EDGAR 10-K Filing

Company CIK: 1551901
Filing Year: 2021
Filename: 1551901_10-K_2021_0001104659-21-032149.json

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ITEM 1. BUSINESS
Item 1. Business
Except as otherwise indicated, the terms “we,” “us,” “our,” and the “Company” refer to Stellus Capital Investment Corporation; and “Stellus Capital Management” refers to our investment adviser and administrator, Stellus Capital Management, LLC.
General
We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). We were organized as a Maryland corporation on May 8, 2012, and formally commenced operations on November 7, 2012. We originate and invest primarily in private 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, unitranche, second lien, and unsecured debt financing, often with corresponding equity co-investments. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with second lien and subordinated loans to the extent we invest in the “last-out” tranche. Unsecured debt includes senior unsecured and subordinated loans.
Our investment activities are managed by our investment adviser, Stellus Capital Management, an investment advisory firm led by Robert T. Ladd and its other senior investment professionals. We source investments primarily through the extensive network of relationships that the senior investment professionals of Stellus Capital Management have developed with financial sponsor firms, financial institutions, middle-market companies, management teams and other professional intermediaries. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies will not be rated by national rating agencies. If such investments were rated, we believe that they would likely receive a rating that is often referred to as “junk.”
Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation. We seek to achieve our investment objective by:
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accessing the extensive origination channels that have been developed and established by the Stellus Capital Management senior investment professionals that include long-standing relationships with private equity firms, commercial banks, investment banks and other financial services firms;
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investing in what we believe to be companies with strong business fundamentals, generally within our core middle-market company focus;
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focusing on a variety of industry sectors, including business services, energy, general industrial, government services, healthcare, software and specialty finance;
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focusing primarily on directly originated transactions;
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applying the disciplined underwriting standards that the Stellus Capital Management senior investment professionals have developed over their extensive investing careers; and
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capitalizing upon the experience and resources of the Stellus Capital Management investment team to monitor our investments.
We previously received an exemptive order (the “Prior Order”) from the Securities and Exchange Commission (the “SEC”) to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). On December 18, 2018, we received a new exemptive order (the “Order”) that supersedes the Prior Order and permits us greater flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows us to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein. Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our directors who are not “interested persons,” as such term is defined in Section 2(a)(19)
of the 1940 Act (the “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. We co-invest, subject to the conditions in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is similar or identical to our investment strategy, and the we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future. We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.
Additionally, pursuant to an exemptive order applicable to all BDCs that was issued by the SEC on April 8, 2020, we were able, through December 31, 2020, and subject to the satisfaction of certain conditions, co-invest in our existing portfolio companies with the private funds, other BDCs, and registered investment companies covered by the Order (the “Affiliated Funds”), even if such Affiliated Funds have not previously invested in such existing portfolio company. Without this order, these Affiliated Funds would not have been able to participate in such co-investments with us unless the Affiliated Funds had previously acquired securities of the portfolio company in a co-investment transaction with us.
As a BDC, we are required to comply with certain regulatory requirements. For instance, as a BDC, we may 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.” 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 $250.0 million, in each case organized and with their principal of business in the United States.
We have elected to be treated for U.S. federal income tax purposes as a regulated investment company (“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 December 31, 2020, 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 timely 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, our 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 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 29, 2018 and we can now borrow $2.00 for investment purposes for every $1.00 of investor equity. As of December 31, 2020, our asset coverage ratio was 223%. 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.
Our principal executive office is currently located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, and our telephone number is (713) 292-5400. We maintain a website on the Internet at www.stelluscapital.com (under the “Public Investors” section). Information contained on our website is not incorporated by reference into this Annual Report on Form 10-K and you should not consider information contained on our website to be part of this Annual Report on Form 10-K.
SBIC Licenses
Two of our wholly owned subsidiaries (the “SBIC subsidiaries”) hold a license to operate as small business investment companies (“SBICs”). Current Small Business Administration (“SBA”) regulations allow an SBIC to obtain leverage by issuing debentures guaranteed by the SBA up to a maximum of $175.0 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary, SBA approval, and other requirements. SBA-guaranteed debentures have fixed interest rates that equal prevailing 10-year 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. We believe that the SBA-guaranteed debentures are an attractive source of debt capital.
We have obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiaries guaranteed by the SBA from our asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 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.
COVID-19 Pandemic
On March 11, 2020 the World Health Organization declared COVID-19 a pandemic and recommended containment and mitigation measures worldwide. Since then, the COVID-19 pandemic has severely impacted global economic activity and caused significant volatility in financial markets. The global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by instituting quarantines, mandating business and school closures and restricting travel. Such actions created and continue to create disruption in global supply chains and are adversely impacting several industries. While several countries, as well as certain states in the United States, have begun to lift public health restrictions with the view to reopening their economies, recurring COVID-19 outbreaks have led to the re-introduction of such restrictions in certain states in the United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere. The COVID-19 pandemic could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown. The COVID-19 pandemic presents material uncertainty and risks with respect to the underlying value of our portfolio companies and with respect to our business, financial condition, results of operations, and cash flows, such as the potential negative impact to financing arrangements, increased costs of operations, changes in law and/or regulation, and uncertainty regarding government and regulatory policy.
Operations
All partners and employees of Stellus Capital Management have been primarily operating remotely since March 16, 2020 without disruption to its operations and are prepared to continue working remotely as long as is necessary for the health and safety of all personnel.
Our COVID-19 response
Since the onset of the COVID-19 pandemic, we have been in regular contact with all of our portfolio companies and/or their sponsors to assess among other things their ability to function in the new environment. Discussions have addressed the portfolio companies’ liquidity position, expected covenant compliance, and the health of their workforce and customers.
Financial impact
We will continue to closely monitor the financial condition of our portfolio companies as part of our efforts to mitigate the impact of the COVID-19 pandemic. Historical information may be relatively less significant.
Summary Risk Factors
Investing in our securities involves a high degree of risk. You should carefully consider the information in “Item 1A. Risk Factors”, including, but not limited to, the following risks:
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Political, social and economic uncertainty, including uncertainty related to the COVID-19 pandemic, creates and exacerbates risks.
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We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
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Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
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Our incentive fee may induce Stellus Capital Management to make speculative investments.
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We may be obligated to pay Stellus Capital Management incentive compensation even if we incur a loss and may pay more than 20.0% of our net capital gains because we cannot recover payments made in previous years.
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We will be subject to corporate-level income tax and may default under our revolving credit facility if we are unable to maintain our tax treatment as a RIC under Subchapter M of the Code.
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We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
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Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.
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Substantially all of our assets are subject to security interests under the Credit Facility or claims of the SBA with respect to SBA-guaranteed debentures we may issue and, if we default on our obligations thereunder, we may suffer adverse consequences, including foreclosure on our assets.
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The current period of capital markets disruption and economic uncertainty may make it difficult to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness and any failure to do so could have a material adverse effect on our business, financial condition or results of operations.
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Most of our portfolio investments are recorded at fair value as determined in good faith by our Board and, as a result, there may be uncertainty as to the value of our portfolio investments
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If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.
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Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiaries’ operations.
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Because we intend to distribute substantially all of our income to our stockholders to obtain and maintain our status as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow may be impaired.
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The time and resources that Stellus Capital Management devote to us may be diverted, and we may face additional competition due to the fact that Stellus Capital Management and its affiliates are not prohibited from raising money for, or managing, another entity that makes the same types of investments that we target.
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If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs or be precluded from investing according to our current business strategy.
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The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.
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Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of our investment.
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Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.
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Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
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The interest rates of our floating-rate loans to our portfolio companies that extend beyond 2021 might be subject to change based on recent regulatory changes.
Portfolio Composition
Our investments generally range in size from $5.0 million to $30.0 million, and we may also selectively invest in larger positions. We generally expect that the size of our positions will increase in proportion to the size of our capital base. Pending such investments, we may reduce our outstanding indebtedness or invest in cash, cash equivalents, U.S. government securities and other high-quality debt investments with a maturity of one year or less. In the future, we may adjust opportunistically the percentage of our assets held in various types of loans, our principal loan sources and the industries to which we have greatest exposure, based on market conditions, the credit cycle, available financing and our desired risk/return profile.
The following table provides a summary of our portfolio investments as of December 31, 2020:
As of
December 31, 2020
($ in millions)
Number of investments in portfolio companies
Fair value(a)
$ 653.4
Cost
$ 658.6
% of portfolio at fair value - first lien debt(b)
77.8%
% of portfolio at fair value - second lien debt
10.8%
% of portfolio at fair value - unsecured debt
3.3%
% of portfolio at fair value - equity
8.1%
Weighted-average annual yield(c)
8.3%
(a)
As of December 31, 2020, $557.1 million of our debt investments at fair value were at floating interest rates, which represented approximately 93% of our total portfolio of debt investments at fair value. As of December 31, 2020, $43.4 million of our debt investments at fair value were at fixed interest rates, which represented approximately 7% of our total portfolio of debt investments at fair value.
(b)
Includes unitranche investments, which account for 13.0% of our portfolio at fair value.
(c)
The weighted average yield on all of our debt investments as of December 31, 2020, was approximately 8.3%, of which approximately 7.8% was current cash interest. The weighted average yield on all of our investments, including non-income producing equity positions, as of December 31, 2020 and December 31, 2019 was approximately 7.9% and 8.8%, respectively. The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investments, which represents the interest rate on our debt investments restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount. There can be no assurance that the weighted average yield will remain at its current level.
Stellus Capital Management
Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments,
negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.
The senior investment professionals of Stellus Capital Management have an average of over 31 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management senior investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing loans and debt securities through market cycles. The Stellus Capital Management senior investment professionals continue to provide investment sub-advisory services to the D. E. Shaw & Co., L.P. and its associated investment funds (the “D.E. Shaw group”).
In addition to serving as our investment adviser and the sub-advisor to the D. E. Shaw group as noted above, Stellus Capital Management currently manages private credit funds, some of which have an investment strategy that is similar or identical to our investment strategy. We received the Order from the SEC, which permits us to co-invest with investment funds managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification. In addition, we will not co-invest with D.E. Shaw group funds.
Stellus Capital Management is headquartered in Houston, Texas, and also maintains offices in the Washington, D.C. area and Charlotte, North Carolina.
Market Opportunity
We originate and invest primarily in private middle-market companies through first lien (including unitranche), second lien and unsecured debt financing, often with corresponding equity co-investments. We believe the environment for investing in middle-market companies is attractive for several reasons, including:
Robust Demand for Debt Capital.
We believe that private equity firms have significant committed but uncalled capital, a large portion of which is still available for investment in the United States. We expect the large amount of uninvested capital commitments will drive buyout activity over the next several years, which should, in turn, create lending opportunities for us.
Attractive Environment to Lend To Middle-Market Companies.
The current strength of the U.S. economy provides an attractive environment to lend to middle-market companies. The U.S. services, healthcare, technology and consumer products sectors continue to show strong growth and profitability, allowing middle market companies to continue to service their debt and prudently borrow to support growth initiatives and mergers and acquisitions activity. This dynamism, coupled with ample capital from private equity firms to support middle market companies, is creating a large population of credit worthy companies looking for debt capital.
Attractive Deal Pricing and Structures.
We believe that the pricing of middle-market debt investments is higher, and the terms of such investments are more conservative, compared to larger liquid, public debt financings, due to the more limited universe of lenders as well as the highly negotiated nature of these financings. These transactions tend to offer stronger covenant packages, higher interest rates, lower leverage levels and better call protection compared to larger financings. In addition, middle-market loans typically offer other investor protections such as default penalties, lien protection, change of control provisions and information rights for lenders.
Specialized Lending Requirements.
Lending to middle-market companies requires in-depth diligence, credit expertise, restructuring experience and active portfolio management. We believe that several factors render many U.S. financial
institutions ill-suited to lend to middle-market companies. For example, based on the experience of Stellus Capital Management’s senior investment professionals, lending to middle-market companies in the United States (a) is generally more labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of the information available with respect to such companies, (b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive ongoing monitoring by the lender. We believe that, through Stellus Capital Management, we have the experience and expertise to meet these specialized lending requirements.
Competitive Strengths
We believe that the following competitive strengths will allow us to achieve positive returns for our investors:
Experienced Investment Team.
Through our investment adviser, Stellus Capital Management, we have access to the experience and expertise of the Stellus Capital Management senior investment professionals, including its senior investment professionals who have an average of over 31 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies. The Stellus Capital Management investment professionals have a wide range of experience in middle-market investing, including originating, structuring and managing debt and equity securities through market cycles. We believe the members of Stellus Capital Management’s senior investment team are proven and experienced, with extensive capabilities in credit investing, having participated in these markets for the predominant portion of their careers. We believe that these characteristics enhance the quantity and quality of investment opportunities available to us.
Established, Rigorous Investment and Monitoring Process.
The Stellus Capital Management investment professionals have developed an extensive review and credit analysis process. Each investment that is reviewed by Stellus Capital Management is brought through a structured, multi-stage approval process. In addition, Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. Stellus Capital Management’s investment and monitoring process and the depth and experience of its investment professionals should allow it to conduct the type of due diligence and monitoring that enables it to identify and evaluate risks and opportunities.
Demonstrated Ability to Structure Investments Creatively.
Stellus Capital Management has the expertise and ability to structure investments across all levels of a company’s capital structure. Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, PIK, interest and various forms of equity securities.
Resources of Stellus Capital Management Platform.
We have access to the resources and capabilities of Stellus Capital Management, which has 16 investment professionals, including Robert T. Ladd, Dean D’Angelo, and Joshua T. Davis, who are supported by five managing directors, two vice presidents and four analysts. These individuals have developed long-term relationships with middle-market companies, management teams, financial sponsors, lending institutions and deal intermediaries by providing flexible financing throughout the capital structure. We believe that these relationships provide us with a competitive advantage in identifying investment opportunities in our target market. We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis, origination and transaction execution experience and capabilities, including the support provided with respect to those functions by Mr. Huskinson, who serves as our Chief Financial Officer and Chief Compliance Officer, and his staff of nine finance and operations professionals.
Investment Strategy
The Stellus Capital Management senior investment professionals employ an opportunistic and flexible investing approach, combined with strong risk management processes, which we believe yields a highly diversified portfolio across companies, geographies, industries, and investment types. We seek direct origination opportunities of first lien (including unitranche), second lien, and unsecured debt financing, often with corresponding equity co-investments, in middle-market companies. We believe that businesses in this size range often have limited access to public financial markets, and will benefit from Stellus Capital Management’s reliable lending approach. Many financing providers have chosen to focus on large corporate clients and managing capital markets transactions rather than lending to middle-market businesses. Further, many financial institutions and traditional lenders are faced with constrained balance sheets and are requiring existing borrowers to reduce leverage.
With an average of over 31 years of investing, corporate finance, restructuring, consulting and accounting experience, the senior investment professionals of Stellus Capital Management have demonstrated investment expertise throughout the balance sheet and in a variety of situations, including financial sponsor buyouts, growth capital, debt refinancing, balance sheet recapitalizations, rescue financings, distressed opportunities, and acquisition financings. Our investment philosophy emphasizes capital preservation through superior credit selection and risk mitigation. We expect our portfolio to provide downside protection through conservative cash flow and asset coverage requirements, priority in the capital structure and information requirements. We also anticipate benefiting from equity participation through equity co-investments. This flexible approach enables Stellus Capital Management to respond to market conditions and offer customized lending solutions.
Stellus Capital Management invests across a wide range of industries with deep expertise in select verticals including, but not limited to, business services, retail, general industrial, government services, healthcare, software and specialty finance. Our typical transactions include providing financing for leveraged buyouts, acquisitions, recapitalizations and growth opportunities. We seek to maintain a diversified portfolio of investments as a method to manage risk and capitalize on specific sector trends. In addition, we co-invest with private credit funds managed by Stellus Capital Management that have a similar, overlapping or identical investment strategy as us and where doing so is consistent with conditions of the Order, and we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future.
Our objective is to act as the lead or largest investor in transactions, generally investing between $5.0 million and $30.0 million per transaction. We expect the average investment holding period to be between two and four years, depending upon portfolio company objectives and conditions in the capital markets.
We focus on middle-market companies with between $5.0 million and $50.0 million of EBITDA in a variety of industry sectors with positive long-term dynamics and dependable cash flows. We seek businesses with management teams with demonstrated track records and economic incentives in strong franchises and sustainable competitive advantages with dependable and predictable cash flows.
We employ leverage prudently and within the limitations of the applicable laws and regulations for BDCs. Any decision on our part to use leverage will depend upon our assessment of the attractiveness of available investment opportunities in relation to the costs and perceived risks of such leverage.
Transaction Sourcing
As access to investment opportunities is highly relationship-driven, the senior investment team and other investment professionals of Stellus Capital Management spend considerable time developing and maintaining contacts with key deal sources, including private equity firms, investment banks and senior lenders. The senior investment team and other investment professionals of Stellus Capital Management have been actively investing in the middle-market for more than a decade and have focused on extensive calling and marketing efforts via speaking engagements, sponsorships, industry events and referrals to broaden their
relationship network. Existing relationships are constantly cultivated through transactional work and other personal contacts.
In addition to financial sponsors, Stellus Capital Management has developed a network of other deal sources, including:
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management teams and entrepreneurs;
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portfolio companies of private equity firms;
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other investment firms that have similar strategies to Stellus Capital Management and are seeking co-investors;
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placement agents and investment banks representing financial sponsors and issuers;
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corporate operating advisers and other financial advisers; and
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consultants, attorneys and other service providers to middle-market companies and financial sponsors.
We believe that Stellus Capital Management’s broad network of deal origination contacts will afford us with a continuous source of investment opportunities.
These origination relationships provide access not only to potential investment opportunities but also to market intelligence on trends across the credit markets. Since inception, Stellus Capital Management has completed financing transactions with more than 150 equity sponsors and completed multiple financing transactions with 33 of those equity sponsors.
We believe that, over the past decade, the senior investment team and other investment professionals of Stellus Capital Management have built a reputation as a thoughtful and disciplined provider of capital to middle-market companies and a preferred financing source for private equity sponsors and management teams. We believe these factors give Stellus Capital Management a competitive advantage in sourcing investment opportunities, which are put to use for our benefit.
Investment Structuring
Stellus Capital Management believes that each investment has unique characteristics that must be considered, understood and analyzed. Stellus Capital Management structures investment terms based on the business, the credit profile, the outlook for the industry in which a potential portfolio company operates, the competitive landscape, the products or services which the company sells and the management team and ownership of the company, among other factors. Stellus Capital Management relies upon the analysis conducted and information gathered through the investment process to evaluate the appropriate structure for our investments.
We invest primarily in the debt securities of middle-market companies. Our investments typically carry a high level of cash pay interest and may incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, PIK interest and some form of equity participation, including preferred stock, common stock, warrants and other forms of equity participation. We expect that a typical debt investment in which we invest will have a term at origination of between five and seven years. We expect to hold most of our investments to maturity or repayment, but we may sell some of our investments earlier if a liquidity event occurs, such as a sale, recapitalization or worsening of the credit quality of the portfolio company.
Stellus Capital Management negotiates covenants in connection with debt investments that provide protection for us but allow appropriate flexibility for the portfolio company. Such covenants may include affirmative and negative covenants, default penalties, lien protection and change of control provisions. Stellus Capital Management requires comprehensive information rights including access to management, financial statements and budgets and, in some cases, membership on the portfolio company’s board of directors or board observation rights. Additionally, Stellus Capital Management generally requires financial covenants and terms that restrict an issuer’s use of leverage and limitations on asset sales and capital expenditures.
Secured Debt
Secured debt, including first lien (including unitranche) and second lien financing, has liens on the assets of the borrower that serve as collateral in support of the repayment of such loans.
First Lien Debt. First lien debt is structured with first-priority liens on the assets of the borrower that serve as collateral in support of the repayment of such loans. First lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity.
Unitranche Debt. Unitranche debt typically is structured as first lien loans that combine both senior and junior debt with lenders agreeing separately to an order of priority among them. To the extent that we invest in the “last out” tranche of a unitranche facility, our unitranche investments will have certain risk characteristics of second lien debt. Unitranche debt typically provides for moderate loan amortization in the initial years of the debt, with the majority of the principal payment deferred until loan maturity. Since unitranche debt generally allows the borrower to make a large lump sum payment of principal at the end of the loan term, there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. In some cases, we will be the sole lender, or we together with our affiliates will be the sole lender, of unitranche debt, which can provide us with more influence interacting with a borrower in terms of monitoring and, if necessary, remediation in the event of underperformance.
Second Lien Debt. Second lien debt is structured as junior, secured loans, with second priority liens on an issuer’s assets. These loans typically provide for moderate loan amortization in the initial years of the loan, with the majority of the amortization deferred until loan maturity.
Unsecured Debt
Unsecured debt, including senior unsecured and subordinated loans, is not secured by any collateral and is effectively subordinated to the borrower’s secured indebtedness (to the extent of the collateral securing such indebtedness), including pursuant to one or more intercreditor agreements that we enter into with holders of a borrower’s senior debt.
Senior Unsecured Loans. Senior unsecured loans are structured as loans that rank senior in right of payment to any of the borrower’s unsecured indebtedness that is contractually subordinated to such loans. These loans generally provide for fixed interest rates and amortize evenly over the term of the loan. Senior unsecured loans are generally less volatile than subordinated loans due to their priority over subordinated loans.
Subordinated Loans. Subordinated loans are structured as unsecured, subordinated loans that provide for relatively high, fixed interest rates that provide us with significant current interest income. These loans typically have interest-only payments (often representing a combination of cash pay and PIK interest) in the early years, with amortization of principal deferred to maturity. Subordinated loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity. Subordinated loans are generally more volatile than secured loans and senior unsecured loans and may involve a greater risk of loss of principal as compared to other types of loans. Subordinated loans often include a PIK feature, which effectively operates as negative amortization of loan principal, thereby increasing credit risk exposure over the life of the loan.
Equity Securities
In connection with some of our debt investments, we may also invest in preferred or common stock or receive nominally priced warrants or options to buy an equity interest in the portfolio company. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure such equity investments and warrants to include provisions protecting our rights as a minority-interest holder, as well as a “put,” or right to sell such securities back to the issuer, upon the occurrence of specified events. In many cases, we may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights.
Investment Process
Through the resources of Stellus Capital Management, we have access to significant research resources, experienced investment professionals, internal information systems and a credit analysis framework and investment process. Stellus Capital Management has designed a highly involved and interactive investment management process, which is the core of its culture and the basis for what we believe is a strong track record of investment returns. The investment process seeks to select only those investments that it believes have the most attractive risk/reward characteristics. The process involves several levels of review and is coordinated in an effort to identify risks in potential investments. Stellus Capital Management applies its expertise to screen our investment opportunities as described below. This rigorous process, combined with our broad origination capabilities, has allowed the Stellus Capital Management team to be prudent in selecting opportunities in which to make an investment.
All potential investment opportunities undergo an initial informal review by Stellus Capital Management’s investment professionals. Each potential investment opportunity that an investment professional determines merits consideration is presented and evaluated at a weekly meeting during which Stellus Capital Management’s senior investment professionals discuss the merits and risks of a potential investment opportunity as well as the due diligence process and the pricing and structure. If Stellus Capital Management’s senior investment professionals believe an investment opportunity merits further review, the investment opportunity is assigned a deal team and the deal team prepares and presents to the investment committee for initial review a prescreen memorandum that generally describes the potential transaction and includes a description of the risks, due diligence process and proposed structure and pricing for the proposed investment opportunity.
Prior to making an investment, Stellus Capital Management conducts rigorous diligence on each investment opportunity. In connection with its due diligence on a potential investment opportunity, Stellus Capital Management utilizes its internal diligence resources, which include its internally developed credit analytical framework, subscriptions to third party research resources, discussions with industry experts, internal information sharing systems and the analytical expertise of its investment professionals. Stellus Capital Management typically reviews the company’s historical financials; industry drivers and outlook, competitive threats, customer concentration, asset coverage, projected financials and credit metrics; management background checks; and, if applicable, the track record and funding capabilities of the private equity sponsor.
Upon review of the prescreen memorandum, if the investment committee determines to proceed with the review of an investment opportunity, the deal team continues its diligence and deal structuring plans and prepares a credit approval memorandum for review by the investment committee. The credit approval memorandum updates the prescreen memorandum with more deal specific detail, including an update to the diligence process and any changes in the structure and pricing of the proposed investment.
Investment Committee
The purpose of Stellus Capital Management’s investment committee is to evaluate and approve all of our investments, subject at all times to the oversight of our Board. The investment committee process is intended to bring the diverse experience and perspectives of the committee’s members to the analysis and consideration of each investment. The investment committee consists of Messrs. Ladd, D’Angelo, Davis, Overbergen and Huskinson. The investment committee serves to provide investment consistency and adherence to our core investment philosophy and policies. Each new investment opportunity must be unanimously approved by Stellus Capital Management’s investment committee. Follow-on investments in existing portfolio companies also require the investment committee’s unanimous approval. Stellus Capital Management’s Chief Investment Officer, Robert T. Ladd, reviews any amendments before finalizing and closing negotiations with the prospective portfolio company. The investment committee also determines appropriate investment sizing and suggests ongoing monitoring requirements.
In addition to reviewing investments, investment committee meetings serve as a forum to discuss credit views and outlooks. Potential transactions and deal flow are reviewed on a regular basis. Members of the investment team are encouraged to share information and views on credits with the investment committee
early in their analysis. We believe this process improves the quality of the analysis and assists the deal team members to work more efficiently.
Each member of the investment committee performs a similar role for other accounts managed by Stellus Capital Management. In certain instances, including in connection with co-investments under our exemptive order, approval by our Board may also be required prior to the making of an investment.
Monitoring Investments
In most cases, we do not have board influence over our portfolio companies. In some instances, Stellus Capital Management’s senior investment professionals may obtain board representation or observation rights in conjunction with our investments. Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management. The monitoring process begins with structuring terms and conditions, which require the timely delivery and access to critical financial and business information on portfolio companies.
Specifically, Stellus Capital Management’s monitoring system consists of the following activities:
Regular Investment Committee Updates. Key portfolio company developments are discussed each week as part of the standard investment committee meeting agenda.
Written Reports. The deal teams provide periodic written updates as appropriate for key events that impact portfolio company performance or valuation. In addition, deal teams provide written updates following each portfolio company board meeting.
Quarterly Full Portfolio Review. Stellus Capital Management’s Chief Investment Officer and our Chief Compliance Officer perform a quarterly comprehensive review of every portfolio company with the deal teams. This process includes a written performance and valuation update, and credit-specific discussion on each of our portfolio companies. In addition, pursuant to our valuation policy, the valuation of each portfolio investment for which a market quotation is not readily available is reviewed by our independent third-party valuation firm at least twice annually. In addition, portfolio investments that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our Board based on the input of our Stellus Capital Management’s investment professionals and our audit committee.
As part of the monitoring process, Stellus Capital Management also tracks developments in the broader marketplace. Stellus Capital Management’s investment professionals have a wealth of information on the competitive landscape, industry trends, relative valuation metrics, and analyses that assist in the execution of our investment strategy. In addition, Stellus Capital Management’s extensive communications with brokers and dealers allows its investment professionals to monitor market and industry trends that could affect portfolio investments. Stellus Capital Management may provide ongoing strategic, financial and operational guidance to some portfolio companies either directly or by recommending its investment professionals or other experienced representatives to participate on the board of directors. Stellus Capital Management maintains an extensive network of strategic and operational advisers to call upon for industry expertise or to supplement existing management teams.
Asset Quality
In addition to various risk management and monitoring tools, Stellus Capital Management uses an investment ranking system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment ranking system uses a five-level numeric scale. The following is a description of the conditions associated with each investment category:
Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.
Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of contractual return but no loss of principal is expected.
Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.
In the event that Stellus Capital Management determines that an investment is underperforming, or circumstances suggest that the risk associated with a particular investment has significantly increased, Stellus Capital Management will increase its monitoring intensity and prepare regular updates for the investment committee, summarizing current operating results and material impending events and suggesting recommended actions. While the investment ranking system identifies the relative risk for each investment, the ranking alone does not dictate the scope and/or frequency of any monitoring that is performed. The frequency of Stellus Capital Management’s monitoring of an investment is determined by a number of factors, including, but not limited to, the trends in the financial performance of the portfolio company, the investment structure and the type of collateral securing the investment.
Determination of Net Asset Value and Portfolio Valuation Process
The net asset value per share of our outstanding shares of common stock is determined quarterly by dividing the value of total assets minus liabilities by the total number of shares outstanding.
In calculating the value of our total assets, investment transactions will be recorded on the trade date. Realized gains or losses will be computed using the specific identification method. Investments for which market quotations are readily available may be valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our Board based on the input of Stellus Capital Management’s investment professionals and our audit committee. In addition, our Board retains one or more independent valuation firms to review at least twice annually, the valuation of each portfolio investment for which a market quotation is not readily available. We also have adopted Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC 820”). This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the market in which we can exit portfolio investments with the greatest volume and level activity is considered our principal market.
A readily available market value is not expected to exist for most of the investments in our portfolio, and we value these portfolio investments at fair value as determined in good faith by our Board under our valuation policy and process. The types of factors that our Board may take into account in determining the fair value of our investments generally include, as appropriate, comparisons of financial ratios portfolio company to peer companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, and other relevant factors.
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we consider the pricing indicated by the external event to corroborate our valuation. 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 the investments may differ materially from the values that would have been used had a readily available market value existed for such investments. In addition, changes in the market
environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned.
With respect to investments for which market quotations are not readily available, our Board undertakes a multi-step valuation process each quarter, as described below:
•
our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of Stellus Capital Management responsible for the portfolio investment;
•
preliminary valuation conclusions are then documented and discussed with our senior investment professionals and Stellus Capital Management;
•
at least twice annually, the valuation for each portfolio investment is reviewed by an independent valuation firm; and
•
the audit committee of our board of directors then reviews these preliminary valuations;
•
the Board then discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management’s investment professionals, the independent valuation firm and the audit committee.
In following these approaches, the types of factors that are taken into account in fair value pricing our investments include, as relevant, but are not limited to:
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available current market data, including relevant and applicable market trading and transaction comparables;
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applicable market yields and multiples;
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security covenants;
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call protection provisions;
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information rights;
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the nature and realizable value of any collateral;
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the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
•
comparisons of financial ratios of peer companies that are public;
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comparable merger and acquisition transactions; and
•
the principal market and enterprise values.
Realization of Investments
The potential exit scenarios of a portfolio company play an important role in evaluating investment decisions. Our debt-orientation provides for increased potential exit opportunities, including (a) the sale of investments in the private markets, (b) the refinancing of investments held, often due to maturity or recapitalizations, and (c) other liquidity events including the sale or merger of the portfolio company. Since we seek to maintain a debt orientation in our investments, we expect to receive interest income over the course of the investment period, resulting in a return on invested capital well in advance of final exit.
Derivatives
We may utilize hedging techniques such as interest rate swaps to mitigate potential interest rate risk on our indebtedness. Such interest rate swaps would principally be used to protect us against higher costs on our indebtedness resulting from increases in both short-term and long-term interest rates. We also may use various hedging and other risk management strategies to seek to manage various risks, including changes in currency exchange rates and market interest rates. Such hedging strategies would be utilized to seek to protect the value of our portfolio investments, for example, against possible adverse changes in the market value of securities held in our portfolio.
Managerial Assistance
As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. Stellus Capital Management or an affiliate of Stellus Capital Management provides such managerial assistance on our behalf to portfolio companies that request this assistance. We may receive fees for these services and will reimburse Stellus Capital Management or an affiliate of Stellus Capital Management for its allocated costs in providing such assistance, subject to the review by our Board, including our independent directors.
Competition
Our primary competitors in providing financing to middle-market companies include public and private funds, other BDCs, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or to the distribution and other requirements we must satisfy to maintain our qualification as a RIC.
We use the expertise of the investment professionals of Stellus Capital Management to which we have access to assess investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we believe that the relationships of the investment professionals of Stellus Capital Management enable us to learn about, and compete effectively for, financing opportunities with attractive middle-market companies in the industries in which we invest.
Employees
We do not have any direct employees, and our day-to-day investment operations are managed by Stellus Capital Management. We have a Chief Executive Officer and President and a Chief Financial Officer, Chief Compliance Officer, Treasurer and Secretary. To the extent necessary, we may hire additional personnel going forward. Our officers are employees of Stellus Capital Management and our allocable portion of the cost of our Chief Financial Officer and Chief Compliance Officer and his staff is paid by us pursuant to the administration agreement that we have entered into with Stellus Capital Management.
Management Agreements
Stellus Capital Management serves as our investment adviser and is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). In addition, Stellus Capital Management serves as our administrator.
Investment Advisory Agreement
Subject to the overall supervision of our Board and in accordance with the 1940 Act, Stellus Capital Management manages our day-to-day operations and provides investment advisory services to us. Under the terms of the investment advisory agreement, Stellus Capital Management:
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determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;
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identifies, evaluates and negotiates the structure of the investments we make;
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executes, closes, services and monitors the investments we make;
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determines the securities and other assets that we purchase, retain or sell;
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performs due diligence on prospective portfolio companies; and
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provides us with such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment of our funds.
