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Capital Southwest Corp  (NASDAQ:CSWC)
Q3 2019 Earnings Conference Call
Feb. 05, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Thank you for joining today's Capital Southwest Third Fiscal Quarter 2019 Earnings Call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP Finance.

I will now turn the call over to Chris Rehberger.

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 off to our President and Chief Executive Officer, Bowen Diehl.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks, Chris. And thanks to everyone for joining us for our third quarter fiscal year 2019 earnings call. 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 are pleased to be with you this morning to announce our results for the quarter. In summary, we had a strong quarter for net investment income growth and a solid quarter of originations as our deal teams continue to do an excellent job generating significant deal flow allowing us to exercise our conservative investment discipline in determining, which deals we want to pursue to closing.

As we have consistently stated, our focus remains on building a predominantly Lower Middle Market portfolio, consisting largely of 1st Lien Senior Secured Debt with equity co-investments across the loan portfolio where we believe significant equity upside opportunity exists. Further, we continue to execute under our shareholder friendly internally managed structure, which at its foundation closely aligns our interest with the interest of our fellow shareholders in generating sustainable long-term value through stable increasing dividends, operating cost efficiency, capital preservation and NAV per share growth.

In general, we added a different quarter. We exited one of our two remaining legacy equity assets at a modest gain. We completed the company's first ever follow-on equity offering, raising $13.2 million from two prominent BDC investors. We completed the upsize and refinance of our ING Capital-led balance sheet credit facility and we opportunistically repurchased shares of Capital Southwest stock through our 10b5-1 program during the time of excessive market volatility that we saw in December.

Laid out on Slide 6 are some important summary points on our performance for the quarter. During the quarter, we earned $0.40 per share of pre-tax net investment income and paid a regular dividend of $0.36 per share. In addition, our Supplemental Dividend Program paid out $0.10 per share, funded from our sizable, undistributed taxable income balance or UTI generated by excess income and capital gains accumulated from our investment strategy to date. For the quarter, the $0.46 per share paid out in total dividends, generated a total annualized dividend yield of 9.6%. During the quarter, we grew our portfolio on a net basis from $492 million at September 30, 2018 to $497 million at December 31, 2018.

Originating for $26 million in total commitments to two new portfolio companies and one add-on investments in an existing portfolio company, offset by $18 million in proceeds from exits during the quarter. Again this quarter all of the capital deployed by Capital Southwest was in deals directly originated and led by our investment teams as they continue to demonstrate our traction in the market. Our senior loan fund I-45 also continued its solid performance providing a 15.5% annualized yield on our capital in the fund for the quarter. During the quarter, we continued to grow the right side of our balance sheet by increasing the size of our balance sheet credit facility. As part of our comprehensive credit facility amendment we were able to obtain a significant increase in commitments for our bank lenders while reducing pricing and the overall cost of the facility.

Importantly, we were also able to incorporate the ability to access the increased leverage allowable under the Small Business Credit Availability Act passed in 2018. As a reminder, while both the legislation and our amended credit facility allows us to increase leverage at the BDC at 2 to 1 debt-to-equity, our Board also approved a policy of limiting the regulatory leverage at Capital Southwest no more than 1.5 to 1. Mike will discuss the specifics of the amendment in a moment. While prudently increasing leverage at the BDC, we will enhance our ability to increase the quality of our loan portfolio, while also driving higher returns to our shareholders. All through an internet -- internally managed structure in which virtually 100% of the economics from the increased leverage in asset base will flow to our shareholders.

Turning to Slide 7, we illustrate our continued track record of growing shareholder dividends as we continue to migrate the BDC to target leverage levels through softly building a portfolio of well-performing income generating assets. On the Slide, we also illustrate both NAV per share over time as well as adjusted NAV per share which adjusts for supplemental dividends paid out to shareholders. For the quarter NAV per share decreased from $18.43 as of December 31, 2018 or $18.84 dollars as of September 30, 2018. The 41% -- the $0.41 or approximately 2% decrease in NAV this quarter was driven by three things.

First, we experienced $2.4 million or $0.14 a share in net depreciation on -- of our net investment portfolio which I'll comment on in a moment. Second, we paid out a quarterly supplemental dividend of $0.10 per share from our UTI balance. And third, the Board made an annual grant of restricted stock to the Capital Southwest employees. While restricted stock grants invest over four years, all granted shares are added to our total shares outstanding immediately upon grant. As a frame of reference, if you isolate the effect on NAV per share from solely portfolio asset valuations, by adding back both the effect from the supplemental dividend paid and the effect from the annual restricted stock grant to employees our NAV per share would have decreased by approximately $0.14 per share, representing a decrease of 0.75% or 75 basis points.

As you might expect, the extreme with market volatility we saw in December had a negative effect on the valuations of all BDC portfolios including ours as quarterly valuations are generally measured as of the last day of the quarter, which in this case was when the markets were at near lows for the year. Specifically the levels of the various relevant market indices, which are key inputs in our quarterly evaluation process were down meaningfully at the end of the quarter from levels at the end of the September quarter. On the equity side, we saw public market multiples come down while on the debt side we saw corporate credit spreads the rise and syndicated loan quotes from syndication desks fall. Though the syndicated markets were down significantly at year end in virtually all instances the discounted market quote was not accompanied by paper for sale at the lower price levels.

