Stellus Capital Investment Corp (SCM) 2022 Q3 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 third fiscal quarter ended September 30, 2022. (Operator Instructions) This conference is being recorded today, November 4, 2022.

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, Alan. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended September 30, 2022. 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 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.

Okay. Thank you, Todd. I'm pleased to report our results in the third quarter, in which we grew our investment portfolio to $872 million, maintaining the asset quality and notably generated $0.37 per share of GAAP NII. We continue to benefit from the rising interest rate environment as the yield on our loan portfolio has now risen approximately 140 basis points from the end of the second quarter. We continue to see many interesting opportunities and as a result have funded approximately $57 million on a cost basis during the third quarter.

Todd will begin by discussing our operating results, followed by a review of the portfolio, including asset quality, our dividend strategy, and then I'll cover the outlook.

Thank you, Rob. For the quarter ended September 30, 2022, we covered our total dividends, both regular and additional of $0.34 per share with net investment income of $0.37 per share.

Core net investment income was $0.35 per share, which excludes income tax expense related to our spillover income and this quarter included a $600,000 reversal of the capital gains incentive fee accrual. Primarily as a result of widening credit spreads during the quarter and some write-downs on specific positions, our portfolio valuation declined $4.8 million quarter-over-quarter. However, we had $1.5 million of net realized gains from realizations in our equity portfolio.

I'd like to now cover the following areas: our life-to-date review, portfolio and asset quality and dividends. Since our IPO in November 2012, we've invested approximately $2.2 billion in over 775 companies and received approximately $1.3 billion of repayments, while maintaining stable asset quality. We paid over $202 million of dividends to our investors, which represents $13.01 per share to an investor in our IPO in November 2012.

We ended the quarter with an investment portfolio at fair value of $872 million across 89 portfolio companies, up from $852 million across 83 companies at June 30, 2022. During the third quarter, we invested $56.9 million in 7 new and 19 existing portfolio companies, all of which were first lien unitranche with a weighted average yield of over 10%. In addition, we received $34.2 million of repayments for net portfolio growth at cost of $25.5 million for the quarter.

Overall, our asset quality is stable at a 2 on our investment rating system or on plan. 82% of our portfolio is rated at 2 or higher, meaning at or above plan. Thus, 18% of the portfolio is marked at an investment category of 3 or below. In total, we have 4 loans on nonaccrual, which comprised 2.5% of fair value of the total loan portfolio. This is effectively unchanged from 4 loans on nonaccrual at June 30, which comprise 2.8% of fair value.

With respect to dividends, in addition to our regular dividend of $0.28 per share in the aggregate for the fourth quarter, our Board declared an additional dividend for the fourth quarter of 2022 of $0.06 per share in the aggregate or $0.02 paid per month. As we discussed last quarter, this additional dividend is based on the significant realized gains we're generating, $23.7 million in 2021 or $1.22 per share, $4.7 million year-to-date in 2022 and expected additional realized gains in the fourth quarter. This combined $0.34 dividend each quarter represents based on yesterday's stock price at close of $13.36 per share, an annualized yield of 10.2%.

And with that, I'll turn it back over to Rob to cover the outlook.

Okay. Thank you, Todd. Looking ahead, our outlook is very positive as we see an increasing net investment income and return on equity profile. It appears that higher interest rates are here for the foreseeable future. Our largely floating rate investment portfolio, coupled with our largely fixed rate liability structure, should mean an NII per share in excess of our regular dividend and the additional dividend program, which we have had in place for now a year.

As a result, we expect that in January, we will combine the regular and additional dividends into a regular dividend of $0.34 per share for the quarter, which is a 21% increase in the regular dividend. Further, assuming that our benchmark pricing rates, LIBOR and SOFR, stay at their current levels, if not rising, we would likely look at raising the new regular dividend in January to a level above the $0.34 per share, more to come in January on that.

Relative to equity gains, notwithstanding the slowing economy, we continue to see the benefit of equity gain realizations. As noted earlier, we've had $4.7 million net realized gains this year through September 30 and expect more in the fourth quarter.

With respect to new investments and repayments, we've had a very productive year for new investments with less than normal repayments as you've heard on previous calls. However, repayments are now picking up. As a result, we would expect repayments for the balance of the quarter to approximate new fundings.

And Alan will now open up for questions and answers.

(Operator Instructions) Our first question is coming from Paul Johnson with KBW.

I'm just -- first question is just kind of wondering about your portfolio and kind of how you're thinking about, I guess, EBITDA performance year-to-date as well as other fundamentals just kind of like interest coverage, that sort of thing. As you're getting updates on your portfolio companies here more recently, how does that compare, I guess, to the prior year? Again, just any commentary on your portfolio of companies would be helpful.

Sure, Paul. Thank you for joining this morning. Relative to EBITDA performance across the portfolio, we actually have a slightly improving profile as we go through the year. So no concerns there. Certainly, with higher interest rates, interest coverage will drop some, but we think that the amount of increase is not material relative to people's ability to pay. So, so far, we've seen, as Todd reported, a stable portfolio, stable performance, always company-specific issues. So portfolio is in pretty good shape.

