At this time, I would like to welcome everyone to the Capitala Finance Corp’s Conference Call for the Quarter Ended June 30th, 2020. 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 will be available for replay 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 and Chief Financial Officer and Chief Operating Officer, Steve Arnall. Capitala Finance Corp issued a press release on August 4, 2020 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 historical information, including statements regarding the Company’s goals, beliefs, strategies, future operating results and cash flows.

Although the Company believe in 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 undertake no obligation to update or revise any forward-looking statements.

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

Thank you, operator. Good morning and thank all of you for joining us today. During the second quarter, we modest that [Tech Difficulty] asset to cash -- and clearly reducing portfolio exposure to COVID sensitive companies.

We currently approximately $95 million in cash [Tech Difficulty] balance sheet -- June 30, 2020 was $6.46 per share, up from $6.27 per share in March 31, 2020. The increase was a result of appreciation in our investment portfolio. At June 30th, we had $95.2 million of cash.

During the second quarter, we received $51.1 million repayments resulting from the wind down Capitala Senior Loan Fund II and a number of repayments including the repayment of investment held in COVID sensitive and consumer facing businesses.

As a result, the company is in a great position to reduce leverage through the repayment of SBA debt maturities and the prepayment and/or buyback of other debt outstanding. At quarter end, we had five debt investments on non-accrual status, down from eight at the prior quarter end.

Now our portfolio management team will continue to work with all of our portfolio companies, management teams and sponsors where appropriate in an effort to reduce the level of nonperforming investments. Distribution remains suspended for third quarter of 2020.

We understand the need to rebuild net investment income and support our future distributions and are focused on that end. Continued progress on reducing non-accrual loans and the closing of new investments during the second half of 2020 will help in this regard.

Looking ahead, we are in a good position from a liquidity standpoint both at Capitala Finance Corp and across our entire platform. Our direct origination platform and underwriting team is in various stages of review, investment opportunities in the lower middle market.

Our commitment to lower, total and regulatory leverage should provide future growth and net investment income and ultimately resumption of quarterly distributions. As a platform, we are currently pursuing approximately $100 million of new investments to be completed in the next few weeks.

As a platform, we continue to have an active pipeline of over $700 million of active small business investment opportunities. At this point, I would like to ask Steve to provide some comments on our second quarter results..

Thanks Joe. Good morning, everyone. Total investment income was $7 million during the second quarter of 2020. $4.6 million lower than the second quarter of 2019.

Interest and fee income declined by $4 million resulting from a decline in average debt investments outstanding and the impact of non-accrual investments, which approximated $0.09 per share for the current quarter. Dividend income decreased by $0.4 million due to the wind down of Capitala Senior Loan Fund II during the second quarter of 2020.

Total expenses were $7.6 million for the second quarter of 2020 and 2019. During the second quarter of 2020, the company recorded $1.1 million in deferred financing charges related to the early termination of its senior secured credit facility.

Net realized losses totaled $13.3 million for the second quarter of 2020, compared to net realized losses of $15.1 million for the same period in 2019. Net realized losses during the second quarter of 2020 did not have a material impact to NAV per share, as realized amounts were generally in line with previously reported fair values.

Net unrealized appreciation totaled $17.0 million, or $1.04 per share, for the second quarter of 2020, compared to net unrealized depreciation of $17.4 million for the comparable period in 2019. Net assets at June 30th, 2020 totaled $105.1 million or $6.46 per share compared to $9.14 per share December 31st, 2019.

At June 30, 2020, we had $95.2 million in cash and cash equivalents. Also as of June 30, 2020, our asset coverage ratio was 182.7. If our asset ratio coverage ratio falls below 150% due to decline in the fair value of our portfolio, including the result of the economic impact of COVID-19, we may be limited in our ability to raise additional debt.

During the second quarter of 2020, the company terminated its senior secured credit facility. It is our intent to replace this line during the second half of 2020 though it's premature to provide details at this time.

In addition on July 30th, 2020, our Board approved a bond repurchase program under which the company may repurchase up to an aggregate of $10 million worth of the company's outstanding 5.75% convertible notes due in 2020 and/or its 6% notes due in 2022.