As a result, in our estimation a significant majority of this quarter's depreciation in the Capital Southwest portfolio was related to this market volatility rather than the fundamental performance of our overall portfolio. In fact, on a weighted average basis, across the Capital Southwest portfolio, revenue and EBITDA grew quarter-over-quarter and the weighted average leverage in our lower middle market portfolio due to capital Southwest Security decreased compared to the prior quarter end. Within our internal -- within our internal investment rating process, three portfolio companies received an investment rating upgrade, while two portfolio companies received an investment rating downgrade.

As a reminder, all investments upon origination are initially signed in an investment rating of 2 on a 4 point scale with one being the highest rating and four being the lowest rating. Overall, we were pleased with the performance of the investment portfolio as 96% of the portfolio is rated as investment grade 1 or 2, 4% of the portfolio is rated at an investment grade 3 and no portfolio companies are rated as an investment grade 4.

This quarter, we did place our 1st Lien Senior Secured loan to AG Kings are non-accrual, which was one of the two downgrades. We have $9.2 million at cost invested in this particular loan as a club participant alongside a few other prominent middle market lenders. While I want to be careful not to provide too many specifics on this public call regarding a private company, I will say that, the company has defaulted on certain of its financial covenants in addition the sponsor decided to withhold payments of the December monthly interest payment to be rolled into a broader amendment discussion.

Therefore, today the company remains in payment default with a lender group that is aggressively pursuing revenues. Based on the company's current leverage level of approximately 4 times debt to EBITDA, our estimation of enterprise value and the experience and aggressive posture of the lender group we are optimistic this default will be resolved in a manner that is favorable for Capital Southwest and its lender partners.

Turning to Slide 8. Our investment strategy has remained consistent, since the launch in January 2015. As a reminder, we continue to focus on a blend of both Lower Middle Market and Upper Middle Market assets providing us strategic flexibility as we have built the robust capabilities to seek attractive risk-adjusted returns in both markets. In our core market, the Lower Middle Market, we directly originate opportunities consisting of debt investments as well as equity co-investments are made alongside our debt. Building out a highly performing and granular portfolio of equity co-investments is important to driving growth in NAV per share, while mitigating future credit losses. At the same time, our capability and presence in the upper middle market provides us the ability to opportunistically invest in a more liquid market, when attractive risk adjusted returns exist.

In the Upper Middle Market over the past year or so, we have been in an environment where it has been very difficult to find value in syndicated loans. For the deals and structures, we have found acceptable from a risk return perspective, we have often chosen to take small positions of approximately $5 million, which fit well into I-45. To the extent that market generations continue and we see opportunities to invest in the Upper Middle Market syndicated loans at especially attractive spreads we've the ability and liquidity to capitalize on such opportunities either through additional exposure on our balance sheet or through possibly increasing the size of I-45.

In contrast in the Lower Middle Market, our robust origination platform continues to generate strong deal flow allowing us to close on some highly attractive opportunities from a risk return perspective. We believe that maximizing the top end of our origination funnel is critical to generating strong credit investment performance over time as it ensures that, we consider a wide array of deals so that we are able to employ our conservative underwriting standards in a competitive market. And thoughtfully build a portfolio that will perform through the economic cycle.

Our on-balance sheet credit portfolio at Capital Southwest as seen on Slide 9, excluding I-45 grew from $337 million at September 30, 2018 to $351 million at December 31, 2018 driven by continued Lower Middle Market origination activity. As the portfolio has grown the percentage of the credit portfolio represented by the Lower Middle Market has increased by design to now 77%. While, we've increased the percentage of the portfolio represented by the Lower Middle Market, we have also continued to heavily emphasize 1st Lien Senior Secured Debt in our investment strategy. As of the end of the quarter, we had 86% of our on-balance sheet credit portfolio in 1st Lien Senior Secured Debt.

During the quarter and seen on Slide 10, we committed $26 million to two new portfolio investments and one add-on investment to an existing portfolio company. All of the investments were in the Lower Middle Market and all were directly originated and led by Capital Southwest. On a weighted average basis, the debt investments made during the quarter had a yield to maturity of 11.1%. Our originations this quarter included $24.7 million in senior secured debt, made up of $12.5 million of 1st Lien secured debt, a $10 million split lien secured debt investment and $2.2 million 1st Lien secured -- for a $2.2 million 1st Lien secured Delayed Draw term loan for an existing portfolio companies. We also invested $1 million in an equity co-investment funded alongside one of our new portfolio of transactions.

During the quarter as seen on Slide 11 we received $18 million in proceeds from the exit of three investments; one Upper Middle Market investment and two Lower Middle Market investments. One of our exits resulted from the sale of Deepwater Corrosion Services to a strategic buyer, resulting in a realized gain of $1.7 million or $0.10 per share. Deepwater, a preferred stock investment originated back in 2013 was one of our last two remaining legacy equity positions. After going through a tough time in the energy services industry during 2015 and 2016, Deepwater was able to recover and position itself for a strategic sale, producing a nice outcome for its shareholders.

