Stellus Capital Investment Corp (SCM) 2017 Q3 法說會逐字稿

Good morning, ladies and gentleman, 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 third quarter 2017. (Operator Instructions) This conference is being recorded today, Friday, November 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, Anne. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the third quarter of fiscal year 2017.

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 Public Investor's 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 this morning will be organized to cover 5 areas: our operating results; investment activity; asset quality; capital management; and outlook.

With respect to operating results, net investment income was $0.29 per share for the quarter and $0.31 per share, when you exclude the onetime expense to retire our 2019 unsecured notes. We also earned a $5.2 million or $0.33 per share realized gain from our equity co-investment portfolio, principally one company.

With respect to investment activity, during the quarter, we made four new investments for roughly $71 million at a weighted average yield of 10.2%. All these investments are secured and carry floating interest rates.

We received payoffs of five investments and amortization payments, which total in the aggregate about $53 million. At the end of the quarter, our weighted average yield on the portfolio -- of the debt portfolio was approximately 11% and 77% of the loans were priced at a floating rate. And our investment portfolio increased then in total about $18 million quarter-over-quarter.

Turning now to asset quality. Overall asset quality continues to be stable and is at a 2 on our risk grading system or on plan. Only 11.5% of the portfolio is marked at a risk rate of 3 or below. And we have one loan on nonaccrual representing about 1.8% of the portfolio at fair value.

We continue to maintain good diversification with the largest industry sector at about 13.4% of the total. The average investment per company is approximately $8 million, and the largest investment is approximately $22 million at fair value. I would add that the loan portfolio is 83% secured by either first or second lien.

For capital management, we had a very active quarter and which continued into October. We were able to meaningfully strengthen our capital base in August and October. In August, we issued 40 -- $48.9 million of 5-year unsecured notes, which were used in part to retire $25 million of notes maturing in 2019, as previously indicated. The new notes carry an interest rate of 5.75%, down from the retired notes interest rate of 6.5%.

In October, we were able to extend the maturity of our bank credit facility to 2021 from 2018. We were able to increase the commitment amount to $140 million from $120 million. And we were able to reduce the interest rate to LIBOR plus 2.5 from LIBOR plus 2.5/8. We've also reinstated our At the Market, or ATM, equity program. Thus far, we've raised approximately $4 million of additional equity capital, net of costs.

With respect to outlook now, and I'll turn to the quarter we're in, the fourth quarter. We've closed two new investments for approximately $27 million, and have had one payoff for approximately $20 million. For the balance of the quarters, we usually report, we have a pipeline of activity that would indicate additional fundings of $25 million to $50 million. And we do know of one possible payoff of $10 million.

And then looking to 2018, to next year, our primary goal, while, of course, maintaining asset quality, is to fully deploy the capital raised in 2017. If we were successful, this would take our portfolio to over $500 million.

And with that, I'll open it up for questions. Thank you.

(Operator Instructions) We'll take our first question from Christopher Nolan with Ladenburg Thalmann.

The portfolio seemed to start emphasizing more first-lien debt in the third quarter and less second-lien subordinated debt. Is there any sort of shift here going on? Or is that just normal movement?

So thank you, Chris, for the question. We've over time been moving more to a secured position, whether it'd be first or second. So I think that change has been occurring over a year or 2. And then with respect to first versus second, we've been a little bit more active, I'd say, in the uni-tranche area which would be geared, again, to a first lien versus the second. So I think you'll see us as an active player primarily in first and second liens, when it's first, it's normally uni-tranche. And selectively, we'll look at unsecured or mezz financing, but it will be a modest percentage of the portfolio.

Okay. So as this migration goes on, we should look for the yield on the debt portfolio to continue to move down, absent any sort of changes in the yield curve.

Yes. It would move down some, we don't think, in a material way. And one thing I would note is that, which has been consistent with this move to more secured versus unsecured that you'll see the portfolio being primarily floating rate versus fixed rate.

Great. And what was the cost of the -- average weighted cost of debt in quarter?

Todd, you may want to...

Yes. I was just looking at it. You mean for all facilities, Chris? Like the...

