Stellus Capital Investment Corp (SCM) 2020 Q2 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 Second Quarter 2020 Results. (Operator Instructions) This conference is being recorded today, Friday, July 31, 2020. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Please go ahead, sir.

Okay. Thank you very much. Good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2020. 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.

Thank you, Todd. While the impact of the global pandemic remains, I'm glad to report that our team has remained healthy and safe, and has continued to work remotely without interruption to our operations. Since the onset of the COVID-19 pandemic, we've been in regular contact with all of our portfolio companies and other sponsors to assess the current and expected impact of the pandemic on their businesses and the industries in which they operate. Overall, the portfolio is stable, and all borrowers on accrual made their scheduled principal and interest payments for the second quarter.

I'll discuss the portfolio, including asset quality in more detail shortly, but first, Todd will cover our operating results for the first quarter.

Thank you, Rob. On June 30, we declared a dividend of $0.25 per share, which was covered by net investment income of $0.28 per share for the quarter. Core net investment income, which excludes the impact of excise taxes, was $0.29 per share. We believe a dividend of this size will better match our income for the time being, given our rotation to more senior and unitranche loans and a falling LIBOR rate, which is likely to remain low for some time. Effectively, all floating rates in our portfolio have LIBOR floors, which are approximately 1.2% on average. As a reminder, we announced in April that we would shift from monthly to quarterly distributions to have better visibility into the income for the quarter, our capital position and to better match the dividend with cash income.

Net asset value increased by $35 million or $1.79 per share to $260 million or $13.34 per share, due primarily to unrealized gains resulting from the tightening of market spreads.

With that, I'll turn it back over to Rob.

Okay. Thank you, Todd. I'd like to cover the following areas now: first, liquidity; then portfolio and asset quality; and finally, the outlook.

With respect to the portfolio, as I mentioned earlier, we remain in regular contact with our portfolio companies and sponsors, addressing the liquidity position, expected covenant compliance, the health of their workforce and customers, and the current and expected impact of the pandemic on their operations and industries. I'm pleased to report that our portfolio companies' operations are stable and managing well in the current environment.

In the early part of the quarter, we did see an increase in revolver and delayed draw term loan funding requests from portfolio companies, which has since subsided and many have repaid. During the quarter, we funded $6.6 million of such loans, and received repayments on these investments of $6.8 million over the same period. As of today, our remaining unfunded commitments are $30.7 million, and we have cash and revolver capacity of $48 million, excluding cash and debenture availability at our SBIC subsidiaries.

And next, our overall asset quality is stable at a 2 out of 5 rating on our investment rating system, or "on plan", if you will. 91% of our portfolio is rated 2 or better or on plan, that's 9% is marked at a category of 3 or below. In total, we have loans to 5 portfolio companies on nonaccrual status, which comprised 1.8% of fair value of the total loan portfolio. And no loans have been added to nonaccrual status since April 1.

We ended the quarter with an investment portfolio at fair value of $640.7 million in 65 portfolio companies, which is up from $609.5 million at March 31, due primarily to the unrealized gains, as Todd mentioned earlier. During the second quarter, we did not make any investments in new portfolio companies. However, we are now beginning to see interesting opportunities, and since quarter-end, we made one investment in a new portfolio company totaling $7.1 million, with one additional new investment and follow-on of approximately $10 million that's likely over the next week or so. These companies are SBIC qualifying and therefore are being funded with SBIC capital.

We continue to make good diversification, with the largest industry sector at 15% of the total at fair value at June 30. The average investment per company is $9.9 million and the largest investment is $21.4 million, both at fair value. And finally, 60 out of the 65 portfolio companies are backed by a private equity firm.

With respect to outlook, as we look forward, our focus is to: first, to continue to closely monitor and support our portfolio companies; second, to maintain liquidity; and three -- third, to evaluate new investment opportunities to prudently grow our portfolio. We're starting to see a pickup in refinancings and repayments. Although modest at this time, we expect this activity will likely increase by the fourth quarter.

Finally, we're very glad to report that given the stabilization of asset quality, capital base and liquidity, the company today has declared a regular dividend of $0.25 per share for the third quarter. Of course, this would be early.

With that, I'll open it up for questions. And thank you, Travis. We may begin the -- you may begin the question-and-answer session, please.

(Operator Instructions) Our first question comes from Ryan Lynch with KBW.

The first one, amazed you guys amended and extended your revolving credit facility, but I was curious because it looked like the revolving date was only extended to March of 2021 with the final maturity in October 2021. The final maturity being just a little over a year away and the revolver period 6 months, 7 or 8 months away now, I was just curious, that felt like a shorter time period than we've seen other BDCs typically when they extend the revolver period. So can you just talk about the much more challenging environment and uncertain environment in May, but just was there a pushback from the bank lending groups which were not extending that revolver to a longer, more pushed out date?

