Robert Ladd - Chief Executive Officer Todd Huskinson - Chief Financial Officer.

Chris Kotowski - Oppenheimer & Company Leslie Vandegrift - Raymond James Christopher Nolan - Ladenburg Thalmann Ryan Lynch - KBW.

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 2017 Annual Results. 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, Tuesday, March 6, 2018. 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..

Okay, thank you, Jessica. Good morning everyone and thank you for joining the call. Welcome to our conference call covering the year ended December 31, 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 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 with 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 will cover the following areas; a life-to-date review, a review of 2017 capital management, asset quality, and then an outlook for 2018.

So, first, in terms of the life-to-date review, as we’ve now completed our fifth full year of operations, I am pleased to report that our IPO investors have earned dividends of $7.27 per share.

Since our inception in late 2012, we’ve originated $785 million of new investments across 76 companies, which has offset repayments of $552 million for the same period, a net increase of $233 million. Now turning to 2017. Net investment income plus net realized gains totaled $1.52 per share; dividends paid were $1.36 per share.

During 2017, we experienced a significant level of pay-offs, which we’re able to replace entirely through new fundings. Pay-offs and amortization payments totaled $172.3 million during the year. We made 16 new investments totaling $175.5 million at par value with a weighted average yield of 10.4%.

Twelve of the fourteen debt investments carry floating rate interest rates and all but one of the loans is secured. Over the year, our secured loan portfolio increased to 92% of the total from 80% at December 31, 2016. At the end of 2017, the weighted average yield on the debt portfolio was 10.8% and 87% of the loans are priced at a floating rate.

This is up from 77% at the end of 2016. Our only floating rate liability is the bank credit facility. So we are positively positioned for a rising interest rate environment.

To put this in perspective, 90-day LIBOR, which most of our loans are priced off is now 2.02%, which is 32 basis points higher than at December 31and 68 basis points higher than at September 30. Our net asset value for the year increased by $0.12 per share to $13.81. This is due primarily to realized gains.

Turning now to the fourth quarter, new investments of $55.3 million exceeded repayments of $38.9 million. Since year-end the investment portfolio has increased by $62 million of new investments and no full repayments. Net investment income for the fourth quarter was $0.28 per share, which was left for the distributions of $0.34 per share.

Now to capital management. As you know, during the year 2017, we took a number of steps that meaningfully strengthened our capital base. At April 2017, we issued 3.2 million shares and raised approximately $43 million of equity capital net of fees.

We also reinstated our at-the-market equity program and raised approximately $4 million of additional equity capital, again net of fees. In August, we issued $48.9 million of five-year unsecured notes, which were used in part to retire $25 million of notes maturing in 2019.

The new notes which mature in 2022 carry an interest rate of 5.75%, down from the retired notes rate of 6.5%. In October, we were able to extend the maturity of our bank credit facility to 2021 from 2018, increased the commitment amount to $140 million from $120 million and reduced the interest rate to LIBOR plus 2.5 from LIBOR plus 2.58.

We deployed an additional $25 million of SBA debentures during the year bringing our total debentures outstanding to $90 million. In addition, in January of this year, we contributed additional equity to fully fund our SBIC subsidiary. We expect to receive and deploy the remaining $60 million of debentures under our SBIC license during 2018.

These improvements taken in total to our capital base will allow us to grow our investment portfolio to more than $500 million. Now asset quality. Overall, our asset quality is stable and is at a 2 on our risk grading system or on plan.

Only 11% of the portfolio is marked at risk grade of 3 or below and we have just two loans at non-accrual representing 0.4% of fair value of the total loan portfolio.

Continue to maintain good diversification with our largest industry sector at 13.2% of the total and our average investments in company is $7.7 million; the largest investment is $22.2 million at fair value. And lastly, our outlook. As we look forward to 2018, here are our thoughts.

