Joe Alala - Chairman and CEO Jack McGlinn - COO, Treasurer and Secretary Steve Arnall - CFO.

Mickey Schleien - Ladenburg Ryan Lynch - KBW Christopher Nolan - FBR & Company.

At this time, I would like to welcome everyone to the Capitala Finance Corp’s Conference Call for the Quarter Ended September 30, 2016. All participants are in a listen-only mode. A question-and-answer session will follow the company’s formal remarks.

Today’s call is being recorded, and a replay will be available approximately three hours after the conclusion of the call, on the company’s website at www.capitalagroup.com under the Investor Relations section.

The hosts for today’s call are Capitala Finance Corp’s Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall. Capitala Finance Corp., issued a press release on November 8, 2016 with details of the company’s quarterly financial and operating results.

A copy of the press release is available on the company’s website. Please note that this call contains forward-looking statements that provide information other than historical information including statements regarding the company’s goals, beliefs, strategies, future operating results, and cash flows.

Although the company believes these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements.

These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled, Risk Factors and Forward-Looking Statements in the company’s quarterly report on Form 10-Q. Capitala undertakes no obligation to update or revise any forward-looking statements.

At this time, I would like to turn the meeting over to Joe Alala. Please begin. .

Thank you, Operator. Good morning everyone. Thank you for joining us. I realize a lot of you including everyone in this room were likely up late in to the night and this is not the last scene, but if you’re able to see what we’re wearing. We all have on green hat to say make Capitala great again. So with that we’re going again.

We began 2016 with limited liquidity and energy exposure on the hind side of the industry average as a percentage of portfolio assets. Management began focusing on addressing both the liquidity issue and the energy investments issue. These efforts culminated in the successful activity in the third quarter.

One, in August management found without the help of any advisors and paid no advisory fees and the institutional buyer of a strip of BDC assets that represented some of the larger investment holdings of the BDC. These assets were sold at fair value, no discount as determined by the BDC third party mark of the prior quarter.

Two, in August management held an initial closing on its Capitala Private Credit Fund V, the target size of 500 million.

The BDC benefits from the ability to co-invest with Fund V in accordance with the SEC co-investment order and Fund V increased its lower middle market strategy liquidity with several years of expected liquidity in the strategy, thus allowing the BDC to always be active in the lower middle market irrespective of the BDC’s access to public market capital races.

Three, by exiting (inaudible) investment and addressing pro-actively our energy investments, the BDC has lowered its energy exposure from 12% at the end of 2014 to 4% at September 30. Management was able to maintain its direct origination capabilities even though liquidity was tight throughout 2016, until August liquidity events concluded.

Since August, management has closed 47.5 million of directly originated deals to new portfolio companies.

These new investments were approximately 90% senior secured and have an average cash yield in excess of 12%, conclusively showing how we’re not tasting yield but rather relying on our strong direct origination ability to source high quality deals.

Management continues to see a solid pipeline of cloudy deal to its direct origination platform and is focused on converting the existing pipeline of new investments. Pipeline activity is similar to recently closed new investment.

Management with its Board of Directors decided to cut the distribution by 17% to $0.39 per quarter beginning in the fourth quarter of this year, a distribution still in line with our peers.

The reduction generates a more secure distribution that should be covered by NII and has the ability to generate maximum spillover income in effect creating distribution reserve.

Moreover, management continues to expect to monetize equity investments as part of its investment strategy, but no longer focusing on monetized capital gains to contribute to distribution coverage. As monetized capital gains occur, management has the ability to consider special distribution as it has paid in the past.

Management is prepared to continue to waive incentive fees to assist in the covering of its distribution by NII if needed. At this point, I’d like to turn the meeting over to Steve and Jack to provide additional comments on our operating and financial performance. .

Thanks Joe. Good morning. As previously mentioned, on November 8 without a press release was our third quarter 2016 earnings.

I would invite you to visit the investor relations portion of our website to learn more about the company, review quarterly investment updates and to automatically receive email notifications of company, financial information, press releases, stock alerts or other corporate filings.

During the third quarter of 2016, total investment income was 17.4 million, 0.9 million lower than the comparable period in 2015. Fee income for the current quarter was 1.2 million lower than the same period in 2015. All other income collectively was 0.3 million higher to third quarter 2016 compared to 2015.

Total expenses for the third quarter of 2016, net of incentive fee waiver were 9.9 million compared to 10.5 million last year. There are no material bearings since to report. Net investment income totaled 7.4 million or $0.47 per share for the third quarter of 2016, compared to 7.8 million or $0.48 per share for the same period last year.

