Stellus Capital Investment Q4 2023 Earnings Call Transcript

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March 5, 2024

There are 8 speakers on the call.

Operator

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 4th fiscal quarter and year ended December 31, 2023. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. This conference is being recorded today, March 5, 2024.

Operator

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.

Speaker 1

Okay. Thank you, Holly. Good afternoon, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter year ended December 31, 2023. Joining me, of course, 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.

Speaker 2

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.

Speaker 2

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.

Speaker 1

Okay. Thank you, Todd. We'll begin this afternoon by discussing our operating results, followed by a life to date review, a review of the portfolio, including asset quality and then the outlook.

Speaker 2

Thank you, Rob. First, I'll cover operating results. We continue to benefit from our favorable asset liability mix in which 98% of our loans are floating and only 27% of our liabilities are floating. As a result, we had solid results in the 4th quarter as we more than covered our $0.40 per share dividend through core net investment income of $0.50 per share and GAAP net investment income of $0.49 per share. Net asset value increased $0.07 per share to $13.26 per share.

Speaker 2

During the Q4, we recorded a tax refund of $3,000,000 which was the result of recording a realized loss on previously marked down positions. Since our IPO in November 2012, we've invested approximately $2,400,000,000 in over 195 companies and received approximately $1,500,000,000 of repayments while maintaining stable asset quality. We have paid over $246,000,000 of dividends to our investors, which represents $15.08 per share to an investor in our IPO in November 2012. Now turning to portfolio and asset quality. We ended the quarter with an investment portfolio at fair value of $874,000,000 across 93 portfolio companies, slightly down from $886,000,000 across 96 companies at September 30, 2023.

Speaker 2

During the Q4, we invested $40,300,000 in 3 new and 11 existing portfolio companies and along with additional fundings of $3,900,000 and received 5 full repayments and 4 full realizations totaling $39,900,000 and $153,000,000 dollars of other repayments resulting in net portfolio decline at cost of $39,500,000 In December 31, 99 percent of our loans were secured and 98% were priced at floating rates. We're always focused on diversification. The average loan per company is $9,900,000 and the largest overall investment is $18,900,000 both at fair value. Substantially, all of the portfolio companies are backed by a private equity firm. The average leverage of the portfolio companies is around 4 times and average EBITDA of approximately $19,000,000

Speaker 3

per company.

Speaker 2

Overall, our asset quality is slightly better than planned. 24% of our portfolio is rated a 1 or ahead of plan and 14% of the portfolio is marked at an investment category of 3 or below. As of year end, we had 4 loans on non accrual, which comprised 1.3% of fair value of the total loan portfolio.

Speaker 3

With that, I'll turn it back over to Rob to discuss dividends and overall outlook.

Speaker 1

Okay. Thank you, Todd. As a reminder, part of our investment strategy has been to invest in the equity of our portfolio companies in a modest way, but in order to generate realized gains sufficient to offset losses over time. While we've had modest equity realizations more recently, we expect this activity to pick up over the next 6 to 12 months. To this end, we are aware of 2 possible equity realizations that could occur in the Q2, that aggregate proceeds of approximately 7,000,000 dollars and a potential realized gain of $4,000,000 As of the end of the year, we have $60,000,000 of equity investments at cost that were marked at $72,000,000 Our historical performance would indicate that the ultimate realization for this portfolio will be greater than 2 times our portfolio's cost basis.

Speaker 1

However, of course, the ultimate performance of our current equity positions will depend on a variety of factors including among other things, the current economic environment and sponsors' exit strategies. Now turning to dividends. We continue to cover our dividend $0.40 per share per quarter as a result of the greater earnings that we are generating in this higher interest rate environment. As Todd mentioned, we are well positioned to benefit from the higher interest rates as our portfolio is over 98% floating and our liability structure is approximately 73% fixed rate. Looking forward to Q2 of this year, we expect subject to our Board of Directors approval to continue our monthly dividend of approximately $0.13 per share, resulting in aggregate dividends of $0.40 per share for the Q2.

Speaker 1

It's worth noting that based on the average price of our stock over the last 10 days and yesterday, our current dividend equates to an annual yield of about 12.4%. Now turning to outlook. Since year end, we have funded $4,700,000 at par in 7 existing portfolio companies and have received one full repayment of $16,200,000 This brings our total portfolio to approximately $863,000,000 at fair value with 92 portfolio companies. We are experiencing a somewhat slower environment for originations than in the previous few quarters and we expect our funding for the remainder of the quarter will be offset by expected repayments of approximately the same amount. It is worth noting, we do expect for a variety of reasons that investment activity will pick up in the second half of this year.

