Robert Ladd - CEO Todd Huskinson - CFO.

Christopher Nolan - Ladenburg Thalmann Robert Dodd - Raymond James Paul Johnson - KBW Bryce Rowe - Baird Greg Mason - Ares Management.

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 Third Quarter 2017. At this time, all participants have been placed on a listen-only mode.

The call will be opened for a question-and-answer session following the speakers’ remarks. This conference is being recorded, today, Friday, November 10, 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, Anna. Good morning everyone and thank you for joining the call. And welcome to our conference call covering the third quarter of fiscal year 2017. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information of our forward-looking statements as well as an overview of our financial information. .

Thank you, Rob. I would 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 Public Investors link or call us at 713-292-5400. At this time, I would like to turn the call back over to our Chief Executive Officer, Rob Ladd..

Thank you, Todd. My remarks this morning will be organized to cover five areas; our operating results, investment activity, asset quality, capital management and outlook.

With respect to operating results, net investment income was $0.29 per share for the quarter and $0.31 per share when you exclude the one-time expense to retire our 2019 unsecured notes. We also earned a 5.2 million or $0.33 per share realized gain from our equity co-investment portfolio principally one company.

With respect to investment activity, during the quarter, we made four new investments or roughly 71 million at a weighted average yield of 10.2%. All these investments are secured and carry floating interest rates. We received payoffs of five investments and amortization payments, which totaling the aggregate about $53 million.

At the end of the quarter, our weighted average yield on the portfolio -- of the debt portfolio was approximately 11% and 77% of loans of price at a floating rate. And our investment portfolio increased than a total about 18 million quarter-over-quarter.

Turning now to asset quality, overall asset quality continues to be stable and has added two on our risk rating system or on plan. Only 11.5% of the portfolio is marked at a risk rate of three or below, and we have one loan in non-accrual representing about 1.8% of the portfolio at fair value.

We continue to maintain good diversification with the largest industry sector at about 13.4% of the total, the average investment per company is approximately 8 million, and the largest investment is approximately 22 million at fair value, and would add that the loan portfolio is 83% secured by either first or second liens.

On capital management, we had very active quarter and which continued into October. We were able to meaningfully strengthen our capital base in August and October.

In August, we issued 48.9 million on five year unsecured notes, which we used in part to retire $25 million of notes maturing in 2019, as previously indicated, the new notes carrying interest rate of 5.75%, down from the retired notes interest rate of 6.5%. In October, we were able to expand the maturity of our bank credit facility to 2021 from 2018.

We were able to increase the commitment amount to 140 million from 120 million, and we were able to reduce the interest rate to LIBOR plus 2.50 from LIBOR plus 2.625. We have also reinstated our at-the-market or ATM Equity program thus far we bridged approximately 4 million of additional equity capital to net of cost.

With respect to outlook now an alternative the quarter we are in the first quarter, we closed two new investments for approximately $27 million and have had one payoff for approximately $20 million.

For the balance of the quarter is usually report we have a pipeline of activity that would indicate additional fundings of 25 million to 50 million, and we do know one possible payoff of 10 million, and then looking to 2018 to next year, our primary goal while of course maintaining asset quality is to fully deploy the capital raise in 2017.

If we were successful, this would take our portfolio to over $500 million. And with that, I'll open it up for questions. Thank you..

[Operator Instructions] We'll take our first question from Christopher Nolan with Ladenburg Thalmann..

The portfolios seem to start emphasizing more first lien debt in the third quarter and less second lien, some subordinate debt.

Is there any sort of shift here going on or that's just normal movements?.

So thank you Chris for the question, we've over time been moving more to a secured position whether it'd be first or second. So I think that change has been occurring over a year or two.

And then with respect to first versus second, we've been a little more active I'd say in the unitranche area which would be geared again to a first lien versus a second. So I think you'll see us an active player primarily in first and second liens when it's first, it’s normal unit tranche.

And selectively, we'll look at unsecured mezz financing but it will be a modest percentage of the portfolio..

So, this migration goes on we should look for the yield on the debt portfolio to continue to move down, absent any sort of changes in yield curve?.