Pursuant to the investment advisory agreement, we have agreed to pay Stellus Capital Management a fee for investment advisory and management services consisting of two components - a base management fee and an incentive fee. The cost of both the base management fee and the incentive fee are borne by our stockholders.
Management Fee
The base management fee is calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage (including preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents. For services rendered under the investment advisory agreement, the base management fee is payable quarterly in arrears. The base management fee is calculated based on the average value of our gross assets, excluding cash and cash equivalents, at the end of the two most recently completed calendar quarters. Base management fees for any partial month or quarter are appropriately pro-rated.
Incentive Fee
We pay Stellus Capital Management an incentive fee. Incentive fees are calculated as below. The incentive fee, which provides Stellus Capital Management with a share of the income that it generates for us, has two components, ordinary income and capital gains, calculated as follows:
The ordinary income component is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter, subject to a total return requirement, and deferral of non-cash amounts, and is 20.0% of the amount, if any, by which our pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets attributable to our common stock, for the immediately preceding calendar quarter, exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision, for the benefit off Stellus Capital Management, measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, Stellus Capital Management receives no incentive fee until our pre-incentive fee net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%.
The effect of the “catch-up” provision is that, subject to the total return provision discussed below, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, Stellus Capital Management receives 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. For this purpose, pre-incentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement (as described below), and any interest expense and any distributions paid on any issued and outstanding preferred stock, but 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 we have not yet received in cash. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s pre-incentive fee net investment income will be 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 quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20.0% of the amount by which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20.0% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar 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 portion of such incentive fee that is attributable to deferred interest (such as PIK interest or OID) will be paid to Stellus Capital Management, without any interest thereon, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possible elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if prior quarters are below the quarterly hurdle. Stellus Capital Management has agreed to permanently waive any interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).
Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss, subject to the total return requirement. For example, if we receive pre-incentive fee net investment income in excess of the quarterly minimum hurdle rate, we will pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized and unrealized capital losses. Our net investment income used to calculate this component of the incentive fee is also included in the amount of our gross assets used to calculate the 1.75% base management fee. These calculations are appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.
The following is a graphical representation of the calculation of the income-related portion of the incentive fee:
Quarterly Incentive Fee Based on Net Investment Income
Pre-Incentive Fee Net Investment Income
(expressed as a percentage of the value of net assets)
Percentage of Pre-incentive Fee Net Investment Income
Allocated to Income-Related Portion of Incentive Fee
The capital gains component of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement, as of the termination date), is equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital gains incentive fees. If such amount is negative, then no capital gains incentive fee will be payable for such year. Additionally, if the investment advisory agreement is terminated as of a date that is not a calendar year end, the termination date will be treated as though it were a calendar year end for purposes of calculating and paying the capital gains incentive fee.
Examples of Quarterly Incentive Fee Calculation
Example 1: Income Related Portion of Incentive Fee before Total Return Requirement Calculation:
Alternative 1
Assumptions
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 0.6125%
Pre-incentive fee net investment income does not exceed hurdle rate, therefore there is no income-related incentive fee.
Alternative 2
Assumptions
Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 2.2625%
Incentive fee
= 100% × Pre-incentive fee net investment income (subject to “catch-up”)(3)
= 100% × (2.2625% - 2.0%)
= 0.2625%
Pre-incentive fee net investment income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision, therefore the income related portion of the incentive fee is 0.2625%.
Alternative 3
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses)) = 2.8625%
Incentive fee = 100% × Pre-incentive fee net investment income (subject to “catch-up”)(3)
Incentive fee = 100% × “catch-up” + (20.0% × (Pre-Incentive Fee Net Investment Income - 2.5%))
“Catch-up”
= 2.5% - 2.0%
= 0.5%
Incentive fee
= (100% × 0.5%) + (20.0% × (2.8625% - 2.5%))
= 0.5% + (20.0% × 0.3625%)
= 0.5% + 0.0725%
= 0.5725%
Pre-incentive fee net investment income exceeds the hurdle rate, and fully satisfies the “catch-up” provision, therefore the income related portion of the incentive fee is 0.5725%.
(1)
Represents 8.0% annualized hurdle rate.
(2)
Represents 1.75% annualized base management fee.
(3)
The “catch-up” provision is intended to provide Stellus Capital Management with an incentive fee of 20.0% on all pre-incentive fee net investment income as if a hurdle rate did not apply when our net investment income exceeds 2.5% in any fiscal quarter.
Example 2: Income Portion of Incentive Fee with Total Return Requirement Calculation:
Alternative 1:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $8,000,000
Although our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% (as shown in Alternative 3 of Example 1 above), no incentive fee is payable because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters did not exceed the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters.
Alternative 2:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 3.5%
Hurdle rate(1) = 2.0%
Management fee(2) = 0.4375%
Other expenses (legal, accounting, custodian, transfer agent, etc.) = 0.2%
Pre-incentive fee net investment income
(investment income - (management fee + other expenses) = 2.8625%
Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000
20.0% of cumulative net increase in net assets resulting from operations over current and preceding
11 calendar quarters = $10,000,000
Because our pre-incentive fee net investment income exceeds the hurdle rate of 2.0% and because 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 and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters, an incentive fee would be payable, as shown in Alternative 3 of Example 1 above.
(1)
Represents 8.0% annualized hurdle rate.
(2)
Represents 1.75% annualized base management fee.
Example 3: Capital Gains Portion of Incentive Fee(*):
Alternative 1:
Assumptions
Year 1: $2.0 million investment made in Company A (“Investment A”), and $3.0 million investment made in Company B (“Investment B”)
Year 2: Investment A sold for $5.0 million and fair market value (“FMV”) of Investment B determined to be $3.5 million
Year 3: FMV of Investment B determined to be $2.0 million
Year 4: Investment B sold for $3.25 million
The capital gains portion of the incentive fee would be:
Year 1: None
Year 2: Capital gains incentive fee of $0.6 million - ($3.0 million realized capital gains on sale of Investment A multiplied by 20.0%)
Year 3: None - $0.4 million (20.0% multiplied by ($3.0 million cumulative capital gains less $1.0 million cumulative capital depreciation)) less $0.6 million (previous capital gains fee paid in Year 2)
Year 4: Capital gains incentive fee of $50,000 - $0.65 million ($3.25 million cumulative realized capital gains multiplied by 20.0%) less $0.6 million (capital gains incentive fee taken in Year 2)
Alternative 2
Assumptions
Year 1: $2.0 million investment made in Company A (“Investment A”), $5.25 million investment made in Company B (“Investment B”) and $4.5 million investment made in Company C (“Investment C”)
Year 2: Investment A sold for $4.5 million, FMV of Investment B determined to be $4.75 million and FMV of Investment C determined to be $4.5 million
Year 3: FMV of Investment B determined to be $5.0 million and Investment C sold for $5.5 million
Year 4: FMV of Investment B determined to be $6.0 million
Year 5: Investment B sold for $4.0 million
The capital gains incentive fee, if any, would be:
Year 1: None
Year 2: $0.4 million capital gains incentive fee - 20.0% multiplied by $2.0 million ($2.5 million realized capital gains on Investment A less $0.5 million unrealized capital depreciation on Investment B)
Year 3: $0.25 million capital gains incentive fee(1) - $0.65 million (20.0% multiplied by $3.25 million ($3.5 million cumulative realized capital gains less $0.25 million unrealized capital depreciation)) less $0.4 million capital gains incentive fee received in Year 2
Year 4: $0.05 million capital gains incentive fee - $0.7 million ($3.50 million cumulative realized capital gains multiplied by 20.0%) less $0.65 million cumulative capital gains incentive fee paid in Year 2 and Year 3
Year 5: None - $0.45 million (20.0% multiplied by $2.25 million (cumulative realized capital gains of $3.5 million less realized capital losses of $1.25 million)) less $0.7 million cumulative capital gains incentive fee paid in Year 2, Year 3 and Year 4(2)
*
The hypothetical amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that positive returns will be realized and actual returns may vary from those shown in this example.
(1)
As illustrated in Year 3 of Alternative 1 above, if a portfolio company were to be wound up on a date other than its fiscal year end of any year, it may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if such portfolio company had been wound up on its fiscal year end of such year.
(2)
As noted above, it is possible that the cumulative aggregate capital gains fee received by Stellus Capital Management ($0.70 million) is effectively greater than $0.45 million (20.0% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)).
Payment of Our Expenses
All investment professionals of Stellus Capital Management, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses of personnel allocable to these services to us, are provided and paid for by Stellus Capital Management and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to:
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organization and offering;
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calculating our net asset value (including the cost and expenses of any independent valuation firm);
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fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments;
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interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
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offerings of our common stock and other securities;
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base management and incentive fees;
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administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital Management’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our Chief Compliance Officer and Chief Financial Officer and his staff);
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transfer agent, dividend agent and custodial fees and expenses;
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U.S. federal and state registration fees;
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all costs of registration and listing our shares on any securities exchange;
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U.S. federal, state and local taxes;
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independent directors’ fees and expenses;
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costs of preparing and filing reports or other documents required by the SEC or other regulators;
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costs of any reports, proxy statements or other notices to stockholders, including printing costs;
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costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
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direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs;
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proxy voting expenses; and
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all other expenses incurred by us or Stellus Capital Management in connection with administering our business.
Duration and Termination
Unless terminated earlier as described below, the investment advisory agreement will continue in effect from year to year if approved annually by our Board or by the affirmative vote of the holders of a majority of our outstanding voting securities, and, in either case, if also approved by a majority of the independent directors. The investment advisory agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by Stellus Capital Management and may be terminated by either party without penalty upon 60 days’ written notice to the other. The holders of a majority of our outstanding voting securities may also terminate the investment advisory agreement without penalty upon 60 days’ written notice. See Item 1A. “Risk Factors - Risks Relating to our Business and Structure” in this Annual Report on Form 10-K. We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
Indemnification
The investment advisory agreement provides that Stellus Capital Management 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 us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital Management’s services under the investment advisory agreement or otherwise as our investment adviser. Our obligation to provide indemnification under the investment advisory agreement, however, is limited by the 1940 Act and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying any director, officer or other individual from any liability resulting directly from the willful misconduct, bad faith, gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of the directors, officers or other individuals and require us to set forth reasonable and fair means for determining whether indemnification shall be made.
Board Approval of the Investment Advisory Agreement
Our Board, including a majority of our independent directors, approved the investment advisory agreement at its first meeting, held on September 24, 2012, and approved the annual continuation of the investment advisory agreement on January 13, 2021. In its consideration of the investment advisory agreement, the Board focused on information it had received relating to, among other things: (a) the nature, quality and extent of the advisory and other services to be provided to us by our investment adviser; (b) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives; (c) our projected operating expenses and expense ratio compared to BDCs with similar investment objectives; (d) any existing and potential sources of indirect income to our investment adviser from its relationships with us and the profitability of those relationships; (e) information about the services to be performed and the personnel performing such services under the investment advisory agreement; (f) the organizational capability and financial condition of our investment adviser; and (g) various other factors.
In voting to approve the investment advisory agreement, our Board, including all of the directors who are not “interested persons,” of the Company, made the following conclusions:
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Nature, Extent and Quality of Services. Our Board considered the nature, extent and quality of the advisory and other services to be provided by Stellus Capital Management, including the investment performance of Stellus Capital Management’s investment team. Our Board also considered the investment selection process expected to be employed by Stellus Capital Management, including the flow of transaction opportunities resulting from its investment team’s significant experience in originating, structuring and managing loans and debt securities through market cycles; the employment of Stellus Capital Management’s investment strategy, rigorous due diligence process, investment structuring, and ongoing relationships with and monitoring of portfolio companies, in light of the investment objective of the Company. Our Board also considered Stellus Capital Management’s personnel and their prior experience in connection with the types of investments made by us, including such personnel’s corporate relationships and relationships with private equity firms, investment banks, restructuring advisors, law firms, boutique advisory firms and distressed/specialty lenders. In addition, our Board considered the other terms and conditions of the investment advisory agreement,
including the fact that we have the ability to terminate the investment advisory agreement without penalty upon 60 days’ notice to Stellus Capital Management. As a result, our Board determined that the substantive terms of the investment advisory agreement (other than the fees payable thereunder, which our Board reviewed separately), including the services to be provided, are similar to those of comparable externally managed BDCs described in the available market data and in the best interests of our stockholders. Moreover, our Board concluded that although the substantive terms of the investment advisory agreement, including the services to be provided, are generally the same as those of comparable externally managed BDCs described in the market data then available, it would be difficult to obtain similar services from other third-party service providers in light of the nature, quality and extent of the advisory and other services provided to us by Stellus Capital Management.
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Projected Costs of the Services Provided to the Company. Our Board considered (i) comparative data based on publicly available information with respect to services rendered and the advisory fees (including the base management fee and incentive fees) of other externally managed BDCs that invest in similar securities, our total expenses, and expense ratios compared to other externally managed BDCs of similar size and with similar investment objectives and (ii) the administrative services that Stellus Capital Management will provide to us at cost pursuant to the administration agreement. Based upon its review, our Board concluded that the fees to be paid under the investment advisory agreement are generally comparable to or more favorable than those payable under agreements of comparable externally managed BDCs and reasonable in relation to the services expected to be provided by Stellus Capital Management.
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Projected Profitability of Stellus Capital Management. Our Board considered information about Stellus Capital Management, including the anticipated costs of the services to be provided by Stellus Capital Management and the anticipated profits to be realized by it, including as a result of our investment performance, which would generally be equal or similar to the profitability of investment advisers managing comparable BDCs. Our Board reviewed our investment performance, as well as comparative data with respect to the investment performance of other externally managed BDCs, as it relates to the management and incentive fees we pay Stellus Capital Management. As a result of this review, our Board determined that our investment performance supported the renewal of the investment advisory agreement.
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Economies of Scale. Our Board considered the extent to which economies of scale would be realized as the Company grows, and whether the fees payable under the investment advisory agreement reflect these economies of scale for the benefit of our stockholders. Taking into account such information, our Board determined that the advisory fee structure under the investment advisory agreement was reasonable with respect to any economies of scale that may be realized as the Company grows.
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Limited Potential for Additional Benefits Derived by Stellus Capital Management. Our Board considered existing and potential sources of indirect income Stellus Capital Management would receive as a result of the relationship with us, and whether there would be potential for additional benefits to be derived by Stellus Capital Management as a result of our relationship, and was advised any such potential would be limited.
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Conclusions. In view of the wide variety of factors that our Board considered in connection with its evaluation of the investment advisory agreement, it is not practical to quantify, rank or otherwise assign relative weights to the specific factors it considered in reaching its decision. The Board did not rank or otherwise assign relative weights to the specific factors it considered in connection with its evaluation of the investment advisory agreement, nor did it undertake to make any specific determination as to whether any particular factor, or any aspect of any particular factor, was favorable or unfavorable to the ultimate decision made by our Board. Rather, the Board based its approval of the investment advisory agreement on the totality of information presented to it. In considering the factors discussed above, individual directors may have given different weights to different factors.
Based on the information reviewed and the discussions, the Board, including a majority of the independent directors, concluded that the investment management fee rates and terms are reasonable in
relation to the services to be provided and approved the investment advisory agreement as being in the best interests of our stockholders.
Administration Agreement
Under the administration agreement, Stellus Capital Management furnishes us with office facilities and equipment and will provide us with clerical, bookkeeping, recordkeeping and other administrative services at such facilities. Stellus Capital Management also performs, or oversees the performance of, our required administrative services, which include being responsible for the financial and other records that we are required to maintain and preparing reports to our stockholders and reports and other materials filed with the SEC. In addition, Stellus Capital Management assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports and other materials to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. Under the administration agreement, Stellus Capital Management also provides managerial assistance on our behalf to those portfolio companies that have accepted our offer to provide such assistance.
Payments under the administration agreement are equal to an amount based upon our allocable portion (subject to the review of our Board) of Stellus Capital Management’s overhead in performing its obligations under the administration agreement, including rent, the fees and expenses associated with performing compliance functions and our allocable portion of the cost of our Chief Financial Officer and Chief Compliance Officer and his staff. In addition, if requested to provide significant managerial assistance to our portfolio companies, Stellus Capital Management will be paid an additional amount based on the services provided, which shall not exceed the amount we receive from such portfolio companies for providing this assistance. The administration agreement has an initial term of two years and may be renewed with the approval of our Board. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party. To the extent that Stellus Capital Management outsources any of its functions, we will pay the fees associated with such functions on a direct basis without any incremental profit to Stellus Capital Management. Stockholder approval is not required to amend the administration agreement.
Indemnification
The administration agreement provides that Stellus Capital Management, its affiliates and their respective, officers, managers, partners, agents, employees, controlling persons and members, and any other person or entity affiliated with it, are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of Stellus Capital Management’s services under the administration agreement or otherwise as our administrator. Our obligation to provide indemnification under the administration agreement, however, is limited by the 1940 Act and Investment Company Act Release No. 11330, which, among other things, prohibit us from indemnifying any director, officer or other individual from any liability resulting directly from the willful misconduct, bad faith, gross negligence in the performance of duties or reckless disregard of applicable obligations and duties of the directors, officers or other individuals and require us to set forth reasonable and fair means for determining whether indemnification shall be made.
License Agreement
We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” Under this agreement, we have a right to use the “Stellus Capital” name for so long as Stellus Capital Management or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we have 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 Management is in effect.
Exchange Act Reports
We maintain a website at www.stelluscapital.com (under the public investors section). The information on our website is not incorporated by reference in this Annual Report on Form 10-K.
We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the SEC in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.
Regulation as a Business Development Company
We are a BDC under the 1940 Act that has elected to be treated as a RIC under the Code. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities.
We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act of 1933, as amended. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations. However, we may purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances. We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting stock of any registered investment company, invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses. None of these policies is fundamental and may be changed without stockholder approval upon 60 days’ prior written notice to stockholders.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as “qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are the following:
(1)
Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. Under the 1940 Act and the rules thereunder, “eligible portfolio companies” include (1) private domestic operating companies, (2) public domestic operating companies whose securities are not listed on a national securities exchange (e.g., the New York Stock Exchange), and (3) public domestic operating companies having a market capitalization of less than $250.0 million. Public domestic operating companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC are not listed on a national securities exchange and therefore are eligible portfolio companies.
(2)
Securities of any eligible portfolio company which we control.
(3)
Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the
purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
(4)
Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.
(5)
Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities.
(6)
Cash, cash equivalents, U.S. government securities or high-quality debt securities that mature in one year or less from the date of investment.
The regulations defining qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
In order to count portfolio securities as qualifying assets for the purpose of the 70% test, a BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities significant managerial assistance. However, when the BDC purchases securities in conjunction with one or more other persons acting together and one of the other persons in the group may make available such managerial assistance. Making available managerial assistance means any arrangement whereby the BDC, through its directors, officers, employees or agents, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. With respect to an SBIC, making available managerial assistance means the making of loans to a portfolio company. Stellus Capital Management will provide such managerial assistance on our behalf to portfolio companies that request this assistance.
Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities, repurchase agreements and high-quality debt investments that mature in one year or less from the date of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets or temporary investments. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, so long as the agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price that is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests in order to maintain our qualification as a RIC for U.S. federal income tax purposes. Accordingly, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Stellus Capital Management will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Warrants and Options
Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that it may have outstanding at any time. Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our Board approves such issuance on the basis that the issuance is in the best interests of us and our stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them have been publicly distributed. The 1940 Act also provides
that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities. In particular, the amount of capital stock that would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of the BDC’s total outstanding shares of capital stock.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 150% immediately after each such issuance. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see Item 1A. “Risk Factors - Risks Relating to our Business and Structure - Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage” in this Annual Report on Form 10-K.
Common Stock
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock at a price below the current net asset value of the common stock if our Board determines that such sale is in our best interests and that of our stockholders, and our stockholders approve such sale. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board, closely approximates the market value of such securities (less any distributing commission or discount). We would need 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. We may also make rights offerings to our stockholders at prices per share less than the net asset value per share, subject to applicable requirements of the 1940 Act.
Codes of Ethics
We and Stellus Capital Management have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to each such code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with such code’s requirements. In addition, each code of ethics is available on the EDGAR Database on the SEC’s website at www.sec.gov. You may also obtain copies of each code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to Stellus Capital Management. The proxy voting policies and procedures of Stellus Capital Management are set out below. The guidelines will be reviewed periodically by Stellus Capital Management and our independent directors and, accordingly, are subject to change.
Introduction. As an investment adviser registered under the Advisers Act, Stellus Capital Management has a fiduciary duty to act solely in our best interests. As part of this duty, Stellus Capital Management recognizes that it must vote our securities in a timely manner free of conflicts of interest and in our best interests.
Stellus Capital Management’s policies and procedures for voting proxies for its investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies. Stellus Capital Management votes proxies relating to our portfolio securities in what it perceives to be the best interest of our stockholders. Stellus Capital Management reviews on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities we hold. In most cases Stellus Capital Management will vote in favor of proposals that Stellus Capital
Management believes are likely to increase the value of the portfolio securities we hold. Although Stellus Capital Management will generally vote against proposals that may have a negative effect on our portfolio securities, Stellus Capital Management may vote for such a proposal if there exist compelling long-term reasons to do so.
Stellus Capital Management has established a proxy voting committee and adopted proxy voting guidelines and related procedures. The proxy voting committee establishes proxy voting guidelines and procedures, oversees the internal proxy voting process, and reviews proxy voting issues. To ensure that Stellus Capital Management’s vote is not the product of a conflict of interest, Stellus Capital Management requires that anyone involved in the decision-making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote. Where conflicts of interest may be present, Stellus Capital Management will disclose such conflicts to us, including our independent directors and may request guidance from us on how to vote such proxies.
Proxy Voting Records. You may obtain information about how Stellus Capital Management voted proxies by making a written request for proxy voting information to: Stellus Capital Investment Corporation, Attention: Investor Relations, 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, or by calling us collect at (713) 292-5414. The SEC also maintains a website at www.sec.gov that contains this information.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their nonpublic personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party administrator).
We restrict access to nonpublic personal information about our stockholders to employees of Stellus Capital Management and its affiliates with a legitimate business need for the information. We intend to maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.
Other
We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.
We and Stellus Capital Management are each required to adopt and implement written policies and procedures reasonably designed to prevent violation of relevant federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a Chief Compliance Officer to be responsible for administering the policies and procedures.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 imposes a wide variety of regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us. For example:
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pursuant to Rule 13a-14 under the Exchange Act, our principal executive officer and principal financial officer must certify the accuracy of the financial statements contained in our periodic reports;
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pursuant to Item 307 under Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and procedures;
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pursuant to Rule 13a-15 under the Exchange Act, our management must prepare an annual report regarding its assessment of our internal control over financial reporting; and
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pursuant to Item 308 of Regulation S-K and Rule 13a-15 under the Exchange Act, our periodic reports must disclose whether there were significant changes in our internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Taxation as a Regulated Investment Company
As a BDC, we have elected and intend to qualify annually to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that we timely distribute to our stockholders as dividends. To continue to maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to maintain our RIC treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).
For any taxable year in which we:
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qualify as a RIC; and
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satisfy the Annual Distribution Requirement;
We will not be subject to U.S. federal income tax on the portion of our income we timely distribute to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.
We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (a) 98% of our net ordinary income for each calendar year, (b) 98.2% of our capital gain net income for the one-year period ending December 31 (c) any ordinary income and capital gain net income that we recognized in preceding years, but were not distributed during such years and on which we paid no U.S. 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-level U.S. federal 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). In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
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continue to qualify as a BDC under the 1940 Act at all times during each year;
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derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities, and net income derived from interests in “qualified publicly traded partnerships” (which generally are partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends and other permitted RIC income), or the 90% Income Test; and
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diversify our holdings so that at the end of each quarter of the taxable year:
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at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and
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no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer or of two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or in the securities of one or more qualified publicly traded partnerships, or the Diversification Tests.
We may invest in partnerships, including qualified publicly traded partnerships, which may result in our being subject to state, local or foreign income, franchise or withholding tax liabilities.
We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, with increasing interest rates or issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. If we are not able to obtain sufficient cash from other sources to satisfy the Annual Distribution Requirement, we may fail to maintain our tax treatment as a RIC and become subject to corporate-level U.S. federal income taxes on all of our taxable income without the benefit of the dividends-paid deduction.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy (i) the Annual Distribution Requirement and to otherwise eliminate our liability for U.S. federal income and excise taxes and/or (ii) the Diversification Tests. However, under the 1940 Act, we are not permitted in certain circumstances to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. See Item 1A. “Regulation as a Business Development Company - Senior Securities” in this Annual Report on Form 10-K. Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests may be limited by (a) the illiquid nature of our portfolio and/or (b) other requirements relating to our qualifications as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
In addition, we have formed and operate two SBIC subsidiaries, and are partially dependent on the SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirement. The SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our tax treatment as a RIC. We may have to request a waiver of the SBA’s restrictions for the SBIC subsidiaries to make certain distributions to maintain our RIC tax treatment. We cannot assure you that the SBA will grant such waiver. If the SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may cause us to fail to maintain our tax treatment as a RIC, which would result in us becoming subject to corporate-level U.S. federal income tax.
Certain of our investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other things, (a) treat dividends that would otherwise constitute qualified dividend income as non-qualified dividend income, (b) treat dividends that would otherwise be eligible for the corporate dividends received deduction as ineligible for such treatment, (c) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (d) convert lower-taxed long term capital gain into higher-taxed short-term capital gain or ordinary income, (e) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (f) cause us to recognize income or gain without a corresponding receipt of cash, (g) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (h) adversely alter the characterization of certain complex financial transactions and (i) produce income that will not be qualifying income for purposes of the 90% Income Test. We intend to monitor our transactions and may make certain tax elections to mitigate the effect of these provisions and prevent our disqualification as a RIC.
Gain or loss realized by us from warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such capital gain or loss generally will be long term or short term, depending on how long we held a particular warrant. Some of the income and fees that we may recognize will not satisfy the 90% Income Test. In order to ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may hold assets that generate such income and provide services that generate such fees indirectly through one or more entities treated as
corporations for U.S. federal income tax purposes. Such corporations will be required to pay U.S. federal corporate income tax on their earnings, which ultimately will reduce our return on such income and fees.
If we are unable to qualify for tax treatment as a RIC, and if certain remedial provisions are not available, we would be subject to U.S. federal income tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to stockholders, nor would they be required to be made. Subject to certain limitations under the Code, corporate stockholders would be eligible to claim a dividends received deduction with respect to such distributions, non-corporate stockholders would be able to treat such dividend income as “qualified dividend income,” which is subject to reduced rates of U.S. federal income tax. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. If we fail to qualify as a RIC for a period greater than two taxable years, to requalify as a RIC in a subsequent year we may be subject to regular corporate tax on any net built-in gains with respect to certain of our assets (i.e. , the excess of the aggregate gains, including items of income, over aggregate losses that would have been realized with respect to such assets if we had been liquidated) that we elect to recognize on requalification or when recognized over the next five years.
Our Status as an Emerging Growth Company
We ceased to qualify as an “emerging growth company” beginning January 1, 2017.
The New York Stock Exchange Corporate Governance Regulations
The New York Stock Exchange has adopted corporate governance regulations that listed companies must comply with. We are in compliance with such corporate governance listing standards applicable to BDCs.
Regulation as a Small Business Investment Company
Our wholly-owned subsidiaries’ SBIC licenses allow them to incur leverage by issuing SBA-guaranteed debentures, subject to 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 at the time of issuance at a market-driven spread over U.S. Treasury Notes with ten-year maturities.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses. Under present SBA regulations, eligible small businesses (together with their affiliates) include businesses that have a tangible net worth not exceeding $19.5 million and have average annual net income after U.S federal income taxes not exceeding $6.5 million (average annual net income to be computed without benefit of any carryover loss) for the two most recent fiscal years. In addition, an SBIC must devote 25% of its investment activity to “smaller enterprises” as defined by the SBA. A smaller enterprise is a business (together with their affiliates) that has a net worth not exceeding $6.0 million and has average annual net income after U.S. federal income taxes not exceeding $2.0 million (average annual net income to be computed without benefit of any carryover loss) for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility of a small business or a smaller enterprise, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales of the business and its affiliates. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.
The SBA generally prohibits an SBIC from providing financing to small businesses with certain characteristics, such as relending or businesses with the majority of their employees located outside the United States, and business engaged in certain prohibited industries, such as project finance, real estate, farmland, financial intermediaries or “passive” (i.e. non-operating) businesses. Without prior SBA approval, an SBIC may not provide financing or a commitment to a small business in an amount equal to more than approximately 30.0% of the SBIC’s regulatory capital in any one company and its affiliates.
SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $175.0 million with at least $87.5 million in regulatory capital (as defined in the SBA regulations), subject to SBA approval. The maximum leverage available to a “family” of SBIC affiliated funds is $350.0 million, subject to SBA approval. As of December 31, 2020, our SBIC I subsidiary had $75.0 million in regulatory capital and $150.0 million in SBA-guaranteed debentures outstanding, which approximated their fair value. As of December 31, 2020, our SBIC II subsidiary had $40.0 million in regulatory capital and $26.5 million in SBA-guaranteed debentures outstanding, which approximated their fair value.
We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 150% asset coverage test under the 1940 Act. This allows us increased flexibility under the 150% asset coverage test by permitting us to borrow up to $325.0 million more (subject to SBA approval) than we would otherwise be able to absent the receipt of this exemptive relief.
The SBA restricts the ability of SBICs to repurchase their capital stock. The SBA restricts the ability of an SBIC to provide financing to an “associate” as defined in the SBA regulations, without prior written approval from the SBA. SBA regulations also prohibit, without prior SBA approval, a “change of control” or “change in ownership” of transfer of an SBIC (as such terms are defined in the SBA regulations) and require that SBICs invest idle funds in accordance with SBA regulations. In addition, our SBIC subsidiaries may also be limited in their ability to make distributions to us if they do not have sufficient capital, in accordance with SBA regulations.
Our SBIC subsidiaries are subject to regulation and oversight by the SBA, including, among other things, requirements with respect to maintaining certain minimum financial ratios and other covenants, a periodic examination by an SBA examiner, and the performance of a financial audit by an independent auditor. Receipt of an SBIC license does not assure that our SBIC subsidiaries will receive SBA guaranteed debenture funding, which is dependent upon our SBIC subsidiaries continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will have a superior claim to our SBIC subsidiaries’ assets over our stockholders in the event we liquidate one or both of our SBIC subsidiaries or the SBA exercises its remedies under the SBA-guaranteed debentures issued by our SBIC subsidiaries upon an event of default..

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
RISK FACTORS
Investing in our securities involves a number of significant risks. Before you invest in our securities, you should be aware of various risks, including those described below. You should carefully consider these risk factors, together with all of the other information included in this Annual Report on Form 10-K, before you decide whether to make an investment in our securities. The risks set out below are the principal risks with respect to an investment in our securities generally and with respect to a BDC with investment objectives, investment policies, capital structures or trading markets similar to ours. However, they may not be the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us may also impair our operations and performance. If any of the following events occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected. In such case, our net asset value and the trading price of our securities could decline, and you may lose all or part of your investment.
Risks Relating to our Business and Structure
Political, social and economic uncertainty, including uncertainty related to the COVID-19 pandemic, creates and exacerbates risks.
Social, political, economic and other conditions and events (such as natural disasters, epidemics and pandemics, terrorism, conflicts and social unrest) will occur that create uncertainty and have significant impacts on issuers, industries, governments and other systems, including the financial markets, to which companies and their investments are exposed. As global systems, economies and financial markets are increasingly interconnected, events that once had only local impact are now more likely to have regional or even global effects. Events that occur in one country, region or financial market will, more frequently, adversely impact issuers in other countries, regions or markets, including in established markets such as the U.S. These impacts can be exacerbated by failures of governments and societies to adequately respond to an emerging event or threat.
Uncertainty can result in or coincide with, among other things: increased volatility in the financial markets for securities, derivatives, loans, credit and currency; a decrease in the reliability of market prices and difficulty in valuing assets (including portfolio company assets); greater fluctuations in spreads on debt investments and currency exchange rates; increased risk of default (by both government and private obligors and issuers); further social, economic, and political instability; nationalization of private enterprise; greater governmental involvement in the economy or in social factors that impact the economy; changes to governmental regulation and supervision of the loan, securities, derivatives and currency markets and market participants and decreased or revised monitoring of such markets by governments or self-regulatory organizations and reduced enforcement of regulations; limitations on the activities of investors in such markets; controls or restrictions on foreign investment, capital controls and limitations on repatriation of invested capital; the significant loss of liquidity and the inability to purchase, sell and otherwise fund investments or settle transactions (including, but not limited to, a market freeze); unavailability of currency hedging techniques; substantial, and in some periods extremely high, rates of inflation, which can last many years and have substantial negative effects on credit and securities markets as well as the economy as a whole; recessions; and difficulties in obtaining and/or enforcing legal judgments.