Speaker 1

We have substantial capacity for new investments, which of course would increase with likely repayments. With that, we'll open it up for questions and Holly, we can begin the Q and A session, please.

Operator

Certainly. At this time, we will be conducting a question and answer session. Your first question for today is from Paul Johnson with KBW.

Speaker 4

Hey, good morning. Thanks for taking my question. So just on some of the remarks you gave on the portfolio, 14% or so as fair value in your sort of internal risk rated 3 or below. Kind of setting aside the non accrual, I think that accounts for 1% of that, correct me if I'm wrong, I mean, how do you kind of think about those situations? I mean, do you think that those are situations you feel are stabilized and performing, albeit maybe below sort of projection?

Speaker 4

Or are they still are any of these still work in progress?

Speaker 1

Yes. So Paul, as a general matter, we certainly think these are all manageable positions. They vary by company. The one attribute that would be true for substantially all of them is that they do have private equity ownership and backing and support. And so I think the way to think about our risk grade 3s and below is perhaps performing under plan that combined though with private equity support, we think that the results are quite predictable.

Speaker 1

But again, ups and downs in the portfolio, but I'd say no change, substantial change over our history.

Speaker 4

Thanks for that, Rob. And then kind of looking into next year, fee income this other income this year is relatively light. I mean, I'm just thinking about kind of activity, as you mentioned, if you expect to sort of pick up in the next year, you expect that to drive any sort of central prepayment income activity in your depending on what sort of turnover I guess you're expecting for the year?

Speaker 1

Yes. And Paul, just in terms of so one way to think about it, we had a little bit more than normal other income in the Q4 based on repayments. We think that slowed in the Q1 of this year, but we see repayments picking up for the middle and latter part of the year. So on balance, you'll see it more, but just to flag that in the Q1, we would expect less of that other income than we had in the Q4.

Speaker 4

Thanks for the clarification there. And then last one for me, just on in terms of liabilities. I realize I think your unsecured notes are due in 2026, but there's some SBA debentures that are rolling off in the next year or so. Where are you guys in terms of SDIC licenses and current capacity on those licenses?

Speaker 1

Yes. So as a quick recap and then Todd will add in here. The so we have 2 licenses currently. All of the debentures have been drawn, which amount to 325,000,000 dollars We do have some debentures from the 1st license that come due next year in 2025, roughly 25,000,000 dollars So those will be prepared to retire certainly honoring in advance of their coming due. And then so we are looking at working with the SBA for a third license as we've reached some of the debentures from the first license that's starting to come due.

Speaker 1

And our investment period for the second license is coming up toward the end of this year. So we'll be in discussions with the SBA to see if we can obtain a third license.

Operator

Your next question is from Eric Zwick with Hovde Group.

Speaker 3

Good afternoon. Wanted to start just on the comments Ravi made about expectations for funding to pick up in the second half of the year. And just curious if that is driven by kind of increase in pipeline activity that you're saying or more based on kind of broad market developments or potentially a combination of both of those?

Speaker 1

Yes. So probably, Erika, thank you for joining. So a variety of factors. So certainly, when we've in over time, if things are slower, they tend to pick up. So that'd be one overall observation.

Speaker 1

But more importantly, we know there's a tremendous amount of dry powder in all of private equity hands, but especially in the lower middle market where we operate. We also know that there are holdings in private equity firms that are either the fund life is reaching an end or some continuation end. And there'll be some realizations that the private equity firms will start to generate. So our general impression is that things will pick up toward the second half of the year. We are seeing activity, but it's not as heavy as it has been.

Speaker 1

So this is a more forward looking toward the end of Q2 and third and fourth quarters.

Speaker 3

Thanks for the insight there. And then just looking at the 4Q funding activity as well as what's been done quarter to date, greater percentage of add on new investments versus new and wondering if that's just kind of based on the opportunities that you're seeing or if you have a preference for those, certainly companies that you already made investments for and continue to grow. I'm sure you would love to be able to continue to support them. So curious about that mix as we look out into 2024, what it could look like as well. Sure.