Yes. Ryan, so this is Rob. I'll cover that. No, not at all. Very good support from our banking group. I think as you'll recall that, that amendment we worked on in April and then closed in May during the -- maybe more of the height of the pandemic. And so I think as a group, the thought was, let's get through this, see how the second quarter is, and then we'll readdress a longer-term extension, which we're in the process of doing.

Okay. And then I think you want to make sure I got these numbers right. I know you gave some numbers out on the cash availability. But you had $23 million of cash and $45 million of capacity under credit facility as of June 30. Can you provide the numbers of how much of that cash was remained in the SBIC as well as of the $45 million of available credit facility capacity, how much of that capacity was fully available to access to you all today?

So with respect to -- and Todd, you should correct me if I'm mistaken here, but -- so cash at June 30 that's not in the SBIC entities, it was approximately $3 million. And in terms of the $45 million that could be borrowed, it would be roughly 30 -- let's say, 30 -- $37 million or $38 million that could be borrowed without increasing the borrowing base from any loans. And therefore, if we made any loans under the revolvers, we will be fully available. So we view it as fully available, but it can be drawn down to within -- I think it was $222 million of the $230 million without any additional borrowing -- additional assets contributed.

Yes, that's right.

Okay, okay. And then this quarter, it looks like you guys are stuck between your hurdle rates from an incentive fee standpoint. Given your kind of outlook as far as capital deployment, is it reasonable to expect that you guys will be operating to the low and upper end of your guys' incentive fee hurdle rates for the foreseeable future?

Todd, why don't you cover that, please?

Sure. Sure, Ryan. Yes. I think with the hurdle where we're set today and LIBOR where it is as well, as I mentioned earlier, the rotation to more senior debt, so the yield is a bit lower for those 2 reasons. And that's right, I think for now, we'll be operating at the lower end of the incentive fee range. That could change somewhat over time to the extent we further deploy primarily SBIC debentures from our second SBIC license, which are at a -- in a really low rate right now. So that would help some in terms of just getting over the hurdle, but that's correct in terms of where we feel like we'll operate for the time being.

Okay. And then just one last one, if I could, just kind of generally on the market. You mentioned you guys are starting to see some more opportunities come through. You expect some more refinancing. Can you just talk about, from your opinion, what's it going to take before we start seeing some more deal activity. Obviously, there's a great uncertainty about the economy going forward and when things will start to really reopen. I know there's difficult discussions as far as pricing in the market today, both on -- from interest rates and purchase price multiples. So just what do you think needs to happen before we start seeing some increased deal activity, in your opinion?

Yes, Ryan, so this is a general matter that -- and just to address current investing and then longer term, I'd say, in the current environment, we continue to be cautious for the reasons that we all know and continue to be very selective in the investing. So if you see us making a new investment, we certainly think that it endures even if the pandemic also endures for some period of time. So that's the approach we're taking. And then separately, because of maintaining good liquidity, you'll see those investments principally coming out of our SBIC capital where we have a capacity.

In terms of longer-term of -- or pricing, maybe, we are seeing roughly 50 to 100 basis points higher pricing than we might have seen 6 months ago or so. It depends certainly on the credit and the leverage. But I think there's a fair amount of private capital available, which certainly in the credit world as well as the private equity world. And so we are seeing some loosening up, principally starting with the add-on acquisitions where a company has already bought -- private equity firms already invested and they have an add on 1 or 2 acquisitions that they might have been looking at pre-COVID. So that's what we're seeing first, but we're starting to see more activity generally. So I think values have held up pretty well overall. And then, of course, if you're involved in an industry sector that's been directly impacted by COVID, that's quite a different story.

(Operator Instructions) Our next question comes from Bryce Rowe, National Securities.

I wanted to ask, obviously, you saw some very substantial NAV expansion here in the quarter. And just going through the portfolio, it looks like a good chunk of the debt investments were marked higher, I assume because of credit spreads having tightened in the quarter. And then you've seen some valuation expansion within some of the equity investments, too. So I was hoping you might be able to speak to the equity side of things, what you're seeing from a valuation perspective that gave you a little bit more comfort to mark the equity investments higher, especially in the -- in this environment that's still uncertain.

Yes. Todd, if you would address that?

Sure, I'd be happy to, Rob. So on the equity side of things, it really is a bit of a mixed bag, either because of -- in some cases, the market comparables were slightly -- were higher than they were in March, at March 31. And in other cases, we had companies where their EBITDA was a bit higher than it was at that time, too. So I would say there's nothing individually pointing to a particular position. It was up; some were down certainly. So just on average, that's what it is. So I wouldn't say there's an overall necessarily trend. It was kind of more idiosyncratic now between -- across the portfolio for 1 of those 2 reasons.

