Stellus Capital Investment Corp (SCM) 2020 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 Year-end 2020 Results Conference Call. (Operator Instructions) Please note, this conference is being recorded today, Friday, March 5, 2021.

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, Holly. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter and year ended December 31, 2020. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements, and then also cover 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 a 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.

Thank you, Todd. The past year has certainly been a challenging one for everyone. We're thankful that the members of our firm have remained healthy, and that we've been able to operate remotely without interruption. Our portfolio has performed well throughout the unprecedented pandemic, and we've been able to significantly improve our liquidity and available capital position. In addition, our net asset value has risen back to about $14 per share.

For 2021, we've seen an increase in investment opportunities, and has a result of $158 million on a cost basis thus far in the first quarter. So since year-end, our portfolio has increased by $43 million net of payouts.

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

Thank you, Rob. For fiscal year 2020, we covered our dividend (technical difficulty) $14.14 to $14.03. Turning to the fourth quarter, our distributions of $0.25 per share, which we declared in the third quarter, were covered through net investment income of $0.26 per share and core net investment income of $0.28 per share. Net asset value per share increased $0.86 during the quarter from $13.17 to $14.03 due to the early declaration of the fourth quarter dividend and net appreciation on our investment portfolio.

We reported a net realized loss of $7.7 million primarily related to 1 investment, which was offset by unrealized gains during the quarter of $19.6 million due primarily to the reversal of previously recorded unrealized losses on the debt portfolio and unrealized gains in our equity portfolio.

Over the last 9 months, we've taken a number of steps to improve our liquidity and capital position. During 2020, we increased our bank facility by $10 million to $230 million, amended the covenants to increase our maximum regulatory leverage to 1.5x net asset value and extended the maturity to September 2025.

In January 2021, we completed an institutional bond offering of $100 million of notes due in March 2026 at a fixed rate of 4.875%. We used the proceeds to redeem our $48.9 million of notes in 2022, and the remainder to pay down our bank facility. We actively worked during the year to decrease our unfunded commitments from $37.5 million at the beginning of the year to $24.2 million today.

Finally, we continued to commit on fund equity capital to our second SBIC subsidiary, which allows us to draw low-cost, 10-year debentures on a 2:1 basis.

And with that, I'll turn it back over to you, Rob.

Thank you, Todd. I'd now like to cover the following areas: our life-to-date review, our portfolio and asset quality, and then turn to outlook. Relative to life-to-date system, our IPO in November 2012, we've invested approximately $1.7 billion in over 130 companies, we received approximately $983 million of repayments while maintaining stable asset quality. Life-to-date, we paid over $161 million of dividends to our investors, which represents $11 per share to an investor in our IPO at -- again, at November of 2012.

Relative to our portfolio and asset quality, we ended the year with an investment portfolio at fair value of $653 million across 66 portfolio companies. This is up $629 million -- up from $629 million across 63 companies back a year ago in December 31 of '19.

During 2020, we invested $152 million in 10 new and 20 existing portfolio companies, and received $129 million of repayments. So our net portfolio growth at cost was about $23 million for the year.

Our portfolio of companies continue to be weighted towards secured lending at floating rates, therefore, at December 31, 97% of our loans were secured and 93% were priced at floating rates. This move has coincided with greater first lien movement or tranche lending.

We continue to maintain good diversification with the largest industry sector at 17% of the total. Our average investment per company is about $10 million, and our largest investment is $21.6 million, both numbers measured at fair value. And of the 66 portfolio company, 62 are backed by private equity firms.

Overall, our asset quality is stable at a 2.0 on our investment rating system, or on plan; 13% of our portfolio is rated a 1, or ahead of plan; and approximately 11% of the portfolio is marked at investment grade of 3 or below. And then relative to nonaccruals, we have 3 of loans are nonaccrual, which comprise 1% at fair value of the total loan portfolio.

Now turning to outlook. So as you've -- as I've said in the past, part of our strategy has been to invest in the equity of our portfolio companies in a modest way, but unable to generate realized gains sufficient to offset losses over time. As our business has matured over the last 7 to 8 years, we began to see what seem somewhat regular realized gains from our portfolio.

During 2019, we generated $19.6 million of net realized gains, and those gains were helpful in offsetting approximately $10 million of realized losses during 2020. Life-to-date, we generated net realized gains of $8.4 million.

