Stellus Capital Investment Corp (SCM) 2017 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 Stellus Capital Investment Corporation's Conference Call to report 2017 annual results. (Operator Instructions) This conference is being recorded today, Tuesday, March 6, 2018.

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.

Okay. Thank you, Jessica. Good morning, everyone, and thank you for joining the call, and welcome to our conference call covering the year ended December 31, 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 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 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 with 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 will cover the following areas: a life-to-date review; a review of 2017; capital management; asset quality; and then an outlook for 2018.

So first, in terms of the life-to-date review. As we've now completed our fifth full year of operations, I'm pleased to report that our IPO investors have earned dividends of $7.27 per share. Since our inception in late 2012, we've originated $785 million of new investments across 76 companies, which is to offset repayments at $552 million for the same period, a net increase of $233 million.

Now turning to 2017. Net investment income plus net realized gains totaled $1.52 per share, dividends paid were $1.36 per share. During 2017, we experienced a significant level of payoffs, which we're able to replace entirely through new fundings. Payoffs and amortization payments totaled $172.3 million during the year. We made 16 new investments totaling $175.5 million in par value with a weighted average yield of 10.4%.

12 of the 14 debt investments carry floating rate interest rates, and all but 1 of the loans is secured.

Over the year, our secured loan portfolio increased to 92% of the total from 80% at December 31, '16.

At the end of 2017, the weighted average yield on the debt portfolio was 10.8%, and 87% of the loans are priced at a floating rate. This is up from 77% at the end of 2016. Our only floating rate liability is the bank credit facility, so we are positively positioned for a rising interest rate environment. To put this in perspective, 90-day LIBOR, which most of our loans are priced off, is now 2.02% which is 32 basis points higher than at December 31, and 68 basis points higher than at September 30.

Our net asset value for the year increased by $0.12 per share to $13.81. This is due primarily to realized gains.

Turning now to the fourth quarter. New investments of $55.3 million exceeded repayments of $38.9 million. Since year-end, the investment portfolio has increased by $62 million of new investments and no forward payments. Net investment income for the fourth quarter was $0.28 per share, which was less than the distributions of $0.34 per share --

Now to capital management. As you know, during the year of 2017, we took a number of the steps to meaningfully strengthen our capital base. In April '17, we issued 3.2 million shares that raised approximately $43 million of equity capital net of fees. We also reinstated our at-the-market equity program and raised approximately $4 million of additional equity capital, again, net of fees.

In August, we issued $48.9 million of 5-year unsecured notes which were used in part to retire $25 million of notes maturing in 2019. The new notes, which mature in 2022, carry an interest rate of 5.75%, down from the retired notes rate of 6.5%.

In October, we were able to extend the maturity of our bank credit facility to 2021 from 2018, increased the commitment amount to $140 million from $120 million, and reduced the interest rate to LIBOR plus 2.5 from LIBOR plus 2 5/8.

We deployed an additional $25 million of SBA debentures during the year, bringing our total debentures outstanding to $90 million. In addition, in January of this year, we contributed additional equity to fully fund our SBIC subsidiary. We expect to receive and deploy the remaining $60 million of debentures under our SBIC license during 2018. These improvements taken in total to our capital base will allow us to grow our investment portfolio to more than $500 million.

Now asset quality. Overall, our asset quality is stable and is at a 2 in our risk rating system, or on plan. Only 11% of the portfolio is market risk grade of 3 or below, and we have just 2 loans on nonaccrual, representing 0.4% of fair value of the total loan portfolio.

We continue to maintain good diversification with our largest industry sector at 13.2% of the total, and our average investment in the company is $7.7 million. The largest investment is $22.2 million at fair value.

And lastly, our outlook.

As we look forward to 2018, here are our thoughts. Our primary goal, while maintaining selectivity, is to substantially deploy the capital rates in 2017. While net portfolio growth is difficult to forecast, we believe we have a path to closing 2018 with a portfolio in excess of $500 million. The portfolio today is approximately $430 million.

As I mentioned earlier, we've had a strong start to 2018. We've closed $62.4 million of new investments and are working on a number of new opportunities. We will likely have repayments of $14 million or so over the next 30 to 60 days.

For the fourth -- I'm sorry, for the first quarter, net investment income is likely to be less than the distributions as we build up the portfolio, but we have already recorded another equity gain of approximately $1.3 million, which should offset that shortfall.

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

(Operator Instructions) And we'll first go to Chris Kotowski from Oppenheimher & Co.

I guess, one thing I would start with is the interest income was somewhat less than what we were looking for, and I know the nonaccrual, the additional nonaccrual weighed on that. But was there any other unusual factor? Because I guess it's down like $0.5 million year-on-year, and it just looked, especially with a lot of prepayments, I would've thought there might have been some pick-up on prepayment penalties.

Yes. Chris, the repayments that came in had very modest fee income associated with them. And then I think you are seeing the impact of the nonaccrual.

