Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-35730
STELLUS CAPITAL INVESTMENT CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Maryland
46-0937320
(State or other Jurisdiction ofIncorporation or Organization)
(I.R.S. EmployerIdentification No.)
4400 Post Oak Parkway, Suite 2200
Houston, Texas 77027
(Address of Principal Executive Offices) (Zip Code)
(713) 292-5400
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.001 per share
SCM
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the issuer’s Common Stock, $0.001 par value per share, outstanding as of November 3, 2022 was 19,545,935.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Statements of Assets and Liabilities as of September 30, 2022 (unaudited) and December 31, 2021
1
Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2022 and 2021 (unaudited)
2
Consolidated Statements of Changes in Net Assets for the three and nine-month periods ended September 30, 2022 and 2021 (unaudited)
3
Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2022 and 2021 (unaudited)
Consolidated Schedules of Investments as of September 30, 2022 (unaudited) and December 31, 2021
5
Notes to Unaudited Financial Statements
23
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
52
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
70
Item 4.
Controls and Procedures
71
PART II. OTHER INFORMATION
Legal Proceedings
72
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
73
SIGNATURES
74
PART I — FINANCIAL INFORMATION
CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES
September 30,
2022
December 31,
(unaudited)
2021
ASSETS
Non-controlled, non-affiliated investments, at fair value (amortized cost of $899,059,872 and $785,005,957, respectively)
$
871,733,280
772,873,326
Cash and cash equivalents
12,419,743
44,174,856
Receivable for sales and repayments of investments
562,133
536,105
Interest receivable
3,852,386
2,944,599
Other receivables
60,495
54,752
Deferred tax asset
—
151,278
Related party receivable
19,034
Deferred offering costs
241,997
14,888
Prepaid expenses
219,079
512,214
Total Assets
889,108,147
821,262,018
LIABILITIES
Notes payable
98,437,095
98,102,973
Credit Facility payable
197,371,231
175,451,116
SBA-guaranteed debentures
300,157,597
244,615,903
Dividends payable
2,214,557
1,171,059
Management fees payable
7,032,721
3,454,225
Income incentive fees payable
1,909,651
1,749,130
Capital gains incentive fees payable
1,715,602
3,388,151
Interest payable
885,348
3,693,662
Unearned revenue
344,555
529,726
Administrative services payable
376,887
386,368
Income tax payable
1,086,338
3,269,514
Other accrued expenses and liabilities
398,581
338,958
Total Liabilities
611,930,163
536,150,785
Commitments and contingencies (Note 7)
Net Assets
277,177,984
285,111,233
NET ASSETS
Common stock, par value $0.001 per share (100,000,000 shares authorized; 19,545,935 and 19,517,595 issued and outstanding, respectively)
19,546
19,518
Paid-in capital
274,864,296
274,559,121
Accumulated undistributed surplus
2,294,142
10,532,594
Total Liabilities and Net Assets
Net Asset Value Per Share
14.18
14.61
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
For the three months ended
For the nine months ended
INVESTMENT INCOME
Interest income
19,617,468
16,460,579
50,392,437
44,819,754
Other income
524,799
568,764
1,353,279
1,301,827
Total Investment Income
20,142,267
17,029,343
51,745,716
46,121,581
OPERATING EXPENSES
Management fees
3,827,669
3,473,041
11,025,435
9,715,381
Valuation fees
145,865
141,012
315,482
289,447
Administrative services expenses
447,381
437,804
1,388,602
1,354,295
Income incentive fees
1,635,641
1,451,752
1,507,651
Capital gains incentive (reversal) fees
(646,757)
1,742,904
(1,672,549)
1,840,572
Professional fees
315,809
267,332
845,275
772,509
Directors’ fees
83,500
74,500
254,500
240,500
Insurance expense
127,274
120,119
377,671
356,439
Interest expense and other fees
6,448,280
4,854,388
16,864,255
13,869,834
Income tax expense
361,115
192,612
1,066,768
718,869
Other general and administrative expenses
207,170
209,779
766,562
796,338
Total Operating Expenses
12,952,947
12,965,243
32,867,642
31,461,835
Net Investment Income
7,189,320
4,064,100
18,878,074
14,659,746
Net realized gain on non-controlled, non-affiliated investments
1,553,450
7,921,322
4,658,817
6,601,885
Net realized loss on foreign currency translation
(676)
(8,026)
Loss on debt extinguishment
(539,250)
Net change in unrealized (depreciation) appreciation on non-controlled, non-affiliated investments
(4,798,980)
2,080,603
(12,810,173)
3,868,463
Net change in unrealized depreciation on foreign currency translations
(18,120)
(53,874)
Benefit (provision) for taxes on net unrealized depreciation (appreciation) on investments
30,535
(606,377)
(151,278)
(586,460)
Provision for taxes on realized gain on investments
(681,027)
Net Increase in Net Assets Resulting from Operations
3,955,529
12,778,621
10,513,540
23,323,357
Net Investment Income Per Share—basic and diluted
0.37
0.21
0.97
0.75
Net Increase in Net Assets Resulting from Operations Per Share—basic and diluted
0.20
0.66
0.54
1.20
Weighted Average Shares of Common Stock Outstanding—basic and diluted
19,545,935
19,486,003
19,535,708
Distributions Per Share—basic and diluted
0.34
0.58
0.96
1.08
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (unaudited)
Common Stock
Accumulated
Number
Par
Paid-in
undistributed
of shares
value
capital
surplus (deficit)
Balances at December 31, 2020
19,486
276,026,667
(2,685,504)
273,360,649
Net investment income
5,060,631
462,228
Net change in unrealized appreciation on non-controlled, non-affiliated investments
121,983
Provision for taxes on unrealized appreciation on investments
(167,804)
Distributions from net investment income
(4,869,552)
Balances at March 31, 2021
(2,617,268)
273,428,885
5,535,015
Net realized loss on non-controlled, non-affiliated investments
(1,781,665)
1,665,877
Benefit for taxes on unrealized depreciation on investments
187,721
Balances at June 30, 2021
(1,879,872)
274,166,281
(11,299,933)
Balances at September 30, 2021
(401,184)
275,644,969
Balances at December 31, 2021
19,517,595
5,514,183
3,458,090
(7,350)
Net change in unrealized depreciation on non-controlled, non-affiliated investments
(3,721,602)
(21,157)
(5,464,666)
Issuance of common stock, net of offering costs
14,924
15
167,655
167,670
Balances at March 31, 2022
19,532,519
19,533
274,726,776
10,290,092
285,036,401
6,174,571
(352,723)
(4,289,591)
(35,754)
(160,656)
(6,643,663)
13,416
13
137,520
137,533
Balances at June 30, 2022
4,982,276
279,866,118
Balances at September 30, 2022
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
For the
nine months ended
Cash flows from operating activities
Net increase in net assets resulting from operations
Adjustments to reconcile net increase in net assets from operations to net cash used in operating activities:
Purchases of investments
(180,956,810)
(243,298,147)
Proceeds from sales and repayments of investments
74,385,466
123,617,259
Net change in unrealized depreciation (appreciation) on investments
12,810,173
(3,868,463)
28,405
Increase in investments due to PIK
(1,010,061)
(607,393)
Amortization of premium and accretion of discount, net
(1,839,720)
(1,747,423)
Deferred tax provision
586,460
Amortization of loan structure fees
420,356
390,298
Amortization of deferred financing costs
334,122
346,123
Amortization of loan fees on SBA-guaranteed debentures
905,294
801,259
Net realized gain on investments
(4,658,817)
(6,595,217)
539,250
Changes in other assets and liabilities
Increase in interest receivable
(907,787)
(614,133)
Increase in other receivables
(5,743)
(110,000)
Increase in related party receivable
(19,034)
Increase in prepaid expenses
293,135
300,867
Increase in management fees payable
3,578,496
2,426,198
Increase in income incentive fees payable
160,521
948,489
(Decrease) increase in capital gains incentive fees payable
(Decrease) increase in administrative services payable
(9,481)
371,745
Decrease in interest payable
(2,808,314)
(1,406,381)
Decrease (increase) in unearned revenue
(185,171)
7,847
(Decrease) increase in income tax payable
(2,183,176)
511,851
Increase in other accrued expenses and liabilities
59,623
140,302
Net Cash Used In Operating Activities
(92,616,254)
(102,095,280)
Cash flows from Financing Activities
Proceeds from the issuance of common stock
420,004
Sales load for commons stock issued
(5,957)
Offering costs paid for common stock issued
(335,953)
Stockholder distributions paid
(17,708,494)
(13,636,301)
Repayment of Notes
(48,875,000)
Proceeds from issuance of Notes
100,000,000
Financing costs paid on Notes
(2,237,835)
Proceeds from SBA-guaranteed debentures
56,000,000
73,500,000
Financing costs paid on SBA-guaranteed debentures
(1,363,600)
(3,139,725)
Financing costs paid on Credit facility
(193,659)
(39,843)
Borrowings under Credit Facility
121,608,702
191,200,000
Repayments of Credit Facility
(97,559,902)
(175,400,000)
Net Cash Provided by Financing Activities
60,861,141
121,371,296
Net (Decrease) Increase in Cash and Cash Equivalents
(31,755,113)
19,276,016
Cash and Cash Equivalents balance at beginning of period
18,477,602
Cash and Cash Equivalents Balance at End of Period
37,753,618
Supplemental and Non-Cash Activities
Cash paid for interest expense
18,012,797
13,733,216
Income and excise tax paid
3,249,944
870,000
Increase in dividends payable
1,043,498
7,402,736
Increase (decrease) in deferred offering costs
227,109
(90,000)
Gain on conversion of equity investment
6,668
4
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
September 30, 2022
Principal
% of
Investment
Headquarters/
Amount/
Amortized
Fair
Net
Investments
Footnotes
Security(2)
Coupon
Floor
Cash
PIK
Date
Maturity
Industry
Shares(3)
Cost
Value(1)
Assets
Non-controlled, non-affiliated investments
(4)(5)
Ad.Net Acquisition, LLC
(9)
Los Angeles, CA
Term Loan (SBIC II)
(5)(11)
First Lien
3M LIBOR+
6.00
%
1.00
9.67
5/7/2021
5/7/2026
Services: Business
15,393,382
15,218,437
15,085,514
5.44
Ad.Net Holdings, Inc. Series A Common Stock (SBIC II)
(5)
Equity
7,794
77,941
86,711
0.03
Ad.Net Holdings, Inc. Series A Preferred Stock (SBIC II)
7,015
701,471
780,401
0.28
Total
15,997,849
15,952,626
5.75
ADS Group Opco, LLC
Lakewood, CO
6.75
10.42
6/4/2021
6/4/2026
Aerospace & Defense
14,625,000
14,397,840
14,040,000
5.07
Revolver
(11)
100,000
96,000
ADS Group Topco, LLC Class A Units
77,626
288,691
79,354
ADS Group Topco, LLC Class B Units
56,819
211,309
58,084
0.02
ADS Group Topco, LLC Class Z Units
6/15/2022
72,043
267,929
281,865
0.10
15,265,769
14,555,303
5.25
Advanced Barrier Extrusions, LLC
Rhinelander, WI
Term Loan B (SBIC)
(4)(11)
1M LIBOR+
7.50
10.69
11/30/2020
11/30/2026
Containers, Packaging, & Glass
17,193,750
16,938,263
14,528,718
5.24
GP ABX Holdings Partnership, L.P. Partner Interests
8/8/2018
644,737
528,395
17,466,658
AIP ATCO Buyer, LLC
Sterling Heights, MI
Term Loan
6M SOFR+
6.50
8.40
5/17/2022
5/17/2028
98,086
97,500
0.04
1M SOFR+
9.45
76,667
74,750
174,753
172,250
0.07
Anne Lewis Strategies, LLC
Washington, DC
10.17
3/5/2021
3/5/2026
10,637,500
10,481,779
3.84
4/15/2022
6,393,867
6,279,732
2.31
SG AL Investment, LLC Common Units
(6)
1,000
680,630
3,687,107
1.33
17,442,141
20,718,474
7.48
APE Holdings, LLC
Deer Park, TX
Class A Units
9/5/2014
Chemicals, Plastics, & Rubber
375,000
58,226
Atmosphere Aggregator Holdings II, L.P.
Atlanta, GA
Common Units
1/26/2016
254,250
2,036,832
0.73
Stratose Aggregator Holdings, L.P. Common Units
6/30/2015
750,000
6,008,353
2.17
8,045,185
2.90
ArborWorks Acquisition LLC
Oakhurst, CA
7.00
9.87
11/23/2021
11/9/2026
Environmental Industries
14,662,500
14,536,791
14,076,000
5.08
9.81
2,307,692
2,215,384
0.80
ArborWorks Holdings LLC Units
12/29/2021
115
115,385
2,951
16,959,868
16,294,335
5.88
Archer Systems, LLC
Houston, TX
3M SOFR+
10.20
8/11/2022
8/11/2027
1,000,000
980,516
0.35
9.65
11,250
11,031
CF Arch Holdings LLC Class A Units
8/10/2022
1,091,766
1,091,547
0.39
Axis Portable Air, LLC
Phoenix, AZ
3/22/2022
3/22/2028
Capital Equipment
12,000,000
11,776,310
11,820,000
4.26
Delayed Draw Term Loan
99,015
98,500
Axis Air Parent, LLC Preferred Units
4,436
443,636
558,591
12,318,961
12,477,091
4.50
Baker Manufacturing Company, LLC
Evansville, IN
(5)(10)(12)
9.73
7/5/2022
7/5/2027
13,863,087
13,590,887
4.90
BSC Blue Water Holdings, LLC Series A Units (SBIC II)
743,770
0.27
14,334,657
5.17
BDS Solutions Intermediateco, LLC
Tampa Bay, FL
Term Loan (SBIC)
6.25
9.14
2/24/2022
2/7/2027
13,422,278
13,300,876
13,220,944
4.77
9.03
83,398
82,147
13,384,274
13,303,091
4.80
BLP Buyer, Inc.
2/1/2022
2/1/2027
6,194,304
6,084,038
6,070,418
2.19
8.93
36,566
35,835
0.01
BL Products Parent, L.P. Class A Units
754,598
733,801
0.26
6,875,202
6,840,054
2.46
Café Valley, Inc.
1.25
10.03
8/28/2019
8/28/2024
Beverage, Food, & Tobacco
15,769,048
15,633,234
15,295,977
5.52
CF Topco LLC Units
9,160
916,015
499,394
0.18
16,549,249
15,795,371
5.70
Camp Profiles LLC
Boston, MA
9/3/2021
9/3/2026
Media: Advertising, Printing & Publishing
10,147,500
9,981,602
3.66
CIVC VI-A 829 Blocker, LLC Units
250
250,000
419,700
0.15
10,231,602
10,567,200
3.81
CEATI International Inc.
(7)(9)
Montreal, Canada
2/19/2021
2/19/2026
13,297,500
13,104,136
12,965,063
4.68
CEATI Holdings, LP Class A Units
279,287
13,354,136
13,244,350
4.78
CF512, Inc.
Blue Bell, PA
9.08
9/1/2021
9/1/2026
14,216,860
13,984,433
13,719,270
4.95
3,069,826
3,043,683
2,962,382
1.07
StellPen Holdings, LLC Membership Interests
22.09%
220,930
218,450
0.08
17,249,046
16,900,102
6.10
Colford Capital Holdings, LLC
(7)
New York, NY
8/20/2015
Finance
38,893
195,036
22,408
CompleteCase, LLC
Seattle, WA
12/21/2020
12/21/2025
Services: Consumer
11,277,391
11,120,807
10,826,295
3.91
Revolver A
40,000
38,400
CompleteCase Holdings, Inc. Class A Common Stock (SBIC II)
417
CompleteCase Holdings, Inc. Series A Preferred Stock (SBIC II)
522
521,734
348,236
0.13
11,682,546
11,212,934
4.05
Credit Connection, LLC
Fresno, CA
9.42
7/30/2021
7/30/2026
Software
9,900,000
9,742,242
9,801,000
3.54
3/31/2022
7,462,500
7,328,169
7,387,875
2.67
Series A Units
804,384
1,051,632
0.38
17,874,795
18,240,507
6.59
Curion Holdings, LLC
Chicago, IL
9.95
7/29/2022
7/29/2027
13,060,001
12,805,673
4.62
50,000
49,026
SP CS Holdings LLC Class A Units
739,999
13,595,672
13,594,698
4.91
Data Centrum Communications, Inc.