Our primary goal, while maintaining selectivity is to substantially deploy the capital raised in 2017. While net portfolio growth is difficult to forecast, we believe we have a path to closing 2018 with a portfolio in excess of $500 million. The portfolio today is approximately $430 million. As I mentioned earlier, we’ve had a strong start to 2018.

We’ve closed $62.4 million of new investments and are working on a number of new opportunities. We will likely have repayments of $14 million or so over the next 30 to 60 days.

For the fourth – I am sorry – for the first quarter, net investment income is likely to be less than the distributions as we build up the portfolio, but we have already recorded another equity gain of approximately $1.3 million, which should offset that shortfall. With that, I’ll open it up for questions. Thank you..

[Operator Instructions] And we’ll first go to Chris Kotowski from Oppenheimer & Company. .

Yes, good morning. I guess, one thing I would start with is the interest income was somewhat less than what we were looking for and I know the non-accrual, the additional non-accrual weighed on that.

But was there any other unusual factors? Because I guess, it’s down like $0.5 million year-on-year and it just looked, especially with a lot of prepayments, I would thought there might have been some pick up on prepayment penalties. .

Chris, the repayments that came in had very modest fee income associated with them. And then, I think you are seeing the impact of the non-accrual. .

That’s it mainly.

And is there anything you can tell us on the outlook for the second lien investment in Grupo Hima?.

We really can’t comment on it. As you know, this is a hospital system based in Puerto Rico that like many businesses were affected by the hurricane. So we’ve tried to mark the position on the second lien and the first for that matter at our best estimate of value.

But more to come and one thing we do know is this is a very important hospital system in Puerto Rico and was up and running very shortly after the hurricane struck..

Okay.

And when you – you called it on the call, you called it an equity gain, in the press release, it said a dividend, is that the same $1.3 million?.

Yes, Chris. It was actually not the sale of a company, but rather a dividend. But I think it will be accounted for as a realized gain, but it’s technically dividend. .

Okay.

And then, in the subsequent events section, it looks like there are lot of new commitments early in the year and was it just that you had finally had the liquidity to be able to fill a backlog or is this kind of indicative of expanded marketing efforts or and what’s the outlook for the next couple of months?.

So, the activity in the first month or so of this quarter and I’d say, the fourth quarter would be just the continued activity that we’ve had for since inception. I think one thing that’s impacted, as you know, the ultimate growth has been first capital, but then just pay-offs and repayments. So, I mentioned that robust number from 2017.

So I think that what you are seeing is a continued – our normal activity. We try to be very active all over the country.

And in terms of an outlook, as I said, we have a number of opportunities we are working on and we’d certainly expect over the – as I said earlier that we think we may have repayments of approximately $14 million over the next 30 to 60 days. I’d be surprised if we weren’t able to more than replace those with new fundings..

Okay. All right, that’s it for me. Thank you..

Okay, thank you, Chris..

And we’ll now go to Leslie Vandegrift from Raymond James. .

Hi, good morning. Thank you for taking my questions. Just a quick one on the timing of the repayments in the quarter. I know you just had – there is, call it, modest fee income associated with them.

But were the repayments earlier or later in the quarter? And the same question for the origination?.

Go ahead, let me – we’ll pull that up. But go ahead with your next question..

Okay.

On the outlook, you said the next 30 to 60 days, about $14 million repayments, so those looks like they will have highest repayment fee income with them or in line with the fourth quarter repayments?.

We would not expect for them to have a material fees associated with them. .

Okay.

And then, you talked about rising LIBOR, your portfolio is positively exposed, but with spread compressions on the other side and the reinvestments as you get these repayments, how much of a benefit do you realize here over the next year through yield?.

So, it’s a good question, Leslie. I would say, the forward curve for LIBOR from here would indicate 2.5% by the end of the year, up from little over 2 today. So we would expect that will impact yields. The new loans that were closing are roughly 10 plus percent yields. So not materially less than our current average.

