Earnings Transcript for SCM - Q2 Fiscal Year 2023

Operator: 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 second fiscal quarter ended June 30, 2023. At this time, all participants have been placed on a listen-only mode. [Operator Instructions]. This conference is being recorded today, August 10, 2023. 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.

Robert Ladd: Thank you, Matthew, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended June 30, 2023. 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.

Todd Huskinson: 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.

Robert Ladd: Thank you, Todd. We'll begin by discussing our operating results followed by a review of the portfolio, including asset quality and then the outlook. Todd will cover our operating results.

Todd Huskinson: Thank you, Rob. As interest rates have continued to rise in recent quarters, we continue to benefit from our favorable asset liability mix, in which 97% of our loans are floating and only 37% of our liabilities are floating. As a result, we had another quarter of solid earnings. In the second quarter, we more than covered the dividend of $0.40 per share with GAAP net investment income of $0.49 per share. Core net investment income was $0.51 per share, which excludes estimated excise taxes. Net asset value increased $27.5 million due primarily to the issuance of equity under our ATM program and earnings in excess of the dividend of $1.8 million, offset by net unrealized losses on our investment portfolio of $6.3 million. The unrealized loss was driven primarily by markdowns on specific positions, offset by markups on many of the other loans in the portfolio due to tightening spreads. During the quarter, we issued 2.3 million shares under the ATM, which were at or above net asset value per share for net proceeds of $32.4 million. This brings total equity raised under the ATM in 2023 to $40.7 million net. And with that, I'll turn it back over to Rob.

Robert Ladd: Okay. Thank you, Todd. I'd like to cover the following areas

Operator: Certainly. Everyone at this time, we'll be conducting a question-and-answer session. [Operator Instructions]. Your first question is coming from Christopher Nolan from Ladenburg Thalmann. Your line is live.

Robert Ladd: Good morning, Chris.

Christopher Nolan: Yes. Rob, on EH Real Estate investments, it seems like there was a material expansion number of non-accruals there. Is that related to the higher interest rate environment.

Robert Ladd: Yes. This is a specific situation tied to the housing industry in the Midwest and just tied to the slowdown there that's occurred there and throughout the country in terms of real estate residential closings.

Christopher Nolan: Okay. So I guess the gist of my question is we're not -- I'm seeing increased non-accruals across BDCs. I just want to see whether or not this might be just related to companies being unable to handle the change in the interest rate environment. But that's not the case with EH, right?

Robert Ladd: Yes. The question would be tied, though, to the fact that interest rates have risen, which has caused fewer home sales.

Christopher Nolan: Got you. I guess for Todd, is -- was there any non-accruing -- non-recurring items in the earnings?

Todd Huskinson: No, nothing material. No, it's nothing unusual.

Christopher Nolan: Great. And then on, finally, the facility. Before and after, it seems like the capacity is $265 million, which didn't really seem to change. I'm just trying to understand what the material changes were for the...

Todd Huskinson: Yes. So in -- the credit facility didn't increase in size. The $265 million is the total amount of the facility. The borrowing base is lower than that, about $225 million. And then what had changed at the end of the year is with the ATM proceeds, we paid down the credit facility. But then also we had a very active quarter in terms of fundings as well. So kind of the movements in there have masked -- kind of pay downs as well as draws on the facility made it look a little bit smaller than you might otherwise expect. But there wasn't a change in the credit facility itself.

Christopher Nolan: Okay, that's it for me. Thank you.

Todd Huskinson: Thank you, Chris.

Operator: Thank you. Your next question is coming from Erik Zwick from Hovde Group. Your line is live.

Robert Ladd: Good morning, Erik.

Erik Zwick: Thank you. Thanks, good morning, hi. I wanted to start just first on the increase in PIK income in the quarter. What's driving that? And whether you think that's going to be something temporary or whether that lasts potentially a couple of quarters?

Robert Ladd: Yes, the PIK income is very modest. Todd, it's less than 1%, as I recall? And -- but in any event, you may find some situations in this higher interest rate environment where there may be a PIK-ing of a few points. But we would not expect that to be a material part of the portfolio, Erik.

Erik Zwick: Great. Thank you. And then similarly, the increase in kind of repayment in sales activity in the quarter, curious if that was reflective of one or two companies or maybe something more larger in the market. We've heard from some other BDCs that the M&A market is starting to increase again. So maybe there was just some companies that decided to sell or curious what drove the uptick there?

Robert Ladd: Yes. So I'd say that if you'd asked this in May, we would have said things have slowed down. And if you'd ask us now, things have sped up. So quite a bit of activity over the summer so far. And I'd say those are kind of company-specific things but tied to either refinancings or sales. But I think the things have picked up on both ends. And we've had limited repayments, though, in the last couple of quarters. So we would expect more deal flow and more repayments going forward.