Montvale, NJ
Term Loan B
8.50
12.25
5/15/2019
5/15/2024
15,760,360
15,644,809
15,445,153
5.57
Health Monitor Holdings, LLC Series A Preferred Units
440,821
0.16
16,644,809
15,885,974
5.73
Douglas Products Group, LP
Liberty, MO
Partnership Interests
12/27/2018
322
139,656
890,380
0.32
Dresser Utility Solutions, LLC
Bradford, PA
Second Lien
11.62
10/1/2018
4/1/2026
Utilities: Oil & Gas
10,000,000
9,916,397
9,800,000
DRS Holdings III, Inc.
St. Louis, MO
8.87
11/1/2019
11/1/2025
Consumer Goods: Durable
9,512,699
9,458,228
9,227,318
3.33
DTE Enterprises, LLC
Roselle, IL
1.50
10.44
4/13/2018
4/13/2023
Energy: Oil & Gas
7,884,219
7,862,214
2.84
DTE Holding Company, LLC Class A-2 Units
776,316
466,204
599,868
0.22
DTE Holding Company, LLC Class AA Units
723,684
106,710
9,052,102
8,590,797
3.10
EC Defense Holdings, LLC
Reston, VA
Class B Units (SBIC)
(4)
7/31/2020
20,054
500,000
1,100,000
0.40
EH Real Estate Services, LLC
Skokie, IL
10.00
FIRE: Real Estate
7,894,294
7,763,397
6,591,735
2.38
EH Holdco, LLC Series A Preferred Units
7,892
7,891,642
4,711,587
1.70
15,655,039
11,303,322
4.08
6
Elliott Aviation, LLC
Moline, IL
8.00
1.75
9.12
2.00
1/31/2020
1/31/2025
9,960,214
9,860,416
9,063,795
3.27
1,375,182
1,251,416
0.45
SP EA Holdings LLC Class A Units
900,000
12,135,598
10,315,211
3.72
EOS Fitness Holdings, LLC
Class A Preferred Units
12/30/2014
Hotel, Gaming, & Leisure
118
228,711
Class B Common Units
3,017
456,497
685,208
0.24
Exacta Land Surveyors, LLC
Cleveland, OH
2/8/2019
2/8/2024
16,416,875
16,310,822
16,088,538
5.80
7/15/2022
997,500
980,344
977,550
SP ELS Holdings LLC Class A Units
1,122,250
853,749
0.31
18,413,416
17,919,837
6.46
Exigo, LLC
Dallas, TX
3/16/2022
3/16/2027
9,015,537
8,891,774
8,880,304
3.20
20,000
19,700
Gauge Exigo Coinvest, LLC Common Units
377,535
361,837
9,289,309
9,261,841
3.34
Florachem Corporation
Jacksonville, FL
4/29/2022
4/29/2028
9,975,000
9,786,431
9,775,500
3.53
SK FC Holdings, L.P. Class A Units
362
362,434
371,464
10,148,865
10,146,964
General LED OPCO, LLC
San Antonio, TX
(11)(15)
9.00
-
5/1/2018
3/31/2026
4,500,000
4,460,434
3,937,500
1.42
Grupo HIMA San Pablo, Inc., et al
San Juan, PR
(13)(18)
13.75
2/1/2013
Healthcare & Pharmaceuticals
4,109,524
GS HVAM Intermediate, LLC
Carlsbad, CA
9.62
10/18/2019
10/2/2024
12,667,555
12,609,372
12,604,217
4.55
2,651,515
2,638,257
0.95
HV GS Acquisition, LP Class A Interests
10/2/2019
2,144
1,967,133
1,303,634
0.47
17,228,020
16,546,108
5.97
Heartland Business Systems, LLC
Little Chute, WI
9.31
8/26/2022
8/26/2027
9,802,596
AMCO HBS Holdings, LP Class A Units
2,861
286,065
10,088,661
3.64
Heat Makes Sense Shared Services, LLC
Brooklyn, NY
5.50
9.63
7/1/2022
7/1/2029
Consumer Goods: Non-Durable
98,004
8.19
7/1/2028
32,000
31,361
Ishtar Co-Invest-B LP Partnership Interests
77,778
Oshun Co-Invest-B LP Partnership Interests
22,222
230,004
229,365
0.09
HV Watterson Holdings, LLC
Schaumburg, IL
12/17/2021
12/17/2026
13,335,828
13,103,063
13,002,432
4.69
16,000
15,600
323,918
320,730
315,820
0.11
HV Acquisition VI, LLC Class A Units
1,632
1,631,591
1,692,273
0.61
15,071,384
15,026,125
5.42
I2P Holdings, LLC
Series A Preferred Units
1/31/2018
3,063,272
1.11
ICD Holdings, LLC
San Francisco, CA
1/1/2018
9,962
464,619
604,270
Infolinks Media Buyco, LLC
Ridgewood, NJ
11/1/2021
11/1/2026
8,461,063
8,317,819
8,418,758
3.04
Tower Arch Infolinks Media, LP LP Interests
(6)(19)
10/28/2021
446,090
428,414
773,203
8,746,233
9,191,961
3.32
7
Inoapps Bidco, LLC
3M SONIA
7.70
2/15/2022
2/15/2027
£
13,282,349
11,017,372
3.97
8.54
83,333
82,524
82,083
Inoapps Holdings, LLC Series A-1 Preferred Units
739,844
783,756
946,858
14,148,629
12,046,313
4.34
Integrated Oncology Network, LLC
Newport Beach, CA
8.23
7/17/2019
6/24/2025
15,872,258
15,747,473
15,316,729
5.53
1,098,683
1,083,753
1,060,229
16,831,226
16,376,958
5.91
International Designs Holdings LLC
Farmingville, NY
4/1/2022
Construction & Building
200,000
194,990
Interstate Waste Services, Inc.
Amsterdam, OH
1/15/2020
21,925
946,125
648,147
0.23
Intuitive Health, LLC
Plano, TX
9.17
10/18/2027
5,850,000
5,781,953
2.11
8,227,806
8,132,503
2.97
8/31/2021
3,081,212
3,041,733
Legacy Parent, Inc. Class A Common Stock
10/30/2020
58
229,776
16,956,189
17,388,794
6.27
Invincible Boat Company LLC
Opa Locka, FL
8/28/2025
5,381,042
5,287,584
5,273,421
1.90
4,967,116
4,912,592
4,867,774
1.76
6/1/2021
1,104,255
1,088,258
1,082,170
744,681
729,787
Warbird Parent Holdco, LLC Class A Units
1,362,575
1,299,691
1,004,866
0.36
13,332,806
12,958,018
4.67
J.R. Watkins, LLC
3.00
12/22/2017
12/22/2022
12,694,221
12,679,701
11,234,386
J.R. Watkins Holdings, Inc. Class A Preferred Stock
1,133
1,132,576
169,964
0.06
13,812,277
11,404,350
4.11
Jurassic Acquisition Corp.
Sparks, MD
8.63
12/28/2018
11/15/2024
Metals & Mining
16,843,750
16,741,058
16,591,093
5.98
Kelleyamerit Holdings, Inc.
Walnut Creek, CA
(4)(10)(12)
1M BSBY
10.87
12/24/2020
12/24/2025
Automotive
9,750,000
9,615,065
9,555,000
3.45
(10)(12)
1,500,000
1,479,241
1,470,000
0.53
11,094,306
11,025,000
3.98
KidKraft, Inc.
5.00
7.29
4/3/2020
8/15/2022
1,580,768
0.57
KidKraft Group Holdings, LLC Preferred B Units
4,000,000
1.44
5,580,768
2.01
Ledge Lounger, Inc.
Katy, TX
Term Loan A (SBIC)
9.92
11/9/2021
7,587,401
7,458,817
7,359,779
2.66
SP L2 Holdings LLC Class A Units (SBIC)
407,423
7,833,817
7,767,202
2.81
Lightning Intermediate II, LLC
8.60
6/6/2022
6/6/2027
13,673,061
13,414,116
13,262,869
17,500
16,975
Gauge Vimergy Coinvest, LLC Units
399
398,677
531,764
0.19
13,830,293
13,811,608
4.98
MacKenzie-Childs Acquisition, Inc.
Aurora, NY
9/2/2022
9/2/2027
98,519
86,667
85,384
MacKenzie-Childs Investment, LP Partnership Interests
285,186
283,903
Madison Logic, Inc.
8.62
2/4/2021
11/22/2026
Media: Broadcasting & Subscription
3,762,813
3,752,130
1.36
11/22/2021
6,823,772
6,765,322
Madison Logic Holdings, Inc. Common Stock (SBIC)
11/30/2016
5,000
3,738,254
1.35
10,517,452
14,324,839
8
Microbe Formulas LLC
Meridian, ID
4/4/2022
4/3/2028
10,554,880
10,456,322
10,238,234
3.69
MOM Enterprises, LLC
Richmond, CA
5/19/2021
5/19/2026
16,260,833
16,009,846
15,773,008
5.69
MBliss SPC Holdings, LLC Units
933,333
748,262
16,943,179
16,521,270
5.96
Monitorus Holding, LLC
London, UK
10.68
5/24/2022
5/24/2027
Media: Diversified & Production
99,054
€
100,932
96,504
Sapphire Aggregator S.a r.l. Class A Shares
9/1/2022
557,689
11,156
Sapphire Aggregator S.a r.l. Class B Shares
557,682
Sapphire Aggregator S.a r.l. Class C Shares
Sapphire Aggregator S.a r.l. Class D Shares
Sapphire Aggregator S.a r.l. Class E Shares
Sapphire Aggregator S.a r.l. Class F Shares
Sapphire Aggregator S.a r.l. Class G Shares
Sapphire Aggregator S.a r.l. Class H Shares
Sapphire Aggregator S.a r.l. Class I Shares
300,390
295,408
Naumann/Hobbs Material Handling Corporation II, Inc.
10.30
8/30/2019
8/30/2024
8,600,197
8,525,811
8,557,196
3.09
5,423,316
5,376,408
5,396,199
1.95
Naumann Hobbs Holdings, L.P. Class A-1 Units
9/29/2022
123
220,379
316,291
Naumann Hobbs Holdings, L.P. Class A-2 Units
14,342,977
14,585,977
5.26
NS412, LLC
12.17
5/6/2019
11/6/2025
7,615,000
7,530,601
7,386,550
NS Group Holding Company, LLC Class A Units
782
795,002
563,856
8,325,603
7,950,406
2.86
NuMet Machining Techniques, LLC
Birmingham, United Kingdom
(11)(16)
PRIME
11/5/2019
5/5/2026
12,675,000
12,516,116
10,266,750
3.70
Bromford Industries Limited Term Loan
7,800,000
7,699,060
6,318,000
2.28
Bromford Holdings, L.P. Class A Membership Interests
0.83%
866,629
Bromford Holdings, L.P. Class D Membership Interests
3/18/2021
0.82%
280,078
21,361,883
16,584,750
NuSource Financial, LLC
Eden Prairie, MN
11.56
1/29/2021
1/29/2026
11,646,923
11,475,772
11,239,281
NuSource Financial Acquisition, Inc. (SBIC II)
Unsecured
13.75%
4.00
9.75
7/29/2026
5,501,492
5,427,926
4,676,268
1.69
NuSource Holdings, Inc. Warrants (SBIC II)
54,966
16,903,698
15,915,549
5.74
Nutritional Medicinals, LLC
Centerville, OH
11/15/2018
11/15/2025
10,199,016
10,124,553
9,995,036
3.61
4,340,881
4,288,721
4,254,063
1.53
Functional Aggregator, LLC Units
12,500
972,803
1,403,867
0.51
15,386,077
15,652,966
5.65
Onpoint Industrial Services, LLC
7.25
10.92
3/15/2021
3/15/2026
10,342,500
10,190,568
10,083,938
Onpoint Parent Holdings, LLC Class A Units
499,036
722,886
10,689,604
10,806,824
3.90
PCP MT Aggregator Holdings, L.P.
Oak Brook, IL
3/29/2019
825,020
119,281
1,266,578
0.46
9
PCS Software, Inc.
Shenandoah, TX
9.70
7/1/2019
7/1/2024
Transportation & Logistics
14,100,930
13,986,295
5.09
1,849,302
1,834,268
0.67
975,000
PCS Software Parent, LLC Class A Common Units
9/16/2022
461,216
492,724
16,795,563
17,417,956
6.29
Pearl Media Holdings, LLC
Garland, TX
9.30
8/31/2022
8/31/2027
11,667
11,437
9,814,263
9,814,033
Peltram Plumbing Holdings, LLC
Auburn, WA
12/30/2021
12/30/2026
16,621,626
16,331,509
16,122,976
5.82
Peltram Group Holdings LLC Class A Units
508,516
333,383
0.12
16,840,025
16,456,359
5.94
Premiere Digital Services, Inc.
8.37
11/3/2021
11/3/2026
14,314,904
14,254,313
14,171,755
5.11
Premiere Digital Holdings, Inc. Common Stock
10/18/2018
2,597,456
0.94
16,769,211
6.05
Protect America, Inc.
Austin, TX
(11)(14)
7.75
8/30/2017
9/1/2024
17,979,749
Rogers Mechanical Contractors, LLC
9.52
4/28/2021
9/9/2025
10,136,218
10,009,107
9,730,769
3.51
Sales Benchmark Index, LLC
1/7/2020
1/7/2025
12,481,823
12,354,282
12,169,777
4.39
SBI Holdings Investments LLC Class A Units
66,573
665,730
456,893
13,020,012
12,626,670
Service Minds Company, LLC
Bradenton, FL
2/7/2022
2/7/2028
5,371,417
5,273,689
5,210,274
1.88
32,162
31,859
31,197
5,305,548
5,241,471
1.89
SIB Holdings, LLC
Charleston, SC
9.33
10/29/2021
10/29/2026
12,952,045
12,733,560
12,628,244
4.56
870,629
853,361
848,863
7/20/2022
2,321,678
2,276,748
2,263,636
0.82
2,902,098
2,874,935
2,829,546
1.02
54,754
53,385
SIB Holdings, LLC Units
238,095
396,384
0.14
19,293,358
19,020,058
6.87
Skopos Financial Group, LLC
Irving, TX
6/29/2018
1,120,684
1,162,544
279,930
Spire Power Solutions, L.P.
Franklin, WI
9.82
11/22/2019
8/12/2026
4,850,000
4,802,657
4,704,500
8/12/2021
3,521,564
3,471,853
3,415,917
1.23
8,274,510
8,120,417
2.93
TAC LifePort Holdings, LLC
Woodland, WA
3/1/2021
741,794
TFH Reliability, LLC
10.75
14.42
10/21/2016
9/30/2023
5,875,000
5,857,590
5,786,875
2.09
5,000,000
4,931,166
4,925,000
1.78
TFH Reliability Group, LLC Class A-1 Units
6/29/2020
27,129
21,511
26,748
TFH Reliability Group, LLC Class A Units
231,521
184,885
11,041,788
10,923,508
3.95
Tilley Distribution, Inc.
Baltimore, MD
8.78
12/31/2026
99,497
98,116
95,517
53,878
51,723
151,994
147,240
0.05
10
Trade Education Acquisition, L.L.C.
