Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Stellus Capital Investment Corporation Second Quarter 2021 Results conference call. At this time, all participants have been placed on a listen-only mode. The call will be open for a question-and-answer session following the speakers' remarks. This conference is being recorded today, Tuesday, August 3, 2021. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Mr. Ladd, you may begin your conference.

Thank you, Shelby and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2021. Joining me this morning as usual is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements as well as an overview of our financial information.

Thank you, Rob. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of Stellus Capital Investment Corporation and any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone number and PIN provided in our press release announcing this call. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these projections. We will not update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.stelluscapital.com under the Public Investors link or call us at 713-292-5400. At this time, I'd like to turn the call back over to our Chief Executive Officer, Rob Ladd.

Okay. Thank you, Todd. I'm pleased to report another solid quarter, in which our net asset value and asset quality were stable. We covered our dividend and had significant originations. As a result of our dividend coverage, our Board approved an increase in our regular dividend to $0.27 a share from $0.25 per quarter and also declared $0.03 of supplemental dividends. We have continued to see an increase in investment opportunities and as a result, we funded $92 million on a cost basis during the second quarter. Since year-end, we've originated $185 million of new investments and our portfolio has increased by $127 million year-to-date, net of pay-offs, which now brings us to $785 million on a cost basis. We'll begin this morning by discussing our operating results followed by a review of the portfolio including asset quality and the outlook and Todd will now cover our operating results.

Thank you, Rob. For the quarter ended June 30, 2021, we covered our dividends of $0.25 per share with GAAP net investment income of $0.28 per share. Core net investment income was $0.30 per share, which excludes the capital gains incentive fees and income tax expense. During the quarter, the portfolio valuation increased slightly, which when coupled with the excess dividend coverage led to net asset value per share increasing to $14.07 per share from $14.03 per share. We continue to recycle capital on our first SBIC license and deploy the low-cost debentures in our second license. The all-in rate on the $60 million of debentures, which have pooled so far is 2.7%. To date, we've committed the full $87.5 million of equity to SBIC two and have funded $60 million of that commitment.

Thank you, Todd. I'll now cover the following areas: the life-to-date review, portfolio and asset quality and then outlook. Since our IPO in November of 2012, we've invested in approximately $1.8 billion, over 139 companies and have received approximately $1 billion of repayments while maintaining stable asset quality throughout. We've paid over $169 million of dividends to our investors, which represents $11.41 per share to an investor in our IPO dating back to November of 2012. Let's turn to portfolio and asset quality. As mentioned earlier, we ended the quarter with an investment portfolio at fair value of $782 million. This is across 76 portfolio companies and this is up from $653 million across 66 companies just at 12/31/20. During the second quarter, we invested $91.5 million in seven new and eight existing portfolio companies and received $24.8 million of repayments for net portfolio growth at cost of $66.7 million for the quarter. We continue to maintain good diversification by industry sector, and there are 60 portfolio companies where we have debt and/or equity positions and that's an average investment of about $12.7 million at fair value per company. 71 of the 76 portfolio companies are backed by a private equity firm. Overall, our asset quality is stable at a 1.9 on our investment rating system, or slightly better than planned. 19% of our portfolio is rated a one or ahead of plan and 11% of the portfolio's market and investment category is three or below, which is below plan. In total, we have four loans on nonaccrual, which comprised 1.1% of the fair value of the total loan portfolio. Now turning to outlook. Beginning in the fourth quarter of last year, we began to see a significant increase in our actionable pipeline. Since quarter end, we have funded $11 million in costs in one new portfolio company and received one repayment of $2 million. For the balance of the quarter, we expect some growth in the portfolio. I will note repayments are picking up. These potential repayments could also result in equity gains, which for the balance of the year could be as much as $10 million to $15 million. With that, I'll open it up for questions. And thank you. Shelby, please start the question-and-answer period.

Thank you. We'll take our first question from Bryce Rowe with Hovde Group.

Thanks. Good morning. Hi, Rob and Todd. I guess, good morning.

Good morning, Bryce.

Wanted to just ask about the last comment you just made, Rob. You mentioned you expect some level of growth in the portfolio for the balance of the quarter. Does that contemplate the repayment activity that you just mentioned?

Yes, it does. It does, but that's why I wanted to qualify that. Whereas we've seen through COVID and really through the first six months of the year less repayments than normal, we now have visibility that that will pick up. But we'd still expect to have the portfolio increase somewhat in the quarter and certainly over the balance of the year.

Okay. Okay. That's helpful. And then maybe a couple more for me. In terms of pricing, wanted to get a sense for what you're seeing on kind of new originations in terms of pricing relative to the current portfolio yield? And are you – I guess, I've kind of seen in other companies some level of stability in terms of spreads and pricing but wanted to get a sense for whether you're seeing that as well?

Yes. So I'd say that our overall portfolio yield on the debt side is a little in the low 8%. We would expect that to continue. And of course, that's a combination of the coupon and the amortization of the upfront fees. So seeing that in the portfolio, probably on unitranche is slightly less, but I'd say overall should be able to hold at about the 8% level.

Okay. Okay. And then last one for me. It looks like you all even subsequent to quarter end drew more on the SBA or drew more SBA debentures. Any sense for kind of the pace of SBA draws whether it be over the next six months or beyond? Just trying to get a sense for when you feel you might kind of max out the current capacity there?