For example, in December 2019, a novel strain of coronavirus (also known as “COVID-19”) emerged in China and has since spread rapidly to other countries, including the United States. This outbreak has led and for an unknown period of time will continue to lead to disruptions in local, regional, national and global markets and economies affected thereby. With respect to the U.S. credit markets (in particular for middle-market loans), this outbreak has resulted in, and until fully resolved is likely to continue to result in, the following, among other things: (i) government imposition of various forms of shelter in place orders and the closing of “non-essential” businesses, resulting in significant disruption to the businesses of many middle-market loan borrowers including supply chains, demand and practical aspects of their operations, as well as in lay-offs of employees, and, while these effects are hoped to be temporary, some effects could be persistent or even permanent; (ii) increased draws by borrowers on revolving lines of credit; (iii) increased requests by borrowers for amendments and waivers of their credit agreements to avoid default, increased
defaults by such borrowers and/or increased difficulty in obtaining refinancing at the maturity dates of their loans; (iv) volatility and disruption of these markets including greater volatility in pricing and spreads and difficulty in valuing loans during periods of increased volatility, and liquidity issues; and (v) rapidly evolving proposals and/or actions by state and federal governments to address problems being experienced by the markets and by businesses and the economy in general which will not necessarily adequately address the problems facing the loan market and middle-market businesses. This outbreak is having, and any future outbreaks could have, an adverse impact on the markets and the economy in general, which could have a material adverse impact on, among other things, the ability of lenders to originate loans, the volume and type of loans originated, and the volume and type of amendments and waivers granted to borrowers and remedial actions taken in the event of a borrower default, each of which could negatively impact the amount and quality of loans available for investment by us and returns to us, among other things. As of the date of this Annual Report on Form 10-K, it is impossible to determine the scope of this outbreak, or any future outbreaks; how long any such outbreak, market disruption or uncertainties may last; the effect any governmental actions will have; and the full potential impact on us, our investment adviser, and our portfolio companies.
Although it is impossible to predict the precise nature and consequences of these events, or of any political or policy decisions and regulatory changes occasioned by emerging events or uncertainty on applicable laws or regulations that impact us, our portfolio companies and our investments, it is clear that these types of events are impacting and will, for at least some time, continue to impact us and our portfolio companies. In many instances, the impact will be adverse and profound. For example, middle-market companies in which we may invest are being significantly impacted by these emerging events and the uncertainty caused by these events. The effects of a public health emergency may materially and adversely impact: (i) the value and performance of us and our portfolio companies, (ii) the ability of our borrowers to continue to meet loan covenants or repay loans provided by us on a timely basis (or at all), which may require us to restructure our investments or write down the value of our investments, (iii) our ability to repay debt obligations, on a timely basis (or at all), and (iv) our ability to source, manage and divest investments and achieve our investment objectives, all of which could result in significant losses to us. We will also be negatively affected if the operations of our investment adviser or our portfolio companies (or any of their key personnel or service providers) are compromised, or if necessary or beneficial systems and processes within our investment adviser or our portfolio companies are disrupted.
The COVID-19 pandemic has caused severe disruptions in the U.S. economy and has disrupted financial activity in the areas in which we or our portfolio companies operate.
The COVID-19 pandemic has resulted in numerous deaths, adversely impacted global commercial activity, and contributed to significant volatility in certain equity and debt markets. The global impact of the outbreak is rapidly evolving, and many countries have reacted to the outbreak by instituting quarantines, “work from home” measures, prohibitions on travel, and the closure of offices, businesses, schools, retail stores and other public venues. Businesses are also implementing similar precautionary measures. Such measures, as well as the general uncertainty surrounding the dangers and impact of COVID-19, have created significant disruption in supply chains and economic activity, and are having a particularly adverse impact on transportation, hospitality, tourism, entertainment and other industries, including industries in which certain of our portfolio companies operate. The impact of COVID-19 has led to significant volatility and declines in the global public equity markets, and it is uncertain how long this volatility will continue. As COVID-19 continues to spread, potential future impacts, including a global, regional or other economic recession, are increasingly uncertain and difficult to assess. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a world-wide economic downturn.
Disruptions in the capital markets caused by the COVID-19 pandemic have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. These and future market disruptions and/or illiquidity would be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets, and result in decisions by lenders not to extend credit to us. These events have limited and could continue to
limit our investment originations, limit our ability to grow, and have a material adverse impact on our and our portfolio companies’ operating results and the fair values of our debt and equity investments.
Any public health emergency, including the COVID-19 pandemic and any outbreak of other existing or new epidemic diseases, or the threat thereof, and the resulting financial and economic market uncertainty, could have a significant adverse impact on us and the fair value of our investments and our portfolio companies.
The extent of the impact of any public health emergency, including the COVID-19 pandemic, on our and our portfolio companies’ operational and financial performance will depend on many factors, including the duration and scope of such public health emergency, the actions taken by governmental authorities to contain the financial and economic impact of the public health emergency, the extent of any related travel advisories and restrictions implemented, the impact of such public health emergency on overall supply and demand, goods and services, investor liquidity, consumer confidence and levels of economic activity, and the extent of the public health emergency’s disruption to important global, regional and local supply chains and economic markets, all of which are highly uncertain and cannot be predicted. In addition, our and our portfolio companies’ operations may be significantly impacted, or even temporarily or permanently halted, as a result of government quarantine measures, voluntary and precautionary restrictions on travel or meetings and other factors related to a public health emergency, including the potential adverse impact of the public health emergency on the health of any of our or our portfolio companies’ personnel. This could create widespread business continuity issues for us and our portfolio companies.
While several countries, as well as certain states, counties and cities in the United States, have relaxed initial public health restrictions with the view to partially or fully reopening their economies, many cities have since experienced a surge in the reported number of cases, hospitalizations and deaths related to the COVID-19 pandemic. These surges have led to the re-introduction of such restrictions and business shutdowns in certain states in the United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere. Health advisors warn that recurring COVID-19 outbreaks will continue if reopening is pursued too soon or in the wrong manner, which may lead to the re-introduction or continuation of certain public health restrictions (such as instituting quarantines, prohibitions on travel and the closure of offices, businesses, schools, retail stores and other public venues). Additionally, as of late December 2020, travelers from the United States are not allowed to visit Canada, Australia or the majority of countries in Europe, Asia, Africa and South America. These continued travel restrictions may prolong the global economic downturn. In addition, although the Federal Food and Drug Administration authorized vaccines produced for emergency use starting in December 2020, it remains unclear how quickly the vaccines will be distributed nationwide and globally or when “herd immunity” will be achieved and the restrictions that were imposed to slow the spread of the virus will be lifted entirely. The delay in distributing the vaccines could lead people to continue to self-isolate and not participate in the economy at pre-pandemic levels for a prolonged period of time. Even after the COVID-19 pandemic subsides, the U.S. economy and most other major global economies may continue to experience a recession, and we anticipate our business and operations could be materially adversely affected by a prolonged recession in the United States and other major markets.
The COVID-19 pandemic is having, and any future outbreaks of COVID-19 could have, an adverse impact on the markets and the economy in general, which could have a material adverse impact on, among other things, the ability of lenders to originate loans, the volume and type of loans originated, and the volume and type of amendments and waivers granted to borrowers and remedial actions taken in the event of a borrower default, each of which could negatively impact the amount and quality of loans available for investment by us and returns to us, among other things. As of the date of this annual report on Form 10-K, it is impossible to determine the scope of the COVID-19 pandemic, or any future outbreaks of COVID- 19, how long any such outbreak, market disruption or uncertainties may last, the effect any governmental actions will have or the full potential impact on us and our portfolio companies. Any potential impact to our results of operations will depend to a large extent on future developments and new information that could emerge regarding the duration and severity of the COVID-19 pandemic and the actions taken by authorities and other entities to contain COVID-19 or treat its impact, all of which are beyond our control. These potential impacts, while uncertain, could adversely affect our and our portfolio companies’ operating results.
If the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period, loan delinquencies, loan non-accruals, problem assets, and bankruptcies may increase. In
addition, collateral for our loans may decline in value, which could cause loan losses to increase and the net worth and liquidity of loan guarantors could decline, impairing their ability to honor commitments to us. An increase in loan delinquencies and non-accruals or a decrease in loan collateral and guarantor net worth could result in increased costs and reduced income which would have a material adverse effect on our business, financial condition or results of operations. Additionally, oil prices collapsed to an 18-year low on supply glut concerns, as shutdowns across the global economy sharply reduced oil demand while Saudi Arabia and Russia engaged in a price war. Central banks and governments have responded with liquidity injections to ease the strain on financial systems and stimulus measures to buffer the shock to businesses and consumers. These measures have helped stabilize certain portions of the financial markets over the short term, but volatility will likely remain elevated until the health crisis itself is under control (via fewer new cases, lower infection rates and/or verified treatments). There are still many unknowns and new information is incoming daily, compounding the difficulty of modeling outcomes for epidemiologists and economists alike.
We cannot be certain as to the duration or magnitude of the economic impact of the COVID-19 pandemic in the markets in which we and our portfolio companies operate, including with respect to travel restrictions, business closures, mitigation efforts (whether voluntary, suggested, or mandated by law) and corresponding declines in economic activity that may negatively impact the U.S. economy and the markets for the various types of goods and services provided by U.S. middle market companies. Depending on the duration, magnitude and severity of these conditions and their related economic and market impacts, certain portfolio companies may suffer declines in earnings and could experience financial distress, which could cause them to default on their financial obligations to us and their other lenders.
We will also be negatively affected if our operations and effectiveness or the operations and effectiveness of a portfolio company (or any of the key personnel or service providers of the foregoing) is compromised or if necessary or beneficial systems and processes are disrupted.
Any public health emergency, including the COVID-19 pandemic or any outbreak of other existing or new epidemic diseases, or the threat thereof, and the resulting financial and economic market uncertainty could have a significant adverse impact on us and the fair value of our investments. Our valuations, and particularly valuations of private investments and private companies, are inherently uncertain, may fluctuate over short periods of time and are often based on estimates, comparisons and qualitative evaluations of private information that may not show the complete impact of the COVID-19 pandemic and the resulting measures taken in response thereto. These potential impacts, while uncertain, could adversely affect our and our portfolio companies’ operating results.
We are dependent upon key personnel of Stellus Capital Management for our future success. If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.
We depend on the diligence, skill and network of business contacts of the senior investment professionals of Stellus Capital Management to achieve our investment objective. Stellus Capital Management’s team of investment professionals evaluates, negotiates, structures, closes and monitors our investments in accordance with the terms of our investment advisory agreement. We can offer no assurance, however, that Stellus Capital Management’s investment professionals will continue to provide investment advice to us.
Stellus Capital Management’s investment committee, which provides oversight over our investment activities, is provided to us by Stellus Capital Management under the investment advisory agreement. Stellus Capital Management’s investment committee consists of five members, including Messrs. Ladd, and D’Angelo, each a member of our Board, Mr. Huskinson, chief financial officer and chief compliance officer for us and Stellus Capital Management, Joshua T. Davis, the Co-Head of Stellus Capital Managament’s Private Credit Strategy and Mr. Overbergen, a senior investment professional of Stellus Capital Management. The loss of any of Messrs. Ladd, and D’Angelo, Huskinson or Davis may limit our ability to achieve our investment objective and operate our business. This could have a material adverse effect on our financial condition, results of operations and cash flows.
Our business model depends to a significant extent upon strong referral relationships. Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
We depend upon the investment professionals Stellus Capital Management to maintain their relationships with private equity sponsors, placement agents, investment banks, management groups and
other financial institutions, and we rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the investment professionals of Stellus Capital Management fail to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the investment professionals of Stellus Capital Management have relationships are not obligated to provide us with investment opportunities, and we can offer no assurance that these relationships will generate investment opportunities for us in the future.
Our financial condition, results of operations and cash flows will depend on our ability to manage our business effectively.
Our ability to achieve our investment objective will depend on our ability to manage our business and to grow our investments and earnings. This will depend, in turn, on Stellus Capital Management’s ability to identify, invest in and monitor portfolio companies that meet our investment criteria. The achievement of our investment objective on a cost-effective basis will depend upon Stellus Capital Management’s execution of our investment process, its ability to provide competent, attentive and efficient services to us and, to a lesser extent, our access to financing on acceptable terms. Stellus Capital Management’s senior investment professionals will have substantial responsibilities in connection with the management of other investment funds, accounts and investment vehicles. The personnel of Stellus Capital Management may be called upon to provide managerial assistance to our portfolio companies. These activities may distract them from sourcing new investment opportunities for us or slow our rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our business, financial condition, results of operations and cash flows.
There are significant potential conflicts of interest that could negatively affect our investment returns.
The members of Stellus Capital Management’s investment committee serve, or may serve, as officers, directors, members, or principals of entities that operate in the same or a related line of business as we do, or of investment funds, accounts, or investment vehicles managed by Stellus Capital Management. Similarly, Stellus Capital Management may have other clients with similar, different or competing investment objectives. In serving in these multiple capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in the best interests of us or our stockholders. For example, Stellus Capital Management currently manages private credit funds that have an investment strategy that is similar to, overlapping with or identical to our investment strategy, and with which we co-invest. Stellus Capital Management also provides sub-advisory services to the D. E. Shaw group with respect to a private investment fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves as investment adviser that have an investment strategy similar to our investment strategy.
In addition, there may be times when Stellus Capital Management, members of its investment committee or its other investment professionals have interests that differ from those of our stockholders, giving rise to a conflict of interest. In particular, a private investment fund for which Stellus Capital Management provides investment advisory services hold minority equity interests in certain of the portfolio companies in which we hold debt investments. As a result, Stellus Capital Management, members of its investment committee or its other investment professionals may face conflicts of interest in connection with making business decisions for these portfolio companies to the extent that such decisions affect the debt and equity holders in these portfolio companies differently. In addition, Stellus Capital Management may face conflicts of interests in connection with making investment or other decisions, including granting loan waivers or concessions, on our behalf with respect to these portfolio companies given that they also provide investment advisory services to a private investment fund that holds the equity interests in these portfolio companies. Although our investment adviser will endeavor to handle these investment and other decisions in a fair and equitable manner, we and the holders of the shares of our common stock could be adversely affected by these decisions. Moreover, given the subjective nature of the investment and other decisions made by our investment adviser on our behalf, we are unable to monitor these potential conflicts of interest between us and our investment adviser; however, our Board, including the independent directors, reviews conflicts of interest in connection with its review of the performance of our investment adviser.
The senior investment professionals and other investment team members of Stellus Capital Management may, from time to time, possess material non-public information, limiting our investment discretion.
The senior investment professionals and other investment team members of Stellus Capital Management, including members of Stellus Capital Management’s investment committee, may serve as directors of, or in a similar capacity with, portfolio companies in which we invest, the securities of which are purchased or sold on our behalf. In the event that material nonpublic information is obtained with respect to such companies, or we become subject to trading restrictions under the internal trading policies of those companies or as a result of applicable law or regulations, we could be prohibited for a period of time from purchasing or selling the securities of such companies, and this prohibition may have an adverse effect on us.
Our management and incentive fees may induce Stellus Capital Management to incur additional leverage.
Generally, the management and incentive fees payable by us to Stellus Capital Management may create an incentive for Stellus Capital Management to use the additional available leverage if this proposal is approved. For example, the fact that the base management fee that we pay to Stellus Capital Management is payable based upon our gross assets (which includes any borrowings for investment purposes) may encourage Stellus Capital Management to use leverage to make additional investments. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during cyclical economic downturns. Under certain circumstances, the use of additional leverage may increase the likelihood of our default on our borrowings, which would disfavor holders of our common stock.
In addition, because the incentive fee on net investment income is calculated as a percentage of our net assets subject to a hurdle, having additional leverage available may encourage Stellus Capital Management to use leverage to increase the leveraged return on our investment portfolio. To the extent additional leverage is available at favorable rates, Stellus Capital Management could use leverage to increase the size of our investment portfolio to generate additional income, which may make it easier to meet the incentive fee hurdle. Our adoption of the reduced minimum asset coverage will allow us to incur additional leverage above the previous 1940 Act limitations. As a result, the incentives for Stellus Capital Management to cause us to use additional leverage may be greater.
Our Board is charged with protecting our interests by monitoring how Stellus Capital Management addresses these and other conflicts of interests associated with its management services and compensation. While our Board is not expected to review or approve each investment decision, borrowing or incurrence of leverage, our independent directors will periodically review Stellus Capital Management’s services and fees as well as its portfolio management decisions and portfolio performance. In connection with these reviews, our independent directors will consider whether our fees and expenses (including those related to leverage) remain appropriate.
Our incentive fee may induce Stellus Capital Management to make speculative investments.
We pay Stellus Capital Management an incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. Additionally, under the incentive fee structure, Stellus Capital Management may benefit when capital gains are recognized and, because Stellus Capital Management will determine when to sell a holding, Stellus Capital Management will control the timing of the recognition of such capital gains. As a result, Stellus Capital Management may have a tendency to invest more capital in investments that are likely to result in capital gains as compared to income producing securities. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
We may be obligated to pay Stellus Capital Management incentive compensation even if we incur a loss and may pay more than 20.0% of our net capital gains because we cannot recover payments made in previous years.
Stellus Capital Management is entitled to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive
compensation) above a threshold return for that quarter and subject to a total return requirement. The general effect of this total return requirement is to prevent payment of the foregoing incentive compensation 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 incentive fees accrued and/or paid for the 11 preceding calendar quarters. Consequently, we may pay an incentive fee if we incurred losses more than three years prior to the current calendar quarter even if such losses have not yet been recovered in full. Thus, we may be required to pay Stellus Capital Management incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter. If we pay an incentive fee of 20.0% of our realized capital gains (net of all realized capital losses and unrealized capital depreciation on a cumulative basis) and thereafter experience additional realized capital losses or unrealized capital depreciation, we will not be able to recover any portion of the incentive fee previously paid.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we make. We compete with public and private funds, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, we believe some of our competitors may have access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or the source-of-income, asset diversification and distribution requirements we must satisfy to maintain our RIC qualification. The competitive pressures we face may have a material adverse effect on our business, financial condition, results of operations and cash flows. As a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we may not be able to identify and make investments that are consistent with our investment objective.
With respect to the investments we make, we do not seek to compete based primarily on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that are lower than the rates we offer. With respect to all investments, we may lose some investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net interest income, lower yields and increased risk of credit loss. We may also compete for investment opportunities with investment funds, accounts and investment vehicles managed by Stellus Capital Management. Although Stellus Capital Management will allocate opportunities in accordance with its policies and procedures, allocations to such investment funds, accounts and investment vehicles will reduce the amount and frequency of opportunities available to us and may not be in the best interests of us and our stockholders.
We will be subject to corporate-level income tax and may default under our revolving credit facility if we are unable to maintain our tax treatment as a RIC under Subchapter M of the Code.
To maintain our tax treatment as a RIC under Subchapter M of the Code, we must meet certain source-of-income, asset diversification and distribution requirements. The distribution requirement for a RIC is satisfied if we distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Because we incur debt, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to maintain our tax treatment as a RIC. If we are unable to obtain cash from other sources, we may fail to maintain our tax treatment as a RIC and, thus, may be subject to corporate-level income tax. To maintain our tax treatment as a RIC, we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of our tax treatment as a RIC. Because most of our investments are in private or thinly-traded public companies, any such dispositions may be made at disadvantageous prices and may result in substantial losses. No certainty can be provided, that we will satisfy the asset diversification requirements or the other requirements necessary to maintain our tax treatment as a RIC. If we fail to
maintain our tax treatment as a RIC for any reason and become subject to corporate income tax, the resulting corporate income taxes could substantially reduce our net assets, the amount of income available for distributions to our stockholders and the amount of funds available for new investments. Furthermore, if we fail to maintain our tax treatment as a RIC, we may be in default under the terms of our amended and restated senior secured revolving credit agreement with certain lenders party thereto and Zions Bancorporation, N.A. dba Amegy Bank, as administrative agent (as amended from time to time, the “Credit Facility”). Such a failure could have a material adverse effect on us and our stockholders.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
For U.S. federal income tax purposes, we include in income certain amounts that we have not yet received in cash, such as the accrual of original issue discount. This may arise if we receive warrants in connection with the making of a loan and in other circumstances, or through contracted PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount, which could be significant relative to our overall investment activities, and increases in loan balances as a result of contracted PIK arrangements are included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we will not receive in cash.
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to maintain our tax treatment as a RIC. In such a case, we may have to sell some of our investments at times we would not consider advantageous or raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If we are not able to obtain such cash from other sources, we may fail to maintain our tax treatment as a RIC and thus be subject to corporate-level income tax.
We may in the future choose to pay dividends in our own common stock, in which case you may be required to pay tax in excess of the cash you receive.
We may distribute taxable dividends that are payable in part in our common stock. In accordance with certain applicable Treasury regulations and published guidance issued by the Internal Revenue Service, a publicly offered RIC may treat a distribution of its own stock as fulfilling the RIC distribution requirements if each shareholder 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 shareholders must be at least 20.0% of the aggregate declared distribution. If too many shareholders elect to receive cash, the cash available for distribution must be allocated among the shareholders electing to receive cash (with the balance of the distribution paid in stock). In no event will any shareholder, electing to receive cash, receive less than the lesser of (a) the portion of the distribution such shareholder has elected to receive in cash or (b) an amount equal to his or her entire distribution times the percentage limitation on cash available for distribution. 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. Taxable shareholders receiving such dividends will be required to include the amount of the dividends as ordinary income (or as long-term capital gain to the extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, a U.S. shareholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. shareholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our common stock at the time of the sale. Furthermore, with respect to non-U.S. shareholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common stock. In addition, if a significant number of our shareholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.
PIK interest payments we receive will increase our assets under management and, as a result, will increase the amount of base management fees and incentive fees payable by us to Stellus Capital Management.
Certain of our debt investments may contain provisions providing for the payment of PIK interest. Because PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt
by us of PIK interest will have the effect of increasing our assets under management. As a result, because the base management fee that we pay to Stellus Capital Management is based on the value of our gross assets, the receipt by us of PIK interest will result in an increase in the amount of the base management fee payable by us. In addition, any such increase in a loan balance due to the receipt of PIK interest will cause such loan to accrue interest on the higher loan balance, which will result in an increase in our pre-incentive fee net investment income and, as a result, an increase in incentive fees that are payable by us to Stellus Capital Management.
Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital. As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we are permitted as a BDC that has satisfied certain requirements to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 150% of our gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we would not be able to borrow additional funds until we were able to comply with the 150% asset coverage ratio applicable to us under the 1940 Act. Also, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders. If we issue senior securities, we will be exposed to typical risks associated with leverage, including an increased risk of loss.
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below then-current net asset value per share of our common stock if our Board determines that such sale is in our best interests, and if our stockholders approve such sale. A proposal, approved by our stockholders at our 2020 annual stockholders meeting, authorizes us to sell shares equal to up to 25% of our outstanding common stock of our common stock below the then current net asset value per share of our common stock in one or more offerings. This approval will expire on the earlier of our 2020 annual stockholder meeting or June 25, 2021, the one-year anniversary of our 2020 annual stockholders meeting. The proposal approved by our stockholders did not specify a maximum discount below net asset value at which we are able to issue our common stock, although the number of shares sold in each offering may not exceed 25% of our outstanding common stock immediately prior to such sale. 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. In addition, we cannot issue shares of our common stock below net asset value unless our Board determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. If we raise additional funds by issuing common stock, then the percentage ownership of our stockholders at that time will decrease, and you may experience dilution.
Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.
The use of leverage magnifies the potential for gain or loss on amounts invested. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. If we continue to use leverage to partially finance our investments through banks, insurance
companies and other lenders, you will experience increased risks of investing in our common stock. Lenders of these funds have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such lenders to seek recovery against our assets in the event of a default. We, through our SBIC subsidiaries, intend to issue debt securities guaranteed by the SBA and sold in the capital markets. Upon any such issuance of debt securities and as a result of its guarantee of the debt securities, if any, the SBA would also have fixed dollar claims on the assets of our SBIC subsidiaries that are superior to the claims of our common stockholders.
Upon the issuance of any debt securities guaranteed by the SBA, if we are unable to meet the financial obligations under our 4.875% notes due 2026 or (the “2026 Notes”), as issued on January 14, 2021, or the Credit Facility, the SBA, as a creditor, would have a superior claim to the assets of our SBIC subsidiaries over our stockholders in the event we liquidate or the SBA exercises its remedies under such debentures as the result of a default by us. In addition, under the terms of the Credit Facility and any borrowing facility or other debt instrument we may enter into, we are likely to be required to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or instrument before applying such net proceeds to any other uses. If the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make distributions with respect to our common stock. Our ability to service any debt depends largely on our financial performance and is subject to prevailing economic conditions and competitive pressures. Moreover, as the base management fee payable to Stellus Capital Management is payable based on the value of our gross assets, including those assets acquired through the use of leverage, Stellus Capital Management will have a financial incentive to incur leverage, which may not be consistent with our stockholders’ interests. In addition, our common stockholders bear the burden of any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the base management fee payable to Stellus Capital Management.
As a BDC that has satisfied certain requirements under the 1940 Act, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock that we may issue in the future, of at least 150%. If this ratio declines below 150%, we will not be able to incur additional debt until we are able to comply with the 150% asset coverage ratio applicable to us under the 1940 Act. This could have a material adverse effect on our operations, and we may not be able to make distributions. The amount of leverage that we employ will depend on Stellus Capital Management’s and our Boards’ assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that we will be able to obtain credit at all or on terms acceptable to us.
We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 150% asset coverage ratio we are required to maintain under the 1940 Act. This relief allows us increased flexibility under the 150% asset coverage test by allowing us to borrow up to $325.0 million more through our SBIC subsidiaries than we would otherwise be able to borrow absent the receipt of this exemptive relief.
In addition, our debt facilities may impose financial and operating covenants that restrict our business activities, including limitations that hinder our ability to finance additional loans and investments or to make the distributions required to maintain our qualification as a RIC under the Code.
Substantially all of our assets are subject to security interests under the Credit Facility or claims of the SBA with respect to SBA-guaranteed debentures we may issue and, if we default on our obligations thereunder, we may suffer adverse consequences, including foreclosure on our assets.
As of December 31, 2020, substantially all of our assets were pledged as collateral under the Credit Facility or are subject to a superior claim over the holders of our common stock by the SBA pursuant to the SBA-guaranteed debentures. If we default on our obligations under the Credit Facility or the SBA-guaranteed debentures the lenders and/or the SBA may have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests or their superior claim. In such event, we may be forced to sell our investments to raise funds to repay our outstanding borrowings in order to avoid foreclosure
and these forced sales may be at times and at prices we would not consider advantageous. Moreover, such deleveraging of our company could significantly impair our ability to effectively operate our business in the manner in which we have historically operated. As a result, we could be forced to curtail or cease new investment activities and lower or eliminate the dividends that we have historically paid to our stockholders.
In addition, if the lenders exercise their right to sell the assets pledged under the Credit Facility, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the Credit Facility.
Because we use debt to finance our investments and may in the future issue senior securities including preferred stock and debt securities, if market interest rates were to increase, our cost of capital could increase, which could reduce our net investment income.
Because we borrow money to make investments and may in the future issue additional senior securities including preferred stock and debt securities, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates would not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates to the extent permitted by the 1940 Act. For example, to the extent any such instruments were to constitute senior securities under the 1940 Act, we would have to and will comply with the asset coverage requirements thereunder or, as permitted in lieu thereof, place certain assets in a segregated account to cover such instruments in accordance with SEC guidance, including, for example, Investment Company Act Release No. IC-10666, as applicable. There is otherwise no limit as to our ability to enter into such derivative transactions. In addition, a rise in the general level of interest rates typically leads to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates may result in an increase of the amount of our pre-incentive fee net investment income and, as a result, an increase in incentive fees payable to Stellus Capital Management. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations.
Provisions in the Credit Facility or any other future borrowing facility may limit our discretion in operating our business.
The Credit Facility is, and any future borrowing facility may be, backed by all or a portion of our loans and securities on which the lenders will or, in the case of a future facility, may have a security interest. We may pledge up to 100% of our assets and may grant a security interest in all of our assets under the terms of any debt instrument we enter into with lenders. We expect that any security interests we grant will be set forth in a guarantee and security agreement and evidenced by the filing of financing statements by the agent for the lenders. In addition, we expect that the custodian for our securities serving as collateral for such loan would include in its electronic systems notices indicating the existence of such security interests and, following notice of occurrence of an event of default, if any, and during its continuance, will only accept transfer instructions with respect to any such securities from the lender or its designee. If we were to default under the terms of any debt instrument, the agent for the applicable lenders would be able to assume control of the timing of disposition of any or all of our assets securing such debt, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.
In addition, any security interests as well as negative covenants under the Credit Facility or any other borrowing facility may limit our ability to incur additional liens or debt and may make it difficult for us to restructure or refinance indebtedness at or prior to maturity or obtain additional debt or equity financing. For example, under the terms of the Credit Facility, we have generally agreed to not incur any additional secured indebtedness, other than certain indebtedness that we may incur, in accordance with the Credit Facility, to allow us to purchase investments in U.S. Treasury Bills. In addition, we have agreed not to incur any additional indebtedness that has a maturity date prior to the maturity date of the Credit Facility. Further,
if our borrowing base under the Credit Facility or any other borrowing facility were to decrease, we would be required to secure additional assets in an amount equal to any borrowing base deficiency. In the event that all of our assets are secured at the time of such a borrowing base deficiency, we could be required to repay advances under the Credit Facility or any other borrowing facility or make deposits to a collection account, either of which could have a material adverse impact on our ability to fund future investments and to make stockholder distributions.
In addition, under the Credit Facility or any other borrowing facility, we may be subject to limitations as to how borrowed funds may be used, which may include restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings, as well as regulatory restrictions on leverage which may affect the amount of funding that may be obtained. There may also be certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could limit further advances and, in some cases, result in an event of default. Furthermore, we expect that the terms of the Credit Facility will contain a covenant requiring us to maintain compliance with RIC provisions at all times, subject to certain remedial provisions. Thus, a failure to maintain compliance with RIC provisions could result in an event of default under the Credit Facility. An event of default under the Credit Facility or any other borrowing facility could result in an accelerated maturity date for all amounts outstanding thereunder, which could have a material adverse effect on our business and financial condition. This could reduce our revenues and, by delaying any cash payment allowed to us under the Credit Facility or any other borrowing facility until the lenders have been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our qualification as a RIC.
We may in the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.
Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on any preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference.
Adverse developments in the credit markets may impair our ability to enter into any other future borrowing facility.
In past economic downturns, such as the financial crisis in the United States that began in mid-2007 and during other times of extreme market volatility, many commercial banks and other financial institutions stopped lending or significantly curtailed their lending activity. In addition, in an effort to stem losses and reduce their exposure to segments of the economy deemed to be high risk, some financial institutions limited routine refinancing and loan modification transactions and even reviewed the terms of existing facilities to identify bases for accelerating the maturity of existing lending facilities. If these conditions recur, for example as a result of the COVID-19 pandemic, it may be difficult for us to obtain desired financing to finance the growth of our investments on acceptable economic terms, or at all.
The COVID-19 pandemic could result in, among other things, increased draws by borrowers on revolving lines of credit and increased requests by borrowers for amendments, modifications and waivers of their credit agreements to avoid default or change payment terms, increased defaults by such borrowers and/or increased difficulty in obtaining refinancing at the maturity dates of their loans. In addition, the duration and effectiveness of responsive measures implemented by governments and central banks cannot be predicted. The commencement, continuation, or cessation of government and central bank policies and economic stimulus programs, including changes in monetary policy involving interest rate adjustments or governmental policies, may contribute to the development of or result in an increase in market volatility, illiquidity and other adverse effects that could negatively impact the credit markets and the Company.
If we are unable to consummate credit facilities on commercially reasonable terms, our liquidity may be reduced significantly. If we are unable to repay amounts outstanding under any facility we may enter into and are declared in default or are unable to renew or refinance any such facility, it would limit our ability to
initiate significant originations or to operate our business in the normal course. These situations may arise due to circumstances that we may be unable to control, such as inaccessibility of the credit markets, a severe decline in the value of the U.S. dollar, a further economic downturn or an operational problem that affects third parties or us, and could materially damage our business. Moreover, we are unable to predict when economic and market conditions may become more favorable. Even if such conditions improve broadly and significantly over the long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
The current period of capital markets disruption and economic uncertainty may make it difficult to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness and any failure to do so could have a material adverse effect on our business, financial condition or results of operations.
Current market conditions may make it difficult to extend the maturity of or refinance our existing indebtedness or obtain new indebtedness with similar terms and any failure to do so could have a material adverse effect on our business. The debt capital that will be available to us in the future, if at all, may be at a higher cost and on less favorable terms and conditions than what we currently experience, including being at a higher cost in rising rate environments. If we are unable to raise or refinance debt, then our equity investors may not benefit from the potential for increased returns on equity resulting from leverage and we may be limited in our ability to make new commitments or to fund existing commitments to our portfolio companies. An inability to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness could have a material adverse effect on our business, financial condition or results of operations.
Most of our portfolio investments are recorded at fair value as determined in good faith by our Board and, as a result, there may be uncertainty as to the value of our portfolio investments.