9.37
12/28/2021
12/28/2027
Education
10,523,039
10,333,919
10,049,502
3.63
Trade Education Holdings, L.L.C. Class A Units
662,660
359,731
10,996,579
10,409,233
3.76
TradePending, LLC
Carrboro, NC
3/2/2021
3/2/2026
9,750,505
9,608,272
9,506,742
3.43
TradePending Holdings, LLC Series A Units
829,167
868,750
1,115,207
10,477,022
10,621,949
3.83
Unicat Catalyst Holdings, LLC
Alvin, TX
4/27/2021
4/27/2026
7,265,625
7,155,797
6,902,344
2.49
Unicat Catalyst, LLC Class A Units
7,500
242,294
7,905,797
7,144,638
2.58
U.S. Auto Sales, Inc. et al
Lawrenceville, GA
USASF Blocker II LLC Units
6/8/2015
441
441,000
360,274
USASF Blocker III LLC 2018 Series Units
2/13/2018
50
USASF Blocker III LLC 2019 Series Units
12/27/2019
75
75,000
150,000
USASF Blocker IV LLC Units
5/27/2020
110
110,000
330,000
USASF Blocker IV LLC 2022 Series Units
7/28/2022
100
300,000
USASF Blocker LLC Units
9,000
785,000
1,240,274
U.S. Expediters, LLC
Stafford, TX
12/22/2021
12/22/2026
15,906,865
15,629,225
Cathay Hypnos LLC Units
1,372,932
1,316,740
2,490,988
0.90
16,945,965
18,397,853
6.64
Venbrook Buyer, LLC
3/13/2020
3/13/2026
12,873,446
12,709,792
12,487,243
4.51
146,474
144,612
142,080
2,225,556
2,158,789
0.78
4,388,812
4,356,350
4,257,148
1.54
Venbrook Holdings, LLC Term Loan
(17)
10.00%
12/20/2028
87,095
84,482
Venbrook Holdings, LLC Common Units
822,758
819,262
277,901
20,342,667
19,407,643
7.01
Vortex Companies, LLC
9.50
13.15
6/21/2026
9,851,144
Whisps Holdings LP
Elgin, IL
4/18/2019
173,747
Xanitos, Inc.
Newtown Square, PA
6/25/2021
6/25/2026
12,640,000
12,441,303
12,197,600
4.40
2,226,790
2,207,719
2,148,852
Pure TopCo, LLC Class A Units
442,133
1,053,478
918,889
0.33
15,702,500
15,265,341
5.51
Total Non-controlled, non-affiliated investments
899,059,872
314.50
Net Investments
LIABILITIES IN EXCESS OF OTHER ASSETS
(594,555,296)
(214.50)
100.00
11
Unused
Unfunded
Commitment
Security
Fee
1,299,020
0.50%
May 7, 2026
23,333
May 17, 2028
March 5, 2026
ArborWorks Acquisition LLC (a)
1,153,846
November 9, 2026
88,750
August 11, 2027
March 22, 2028
16,602
February 7, 2027
63,434
February 1, 2027
3,750,000
1.00%
September 3, 2026
February 19, 2026
September 1, 2026
60,000
December 21, 2025
July 30, 2026
July 29, 2027
909,091
November 1, 2025
April 13, 2023
February 8, 2024
80,000
March 16, 2027
April 29, 2028
August 26, 2027
68,000
July 1, 2028
2,555,354
December 17, 2026
84,000
LP Interests
303,910
2,475,000
November 1, 2026
16,667
February 15, 2027
553,517
June 24, 2025
319,149
August 28, 2025
82,500
June 6, 2027
13,333
September 2, 2027
542,169
November 22, 2026
April 3, 2028
May 19, 2026
May 24, 2027
Revolver – Working Capital
1,763,033
August 30, 2024
2,000,000
November 15, 2025
1,318,143
July 1, 2024
88,333
August 31, 2027
December 30, 2026
576,923
November 3, 2026
September 9, 2025
0.75%
1,331,461
January 7, 2025
67,677
February 7, 2028
45,246
October 29, 2026
46,122
December 31, 2026
December 28, 2027
March 2, 2026
December 22, 2026
April 27, 2026
1,556,383
June 25, 2026
12
Abbreviation Legend
BSBY — Bloomberg Short-Term Bank Yield Index
LIBOR — London Interbank Offered Rate
PIK — Payment-In-Kind
SOFR — Secured Overnight Financing Rate
December 31, 2021
LIBOR
Security(3)
floor
Shares
Fair Value(1)
(2)(9)
(19)
(9)(35)
3M L+
15,510,294
15,303,443
15,277,640
5.36
81,692
735,229
16,082,855
16,094,561
14,850,000
14,581,135
14,478,750
(33)(35)
70,000
68,250
Pluto Aggregator, LLC Class A Units
250,169
Pluto Aggregator, LLC Class B Units
183,114
15,151,135
14,980,283
(2)(35)
1M L+
17,325,000
17,028,817
17,151,749
6.02
559,158
17,557,212
17,710,907
6.22
(20)
11,068,750
10,877,646
3.88
920,488
2,069,142
11,798,134
13,137,892
4.61
83,576
1,919,315
5,661,697
1.99
7,581,012
(35)
15,000,000
14,852,082
5.21
(31)(35)
1,084,615
1,073,920
16,052,082
16,041,387
5.63
ASC Communications, LLC
6/29/2017
6/29/2023
3,395,062
3,385,618
1.19
2/4/2019
5,771,605
5,744,381
2.02
ASC Communications Holdings, LLC Class A Units (SBIC)
(2)(4)
73,529
1,304,094
9,129,999
10,470,761
3.67
8.25
15,901,190
15,715,924
15,344,649
5.38
320,352
16,631,939
15,665,001
5.49
14
(8)(16)
10,224,375
10,031,055
10,071,009
277,332
10,281,055
10,348,341
(39)
(5)(35)
13,398,750
13,168,371
12,996,788
268,536
13,418,371
13,265,324
4.65
(49)
14,324,564
14,053,719
13,966,450
(35)(50)
3,093,023
3,062,540
3,015,698
1.06
22.09
246,500
17,337,189
17,228,648
11,363,478
11,174,252
11,079,391
3.89
(21)(35)
48,750
Revolver B
11/18/2021
8/17/2022
1,950,000
0.68
0.00
375,747
13,745,991
13,453,892
4.72
(36)
9,789,605
842,326
0.30
10,539,605
10,617,826
3.73
15,882,235
15,717,629
14,532,245
5.10
215,580
16,717,629
14,747,825
5.18
800,866
9,901,900
3.44
(10)
9,732,277
(18)
(6)(35)
0.50
9,368,725
9,310,842
9,087,663
3.19
605,420
10,500,730
9,693,083
3.40
(2)
616,212
7,954,099
7,803,059
7,834,788
2.75
7,990,210
2.80
15,694,701
15,824,998
5.55
17,641,992
17,408,385
17,024,522
1,354,425
1,307,020
SP EA Holdings, LLC Class A Units
233,145
19,662,810
18,564,687
6.51
Energy Labs Holding Corp.
9/29/2016
598
598,182
768,334
218,008
266,242
484,250
0.17
(23)
16,544,375
16,385,082
16,048,044
SP ELS Holdings LLC, Class A Units
1,069,143
452,649
17,454,225
16,500,693
5.79
(35)(40)
4,453,726
3,690,000
1.29
(25)
(27)(35)(41)
4,061,688
670,178
(15)(27)
0
(38)(51)
12.00
11/24/2021
147,344
(35)(38)(51)
442,033
331,525
8,760,589
1,149,047
0.41
12,765,248
12,687,507
4.48
0.93
1,796
1,618,844
2,266,541
0.79
16,957,866
17,683,304
6.20
(37)
13,436,603
13,167,870
(34)(35)
39,200
1,084
1,084,126
14,291,996
14,291,196
5.01
3,523,110
1.24
834,320
0.29
16
(43)
8,525,000
8,359,127
(60)
441,718
8,800,845
3.08
(30)
6/24/2024
15,993,848
15,819,044
5.61
1,107,034
1,084,893
16,903,937
17,100,882
514,402
5,895,000
5,818,411
2.07
11,298,750
11,151,955
3.96
3,104,554
3,060,021
1.09
230,224
20,030,387
20,528,528
7.20
(28)
5,579,004
5,460,897
5,551,109
5,149,850
5,080,887
5,124,101
1.80
1,144,879
1,124,655
1,139,155
1,405,979
0.49
12,966,130
13,220,344
4.64
San Francisco
(2)(6)
12,500,354
12,443,581
11,937,838
4.19
316,397
13,576,157
12,254,235
4.30
(12)
5.72
16,975,000
16,838,603
16,974,999
5.95
(2)(13)(22)
8.82
9,589,330
9,360,000
3.28
(13)(22)
1,475,282
1,440,000
11,064,612
10,800,000
3.79
(22)(29)
0.55
1.40
7,644,737
7,495,964
2.63
(35)(52)
66,667
65,369
7,937,631
7,936,333
2.78
(53)
3,791,247
3,778,850
3,753,335
1.32
6,875,337
6,807,544
6,806,583
2.39
1,773,443
0.62
10,586,394
12,333,361
4.33
17
Mobile Acquisition Holdings, LP
Santa Clara, CA
Class A2 Units
11/1/2016
750
455,385
2,863,270
(54)
16,384,333
16,087,954
16,138,568
5.66
1,054,829
17,021,287
17,193,397
6.03
(32)
8,744,721
8,642,580
8,700,997
3.05
5,514,453
5,450,043
5,486,881
1.92
CGC NH, Inc. Common Stock
440,758
780,155
14,533,381
14,968,033
7,513,674
7,462,700
2.62
686,742
8,308,676
8,149,442
11.00
12,491,009
11,851,125
4.16
7,683,112
7,293,000
2.56
0.83
393,106
21,320,828
19,537,231
6.86
11,081,250
10,892,077
10,804,219
(6)(9)
5,113,983
5,030,143
4,883,854
1.71
15,922,220
15,688,073
(24)
11,627,085
11,524,782
11,452,678
4.02
4,975,866
4,903,854
4,901,228
1.72
1,326,406
17,401,439
17,680,312
6.21
10,421,250
10,240,997
10,160,719
3.56
448,143
10,740,997
10,608,862
1,779,415
14,210,240
14,051,962
1,863,638
1,842,880
0.65
982,500
PCS Software Holdings, LLC Series A Preferred Units
325,000
468,263
PCS Software Holdings, LLC Series A-2 Preferred Units
11/12/2020
63,312
91,220
18,583,797
18,934,004
6.62
18
of Net
16,747,230
16,412,285
5.76
(11)(35)
31,500
30,870
16,952,301
16,951,671
(55)
14,423,077
14,352,950
14,350,962
5.03
Premiere Digital Holdings, Inc., Common Stock
1,228,760
0.43
15,579,722
5.46
(2)(26)(35)
17,979,748
1,078,785
(44)(45)
10,541,667
10,381,059
10,330,833
3.62
13,222,835
13,049,505
13,090,606
4.59
SBI Holdings Investments, LLC Class A Units
532,800
13,715,235
13,623,406
(57)
13,017,131
12,763,993
(35)(56)
6,667
6,537
13,270,660
13,270,530
4.66
338,616
4,887,500
4,832,386
4,740,875
1.66
6M L+
3,548,310
3,490,420
3,441,861
1.21
8,322,806
8,182,736
2.87
SQAD LLC
Tarrytown, NY
Media:
Broadcasting &
Subscription
14,179,594
14,162,082
4.97
SQAD Holdco, Inc. Series A Preferred Stock (SBIC)
10/31/2013
5,624
156,001
715,621
0.25
SQAD Holdco, Inc. Common Stock (SBIC)
5,800
62,485
83,839
14,380,568
14,979,054
TAC LifePort Purchaser, LLC
(42)
10,042,067
9,869,166
9,791,015
TAC LifePort Holdings, LLC Common Units
594,363
10,369,166
10,385,378
11.55
Chemicals,
Plastics, &
Rubber
5,845,883
5,757,500
24,883
85,123
6,098,915
5,867,506
2.06
(58)
10,602,558
10,390,507
11,053,167
3.87
(14)
9,925,000
9,753,957
9,676,875
3.39
683,646
10,503,957
10,360,521
(46)
7,406,250
7,274,639
7,221,094
2.53
315,280
8,024,639
7,536,374
2.64
553,597
685,000
1,133,597
19
(59)
16,027,068
15,706,527
0.48
17,079,459
5.99
12,952,771
12,758,396
4.54
147,377
145,165
2,222,222
4,415,556
4,376,990
1.55
645,469
20,322,035
20,383,395
7.15
10.50
9,828,022
442,742
(47)
NewtownSquare, PA
12,736,000
12,502,437
12,481,280
4.38
(35)(48)
2,243,617
2,221,181
2,198,745
0.77
379,327
904,000
895,329
15,627,618
15,575,354
785,005,957
271.08
(487,762,093)
(171.08)
20
21
Abbreviation LegendPIK — Payment-In-KindL — LIBOR
22
NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Stellus Capital Investment Corporation (“we”, “us”, “our” and the “Company”) was formed as a Maryland corporation on May 18, 2012 (“Inception”) and is an externally managed, closed-end, non-diversified investment management company. The Company is applying the guidance of Accounting Standards Codification (“ASC”) Topic 946, Financial Services Investment Companies (“ASC Topic 946”). The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), and treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), for U.S. federal income tax purposes. The Company’s investment activities are managed by our investment adviser, Stellus Capital Management, LLC (“Stellus Capital” or the “Advisor”).
As of September 30, 2022, the Company had issued a total of 19,545,935 shares and raised $287,476,304 in gross proceeds since Inception, incurring $9,406,067 in offering expenses and sales load fees. Additionally, the Company has received $131,257 in offering expenses reimbursements from the Advisor for net proceeds from offerings of $278,201,494. The Company’s shares are currently listed on the New York Stock Exchange under the symbol “SCM”. See Note 4 for further details.
The Company has established the following wholly owned subsidiaries: SCIC — Consolidated Blocker, Inc., SCIC — ICD Blocker 1, Inc., SCIC — Invincible Blocker 1, Inc., SCIC — SKP Blocker 1, Inc., SCIC — APE Blocker 1, Inc., SCIC — Venbrook Blocker, Inc., SCIC — CC Blocker 1, Inc., SCIC — ERC Blocker 1, Inc., and SCIC — Hollander Blocker 1, Inc., which are structured as Delaware entities, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities) (collectively, the “Taxable Subsidiaries”). The Taxable Subsidiaries are consolidated for U.S. generally accepted accounting principles (“U.S. GAAP”) reporting purposes, and the portfolio investments held by them are included in the consolidated financial statements.
On June 14, 2013, the Company formed Stellus Capital SBIC, LP (the “SBIC subsidiary”), a Delaware limited partnership, and its general partner, Stellus Capital SBIC GP, LLC, a Delaware limited liability company, as wholly owned subsidiaries of the Company. On June 20, 2014, the SBIC subsidiary received a license from the U.S. Small Business Administration (“SBA”) to operate as a Small Business Investment Company (“SBIC”) under Section 301(c) of the Small Business Investment Company Act of 1958, as amended (the “SBIC Act”). The SBIC subsidiary and its general partner are consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.
On November 29, 2018, the Company formed Stellus Capital SBIC II, LP (the “SBIC II subsidiary”), a Delaware limited partnership. On August 14, 2019, the SBIC II subsidiary received a license from the SBA to operate as an SBIC under Section 301(c) of the SBIC Act. The SBIC II subsidiary and its general partner, Stellus Capital SBIC GP, LLC, are consolidated for U.S. GAAP reporting purposes, and the portfolio investments held by it are included in the consolidated financial statements.
