity consistent with past practice.

Finally, as we've discussed on prior calls, we have now begun operations within our SBIC subsidiary, which you will see, going forward, denoted as SBIC-1. As a reminder, our initial equity commitment to the fund is $40 million, and we have received an additional commitment from the SBA for $40 million of fund leverage, which is also referred to as one tier of leverage. We expect to fully invest this initial $80 million of capital over the next six months, at which point we will apply for a second tier of leverage. Over the life of the fund, we plan to draw the full $175 million in SBIC debentures alongside $87.5 million in capital from Capital Southwest.

We're excited to be part of this program and believe it is a natural fit with our investment strategy. Overall, we are pleased to report that our balance sheet liquidity continues to be strong with approximately $166 million in cash and undrawn leverage commitments as of the end of the quarter. As of September 30, 2021, approximately 50% of our capital structure liabilities were unsecured and our earliest debt maturity is in January 2026. Our regulatory leverage, as seen on Slide 21, ended the quarter at a debt-to-equity ratio of 1.18:1.

I will now hand the call back to Bowen for some final comments.

Bowen Diehl -- President and Chief Executive Officer

Thanks, Michael, and thank you, everyone, for joining us today. Capital Southwest continues to perform well and consistent with our original vision and strategy we communicated to our shareholders when we began this journey. Our team has done an excellent job building a robust asset base, deal origination capability, as well as a flexible capital structure that prepares us for all environments throughout the economic cycle. We believe that our performance continues to demonstrate the investment acumen of our team at Capital Southwest and the merits of our first-lien senior secured debt strategy.

We feel very good about the health of our company and portfolio, and we are excited to continue to execute our investment strategy going forward. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long-term sustainable value for all our stakeholders. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question comes from the line of Devin Ryan with JMP Securities. Your line is open. Please go ahead.

Kevin Fultz -- JMP Securities -- Analyst

Hi, good morning. This is Kevin on for Devin. First question. Just looking at nonaccruals, can you provide the name of the new company that was added to nonaccrual? And then, separately, can you share any developments in the two existing nonaccrual investments?

Bowen Diehl -- President and Chief Executive Officer

Yeah, so I'd rather not say the name of the nonaccrual on a public call like this because it will wind up in a transcript, but there'll be -- it will be in the queue, which will be announced later tonight. But it's a company that's been affected by the supply chain that we've all heard about out, out in the market and which certainly we all hope is temporary but real, and just the company's sales cycle as a result of that in its market has extended. So restructuring this quarter. We think about a third of it or so will come back on accrual and we'll own equity in the business going forward as it recovers.

Kevin Fultz -- JMP Securities -- Analyst

What was the other two that -- if you can --

Bowen Diehl -- President and Chief Executive Officer

Yeah, one of them is a large syndicated deal. It's currently still working on its restructuring. And so, really, no update on that.

Kevin Fultz -- JMP Securities -- Analyst

Is it definite?

Bowen Diehl -- President and Chief Executive Officer

Yes. And then, the other one continues to actually improve within the pharmaceutical services space. Same -- kind of same report as last quarter, pipeline continues to build, starting to convert the increased pipeline actually pretty encouragingly. And so, we think that one's gonna be -- gonna end up being fine, so.

Michael Sarner -- Chief Financial Officer

Yeah, so we've accrued a bit of PEC. There was a bit of PEC accrued on that company. So as the recovery occurs and our -- the enterprise value exceeds the debt value, that will come back on accrual as well.

Kevin Fultz -- JMP Securities -- Analyst

OK, thank you. That information is helpful. And then, just touching on quarter-to-date investment activity. Can you give us a sense how originations are tracking so far and then also repayment activity as well?

Bowen Diehl -- President and Chief Executive Officer

Yeah, So, I mean, originations this quarter are strong. They'll be strong through the end of the quarter. Prepayments, as you can imagine, with all the market activity that's out there, prepayments are gonna be heavy this quarter, too. We do believe we'll have net portfolio growth for the quarter.