Most of our portfolio investments will take the form of securities that are not publicly traded. The fair value of loans, securities and other investments that are not publicly traded may not be readily determinable, and we value these investments at fair value as determined in good faith by our Board, including to reflect significant events affecting the value of our investments. Most, if not all, of our investments (other than cash and cash equivalents) are classified as Level 3 under ASC Topic 820. This means that our portfolio valuations are based on unobservable inputs and our own assumptions about how market participants would price the asset or liability in question. Inputs into the determination of fair value of our portfolio investments require significant management judgment or estimation. Even if observable market data is available, such information may be the result of consensus pricing information or broker quotes, which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimers materially reduces the reliability of such information. We have retained the services of independent service providers to review the valuation of these loans and securities. The types of factors that Board may take into account in determining the fair value of our investments generally include, as appropriate, comparison to publicly traded securities including such factors as yield, maturity and measures of credit quality, the enterprise value of a portfolio company, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these loans and securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such loans and securities.
We adjust quarterly the valuation of our portfolio to reflect our Boards’ determination of the fair value of each investment in our portfolio. Any changes in fair value are recorded in our statement of operations as net change in unrealized appreciation or depreciation.
We may expose ourselves to risks if we engage in hedging transactions.
We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from
changes in currency exchange rates and market interest rates. Use of these hedging instruments may expose us to counter-party credit risk. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is generally anticipated at an acceptable price.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection with Section 404 of the Sarbanes-Oxley Act may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our consolidated financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
We incur significant costs as a result of being a publicly traded company.
As a publicly traded company, we incur legal, accounting, investor relations and other expenses, including costs associated with corporate governance requirements, such as those under the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, other rules implemented by the SEC and the listing standards of the NYSE.
We are obligated to maintain proper and effective internal control over financial reporting. We may not complete our analysis of our internal control over financial reporting in a timely manner, or our internal controls may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our securities.
Complying with Section 404 requires a rigorous compliance program as well as adequate time and resources. We may not be able to complete our internal control evaluation, testing and any required remediation in a timely fashion. Additionally, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal control over financial reporting is effective we could lose investor confidence in the accuracy and completeness of our financial reports, which would have a material adverse effect on the price of our securities.
We are required to disclose changes made in our internal control and procedures on a quarterly basis and our management is required to assess the effectiveness of these controls annually. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.
New or modified laws or regulations governing our operations may adversely affect our business.
We and our portfolio companies are subject to regulation by laws at the U.S. federal, state and local levels. These laws and regulations, as well as their interpretation, could change from time to time, including as the result of interpretive guidance or other directives from the U.S. President and others in the executive branch, and new laws, regulations and interpretations could also come into effect. Any such new or changed laws or regulations could have a material adverse effect on our business, and political uncertainty could increase regulatory uncertainty in the near term.
The effects of legislative and regulatory proposals directed at the financial services industry or affecting taxation, could negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies, intensify the regulatory supervision of us or our portfolio companies or otherwise adversely affect our business or the business of our portfolio companies. In addition, if we do not comply with applicable laws and regulations, we could lose any licenses that we then hold for the conduct of our business and could be subject to civil fines and criminal penalties.
We invest in securities of issuers that are subject to governmental and non-governmental regulations, including by federal and state regulators and various self-regulatory organizations. Companies participating in regulated activities could incur significant costs to comply with these laws and regulations. If a company in which we invest fails to comply with an applicable regulatory regime, it could be subject to fines, injunctions, operating restrictions or criminal prosecution, any of which could materially and adversely affect the value of our investment.
Additionally, changes to the laws and regulations governing our operations, including those associated with RICs, could cause us to alter our investment strategy in order to avail ourselves of new or different opportunities or result in the imposition of corporate-level taxes on us. Such changes could result in material differences to our strategies and plans and could shift our investment focus from the areas of expertise of Stellus Capital Management to other types of investments in which Stellus Capital Management may have little or no expertise or experience. Any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment. If we invest in commodity interests in the future, Stellus Capital Management could determine not to use investment strategies that trigger additional regulation by the U.S. Commodity Futures Trading Commission (“CFTC”) or could determine to operate subject to CFTC regulation, if applicable. If we or Stellus Capital Management were to operate subject to CFTC regulation, we could incur additional expenses and would be subject to additional regulation.
Over the last several years, there also has been an increase in regulatory attention to the extension of credit outside of the traditional banking sector, raising the possibility that some portion of the non-bank financial sector will be subject to new regulation. While it cannot be known at this time whether any regulation will be implemented or what form it will take, increased regulation of non-bank credit extension could negatively impact our operations, cash flows or financial condition, impose additional costs on us, intensify the regulatory supervision of us or otherwise adversely affect our business, financial condition and results of operations.
Legislative or other actions relating to taxes could have a negative effect on us.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. New legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax consequences to us and our investors of such qualification, or could have other adverse consequences. Investors are urged to consult with their tax advisor regarding tax legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our securities.
Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiaries’ operations.
On June 20, 2014 and August 14, 2019, our wholly-owned subsidiaries, Stellus Capital SBIC LP, and Stellus Capital SBIC II LP, respectively, received licenses from the SBA to operate as SBICs. The SBA places certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBIC requirements may cause our SBIC subsidiaries to forgo attractive investment opportunities that are not permitted under SBA regulations.
Further, SBA regulations require that an SBIC be examined by the SBA to determine its compliance with the relevant SBA regulations at least every two years. The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result in any person (or a group of persons acting in concert) owning 10% or more of a class of capital stock of an SBIC. If either of our SBIC subsidiaries fails to comply with applicable SBA regulations, the SBA could, depending on the severity of
the violation, limit or prohibit its use of debentures, declare outstanding debentures immediately due and payable, and/or limit it from making new investments. In addition, the SBA can revoke or suspend a license for willful or repeated violation of, or willful or repeated failure to observe, any provision of the Small Business Investment Act of 1958 or any rule or regulation promulgated thereunder. These actions by the SBA would, in turn, negatively affect us because our SBIC subsidiaries are our wholly-owned subsidiaries.
Risks Related to Our Operations
Because we intend to distribute substantially all of our income to our stockholders to obtain and maintain our status as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow may be impaired.
We will need additional capital to fund new investments and grow our portfolio of investments. We intend to access the capital markets periodically to issue debt or equity securities or borrow from financial institutions in order to obtain such additional capital. Unfavorable economic conditions could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. A reduction in the availability of new capital could limit our ability to grow. In addition, we are required to distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders to maintain our qualification as a RIC. As a result, these earnings will not be available to fund new investments. An inability on our part to access the capital markets successfully could limit our ability to grow our business and execute our business strategy fully and could decrease our earnings, if any, which would have an adverse effect on the value of our shares of common stock.
As a BDC that has satisfied certain conditions under the 1940 Act, we are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities and excluding SBA-guaranteed debentures as permitted by exemptive relief obtained from the SEC, to total senior securities, which includes all of our borrowings with the exception of SBA-guaranteed debentures, of at least 150%. This requirement limits the amount that we may borrow. Since we continue to need capital to grow our investment portfolio, these limitations may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. While we expect that we will be able to borrow and to issue additional debt securities and expect that we will be able to issue additional equity securities, which would in turn increase the equity capital available to us, we cannot assure you that debt and equity financing will be available to us on favorable terms, or at all. In addition, as a BDC, we generally are not permitted to issue equity securities priced below net asset value without stockholder approval. If additional funds are not available us, we may be forced to curtail or cease new investment activities, and our net asset value could decline.
Our wholly-owned SBIC subsidiaries may be unable to make distributions to us that will enable us to maintain RIC tax treatment, which could result in the imposition of an entity-level tax.
In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we are required to distribute substantially all of our net ordinary income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiaries. We are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our tax treatment as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC tax treatment. We cannot assure you that the SBA will grant such waiver and if our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC tax treatment and a consequent imposition of an entity-level tax on us.
Our ability to enter into certain transactions with our affiliates is restricted, which may limit the scope of investments available to us.
We are prohibited under the 1940 Act from participating in certain transactions with our affiliates without the prior approval of our independent directors and, in some cases, the SEC. Any person that
owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act, and we are generally prohibited from buying or selling any security from or to such affiliate without the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include concurrent investments in the same portfolio company, without prior approval of our independent directors and, in some cases, of the SEC. We are prohibited from buying or selling any security from or to any person that controls us or who owns more than 25% of our voting securities or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC. As a result of these restrictions, we may be prohibited from buying or selling any security (other than any security of which we are the issuer) from or to any portfolio company of a private fund managed by Stellus Capital Management or its affiliates without the prior approval of the SEC, which may limit the scope of investment opportunities that would otherwise be available to us.
We have received exemptive relief from the SEC to co-invest with investment funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC). Under the terms of the relief permitting us to co-invest with other funds managed by Stellus Capital Management, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies.
The involvement of our interested directors in the valuation process may create conflicts of interest.
We make many of our portfolio investments in the form of loans and securities that are not publicly traded and for which no market-based price quotation is available. As a result, our Board determines the fair value of these loans and securities in good faith as described elsewhere in this Annual Report on Form 10-K. In connection with that determination, investment professionals from Stellus Capital Management provide our Board with valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. While the valuation for each portfolio investment is reviewed by an independent valuation firm at least twice annually, the ultimate determination of fair value is made by our Board, including our interested directors, and not by such third-party valuation firm. In addition, Messrs. Ladd and D’Angelo, each an interested member of our Board, has a direct pecuniary interest in Stellus Capital Management. The participation of Stellus Capital Management’s investment professionals in our valuation process, and the pecuniary interest in Stellus Capital Management by certain members of our Board, could result in a conflict of interest as Stellus Capital Management’s management fee is based, in part, on the value of our gross assets, and incentive fees are based, in part, on realized gains and realized and unrealized losses.
There are conflicts related to other arrangements with Stellus Capital Management.
We have entered into a license agreement with Stellus Capital Management under which Stellus Capital Management has agreed to grant us a non-exclusive, royalty-free license to use the name “Stellus Capital.” In addition, we have entered into an administration agreement with Stellus Capital Management pursuant to which we are required to pay to Stellus Capital Management our allocable portion of overhead and other expenses incurred by Stellus Capital Management in performing its obligations under such administration agreement, such as rent and our allocable portion of the cost of our Chief Financial Officer and Chief Compliance Officer and his staff. This will create conflicts of interest that our Board will monitor. For example, under the terms of the license agreement, we will be unable to preclude Stellus Capital Management from licensing or transferring the ownership of the “Stellus Capital” name to third parties, some of whom may compete against us. Consequently, we will be unable to prevent any damage to goodwill that may occur as a result of the activities of Stellus Capital Management or others. Furthermore, in the event the license agreement is terminated, we will be required to change our name and cease using “Stellus Capital” as part of our name. Any of these events could disrupt our recognition in the marketplace, damage any goodwill we may have generated and otherwise harm our business.
The investment advisory agreement and the administration agreement with Stellus Capital Management were not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
The investment advisory agreement and the administration agreement were negotiated between related parties. Consequently, their terms, including fees payable to Stellus Capital Management, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing relationship with Stellus Capital Management and its affiliates. Any such decision, however, would breach our fiduciary obligations to our stockholders.
The time and resources that Stellus Capital Management devote to us may be diverted, and we may face additional competition due to the fact that Stellus Capital Management and its affiliates are not prohibited from raising money for, or managing, another entity that makes the same types of investments that we target.
Stellus Capital Management and some of its affiliates, including our officers and our non-independent directors, are not prohibited from raising money for, or managing, another investment entity that makes the same types of investments as those we target. For example, Stellus Capital Management currently manages private credit funds that have investment strategies that are similar, overlapping or identical to our investment strategy and with which we co-invest. In addition, pursuant to sub-advisory arrangements, Stellus Capital Management provides non-discretionary advisory services to the D. E. Shaw group related to a private investment fund and a strategy of a private multi-strategy investment fund to which the D. E. Shaw group serves as investment adviser. As a result, the time and resources they could devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities.
Our incentive fee arrangements with Stellus Capital Management may vary from those of other investment funds, account or investment vehicles managed by Stellus Capital Management, which may create an incentive for Stellus Capital Management to devote time and resources to a higher fee-paying fund.
If Stellus Capital Management is paid a higher performance-based fee from any of its other funds, it may have an incentive to devote more research and development or other activities, and/or recommend the allocation of investment opportunities, to such higher fee-paying fund. For example, to the extent Stellus Capital Management’s incentive compensation is not subject to a hurdle or total return requirement with respect to another fund, it may have an incentive to devote time and resources to such other fund.
Stellus Capital Management’s liability is limited under the investment advisory agreement and we have agreed to indemnify Stellus Capital Management against certain liabilities, which may lead Stellus Capital Management to act in a riskier manner on our behalf than it would when acting for its own account.
Under the investment advisory agreement, Stellus Capital Management has not assumed any responsibility to us other than to render the services called for under that agreement. It will not be responsible for any action of our Board in following or declining to follow Stellus Capital Management’s advice or recommendations. Under the investment advisory agreement, Stellus Capital Management, its officers, members and personnel, and any person controlling or controlled by Stellus Capital Management will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the investment advisory agreement, except those resulting from acts constituting gross negligence, willful misfeasance, bad faith or reckless disregard of the duties that Stellus Capital Management owes to us under the investment advisory agreement. In addition, as part of the investment advisory agreement, we have agreed to indemnify Stellus Capital Management and each of its officers, directors, members, managers and employees from and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations or any action taken or omitted on our behalf pursuant to authority granted by the investment advisory agreement, except where attributable to gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under the investment advisory agreement. These protections may lead Stellus Capital Management to act in a riskier manner when acting on our behalf than it would when acting for its own account.
Stellus Capital Management can resign as our investment adviser or administrator upon 60 days’ notice and we may not be able to find a suitable replacement within that time, or at all, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
Stellus Capital Management has the right under the investment advisory agreement to resign as our investment adviser at any time upon 60 days’ written notice, whether we have found a replacement or not. Similarly, Stellus Capital Management has the right under the administration agreement to resign at any time upon 60 days’ written notice, whether we have found a replacement or not. If Stellus Capital Management was to resign, we may not be able to find a new investment adviser or administrator or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions to our stockholders are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management and investment or administrative activities, as applicable, is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by Stellus Capital Management. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.
If we fail to maintain our status as a BDC, our business and operating flexibility could be significantly reduced.
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act imposes numerous constraints on the operations of BDCs. For example, BDCs are required to invest at least 70.0% of their total assets in specified types of securities, primarily in private companies or thinly-traded U.S. public companies, cash, cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less. Failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us and/or expose us to claims of private litigants. In addition, upon approval of a majority of our stockholders, we may elect to withdraw their respective election as a BDC. If we decide to withdraw our election, we may be required to register as an investment company under the 1940 Act and be subject to the substantially greater regulation under the 1940 Act as a closed-end investment company. Compliance with these regulations would significantly decrease our operating flexibility and could significantly increase our cost of doing business.
If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs or be precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe to be attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of our position).
If we do not maintain our election to be regulated as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end investment company, we would be subject to substantially more regulatory restrictions under the 1940 Act which would significantly decrease our operating flexibility.
We may experience fluctuations in our annual and quarterly operating results.
We could experience fluctuations in our annual and quarterly operating results due to a number of factors, including the interest rate payable on the loans and debt securities we acquire, the default rate on such loans and securities, the level of our expenses, variations in and the timing of the recognition of realized
and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. In light of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
Our Board may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
Our Board has the authority, except as otherwise provided in the 1940 Act, to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and the market price of our common stock. Nevertheless, any such changes could adversely affect our business and impair our ability to make distributions to our stockholders.
Our Board is authorized to reclassify any unissued shares of common stock into one or more classes of preferred stock, which could convey special rights and privileges to its owners.
Under Maryland General Corporation Law and our charter, our Board is authorized to classify and reclassify any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to issuance of shares of each class or series, the Board will be required by Maryland law and our charter to set the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to stockholder distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the Board could authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or that otherwise might be in their best interest. The cost of any such reclassification would be borne by our common stockholders. Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock. For example, the 1940 Act provides that holders of preferred stock are entitled to vote separately from holders of common stock to elect two preferred stock directors. We currently have no plans to issue preferred stock. The issuance of preferred shares convertible into shares of common stock may also reduce the net income and net asset value per share of our common stock upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder approval. These effects, among others, could have an adverse effect on your investment in our common stock.
Provisions of the Maryland General Corporation Law and of our charter and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.
The Maryland General Corporation Law and our charter and bylaws contain provisions that may discourage, delay or make more difficult a change in control of Stellus Capital Investment Corporation or the removal of our directors. We are subject to the Maryland Business Combination Act, subject to any applicable requirements of the 1940 Act. Our Board has adopted a resolution exempting from the Business Combination Act any business combination between us and any other person, subject to prior approval of such business combination by our Board, including approval by a majority of our independent directors. If the resolution exempting business combinations is repealed or our Board does not approve a business combination, the Business Combination Act may discourage third parties from trying to acquire control of us and increase the difficulty of consummating such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions of our stock by any person. If we amend our bylaws to repeal the exemption from the Control Share Acquisition Act, the Control Share Acquisition Act also may make it more difficult for a third party to obtain control of us and increase the difficulty of consummating such a transaction.
We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our charter classifying our Board in three classes serving staggered three-year terms, and authorizing our Board to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, to amend our charter without stockholder approval and
to increase or decrease the number of shares of stock that we have authority to issue. These provisions, as well as other provisions of our charter and bylaws, may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders.
We are highly dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to make distributions to our stockholders.
Our business is highly dependent on the communications and information systems of Stellus Capital Management. In addition, certain of these systems are provided to Stellus Capital Management by third party service providers. Any failure or interruption of such systems, including as a result of the termination of an agreement with any such third-party service provider, could cause delays or other problems in our activities. This, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to make distributions to our stockholders.
The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.
The occurrence of a disaster, such as a cyber-attack against us or against a third-party that has access to our data or networks, a natural catastrophe, an industrial accident, failure of our disaster recovery systems, or consequential employee error, could have an adverse effect on our ability to communicate or conduct business, negatively impacting our operations and financial condition. This adverse effect can become particularly acute if those events affect our electronic data processing, transmission, storage, and retrieval systems, or impact the availability, integrity, or confidentiality of our data.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems, networks, and data, like those of other companies, could be subject to cyber-attacks and unauthorized access, use, alteration, or destruction, such as from physical and electronic break-ins or unauthorized tampering, malware and computer virus attacks, or system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary, and other information processed, stored in, and transmitted through our computer systems and networks. Such an attack could cause interruptions or malfunctions in our operations, which could result in financial losses, litigation, regulatory penalties, client dissatisfaction or loss, reputational damage, and increased costs associated with mitigation of damages and remediation.
Third parties with which we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and these relationships allow for the storage and processing of our information, as well as customer, counterparty, employee and borrower information. Cybersecurity failures or breaches by Stellus Capital Management and other service providers (including, but not limited to, accountants, custodians, transfer agents and administrators), and the issuers of securities in which we invest, also have the ability to cause disruptions and impact business operations, potentially resulting in financial losses, interference with our ability to calculate its net asset value, impediments to trading, the inability of our stockholders to transact business, violations of applicable privacy and other laws, regulatory fines, penalties, reputation damages, reimbursement of other compensation costs, or additional compliance costs. While we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure or destruction of data, or other cybersecurity incidents, with increased costs and other consequences, including those described above. In addition, substantial costs may be incurred in order to prevent any cyber incidents in the future.
Privacy and information security laws and regulation changes, and compliance with those changes, may result in cost increases due to system changes and the development of new administrative processes. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. We currently do not maintain insurance coverage relating to cybersecurity risks, and we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are not fully insured.
We and our service providers are currently impacted by quarantines and similar measures being enacted by governments in response to the COVID-19 pandemic, which are obstructing the regular functioning of business work forces (including requiring employees to work from external locations and their homes). Accordingly, the risks described above are heightened under current conditions.
We, Stellus Capital Management and our portfolio companies are subject to risks associated with “phishing” and other cyber-attacks.
Our business and the business of our portfolio companies relies upon secure information technology systems for data processing, storage and reporting. Despite careful security and controls design, implementation and updating, ours and our portfolio companies’ information technology systems could become subject to cyber-attacks. Cyber-attacks include, but are not limited to, gaining unauthorized access to digital systems (e.g., through “hacking”, malicious software coding, social engineering or “phishing” attempts) for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. Cyber-attacks may also be carried out in a manner that does not require gaining unauthorized access, such as causing denial-of service attacks on websites (i.e., efforts to make network services unavailable to intended users). Stellus Capital Management’s employees have been and expect to continue to be the target of fraudulent calls, emails and other forms of activities. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen information, misappropriation of assets, increased cybersecurity protection and insurance costs, litigation and damage to our business relationships, regulatory fines or penalties, or other adverse effects on our business, financial condition or results of operations. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security risks related to cyber-attacks.
Stellus Capital Management’s and other service providers’ increased use of mobile and cloud technologies could heighten the risk of a cyber-attack as well as other operational risks, as certain aspects of the security of such technologies may be complex, unpredictable or beyond their control. Stellus Capital Management’s and other service providers’ reliance on mobile or cloud technology or any failure by mobile technology and cloud service providers to adequately safeguard their systems and prevent cyber-attacks could disrupt their operations and result in misappropriation, corruption or loss of personal, confidential or proprietary information. In addition, there is a risk that encryption and other protective measures against cyber-attacks may be circumvented, particularly to the extent that new computing technologies increase the speed and computing power available.
Additionally, remote working environments may be less secure and more susceptible to cyber-attacks, including phishing and social engineering attempts that seek to exploit the COVID-19 pandemic. Accordingly, the risks associated with cyber-attacks are heightened under current conditions.
Risks Related to Economic Conditions
Global economic, political and market conditions may adversely affect our business, results of operations and financial condition, including our revenue growth and profitability.
The current worldwide financial market situation, as well as various social and political tensions in the United States and around the world, may contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets and may cause economic uncertainties or deterioration in the U.S. and worldwide. The impact of downgrades by rating agencies to the U.S. government’s sovereign credit rating or its perceived creditworthiness as well as potential government shutdowns could adversely affect the U.S. and global financial markets and economic conditions. Since 2010, several European Union, or EU, countries have faced budget issues, some of which may have negative long-term effects for the economies of those countries and other EU countries. There is continued concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal policy of foreign nations, such as Russia and China, may have a severe impact on the worldwide and U.S. financial markets. The decision made in the United Kingdom referendum to leave the EU (“Brexit”) has led to volatility in global financial markets and may lead to weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. On January 31, 2020, the United Kingdom ended its membership in the EU. Under the terms of the withdrawal agreement negotiated and agreed between the United Kingdom and the EU the United Kingdom’s departure from the EU is followed by a transition period (the “Transition Period”), which runs until December 31, 2020 and during which the United Kingdom shall continue to apply EU law and be treated for all material purposes as if it were still a member of the EU. On December 24, 2020, the European Union and UK governments signed a trade deal that became provisionally effective on January 1, 2021 and that now governs the relationship between the UK and European Union (the “Trade Agreement”). The Trade Agreement implements significant regulation around trade, transport of goods and travel restrictions between the United Kingdom and the EU. The longer term economic, legal, political and social implications of Brexit are unclear at this stage. Brexit has led to ongoing political and economic uncertainty and periods of increased volatility in both the United Kingdom and in wider European markets for some time. In particular, Brexit could lead to calls for similar referendums in other European jurisdictions, which could cause increased economic volatility in the European and global markets. This mid- to long-term uncertainty could have adverse effects on the economy generally and on our ability to earn attractive returns. In particular, currency volatility could mean that our returns are adversely affected by market movements and could make it more difficult, or more expensive, for us to execute prudent currency hedging policies. Potential decline in the value of the British Pound and/or the Euro against other currencies, along with the potential further downgrading of the United Kingdom’s sovereign credit rating, could also have an impact on the performance of certain investments made in the United Kingdom or Europe.
There is uncertainty surrounding potential legal, regulatory and policy changes by new presidential administrations in the United States that may directly affect financial institutions and the global economy.
As a result of the November 2020 elections in the United States, the Democratic Party gained control of both the Presidency and the Senate from the Republican Party. Therefore, changes in federal policy, including tax policies, and at regulatory agencies are expected to occur over time through policy and personnel changes, which may lead to changes involving the level of oversight and focus on the financial services industry or the tax rates paid by corporate entities. The nature, timing and economic and political effects of potential changes to the current legal and regulatory framework affecting financial institutions remain highly uncertain. Uncertainty surrounding future changes may adversely affect our operating environment and therefore our business, financial condition, results of operations and growth prospects.
Further downgrades of the U.S. credit rating, impending automatic spending cuts, another government shutdown or a failure to raise the statutory debt limit of the United States could negatively impact our liquidity, financial condition and earnings.
U.S. debt ceiling and budget deficit concerns have increased the possibility of additional credit-rating downgrades and economic slowdowns, or a recession in the United States. Although U.S. lawmakers passed legislation to raise the federal debt ceiling on multiple occasions, including a suspension of the federal
debt ceiling in August 2019, ratings agencies have lowered or threatened to lower the long-term sovereign credit rating on the United States. Further, the federal debt ceiling is scheduled to come back into effect on August 1, 2021, unless Congress takes legislative action to further extend or defer it.
The impact of this or any further downgrades to the U.S. government’s sovereign credit rating or its perceived creditworthiness could adversely affect the U.S. and global financial markets and economic conditions. Absent further quantitative easing by the Federal Reserve, these developments could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms. In addition, disagreement over the federal budget has caused the U.S. federal government to shut down for periods of time. Continued adverse political and economic conditions could have a material adverse effect on our business, financial condition and results of operations.
Increased geopolitical unrest, terrorist attacks, or acts of war may affect any market for our common stock, impact the businesses in which we invest, and harm our business, operating results, and financial conditions.
Terrorist activity and the continued threat of terrorism and acts of civil or international hostility, both within the United States and abroad, as well as ongoing military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and declines in the global markets, loss of life, property damage, disruptions to commerce and reduced economic activity, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results, and financial condition. Losses from terrorist attacks are generally uninsurable.
Risks Related to our Investments
Economic recessions or downturns could impair our portfolio companies, which would harm our operating results.
Many of the portfolio companies in which we make, and expect to make, investments, including those currently included in our portfolio, are likely to be susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. Therefore, the number of our non-performing assets is likely to increase, and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions may decrease the value of collateral securing some of our loans and debt securities and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the loans and debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, lenders in certain cases can be subject to lender liability claims for actions taken by them when they become too involved in the borrower’s business or exercise control over a borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken if we render significant managerial assistance to the borrower. Furthermore, if one of our portfolio companies were to file for bankruptcy protection, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to claims of other creditors, even though we may have structured our investment as senior secured debt. The likelihood of such a re-characterization would depend on the facts and circumstances, including the extent to which we provided managerial assistance to that portfolio company.
Our investments in leveraged portfolio companies may be risky, and we could lose all or part of our investment.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which we invest may have limited financial resources and may be unable to meet their obligations under their loans and debt securities that we hold. Such developments may be accompanied by a deterioration in
the value of any collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in connection with our investment. Smaller leveraged companies also may have less predictable operating results and may require substantial additional capital to support their operations, finance their expansion or maintain their competitive position.
We may hold the loans and debt securities of leveraged companies that may, due to the significant operating volatility typical of such companies, enter into bankruptcy proceedings.
Leveraged companies may experience bankruptcy or similar financial distress. The bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversary proceedings and are beyond the control of the creditors. A bankruptcy filing by a portfolio company may adversely and permanently affect that company. If the proceeding is converted to a liquidation, the value of the portfolio company may not equal the liquidation value that was believed to exist at the time of the investment. The duration of a bankruptcy proceeding is also difficult to predict, and a creditor’s return on investment can be adversely affected by delays until the plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have priority by law (for example, claims for taxes) may be substantial.
Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of our investment.
Investment in private and middle-market companies involves a number of significant risks. Generally, little public information exists about these companies, and we rely on the ability of Stellus Capital Management’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. Middle-market companies may have limited financial resources and may be unable to meet their obligations under their loans and debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees we may have obtained in connection with our investment. In addition, such companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. Additionally, middle-market companies are more likely to depend on the management talents and efforts of a small group of persons. Therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on one or more of the portfolio companies we invest in and, in turn, on us. Middle-market companies also may be parties to litigation and may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence. In addition, our executive officers, directors and investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in portfolio companies.
The lack of liquidity in our investments may adversely affect our business.
Most of our assets are invested in illiquid loans and securities, and a substantial portion of our investments in leveraged companies are subject to legal and other restrictions on resale or are otherwise less liquid than more broadly traded public securities. The illiquidity of these investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. Also, as noted above, we may be limited or prohibited in our ability to sell or otherwise exit certain positions in our portfolio as such a transaction could be considered a joint transaction prohibited by the 1940 Act.
Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by our Board. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments:
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available current market data, including relevant and applicable market trading and transaction comparables;
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applicable market yields and multiples;
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security covenants;
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call protection provisions;
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information rights;
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the nature and realizable value of any collateral;
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the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
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comparisons of financial ratios of peer companies that are public;
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comparable merger and acquisition transactions; and
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the principal market and enterprise values.
When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation. We record decreases in the market values or fair values of our investments as unrealized depreciation. Declines in prices and liquidity in the corporate debt markets may result in significant net unrealized depreciation in our portfolio. The effect of all of these factors on our portfolio may reduce our net asset value by increasing net unrealized depreciation in our portfolio. Depending on market conditions, we could incur substantial realized losses and may suffer additional unrealized losses in future periods, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we are not limited with respect to the proportion of our assets that may be invested in securities of a single issuer.
We are classified as a non-diversified investment company within the meaning of the 1940 Act, which means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in securities of a single issuer. Beyond the asset diversification requirements associated with our qualification as a RIC under the Code, we do not have fixed guidelines for diversification. To the extent that we assume large positions in the securities of a small number of issuers or our investments are concentrated in relatively few industries, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments, in seeking to:
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increase or maintain in whole or in part our position as a creditor or equity ownership percentage in a portfolio company;
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exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or
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preserve or enhance the value of our investment.
We have discretion to make follow-on investments, subject to the availability of capital resources. Failure on our part to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our level of risk, because we prefer other opportunities or because we are inhibited by compliance with BDC requirements of the 1940 Act or the desire to maintain our qualification as a RIC. Our ability to make follow-on investments may also be limited by our compliance with the conditions under the exemptive relief order we received from the SEC related to co-investments with investment funds managed by Stellus Capital Management or Stellus Capital Management’s allocation policy.
Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
We do not hold controlling equity positions in any of the portfolio companies included in our portfolio and, although we may do so in the future, we do not currently intend to hold controlling equity positions in our portfolio companies (including those included in our portfolio). As a result, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore suffer a decrease in the value of our investments.
Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its assets. This could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under the loans or debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and ability to make stockholder distributions and result in a decline in the market price of our shares.
We are subject to the risk that the debt investments we make in our portfolio companies may be repaid prior to maturity. We expect that our investments will generally allow for repayment at any time subject to certain penalties. When this occurs, we intend to generally reinvest these proceeds in temporary investments, pending their future investment in accordance with our investment strategy. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our ability to make, or the amount of, stockholder distributions with respect to our common stock, which could result in a decline in the market price of our shares.
The interest rates of our floating-rate loans to our portfolio companies that extend beyond 2021 might be subject to change based on recent regulatory changes.
Because we may borrow money to make investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. A reduction in the interest rates on new investments relative to interest rates on current investments could have an adverse impact on our net investment income. However, an increase in interest rates could decrease the value of any investments we hold which earn fixed interest
rates and also could increase our interest expense, thereby decreasing our net income. Also, an increase in interest rates available to investors could make an investment in our common stock less attractive if we are not able to increase our distribution rate, which could reduce the value of our common stock. Further, rising interest rates could also adversely affect our performance if such increases cause our borrowing costs to rise at a rate in excess of the rate that our investments yield.
In periods of rising interest rates, to the extent we borrow money subject to a floating interest rate, our cost of funds would increase, which could reduce our net investment income. Further, rising interest rates could also adversely affect our performance if we hold investments with floating interest rates, subject to specified minimum interest rates (such as a London Interbank Offered Rate (“LIBOR”) floor), while at the same time engaging in borrowings subject to floating interest rates not subject to such minimums. In such a scenario, rising interest rates may increase our interest expense, even though our interest income from investments is not increasing in a corresponding manner as a result of such minimum interest rates.
If general interest rates rise, there is a risk that the portfolio companies in which we hold floating rate securities will be unable to pay escalating interest amounts, which could result in a default under their loan documents with us. Rising interest rates could also cause portfolio companies to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on their business and operations and could, over time, lead to increased defaults. In addition, rising interest rates may increase pressure on us to provide fixed rate loans to our portfolio companies, which could adversely affect our net investment income, as increases in our cost of borrowed funds would not be accompanied by increased interest income from such fixed-rate investments.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time whether LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities called the Secured Overnight Financing Rate (“SOFR”). The first publication of SOFR was released in April 2018. Whether or not SOFR attains market traction as a LIBOR replacement remains a question and the future of LIBOR at this time is uncertain. In addition, on March 25, 2020, the FCA stated that although the central assumption that firms cannot rely on LIBOR being published after the end of 2021 has not changed, the outbreak of COVID-19 has delayed the timing of many firms’ transition planning, and the FCA will continue to assess the impact of the COVID-19 outbreak on transition timelines and update the marketplace as soon as possible. Furthermore, on November 30, 2020, Intercontinental Exchange, Inc. (“ICE”) announced that the ICE Benchmark Administration Limited, a wholly-owned subsidiary of ICE and the administrator of LIBOR, will consult in early December 2020 to consider extending the LIBOR transition deadline to the end of June 2023. The consultation was published on December 4, 2020 and is open for feedback until January 25, 2021. Now that the consultation period has passed, an announcement from the IBA (and/or the FCA) about the cessation of LIBOR appears imminent. Despite this potential extension of the US LIBOR transition deadline, US regulators continue to urge financial institutions to stop entering into new LIBOR transactions by the end of 2021. Although SOFR appears to be the preferred replacement rate for U.S. dollar LIBOR, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be enacted. The elimination of LIBOR or any other changes or reforms to the determination or supervision of LIBOR could have an adverse impact on the market for or value of any LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us or on our overall financial condition or results of operations.