It would move down some, we don’t think in a material way, and one thing I would note is that which has been consistent with this move to more secured versus unsecured that you'll see that portfolio being primarily floating rate versus fixed growth..

Great, and what was the cost of the average weighted cost of debt in the quarter..

Todd, you may want to?.

Yes, I was just looking at.

You mean for all facilities Chris like the SBA debentures?.

Yes, please..

Let me make it simple. I'm sorry, go ahead..

I was going to say, I don't have the exact figure Chris, but I would say close to 4%..

We'll take our next question from Robert Dodd with Raymond James..

Just following up on Chris's question. On the interest expense, obviously a lot of moving parts in the quarter, the loss extinguishment etc, and then you just kind of restructured or redone the revolver.

I think, are there going to be any one-time expenses in the fourth quarter related to changing the revolver in terms of accelerated fees on the old one when you replace it with the new one or anything like that? And can you give us an idea such as kind of what's the run rate interest right now once all these changes have been floated?.

Sure so, with respect to the deferred fees, the right upper costs in the fourth quarter, how we're going to account for them is still being evaluated because the facility had some changes but in many ways it's the same you know the same facility.

And so the total cost that were deferred would be approximately $450,000, and so it's hard to know at this point whether they will all be charged in the quarter or a portion of those would be charged in the quarter.

So I would say, I'd say Robert you look for, any either it's going to something, so maybe it’s a 100,000 of it depending on one method versus 450 on the other. We just need to work through that internally and you know from the appropriate accounting..

And Robert to your question about the kind of run rate interest rate, we can come back to you on that but I would think of it as maybe the three buckets. So one would be the credit facility which is modestly borrowed currently, effectively about a 3.8% run rate, floating rate little under 4, the bond position again at 49 is the 5.75.

And then our debentures are under 4% currently, so we could come back to you, give you kind of a pro forma where we think the interest is that I'd say the debenture costs if you factor in roughly 4 that includes all the fees.

The bond cost of course is a little bit higher than the 5.75 cause of the amortization of the fees associated with the new bonds. And then we have I'd say more modest fees on the bank facility, but there'll be a little bit additional cost.

So maybe to come back, think of the bank facility in the low 4s all in, the bonds in the low 6s all in and the debentures is a good number a little under 4.

So I think the good news is, the liability side of the balance sheet has interest cost, it looks like that would approximate something in the 4s in total, and that in terms of our floating or interest rate sensitivity, the bulk of the assets are floating rate and only the bank facility on the liability side is floating rate..

Right, right. Got it. Thank you.

Yes.

Just one essay on the portfolio, obviously Grupo HIMA, I just wanted to touch on that. Couple of other BDCs owned it, obviously it’s in Puerto Rico marks frankly when we look at yield marks of other BDCs, obviously, they seem to be all over the place to be honest.

Could you give us a kind of an update on what the status is that if you’re aware because obviously it has hospitals in Puerto Rico and obviously we know the hurricane issues down there? And why your yield marks a bit above some competitor marks? And give us any feedback on, what the approach was to get them you know why you feel comfortable where you are?.

Yes, okay. So maybe, I will take into a few steps. One the hurricane, two Port Rico, then kind of company outlook, and then valuation, which Todd will address..

Perfect..

So one thing that is for the benefit of -- for the quarter, so we did - of our 46 portfolio companies, we had a handful of companies that had some impact from the hurricanes that range from Texas to Florida and the Caribbean.

Fortunately, the impact of the hurricane was not material in any respect in terms of the portfolio, but I would say the one area that was most impacted would have been Puerto Rico; and then in particular on a gross basis Grupo HIMO, which operates a number of hospitals, the second largest hospital operator in the territory of Puerto Rico.

So we -- in terms of the Company itself, and as we’ve been learning it from Puerto Rico, they were able to operate soon after the hurricane went through, many hospitals were not able to, and so they had immigration of patients from around the island. So as net benefit they appear to benefit, but obviously, fantastic for the island.