This quarter's exits continue our track record of generating strong risk adjusted returns on our shareholders capital, as we now have 25 exits since the launch of our credit strategy, four years ago, representing approximately $180 million in proceeds generating a weighted average IRR on the exit of 16.3%. This now leads Media Recovery as the last remaining legacy equity investment in our portfolio. Media Recovery does business under the banner Spotsee. Spotsee's management team continues to do an excellent job growing and increasing the profitability of the business. As we have mentioned on prior earnings calls, there continues to be significant interest in the acquisition of this company. We have now hired an investment banker and have been working with them in earnest to launch a sales process. Consistent with our past commentary, we expect to exit this investment during the calendar year 2019.

On Slide 12, we break out our on-balance sheet credit portfolio again excluding I-45 between the Lower Middle Market and the Upper Middle Market. As of the end of the quarter, the total portfolio was weighted approximately 79% to the Lower Middle Market and 21% to the Upper Middle Market on a cost basis. We had 25 Lower Middle Market investments with an average hold size of $12.3 million and weighted average EBITDA of $9.3 million and weighted average yield of 11.9% and leverage measured as debt to EBITDA through our security of 3.2 times.

I should also note that 3.2 times weighted average portfolio leverage in our Lower Middle Market portfolio is down from 3.4 times as of the end of the prior quarter. Within our Lower Middle Market portfolio, as of the end of the quarter, we held equity ownership in approximately 72% of our portfolio companies. Our Upper Middle Market portfolio consisted of 10 loans with an average hold size of $8.3 million, a weighted average EBITDA of $71.1 million, a weighted average yield of 10.4% and leverage through our security of 3.8 times which was flat from the prior quarter.

As illustrated on Slide 13, we have established a well diversified portfolio, heavily biased toward 1st Lien Secured Debt investments, providing strong capital preservation security for our shareholders capital. In addition, 97% of our credit exposure is invested in floating rate securities as can be seen on Slide 14, such that our shareholders should continue to benefit should interest rates continue to rise.

As shown on Slide 15, as of the end of the quarter the I-45 portfolio was 95% 1st Lien, with diversity among industries and an average hold size of 2.1% of the portfolio. The I-45 portfolio had a weighted average EBITDA of approximately $70 million and weighted average leverage through the I-45 security of 3.7 times down from the 3.8 times at the end of the prior quarter. We have been pleased with the solid performance of I-45 over the past 3.5 years. We and our partner in I-45, Main Street Capital, have invested approximately $500 million through the fund and harvested 50 exits, generating $196 million in proceeds at a weighted average IRR on the exits of 11.4%.

I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.

Michael S. Sarner -- Chief Financial Officer

Thanks, Bowen. As seen on Slide 16, our investment portfolio produced $13.9 million of investment income this quarter with a weighted average yield on all investments of 11.1%. This represents an increase of $1.3 million from the previous quarter, mostly attributable to net portfolio growth. The weighted average yield on our credit portfolio was 11.6% for the quarter, flat from the previous quarter. As of the end of the quarter, there was one assets on non-accrual with a fair value of $8.6 million representing 1.7% of our total investment portfolio.

Excluding interest expense, we incurred $3.7 million in operating expenses this quarter, which was flat with the previous quarter. We earned pre-tax net investment income of $6.8 million, or $0.40 per share, during the quarter compared to $0.36 per share during the prior quarter. We paid out $0.36 per share in regular dividends for the quarter, an increase of $0.02 per share over the $0.34 per share paid out in the prior quarter. We continue to focus on growing our regular dividends in a sustainable manner demonstrated by our cumulative regular dividend coverage of 103% since the launch of our credit strategy four years ago.

As Bowen mentioned earlier, we also paid out a $0.10 per share supplemental dividend this quarter as part of our Supplemental Dividend Program. This program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio. The program will continue to be funded from our undistributed taxable income earned from both realized gains on debt and equity, as well as undistributed net investment income earned each quarter in excess of our regular dividends. This quarter the realized gain from Deepwater, coupled with our significant regular dividend coverage provided additional UTI to further bed the program. At year-end December 31 2018, our UTI balance was $1.20 per share thus providing visibility to funding the supplement program at its current level into calendar year 2021.

As we look ahead, future realized gains and net investment income earned in excess of our regular dividend will replenish the UTI balance extending the supplemental program beyond 2021. For example, if we were to assume a sale of SpotSee during the calendar year 2019 at our current valuation with no other realized gains or additional UTI from net investment income, we would expect the Supplemental Dividend Program to extend into calendar year 2023. Beyond 2023, we would hope that our numerous equity co-investments made as part of our Lower Middle Market strategy would serve to continue to replenish the UTI for further extension of the Supplemental Dividend Program.

On Slide 17, we illustrate our operating leverage, which has improved significantly from 4.9% in 2016 to 2.9% as of the quarter ended December 31, 2018. We continue to actively manage operating costs in lockstep with portfolio growth toward the goal of achieving our longer-term operating leverage of sub 2.5% which we expect to achieve over the next several quarters. With all senior professionals and corporate infrastructure largely in place portfolio growth from here should continue to improve our operating leverage due to our internally managed structure. As Bowen mentioned earlier, during the quarter, our NAV per share decreased by $0.41 or 2% to $18.43 per share as seen on Slide 18.