There is no guarantee that a transition from LIBOR to an alternative will not result in financial market disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have a material adverse effect on our business, result of operations, financial condition, and unit price.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs of
customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition, through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs, and can contribute to increased system stresses, including service interruptions.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We invest a portion of our capital in second lien and subordinated loans issued by our portfolio companies. The portfolio companies usually have, or may be permitted to incur, other debt that ranks equally with, or senior to, the loans in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the loans in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying senior creditors, a portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with loans in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Additionally, certain loans that we make to portfolio companies may be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by first priority liens on the collateral will generally control the liquidation of, and be entitled to receive proceeds from, any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds were not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the portfolio company’s remaining assets, if any.
We may also make unsecured loans to portfolio companies, meaning that such loans will not benefit from any interest in collateral of such companies. Liens on such portfolio companies’ collateral, if any, will secure the portfolio company’s obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured loan agreements. The holders of obligations secured by such liens will generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured loan obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding secured loan obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors’ claims against the portfolio company’s remaining assets, if any.
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of such senior debt. Under a typical intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens:
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the ability to cause the commencement of enforcement proceedings against the collateral;
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the ability to control the conduct of such proceedings;
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the approval of amendments to collateral documents;
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releases of liens on the collateral; and
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waivers of past defaults under collateral documents.
We may not have the ability to control or direct such actions, even if our rights are adversely affected.
We may be exposed to special risks associated with bankruptcy cases.
One or more of our portfolio companies may be involved in bankruptcy or other reorganization or liquidation proceedings. Many of the events within a bankruptcy case are adversarial and often beyond the control of the creditors. While creditors generally are afforded an opportunity to object to significant actions, we cannot assure you that a bankruptcy court would not approve actions that may be contrary to our interests. There also are instances where creditors can lose their ranking and priority if they are considered to have taken over management of a borrower.
To the extent that portfolio companies in which we have invested through a unitranche facility are involved in bankruptcy proceedings, the outcome of such proceedings may be uncertain. For example, it is unclear whether a bankruptcy court would enforce an agreement among lenders which sets the priority of payments among unitranche lenders. In such a case, the “first out” lenders in the unitranche facility may not receive the same degree of protection as they would if the agreement among lenders was enforced.
The reorganization of a company can involve substantial legal, professional and administrative costs to a lender and the borrower. It is subject to unpredictable and lengthy delays and during the process a company’s competitive position may erode, key management may depart and a company may not be able to invest adequately. In some cases, the debtor company may not be able to reorganize and may be required to liquidate assets. The debt of companies in financial reorganization will, in most cases, not pay current interest, may not accrue interest during reorganization and may be adversely affected by an erosion of the issuer’s fundamental value.
In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrower’s business or exercise control over the borrower. For example, we could become subject to a lender liability claim (alleging that we misused our influence on the borrower for the benefit of its lenders), if, among other things, the borrower requests significant managerial assistance from us and we provide that assistance. To the extent we and an affiliate both hold investments in the same portfolio company that are of a different character, we may also face restrictions on our ability to become actively involved in the event that portfolio company becomes distressed as a result of the restrictions imposed on transactions involving affiliates under the 1940 Act. In such cases, we may be unable to exercise rights we may otherwise have to protect our interests as security holders in such portfolio company.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash flow to service their debt obligations to us.
We may make subordinated investments that rank below other obligations of the obligor in right of payment. Subordinated investments are subject to greater risk of default than senior obligations as a result of adverse changes in the financial condition of the obligor or economic conditions in general. If we make a subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its relatively high debt-to-equity ratio may create increased risks that its operations might not generate sufficient cash flow to service all of its debt obligations.
The disposition of our investments may result in contingent liabilities.
Substantially all of our investments involve loans and private securities. In connection with the disposition of an investment in loans and private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with
the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to potential liabilities. These arrangements may result in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of distributions previously made to us.
We may not realize gains from our equity investments.
When we invest in loans and debt securities, we may acquire warrants or other equity securities of portfolio companies as well. We may also invest in equity securities directly. To the extent we hold equity investments, we will attempt to dispose of them and realize gains upon our disposition of them. However, the equity interests we receive may not appreciate in value and, may decline in value. As a result, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.
Changes in healthcare laws and other regulations applicable to some of our portfolio companies’ businesses may constrain their ability to offer their products and services.
As of December 31, 2020, our investments in Services: Business companies represented 16.8% of our total portfolio, at fair value. Changes in healthcare or other laws and regulations applicable to the businesses of some of our portfolio companies may occur that could increase their compliance and other costs of doing business, require significant systems enhancements, or render their products or services less profitable or obsolete, any of which could have a material adverse effect on their results of operations. There has also been an increased political and regulatory focus on healthcare laws in recent years, and new legislation could have a material effect on the business and operations of some of our portfolio companies.
Our investments in the business services industry are subject to unique risks relating to technological developments, regulatory changes and changes in customer preferences.
Our investments in portfolio companies that operate in the business services industry represent 16.8% of our total portfolio as of December 31, 2020. Our investments in portfolio companies in the business services sector include those that provide services related to data and information, building, cleaning and maintenance services, and energy efficiency services. Portfolio companies in the business services sector are subject to many risks, including the negative impact of regulation, changing technology, a competitive marketplace and difficulty in obtaining financing. Portfolio companies in the business services industry must respond quickly to technological changes and understand the impact of these changes on customers’ preferences. Adverse economic, business, or regulatory developments affecting the business services sector could have a negative impact on the value of our investments in portfolio companies operating in this industry, and therefore could negatively impact our business and results of operations.
We may be subject to risks associated with our investments in the healthcare industry.
Our investments in portfolio companies that operate in the healthcare & pharmaceuticals industry represent 12.69% of our total portfolio as of December 31, 2020. Any of our portfolio companies operating in the healthcare information and services industry are subject to extensive government regulation and certain other risks particular to that industry. As part of our investment strategy, we plan to invest in companies in the healthcare information and services industry. Such portfolio companies provide technology to companies that are subject to extensive regulation, including Medicare and Medicaid payment rules and regulation, the False Claims Act and federal and state laws regarding the collection, use and disclosure of patient health information and the storage handling and administration of pharmaceuticals. If any of our portfolio companies or the companies to which they provide such technology fail to comply with applicable regulations, they could be subject to significant penalties and claims that could materially and adversely affect their operations. Portfolio companies in the healthcare information or services industry are also subject to the risk that changes in applicable regulations will render their technology obsolete or less desirable in the marketplace.
Portfolio companies in the healthcare information and services industry may also have a limited number of suppliers of necessary components or a limited number of manufacturers for their products, and therefore face a risk of disruption to their manufacturing process if they are unable to find alternative
suppliers when needed. Any of these factors could materially and adversely affect the operations of a portfolio company in this industry and, in turn, impair our ability to timely collect principal and interest payments owed to us.
Our ability to enter transactions involving derivatives and financial commitment transactions may be limited.
In November 2020, the SEC adopted new rules regarding the ability of a BDC (or a registered investment company) to use derivatives and other transactions that create future payment or delivery obligations. BDCs that use derivatives would be subject to a value-at-risk (“VaR”) leverage limit, certain other derivatives risk management program and testing requirements and requirements related to board reporting. These new requirements would apply unless the BDC qualified as a “limited derivatives user,” as defined in the SEC’s adopted rules. A BDC that enters into reverse repurchase agreements or similar financing transactions could either comply with the asset coverage requirements of Section 18 when engaging in reverse repurchase agreements or (ii) chose to treat such agreements as derivatives transactions under the adopted rule. Under the adopted rule, a BDC may enter into an unfunded commitment agreement that is not a derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has a reasonable belief, at the time it enters into such an agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as it becomes due. If the BDC cannot meet this test, it is required to treat unfunded commitments as a derivatives transaction subject to the requirements of the rule. Collectively, these requirements may limit our ability to use derivatives and/or enter into certain other financial contracts.
Risks Relating to Our Common Stock
There is a risk that you may not receive distributions or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
We intend to make distributions on a monthly basis to our stockholders out of assets legally available for distribution (i.e., not subject to any legal restrictions under Maryland law on the distribution thereof). We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. All distributions will be made at the discretion of our Board and will depend on our earnings, financial condition, maintenance of RIC status, compliance with applicable BDC, SBA regulations and such other factors as our Board may deem relative from time to time. We cannot assure you that we will make distributions to our stockholders in the future.
Our ability to pay distributions might be adversely affected by the impact of one or more of the risk factors described in this Annual Report on Form 10-K. Due to the asset coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make distributions. In addition, restrictions and provisions in our Credit Facility, the 2026 Notes (as defined below) and any future credit facilities, as well as in the terms of any debt securities we issue, may limit our ability to make distributions in certain circumstances.
When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain.
Stockholders may experience dilution in their ownership percentage if they do not participate in our dividend reinvestment plan.
All distributions declared in cash payable to stockholders that are participants in our dividend reinvestment plan are generally automatically reinvested in shares of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan may experience dilution over time. Stockholders who receive distributions in shares of common stock may experience accretion to the net asset value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount. The level of accretion or discount would depend on various factors, including the proportion of
our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the distribution payable to a stockholder.
Our shares might trade at premiums that are unsustainable or at discounts from net asset value.
Shares of BDCs like us may, during some periods, trade at prices higher than their net asset value per share and, during other periods, as frequently occurs with closed-end investment companies, trade at prices lower than their net asset value per share. The perceived value of our investment portfolio may be affected by a number of factors including perceived prospects for individual companies we invest in, market conditions for common stock generally, for initial public offerings and other exit events for venture capital backed companies, and the mix of companies in our investment portfolio over time. Negative or unforeseen developments affecting the perceived value of companies in our investment portfolio could result in a decline in the trading price of our common stock relative to our net asset value per share.
The possibility that our shares will trade at a discount from net asset value or at premiums that are unsustainable are risks separate and distinct from the risk that our net asset value per share will decrease. The risk of purchasing shares of a BDC that might trade at a discount or unsustainable premium is more pronounced for investors who wish to sell their shares in a relatively short period of time because, for those investors, realization of a gain or loss on their investments is likely to be more dependent upon changes in premium or discount levels than upon increases or decreases in net asset value per share.
Investing in our securities may involve an above average degree of risk.
The investments we make in accordance with our investment objective may result in a higher amount of risk, and higher volatility or loss of principal, than alternative investment options. Our investments in portfolio companies may be speculative and, therefore, an investment in our securities may not be suitable for someone with lower risk tolerance.
The market price of our securities may fluctuate significantly.
The market price and liquidity of the market for our securities may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:
•
significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies;
•
changes in regulatory policies or tax guidelines, particularly with respect to RICs, BDCs and SBICs;
•
loss of our qualification as a RIC or BDC or the status of either of our SBIC subsidiaries as a SBIC;
•
changes in earnings or variations in operating results;
•
changes in the value of our portfolio of investments;
•
changes in accounting guidelines governing valuation of our investments;
•
any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
•
departure of Stellus Capital Management’s key personnel;
•
operating performance of companies comparable to us; and
•
general economic trends and other external factors.
Risks Relating to Our Debt Securities
The 2026 Notes are unsecured and therefore are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future and will rank pari passu with, or equal to, all outstanding and future unsecured indebtedness issued by and us and our general liabilities (total liabilities, less debt).
The 2026 Notes are not and will not be secured by any of our assets or any of the assets of any of our subsidiaries. As a result, the 2026 Notes are effectively subordinated to any secured indebtedness we or our
subsidiaries have incurred and may incur in the future (or any indebtedness that is initially unsecured as to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness and the secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the 2026 Notes. In addition, the 2026 Notes will rank pari passu with, or equal to, all outstanding and future unsecured, unsubordinated indebtedness issued by us and our general liabilities (total liabilities, less debt). As of December 31, 2020 we had $174.0 million in outstanding indebtedness under our Credit Facility. The indebtedness under the Credit Facility is effectively senior to the 2026 Notes to the extent of the value of the assets securing such indebtedness.
The 2026 Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The 2026 Notes are obligations exclusively of Stellus Capital Investment Corporation, and not of any of our subsidiaries. None of our subsidiaries are or will be a guarantor of the 2026 Notes, and the 2026 Notes are not required to be guaranteed by any subsidiary we may acquire or create in the future. Any assets of our subsidiaries are not directly available to satisfy the claims of our creditors, including holders of the 2026 Notes. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity interests in such entities (and therefore the claims of our creditors, including holders of the 2026 Notes) with respect to the assets of such entities. Even if we are recognized as a creditor of one or more of these entities, our claims would still be effectively subordinated to any security interests in the assets of any such entity and to any indebtedness or other liabilities of any such entity senior to our claims. Consequently, the 2026 Notes are structurally subordinated to all indebtedness and other liabilities, including trade payables, of any of our existing or future subsidiaries, including the SBIC subsidiaries. As of December 31, 2020, our subsidiaries had total indebtedness outstanding of $176.5 million. Certain of these entities (excluding our SBIC subsidiaries) currently serve as guarantors under our Credit Facility, and in the future our subsidiaries may incur substantial additional indebtedness, all of which is and would be structurally senior to the 2026 Notes.
The indenture under which the 2026 Notes are issued contains limited protection for holders of the 2026 Notes.
The indenture under which the 2026 Notes are issued offers limited protection to holders of the 2026 Notes. The terms of the indenture and the 2026 Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have a material adverse impact on your investment in the 2026 Notes. In particular, the terms of the indenture and the 2026 Notes do not place any restrictions on our or our subsidiaries’ ability to:
•
issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the 2026 Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the 2026 Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the 2026 Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to the 2026 Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(2) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect, in either case, to any exemptive relief granted to us by the SEC, which generally prohibit us from incurring additional indebtedness, including through the issuance of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 150% after such incurrence or issuance;
•
pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the 2026 Notes, including subordinated indebtedness, except that we have agreed that, for the period of time during which the 2026 Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section 61(a)(2) of the 1940 Act or any successor provisions and after giving effect to any exemptive relief granted to us by the SEC and (ii) the
following two exceptions: (A) we will be permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(2) of the 1940 Act or any successor provisions, but only up to such amount as is necessary for us to maintain our status as a RIC under Subchapter M of the Code; and (B) this restriction will not be triggered unless and until such time as our asset coverage has not been in compliance with the minimum asset coverage required by Section 18(a)(1)(B) as modified by Section 61(a)(2) of the 1940 Act or any successor provisions (after giving effect to any exemptive relief granted to us by the SEC) for more than six consecutive months. If Section 18(a)(1)(B) as modified by Section 61(a)(2) of the 1940 Act were currently applicable to us in connection with this offering, these provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, were below 150% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase;
•
sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);
•
enter into transactions with affiliates;
•
create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;
•
make investments; or
•
create restrictions on the payment of dividends or other amounts to us from our subsidiaries.
Furthermore, the terms of the indenture and the 2026 Notes do not protect holders of the 2026 Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.
Our ability to recapitalize, incur additional debt (including additional debt that matures prior to the maturity of the 2026 Notes) and take a number of other actions that are not limited by the terms of the 2026 Notes may have important consequences for holders of the 2026 Notes, including making it more difficult for us to satisfy our obligations with respect to the 2026 Notes or negatively affecting the market value of the 2026 Notes.
Other debt we issue or incur in the future could contain more protections for its holders than the indenture and the 2026 Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, trading levels, and prices of the 2026 Notes.
There is no active trading market for the 2026 Notes. If an active trading market does not develop for the 2026 Notes, you may not be able to sell them.
The 2026 Notes are debt securities for which there currently is no trading market. We do not intend to list the 2026 Notes on any securities exchange or for quotation of the 2026 Notes on any automated dealer quotation system. If the 2026 Notes are traded after their initial issuance, they may trade at a discount to their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, our financial condition, performance and prospects, general economic conditions, including the impact of COVID-19, or other relevant factors. Although the underwriter has informed us that it intends to make a market in the 2026 Notes, it is not obligated to do so, and the underwriter may discontinue any market-making in the 2026 Notes at any time at its sole discretion. Accordingly, we cannot assure you that a liquid trading market will develop or be maintained for the 2026 Notes, that you will be able to sell your 2026 Notes at a particular time or that the price you receive when you sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the 2026 Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the 2026 Notes for an indefinite period of time.
If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the 2026 Notes.
Any default under the agreements governing our indebtedness, including a default under the Credit Facility or other indebtedness to which we may be a party, that is not waived by the required lenders or holders, and the remedies sought by the lenders or holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the 2026 Notes and substantially decrease the market value of the 2026 Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, as applicable, in the instruments governing our indebtedness (including the Credit Facility), we could be in default under the terms of the agreements governing such indebtedness, including the 2026 Notes. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Credit Facility or other debt we may incur in the future could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to refinance or restructure our debt, including the 2026 Notes, sell assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the required lenders under the Credit Facility or other debt that we may incur in the future to avoid being in default. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the 2026 Notes or our other debt. If we breach our covenants under the Credit Facility or our other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders thereof. If this occurs, we would be in default under the Credit Facility or other debt, the lenders or holders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations, including the lenders under the Credit Facility, could proceed against the collateral securing the debt. Because the Credit Facility has, the indenture governing the 2026 Notes has, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness under the 2026 Notes, the Credit Facility or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due.
We may choose to redeem the 2026 Notes when prevailing interest rates are relatively low.
The 2026 Notes are redeemable in whole or in part upon certain conditions at any time or from time to time at our option. We may choose to redeem the 2026 Notes from time to time, especially if prevailing interest rates are lower than the rate borne by the 2026 Notes. If prevailing rates are lower at the time of redemption, and we redeem the 2026 Notes, you likely would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the 2026 Notes being redeemed.
We may not be able to repurchase the 2026 Notes upon a Change of Control Repurchase Event.
We may not be able to repurchase the 2026 Notes upon a Change of Control Repurchase Event because we may not have sufficient funds. We would not be able to borrow under our Credit Facility to finance such a repurchase of the 2026 Notes, and we expect that any future credit facility would have similar limitations. Upon a Change of Control Repurchase Event, holders of the 2026 Notes may require us to repurchase for cash some or all of the 2026 Notes at a repurchase price equal to 100% of the aggregate principal amount of the 2026 Notes being repurchased, plus accrued and unpaid interest to, but not including, the repurchase date. The terms of our Credit Facility provide that certain change of control events will constitute an event of default thereunder entitling the lenders to accelerate any indebtedness outstanding under our Credit Facility at that time and to terminate our Credit Facility. In addition, the occurrence of a Change of Control Repurchase Event enabling the holders of the 2026 Notes to require the mandatory purchase of the 2026 Notes will constitute an event of default under our Credit Facility, entitling the lenders to accelerate any indebtedness outstanding under our Credit Facility at that time and to terminate our Credit Facility. Our and our subsidiaries’ future financing facilities may contain similar restrictions and provisions. Our failure to purchase such tendered Notes upon the occurrence of such Change of Control Repurchase Event would cause an event of default under the indenture governing the 2026 Notes and a cross-default under the agreements governing the Credit Facility, which may result in the acceleration of such indebtedness requiring us to repay that indebtedness immediately. If the holders of the 2026 Notes exercise
their right to require us to repurchase Notes upon a Change of Control Repurchase Event, the financial effect of this repurchase could cause a default under our current and future debt instruments, and we may not have sufficient funds to repay any such accelerated indebtedness.
A downgrade, suspension or withdrawal of the credit rating assigned by a rating agency to us or the 2026 Notes or change in the debt markets could cause the liquidity or market value of the 2026 Notes to decline significantly.
Our credit ratings are an assessment by rating agencies of our ability to pay our debts when due. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of the 2026 Notes. These credit ratings may not reflect the potential impact of risks relating to the structure or marketing of the 2026 Notes. Credit ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization in its sole discretion. Neither we nor the underwriter undertakes any obligation to maintain our credit ratings or to advise holders of Notes of any changes in our credit ratings. There can be no assurance that our credit ratings will remain for any given period of time or that such credit ratings will not be lowered or withdrawn entirely by the rating agencies if in their judgment future circumstances relating to the basis of the credit ratings, such as adverse changes in our Company, so warrant. The conditions of the financial markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future, which could have an adverse effect on the market prices of the 2026 Notes.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
Not applicable.

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ITEM 2. PROPERTIES
Item 2. Properties
We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located at 4400 Post Oak Parkway, Suite 2200, Houston, Texas. We also maintain offices in Charlotte, North Carolina and in the Washington, D.C. area. All locations are provided to us by Stellus Capital Management pursuant to the administration agreement. We believe that our office facilities are suitable and adequate for our business as we contemplate conducting it.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
We, Stellus Capital Management or our subsidiaries are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us, Stellus Capital Management 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.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “SCM.” As of January 31, 2021, we had nine stockholders of record, which did not include stockholders for whom shares are held in nominee or street name.
We generally intend to pay distributions to our stockholders out of assets legally available for distribution. Our distributions and their frequency, if any, will be determined by our board of directors. From January 2014 through March 2020, we paid aggregate monthly distributions of $0.1133 per share on our common shares. For the period April 2020 through December 2020, we paid quarterly distributions of $0.25 per share on our common shares. Payment of dividends on our common shares is within the discretion of the Board, and depends on, among other factors, net earnings, capital requirements and the financial condition of the Company. However, the Company intends to continue to pay comparable dividends to shareholders in the future.
Recent Sales of Unregistered Securities
During the year ended December 31, 2020, we issued a total of 21,666 shares of common stock under the distribution reinvestment program (“DRIP”). During the year ended December 31, 2019, we did not issue shares of common stock under the DRIP. During the year ended December 31, 2018, we issued a total of 7,931 shares of common stock under the DRIP. Issuances under the DRIP are not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value of the shares of our common stock issued under the DRIP for the years ended December 31, 2020 and 2018 was $228,943 and $94,788, respectively.
Use of Proceeds from Recent Sales of Registered Securities
In January 2020, the Company sold 332,591 shares of common stock through an at-the-market sales program (the “ATM Program”) for net proceeds of $4,771,144, which was used to repay borrowings under the Credit Facility.
Purchases of Equity Securities
Dividend Reinvestment Plan
During the year ended December 31, 2020, as a part of our DRIP, we purchased 117,687 shares of our common stock for an average price per share of $9.58 in the open market in order to satisfy the reinvestment portion of our dividends. The following chart outlines such purchases of our common stock during the year ended December 31, 2020:
Period
Total
Number of
Shares
Purchased
Average
Price Paid
Per Share
January 1, 2020 through January 31, 2020
-
$ -
February 1, 2020 through February 29, 2020
8,894
14.86
March 1, 2020 through March 31, 2020
13,635
9.20
April 1, 2020 through April 30, 2020
11,784
7.95
May 1, 2020 through May 31, 2020
-
-
June 1, 2020 through June 30, 2020
-
-
July 1, 2020 through July 31, 2020
-
-
August 1, 2020 through August 31, 2020
26,664
7.75
September 1, 2020 through September 30, 2020
-
-
Period
Total
Number of
Shares
Purchased
Average
Price Paid
Per Share
October 1, 2020 through October 31, 2020
26,237
8.83
November 1, 2020 through November 30, 2020
-
-
December 1, 2020 through December 31, 2020
30,473
11.06
Total
117,687
$ 9.58
Price Range of Common Stock
Our shares of common stock are traded on the NYSE under the symbol “SCM.” In connection with our initial public offering, our shares of common stock began trading on November 8, 2012, and before that date, there was no established trading market for shares of our common stock.
The following table sets forth, for each fiscal quarter of the three most recent fiscal years, the range of high and low closing prices of our shares of common stock as reported on the NYSE and the sales price as a percentage of our net asset value (“NAV”).
Fiscal Year Ended
NAV Per
Share(1)
Closing Sales Price(2)
Premium or Discount
of High Sales NAV(3)
Premium or Discount
of Low Sales NAV(3)
High
Low
December 31, 2020
Fourth quarter
$ 14.03
$ 12.07
$ 8.04
-13.97%
-42.69%
Third quarter
$ 13.17
$ 8.94
$ 7.22
-32.12%
-45.18%
Second quarter
$ 13.34
$ 8.75
$ 5.58
-34.41%
-58.17%
First quarter
$ 11.55
$ 15.03
$ 5.06
30.13%
-56.19%
December 31, 2019
Fourth quarter
$ 14.14
$ 14.46
$ 13.02
2.26%
-7.92%
Third quarter
$ 14.40
$ 14.62
$ 12.80
1.53%
-11.11%
Second quarter
$ 14.29
$ 14.58
$ 13.49
2.03%
-5.60%
First quarter
$ 14.32
$ 15.20
$ 13.27
6.15%
-7.33%
December 31, 2018
Fourth quarter
$ 14.09
$ 13.65
$ 11.91
-3.12%
-15.47%
Third quarter
$ 14.29
$ 13.93
$ 12.79
-2.52%
-10.50%
Second quarter
$ 14.07
$ 13.60
$ 11.56
-3.34%
-17.84%
First quarter
$ 13.93
$ 13.00
$ 11.34
-6.68%
-18.59%
(1)
NAV is determined as of the last date in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period.
(2)
Closing sales price is determined as the high or low closing sales price noted within the respective quarter, not adjusted for dividends.
(3)
Calculated as of the respective high or low sales price divided by the quarter end NAV.
Shares of BDCs’ common stock may trade at a market price that is less than the value of the net assets attributable to those shares of common stock. The possibility that our shares of common stock will trade at a discount from NAV or at premiums that are unsustainable over the long term are separate and distinct from the risk that our NAV will decrease. Since our shares of common stock began trading on November 8, 2012, in connection with our initial public offering, our shares of common stock have traded at times at a discount to the net assets attributable to those shares of common stock.
Stock Performance Graph
This graph compares the return on our shares of common stock with that of the Standard & Poor’s 500 Stock Index, the Russell 2000 Financial Services Index, and the Raymond James BDC Index, for the period from inception through March 1, 2021. The graph assumes that, at inception, a person invested $100 in each share of our common stock, the S&P 500 Index, the Russell 2000 Financial Services Index, and the Raymond James BDC Index. The graph measures total stockholder return, which takes into account both changes in stock price and dividends. It assumes that dividends paid are invested in like securities.
The graph and other information furnished under this Part II Item 5 of this Annual Report on Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934 (the “1934 Act”). The stock price performance included in the above graph is not necessarily indicative of future stock price performance.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data
The selected financial data for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 set forth below was derived from our financial statements. The data should be read in conjunction with our financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.
Statement of Operations Data:
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
Total investment income
$ 56,658,314
$ 58,911,889
$ 53,266,338
$ 39,648,193
$ 39,490,197
Total expenses, net of fee
waiver
$ 34,666,411
$ 36,473,080
$ 30,629,801
$ 21,677,433
$ 22,177,996
Net investment income
$ 21,991,903
$ 22,438,809
$ 22,636,537
$ 17,970,760
$ 17,312,201
Net increase in net assets resulting from operations
$ 20,192,441
$ 26,438,186
$ 26,194,578
$ 22,613,257
$ 23,199,062
Per Share Data:
Net asset value
$ 14.03
$ 14.14
$ 14.09
$ 13.81
$ 13.69
Net investment income
$ 1.13
$ 1.23
$ 1.42
$ 1.21
$ 1.39
Net increase in net assets resulting from operations
$ 1.04
$ 1.45
$ 1.64
$ 1.52
$ 1.86
Distributions declared
$ 1.15
$ 1.36
$ 1.36
$ 1.36
$ 1.36
Balance Sheet Data:
As of
December 31,
As of
December 31,
As of
December 31,
As of
December 31,
As of
December 31,
Investments at fair value
$ 653,424,495
$ 628,948,077
$ 504,483,668
$ 371,839,772
$ 365,625,891
Cash and cash
equivalents
$ 18,477,602
$ 16,133,315
$ 17,467,146
$ 25,110,718
$ 9,194,129
Total assets
$ 674,910,157
$ 648,513,227
$ 526,287,251
$ 400,260,855
$ 379,878,729
Total liabilities
$ 401,549,508
$ 377,942,054
$ 301,442,244
$ 180,013,613
$ 208,996,944
Total net assets
$ 273,360,649
$ 270,571,173
$ 224,845,007
$ 220,247,242
$ 170,881,785
Other Data:
Number of portfolio companies at period end
Weighted average yield on debt investments at period
end﻿(1)(2)
8.3%
9.2%
10.9%
10.8%
11.0%
(1)
Computed using the effective interest rates for all of our debt investments, including accretion of original issue discount.
(2)
The weighted average yield of our debt investments is not the same as a return on investment for our stockholders, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates for all of our debt investment restated as an interest rate payable annually in arrears and is computed including cash and payment in kind, or PIK interest, as well as accretion of original issue discount.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Some of the statements in this Annual Report on Form 10-K constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this Annual Report on Form 10-K involve risks and uncertainties, related to the COVID-19 pandemic and otherwise, including statements as to:
•
our future operating results;
•
our business prospects and the prospects of our portfolio companies;
•
the effect of investments that we expect to make;
•
our contractual arrangements and relationships with third parties;
•
actual and potential conflicts of interest with Stellus Capital Management;
•
the dependence of our future success on the general economy and its effect on the industries in which we invest;
•
the ability of our portfolio companies to achieve their objectives;
•
the use of borrowed money to finance a portion of our investments;
•
the adequacy of our financing sources and working capital;
•
the timing of cash flows, if any, from the operations of our portfolio companies;
•
the ability of Stellus Capital Management to locate suitable investments for us and to monitor and administer our investments;
•
the ability of Stellus Capital Management to attract and retain highly talented professionals;
•
our ability to maintain our qualification as a registered investment company (“RIC”) and as a business development company (“BDC”); and
•
the effect of future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to BDCs or RICs.
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 Annual Report on Form 10-K on information available to us on the date of this Annual Report on Form 10-K. 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 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 1940 Act. Our investment activities are managed by our investment adviser, Stellus Capital Management.
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.” 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 $250.0 million, in each case organized and with their principal of business in the United States.
We have elected to be treated for tax purposes as a RIC under Subchapter M of 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 December 31, 2020, 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 Investment Company Act of 1940, as amended (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 29, 2018, which effectively increased the amount of leverage we may incur. As of December 31, 2020, our asset coverage ratio was 223%. 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.
COVID-19 Developments
On March 11, 2020, the World Health Organization declared COVID-19 a pandemic and recommended containment and mitigation measures worldwide. During the year ended December 31, 2020, and subsequent to December 31, 2020, the COVID-19 pandemic has had a significant impact on the U.S. and global economy. 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.
The global impact of the outbreak continues to evolve, and many countries have reacted by instituting quarantines, prohibitions on travel and the closure of offices, businesses, schools, retail stores and other public venues. Businesses are also implementing similar precautionary measures. Such measures, as well as the general uncertainty surrounding the dangers and impact of the COVID-19 pandemic, have created significant disruption in supply chains and economic activity. While several countries, as well as certain states in the United States, have begun to lift public health restrictions with the view to reopening their economies, recurring COVID-19 outbreaks have led to the re-introduction of such restrictions in certain states in the United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere. The Federal Food and Drug Administration authorized vaccines produced for emergency use starting in December 2020, it remains unclear how quickly the vaccines will be distributed nationwide and globally or when “herd immunity” will be achieved and the restrictions that were imposed to slow the spread of the virus will be lifted entirely. The delay in distributing the vaccines could lead people to continue to self-isolate and not participate in the economy at pre-pandemic levels for a prolonged period of time. Even after the COVID-19 pandemic subsides, the U.S. economy and most other major global economies may continue to experience a recession, and we anticipate our business and operations could be materially adversely affected by a prolonged recession in the United States and other major markets.
As COVID-19 continues to spread, the potential impacts, including a global, regional, or other economic recession, remain uncertain and difficult to assess. 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 outlook
The Federal Food and Drug Administration authorized vaccines produced for emergency use starting in December 2020, it remains unclear how quickly the vaccines will be distributed nationwide and globally or when “herd immunity” will be achieved and the restrictions that were imposed to slow the spread of the virus will be lifted entirely. The delay in distributing the vaccines could lead people to continue to self-isolate and not participate in the economy at pre-pandemic levels for a prolonged period. The COVID-19 pandemic could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown. The COVID-19 pandemic presents material uncertainty and risks with respect to the underlying value of our portfolio companies and with respect to our business, financial condition, results of operations, and cash flows, such as the potential negative impact to financing arrangements, increased costs of operations, changes in law and/or regulation, and uncertainty regarding government and regulatory policy.