Beginning in the fourth quarter, we began to see a significant increase in our actionable pipeline. As I mentioned previously, since year-end, we funded $58 million at cost in 4 new portfolio companies and received 1 repayment of $14.8 million. We've identified likely fundings of approximately $28 million for the balance of this quarter, so therefore, in the month of March. And are aware of approximately $25 million of potential repayments over the next 30 to 60 days.

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

Holly, you may begin the Q&A session, please.

(Operator Instructions) And our first question today will come from Christopher Nolan with Ladenburg Thalmann.

I guess, Todd, keep track, as I recall, that was a nonaccrual last quarter and still longer there, is that a fair read of it? So it's back on accrual?

Well, we've got a preferred equity position in it that's been written up. But Rob, you may want to address it more fully than that.

Yes. So Chris, two things have happened. One, there's a note for about $1.5 million in an equity -- preferred equity position for $4 million. The equity position was written up based on really outstanding performance since this number, and the loan amount was put on accrual. So that's -- it has gone on accrual.

Okay. My second question is more strategic. Congratulations on the investment-grade offering, but given the coupon is so low, and given the risk of inflation coming back, and given that you guys have relatively low leverage ratios, is there a temptation to actually put on more investment-grade debt? And would you use the revolver less going forward? And that's it for me.

Yes. So good question, Chris. So on our revolver, we borrow at the margin at 2.75%. And think about the fees associated with it have already been paid, so that's the marginal cost. And the bond offering, which was attractive at 4 7/8%, and includes some sales growth, is a little over 5% all-in cost. So additional bonds, it's certainly more expensive than the bank facility.

We think we've got the right mix currently in terms of both fixed rate and floating rate liability structure, and -- but having said that, if we saw bond yields come down even more from the 4 7/8%, we might look at that in a modest way.

And our next question will come from Robert Dodd with Raymond James.

Congrats on the quarter, and again, NAV back over $14. On the pipeline, Rob, I mean, you say you're seeing increased opportunities, you've funded a lot already. How many of those opportunities that look like they can close this quarter? Your original -- change your attention, so to speak, in Q4. I mean, is the pipeline continuing to refill in Q1? Or is this kind of spillover from Q4?

Yes. So Robert, I'd say that it's a pretty constant pipeline. And I'd say if something is closing in, say, the first week in March, we would have likely seen it in November, December, or perhaps as latest January, and so there's a gestation period here. So -- but again, we're seeing lots of interesting opportunities.

And one thing, so we would continue to -- we would expect this to continue. And probably, some pent-up demand from an M&A perspective, certainly coming out of COVID. And then also, interestingly, just want to clear, about half of what we looked at is SBIC qualified. And it is helpful over the last -- in the fourth quarter and including what we're doing this quarter, roughly 80% of what we're closing is SBIC qualifying. So this is very helpful because of our second license.

That is very helpful, and the SBIC has -- it attracts some cost of capital as well on financial. I mean, what about -- and just to kind of, you gave us some color on repayments over the next 30, 60 days, possible repayments, and they are very hard to predict. But can you give us any color on kind of how you feel that may flow through the course of the year? Do you expect it to be a high repayment year? And then obviously, there was that balance where if you've seen a lot of opportunities, that those who offset. But can you give us any color on there? And I guess, one again, over the course of the year, do you expect the portfolio to grow? Or bounce around a little bit and come out even the same?

Yes. So again, hard to predict the future, but our goal this year, after the fundings of this quarter and finish up the month we're in, we would expect our portfolio to be roughly $700 million, and our goal this year is to get that to $800 million by the end of the year. So we would expect additional investments net of repayments, we'll probably go to the portfolio close to $100 million this year, and a lot of that will come in SBIC financings.

Got it. I appreciate that. On just the last kind of -- on this, the quality of the deals you're seeing when obviously secured unitranche, et cetera. But I mean, are you -- is leverage starting to rise in those deals? So is structured starting to weaken? Or how is that going, given the amount of kind of pent-up M&A that's coming?

Yes. So I think the good news is that -- so first, almost everything we're looking at is first lien unit tranche. In case we see an interesting second lien, so you may see us -- so now 1 or 2 of those might come forward, but most everything we're doing now is in this first lien unit tranche.

The leverage quotients have stayed the same. And that leverage is as low as 3x. We looked at something this morning that was under 3x. And then as high as high 4s. But on average, around 4x EBITDA multiple, so leverage has not changed. And then the same structure we've always had, equity checks approximate 45% to 50% of the capital structure. And if the business is being purchased for, let's say, 12 or 13x that the leverage quotient hasn't changed, but that equity component is much higher.