Speaker 1

So I'd say that I'd say we like both. We really like the new financing where it's an acquisition of a fresh company, fresh diligence, new equity capital. So that's an ideal structure for us. But that I'd say equally as good would be an add on where we already know the company, it's performing well and they're expanding. This would be a lot of the strategy of the companies that we back is that the private equity firm takes the platform, the initial acquisition and then their plan is to grow it from here with add ons or acquisitions if you will.

Speaker 1

So again both are attractive to us. The add ons come more naturally and as when we're already in the credit. In terms of looking forward this year, we would expect many of our portfolio companies and their owners to be acquisitive. So you should see more activity there. But I think that that comes naturally with the existing and then of course we're always searching for new opportunities in new companies.

Speaker 3

Thanks. And then last one for me and I'll step aside. Just looking at the kind of the exits and some of the restructurings that took place towards the back half of the year. Any expectations for what our PIK income may look like in 2024?

Speaker 1

It would be we've had a little bit of an increase in 2023 where we've had some restructurings we worked on. So I don't think we expect it to materially change in 2024. We have noted in the past that when we're the only lender or just a small group of lenders and you have a company that might be struggling making their interest coverage, which most of our substantial of ours can. But if you have that case, we have the flexibility as a lender to provide some PIK interest. Ultimately, we'll collect it, but this can help the cash flow.

Speaker 1

So but don't expect that to materially change in 2024.

Speaker 3

Thanks for taking my questions today.

Speaker 1

Thank you.

Operator

Your next question for today is from Christopher Nolan with Ladenburg Thalmann.

Speaker 5

Hey, guys. Rob, on your comments in terms of slowing deal activity, I presume that's simply because the private equity partners you work with are just seeing slower investment activity as well. Is that a correlation?

Speaker 1

That's correct. It's highly correlated. I'd say it's M and A activity is down and I think you may have heard that from others as well. So that's the most impact for sure.

Speaker 5

And then I guess in terms of the reinvestments, do the private equity firms have a drag along clause for you guys where if they reinvest into a portfolio company, you need to invest as well or how does that work?

Speaker 1

Yes. And Chris, do you mean when they're making a new acquisition?

Speaker 5

A follow on acquisition to an existing portfolio company.

Speaker 1

Sure. So in many cases, we'll have already established a delayed draw term loan that they would automatically draw upon if the acquisition follow on qualified. So this would be normal. Absent that, where there's not a pre existing commitment, any new acquisition they'd make, we'd have to re underwrite.

Speaker 5

Got you. And then I guess final question is, last year you had some pretty good dividend supplements. What's the spillover income and what are your thoughts about supplements these days?

Speaker 1

Sure. Let me turn it over to Todd for that.

Speaker 2

Sure, Chris. So our spillover is going to be about $37,000,000 and our current dividends are $38,500,000 So at our current dividend level, with the additional shares that we've raised or issued, we've got enough regular dividend to cover the spillover going forward. But things could change in terms of gains and losses and taxable income in future years.

Speaker 5

Got it. Okay. Thank you for that detail. That's it for me. Thanks guys.

Speaker 2

Thank you, Chris. Thank you, Chris.

Operator

Your next question is from Robert Dodd with Raymond James.

Speaker 6

Hi, guys. On the you mentioned there's going to be potentially realizations in the quarter and maybe equity realizations and realized gains and maybe more activity in the second half of the year. I mean, everything we're hearing is private equity or LPs and private equity funds want realizations before they'll fund new funds. If there are more realizations from your private equity partners and private equity environment as a whole, would you expect or are there going to be more equity realizations in the back half of the year? Could we accelerate that as a source of capital to be reinvested as we get later into this year?

Speaker 1

Yes, Robert. And that's a good point that you brought out that I alluded to, which is LPs and longer dated funds looking for realization. So we think this will drive new activity for us as these companies are sold and we have the chance to finance it for the next owner. But as you're pointing out, would also result in realizations for us. So, yes, and as I said in my remarks that we do think that the equity realizations activity will pick up.

Speaker 1

And there are a few more that we know of that I didn't mention, but not as clear as the 2 that we're hearing about. So I think that's right. And again, we have substantial capital to invest. As a reminder, our entire platform is roughly $2,800,000,000 of AUM across the Stellus platform. So and then within the public company, of course, quite a bit of given that our credit facility were only borrowed at about $150,000,000 currently.

Speaker 1

So again, that coupled with repayments, so we'll be ready for the new deals that come in the second half of the year.

Speaker 6

Got it. Thank you. Any particular industries that you're thinking are increasingly attractive in this if we've got higher rates right now, but if they are going to decline, are there any particular areas you think are appealing in that kind of environment?