We do think that U.S. government response to help Puerto Rico could be positive for the Company, but again, I think we just need to see how that all plays out. With respect to the valuation, we did -- and so I’ll just put it in context, we have both the first lien and second lien position.

The second lien position is -- has the gross value for $1 and we marketed at under -- little under $0.50.

So this was just giving rise to looking at the entire enterprise value and then perhaps the uncertainty that’s developed now because of the hurricane, of course that went through Puerto Rico, so we’ve got that was our best estimate of kind of look at position without having further information at this point.

So that’s and we do have the - as a recall, the first lien position we have marked at about $0.91. So again if it helpful too in the context of the overall portfolio of, last reported $3.55 million, our exposure at current mark for HIMA and in the second lien is $2 million..

Last question for me. On the dividend, obviously, you talked in the past about the focus on unrealized earnings covering the dividend, which obviously more than did that in this quarter with substantial gains.

So I mean, is that still the focus to look at the dividend in relation to realized earnings rather than just low NII? And that’s the first question. And then the second question is kind of dividend strategy as we go into next year, with or without the certainty of gains, right.

Just what’s your current assessment of your confidence level in the dividend and the ability of the portfolio to generate whichever is the appropriate earnest metric to cover that?.

Yes. So I’d say, let me start with, as you look into 2018. So we think that we have the ability to the growth in the portfolio, the type of investments or looking at that would get us to the ability to cover the dividend next year. And again we needed time to redeploy the capital. So we think that’s very achievable for calendar year 2018.

With respect to the -- we’re still building that portfolio using the 43 million of equity raise in April. So it would be unlikely, we would cover in the fourth quarter. But we think, we’ll start getting there into the first half of next year.

So with the approach we’re taking is a very positive change for the Company, but sometime to redeploy the capital. And then the other thing I would say about coverage, we do think that the realized gains are important, but we also remindful that we think they first go to cover realized losses. So, we need to do some work on that.

So think of it is we still think that the appropriate measures to look at NII. Unless the realized gains Robert would have come from this the accounting for loan fee to pay off early. So we think the right measure still NII and relative to what our different coverage is.

So we’re still working on that, but are optimistic, we’ll be able to fully cover next year..

We’ll go next to Paul Johnson with KBW..

My first question has to do with your leverage.

Just wondering, as you’re trying to focus more on senior secured debt investments, does that at all change? What you would view as sort of an optimal leverage ratio that you can run with the portfolio at all?.

Yes, Paul. Is your question at a balance sheet level, not a company specific or portfolio level, but actually Stellus in total leverage we would operate at. .

Correct. Yes. The debt to equity that you guys would operate with that Stellus..

Yes. So, we feel we’re less levered than we've been because of the equity raise, but historically we've operated in this sub-roughly 0.7 to 0.75 to 1 leverage ratio from a regulatory capital standpoint, and we would plan to get to that level again. That’s helpful.

And then in addition to that would be the SBIC debentures, which could get us certainly over that level. But we do plan to re-lever in a prudent way, and I’d say in a proportion that will be consistent with previous years..

And then my last question is just really, I guess, how you feel comfortable with getting earnings back-up to a sustainable rate, as you kind of look out your combined with your short-year outlook on the investment environment and taking a slower and steady approach, which we certainly prefer and over quickly just deploying capital for the sack of deploying.

Given obviously the room that's left in your leverage ratio and the rooms for growth, I am just wondering how you guys sort of look at balancing that along with just outlook on a competitive environment?.

Yes and so. I’m sorry, didn’t quite follow you. So I got the question about the competitive environment.

What was the first part of that the question just at the end there?.

Yes.

Just I mean, how you balance what in your thoughts, what your outlook are with market that you operate within and growing the portfolio steadily and carefully?.

Yes. So, one way to think about it is what have we been doing? And so, if you look at 2017 thus far, we’ve had fundings of roughly 120 million and payoffs of 133, so pretty robust payoff here. We think that those payoffs will likely slow. And then we think we have a pretty good fourth quarter.

So I think our outlook Paul is really based on what we have been doing. And in this quarter that we are now in the opportunities that we are looking at that have closed or may closed or will close of the yields on average are greater than 10% of their all secured and floating rate.