Got it. And then I just ask you as far as maybe what you're seeing in the middle market in terms of just spreads and terms and the deals that you're seeing, if there's been any market improvement there that you expect to potentially take advantage of just given the level of repayments coming in over the next quarter or so?

Sure, sure. We're very active. There's been a little bit of a slowdown, but we're finding private equity firms who have significant dry powder are continuing to be acquisitive. In terms of the terms of deals are pretty much the same as they've always been, typically seeing equity checks of approximately 50% of the capital structure. Important covenants, I'd say that spreads and pricing have maintained fine, our normal fee structures.

So I'd say not a material change and probably seeing a slight improvement. We certainly noticed in the upper middle market, higher pricing. And that's starting to translate into the -- or we operate more in the lower middle market. But no big change, same business we've been running and expect to be busy again in 2023.

Appreciate that. My last question, I think you've been pretty clear over the last few years, and I guess you've shifted the portfolio to more senior secured assets. Obviously, probably not a high demand for junior capital at the moment, but there may come a time, obviously, as when we move through the cycle where that begins to potentially look attractive again. I'm just wondering if that's potential opportunity that you're looking at of increasing exposure once again to junior capital type of loans in the future? Or if you're looking at more just kind of stay the course with what you've been doing with mainly just with senior secured portfolio?

Sure, Paul. So you're good to note that strategic shift. So that will continue. We're not interested in junior capital. Occasionally, there might be something of interest for the sponsor, we know really well. But I'd say that think of us going forward as was evidenced in this quarter, we're all in the first lien unitranche mode.

Our next question is coming from Christopher Nolan with Ladenburg Thalmann.

Rob, are there any industry sectors which you guys are sort of emphasizing more now given the change in interest rate environment and less than others?

Chris, the approach we take to investing is -- which we've had built from inception, is really looking for significant free cash flow-generating businesses that also have a growth profile. And so -- and as a result, which means low maintenance capital expenditures. And so that's what we'll continue to focus on. And yes, they do well in a rising interest rate environment and that they can manage or they can certainly handle an increase in the base interest rate. So I'd say no change from the past, a continued focus on significant free cash flow-generating businesses.

Great. And then as a follow-on to your comments in terms of increasing the base dividend starting in January, were your comments about the NII covering the dividend, would that extend into 2023 given what you guys can currently see in terms of the outlook?

Yes. So I'd say a couple of things. One, as I indicated in the remarks that, it is clear now given our asset liability mix that we have the NII to more than cover the combined dividend. So we're going to go back to a regular dividend of our original $0.34 per share per quarter, $1.36 a year and, of course, paid monthly. So this is kind of the starting point.

And then given that rates have even increased since 9/30, and if that holds, it would indicate earnings potential greater than that, always subject to any additional nonaccruals, but we don't expect those to be material. So if that holds out, we're going to have the capacity to potentially pay a higher regular dividend, but we'll start with a new regular dividend of $0.34 a share in January, payable monthly. And this would, of course, subject to Board approval.

Final question. Should we expect more volatility on NAV per share, given how -- given the higher discount rate used in free cash flow valuations and also the differences in how different companies handle the higher interest rate load?

Yes. Not expecting a material change there. Obviously, if you get a real widening in the spreads, that's the most impactful impact. You will have a higher discount rate in a higher interest rate environment. But remember, offsetting that is the higher forward coupons that are coming in is the cash flow. So I wouldn't expect the higher interest rate environment on a model to be impactful. It would be the spreads, if they widen more, and it would be more company-specific performance.

Our next question is coming from Sean-Paul Adams with Raymond James.

It looks like part of my question has already touched on, but it looks like you guys have the highest net interest margin exposure to base rates from any BDC under coverage, especially among the peers. So I just wanted to get a little bit of your outlook on base rates for 2023?

Yes. And sorry, Sean, just to clarify, the base rate of our investment portfolio?

Yes.

Yes. So the LIBOR rate -- so we still have a majority of the loans on LIBOR as a base rate with some new loans are certainly under SOFR. But those rates are basically over 4% today. They were under 4% at 9/30. And so if you -- if we just follow the forward curve, you're going to have a higher rate than that in 2023, which is the market's best estimate. But what I'm describing is really just take the current rate LIBORs in the mid-4s, SOFRs in the low 4s. And that would be our assumption for 2023.

And one thing that you've noted, Sean, is that what we're also benefiting from, if you think of our liability structure, roughly $200 million kind of average bank borrowings, which are floating. But the rest of the liability structure is roughly $300 million of SBIC debentures that have an all-in cost in the low 3s. And our notes, which were issued in March of last year, and they have a coupon of 4 7/8%. So this is where we're really -- you're going to see a meaningful increase in the margin as a result of this asset liability mix and roughly 97% of our loan portfolio is floating.

As there are no further questions in queue at this time, I would like to turn the call back over to Mr. Ladd for any closing comments.

Okay. No, thank you very much, everyone, for joining. Thank you for your continued support, and we look forward to speaking with you in the new year. Take care.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day. And we thank you for your participation.