As seen on Slide 19, on the right side of the balance sheet, we have established multiple pockets of capital with extended maturities to provide us maximum flexibility to thoughtfully grow our investment portfolio. In fact, due to the recent ING credit facility amendment, we currently have approximately $155 million in cash and undrawn commitments available on-balance sheet with no payment obligations till the end of calendar year 2022, with an additional $11 million in undrawn capacity within our I-45 credit facility. Our balance sheet leverage ended the quarter at 0.62 to 1 debt to equity.

As Bowen indicated earlier, we upsized, extended and amended our credit facilities with ING Capital in December. Total commitments under the credit facility increased by $60 million from $210 million to an aggregate total of $270 million at flows provided by diversified group of nine lenders. The amendment includes an expansion of the accordion feature to $350 million to accommodate future growth of the company. The credit facilities revolving period was extended from November 2020 to December 2022 and the final maturity was extended from November 2021 to December 2023. The pricing on the credit facility was reduced from LIBOR plus 3% to LIBOR plus 2.5%.

The credit facility amended -- the credit facility amendment reduces the minimum asset coverage covenant from 200% to 150% effective at the one year anniversary of our board approval which is April 25, 2019. We believe this amendment significantly enhances our funding flexibility and improves our competitive position in the market going forward. In addition, in October 2018, we issued 700,000 shares of common stock at a net price of $18.90 per share to two BDC institutional investors. The offering was priced above net asset value and less than a 2% discount to the market price at the time generating proceeds of $13.2 million.

During the quarter, we also executed on our share repurchase program, which was originally approved by our board in 2016. The market volatility in December temporarily drove Capital Southwest's stock price below NAV, triggering our repurchase program and resulting in the repurchase of approximately 10,500 shares at an average price of $17.72, a 6% discount to NAV at the time of the repurchases. We continue to be willing buyers of Capital Southwest stock should time -- market volatility but the shares on sale at a meaningful discount to NAV.

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

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks, Michael and thank you everyone for joining us today. Capital Southwest has grown and the business and portfolio have developed consistent with the vision and strategy we communicated to our shareholders over four years ago. Our team has done an excellent job generating strong returns for our shareholders. Everyone here 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 our shareholders.

This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

Questions and Answers:

Operator

Ladies and gentlemen, (Operator instruction) Our first question comes from Mickey Schleien with Ladenburg. Your line is open.

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

Yes. Good morning, everyone. I wanted to just clarify some language, if I may. I think, you indicated your Lower Middle Market deals this quarter were directly originated. But if I'm not mistaken those are also are sponsored deals, so does that imply that you found the transactions and then went out and found sponsors or what does it mean exactly when you say directly originated?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. Hi, Mickey. It's Bowen. Thanks for the question. So, when we think about that is a lot of what we do is go out and we network and we find deals and a lot of who we network to and market to our private equity sponsor. So as opposed to having another lending firm, find the sponsored or have the relationship with the sponsor, in which we club with them, which we did a little bit of that. But mostly what we do is our response relationships that we initiate -- the sponsors actually find the actual company opportunity in those situations and then they call us and then we work with them due to our relationships with them to partner with them on those deals. And so when I say directly originated, I mean that's a sponsor relationship that we have that we've harvested and found an opportunity in partner willing to buy a company.

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

And Bowen, in that process or the sponsors, pricing this thing out or is it an exclusive sort of negotiation with you?

Bowen S. Diehl -- President, Chief Executive Officer and Director

So, usually the sponsors -- the vast majority of time the sponsors have relationships with multiple lenders, right? So I would say that we're virtually always competing with other lenders for a situation and one of those that -- one of the metrics in our decision that sponsor makes s is pricing but also the other metrics are reputation of the firm, track record of the individuals and that type of things. So in our knowledge of the certain space or what have you...

Michael S. Sarner -- Chief Financial Officer

Liquidity as well.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah, liquidity as well. I mean how much staying power does our entity have long-term and that type of things. So, but in all the cases, this quarter, we had other lenders looking at the deals as well.

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

Okay, I understand. If I could just ask about valuation, particularly with the volatility at the end of last year, we saw the S&P leverage loan index widened by about 150 basis points, which I assume probably impacted the valuation of your upper middle market and senior loan fund investments. So does that widening go directly into your, the discount rate calculation that use at least with respect to the income approach investments or is there some other methodology that you use?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Well, I would first of all say, Michael you comment on this well, but the metric goes, it's one component if that goes into that -- so the metric itself, the actual index, that we're utilizing for loan absolutely on a 1 to 1 basis goes into the loan. And then, just like your (Technical Difficulty) private company on an equity basis you might use public company comps, but then you have to discount, the concluding multiple on a large public company. If a discount that multiple down to get what an equivalent private multiple would be. The same concept applies to debt as well as thinking about widening of spread versus what a large loan would be. So there's adjustments made to both equity indexes, as well as debt indexes. But the core index, if you will goes into the calculation is a basis that you start with.

Michael S. Sarner -- Chief Financial Officer

On the syndicated side, the broker quotes really where we ended the quarter at 12/31 (ph) with the market being quite down, those are the word -- dictate a lot where like I-45 would have ended.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. We take the market growth irrespective of whether there is actually paper for sale of that market quote. If the market quote move and is often the case, no papers or sale at the discounted price, our valuation comes down.

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

I understand. Just one last question, then I'll get back in the queue. Was there any impact on your borrowers from the government's shutdown?