The SBIC licenses allow the SBIC subsidiary and SBIC II subsidiary (together, “the SBIC subsidiaries”) to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten-year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities. The SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over the Company’s stockholders in the event the Company liquidates one or both of the SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiaries upon an event of default. For the SBIC subsidiary, SBA regulations currently limit the amount that a single licensee may borrow to a maximum of $150,000,000 when it has at least $75,000,000 in regulatory capital, as such term is defined by the SBA, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. For the SBIC II subsidiary, SBA regulations limit these amounts to $175,000,000 of borrowings when it has at least $87,500,000 of regulatory capital.
As of both September 30, 2022 and December 31, 2021, the SBIC subsidiary had $75,000,000 in regulatory capital. As of both September 30, 2022 and December 31, 2021, the SBIC II subsidiary had $87,500,000 in regulatory capital.
As of both September 30, 2022 and December 31, 2021, the SBIC subsidiary had $150,000,000 of SBA-guaranteed debentures outstanding. As of September 30, 2022 and December 31, 2021, the SBIC II subsidiary had $156,000,000 and $100,000,000 of SBA-guaranteed debentures outstanding, respectively. See footnote (2) of the Consolidated Schedule of Investments for additional information regarding the treatment of investments in the SBIC subsidiaries with respect to the Credit Facility (as defined in Note 9).
As a BDC, the Company is required to comply with certain regulatory requirements. On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.
On April 4, 2018, the Company’s board of directors (the “Board”), including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. At the Company’s 2018 annual meeting of stockholders, our stockholders also approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company was decreased from 200% to 150%, effective June 29, 2018. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing. As of September 30, 2022, our asset coverage ratio was 193%.
The Company’s investment objective is to maximize the total return to its stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies. The Company seeks to achieve its investment objective by originating and investing primarily in private U.S. middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, second lien, unitranche and unsecured debt financing, with corresponding equity co-investments. The Company sources investments primarily through the extensive network of relationships that the principals of Stellus Capital have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries.
Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with generally accepted accounting principles in the U.S. GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, certain disclosures accompanying the annual financial statements prepared in accordance with U.S. GAAP are omitted. The unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.
In the opinion of management, the unaudited consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of the financial statements for the interim periods included herein. The results of operations for the three and nine months ended September 30, 2022 and September 30, 2021 are not necessarily indicative of the operating results to be expected for the full year. Also, the unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2021.
In accordance with Regulation S-X under the Exchange Act, the Company does not consolidate portfolio company investments. The accounting records of the Company are maintained in U.S. dollars.
COVID-19 Developments
The effect on the U.S. and global economy of the ongoing pandemic caused by the novel coronavirus, SARS-CoV-2 (also referred to as “COVID-19” or “Coronavirus”), uncertainty relating to new variants of the Coronavirus that have emerged in the United States and globally, vaccine distribution, hesitancy and efficacy, the length of economic recovery, and policies of the U.S. presidential administration have created stress on the market and could affect our portfolio companies. Each portfolio company has been assessed on an individual basis to identify the impact of the COVID-19 pandemic on the valuation of our investments in such company. We believe that any such COVID-19 pandemic impacts have been reflected in the valuation of our investments.
24
The extent of the impact of the COVID-19 pandemic on the financial performance of our current and future investments will depend on future developments, including the duration and spread of the virus, related advisories and restrictions, and the health of the financial markets and economy, all of which are highly uncertain and cannot be predicted. To the extent our portfolio companies are adversely impacted by the effects of the COVID-19 pandemic, it may have a material adverse impact on our future net investment income, the fair value of our portfolio investments and our financial condition.
Economic Developments
Economic activity has continued to accelerate across sectors and regions. Nonetheless, we have observed and continue to observe supply chain interruptions, labor resource shortages, commodity inflation, rising interest rates, economic sanctions in response to international conflicts and instances of geopolitical, economic and financial market instability in the United States and abroad. One or more of these factors may contribute to increased market volatility and may have long- and short-term effects in the United States and worldwide financial markets.
Portfolio Investment Classification
The Company classifies its portfolio investments in accordance with the requirements of the 1940 Act as follows: (a) “Control Investments” are defined as investments in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation, (b) “Affiliate Investments” are defined as investments in which the Company owns between 5% and 25% of the voting securities and does not have rights to maintain greater than 50% of the board representation, and (c) “Non-controlled, non-affiliate investments” are defined as investments that are neither Control Investments or Affiliate Investments.
Cash and Cash Equivalents
At September 30, 2022, cash balances totaling $242,911 did not exceed the Federal Deposit Insurance Corporation insurance protection levels of $250,000. In addition, at September 30, 2022, the Company held $11,961,055 in cash equivalents, which are carried at cost, which approximates fair value, and held foreign currency of $215,777 (acquisition cost of $241,247). All of the Company’s cash deposits are held at large established high credit quality financial institutions and management believes that risk of loss associated with any uninsured balances is remote.
Cash consists of bank demand deposits. We deem certain U.S. Treasury Bills and other high-quality, short-term debt securities as cash equivalents.
Fair Value Measurements
We account for all of our financial instruments at fair value in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”). ASC Topic 820 defines fair value, establishes a framework used to measure fair value, and requires disclosures for fair value measurements, including the categorization of financial instruments into a three-level hierarchy based on the transparency of valuation inputs. ASC Topic 820 requires disclosure of the fair value of financial instruments for which it is practical to estimate such value. We believe that the carrying amounts of our financial instruments such as cash, receivables and payables approximate the fair value of these items due to the short maturity of these instruments. This is considered a Level 1 valuation technique. The carrying values of our Credit Facility and SBA-guaranteed debentures approximate fair value because the interest rates adjusts to the market interest rates (Level 3 input). The carrying value of our 2026 Notes (as defined in Note 11) is based on the cost of the security, which approximates fair value (Level 2 input). See Note 6 to the consolidated financial statements for further discussion regarding the fair value measurements and hierarchy.
The COVID-19 pandemic is an unprecedented circumstance that could materially impact the fair value of the Company’s investments. As a result, the fair value of the Company’s portfolio investments may be further negatively impacted after September 30, 2022, by circumstances and events that are not yet known. The COVID-19 pandemic may impact the Company’s portfolio companies’ ability to pay their respective contractual obligations, including principal and interest due to the Company, and some portfolio companies could require interest or principal deferrals to fulfill short-term liquidity needs. The Company works with each of its portfolio companies, as necessary, to help them access short-term liquidity through potential interest deferrals, funding on unused lines of credit, and other sources of liquidity. During the quarter ended September 30, 2022, no interest deferrals have been made related to COVID-19 or otherwise.
25
Consolidation
As permitted under Regulation S-X under the Exchange Act and ASC Topic 946, we generally do not consolidate our investment in a portfolio company other than an investment company subsidiary. Accordingly, we consolidated the results of the SBIC subsidiaries and the Taxable Subsidiaries. All intercompany balances have been eliminated upon consolidation.
Use of Estimates
The preparation of the Statements of Assets and Liabilities in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially. Additionally, as explained in Note 1 contained herein, the Consolidated Financial Statements includes investments in the portfolio whose values have been estimated by the Company, pursuant to procedures established by our Board, in the absence of readily ascertainable market values. Because of the inherent uncertainty of the investment portfolio valuations, those estimated values may differ materially from the values that would have been determined had a ready market for the securities existed.
Deferred Financing Costs
Deferred financing costs, prepaid loan fees on SBA-guaranteed debentures and prepaid loan structure fees consist of fees and expenses paid in connection with the closing of our Credit Facility, 2026 Notes and SBA-guaranteed debentures and are capitalized at the time of payment. These costs are amortized using the straight line method over the term of the respective instrument and presented as an offset to the corresponding debt on the Consolidated Statements of Assets and Liabilities.
Offering Costs
Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement. These costs are capitalized when incurred and recognized as a reduction of offering proceeds when the offering is consummated and shown on the Consolidated Statements of Changes in Net Assets and Liabilities as a reduction to Paid-in-Capital.
In December 2020, the U.S. Securities and Exchange Commission (the “SEC”) adopted a new rule providing a framework for fund valuation practices. Rule 2a-5 under the 1940 Act (“Rule 2a-5”) establishes requirements for determining fair value in good faith for purposes of the 1940 Act. Rule 2a-5 permits boards, subject to board oversight and certain other conditions, to designate certain parties to perform fair value determinations. Rule 2a-5 also defines when market quotations are “readily available” for purposes of the 1940 Act and the threshold for determining whether a fund must determine the fair value of a security. The SEC also adopted new Rule 31a-4 under the 1940 Act (“Rule 31a-4”), which provides the recordkeeping requirements associated with fair value determinations. Finally, the SEC is rescinding previously issued guidance on related issues, including the role of the board in determining fair value and the accounting and auditing of fund investments. Rule 2a-5 and Rule 31a-4 became effective on March 8, 2021, and have a compliance date of September 8, 2022. While our board of directors has not elected to designate the Advisor as the valuation designee, the Company has adopted certain revisions to its valuation policies and procedures in order comply with the applicable requirements of Rule 2a-5 and Rule 31a-4.
As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity securities of private middle-market companies. Section 2(a)(41)of the 1940 Act requires that a BDC value its assets as follows: (i) the third party price for securities for which a quotation is readily available; and (ii) for all other securities and assets, fair value, as determined in good faith by a BDC's Board of Directors. Under procedures established by our Board of Directors, the Company intends to value investments for which market quotations are readily available at such market quotations. The Company will obtain these market values from an independent pricing service or at the midpoint of the bid and ask prices obtained from at least two brokers or dealers (if available, otherwise by a principal market maker or a primary market dealer). Debt and equity securities that are not publicly traded or whose market prices are not readily available will be valued at fair value as determined in good faith by our Board of Directors. Such determination of fair values may involve subjective judgments and estimates. The Company also engages independent valuation providers to review the valuation of each portfolio investment that does not have a readily available market quotation at least twice annually.
26
Debt and equity investments purchased within approximately 90 days of the valuation date will be valued at cost, plus accreted discount, or minus amortized premium, which approximates fair value. With respect to unquoted securities, our Board will value each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the Board will use the pricing indicated by the external event to corroborate and/or assist us in our valuation. Because the Company expects that there will not be a readily available market quotation for many of the investments in its portfolio, the Company expects to value most of its portfolio investments at fair value as determined in good faith by the Board using a documented valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.
In following these approaches, the types of factors that will be taken into account in fair value pricing investments will include, as relevant, but not be limited to:
Revenue Recognition
We record interest income on an accrual basis to the extent such interest is deemed collectible. Payment-in-kind (“PIK”) interest, represents contractual interest accrued and added to the loan balance that generally becomes due at maturity. We will not accrue any form of interest on loans and debt securities if we have reason to doubt our ability to collect such interest. Loan origination fees, original issue discount and market discount or premium are capitalized, and we then accrete or amortize such amounts using the effective interest method as interest income. Upon the prepayment of a loan or debt security, any unamortized loan origination fee is recorded as interest income. We record prepayment premiums on loans and debt securities as other income. Dividend income, if any, will be recognized on the declaration date.
27
A presentation of the interest income we have received from portfolio companies for the three and nine months ended September 30, 2022 and 2021 is as follows:
Loan interest
18,194,230
14,812,457
46,926,570
41,336,827
PIK income
356,527
247,391
1,010,061
607,393
Fee amortization income(1)
769,272
701,489
2,070,733
936,083
Fee income acceleration(2)
297,439
699,242
385,073
1,939,451
Total Interest Income
To maintain our treatment as a RIC, substantially all of this income must be paid to stockholders in the form of distributions, even if we have not collected any cash.
Management considers portfolio company specific circumstances as well as other economic factors in determining collectability. As of September 30, 2022, we had four loans on non-accrual status, which represented approximately 5.5% of our loan portfolio at cost and 2.5% at fair value. As of December 31, 2021, we had three loans on non-accrual status, which represented approximately 4.2% of our loan portfolio at cost and 0.8% at fair value. As of September 30, 2022 and December 31, 2021, $6,200,882 and $10,363,904, respectively, of income from investments on non-accrual has not been accrued. If a loan or debt security’s status significantly improves regarding the debtor’s ability to service the debt or other obligations, or if a loan or debt security is sold or written off, we will remove it from non-accrual status.
Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation
Realized gains or losses are measured by the difference between the net proceeds from the repayment, sale or disposition and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.
Investment Transaction Costs
Costs that are material associated with an investment transaction, including legal expenses, are included in the cost basis of purchases and deducted from the proceeds of sales unless such costs are reimbursed by the borrower.
Receivables and Payables for Unsettled Securities Transaction
The Company records all investments on a trade date basis.
U.S. Federal Income Taxes
The Company has elected, qualified, and intends to continue to qualify annually to be treated as a RIC under Subchapter M of the Code, and to operate in a manner to qualify for the tax treatment applicable to RICs. To qualify for tax treatment as a RIC, among other things, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. So long as the Company maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as dividends. Rather, any tax liability related to income earned by the Company represents obligations of the Company’s investors and will not be reflected in the consolidated financial statements of the Company.
28
To avoid a 4% U.S federal excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending December 31 (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax or the Excise Tax Avoidance Requirement. For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid). The Company, at its discretion, may choose not to distribute all its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned. Income tax expense for the three and nine months ended September 30, 2022 of $361,115 and $1,086,338, respectively, was mostly related to excise and franchise taxes. Income tax expense for the three and nine months ended September 30, 2021 of $192,612 and $718,869, respectively, was related mostly to excise tax.
The Company evaluates tax positions taken or expected to be taken while preparing its tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the applicable period. As of September 30, 2022 and December 31, 2021, the Company had not recorded a liability for any unrecognized tax positions. Management’s evaluation of uncertain tax positions may be subject to review and adjustment at a later date based upon factors including, but not limited to, an on-going analysis of tax laws, regulations and interpretations thereof. The Company’s policy is to include interest and penalties related to income taxes, if applicable, in general and administrative expenses. Any expenses for the three and nine months ended September 30, 2022 and 2021 were de minimis.
The Taxable Subsidiaries are direct wholly-owned subsidiaries of the Company that have elected to be taxable entities. The Taxable Subsidiaries permit the Company to hold equity investments in portfolio companies that are “pass through” entities for tax purposes and continue to comply with the “source-of-income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in the Company’s consolidated financial statements.
The Taxable Subsidiaries use the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, using statutory tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. Taxable income generally excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.
For the three and nine months ended September 30, 2022, the Company recorded deferred income tax benefit of $30,535 and provision of ($151,278), respectively, related to the Taxable Subsidiaries. For the three and nine months ended September 30, 2021, the Company recorded deferred income tax provision related to the Taxable Subsidiaries of ($606,377) and ($586,640), respectively. In addition, as of September 30, 2022 and December 31, 2021, the Company had a deferred tax liability of $0 and deferred tax asset of $151,278, respectively.
Earnings per Share
Basic per share calculations are computed utilizing the weighted average number of shares of the Company’s common stock outstanding for the period. The Company has no common stock equivalents. As a result, there is no difference between diluted earnings per share and basic per share amounts.
Paid In Capital
The Company records the proceeds from the sale of shares of its common stock on a net basis to (i) capital stock and (ii) paid in capital in excess of par value, excluding all commissions and marketing support fees.