Yes, please.

The SBA debentures.

Let me make it simple. I'm sorry, go ahead.

I was going to say, I would -- I don't have the exact figure, Chris. But I'd say close to 4%.

We will take our next question from Robert Dodd with Raymond James.

Just following up on Chris' question. On the interest expense, obviously, a lot of moving parts in the quarter, the loss extinguishment, et cetera. And then you've just kind of restructured or redone the revolver. Are they going -- are they going to be a onetime expenses in the fourth quarter related to changing the revolver in terms of accelerated fees on the old one when you replace it with the new one or anything like that? And can you give us an idea such as you can -- what's the run rate interest right now once all these changes have been flowed through?

Sure. So with respect to the deferred fees, the writeoff of cost in the fourth quarter, how we're going to account for them is still being evaluated because the facility had some changes, but in many ways, it's the same facility. And so the total costs that were deferred would be approximately $450,000. And so it's hard to know at this point whether they will all be charged in the quarter or a portion of those would be charged in the quarter. So I would say, Robert, look for -- either it's going to be something. So maybe it's a $100,000 of it depending on one method versus $450,000 on the other. We just need to work through that internally and from appropriate accounting.

And Robert to your question about the kind of run rate interest rate, we can come back to you on that, but I would think of it as maybe the three buckets. So one would be the credit facility, which is modestly borrowed currently. It's effectively about a 3.8% run rate, floating rate or a little under 4%. The bond position, again, at $49 million is 5.75%. And then, our debentures are under 4% currently. So we could come back to you with the -- to give you kind of a pro forma where we think the interest is. I would say that the debenture costs, if you factor in roughly 4% that includes all the fees, the bond cost, of course, would be a little bit higher than 5.75% because of the amortization of the fees associated with the new bonds. And then we have, I'd say, more modest fees on the bank facility, but there will be a little bit additional costs. So maybe to come back, think of the bank facility in the low 4s all in, and the bonds in the low 6s all in, and the debentures as a good number of a little under 4%. So I think the good news is, the liability side of the balance sheet has interest cost, it looks like that would approximate something in the 4s in total. And that in terms of our floating or interest rate sensitivity, the bulk of the assets are floating rate. And only the bank facility on the liability side is floating rate.

Yes, got it, got it. On -- just one I'd say on the portfolio, obviously, Grupo Hima, I just wanted to touch on that. Couple of other BDCs own it, obviously it's in Puerto Rico. Marks, frankly, when we look at your marks or other BDCs, honestly, they seem to be all over the place to be honest. Could you give us kind of an update on what the status is there, if you're aware because obviously it's hospitals in Puerto Rico and, obviously, we know the hurricane issues down there. And the -- why your yield marks are a bit above some competitor marks. And could you give us any feedback on what the approach was to get them. And then, why you feel comfortable where you are?

Yes, okay. So, maybe, I'll take it in few steps. One, the hurricane; two, Puerto Rico; then kind of company outlook; and then valuation, which Todd will address that. So one thing that -- just for the benefit of the quarter, so we did -- of our 46 portfolio companies, we had a handful of companies that had some impact from the hurricanes that ranged from Texas to Florida and then the Caribbean. Fortunately, the impact of the hurricane was not material in any respect in terms of the portfolio. But I'd say the one area that was most impacted would have been Puerto Rico. And then in particular, on a gross basis, Grupo Hima which operates a number of hospitals, the second-largest hospital operator in the territory of Puerto Rico. So we -- in terms of the company itself as we have been learning it from Puerto Rico, they were able to operate soon after the hurricane went through, many hospitals were not able to. And so they had in-migration of patients from around the island. So as a net benefit, they appeared to benefit but, obviously, a catastrophe for the island. We do think that the U.S. government response to help Puerto Rico could be positive for the company. But again, I think we just need to see how that all plays out. With respect to the valuation, we did -- and so as to put it into context, we have both a first lien and a second-lien position. The second-lien position is -- as a gross value for one, and we marketed it under -- a little under $0.50. And so this was just giving rise to looking at the entire enterprise value. And then perhaps the uncertainty that's developed now because of the hurricane, of course that went through Puerto Rico. So we thought that was our best estimate of how to look at the position without having further information at this point. So that's -- and we do have the, as I recall, the first-lien position we have marked at around $0.91. So again, if it's helpful too in the context of the overall portfolio of last reported 3.55%, our exposure at current mark for Hima in the second lien is $2 million.