Oh, that's it mainly? And is there anything you can tell us on the outlook for the second-lien investment in Grupo Hima?

We really can't comment on it. As you know, this is a hospital system based in Puerto Rico that, like many businesses, were affected by the hurricane. So we've tried to mark the position on the second lien and the first, for that matter, at our best estimate of value, but more to come. And one thing we do know is this is a very important hospital system in Puerto Rico and was up and running very shortly after the hurricane struck.

Okay. And when -- you called it on the call, you called it an equity gain. In the press release, it said a dividend. Is that the same $1.3 million?

Yes, Chris. The -- it was actually not the sale of a company, but rather a dividend. But I think it will be accounted for as a realized gain, but it's technically a dividend.

Okay. And then in the subsequent events section, it looked like there are a lot of new commitments early in the year and was it just that you'd finally had the liquidity to be able to fill the backlog? Or is this kind of indicative of expanded marketing efforts? Or -- and what's the outlook for the next couple of months?

So the activity in the first month or so of this quarter, and I'd say the fourth quarter, would be just the continued activity that we've had for -- since inception. I think one thing that's impacted, as you know, the ultimate growth has been, first, capital, but then just payoffs and repayments. So, again, I mentioned that robust number from 2017. So I think that what you're seeing is a continued -- our normal activity. We try to be very active all over the country. And in terms of an outlook, as I said, we have a number of opportunities we're working on and would certainly expect over the, as I said earlier, that we think we may have repayments of approximately $14 million over the next 30 to 60 days. I'd be surprised if we weren't able to more than replace those with new fundings.

And we'll now go to Leslie Vandegrift from Raymond James.

Just a quick one on the timing of the repayments in the quarter. I know you discussed (inaudible) as probably modest fee income associated with them. But were the repayments earlier or later in the quarter? And same question for the origination.

Go ahead -- let me -- we'll pull that up, but go ahead with your next question.

Okay. Of course. On the outlook, you said the next 30 to 60 days, about $14 million repayments. So those look like they will have high prepayment fee income with them or in line with the fourth quarter repayments?

We would not expect for them to have material fees associated with them.

Okay. And then you talked about rising LIBOR. Your portfolio is possibly exposed. But with spread inflations on the other side and the reinvestments as you get these repayments, how much of a benefit do you really see over the next year through yield?

So it's a good question, Leslie. I would say the forward curve for LIBOR from here would indicate 2.5% by the end of the year, up from a little over 2 today. So we would expect that will impact yield. The new loans that we're closing are roughly 10-plus-percent yield. So not materially less than our current average. So as we sit here today, we would expect the yield to rise overall. The one thing that is impacting that is, as you can see, year-over-year a movement from almost secured lending for a second really unit tranche lending. We've become more active on the unit tranche side. And so you can see some slightly lower yields there. We think it makes sense. But I think on average, we would expect the overall yield of the portfolio to rise this year.

Okay. And on the incident fees, they were lower in the quarter. Obviously, we had [Caruso] go onto nonaccrual, so that impacted that. But on the fee waivers going forward, in the past, you guys have used those to cover the dividend by NII, and I know that you had some of the realizations this quarter and discussed coverage from realized. But what's the outlook for use of waivers if you need them? Will it be based on coverage from realized earnings or from raw NII?

Yes. So I think as a general matter, as I've mentioned, in terms of the outlook for growth given the capital base we have, that if we're able to achieve that level of growth this year, we should be able to cover the dividend from NII. I've said previously that we think covering the dividend from earnings, overall earnings, is certainly important. And I think the one thing we tried to do, though, was look at it over a period of time, not just 1 quarter or 2. So we -- our goal this year is to cover the dividend from NII, and we'll certainly look at a waiver if necessary. And we also think it's important to look at the gains that come in. So a waiver is certainly possible as we've done in the past. We have to go back to 2015 since we've had a few waivers, but we certainly will consider it if the earnings are not sufficient.

Okay. And just last quick question, I know that you are probably in a blackout period for using any repurchase agreements in the quarter for -- probably until today -- but what's the outlook there for use of that program going forward?

Yes. So we view it's more important at this point to use the capital base we've built up to build to a larger size, which enables us to win larger deals. So it would not be an immediate focus of the company to be repurchasing shares, but rather to invest the equity capital that's been raised. And also, Leslie, just going back to your questions. So I would direct you, in terms of fourth quarter activity, in the press release, we scheduled when the investments, the new investments, were made and when the payoffs were received. So they roughly occurred through the quarter, but that would be my best guidance to give you if you just follow that schedule.

And we'll now go to Christopher Nolan from Ladenburg Thalmann.

Todd, in your comments earlier, you indicated that the intention is for NII to cover the dividend in 2018. Is it correct to say that, that implies taking up the leverage?

Yes. So this is Rob who said that, so Todd can -- I'll let Todd answer the question.