So it's a fair amount of churn, which you would expect with a strong portfolio like ours that we're going to get refinanced out of a number of deals. But our guys, our deal team have done a fantastic job, like as I said in my remarks, expanding the top end of the funnel. So we've been very active in the market. And again, at the end of the day, we believe we'll get to have net portfolio growth this quarter.

Kevin Fultz -- JMP Securities -- Analyst

Great. Thanks for taking my questions, and congratulations on the quarter.

Operator

Thank you. And our next question comes from the line of Mickey Schleien with Ladenburg. Your line is open. Please go ahead.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Good morning, Bowen and Michael. Bowen, as we all know, there's this tremendous search for yield, and that's attracting more and more capital to private debt, which seems to be increasing payment risk -- prepayment risk across the sector. Obviously, those can generate near-term fees, which is great. But can you maybe talk a little bit more about what you're doing in your organization to help defend your market share as we look forward?

Bowen Diehl -- President and Chief Executive Officer

Yeah, I mean, defending your market share really is a function of covering the market being good partners with your deal sources, sponsors mainly, and really the track record you develop over a lot of years. And we have every market across the country covered with a primary, secondary coverage person. And it's pretty interesting, to me anyway, that's been doing this -- in this business for a long time. The number of sponsors that we've been doing business with or we have deals from that candidly that I had yet heard of.

And usually, that's junior partners at PE funds that spin off into their own PE funds, start their own funds and that type of thing and kind of -- and in being able to really broaden the number of deal sources that we get deals from. And we've really seen that, which has been super encouraging. And then, when you go through the pandemic, things like a pandemic, and you have stress in the portfolio and you sit across the table as a first-lien lender, which, by the way, gives you the freedom to make good business decisions that balance your shareholders' capital interest with the interest of that company and that sponsor to make reasonable fair decisions on how you deal with stress. We had stress in the portfolio during the pandemic.

Fortunately, everything recovered nicely. And we -- along the way, we extracted extra economics here and there where it was fair and the sponsors supported the company where -- companies where necessary. And so, going through something like that really gives us street credibility that we might not have necessarily had three years ago. So that's a big deal.

And then, we're also seeing more and more sponsors that are new to us, ask us for references of other sponsors that we've been doing business with and actually calling those sponsors. And so, how you act, how you make decisions and how you operate in the market is becoming increasingly important among the sponsors and other deal sources. And so, for me, that's hugely encouraging. So that's -- because that's what you want, that you wanna get a benefit from the way you act and the way you operate in the market.

And so, those are all ways you defend your market share at the end of the day.

Michael Sarner -- Chief Financial Officer

Yeah, and the other thing, Mickey, is over the last few years, we've reduced our cost of capital. We were at 5.5%. Now we're down closer to 3.5%. Operating leverage came down from 5% down to 2.3%.

So this allows us to be more competitive. It doesn't mean we're chasing deals and offering less yield for riskier businesses, but we are able to look at deals at L plus 600 or 650, whereas those are deals we wouldn't have considered two, three years ago. And it also helped us when we are looking to -- when you say defend, there are certain deals that get refinanced that historically, if it was an L 850 deal, and it came down to L 650, we didn't bother staying in the deal just on yield alone. And today, we have the ability to look at the credit -- specialty credits where we know well and stay in the deal based on our net interest margin.

Bowen Diehl -- President and Chief Executive Officer

And of course, the reason that happens, as most people on the call know, is that these companies grow, leverage comes down clearly spread or their cost of capital is going to come down. So the question really is how long can we stay in that credit from a net interest margin perspective. And so, Michael is right. As we drop our cost of capital and increase our operating leverage, then it allows us to extend the tail on growing businesses.

And then, on new businesses, being able to lend to companies at lower loan to value, tighter spreads, that kind of thing.