So as we sit here today, we would expect the yield to rise overall. The one thing that is impacting that is, as you can see year-over-year a movement from almost secured lending for a second, really unittranche lending, we become more active on the unittranche side and so you can see some slightly lower yields there. We think it makes sense.

But I think on average, we would expect the overall yield of the portfolio to rise this year. .

Okay. And on the incident fees, they are lower in the quarter. Obviously, we had Puerto go on to non-accrual. And so that impacted that.

But on the fee waivers going forward, in the past, you guys have used those to cover the dividends by NII and I know you had some of the realizations this quarter and distressed coverage from realized, but what’s the outlook for you to waivers if you need them or would be based on coverage from realized earnings or from raw NII?.

Yes, so I think as a general matter, as I mentioned in terms of the outlook for growth, given the capital base we have, that if we are able to achieve that level of growth this year, we should be able to cover the dividend from NII. I’ve said previously that we think covering the dividend from earnings, overall earnings is certainly important.

And I think the one thing we tried to there was to look at it over a period of time, not just one quarter or two. So, we – our goal this year is to cover the dividend from NII and we’ll certainly look at a waiver if necessary. And we also think it’s important to look at the gains to come in. So, waiver is certainly possible as we’ve done in the past.

We have to go back to 2015, so as we’ve had a few waivers, but we certainly will consider it if the earnings are not sufficient. .

Okay. And just last quick question.

I know you are probably in a blackout period for using any repurchase agreements in the quarter for probably until today, but what’s the outlook there for use of that program going forward?.

Yes, so, we view it’s more important at this point to use the capital base we’ve built up to build to a larger size, which enables us to win larger deals. So it would not be an immediate focus of the company to be repurchasing shares, but rather to invest the equity capital that’s been raised. .

Okay. Thank you for answering my questions this morning..

You are welcome. And also, Leslie, just come back to your question, so I would direct you in terms of fourth quarter activity, in the press release, we scheduled when the investments, the new investments were made and when the pay-offs were received.

So, they roughly occurred through the quarter, but that will be my best guidance to give you if you just follow that schedule..

Perfect, good. I did see that as soon as I asked the question. I appreciate that. .

Okay, yes, no worries. I had to look it up too. Okay, thank you..

Thank you..

Thank you..

And we’ll now go to Christopher Nolan from Ladenburg Thalmann. .

Hey guys. Todd, in your comments earlier, you indicated that the intention is for an NII to cover the dividend in 2018.

Is it correct to say that that implies taking up the leverage?.

Yes, so, this is Rob. We’ve said that. So, Todd can – I’ll let Todd answer the question..

Yes, so, we would expect leverage to continue to leverage. Our leverage has been lower than normal since we raised the equity earlier this year. But as we continue to deploy both the credit facility and draw that up and we’d expect that we would draw that up to – we could get up to – back up to 0.8 times, I think, total excluding the SBIC debentures.

And then, the other part of that is, we have a capacity for $150 million of SBIC debentures and we are currently at 90. So, I mean, as Rob mentioned earlier, we’d expect that we would draw down and deploy the remaining $60 million underneath our SBIC business..

And I would just add to that, just to add to that – so to get to the $500 million level of assets, it does require, as Todd pointed out, both one, drawing on – further on the line of credit as well as fully deploying the SBIC debentures and in terms of target, this would – Chris has been for a year of time covering us, we target statutory leverage to be under 0.8 times.

So, we’ve kind of a self-governing feature there. But we definitely will have more leverage by the end of the year. We are optimistic we will in building the portfolio..

Okay, so the regulatory leverage should go up primarily from the bank facility, at least as of thinking now, as well as again, incremental growth from the SBA?.

That’s correct..

Okay, great.

And then, on the non-accruals, I know you’ve got Grupo San Pablo, but the other one Hostway?.

Yes, it was. So, Hostway was on non-accrual, it is now back on accrual. The other non-accrual would be the Binder position which is – I think at the end of the year, $380,000. .

