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 second quarter 2017. [Operator Instructions] This conference is being recorded today, Friday, August 4, 2017. .

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, and good morning, everyone. Thank you for joining the call. Welcome to our conference call covering the second quarter of fiscal year 2017. 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 today 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'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking financial 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 Stellus Capital Investment Corporation 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. .

first, investment activity; second, asset quality; then earnings; and finally, capital management. .

With respect to investment activity, we had a very active second quarter, with 3 new investments totaling approximately $25 million. The new loans are 68% second lien and 32% first lien, with approximately a 10.3% weighted average yield.

All of these new portfolio companies are backed by private equity firms, which have many years each of investing history..

We also received 5 repayments totaling $37.4 million, which were 47% first lien and 53% second lien with an average yield of approximately 10.3% or similar to the new fundings. Since quarter end, we've had 2 additional repayments that totaled about $12 million and one new funding in the amount of $23.3 million. .

So looking forward for the remainder of the quarter. Again, very active quarter. We have potential repayments of approximately $11 million to $31 million but funding prospects of a greater amount of approximately $40 million to $60 million, most of which are SBIC conforming. .

Now turning to asset quality. So as of June 30 of this year, we have 46 portfolio companies, 45 of which have private equity sponsorship. These companies are across 22 industry sectors with the largest exposure at 16%. Our largest investment is $23 million in fair value, and the average investment is approximately $7 million.

The weighted average yield remained at 11.3%, the same as the first quarter. .

The weighted average EBITDA of our portfolio companies is approximately $22 million, and the leverage quotient is in the low 4x. Approximately 70% of our loans are floating rate, and all but 3 of our loans are through their LIBOR floors. 87% of our portfolio is rated a 1 or a 2, meaning at or ahead of plan.

And we have one nonaccrual loan in the amount of $6.7 million [ between the ] interest payment to fall..

I'll now turn over the balance of the discussion to Todd Huskinson. .

Thank you, Rob. With respect to earnings, net investment income for the second quarter was $0.32 per share or within approximately $380,000 of the distributions, which were paid out. Those distributions increased this quarter due to the additional shares raised in our April offering. The net asset value remained constant at $13.84, similar to March 31.

And as a reminder, again, we paid distributions in the quarter on 3.1 million more shares than we did in the first quarter. .

Regarding capital management. As previously reported, in April, we issued 3.1 million shares of new equity at $14.10 a share, resulting in net proceeds to the company of $43.1 million. These proceeds were used initially to reduce our bank credit facility, which currently has an outstanding balance of $51.5 million.

And on July 25, the company contributed $20.5 million to our SBIC subsidiary, bringing total regulatory capital contributed to $58.5 million, which, subject to SBA approval, will allow us to obtain additional debenture commitments of $52 million. .

And those are all my remarks for earnings and capital management. .

Okay. Thank you, Todd. And with that, we'll open up for questions. .

[Operator Instructions] We'll take our first question from Robert Dodd with Raymond James. .

It's actually Leslie this morning. Sorry about that. So a quick question on repayments. Obviously, we've seen a few already this quarter, and it was a good quarter for that as well in the second. So you gave $11 million to $31 million as guidance.

Do you see that just in the third quarter? Are you seeing fourth quarter '17 remaining high and waiting to ebb until 2018?.

Yes, Leslie. So we don't have any prospects for repayments in the fourth quarter at least that are substantial. But history would tell you, based on how the year has gone overall, we will likely see more in the fourth quarter. So again, we should have or could have some additional repayments. .

Okay.

And then on the 3 loans that you mentioned are the only ones that aren't above LIBOR floors, how much of the portfolio is there in those 3 ones? Is it a -- are they on the smaller end? Or are they some of the larger ones?.

That would be a small percentage of the total. .

Okay. And then last question. On the Scopus investment, obviously, the equity is the only thing that's marked down there, still doing well.

I don't know if you guys had an update from the company on outlook for the next 12 months on how they're doing and what you guys see as, again, just prospects for the equity from that company?.

Leslie, I'm not sure which company is that. .

Scopus. .

Oh, Scopus. So as you know, we don't comment on specific private companies for obvious reasons. But -- so, probably should leave it at that. And it's been a good earning asset for us. .

And we'll go next to Chris Kotowski with Oppenheimer. .

Yes. I wanted to ask about the right-hand side of the balance sheet. As you noted in your comments, you used the proceeds mainly to pay down the credit facility.

Just as you look at your forward pipeline of likely fundings, should we expect that to go primarily against the SBA or a mix of the 2? Or what should we expect?.

Yes, Chris. So historically, roughly half of what we've looked at as a firm has been SBIC conforming. Doesn't necessarily mean that's -- we'd close half of the deals in that way. But we're optimistic. We're seeing very interesting flow that way.

And in fact, of the potential fundings for the balance of this quarter, I think all but one are SBIC conforming. So I think history would tell us it's probably more like a 50-50 split, if you will, in terms of the growth. But certainly, our capacity to grow is greater to the SBIC debentures.

There's a pretty good chance this quarter we will fully capitalize the SBIC subsidiary, so up to $75 million of equity capital. And the current debentures drawn are just $65 million. So roughly $85 million of additional capacity there.

So it'll come from both, but in terms of ability to grow meaningfully more, it would come more on the SBIC side, for which we're seeing interesting opportunities. .

Okay. And remind me of the split floating rate versus -- I was interested in your comment about that all but 3 of your loans are through the floors now.

And I guess if you can help us think about your sensitivity to rising rates or your potential sort of benefit from rising rates, say, from the next hike or 2 as compared to the 2 last ones, is there a way to quantify how much greater the impact might be? And then I guess as a follow-up to that is, if -- with the SBA, if you're likely -- if you're able to put on more fixed-rate liabilities, does -- will you be funding floating-rate assets for those?.

