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

John Hecht - Jefferies Christopher Nolan - Ladenburg Thalmann Chris Kotowski - Oppenheimer Ryan Lynch - KBW Chris York - JMP Securities.

At this time, I would like to welcome everyone to Capitala Finance Corp.'s Conference Call for the quarter ended March 31, 2018. All participations 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 May 7, 2018 with details of the company's quarterly financial and operating results.

A copy of the press release is available on the company's website. In addition, the company posted a prerecorded podcast of its quarterly results May 7, 2018 on its 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 section 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 Mr. Joe Alala..

Thank you, operator. Good morning, everyone. Thank you for joining us. Yesterday we released our results for the first quarter of 2018. Net investment income was $0.28 per share covering our first quarter distributions of $0.25 per share. Net asset value per share was 13.66 at quarter end, down slightly from the year end.

During the quarter, we invested $27.8 million into new and five existing portfolio of companies, $27 million represented debt investments all of which were senior secured structured with a weighted average yield of 10.8%.

Since the second quarter of 2016, we have publicly discussed our desire to underwrite less risky senior secured structures moving away from mezzanine, second lien and subordinated debt loans.

During that seven quarter period, we have invested 196 million of new debt investments, 85% of which were senior secured structures with a weighted average yield of 10.15%. Reducing balances of non-accrual investments remains the focus for our management and the portfolio management team.

During the quarter we exited our position in American Exteriors LLC. Subsequent to the quarter end, our investment in Cedar Electronics Holdings Corp. was restructured into a preferred equity position, thus removing it from non-accrual status.

We continue to evaluate options to monetize certain equity positions, while we anticipate additional exits during the normal course of business. We are also evaluating other opportunities to allow us to reduce equity as a percentage of our investment portfolio.

Lastly, I want to talk for a moment about the recent announcement regarding Capitala Specialty Lending Corp. This new vehicle is a $1 billion permanent cap or vehicle that was raised from global institutional investors.

This vehicle benefits the BDC by one providing platform liquidity that allows the BDC to actively co-invest in transactions irrespective of the BDCs liquidity and hold size limitations.

Two, the BDC benefits from the additional resources as the firm is actively growing and hiring very talented seasoned professionals, opening new full service offices and significantly upgrading its information technologies and platform software.

Lastly, it validates the long-term 20 year track record of the firm and its ability to generate top tier risk adjusted returns and its various investment strategies over a long periods of time.

To our knowledge this private flow of capital is one of the largest permanent capital vehicle that has been raised from all global institutional investors that targets a lower middle market senior debt investment strategy.

While the BDC began to shift its investment focus to senior debt loans in early 2016, this new vehicle is a substantially different investment strategy from Capitala's prior funds that were focused on mezzanine investments.

By raising a significant size private pool of capital that focuses exclusively on senior debt loans, the BDC can further commit to its senior debt focus and now it has the parallel liquidity on the platform to be very active in this new senior debt investment strategy through its ability to selectively co-invest of Capitala Specialty Lending Corp.

At this point, operator we will open the line for questions..

Thank you. [Operator Instructions] And our first question comes from the line of John Hecht with Jefferies. Your line is now open..

Morning, guys. Thanks for taking my questions.

First, just want to get your thoughts in tax reform are you seeing any different, you know, just discussing - in discussions with your borrowers any changes in their appetite for borrowing or changes in their optimism around the business with respect to their initial takes on tax reform?.

John, this is Steve. From us, I have not seen or heard of either of those conversations going on with our portfolio companies. It's a good question. I think there's still more to come..

Okay.

And then maybe can talk about EBITDA, then EBITDA and revenue trends within the portfolio just in terms of thinking about the forward credit book?.

So this is Jack McGlinn. I would say it's stable, probably better this year than it was last year at this time. I think forecast for 2018 were pretty in line with 2017 in general.

So I don't think anybody was overly optimistic going into '18 at the same time they weren't looking for any downturns either and I think for the most part people are on budget and kind of tracking towards their 2018 goals. So I would say it's pretty stable year all in..