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Distributable Earnings (Accumulated Undistributed Deficit)
The components that make up distributable earnings (accumulated undistributed deficit) on the Statements of Assets and Liabilities as of September 30, 2022 and December 31, 2021 are as follows:
Accumulated net realized gain from investments, net of cumulative dividends of $25,571,955 for both periods
7,461,702
2,810,908
Net unrealized depreciation on non-controlled non-affiliated investments and cash equivalents, net of benefit for taxes of $0 and $151,278, respectively
(24,942,806)
(11,981,353)
Net unrealized depreciation on foreign currency translations
Accumulated undistributed net investment income
19,829,121
19,703,039
Recently Issued Accounting Standards
In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-04, Reference Rate Reform. The amendments in ASU 2020-04 provide optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The standard is effective as of March 12, 2020 through December 31, 2022. The Company has agreements that have the London Interbank Offered Rate (“LIBOR”) as a reference rate with certain portfolio companies and with certain lenders. Many of these agreements include language for choosing an alternative successor rate if LIBOR reference is no longer considered to be appropriate. Contract modifications are required to be evaluated in determining whether the modifications result in the establishment of new contracts or the continuation of existing contracts. The Company adopted this amendment in March 2020 and plans to apply the amendments in this update to account for contract modifications as contracts are amended to include a new reference rate or when LIBOR reference is no longer used. The Company did not utilize the optional expedients and exceptions provided by ASU 2020-04 during the nine months ended September 30, 2022.
From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. We believe the impact of the recently issued standards and any that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
NOTE 2 — RELATED PARTY ARRANGEMENTS
Investment Advisory Agreement
The Company has entered into an investment advisory agreement with Stellus Capital pursuant to which Stellus Capital serves as its investment adviser. Pursuant to this agreement, the Company has agreed to pay to Stellus Capital an annual base management fee of 1.75% of gross assets, including assets purchased with borrowed funds or other forms of leverage and excluding cash and cash equivalents, and an incentive fee.
For the three and nine months ended September 30, 2022, the Company recorded an expense for base management fees of $3,827,669 and $11,025,435, respectively. For the three and nine months ended September 30, 2021, the Company recorded an expense for base management fees of $3,473,041 and $9,715,381, respectively. As of September 30, 2022 and December 31, 2021, $7,032,721 and $3,454,225, respectively, were payable to Stellus Capital.
The incentive fee has two components, the investment income incentive fee and the capital gains incentive fee, as follows:
Investment Income Incentive Fee
The investment income component (“Income Incentive Fee”) is calculated, and payable to the Advisor, quarterly in arrears based on the Company’s pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The pre-incentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar
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quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as the “Hurdle”). Pre-incentive fee net investment income means interest income, dividend income and any other income accrued during the calendar quarter, minus the Company’s operating expenses for the quarter excluding the incentive fee. Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s pre-incentive fee net investment income does not exceed the Hurdle. Subject to the cumulative total return requirement described below, the Advisor receives 100% of the Company’s pre-incentive fee net investment income for any calendar quarter with respect to that portion of the pre-incentive net investment income for such quarter, if any, that exceeds the Hurdle but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “Catch-up”) and 20.0% of the Company’s pre-incentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets.
The foregoing Income Incentive Fee is subject to a total return requirement, which provides that no Income Incentive Fee in respect of the Company’s pre-incentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative Income Incentive Fees accrued and/or paid for the 11 preceding quarters. In other words, any Income Incentive Fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the Catch-up, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such Income Incentive Fee that is attributable to deferred interest until the Company actually receives such interest in cash.
For both the three and nine months ended September 30, 2022, the Company incurred $1,635,641 of Income Incentive Fees. For the three and nine months ended September 30, 2021, the Company incurred $1,451,752 and $1,507,651 of Income Incentive Fees, respectively. As of September 30, 2022 and December 31, 2021, $1,909,651 and $1,749,130, respectively, of such Income Incentive Fees were payable to the Advisor, of which $1,591,753 and $1,459,942, respectively, are currently payable (as explained below). As of September 30, 2022 and December 31, 2021, $317,898 and $289,188, respectively, of Income Incentive Fees incurred but not paid by the Company were generated from deferred interest (i.e. PIK, certain discount accretion and deferred interest) and are not payable until such amounts are received by the Company in cash.
Capital Gains Incentive Fee
The Company also pays the Advisor an incentive fee based on capital gains (the “Capital Gains Incentive Fee”). The Capital Gains Incentive Fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). The Capital Gains Incentive Fee is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from Inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid Capital Gain Incentive Fees is subtracted from such Capital Gain Incentive Fees when the calculated.
U.S. GAAP requires that the Capital Gains Incentive Fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation or depreciation of investments and other financial instruments in the calculation, as an incentive fee would be payable if such realized gains and losses and unrealized capital appreciation or depreciation were realized, even though such realized gains and losses and unrealized capital appreciation or depreciation is not permitted to be considered in calculating the Capital Gains Incentive Fee actually payable under the investment advisory agreement. There can be no assurance that unrealized appreciation or depreciation will be realized in the future. Accordingly, such fees, as calculated and accrued, may not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of incentive fees in subsequent periods.
For the three and nine months ended September 30, 2022, the Company reversed $646,757 and $1,672,549, respectively, related to the Capital Gains Incentive Fee. For the three and nine months ended September 30, 2021, the Company accrued $1,742,904 and $1,840,572, respectively, related to the Capital Gains Incentive Fee. As of September 30, 2022 and December 31, 2021, $1,715,602 and $3,388,151, respectively, of Capital Gains Incentive Fees were accrued but not currently payable to the Advisor.
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The following tables summarize the components of the incentive fees discussed above:
Three Months Ended
Nine Months Ended
Investment income incentive fees incurred
Capital gains incentive fees (reversed) incurred
Incentive fees (reversal) expense
988,884
3,194,656
(36,908)
3,348,223
Investment income incentive fee currently payable
1,591,753
1,459,942
Investment income incentive fee deferred
317,898
289,188
Capital gains incentive fee deferred
Incentive fee payable
3,625,253
5,137,281
Director Fees
For the three and nine months ended September 30, 2022, the Company recorded an expense relating to director fees of $83,500 and $254,500, respectively. For the three and nine months ended September 30, 2021, the Company recorded an expense relating to director fees of $74,500 and $240,500, respectively. As of both September 30, 2022 and December 31, 2021, the Company had no unpaid independent director fees.
Co-Investment Pursuant to SEC Order
On October 23, 2013, the Company received an exemptive order (the “2013 Order”) from the SEC to co-invest with private funds managed by Stellus Capital where doing so is consistent with the Company’s investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, the Company received a new exemptive order (the “2018 Order”) that superseded the 2013 Order. On May 9, 2022, the Company received a new exemptive order (the “Order”) that superseded the 2018 Order and permits the Company greater flexibility to enter into co-investment transactions. The Order expands on the 2013 Order and 2018 Order and allows the Company to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital or an adviser that is controlled, controlling, or under common control with Stellus Capital, subject to the conditions included therein. Additionally, the Order provided added relief which allows the Company, subject to the satisfaction of certain conditions, to co-invest in existing portfolio companies with certain affiliates that are private funds if such private funds did not have an investment in such existing portfolio company. Without the added relief, such private funds would not be able to participate in such co-investments with the Company unless the private funds had previously acquired securities of the portfolio company in a co-investment transaction with the Company. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with its investment objectives and strategies. The Company co-invests, subject to the conditions in the Order, with private credit funds managed by Stellus Capital that have an investment strategy that is similar or identical to the Company’s investment strategy, and the Company may co-invest with other BDCs and registered investment companies managed by Stellus Capital or an adviser that is controlled, controlling, or under common control with Stellus Capital in the future. The Company believes that such co-investments may afford it additional investment opportunities and an ability to achieve greater diversification.
Administrative Agent
The Company serves as the administrative agent on certain investment transactions, including co-investments with its affiliates under the Order. As of both September 30, 2022 and December 31, 2021, there was no cash due to other investment funds related to interest paid by a borrower to the Company as administrative agent. Any such amount would be included in “Other Accrued Expenses and Liabilities” on the Consolidated Statements of Assets and Liabilities.
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License Agreement
The Company has entered into a license agreement with Stellus Capital under which Stellus Capital has agreed to grant the Company a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, the Company has a right to use the “Stellus Capital” name for so long as Stellus Capital or one of its affiliates remains its investment adviser. Other than with respect to this limited license, the Company has no legal right to the “Stellus Capital” name. This license agreement will remain in effect for so long as the investment advisory agreement with Stellus Capital is in effect.
Administration Agreement
The Company entered into an administration agreement with Stellus Capital pursuant to which Stellus Capital will furnish the Company with office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative services necessary to conduct day-to-day operations. Under this administration agreement, Stellus Capital will perform, or oversee the performance of, its required administrative services, which includes, among other things, being responsible for the financial records which the Company is required to maintain and preparing reports to its stockholders and reports filed with the SEC.
For the three months ended September 30, 2022 and 2021, the Company recorded expenses of $369,209 and $368,680, respectively, related to the administration agreement and are included in administrative services expenses on our Consolidated Statements of Operations. For the nine months ended September 30, 2022 and 2021, the Company recorded expenses of $1,162,527 and $1,133,108, respectively, related to the administration agreement and are included in administrative services expenses on our Consolidated Statements of Operations. As of September 30, 2022 and December 31, 2021, $369,209 and $382,322, respectively, remained payable to Stellus Capital related to the administration agreement and are included in administrative services payable on our Consolidated Statements of Assets and Liabilities.
Indemnifications
The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations under the investment advisory agreement, Stellus Capital and its officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital’s services under the investment advisory agreement or otherwise as our investment adviser.
The Company has also entered into indemnification agreements with its directors. The indemnification agreements are intended to provide the Company’s directors the maximum indemnification permitted under Maryland law and the 1940 Act. Each indemnification agreement provides that the Company shall indemnify the director who is a party to the agreement (an “Indemnitee”), including the advancement of legal expenses, if, by reason of his or her corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, other than a proceeding by or in the right of the Company.
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NOTE 3 — DISTRIBUTIONS
Distributions are generally declared by the Company’s Board each calendar quarter and recognized as distribution liabilities on the declaration date. The stockholder distributions, if any, will be determined by the Board. Any distribution to stockholders will be declared out of assets legally available for distribution.
For the three and nine months ended September 30, 2022, the Company has declared aggregate distributions of $0.34 and $0.96 per share on its common stock. The Company has declared aggregate distributions of $13.01 per share on its common stock since Inception:
Date Declared
Record Date
Payment Date
Per Share(1)
Fiscal 2012
Fiscal 2013
Fiscal 2014
Fiscal 2015
Fiscal 2016
Fiscal 2017
Various
Fiscal 2018
Fiscal 2019
Fiscal 2020
1.15
Fiscal 2021
1.14
Fiscal 2022
January 13, 2022
January 28, 2022
February 15, 2022
0.0933
February 25, 2022
March 15, 2022
March 31, 2022
April 15, 2022
April 19, 2022
April 29, 2022
May 13, 2022
0.1133
May 27, 2022
June 15, 2022
June 30, 2022
July 15, 2022
July 13, 2022
July 29, 2022
August 15, 2022
August 31, 2022
September 15, 2022
October 14, 2022
13.01
The Company has adopted an “opt out” dividend reinvestment plan (“DRIP”) pursuant to which a stockholder whose shares are held in his own name will receive distributions in shares of the Company’s common stock under the Company’s DRIP unless it elects to receive distributions in cash. Stockholders whose shares are held in the name of a broker or the nominee of a broker may have distributions reinvested only if such service is provided by the broker or the nominee, or if the broker of the nominee permits participation in the Company’s DRIP.
Although distributions paid in the form of additional shares of the Company’s common stock will generally be subject to U.S. federal, state and local taxes in the same manner as cash distributions, investors participating in the Company’s DRIP will not receive any corresponding cash distributions with which to pay any such applicable taxes. Any distributions reinvested through the issuance of shares through the Company’s DRIP will increase the Company’s gross assets on which the base management fee and the incentive fee are determined and paid to Stellus Capital. The Company did not issue shares through the DRIP during either of the three and nine months ended September 30, 2022 or 2021.
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NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES
The table below illustrates the number of common stock shares the Company issued since Inception through various equity offerings and pursuant to the Company’s DRIP.
Average
Number of
Gross
Underwriting
Offering
Fees Covered
Issuance of Common Stock
Proceeds(1)(2)
fees
Expenses
by Advisor
Proceeds(3)
Price
Year ended December 31, 2012
12,035,023
180,522,093
4,959,720
835,500
174,726,873
14.90
Year ended December 31, 2013
63,998
899,964
14.06
Year ended December 31, 2014
380,936
5,485,780
75,510
29,904
5,380,366
14.47
Year ended December 31, 2017
3,465,922
48,741,406
1,358,880
307,021
47,075,505
Year ended December 31, 2018
7,931
93,737
11.85
Year ended December 31, 2019
3,177,936
45,862,995
1,015,127
559,261
37,546
44,326,153
14.43
Year ended December 31, 2020
354,257
5,023,843
5,680
84,592
66,423
4,999,994
14.40
Year ended December 31, 2021
31,592
449,515
6,744
53,327
4,255
393,699
14.23
Quarter ended March 31,2022
209,006
3,137
50,369
12,170
14.00
Quarter ended June 30, 2022
187,965
2,820
58,475
10,863
14.01
Quarter ended September 30, 2022
NA
287,476,304
7,427,618
1,978,449
131,257
278,201,494
On November 16, 2021, the Company entered into an equity distribution agreement, as amended and restated on August 29, 2022 (the “Equity Distribution Agreement”), with Keefe Bruyette & Woods, Inc. and Raymond James & Associates, Inc., as sales agents and/or principal thereunder. Under the Equity Distribution Agreement, the Company may, issue and sell, from time to time, up to $50,000,000 in aggregate offering price of shares of common stock, par value $0.001 per share, with the intention to use the net proceeds from this at-the-market sales program (the “ATM Program”) to repay certain outstanding indebtedness and make investments in portfolio companies in accordance with its investment objective and strategies.
During the nine months ending September 30, 2022, the Company issued 28,340 shares under the ATM Program, for gross proceeds of $396,971 not including underwriting fees and other expenses of $114,801. The average per share offering price of shares issued in the ATM Program during the nine months ended September 30, 2022 was $14.01. The Advisor agreed to reimburse the Company for underwriting fees and expenses to the extent the per share price of the shares to the public, less underwriting fees, was less then net asset value per share. For the nine months ending September 30, 2022, the Advisor reimbursed the Company $23,033, which resulted in net proceeds of $414,047, or $14.61 per share, excluding the impact of offering expenses. The Company did not issue any shares during the nine months ended September 30, 2021.
The Company issued 0 shares of common stock through the DRIP for both the nine months ended September 30, 2022 and 2021.
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NOTE 5 — NET INCREASE IN NET ASSETS PER COMMON SHARE
The following information sets forth the computation of net increase in net assets resulting from operations per common share for the three and nine months ended September 30, 2022 and September 30, 2021.
Weighted average common shares
Net increase in net assets from operations per share
NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE
In accordance with the authoritative guidance on fair value measurements and disclosures under U.S. GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:
Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 — Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;
Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.
The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.
At September 30, 2022, the Company had investments in 89 portfolio companies. The total cost and fair value of the investments were $899,059,872 and $871,733,280, respectively. The composition of our investments as of September 30, 2022 is as follows:
Fair Value
Senior Secured – First Lien(1)
756,556,124
742,272,654
Senior Secured – Second Lien
84,851,781
58,220,675
Unsecured Debt
5,515,021
4,760,750
52,136,946
66,479,201
Total Investments
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At December 31, 2021, the Company had investments in 73 portfolio companies. The total cost and fair value of the investments were $785,005,957 and $772,873,326 respectively. The composition of our investments as of December 31, 2021 was as follows:
652,561,144
646,352,935
79,806,598
56,733,110
47,608,072
64,903,427
The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of September 30, 2022 and December 31, 2021, the Company had 49 and 32 of such investments with aggregate unfunded commitments of $30,269,900 and $30,982,734, respectively. The Company maintains sufficient liquidity (through cash on hand and available borrowings under the Credit Facility) to fund such unfunded loan commitments should the need arise.
