Stellus Capital Investment Corp (SCM) 2020 Q1 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 First Quarter 2020 Results. (Operator Instructions)

This conference is being recorded today, Tuesday, May 12, 2020. 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, Valerie, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended March 31, 2020. Joining me, as usual, 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 pad 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 filings 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. As you all know, we're in unprecedented times. I'm glad to report, however, that our team has been working remotely since March 16 without interruption to our operations and all of our employees are healthy and safe. And we're prepared to continue to work in this manner as long as it's necessary.

Since the onset of the COVID-19 pandemic, we've been in regular contact with all of our portfolio companies and/or their sponsors to assess the current unexpected 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 first 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. In the first quarter, we more than covered the dividend of $0.34 per share with realized income of $0.39 per share, which included a $1.3 million of realized gains or $0.07 per share.

Core net investment income, excluding the impact of capital gains incentive fee reversal and excise tax, was $0.29 per share, and GAAP net investment income was $0.32 per share. Net investment income includes the accrual of $1.3 million of incentive fees, or $0.07 per share, which are not payable to the manager due to the limitation of the 12-Quarter Test resulting from the unrealized losses recorded during the quarter.

Net asset value decreased $45.7 million, or $2.59 per share, from $276 million -- $270.6 million to $224.9 million, due primarily to unrealized losses on our portfolio for the quarter, resulting primarily from the increased uncertainty caused by the COVID-19 pandemic, in addition to approximately $17.2 million of portfolio company-specific depreciation. As a reminder, we did generate approximately $20 million of realized gains during 2019.

We recently announced that we're moving our dividend payment timing from monthly to quarterly beginning with the second quarter dividend. We're doing this to add visibility into the income for the quarter as well as our capital position, and to better match the dividend with cash income. We will announce the second quarter dividend in early July.

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

Okay. Thank you, Todd. I'd like to cover the following areas: Portfolio, asset quality and then outlook.

As I mentioned earlier, we've been in regular contact with our portfolio companies and sponsors, addressing their 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. We have taken this information into account for our asset quality risk rating and valuation work for the quarter. We did see an increase in revolver and delayed draw term loan funding requests from our portfolio companies initially, which have since subsided. Since March 1, we funded $17.2 million of such requests while maintaining sufficient liquidity for the remaining unfunded commitments.

We've not made any new investments in new portfolio companies since mid-March and in the near term plan to focus on our existing portfolio companies.

As of yesterday, the remaining unfunded commitments are $22.7 million, and we have cash and revolver capacity of $27 million, excluding cash and debenture availability at our SBIC subsidiaries.

Overall, our asset quality is stable at 2 on our investment rating system or "on plan." 92% of our portfolio is rated at 2 or better or "on plan" and 8% of the portfolio is market investment grade category of 3 or below. In total, we have 5 loans on nonaccrual, which comprise 2.4% of fair value of the total loan portfolio.

During the first quarter, we invested $61.5 million in 3 new and 11 existing portfolio companies, all of which were First Lien and received $31.8 million from amortization and repayments, resulting in net fundings of $29.7 million. However, that portfolio growth was more than offset with the unrealized losses across the portfolio previously mentioned by Todd. As a result, we ended the quarter with an investment portfolio at fair value of $609.5 million across 65 portfolio companies. This is down from $628.9 million at 12/31/19. In terms of the loan portfolio, I do want to remind everyone that all but one of our loans have LIBOR floors which on average are approximately 1.1%.

We continue to maintain good diversification with the largest industry sector at 15% of the total. The average investment per company is approximately $9.4 million, and our largest investment is $20.5 million, both measured at fair value. And finally, 61 of the 65 portfolio companies are backed by a private equity firm.

Now turning to outlook. As we look forward, our primary focus, as previously stated, is to focus on maintaining liquidity and continuing to closely monitor and support our portfolio companies. Given the current environment, we do not expect the portfolio to grow materially in the near term, at least until the uncertainty associated with COVID-19 has passed. While we do not expect any near-term repayments, we would expect repayments to pick up in the second half of the year.

With respect to portfolio valuation, credit spreads generally have tightened approximately 40% since quarter end. And of course, should this trend continue through June, our portfolio valuation could recoup a portion of the unrealized loss from the quarter.

With that, we'll open it up for questions, and Valerie, you may begin the question-and-answer session, please.

(Operator Instructions) I will move to our first question from Christopher Nolan of Ladenburg Thalmann.