Bowen S. Diehl -- President, Chief Executive Officer and Director

I mean, I would almost say really none. I mean, we might find out, at the end of March quarter, looking back on the quarterly performance and reflecting at our various Board meetings that maybe we would theorize it something effect of the business here and there, but nothing that would be like a phone call to us on a situation that was material.

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

Okay. Fair enough. That's it from me. Thank you for your time.

Operator

Thank you. And our next question comes from the line of Chris York with JMP Securities. Your line is open.

Christopher John York -- JMP Securities -- Analyst

Hi. Good morning, guys. Thanks for taking my question. Maybe Michael or Bowen, dividend income from the quarterly record on the dollar basis and also yield basis and the acute not out to, having to kind of dig a little bit further so a couple of questions. One was there any non-recurring income in the quarter embedded in the distribution? And then two, is that level of dividend income and therefore yield sustainable?

Michael S. Sarner -- Chief Financial Officer

Yes. So this quarter, we had about $0.01 from prepayment penalties, from exits in our company -- from portfolio companies. So embedded in interest -- in prepayment penalties and I-45, we had an increase in leverage at the fund. We increased it from 1.75 to about 1.87, which increased about 100,000 of additional income from I-45. The rest of the income pick up for the quarter was really -- related to seasoning from originations in the 9/30 quarter (ph) and originations from the 12/31 (ph) quarter. So we'd say, that if you're looking at the $0.40 run rate, the net investment income that is sustainable.

Christopher John York -- JMP Securities -- Analyst

Got it. I'm looking specifically at the dividend income, the $2.5 million provided to Capital Southwest, as opposed the $0.40 there?

Michael S. Sarner -- Chief Financial Officer

Yeah. So that would be sustainable, that is -- we're saying earlier, the I-45 pickup in leverage, increased debt plus repayments at the I-45 fund as well. So I would tell you that's $2.5 million should be sustainable into the following quarters.

Christopher John York -- JMP Securities -- Analyst

Got it. Okay. Great. And then, Bowen, maybe a little bit on investment strategy. So with the approval of additional leverage could that the shareholders and then an increase in committed capital under the revolver. How are you thinking about the trade-offs today of investing or holding in price of deal sizes with other partner versus the risks that could manifest in the concentration risk in the portfolio?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yes. I think as we've talked about before, I mean concentration risk is something that we are very cognizant of. So one of the things that excites us over time is, as we grow the asset base, we can hold larger and larger pieces of the loans. And so if you look across our portfolio, I think 40% of our lower middle market portfolio are deals that we have led and originated, but that we have brought in a co-lender alongside us. And so over time, as we can hold larger loans, given a certain level of granularity, and frankly, I'd like to improve the granularity from where we are today. So, and so I look at it as -- that's a nice upside for us as we grow, we can improve granularity and hold more of the loans and have to rely less on partners that we bring in.

And so, so the actual increase in the credit facility is part of that funding the asset growth. And so, our opportunistically when we raise bonds or even equity, I mean it's all part of growing scale and it's not growing scale, we just say, hey, we're larger -- hey, we can do larger deals, it's actually the scale growth is going to allow us to do all of more of our existing deals. And so, there is no scope creep into larger -- a larger deal sandbox where competition is greater and leverage is higher et cetera. It's all about growing scale to be able to hold more -- 100% of more of our loans in our existing sandbox. And so the credit facility is a step in that process. Does that makes sense?

Christopher John York -- JMP Securities -- Analyst

It does, its helpful.

Michael S. Sarner -- Chief Financial Officer

And Chris on the granularity was helpful in our ING negotiation. In fact that we've moved down on granularity overtime, plus the drop 50 basis points. We see the same sort of dynamic hopefully at I-45 with us dropping down to 2.1% in granularity in the I-45 fund and that should hopefully translate to a lower cost of capital there as well.

Christopher John York -- JMP Securities -- Analyst

Yeah. That would be great. Okay. That's helpful. Thanks a lot. And then, in reference to AG Kings, there are (inaudible) that 94% versus your September (inaudible) mark of 98% -- 100% (inaudible) in this quarter, but maybe just I don't think BDC have recorded yet, but (inaudible) explain the previous quarter residual in valuation?

Bowen S. Diehl -- President, Chief Executive Officer and Director

I don't really know. I can't speak for WhiteHorse financed as the other one in there that you're probably referring to because they're a public BDC like us. And I can't explain the difference between the two. I mean, we've got our valuation process actually I'll tell you, our valuations are -- have always been within the range of our third-party valuation consultants range. And frankly, vast majority of the time, it's been at the lower end of the range from our third-party consultant, so we try to be conservative -- on the conservative end of correct.

And frankly, there's a debate probably interesting to see across the BDC space as why we put this on non-accrual. We think it was the right thing to do based on the criteria we look at. We think maybe in the hindsight we view it as conservative, who knows, but that's what we decided to do. So, last quarter, I don't really know. I would tell you that it's the -- our valuations within our third-party tell us and so we tend to be conservative in that range. But I can't really speak to white horses view on that.

Christopher John York -- JMP Securities -- Analyst

Understood. (inaudible) BDC you have forward observation analysis another qualitative input that can move the difference valuation about risk. I was just wondering if that was the case for you guys.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. There's only three of us in this deal, I should say four. There's three BDCs and there's one private loan group. It's a relatively speaking a tight club. We all communicate pretty often and frequently, so.