Michael Sarner -- Chief Financial Officer

And also, the ATM issuance we're doing at 1.6 or 1.7 times, that's, obviously, a lot less dilutive than raising equity at one or 1.2 times where we would have done so in the -- two years ago.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

I agree. And thanks for that, Michael. Bowen, you mentioned just now sitting across the table -- Zoom meetings are great, but in the end of the day, I agree with you sitting at a table, eye to eye engaging a new relationship is important. Are you doing more of that now? Or is travel still an issue for the origination team?

Bowen Diehl -- President and Chief Executive Officer

Well, we have -- the industry has definitely become functional over Zoom. But the answer is yes, we're traveling again. And management meetings in person are certainly superior to Zoom calls. Candidly, from a deal professional perspective, it also adds a dynamic to your job that's interesting, right? You get to travel, get to see manufacturing plants, operations, that type of thing.

It just adds a dynamic to your -- the cadence of your work, which I believe -- as a former -- as a deal professional myself, that's a really important thing. And so, we've seen that. So thankfully, yes, we're traveling again and very happy to be doing that.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Thank you for that. Well, one other high-level question, Bowen. So apart from repayments this year, which is a trend across the sector, BDCs have certainly had a lot of wind at their back in terms of very strong economic growth and a very low default environment. But I'm starting to think next year will be more challenging with potential Fed tightening, probably lower economic growth and volatility around the election.

How are you thinking about those risks in terms of new originations that you're seeking and your own balance sheet leverage?

Bowen Diehl -- President and Chief Executive Officer

Yes. So well, first of all, new deals, we're kind of doing like we've always done, which is saying, OK, what could go wrong in the system, if you will. Part of that is a recession, part of that is pandemic, black swan events. Those are the type of things we stress test in models before we do deals upfront.

So hopefully -- we certainly believe that that's the best we can do in setting the asset base up to be able to weather different things. Obviously, as interest rates increase, we have -- the vast majority of our capital is in floating rate loans. We, obviously, are very attuned to fixing the rate on the liability side. Hence, being able to issue our most recent 3.375% bond issue on an unsecured basis.

And so, I think, those are the things that we do as we look forward really to -- we've always -- you've been hearing us say this from the very beginning. We are always paranoid about a recession in the next year or two. That's just -- I feel like that's what our shareholders pay us to do and then to protect the institution for that. And if we don't have a recession, fantastic, that's upside.

But we always have to be thinking about that mentally. As far as the election year, that can be -- there's gonna be volatility around that clearly. But at the end of the day, it's economic volatility. And so, hopefully, the -- all the things we do and we're underwriting and thinking about atmospherically in the system, things that can go wrong, the election could be catalyst to that, but it could be other things the catalyst to that, too.

But at the end of the day, it's the same answer, which is what's the economy going to do.

Michael Sarner -- Chief Financial Officer

Right. And obviously, that's by pushing out our maturities as far as we did. I mean, that's essentially taking a lot of that risk off the table, allowing us to draw additional debt off the SBA, which will have some interest rate volatility, but not nearly what you'd expect in the broader market.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Gotcha. Just one small housekeeping question for Michael. Did you reverse any previous income accruals for the new NPL?

Michael Sarner -- Chief Financial Officer

No, we didn't accrue anything this quarter for that asset.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

And you didn't reverse anything for previous accruals?

Michael Sarner -- Chief Financial Officer

No, no. We just reversed out whatever was reserved for this quarter.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

OK, terrific. That's it for me. I appreciate your time.

Michael Sarner -- Chief Financial Officer

Thanks, Mickey.

Operator

Thank you. And our next question comes from the line of Bryce Rowe with Hovde. Your line is open. Please go ahead.

Bryce Rowe -- Hovde Group -- Analyst

Thanks. Good morning. I wanted to ask kind of about the level of commitments here over the last couple of quarters relative to funded debt investments. You've seen kind of an uptick in unfunded, so to speak, within the new investment activity.