Okay. And then final question, you guys gave a good slide of your recent deals. Clearly you've been successful in moving up, I guess up capital structure, I think cannibal [ph] 11 deals, the first three that you highlight.

What can you tell us within that category where is the average now, what type of terms are you seeing in that market?.

Yes, the recent leverage trends on our last sort of seven quarters of deal with the BDC, we think we're still getting pretty good pricing, double-digit yield on the senior debt structures. The majority of those structures if not all of those structures are under 4 x on average total funded debt to EBITDA which is a leverage ratio.

We monitor - another way to monitor it would look at loans of value. So what's the loan outstanding relative to the enterprise value with the bulk of those being 50% or less, loan to value loans. So we are very much focused and disciplined on structure not sacrificing structure at this point in the credit cycle.

Pricing is competitive on some deals, especially some sponsor activity deals, but we've been able to hold our pricing and the senior structures and still getting double-digit yields on average on these loans and we're being very disciplined at this part of the cycle where we are still seeing lots of opportunity and we will miss a deal if the structure gets outside of our comfort zone and our risk tolerance zone.

And we're trying to be very competitive on price..

Great. Thanks very much for the color. I appreciate that..

Thanks, John..

Thank you. And our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Your line is now open..

Hey, guys. The weighted yield on the debt portfolio in the quarter was 12%, last quarter the press release says 12.8%, but now it currently says the fourth quarter is 11.9%.

I'm just trying to understand what the difference is?.

Yeah, we now are showing the yield inclusive of the impact of non-accrual loans where previously we had disclosed, it got a little complicated, we were excluding non-accrual loans, so that's inclusive now..

Got it.

And correct, that you guys are still sort of in a wait and see in terms of increasing a threshold, you have not got an board approval or shareholder approval?.

Yeah, Chris. This is Joe. At the BDC we're still focusing on really the same three things that we've been focusing on for several quarters.

These things ultimately should help our earnings grow and drive NAV stability in our growth and that is we've rotated into focusing on quality senior debt loans move up the balance sheet, move in a better risk position. So we get paid for it.

We're still focused on rotating some of those equity at around 25% equity and the portfolio has too high of a concentration of equity for the BDC, we need to get that down much closer to 10 and we're working hard to try to do that. And lastly we're spending a lot of time you know, folks on the non-accruals and approving those underperforming loans.

So as we manage or work through those things and you have a portfolio that has less equity, more less risky senior debt structures and less non-accruals., we think that's the best time for it to look at some of the regulatory leverage options that are out there and folks at that time own shareholder discussions and board discussions on whether that's appropriate thing for this BDC..

Got it.

And Joe pending any sort of approval from the board or any approval from shareholders, what is now the internal leverage threshold for the BDC?.

Chris, this is Steve. I think if we can get up in 0.7, 0.75 five range that's probably optimal for us right now from an earnings perspective and again still giving us that cushion with this equity book for some cushion there. So 0.7, 0.75 is probably a good number for us..

Okay.

So it's pretty steady from before?.

It is..

Okay. Vallum Global Credit [ph] I know it matured at yearend 2017.

Any sort of update on that?.

No there really isn't too much of an update on that. That's also kind of wait and see - there are some assets in the underlying business there that we're waiting for them to be monetized. And it's really - you know, we're not sure when that will happens. So it just kind of wait and see..

Okay. Thanks.

And Jack for Cedar Electronics, I know it's restructured into preferred equity with a 19% coupon from part of that is that a cash coupon or this that a PIK?.

No that's non-cash..

Okay.

So you're PIK [ph] should be going up?.

No, we will be recognizing that PIK income..

Okay.

So [indiscernible] remain non-accrual?.

It's not a debt investment anymore. If you look at the subsequent disclosures it will be not debt..

Okay. That's it….

You want to....

Sure. Okay. Thanks for taking my questions guys..

Pleasure..

Thank you. And our next question comes from the line of Chris Kotowski with Oppenheimer. Your line is now open..

Yeah. Good morning. Most mine were asked, but just wondering on the $1 billion Capitala Specialty Lending Corp. is that all closed.

Do you have exempted of release and how do you - how do you plan to allocate investments between the two vehicles this and the BDC?.