Net realized losses totaled $17.0 million or $1.08 per share for the third quarter of 2016, compared to a loss of 16 million last year. Jack will provide more about on net realized losses in just one moment.

Net unrealized appreciation for the third quarter of 2016 including the written call option depreciation was 7.6 million compared to appreciation of 16.2 million the previous year. The net decrease in net assets resulting from operations during the third quarter of 2016 was $2 million or $0.13 per share.

That’s compared to an increase of $8 million or $0.49 per share for the same period last year. Total net assets were $248.4 million at September 30, 2016 equates to $15.68 per share, compared to $17.04 per share at December 31, 2015.

From a liquidity standpoint, we have cash and cash equivalents of $60.6 million at September 30, 2016 compared to $34.1 million in December 31, 2015. SBA debentures outstanding at September 30, 2016 totaled a 107.7 million with an annual rated average interest rate of 3.29%.

In addition, the company has a 113.4 million of notes outstanding bearing a fixed interest rate of (inaudible). Lastly, the company has 38 million drawn and 82 million available under its senior secured revolving credit facility and a regulatory leverage ratio of [0.61x] at quarter end.

At September 30, 2016, the company’s balance sheet and future net investment income will not be maturely impacted by changes in short term interest rates, please see Form 10-Q for detailed information on the company’s interest rate sensitivity. At this point, I will turn the call over to Jack. .

Thanks Steve. During the quarter, we had gross deployment of 26 million for the 12.1% yield on debt securities, repayments amounted to 112 million and included full repayment from Merlin and Sparus in energy related investment, the successful exits from MTI Holdings and STX, and the fair value asset sale that Joe referenced.

Net realized losses of 17 million were recognized during the quarter, mostly related to the $28 million write-off of TCE Holdings that have previously been appreciated to zero, offset by realized gains associated mostly with the exits from MTI and STX.

Net unrealized appreciation was 7.6 million that was largely impacted from reversals from the realized gains and losses. As of the end of the third quarter, the Capitala portfolio consists of 51 companies, with a fair market value of $503.8 million or a cost basis of 477 million.

Senior debt investments represented 41.5% of portfolio, senior subordinated debt 38.1%, senior liquid loan fund 4%, and equity warrant value of 16.4%. The total weighted average yield of our debt portfolio increased to 12.7%. In regards to portfolio of quality, we continue to maintain a sub-2 internal weighted average risk rating at 1.89.

While average leverage of the portfolio remains slightly increased to 3.8x. At the end of the quarter there were two investments on non-accrual, with a fair value and cost basis of 9.5 million and 13.3 million respectively, and energy investments at fair value now represent approximately 4% of the portfolio.

In regards to market conditions, we have seen a meaningful uptick in activity and several proprietary deals under [turn key], we’ve had one subsequent transaction a $22.5 million senior secured debt investment with a 13% cash rate and movable warrant 3% [PIK] interest. And with that I will turn over to Joe. .

Thank you, Jack. Thanks Steve. With that we’re going to open it up to questions. .

[Operator Instructions] And our first question comes from Mickey Schleien from Ladenburg. Your line is open. .

Wanted to start by asking about a couple of credits. The Board reduced the valuation of medical depot by almost 5 million and D-12 by a little over 2 million which together is about $0.40 per share, which caught me by surprise.

I’d like to get some sense to what caused those fairly sharp declines and what is the outlook for those companies?.

Mickey this is Jack. I think we had discussed medical depot a bit last call, but they were in the midst of a process they are running still are. Really the adjustment there was - the adjustment from initial indications that were received and then the closure to final valuation that we’re expecting for that.

So the good news is it’s been growing so fast, there are a lot of pro forma adjustments that’s through the process the valuation sinks down from earlier initial indications that we were - sense sparking off of. Similar story to B-12, where we are looking to exit with just some changes in the overall valuation. .

So Jack how do those valuations compare to a few quarters ago before these processes started?.

Yes, if you back several quarters, they were probably similar to where we have now. I know both of them had been marked up as they were going through the earlier stages of their process. So in both cases there was an early indication that the valuations would be higher.

We’ve marked up to reflect that and then both have come down as we get closer to the cash flow to exit on. .

Okay, I understand. There were some other credits that saw deterioration not to the same extent but some downward movement, specifically emerging markets communications, US Wealth and Print Direction.

Any comments that you care to make on those three names?.

