Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Stellus Capital Investment Corporation's Conference Call to Report Third Quarter 2019 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, Thursday, November 7, 2019.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, Justin. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended September 30, 2019. 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 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 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'd like to turn the call back over to our Chief Executive Officer, Rob Ladd..

Thank you, Todd. We'll begin by discussing our operating results followed by a review of the portfolio, which will include asset quality, and then I'll provide an outlook. And Todd will now cover our operating results..

Thank you, Rob. We're pleased to report another quarter of solid earnings in which we generated realized income of $0.63 per share, including gains of $0.33 per share, which exceeded our $0.34 per share dividend by $0.29.

Coordinate investment income, which excludes the capital gains incentive the accrual and excise taxes was $0.35 per share, and GAAP net investment income was $0.31 per share.Total realized income to-date, including $19.1 million of realized gains is $1.92 per share, which exceeds our distributions of $1.02 per share for the same period.

This represents an annualized return on equity of 12.4% during the third quarter in 12.7% year to date.

As a result of these realized gains we believe it is likely that more than half of the dividends paid this year will be characterized as long term capital gains for tax purposes.Finally, net asset value increased $2.1 million over the quarter or $0.11 per share from $14.29 to $14.40 per share, primarily due to the realized gains.And with that, I'll turn it back over to Rob..

Okay, thank you, Todd. I'd like to now cover the areas of portfolio and asset quality and then outlook. With respect to the portfolio we ended the quarter with a portfolio of $586.4 million at fair value, which is across 61 portfolio companies, approximately a $55 million increase over the second quarter.

This increase included $96.6 million at par value of new investments in 6 new and 2 existing portfolio companies and also a reduction from repayments and realizations of approximately $43 million.Our portfolio continues to be weighted toward first lien and unitranche loans which now stands at 73% of the total portfolio.

This moved to more senior lending is resulting in lower coupons, however we expect it will also result in stronger asset quality overtime. We continue to make good diversification with the largest industry sector, approximately 13% of the total portfolio.

The average investment for company is $9.6 million and the largest investment is $21.2 million, both at fair value.Our largest exposure at the end of June was $21.6 million and that loan was repaid during the third quarter. 57 of the 61 portfolio companies are backed by private equity firm.

80% of our total investment portfolio is rated at a category two or better meaning on plan or ahead of plan.With respect to non-accrual loans, a $7.9 million loan that was on non-accrual as of June 30th, was repaid in full during the quarter including unpaid interest.

The unpaid interest had been produced and reserved which resulted in an additional interest in fee income of approximately $1.3 million during the quarter. As a result of this payoff, we now have loans to just three portfolio companies that are non-accrual and they comprise 2.3% of fair value of the total portfolio.

This is down from four loans and 4.8% in the prior quarter.With respect to outlook, first, we're pleased to report that in August we received our second SBIC license. When fully capitalized, this will allow us to have access to up to $175 million of SBA debentures, which are long term low cost source of capital.

And as of today we funded $12 million of equity and drawn $6 million of debentures under the new license.

As we discussed on last quarter's call and is reflected in our current yield, we're expecting a lower overall yield in the loan portfolio.During 2019, the yield on our debt portfolio is decreased from 10.9% to 9.4%, which was principally driven by a lower LIBOR rate and a continued rotation towards first lien and unitranche loans.

During the quarter now since quarter end we funded $63.7 million of debt at par in three new and one existing portfolio companies and have received repayments of $18.9 million in one company.Also, as of today, our portfolio is approximately $630 million up $42 million since quarter end.

I will say that for the balance of the quarter, we're just expecting modest growth given the activity we've already experienced in the first part of the quarter. Then with respect to earnings for the fourth quarter, we do not expect to fully cover the dividend from GAAP NII due to the lower yields and our current leverage level.

But we will likely cover that gap from additional realized gains, which we expect will exceed $1 million.With that I will open it up for questions. And thank you, Justin, we will go to the Q&A session please..

