Stellus Capital Investment - Earnings Call - Q1 2025

Transcript

Operator (participant)

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 first fiscal quarter ended March 31, 2025. This conference is being recorded today, May 13, 2025. 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.

Robert Ladd (CEO)

Okay, thank you, Jenny. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31st, 2025. Joining me, as usual 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 and portfolio.

Todd Huskinson (CFO)

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 any 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. Now, I'd like to cover our operating results for the quarter, but start first with life-to-date activity. Since our IPO in November 2012, we have invested approximately $2.7 billion in over 200 companies and received approximately $1.7 billion of repayments while maintaining stable asset quality. We have paid $295 million of dividends to our investors, which represents $17.09 per share to an investor in our IPO in November 2012, which was offered at $15 per share. Turning to operating results, in the first quarter, we generated $0.35 per share of GAAP net investment income and core net investment income of $0.37 per share, which excludes estimated excise taxes.

Net asset value per share decreased $0.21 during the quarter due primarily to company-specific write-downs in our loan portfolio and a reduction of spillover income. Our ATM program was active during the quarter, and we issued 656,085 shares for $9.3 million at an average gross price of $14.11. All issuances were above net asset value. Turning to portfolio and asset quality, we ended the quarter with an investment portfolio at fair value of $991.1 million across 110 portfolio companies, up from $953.5 million across 105 companies as of December 31st, 2024. During the first quarter, we invested $46.7 million in seven new portfolio companies and had $8.7 million in other investment activity at par. We also received one full repayment totaling $8.5 million and received $6.5 million of other repayments, both at par. At March 31, 98% of our loans were secured and 91% were priced at floating rates.

The average loan per company is $9.4 million, and the largest overall investment is $21.9 million, both at fair value. All but one of our portfolio companies are backed by a private equity firm. Overall, our asset quality is slightly better than planned. At fair value, 52% of our portfolio is rated a 2 or on or ahead of plan, and 21% of the portfolio is marked at an investment category of 3 or below, meaning not meeting plan or expectations. Currently, we have loans to five portfolio companies on non-accrual, which comprise 6.7% of the total cost and 4% of fair value of the total loan portfolio, respectively, which represents a decrease from the prior quarter. Turning to capital, on April 1, 2025, we issued $75 million in aggregate principal amount of 7.25% notes due April 1, 2030. We used the proceeds to repay the bank facility.

On April 24th, 2025, we received a green light letter from the Small Business Administration for Stellus Capital SBIC3. This is an important step in the process, and we therefore expect to receive a license, although it's not guaranteed. In general, as our existing debentures are repaid, we intend to draw new leverage under the SBIC3 license to continue funding qualifying portfolio company investments. With that, I'll turn it back over to Rob to discuss the overall outlook.

Robert Ladd (CEO)

Okay, thank you, Todd. As we look ahead to this, the second quarter of 2025, I'll cover portfolio growth, equity realizations, and dividends. We expect to end the second quarter of 2025 with a portfolio which approximates where we are today at about $985 million. We expect new loan originations to be offset by loan repayments for the remainder of the second quarter. As Todd noted earlier, we had a good first quarter for equity issuance under our ATM program. Given our current capitalization, we certainly have the ability to grow the portfolio to over a billion dollars. For our equity co-investment portfolio, which is $83 million at fair value, we have the potential for more than $10 million of equity gains by year-end.

Finally, regarding dividends, we declared the dividend for the second quarter of this year at a rate of $0.40 per share for the quarter, payable monthly, and we expect the third quarter to also be payable at $0.40 per share, of course, subject to board approval. With that, I'll open it up for questions. Jenny, you may begin the Q&A session, please.

Operator (participant)

Thank you very much. At this time, we are conducting our question and answer session. If you would like to ask a question, please press star one on your phone keypad now. A confirmation tone will indicate that your line is in the queue. You may press star two if you would like to remove your question from the queue. For anyone using speaker equipment, it may be necessary to pick up your handset before you press the keys. Please wait a moment while we poll for questions. Thank you. Your first question is coming from Erik Zwick of Lucid Capital Markets. Erik, your line is live.

Erik Zwick (Managing Director of Equity Research)

Thank you. Good morning, Rob and Todd. Wanted to start with a question. I wanted to start with a question just in terms of kind of maybe the yield and timing on the first quarter originations and just trying to get a sense of how much impact there was in the first quarter to interest income and whether there might be some additional impact for the full quarter effect.

Robert Ladd (CEO)

Yes. A couple of things. The average portfolio in the first quarter was higher than the fourth, and that will continue on for the full second quarter. There should be some pickup there in terms of yield in dollars. Todd was reminding me there in the first quarter, we had lighter other income than in the fourth quarter. To be determined what that number will be for the second quarter. We should pick up some earnings in actual dollars as a result of the higher portfolio Q2 over Q1.

Erik Zwick (Managing Director of Equity Research)

Excellent. That's helpful. Just given the strength of the originations in 1Q, and I did hear some commentary that you thought in 2Q originations and repayments would be balanced. I'm just curious kind of what the, if you could provide any color in terms of what the pipeline looks like today relative to maybe three months ago and where you're seeing opportunities, whether there are certain industries or certain types of lending opportunities, new versus add-on. Just a little kind of color there would be great.