Gotcha. And then, shares were issued in the fourth quarter.

Is that under the ATM?.

That’s right..

And what was the average – I mean, I am just in back of the envelope calculation, it looks like it was well below NAV per share, I mean, am I correct in that?.

Yes, that’s right. So, we’ve of course had authorization from the shareholders to issue for the NAV, which we also met our board and talked to them about at what target would be. So, the limit there was to stay above 97% of NAV and those shares were issued above that – slightly above that. So that’s right..

Okay. Thanks for taking my questions..

Yes, that level is something that could vary over time. .

Right..

But that’s probably, I think 13, 47..

That’s right. That’s right..

Great. Thanks for taking my questions guys. .

Sure..

Thank you..

[Operator Instructions] We’ll now go to Ryan Lynch from KBW..

Good morning. I wanted to follow-up maybe on Chris’s question with the non-accruals. Hostway Corporation, you mentioned that came back on accrual status. Can you just talk about was that investment restructured? Or did just operations improved there where they started making interest payments? Any update on that would be appreciated..

Sure, Ryan. So, as you know, we limit discussion about these private companies and their activities. But let’s say as a general matter, the operations have improved; one, and two, there was a reorganization of the activities. The company is doing well, better and we are back on a cash pay. We had not been receiving current interest, but we now are. .

Okay, excuse me. And in this quarter, you guys had quite a few unsecured loans to repay, the percentage of your portfolio on unsecured investments has decreased pretty meaningfully quarter-over-quarter.

Do you guys expect to grow that bucket? Or are you guys kind of fine with the current composition of your portfolio having what is a lower unsecured book than you guys have historically had?.

Yes, so I’d say, if you look back really since inception, we’ve made two meaningful changes in the portfolio.

One is to go from less secured to – or more unsecured to mostly secured, which we close to of accomplishing and the other which goes hand-in-hand is to become much more floating rate assets than fixed rate and typically fixed rate is associated with unsecured. So, we think the percentage we’ve achieved is about right.

It could even be higher secured level than currently at 90%. But, more to come. We are very selective about mezzanine or unsecured opportunities that would take the right ingredients in terms of the size of the business and equity capital structure. So, you will see some, but it will be limited and we really like the position we are now in. .

Okay, makes sense. And then, going back to the dividend, when I look – you guys mentioned, you think it’s important to cover the dividend through NII.

When I look at the dividend this quarter or are any of this quarter of $0.28 with very little and incentive fees paid versus a $0.34 dividend, I understand you guys had a lot of capital available in the form of leverage to deploy which will obviously grow earnings and overall credit quality, you guys have done a good job with credit quality historically.

But just given the environment that we are in, where we are seeing a lot of competition and tighter spreads across the market.

Is it reasonable to expect that you guys should be able to generate a 9.8% dividend yield on your book value without taking excess credit risk and reaching on credit which could ultimately turn in credit issues down the road if you are not careful?.

Sure, sure. So, I’d just say, as I said in my remarks that our goal to grow the portfolio this year is to fully deploy this capital we’ve raised is would continue to follow our selectivity. So, we have no intention of changing the way we’ve invested for a decade or so. So, that’s not a focus of our area.

One thing that might be helpful too, Ryan is that, as you described a competitive market and a best evidence of how we are performing is the opportunities we’ve closed over the last six to 12 months that are well priced and we would say well structured in terms of covenants and equity capital basis.

So our plan is to continue to do that and if we don’t find opportunities like that, we won’t make the investments. .

Okay, that’s all from me. Thanks for taking my questions. .

Great, thank you. .

And there are no further questions. I’ll turn the conference back over to our presenters for any additional or closing remarks. .

Okay, well, thank you everyone for being on. Thank you for your support and we look forward to covering the first quarter in May. Thank you..

This concludes today’s presentation. Thank you for your participation..