We do have ups and downs, we’ve improved directions one where we have a large amount of equity in it, so that one is subjected to variability just from even small changes or temporary changes in EBITDA. So I experienced most of that one.

US, well obviously is one of our two remaining energy investments and as that market continues to go through their downturn or just trying to be conservative with where we’re marking it, and I think relative to some other investors in that space, I think our markets are conservative and again there’s still no personal [wall] on where the oil and gas markets’ going to go, pricing is stabilized in that market, so that’s a good sign.

I think there is better availability for production companies in 2017 to set their budgets, which should help things and keep things stable, but at the end of the day it’s still prices that are less than half of what they weren’t to be. .

And Print Direction?.

Again Print Direction when we own a lot of equity in, so let’s say there was a downturn in EBITDA and it impacts us with that equity holding the [asset]. .

Turning to the balance sheet, you’re carrying a lot of cash, which I assume means a lot of it is in the SBIC subsidiary. So you previously mentioned that the pipeline looked similar to the deal flow we’ve seen in the last couple of transactions.

How much of the pipeline would qualify for SBA funding and how quickly can you put that money to work to make this balance sheet more efficient?.

This is Steve, good question. The pipeline is a mix of deals that will be SBIC eligible and some that will be done out of the parent. In terms of timing, we’re somewhat optimistic that we’ll be able to report some things out to you before too long, but I wish I could give you more clarity on that, but we did pay down the line during the quarter.

We did pay off $11.5 million worth of notes during the quarter and even with all of that we’re still pretty liquid and it allows us to show investment Fund V and do some good things during this fourth quarter. So we’ll certainly let you know like we did with the deal on Vintage that we just announced.

So soon as we fund those deals we’ll certainly let the market know. .

It is Vintage and SBIC deal?.

Yes. .

And my last question, any comments that you can make on the senior loan fund, and that’s it from me, and the outlook for the fund..

As some may know our partner left during the second quarter and we’ve kind of refocused our strategy on directly listing lower middle market investment opportunities.

So to that end we are in the final stages of winding down the senior loan fund, and by the end of the year we’ll have that fund wound down and the proceeds sent back to the two equity holders and we’ll re-divert those cash in to debt securities.

And we had good dividend in the third quarter, full dividend to be determine what we do in the fourth quarter. But our partner kind of helped us wind down out of this position and it was pretty efficient process and that’s where that’s going. .

But Steve those structures have been popular across the industry.

So can you give us any background on what caused this particular joint venture not to work out?.

Mickey, this is Joe. I would not say it all, but the joint venture did work out. And in fact we think our current partner in that joint venture would do various other joint ventures with us, and it also is an investor in our private fund.

I would say we really decided to get back to basics and get focused on using our direct origination platforms, so we’re able to find high quality deals many with senior secured positions yielding double digit yields.

If you looked at the liquid senior loan fund, it was paying a nice dividend, but we were able to originate like we have in the past few transactions. Senior secured loans and companies with double digit EBITDA, with less than 4x total leverage, we would do those all day long.

So we just had a shift back to basics really relying on our origination platform and that’s where we wanted to focus. And with that shift the partner that we brought along to manage that vehicle, he had to go back to invest in the strategy which was his background. So he left very good terms, he assisted in our process of winding it down.

And I think you will notice in the statement of investments, we actually had a nice appreciation in that position the last quarter. So it will be wound down by the end of this quarter definitely and I’m not sure we may not even have any of the TRS outstanding right now, because the wind down has gone very favorably and as expected. .

And our next question comes from Ryan Lynch from KBW. Your line is open. .

As I look at your balance sheet you guys have about $60 million of cash as well as 80 million available. On your credit facility you all have de-levered the balance sheet over the last couple of quarters, but from a GAAP standpoint, the GAAP leverage ratio is still about 1.27 times and regulatory is at 0.59 times.

So still fairly elevated leverage ratio. So how should we think about your guys’ practical dry powder in the BDC to the point in new investments and then how should we think about those leverage ratios both to GAAP and the regulatory leverage ratios going forward. .

Ryan, this is Steve. I think we feel pretty confident that if we keep our regulatory levers at or below 0.8x that puts in an optimum position from an NII standpoint, gives us some cushion for valuations, fluctuations and that’s kind of been our theme for the last few quarters.

We did as you noted paid down some SBA debt which is excluded, but we also paid down line during the latter part of the third quarter. But will we draw on that line? Yeah we’ve got 82 million available certainly we’re trying to get that, stay under 0.8x.

