Stellus Capital Investment Corporation
Q1 2022 Earnings Call Transcript

Published: 12 May 2022

[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 2022 Results Conference Call. Today's conference is being recorded, Thursday, May 12, 2022. 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:]

Okay. Thank you, Kyle, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31, 2022. 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 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 [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 solid results in the first quarter in which we grew our investment portfolio, maintained at net asset value, covered the dividend and generated $3.5 million of realized gains. We continue to see many interesting opportunities and as a result, it funded $75 million on a cost basis during the first quarter. Our portfolio at fair value increased by $65 million, ending the quarter at $854 million on a cost basis. We will begin by discussing our operating results followed by a review of the portfolio, including asset quality, our dividend strategy and then the outlook. Todd will now cover our operating results.

[Todd Huskinson:]

Thank you, Rob. For the quarter ended March 31, 2022, we covered our regular dividends of $0.28 per share, with core net investment income of $0.29 per share. GAAP net investment income was $0.28 per share, which includes income tax expense related to our spillover income. We generated net realized gains of $3.5 million related to the realization of an equity investment. Our portfolio valuation, excluding unrealized gain reversals related to our realized gains, was effectively unchanged, declining $1.3 million quarter-over-quarter. We continue to recycle capital in our first SBIC license and deploy the low-cost debentures in our second license. To date, we've committed the full $87.5 million of equity to SBIC II and have funded $70 million. We have drawn down $140 million of the $175 million in debentures that will be available when the equity is fully funding. And with that, I'll turn it back over to Rob.

[Robert Ladd:]

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

[Operator:]

We take our first question from Paul Johnson with KBW.

[Paul Johnson:]

My first question is just on the pace of deployment. It sounds like you have some net deployment here quarter-to-date, and I believe your regulatory leverage, not including the SBA debt, is a little around 1x or 1.1 or so, but gross leverage is much higher. Just hoping to get maybe a little bit of color how you guys consider that while you're making deployments into the quarter, if that factors into potentially pulling back on new originations? Or any sort of insight you might have into realizations within the portfolio, if that helps?

[Robert Ladd:]

Sure, sure, Paul, I'd be glad to. So you're right, the target leverage from a regulatory standpoint is 1 or a little bit over 1

[Paul Johnson:]

Got it. Yes, I know those are very beneficial sources of funding, and that's very good color on that. I appreciate that. My last question is just on just the slight drop quarter-over-quarter in interest income. Just wondering if anything in particular drove that? With rates obviously being higher, I think nonaccruals dropped a little bit. Is there anything higher yielding that paid off during the quarter? And those are all my questions.

[Robert Ladd:]

Yes. Sure, sure, Paul. I’d say the delta between the first quarter of this year versus the fourth quarter of last year was just driven by much fewer repayments. So a very little fee acceleration in the first quarter versus the fourth quarter of last year. And again, it’s likely with slower repayments that, that may continue at least for another quarter or so. So that’s the explanation. And in terms of the yield, so we’re still holding. As you see, we reported a debt yield of 8%. We have average LIBOR floors of 1.12%. And at March 31, when most of the loans repriced, LIBOR was just under 1%. Now it’s about 1.4%, so through the floors, many of the floors. So that holds, as I say, you should see an uptick at the repricing at June 30, but that won’t flow through until the third quarter as the loans reprice on, say, June 30 and then the impact in the third quarter of this year.

[Operator:]

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

[Christopher Nolan:]

I know you mentioned you expect slowing prepayments in the quarter. What are your assumptions in terms of asset quality given the rise in interest rate, the incrementally higher interest burden on your portfolio companies?

[Robert Ladd:]

So we don't expect the rising interest rate environment to have a material impact on asset quality. And so again, as I said earlier, if you take the forward curve and LIBOR goes from what had been 1% at March 31, to say, 3% at -- in January or March of the year from now, we don't think that's material. What would be material would be a 500 basis point increase. So we don't expect that to impact asset quality. But again, there's no question given the headwinds that we've all been talking about, and I mentioned earlier that this will have an impact on the economy and will impact on a number of companies. But as I said, I think we're well positioned to weather it. But I don't think the near-term interest rate forecast is sufficient to have a material impact.

