Earnings Call Transcript - SCM Q1 2021

Operator, Operator

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 First 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, Friday, May 7, 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.

Robert Ladd, CEO

Yes, thank you, Katie. And good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31, 2021. Joining me this morning 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.

Todd Huskinson, CFO

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 that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using a 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.

Robert Ladd, CEO

Thank you, Todd. I'm pleased to report a solid quarter in which net asset value and asset quality were stable. We covered our dividend and notably had significant originations. We continue to see an increase in investment opportunities and as a result have funded $93 million on a cost basis during the quarter and $19 million since quarter end. Since year-end through today, our portfolio has increased by $69 million net of payoffs to $727 million on a cost basis. We'll begin by discussing our operating results followed by a review of the portfolio, which will include asset quality and then an outlook. Todd will cover our operating results first.

Todd Huskinson, CFO

Thank you, Rob. For the quarter ended March 31, 2021, we covered our dividends of $0.25 per share with GAAP net investment income of $0.26 per share. Core net investment income was $0.28 per share, which excludes the capital gains incentive fees and income tax expense. Net asset value per share was unchanged at $14.03. In January 2021, we completed an institutional bond offering of $100 million of notes due on March 30, 2026, at a fixed rate of 4.875%. We used the proceeds to redeem our $48.9 million of notes due in 2022 and the remainder to pay down our bank credit facility. Finally, we continued to commit and fund equity capital to our second SBIC subsidiary, which allows us to draw low-cost, 10-year debentures on a 2:1 basis. And with that, I'll turn it back over to you, Rob.

Robert Ladd, CEO

Okay, yes. Thank you, Todd. I'd now like to cover the following areas: just a reminder about the life-to-date review and then portfolio and asset quality and outlook. So since our IPO in November 2012, we've invested approximately $1.7 billion in over 135 companies and received approximately $1 billion of repayments while maintaining stable asset quality. We paid over $164 million of dividends to our investors, which represents $11.16 per share to an investor in our IPO back in November of 2012. Now turning to the portfolio. We ended the quarter with an investment portfolio at fair value of $714.5 million. This is across 70 portfolio companies, and this is up from $653 million across 66 companies at year-end. During the first quarter, we invested $93.4 million in seven new and eight existing portfolio companies and received $33.6 million of repayments, which again resulted in growth of about $60 million for the quarter. Our portfolio continues to be weighted towards secured lending at floating rates. As of March 31, 95% of loans were secured, and 93% were at floating rates. Currently, 86% of the loan portfolio is first lien or unit tranche. We continue to maintain good diversification across the portfolio. Our average investment for companies is $10.2 million, and the largest investment is $21.6 million above the fair value. Additionally, 65 of the 70 portfolio companies are backed by a private equity firm. Overall, our asset quality is stable at a rating of two on our investment rating system, or on plan. 17% of our portfolio is rated one, or ahead of plan, and about 8% of the portfolio is marked at an investment category of three or below, which is below plan. In total, we have four loans on non-accrual, which comprised 1.8% of the fair value of the loan portfolio. Now turning to outlook. Beginning in the fourth quarter last year, we began to see a significant increase in our actionable pipeline. As mentioned previously, since quarter-end, we funded another $19 million in costs for two companies. We have received one repayment since quarter-end of $14 million. Probably, more importantly, we've identified potential fundings of approximately $75 million that we could very well fund by the end of this quarter we're in, and we're not aware of any substantial payments in the next 30 to 60 days. With that, I'll open it up for questions. Thank you, and Katie, you may begin the Q&A session, please.

Operator, Operator

Thank you, sir. Thank you. Our first question will come from Christopher Nolan with Ladenburg Thalmann.

Christopher Nolan, Analyst

Hey guys.

Robert Ladd, CEO

Hey, good morning, Chris.

Todd Huskinson, CFO

Hey, Chris.

Christopher Nolan, Analyst

What are you guys thinking about using this excess cash for in the second quarter? Are you just keeping it for potential investments, or should we expect paydowns of the facility?

Robert Ladd, CEO

Yes. So, Chris, most of the cash that we had at quarter-end is in the SBIC licenses one and two. In the case of the first license from payoffs, that will be reinvested, and in the case of the second license from debentures that we've drawn. So we would expect, I think likely all of that to be invested by June 30.

Christopher Nolan, Analyst

Got you. And Grupo HIMA, if I'm correct, you have two investments with them on non-accrual, a new first lien investment, as well as a second lien investment, which has been on non-accrual for a long time. What is your outlook for Grupo? I know it's been a problem for a while.

Robert Ladd, CEO

Yes. So, this is a Puerto Rican hospital system. I think you know that. And so, obviously, it’s a troubled situation and has been for quite a while. We put the first lien loan on non-accrual in the first quarter, and as you said, the second lien has been on non-accrual for some time. We have the second lien marked at zero, and I believe the first lien is less than $0.50. So, it will probably be resolved in the next 12 months or so. But unfortunately, it's a very small position relative to the total portfolio.

Christopher Nolan, Analyst

Got you. That's it for me. Thanks, guys.