Rob, given everything that's going on, where do you think leverage will wind up going? Regulatory leverage ratios for SCM will increase as the year progresses.

Chris, we would -- we're optimistic that the valuation adjustment that occurred in the first quarter would not increase from here. And as a result, leverage, where we are, which is a little over 1x, would be about where we'd end up. It certainly can move a little bit more or less, but we'll target, as we have in the past, to try to keep leverage at 1:1.

Okay. And then am I correct, from your comments, that there are no additional nonaccruals in the second quarter to date?

One loan was placed on nonaccrual effective April 1. They made their March payment, but we put it on nonaccrual, and that was included in the total. So 5 companies in total, and again, roughly 2.4% at fair value.

Got you. And then I guess the final question would be, given everything that's going on with the SBA and all these new programs and so forth, and as I recall, you have 2 licenses. Are they giving any flexibility to BDC, especially quality ones like Stellus to get an additional license or get additional lending capacity?

So our relationship with the SBA has been great. And as you pointed out, we obtained a second license in August of last year. And so there's all the things that we would need to do. They are being helpful to us. So we're -- we have plenty of room to grow the second license. Currently, just $11 million of debentures have been drawn, and there's $9 million that could be drawn. But -- so we're in good shape and a lot of room to grow with the second license before we would certainly consider a third.

(Operator Instructions) We'll take our next question from Bryce Rowe of National Securities.

Rob, Todd. I wanted to ask about a couple of things here. Rob, you made the comment about the expectations for repayments possibly picking up in the second half of this year. Just wondering, are you seeing something or hearing something from portfolio companies that indicate that might be happening? Or is there the expectation that conditions will improve in the second half of the year and the natural pace of repayment activity might pick up from what it is right now?

Yes. So this is an assumption based on, we had a few portfolio companies that were in the market to be sold by the second quarter until the pandemic hit. And so companies that are performing well still continue to perform well that could be candidates for a sale still this year, but we'd certainly need to have a more positive climate than we currently have. So it's principally, Bryce, based on that expectation that at some point well-performing companies that may have been sold may end up being sold by the end of the year, sort of could come from some refinancings. But also, we do not have a specific -- nothing specific at this point. Just projecting out there'll be something closer to maybe quasi-normalcy as we get to the second half of the year.

That makes sense. Okay. Next question is about the credit facility. Obviously, there's commentary in the Q or the press release about ongoing negotiations with the agent on that credit facility. You ended the quarter maybe $10 million shy of what is currently available. So curious, are you looking to upsize it? And maybe you could describe how those negotiations are kind of playing out at this point in light of kind of the environment, the COVID environment right now?

Sure. So as a general matter that our bank group has been very supportive through the history of the company and certainly in these times. So we're, at this point, principally focused on extending the revolving period from this fall out to next year. So again, things are going well. They have been supportive and so we still have to accomplish that, but don't expect any difficulties in being able to do that.

Okay. And then 1 last question. You mentioned that the majority of your companies are sponsor backed. I was wondering the support that the sponsors are giving to portfolio companies now if you have some that are in more need of, I guess, immediate liquidity versus those that may not be, but just wanted to get a feel for how your interaction with those private equity sponsors has been and what they've kind of indicated in terms of supporting these companies, where need be?

Yes. So of course, this is -- a lot of our investment philosophy or strategy is to be backing companies that have serious owners with both intellectual as well as capital to -- intellectual capital and real capital to support the company. So we found that over time good private equity firms that were backing do such -- do that and very much support their companies. We're seeing that currently where you may find a situation where if the sponsor is economically out of the money, materially or perhaps this is an older fund, it may be more difficult. But most of our companies are certainly being well supported by their sponsors.

I'd also indicate that most of our companies have good liquidity positions, both in terms of cash or unused capacity, whether it be revolver with us or a revolver with another lender that's part of the group. So we've seen good support there. And again, probably the best metric I can share is the one we said in the prepared remarks that all companies that were on accrual in the first quarter made their payments, and we're expecting to continue to see that through the second quarter. And so overall, to answer your question specifically, good support from the private equity firms who are very capable and are smart and have been through difficult times like we have been through before and are doing same things -- types of things that we're doing, which is maintaining liquidity, focused on the operations of the business.

We'll move to our next question from Paul Johnson of KBW.

I had another question on the credit facility. As you mentioned, I think it's about $10 million remaining capacity there. I'm curious, I mean, is all of that currently available to be drawn by the company? Or are there any sort of borrowing restrictions that are restricting, sort of, availability there?