Got it. I appreciate that. Last question from me. On the dividend, obviously, you've talked in the past about the focus on realized earnings covering the dividend, which, obviously, more than did that in this quarter with substantial gains. So you know -- I mean, is that still the focus to look at the dividend in relation to realized earnings rather than just raw NII. And that's the first question. And then the second question is kind of dividend strategy. As we go into next year with or without the certainty of gains, right, what's your current assessment of your confidence level in the dividend and the ability of the portfolio to generate whichever is the appropriate earnest metrics to cover that dividend?

Yes. So I'd say -- let me start with this, you look into 2018. So we think that we have the ability through the growth in the portfolio and the type of investments we're looking at that would get us to the ability to cover the dividend next year. And again, we needed time to redeploy the capital that we think that's very achievable for calendar year 2018. With respect to the -- we're still building that portfolio using the $43 million of equity we raised in April. So it would be unlikely we would cover it in fourth quarter, though we think we'll start getting there into the first half of next year. So for the approach we're taking is a very positive change for the company, but some time to redeploy the capital. And then the other thing, I would say about coverage, we do think that the realized gains are important. But we also are mindful that we think they first go to cover realized losses. So we need to do some work on that. So think of it as we still think that the appropriate measure is to look at NII, unless the realized gain. Robert, would have come from just the accounting for a loan fee that paid off early. So we think that the right measure is still NII, and relative to what our dividend coverage is. So we're still working on that, but are optimistic we'll be able to fully cover next year.

We'll go next to Paul Johnson with KBW.

My first question has to do with your leverage. I'm just wondering as you're trying to focus more on senior secured debt investments. Does that at all change, what you would view as sort of an optimal leverage ratio that you could run with in the portfolio at all?

Yes, Paul. Is your question at a balance sheet level, not a company specific or portfolio level, but actually Stellus in total the leverage we would operate at?

Correct. Yes, the debt to equity that you guys would operate with at Stellus.

Yes. So we've -- we're less levered than we've been because of the equity raise. But historically, we've operated in this roughly 0.7 to 0.75 to 1 leverage ratio from a revelatory capital standpoint. And we would plan to get to that level again, if that's helpful. And then in addition to that would be the SBIC debentures, which could get us certainly over that level. But we do plan to relever in a prudent way, and I'd say, in a proportion that would be consistent with previous years.

Okay. And then my last question is just, really, I guess, how you feel comfortable with getting earnings back up to a sustainable rate as you kind of look out your -- fine with your short-year outlook on investment environment and taking a slower and steady approach, which we certainly prefer over quickly just deploying capital for the sake of deploying. Given obviously, the room that's left in your leverage ratio and the room for growth, I'm just wondering how you guys sort of look at balancing that along with your just outlook on a competitive environment?

Yes. And so I'm sorry, didn't quite follow you. So I got the question about the competitive environment. What was the first part of that question, just at the end there?

Yes. Just I mean, how do you balance in your thoughts what your outlook are with the market that you operate within and growing the portfolio steadily and carefully?

Yes, yes. So one way to think about it is, what have we been doing. And so if you look at 2017 thus far, we've had fundings of roughly $120 million and payoffs of $133 million. So pretty robust payoff year. We think that those payoffs will likely slow, and then we think we'll have a pretty good fourth quarter. So I think our outlook, Paul, is really based on what we've been doing. And in this quarter that we're now in, the opportunities that we're looking at that have closed or may close, hopefully will close, the yields on average are greater than 10%, they're all secured and floating rate. So I think we are basing our outlook on what we've been doing this year and what we're doing in the fourth quarter. It is a competitive environment, but we're having good success with the sponsors we've worked with historically and developing new ones. So we feel good about it overall. So again, I think the future is based on more recent activity. And we're not expecting any material change in that.

