Stellus Capital Investment Corporation
Q1 2021 Earnings Call Transcript

Published: 7 May 2021

[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:]

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:]

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 [phone]. At this time, I'd like to turn the call back over to our Chief Executive Officer, Rob Ladd.

[Robert Ladd:]

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 the $19 million since quarter end. Since year end through today, our portfolio is increased by $69 million net of payoffs to $727 million on a cost basis. We'll begin by discussing our operating results followed by review of the portfolio, which will include asset quality and then an outlook. Todd will cover our operating results first.

[Todd Huskinson:]

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 a $100 million of notes due in March 30, 2026 at a fixed rate of 4.875%. We use 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

[Robert Ladd:]

Okay, yes. Thank you, Todd. I'd now like to cover the following areas

[Operator:]

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

[Christopher Nolan:]

Hey guys.

[Robert Ladd:]

Hey, good morning, Chris.

[Todd Huskinson:]

Hey, Chris.

[Christopher Nolan:]

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

[Robert Ladd:]

Yes. So, Chris most of the cash that we had at quarter end is in the SBIC licenses one and two. And so one in the case of the first license from payoffs that will be reinvested and 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:]

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 the second lien investment, which has been non-accrual for a long time. What is your outlook for Grupo? I know it's been a problem for awhile.

[Robert Ladd:]

Yes. So, this is a Puerto Rican hospital system. I think you know that. And so obviously a troubled situation has been for a good while. We put the long, the first lien loan on non-accrual in the first quarter. And as you said, the second liens that are 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 probably would be resolved in the next 12 months or so. But unfortunately it's a very small position relative to the total portfolio.

[Christopher Nolan:]

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

[Robert Ladd:]

Yes. Thank you, Chris.

[Operator:]

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

[Robert Ladd:]

Good morning, Robert.

[Robert Dodd:]

Hi, guys. Good morning. Another non-accrual question, the – I can't remember the name, it's commercializing 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 – or is it a new event at that company? Any color you can give us on that would be appreciated.

[Todd Huskinson:]

Sure. And as you know, we typically, for these private companies, for privacy reasons don't say a lot. But I'd say less COVID-related, little bit of challenges with it over time. It's a structural issue about the nonaccrual. But if it's helpful we think that ultimately, we should do fine there. It's a well sponsored company.

[Robert Dodd:]

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

[Todd Huskinson:]

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

[Robert Dodd:]

Okay. Got it. Perfect, thank you. Just then on, obviously seeing a lot of activity and incremental, 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 the terms look like in the very early-stage companies, early-stage in terms of early-stage in your pipeline that you are looking at today, versus things that you looked at maybe in Q4, and have closed already?

[Todd Huskinson:]

Yes, so I'd say, Robert’s characteristics would be very similar. So, I don't think it's changed materially since the fourth quarter. So arguably, with some pent-up demand after the second and third quarters were relatively slow for everyone. I think it's a continuation of what we saw in the fourth quarter. And, again, as you as you heard earlier, so pretty robust second quarter expected for us. So, I think the good news is that the underwriting and selectivity that we've always had, is the same. And so, on average, these companies have 45% to 50% equity checks below us. So, in terms of the overall capital structure, and the leverage quotients are the same as we've always done typically in the low four times, kind of an average leverage. The one difference, though, and I mentioned this, on our last call, is we're finding more SBIC qualifying opportunities, which is very helpful because of our second license. And as a result, the EBITDA of the businesses would typically be a little bit less. So, perhaps in the high-single digits $10 million, to $12 million, versus an average, it might be more like $15 million in non-SBIC qualifying. But all have covenants are properly structured. All the transactions that we've been closing, have private equity sponsorship with firms that we know well. So, I think that's the good news, just a continuation of our normal business and a lot of very interesting activity. And these are typically businesses that we expect quite a bit of growth from, which is helpful in two ways. One, in that they, therefore would, if the company meets their plan, they'll likely do lever in both absolute and relative terms over the first couple of years. So, a nice turnover of capital, and then in turn, would make their equity co-investments valuable. So again, I think, the only good news – I mean, the good news is that they are very active, more SBIC than not, and using our lower of cost to capital base as a result.

[Robert Dodd:]

Got it. Thank you.

[Todd Huskinson:]

Yes, thank you, Robert.

[Operator:]

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

[Ryan Lynch:]

Hey, good morning. Thanks for taking my questions. The first one I had was, if I kind – I'm glad you kind of mentioned some of your performance, longer term, because, if I look back at kind of 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 much, I would say, a pretty significant de-risking of the portfolio as far as 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:]

Yes, thank you, Ryan. That's a really good question. And I think the statistics you indicated there go back quite a ways. So, maybe close to our inception is that first lien would have been much slower. So, I think it's probably the latter that this is the – this is our investing philosophy and style today and not expecting to change it materially.

[Ryan Lynch:]

Okay. And then last that I remember, when I was kind of talking with you about the leverage, you kind of talked about running, regulatory leverage, closer to one-to-one is kind of a target. And maybe total leverage of upwards to two to one potentially. I'm just wondering, is that where you guys are thinking post-COVID, or any sort of update up just give on where you guys see operating from a leverage standpoint, kind of post-COVID, both from a regulatory standpoint, or total standpoint, however, you guys are thinking about it?

[Robert Ladd:]

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. So 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 that we could operate at a little bit higher leverage, so you may see us have that creep up could be 1.1 or so on the on the regulatory side. But materially higher.

[Ryan Lynch:]

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

[Robert Ladd:]

Yes, thank you very much, Ryan.

[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:]

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

[Operator:]

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