Okay. Maybe just to add to that, Bryce, that of course, there are companies that are performing well in this environment, and that would certainly be reflected in those companies' specific markets.

Okay. That's helpful. And then, obviously, you all have had good success in generating realized gains over the past several years on many of your equity investments. And I think when you entered into 2020, there were prospects for some of that activity to continue. The pandemic has put those on hold. And I think you talked about that over the last couple of calls. So I'm curious if some of those processes have rekindled to a certain extent, and what your outlook is for that type of exit activity over the coming quarters. And if you could speak to that relative to your comment about refinancing and repayment activity possibly picking up in the second half of this year and into next year.

Yes. So we're not seeing the pickup in actual sales as much as we are in the refinancings activity. So you're right, Bryce. We had a -- I want to say, 3 companies in the first quarter we thought might be sold by this summer. All 3 of those possibilities are on hold. So more of what we're seeing is sponsors, owners of businesses focusing on the opportunity to reduce the cost of their financing where the company is performing well, but not quite where they're ready to sell the company. So we're not expecting any realized gains, materialized gains this year. Of course, that could change. But for the moment, it's more in this area of refinancing.

Okay. That's great. Rob, I wanted to ask 2 more questions, if that's okay. You all talked about pricing being 50 to 100 basis points higher here as the COVID environment has evolved. And it looks like your weighted average yield on the debt side of things is just over 8%. So as we think about new investments coming online or potentially coming online or investments getting refinanced, do you think that, that weighted average portfolio yield kind of holds here? Or is there still room to move lower as you're adding first lien and unitranche-type investments?

Yes. So I would say that I think a base case would certainly be that we would hold here. So the influences will be one, loan's refinancing or paying off that are higher yield, so that will be a negative impact. I think the new investing, you'll see us be pretty close to the holding to this level and hopefully, slightly above. So I think this is a good base case at this point in terms of the go-forward yield. Again, the pressure would be refinancings of higher yield. But we think this is a good base case for now.

Okay. That's great. And then the last question is just on kind of capital structure. Obviously, your GAAP balance sheet leverage was on the higher side heading into COVID. And so I'm just curious if your thought process has changed in terms of the level of balance sheet leverage you're comfortable with, understanding that the SBA debentures are excluded from that statutory calculation. Just maybe if you could comment on your overall balance sheet leverage and then comment on the mix of your debt capital, whether you would prefer to maybe extend the maturity or refinance the current unsecured notes that you have outstanding. And if you would prefer to kind of mix shift the debt capital mix to be more unsecured/baby bonds away from the credit facility.

Yes. So with respect to leverage overall, we're comfortable with the 1:1 leverage quotient for regulatory purposes. And then -- and the reason for that is, although the GAAP leverage is higher, as we've noted before, that one of the SBIC debentures, the first payment due is not until the spring of 2025, and it's a modest amount. So we're comfortable with focusing on the regulatory leverage of approximately 1x. In terms of the mix, and I think I mentioned this last time, we -- one of our goals for the balance of the year would be to raise some more unsecured debt, which could be used to refinance the current bonds. And certainly, that perhaps reduced reliance on our bank facility and potentially also to -- for capital reasons that our SBIC 2 license. So our goal this year, we'd like to raise more fixed income financing or -- and therefore, unsecured. Not required, where we are today, but that's one of the things that we're looking to do.

And if it's helpful, we've tried to be patient with respect to the rate. And so the vendors -- as you guys have seen there, the government seemed to have done some bond offerings in the 8% and 7% ranges. And because we don't need to do it currently, we thought we would be patient and perhaps get to a lower coupon level. So that's the plan for the rest of the year, and we're watching the market accordingly.

Our next question comes from Christopher Nolan, Ladenburg Thalmann.

I'm just kind of curious to know, Furniture Factory Outlet, which is nonaccrual, what's going on there? Because I saw your cost basis went down, but also your fair value marks went down. And trying to get a little color on that credit.

Sure. As you know, we don't talk specifically about companies for privacy reasons, but this is a business that's involved in the furniture retailing aspect in the Central and Southeast part of the United States, and certainly been impacted initially by what happened due to COVID. And so this is just a reflection of our current view. If it's helpful, the business has picked up as we've gone further along since the COVID really hit initially. But that's the reason.

Okay. Great. And then unfunded commitments, I see the $27 million and they've been going down through the year. Is the strategy to whittle that balance down in the second half of the year, or the thoughts there?

Yes, yes. And then just to be clear, the amount currently as of today is approximately $30 million. This is because some of the revolvers -- and it was more like $22 million at March 31. This is because some of the revolvers have repaid a payback. So it's certainly our approach to manage that number. Of that $30 million, approximately $12 million are delayed draw term loans which may not fund. And then I would also say, Chris, that we would expect that it's unlikely more than half of that $30 million would fund over time. So more to come. But -- so we think it's a very manageable number, but directly answer your question, it's certainly a number we'd like to reduce over time. And when we have that opportunity, we've been doing so.

