Stellus Capital Investment - Q2 2024

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 second fiscal quarter ended June 30th, 2024. There will be an opportunity to ask questions after today's presentation. Please press star one on your phone if you wish to ask a question today. This conference is being recorded August 8th, 2024. 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, Paul, and good morning everyone, and thank you for joining our conference call today covering the quarter ended June 30, 2024. 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.

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 materially differ 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'll cover our operating results for the quarter, but would like to start with our life-to-date activity. Since our IPO in November 2012, we've invested approximately $2.5 billion in over 195 companies and received approximately $1.6 billion of repayments, while maintaining stable asset quality. We've paid over $262 million of dividends to our investors, which represents $15.75 per share to an investor in our IPO in November 2012, which was offered at $15 per share. Turning to operating results.

In the second quarter, we more than covered the declared dividend of $0.40 per share, with GAAP net investment income of $0.48 per share. Core net investment income was $0.50 per share, which excludes estimated excise taxes. Net investment income per share was benefited by increased fee income from a variety of sources and the waiver of $1.6 million, or $0.06 per share, of incentive fees during the quarter due to a limitation from the total return test. Net asset value per share decreased $0.05 during the quarter due to net unrealized depreciation on our investment portfolio, offset by the generation of net investment income in excess of the dividend. We also realized a gain of $2 million, or $0.08 per share, on an equity investment during the quarter.

Our ATM program was active during the quarter, and we issued $25.2 million in shares at an average gross price of $13.89 per share. All issuances were above net asset value. We ended the quarter with an investment portfolio at fair value of $900 million across 100 portfolio companies, up from $876 million across 94 companies as of March 31st, 2024. During the second quarter, we invested $53 million in eight new portfolio companies and had $13.3 million in other investment activity at par. We also received two full repayments totaling $31 million and $9.7 million of other repayments, both at par, resulting in net portfolio growth of $23.8 million at fair value.

At June 30th, 99% of our loans were secured and 98% were priced at floating rates. Our average loan per company is $9.5 million, and the largest overall investment is $19.6 million, both at fair value. All but one portfolio company of our portfolio companies are backed by a private equity firm. Overall, our asset quality is slightly better than planned. At fair value, 23% of our portfolio is rated a 1 or ahead of plan, and 15% of the portfolio is marked at an investment category of 3 or below, meaning not meeting plan or expectations. Currently, we have five loans on non-accrual, which comprise 2.9% of the fair value of the total loan portfolio. 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 the third and fourth quarters, I'll cover portfolio growth, equity realizations, capital management, and dividends. Based on an active pipeline, we expect to end the third quarter with a portfolio of between $900 million and $940 million. We do not know of any loan repayments in Q3, although we did have an equity realization, which is disclosed in our subsequent events for $2.6 million of proceeds and a realized gain of a little over $2 million. For Q4, we are aware of two likely repayments totaling $17 million, and one of the companies has an equity co-investment, which is currently carried at $1.8 million at fair value. We expect that new fundings will exceed repayments for Q4.

As Todd noted earlier, we had a good second quarter for equity issuance under our ATM program. We have a meaningful amount of capacity in our bank facility and cash in our SBICs, but we will look to continue to increase the bank facility over time. Given our current capital base, we have the ability to grow the portfolio to over $960 million. Finally, regarding dividends, we expect to continue, subject to board approval, to distribute at a rate of $0.40 per share per quarter, payable monthly through the rest of the year. This should be supported by earnings and a large amount of spillover income. With that, I'll open up for questions. Paul, please, we'll start the Q&A session now.

Operator (participant)

Certainly. Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that is star one if you wish to ask a question on today's call. One moment, please, while we poll for questions. The first question today is coming from Christopher Nolan from Ladenburg Thalmann. Christopher, your line is live.

Christopher Nolan (Analyst)

Hey, guys. Can you hear me?

Todd Huskinson (CFO)

We can, Chris.

Operator (participant)

Yes.

Robert Ladd (CEO)

Good morning, Chris.

Christopher Nolan (Analyst)

Hey, nice quarter, by the way. The fee waiver, is that something that we should expect to repeat in coming quarters?

