Robert Ladd - CEO Todd Huskinson - CFO.

Ryan Lynch - KBW Robert Dodd - Raymond James Matt Reams - Buckhead Capital David Miyazaki - Confluence Investment Management.

Welcome everyone to Stellus Capital Investment Corporation's Conference Call To Report Third Quarter Financial Results. [Operator Instructions]. 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, Melanie. Good morning, everyone. Thank you for joining the call. Welcome to our conference call covering the quarter ended September 30, 2015. 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 would 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 would 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. 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 Stellus Capital Investment Corporation link or call us at 713-292-5400. At this time, I would like to return the call over to our Chief Executive Officer, Rob Ladd..

Okay. Thank you, Todd. I will review our third quarter by covering three areas, the first, earnings; second, portfolio growth; and third, portfolio quality. With respect to earnings, our earnings per share in the third quarter were $0.31 as compared to our normal dividend of $0.34 per share.

With respect to portfolio quality, our investments in two new portfolio growth - our investments in two new portfolio companies and two follow-on investments in existing portfolio companies for the third quarter totaled $25.5 million which more than covered the pay-offs and amortization totaling $22.5 million, during the third quarter.

The originations were made in a diversified way. The largest addition was $12.5 million. The average new position was approximately $11 million. One of the loans was funded principally with SBA debentures. We now have approximately $31 million of SBA debentures that may still be drawn by the Company from the current tranche.

We intend to utilize the proceeds from additional drawdowns of these debentures to fund additional portfolio investments and therefore increase our portfolio.

For the nine months, ending September 30, 2015, we have closed approximately $85 million of investments, so this is year-to-date which have more than offset approximately $76 million of repayments and amortization.

As mentioned last quarter, we have been repositioning over time, the loan portfolio to increase our exposure to more secured first- and second-lien loans and less unsecured loans. To illustrate our portfolio of secured loans over total loans increased to 76% at September 30, up from 72% at June 30 and 64% at March 31.

This repositioning is also resulting in more floating-rate loans. Our floating-rate portfolio increased from 68% to 73% quarter over quarter. With respect, now, to portfolio quality, overall risk rate of the portfolio stable at about a 2 rating, on plan. We have one non-accrual loan which represents approximately 2% of the portfolio at fair value.

We continue to have a diversified portfolio from an industry standpoint with the largest industry sector at approximately 14% of the total. Now looking forward to the fourth quarter, we funded $10.5 million investments through yesterday and received one pay-off of $15 million. This will be a change for this quarter, perhaps over prior quarters.

We do not anticipate significant pay-offs during the remainder of the year and likely will be making additional investments between now and year end. With that, I will turn it over to Todd to cover the financial results..

Thanks, Rob. Our total investment income for the quarter was $8.6 million, most of which was interest income.

Operating expenses totaled $4.8 million for the quarter and consisted of base management fees of $1.5 million, incentive fees of $1 million, fees and expenses related to our borrowings of $1.5 million, including commitment and other loan fees, administrative expenses of $200,000 and other expenses of $600,000.

Net investment income for the quarter was $3.8 million or $0.31 per share. The net decrease in net assets from operations totaled $600,000 or $0.05 per share. The net change in unrealized depreciation on investments was $4.6 million for the quarter, primarily related to market spreads widening.

$1.6 million of the unrealized depreciation was related to our loan to Binder & Binder. As of September 30, 2015, our portfolio included approximately 30% of first-lien debt, 44% of second-lien debt, 23% mezzanine debt and 3% of equity co-investments at fair value. Our debt portfolio consisted of 73% floating-rate loans and 27% fixed-rate investments.

Our average portfolio of Company investment was approximately $9.2 million. Our largest portfolio of Company investment was approximately $21.6 million, both at fair value. Additional information regarding the composition of our portfolio is included in the MD&A section of our quarterly report on Form 10-Q that was filed this morning.

With respect to liquidity, at September 30, 2015, we had $110.8 million outstanding under our credit facility. As of November 5, 2015, we had $94.5 million outstanding under the facility. Our unsecured bonds have a carrying value of $25 million and mature on April 30, 2019.