And then I guess, finally, just a general strategy. I know every one in BDC land has sort of been migrating to first lien credits over the last couple of years. But given the change in the landscape in the last few months, and given that private equity firms are probably going to look to tap any sort of lenders to their portfolio companies, now is the risk-adjusted returns on second lien actually starting to look better than first lien? I'm just trying to get your perspective on this.

Yes. So it's not often we see a second lien opportunity. And the principal reason is, as you're pointing out, that private equity firms and other owners that really moved to what I'd call a one-stop shopping where that gives you all the debt in one tranche and makes it simple for them. So I think that, that trend, we'd expect would continue. Now if there's an opportunity for a second lien financing, and we thought it was attractively priced and then very well capitalized and a stable business, we certainly would consider it. But very little activity, Chris, in that area today.

Our next question comes from Robert Dodd, Raymond James.

First, several questions. Some of them might get a little down in the weeds. But on the dividend plan, can you remind us how much -- after the declaration of the third quarter dividend, how much remaining spillover you have to distribute this year and what the deadline is for that?

Yes. So the remaining still -- we'll express it in cents per share would be $0.42, which if you broke that up would be -- this would be in addition to what we're -- we declared today, would be a regular dividend of $0.25 and a -- potentially a special dividend of $0.17. And that for tax reasons would need to be declared by September 15.

Got it. Then when I look at -- to kind of follow on to Ryan's questions. On the revolver, can you give us kind of the definition of the interest coverage covenant in the revolver? Because obviously, I mean you're in -- you're compliant with everything right now, but if yields compress, et cetera, can you give us a definition of what that is? And does it apply just within the level? Or is it total corporate interest coverage?

Yes. Todd, would you like to cover that?

Sure. Yes. No, it's -- Robert, so the covenant today is 1.7x, and that will move back to 2x at 12/31. And as you mentioned, we're comfortably ahead of that now. And so I would just say it's total interest income and then will go down and also -- that's over the revolver interest, the revolver interest for the bank facility.

Got it. Okay. So you've got a pretty big cushion on that.

Yes.

So on -- then the other -- so when you take into account the spillover that still has to be distributed this year, the timing of that as well, and the amount of liquidity you have, I mean I'll put you on the spot. Would you expect, based on everything today, obviously, to be declaring any components of your dividends, remaining dividends this year in stock? Or would you right now expect to be able to declare all of those in cash?

We would expect to declare them all in cash.

Got it. Got it. I mean one of your points earlier, Rob, in your prepared remarks was about the refinancing repayment activity coming back in, kind of picking up by Q4. Are those discussions that are underway already? Or is that just kind of an assessment of, obviously, spreads of that -- they're 50 to 100 wider now, but that's a lot higher than they were back in 3 months ago. So is that actual discussions? Or is it just kind of a sense of where things are moving given relative compression in spreads over the last 3 months?

And Robert, I'm sorry, is the question with respect to our yield -- overall yield?

No, no, I'm talking about when you talked about refinancing and repayment activity within the portfolio in the latter part of this year. Because obviously, that would be a considerable -- potential considerable source of liquidity on top of the liquidity you already have.

Yes. So this would be based on actual discussions that we're having, are they occurring? And then in the near term, what we're finding is they, at least so far, are more SBIC assets versus the regular way, SCIC assets. So it creates more liquidity for reinvesting, whereas at the parent, it would be more liquidity generally. So -- but we expect -- we're seeing it on both fronts.

Okay. Got it. And then one last one, if I can. Just on the dividend again. I mean basically, all the dividend payments so far this year, obviously, have come out of actually spillover from last year, which means you're currently likely to head into next year with a substantial spillover balance. Has there been any consideration about -- what's the strategy there? Or are you happy to continue running those very large relative spillover balances? Or would you prefer to moderate that down or not? And if you've got a particular opinion on that, how would you go about it?

Yes. So Robert, I'm not sure if we lost Rob there. Go ahead, but I would -- yes, no, I would say, at this point, I think we're happy to carry the spillover balance. And if you think about where it is likely to be for next year, our forecast would show you it would be maybe a little over $20 million of book income, taxable income, maybe a little bit less than that, I mean different than that, I would say, but roughly that amount. And so I think at this point, until we have better visibility going forward, we probably carry that. And we really haven't made any kind of decisions in terms of paying it out over time with special dividends or a special dividend at the end of the year. I think our normal dividends for next year, assuming earnings stay the same, would roughly cover that spillover.

There are no further questions in the queue.

Okay. Very good. Thank you, everyone, for your participation today and your support, and we look forward to speaking with you again in early November.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.