Christopher John York -- JMP Securities -- Analyst

Okay. And then last one I'll jump back in the queue, easy one here. How many employees were at the firm at quarter end?

Bowen S. Diehl -- President, Chief Executive Officer and Director

21.

Christopher John York -- JMP Securities -- Analyst

Okay. And then, is the other I think we had 19 at year end so quarter-over-quarter was there any increases?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Here, we added associate and then I think an analyst.

Christopher John York -- JMP Securities -- Analyst

Okay. So, up to from the September quarter? Is that right?

Chris Rehberger -- Vice President Finance

No. Maybe 19 I think there was...

Michael S. Sarner -- Chief Financial Officer

I don't know who joined.

Chris Rehberger -- Vice President Finance

I think don't there were 19.

Bowen S. Diehl -- President, Chief Executive Officer and Director

We haven't -- what's that? They were 19 at the end of March.

Michael S. Sarner -- Chief Financial Officer

Yes.

Bowen S. Diehl -- President, Chief Executive Officer and Director

And then since then we have added an analyst and an associate.

Michael S. Sarner -- Chief Financial Officer

And we have one more analyst on the way.

Bowen S. Diehl -- President, Chief Executive Officer and Director

We have one more analyst that is scheduled to start this summer.

Christopher John York -- JMP Securities -- Analyst

Got it. That's it from me. Thanks guys.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks, Chris.

Operator

Thank you. And our next question comes from the line of Christopher Testa with National Securities. Your line is open.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Hi. Good morning, guys. Thank you for taking my questions. Just given the volatility we've seen obviously in the broadly syndicated market during the quarter just curious, why there wasn't this more Upper Middle Market originations done during the quarter. Are you guys still concerned what the obvious the lack of documentation and EBITDA add-backs? Is that kind of outweighing the back of the yields that you're seeing? Just curious kind of what the thinking was on that?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yes. So thanks -- hi, Chris. Thanks. Couple of things I would say, first of all, as I said in my remarks that probably didn't hear out clear. But the vast majority of it, when these at least in our book, as we saw the markdown in quotes. And I think this is probably fair across the market. Certainly, when a quote comes down on a syndication debt, they mark coming down from 98% to 94% for that. That does not as you know that does not necessarily mean there is paper available at 94. So we didn't see a lot of opportunities to buy paper at significant discounts to what we thought value would be, we just didn't see the paper for sale.

That said, I would also tell you -- and frankly, there would need to be probably gyrations in the market that last in a little bit longer, so that you actually had assets (inaudible) at funds. So that funds would start selling paper at a discounted price. That's a different. You've got to have something more than just the last two weeks of December to cause that. And so -- and we may see that in the future, we didn't see that in December and I'd also tell you that from the caution perspective, we absolutely are cautious on from the add backs and all the other things that we're cautious about six months ago, we were still cautious about now.

And I would tell you that the first time we see gyrations in the market, we're not going to be diving in and buying in, catching a falling knife. We're pretty cognizant of that. And so net-net it's all kind of happened really quickly at the end of December, frankly a lot of its bounce back now, so when we just didn't see a lot of opportunities out there to really buy paper at the discounted price. And against the backdrop of being cautious the first time you see market gyrations just start going and buying things. We were going to be cautious in that respect.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Okay. No that makes sense. And staying on this topic, given the volatility if this does indeed now it's, obviously, snap back but if it does indeed be sustained over a longer period of time, is this something that could potentially get you guys thinking about upsizing the I-45 to more so take advantage of some gyrations that last for longer period of time?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. So as we think about it -- look, the first question is, is there value in the asset class, do we see value, do we want to buy in and do we want to increase our exposure to the asset class? That's the first question, so setting that question aside. The answer to that question at some point in the future very well could be, yes, and so then the question is how do we fund it? And so we would be able to fund it. We've increased the liquidity on our credit facility substantially and will continue managing that up, we'll continue to drive to stay half a step ahead on capitalization through bond offering and potentially equity that type of thing.

But we also have the opportunity -- we also possibly, I don't want to speak for our partner at Main Street, but we do have the option potentially to increase I-45. I would tell you that we're very happy with the relationship with Main Street, we're like-minded firms. The fund management it's been very smooth and so -- and its in a very efficient funding vehicle. Thanks to the capitalization, credit facility that Michael and his team have put together around that fund. So from an ROE perspective, it's definitely an option for a place that we could either put the capital on our I-45, levered up through our credit facility there, or we could put the investments on our balance sheet and lever it with ING's credit facility. And that's more of an ROE question and a relationship question.

So I would definitely tell you that there is a possibility on the table. Nothing imminent, nothing -- frankly the initial question of -- is there value in the asset class, we're still very cautious in that as a general matter in that asset class, so we're not itching to greatly increase the exposure to asset class at the moment. But like I said, we would capitalize on our balance sheet to increase exposure if we change our mind on that. And I do think that, that increasing I-45 over time could be an option.

