Stellus Capital Investment Corporation — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet comparisons are with December 31, 2022. Stellus is an externally managed business development company (BDC) investing principally in debt and related equity of U.S. middle-market companies. Figures are unaudited.
Financial results and position
| Metric | Q1 2023 / March 31, 2023 | Comparable period / December 31, 2022 |
|---|---|---|
| Investment income | $24.1 million | $15.5 million in Q1 2022 |
| Net investment income (NII) | $9.1 million; $0.46 per share | $5.5 million; $0.28 per share in Q1 2022 |
| Net increase in net assets from operations | $4.7 million; $0.24 per share | $5.2 million; $0.27 per share in Q1 2022 |
| Net asset value (NAV) per share | $13.87 | $14.02 |
| Investment portfolio, fair value | $877.5 million across 88 portfolio companies | $844.7 million across 85 companies |
| Cash and cash equivalents | $17.9 million | $48.0 million |
| Debt outstanding, principal amount | About $611.9 million: $100.0 million notes, $198.3 million credit facility and $313.6 million SBA debentures | About $612.8 million on the same principal basis |
| Asset coverage ratio | 194% | 192% at December 31, 2022 |
| Distribution per share | $0.40 declared in Q1 | $0.28 declared in Q1 2022 |
Portfolio fair value was $35.1 million below amortized cost of $912.6 million. All portfolio investments were classified as Level 3 fair value measurements, relying on significant unobservable valuation inputs. First-lien debt represented about 87% of portfolio fair value; 97% of debt investments bore floating rates.
Operating cash flow was negative $32.0 million, principally reflecting investment purchases of $41.2 million, partly offset by $5.9 million of sales and repayments. Financing activities provided $1.9 million; cash decreased by $30.2 million. The filing reports annualized NII to net assets of 13.24% and annualized gross operating expenses to net assets of 21.94% for the quarter; these are BDC-specific ratios, not conventional operating margins.
Changes versus comparable periods
- Investment income rose about 55% year over year, primarily due to portfolio growth and higher interest rates. NII increased about 64%.
- Operating expenses rose to $15.0 million from $10.0 million. Interest expense and other fees increased to $7.9 million from $4.9 million; the credit facility’s weighted average rate rose to 7.3% from 2.8%.
- Despite higher NII, operating results fell to $4.7 million from $5.2 million, as Q1 2023 included $4.2 million of net unrealized investment depreciation and only nominal realized gains; Q1 2022 included $3.5 million of realized gains.
- NAV per share declined from $14.02 to $13.87. Portfolio fair value increased from year-end, while the number of portfolio companies also grew.
- Non-accrual loans increased from three to four, representing 5.9% of the loan portfolio at cost and 2.5% at fair value, versus 5.2% and 2.3%, respectively, at year-end. The filing identifies EH Real Estate Services as newly placed on non-accrual in January 2023.
- The company issued 581,614 shares through its at-the-market program for $8.4 million gross proceeds at an average $14.47 per share. The issue price exceeded quarter-end NAV per share.
Outlook, risks and notable items
- No formal earnings or portfolio guidance is provided. Management cites ongoing supply-chain interruptions, labor shortages, commodity inflation, rising interest rates, bank impairments and failures, sanctions, and geopolitical and financial-market instability.
- Management stated it had sufficient liquidity, including cash and available credit-facility borrowings, to fund approximately $25.5 million of unfunded debt commitments and $0.3 million of unfunded equity commitments at quarter-end. The facility requires at least $10 million of qualifying liquidity; the company reported compliance with its covenants.
- The $265 million committed revolving facility had approximately $198.3 million drawn at quarter-end, bears floating-rate interest, and its borrowing commitment expires September 18, 2024; amounts drawn mature September 18, 2025. SBA-guaranteed debentures are fixed-rate, generally ten-year obligations; $313.6 million was outstanding.
- Interest-rate sensitivity analysis estimates that a 100-basis-point increase would raise annual net interest income by $6 million, while a 100-basis-point decrease would reduce it by $6 million, assuming the balance sheet remains constant. The filing cautions that actual results may differ and that the estimate excludes possible changes in portfolio composition, credit quality and incentive fees.
- Management notes that illiquid portfolio holdings may be difficult to sell at recorded values. Fair values depend on board valuation judgments and assumptions. Non-accrual income not accrued was $6.7 million at quarter-end.
- The filing identifies potential indirect effects of bank failures on portfolio companies, including restricted access to deposits, borrower defaults and tighter funding markets. No material legal proceedings were reported.
- The board declared monthly distributions of $0.1333 per share for April, May and June 2023. Subsequent to quarter-end, the company also disclosed $8.2 million of net ATM proceeds and new and add-on portfolio investments.
Investor verification priorities
- Review the four non-accrual loans, including the newly non-accrual EH Real Estate position, their valuation marks, payment status and recovery assumptions.
- Assess Level 3 valuation sensitivity and the largest unrealized markdowns, including the portfolio’s $34.1 million net unrealized depreciation relative to cost.
- Check whether NII and cash receipts support distributions, given the $0.40 per-share Q1 distribution, accrued PIK income and the requirement to distribute taxable income as a RIC.
- Monitor borrowing costs, leverage, asset coverage and remaining credit-facility availability as floating-rate costs rise and the facility approaches its 2024 borrowing expiration.
- Verify the status and draw needs of unfunded portfolio commitments, as well as post-quarter-end investments and ATM share issuance.
- Consider portfolio concentration: business services comprised 25.7% and healthcare and pharmaceuticals 10.5% of fair value; California and Texas represented 20.2% and 19.3%, respectively.