The aggregate gross unrealized appreciation and depreciation and the aggregate cost and fair value of the Company’s portfolio company securities as September 30, 2022 and December 31, 2021 were as follows:
Aggregate cost of portfolio company securities
Gross unrealized appreciation of portfolio company securities
30,662,296
27,283,421
Gross unrealized depreciation of portfolio company securities
(57,988,888)
(39,416,052)
Aggregate fair value of portfolio company securities
The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of September 30, 2022 are as follows:
Quoted Prices
in Active
Markets
Significant Other
Significant
for Identical
Observable
Unobservable
Securities
Inputs
(Level 1)
(Level 2)
(Level 3)
Senior Secured – First Lien
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The fair values of our investments disaggregated into the three levels of the fair value hierarchy based upon the lowest level of significant input used in the valuation as of December 31, 2021 are as follows:
The aggregate values of Level 3 portfolio investments change during the nine months ended September 30, 2022 are as follows:
Senior Secured
Loans-First
Loans-Second
Lien
Debt
Fair value at beginning of period
168,278,616
4,900,000
83,511
7,694,683
180,956,810
Payment-in-kind interest
618,968
391,093
Sales and redemptions
(62,655,976)
(11,897,663)
(74,553,639)
Realized gains
(3,930,891)
8,731,852
4,800,961
Change in unrealized depreciation included in earnings(1)
(5,691,477)
(3,557,615)
(607,983)
(2,953,098)
Change in unrealized depreciation on foreign currency included in earnings
(2,383,786)
1,684,265
145,180
10,275
1,839,720
Fair value at end of period
There were no Level 3 transfers during the nine months ended September 30, 2022.
The aggregate values of Level 3 portfolio investments change during the year ended December 31, 2021 are as follows:
508,673,064
70,720,186
21,191,245
52,840,000
653,424,495
354,637,555
965,250
11,705,915
22,105,811
389,414,531
521,595
417,435
939,030
(214,319,978)
(13,161,428)
(29,384,595)
(33,210,915)
(290,076,916)
Realized gains (losses)
1,475,577
23,993,443
23,687,355
Change in unrealized (depreciation) appreciation included in earnings(1)
(6,821,212)
(157,390)
875,354
(824,912)
(6,928,160)
2,186,334
148,157
78,500
2,412,991
There were no Level 3 transfers during the twelve months ended December 31, 2021.
38
The following is a summary of geographical concentration of our investment portfolio as of September 30, 2022:
% of Total
Texas
201,139,725
179,543,296
20.60
California
161,803,119
159,142,278
18.26
Illinois
66,129,076
60,270,478
6.91
Florida
56,001,786
55,461,152
6.36
Arizona
43,211,187
43,543,647
4.99
Pennsylvania
42,867,943
41,965,443
4.81
Ohio
34,745,618
37,284,222
4.28
Wisconsin
35,829,829
32,737,796
3.75
Washington
29,022,571
28,411,087
3.26
New Jersey
25,391,042
25,077,935
2.88
District of Columbia
Georgia
10,794,107
19,016,228
2.18
South Carolina
United Kingdom
21,662,273
16,880,158
1.94
16,893,052
16,738,333
Minnesota
1.83
New York
11,427,678
15,055,505
1.73
Colorado
1.67
Indiana
1.64
Canada
1.52
North Carolina
1.22
Massachusetts
Idaho
1.17
Missouri
9,597,884
10,117,698
1.16
Virginia
Michigan
Puerto Rico
39
The following is a summary of geographical concentration of our investment portfolio as of December 31, 2021:
at fair value
153,793,390
157,446,299
20.37
161,550,893
142,657,160
18.46
69,780,236
71,066,882
9.20
42,866,707
42,604,002
41,067,458
40,790,941
5.28
36,551,789
38,218,517
4.94
31,165,320
31,117,284
4.03
25,161,998
27,334,823
25,880,018
25,893,643
3.35
25,518,474
23,548,670
11,066,059
19,045,442
2.20
2.03
9,871,933
10,600,866
1.37
1.34
40
The following is a summary of industry concentration of our investment portfolio as of September 30, 2022:
204,607,775
216,144,996
24.80
85,931,481
83,081,912
9.53
52,871,690
52,545,237
55,272,075
52,204,827
46,305,068
45,631,242
5.23
49,263,250
42,197,058
4.84
41,803,330
41,772,219
4.79
37,641,126
38,124,297
4.37
34,277,269
32,515,226
24,771,765
31,094,050
3.57
29,763,100
29,310,956
3.36
27,757,137
26,742,482
3.07
27,049,132
26,382,118
3.03
43,293,446
24,404,811
Retail
High Tech Industries
1.38
1.30
11,269,059
11,197,250
1.28
1.12
0.99
2,726,480
3,413,460
41
The following is a summary of industry concentration of our investment portfolio as of December 31, 2021:
167,253,835
177,242,299
22.93
104,933,428
99,584,343
12.89
66,503,939
63,467,579
8.21
53,136,718
51,125,659
39,319,912
42,892,137
36,216,806
36,537,445
4.73
34,089,805
33,791,047
30,597,444
29,447,632
27,333,360
27,282,504
26,826,229
26,355,789
3.41
21,498,947
23,841,617
40,034,415
22,682,119
2.45
2.29
2.05
14,638,210
14,288,322
1.85
1.43
11,098,912
10,461,417
1.27
2,507,199
4,108,356
The following provides quantitative information about Level 3 fair value measurements as of September 30, 2022:
Description:
Valuation Technique
Unobservable Inputs
Range (Average)(1)(3)
First lien debt
Income/Market
HY credit spreads,
-1.31% to 5.10% (1.68%)
approach(2)
Risk free rates
-0.33% to 3.88% (2.72%)
Market multiples
3.7x to 23.6x (10.7x)(4)
Second lien debt
-0.27% to 2.34% (1.39%)
1.18% to 3.91% (2.59%)
5.8x to 18.3x (12.5x)(4)
Unsecured debt
4.65% to 4.65% (4.65%)
3.66% to 3.66% (3.66%)
9.5x to 9.5x (9.5x)(4)
Equity investments
Market approach(5)
Underwriting multiple/
EBITDA Multiple
1.1x to 24.6x (11.5x)
Total Long Term Level 3 Investments
42
The following provides quantitative information about Level 3 fair value measurements as of December 31, 2021:
Income/Market(2)
-3.93% to 0.48% (-0.24%)
approach
-1.95% to 0.86% (-0.05%)
4.5x to 25x (11.6x)(4)
-2.54% to 0.53% (-0.53%)
-1.79% to 0.94% (-0.29%)
7.1x to 16.4x (12.9x)(4)
0.25% to 0.25% (0.25%)
0.75% to 0.75% (0.75%)
12.4x to 12.4x (12.4x)(4)
1.6x to 24.9x (11.5x)
43
NOTE 7 — COMMITMENTS AND CONTINGENCIES
The Company is currently not subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our business, financial condition or results of operations.
As of September 30, 2022, the Company had $29,965,990 in unfunded debt commitments and $303,910 in unfunded equity commitments to 49 existing portfolio companies. As of December 31, 2021, the Company had $30,674,452 in unfunded debt commitments and $308,282 in unfunded equity commitments to 32 existing portfolio companies. As of September 30, 2022, the Company had sufficient liquidity (through cash on hand and available borrowings under the Credit Facility) to fund such unfunded loan commitments should the need arise.
NOTE 8 — FINANCIAL HIGHLIGHTS
Per Share Data:(1)
Net asset value at beginning of period
14.03
Change in unrealized (depreciation) appreciation on investments
(0.66)
Net realized gain
(0.03)
(0.01)
Total from operations
Sales load
(0.00)
Offering costs
Stockholder distributions from:
(0.96)
(1.08)
Net asset value at end of period
14.15
Per share market value at end of period
11.93
13.06
Total return based on market value(2)
(2.3)
25.9
Weighted average shares outstanding for the period
44
Ratio/Supplemental Data:(1)
Net assets at end of period
Weighted average net assets
283,289,645
273,663,257
Annualized ratio of gross operating expenses to net assets(5)
15.57
15.59
Annualized ratio of interest expense and other fees to net assets
7.96
6.78
Annualized ratio of net investment income to net assets(5)
8.91
6.95
Portfolio turnover(3)
8.92
17.17
199,033,419
189,800,000
306,000,000
Asset coverage ratio(4)
1.93
x
NOTE 9 — CREDIT FACILITY
On October 11, 2017, the Company entered into a senior secured revolving credit agreement, as amended, dated as of October 10, 2017, that was amended and restated on December 21, 2021, February 28, 2022 and May 13, 2022, with Zions Bancorporation, N.A., dba Amegy Bank and various other lenders (the “Credit Facility”).
The Credit Facility provides for borrowings up to a maximum of $265,000,000 on a committed basis with an accordion feature that allows the Company to increase the aggregate commitments up to $280,000,000, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.
Pursuant to the Third Amendment and Commitment Increase to Amended and Restated Senior Secured Revolving Credit Agreement, the Credit Facility will bear interest, subject to the Company’s election, on a per annum basis equal to (i) term SOFR plus 2.50% (or 2.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus a SOFR credit spread adjustment (0.10% for one-month term SOFR and 0.15% for three-month term SOFR), with a 0.25% SOFR floor, or (ii) 1.50% (or 1.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus an alternate base rate based on the highest of the prime rate (subject to a 3% floor), Federal Funds Rate plus 0.50% and one month term SOFR plus 1.00%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable monthly or quarterly in arrears. The commitment to fund the revolver expires on September 18, 2024, after which the Company may no longer borrow under the Credit Facility and must begin repaying principal equal to 1/12 of the aggregate amount outstanding under the Credit Facility each month. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on September 18, 2025.
45
The Company’s obligations to the lenders are secured by a first priority security interest in its portfolio of securities and cash not held at the SBIC subsidiaries, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10,000,000, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 1.67 to 1.00, (iii) maintaining a minimum stockholder’s equity, and (iv) maintaining a minimum interest coverage ratio of at least 2.00 to 1.00. As of September 30, 2022 and December 31, 2021, the Company was in compliance with these covenants.
As of September 30, 2022 and December 31, 2021, $199,033,419 and $177,340,000, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair value of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. The Company has incurred costs of $3,967,310 in connection with the current Credit Facility, which are being amortized over the life of the facility. Additionally, $341,979 of costs from a prior credit facility will continue to be amortized over the life of the Credit Facility. As of September 30, 2022 and December 31, 2021, $1,662,188 and $1,888,884 of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
The following is a summary of the Credit Facility, net of prepaid loan structure fees:
177,340,000
Prepaid loan structure fees
(1,662,188)
(1,888,884)
Credit facility payable, net of prepaid loan structure fees
Interest is paid monthly or quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three and nine months ended September 30, 2022 and 2021:
Interest expense
2,575,787
1,406,123
5,800,223
3,873,550
Loan fee amortization
148,121
150,598
Total interest and financing expenses
2,723,908
1,556,721
6,220,579
4,263,848
Weighted average interest rate
4.9
2.8
3.8
Effective interest rate (including fee amortization)
5.2
3.2
4.1
3.3
Average debt outstanding
207,437,767
191,891,304
201,712,826
174,057,143
Cash paid for interest and unused fees
2,548,660
1,415,901
5,772,502
3,904,908
NOTE 10 — SBA-GUARANTEED DEBENTURES
Due to the SBIC subsidiaries’ status as licensed SBICs, the Company has the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the regulations applicable to SBIC funds, a single licensee can have outstanding debentures guaranteed by the SBA subject to a regulatory leverage limit, up to two times the amount of “regulatory capital”, as such term is defined by the SBA. As of both September 30, 2022 and December 31, 2021, the SBIC subsidiary had $75,000,000 in regulatory capital, as such term is defined by the SBA, and $150,000,000 of SBA-guaranteed debentures outstanding.
As of September 30, 2022, and December 31, 2021, the SBIC II subsidiary had $87,500,000 both in regulatory capital, as such term is defined by the SBA and $156,000,000 and $100,000,000 of SBA-guaranteed debentures outstanding, respectively.
On August 12, 2014, the Company obtained exemptive relief from the SEC to permit it to exclude the debt of the SBIC subsidiaries guaranteed by the SBA from its asset coverage test under the 1940 Act. The exemptive relief provides the Company with increased
46
flexibility under the asset coverage test by permitting it to borrow up to $325,000,000 more than it would otherwise be able to absent the receipt of this exemptive relief.
On a stand-alone basis, the SBIC subsidiaries held $463,857,626 and $403,333,676 in assets at September 30, 2022 and December 31, 2021, respectively, which accounted for approximately 52.2% and 49.1% of the Company’s total consolidated assets, respectively.
Debentures guaranteed by the SBA have fixed interest rates that equal prevailing 10-year U.S. Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity, but may be pre-paid at any time with no prepayment penalty. SBA-guaranteed debentures drawn before October 1, 2019 incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. SBA-guaranteed debentures drawn after October 1, 2019 incur upfront fees of 3.435%, which consists of a 1.00% commitment fee and a 2.435% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September of each applicable year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.
The following table summarizes the SBIC subsidiaries’ aggregate SBA-guaranteed debentures as of September 30, 2022:
Issuance Date
Licensee
Maturity Date
Debenture Amount
Interest Rate
SBA Annual Charge
October 14, 2014
SBIC I
March 1, 2025
6,500,000
2.52
October 17, 2014
December 24, 2014
3,250,000
June 29, 2015
September 1, 2025
2.83
October 22, 2015
March 1, 2026
2.51
0.74
November 10, 2015
8,800,000
November 18, 2015
November 25, 2015
December 16, 2015
2,200,000
December 29, 2015
9,700,000
November 28, 2017
March 1, 2028
25,000,000
April 27, 2018
September 1, 2028
40,000,000
3.55
July 30, 2018
17,500,000
September 25, 2018
March 1, 2029
2,500,000
3.11
Total SBIC I SBA-guaranteed Debentures
150,000,000
47
October 17, 2019
SBIC II
March 1, 2030
6,000,000
2.08
November 15, 2019
December 17, 2020
March 1, 2031
9,000,000
February 16, 2021
13,500,000
February 26, 2021
March 2, 2021
April 21, 2021
September 1, 2031
May 14, 2021
6,700,000
May 28, 2021
7,300,000
July 23, 2021
16,000,000
March 1, 2032
2.94
March 29, 2022
September 1, 2032
April 1, 2022
6,670,000
April 12, 2022
6,665,000
April 21, 2022
3,600,000
July 28, 2022
6,400,000
September 9, 2022
March 1, 2033
4.07
%(1)
Total SBIC II SBA-guaranteed Debentures
156,000,000
Total SBA-guaranteed debentures
As of September 30, 2022 and December 31, 2021, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures are estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At September 30, 2022 and December 31, 2021, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.
As of September 30, 2022, the Company has incurred $10,686,100 in financing costs related to the SBA-guaranteed debentures since receiving its licenses, which were recorded as prepaid loan fees. As of September 30, 2022 and December 31, 2021, $5,842,403 and $5,384,097 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
The following is a summary of the SBA-guaranteed debentures, net of prepaid loan fees:
SBA debentures payable
250,000,000
Prepaid loan fees
(5,842,403)
(5,384,097)
SBA Debentures, net of prepaid loan fees
48
The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three and nine months ended September 30, 2022 and 2021:
2,076,751
1,661,946
5,743,011
4,644,014
Debenture fee amortization
316,274
299,373
801,258
2,393,025
1,961,319
6,648,305
5,445,272
2.7
299,556,522
246,173,913
280,681,996
220,354,579
Cash paid for interest
3,955,224
3,201,057
7,360,295
5,907,676
NOTE 11 — NOTES
On August 21, 2017, the Company issued $42,500,000 in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, the Company issued an additional $6,375,000 in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. On January 13, 2021, the Company caused notices to be issued to the holders of its 2022 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2022 Notes, pursuant to the Second Supplemental Indenture dated as of August 21, 2017, between the Company and U.S. Bank National Association, as trustee. The Company redeemed all $48,875,000 in aggregate principal amount of the 2022 Notes on February 12, 2021. The 2022 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date. As a result of the redemption, the Company recognized a loss on debt extinguishment of $539,250 due to the write off of the remaining deferred financing costs on the 2022 Notes. This loss is included in the Consolidated Statements of Operations for the nine months ended September 30, 2021.