We probably don’t have availability to draw that whole amount, but we’ve got some cash we’ll use that and to the extent we need to draw on the facilities, the fund deals will do that as well. .

And then over the last several quarters, may be in the last survey in 2016 and maybe within the last five quarters, you guys had some pretty sizeable net realized losses in the portfolio.

So have you done any sort of internal study to identify any deficiencies in the credit process to clear out what went wrong with these credits, are these company specific issues that went bad or is there something more systematic that you guys need to evaluate and try to limit those loss.

Any study and identified anything in that process?.

Yes, this is Jack. We obviously do a lot of study on all our good and our bad investments to always more investments from. Unfortunately the answer is a little bit too easy on the realized losses here where most of them relate to oil and gas investments.

So, with 38 million of realized losses on oil and gas and another 8 million of unrealized losses there. But as we’ve talked about for several quarters now, we were exposed in that area and we had the long decrease in prices. I guess a lesson learned. Its commodity based pricing.

We had a lot of sensitivity around pricing as much as 50% discount as we know that the decline in oil and gas prices was more than 50% and lasted for much longer than anybody had predicted a downturn it won’t last and we’re still in it. So that is really the biggest factor right there. .

And then just one last one, you mentioned in the opening comments that you all are prepared to waive management fees if necessary to cover the current dividend, the nearly reduced dividend.

Do you guys anticipate over the near term the next quarter to having to waive any fees to cover the dividend or are you guys expect to fully cover without any sort of waiver?.

This is Joe. We have a very active pipeline, so the fourth quarter is how much we can burn out of that pipeline. We closed a nice one last week, but we are committed to the waiver this quarter.

Our model shows that if we can continue to have a liquidity to invest and convert the pipeline, the waiver is really minimizing and 2017 should be eliminated, but we are committed to having an incentive fee waiver in place, we did have to waive I think 300,000 this quarter to make it happen. So we’re slowly working our way out of that.

We waived 2.7 since Q4 last year [million], and these are permanent waiver. So we’re committed to it, but with the ability to create the liquidity and now do deals, and we are finding some great quality deals. We should not be relying on this incentive fee waiver in 2017 to any material event. .

And our next question comes from Christopher Nolan from FBR & Company. Your line is open. .

You mentioned the new deals originations are senior secured, can you give us a little detail is a bank ahead of you in many of these deals, are you first lien, how do you characterize it?.

This is Joe. The way we define senior secured really is, there is no term debt ahead of us. There may be a revolver of status, and despite some inner dynamics and inner credit with the revolver. But we really are first lien on that company in the cash flow. So there’s no debt above us, there’s probably an asset based revolver facility beside us.

And the overall leverage is still under 4x on these deals on average. .

And separately, what’s the debt funding strategy going forward.

I mean, presuming that you are unable to grow SBA and you also have the baby bond callable in mid-2017, is the strategy right now to call the baby bond when you are able and then just use the credit facility?.

Yeah, I’m going to talk about your SBIC question and let’s see talk about the balance sheet question on the bonds. We are in very good standing with the SBA, our profit fund was one of the first fund in the nation to receive incremental leverage once the family of fund limit was increased in early 2016.

We will run that process through again to get additional leverage in the BDC that we could utilize the SBIC program for additional debt now that the family of funds limit has increased. And with Steve can comment on the baby bond..

Chris we’re certainly in active discussions with a number of party exploring all of our options as it relates to calling and/or retiring those notes in June. It’s way premature to offer any specifics there.

But certainly something we are highly attentive to and very optimistic that we can find a good solution there for us to reduce that interest carry on that. .

Thanks Steve. So Joe back to your SBA comments and thank you for the detail.

Should we interpret that as you’re going to be applying for another license possibly in 2017, you could see a potential increase in the SBA limit?.

Well the family funds limit has increased. We access that with our profit fund. We are always in communication with SBA. We would like to proceed with the initial SBIC license in 2017.

What we do know is that the SBA is an unpredictable on how they process licenses even though we are great standing, and typically when there is a change of administration sometimes that causes delays. We’ve been in the program for three different administrations. I think we entered the program with the Clinton, over to Bush, then Bush, Obama.

So we have experienced the change of administration a few times being in the SBIC program and that actually adds to the unpredictability of the process. .

[Operator Instructions]..

I think that’s all the questions. Thank you everyone for your time. If you like a copy of our hat that we are wearing on our head, just let us know and we’ll send you one. Everyone have a great day and thank you..

Ladies and gentlemen, thank you for participating in todays’ conference. This does conclude the program, and you may all disconnect. Everyone have a great day..