Todd Huskinson (CFO)

So, Chris, and first I would say, you know, it depends, of course, on each quarter's performance going forward and the, you know, mechanics of the 12-quarter test. But I think, at this point, we don't expect anything for the remainder of this year under the test, you know, absent any other movements in the current performance.

Christopher Nolan (Analyst)

Got it. And then I guess, turning to non-accruals, EH Real Estate, obviously that's a big position there. It's a big driver for the non-accruals. Can you give a little color in terms of what sector they're involved in and a little color?

Robert Ladd (CEO)

Sure, Chris. Yeah, Chris, this is a residential Realtor, title company, insurance business in the Midwest.

Christopher Nolan (Analyst)

Okay. And then I guess the final question, just the unrealized appreciation in the quarter, you know, any particular color, or was this normal mark adjustments?

Robert Ladd (CEO)

So it's driven more on company-specific activities, but again, overall, not a large number.

Christopher Nolan (Analyst)

Okay. And then I guess finally, and Rob, you mentioned how you're looking to increase the credit facility, but your leverage ratios are so low. Is the thinking here to, you know, given the uncertain credit environment, to tap the credit facility more going forward, or are you just, you know, be more cautious?

Robert Ladd (CEO)

Yes. Yes. So we have quite a bit of unused capacity in the current credit facility, which has a commitment of $260 million, and so we certainly will use that up as we grow the portfolio. But again, we'd like to, given the additional capital base that was raised last year and so far this year, to have that start to better match the the equity base. And this would enable us to take what I described as a portfolio potential of over $960 million to over $1 billion.

Christopher Nolan (Analyst)

Okay. That's it for me, guys. Thank you.

Robert Ladd (CEO)

Thank you, Chris.

Operator (participant)

Thank you. The next question is coming from Sean-Paul Adams from Raymond James. Your line is live.

Sean-Paul Adams (Analyst)

Hey, guys. Good afternoon, and congrats on the quarter. Really quick question, touching back on the non-accruals. I know you guys added one new non-accrual last quarter, J.R. Watkins. I think now we're sitting at five total non-accruals. Is there any timeline or pathway for resolution for any of these?

Robert Ladd (CEO)

You know, they all have kind of specific paths from here, Sean, so, you know, probably wouldn't describe anything. As you know, we're somewhat guarded about talking about individual companies that operate in our country, but, each will have their own path, and, they're being worked hard. How's that?

Sean-Paul Adams (Analyst)

Yeah, that's perfect. That's great. And then turning over to leverage, you, you guys are a little bit higher in terms of the total leverage basis. What is—what are your thoughts on either moderating or staying exactly where you're at over the coming quarters in terms of the changes and, like, the forward rate curve?

Robert Ladd (CEO)

Sure, sure. So I'd say a few things to look at leverage. So we're actually less levered now than we normally are. This is due to the equity raise. So as we bring the portfolio back up to kind of full potential, you know, think of us being target leverage on a regulatory test would be about 1 to 1, and on a total test, GAAP test, including the SBIC debentures, at a little over 2 to 1. So we'd like to increase the leverage, but, you know, not significantly, but more back to our target levels. One thing that might be less obvious is we have over $30 million of cash right now in our SBIC licenses. So when that's deployed, that won't increase the leverage. So it's just as a footnote there.

And then as we look ahead, we think it's a very interesting time to invest in the lower middle market in this country, and we're optimistic about the future and, you know, the many private equity firms we work with. So we're very selective in our investing, and so we'll continue to invest in a smart way. And again, we'd like to see our leverage come back up to more of the target.

Sean-Paul Adams (Analyst)

That's a wonderful answer. Thank you for the color. I appreciate it.

Robert Ladd (CEO)

Yeah, thank you.

Operator (participant)

Thank you. There were no other questions in queue at this time. I would now like to hand the call back to Mr. Robert Ladd for closing remarks.

Robert Ladd (CEO)

Okay. Thanks, everyone, for your support of our company, and we'll look forward to updating you again in early November for the results from the third quarter.

Operator (participant)

Thank you. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.