Prior to their redemption on February 12, 2021, the 2022 Notes were listed on New York Stock Exchange under the trading symbol “SCA”. As of December 31, 2020, the fair value of the 2022 Notes was $49,168,250. The carrying value of the 2022 Notes approximates fair value.
The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the nine months ended September 30, 2021:
320,063
Deferred financing costs
28,232
Administration fees
357,295
Loss on debt extinguishment(1)
Weighted average interest rate(2)
5.7
Effective interest rate (including fee amortization)(2)
6.4
Average debt outstanding(3)
48,875,000
453,966
49
On January 14, 2021, the Company issued $100,000,000 in aggregate principal amount of 4.875% fixed-rate notes due 2026 (the “2026 Notes”). The 2026 Notes will mature on March 30, 2026 and may be redeemed in whole or in part at any time or from time to time at our option on or after December 31, 2025 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest on the 2026 Notes is payable semi-annually beginning September 30, 2021.
The Company used the net proceeds from the 2026 Notes offering to fully redeem the 2022 Notes and repay a portion of the amount outstanding under the Credit Facility. As of both September 30, 2022 and December 31, 2021, the aggregate carrying amount of the 2026 Notes was approximately $100,000,000.
In connection with the issuance and maintenance of the 2026 Notes, the Company incurred $2,327,835 of fees which are being amortized over the term of the 2026 Notes. As of September 30, 2022 and December 31, 2021, $1,562,905 and $1,897,027 of prepaid financing costs had yet to be amortized, respectively. These financing costs are presented on the Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2026 Notes for the three and nine months ended September 30, 2022 and 2021:
1,218,750
3,656,250
3,480,208
112,598
117,598
339,122
323,211
1,331,348
1,336,348
3,995,372
3,803,419
4.8
5.3
100,000,000(1)
2,437,500
3,466,667
4,880,000
The following is a summary of the 2026 Notes Payable, net of deferred financing costs:
(1,562,905)
(1,897,027)
Notes payable, net of deferred financing costs
The indenture and supplements thereto relating to the 2026 Notes contain certain covenants, including but not limited to (i) a requirement that the Company comply with the asset coverage requirements of the 1940 Act or any successor provisions, and (ii) a requirement to provide financial information to the holders of the notes and the trustee under the indenture if the Company should no longer be subject to the reporting requirements under the Exchange Act. As of September 30, 2022 and 2021, the Company was in compliance with these covenants.
NOTE 12 — SUBSEQUENT EVENTS
Investment Portfolio
New and Add-On Investments
Activity Type
Company Name
Company Description
Investment Amount
Instrument Type
New Investment
October 12, 2022
NINJIO, LLC
Cybersecurity awareness and training platform
$5,000,000
First lien term loan
$100,000
Revolver commitment
Delayed draw term loan commitment
$313,253
Equity investment
Full Repayments and Realizations
Proceeds Received
Realized Gain
Full Realization
October 17, 2022
Existing portfolio company
$1,159,638
$950,000
Credit Facility
The outstanding balance under the Credit Facility as of November 3, 2022 was $206,828,283.
Dividends Declared
On October 4, 2022, the Board declared a regular monthly dividend for each of October 2022, November 2022 and December 2022 as follows:
Ex-Dividend
Record
Payment
Amount per
Declared
Share
10/04/2022
10/28/2022
10/31/2022
11/15/2022
11/29/2022
11/30/2022
12/15/2022
12/16/2022
12/29/2022
On October 4, 2022, the Board declared an additional monthly dividend for each of October 2022, November 2022 and December 2022 as follows:
Custody Agreement
Ðn November 2, 2022, the Company's SBIC Subsidiary, a wholly owned subsidiary of the Company, entered into a Custody Agreement, dated as of November 2, 2022 (the "Frost Agreement”), with Frost Bank (“Frost”), pursuant to which Frost was appointed as a custodian to hold certain securities, loans, cash, and other assets on behalf of the SBIC Subsidiary. Either party may terminate the Frost Agreement at any time upon sixty (60) days’ prior written notice.
51
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements, which relate to future events or Stellus Capital Investment Corporation’s (“we”, “us”, “our” and the “Company”) future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties, related to the current COVID-19 pandemic and otherwise, including statements as to:
Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.
We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or U.S. Securities and Exchange Commission (“SEC”) rule or regulation. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Overview
We were organized as a Maryland corporation on May 18, 2012, and formally commenced operations on November 7, 2012. Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through debt and related equity investments in middle-market companies.
We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the Investment Company Act of 1940, as amended (the “1940 Act”). Our investment activities are managed by our investment adviser, Stellus Capital.
As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets. Qualifying assets include investments in “eligible portfolio companies.” (as defined in the 1940 Act). Under the relevant SEC rules, the term “eligible portfolio company” includes all private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized and with their principal of business in the United States.
We have elected, qualified, and intend to continue to qualify annually to be treated for tax purposes as a RIC under Subchapter M of the internal Revenue Code of 1986, as amended (the “Code”). To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As of September 30, 2022, we were in compliance with the RIC requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income we distribute to our stockholders.
On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs. The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.
On April 4, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. At our 2018 annual meeting of stockholders our stockholders also approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio applicable to us was decreased from 200% to 150%, effective June 28, 2019 which effectively increased the amount of leverage we may incur. As of September 30, 2022, our asset coverage ratio was 193%. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.
The effect on the U.S. and global economy of the ongoing pandemic caused by the novel coronavirus, SARS-CoV-2 (also referred to as “COVID-19” or “Coronavirus”, uncertainty relating to new variants of the Coronavirus that have emerged in the United States and globally, vaccine distribution, hesitancy and efficacy, the length of economic recovery, and policies of the U.S. presidential administration have created stress on the market and could affect our portfolio companies. Each portfolio company has been assessed on an individual basis to identify the impact of the COVID-19 pandemic on the valuation of our investments in such company. We believe that any such COVID-19 pandemic impacts have been reflected in the valuation of our investments.
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Portfolio Composition and Investment Activity
Portfolio Composition
We originate and invest primarily in privately-held middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien (including unitranche), second lien, and unsecured debt financing, often times with a corresponding equity investment.
As of September 30, 2022, we had $871.7 million (at fair value) invested in 89 portfolio companies. As of September 30, 2022, our portfolio included approximately 85% of first lien debt, 7% of second lien debt, 0% of unsecured debt and 8% of equity investments at fair value. The composition of our investments at cost and fair value as of September 30, 2022 was as follows:
As of December 31, 2021, we had $772.9 million (at fair value) invested in 73 portfolio companies. As of December 31, 2021, our portfolio included approximately 84% of first lien debt, 7% of second lien debt, 1% of unsecured debt and 8% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2021 was as follows:
Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms and conditions of the underlying loan agreements. As of September 30, 2022 and December 31, 2021, we had unfunded commitments of $30.3 million and $31.0 million, respectively, to provide debt financing to 49 and 32 portfolio companies, respectively. As of September 30, 2022, we had sufficient liquidity (through cash on hand and available borrowings under the Credit Facility) to fund such unfunded commitments should the need arise.
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55
56
57
At September 30, 2022, our average portfolio company investment at amortized cost and fair value was approximately $10.1 million and $9.8 million, respectively, and our largest portfolio company investment at amortized cost and fair value was $20.7 million and $20.5 million, respectively. At December 31, 2021, our average portfolio company investment at amortized cost and fair value was approximately $10.8 million and $10.6 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $21.3 million and $20.5 million, respectively.
At September 30, 2022, 97% of our debt investments bore interest based on floating rates (subject to interest rate floors) and 3% bore interest at fixed rates. At December 31, 2021, 96% of our debt investments bore interest based on floating rates (subject to interest rate floors) and 4% bore interest at fixed rates.
The weighted average yield on all of our debt investments as of September 30, 2022 and December 31, 2021 was approximately 9.8% and 8.0%, respectively. The weighted average yield on all of our investments, including non-income producing equity positions, as of September 30, 2022 and December 31, 2021 was approximately 9.2% and 7.5%, respectively. The weighted average yield was computed using the effective interest rates for all of our debt investments, including accretion of original issue discount. The weighted average yield of our debt investments is not the same as a return on investment for our stockholder, but rather relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses.
As of September 30, 2022 and December 31, 2021, we had cash and cash equivalents of $12.4 million and $44.2 million, respectively.
Investment Activity
During the nine months ended September 30, 2022, we made an aggregate of $181.0 million of investments in 20 new portfolio companies and 26 existing portfolio companies. During the nine months ended September 30, 2022, we received an aggregate of $74.4 million in proceeds from repayments of our investments.
Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital to middle-market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.
Asset Quality
In addition to various risk management and monitoring tools, Stellus Capital uses an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:
As of September 30, 2022
As of December 31, 2021
(dollars in millions)
Portfolio
Investment Category
Companies
158.8
63.6
559.6
64
585.0
76
132.8
118.4
20.5
3.7
2.2
871.7
89
772.9
Loans and Debt Securities on Non-Accrual Status
We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. As of September 30, 2022, we had loans to four portfolio companies that were on non-accrual status, which represented approximately 5.5% of our loan portfolio at cost and 2.5% at fair value. As of December 31, 2021, we had loans to three portfolio companies that were on non-accrual status, which represented approximately 4.2% of our loan portfolio at cost and 0.8% at fair value. As of September 30, 2022 and December 31, 2021, $6.2 million and $10.4 million of income from investments on non-accrual has not been accrued, respectively.
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Results of Operations
An important measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses including interest on borrowed funds. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.
Comparison of the three months and nine months ended September 30, 2022 and 2021
Revenues
We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at primarily at floating rates. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in-kind, or PIK interest. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the total dollar amount of interest and any dividend income that we earn will increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.
The following shows the breakdown of investment income for the three and nine months ended September 30, 2022 and 2021 (in millions).
September 30, 2021
Interest income(1)
19.0
16.2
49.0
44.2
PIK interest
0.3
0.2
1.0
0.6
Miscellaneous fees(1)
0.8
1.7
1.3
20.1
17.0
51.7
46.1
The increase in interest income from the respective periods was due primarily to growth in the overall investment portfolio.
Our primary operating expenses include the payment of fees to Stellus Capital under the investment advisory agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:
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The following shows the breakdown of operating expenses for the three and nine months ended September 30, 2022 and 2021 (in millions).
Operating Expenses
3.5
11.0
9.7
0.1
0.5
0.4
1.4
1.6
1.5
(0.6)
(1.7)
1.8
Directors' fees
6.5
16.9
13.9
1.1
0.7
13.0
32.9
31.5
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The increase in operating expenses for both the three months ended September 30, 2021 and nine months ended September 30, 2021 was due to (1) higher interest expense as a result of higher outstanding balances on our SBA-guaranteed debentures and 2026 Notes and (2) higher management fees due to a larger investment portfolio.
For the three months ended September 30, 2022, net investment income was $7.2 million, or $0.37 per common share (based on 19,545,935 weighted average shares outstanding for the quarter ended September 30, 2022).
For the three months ended September 30, 2021, net investment income was $4.1 million, or $0.21 per common share (based on 19,486,003 weighted average shares outstanding for the quarter ended September 30, 2021).
For the nine months ended September 30, 2022, net investment income was $18.9 million, or $0.97 per common share (based on 19,535,708 weighted average shares outstanding for the nine months ended September 30, 2022).
For the nine months ended September 30, 2021, net investment income was $14.7 million, or $0.75 per common share (based on 19,486,003 weighted average shares outstanding for the nine months ended September 30, 2021).
The increase in net investment income over the respective periods was due to higher investment income as a result of a larger investment portfolio, rising interest rates, offset by the increase in expenses as explained in the “Expenses” section above.
Net Realized Gains and Losses
We measure realized gains or losses by the difference between the net proceeds from the repayment, sale or other disposition and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.
Proceeds from repayments of investments and amortization of certain other investments for the three months ended September 30, 2022 totaled $16.2 million and net realized gains totaled $1.6 million.
Repayments and sales of investments and amortization of other certain investments for the three months ended September 30, 2021 totaled $67.6 million, and net realized gains totaled $7.9 million, primarily attributable to the loss after the restructuring of one specific investment.
Proceeds from repayments of investments and amortization of certain other investments for the nine months ended September 30, 2022 totaled $74.4 million and net realized gains totaled $4.7 million.
Repayments and sales of investments and amortization of other certain investments for the nine months ended September 30, 2021 totaled $123.6 million, and net realized gains totaled $6.6 million, primarily attributable to the loss after the restructuring of one specific investment.
Net Change in Unrealized Appreciation (Depreciation) of Investments
Net change in unrealized appreciation (depreciation) primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.
Net change in unrealized (depreciation) appreciation on investments and cash equivalents for the three months ended September 30, 2022 and 2021 totaled ($4.8) million and $2.1 million, respectively.
Net change in unrealized (depreciation) appreciation on investments and cash equivalents for the nine months ended September 30, 2022 and 2021 totaled ($12.8) million and $3.9 million, respectively.
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The change in unrealized depreciation over the respective periods was due to the accounting reversal upon realization of one portfolio company and the widening of credit spreads and swap rates caused by the macro-economic environment which have been reflected in the valuation of our investments.
Provision for Taxes on Unrealized Appreciation on Investments
We have direct wholly owned subsidiaries that have elected to be taxable entities (the “Taxable Subsidiaries”). The Taxable Subsidiaries permit us to hold equity investments in portfolio companies which are “pass through” entities for U.S. federal income tax purposes and continue to comply with the “source income” requirements contained in RIC tax provisions of the Code. The Taxable Subsidiaries are not consolidated with us for U.S. federal income tax purposes and may generate U.S. federal income tax expense, benefit, and the related tax assets and liabilities, as a result of their ownership of certain portfolio investments. The U.S. federal income tax expense, or benefit, if any, and related tax assets and liabilities are reflected in our consolidated financial statements. For the three months ended September 30, 2022 and 2021, we recognized a benefit (provision) for income tax on unrealized investments of $30.5 thousand and $(151.3) thousand for the Taxable Subsidiaries, respectively. For the nine months ended September 30, 2022 and 2021, we recognized aprovision for income tax on unrealized investments of $606.4 thousand and $586.5 thousand, respectively. As of September 30, 2022 and December 31, 2021, there was $0 and $151.3 thousand of deferred tax assets on the Consolidated Statements of Assets and Liabilities, respectively.
For the three months ended September 30, 2022, net increase in net assets resulting from operations totaled $4.0 million, or $0.20 per common share (based on 19,545,935 weighted average shares outstanding for the quarter ended September 30, 2022).
For the three months ended September 30, 2021, net increase in net assets resulting from operations totaled $12.8 million, or $0.66 per common share (based on 19,486,003 weighted average shares outstanding for the quarter ended September 30, 2021).
For the nine months ended September 30, 2022, net increase in net assets resulting from operations totaled $10.5 million, or $0.54 per common share (based on 19,535,708 weighted average shares outstanding for the nine months ended September 30, 2022).
For the nine months ended September 30, 2021, net increase in net assets resulting from operations totaled $23.3 million, or $1.20 per common share (based on 19,486,003 weighted average shares outstanding for the nine months ended September 30, 2021).
The net increase in net assets between the respective periods was due to a larger amount of realized gains on investments and an increase in net investment income, offset by net unrealized depreciation.
