SCM - NYSE

Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to Stellus Capital Investment Corporation's conference call to report financial results for its fiscal quarter ended March 31, 2023. This conference is being recorded today, May 10, 2023. 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, Kelly, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31, 2023. 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.

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 the 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.

Thank you, Todd. We'll begin by discussing our operating results followed by a review of the portfolio, including asset quality and then the outlook. Todd will cover our operating results.

Thank you, Rob. As interest rates have continued to rise in recent quarters, we continue to benefit from our favorable asset liability mix, in which 97% of our loans are floating and only 32% of our liabilities are floating. As a result, we had another quarter of solid earnings. In the first quarter, we more than covered the dividend of $0.40 per share with GAAP net investment income of $0.46 per share. Core net investment income was $0.45 per share, which excludes estimated excise taxes and the reversal of approximately $600,000 of capital gains incentive fees. Net asset value increased $5.1 million due to the issuance of equity under our ATM program and earnings in excess of the dividend of $1.2 million, offset by net unrealized losses on our investment portfolio of $4.2 million. On a per share basis, net asset value for the quarter dropped from $14.02 to $13.87, or $0.15 per share. With that, I'll turn it back over to Rob.

Thank you, Todd. I'd like to cover the following areas: a life-to-date review, portfolio and asset quality, dividends and then outlook. Since our IPO in November of 2012, we've now invested approximately $2.3 billion in over 180 companies and received approximately $1.4 billion of repayments, while maintaining stable asset quality. We have declared over $223 million of dividends to our investors, which represents $14.15 per share to an investor from our IPO back in November of 2012. Portfolio and asset quality. We ended the quarter with an investment portfolio at fair value of $877 million across 88 portfolio companies, up from $845 million across 85 companies at year-end. During the first quarter, we invested $41 million in 4 new and 2 existing portfolio companies, yet received no full repayments. We did have $6 million of other repayments, which resulted in net portfolio growth of $35 million. At March 31, 99% of our loans were secured and 97% were priced at floating rates, as Todd indicated earlier. We continue to move toward first lien loans. In fact, those are principally the only loans we're making today is unitranche. They were 88% of our home portfolio at quarter end, up slightly from 87% at year-end. We're always focused on diversification. The average loan per company is about $10.8 million, and our largest overall investment is $20.8 million. These numbers are both at fair value. 86 of the 88 portfolio companies are backed by a private equity firm. Overall, our asset quality is stable at a 2 on our investment rating system or on plan. 17% of our portfolio is rated a 1 or ahead of plan and 70% of the portfolio is market and investment category 3 or below, which would be below plan. In total, we have four loans on nonaccrual, which comprised 2% of fair value of the total loan portfolio. Now turning to dividends. As you know, we raised our dividend meaningfully in the first quarter. We continue to cover it as a result of greater earnings that we're generating in this higher interest rate environment. As I said earlier, we're well positioned to benefit from the higher interest rates as our portfolio is 97% floating rate and our liability structure is over 65% fixed rate. Since interest rates have increased again at March 31 for the second quarter, that's when most of our loans reprice, we would expect second quarter earnings to exceed those of the first quarter. As a reminder, part of our strategy has been to invest in the equity of our portfolio companies in a modest way in order to generate realized gains sufficient to offset losses over time. As our business has matured over the last 10 years, we've begun to see somewhat regular realized gains in our portfolio. While we did not have any equity realizations during the first quarter, we do expect some during 2023. Now turning to outlook. As a reminder, our platform at Stellus Capital Management includes a number of private institutional funds that co-invest along SCIC, our public company. This additional capital allows us to invest in larger transactions remain active in the market when our public company may have limited capital and built all portfolios in a diversified manner. Today, total assets under management across the Stellus platform were $2.9 billion. From a macro perspective, the higher interest rate environment, coupled with stress in the regional banking sector, we are approaching the overall economic environment cautiously. Since quarter end, we have funded $17.1 million at par in 2 new and 6 existing portfolio companies and have received no repayments. This brings our portfolio now to $892 million in 90 portfolio companies. With the additional equity raised since 12/31 that Todd referred to earlier under our ATM program, we expect to grow our investment portfolio to over $900 million this year. For the balance of the quarter, we are starting to see repayments pick up, however. As a result, it is likely that new fundings for the rest of this quarter will be at least offset by repayments. And with that, I'll open it up for questions. Kelly, please begin the question-and-answer session, please.

[Operator Instructions]. Your first question is coming from Erik

I wanted to first start, I guess, on the dividend. I'm curious, if you can update us on the level of spillover income you have today and just kind of update us on your thoughts in terms of potentially paying a special dividend at some point?

Yes, Erik, it's Todd. Thanks for the question. So our current spillover income from last year is a little over $28 million. So the current dividend level in 2023 will be enough to repay that spillover. Going into -- so we don't expect a special dividend with respect to that. Now our earnings going forward could -- we could wind up having spillover income in a special dividend next year, but don't expect to have one this year.