Robert Ladd, CEO

Yes. Thank you, Chris.

Operator, Operator

Thank you. Our next question comes from Robert Dodd with Raymond James.

Robert Dodd, Analyst

Good morning, Robert.

Robert Ladd, CEO

Good morning, Robert.

Robert Dodd, Analyst

Hi, guys. Good morning. Another non-accrual question: the – I can't remember the name, it’s a commercialization company that appears to be non-accrual. Is that kind of legacy COVID issues kind of finally flowing through to necessitate a non-accrual? Could you give us any color on that? Or is it a new event at that company? Any color you can give us on that would be appreciated.

Todd Huskinson, CFO

Sure. And as you know, we typically, for these private companies, for privacy reasons, don't say a lot. But I'd say it's less COVID-related and more about structural issues over time that led to the non-accrual. However, if it's helpful, we think that ultimately, we should do fine there. It's a well-sponsored company.

Robert Dodd, Analyst

Has the sponsor put in additional capital over the last 12 months there?

Todd Huskinson, CFO

The sponsor has done all the right things there, yes.

Robert Dodd, Analyst

Okay. Got it. Perfect, thank you. Just then on, obviously seeing a lot of activity and considerably more, potentially closing in the remainder of this quarter. Since kind of Q4, with all this activity, have you – what have you seen on the terms front for those? And maybe what do the terms look like in the very early-stage companies that you are looking at today versus things that you looked at maybe in Q4 and have closed already?

Todd Huskinson, CFO

Yes, so I'd say, Robert, the characteristics would be very similar. I don't think it's changed materially since the fourth quarter. With some pent-up demand after the second and third quarters were relatively slow for everyone, we're seeing a continuation of what we observed in the fourth quarter. Again, as you heard earlier, we expect a pretty robust second quarter. The good news is that the underwriting and selectivity that we've always had remains the same. On average, these companies have 45% to 50% equity checks below us. In terms of the overall capital structure, the leverage quotients are still typically around the low four times. The one difference, though, is that we are finding more SBIC qualifying opportunities, which is very helpful because of our second license. As a result, the EBITDA of the businesses would typically be a bit less, possibly in the high single digits, around $10 million to $12 million, versus an average of about $15 million in non-SBIC qualifying. But all have properly structured covenants. All the transactions we've been closing have private equity sponsorship with firms that we know well. So, again, I think the good news is that they are very active, more SBIC than not, and using our lower-cost of capital base as a result.

Robert Dodd, Analyst

Got it. Thank you.

Todd Huskinson, CFO

Yes, thank you, Robert.

Operator, Operator

Thank you. Our next question comes from Ryan Lynch with KBW.

Ryan Lynch, Analyst

Hey, good morning. Thanks for taking my questions. The first one I had was, if I'm glad you kind of mentioned some of your performance, longer term. Because if I look back at your portfolio construction over the last several years, it's changed pretty dramatically. At one point, a few years ago, you guys were running with almost 30% first lien debt investments, and now it's closer to 80%. And you had a portfolio yield in the 11% to 12% range, and now that's 8.3%. So, you've seen a pretty significant de-risking of the portfolio regarding where you are in the capital structure, as well as the portfolio yield standpoint. So, I'm just curious, as we start to come out of COVID and the economy starts to recover, should we expect any sort of tilt back into the portfolio, from a risk standpoint, to move, to reduce the first lien exposure to try to increase the portfolio yield at all? Or is this sort of the new norm of how you guys want to operate the BDC?

Robert Ladd, CEO

Yes, thank you, Ryan. That's a really good question. I think the statistics you indicated there go back quite a ways. So, it's probably the latter that this is our investing philosophy and style today, and we’re not expecting to change it materially.

Ryan Lynch, Analyst

Okay. And then lastly, I remember when I was talking with you about the leverage, you mentioned wanting to run regulatory leverage closer to one-to-one as a target and maybe total leverage of upwards to two-to-one potentially. I'm just wondering if that’s where you guys are thinking post-COVID or if there's any sort of update on where you see yourselves operating from a leverage standpoint, both from a regulatory or total standpoint in whatever way you guys are considering it?

Robert Ladd, CEO

Sure, Ryan. Those are still good numbers. So, one-to-one on a regulatory test and two-to-one on a GAAP test, which includes the SBIC debentures. We don't expect that to change materially. There's a good argument that on perhaps both fronts, because of the nature of the first lien portfolio, we could operate at a little bit higher leverage, so you may see us have that creep up to around 1.1 or so on the regulatory side, but not materially higher.

Ryan Lynch, Analyst

Okay. Understood. That's all for me. I appreciate the time today. Thanks.

Robert Ladd, CEO

Yes, thank you very much, Ryan.

Operator, Operator

Thank you. That concludes today's Q&A. I would now like to turn the call back over to Mr. Ladd for closing remarks.

Robert Ladd, CEO

Okay, great. Well, thank you, everyone, for being on the call. Thank you very much for your support of the company. We look forward to speaking with you again in early August when we report the second quarter results. Thanks again.

Operator, Operator

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