Robert Ladd (CEO)

Yeah, no, good question. In fact, I'm glad you mentioned the add-on. As you can see from our results, we continue to have some interesting add-ons for existing portfolio companies, which is very helpful because we're already in the credit. We understand the company. We think those will continue. In terms of pipeline today versus three months ago, slower. No question, I think this has affected the industry and maybe the economy overall that the tariff activity has caused some slowness in this country, in particular around M&A. We're optimistic that will be picking up now that there is greater clarity. A little bit slower than we were. We do have interesting opportunities that we expect to close this quarter and next, but just being a little bit conservative, we know of some payoffs too, so you can't quite predict the timing.

That is why I indicated, I think, will be flat on average for this quarter.

Erik Zwick (Managing Director of Equity Research)

Got it. You mentioned potential for some pickup in interest income, and the adjusted NII this quarter was a little bit shy of the dividends, and it sounds like you'd like to maintain that at least in the third quarter at the $0.40 level. Remind me if I'm incorrect here, but I do believe that the spillover amount is probably equal to about four quarters or so of the regular dividend. Just curious about your thoughts on the trajectory of NII to cover the regular dividend going forward. I know you're kind of aiming to get the portfolio to at least $1 billion or so, but just your expectations for closing that gap.

Robert Ladd (CEO)

Sure. Let me take it first, and then Todd should add to this. We are running at a level of NII less than the dividend. As you point out, we entered the year, Todd, I think about $45 million of spillover income, which we are starting to reduce. We think as we get to the end of this year, we will be in a good spot for next year. I think just based on current yields and the level of SOFR, we will be less than that $0.40 throughout the balance of the year from NII.

Just as a reminder, as I indicated in my remarks, and this has happened to us in the past, we do have some interesting equity co-investments that we think we'll start to take in, and this would cause us to be in excess of the dividend in terms of realized earnings for the year. We are entering a phase to also look at that. From a pure NII basis, we would be short.

Erik Zwick (Managing Director of Equity Research)

Okay. Thanks. I think you mentioned there's about $10 million or so in terms of what you can see for potential realized gains by the end of the year.

Robert Ladd (CEO)

Yes. In fact, in excess of $10 million.

Erik Zwick (Managing Director of Equity Research)

In excess. Okay, great. Just one last one for me and I'll step aside. Excuse me. Just curious a little bit about Trade Education Acquisition. It looks like that was a non-accrual from about the middle of last year. Looks like that may have been restructured into Simpler Trading, but just curious if you could provide any commentary in terms of what transpired and your expectations going forward.

Robert Ladd (CEO)

Yes. We do not like to talk about private businesses in this country, but at the same time, we will say that a business was restructured, as you indicated, in the first quarter and was recapitalized, we think, in a satisfactory way and expected to perform well from here.

Erik Zwick (Managing Director of Equity Research)

Okay. Did that have an equity sponsor, and did they contribute any additional capital as part of the restructure?

Robert Ladd (CEO)

Yes, they did. It did have an equity sponsor, and they did contribute capital meaningfully. It reached the point at this recapitalization, no further capital was available. We have together restructured it in a new form, if you will.

Erik Zwick (Managing Director of Equity Research)

Great. Thanks for taking my questions today.

Robert Ladd (CEO)

Yes, thank you, Erik.

Operator (participant)

Thank you very much. Your next question is coming from Christopher Nolan of Ladenburg Thalmann. Christopher, your line is live.

Christopher Nolan (Senior VP of Equity Research)

Hey, guys.

Robert Ladd (CEO)

Hey, good morning, Chris.

Christopher Nolan (Senior VP of Equity Research)

Rob, thank you for your comments. Given the markets pricing in rate cuts by the Fed later in 2025, last time I checked was the forward markets pricing in three rate cuts. What was the logic behind issuing the fixed-rate debt?

Robert Ladd (CEO)

Yes. We had a couple of things, Chris. We have bonds that are maturing in March of 2026. This was part of these proceeds we would expect will retire some of those bonds. Something we needed to do from a fixed-rate basis. Also, it is helpful to have some unsecured debt in the capital stack to supplement our floating-rate liabilities. Hard to know the right timing for these things, but that was the timing we took. Also, to be frank, wanted to avoid what might have been more uncertainty as the year draws on.

Christopher Nolan (Senior VP of Equity Research)

Great. I saw that quarter to date, you guys issued roughly 300,000 shares, common shares. Were those under the ATM, and were these accretive?

Robert Ladd (CEO)

Yes, they were all under the ATM and all were issued above NAV. Therefore, accretive.

Christopher Nolan (Senior VP of Equity Research)

Should we expect that you guys are going to be hitting the ATM a bit harder as opportunity presents itself?

Robert Ladd (CEO)

It'd really be a function of how our stock price is trading. We want these to be accretive or certainly not dilutive to NAV. I think that will drive it more of what our market price is. We certainly will be considering issuances throughout the year.

