Stellus Capital Investment Corp (SCM) 2016 Q4 法說會逐字稿

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 financial results for its fourth-quarter 2016 and FY16.

(Operator Instructions)

This conference is being recorded today, Friday, March 10, 2017. 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, Eric. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the year ended December 31, 2016. 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 Stellus Capital Investment Corporation 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. My remarks will be structured as follows. First, life-to-date review; second, a review of the year 2016; third, a review of the fourth quarter; and fourth, a look to the future, 2017.

As we've just completed our fourth full year of operations, I'm pleased to report that our IPO investors have now earned dividends of $5.91 per share through February of this year. Further, these dividends have been covered by earnings of the Company. Also since our inception in late 2012, we've originated $547 million of new investments across 59 companies.

Turning now to 2016, for the year of 2016 I'm pleased to report that our earnings of $1.39 per share comfortably covered our annual dividend of $1.36 per share, making 2016 the best year for NII in our Company's history. This was due in part to the full use of our SBIC debentures.

We were able to continue to reinvest our payoffs with new fundings, making $66.5 million of new investments at par, and ending the year with a portfolio balance of approximately $367 million, again at par. These payoffs, including amortization payments, provided proceeds of $56 million, and generated approximately $1.25 million of income related to prepayments, or $0.10 per share. Finally for 2016, our NAV increased by $0.50 year over year to $13.69 per share.

Now turning to the fourth quarter, we were essentially fully invested, earning an average yield of 11% on our loan portfolio, and taking in good fee income. We did receive proceeds of $16.8 million from payoffs, including amortization payments in the quarter, which were more than replaced by new fundings of $28.7 million at par value. Asset quality at year end was stable, with our weighted average risk rate at about a 2, which is on plan.

We've been able to maintain good diversification in our investment portfolio by size, industry, and geography. Our mean investment size is $8.1 million at fair value. We are in 21 industry sectors, the largest is 16%, and the companies are principally spread throughout the United States. All but 2 of our 45 portfolio companies have private equity sponsors behind them. And finally, the weighted average leverage quotient of our portfolio is in the low 4s, and the weighted average EBITDA of the portfolio companies is approximately $31 million.

Now, looking forward to the year of 2017, our outlook is positive; allow me to describe why. We've entered an interest rate environment in which fixed-rate assets are likely to depreciate, and floating-rate assets are likely to appreciate. For example, 90-day LIBOR, which is the base rate for most of our loans, is now at 112 basis points, up approximately 50 basis points from a year ago. Our loan portfolio is currently over 70% floating rate, and all but five of our floating-rate loans are now through their LIBOR floors.

Second point I'd make is, most of our lending supports private equity sponsors when acquiring platform businesses. We believe that these are high-quality private equity firms who have good track records and who we believe properly capitalize their companies. These private equity firms have capital, and are deploying it.

Third point is, the US economy, by many metrics, appears strong and well positioned for measured growth. The proposed changes to the tax code are positive for near-term growth, although may be inflationary longer term.

Fourth point, although we're always wary of the next economic downturn, we don't see any evidence of a recession in the near term. From our 45 portfolio company view, where we see underperformance, it is company-specific and not broad-based.

And finally, we're likely entering a new phase in our portfolio, in which equity co-invests from 3 to 4 years ago may now start to be realized. To this end, we're aware of five companies that may be sold within the next 12 months.

Also looking forward, we're likely to continue to see loan repayments, which we'll need to replace. This is, of course, the business we're in, to make new loans through our robust origination platform. As a reminder, we've originated over $500 million in new investments since inception in 2012. With that, I'd like to turn the call over to Todd for one additional discussion item.

Thank you, Rob. In October 2016, Binder & Binder emerged from bankruptcy, and as a result, the Company reclassified its previously recorded unrealized loss on the investment to a realized loss. This reclassification had no impact on net asset value during the fourth quarter.

With that, Eric, we completed our prepared comments. We'll open it up for question and answer.

(Operator Instructions)

Ryan Lynch, KBW.