[Christopher Nolan:]

Great. And then I guess as a follow-up, what are your -- excuse me, your private equity partners doing to position themselves for the changing interest rate environment?

[Robert Ladd:]

I'm sorry, the changing interest rate environment?

[Christopher Nolan:]

Yes, the slowing economy and the rising interest rates, are the private equity partners actually doing anything that you might notice that position themselves for the changing environment?

[Robert Ladd:]

Sure, sure. Well, so a few thoughts. One, the good news is that as almost all of our companies are owned by private equity firms, so very smart investment professionals in all cycles. And certainly, we’re preparing and thinking through the headwinds ahead. So I think that, that would be normal, and it’s why we have the strategy overall. We’ve seen a little bit of a slowdown in activity in the first quarter, but there’s substantial dry powder in private equity firms. So we do expect there continue to be acquisitions occurring throughout the year. But you would think that, again, with these headwinds that there’ll be even more selectivity and perhaps you’ll see lower multiples paid for companies but we’re still waiting to observe that. But again, I’d say the most important point about your question, Chris, is the – how it’s very positive for our portfolio to have such smart able investors back in the companies.

[Operator:]

We take our next question from Robert Dodd with Raymond James.

[Robert Dodd:]

On the expectations for lower prepayments or repayments to persist, is that primarily a function of what you're hearing from the companies? Or is it that in this kind of a market environment, you don't necessarily see a lot of repayments or a lot of M&A activity? So kind of related to it, if the market normalizes in the second half, maybe, would you expect them to ramp up? Or is it just you expect it to be low all year just because of what you've heard from portfolio companies?

[Robert Ladd:]

Yes, Robert, so it's a really good question. So allow me to elaborate on what I've said earlier. So I'm basing it just at this point on what we're observing. But at the same time, history would tell us that were running lower, much lower than normal on repayments. They were unusually higher in the third and fourth quarters of last year and are now unusually low in the first and second quarters of this year. So in the reversion to the mean, we should see some pickup in the third and fourth quarters, but there's only one that we're aware of currently. And so I just wanted to make sure everyone had a sense of that could very well pick up, but it's not as obvious at this point.

[Robert Dodd:]

I appreciate that color there. May be related, right, I mean you've had equity guidance, I mean, already $6 million this year. Since a disproportionate number of repayments are usually driven by M&A, which may tie to an equity, if repayments are low, equity gains aren't, right? I mean they're not 0. Should we suspect -- yes, what's the -- is that a connection? What are your thoughts on that?

[Robert Ladd:]

Yes. So then in contrast, so because we have a number of equity co-invest positions where the loan has previously been repaid, I'm really flagging more -- we're flagging more that those could start to come to fruition. So even though the repayments may slower or slowing, we have a number of equity co-investments that do not have debt associated with this point and that they are reaching the point where those companies will be sold. So that would be the distinction.

[Robert Dodd:]

I appreciate that. And then one more, if I can? Obviously, on the rate sensitivity, what is your -- the feel so far that you have on pricing in your market? I mean, obviously, you're not -- the end of the market you're in with a lot of SBA-eligible assets, et cetera, you're not bumping up against the BSL market that much. But I mean, what are you seeing on pricing discussions? And do you think rates have the basis that is going to have an influence on that? Or do you think that's not going to be a huge factor impacting the spread on your first lien?

[Robert Ladd:]

Sure, sure. So the first point is you're right, we do not compete with the or tied at all to the BSL market. And so our pricing continues, it's competitive, but our pricing continues to hold where it is currently and have not seen any issues there. You can make an argument if LIBOR then becomes 3% and your spread is 6% and the rate is 9%, could you see some impact on the spread? But so far, we've not seen that. But LIBOR moving up has just started to happen above 1%. Most -- pretty much the market floor right now has been a LIBOR floor of 1%, and so now we're at 1.40% or so. But so far, no impact on what we're able to charge. It's very competitive, but the pricing has held stable.

[Operator:]

And that concludes today's question-and-answer session, and I'd like to turn it back to Mr. Ladd for any additional closing remarks.

[Robert Ladd:]

Okay. Thank you, everyone, for, of course, your support and for being on the call today. We look forward to speaking again with you. We’ll likely report in late July or early August for the second quarter. Thanks again.

[Operator:]

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