[Operator Instructions] Our first question comes from Paul Johnson with KBW..

Hey guys, good morning. Thanks for taking the question..

Good morning, Paul..

My first question is since on portfolio [technical difficulty] and purchase factory outlet [technical difficulty] down slightly in the quarter and while the smaller subdebt of portfolios that are basically in terms of spends. Any kind of color on [technical difficulty].

Excuse me, Paul. We're having trouble hearing you. Why don't we start first with repeating the question and….

Sure.

Are you able to hear me now?.

Better. Please go ahead..

Sorry about that. I am having issues. My question was just around the portfolio company, furniture factory outlet.

So hoping you can give a little bit of color on the performance of that company just given the mark down or slight mark down in the first lien piece while the smaller sub-debt pieces basically marked at zero?.

Well as you know, we don't talk about the private companies in our portfolio for obvious privacy reasons. But this is a business based in the retailing sector of the Midcontinent or Midwest United States. The small note that is zero value is kind of a sub piece of equity. So we really look at the first lien loan as relevant..

Okay, thanks.

And then I was wondering, for the debentures, the SBA debentures, as you've drawn down quarter to date, what has been sort of the average cost range of those debentures?.

Yes.

So one thing I'd like to say as a general matter that given the current rate environment, so far although these weren't priced in September, they'll be priced in March, but the debentures that were priced in September as a general matter, and the rate that's paid during the interim period are less than our current debentures we hold.So I would think that this has been lower - if the current rate environment continues, these will be at a lower cost and our current debentures which are priced in the high 3s fall in when you include fees.

So Paul to give you a sense, think of it more like 3% than 4%. So lower the current environment, which will be helpful to us..

Sure, yeah. Great. And then lastly, on the tax expense that you guys recorded this quarter, the $350,000 or so that you adjusted in earnings.

Is that related to an excise tax for the quarter or is that related to some sort of capital gain accrual?.

Yeah, Paul, this is Todd. It is effectively all excise tax that we've been accruing during the year we've been accruing each quarter based on what our current estimate spillover is..

Okay, great. Thanks. Those are all my questions..

Okay, thank you..

The next question comes from Christopher Nolan with Ladenburg Thalmann..

Hey, guys..

Hey, good morning..

Hey, Rob.

What percentage of your deal flow would you say is SBIC compliant? I mean, I guess my point is how quickly can you deploy - can you grow the SBIC sum?.

Yes. So historically, what we've found is that approximately 50% of our activity, now we may not close everything, but 50% of what we're looking at has qualified and this goes back for roughly seven or eight years. So that's a good number to think of. But we actually closed, could be a different percentage, could be a little bit less.

I would say realistically, it'll take us a couple of years to deploy the debentures in full.Our last license was probably over three years or so. But it's a very important source for us. As pointed out earlier, we think that this will be one of the things that assists us as LIBOR is lower. And our first lien unitranche business is growing.

That will still provide us interesting margin to cover the dividend. So we're very incentivized to deploy it. But realistically, I would say it'll take a couple of years in total, probably 18 months if not earlier..

So funding with the SBIC is a more profitable business than funding on balance sheet?.

It is. Although I would also point out that from here as we grow portfolio, the goal now will be in excess of $700 million. We're now at over $600 million. Incremental growth from here will come from; one, the SBIC debentures; but two, our bank facility, which is a floating rate facility priced off the 30 day LIBOR rate.

And so marginal growth will come in at - marginal cost, if you will, is now at a low 4s..

Right, and I guess a follow up would be on the bank facility itself. I mean fees jumped quite a bit.

And I can understand that is a source of future funding, but what sort of advance rate are banks charging these days?.

So advanced rate or borrowing rate?.

The advance rate, how much is exactly collateralized with [indiscernible] borrowings..

Sure. So it varies by the lien position and company specifics, but it's certainly in excess of 50%. That's probably closer to 60% on our unitranche financings..