Operations
All partners and employees of Stellus Capital have been operating remotely since March 16, 2020 without disruption to its operations and are prepared to continue working remotely as long as is necessary for the health and safety of all personnel.
Our COVID-19 response
Since the onset of the COVID-19 pandemic, we have been in regular contact with all our portfolio companies and/or their sponsors to assess among other things their ability to function in the new environment. Discussions have addressed the portfolio companies’ liquidity position, expected covenant compliance, and the health of their workforce and customers.
Financial impact
We will continue to closely monitor the financial condition of our portfolio companies as part of our efforts to mitigate the impact of the COVID-19 pandemic. Historical information may be relatively less significant.
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 December 31, 2020, we had $ 653.4 million (at fair value) invested in 66 companies. As of December 31, 2020, our portfolio included approximately 78% of first lien debt (including unitranche investments), 11% of second lien debt, 3% 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, 2020 was as follows:
Cost
Fair Value
Senior Secured - First Lien(1)
$ 508,060,059
$ 508,673,064
Senior Secured - Second Lien
93,636,285
70,720,186
Unsecured Debt
22,212,888
21,191,245
Equity
34,719,734
52,840,000
Total Investments
$ 658,628,966
$ 653,424,495
(1)
Includes unitranche investments, which account for 13.0% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans. Our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.
As of December 31, 2019, we had $628.9 million (at fair value) invested in 63 companies. As of December 31, 2019, our portfolio included approximately 72% of first lien debt (including unitranche investments), 18% of second lien debt, 4% of unsecured debt and 6% of equity investments at fair value. The composition of our investments at cost and fair value as of December 31, 2019 was as follows:
Cost
Fair Value
Senior Secured - First Lien(1)
$ 461,107,595
$ 455,169,878
Senior Secured - Second Lien
130,600,172
111,961,013
Unsecured Debt
22,279,519
22,137,186
Equity
28,720,538
39,680,000
Total Investments
$ 642,707,824
$ 628,948,077
(1)
Includes unitranche investments, which account for 14.4% of our portfolio at December 31, 2019 fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans. Our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.
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 December 31, 2020 and December 31, 2019, we had unfunded commitments of $28.9 million and $37.5 million, respectively, to provide debt financing for 19 and 17 portfolio companies, respectively. As of December 31, 2020, we had sufficient liquidity (through cash on hand and available borrowings under the Credit Facility (as defined below)) to fund such unfunded commitments should the need arise.
The following is a summary of geographical concentration of our investment portfolio as of December 31, 2020:
Cost
Fair Value
% of Total
Investments
at fair value
Texas
$ 151,640,862
$ 135,146,776
20.68%
California
86,050,467
92,069,851
14.09%
Illinois
57,330,756
57,535,404
8.81%
Arizona
50,822,139
52,015,600
7.96%
New Jersey
38,228,359
37,765,139
5.78%
Ohio
34,109,657
35,827,682
5.48%
Wisconsin
22,721,856
22,827,500
3.49%
Canada
21,318,659
21,540,925
3.30%
Cost
Fair Value
% of Total
Investments
at fair value
New York
19,527,594
20,547,579
3.14%
Tennessee
19,832,576
19,959,613
3.05%
United Kingdom
20,159,650
18,727,500
2.87%
South Carolina
15,834,471
18,132,490
2.77%
Indiana
17,741,889
18,026,339
2.76%
Maryland
16,970,057
17,064,250
2.61%
Florida
12,404,739
12,299,545
1.88%
Alabama
12,252,768
12,252,768
1.88%
Washington
11,803,768
11,801,363
1.81%
Missouri
9,956,554
10,720,000
1.64%
Pennsylvania
9,884,148
9,900,000
1.52%
Virginia
7,505,287
7,759,020
1.19%
Washington, D.C.
6,937,907
7,030,512
1.08%
Georgia
685,000
6,420,000
0.98%
North Carolina
4,979,153
2,925,000
0.45%
Puerto Rico
8,613,244
2,589,639
0.40%
Massachusetts
1,317,406
1,780,000
0.27%
Utah
-
760,000
0.11%
$ 658,628,966
$ 653,424,495
100.00%
The following is a summary of geographical concentration of our investment portfolio as of December 31, 2019:
Cost
Fair Value
% of Total
Investments
at Fair Value
Texas
$ 134,451,527
$ 120,672,985
19.19%
California
79,090,474
78,136,331
12.42%
Arizona
52,390,949
53,274,526
8.47%
New Jersey
52,548,769
51,637,750
8.21%
Ohio
48,502,609
50,092,839
7.96%
Illinois
41,869,947
44,406,252
7.06%
Canada
21,201,137
21,217,811
3.37%
New York
19,922,689
20,584,020
3.27%
United Kingdom
20,116,695
20,116,695
3.20%
Wisconsin
19,207,770
19,466,054
3.10%
South Carolina
19,935,337
19,366,716
3.08%
Tennessee
19,854,956
19,260,076
3.06%
Pennsylvania
17,408,508
17,566,213
2.79%
Maryland
17,103,044
17,325,000
2.75%
Indiana
14,064,012
13,997,251
2.23%
Florida
13,663,116
13,820,256
2.20%
Colorado
10,867,843
12,444,250
1.98%
Arkansas
14,920,694
11,989,446
1.91%
Cost
Fair Value
% of Total
Investments
at Fair Value
Missouri
10,078,235
10,428,223
1.66%
Georgia
575,000
5,250,000
0.83%
North Carolina
4,961,969
4,375,000
0.70%
Puerto Rico
8,613,244
3,490,383
0.55%
Utah
41,894
30,000
0.00%
Massachusetts
1,317,406
-
-%
$ 642,707,824
$ 628,948,077
100.00%
The following is a summary of industry concentration of our investment portfolio as of December 31, 2020:
Cost
Fair Value
% of Total
Investments
at fair value
Services: Business
$ 102,005,864
$ 109,873,364
16.82%
Healthcare & Pharmaceuticals
87,198,279
82,945,887
12.69%
Aerospace & Defense
53,615,886
52,184,338
7.99%
Beverage, Food, & Tobacco
39,339,090
41,012,620
6.28%
Media: Broadcasting & Subscription
31,889,423
34,418,869
5.27%
High Tech Industries
33,571,427
33,793,693
5.17%
Consumer Goods: Durable
27,802,124
27,780,032
4.25%
Environmental Industries
25,454,549
24,977,427
3.82%
Education
26,428,607
24,494,108
3.75%
Services: Consumer
38,026,487
22,600,924
3.46%
Media: Advertising, Printing & Publishing
21,903,057
21,348,217
3.27%
Capital Equipment
20,005,255
20,680,904
3.17%
Finance
18,016,762
19,435,000
2.97%
Transportation & Logistics
18,690,276
18,944,945
2.90%
Retail
15,834,471
18,132,490
2.77%
Containers, Packaging, & Glass
17,853,813
17,890,000
2.74%
Metals & Mining
16,970,057
17,064,250
2.61%
Consumer goods: non-durable
13,272,383
12,930,000
1.98%
Automotive
11,028,125
11,028,125
1.69%
Construction & Building
10,446,055
10,750,000
1.65%
Energy: Oil & Gas
11,015,013
9,991,177
1.53%
Utilities: Oil & Gas
9,884,148
9,900,000
1.52%
Chemicals, Plastics, & Rubber
6,605,024
6,808,125
1.04%
Software
1,772,791
4,430,000
0.66%
Hotel, Gaming, & Leisure
-
10,000
0.00%
$ 658,628,966
$ 653,424,495
100.00%
The following is a summary of industry concentration of our investment portfolio as of December 31, 2019:
Cost
Fair Value
% of Total
Investments
at Fair Value
Healthcare & Pharmaceuticals
$ 98,307,360
$ 94,000,860
14.95%
Services: Business
56,354,433
62,410,845
9.92%
Aerospace & Defense
44,970,957
46,547,324
7.40%
Consumer Goods: Durable
47,933,468
44,158,660
7.02%
Beverage, Food, & Tobacco
42,131,354
42,592,966
6.77%
Media: Broadcasting & Subscription
32,353,301
33,218,991
5.28%
Finance
27,776,880
29,562,500
4.70%
Education
26,594,771
25,661,125
4.08%
Media: Advertising, Printing & Publishing
22,425,972
21,965,124
3.49%
High Tech Industries
21,201,137
21,217,811
3.37%
Capital Equipment
20,093,379
20,237,066
3.22%
Retail
19,935,337
19,366,716
3.08%
Metals & Mining
17,103,044
17,325,000
2.75%
Transportation & Logistics
17,173,599
17,226,294
2.74%
Automotive
17,151,902
17,221,213
2.74%
Software
15,807,191
15,516,250
2.47%
Containers, Packaging, & Glass
14,306,286
14,564,570
2.32%
Environmental Industries
15,256,675
14,410,327
2.29%
Energy: Oil & Gas
12,624,269
13,582,102
2.16%
Services: Consumer
26,075,606
13,345,105
2.12%
Chemicals, Plastics, & Rubber
11,880,825
11,857,228
1.89%
Consumer goods: non-durable
14,973,711
11,770,000
1.87%
Construction & Building
10,408,323
10,750,000
1.71%
Utilities: Oil & Gas
9,868,044
9,900,000
1.57%
Hotel, Gaming, & Leisure
-
540,000
0.09%
$ 642,707,824
$ 628,948,077
100.00%
At December 31, 2020, our average portfolio company investment at amortized cost and fair value was approximately $10.0 million and $9.9 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $21.4 million and $21.6 million, respectively. At December 31, 2019, our average portfolio company investment at amortized cost and fair value was approximately $10.2 million and $10.0 million, respectively, and our largest portfolio company investment at amortized cost and fair value was approximately $21.6 million and $21.3 million, respectively.
At December 31, 2020, 93% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as London Interbank Offered Rate (“LIBOR”), and 7% bore interest at fixed rates. At December 31, 2019, 93% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 7% bore interest at fixed rates.
The weighted average yield on all of our debt investments as of December 31, 2020 and December 31, 2019 was approximately 8.3% and 9.2%, respectively. The weighted average yield on all of our investments, including non-income producing equity positions, as of December 31, 2020 and December 31, 2019 was approximately 7.9% and 8.8%, 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 stockholders, 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 December 31, 2020 and December 31, 2019, we had cash and cash equivalents of $18.5 million and $16.1 million, respectively.
Investment Activity
During the year ended December 31, 2020, we made $152.0 million of investments in ten new portfolio companies and twenty existing portfolio companies. During the year ended December 31, 2020, we received $128.8 million in proceeds principally from prepayments of our investments, including $38.3 million from amortization of certain other investments.
During the year ended December 31, 2019, we made $246.5 million of investments in seventeen new portfolio companies and twelve existing portfolio companies. During the year ended December 31, 2019, we received $128.2 million in proceeds principally from prepayments of our investments, including $19.2 million from amortization of certain other 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.
For example, during the twelve months ended December 31, 2020, the uncertainty and economic ramifications of the rapid spread of COVID-19 led to a general slowing of investment activity in the U.S. lower middle market. As a result, we did not make any investments in new portfolio companies from March 13, 2020 until July 17, 2020. Since then, the investment activity has increased and we have invested $76.7 million (net of fees) in seven new portfolio companies. See Note 15 to the Consolidated Financial Statements for information on investments made subsequent to quarter end.
Asset Quality
In addition to various risk management and monitoring tools, Stellus Capital Management 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:
•
Investment Category 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
•
Investment Category 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
•
Investment Category 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.
•
Investment Category 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected.
•
Investment Category 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.
(dollars in millions)
As of December 31, 2020
As of December 31, 2019
Investment Category
Fair Value
% of
Total
Portfolio
Number of
Portfolio
Companies
Fair Value
% of
Total
Portfolio
Number of
Portfolio
Companies(1)
$ 87.3
14%
$ 70.4
11%
496.5
76%
492.2
78%
61.3
9%
49.3
8%
-
-%
-
12.0
2%
8.3
1%
5.0
1%
Total
$ 653.4
100%
$ 628.9
100%
(1)
One portfolio company appears in two categories as of December 31, 2019.
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 December 31, 2020, we had loans to three portfolio companies that were on non-accrual status, which represented approximately 4.3% of our loan portfolio at cost and 1.0% at fair value. As of December 31, 2019, we had loans to two portfolio companies that were on non-accrual status, which represented approximately 3.6% of our loan portfolio at cost and 0.9% at fair value. As of December 31, 2020 and December 31, 2019, $7.1 million and $3.8 million of income from investments on non-accrual has not been accrued, respectively.
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 Years ended December 31, 2020, 2019, and 2018
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 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 years ended December 31, 2020, 2019, and 2018 (in millions).
Year ended
December 31,
Year ended
December 31,
Year ended
December 31,
Interest Income(1)
$ 54.7
$ 56.5
$ 49.6
PIK Income
0.7
0.4
1.9
Miscellaneous fees(1)
1.3
2.0
1.8
Total
$ 56.7
$ 58.9
$ 53.3
(1)
For the years ended December 31, 2020, 2019, and 2018, we recognized $2.1, million, $2.8 million and $3.4 million of non-recurring income, respectively. Non-recurring income was related to early repayments, the recognition of previously reserved income from a prior period, and amendments to specific loan positions.
The decrease in interest income from the year ended December 31, 2019 to the year ended December 31, 2020 was due primarily to a decline in the market indices that are used for the floating rate loans, subject to interest rate floors. The increase in interest income from the year ended December 31, 2018 to the year ended December 31, 2019 was due primarily to growth in the overall investment portfolio.
Expenses
Our primary operating expenses include the payment of fees to Stellus Capital Management 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:
•
organization and offering;
•
calculating our net asset value (including the cost and expenses of any independent valuation firm);
•
fees and expenses payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments;
•
interest payable on debt, if any, incurred to finance our investments and expenses related to unsuccessful portfolio acquisition efforts;
•
base management and incentive fees;
•
administration fees and expenses, if any, payable under the administration agreement (including our allocable portion of Stellus Capital’s overhead in performing its obligations under the administration agreement, including rent and the allocable portion of the cost of our chief compliance officer and chief financial officer and their respective staff);
•
transfer agent, dividend agent and custodial fees and expenses;
•
U.S. federal and state registration fees;
•
all costs of registration and listing our securities on any securities exchange;
•
U.S. federal, state and local taxes;
•
independent directors’ fees and expenses;
•
costs of preparing and filing reports or other documents required by the SEC or other regulators;
•
costs of distributing any reports, proxy statements or other notices to stockholders, including printing costs;
•
costs and fees associated with any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
•
direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs;
•
proxy voting expenses; and
•
all other expenses incurred by us or Stellus Capital in connection with administering our business.
The following shows the breakdown of operating expenses for the years ended December 31, 2020, 2019 and 2018 (in millions).
Operating Expenses
Year ended
December 31,
Year ended
December 31,
Year ended
December 31,
Management Fees
$ 11.1
$ 9.7
$ 8.2
Valuation Fees
0.3
0.3
0.3
Administrative services expenses
1.8
1.7
1.4
Income incentive fees
2.5
5.8
5.5
Capital gain incentive (reversal) fees
(0.4)
0.8
0.1
Professional fees
1.0
1.0
1.2
Directors’ fees
0.4
0.4
0.3
Insurance expense
0.3
0.3
0.3
Interest expense and other fees
16.0
15.0
12.3
Income tax expense
0.8
0.9
0.3
Other general and administrative
0.9
0.6
0.7
Total Operating Expenses
$ 34.7
$ 36.5
$ 30.6
The decrease in operating expenses for the respective periods was primarily due to lower income incentive fees, as a result of pre-incentive fee net investment income being lower than the hurdle rate, mainly due to lower LIBOR rates over the period; and the reversal of a previously accrued capital gains incentive fee, which resulted from realized losses incurred over the period. The decrease was offset by an increase in management fees, directly related to the growth of our portfolio and an increase in interest expense due to the higher balances on the Credit Facility and SBA-guaranteed debentures (as defined below) outstanding during the period.
Net Investment Income
For the year ended December 31, 2020, net investment income was $22.0 million, or $1.13 per common share based on 19,471,500 weighted-average common shares outstanding. For the year ended December 31, 2019, net investment income was $22.4 million, or $1.23 per common share based on 18,275,696 weighted-average common shares outstanding. For the year ended December 31, 2018, net investment income was $22.6 million, or $1.42 per common share based on 15,953,571 weighted-average common shares outstanding.
Net investment income for the year ended December 31, 2020 decreased compared to the year ended December 31, 2019 as a result of lower interest income due to a decline in the market indices that are used for our floating rate loans, subject to interest rate floors; offset by lower operating expenses as explained in the “Expenses” section above.
Net investment income for the year ended December 31, 2019 decreased compared to the year ended December 31, 2018 as a result of an increase in accrued capital gains incentive fees and excise taxes generated by realized gains on certain equity positions and higher interest expense from larger amounts outstanding under the Credit Facility and SBA-guaranteed debentures; offset by higher investment income due to a larger portfolio.
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 year ended December 31, 2020 totaled $128.6 million and net realized losses totaled ($10.1) million. Proceeds from repayments of investments and amortization of certain other investments for the year ended December 31, 2019 totaled $128.2 million and net realized gains totaled $19.6 million. Proceeds from the sales and repayments of investments and amortization of certain other investments for the year ended December 31, 2018 totaled $147.5 million and net realized gains totaled $5.5 million. Net realized losses during the year ended December 31, 2020 resulted primarily from the disposition of a loan in our portfolio, partially offset by gains from the realization of our equity investments in certain portfolio companies. Net realized gains for the years ended December 31, 2019 and 2018 resulted primarily from the realization of our equity investments in certain portfolio companies.
Net Change in Unrealized Appreciation (Depreciation) of Investments
Net change in unrealized appreciation 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 appreciation (depreciation) on investments and cash equivalents for the year ended December 31, 2020, 2019 and 2018 totaled $8.6 million, ($15.5) million, and ($1.6) million, respectively.
The change in unrealized appreciation in 2020 was primarily due to portfolio company specific performance on several of our equity investments. The change in unrealized depreciation in 2019 was primarily due to write downs on specific investments. The change in unrealized depreciation in 2018 was due to a significant widening of spreads right at year end, offset by the write up of a specific equity investment.
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 year ended December 31, 2020, 2019 and 2018, we recognized a deferred tax provision related to unrealized appreciation on certain equity investments for income tax at our Taxable Subsidiaries of $224.9 thousand, $66.8 thousand and $68.0 thousand, respectively. As of December 31, 2020 and 2019, deferred tax liabilities of $359.6 thousand and $134.7 thousand, respectively, were included on the Consolidated Statement of Assets and Liabilities.
For the year ended December 31, 2018, we recognized tax expense related to the realized gains on certain equity investments at our taxable subsidiaries of $267.0 thousand. There was no such tax expense for the years ended December 31, 2020 and 2019. As of December 31, 2020 and 2019, no tax liability related to the taxes on realized gains were included on the Consolidated Statement of Assets and Liabilities.
Net Increase in Net Assets Resulting from Operations
Net increase in net assets resulting from operations totaled $20.2 million, or $1.04 per common share based on weighted-average shares of 19,471,500 for the year ended December 31, 2020, as compared to $26.4 million, or $1.45 per common share based on weighted-average shares of 18,275,696 common shares
outstanding for the year ended December 31, 2019, as compared to $26.2 million, or $1.64 per common share based on weighted-average shares of 15,953,571 common shares outstanding for the year ended December 31, 2018.
The decrease in net increase in net assets for the year ended December 31, 2020 was primarily due to net realized losses, offset by net unrealized gains. The net increase in net assets resulting from operations for the year ended December 31, 2019 as compared to the year ended December 31, 2018 was higher due primarily to a larger amount of realized gains, offset by unrealized depreciation.
Financial condition, liquidity and capital resources
Cash Flows from Operating and Financing Activities
Our operating activities used net cash of $3.5 million for the year ended December 31, 2020, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. The decrease in net cash used in operating activities over the period is because we did not make any new investments during the first half of 2020, primarily due to the COVID-19 pandemic. Our financing activities for the year ended December 31, 2020 provided cash of $5.8 million primarily from proceeds from SBA-guaranteed debentures, net borrowings on our Credit Facility, and proceeds from the issuance of common stock.
Our operating activities used net cash of $93.3 million for the year ended December 31, 2019, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. Our financing activities for the year ended December 31, 2019 provided cash of $92.0 million primarily from proceeds from the issuance of common stock, proceeds from SBA-guaranteed debentures and net borrowings on our Credit Facility.
Our operating activities used net cash of $102.4 million for the year ended December 31, 2018, primarily in connection with the purchase of portfolio investments, offset by sales and repayments of portfolio investments. Our financing activities for the year ended December 31, 2018 used cash of $94.8 million, primarily from proceeds from SBA-guaranteed debentures and net borrowings on our Credit Facility.
Liquidity and Capital Resources
Our liquidity and capital resources are derived from the Credit Facility, the 2022 Notes (as defined below), 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 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 of directors makes certain determinations in connection therewith. A proposal, approved by our stockholders at our 2020 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 25, 2021, the one-year anniversary of our 2020 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 December 31, 2020 and December 31, 2019, our asset coverage ratio was 223% and 229%, 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 December 31, 2020 and December 31, 2019, we had cash and cash equivalents of $18.5 million and $16.1 million, respectively.
Credit Facility
On October 11, 2017, we entered a senior secured revolving credit agreement, dated as of October 10, 2017, as amended, that was amended and restated on September 18, 2020 with ZB, N.A., dba Amegy Bank and various other lenders (the “Credit Facility”).
The key changes in the amended and restated Credit Facility are as follows:
Prior agreement
As amended and restated
Maturity Date
October 10, 2021
September 18, 2025
Commitment termination date
March 10, 2021
September 18, 2024
LIBOR floor
None
0.25%
Prime rate floor
None
3.00%
Asset coverage ratio
Minimum of 1.75 to 1.00 (maximum leverage of 1.33x)
Minimum of 1.67 to 1.00 (maximum leverage of 1.5x)
Refinancing of 2022 Notes(1)
Not required
Required by March 15, 2022
(1)
See subsequent events section below for discussion on activity related to the 2022 Notes subsequent to December 31, 2020.
The Credit Facility, as amended and restated, provides for borrowings up to a maximum of $230.0 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.
Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) LIBOR plus 2.50% (or 2.75% during certain periods in which our asset coverage ratio is equal to or below 1.90 to 1.00) with a 0.25% LIBOR floor, or (ii) 1.50% (or 1.75% during certain periods in which our 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, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. We pay unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable quarterly in arrears. The commitment to fund the revolver expires on September 18, 2024, after which we 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. 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 $10,000,000, including cash, liquid investments and undrawn availability, (ii) maintaining an asset coverage ratio of at least 1.67 to 1.0, (iii) maintaining a minimum shareholder’s equity, and (iv) maintaining a minimum interest coverage ratio of at least 2.00 to 1.00.
As of December 31, 2020 and December 31, 2019, the outstanding balance under the Credit Facility was $174.0 million and $161.6 million, respectively. 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. We have incurred costs of $3.6 million in connection with the current Credit Facility, which were capitalized and 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 life of the Credit Facility. As of December 31, 2020 and 2019, $2.3 million and $1.0 million of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our consolidated statement of assets and liabilities as a deduction from the debt liability attributable to the Credit Facility.
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 years ended December 31, 2020, 2019, and 2018 (dollars in millions):
For the years ended
December 31,
December 31,
December 31,
Interest expense
$ 5.8
$ 5.1
$ 3.7
Loan fee amortization
0.6
0.5
0.4
Commitment fees on unused portion
0.2
0.4
0.4
Administration fees
0.1
-
0.1
Total interest and financing expenses
$ 6.7
$ 6.0
$ 4.6
Weighted average interest rate
3.2%
4.8%
4.7%
Effective interest rate (including fee amortization)
3.7%
5.7%
5.7%
Average debt outstanding
$ 181.9
$ 106.2
$ 79.8
Cash paid for interest and unused fees
$ 6.3
$ 5.2
$ 4.2
SBA-guaranteed debentures
Due to the SBIC subsidiaries’ status as licensed SBICs, we can 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 December 31, 2020 and 2019, the SBIC subsidiary had $75.0 million in “regulatory capital”, as such term is defined by the SBA.
As of December 31, 2020 and 2019, the SBIC II subsidiary had $40.0 million and $20.0 million in regulatory capital, respectively.
On August 12, 2014, we obtained exemptive relief from the SEC to permit us to exclude the SBA-guaranteed debentures from our asset coverage test under the 1940 Act. The exemptive relief provides us with increased flexibility under the 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 $277.3 million and $240.1 million in assets at December 31, 2020 and 2019, respectively, which accounted for approximately 41.1% and 37.0% of our total consolidated assets at December 31, 2020 and 2019, respectively.
SBA-guaranteed debentures have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the SBA-guaranteed debentures is not required to be paid before maturity but may be pre-paid at any time with no prepayment penalty. As of December 31, 2020 and 2019, the SBIC subsidiaries had $176.5 million and $161.00 of the SBA-guaranteed debentures outstanding, respectively. 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 each 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 December 31, 2020 and 2019, the carrying amount of the SBA-guaranteed debentures approximated their fair value. The fair value of the SBA-guaranteed debentures 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 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 December 31, 2020 and 2019, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.
As of December 31, 2020, we have incurred $6.2 million in financing costs related to the SBA-guaranteed debentures since the SBIC subsidiaries have received their licenses, which were recorded as prepaid loan fees. As of December 31, 2020 and 2019, $3.3 million and $3.5 million of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement 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 years ended December 31, 2020, 2019 and 2018 (dollars in millions):
For the years ended
December 31,
December 31,
December 31,
Interest expense
$ 5.4
$ 5.2
$ 4.0
Debenture fee amortization
0.7
0.6
0.6
Total interest and financing expenses
$ 6.1
$ 5.8
$ 4.6
Weighted average interest rate
3.3%
3.4%
3.2%
Effective interest rate (including fee amortization)
3.8%
3.8%
3.7%
Average debt outstanding
$ 161.6
$ 151.9
$ 125.4
Cash paid for interest
$ 5.3
$ 5.0
$ 3.1
Notes Offering
On August 21, 2017, we issued $42.5 million in aggregate principal amount of 5.75% fixed-rate notes due 2022 (the “2022 Notes”). On September 8, 2017, we issued an additional $6.4 million in aggregate principal amount of the 2022 Notes pursuant to a full exercise of the underwriters’ overallotment option. The 2022 Notes will mature on September 15, 2022, and may be redeemed in whole or in part at any time or from time to time at our option on or after September 15, 2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly.
We used all of the net proceeds from this offering to fully redeem notes issued in a prior public offering and a portion of the amount outstanding under our prior credit facility. As of both December 31, 2020 and 2019, the aggregate carrying amount of all Notes was $48.9 million and the fair value of the Notes was approximately $49.2 million and $49.7 million, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.
In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1.7 million of fees which are being amortized over the term of the 2022 Notes, of which $0.6 million and $0.9 million remained to be amortized as of December 31, 2020 and 2019, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the years ended December 31, 2020, 2019, 2018 (in millions):
For the years ended
December 31,
December 31,
December 31,
Interest expense
$ 2.8
$ 2.8
$ 2.8
Deferred financing costs
0.3
0.3
0.3
Total interest and financing expenses
$ 3.1
$ 3.1
$ 3.1
Weighted average interest rate
5.7%
5.8%
5.8%
Effective interest rate (including fee amortization)
6.4%
6.4%
6.4%
Average debt outstanding
$ 48.9
$ 48.9
$ 48.9
Cash paid for interest
$ 2.8
$ 2.8
$ 2.8
Contractual Obligations
As of December 31, 2020, our future fixed commitments for cash payments on contractual obligations for each of the next five years and thereafter are as follows:
Total
2026 and
thereafter
(dollars in thousands)
Credit Facility payable
$ 174,000
-
-
-
$ 58,000
$ 116,000
-
Notes payable(1)
$ 48,875
-
$ 48,875
-
-
-
-
SBA-guaranteed debentures
$ 176,500
-
-
-
-
-
$ 176,500
Total
$ 399,375
$ -
$ 48,875
$ -
$ 58,000
$ 116,000
$ 176,500
(1)
See Note 15 for the discussion regarding the 2022 Notes subsequent to December 31, 2020
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 December 31, 2020, our only off-balance sheet arrangements consisted of $28.9 million of unfunded commitments to provide debt financing to 19 of our portfolio companies. As of December 31, 2019, our only off-balance sheet arrangements consisted of $37.5 million unfunded commitments to provide debt financing to 17 of our portfolio companies. As of December 31, 2020, 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 to be treated 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 to avoid a U.S. federal excise tax on our undistributed earnings of a RIC. As of December 31, 2020, we had $21,051,549 of undistributed taxable income that will be carried forward toward distributions paid during the year ending December 31, 2021.
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 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 shares of 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 BDC under the 1940 Act and due to provisions in the 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 shares of our common stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash, except as described below.
Recently, in recognition of the need for enhanced liquidity during the current period of economic disruption, the IRS temporarily reduced the minimum required aggregate amount of cash that shareholders may receive in such a distribution from 20% down to 10% percent of the aggregate declared distribution. This temporary modification was effective solely with respect to distributions declared on or after April 1, 2020, and on or before December 31, 2020.
If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in shares of our common 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 common 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.
Recent Accounting Pronouncements
See Note 1 to the financial statements 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
Investment Portfolio
On January 14, 2021, we received full repayment on the first lien term loan and revolver of BFC Solmetex, LLC. for total proceeds of $13.6 million. We also received full repayment on the first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex, LLC, for total proceeds of $1.2 million.
On January 29, 2021, we invested $11.3 million in the first lien term loan of NuSource Financial, LLC, a provider of technology integration and installation of Automated Teller Machines / Integrated Teller Machines (“ATM” / “ITM”), maintenance services, and security solutions. Additionally, we invested $4.8 million in the subordinated debt and warrants of the company.
On February 1, 2021, we invested $0.4 million in the equity of Tailwind Core Investor, LLC, an existing portfolio company.
On February 11, 2021, we invested $7.2 million in the first lien term loan of Time Manufacturing Acquisition, LLC, an existing portfolio company. Additionally, we invested $0.1 million in the equity of the company.
On February 19, 2021, we invested $13.5 million in the first lien term loan and committed $0.1 million in the unfunded revolver of CEATI International, Inc., a provider of intellectual content, technical trade programs, research groups, and conferences for utility companies. Additionally, we invested $0.3 million in the equity of the company.
On March 1, 2021, we invested $10.8 million in the first lien term loan and committed $0.1 million in the unfunded revolver of TAC LifePort Purchaser, LLC, a provider of aerospace products for the U.S. military / government, air medical, and high-end VIP aircraft end markets. Additionally, we invested $0.5 million in the equity of the company.
On March 2, 2021, we invested $10.0 million in the first lien term loan and $0.1 million in the unfunded revolver of TradePending, LLC, a provider of vehicle trade-in and merchandising intelligence solutions for auto dealerships, primarily flagship dealerships. Additionally, we invested $0.8 million in the equity of the company.
2026 Notes
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 all of the net proceeds from this offering to fully redeem the 2022 Notes and repay a portion of the outstanding amount under the Credit Facility.
Redemption of the 2022 Notes
On February 12, 2021, we redeemed all $48.875 million in aggregate principal amount of the 2022 Notes. The 2022 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.
Credit Facility
The outstanding balance under the Credit Facility as of March 3, 2021 was $164.5 million.
SBA-guaranteed Debentures
The outstanding balance under SBA-guaranteed debentures as of March 3, 2021 was $210.0 million.
SBIC II Subsidiary
On January 21, 2021, we contributed $15.0 million to the SBIC II subsidiary, bring total contributed capital to $35.0 million. On January 25, 2021, we increased committed capital to $60.0 million.
Dividend Declared
On January 15, 2021, our Board changed the frequency of distributions from quarterly to monthly and declared a regular monthly dividend for each of January, February and March 2021 as follows:
Declared
Ex-Dividend
Date
Record
Date
Payment
Date
Amount
per Share
1/15/2021
1/28/2021
1/29/2021
2/16/2021
$ 0.0833
1/15/2021
2/25/2021
2/26/2021
3/15/2021
$ 0.0833
1/15/2021
3/30/2021
3/31/2021
4/15/2021
$ 0.0833

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to financial market risks, including changes in interest rates. U.S. and global capital markets and credit markets have experienced a higher level of stress due to the COVID-19 pandemic, which has resulted in an increase in the level of volatility across such markets. The U.S. Federal Reserve and other central banks have reduced certain interest rates and LIBOR has decreased. In a prolonged low interest rate environment, including a reduction of LIBOR to zero, the difference between the total interest income earned on interest earning assets and the total interest expense incurred on interest bearing liabilities may be compressed, reducing our net interest income and potentially adversely affecting our operating results. For both years ended December 31, 2020 and 2019, 93% of the loans in our portfolio bore interest at floating rates. These floating rate loans typically bear interest in reference to LIBOR, which are indexed to 30-day or 90-day LIBOR rates, subject to an interest rate floor. As of December 31, 2020 and 2019, the weighted average interest rate floor on our floating rate loans was 1.21% and 1.13%, respectively.