Yeah, Chris. This is Joe. Thanks for the question. The Lending Corp. has not closed, we will continue to raise money, it structures a permanent capital vehicle that can have access - new investors can have access and that pool can grow.

We received SEC exemption of relief by 18 to 24 months ago and it's standard relief that allows you to co-invest in the same strategy based on your liquidity at the time pro-rata, same security, same structures. We think this is a really big benefit for the BDC for that exact reason.

As we move towards a senior debt focus back in early '16, we also moved to much smaller hold sizes in the BDC and having a parallel pool of liquidity allows the BDC to maintain its investment strategy in a much smaller hold size.

And I think you'll see the trend over the past two years that hold size is almost cut in half at the BDC, we're trying to have a much more [indiscernible] portfolio of senior credit loans. And one key to that is having some parallel liquidity that you can run your strategy and hold smaller hold sizes across the vehicle.

So we think that's a very big benefit. We do have SEC exempted relief to do that and that's very much a part of our strategy going forward..

And when do you anticipate the close on the vehicle and when can you start kind of co-investing?.

Oh I'm sorry, the vehicle is ready to - I thought you meant close meaning, can we accept new investors, this vehicle has already closed. We're about to take some assets off the warehouse any day now and any new loans that are being pursued or are being led by the private vehicles, including this vehicle, Specialty Lending Corp.

and the BDC has the right but not the obligation to co-invest. And that's sort of how the SEC exempt relief order processes that. So all new deals are being led by the private vehicles now which allowed the BDC the right to co-invest to the degree it feels it wants to..

Okay. All right that's it for me. Thank you..

Thank you, Chris..

Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is now open..

Hey. Good morning, guys. I just want to follow up on Chris question on the permanent capital fund you've closed and exempt of relief. So you know, this is a senior debt focused, permanent capital fund. I know you guys have kind of shifted CPTAs investment focus to more senior debt, but historically it has been a little more subordinated mezzanine debt.

Just wondered what - I guess is there going to be a high percentage or low percentage of crossover deals that you think CPTA will be able to co-invest with this private fund?.

Yes. Brian, that's a great question. This is Joe. We think it'll be a very high percentage. We are still able to through our direct originations do senior structured deals and get double-digit on average yields. So you know, call it 10% of what we were talking about earlier in the release. We think that's an attractive opportunity for the BDC.

We do have a private mandate that believes that's an attractive opportunity. So we think there'll be heavy co-investing and we're just continuing to move the BDC away from these mezzanine loans where we had our credit stress and losses much more to the senior debt focus.

And I think if you look at the loans over the last two years in that focus very little credit if any credit stress at all.

Performing loans are top of the capital structure and we believe that's the best place to be if there is any type of reset in the credit markets, we want to own the balance sheet and we want to be actively working with issuers to restructure the companies if needed to get them through any kind of economic stress..

Okay. That makes sense. That's my only question. Thank you..

Thanks, Ryan..

And our next question comes from the line of Chris York with JMP Securities. Your line is now open..

Good morning, guys. And thanks for taking my questions. So I'm going to stay on the positive topic of the Capitala Specialty Lending. I'm curious what types of changes do you expect to occur at the platform, maybe via new hires risk management.

And then secondly are there any economic benefits that you expect accrue to CPTA in either the short term or long-term?.

That's great question. Chris, we sort of mentioned it a little bit in the prior conversations on the release, but we're growing again.

So this new pool of capital allows us to start hiring again because it increases the revenues across the platform where - we have opened a New York office that we've hired a partner, very talented professional, 20, 25 years in the business. He's opened that office in New York. We're hiring more at both underwriting and the portfolio side of the team.

We're putting in a very sophisticated not cheap at all software and IT system upgrade which is very dynamic, which is very seldom seen in lower middle market credit managers. So we're hiring.

And another great benefit is other than the software and IT is the ability for the BDC to still maintain its lower hold sizes and continue a strategy and that's key. We want to focus on $30 million to $60 million unit traunch, senior debt loans. The BDC as a standalone entity could not hold those.