So Bowen and Michael, maybe you could speak to whether you expect that structure to continue? And then, any feel for kind of the pace of those unfunded commitments maybe converting to some level of funding here in the near future?

Bowen Diehl -- President and Chief Executive Officer

Yeah, sure. Well, thanks, Bryce. I mean, we're clearly managing -- I mean, unfunded commitments is a first-lien lender. Clearly, revolvers are oftentimes you providing revolvers, as well as the term loan -- revolvers that aren't used a whole lot aren't that interesting to banks.

And so, we can offer the revolver, get ticking fees, the rate on the revolver is the same as the rate on the term loan, which is higher than a bank would charge. So it ends up being a nice security for us, but we have to manage our balance sheet liquidity such that -- in the pandemic, for example, I think we had 35% of our revolver capital drawn, which is lower than I maybe would have thought it would have been. But we have to have a liquidity on our balance sheet to fund that. And obviously, those revolvers, obviously, -- not obvious.

Those revolver fundings are a function of the companies being with covenant compliance. That's the revolvers. On the delayed draw term loan. So our unfunded commitments this quarter are about half revolver, about half delayed draw term loans.

Delayed draw term loans are different. Those are usually a function of a specific acquisition strategy based on buying similar businesses, maybe it's funding and -- partly funding an earn-out on a purchase. In other words, the earn-out means that they hit a higher EBITDA number, a higher earnings number. And so then, by definition, the earn-out is paying out when the companies are doing well.

And so, that's not really -- those unfunded commitments are different. I mean, it's not like all of a sudden the world starts to fall apart, pandemic or otherwise. And they just all of a sudden draw on the delayed draw term loan. That's not how those work.

But what those are is those are future originations. So those are companies that, again, if there's -- if a company grows, hits a higher EBITDA target, we're gonna be funding a new origination. That's good. That's quality that we'd like to do that.

Or if there's an add-on acquisition, which, obviously, further diversifies that business, allows the business to realize synergies on the acquisition. So those are also originations that we'd like to do. And it also sets us up in the facility to already have a prebaked financing for that acquisition. And I believe it decreases the odds significantly that that company goes out on the outside and refinances us out with another deal on the acquisition.

So it just kind of puts you in the pole position to fund into a very attractive situation. So delayed draw term loans are future originations. We would affect -- candidly, we'd expect to fund most of that, if not all, of the delayed draw. Some of the delayed draws are usually 12 months, maybe 18 months in extension.

So when you get closer to the 12 months and you're not going to fund it or the earn-out period passes and they haven't earned the earn-out, then that would tend to fade. But most of the delayed draw term loans that we have in our financials, we would intend to -- we would expect to fund.

Michael Sarner -- Chief Financial Officer

And we've seen -- on a normal quarterly basis, we see about maybe 10% of the revolvers get drawn, but we also see 10% of them be repaid. So on a quarterly basis, and this is most all quarters, you have a net funding of zero on the revolvers. To Bowen's point, during COVID, the 35% that was funded, that was funded really soon after the COVID hit. And then, those were all repaid as well.

And then, on the -- from a planning perspective, the DDTLs, those are all scheduled out. They HAD dates in which their -- those earnings can be met. So we are closely monitoring that, and that will impact how much equity we raised on an ATM or, obviously, our planning purposes for raising additional debt.

Bryce Rowe -- Hovde Group -- Analyst

OK, that's helpful. And so, kind of along those same lines in terms of kind of pace of investment activity. When we think about -- and it sounds like this current quarter, you continued to see good activity both on the origination and on the repayment side of things. How do you all -- when you look at the income statement, obviously, you have some prepayment activity that came into the income statement here in the September quarter.

Does that feel kind of outsized relative to the amount of repayment activity that you had? Or would we expect at least another quarter of that level here in the December quarter?

