Stellus Capital Investment Corporation (NYSE:SCM) Q4 2022 Earnings Call Transcript

Stellus Capital Investment Corporation (NYSE:SCM) Q4 2022 Earnings Call Transcript March 1, 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 Fourth Fiscal Quarter ended December 31, 2022. This conference is being recorded today, March 1, 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 the conference.

Robert Ladd: Thank you, Ali, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter and year ended December 31, 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.

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 now.

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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 32% of our liabilities are floating. As a result, we had solid results in the fourth quarter and for fiscal year 2022. First, I’ll cover our annual results. For fiscal year 2022, we more than covered the dividend of $1.30 per share with realized income of $1.65 per share which included $3.7 million of net realized gains or $0.19 per share. Core net investment income was $1.38 per share and GAAP net investment income was $1.46 per share. As a reminder, core net investment income excludes the reversal of $2.8 million of capital gains incentive fees accrued on realized and unrealized gains, which are not included in net investment income and $1.2 million of estimated income taxes.

Net asset value decreased by $9.3 million, primarily — or $0.59 per share year-over-year, primarily due to portfolio company specific issues, offset by realized earnings in excess of our dividends. Turning to the fourth quarter. Our total distributions of $0.34 per share were covered through core net investment income of $0.44 per share and GAAP net investment income of $0.50 per share. And with that, I’ll turn the call back over to Rob.

Robert Ladd : Okay. Thank you, Todd. I’d like to now cover the following areas: life-to-date review, portfolio and asset quality, dividends and then outlook. So life-to-date review. Since our IPO in November of 2012, we’ve invested approximately $2.2 billion in over 175 companies and have received approximately $1.4 billion of repayments while maintaining stable asset quality. We have paid over $207 million of dividends to our investors, which represents $13.35 per share to an investor in our IPO in November of 2012. Now turning to the portfolio. We ended the year with an investment portfolio at fair value of $845 million across 85 portfolio companies. This is up from $773 million across 73 companies as of December 31, 2021.

During 2022, we invested $211 million in 22 new and 28 existing portfolio companies and received $90 million of repayments for net portfolio growth of $90.8 million for the year. With respect to the fourth quarter, we’ve invested $30 million in 4 new and 2 existing portfolio companies and have received repayments of $48 million. At December 31, 99% of our loans were secured and 97% were priced at floating rates. We continue to move toward first lien loans, which were 87% of our loan portfolio at year-end. This is up from 84% at the end of 2021. We are always focused on diversification. The average loan per company is $10.8 million and the largest overall investment is $21.1 million, both expressed at fair value. And 83 of the 85 portfolio companies are backed by a private equity firm.

Overall, our asset quality is stable at a 2 on our investment rating system or on plan. 17% of our portfolio is rated a 1 or ahead of plan, 17% of the portfolio is marked at an investment category of 3 or below plan. In total, we have 3 loans on nonaccrual, which comprised 2.3% of fair value of the total loan portfolio. Now turning to dividends. We’ve increased our regular dividend 43% from $0.28 per share per quarter in the first quarter of 2022 to now $0.40 per share per quarter beginning in the first quarter of 2023. This is payable, as you know, in monthly increments. This increase in our dividend reflects the greater earnings that we are generating in this higher interest rate environment in which our loan portfolio is over 97% floating and our liability structure is over 65% — pardon me, over 65% fixed rate.

As a reminder, part of our strategy has been to invest in the equity of our portfolio companies in a modest way in order to generate realized gains sufficient to offset losses over time. As our business has matured over the last 10-plus years, we’ve begun to see somewhat regular realized gains from our portfolio. And during 2022, we generated $3.7 million of net realized gains. And now turning to outlook. As a reminder, across our platform of Stellus Capital Management, our total assets under management is approximately $2.8 billion. This additional capital allows us to invest in larger transactions, remain active in the market when SCIC has limited capital and helps us build our portfolios in a diversified way. Since year-end, we funded $25.5 million at par in 2 new and 1 existing portfolio companies and have received no repayments.

This brings our portfolio to approximately $870 million today, which is where we would expect it will finish the quarter at the end of March. Finally, repayments and equity realizations seem to be slowing, but we expect to be able to maintain our investment portfolio between $850 million and $900 million throughout the year of 2023. And with that, we’ll open it up for questions. Thank you. And Ali, would you please start the Q&A session?

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Q&A Session

Operator: Our first question is coming from Erik Zwick with Hovde Group.

Erik Zwick : First, I just wanted to kind of get your thoughts a little bit on the new dividend level at $0.40 a share. I’m just curious. Certainly, the interest rate environment continues to go up, and that will be likely additive to earnings but at some point, a couple of years out, could normalize. So just wondering if you could kind of frame your confidence in having the dividend at this level relative to the outlook for longer-term earnings at this point.

Robert Ladd: Yes. Sure. So in setting the dividend for this year, certainly the first quarter, we expect for the year to earn more than that level of $1.60 or $0.40 a quarter. So we’re keeping in mind that rates could certainly moderate in the future. And if you look at the forward curve, we should be able to maintain this level of dividend based on earnings for at least a couple of years, if not longer.

Erik Zwick : And switching gears to credit. As you pointed out, nonaccrual is still very, very minimal at this point. There’s obviously a lot of concern that the economy may be dipping into a more kind of stressful environment, which could impact some lenders and some businesses. So just curious, one, are you seeing any signs of that the business activity weakening for any of your borrowers? And also are you experiencing any increase in amendment request at this point?

Robert Ladd: Yes. So in terms of any stress, not a material amount. I think what’s been true for us historically is given our underwriting that if we have concerns, it’s more company specific than kind of a broad-based impact. So I’d say that the portfolio has held up relatively well. We’ll always have company-specific issues. And I’m sorry, the second part of your question?

Erik Zwick : Just if you’ve seen any increase in amendment requests from any portfolio companies.

Robert Ladd: We have not. Now one thing I’ll share is that as rates continue to increase, you certainly reach a level where you could have some more stress on portfolio companies, but we think we’ve got a good ways to run before that will — higher rates will be impactful.

Erik Zwick : And then last 1 for me, and I’ll step aside. Just curious if you could update me on the value of spillover income at this point? And how you think about that either as supporting that dividend or a potential for maybe a special dividend at some point?

Robert Ladd: Yes. So I’ll turn that over to Todd.

Todd Huskinson: Yes. Sure, Erik. So our current spillover level from last year into this year is a little over $28 million. And our dividend at the current level in the current number of shares is about $31 million of dividends. So for this current year, our regular $1.60 a share will a little bit more than pay out the spillover and then will pay out a little bit of the current year earnings as well. All other things being equal and kind of what we would expect from this year’s earnings going into the following year, if we continue with $1.60 dividend then there might need to be a special dividend at the end of that year just because we expect to out earn $1.60 dividend. But the way I think about it is, we want to earn our dividend from realized income, which we always have. And then we also have a substantial amount of spillover that’s available to support that dividend as well.

Robert Ladd: Maybe just to add to that. So as we look forward, there could be a need next year for a special dividend, but we’re a good ways off from that.

Operator: Our next question is coming from Robert Dodd with Raymond James.