Assuming that the Statement of Assets and Liabilities as of December 31, 2020 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)
Change in Basis Points
Interest
Income
Interest
Expense
Net Interest
Income(1)
Up 200 basis points
$ 11.4
$ (3.5)
$ 7.9
Up 150 basis points
7.6
(2.6)
5.0
Up 100 basis points
2.9
(1.7)
1.2
Up 50 basis points
0.5
(0.9)
(0.4)
Down 25 basis points
-
-
-
(1)
Excludes the impact of incentive fees based on pre-incentive fee net investment income. See Note 2 for more information on the incentive fee.
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 years ended December 31, 2020 and 2019, we did not engage in hedging activities.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
Page
Report of Independent Registered Public Accounting Firm
Statements of Assets and Liabilities as of December 31, 2020 and December 31, 2019
Statements of Operations for the years ended December 31, 2020, 2019, and 2018
Statements of Changes in Net Assets for the years ended December 31, 2020, 2019, and 2018
Statements of Cash Flows for the years ended December 31, 2020, 2019, and 2018
Schedule of Investments as of December 31, 2020 and December 31, 2019
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Stellus Capital Investment Corporation
Opinion on the financial statements
We have audited the accompanying consolidated statements of assets and liabilities of Stellus Capital Investment Corporation (a Maryland corporation) and subsidiaries (the “Company”), including the consolidated schedule of investments as of December 31, 2020 and 2019, the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”) and financial highlights for each of the five years in the period ended December 31, 2020. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 and the financial highlights for each of the five years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Fair Value of Investments
As described further in Note 6 to the financial statements, the Company has investments in portfolio companies with a fair value of $653,424,495. Investment values are based on prices or valuation techniques that require inputs that are significant and unobservable. The determination of fair value also requires management judgement. As such, we identified fair value of investments as a critical audit matter.
The principal considerations for our determination that the fair value of investments is a critical audit matter are that the assets are valued using unobservable inputs, which are considered level 3 in nature under the valuation hierarchy of US GAAP. In addition, valuation is material to the financial statements, and
there is a high level of judgement in determining the fair value. As a result, obtaining sufficient appropriate audit evidence related to the fair value measurement required significant auditor judgement.
Our audit procedures related to the fair value of investments included the following, among others.
•
Testing the design and operating effectiveness of relevant controls over management’s process relating to the fair value measurement of investments.
•
With the assistance of internal valuation specialists to evaluate and test management’s process to develop valuation estimates, we performed audit procedures to determine that the data, methods, and assumptions used to determine investment fair value was reasonable. We also tested the mathematical accuracy of investment valuations. Certain key inputs/assumptions tested by us included the following:
•
Discount rate
•
Credit yields
•
Market multiples,
•
Revenue and EBITDA multiples
•
Weighting between valuation techniques,
•
In testing the inputs/assumptions above, we considered available third-party market information, current economic conditions, and client specific source information.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2012.
Dallas, Texas
March 4, 2021
PART I - FINANCIAL INFORMATION
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
December 31,
December 31,
ASSETS
Non-controlled, non-affiliated investments, at fair value (amortized cost of $658,628,966 and $642,707,824, respectively)
$ 653,424,495
$ 628,948,077
Cash and cash equivalents
18,477,602
16,133,315
Receivable for sales and repayments of investments
215,929
123,409
Interest receivable
2,189,448
2,914,710
Other receivables
25,495
25,495
Deferred offering costs
90,000
-
Prepaid expenses
487,188
368,221
Total Assets
$ 674,910,157
$ 648,513,227
LIABILITIES
Notes payable
$ 48,307,518
$ 47,974,202
Credit facility payable
171,728,405
160,510,633
SBA-guaranteed debentures
173,167,496
157,543,853
Dividends payable
-
2,167,630
Management fees payable
2,825,322
2,695,780
Income incentive fees payable
681,660
1,618,509
Capital gains incentive fees payable
521,021
880,913
Interest payable
2,144,085
2,322,314
Unearned revenue
523,424
559,768
Administrative services payable
391,491
413,278
Deferred tax liability
359,590
134,713
Income tax payable
724,765
917,000
Other accrued expenses and liabilities
174,731
203,461
Total Liabilities
$ 401,549,508
$ 377,942,054
Commitments and contingencies (Note 7)
Net Assets
$ 273,360,649
$ 270,571,173
NET ASSETS
Common stock, par value $0.001 per share (100,000,000 shares authorized; 19,486,003 and 19,131,746 issued and outstanding, respectively)
$ 19,486
$ 19,132
Paid-in capital
276,026,667
272,117,091
Accumulated undistributed deficit
(2,685,504)
(1,565,050)
Net Assets
$ 273,360,649
$ 270,571,173
Total Liabilities and Net Assets
$ 674,910,157
$ 648,513,227
Net Asset Value Per Share
$ 14.03
$ 14.14
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
For the
year ended
December 31,
For the
year ended
December 31,
For the
year ended
December 31,
INVESTMENT INCOME
Interest income
$ 55,350,781
$ 56,895,990
$ 51,463,033
Other income
1,307,533
2,015,899
1,803,305
Total Investment Income
$ 56,658,314
$ 58,911,889
$ 53,266,338
OPERATING EXPENSES
Management fees
$ 11,084,450
$ 9,703,706
$ 8,154,842
Valuation fees
290,445
265,103
307,838
Administrative services expenses
1,781,603
1,691,764
1,390,375
Income incentive fees
2,527,813
5,809,672
5,529,376
Capital gains incentive (reversal) fees
(359,892)
799,876
81,038
Professional fees
950,716
1,040,011
1,189,071
Directors’ fees
394,816
383,000
317,000
Insurance expense
384,774
352,382
348,500
Interest expense and other fees
15,950,087
14,976,024
12,338,755
Income tax expense
771,134
903,905
275,106
Other general and administrative expenses
890,465
547,637
697,900
Total Operating Expenses
$ 34,666,411
$ 36,473,080
$ 30,629,801
Net Investment Income
$ 21,991,903
$ 22,438,809
$ 22,636,537
Net realized (loss) gain on non-controlled, non-affiliated investments
$ (10,129,859)
$ 19,565,903
$ 5,540,518
Tax provision on realized gain on investment
$ -
$ -
$ (267,975)
Net change in unrealized appreciation (depreciation) on non-controlled, non-affiliated investments
$ 8,555,274
$ (15,501,951)
$ (1,706,549)
Net change in unrealized appreciation on non-controlled, affiliated investments
$ -
$ 2,185
$ 60,000
Provision for taxes on net unrealized gain on investments
$ (224,877)
$ (66,760)
$ (67,953)
Net Increase in Net Assets
Resulting from Operations
$ 20,192,441
$ 26,438,186
$ 26,194,578
Net Investment Income Per Share
$ 1.13
$ 1.23
$ 1.42
Net Increase in Net Assets Resulting from Operations Per
Share
$ 1.04
$ 1.45
$ 1.64
Weighted Average Shares of Common Stock
Outstanding
19,471,500
18,275,696
15,953,571
Distributions Per Share
$ 1.15
$ 1.36
$ 1.36
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
For the
year ended
December 31,
For the
year ended
December 31,
For the
year ended
December 31,
Increase in Net Assets Resulting from Operations
Net investment income
$ 21,991,903
$ 22,438,809
$ 22,636,537
Net realized (loss) gain on non-controlled,
non-affiliated investments
(10,129,859)
19,565,903
5,540,518
Tax provision on realized gain on investments
-
(267,975)
Net change in unrealized appreciation (depreciation) on non-controlled, non-affiliated investments
8,555,274
(15,501,951)
(1,706,549)
Net change in unrealized appreciation on
non-controlled, affiliated investments
-
2,185
60,000
Provision for taxes on unrealized appreciation on investments
(224,877)
(66,760)
(67,953)
Net Increase in Net Assets Resulting from Operations
$ 20,192,441
$ 26,438,186
$ 26,194,578
Stockholder Distributions From:
Net investment income
$ (22,402,959)
$ (10,000,000)
$ (16,418,007)
Net realized capital gains
-
(15,038,173)
(5,272,543)
Total Distributions
$ (22,402,959)
$ (25,038,173)
$ (21,690,550)
Capital Share Transactions
Issuance of common stock
$ 5,023,937
$ 45,862,239
$ 94,788
Sales load
(18,169)
(1,015,127)
-
Offering costs
(5,681)
(521,715)
-
Partial share transactions
(94)
(1,051)
Net Increase in Net Assets Resulting From
Capital Share Transactions
$ 4,999,993
$ 44,326,153
$ 93,737
Total Increase in Net Assets
$ 2,789,476
$ 45,726,166
$ 4,597,765
Net Assets at Beginning of Period
$ 270,571,173
$ 224,845,007
$ 220,247,242
Net Assets at End of Period
$ 273,360,649
$ 270,571,173
$ 224,845,007
STELLUS CAPITAL INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the
year ended
December 31,
December 31,
For the
year ended
December 31,
Cash flows from operating activities
Net increase in net assets resulting from operations
$ 20,192,441
$ 26,438,186
$ 26,194,578
Adjustments to reconcile net increase in net assets from operations to net cash used in operating activities:
Purchases of investments
(152,007,165)
(246,438,384)
(272,927,459)
Proceeds from sales and repayments of
investments
128,627,422
128,206,318
147,528,448
Net change in unrealized (appreciation) depreciation
on investments
(8,555,274)
15,499,766
1,646,549
Increase in investments due to PIK
(664,992)
(415,933)
(1,869,905)
Amortization of premium and accretion of discount, net
(2,098,788)
(1,774,469)
(1,553,333)
Deferred tax provision
224,877
66,760
67,953
Amortization of loan structure fees
647,872
519,995
456,151
Amortization of deferred financing costs
333,316
332,407
335,309
Amortization of loan fees on SBA-guaranteed debentures
701,068
623,900
623,989
Net realized loss (gain) on investments
10,129,859
(19,565,903)
(5,540,518)
Changes in other assets and liabilities
Decrease (increase) in interest receivable
725,262
873,974
(866,480)
Decrease (increase) in other receivable
-
59,751
(85,246)
(Increase) decrease in prepaid expenses
(118,967)
(23,600)
16,649
Increase in management fees payable
129,542
511,805
562,383
(Decrease) increase in incentive fees payable
(936,849)
(318,029)
1,564,891
(Decrease) increase in capital gains incentive fees payable
(359,892)
799,875
81,038
(Decrease) increase in administrative services payable
(21,787)
21,087
65,158
(Decrease) increase in interest payable
(178,229)
458,748
842,393
(Decrease) Increase in unearned revenue
(36,344)
149,175
271,289
(Decrease) increase in income tax payable
(192,235)
600,908
316,092
(Decrease) increase in other accrued expenses and liabilities
(28,730)
87,559
(152,511)
Net Cash Used In Operating Activities
$ (3,487,593)
$ (93,286,104)
$ (102,422,582)
Cash flows from Financing Activities
Proceeds from the issuance of common stock
$ 4,794,994
$ 45,862,239
$ -
Sales load for common stock issued
(18,169)
(1,015,127)
-
Offering costs paid for common stock
(95,681)
(503,042)
(18,673)
Stockholder distributions paid
(24,341,646)
(24,678,113)
(21,594,863)
For the
year ended
December 31,
December 31,
For the
year ended
December 31,
Proceeds from SBA-guaranteed debentures
15,500,000
11,000,000
60,000,000
Financing costs paid on SBA-guaranteed debentures
(577,425)
(467,850)
(2,055,000)
Borrowings under Credit Facility
120,950,000
245,750,000
246,300,000
Repayments of Credit Facility
(108,500,000)
(183,750,000)
(187,500,000)
Financing costs paid on Credit facility
(1,880,099)
(246,589)
(351,403)
Partial share transactions
(94)
(1,051)
Net Cash Provided by Financing Activities
$ 5,831,880
$ 91,952,273
$ 94,779,010
Net Increase in Cash and Cash Equivalents
$ 2,344,287
$ (1,333,831)
$ (7,643,572)
Cash and cash equivalents balance at beginning of period
16,133,315
17,467,146
25,110,718
Cash and Cash Equivalents Balance at End of Period
$ 18,477,602
$ 16,133,315
$ 17,467,146
Supplemental and Non-Cash Activities
Cash paid for interest expense
$ 14,441,061
$ 13,035,976
$ 10,075,913
Excise tax paid
940,000
280,000
27,717
Shares issued pursuant to Dividend Reinvestment Plan
228,943
-
94,788
(Decrease) increase in dividends payable
(2,167,630)
360,060
Increase (decrease) in deferred offering costs
90,000
(18,673)
18,673
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2020
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
Non-controlled, non-affiliated investments
(2)(9)
Adams Publishing Group, LLC
Greenville, TN
Term Loan
(35)
First Lien
1M
L+7.00%
1.75%
8.75%
8/3/2018
6/30/2023
Media:
Advertising,
Printing &
Publishing
$4,990,080
4,962,046
4,990,080
1.83%
Delayed Draw Term Loan
(35)
First Lien
1M
L+7.00%
1.75%
8.75%
8/3/2018
6/30/2023
$162,106
162,106
162,106
0.06%
Total
$ 5,124,152
$ 5,152,186
1.89%
Advanced Barrier Extrusions, LLC
Rhinelander, WI
Term Loan
(SBIC)
(2)(35)
First Lien
1M
L+6.50%
1.00%
7.50%
11/30/2020
11/30/2026
Containers,
Packaging &
Glass
$17,500,000
17,153,813
17,150,000
6.27%
GP ABX Holdings Partnership, L.P.
Common Stock
(4)
Equity
8/8/2018
644,737
units
700,000
740,000
0.27%
Total
$ 17,853,813
$ 17,890,000
6.54%
APE Holdings, LLC
Deer Park, TX
Class A Common
Units
(4)
Equity
9/5/2014
Chemicals,
Plastics, &
Rubber
375,000
units
375,000
80,000
0.03%
Atmosphere Aggregator Holdings II, LP
Atlanta, GA
Common Units
(4)
Equity
1/26/2016
Services:
Business
254,250
units
1,350,000
0.49%
Stratose Aggregator Holdings, LP Common Units
(4)
Equity
6/30/2015
750,000
units
3,970,000
1.45%
Total
$
$ 5,320,000
1.94%
ASC Communications, LLC
(17)
Chicago, IL
Term Loan
(SBIC)
(2)(35)
First Lien
1M
L+5.00%
1.00%
6.00%
6/29/2017
6/29/2023
Healthcare &
Pharmaceuticals
$4,058,642
4,044,314
3,896,296
1.43%
Term Loan
(35)
First Lien
1M
L+5.00%
1.00%
6.00%
2/4/2019
6/29/2023
$6,899,691
6,847,391
6,623,704
2.42%
ASC Communications Holdings, LLC Class A Preferred Units (SBIC)
(2)(4)
Equity
6/29/2017
73,529
shares
58,828
330,000
0.12%
Total
$ 10,950,533
$ 10,850,000
3.97%
BFC Solmetex, LLC
Nashville, TN
Revolver
(35)
First Lien
3M
L+8.50%
1.00%
9.50%
4/2/2018
9/26/2023
Environmental
Industries
$2,139,364
2,139,364
2,139,364
0.78%
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+8.50%
1.00%
9.50%
4/2/2018
9/26/2023
$11,474,603
11,384,927
11,474,603
4.20%
Bonded Filter Co. LLC, Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+8.50%
1.00%
9.50%
4/2/2018
9/26/2023
$1,193,460
1,184,133
1,193,460
0.44%
Total
$ 14,708,424
$ 14,807,427
5.42%
BW DME Acquisition, LLC
Tempe, AZ
Term Loan
(SBIC)
(2)(13)(22)
First Lien
3M
L+6.00%
1.00%
8.58%
8/24/2017
8/24/2022
Healthcare &
Pharmaceuticals
$16,695,804
16,496,876
16,695,804
6.11%
BW DME Holdings, LLC, Term Loan
(6)
Unsecured
17.50%
17.50%
6/1/2018
6/30/2020
$391,063
391,063
391,063
0.14%
BW DME Holdings, LLC Class A-1
Preferred Units
(4)
Equity
8/24/2017
1,000,000 shares
1,000,000
1,500,000
0.55%
BW DME Holdings, LLC Class A-2
Preferred Units
(4)
Equity
1/26/2018
937,261 shares
937,261
1,410,000
0.52%
Total
$ 18,825,200
$ 19,996,867
7.32%
Café Valley, Inc.
Phoenix, AZ
Term Loan
(35)
First Lien
1M
L+7.00%
1.25%
8.25%
8/28/2019
8/28/2024
Beverage,
Food, & Tobacco
$16,077,381
15,829,176
15,675,447
5.73%
CF Topco LLC, Common Units
(4)
Equity
8/28/2019
9,160
shares
916,015
720,000
0.26%
Total
$ 16,745,191
$ 16,395,447
5.99%
Colford Capital Holdings, LLC
New York, NY
Preferred Units
(4)(5)
Equity
8/20/2015
Finance
38,893
units
195,036
20,000
0.01%
CommentSold, LLC
(8)
Huntsville, AL
Term Loan
(SBIC)
(2)(35)
First Lien
1M L+6.00%
1.00%
7.00%
11/20/2020
11/20/2026
High Tech
Industries
$12,500,000
12,252,768
12,252,768
4.48%
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
CompleteCase, LLC
(21)
Seatlle, WA
Term Loan (SBIC II)
(9)(35)
First Lien
3M
L+6.50%
1.00%
7.50%
12/21/2020
12/21/2025
Services:
Consumer
$11,478,261
11,248,696
11,248,696
4.11%
Revolver
(35)
First Lien
3M
L+6.50%
1.00%
7.50%
12/21/2020
12/21/2025
$33,333
33,333
32,667
0.01%
CompleteCase Holdings, Inc. Class A
Common Units (SBIC II)
(4)(9)
Equity
12/21/2020
417 units
0.00%
CompleteCase Holdings, Inc. Series A Preferred Units (SBIC II)
(4)(9)
Equity
12/21/2020
522 units
521,734
520,000
0.19%
Total
$ 11,803,768
$ 11,801,363
4.31%
Convergence Technologies, Inc.
Indianpolis, IN
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+6.75%
1.50%
8.25%
8/31/2018
8/30/2024
Services:
Business
$6,982,143
6,888,406
6,982,143
2.55%
Term Loan
(35)
First Lien
3M
L+6.75%
1.50%
8.25%
2/28/2019
8/30/2024
$1,403,571
1,383,414
1,403,571
0.51%
Term Loan B (SBIC)
(2)(35)
First Lien
3M
L+6.75%
1.50%
8.25%
8/14/2020
8/30/2024
$3,740,625
3,672,274
3,740,625
1.37%
Delayed Draw Term Loan
(35)
First Lien
3M
L+6.75%
1.50%
8.25%
8/31/2018
8/30/2024
$5,250,000
5,250,000
5,250,000
1.92%
Tailwind Core Investor, LLC Class A
Preferred Units
(4)
Equity
8/31/2018
5,282 units
547,795
650,000
0.24%
Total
$ 17,741,889
$ 18,026,339
6.59%
Data Centrum Communications, Inc.
Montvale, NJ
Term Loan
(35)
First Lien
3M
L+5.50%
1.00%
6.50%
5/15/2019
5/15/2024
Media:
Advertising,
Printing &
Publishing
$16,006,250
15,778,905
15,446,031
5.65%
Health Monitor Holdings, LLC Seires
A Preferred Units
(4)
Equity
5/15/2019
1,000,000 shares
1,000,000
750,000
0.27%
Total
$ 16,778,905
$ 16,196,031
5.92%
Douglas Products Group, LP
Liberty, MO
Class A Common Units
(4)
Equity
12/27/2018
Chemicals,
Plastics, &
Rubber
322 shares
139,656
820,000
0.30%
DRS Holdings III, Inc.
(10)
St. Louis, MO
Term Loan
(35)
First Lien
1M
L+5.75%
1.00%
6.75%
11/1/2019
11/1/2025
Consumer
Goods:
Durable
$9,900,000
9,816,898
9,900,000
3.62%
DTE Enterprises, LLC
(18)
Roselle, IL
Term Loan
(35)
First Lien
6M
L+8.50%
1.50%
10.00%
4/13/2018
4/13/2023
Energy:
Oil & Gas
$9,323,691
9,226,943
8,531,177
3.12%
DTE Holding Company, LLC Common Shares, Class A-2
(4)
Equity
4/13/2018
776,316 shares
466,204
220,000
0.08%
DTE Holding Company, LLC Preferred Shares, Class AA
(4)
Equity
4/13/2018
723,684 shares
723,684
200,000
0.07%
Total
$ 10,416,831
$ 8,951,177
3.27%
Elliott Aviation, LLC
Moline, IL
Term Loan
(35)
First Lien
3M
L+6.00%
1.75%
7.75%
1/31/2020
1/31/2025
Aerospace &
Defense
$18,427,500
18,115,703
18,151,088
6.64%
Revolver
(3)(35)
First Lien
3M
L+6.00%
1.75%
7.75%
1/31/2020
1/31/2025
$450,000
450,000
443,250
0.16%
SP EA Holdings, LLC Preferred Shares, Class A
(4)
Equity
1/31/2020
900,000 shares
900,000
560,000
0.20%
Total
$ 19,465,703
$ 19,154,338
7.00%
Empirix Holdings I, Inc.
Billerica, MA
Common Shares, Class A
(4)
Equity
11/1/2013
Software
1,304 shares
1,304,232
1,760,000
0.64%
Common Shares, Class B
(4)
Equity
11/1/2013
1,317,406 shares
13,174
20,000
0.01%
Total
$ 1,317,406
$ 1,780,000
0.65%
Energy Labs Holding Corp.
Houston, TX
Common Stock
(4)
Equity
9/29/2016
Energy:
Oil & Gas
598 shares
598,182
1,040,000
0.38%
Exacta Land Surveyors, LLC
(23)(25)
Cleveland, OH
Term Loan (SBIC)
(2)(35)
First Lien
3M
L+5.75%
1.50%
7.25%
2/8/2019
2/8/2024
Services:
Business
$16,714,375
16,488,364
16,547,231
6.05%
SP ELS Holdings LLC, Class A Common Units
(4)
Equity
2/8/2019
1,069,143 shares
1,069,143
720,000
0.26%
Total
$ 17,557,507
$ 17,267,231
6.31%
EOS Fitness Holdings, LLC
Phoenix, AZ
Preferred Units
(4)
Equity
12/30/2014
Hotel,
Gaming, &
Leisure
118 shares
10,000
0.00%
Class B Common Units
(4)
Equity
12/30/2014
3,017
shares
0.00%
Total
$
$ 10,000
0.00%
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
Fast Growing Trees, LLC
(16)
Fort Mill, SC
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+6.75%
1.00%
7.75%
2/5/2018
02/05/23
Retail
$14,992,490
14,850,620
14,992,490
5.48%
SP FGT Holdings, LLC, Class A Common
(4)
Equity
2/5/2018
1,000,000 shares
983,851
3,140,000
1.15%
Total
$ 15,834,471
$ 18,132,490
6.63%
FB Topco, Inc.
Camden, NJ
Term Loan
(13)(22)
First Lien
6M
L+6.35%
1.00%
9.52%
6/27/2018
4/24/2023
Education
$20,550,738
20,322,696
20,447,984
7.48%
Delayed Draw Term Loan
(13)(22)
First Lien
6M
L+6.35%
1.00%
9.55%
6/27/2018
4/24/2023
$1,126,758
1,126,758
1,121,124
0.41%
Total
$ 21,449,454
$ 21,569,108
7.89%
GK Holdings, Inc.
Cary, NC
Term Loan
(33)(35)
Second Lien
3M
L+10.25%
1.00%
0.00%
1/30/2015
1/20/2022
Education
$5,000,000
4,979,153
2,925,000
1.07%
General LED OPCO, LLC
San Antonio, TX
Term Loan
(35)
Second Lien
3M
L+9.00%
1.50%
10.50%
5/1/2018
11/1/2023
Services:
Business
$4,500,000
4,447,700
3,690,000
1.35%
GS HVAM Intermediate, LLC
(34)
Carlsbad, CA
Term Loan
(35)
First Lien
1M
L+5.75%
1.00%
6.75%
10/18/2019
10/2/2024
Beverage,
Food, &
Tobacco
$12,895,506
12,792,753
12,895,506
4.72%
HV GS Acquisition, LP Class A Interests
(4)
Equity
6/29/2018
1,796
shares
1,618,844
2,460,000
0.90%
Total
$ 14,411,597
$ 15,355,506
5.62%
Grupo HIMA San Pablo, Inc., et al
San Juan, PR
Term Loan
(27)(35)
First Lien
3M
L+7.00%
1.50%
8.50%
2/1/2013
1/31/2018
Healthcare &
Pharmaceuticals
$4,503,720
4,503,720
2,589,639
0.95%
Term Loan
(15)(27)
Second Lien
13.75%
0.00%
2/1/2013
7/31/2018
$4,109,524
4,109,524
0.00%
Total
$ 8,613,244
$ 2,589,639
0.95%
I2P Holdings, LLC
Cleveland, OH
Series A Preferred
(4)
Equity
1/31/2018
Services:
Business
750,000 shares
750,000
3,160,000
1.16%
Ian, Evan & Alexander Corporation
(36)
Reston, VA
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+8.50%
1.00%
9.50%
7/31/2020
7/31/2025
Services:
Business
$7,140,425
7,005,287
7,069,020
2.59%
EC Defense Holding, Class B Units (SBIC)
(2)(4)
Equity
7/31/2020
20,054
shares
500,000
690,000
0.25%
Total
$ 7,505,287
$ 7,759,020
2.84%
ICD Holdings, LLC
San Francisco, CA
Class A Preferred
(4)(5)
Equity
1/1/2018
9,962 shares
474,182
2,090,000
0.76%
Industry Dive, Inc.
Washington, D.C.
Term Loan
(SBIC)
(2)(35)
First Lien
1M
L+6.75%
1.00%
7.75%
7/17/2020
8/30/2024
Services:
Business
$7,015,841
6,887,907
6,980,762
2.55%
Revolver
(35)(37)
First Lien
1M
L+6.75%
1.00%
7.75%
7/17/2020
8/30/2024
$50,000
50,000
49,750
0.02%
Total
$ 6,937,907
$ 7,030,512
2.57%
Integrated Oncology Network, LLC
(30)
Newport Beach,
CA
Term Loan
(35)
First Lien
3M
L+5.50%
1.50%
7.00%
7/17/2019
6/24/2024
Healthcare &
Pharmaceuticals
$16,470,413
16,227,281
16,470,413
6.03%
Revolver
(35)
First Lien
3M
L+5.50%
1.50%
7.00%
7/17/2019
6/24/2024
$553,517
553,517
553,517
0.20%
Total
$ 16,780,798
$ 17,023,930
6.23%
Interstate Waste Services, Inc.
Amsterdam, OH
Common Units
(4)
Equity
10/30/2015
Environmental
Industries
21,925
shares
946,125
370,000
0.14%
Intuitive Health, LLC
Plano, TX
Term Loan (SBIC II)
(9)(35)
First Lien
3M
L+6.00%
1.50%
7.50%
10/18/2019
10/18/2024
Healthcare &
Pharmaceuticals
$5,940,000
5,844,850
5,940,000
2.17%
Term Loan
(35)
First Lien
3M
L+6.00%
1.50%
7.50%
10/18/2019
10/18/2024
$11,385,000
11,202,629
11,385,000
4.16%
Legacy Parent, Inc. Class A Common
Units
(4)
Equity
10/30/2020
58 shares
125,000
130,000
Total
$ 17,172,479
$ 17,455,000
6.33%
Invincible Boat Company, LLC
(28)
Opa Locka, FL
Term Loan (SBIC II)
(9)(35)
First Lien
3M
L+6.50%
1.50%
8.00%
8/28/2019
8/28/2025
Consumer
Goods:
Durable
$5,469,818
5,380,207
5,469,818
2.00%
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
Term Loan
(35)
First Lien
3M
L+6.50%
1.50%
8.00%
8/28/2019
8/28/2025
$5,925,636
5,772,336
5,925,636
2.17%
Revolver
(35)
First Lien
3M
L+6.50%
1.50%
8.00%
8/28/2019
8/28/2025
$284,091
284,091
284,091
Invincible Parent Holdco, LLC Class A Common Units
(4)
Equity
8/28/2019
1,000,000 shares
968,105
620,000
0.23%
Total
$ 12,404,739
$ 12,299,545
4.40%
J.R. Watkins, LLC
San Francisco, CA
Term Loan
(SBIC)
(2)
First Lien
7.00%
7.00%
12/22/2017
12/22/2022
Consumer
Goods:
non-durable
$12,250,000
12,139,807
12,250,000
4.48%
J.R. Watkins Holdings, Inc. Class A
Preferred
(4)
Equity
12/22/2017
1,133 shares
1,132,576
680,000
0.25%
Total
$ 13,272,383
$ 12,930,000
4.73%
Jurassic Acquisiton Corp.
Sparks, MD
Term Loan
(12)
First Lien
3M
L+5.50%
0.00%
5.75%
12/28/2018
11/15/2024
Metals &
Mining
$17,150,000
16,970,057
17,064,250
6.24%
Kelleyamerit Holdings, Inc.
Walnut Creek, CA
Term Loan
(SBIC)
(2)(13)(22)
First Lien
3M
L+6.50%
1.00%
8.89%
12/24/2020
12/24/2025
Automotive
$9,750,000
9,557,708
9,557,708
3.50%
Term Loan
(13)(22)
First Lien
3M
L+6.50%
1.00%
8.89%
12/24/2020
12/24/2025
$1,500,000
1,470,417
1,470,417
0.54%
Total
$ 11,028,125
$ 11,028,125
4.04%
KidKraft, Inc.
(38)
Dallas, TX
Term Loan
(22)(29)
First Lien
3M
L+5.00%
1.00%
6.00%
9/30/2016
8/15/2022
Consumer
Goods:
Durable
$1,580,487
1,580,487
1,580,487
0.58%
KidKraft Group Holdings, LLC Preferred B Units
(4)
Equity
4/3/2020
4,000,000 shares
4,000,000
4,000,000
1.46%
Total
$ 5,580,487
$ 5,580,487
2.04%
Lynx FBO Operating, LLC
(31)
Houston, TX
Term Loan
(35)
First Lien
3M
L+5.75%
1.50%
7.25%
9/30/2019
9/30/2024
Aerospace &
Defense
$13,612,500
13,397,053
13,612,500
4.98%
Lynx FBO Investments, LLC Class A-1 Common Units
(4)
Equity
9/30/2019
4,288 shares
593,480
690,000
0.25%
Total
$ 13,990,533
$ 14,302,500
5.23%
Madison Logic, Inc.
New York, NY
Term Loan
(SBIC)
(2)(35)
First Lien
1M
L+7.50%
0.50%
8.00%
11/30/2016
11/30/2021
Media:
Broadcasting &
Subscription
$4,323,985
4,314,586
4,323,985
1.58%
Madison Logic Holdings, Inc. Common Stock (SBIC)
(2)(4)
Equity
11/30/2016
5,000 shares
50,000
70,000
0.03%
Madison Logic Holdings, Inc. Series A Preferred Stock (SBIC)
(2)(4)
Equity
11/30/2016
4,500 shares
450,000
670,000
0.25%
Total
$ 4,814,586
$ 5,063,985
1.86%
Mobile Acquisition Holdings, LP
Santa Clara, CA
Class A Common Units
(4)
Equity
11/1/2016
Software
750 units
455,385
2,650,000
0.97%
Munch’s Supply, LLC
New Lenox, IL
Term Loan
(35)
First Lien
3M
L+6.25%
1.00%
7.25%
4/11/2019
4/11/2024
Capital
Equipment
$7,229,111
7,178,680
7,229,111
2.64%
Delayed Draw Term Loan
(20)(35)
First Lien
3M
L+6.25%
1.00%
7.25%
4/11/2019
4/11/2024
$649,111
640,345
649,111
0.24%
Cool Supply Holdings, LLC Class A
Common Units
(4)
Equity
4/11/2019
500,000 units
496,362
710,000
0.26%
Total
$ 8,315,387
$ 8,588,222
3.14%
National Trench Safety, LLC, et al
Houston, TX
Term Loan
(SBIC)
(2)
Second Lien
11.50%
11.50%
3/31/2017
3/31/2022
Construction &
Building
$10,000,000
9,946,055
10,000,000
3.66%
NTS Investors, LP Class A Common
Units
(4)
Equity
3/31/2017
2,335 units
500,000
750,000
0.27%
Total
$ 10,446,055
$ 10,750,000
3.93%
Naumann/Hobbs Material Handling Corporation II, Inc.