Yes. So we would expect leverage to continue to employ the leverage. Our leverage has been lower than normal since we raised the equity earlier this year. But as we continue to deploy both the credit facility and draw that up, and we'd expect that we would draw that up to -- we could get up to, back up to 0.8x I think total, excluding the SBIC debentures. And then the other part of that is we have a capacity for $150 million of SBIC debentures, and we're currently at $90 million. So as Rob mentioned earlier, we'd expect that we would drawdown and deploy the remaining $60 million underneath our SBIC program.

And just to add to that -- just to add to that, so to get to the $500 million level of assets, it does require us, as Todd pointed out, both: One, drawing on -- further on the line of credit, as well as fully deploying the SBIC debentures. And in terms of target, (inaudible) Chris, has been, for 4 years' time, covering us, we target statutory leverage to be under 0.8x. So kind of a self-governing feature there, but we definitely will have more leverage by the end of the year. We're optimistic we will in building the portfolio --

Okay. So the regulatory leverage should go up primarily from the bank facility, at least that's the thinking now, as well as, again, incremental growth from the SBA?

That's correct.

Okay, great. And then on the nonaccruals, I know you got a Grupo San Pablo. But is the other one Hostway?

Yes. It was. So mostly, it was on nonaccrual. It is now back on accrual. The other nonaccrual would be the vendor position, which is, I think, at the end of the year, 380,000.

Got you. And then shares were issued in the fourth quarter. Is that under the ATM?

That's right.

And what was the -- I mean, just back of the envelope calculation, it looks like it was well below NAV per share. Am I correct in that?

Yes, that's right. So we -- of course, that authorization from the shareholders to issue below NAV, which we also went to our board and talked to them about kind of what target would be. So the limit there was to stay above 97% of NAV, and those shares were issued above that, slightly above that. So that's right --

Yes, that level is something that could vary over time. So that's, hopefully, I think, 13 47.

That's right. That's right.

(Operator Instructions) We'll now go to Ryan Lynch from KBW.

I wanted to follow up maybe on Chris's question with the nonaccruals. Hostway corporation, you mentioned that came back on accrual status. Can you just talk about was that investment restructured? Or did just operations improve there where they started making interest payments? Any update on that would be appreciated.

Sure, Ryan. So as you know, we limit discussion about these private companies and their activities, but I'd say as a general matter, the operations have improved, one. And two, there was a reorganization of the activities. The company is doing well or better. And we -- back on a cash pay, we had not been receiving current interest, but we now are.

Okay. And then this quarter, you guys had quite a few unsecured loans repay the percentage of your portfolio, and unsecured investments has decreased pretty meaningfully quarter-over-quarter. Do you guys expect to grow that bucket? Or are you guys kind of fine with the current composition of your portfolio in having what is the lower unsecured book than you guys have historically had?

Yes. So I'd say, if you look back really since inception, we've made 2 meaningful changes in the portfolio. One is to go from less secured to -- or unsecured -- more unsecured to mostly secured, which we're very close to have accomplishing. And the other, which goes hand-in-hand, is to become much more floating rate assets than fixed rate. And typically, fixed rate's associated with unsecured. So we think the percentage we've achieved is about right. Could even be higher secured level than currently at 90%, but more to come. We're very selective about mezzanine or unsecured opportunities. It would take the right ingredients in terms of the size of the business and equity capital structure. So you'll see some, but it would be limited, and we really like the position we're now in.

Okay. Makes sense. And then going back to the dividend, when I look -- you guys mentioned you think it's important to cover the dividend through NII. When I look at the dividend this quarter -- or the earnings this quarter of $0.28 with very little in incentive fees paid versus $0.34 dividend, I understand you guys had a lot of capital available in the form of leverage to deploy, which will obviously grow earnings. And overall, credit quality, you guys have done a good job with credit quality historically. But just given the environment that we're in, where we're seeing a lot of competition and tighter spreads across the market, is it reasonable to expect that you guys should be able to generate a 9.8% dividend yield on your book value without taking excess credit risk and reaching on credit, which could ultimately turn into credit issues down the road if you're not careful?

Sure, sure. So I'll just say, as I said in my remarks, that our goal to grow the portfolio this year, to fully deploy this capital we raised, is we'd continue to follow our selectivity. So we have no intention of changing the way we've invested for a decade or so. So that's not a focus of it -- of our area. One thing that might be helpful, too, Ryan, is that as you described the competitive market, and that's the evidence of how we're performing, is the opportunities we've closed over the last 6 to 12 months, that are well-priced and, we would say, well-structured in terms of covenants and equity capital basis. But our plan is to continue to do that, and if we don't find opportunities like that, we won't make the investments.

And there are no further questions. I'll turn the conference back over to our presenters for any additional or closing remarks.

Okay. Well thank you, everyone, for being on. Thank you for your support, and we'll look forward to covering the first quarter in May. Thank you.

This concludes today's presentation. Thank you for your participation.