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 Second Quarter 2020 Results. At this time, all participants have been placed on a listen-only mode. The call will open for a question-and-answer session following the speaker's remarks. 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 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 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. 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/or their 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 in the following 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 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 outlook. With respect to the portfolio, as I mentioned earlier, we remained 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 unexpected 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 the 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. Next, our overall asset quality is stable at two out of the five rating on our investment rating system or "on plan, if you will." 91% of our portfolio is rated at two or better or on plan, that's 9% is marked at a category of three or below. In total, we have loans to five portfolio companies on non-accrual status, which comprise 1.8% of fair value of the total loan portfolio. And no loans have been added to non-accrual status since April 1st. 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 31st, due primarily to the unrealized gains Todd mentioned earlier. During the second quarter, we did not make…

Thank you, sir. [Operator Instructions] Our first question comes from Ryan Lynch with KBW.

Hey, good morning. Thanks for taking my questions. The first one, in May you guys amended and extended your revolving credit facility. And I was curious because it looked like the revolving day was only extended to March of 2021 with a final maturity in October, 2020, the final maturity being just a little over a year away and the revolver period six months, so seven or eight months away now. I was just curious that felt like a shorter time period than we've seen other BDCs typically when they expand the revolver periods. So can you just talk about, if it's much more challenging environment and uncertain environment in May, but just was there a pushback from the bank lending groups for 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 will recall that amendment we worked on in April and then closed in May during the mid – more of the height of the pandemic. And so I think as a group, the thought was 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, and maybe if some number is out on the cash availability, but you had $23 million of cash and $45 million of capacity under credit facility as of June 30th. Can you provide the numbers of how much of that cash was remained in the SBIC as well as, of the $45 million 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've mistaken here. But say 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 would be roughly $30 million – I want to say $37 million or $38 million that could be borrowed without increasing the volume base for many loans. And therefore, if we made any loans under the revolvers, we would be fully available. So we view it as fully available, but it could be drawn down to – I think it was $222 million of the $230 million without any additional borrowing, initial assets contributed.

Yes. That's right.

Okay. Makes sense. 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 both low and upper end of your guys' incentive, the hurdle rates for the foreseeable future?

Todd, why don’t you cover that, please.

Sure, Ryan. Yes, I think with a hurdle rate set today and in 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 two 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 were at 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 refinancings. Can you just talk about – from your opinion, what's it going to take before we start seeing since the more deal activity, obviously, there's a great uncertainty, the economy going forward and when things will start to really reopen, I know there is difficult to start discussions, as far as pricing in the markets, say both on from interest rates and purchase price multiples. So just what do you think need to happen before we start seeing some increased deal activity in your opinion?

Ryan, such as a general matter that 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 or pricing maybe, we are seeing roughly 50 basis points to 100 basis points higher pricing, that we might've seen six months ago or so, it depends only on the credit and the leverage. But I think there is 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 is already involved, private equity firms already invested and they haven't had one or two acquisitions that they might've 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.

Okay. Understood. I appreciate the time today.

Yes. Thank you, Ryan very much.

[Operator Instructions] Our next question comes from Bryce Rowe, National Securities.

Yes. Good morning, Bryce.

Thanks. Good morning, Rob and Todd. Thanks for taking the question. 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. Thank you.

Sure. Would be happy to Rob. So, good morning, Bryce. 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, we’re – slightly we're higher than they were at in March – at March 31st. And in other cases, we had companies where their EBITDA was a bit higher than it was at that time too. So we – so I would say there is nothing individually point to particular position that was up, some were down certainly. So just on average, that's what it is. So I wouldn't say there is an overall necessarily trend, it was kind of more idiosyncratic between – across the portfolio for one of those two reasons.

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 three companies in the first quarter we thought might be sold by the summer, all three 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 their company is performing well, but not quite where they ready to sell the company. So, we're not expecting any realized gains and materialized gains this year, of course, that could change, but for the moment it's more in this area of refinancings.

Okay. That's great, Rob. I wanted to ask two more questions if that's okay. You all talked about pricing being 50 basis points 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 weighted average portfolio yield kind of holds here? Or is there still room to move lower as you're adding personally in 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 loans 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 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, and again the pressure would be refinancings of higher yielding. 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 this 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 a one-to-one 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 when 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, 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, perhaps reduce reliance on a bank facility and potentially also to, for capital reasons that are SBIC II license. So our goal this year would like to raise more fixed income financing or – and therefore unsecured, not requires 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 their – seen there have been some bond offerings in the 8%s 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.

All right. Thank you for your answers. Appreciate the time, have a good day.

Yes. Thank you, Bryce. Appreciate it.

Our next question comes from Christopher Nolan, Ladenburg Thalmann.

Good morning, Chris.

Hi, guys. How are you doing?

Good.

I'm just kind of curious, 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 it'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 with 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, the $27 million and they've been going down through the years is the strategy to whittle that balance down in the second half of the year or what's the thoughts there?

Yes. Yes. And then just to be clear, the amount at 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 the 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 or 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, it's just a general strategy. I know every one in BDC-land, who have 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, 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'd see a second lien opportunity. And the principle reason is as you're pointing out that private equity firms and other owners have really moved to what I'd call a one-stop shopping, where that you'd like to do all the debt in one tranche and makes it simpler for them. So I think that trend we 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.

Okay. Thanks, Rob.

Yes. Thank you.

Our next question comes from Robert Dodd, Raymond James.

Good morning, Robert.

Hi, guys. Good morning and congrats on the quarter. First, several questions, some of them might get a little down in the weeds. But on the dividend front, 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 spillover will express it in the cents per share would be $0.42, which would be broke that up would be – this would be in addition to what we've declared today, would be a regular dividend of 25 and potentially a special dividend of 17. And that for tax reasons would need to be declared by September 15.

Got it. Then when I look at – yes, this is kind of follow on to Bryce’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 compliant – 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 revolver or is it total interest coverage?

Yes. Todd, would you like to cover that?

Sure. Yes, I know it's going 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 we'll go down and also that's over the revolver interest, the revolver interest for the bank facility.

Got it. Okay. So you got to put a big cushion there hopefully.

Yes.

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, right, based on everything today obviously, to be declaring any components of your dividend – remaining dividend this year in stock or would you right now expect to be able to declare that all of those in cash?

We would expect to declare them all in cash.

Got it. I mean, one of your points earlier, Rob in your prepared remarks, about the refinancing repayment activity coming back in kind of picking up by Q4. Those discussions that are underway already or is that just kind of an assessment of, obviously, spreads of that 50 to 100 widen out, but that's a lot tighter than they were back in three months ago. So is that actual discussions or is it just kind of a sense of where things are moving, given relative complexion in spreads over the last three months?

And Robert, I'm sorry, was your 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, obviously that would be a considerable – potential considerable source of liquidity on top of that liquidity already have?

Yes. So this would be based on actual discussions that we're having or they're occurring. And then in the near-term, what we're finding is they – at least so far are more SBIC assets versus or the regular way SBIC assets. So it creates more liquidity for reinvesting whereas if 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 if you 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.

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'd be maybe a little over $20 million of book income, taxable income maybe a little bit less than that, a little 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 earning staying the same would roughly cover that spillover.

Got it. I appreciate it. Thank you, guys.

Okay. Thank you, Robert.

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.