Michael Sarner -- Chief Financial Officer

Yes. So I think, September, I think the originations and the repayments were both above what we would have anticipated, but the net growth was modest, but fine. I think, this coming quarter, we're -- as I think Bowen said earlier, we expect to see net portfolio growth, but it's gonna be on significant repayments, as well as significant originations. So what we're seeing, I think Bowen can speak to this best is, there's a lot of deals that are just being pulled forward into the 12/31 quarter.

And so, the -- I think, the question mark we have is going to see how much deals in the 3/31 quarter will be left to have? Or how much was pulled forward, and therefore, it's gonna be until 6/30 when you see sort of the -- an increase come back again.

Bowen Diehl -- President and Chief Executive Officer

Yeah, I mean, that's more of a theory. I mean, I think, a lot of people in the market have that theory that, with tax regime changes and that type of thing, that if you were a founder of a business and you were looking to monetize a portion of your earnings, a private equity transaction is attractive because you can roll over a heavy amount to stay involved with the company, but you can also monetize some of your lifelong work. And if you were thinking about doing that sometime in the next couple of years or year whatever, this would be a pretty good year to do it. You just live through the pandemic.

You learned that life is not forever and things can happen, and you're not getting any younger. And oh, by the way, tax regimes are changing. So there's a lot of things that would drive a founder-owned business to seek a sale if a sale was already on the docket in their mind. And that's also a sponsor selling, too.

So we'll see. But theoretically, I believe that a lot of the market activity is some of the dynamics -- at least in the lower middle market, some of the dynamics I just described but we'll see.

Michael Sarner -- Chief Financial Officer

And on the P&L, to your question, we would expect to see inflated prepayment penalties in the 12/31 quarter. And the exits are sort of spread across -- I mean, we've already had -- significant amount of exits have already occurred and we're anticipating more in November and December. So you'll get some level of interest off of those assets, but you're also going to see those prepayment penalties.

Bryce Rowe -- Hovde Group -- Analyst

Got it. OK, and then, maybe one last one from me. You've got your liability structure "cleaned up" in terms of extending. Do you all -- do you expect the same pace of ATM activity to continue? Or is that really more a function of net originations and where the stock is trading relative to NAV?

Bowen Diehl -- President and Chief Executive Officer

So it's a lot of variables. Certainly, one of the metrics we look at and manage to is leverage, right? So we've talked about kind of target leverage range but that's a function of originations, it's a function of prepayments, and at the end of the day, net portfolio growth. And then, against the backdrop of where the stock price trades too. But I mean, it's mainly -- it's net portfolio growth and portfolio BDC leverage.

It's less a function of the actual stock price. It's more of a -- I mean, our business model is an organic growth story with respect to just developing an excellent track record, just keeping our head down and just executing what our guys know how to do and then have access to the equity market to grow -- slowly grow the equity after the permanent capital base in lockstep with the net portfolio growth. And so, at the end of the day, again, it's -- your BDC leverage is what you're looking at, but you're raising equity in lockstep with portfolio growth. Anything to add, Michael?

Michael Sarner -- Chief Financial Officer

Yeah, I agree. I mean, it's very variable. I mean, this quarter, before -- at this point right now, we know there's a lot of repayments. We're expecting a lot of originations.

And so, if we think that if some of the originations don't occur, then we will pull back on ATM usage. We certainly are cognizant of the dilution that the ATM brings to following quarters. So we are not going to raise equity for equity's sake. So it's about being prudent.

One thing -- actually, I'll just take the opportunity to also mention is that we put in our shelf registration. We -- last week, we refreshed it, as well as our ATM equity distribution agreement. And that -- the whole point of that was not to raise equity in a secondary offering, but to have a shelf available to raise capital over the next three years, public debt and ATM equity. I know that there is some level of confusion in the market on that.

But we're still resolved to raise ATM equity as our primary source, if not only source of equity going forward.