Yes. So Chris, so a few things. So we covered the change in LIBOR in the Q, so I'll let Todd to address that. I would think of it this way, so we're substantially all -- of the 70% that are floating, or consider them substantially floating, we've seen a meaningful rise in the 90-day LIBOR, under which most of our loans are priced.

And so now it's around 131, I believe. So could go higher. But I think to have a meaningful impact on the profitability, it would have to be like a 100 basis point movement. But we'll -- Todd will give a little bit more color about that. .

Sure. Chris, so if you had a 100 basis point movement up in LIBOR and just repriced our loans with respect to that, it would generate an additional $490,000 of income. So we would -- because most of them are through the LIBOR floors, you would capture most of that.

On the way down, if you went down 100 basis points in LIBOR now, it would impact the P&L by about $150,000. So even the LIBOR floors would kick back in, in that case. .

And Todd, for what period is that?.

That's for a 1 -- that's for the coming 1-year period. .

For a full year. .

Yes. .

Yes. And one other comment in terms of sensitivity on that, Chris. The loans typically reprice every 90 days. So even though you could have a movement up during the quarter -- and then you've got to reprice on the calendar quarter.

So even though you have a movement up during the quarter, you need to wait at the repricing, say, which is at most 90 days out. So I think that's the -- I mean, it's impactful, but it takes a meaningful change up to generate meaningful P&L. With respect to the use of the SBA debentures, so this is one of the things that we've been keen about.

The -- interestingly, the -- as you, I'm sure, watch the 5-, 10- and 30-year treasury, the relevant treasury rate for the SBA -- SBIC debentures is the 10-year, and it's relatively flat. And as the short-term rates have increased, that rate -- the longer-term rates have been flat.

So we think there's an opportunity here to take down those fixed-rate instruments over the next, say, year or so, at we think are relatively low rates. And we would expect that the bulk of the lending will continue to be floating rate.

So as you shape up the balance sheet, as you were saying, imagine us having a more meaningful fixed-rate position on the liability side and -- at a relatively low rate and matched off with mostly floating-rate assets, which, as an example, would have been the entirety of the assets put on the books in the second quarter. .

We'll go next to Ryan Lynch with KBW. .

The first one just has to do with the investment you funded in the third quarter, Resolute Industrial, LLC. That's a pretty large investment relative to the size of your portfolio. It looks like you funded maybe $25 million with a little bit of an equity and then as well as a term -- delayed term loan. So it could even grow larger.

So given the size of that investment relative to your portfolio size, can you just provide us some background of what you saw in that investment and why the decision was to invest in that company given the kind of the chunkiness in your portfolio?.

Yes, Ryan. So maybe to summarize it, that -- the capital plan there is that the exposure will be reduced in the near term. So it was opportunity we closed with another party, and the intent is to bring down the exposure shortly after close with an asset-based lender. So you'll see our exposure get more in line with our typical size. .

Okay. When you do something like that, just -- go ahead. .

I would expect it to happen by the end of this quarter. .

Okay. When you... .

The logic behind it was interesting company opportunity. And it -- by being able to move quickly and being flexible, not waiting for the asset-based lender, we're able to win the opportunity, get it closed, very good sponsor, and then knowing that we had in place soon after close a reduction in size. .

Okay. And then just kind of a higher-level question. Can you just comment on the competitive environment certainly in the -- you certainly see some competition in the middle markets or certainly the upper middle market.

Can you just talk about how the competition is in the lower middle market where you guys predominantly play this quarter versus, call it, 6 months ago? Is it improving? Is it getting worse? Is it stabilizing?.

Yes. I would say that overall, it's probably similar to -- if you went back 6, 9, 12 months ago. And I measure that based on what we're closing in the second quarter and the third quarter. We did see some slowness and -- for a while, which appears to have changed a little bit.

But I'd also state, what we did find in -- from a competitive standpoint, the larger the EBITDA business, the more we saw larger players and ourselves come down market, if you will, a little bit, and we're pricing things lower than we would. So I would say overall, though, that the -- our part of the middle market, we still think, is a robust area.

And that's the evidence, I think, of the 3 deals we closed, that the yield on them was roughly the same yield as those they paid off. So overall, it's a relatively -- it's a competitive market, but we're finding interesting opportunities to close. .

Are you seeing on -- I know you had mentioned that yields are staying the same.

What about in terms of leverage? Or maybe more importantly, are you seeing any more pressure on covenant-light structures or an increase in EBITDA adjustments or EBITDA add-backs?.

Yes. So the same phenomenon I mentioned about some of the larger lenders coming down market a little bit would have incorporated covenant-light, greater-leverage multiples than we would be accustomed to or comfortable with. So as we've done in the past, we've resisted that. But we are seeing the larger lenders being more flexible in terms of the terms.

So we've been able to hold to good covenants, good covenant levels and leverage multiples overall. And again, that's evidence of transactions that we're closing are not dissimilar to our overall leverage ratios, which are in the 4x. .

And that will conclude our question-and-answer session. At this time, I'd like to turn the call back over to Mr. Ladd for any additional or closing remarks. .

Uh, yes. Please, Todd. .

So Chris, I just want to correct one thing I've said before on the numbers with respect to the 1% increase or decrease in LIBOR. That was for a quarter, not for a year. .

Okay, good. Any follow-up questions to that? Okay, good. Thank you, everyone. Thank you for your support. And we look forward to speaking with you in November when we cover the third quarter. Bye-bye. .

And that does conclude today's conference. We thank you for your participation. You may now disconnect..