Erik Zwick: Appreciate the color there. That's helpful. And then last one for me just in terms of -- wondering if you could kind of categorize or quantify the size of the pipeline today, how maybe it's changed over the past three to six months and if there's any particular concentrations of industries that are particularly strong in there today as well?

Robert Ladd: We're so active, Erik, around the country in all industries, except for a few. And so I'd say it's pretty broad, which is helpful. So our natural flow creates interesting industry diversification. So nothing in particular.

Erik Zwick: Got it. And in terms of just the size of the pipeline today, how would you...

Robert Ladd: Sorry, so I would just -- we don't describe it in nominal dollars, but I would say that it's said early. It's very active and quite a bit busier than we were in April and May. And again, if it's helpful, too, just in terms of capacity, because of our credit facilities and the equity that we've raised, we have the ability to really get up to $950 million or so as a limit. So think of us today at $915 million. So we have lots of things, but you can quickly fill up the balance. So think of us as we've got more capital to invest, but also we'll be reinvesting repayments. So again, I think plenty of pipeline to keep us full in terms of the portfolio.

Erik Zwick: Thanks so much for taking the questions this morning.

Robert Ladd: Yes, thank you, Erik.

Operator: Thank you. Your next question is coming from Robert Dodd from Raymond James. Your line is live.

Robert Ladd: Good morning, Robert.

Robert Dodd: Hi guys, good morning. On that -- congratulations on the realized equity gain in Q3. I mean on that pipeline pickup, et cetera, are you expecting an acceleration in kind of equity realizations as well? Is that the kind of activity that might go on where you again -- maybe taken out on the debt and of equity gain and then redeploying? Or any color on that?

Robert Ladd: Yes, Robert. So none other that are in front of us that we could speak to. I would say probably there's more of the case of refinancing than actual sales of companies, although we would expect that to pick up as well. So more to come. But I think at this point, just one that we know of for this quarter.

Robert Dodd: Got it. Thank you. And then on the ones where you maybe have seen there's a little bit of PIK because of higher rates and things like that. How are the sponsors responding in these situations in terms of providing additional support if necessary, et cetera? Can you just give us some color on how -- are they stepping forward, being proactive or -- just how is the environment with the sponsor relationships right now?

Robert Ladd: Yes. So I'd say that substantially all of our sponsors have responded very well, which has been true over time throughout our history, and that's the principal reason that we've gone to principally a sponsor-backed strategy. So we found very, very good responses from sponsors. And in many cases, they were putting equity in. So imagine in the -- in a few cases where we might have some PIK in addition to cash income, you can assume sponsors put in cash equity below us.

Robert Dodd: Got it, thank you.

Robert Ladd: Yes, thank you.

Operator: Thank you. Your next question is coming from Ryan Lynch from KBW. Your line is live.

Robert Ladd: Good morning, Ryan.

Ryan Lynch: Hey, good morning. First question I had was you guys mentioned this in the press release about ArborWorks being placed on non-accrual at the beginning of the third quarter. Can you just describe exactly what that business does, provide a little background on it and what, I guess is going on with that business? And as well as does the market you guys currently have at the end of the second quarter sort of reflect the challenges that, that business is facing?

Robert Ladd: Yes. So this business is active principally in the Western part of the United States, including cleaning for power lines and activities related to storms. So that's the general business, and we normally don't talk more than that about it. And then in terms of the mark, we mark things as best we call them at each quarter, and that's reviewed by our outside firm -- valuation firm.

Ryan Lynch: Okay. The other question I had was, obviously, you de-levered a little bit this quarter. Is it the expectation that you guys want to get back up to a higher leverage level? If you look at just kind of like total leverage, gross leverage, including the SBA debentures, you guys were above 2x and now you got below that by a bit. Do you guys have an area that you guys would like to operate at? Or was this just opportunistic of the market being open and deleveraging a little bit to get more capital in a pretty favorable deployment environment?

Robert Ladd: Yes. Chris, good question -- I'm sorry, Ryan, good question. So I'd say that we're -- our target leverage would continue to be 1

Ryan Lynch: Okay, that's all for me. I appreciate the time today.

Robert Ladd: Great, thank you.

Operator: Thank you. That concludes our Q&A session. I will now hand the conference back to CEO Robert Ladd for closing remarks. Please go ahead.

Robert Ladd: Okay. Great. Thanks, everyone, for being on, being a supporter of the company. We look forward to giving you the third quarter results in November.

Operator: Thank you, everyone. This concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.