Lastly, we had $34 million of SBA defenders outstanding as of November 5, 2015, an increase of $8 million outstanding at September 30, 2015. Since September 30, 2015, the following portfolio activities occurred.

On October 9, we received full repayment on our second lien term loan of Health Systems Holding at par, resulting in total proceeds of $15 million. On October 30, we made a $10.5 million investment in the first lien term loan of Apex Environmental with a corresponding $300,000 equity investment. With that, I will turn the call back over to Rob..

Okay. Thank you, Todd. Melanie, you may begin the question-and-answer session, please..

[Operator Instructions]. And we will go first to Ryan Lynch with KBW..

The first one relates to the fair value of Binder & Binder. Over the last several quarters, it has been pretty consistent as you guys have been working through the bankruptcy process. In the most recent quarter, it took about a $2 million write-down.

I was just wondering, was there anything incremental going on with that company or the bankruptcy process, to cause that write-down?.

Ryan, this is Rob. So, an update on the process itself, we filed a motion recently to end exclusivity for the debtor to file an exclusive plan - or the right to file an exclusive plan. That was approved by the judge. So in the case, there is an opportunity for others to present a plan of reorganization, of which we plan to do so.

That would be the fundamental update in the case. The valuation, I would say, just reflects the additional information coming from the Company. But does not reflect, per se, the status of the case. We do, as I have said for a while - we would expect the bankruptcy to take about one year, the Company filed in December of last year.

So we're approaching that anniversary - one-year anniversary. We're optimistic that the case will be resolved in the next couple of months..

Okay. Then moving just to the rest of your portfolio. It looks like you had about $4.5 million of unrealized depreciation in the quarter.

Where any of those write-downs or depreciation related to credit issues?.

Ryan, it's Todd. No, just to clarify, the total write-down was about $4.6 million for the quarter. Of which, $1.6 million was related to Binder. So the remainder of the portfolio was down about $3 million. Those were all adjustments based on market spreads from the results of our valuation models. No credit issues in that..

Okay. Good. Then just kind of a broader question. As I look at SCM as the public vehicle, depending on how high you guys want to run balance sheet leverage, it feels like you guys are relatively capital constrained. If you look at the stock price, you are unable to raise additional equity capital at these current levels.

To be clear, we're fine with BDC not having substantial growth and just kind of churning their portfolio.

But if you guys are relatively capital constrained, how do you guys manage and keep your deal team busy and active with - what I would call, may be limited access to capital?.

Yes. We do have additional access to capital by virtue of the SBIC subsidiary and additional debentures that can be drawn there. So that's, as I've said on previous calls, how we will continue to grow the portfolio beyond the current level. But as a general matter, we also have an institutional fund that we co-invest with the public company.

So we have capacity in general. So our deal teams are quite active and have investment capital to invest. The growth in SCM will come from the SBIC debentures..

And we will go next to Robert Dodd with Raymond James..

On one of your comments in the prepared remarks, that you don't expect additional repayments. I realize all of this is very, very hard to protect. Take it all with a pinch of salt. So you don't expect additional repayments. But do potentially expect additional deployments.

What is your confidence level given I don't think there's any hard deadline? There's not tax changes or anything like that for people to necessarily need to get things done by December 31? What is your confidence level? Some of the activity you are seeing now doesn't slip into next year, say?.

Thank you, Robert. I thought it was important to note that - in previous quarters, when we have had intelligence that would tell us we were expecting pay-offs, we would report that to you. So in this quarter, we don't have such intelligence. So we just wanted to make sure that we were also giving you that color. Again, things could change.

We could have an unexpected pay-off. But at this point, we don't know that any of it's a large that would pay-off. With respect to new fundings. We're active. We're finding interesting opportunities that can also fit in the SBIC area. So we will have to see how we end the quarter, but at this point, we do have a few things we're working on.

It is likely, we will be able to close one or two more before we finish the year..