Yes. So I would say, there's base cases we would substantially all draw the remaining debentures by the end of the year, or as perhaps late as the first quarter of next year. So as I mentioned on our previous calls, we've seen an uptick in loan opportunities that qualify for the debentures. So our plan is I'd say certainly by first quarter of next year to see them be substantially drawn.

Excellent. Good detail. Appreciate you all taking the questions. Good talking to you. Thank you.

Thank you, Bryce, very much.

Thanks, Bryce.

We'll take our next question from Christopher Nolan with Ladenburg Thalmann.

Hey, guys.

Hey, Chris.

Hey, Chris.

Rob, is the $0.27 dividend going to be the new base dividend moving forward?

Yes. And of course, the dividend is always subject to the Board's approval, but we consider that new baseline for the regular dividend.

Great. And then Todd, what was the spillover income?

Yes. We have $21 million, almost exactly $21 million of spillover income from last year into this year. So it's about $1.8 per share on the current share count.

Can you share your thoughts on the current terms and conditions for the deals you are encountering? Is pricing becoming more competitive while you maintain your standards, or any insights you can provide on that would be appreciated?

I would say that the credit structures remain consistent with what we've always done. They include financial covenants, and the equity capitalization of the companies is approximately 40% to 50%. The leverage ratio is likely in the low to mid-4s. So, the structures are very similar to what we've typically implemented. Pricing might be slightly lower, and we've substantially shifted our portfolio towards first lien/unitranche. While there is some pricing pressure, we’ve maintained discipline and there are no changes on the credit side. Additionally, we like to participate in the equity of the companies by acquiring a small equity stake alongside the owners, which has proven to be a beneficial strategy for all parties involved.

Great. Nice quarter. Thank you.

Yeah. Thank you, Chris.

We'll take our next question from Matt Tjaden with Raymond James.

Hey, guys. Appreciate the time. First question for me on the supplemental. I know obviously up to the Board, but any high-level color you can give us on whether or not we should anticipate that three-cent supplemental to be more of a kind of recurring programmatic figure or just solely one time?

Yes. So thank you, Matt. The supplemental will be more quarter-by-quarter and in reviewing with the Board. So more to come on that. I should note that in terms of the dividends for the year, and this is a follow-up to Chris' question on the spillover. So as you may recall that we need to have declared the dividends for the year to take care of the spillover by September 15. So you will see in this quarter we're in as we did last year, by September 15, we'll have declared all of the year's dividends which will take care of the spillover. And so you could see something in addition happen then, but let's see when we get to that point. So the good news is it's already covered, but that will also decrease NAV for the quarter because you're declaring the quarter the full balance of the year dividends and they're actually paid in the fourth quarter.

Got it. Second one for me kind of a two-parter. On repayments picking up, any color you've received from sponsors on kind of what's driving a higher expectation of repayments later in the year? And related to that with repayments picking up, how should we expect other income for the remainder of the year?

Yes. I believe that the increase in repayment activity is largely due to a surge in M&A activity following COVID, which has enhanced our pipeline. Business sales and repayments were previously delayed during the pandemic, but now they are starting to increase, reflecting a natural progression. We anticipate seeing some new funding activity in the fourth quarter as people prepare for potentially higher capital gains taxes next year. However, this tax consideration typically does not influence our repayments, as most owners are private equity firms that are not significantly impacted by these tax issues. Essentially, the growth in M&A activity has led to an uptick in business sales, with more businesses being sold than refinanced at this point. Regarding the potential income impact from these activities, since the loans have been outstanding for a while, there is little call protection remaining, which will result in some modest OID accretion. The more significant impact will come from the equity gains linked to the equity co-invest.

That’s really helpful. I appreciate the time.

Yes. Thank you, Matt.

We'll take our next question from Ryan Lynch with KBW.

Good morning, Ryan. Hey, good morning. I just have one question. If I look at where you guys are today in your incentive fee hurdle, you guys are in the most recent quarter just at the bottom end of that hurdle range. So you guys are generating a pre-operating incentive fee ROE between that 8% and 10% range, which equates to an operating ROE post incentive of just 8%. And since you're just at the bottom of the range today, there's a lot of work that would need to occur to actually get above the upper end of that range to actually grow operating EPS any further than what you guys generated in the second quarter. Is there a desire to try to get above the upper end of that hurdle range and grow operating EPS from here, because you need quite a few things to happen to get there, or are you guys satisfied with just generating within that upper and lower end of you guys put the range at this point?

We definitely want to keep growing our operating EPS for the benefit of our shareholders. However, considering the current risk profile of our portfolio, which is less risky than in the past, that aspect is probably more critical. Our focus starts with credit risk and how it impacts earnings. While we would like to see growth, we feel comfortable with our current return on equity. Additionally, unless interest rates rise—which will eventually affect our portfolio but seems unlikely in the short term—we have LIBOR floors averaging around 1.2%. A significant change in LIBOR would be needed to alter our revenue. However, we do have the advantage of extra SBIC debentures to support further growth. As Todd mentioned earlier, the average cost of those drawn in the second license stands at 2.7%, including fees. We expect to pool another $40 million by mid-September, likely at a comparable or lower cost, which could assist in enhancing our operating EPS income. More updates will follow as we secure additional funding.

Okay. Understood. That’s all I have today. Appreciate the time.

Okay. Thank you.

That concludes today's question-and-answer session. Speakers at this time, I will turn the conference back over to you for any additional or closing remarks.

Okay. Well, thank you everyone for being on the call. Thank you for your support, and we look forward to speaking with you again in early November.

This concludes today's call. Thank you for your participation. You may now disconnect.