The company will repay $19 million of SBA debentures maturing on September 1st of 2020 and is evaluating the prepayment of all or a portion of the $46 million that mature in March 1st, 2021. At June 30th, 2020, our investment portfolio included 37 investments with a fair value of $287.3 million and the cost basis of $305 million.

First lien debt investments on a fair value basis at June 30, 2020 comprise 67.4% of the portfolio. Second lien represents 13.3% and equity warrant investments represent 19.3%. At June 30th, 2020, we had five debt investments on non-accrual established status totaling $23.9 million on a fair value basis compared to $42.9 million at March 31st, 2020.

As Joe mentioned, we're in various stages of review on a number of investment opportunities and our pipeline is active. At this point, we'd like to turn it over for questions..

[Operator Instructions] Your first question comes from the line of Kyle Joseph with Jefferies. .

Hey, good morning, guys. Hope everyone's doing well and thanks for taking my questions. First question, it's great you short up your liquidity in the quarter, but just really wanted to hone in on your capital allocation priorities. You talked about the debt pay down, servicing existing borrowers and then as well as adding new investments.

Is there any rank to those priorities or is it really more of a blend of those three?.

Kyle, this is Steve. I would say it's a blend of all three, way you phrase that certainly we want to make sure our existing portfolio has the liquidity that it needs to make it through this cycle. Certainly delevering the balance sheet is a high priority.

And then thirdly certainly would love to evaluate some new investment opportunities as we have the liquidity available to do so. So a blend of all three..

Got it. That makes sense and then yes your repayments were elevated in the quarter.

Can you give us a sense for the outlook there? Would you expect more repay -- sorry, you guys have done quarter-to-date but going forward any big maturities coming up that you're looking to turn out or what's your outlook for repayments going forward?.

As far as repayments nothing, this is Joe. Hi, Kyle. Nothing out of the ordinary. I do think last quarter we were actively managing those repayments. We wanted to reduce exposure and sort of consumer facing industries which we did materially. We wanted to unwind the Senior Loan Fund II which is part of our deleveraging also created liquidity.

So we intentionally sought repayments to create liquidity last quarter, so a lot of that was not just passive repayments, it was active management and creating those repayments. And we did it by improving NAV.

We think that was -- it's easy to sell things below your mark but when you're getting your mark for those on an average basis improving NAV, we think that was very good. And we continue to maintain a very active pipeline of opportunities as I mentioned the platform in our private funds we're closing about $100 million of deals, the next few weeks.

The pipeline's over $700 million. The BDC once it begins reinvesting has an active pipeline and it can start right away. We continue to balance the wind down of a legacy SBIC fund; we do have a green light that we received in May of this year to pursue a new SBIC fund. So we're sort of managing all the liquidity with those things in mind too..

I understood. And then last one for me and I can hop back in the queue. But there have been some moving parts in terms of the portfolio recently in yields. We have the rate environment some NAP fluctuations and then theoretically wider spreads in the market today.

Can you give us a sense for your outlook for the yield going forward of the overall portfolio?.

Kyle, you were breaking up a little bit at our end. Could you ask that again? I'm sorry..

Oh sure. I was just talking about your outlook for the yield on the portfolio going forward, balancing some movements in NAP, the rate environment, LIBOR floors and all of those factors. And how you see and then theoretically wider spread on new deals..

Yes. This is this is Joe again. The current deals pending on the credit side yields are double digit [Tech Difficulty] in nature -- the loan to values are materially lower than pre-COVID. So it's a nice set of assets.

We continue to pursue and close in our private funds and when the BDC is ready to participate, it will plug right into those opportunities. But it's a good time to be providing investments to small businesses in the right industries and we're in a unique position that we have seven offices.

We're able to visit companies and participate in on-site diligence meetings. We're primarily doing that by driving to opportunities versus flying and that's something unique about our origination platform is that we have these seven offices throughout the country.

And we're visiting companies and completing diligence on these deals and getting them closed..

Your next question comes from the line of Christopher Nolan with Ladenburg Thalmann. .

Hi, guys.

Steve, can you tell me what the drivers of the realized losses were please?.

Certainly, really related to two items if you'll note in there one was related to an investment in ABS where we really converted the debt to equity, so it's kind of a change in our structure. And the other one was related to our investment [Silver top] where we sold our position in the company to a third party..