So I think we are basing our outlook on what we've been doing this year and what we are doing in the fourth quarter. It is a competitive environment but we are having good success with the sponsors we work historically and developing new one. So we feel good about it overall.

Again I think the future is based on more recent activity and we are not expecting any material change in that..

We will go next to Bryce Rowe with Baird..

Rob just curious with the repayment you have seen here in the fourth quarter of $20 million, it's obviously one of your larger positions.

Is that debt and equity that’s getting repaid, and if so, is there gain associated with repayment?.

Yes, Bryce. So, one, we've had our repayment so far as you said for approximate $20 million, and it was principally all debt. It was an unsecured note than a fixed rate. And I know we had it for good while, so we thought it was positive that repaid.

There still is a remaining equity position for which we probably will realize more value, but that is -- company has not been sold. And then with respect to the as I said, actually, I haven't said it more clearly, but the one position that we think might be repaid this -- the balance of the quarter of 10 million yes, it is a debt position.

So then the further comment that the 20 that’s already been received, there was really no meaningful fee income associated with it. And the second I think it's modest. So this will be a quarter perhaps less repayments, but not meaningful fee income which by the way would have been consistent with the third quarter.

We did have a just to know we had a robust second quarter payoffs which included meaningful fee income, but again we are not projecting a lot of the fee income for the payoffs this quarter..

We will go next to Greg Mason with Ares Management..

Rob, I just want to talk about the broader Stellus platform kind of what you're building there? What other pockets of capital do you guys have? What is the platform look like? And how does the -- has been BDC able to benefit from other pools of capital that you have there?.

Thank you, Greg. So as a firm we manage roughly a $1 billion of assets in total. And of course, the primary vehicle is the public BDC which we are talking about. We also managed two private credit funds which co-invest with the public company. The first of those funds is now in harvesting mode and the second fund is active.

So we have benefited for a number of years now by having a private vehicle as well as the public company. And what it's done for us is really twofold, principally two fold. One provides greater diversification and that was splitting new investments across two funding vehicles.

And the other thing that's been helpful is when our public company has been fully invested it's enabled us to be active in the marketplace and as a new opportunity comes in and we have to pay off in the public company we now have an active pipeline than silver repayment.

So we benefited in at least those two ways by having as you say a broader platform. I'd say the other benefit is that it enables us to work on and close larger investments, because of the splitting of the -- so not on diversification but able to win larger investment opportunities..

So as we think about the available capital in the vehicles, when you come across a new deal.

Is that kind of roughly split 50-50 BDC with the other fund? Or what is the split between those two pools of capital?.

Yes, they would be split 50-50 in all cases then just subject to available capital at the time..

We'll take a follow-up from Christopher Nolan with Ladenburg Thalmann..

Rob, in the second quarter, did you see any sort of improvement in terms of the performance of your portfolio companies given that the GDP was around 3% or so up from before, just didn't know whether or not that translated to better financial performance by your, the companies you're invested in?.

Yes Chris, so of course we monitor each of the portfolio companies. So a few changes overall in the mix, but primarily the same number of 46 quarters and a few out and a few in. So I'd say in general I don't think we will show meaningfully better, but I would say very stable performance quarter-over-quarter.

The leverage quotient for the portfolio is slightly less levered at the third quarter versus the second, which would imply a slightly better improvement.

But as a general matter I have when asked, we think our portfolio's an interesting window into the lower middle market of the United States privately held companies you know we're in 20, roughly 20 industry sectors in roughly 20 states, and that all are performing relatively well.

And if we have a problem as I mentioned you know where we have some underperformance, it's a modest part of the portfolio and it’s kind of specific company issues and not something we’re seeing in the economy more broadly. So maybe to summarize, we see the U.S.

economy is positive, and continued to improve and we think that's reflected in our portfolio companies..

And with no more questions in the queue, I would like to turn the call back over to Mr. Ladd for any additional or closing remarks..

Okay, thank you Anna. I think we're done here. Thanks everyone for your support and we look forward to speaking with you after the New Year. Bye, bye..

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