Stellus Capital Investment Q1 2024 Earnings Call Transcript

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May 10, 2024

There are 6 speakers on the call.

Operator

Good afternoon, 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 1st fiscal quarter ended March 31, 2024. This conference is being recorded today, May 10, 2024. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation.

Operator

Mr. Ladd, you may begin your conference.

Speaker 1

Thank you, Kelly, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31, 2024. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward looking statements.

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 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 any forward looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.stellascapital.com under the Public Investors link or call us at 713-292-5400. Now, I'd like to turn the call back over to our Chief Executive Officer, Bob Ladd.

Speaker 1

Thank you, Todd. We'll begin this morning by discussing our operating results followed by a review of the portfolio, including asset quality. I'll then talk about dividends and outlook.

Speaker 2

In the Q1, we more than covered the dividend of $0.40 per share with GAAP net investment income of $0.42 per share. Core net investment income was $0.44 per share, which excludes estimated excise taxes. Net asset value per share increased $0.15 during the quarter as a result of net unrealized appreciation on our investment portfolio, as well as generating NII in excess of the dividend. Life to date review overall, since our IPO in November 2012, we've invested approximately $2,500,000,000 in over 190 companies and received approximately $1,600,000,000 of repayments, while maintaining stable asset quality. We've paid over $252,000,000 of dividends to our investors, which represents $15.35 per share to an investor in our IPO in November 2012.

Speaker 2

Turning to portfolio and asset quality. We ended the quarter with an investment portfolio at fair value of $876,000,000 across 94 portfolio companies, up from $874,000,000 across 93 companies at December 31, 2023. During the Q1, we invested $23,800,000 dollars in 3 new portfolio companies, dollars 5,800,000 in other investment activity at par. We also received 2 full repayments totaling $26,200,000 $5,000,000 of other repayments, both at par, resulting in net portfolio growth and value of $1,400,000 including the impact of net unrealized gains of $3,100,000 In March 31, 99 percent of our loans were secured and 98% were priced at floating rates. The average loan per company is $9,900,000 and the largest overall investment is $19,500,000 both at fair value.

Speaker 2

Substantially all of the portfolio companies are backed by a private equity firm. Overall, our asset quality is slightly better than planned, 25% of our portfolio is rated at 1 or ahead of plan and 19% of the portfolio is marked in an investment strategy investment category of 3 or below, meaning not meeting plan or expectations. Currently, we have 4 loans on non accrual, which comprise 2.1% of the fair value of the total loan portfolio. And with that, I'll turn it back over to Rob to discuss dividends and the overall outlook.

Speaker 1

Yes. 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 in order to generate realized gains sufficient to offset losses over time. Although we did not have any realizations in the Q1, so far in the Q2, we have realized one equity position and expect to realize one more, which will mean combined proceeds of about $5,300,000 and expected to generate 3,800,000 of realized gains and a slight uptick in NAV. It was noting the combined multiple of these two realizations is just over 3 times our original cost basis.

Speaker 1

At the end of the quarter, we have $60,600,000 of equity investments at cost that were marked at $74,900,000 Our historical performance would indicate that the ultimate realization for this portfolio would be greater than 2 times our portfolio's cost basis. Of course, however, the ultimate performance of our current equity positions will be dependent on a variety of factors including among other things, the economic environment and sponsors exit strategies. Now, about dividends. As you see, we continue to cover our dividend of $0.40 per share per quarter. And to this end, looking forward to Q3 of 2024, we expect subject to our Board of Directors approval to continue our monthly dividend of approximately $0.13 per share excuse me, resulting in aggregate dividends of $0.40 per share for the 3rd quarter.

Speaker 1

And now to outlook. Since quarter end, we have funded $10,900,000 in 2 new and 2 existing portfolio companies at par. Additionally, we did receive one repayment of $11,400,000 at par and one equity realization previously noted. Proceeds for that were approximately $3,000,000 which resulted in a realized gain of 2. You then combine this activity with our other net funding of about $2,800,000 this brings our total portfolio to approximately 8.70 $5,000,000 at fair value with 95 portfolio companies.

Speaker 1

Again, this is as of today. Now looking forward to the balance of the quarter, we are expecting a meaningful increase in fundings and no known loan repayments. As a result, we expect to end the quarter with a portfolio, which will be in excess of $925,000,000 in other words $50,000,000 higher than where we are today. And with that, I'll open it up for questions. Kelly, if you'd begin the Q and A session, please.

Operator

Certainly. The floor is now open for questions. Your first question is coming from Christopher Nolan with Ladenburg Thalmann. Please proceed with your question. Your line is live.

Speaker 1

Good morning, Chris.

Speaker 3

Hey, guys. How are you doing? Were the realized losses from new met machining? Wasn't clear to me.

