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Capital Southwest Corporation: Earn an 8% Yield From an “Alternative Bank?” Income Investors 2020-02-28 15:24:37 Capital Southwest Corporation Capital Southwest stock CSWC CSWC stock NASDAQ:CSWC BDC alternative bank high yield stock This is a look at Capital Southwest Corporation (NASDAQ:CSWC), which currently pays 8%. But in reality, investors could collect even more. Here's why. Capital Southwest Stock

Capital Southwest Corporation: Earn an 8% Yield From an “Alternative Bank?”

This High-Yield Stock Looks Interesting

Income investors love bank stocks. But because many people have been buying shares of these banks, the most well-known ones don’t really yield much these days. And that’s why some investors have been using what I call “alternative banks” to boost the returns of their income portfolios.

One alternative bank worth considering is Capital Southwest Corporation (NASDAQ:CSWC), which is an internally managed business development company (BDC) headquartered in Dallas, Texas.

I call it an alternative bank because it doesn’t have any branch and it doesn’t serve any retail customers. Instead, it’s a “middle-market lending firm focused on supporting the acquisition and growth of middle-market companies across the capital structure.” (Source: “Capital Southwest Corporation Investor Presentation,” Capital Southwest Corporation, last accessed February 19, 2020.)

A typical direct borrower from this alternative bank would have annual earnings before interest, tax, depreciation, and amortization (EBITDA) of $3.0 million to $15.0 million. Each investment is usually between $5.0 million and $20.0 million. And because Capital Southwest invests across the capital structure, its portfolio includes first lien, unitranche, second lien, subordinated debt, and equity co-investments.

The main focus though, is still lending, which means the company can earn a predictable stream of interest income. As of December 31, 2019, 88% of Capital Southwest’s total assets were generating recurring income.

And with that recurring income, the company can dish out recurring dividend payments.

On January 22, the board of directors of Capital Southwest declared a regular quarterly cash dividend of $0.41 per share. The dividend will be paid on March 31 to shareholders of record as of March 16. (Source: “Capital Southwest Announces Financial Results for Third Fiscal Quarter Ended December 31, 2019 and Announces Total Dividends of $0.51 Per Share for the Quarter Ended March 31, 2020,” Capital Southwest Corporation, February 3, 2020.)

The ex-dividend date—the day on which sellers of the stock get the dividend instead of buyers—is March 13. So to be eligible for this dividend, investors would need to own CSWC stock before March 13.

There are two important things to note about Capital Southwest stock’s upcoming dividend payment. First, the $0.41-per-share regular dividend represents a 2.5% increase from its previous regular quarterly dividend rate.

Second, in addition to the regular dividend, Capital Southwest will pay a supplemental dividend of $0.10 per share on March 13, with the same ex-dividend date as for the regular dividend. In other words, CSWC stock investors will be collecting a total payment of $0.51 per share at the end of March.

Is the Dividend Safe?

For those wondering whether the payout is safe, let’s check out Capital Southwest’s latest earnings report.

For the third quarter of Capital Southwest’s fiscal-year 2020, which ended December 31, 2019, the company generated pre-tax net investment income of $0.44 per share. The amount was in excess of its regular dividend of $0.40 per share paid for the quarter. (Source: Capital Southwest Corporation, February 3, 2020, op. cit.)

In the 12 months ended December 13, 2019, the BDC generated $1.72 per share of pre-tax net investment income while paying $1.57 per share in regular dividends. Therefore, it achieved a regular dividend coverage ratio of 1.1 times, leaving a margin of safety. (Source: “Capital Southwest Corporation Investor Presentation,” Capital Southwest Corporation, op. cit.)

Now, as the company’s name suggests, supplemental dividends don’t always recur. But Capital Southwest has been paying the $0.10-per-share quarterly supplemental dividend since mid-2018. Will the company continue paying supplemental dividends after its recently-declared March 2019 payment?

Well, Capital Southwest Corporation uses its undistributed taxable income (UTI) balance to fund its supplemental dividends.

In the company’s latest earnings conference call, chief financial officer Michael Sarner said, “Due to the successful sale of MRI, we were able to replenish our UTI balance to a level of $1.48 per share as of December 31, 2019 which we believe provides visibility to the continuation of our supplemental dividend program well into the future.” (Source: “Capital Southwest Corp. (CSWC) CEO Bowen Diehl on Q3 2020 Results – Earnings Call Transcript,” Seeking Alpha, February 4, 2017.)

Bottom Line on Capital Southwest Corporation

With Capital Southwest stock trading at $20.65 apiece, its regular quarterly dividend rate of $0.41 per share already translates to a generous annual yield of about eight percent.

If the company keeps paying the $0.10-per-share supplemental dividend on a quarterly basis—which it likely will, given the financials—it would be offering an annual yield of about 10%. However you look at it, this alternative bank could be an opportunity for yield hunters.

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