Good morning. Thanks for taking my questions.

Good morning, Ryan.

Good morning. First one, within the BDC when I looked at your balance sheet, you guys looked -- capital looks pretty constrained, and I don't expect very much capital, or limited capital to [pool] into new investments without increasing the leverage, and you guys are at pretty high levels right now. Kind of a broader question, how are you guys able to keep your deal team active and stay active with private equity sponsors and deal flowing in the market with limited capital within the BDC? Are you guys able to -- what are you guys able to do on your platform, the broader Stellus platform, to allow you guys to stay active in the market?

Sure, Ryan. The, as we've reported in the past, we also serve as advisor or manager for a private institutional fund, which has an identical strategy to the BDC and that vehicle has had substantial available capital. So that has enabled us to be active in the marketplace.

Again, as you're pointing out that, as I've said in the past, we've had pretty good success within 30 to 60 days of a payoff in the BDC to replace it through that pipeline. So that's how we've been able to do it, and we expect to be able to continue to do that for the foreseeable future.

Okay. Then can you just give a little commentary on the market? Obviously if you look at the stock market, it's just been on fire, basically since the election, and certainly sentiment is certainly very high about growth prospects of the US economy, which is moving the stock market up. However, I think when you look at it, there's not been a ton of data points that have really changed.

The economy has been improved a little bit, but there's still a lot of uncertainties about what the administration's going to do going forward, although, at least public equity investors are certainly excited about it. Can you talk about what you guys are hearing or seeing from sentiment from either existing portfolio companies or private equity sponsors about how they feel about 2017, or are you guys hearing that there's going to be more activity for M&A opportunities or growth opportunities? What are the kind of outlook from that standpoint?

Sure, and it's a good question because that's a lot of our business, is as financing, the acquisitions of new companies by private equity firms. I'd say as a general matter those firms have raised meaningful levels of capital in private equity funds, and would appear to continue to do so. So I think the availability of capital is robust.

What, of course, is happening is -- and as their expectations from the public markets tend to flow to the private markets, is sellers' expectation of value has appreciated. So what we are seeing is that companies, or purchase prices, are going up, certainly as expressed as a multiple of EBITDA. And what we are finding is that those acquisitions are typically -- there's a greater level of equity capital being contributed, and the leverage relationships are not very different than they've been historically.

What it could mean for the future is that equity turns for our can equity co-invest book could be somewhat muted, but these private firms have very good track records of creating value through platform vehicles and increasing EBITDA meaningfully. So we're optimistic with respect to that, to the private equity world. Again, we operate in the lower level market, and our sense is those sponsors who have been helpful to us are quite active.

Okay. When you guys think about growth for the future, obviously you guys, from a balance sheet perspective, are pretty capital constrained because of the debt limitations. Your guys' stock price is trading right around book value, it's up been up above around book value recently, has traded down a little bit, but it's been right around that book value level.

How are you guys thinking about growing your capital base, in particular with potentially issuing new equity capital? I know you guys issued a proxy today asking for approval to issue shares below NAV.

As your guys' stock price bounces around NAV, or has up above it recently, if you guys are thinking about coming to the equity markets, what are you guys thinking about? What do you guys need to see in order for you guys to issue new equity?

And you guys are asking for ability to issue equity below net asset value. Is that something you guys would do?

Thank you, Ryan. First, we currently do not have such approval. If we receive approval this summer, up until that time we would not be able to issue below NAV and historically have not as a Company. If we were able to obtain that approval, we would be very cautious about it and, again, my best evidence of history, or other future's history and when we had an ATM program in place a couple of years ago, we were very cautious about issuing, and I don't believe any of the issuances were less than NAV even though they could've been. Now the opportunity, though, for us is that we still have room in our SBIC license for $42.5 million of equity. The current equity capitalization is $32.5 million and the license is for up to $75 million.

We have a real need for equity capital in our Company that would be quite accretive to our shareholders. That would be the primary focus of an equity offering in the future, being mindful of issuing it at a proper price four our shareholders and also knowing that we have a really positive use for it that not many people have. So that's how we would approach the equity markets this year, carefully, but we have a real need for the capital.