Speaker 1

It's interesting. We haven't thought of it in those terms. We were looking for a handful of basic kind of requirements in the companies we look at, which start with substantial free cash flow generation as well as growth that's built into the company. We avoid commodity price risk. We avoid high maintenance CapEx.

Speaker 1

So we really look more at those factors versus any one industry sector per se, if that's helpful. And as you've heard me say before, we also look at companies and industry sectors that there's some history of how they perform in a recession. And this is helpful in terms of resiliency, if you have such a downturn. So again, I think we've approached it more that way versus specific industry sectors.

Speaker 6

I appreciate that. Thank you.

Speaker 1

Thank you, Robert.

Operator

Your next question is from Bryce Rowe with B. Riley.

Speaker 7

Thanks. Good afternoon.

Speaker 1

Good afternoon, Bryce.

Speaker 7

Hey, Rob. Wanted to start with the NAV movement quarter over quarter. Obviously, you covered the dividend and saw the NAV go up here over the quarter. Can you speak to maybe the marks within the quarter? What maybe what kind of effect did broader market broader credit markets have on the fair value marks in the quarter?

Speaker 7

And then were there any kind of specific call outs beyond the non accruals that we've already talked

Speaker 1

about? Yes. So please, I'll turn it over to Todd.

Speaker 2

Sure. Yes, Bryce. So we did have we had the realized loss that was reversed. We had, I'd say, in general, there was a general decline from an unrealized loss perspective, but we also had a few specific write downs on specific companies. You can tell from the SOI, one of them was JR Watkins where we had written that down some as well.

Speaker 2

So that was the primary difference between offsetting the taxes and the dividend.

Speaker 1

And maybe just to add to what Todd said, so no general market decline was these were just be as in previous quarters except during COVID. This was company specific. Yes.

Speaker 7

Okay. Okay. And I mean on a J. R. Watkins, in particular, Todd, I know it's just one investment, but it looks like it's marked below 50% of cost.

Speaker 7

I mean, what's the comfort level there? How do you think about that staying on accrual versus putting it on non accrual or maybe asked a different way? Is there a certain threshold where even if it's still accruing interest, paying interest, even if it's marked at a certain level, you'll consider putting it on non accrual versus keeping it on accrual?

Speaker 1

And I might just jump in here. So I think that's definitely right. And as an example, this one will be looked at in this quarter.

Speaker 7

Okay. That's helpful, Rob. And then last one for me. In terms of kind of balance sheet leverage and managing the balance sheet, no ATM activity in the quarter after a few quarters of some activity. Any reason for that?

Speaker 7

Is that more driven by repayment activity outpacing originations? Or is there something some other way to think about it? Thanks.

Speaker 1

Yes. So, no, I think that's right. We had very fortunate successful year for the ATM coming into the Q4. And as I said earlier, substantial capital invest. So we're focused on investing what we've raised at this point.

Speaker 7

Got it. Okay. I think that's it for me. Appreciate the time.

Speaker 1

Okay. Thank you, Bryce.

Operator

We have reached the end of the question and answer session. And I will now turn the call over to Robert Ladd for closing remarks.

Speaker 1

All right. Very good. Thank you everyone for being on. Thank you for your support. And we look forward to updating you again for the Q1, which our call will be in early May.

Speaker 1

Thanks again.

Operator

This concludes today's conference and you may disconnect your lines at this time. Thank you for

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Key Takeaways

  • In Q4, Stellus covered its $0.40 per share dividend with $0.50 core net investment income and lifted NAV by $0.07 to $13.26 per share.
  • The firm’s favorable asset‐liability mix—98% of loans at floating rates versus 27% of liabilities—drives higher earnings in the current rate environment.
  • As of December 31, the portfolio totaled $874 million across 93 companies—99% secured, 98% floating rate—with average leverage near 4× and only 1.3% of loans on non-accrual, reflecting stable asset quality.
  • Stellus holds $60 million of private equity investments marked at $72 million and expects approximately $7 million of proceeds (with ~$4 million of gains) in Q2, while projecting long-term equity realizations above 2× cost basis.
  • Looking forward, the board plans to maintain a $0.40 quarterly dividend (≈12.4% annualized), anticipates funding to pick up in H2 as originations and repayments balance out, and is pursuing a third SBA license to refinance $25 million of debentures maturing in 2025.
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Earnings Conference Call
Stellus Capital Investment Q4 2023
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