Speaker 1

They were. That was the position had been marked at 0 for some time and that was the final realization, but no impact on NAV. Chris, are you still there?

Operator

It looks like Chris has left the queue.

Speaker 1

Okay. No worries. Why don't we go to our next call and then or question and then we can come back to Chris when he comes back on.

Operator

Okay. There are actually no further questions in queue at this time.

Speaker 1

Okay, good. We'll wait just a second. Let's see if Chris comes back.

Operator

Sure. We do have a question from Bryce Roe with B. Riley. Please proceed with your question. Your line is live.

Speaker 4

Thanks, Bryce. Good morning. Rob, I wanted to just kind of ask about market conditions, if you wouldn't mind. You just talked about some good activity here that is expected in the Q2, especially from here to the end of the quarter. Can you talk about what pricing is looking like, any kind of dynamic from a competitive perspective that you're seeing with these transactions that would compare to others in the portfolio?

Speaker 1

Yes, sure, Bryce. So, and thank you for joining. So, going back to our last earnings call, I'd indicated that we were slower in terms of activity, but that we thought the activity would pick up in the second half of the year. Well, it turned out it picked up in the second quarter, and more recently. So and again, this is the M and A activity we were expecting that would start coming back, which it has.

Speaker 1

So I'd say that in terms of the competitive dynamics and maybe overall market conditions, so all the transactions we're looking at are same type of not over levered, leverage is typically 4 times or less, all have covenants, most of equity co invest. So the typical thing the one thing that has changed in the market is a little bit less spread that think of it in 3 or 4 months ago in the 6s overall and we've seen spreads come down 50 basis points or a little bit more over time. That's the only change we've noticed, but again, quite a bit of pickup in activity. And the other thing I wanted to note is, I talked about the equity gains that are expect one that's already occurred, another expected this quarter could slip into the 1st month of the following quarter. But did learn about recently, we have a couple of more that we are hearing might come in the Q4.

Speaker 1

So this would be an indication on both sides. On the new deal front, M and A activity picking up and on the existing portfolio side, M and A activity picking up resulting in more gains for us later in the year.

Speaker 4

Okay. And Rob, when you think about you just said that some of the activity got pulled forward from what you thought to be second half to second quarter. Is there still pretty active pipeline beyond what you see here coming in the second half of the second quarter?

Speaker 1

Yes. So wouldn't expect anything to change there for the balance of the year. It's picked up meaningfully.

Speaker 4

Okay. And then when we think about funding the new activity, how should we think about that? I mean, obviously, you have some room on your credit facility. And I guess with the benefit of visibility here towards what can close in the back half of this quarter, how do you think about using equity versus debt to fund that?

Speaker 1

Yes. So I'd say that relative to equity, our stock price has come back some. So as we were active last year with our ATM program, we would certainly look at that in this year, again really driven by the pipeline. So but I think it would be more likely in that form than in kind of any larger offering. So think of the ATM being something we would use this year.

Speaker 1

But then overall, I think it would be helpful that from a leverage perspective as you pointed out, so we have quite a bit of capacity in our bank facility and we have quite a bit of cash in our SBIC entities that is from repayments. So, as an example, we have quite a bit of capacity to get beyond the 9.25 I indicated is a likely number and certainly the 950 or more. So I think we're in good shape. But again, overall capital is good and we could see some activity in the ATM.

Speaker 4

Okay. Last one for me, just in terms of kind of internal risk ratings, there was some movement from the December quarter to the March quarter. It looks like Category 3 bumped up a bit. Can you talk a little bit about kind of what the dynamic driving that?

Speaker 1

Yes. Just looking at the changes, I'd say normal evolution in the portfolio over time, nothing that we would characterize as overly concerning. You'd have to get to a 4 where we would that's where an investment, a loan investment would be considered non accrual. So 3 would be operating below plan. And then I just would note that we had some upgrades, which again would be normal too.

Speaker 1

We had a couple of positions moved to a 1, a 3 moved to a 2. So but overall, I'd say not worrisome. And so we look at the entirety of the portfolio and our average weighted risk grade is, as Todd mentioned, is a little bit less than 2, which means better than planned.

Speaker 4

Excellent. Okay. Thanks for taking the time. Good to talk to you. Yes.

Speaker 1

Thank you, Bryce.

Operator

Your next question is coming from Eric Zwick with Hovde Group. Please proceed with your question. Your line is live.

Speaker 5

Thank you. Hello, everyone. I wanted to start with a little bit on in terms of your comments about so far in the second quarter, not seeing any repayments from a number of the other BDCs that have reported this quarter, repayment activity has been pretty high. And I know it's tough to have a certain high degree of certainty in your outlook over probably the next couple of months or so. But do you think there's something inherent in your portfolio that's resulting in lower repayments today?