Michael S. Sarner -- Chief Financial Officer

And there's significant interest from our bank as well as other banks in that asset class should we choose to put in more equity and want to lever back up.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. There is definitely interest from the lender community on both our balance sheet as well as I-45 to continue to provide increased leverage dollar on the deal.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Got it. Yeah. Okay. That's helpful Thank you. And just again congrats on exiting Deepwater, so that's one down, one to go for the remaining legacy investments. Given that this was a real small realized gain, should we expect this to just solely be used to pad the UTI going forward, or is there a plan to maybe declare some of this to be a special dividend upfront or is this just too small to really kind of make a difference for that?

Bowen S. Diehl -- President, Chief Executive Officer and Director

No, this one will go into our UTI bucket, as well as the additional UTI from our dividend coverage this quarter, which was $0.03 as well. So that will continue to bed that program.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Okay, got it. And just to the extent you are able to talk about the current non-accrual, you guys had mentioned it's 4 times levered, is that through the last dollar of leverage?

Michael S. Sarner -- Chief Financial Officer

Yeah. That's correct.

Christopher Robert Testa -- National Securities Corporation -- Analyst

And is this -- I know you had said that the sponsor is withholding payment and you guys and the other lenders are obviously pursuing it. Is the sponsor of this one that you have other investments with or have one, two in the past?

Bowen S. Diehl -- President, Chief Executive Officer and Director

No, it's not. It's actually a family office in the Middle East. It's got a US office in New York and representative in New York. So, no, it's not somebody that we've done other business with.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Got it. Okay. And just one last one, if I may, and then I'll hop back in the queue. Looking at the originations during the quarter, you guys did a split lien on an energy company, midstream one, just wondering if you could provide some color on the leverage of that and just any other detail would be helpful.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. So leverage low, it's in the 1.5 to 2 kind of fair way, multiple EBITDA, very low LTV. Let's say, basically it's a gathering company and what they do is, you've got -- there's just a gazillion stripper wells, which are basically wells that produce less than 10 barrels a day, spattered across the Permian basin. And there is no -- the economics don't make sense to build pipelines up to those wells and they've been producing for decades. And so, someone has to go pick up all that oil and take it to market. And so it's a very -- and you can't shut those wells off. I mean you can't really -- they're long-tail wells. And you can't really shut them off and efficiently turn them back on or even to be able to turn them back on. And then, they also clean out oil tanks that are part of the production process.

And so, pretty stable -- very stable business, it exists whether prices are up or prices are down. It had a little bit of flexibility -- a little bit of fluctuation with the commodity prices and that they -- actually, some of the oil that they clean our of their tanks, they do sell that oil into markets. So there's a little bit of a commodity exposure. But -- we think that's more than offset by the low leverage, as it exists, but like I said, it's kind of in the 1.5 to 1.8 kind of multiple EBITDA leverage.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Got it. Okay.

Bowen S. Diehl -- President, Chief Executive Officer and Director

And I should also say it's a sponsor that's very experienced in the energy space.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Got it. Okay. Great. That's all for me. Thanks for taking my questions.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks, Chris.

Operator

And it looks like we do have a follow-up from Chris York with JMP Securities. Your line is open.

Christopher John York -- JMP Securities -- Analyst

Hi, guys. I had two follow ups. In reference to your hire of an investment bankers associated with the sale of Media Recovery. Is the payout of that fee on a contingency basis or should we expect some G&A pickup in '19?

Bowen S. Diehl -- President, Chief Executive Officer and Director

So it's a typical investment banker relationship, it's going to have a retainer and it's going to have a success fee. The vast majority of the fee is paid out to that banker are going to be on the success fee side upon its sale. And that all flows through -- that's a Media Recovery expense.

Christopher John York -- JMP Securities -- Analyst

Right.

Michael S. Sarner -- Chief Financial Officer

It's actually on the flip side. We're actually going to get a success fee with the sale of MRI that will show up in fees in the quarter of the exit.

Christopher John York -- JMP Securities -- Analyst

Got it. Okay. So that's helpful to clarify. So the reference of your hire was Media Recovery, you made the hire of the banker, so its expense borne by MRI as opposed to Capital Southwest. Okay.

Michael S. Sarner -- Chief Financial Officer

Alternatively speaking, that's exactly right.

Christopher John York -- JMP Securities -- Analyst

Okay. And then the last one is just on dividends. So the context of your core dividend being increased for 12 consecutive quarters. And Michael you said, $0.40 per share in pre-tax NII appeared to be reoccurring. How should investors think about the payout ratio going forward? And then maybe, even longer term the ROE target under your leverage above 1 times?

Michael S. Sarner -- Chief Financial Officer

Yes. So I'd tell you, I think what we're going to -- our dividend coverage will continue to be above 100%. I think we're looking at something more in the neighborhood of like 105% going forward. So I think the 40 -- the NII still has a tail to it, but the dividend pace might slow down a bit. What was your second question Chris?

Christopher Robert Testa -- National Securities Corporation -- Analyst

The longer-term ROE target maybe 1 times leverage or 1.25 times?

Michael S. Sarner -- Chief Financial Officer

Sure, sure. I think that we're actually looking at a target somewhere between 9.5% to 10% on an NII, ROE and total earnings probably closer in the 11, 11.5 with our equity investment as they appreciate over time.

Christopher Robert Testa -- National Securities Corporation -- Analyst

Great. That's it for me. Thanks, Michael. Thank you, Bowen.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks Chris.

Michael S. Sarner -- Chief Financial Officer

Thanks, Chris.