Okay, yes. That's good to it hear, because any time, any BDC's looking to issue equity capital, I think one, you have to have good proceeds of use for it, that's probably one of the most important things. But just as important is, at least from an investor's standpoint, is that net asset value is a very critical level in issuing below net asset value, I know certainly sends a negative signal to the market.

If I can, just one last question. Glory Energy Productions looks like that was placed on non-accrual, it's a pretty small energy investment, post-quarter-end in Q1. That was converted to equity. Can you just give an outlook on that investment?

I'm assuming that it's got a different capital structure now. It was probably, I would assume, less leverage which may benefit it in the future of if oil prices do recover, but any general thoughts on that investment?

Sure, be glad to. The par value of the investment is about $1.6 million, the carrying value now is a little over $800,000. A few things.

First of all, through interest and fees over the life of that loan which was made in March of 2014, our actual cost basis in the position is about where it's marked, not only through pay-downs but then actually any kind of fees. As an original investment, the oil and gas area probably did okay.

More importantly, from here we foreclosed on the equity effective February 1, we're effectively operating the properties there, East Texas, long-lived oil properties. And we are optimistic that through working on the properties and the wells that we'll be able to increase production, and it's our expectation that the assets will be sold during 2017, we would say at least for what they're on the books for and possibly higher.

We've already, through some work, been able to increase production about one-third. View that as a likely not here at the end of 2017.

Okay. That's all for me. Thanks for answering my questions.

Yes. Thank you, Ryan.

Robert Dodd, Raymond James.

Hi guys, and congratulations on the quarter and the year. Just going through the SBIC and the capital, obviously yes, you're a little constrained but you do have capacity there in the FDIC -- the SBIC if you put more equity down there. Obviously you have some repayments.

One of the components of the calculus, obviously, is you can take repayment proceeds and downstream that to the SBIC and then double over that, or make investments in more of the parent, which is obviously what you decided to do. Is this a timing thing, because obviously, like you say, you continually have opportunities, given your private credit fund, and is it more of a focus of importance of relatively rapidly putting the capital back to work? Or what's the dynamic between the decision of maybe down-streaming repayments to capitalize the SBIC versus reinvesting at -- with the double leverage there versus reinvesting at the parent?

Sure. Thank you, Robert. We've of course looked at that over time, and what's historically happened is about the time we would do that, we have something very interesting that comes up in terms of investing. But we will be disciplined, and this is of course is the premise of your question, is of course that we're not issuing new equity for the year.

So under that case, we'll continue to look at possibly further capitalizing the SBIC entity. We have, as you'll see in the subsequent events since year end, we've continued to have some nice repayments, two of which were in the SBIC entity. We do have some available cash yet to reinvest.

We have a couple of opportunities that may very well soak up that cash within the next 30 days. So we would then refocus on your point specifically.

Okay.

Yes.

I appreciate that. That's understood, yes, sometimes the repayments have been done that, right? I appreciate that, and obviously you're in a better position to raise equity potentially this year, anyway.

Secondly, I hate to ask this in a way, you over-dividend this year with no fee waiver. But just to clarify, hypothetically, and in a rising rate environment you should be in a pretty good position to overrun the dividend again without the fee waiver so take all his all with a pinch of salt. If you've got a lot of repayments or something impaired the earnings power, just want to get some clarity, again, if you would kind of restate your -- what's the position on, if necessary, not expecting it to be so, but if necessary, what position would you take on fees versus earning the dividend, just for clarity?

Sure, sure, glad to provide the clarity. As we've done since inception in late 2012, we believe that the dividends paid out should be earned by the Company, and so we would -- one of the mechanism that we have to do that is our incentive fee. Our plan is over time is that we would earn the dividend. If it's required that we modify that incentive fee, we would so do.

Okay. Appreciate it, and congratulations. Good quarter.

Yes. Thanks so much, Robert. Thanks for your support.