Bowen Diehl -- President and Chief Executive Officer

I'd say, Bryce, the other thing we look at besides portfolio leverage, as I mentioned earlier, look, balance sheet liquidity, i.e., availability on the credit facility. That's also another important metric that we watch and manage, too.

Bryce Rowe -- Hovde Group -- Analyst

Got it. OK, thanks, guys. I appreciate it.

Operator

Thank you. And our next question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.

Robert Dodd -- Raymond James -- Analyst

Hi, guys, yeah, congratulations on the quarter. Just a couple of kind of market questions more than anything else. I guess, you have a very high level of activity in this quarter, the quarter you reported, $112 million, give or take, but only about 1% of that, just over 1% was equity co-invest. I mean, I want to read a quarter into a trend.

But is there anything to read in there? The market is great right now for equity valuations within your equity portfolio, but is that making it less appealing for co-invest right now with elevated valuations? Or a co-invest is harder to get right now? Any color you can give us on that on maybe not just the quarter, but just the environment for that opportunity?

Bowen Diehl -- President and Chief Executive Officer

Yeah, it's a good question. I'm trying to think about -- I would say, first of all, we definitely wouldn't read too much into the percentage of equity co-investments this quarter or past quarters. I'd love to tell you, we're so precise and everybody's way overpaying and we're just not choosing to participate. I mean, that would be an exaggeration.

I mean, I think, it's a little bit just the kinds of deals, and it could be -- it can be -- I mean, there are times where the sponsor has got excess liquidity and they want to overequitize the balance sheet. There may be a situation where they probably should, but the check is still small. And they -- our equity co-investment might be so small, it's not worth the exercise of putting it on the books and valuing it. I mean, there's a number of things that do come to play over time.

But most of the time, if we have the -- vast majority of time, if we have the relationship with the sponsor and we like the equity story, we'll have an opportunity to invest in the equity of some amount. So yeah, I don't -- I wouldn't read too much into this quarter in particular.

Robert Dodd -- Raymond James -- Analyst

OK, fair enough. This one's sort of related follow-up. So since the credit strategy, as you said, I mean, the IRR on recoup capital is about 15%. My math says about 60% of that's coupon.

Roughly, the other 40% is fees and equity gains, etc. Do you think going forward, right, is the market conducive to maintaining that kind of total IRR going forward? I mean, if coupons are coming down a little bit because your cost of debt has come down or other moving parts? I mean, do you think that's a reasonable target might not be the wrong -- the right word for it. But is that 15% kind of sustainable? Or was that just -- did that benefit from a couple of big wins while you were a smaller business and maybe that number comes down going forward?

Michael Sarner -- Chief Financial Officer

I think, that comes down a little bit based on the fact that our yields have come down. When we started this business, again, we were looking at deals that are probably a little more weighty, the 850s and the 8%. You see now our yield has come down, where we are looking at deals that are L 650 to L 800. And so, the likelihood is that the IRR might come down a few basis points, perhaps, relative to where we were before.

I don't think from an overall yield -- NIM that will come down, but on the individual deals themselves, you'd say maybe that 15 ends up being 13.5 or 14.

Bowen Diehl -- President and Chief Executive Officer

Yeah, you made a comment that the exits being lumpy. I mean, if you look at the list of exits, I mean, it's not -- I mean, that track record that we referenced, the 45 exits or whatever it is, over $460 million of proceeds, that's pretty evenly distributed over time and over companies. And -- I mean, it's -- our guy -- I'm going to give the guys credit. That's a pretty outstanding track record.

And I do think, as a first-lien lender, remember, we always -- the log don't understand, I mean, when the company breaches covenants, I mean, that -- as a first-lien lender, you have all kinds of options and things and way to extract a little bit of economics here and there and its market to do so. So it's not like you're breaking relationship glass to extract economics when small companies bump in the night. And so, it is an element of a first-lien lower middle market strategy that we've done this for, I don't know, 20 years, that's the way that works. And one of the reasons that you want to be a first-lien lender and not a sub-debt lender is to be able to have some of that flexibility.