Christopher Nolan (Senior VP of Equity Research)

Great. Final question.

Robert Ladd (CEO)

Market conditions. Excuse me, market conditions supporting.

Christopher Nolan (Senior VP of Equity Research)

Final question. I've been covering you guys long enough to know that when the outlook starts improving for the market in general, you guys tend to put in a little bit more second-lien loans. I take it that you guys have no contemplation of that at the moment, right?

Robert Ladd (CEO)

That's right. In fact, Chris, I'm glad you raised that. We haven't had any new second-lien loans in a number of years and do not expect to. You could, but it would be unlikely. Our mode of investing has really become very much a first-lien unitranche secured lending with equity co-invests.

Christopher Nolan (Senior VP of Equity Research)

Sure. It is more of a defensive posture, just given the uncertainty of the broader environment. Is that a fair way to look at it?

Robert Ladd (CEO)

I think that's right. We really, I'd say four to five years ago, moved to this mode where, and also was really where unitranche lending became popular also for our private equity clients who were looking for one-stop financing. One lien and ideally one lender. The second-lien and junior capital became less of a demand. We also made that decision for risk management. We thought that the risk-return profile was much more attractive to be in the first-lien unitranche.

Christopher Nolan (Senior VP of Equity Research)

Great. Final question. Given the third SBA green light letter, assuming that you get the approval and you lever up that SBA vehicle, that would basically deceptively, I would say, increase the impact of a lower interest rate environment on your earnings. Is that correct?

Robert Ladd (CEO)

Yes, in a positive way. Yes. Two things. As a reminder, the SBA debentures issued under the SBA agency, if you will, are priced at the 10-year treasury rate plus a market premium, which historically has been 50-80 basis points more, but approximates the 10-year treasury. If you look at our capital stack, the potential for SBIC debentures is $350 million. We are like $309 million right now because we have already paid back some. The full amount that we could have outstanding is $350 million. Think of our capital of $1 billion. $350 million can be at lower rates than we would otherwise borrow both on a fixed-rate basis and on a floating-rate basis. This would be a complement to the question I got earlier about issuing those unsecured notes that are at 7.25%.

These notes, based on the current treasury rate of 10, should be less than 5%. This is very advantageous for us from a funding mix going forward.

Christopher Nolan (Senior VP of Equity Research)

Great. Thank you.

Robert Ladd (CEO)

Okay. Thank you, Chris.

Operator (participant)

Thank you very much. Your next question is coming from Robert Dodd of Raymond James. Robert, your line is live.

Robert Dodd (Director of Specialty Finance)

Hi, guys.

Robert Ladd (CEO)

Good morning, Robert.

Robert Dodd (Director of Specialty Finance)

Morning. Sort of follow up on Erik's question. I mean, on the pipeline, I mean, it makes sense, right? Could you characterize where we're sitting now, like now versus, say, March 31st? How much of the fall-off in pipeline and maybe the expectation of a flat portfolio this quarter is due to the disruption about Liberation Day? If there is a fall, how much of that fall-off there is related to that, do you think is permanently gone versus just delayed maybe into the back half, maybe later? Any color there?

Robert Ladd (CEO)

Yes. Good question, Robert. I would think of it this way for M&A. If a business was being marketed for sale and the seller thought it was a good time, and with clarity now around tariffs for both buyers and sellers, we would expect almost all, if not all, that activity to come back. This would be what we would describe as a temporary disruption. We would expect it to come back.

Robert Dodd (Director of Specialty Finance)

Got it. Got it. Thank you. To your point, I mean, you kind of got ahead of if you can hear that ringing, that's a reminder on my phone. I apologize.

Robert Ladd (CEO)

No worries.

Robert Dodd (Director of Specialty Finance)

On the bonds, what would you do you think the one you've done, the seven and a quarter, you shouldn't act as sufficient that you don't need to do more ahead of the maturity you've got next year? You got good timing on that, by the way, doing it ahead of Liberation Day. Do you think you need to do more on the unsecured fixed-rate ahead of the maturity? Or you've kind of done there in combination with, obviously, the SBIC and the broader revolver?

Robert Ladd (CEO)

Yes. We will need to issue more unsecured debt before the bonds mature, the older bonds mature. The magnitude of that is still being determined. I would think of it this way. The issuance that closed on April 1st of $75 million, we would have wanted at least $25 million to be used for growth and potentially more, which would mean that we'll definitely need to issue more bonds before we get to, I'd say, before we get to the end of the year. More to come. It would not be $100 million.

Robert Dodd (Director of Specialty Finance)

Okay. Got it. Thank you.

Robert Ladd (CEO)

Certainly be less than that.

Operator (participant)

Okay. Thank you so much. We appear to have reached the end of our question and answer session. I will now hand back over to Robert Ladd for closing comments.

Robert Ladd (CEO)

Okay. Very good. Thanks, everyone, for joining us. Thank you for your support of our public company. We look forward to giving you another update as we get to early August to cover the second quarter. Thanks again.

Operator (participant)

Thank you so much, Robert. That does conclude today's conference. You may disconnect your phone lines at this time and have a wonderful day. We thank you for your participation.