Okay.

Neither one of those were non-accrual last quarter?.

Yes. I think both of them were..

Great on the debt repayment priorities, if I heard you correct the SBIC has the maturities in early 2021, so that'd be the priority of the day. .

We've got two maturities; one in September 1st of this year, the other one is March 1st of next year; $19 million and $46 million respectively and so clearly those are priority. We're going to repay the $19 million and some portion or all of the maturity from March as well. So we just haven't determined the amount yet but yes..

Okay and I guess [Tech Difficulty] should we expect task hold to increase as BBC collects repayments and sort of waits for good investment opportunities or should we see that test holding balance go down..

Can you ask that one more time? You broke up just a little bit. I'm sorry..

Sure. Is the plan to hold off on your investments in the second half of the year or is it to make new investments? Like from what Joe says it seems like you guys are going to be making investments in the second half of the year..

Yes, Chris. This is Joe. I think the second of half of the year we will make new investments. The platform continues to be active and completing new investments. We would like to get as many of these new investments into a new SBIC. So we could leverage that. It's a very attractive low-cost, long-term leverage at the SBIC program provides.

And that's we do have substantial liquidity and we're balancing the deleveraging, the funding of a new SBIC; the repurchase of bonds and the support of our existing portfolio companies. So it's a balance that we're evaluating on a daily weekly basis.

But as soon as the BDC is ready to participate in new deals, the pipeline is active and it just needs to begin participating on --it's pro rata basis..

Got it.

And Joe when you expect new SBIC license to be active?.

That's -- it's very hard to predict the SBIC timeline. We received the green light in early May of this year. We need to enter the final stages hopefully sooner rather than later. And if I knew that timeline, I could answer sort of when we begin new investing actively better. But that is a timeline that we do not set.

That it's set by the SBIC, the licensing process but we hope sooner than later..

We do have a question from the line of Robert Ding with Hillside Capital..

Hey, guys. This is Robert from the Hillside Capital and thanks for taking my question. I have two questions. One is that on your presentation you say that the obligor for the SBA debenture is the subsidiary -- SBIC subsidiary. Now you also disclosed that the total asset of the subsidiary was about $238 million.

Could you clarify out of that asset how much is cash and how much is a loan?.

Hello. This is Steve. Sorry. As it relates to the SBIC sub that you're referring to. We've got a number of assets in there. We've got cash and it's very fluid as we make payments and that's, I would say of the 230 -- $60 million in cash roughly with the rest being invested..

You say 6 or 16..

$60 million..

Oh, 60, okay, great. Now my second question is that you -- most of your liabilities concentrate in early 2022 which is less than two years from now on and looking at your portfolio, it seems that by that time early 2022 you might not have enough for a debt mature by that time to pay down the huge balloon of debt.

So any unplanned for the payments of the debt in early 2022 when all the notes and the remaining SBIC, SBA debenture mature?.

Yes. This is Joe. Regarding the debentures with SBA that as you just mentioned there's more assets in there than liabilities. At the BDC parent, there's more asset than liabilities. We're going to -- we've approved a $10 million bond repurchase. So we can buy some of those on the open market or redeem them and just retire them.

We also know that the refinance market is active again. There was a similar lower middle market focused BDC that did a bond raise in the past several weeks. So those markets are open again. We think they'll definitely be open at longer periods of time over the next year and a half. So we will probably do a mixture of repay and refinance..

Okay. Just to follow up a little bit on this. I mean I apparently think that the both your equity and your notes and the convertible notes are way undervalued. But I do -- so you say that you plan to rely on both the payments from your existing portfolio companies and the refinancing to pay down the debt that will mature in 2022.

But given the valuation of both your equity and the notes, do you still believe that it's a good idea to rely on the refinancing of the debt to pay down the debt?.

Well, I think that's part of the -- we will use cash and monetize some. You can refinance them. The markets are open for that. You can also get some asset-based facilities to refinance partial portions of those.

There are several options with those assets since assets are greater than the liabilities over the next period of until maturity date that we can refinance those..

There are no further questions at this time..

Thank you everyone for participating in the call. Steve and I and Kevin around all day today. If you would like to contact us, we look forward to next quarter's call. Thank you.

This concludes today's conference. You may now disconnect..