Stellus Capital Investment Corporation (NYSE: SCM) — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Stellus is an externally managed business development company (BDC) investing primarily in debt and related equity of U.S. middle-market companies. Figures below are in U.S. dollars unless stated otherwise.
Key financial metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Investment income | $16.1 million | $15.1 million | $31.6 million | $29.1 million |
| Net investment income (NII) | $6.2 million; $0.32/share | $5.5 million; $0.28/share | $11.7 million; $0.60/share | $10.6 million; $0.54/share |
| Net increase in net assets from operations | $1.3 million; $0.07/share | $5.6 million; $0.29/share | $6.6 million; $0.34/share | $10.5 million; $0.54/share |
| Distributions per share | $0.34 | $0.25 | $0.62 | $0.50 |
- Portfolio and NAV: Investments had a fair value of $852.0 million, versus amortized cost of $873.6 million, across 83 portfolio companies. Fair value was $772.9 million across 73 companies at December 31, 2021. NAV per share declined to $14.32 from $14.61.
- Cash flow: Operating activities used $76.9 million in the first half, primarily reflecting investment purchases; financing activities provided $59.2 million. Cash and cash equivalents fell to $26.5 million from $44.2 million at year-end.
- Debt and liquidity: At June 30, outstanding principal was $100.0 million of notes, $203.6 million under the revolving credit facility, and $293.6 million of SBA-guaranteed debentures. The facility had $265 million of committed capacity, with an accordion up to $280 million subject to conditions. Cash plus undrawn committed facility capacity was approximately $87.9 million before other restrictions. The company reported compliance with debt covenants.
- Leverage: Asset coverage was 192%, down from 203% at year-end; the BDC statutory threshold is 150%, and the credit facility covenant requires at least 167%.
- Portfolio yields and rates: Weighted average yield was approximately 8.5% on debt investments and 8.0% on all investments, up from 8.0% and 7.5%, respectively, at year-end. About 97% of debt investments were floating-rate.
Changes versus comparable periods
- Q2 investment income rose about 7% and NII rose about 12% year over year; first-half investment income increased about 9% and NII about 10%, primarily reflecting a larger portfolio.
- Despite higher NII, operations-generated net assets fell year over year: Q2 was $1.3 million versus $5.6 million, and the first half was $6.6 million versus $10.5 million. Unrealized depreciation was $4.3 million in Q2 and $8.0 million for the first half, compared with unrealized appreciation in the 2021 periods.
- Management attributed depreciation to the reversal associated with a realized investment and widening credit spreads and swap rates amid the macroeconomic environment. First-half realized gains were $3.1 million, versus realized losses of $1.3 million in 2021.
- Interest expense and other fees increased to $10.4 million for the first half from $9.0 million. The facility’s average interest rate increased to 3.1% from 2.8%; the higher average borrowing balance also contributed.
- Four loans were on non-accrual at June 30, compared with three at year-end. Non-accruals represented 5.7% of loans at cost and 2.8% at fair value, versus 4.2% and 0.8%, respectively.
Outlook, risks, and notable items
- The filing provides no specific earnings, portfolio growth, or NII guidance. Management said investment activity varies with economic and competitive conditions and expects to distribute 90%–100% of annual taxable income, subject to applicable requirements and restrictions.
- Management flagged inflation, supply-chain disruption, geopolitical events, energy prices, possible monetary tightening, COVID-19 uncertainty, and rising interest rates as risks to portfolio-company margins, investment values, and collections. It noted that most debt investments are floating-rate; rate changes can affect both income and funding costs.
- The company reported no COVID-related interest deferrals during the quarter. It had $32.6 million of unfunded debt and equity commitments to portfolio companies and said available liquidity was sufficient to meet them.
- The portfolio is largely Level 3 valued: all $852.0 million of investments were classified as Level 3, relying on significant unobservable inputs. Valuations therefore involve judgment and may differ materially from realizable sale prices.
- The capital gains incentive-fee accrual was reversed by $1.0 million in the first half, including $0.984 million in Q2. No income incentive fee was incurred in the first half.
- After quarter-end, the board declared regular monthly dividends of $0.0933 per share plus an additional $0.02 per share for each of July, August, and September 2022. Also subsequent to quarter-end, ASC Communications was repaid and its equity realized for a reported $1.75 million gain.
- No material legal proceedings or material changes to previously disclosed risk factors were reported. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Review the four non-accrual exposures, their payment status, and the potential for further credit losses.
- Assess Level 3 valuation assumptions and the $21.6 million gap between portfolio cost and fair value, including sensitivity to credit spreads and company performance.
- Track asset coverage, facility availability, covenant headroom, and the effect of rising rates on both floating-rate loan income and borrowing costs.
- Compare NII with distributions: first-half NII was $0.60 per share against $0.62 distributed; confirm future taxable income and cash collections support distributions.
- Monitor portfolio-company concentration, including business services at 26.2% of investment fair value, and the $32.6 million in unfunded commitments.