Right. Okay. That’s it for me. Thanks guys..

Thank you..

Our next question comes from Robert Dodd with Raymond James..

Hi guys. I mean just one. And I know you don't usually like to talk about specifics of the companies in the portfolio, but one of your co-investors in Grupo Hima just gave an update earlier today about some stress that occurred late in the third quarter and even more so that has been disclosed by that since the end of the quarter.

Could you give us any update on how much of that is factored into the mark today? And if you've got any kind of feel about what the driver for that is?.

So, Robert, I would say that our reduction in the mark that occurred in the quarter was to reflect that new news.And then if you would not mind repeat the second part of the question..

I mean, if you've got any [indiscernible] if you've got any idea about what the driver was because it sounded like the weakness there came on relatively separately.

So do you have any visibility about what caused it and whether it's short term operational?.

Yeah, sure. Sure, and again, I hope you will respect that we try not to comment on company specific issues as of competitive and other factors they might have in their marketplace. But again, I would just say that we believe that our reduced mark on the first lien reflects that information.

And reduced mark on the second lien I would say as a general matter the first lien should be worth full value ultimately. So but we can't get this market $0.82 in the first lien reflect with the current information..

Got it. And appreciate that color. And I mean, you gave some indications for Q4. Don't expect to cover the dividend with GAAP NII in the fourth quarter but including the realized - total realized earnings would.

Can you give us any idea about where you think the portfolio needs to be size wise?Given the current market yields you're seeing with some spread contraction more and more first lien, more unitranche, how big does a portfolio need to be to cover the dividends from a GAAP NII basis?.

Yes, Robert. So this would be - thank you for that question. This would be now looking to 2020. And so one of our goals was to get the portfolio to $600 million plus which is now achieved. I would say expressing a couple of ways. One, think of the regulatory leverage would need to be at approximately 1 to 1. We've been operating at about 0.68 or 0.7 to 1.

So that would imply a portfolio in excess of $700 million.And then we are not benefited. So do you think this is positive for the outlook? We are benefited from; one, the lower cost SBIC debentures which will be decline; and two, as our 90 day rate that lent against is dropped.

So as our marginal cost of our bank facilities, which will also fund part of the new growth.So I'd say a combination of greater leverage or portfolio growth, but certainly in excess of $700 million portfolio; a 1 to 1 regulatory leverage, which may approximate closer to up to 2 to 1 including SBIC debentures.

So combination of that and a lower cost of debt should get us in a much better position..

Got you. I appreciate that color. And then this year you've had a very good - a lot of realized gains, harvesting prior equity positions, et cetera.

I mean, what level do you think and this is a speculative, for 2020 do you expect that level to drop significantly given the relative age of some of the equity positions in your portfolio or can you give us any color on that?.

Yeah, yeah, that's also a very good question. So I'd say this is certainly an unusual year, if you looked at our business over the last few years, but has been a growing part of the business as our equity positions have matured.

So we certainly would expect to see additional realized gains, but we certainly not projecting at this point, they would be at the magnitude currently.

And if I had, if I had to give you a number, it certainly could be half as much next year.So a lot of this, I'd say the maturity or the age of the equity positions, there's still a number that are relatively new. So we think there's more gains to come.

But just to be fair this has been an outsized year.And also, I would say that, as you know, that we also think these realized gains can be helpful and potentially will have losses. And hopefully they'll be modest. But this is a nice cushion for us with respect to that..

Got it. I appreciate the color. And good quarter guys. Thanks..

Yeah, thank you, Robert..

Showing no further questions in queue. I would like to turn the conference back over to Mr. Ladd for closing remarks..

Okay, great. Thank you everyone for your support and we'll look forward to speaking with you in the spring. Thank you very much..

Thank you, ladies and gentlemen, this concludes today's teleconference. You may now disconnect..

Justin, thanks very much..