Got it. That makes sense just with the increased base dividend that takes care of the spillover from last year. So okay, great. And then just curious on the -- switching gears to credit, maybe kind of 2 questions there. One, curious if you've seen any uptick or acceleration in amendment request? And secondly, I'm just curious about the sentiment of PE sponsors today if we were to go into a more severe economic environment just as you kind of continue to have ongoing discussions with them, how you would kind of measure or weigh or categorize their current willingness to step up with additional equity if needed?

Okay. Sure. I'll take that one, Erik. This is Rob. So with respect to additional amendment requests, I'd say, not an unusual number. So we have a fluid portfolio, but I'd say no unusual increase in those requests relative to private equity firms. So as part of our underwriting, of course, we're looking at the quality and the history, if you will, and track record of a private equity firm, who's the owner of the business we've lent money to. And so we would expect they will operate as they have for -- now we've been doing this over 19 years that they'll be responsible and when capital is needed to come into a situation that they'll be there to provide it. There does come a time when you get to where it doesn't make both economic sense or reputational sense. But certainly, to solve problems earlier, we found private equity sponsors to step up meaningfully.

Great. And just last one for me. I noticed the PIK income increase in 1Q relative to 4Q. And is that kind of a good run rate to go forward? Or is there anything in the quarter that would not recur in 2Q?

The number is very modest, but we wouldn't expect a material change in that number [indiscernible].

Your next question is coming from Paul Johnson with KBW.

I'm just curious, it sounds like there's a little bit of remaining upside of the portfolio, which is good to hear -- sorry, NII for next quarter potentially. But I'm just kind of hoping to get kind of some color. I mean in terms of NII and kind of ROE for the quarter, which was basically sort of flat quarter-over-quarter, you would have expected that to be a little bit higher just with the net growth, obviously, that you guys had this quarter as well as just the direction of interest rates. I'm curious, was there anything in there that was kind of delayed or just kind of reducing that in any -- in the numbers? Is there -- I think, maybe it's potentially due to the weaker repayments, but any color there would be helpful.

And Paul, is your about NII or NAV?

NII and just kind of the ROE, just I'm looking at roughly like a 12.5% ROE from last quarter is basically flat to this quarter. I just would have expected that to be a little bit higher.

Yes. So I'd say there were some repayments in the fourth quarter that provided key acceleration income. That would probably be the principal difference. And again, as I said earlier, there were no pure repayments in the first quarter.

Got it. And then my last question is just kind of around the -- your comment on equity realizations this year. I mean is your kind of expectation for incremental realizations in some of your equity investments, just sort of normal course for what you would expect in any given year? Or is there any sort of line of sight that you have, I guess, an ongoing discussions and activity taking place in your portfolio?

Sure. Sure. I would say that the comment that I made was just to remind everyone that we do have them. But I would say, just as repayments have slowed, we would expect equity realization to be slowed versus really the last couple of years where they were more robust in '21 and '22. So do we have a line of sight on 2 or 3 but at a reduced pace.

Your next question is coming from Christopher Nolan with Ladenburg Thalmann.

Rob, given your experience, long experience in going through money cycles, what advice are you providing to your portfolio companies in terms of how they can better position themselves financially for the continuation of this current economic cycle?

Well, it probably starts, Chris, and a lot of the kind of die has been cast, it comes with is the company properly capitalized at the start and then or if there's a need over time for additional capital to come in, I'm talking about equity capital to come in. They had a good position from an equity capital base, i.e., not overlevered. And then say the secondary would be, of course, that they have adequate working capital liquidity. So I think that's kind of fundamental and fortunately, that's the way we approach our underwriting. From an operational standpoint, we are focused on businesses that have meaningful growth potential, but also have cost structures that are variable. And so as economic climates change, they have the levers to pull that can allow them to adapt to, as an example, a lower revenue base. So I'd say that would be the overall advice. One thing that is helpful in this higher interest rate environment, which we think is -- appears to have gotten to its higher level. We also think it should stay here for a while. At that level, if it got that much higher, you may get over time requests for, "Gee, could you pick a little bit of the interest here like SOFR went to 7% or so?" And so of course, we have that flexibility to do within our structures since it's principally ourselves or other people of like mind. But we've not gotten to that point. And again, our sense is that interest rates have gotten closer to where they'll be on the high level. And so at this point, not anticipating many of those requests.

Great. And then as a follow-up, and this is more of a general. Are you seeing a broader demand for -- in the manufacturing and the type of cash flow type of lending that you do as offshoring in China starts to come back into the U.S. and so forth like that? Are you start seeing that effect in terms of your deal flow?

Not in a big way. We certainly have seen some companies reposition away from China, and this has been going down on for now 2 or 3 years in terms of other offshoring locations like Vietnam, but have not seen a big increase in terms of U.S. manufacturing, but it's likely to happen to some extent.

There appear to be no further questions in queue at this time. I would now like to turn the floor back over to Rob Ladd for any closing remarks.

Okay. Thank you, Kelly. Again, thanks, everyone, for joining us this morning for our call. We look forward to speaking with you this summer when we report on the second quarter results.