And so, yes, I do think maybe it comes down a little bit, but I mean, we think the business model is pretty attractive in the long term.

Michael Sarner -- Chief Financial Officer

Robert, we also have the $18 million in unrealized depreciation in the portfolio and we probably would have somewhat of a glide path for us exiting some of those deals over the next 24 months. So some of those have sizable gains as well.

Robert Dodd -- Raymond James -- Analyst

Understood. Yeah, no, I appreciate it. And the lumpiness was not -- you, obviously, did have a particularly big winner going back two years, I guess. But -- I mean, you have got a track record of delivering nice IRRs on more than those handful.

So I appreciate it.

Bowen Diehl -- President and Chief Executive Officer

Yeah, it's a completely fair question. I think, that IRR on that lumpy gain that you referred to is like something like 12%. So it actually brought the 15% down on an average basis, if you're talking about IRR. But that's -- the lumpiness and asset performance is a fair question that people should ask.

It's just pretty broad.

Michael Sarner -- Chief Financial Officer

And that's true for Titan Liner and MRI, both of them were within the portfolio for years and years. So the IRRs were in the teens.

Bowen Diehl -- President and Chief Executive Officer

Right. So --

Robert Dodd -- Raymond James -- Analyst

Yeah, got it. Thank you.

Operator

Thank you. And our next question comes from the line of Sarkis Sherbetchyan with B. Riley Securities. Your line is open.

Please go ahead.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Hey, good morning, and congrats on the quarter. Just wanted to touch very quickly on kind of the cost of capital relative to the interest rate environment. It looks like you have some nice tailwinds here to compete in the current backdrop given your lower cost of debt. I was wondering if you can maybe give an update on pricing or spreads real time, just kind of considering any potential interest rate regime shifts or kind of ideologies you guys are carrying going forward.

Michael Sarner -- Chief Financial Officer

Are you looking on the asset side or the liability side?

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Well, from an asset and liability perspective, right? I mean, in the totality of things.

Michael Sarner -- Chief Financial Officer

Yeah, I mean, Bowen, you can speak to the asset side, and I can go through liabilities.

Bowen Diehl -- President and Chief Executive Officer

Yeah, I mean, spreads in the market, I mean, clearly -- if that's what you are asking, I mean, clearly, there's competition in the market. It's -- any kind of COVID premiums long gone. But generally speaking, I wouldn't say that the universe of deals that we're working on and chasing, the spreads have come down terribly in the last quarter. I mean, I think, it's been relatively flat.

I think, our situation is really mainly is being able to compete in deals that just price tighter. And so, you need to get your cost of capital down because at the end of the day, you live on net interest margin. And that's been the main thing. I mean, market's definitely competitive.

So I don't wanna leave anybody wrong in that respect. They're also -- I mean, lenders -- we'll see what happens throughout the end of the year, but lenders' bars are pretty full right now, right? I mean, they got a lot of deals going on. So when someone shows up December 1 and said, got to get a deal done by the end of the year, that incremental lender in the market might not be quite as aggressive on pricing that deal. I mean, that's a little bit more just supply demand theory, but that's -- it'd be interesting to see what happens.

So -- but that's the asset side. I think, it's -- and it's mainly a cost of capital story, I believe so.

Michael Sarner -- Chief Financial Officer

Yeah, so I mean, on the right side, obviously, with the -- we amended and extended our credit facility with ING to L 215. And so, that's going to be locked in for a number of years. We think that's pretty competitive for small mid-to cap BDC. We did look down the road and opportunistically did that bond deal at 3.375% for the very reason.

We do believe it's not an if, it's a when, you see the rates start coming back up, and so locking that in was the prudent thing to do. And then, on the SBA side, they pool debentures twice a year. In between those poolings, the cost of capital is about 1%, and we're in between there right now. So over the next six months, we are going to be drawing -- we would anticipate drawing around $60 million off of the SBA at 1% and that gets pooled into maybe it will be 1.5%, maybe be a little higher than that.