Yes. So as of quarter end, that was the case of $10 million of capacity, all of that could be drawn. Currently, as of yesterday, the facility had $15 million of availability and all of that could be drawn. We're really -- we're well and comfortably in compliance with all of our covenants with the bank and have as well the borrowing base.

Okay. And how much of the cash that was available as of 3/31 of $35 million, how much of that is also available for your use? Or how much is actually an SBIC subsidiary or something like that?

Yes. So I think Todd should correct me, but I want to say roughly of the $35 million, $15 million of that cash at 3/31 is in the SBIC subsidiary. So I think that's right, Todd?

Yes, it's $14 million, Paul.

Okay. And then my next question is just kind of on the portfolio, but I would just ask you, I think you've touched on it a little bit, but maybe kind of asking during kind of the height of the crisis and as we move forward, what has been the process for evaluating your portfolio companies and the steps that are being taken to sustain these companies? And I'd also ask, in the event -- if and in the event, have you been asked for any sort of amendments and how those conversations go, if you have been willing to make them?

Okay. So as I said in the prepared remarks, we've been in constant contact with all the portfolio companies or their private equity owner sponsors throughout the period starting mid-March. This would be not unusual. Anyway, we would typically, have -- we would touch base and have contact with portfolio companies on, roughly, a monthly basis. So more active than normal in terms of gathering data and thinking through issues. We've had very few requests for amendments. We've had a request if someone might be looking to apply for a PPP loan that would require an amendment to the documents to allow the financing. But other than that, there are no material requests. And I think the only one where we've had a payment issue would be the one that we put on nonaccrual in April that was -- did make their March payment, but we put it on nonaccrual in April. So very few kind of true covenant -- financial covenant or certainly payment request changes. So virtually not just -- just one that I mentioned and might have been 1 or 2 others, but very modest amount.

Okay. And my last question, I would just ask, I think it sounds a lot like you're basically focusing on the existing portfolio at this time and your current borrowers and probably not evaluating too many new opportunities. Is that fair to say?

That's correct.

I will move to our next question from Matt Tjaden of Raymond James.

Hope all is well. So first question on the dividend. Can you tell us if you expect to declare any level of cash dividend for 2Q?

So Matt, we -- it's probably best to wait until, as we've said in the press release and previously that we're going to evaluate that after the first -- I'm sorry, after the second quarter results. So you should expect more to come from us in early to mid-July. So we would certainly like to be paying a cash dividend for the second quarter. But -- so probably best to stick with what we said previously but we'll have more to say in early July.

Okay. Great. That's helpful. And then I guess kind of along those lines too, if you can, can you just give us an idea of what framework will be used in setting it specifically as it relates to levels of spillover income, would be of interest?

Yes. So I think as we've said previously, we'll be looking at the actual income received for the quarter. And again, we're optimistic based on the liquidity in portfolio companies and knowledge that we have that most of those payments, if not all, will be made, certainly, the first priority. The second would be just certainly evaluating the -- our overall capital position at the time and is there further concern about the COVID-19 situation. So we should take that into account. So it'd be somewhat forward-looking as well.

And then with respect to the spillover income, it's approximately $18 million remaining from 2019. And so certainly, our plan would be that that would eventually be paid out this year. We certainly have the option -- would have the option to have some of that be in stock versus cash. But certainly our goal to pay as much as we can out of the income. The way we really look at it is the income we generate this year, that would be what we plan to be paying out this year, and then that should do -- go a long way towards covering the spillover.

We'll move to our next question from [Harold Randall], private investor.

Robert Ladd, I'm sure 8 years ago when you joined the company, you did not anticipate a 2020 disaster like we've had. So anyway, I think you've answered most of my questions. The big question is, what would you say the NAV is as of right now, evaluating a portfolio that you have out there? And it sounds as though you're not facing any nonperforming or many nonperforming assets.

Good morning, sir, the -- so with respect to NAV, when we reported the results in March, the NAV is $11.55 a share. And in terms of nonperforming assets, we -- currently, we measure them as approximately 2.4% of the total on fair value. There are 5 individual positions. So that's what we reported as of March 31 and with 1 addition on April 1.

Okay. And again, you -- the dividend is in question as far as the second quarter?

So with respect to the dividend in the second quarter, we'll have more to say in July after we get through the quarter. So unfortunately, I can't be specific about what it will be for the second quarter, but we certainly will talk more about it in July.