Okay. Got it. If I can, one more on, obviously, the dividend versus earnings. Third quarter last year, you waived a fairly sizable chunk of management fees to ensure that you would earn the dividend from essentially realized earnings, not just NII, for the year.

Any thoughts on the potential for that this year? Obviously, it didn't happen in the third quarter, but, hey, we've still got another quarter to go..

Yes. So, as a reminder of what we said previously, that we will look at the dividend coverage over time and at least, over a year's period of time, could be longer than that. So we want to make sure that we're looking at all the income that we're generating, including realized gains. But we will look at it again at the end of this calendar year.

So that is certainly a possibility. But we're mindful - I would just repeat, as I said before that we need to make sure over time that we're earning the dividend we're paying out..

[Operator Instructions]. And we will go next to Matt Reams with Buckhead Capital..

With all the volatility in the credit markets and concerns about the economy, are you seeing any improvement in potential yields or rates that you will be charging? Is there an opportunity to improve the overall yield on the portfolio?.

Thank you for your question, Matt. So, as a general matter, what we're seeing - as I have said on the call, we're moving to more secured than unsecured. So, it may be that our yields are slightly less than they have been, while we believe the risk is less.

So in the world we're living in, I would say, the lending that we're doing is also not more levered than it has been. It is certainly at the current leverage that we have been looking at or it could be less. We're seeing large equity checks being put in by private equity sponsors who are buying companies.

That may be a result of also paying more than they might have paid for a company a couple years ago. But as a general matter, we're seeing interesting investing opportunities that are not - they're properly levered. They are properly structured. They are properly capitalize. I would say the yields are relatively constant.

The only footnote to that is that our yields have been coming down about 10 basis points or so. That is just a reflection of moving to more of a secure portfolio. It is also reflecting some of our original loans. They're paying-off it at higher coupons associated with them. So, overall, I would say the lending opportunities are good.

And I would say that, in our mind, that is a reflection of proper pricing, proper structuring, proper equity checks. We view this as a relatively positive time to be investing..

We will go next to David Miyazaki with Confluence Investment Management..

I was hoping you might be able to share your thoughts philosophically on some of the things that we're seeing within the peer group of BDC's that are trading well below their net asset value. First, in the last few weeks, we have seen a rights offering and dilutive secondary offerings.

I'm pretty sure I know the answer to this question, but I thought I might give you an opportunity to sort of extend on what you said with regard to Ryan's question and growth and your focus on the use of the SBIC rather than other sources of capital.

But could you talk a little bit about how you think about the use of raising - equity capital raised below net asset value?.

Yes, David. As you know, we have the authority for this year, until next June, to raise equity below NAV. But as we currently look at the Company, that is not something we have planned. As I have said before, our growth will come from a further deployment of the SBIC debentures. So, that is where we stand.

Ultimately, of course, that's a decision our Board would be making. It might be worth noting that, on the last call, I believe it was Robert Dodd who asked the question about looking forward to the - not just by quarter, but maybe to the second half of the year which we're about to conclude in a month or so.

Our goal was to be able to replace the regular way BDC assets that we're paying off with new regular way BDC assets and that the growth would come from SBIC qualifying investments. That is exactly what we're doing..

That is great to hear, it's the answer that I expected. But given what has happened, it is always reassuring to hear that because I think that, in many instances, people take rather unfortunate situations or valuations and make them worse with suboptimal capital allocation decisions.

I think that dovetails as well with what Robert asked regarding the dividend and your response in that the dividend ought to be covered with income. To the extent it's not, it doesn't make sense to be engaging in a return of capital when you are significantly below net asset value and a share repurchase would make more sense.

So, I'm pleased to hear that is your philosophy toward that. We look forward to seeing you underwrite good ROEs and maintain good capital allocation..

Thank you, David..

Thank you..

We have no other questions at this time..

Okay. Thank you everyone for joining us. We look forward to speaking with you in the spring and hope everyone has a good holiday..

That does conclude today's conference. We thank you for your participation..