Speaker 5

Or is this just kind of maybe a temporary low, here that we're seeing this quarter?

Speaker 1

Yes, I think it's that, Eric. It certainly ebbs and flows. And but as I mentioned, we've recently learned about a couple of companies that are going to come to market in the 3rd Q4 and they would result in addition to an equity gain would result in some good repayments. So I think we've just gotten to a little bit of a low point here.

Speaker 5

Got it. That makes sense. And the only other question I had, I was just curious given the fact that rates have kind of these rates have remained high now for a while and they seem to kind of be staying here and probably not any near term probability of them going materially lower. As you're underwriting loans and potentially negotiating floors in there, has there been any ability to increase those floors at all? Or are they still kind of sticking around to the levels that we've seen for the past number of years?

Speaker 1

Yes. So we've always been focused on floors and generally they vary between 1% 2% and think of us as being closer to 2%.

Speaker 5

Thank you. That's all I had today. Appreciate it.

Speaker 1

Yes. Thank you.

Operator

Your next question is coming from Christopher Nolan with Ladenburg Thalmann. Please proceed your question. Your line is live.

Speaker 3

All right. I'm back.

Speaker 1

Okay, good, Kurt.

Speaker 3

Yes, my phone works now. You have some maturities coming up on your SBA loans next year, and then just following after that. And I know the amount of maturing in 2025 is only around $12,000,000 or so, but it starts to step up after that. And the cost of that debt is seems to be really low at this point. What are your options?

Speaker 3

I mean, can you refinance that with the SBA and get similarly low cost funding? Or is it something that you're going to have the bank facility refinanced?

Speaker 1

Yes. So the it's a good question. So we do have, as you know, 2 SBIC licenses and the first of those licenses, the debentures will start to come due in March of next year and then they're spread out over a number of years. And so we are in the process of applying for a 3rd license. So this would think of us as going forward and this is a normal evolution in terms of the SBA process.

Speaker 1

And then a follow-up thought would be they are many of those debentures were struck at a lower interest rate environment as you're pointing out. And the debentures are priced off the 10 year treasury plus a market premium, which is typically less than 1%. So our cost of funding, if things don't change by next year, we will be borrowing at somewhat of a higher cost of the SBA. But I would think of it as the 10 year treasury which is now under 4.5% at least it was yesterday. And so we add a premium, so you're probably in the 5s, but that would compare to a regular way bond offering of similar duration in the 8s or higher.

Speaker 1

So still very favorable rates, but yes, higher than we currently have.

Speaker 3

Thanks, Rob. And then I guess more of a strategy question. You got some other BDCs, which well, I guess, I noticed that you had a management fee waiver this quarter, but your leverage is so low. And you had a management fee waiver last quarter. And I'm just thinking why don't you just lever up a little bit more if there's I mean, I don't know why it's going on because your earnings seem to be pretty good.

Speaker 1

Yes. So this I think you're referring not to a management fee waiver, but an incentive fee waiver. And this is just a function of our 12 quarter test. Not all BDCs have this, but we have a 12 quarter test where you look back for historical performance. So we have had a little bit of waiver in the Q1, may have a little bit more this year, but that's just a function of that test.

Speaker 3

Okay, great. Thank you very much.

Speaker 1

Yes. Thank you, Chris.

Operator

There are no additional questions in queue at this time. I would now like to turn the floor back over to Mr. Robert Ladd for any closing remarks.

Speaker 1

Okay. Yes. Thank you, Kelly, and thanks again everyone for being on. Thank you for your support and we look forward to reporting the Q2 in August. Take care.

Speaker 1

Enjoy the summer.

Operator

Thank you, everyone. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

Speaker 2

Thank you, Kelly.

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Key Takeaways

  • Q1 financials: GAAP net investment income of $0.42 per share and core NII of $0.44 fully covered the $0.40 quarterly dividend, driving NAV up by $0.15 per share.
  • Portfolio composition: $876 million in fair-value investments across 94 companies with 99% secured, 98% floating-rate loans and non-accruals at 2.1% of the loan portfolio.
  • Equity realization strategy: In Q2, one realized equity position closed with another expected, generating ~$5.3 million proceeds (~3.0× cost) and underscoring a portfolio marked at $74.9 million on a $60.6 million cost basis.
  • Pipeline and market dynamics: M&A activity has accelerated, with spreads tightening by ~50 bps and robust deal flow expected to fund over $925 million in assets by quarter-end.
  • Dividend outlook: The board plans to maintain the $0.40 quarterly dividend (~$0.13/month) into Q3 2024, supported by a strong capital position and available financing capacity.
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Earnings Conference Call
Stellus Capital Investment Q1 2024
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