So again, it could be in a very expensive business, it's purchased for 12 or 13x, our leverage might be 4, and the delta is being covered by equity, so a much larger percentage of the capital structure. And then we continue to have serious covenants in all the lending we do. And so good news in our market, that's not changed, and we don't expect it to change.

And next, we'll hear from Ryan Lynch with KBW.

My question I had was, of the roughly $20 million of unrealized gains that you guys recorded this quarter, can you give us a ballpark breakdown of what percentage of that was driven by recovery of previously recorded unrealized losses on debt investments versus upside that you recorded unrealized gains in your equity portfolio?

Yes, Ryan. It's Todd, I'll cover that. So of the 19 -- about $19 million of unrealized gains, roughly $10 million of it was related to a reversal of unrealized losses previously for the -- primarily related to FFO. So with that realization, we had about a $2 million pickup from that. And then the remainder of it is the debt was up a little bit with respect to with spreads generally. And then the rest of it, the majority of it was in our equity portfolio, where we had 1 investment made up about half of that. And then the rest, I would say, are -- most of them were under $1 million, but just kind of across the board in the equity portfolio they were written up.

And maybe I'll add to that line. So it's some spread impact on our model but more company-specific. In terms of your equity appreciation or a realization, as Todd said, like for FFO, which was sold in November.

Okay. Understood. And then maybe kind of a higher-level question. As you all, over the last several years, kind of prior to COVID, I think you're all well aware of how far back the last credit cycle was. And I think we're investing as such of a potential credit cycle coming.

Now that 2020 happened, if we're going through a credit cycle, it seems like the economy is now on a little bit of an upswing as the economy gradually recovers and reopens, does your investment philosophy change at all of how you approach the market in 2018, 2019 versus how you're approaching 2021 in terms of either targeted sectors you guys are focusing on? Or just where you're willing to go into the capital structure?

Yes. So I'd say that our investment philosophy or approach has really not changed. And the reason I'd say that is that the characteristics we're looking for in companies is very similar to days, it would have been in the best of times. And one of those that we're looking for is can this business and can this sector survive a downturn in the recession? So that's our initial underwriting screen is, can the company survive a recession?

And so as an example, we'd be looking for a business that has low maintenance capital expenditures and can change their cost structure quickly in response. And we saw them in a number of the businesses at the outset of COVID last year. And then, of course, as things came back, they were able to ramp up the other way. So I'd say, very open-minded to sectors and approach, but if it's helpful, there are a lot of characteristics we look for, but I'd start with how does this business do during a downturn.

Okay. Understood. Kind of on that note, it is interesting though if the investment philosophy at the core really hasn't changed, what's really the driving force behind so many more of your investments today being eligible for the SBIC versus in the past?

Yes. So I'd say it's somewhat of a natural flow. So as you know, we operate a national business and are active with as many as 100 sponsors, and maybe, at one time, 50-or-so, so all over the -- the sponsors are all over the country and the companies you invest in are all over the country and in all kinds of sectors, and frankly, in all kinds of sizes. Other than that, I think it's too large, we're probably now to get a shift. So that natural flow that we see throughout the year, currently is producing more in the SBIC-qualifying way. So I'd like to say we targeted it, but it's more naturally coming out of the flow we're seeing.

Now implied in our SBIC-qualifying investment is a kind of a nominal basis, it would have a lower than a higher EBITDA level. But we're still seeing the EBITDA levels in this area that we'd like to see in them. So anyway, it's that natural flow that's helpful and when you see a lot of opportunities. And I'd say, if it's also helpful, if we're looking at something that's SBIC qualifying or not, our cost of capital for SBIC financing, so we might be more geared to that. But a broad opportunity set, and fortunately, it's more skewed to that level today.

One of the things I'd say that we also look in -- for in businesses is that real growth profile which is true of like lower middle market private equity generally. And so these higher growth companies with low maintenance capital expenditures, if you will, if they perform and meet their claim, they will delevered in both an absolute and relative way in a couple of years and will be refinanced out. So that's another one of the ingredients we look for in the financings we do.

Thank you. And at this time, we have no further questions in our queue. I'll turn the conference back over to our speakers for any additional or closing remarks.

Okay. Nothing more here. We very much appreciate everyone's support, and we'll be back with you in early May to report on the first quarter. Thank you very much.

Thank you. And this concludes today's call. We thank you for your participation. You may now disconnect.