Financial condition, liquidity and capital resources
Cash Flows from Operating and Financing Activities
Our operating activities used net cash of $92.6 million for the nine months ended September 30, 2022, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. Our financing activities for the nine months ended September 30, 2022 provided cash of $60.9 million primarily from proceeds from SBA-guaranteed debentures and net borrowings on our Credit Facility.
Our operating activities used net cash of ($102.1) million for the nine months ended September 30, 2021, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. Our financing activities for the nine months ended September 30, 2021 provided cash of $121.4 million due to the issuance of our 4.875% fixed-rate notes due 2026 (the “2026 Notes”) offset by the repayment of our 5.75% fixed-rate notes due 2022 (the “2022 Notes”) and net repayments on our Credit Facility.
Liquidity and Capital Resources
Our liquidity and capital resources are derived from the Credit Facility, 2026 Notes, SBA-guaranteed debentures and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments
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in portfolio companies and other operating expenses we incur, as well as the payment of dividends to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from turnover within our portfolio and from public and private offerings of securities to finance our investment activities.
Although we expect to fund the growth of our investment portfolio through the net proceeds from future public and private equity offerings and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, if our common stock trades at a price below our then-current net asset value per share, we may be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our Board makes certain determinations in connection therewith. A proposal, approved by our stockholders at our 2022 annual stockholders meeting, authorizes us to sell up to 25% of our outstanding common shares at a price equal to or below the then current net asset value per share in one or more offerings. This authorization will expire on June 23, 2023, the one-year anniversary of our 2022 annual stockholders meeting. We would need similar future approval from our stockholders to issue shares below the then current net asset value per share any time after the expiration of the current approval. In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.
Also, as a BDC, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, over the aggregate amount of the senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 150% effective June 29, 2018 (at least 200% prior to June 29, 2018). This requirement limits the amount that we may borrow. We have received exemptive relief from the SEC to permit us to exclude the debt of Stellus Capital SBIC, LP (“SBIC subsidiary”) and Stellus Capital SBIC II, LP (“SBIC II subsidiary”) (together, “the SBIC subsidiaries”) guaranteed by the Small Business Administration (“SBA”) from the definition of senior securities in the asset coverage test under the 1940 Act. We were in compliance with the asset coverage ratios at all times. As of September 30, 2022 and December 31, 2021, our asset coverage ratio was 193% and 203%, respectively. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of September 30, 2022 and December 31, 2021, we had cash and cash equivalents of $12.4 million and $44.2 million, respectively.
The Credit Facility, as amended and restated, provides for borrowings up to a maximum of $265.0 million on a committed basis with an accordion feature that allows us to increase the aggregate commitments up to $280.0 million, subject to new or existing lenders agreeing to participate in the increase and other customary conditions.
Pursuant to the Third Amendment and Commitment Increase to Amended and Restated Senior Secured Revolving Credit Agreement the Credit Facility will bear interest, subject to the Company’s election, on a per annum basis equal to (i) term SOFR plus 2.50% (or 2.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus a SOFR credit spread adjustment (0.10% for one-month term SOFR and 0.15% for three-month term SOFR), with a 0.25% SOFR floor, or (ii) 1.50% (or 1.75% during certain periods in which the Company’s asset coverage ratio is equal to or below 1.90 to 1.00) plus an alternate base rate based on the highest of the prime rate (subject to a 3% floor), Federal Funds Rate plus 0.50% and one month term SOFR plus 1.00%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable monthly or quarterly in arrears. The commitment to fund the revolver expires on September 18, 2024, after which the Company may no longer borrow under the Credit Facility and must begin repaying principal equal to 1/12 of the aggregate amount outstanding under the Credit Facility each month. Any amounts borrowed under the Credit Facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on September 18, 2025.
Our obligations to the lenders are secured by a first priority security interest in our portfolio of securities and cash not held at the SBIC subsidiaries, but excluding short term investments. The Credit Facility contains certain covenants, including but not limited to: (i) maintaining a minimum liquidity test of at least $10.0 million, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 1.67 to 1.0, and (iii) maintaining a minimum stockholder’s equity, and (iv) maintaining a minimum interest coverage ratio of at least 2.00 to 1.00. As of September 30, 2022, we were in compliance with these covenants.
As of September 30, 2022 and December 31, 2021, $199.0 million and $177.3 million, respectively, was outstanding under the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. The fair values of the Credit Facility is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Credit Facility is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. We incurred costs of $4.0 million in connection with the current Credit Facility, which are being amortized over the life of the facility. Additionally, $0.3 million of costs from a prior credit facility will continue to be amortized over the remaining life of the Credit Facility. As of September 30, 2022 and December 31, 2021, $1.7 million and $1.9 million of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on the Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
Interest is paid quarterly in arrears. The following table summarizes the interest expense and amortized loan fees on the Credit Facility for the three and nine months ended September 30, 2022 and 2021 (in millions):
2.5
5.8
3.9
2.6
5.1
6.2
4.3
207.4
191.9
201.7
174.1
SBA-Guaranteed Debentures
Due to the SBIC subsidiaries’ status as licensed SBICs, we have the ability to issue debentures guaranteed by the SBA at favorable interest rates (“SBA-guaranteed debentures”). Under the regulations applicable to SBIC funds, a single licensee can have outstanding SBA-guaranteed debentures, subject to a regulatory leverage limit, up to two times the amount of regulatory capital. As of both September 30, 2022 and December 31, 2021, the SBIC subsidiary had $75.0 million in “regulatory capital”, as such term is defined by the SBA and $150.0 million of SBA-guaranteed debentures outstanding.
As of September 30, 2022 and December 31, 2021, the SBIC II subsidiary had $87.5 million in regulatory capital, respectively, and $156.0 million and $100.0 million of SBA-guaranteed debentures outstanding, respectively.
On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiaries guaranteed by the SBA from our 150% asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 150% asset coverage test by permitting us to borrow up to $325.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.
On a stand-alone basis, the SBIC subsidiaries held $463.9 million and $403.3 million in assets at September 30, 2022 and December 31, 2021, respectively, which accounted for approximately 52.2% and 49.1% of our total consolidated assets, respectively.
SBA-guaranteed debentures have fixed interest rates that equal prevailing 10-year U.S. Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity but may be pre-paid at any time with no prepayment penalty. SBA-guaranteed debentures drawn before October 1, 2019 incur upfront fees of 3.425%, which consists of a 1.00% commitment fee and a 2.425% issuance discount, which are amortized over the life of
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the SBA-guaranteed debentures. SBA-guaranteed debentures drawn after October 1, 2019 incur upfront fees of 3.435%, which consists of a 1.00% commitment fee and a 2.435% issuance discount, which are amortized over the life of the SBA-guaranteed debentures. Once pooled, which occurs in March and September of each applicable year, the SBA-guaranteed debentures bear interest at a fixed rate that is set to the current 10-year treasury rate plus a spread at each pooling date.
As of September 30, 2022 and December 31, 2021, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair values of the SBA-guaranteed debentures are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the SBA-guaranteed debentures is estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. At September 30, 2022 and December 31, 2021, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.
As of September 30, 2022, we have incurred $10.7 million in financing costs related to the SBA-guaranteed debentures since the SBIC subsidiaries received their licenses, which were recorded as prepaid loan fees. As of September 30, 2022 and December 31, 2021, $5.8 and $5.4 million of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the three and nine months ended September 30, 2022 and 2021 (dollars in millions):
2.1
4.6
0.9
2.4
2.0
6.6
5.4
299.6
246.2
280.7
220.4
4.0
7.4
5.9
Notes Offering
On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due September 15, 2022 (the “2022 Notes”). On September 8, 2017, we issued an additional $6.38 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. On January 13, 2021, we caused notices to be issued to the holders of its 2022 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2022 Notes, pursuant to the Second Supplemental Indenture dated as of August 21, 2017, between the Company and U.S. Bank National Association, as trustee. We redeemed all $48.875 million in aggregate principal amount of the 2022 Notes on February 12, 2021. The 2022 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date. As a result of the redemption, we recognized a loss on debt extinguishment of $0.5 million due to the write off of the remaining deferred financing costs on the 2022 Notes. This loss is included in the Consolidated Statements of Operations for the three months ended September 30, 2021.
Prior to their redemption on February 12, 2021, the 2022 Notes were listed on New York Stock Exchange under the trading symbol “SCA”. As of December 31, 2020, the fair value of the 2022 Notes was $49.2 million. The carrying value of the 2026 Notes approximates fair value.
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The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the nine months ended September 30, 2021 (dollars in millions):
Loss on extinguishment of debt(1)
Weighted average interest rate(2):
48.9
On January 14, 2021, we issued $100.0 million in aggregate principal amount of 4.875% fixed-rate notes due 2026 (the “2026 Notes”). The 2026 Notes will mature on March 30, 2026 and may be redeemed in whole or in part at any time or from time to time at our option on or after December 31, 2025 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable semi-annually beginning September 30, 2021.
We used the net proceeds from this offering to fully redeem the 2022 Notes and repay a portion of the amount outstanding under the Credit Facility. As of both September 30, 2022 and December 31, 2021, the aggregate carrying amount of the 2026 Notes were approximately $100.0 million.
In connection with the issuance of the 2026 Notes, we have incurred $2.3 million of fees which are being amortized over the term of the 2026 Notes, of which $1.6 million and $1.9 million remains to be amortized as of September 30, 2022 and December 31, 2021, respectively. These financing costs are presented on the Consolidated Statements of Assets and Liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2026 Notes for the three and nine months ended September 30, 2022 and 2021 (dollars in millions):
1.2
100.0
100.0(1)
Off-Balance Sheet Arrangements
We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of September 30, 2022 and December 31, 2021, our off-balance sheet arrangements consisted of $30.3 million
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and $30.7 million, respectively, of unfunded commitments to provide debt and equity financings to 49 and 32 of our portfolio companies, respectively. As of September 30, 2022, we had sufficient liquidity (through cash on hand and available borrowings under the Credit Facility) to fund such unfunded commitments should the need arise.
Regulated Investment Company Status and Dividends
We have elected, have qualified, and intend to qualify annually to be treated for U.S. federal income tax purposes as a RIC under Subchapter M of the Code. So long as we maintain our qualification as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders as dividends on a timely basis.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Distributions declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.
To qualify for RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). If we maintain our qualification as a RIC, we must also satisfy certain distribution requirements each calendar year in order to avoid a federal excise tax on our undistributed earnings of a RIC. As of December 31, 2021, we had $24,601,309 of undistributed taxable income that will be carried forward toward distributions paid during the year ending December 31, 2022.
We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, the covenants contained in the Credit Facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in Credit Facility. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.
In accordance with certain applicable U.S. Treasury regulations and private letter rulings issued by the Internal Revenue Service (the “IRS”), a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash.
If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these U.S. Treasury regulations or private letter rulings. However, we continue to monitor the Company’s liquidity position and the overall economy and will continue to assess whether it would be in our and our shareholders best interest to take advantage of the IRS rulings.
68
Recent Accounting Pronouncements
See Note 1 to the consolidated financial statements contained herein for a description of recent accounting pronouncements, if any, including the expected dates of adoption and the anticipated impact on the financial statements.
Critical Accounting Policies
See Note 1 to the consolidated financial statements contained herein for a description of critical accounting policies.
Subsequent Events
The outstanding balance under the Credit Facility as of November 3, 2022 was $206.8 million.
69
Dividend Declared
On November 2, 2022, the Company's SBIC Subsidiary, a wholly owned subsidiary of the Company, entered into a Custody Agreement, dated as of November 2, 2022 (the "Frost Agreement”), with Frost Bank (“Frost”), pursuant to which Frost was appointed as a custodian to hold certain securities, loans, cash, and other assets on behalf of the SBIC Subsidiary. Either party may terminate the Frost Agreement at any time upon sixty (60) days’ prior written notice.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
We are subject to financial market risks, including changes in interest rates. In connection with the COVID-19 pandemic, the U.S. Federal Reserve (the "Federal Reserve") and other central banks had reduced certain interest rates. However, in March 2022, the Federal Reserve raised interest rates for the first time since December 2018, and subsequently raised rates in May, June, July and September, bringing the target for the federal funds rate to 3% - 3.25%. The Federal Reserve also released median projections showing that they anticipate the target rate to be 4.4% by the end of 2022. At September 30, 2022 and December 31, 2021, 97% and 96% of the loans in our portfolio bore interest at floating rates, respectively. These floating rate loans typically bear interest in reference to LIBOR, SOFR, or the Sterling Overnight Index Average, which are indexed to 30-day or 90-day rates, subject to an interest rate floor. As of September 30, 2022 and December 31, 2021, the weighted average interest rate floor on our floating rate loans was 1.03% and 1.13%, respectively.
Assuming that the Consolidated Statements of Assets and Liabilities as of September 30, 2022 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, the following table shows the annual impact on net income of changes in interest rates:
($ in millions)
Interest
Net Interest
Change in Basis Points(2)
Income
Expense(3)
Income(1)
Up 200 basis points
15.6
(4.0)
11.6
Up 150 basis points
11.7
(3.0)
8.7
Up 100 basis points
7.8
(2.0)
Up 50 basis points
(1.0)
2.9
Down 50 basis points
(3.9)
(2.9)
Down 100 basis points
(7.8)
(5.8)
Down 150 basis points
(11.5)
3.0
(8.5)
Down 200 basis points
(14.9)
(10.9)
Although we believe that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect net increase in net assets resulting from operations. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate. We may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contacts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio of investments. For the three and nine months ended September 30, 2022 and 2021, we did not engage in hedging activities.
Item 4.Controls and Procedures
(a)
Evaluation of Disclosure Controls and Procedures
The Company’s management, under the supervision and with the participation of various members of management, including its Chief Executive Officer and its Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. Based upon that evaluation, the Company’s CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.
(b)
Changes in Internal Control Over Financial Reporting
The Company’s management did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2022 that has materially affected, or is reasonable likely to materially affect, the Company’s internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1.Legal Proceedings
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us or our subsidiaries. From time to time, we may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
Item 1A.Risk Factors
There have been no material changes in the information provided under the heading “Risk Factors” in our Annual Report on Form 10-K as of December 31, 2021 other than as provided below. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may materially affect our business, financial condition and/or operating results.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
No shares were issued under the distribution reinvestment program (“DRIP”) during either of the nine months ended September 30, 2022 and 2021.
Item 3.Defaults Upon Senior Securities
Not applicable.
Item 4.Mine Safety Disclosures
Item 5.Other Information
None.
Item 6.EXHIBITS.
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits filed with the SEC:
ExhibitNumber
Description
3.1
Articles of Amendment and Restatement (Incorporated by reference to Exhibit (a)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
Bylaws (Incorporated by reference to Exhibit (b)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
Form of Stock Certificate (Incorporated by reference to Exhibit (d) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.1
Amended and Restated Equity Distribution Agreement, dated August 29, 2022, by and among Stellus Capital Investment Corporation and Stellus Capital Management, LLC, on the one hand, and Keefe, Bruyette & Woods, Inc. and Raymond James & Associates, Inc., on the other hand (Incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 333-184195, filed on August 29, 2022).
10.2
Custody Agreement, dated November 2, 2022, by and among Stellus Capital SBIC LP and Frost Bank, as custodian.*
31.1
Chief Executive Officer Certification pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2
Chief Financial Officer Certification pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1
Chief Executive Officer Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2
Chief Financial Officer Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
101.INS*
XBRL Instance Document — the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*
Inline XBRL Taxonomy Extension Schema Document
101.CAL*
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
Cover Page Interactive Data File — The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
*
Filed herewith
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: November 3, 2022
By:
/s/ Robert T. Ladd
Name:
Robert T. Ladd
Title:
Chief Executive Officer and President
/s/ W. Todd Huskinson
W. Todd Huskinson
Chief Financial Officer