Operator

Our next question comes from the line of Tim Hayes with B. Riley FBR. Your line is open.

Timothy Paul Hayes -- B. Riley FBR -- Analyst

Hi. Good morning guys. Just a few questions on MRI to start. We don't have a queue in front of us, but you mentioned that revenues and EBITDA continues to grow there. Was there any material change in the fair value mark this quarter over the last quarter? We saw the mark on control investments is pretty stable quarter-over-quarter, but I assume the JV was marked down a little bit. So was that offset by some appreciation in MRI?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yes. So MRI, appreciated this quarter by about $4.3 million. So -- go ahead.

Timothy Paul Hayes -- B. Riley FBR -- Analyst

Okay. No I was just -- so does any of that appreciation is that at all fundamental to the company or does any of that reflect any kind of take out premium or increased visibility into the timing of the sale following the hiring of the banker?

Bowen S. Diehl -- President, Chief Executive Officer and Director

So there's no -- it doesn't take into account any official IOIs (ph) or visibility into the market valuation from specifics in sale process. We did do a quality of earnings analysis. We had a third-party account that come in and actually kind of do a QEA, quality of earnings analysis on the company. And that is validated a higher EBITDA number incorporating some of the profit growth that the companies then driving over the last 12 months. And so it is based on that level of EBITDA, which was higher than EBITDA last quarter for example, so that's part of the growth as well.

Timothy Paul Hayes -- B. Riley FBR -- Analyst

Okay. That's helpful. Thank you. And then have you put any more thought and I'm sure you have, but into how you intend to distribute the proceeds once the sale closes in your early investment. Just assuming no further markup in MRI, do you have an idea of how much of the gain or any other exits you might see over that same time? How much of the gain do you believe you'd be willing to payout to shareholders versus retain and reinvest?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. So Tim thanks for the question. I mean, we have not made that decision yet. I would tell you there's three things we can do with the gain. One is that and we will do this which is basically restuff the UTI bucket and there's a limit as you know as to how much UTI we can hold. So whatever that limit is which is a moving target, so at the end of -- lets just say we sell the company in 2019. The tax year 2019 at the end of that tax year we will make an estimation as to how much UTI we can hold. And so whatever that amount is we'll stuff as much of the gain into that bucket as we can because then you will have -- at the current valuation, you most probably would have a significant amount more that you would have to do something with.

And the other two options are retain it and do a deemed distribution to the shareholders or distribute it to shareholders or both -- some of both. And that's the decision that we haven't made yet. And that's going to be a function of a lot of different variables including things like where our stocks trading on a multiples NAV, what our pipeline looks like various things whether we retain or distribute the capital. And so we just haven't made that decision. That's probably a decision that we're making after we closed the sale.

Timothy Paul Hayes -- B. Riley FBR -- Analyst

Got it. That makes sense. Appreciate those comments. And just one more for me. You had one small equity co-investment this quarter and obviously the majority of the existing portfolios come in the form of MRI. Just wondering, how big you see the equity portfolio getting relative to the debt portfolio once MRI is sold?

Bowen S. Diehl -- President, Chief Executive Officer and Director

Yeah. I mean, just as longer-term kind of asset allocation comment I would make. I think for a BDC, I mean, income is really important and that comes from, primarily from interest on loans. And then we've talked about 1st Lien versus sub debt in our view that were very -- it were very heavily emphasizing 1st Lien debt. But within that having some level of equity in the portfolio to drive NAV per share growth over time and to mitigate credit losses as well, we think the equity is also important -- the question is the mix. And I think kind of overall comment I would tell you is kind of 10% to 15% of the portfolio in equity and 85% to 90% of it in income generating debt is probably the right general mix with -- I'd say over time probably, yeah that's probably the range 10% to 15% over time.

Michael S. Sarner -- Chief Financial Officer

After the MRI exit I think our expectation its going to be around 6% to 7%, so it's going to take a bit of time to those point to actually get up to that level over time.

Bowen S. Diehl -- President, Chief Executive Officer and Director

And you may end up hanging around 10% for a long period of time. And that's OK. I mean, we don't make -- we're not out making equity investments solely. I mean, it's usually there equity vast majority of time its equity co-investments alongside, its senior loan we are making as well. So you can't migrate -- we can't migrate it super quickly, but like you said we will come out the gates around 6% or so after we sell MRI.

Timothy Paul Hayes -- B. Riley FBR -- Analyst

Great. Okay. Appreciate taking my questions.

Operator

I'm not showing any further questions. So I'll now turn the call back over to Bowen Diehl for closing remarks.

Bowen S. Diehl -- President, Chief Executive Officer and Director

Thanks operator. And again, thank you everyone for participating on our call today. We look forward to keeping you apprised of our progress on future calls. Have a great week.

Operator

Ladies and gentlemen, this does conclude the program. You may now disconnect.

Duration: 54 minutes

Call participants:

Chris Rehberger -- Vice President Finance

Bowen S. Diehl -- President, Chief Executive Officer and Director

Michael S. Sarner -- Chief Financial Officer

Mickey Max Schleien -- Ladenburg Thalmann & Co. Inc. -- Analyst

Christopher John York -- JMP Securities -- Analyst

Christopher Robert Testa -- National Securities Corporation -- Analyst

Timothy Paul Hayes -- B. Riley FBR -- Analyst

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