We'll move to our next question from David Miyazaki of Confluence Investment Management.

One of the things that I think that I have observed in my conversations with your management team over the years is that you guys are very straight shooters. And you will always discuss things that have been publicly disclosed and you stick very close to that design plan. And I appreciate that. I think all investors want straight shooters from the management team. That said, we are in an environment, I think if you look across the BDC industry, that the news is presumed to be terrible unless told otherwise. And if the news is announced as good, it's still considered, if you look at the valuations, to not be very good.

And against that backdrop, your decision to really not just move away -- well, you're not giving us really anything concrete with regard to your dividend. And I think that can easily be interpreted that you've got a lot of problems that you might not have. And frankly, waiting until July, it's just too long. So I would just -- as a comment, would suggest to you that you think pretty hard about trying to get some dividend [readout] sooner because it would be very helpful.

If the news isn't good, and you need to bring it down for whatever reason it might be, getting the news out there to what it actually is is going to be a lot better than what people are presuming it to be. Your stock right now is at a huge discount to its net asset value and a little bit of clarity on some earnings call would go a long way.

And against that backdrop, I guess I would also say that between your quarters, if you have meaningful news to report with regard to your credit facility amendments, pay downs, portfolio quality, to the extent that you can provide that between your filings in an 8-K or other news, press releases, that would be very helpful. So I'm not sure if you guys are putting any thought into that so I'm wondering what your comments might be.

Yes, Dave. Thank you for joining, and thank you for the questions and ideas. So just in terms of interim reporting, if we have something that's material, we certainly would report that during the quarter. So we will do that for sure.

I mean, I guess I would say that in all the conversations that I have with the different BDC managers, I tend to get the least amount of information from you guys with regard to updates. And let's not to suggest that what other managers are doing is wrong and disclosing more than they should. It's that they have the tendency to provide more information through press releases or their presentations with regard to what might be happening. I think the material bar right now might be too high. It would be helpful, I think, to give information that includes things that may not be considered material, but just some updates on what might be happening.

The way that you have framed things on this call is that you're being cautious and careful with the capital, which we appreciate, but you're not really kind of providing a whole lot of clarity with regard to what is actually happening with the real cash flow. Can you -- is the quality of earnings going to be high enough to support a cash dividend? What are the plans that you might have to do? Are you going to have to raise equity below net asset value? Are you going to introduce maybe a stock out?

If all these things are likely to happen or a possibility, it would be helpful if you could provide updates on that before July. Because until then, investors are going to presume that you're not paying a dividend and if you're going to [delete] them. And if that's the case, then -- if that's the way it is, I think it's a lot better just to get the news out there and whatever it might be, rather than have investors, kind of, handicapped to whatever that's going to be.

Dave, so I understand and understand the request would be to provide more information as we can. So it's duly noted.

We'll move to our next question from Kevin Tripp with Oppenheimer & Company.

My question just pertains to the cumulative total return lookback feature in the base incentive fee calculation. So I see that this quarter's base incentive fees are now deferred. So going forward, I would assume that subsequent incentive fees will be expensed and added to that deferred balance, say, and so the 20% cumulative returns allow for that balance to become currently payable over time. But I did want to see, is there anything that would cause a reversal of these deferred base incentive fees in subsequent quarters, similar to that, say, the capital gains, say, apart from deferred interest income reversals?

Sure. Go ahead, Rob.

Kevin, thank you for your question. Yes, I would say that, that's correct. I mean, at this point, the way it works is that we calculate an incentive fee under the formulas and the investment management agreement and accrue it if there is a -- if the calculation suggests to accrue it and then it's limited by the 12-Quarter Test. And as you pointed out, this quarter's incentive fee was limited by that. And to the extent something in the future happens, as you recalculate the 12-Quarter Test each quarter, that would result in a recruitment of those -- any of those incentive fees, then they would be payable at that time. But at this point, they're just -- they're deferred subject to that. So things that would occur that -- that could occur -- that would cause that to happen would be an unrealized gains or previous -- or realized gains that were not previously unrealized. That's the primary mover on that 12-Quarter Test.

It appears there are no further questions at this time. I'd like to turn it back to the presenters for any additional or closing remarks.

Okay. Thank you, and thanks, everyone, for being on, and thank you for your support of our company and in trying times, but we're working hard to -- for all of our benefits. So thanks again for the support. We look forward to speaking with everyone in August as we report the second quarter. And again, we'll have more to talk about, certainly by July with respect to the second quarter dividend. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.