Over the past two years, we've been focused on the same strategy, but we've been doing a lot of syndicating of those loans of the groups, including some our other private funds, but now that we have the pool of liquidity we can hold the entire loan.

The BDC can still maintain its appropriate hold size of anywhere from $6 million, $8 million, $10 million, $12 million per name, but the entire senior debt of $30 million to $60 million is held throughout the platform and that strategy, that's a key difference.

We were - we have experienced a loss of deals, especially sponsored deals to get more competitive when we show up and we cannot hold the entire senior debt ask. At this point and we can hold that entire senior debt ask.

And we do believe if you go back over the past two years we had that ability, our deployments in senior debt activity would be substantially higher because we did lose deals because we couldn't speak for the entire senior debt needs of that transaction..

That's very important and helpful color. Thanks, Joe. Maybe staying a little bit on the topic of the benefits or specialty lending.

You know, have there been any changes in the market awareness from maybe your private equity sponsors with the closed of the new fund and then maybe somewhat the change in the new strategy?.

Well, I think that's another very important question is that we are now back telling all of our relationships, spending a lot of time, a lot of people who just thought of us as a mezzanine provider. We've really moved away even though we've moved into early 2016 to more senior debt focus.

We've got to keep educating the market and telling the market that this is our new product. The larger senior debt hold size is not just the mezzanine shop and we're spending a lot of time and resources, sort of reintroducing ourselves to the market with this new capacity.

And I think you'll see that over time that really changes our deal flow dynamics and characteristics.

We're seeing that and we believe we're in a really good place now that we do have the ability to hold on the platform this $30 million to $60 million credit and not have to ask the borrower to take the risk of syndication with us, when we had to bring in other partners to close those type hold size.

And we definitely don't want the BDC to get to a place where it hold sizes or out of line with its appetite. We do believe some of hold sizes are little larger than we wanted and now that we can hold lower hold sizes it makes the BDC able to diversify a lot of senior debt risk and loans..

Makes better sense. Then maybe you know, moving up the capital stack to senior secured investments.

Has your pursuit of maybe receiving equity as a co-investment with your with your borrowers changed?.

We are being more selective on these equity co-investments, one because the BDC is working hard to reduce its portfolio from 25% to a much lower number.

Two, we do believe we are later in a in a credit cycle and we are analyzing the equity opportunity on a sort of a separate investment analysis than the credit opportunities, so it may be a great credit. But if you're only going to invest 10% equity, pick the ones we think the equity upside is very achievable, not just in every transaction.

We do have the ability in the new Specialty Lending Corp. to take double-digit equity co-invest in that vehicle which is very unique.

Our strategy is always to take equity, let's be selective on the equity positions we take, let's have a 10% or less in the portfolio and then you can have a nice portfolio of senior debt loans paying double-digit on average yields with some equity upside.

And that's really we're focused in trying to move the BDC portfolio into that same structure or private vehicles..

Makes sense.

And then you know you said equity is 25% of the portfolio, it's going to move to a much lower number, maybe what is that optimal equity number, is that 10% or greater, just trying to get a frame for that?.

I think we spent a lot of time analyzing this. We think 10% on a cost basis is a good number. Just to reiterate the 25% in the BDC at the fair value basis, the cost basis is 12%.

So that's a nice QX appreciation on average in those positions and you'll see because we list those on the NDR, you'll see that lot of those positions are some have depreciated, some have appreciated. So it's a nice diverse pool of equity securities.

Most of the values probably in the top six names and of those top six names we expect a majority of those to normally materialize this year in 2018.

We have no control of that of course, but if that were to happen and we rotate into senior debt loans, would that recycle equity rotation then you start seeing a path of nice earnings growth and you know we hope that happens and we hope to eventually have upward pressure on the dividend..

Got it. That's it for me. Congrats on the call to Specialty Lending. Thank you..

Thanks, Chris..

Thank you. And I am showing no further questions. So with that, I'd like to turn the conference back over to Chairman and CEO Joe Alala for closing remarks..

Thank everybody for participating. Thank you for your questions. We are around all day if you want to call and have any further discussions. Have a great day..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program you may all disconnect. Everyone have a wonderful day..