We'll go next to Bryce Rowe with Baird.

Rob, just curious, the repayment you've seen here in the fourth quarter of $20 million at, obviously, one of your larger positions. Is there -- is that debt and equity that's getting repaid? And if so, is there a gain associated with the repayment?

Yes, Bryce. So one, we've had a repayment so far, as you said, for approximately $20 million. And it was principally all debt. It was an unsecured note and a fixed rate, and a note we'd had for a good while. So we thought it was positive that it repaid. There still is a remaining equity position for which we probably will realize more value, but that is -- the company has not been sold. And then with respect to the, as I said -- actually, I haven't said it more clearly, but the one position that we think might be repaid this -- the balance of the quarter of $10 million, yes, it is a debt position. And so then to further comment, the $20 million that's already been received, there was really no meaningful fee income associated with it, and the second, I think, it's modest. So this will be a quarter perhaps less repayments, but not meaningful fee income, which by the way would have been consistent with the third quarter. We did have just a note. We had a robust second quarter payoffs, which included meaningful fee income. But again, we're not projecting a lot of fee income for the payoffs this quarter.

We'll go next to Greg Mason with Ares Management.

Rob, I just want to talk about the broader Stellus platform, kind of what you're building there? What other pockets of capital do you guys have? What does the platform look like? And how does the -- is the BDC able to benefit from other pools of capital that you have there?

Okay. Thank you, Greg. So as a firm, we manage roughly $1 billion of assets in total. And of course, the primary vehicle is the public BDC, which we're talking about. We also manage two private credit funds, which co-invest with the public company. The first of those funds is now in harvesting mode and the second fund is active. So we have benefited for a number of years now by having a private vehicle as well as the public company. And what it's done for us is really twofold, principally, twofold. One, provides greater diversification, in that we're splitting new investments across two funding vehicles. And the other thing that's been helpful is, when our public company has been fully invested, it's enabled us to be active in the marketplace, and as a new opportunity comes in, and we have a payoff in the public company, we then have an active pipeline that then fill the repayment. So we benefited in, at least, those two ways by having, as you say, a broader platform. I'd say the other benefit is that it enables us to work on and close larger investments because of the splitting of the -- so not only diversification, but able to win larger investment opportunity.

So as we think about the available capital in the vehicles, when you come across a new deal, is that kind of roughly split 50-50 BDC with the other fund? Or what is the split between those two pools of capital?

Yes. They would be split 50-50 in all cases, then subject to available capital at the time.

We'll take a follow-up from Christopher Nolan with Ladenburg Thalmann.

Rob, in the second quarter, did you see any sort of improvement in terms of the performance of your portfolio companies, given that the GDP was around 3% or so up from before. Just to know whether or not what that translated to a better financial performance by your -- the companies you've invested in?

Yes, Chris. So of course, we monitor each of the portfolio companies. So a few changes overall in the mix, but primarily the same number of 46 in both quarters, and a few out and a few in. So I'd say, in general, I don't think we would show meaningfully better, but, I'd say, a very stable performance quarter-over-quarter. The leverage quotient for the portfolio is slightly less levered at the third quarter versus the second, which would imply a slightly better improvement. But as a general matter, I have -- when asked -- we think our portfolio is an interesting window into the lower middle market of the United States, privately-held companies, we're in roughly 20 industry sectors in roughly 20 states, and that all are performing relatively well. And if we have a problem, as I mentioned, where we have some underperformance, it's a modest part of the portfolio, and it's kind of specific company issues, and not something we're seeing in the economy more broadly. So maybe to summarize, we see the U.S. economy as positive and continue to improve, and we think that's reflected in our portfolio companies.

And with no more questions in the queue, I would like to turn the call back over to Mr. Ladd for any additional or closing remarks.

Okay. Thank you, Anne. I think, we're done here. Thanks, everyone, for your support, and we look forward to speaking with you after the new year. Bye-bye.

This does conclude today's conference. We thank you for your participation. You may now disconnect.