Chris Kotowski, Oppenheimer.

Yes, hi. Just as a follow up to Robert's question. In the subsequent events section, of the $33 million or so in prepayments, how much was done at the SBA?

Roughly $22 million.

Okay, so most of it.

I'm sorry, I misspoke. I think it's roughly $20 million.

Roughly $20 million.

Yes, I'm sorry.

I wonder if you could walk us through the math again on how much capacity there? You went a little fast. How much capacity you still have at the SBA, how much of an equity down payment you would have to make to be able to draw all that?

Yes. So just as a refresher. Under our license we currently have $32.5 million of equity capital in the subsidiary. As of the end of 2015 we had drawn all of the available debentures; in other words, $65 million against that. That's been in place since the end of 2015.

Therefore we have up to $42.5 million of additional capacity for equity, and then once the equity is in we then would have the ability to draw against that, $85 million of debentures. Then the actual timing of this is obviously -- or potentially not putting $42.5 million down the first day, but you do need to put down equity before you can draw debentures, and there's a minimum amount, Chris, we understand that to put down. So as an example, I don't think we'd put $1 million down and draw $2 million of debentures, but think of it maybe in terms, and Todd should provide guidance, think of it in terms of we'd put down $10 million, and then that kind of a minimum amount that we could draw once invested, $20 million. Is that right?

Yes, that's reasonable.

I think absent an equity raise this year, it would be more of a step function.

Okay. And none of that requires any additional approval or licenses or anything, that's just funding the license that you have, right?

That's correct. But I would be fair, I think the SBA always has the discretion to make sure that we 're operating properly as a manager and we believe we have been.

Yes, that's right, Chris. When you have equity in the SBIC subsidiary, then you have to make an application for leverage, for a commitment and the SBA will review that commitment application. They have the ability to not approve it, of course. It's just normal part of the operation of the SBA.

Yes. Just as a (multiple speakers)

What I was going to add, so what Todd is describing would be true of all SBICs.

All SBICs, that's right.

Right. Just given the attractiveness of the SBIC funding, why wouldn't that be the absolute 50 top priority for any prepayments you get out of the rest of the firm?

It is a high priority. And again, it's probably managing it, as I shared with Robert, over time, how to do that in a smart way and provide good current earnings for our shareholders at the same time.

Okay. All right, that's it for me. Thank you.

Thank you, Chris.

Ryan Lynch, KBW.

Hey, guys. Yes, I had a follow up since we're talking about the SBIC and potential funding it and without any new additional equity capital. With your leverage today at 0.82 times regulatory leverage, you guys could obviously grow the SBIC facility net debt in there substantially enough and that's not going to effect your regulatory leverage at all, but from a total debt to equity standpoint, you guys are at about 1.2 times, roughly. Is there any sort of limitation that you guys look at from a total GAAP debt to equity standpoint where you guys don't want to move above, or do you guys more focus on the regulatory debt to equity?

Ryan, we definitely look at both, and the principal reason is for overall safety of the Company. It is of course relevant to look at both. Because of the nature of the underlying debentures, which have a 10-year interest-only duration -- not duration, but maturity, so likely duration, we view that as quasi-equity in terms of just safety, which would give us reason to be more levered.

But I would say probably the upper limit would be something like 1.5 to 1, certainly more than we are today. I think the last time I modeled, it was like 1.4, but say the upper limit is 1.5. Another way to say it, we're not intending for this to be a 2 times leveraged Company.

Sure, but you still see significant capacity above the current 1.2 times, I get it. Okay. Thank you.

Yes. Again, I really key off the long-term nature of the notes.

True. Thanks.

Thank you.

And with no questions remaining in queue, I'll turn the call back to Mr. Robert Ladd for any additional remarks.

Thank you very much for everyone that joined, and thank you for your support of our Company. We'll look forward to speaking again with you in May as we cover the first-quarter report -- or first-quarter earnings. Thanks very much.

This concludes today's call. Thank you for your participation. You may now disconnect.