But that's kind of where we alluded to earlier. Our all-in cost of capital is really trending down toward the 3% to 3.5%, and you'll start seeing that as the SBA is fully ramped in the next 12 to 24 months.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Yeah, understood. And I guess, if we're going to think about things here in the near term, obviously, a lot of liquidity, everyone's flush with it. But I suppose if you look at the next six, nine and 12 months, if there's any dislocations, given your liability side of the equation is pretty attractive, do you think there would be an opportunity to kind of take advantage of that NIM potentially expanding a little bit?

Bowen Diehl -- President and Chief Executive Officer

Well, potentially because -- I mean, if by -- we manage our assets in kind of a what-if world, right? What happens if there's a dislocation in the market? What happens? What if, what if, what if, right? And so, obviously, locking in and extending out our maturities on our liability side and then maintaining adequate liquidity or flushing liquidity on our balance sheet. Then if there are dislocations, the only variable that moves in your world is your asset yields expand. And so, if we have the liquidity to invest in a dislocation like that, then that's exactly what would happen here and the net interest margin would expand. And so, we feel like we've kind of set the business up to weather storms on the downside and potentially take advantage of things on the upside from an asset yield perspective.

Michael Sarner -- Chief Financial Officer

And I think, also on the right side, I think we would look opportunistically to raise potentially additional debt on that 3.375% issuance as we see the volume there. I mean, certainly, that's -- at those rates, it's opportunistic, and it would be -- it would expand NIM immediately.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Yeah, no, sounds good. One more from me. If you can maybe describe some key factors on some of the deal quality you're seeing real-time, I just want to understand if maybe covenants are getting looser out there and if this is impacting the way you're underwriting, if so.

Bowen Diehl -- President and Chief Executive Officer

Yeah, no, I would say in the lower -- just macro comment in the lower middle market, I would -- at least our deal, I would imagine other lower middle market lenders will be the same way here. But I don't think -- covenants are really not -- the things you have to watch for, covenants getting looser, that's obvious, but the definition of EBITDA and add-backs and adjustments, those are things that we watch very carefully. We just really haven't seen a lot of that. It's a competitive market, smart sponsors that are well financed with multiple lender relationships, clearly, and the ones that prove to support companies when they bump in the night get better financing terms.

I mean, they just do. And they deserve better financing terms. Situations where the EBITDA -- earnings margin, EBITDA margin is higher and loan to value on the loan is lower, you get better terms, which the risk of those loans is lower and you should have better terms. But generally speaking, loan for loan, we haven't seen a bunch of -- in a lower middle market, it's very different than the syndicated market.

We just haven't seen a lot of deterioration on kind of covenant cushions and that kind of thing. I mean, the looser covenant cushions are the safer deals. But just general broad covenant deterioration in our market, we really haven't seen that.

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

Great. Thank you. That's all for me.

Operator

Thank you. This concludes our question-and-answer session. And I would like to turn the conference back over to Bowen Diehl for any further remarks.

Bowen Diehl -- President and Chief Executive Officer

Thank you, everybody, thanks for joining us, and thanks for all the questions. We like answering the questions. And for the shareholders that are not asking the questions, I get to hear more about our business. And so, thanks for that, and I look forward to giving everyone further updates as we go forward.

Operator

[Operator signoff]

Duration: 58 minutes

Call participants:

Chris Rehberger -- Vice President, Finance

Bowen Diehl -- President and Chief Executive Officer

Michael Sarner -- Chief Financial Officer

Kevin Fultz -- JMP Securities -- Analyst

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Bryce Rowe -- Hovde Group -- Analyst

Robert Dodd -- Raymond James -- Analyst

Sarkis Sherbetchyan -- B. Riley Financial -- Analyst

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