(32)
Phoenix, AZ
Term Loan (SBIC II)
(9)(35)
First Lien
3M
L+6.25%
1.50%
7.75%
8/30/2019
8/30/2024
Services:
Business
$5,817,693
5,727,857
5,817,693
2.13%
Term Loan
(35)
First Lien
3M
L+6.25%
1.50%
7.75%
8/30/2019
8/30/2024
$9,225,593
9,083,133
9,225,593
3.37%
CGC NH, Inc. Common Units
(4)
Equity
8/30/2019
123 shares
440,758
570,000
0.21%
Total
$ 15,251,748
$ 15,613,286
5.71%
NGS US Finco, LLC
Bradford, PA
Term Loan
(SBIC)
(2)(35)
Second Lien
1M
L+8.50%
1.00%
9.50%
10/1/2018
4/1/2026
Utilities:
Oil & Gas
$10,000,000
9,884,148
9,900,000
3.62%
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
NS412, LLC
Dallas, TX
Term Loan
(35)
Second Lien
3M
L+8.50%
1.00%
9.50%
5/6/2019
11/6/2025
Services:
Consumer
$7,615,000
7,492,970
7,462,700
2.73%
NS Group Holding Company, LLC Class A Common Units
(4)
Equity
5/6/2019
750 shares
750,000
550,000
0.20%
Total
$ 8,242,970
$ 8,012,700
2.93%
NuMet Machining Techniques, LLC
Birmingham, UK
Term Loan
(5)(35)
Second Lien
3M
L+9.00%
2.00%
11.00%
11/5/2019
5/5/2026
Aerospace &
Defense
$11,700,000
11,495,790
11,056,500
4.04%
Bromford Industries Limited Term
Loan
(5)(35)
Second Lien
3M
L+9.00%
2.00%
11.00%
11/5/2019
5/5/2026
$7,800,000
7,663,860
7,371,000
2.70%
Bromford Holdings, L.P. Class A Membership
Units
(4)(5)
Equity
11/5/2019
1,000,000 shares
1,000,000
300,000
0.11%
Total
$ 20,159,650
$ 18,727,500
6.85%
Nutritional Medicinals, LLC
(24)
Centerville, OH
Term Loan
(35)
First Lien
3M
L+6.00%
1.00%
7.00%
11/15/2018
11/15/2023
Healthcare &
Pharmaceuticals
$13,270,451
13,106,025
13,270,451
4.85%
Functional Aggregator, LLC Common Units
(4)
Equity
11/15/2018
12,500 shares
1,250,000
1,180,000
0.43%
Total
$ 14,356,025
$ 14,450,451
5.28%
PCP MT Aggregator Holdings, L.P.
Oak Brook, IL
Common LP
Units
(4)
Equity
3/29/2019
Finance
750,000 shares
1,490,000
0.55%
PCS Software, Inc.
Shenandoah, Tx
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+5.75%
1.50%
7.25%
7/1/2019
7/1/2024
Transportation
&
Logistics
$1,970,000
1,940,669
1,970,000
0.72%
Term Loan
(35)
First Lien
3M
L+5.75%
1.50%
7.25%
7/1/2019
7/1/2024
$15,021,250
14,797,600
15,021,250
5.50%
Delayed Draw Term Loan
(35)
First Lien
3M
L+5.75%
1.50%
7.25%
7/1/2019
7/1/2024
$992,500
992,500
992,500
0.36%
Revolver
(35)(11)
First Lien
3M
L+5.75%
1.50%
7.25%
7/1/2019
7/1/2024
$571,195
571,195
571,195
0.21%
PCS Software Holdings, LLC Class A
Preferred Units
(4)
Equity
7/1/2019
325,000 shares
325,000
330,000
0.12%
PCS Software Holdings, LLC Class A-2 Preferred Units
(4)
Equity
11/12/2020
63,312 shares
63,312
60,000
0.02%
Total
$ 18,690,276
$ 18,944,945
6.93%
Pioneer Transformers, L.P.
Franklin, WI
Term Loan (SBIC II)
(9)(35)
First Lien
6M
L+6.00%
1.50%
7.50%
11/22/2019
8/16/2024
Capital
Equipment
$4,937,500
4,868,043
4,937,500
1.81%
Premiere Digital Services, Inc.
Los Angeles, CA
Term Loan
(SBIC)
(2)(13)(22)
First Lien
3M
L+5.50%
1.50%
8.24%
10/18/2018
10/18/2023
Media:
Broadcasting &
Subscription
$9,992,518
9,807,217
9,992,518
3.66%
Term Loan
(13)(22)
First Lien
3M
L+5.50%
1.50%
8.24%
10/18/2018
10/18/2023
$2,428,772
2,385,098
2,428,772
0.89%
Premiere Digital Holdings, Inc., Common Stock
(4)
Equity
10/18/2018
5,000 shares
50,000
150,000
0.05%
Premiere Digital Holdings, Inc., Preferred Stock
(4)
Equity
10/18/2018
4,500 shares
314,550
1,320,000
0.48%
Total
$ 12,556,865
$ 13,891,290
5.08%
Protect America, Inc.
Austin TX
Term Loan
(SBIC)
(2)(6)(26)(35)
Second Lien
3M
L+7.75%
1.00%
0.00%
8/30/2017
10/30/2020
Services:
Consumer
$17,979,749
17,979,749
2,786,861
1.02%
Sales Benchmark Index, LLC
(7)(14)
Dallas, TX
Term Loan
(35)
First Lien
3M
L+6.00%
1.75%
7.75%
1/7/2020
1/7/2025
Services:
Business
$14,315,976
14,076,964
14,315,976
5.24%
SBI Holdings Investments, LLC Class A Preferred Units
(4)
Equity
1/7/2020
66,573 units
665,730
590,000
0.22%
Total
$ 14,742,694
$ 14,905,976
5.46%
Skopos Financial, LLC
Irving, TX
Term Loan
(5)
Unsecured
12.00%
12.00%
1/31/2014
1/31/2021
Finance
$15,500,000
15,500,000
14,415,000
5.27%
Skopos Financial Group, LLC Series A Preferred Units
(4)(5)
Equity
1/31/2014
1,120,684
units
1,162,544
320,000
0.12%
Total
$ 16,662,544
$ 14,735,000
5.39%
SQAD, LLC
Tarrytown, NY
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+6.50%
1.00%
7.50%
12/22/2017
12/22/2022
Media:
Broadcasting &
Subscription
$14,333,594
14,299,486
14,333,594
5.24%
SQAD Holdco, Inc. Preferred Shares,
Series A (SBIC)
(2)(4)
Equity
10/31/2013
5,624 shares
156,001
1,010,000
0.37%
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair Value(1)
% of
Net
Assets
SQAD Holdco, Inc. Common Shares
(SBIC)
(2)(4)
Equity
10/31/2013
5,800 shares
62,485
120,000
0.04%
Total
$ 14,517,972
$ 15,463,594
5.65%
TechInsights, Inc.
Ottawa,
Ontario
Term Loan
(5)(13)(22)
First Lien
3M
L+6.00%
1.00%
8.33%
8/16/2017
10/2/2023
High Tech
Industries
$21,540,925
21,318,659
21,540,925
7.88%
Time Manufacturing Acquisition, LLC
Waco, TX
Term Loan
(6)
Unsecured
11.50%
10.75%
0.75%
2/3/2017
8/3/2023
Capital
Equipment
$6,385,182
6,321,825
6,385,182
2.34%
Time Manufacturing Investments, LLC Class A Common Units
(4)
Equity
2/3/2017
5,000 units
500,000
770,000
0.28%
Total
$ 6,821,825
$ 7,155,182
2.62%
TFH Reliability, LLC
Houston, TX
Term Loan
(SBIC)
(2)(35)
Second Lien
3M
L+10.75%
0.80%
11.55%
10/21/2016
9/30/2023
Chemicals,
Plastics, &
Rubber
$5,875,000
5,837,336
5,728,125
2.10%
TFH Reliability Group, LLC Class A-1 Units
(4)
Equity
6/29/2020
27,129 shares
21,511
10,000
0.00%
TFH Reliability Group, LLC Class A
Common Units
(4)
Equity
10/21/2016
250,000 shares
231,521
170,000
0.06%
Total
$ 6,090,368
$ 5,908,125
2.16%
U.S. Auto Sales, Inc.
et al
Lawrenceville, GA
USASF Blocker II, LLC Common
Units
(4)(5)
Equity
6/8/2015
Finance
441 units
441,000
710,000
0.26%
USASF Blocker III, LLC Series C Preferred Units
(4)(5)
Equity
2/13/2018
125 units
125,000
200,000
0.07%
USASF Blocker IV, LLC Units
(4)(5)
Equity
5/27/2020
110 units
110,000
180,000
0.07%
USASF Blocker LLC Common Units
(4)(5)
Equity
6/8/2015
9,000 units
9,000
10,000
0.00%
Total
$ 685,000
$ 1,100,000
0.40%
Venbrook Buyer, LLC
Los Angeles, CA
Term Loan
(SBIC)
(2)(35)
First Lien
3M
L+6.50%
1.50%
8.00%
3/13/2020
3/13/2026
Services:
Business
$13,084,458
12,851,226
12,953,614
4.74%
Term Loan
(35)
First Lien
3M
L+6.50%
1.50%
8.00%
3/13/2020
3/13/2026
$148,875
146,221
147,386
0.05%
Revolver
(35)
First Lien
6M
L+6.50%
1.50%
8.00%
3/13/2020
3/13/2026
$2,222,222
2,222,222
2,200,000
0.80%
Delayed Draw Term Loan
(19)(35)
First Lien
1M
L+6.50%
1.50%
8.00%
3/13/2020
3/13/2026
$1,333,333
1,320,000
1,320,000
Venbrook Holdings, LLC Common Units
(4)
Equity
3/13/2020
534,959 shares
531,463
480,000
0.18%
Total
$ 17,071,132
$ 17,101,000
5.77%
Vortex Companies, LLC
Houston, TX
Term Loan (SBIC II)
(9)(35)
Second Lien
3M L+9.50%
1.00%
10.50%
12/21/2020
6/21/2026
Environmental
Industries
$10,000,000
9,800,000
9,800,000
3.59%
VRI Ultimate Holdings, LLC
Franklin, OH
Class A Preferred Units
(4)
Equity
5/31/2017
Healthcare &
Pharmaceuticals
326,797 shares
500,000
580,000
0.21%
Whisps Acquisiton Corp.
Elgin, IL
Term Loan
(35)
First Lien
6M
L+6.00%
1.00%
7.00%
4/26/2019
4/18/2025
Beverage,
Food, &
Tobacco
$7,791,667
7,682,302
7,791,667
2.85%
Whisps Holding LP Class A Common Units
(4)
Equity
4/18/2019
500,000 shares
500,000
710,000
0.26%
Total
$ 8,182,302
$ 8,501,667
3.11%
Wise Parent Company, LLC
Salt Lake City, UT
Membership
Units
(4)
Equity
8/27/2018
Beverage,
Food, &
Tobacco
6 units
760,000
0.28%
Total Non-controlled, non-affiliated investments
$ 658,628,966
$ 653,424,495
239.03%
Net Investments
$ 658,628,966
$ 653,424,495
239.03%
LIABILITIES IN EXCESS OF OTHER ASSETS
$ (380,063,846)
(139.03)%
NET ASSETS
$ 273,360,649
100.00%
(1)
See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2)
Investments held by the SBIC subsidiary (as defined in Note 1), which include $14,750,888 of cash and $228,144,990 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility (as defined in Note 9). Stellus
Capital Investment Corporation’s (“the Company”) obligations to the lenders of the Credit Facility are secured by a first priority security interest in all investments and cash and cash equivalents, except for cash and investments held by the SBIC subsidiaries (as defined in Note 1).
(3)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,250,000, with an interest rate of LIBOR plus 6.00% and a maturity of January 31, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(4)
Security is non-income producing.
(5)
The investment is not a “qualifying asset” under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 91% of the Company’s total assets as of December 31, 2020.
(6)
Represents a PIK interest security. At the option of the issuer, interest can be paid in cash or cash and PIK interest. The percentage of PIK interest shown is the maximum PIK interest that can be elected by the issuer.
(7)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,331,461, with an interest rate of LIBOR plus 6.00% and a maturity of January 7, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(8)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $100,000, with an interest rate of LIBOR plus 6.00% and a maturity of November 20, 2026. This investment is accruing an unused commitment fee of 0.50% per annum.
(9)
Investments held by the SBIC II subsidiary (as defined in Note 1), which include $2,653,295 of cash and $43,391,392 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility. The Company’s obligations to the lenders of the Credit Facility are secured by a first priority security interest in all investments and cash and cash equivalents, except for cash and investments held by the SBIC subsidiaries.
(10)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $909,091, with an interest rate of LIBOR plus 5.75% and a maturity of November 1, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(11)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $746,948, with an interest rate of LIBOR plus 5.75% and a maturity of July 1, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(12)
These loans have LIBOR floors which are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13)
These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $3,328,652, with an interest rate of LIBOR plus 6.00% and a maturity of January 7, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(15)
Investment has been on non-accrual since October 31, 2017.
(16)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 6.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(17)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,667, with an interest rate of LIBOR plus 5.00% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(18)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $750,000, with an interest rate of LIBOR plus 7.50% and a maturity of April 13, 2023. The Company has full discretion to fund the revolver commitment.
(19)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $3,111,111, with an interest rate of LIBOR plus 6.50% and a maturity of March 13, 2026. This investment is accruing an unused commitment fee of 0.50% per annum.
(20)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $1,511,111, with an interest rate of LIBOR plus 6.25% and a maturity of April 11, 2024. This investment is accruing an unused commitment fee of 1.00% per annum
(21)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $66,667 with an interest rate of LIBOR plus 6.50% and a maturity of December 21, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(22)
This loan is a unitranche investment.
(23)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000 with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(24)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000 with an interest rate of LIBOR plus 6.00% and a maturity of November 15, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(25)
Excluded from the investment is an undrawn delayed draw term commitment in an amount not to exceed $4,000,000, with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. The Company has full discretion to fund the delayed draw term loan commitment.
(26)
Investment has been on non-accrual since June 28, 2019.
(27)
Maturity date is under ongoing negotiations with portfolio company and other lenders.
(28)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,136,364, with an interest rate of LIBOR plus 6.50% and a maturity of August 28, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(29)
These loans are last-out term loans with contractual rates lower than the applicable LIBOR rates; therefore, the floors are in effect.
(30)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $2,767,584, with an interest rate of LIBOR plus 5.50% and a maturity of June 24, 2024. This investment is accruing an unused commitment fee of 1.00% per annum.
(31)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,875,000, with an interest rate of LIBOR plus 5.75% and a maturity of September 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(32)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,763,033, with an interest rate of LIBOR plus 6.25% and a maturity of August 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(33)
Investment has been on non-accrual since January 1, 2020.
(34)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,651,515, with an interest rate of LIBOR plus 5.75% and a maturity of October 2, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(35)
These loans have LIBOR Floors which are higher than the current applicable LIBOR rates; therefore, the floors are in effect.
(36)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $100,000, with an interest rate of LIBOR plus 8.50% and a maturity of July 31, 2025. This investment is accruing an unused commitment fee of 0.50% per annum. This undrawn revolver commitment is held by SBIC I.
(37)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $50,000, with an interest rate of LIBOR plus 6.75% and a maturity of August 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(38)
Instrument was restructured into a first lien term loan and preferred equity on April 3, 2021.
Abbreviation Legend
PIK - Payment-In-Kind
L - LIBOR
Euro - Euro Dollar
Stellus Capital Investment Corporation
Consolidated Schedule of Investments
December 31, 2019
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
Non-controlled, non-affiliated investments
(2)(9)
Abrasive Products & Equipment, LLC,
et al
Deer Park, TX
Term Loan (SBIC)
(2)(12)
Second Lien
3M
L+10.50%
1.00%
12.45%
9/5/2014
3/5/2021
Chemicals,
Plastics, &
Rubber
$5,325,237
$ 5,320,277
$ 5,112,228
1.89%
APE Holdings, LLC Class A Common Units
(4)
Equity
9/5/2014
375,000
units
375,000
160,000
0.06%
Total
$ 5,695,277
$ 5,272,228
1.95%
Adams Publishing Group, LLC
(3)
Greenville, TN
Term Loan
(12)
First Lien
3M
L+7.50%
1.00%
9.44%
8/3/2018
6/30/2023
Media:
Advertising,
Printing &
Publishing
$5,411,955
5,371,128
5,222,536
1.93%
Delayed Draw Term Loan
(12)
First Lien
3M
L+7.50%
1.00%
9.45%
8/3/2018
6/30/2023
$173,277
173,277
167,213
0.06%
Total
$ 5,544,405
$ 5,389,749
1.99%
Advanced Barrier Extrusions, LLC
(8)
Rhinelander, WI
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+5.75%
1.00%
7.70%
8/8/2018
8/8/2023
Containers,
Packaging &
Glass
$14,286,000
14,056,286
14,214,570
5.25%
GP ABX Holdings Partnership, L.P. Common Stock
(4)
Equity
8/8/2018
250,000
units
250,000
350,000
0.13%
Total
$ 14,306,286
$ 14,564,570
5.38%
Apex Environmental Resources Holdings,
LLC
Amsterdam, OH
Common Units
(4)
Equity
10/30/2015
Environmental
Industries
945 shares
0.00%
Preferred Units
(4)
Equity
10/30/2015
945 shares
945,179
540,000
0.20%
Total
$ 946,124
$ 540,000
0.20%
APG Intermediate Sub 2 Corp.
Castle Rock, CO
Term Loan
(22)
First Lien
P+5.00%
1.00%
9.75%
11/30/2018
11/30/2023
Aerospace &
Defense
$9,925,000
9,740,191
10,024,250
3.70%
APG Holdings, LLC Class A Preferred Units
(4)
Equity
11/30/2018
1,127,652
units
1,127,652
2,420,000
0.89%
Total
$ 10,867,843
$ 12,444,250
4.59%
Atmosphere Aggregator Holdings II,
LP
Atlanta, GA
Common Units
(4)
Equity
1/26/2016
Services:
Business
254,250
units
1,100,000
0.41%
Stratose Aggregator Holdings, LP
Common Units
(4)
Equity
6/30/2015
750,000
units
3,250,000
1.20%
Total
$
$ 4,350,000
1.61%
ASC Communications, LLC
(7)
Chicago, IL
Term Loan (SBIC)
(2)(12)
First Lien
1M
L+6.25%
1.00%
8.05%
6/29/2017
6/29/2023
Healthcare &
Pharmaceuticals
$4,537,037
4,511,837
4,514,352
1.67%
Term Loan
(12)
First Lien
1M
L+6.25%
1.00%
8.05%
2/4/2019
6/29/2023
$7,712,963
7,634,025
7,674,398
2.84%
ASC Communications Holdings, LLC Class A Preferred Units
(SBIC)
(2)(4)
Equity
6/29/2017
73,529
shares
90,895
580,000
0.21%
Total
$ 12,236,757
$ 12,768,750
4.72%
BFC Solmetex, LLC
(23)
Nashville, TN
Revolver
(12)(19)
First Lien
3M
L+6.50%
1.00%
8.45%
4/2/2018
9/26/2023
Environmental
Industries
$1,650,367
1,650,367
1,584,352
0.59%
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+6.50%
1.00%
8.45%
4/2/2018
9/26/2023
$11,592,818
11,468,077
11,129,105
4.11%
Bonded Filter Co. LLC, Term Loan (SBIC)
(2)(12)
First Lien
3M
L+6.50%
1.00%
8.45%
4/2/2018
9/26/2023
$1,205,073
1,192,107
1,156,870
0.43%
Total
$ 14,310,551
$ 13,870,327
5.13%
BW DME Acquisition, LLC
Tempe, AZ
Term Loan (SBIC)
(2)(13)(22)
First Lien
3M
L+6.00%
1.00%
9.59%
8/24/2017
8/24/2022
Healthcare &
Pharmaceuticals
$16,695,804
16,392,213
16,445,367
6.08%
BW DME Holdings, LLC, Term Loan
(6)
Unsecured
17.50%
17.50%
6/1/2018
6/30/2020
$329,504
329,504
329,504
0.12%
BW DME Holdings, LLC Class A-1 Preferred Units
(4)
Equity
8/24/2017
1,000,000
shares
1,000,000
1,110,000
0.41%
See accompanying notes to these consolidated financial statements.
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
BW DME Holdings, LLC Class A-2 Preferred Units
(4)
Equity
1/26/2018
937,261
shares
937,261
1,040,000
0.38%
Total
$ 18,658,978
$ 18,924,871
6.99%
Café Valley, Inc.
Phoenix, AZ
Term Loan
(12)
First Lien
3M
L+6.00%
1.25%
7.95%
8/28/2019
8/28/2024
Beverage,
Food, &
Tobacco
$17,575,000
17,242,956
17,399,250
6.43%
CF Topco LLC, Common Units
(4)
Equity
8/28/2019
8,810
shares
880,952
860,000
0.32%
Total
$ 18,123,908
$ 18,259,250
6.75%
C.A.R.S. Protection Plus, Inc.
Murrysville, PA
Term Loan
(12)
First Lien
1M
L+8.50%
0.50%
10.30%
12/31/2015
12/31/2020
Automotive
$94,003
$ 93,553
$ 94,003
0.03%
Term Loan (SBIC)
(2)(12)
First Lien
1M
L+8.50%
0.50%
10.30%
12/31/2015
12/31/2020
$7,332,210
7,297,083
7,332,210
2.71%
CPP Holdings LLC Class A Common Units
(4)
Equity
12/31/2015
149,828
shares
149,828
240,000
0.09%
Total
$ 7,540,464
$ 7,666,213
2.83%
Colford Capital Holdings, LLC
New York, NY
Preferred Units
(4)(5)
Equity
8/20/2015
Finance
38,893
units
195,036
20,000
0.01%
Condor Borrower, LLC
Clifton, NJ
Term Loan
(12)
Second Lien
3M
L+8.75%
1.00%
10.68%
10/27/2017
4/27/2025
Software
$13,750,000
13,534,399
13,406,250
4.95%
Condor Top Holdco Limited Convertible Preferred Shares
(4)
Equity
10/27/2017
500,000
shares
442,197
330,000
0.12%
Condor Holdings Limited Preferred Shares, Class B
(4)
Equity
10/27/2017
500,000
shares
57,804
40,000
0.01%
Total
$ 14,034,400
$ 13,776,250
5.08%
Convergence Technologies, Inc.
Indianpolis, IN
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+6.75%
1.50%
8.70%
8/31/2018
8/30/2024
Services:
Business
$7,053,571
6,937,850
6,983,036
2.58%
Term Loan
(12)
First Lien
3M
L+6.75%
1.50%
8.70%
2/28/2019
8/30/2024
$1,417,857
1,392,977
1,403,679
0.52%
Delayed Draw Term Loan
(12)
First Lien
3M
L+6.75%
1.50%
8.70%
8/31/2018
8/30/2024
$5,303,571
5,303,571
5,250,536
1.94%
Tailwind Core Investor, LLC Class A Preferred Units
(4)
Equity
8/31/2018
4,275
units
429,614
360,000
0.13%
Total
$ 14,064,012
$ 13,997,251
5.17%
Data Centrum Communications, Inc.
Montvale, NJ
Term Loan
(12)
First Lien
3M
L+5.50%
1.00%
7.44%
5/15/2019
5/15/2024
Media:
Advertising,
Printing &
Publishing
$16,168,750
15,881,567
15,845,375
5.86%
Health Monitor Holdings, LLC Seires A Preferred Units
(4)
Equity
5/15/2019
1,000,000
shares
1,000,000
730,000
0.27%
Total
$ 16,881,567
$ 16,575,375
6.13%
Douglas Products Group, LP
Liberty, MO
Class A Common Units
(4)
Equity
12/27/2018
Chemicals,
Plastics, &
Rubber
322 shares
139,656
490,000
0.18%
DRS Holdings III, Inc.
St. Louis, MO
Term Loan
(12)
First Lien
1M
L+5.75%
1.00%
7.55%
11/1/2019
11/1/2025
Consumer
Goods:
Durable
$10,000,000
9,902,215
9,902,215
3.66%
Revolver
(10)(12)
First Lien
1M
L+5.75%
1.00%
7.55%
11/1/2019
11/1/2025
$36,364
36,364
36,008
0.01%
Total
$ 9,938,579
$ 9,938,223
3.67%
DTE Enterprises, LLC
(18)
Roselle, IL
Term Loan
(12)
First Lien
1M
L+7.50%
1.50%
9.24%
4/13/2018
4/13/2023
Energy:
Oil & Gas
$10,991,941
10,836,199
10,772,102
3.98%
DTE Holding Company, LLC Common Shares, Class A-2
(4)
Equity
4/13/2018
776,316
shares
466,204
1,000,000
0.37%
DTE Holding Company, LLC Preferred Shares, Class AA
(4)
Equity
4/13/2018
723,684
shares
723,684
940,000
0.35%
Total
$ 12,026,087
$ 12,712,102
4.70%
Empirix Holdings I, Inc.
Billerica, MA
Common Shares, Class A
(4)
Equity
11/1/2013
Software
1,304 shares
1,304,232
0.00%
Common Shares, Class B
(4)
Equity
11/1/2013
1,317,406
shares
13,174
0.00%
Total
$ 1,317,406
$
0.00%
Energy Labs Holding Corp.
Houston, TX
Common Stock
(4)
Equity
9/29/2016
Energy:
Oil & Gas
598 shares
598,182
870,000
0.32%
See accompanying notes to these consolidated financial statements.
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
Exacta Land Surveyors, LLC
(14)(25)
Cleveland, OH
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+5.75%
1.50%
7.70%
2/8/2019
2/8/2024
Services:
Business
$16,884,375
16,594,835
16,715,532
6.18%
SP ELS Holdings LLC, Class A Common Units
(4)
Equity
2/8/2019
1,069,143
shares
1,069,143
880,000
0.33%
Total
$ 17,663,978
$ 17,595,532
6.51%
EOS Fitness Holdings, LLC
Phoenix, AZ
Preferred Units
(4)
Equity
12/30/2014
Hotel,
Gaming, &
Leisure
118 shares
530,000
0.20%
Class B Common Units
(4)
Equity
12/30/2014
3,017 shares
10,000
0.00%
Total
$
$ 540,000
0.20%
Fast Growing Trees, LLC
(16)
Fort Mill, SC
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+7.75%
1.00%
9.70%
2/5/2018
02/05/23
Retail
$19,192,490
$ 18,935,337
$ 18,616,716
6.88%
SP FGT Holdings, LLC, Class A Common
(4)
Equity
2/5/2018
1,000,000
shares
1,000,000
750,000
0.28%
Total
$ 19,935,337
$ 19,366,716
7.16%
FB Topco, Inc.
Camden, NJ
Term Loan
(13)(22)
First Lien
3M
L+6.35%
1.00%
10.45%
6/27/2018
4/24/2023
Education
$20,803,881
20,492,224
20,179,764
7.46%
Delayed Draw Term Loan
(13)(22)
First Lien
3M
L+6.35%
1.00%
10.48%
6/27/2018
4/24/2023
$1,140,578
1,140,578
1,106,361
0.41%
Total
$ 21,632,802
$ 21,286,125
7.87%
Furniture Factory Outlet, LLC
Fort Smith, AR
Term Loan
First Lien
7.00%
7.00%
6/10/2016
6/10/2021
Consumer
Goods:
Durable
$14,801,785
14,678,894
11,989,446
4.43%
Furniture Factory Holdings, LLC
Term Loan
(6)
Unsecured
11.00%
11.00%
6/10/2016
2/3/2021
$147,231
147,231
0.00%
Furniture Factory Ultimate Holding, LP Common Units
(4)
Equity
6/10/2016
13,445
shares
94,569
0.00%
Total
$ 14,920,694
$ 11,989,446
4.43%
GK Holdings, Inc.
Cary, NC
Term Loan
(12)
Second Lien
3M
L+10.25%
1.00%
12.19%
1/30/2015
1/20/2022
Education
$5,000,000
4,961,969
4,375,000
1.62%
General LED OPCO, LLC
San Antonio, TX
Term Loan
(12)
Second Lien
3M
L+9.00%
1.50%
10.95%
5/1/2018
11/1/2023
Services:
Business
$4,500,000
4,432,260
4,230,000
1.56%
GS HVAM Intermediate, LLC
(21)(34)
Carlsbad, CA
Term Loan
(12)
First Lien
1M
L+5.75%
1.00%
7.56%
10/18/2019
10/2/2024
Beverage,
Food, &
Tobacco
$13,257,576
13,128,716
13,128,716
4.85%
HV GS Acquisition, LP Class A Interests
(4)
Equity
6/29/2018
1,796
shares
1,618,844
1,620,000
0.60%
Total
$ 14,747,560
$ 14,748,716
5.45%
Grupo HIMA San Pablo, Inc., et al
San Juan, PR
Term Loan
(12)(27)
First Lien
3M
L+7.00%
1.50%
8.94%
2/1/2013
1/31/2018
Healthcare &
Pharmaceuticals
$4,503,720
4,503,720
3,490,383
1.29%
Term Loan
(15)(27)
Second Lien
13.75%
0.00%
2/1/2013
7/31/2018
$4,109,524
4,109,524
0.00%
Total
$ 8,613,244
$ 3,490,383
1.29%
ICD Intermediate Holdco 2, LLC
San Francisco, CA
Term Loan (SBIC)
(2)(5)(12)
Second Lien
3M
L+9.00%
1.00%
10.95%
1/1/2018
7/1/2024
Finance
$10,000,000
9,847,895
10,000,000
3.70%
ICD Holdings, LLC, Class A Preferred
(4)(5)
Equity
1/1/2018
9,962
shares
496,405
1,030,000
0.38%
Total
$ 10,344,300
$ 11,030,000
4.08%
Integrated Oncology Network, LLC
(29)(30)
Newport
Beach, CA
Term Loan
(12)
First Lien
3M
L+5.50%
1.50%
7.43%
7/17/2019
6/24/2024
Healthcare &
Pharmaceuticals
$16,637,202
16,332,432
16,387,644
6.06%
Intuitive Health, LLC
Plano, TX
Term Loan
(SBIC II)
(9)(12)
First Lien
3M
L+6.00%
1.50%
7.95%
10/18/2019
10/18/2024
Healthcare &
Pharmaceuticals
$6,000,000
5,883,278
5,883,278
2.17%
Term Loan
(12)
First Lien
3M
L+6.00%
1.50%
7.95%
10/18/2019
10/18/2024
$11,500,000
11,276,284
11,276,284
4.17%
Total
$ 17,159,562
$ 17,159,562
6.34%
Invincible Boat Company, LLC
Opa Locka, FL
Term Loan (SBIC II)
(9)(12)
First Lien
3M
L+6.50%
1.50%
8.45%
8/28/2019
8/28/2025
Consumer
Goods:
Durable
$5,962,500
5,848,418
5,843,250
2.16%
Term Loan
(12)
First Lien
3M
L+6.50%
1.50%
8.45%
8/28/2019
8/28/2025
$6,459,375
6,264,417
6,330,188
2.34%
See accompanying notes to these consolidated financial statements.
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
Revolver
(12)(28)
First Lien
3M
L+6.50%
1.50%
8.45%
8/28/2019
8/28/2025
$568,182
568,182
556,818
0.21%
Invincible Parent Holdco, LLC Class A Common Units
(4)
Equity
8/28/2019
1,000,000
shares
982,099
1,090,000
0.40%
Total
$ 13,663,116
$ 13,820,256
5.11%
J.R. Watkins, LLC
San Francisco,
CA
Revolver
(12)
First Lien
1M
L+6.50%
1.25%
8.30%
12/22/2017
12/22/2022
Consumer
Goods:
non-durable
$1,750,000
1,750,000
1,470,000
0.54%
Term Loan (SBIC)
(2)(12)
First Lien
1M
L+6.50%
1.25%
8.30%
12/22/2017
12/22/2022
$12,250,000
12,091,135
10,290,000
3.80%
J.R. Watkins Holdings, Inc. Class A Preferred
(4)
Equity
12/22/2017
1,133 shares
1,132,576
10,000
0.00%
Total
$ 14,973,711
$ 11,770,000
4.34%
Jurassic Acquisiton Corp.
Sparks, MD
Term Loan
(12)
First Lien
1M
L+5.50%
0.00%
7.30%
12/28/2018
11/15/2024
Metals &
Mining
$17,325,000
$ 17,103,044
$ 17,325,000
6.40%
Kelleyamerit Holdings, Inc.
Walnut Creek, CA
Term Loan (SBIC)
(2)(13)(22)
First Lien
3M
L+7.50%
1.00%
10.03%
3/30/2018
3/30/2023
Automotive
$9,750,000
9,611,438
9,555,000
3.53%
KidKraft, Inc.
Dallas, TX
Term Loan
(6)
Second Lien
12.00%
11.00%
1.00%
9/30/2016
3/30/2022
Consumer
Goods:
Durable
$9,503,655
9,411,079
8,410,735
3.11%
Lynx FBO Operating, LLC
(31)
Houston, TX
Term Loan
(12)
First Lien
3M
L+5.75%
1.50%
7.86%
9/30/2019
9/30/2024
Aerospace &
Defense
$13,750,000
13,486,379
13,486,379
4.98%
Lynx FBO Investments, LLC Class A-1 Common Units
(4)
Equity
9/30/2019
3,704 shares
500,040
500,000
0.18%
Total
$ 13,986,419
$ 13,986,379
5.16%
Madison Logic, Inc.
New York, NY
Term Loan (SBIC)
(2)(12)
First Lien
1M
L+8.00%
0.50%
9.80%
11/30/2016
11/30/2021
Media:
Broadcasting &
Subscription
$4,581,402
4,561,449
4,581,402
1.69%
Madison Logic Holdings, Inc. Common Stock
(SBIC)
(2)(4)
Equity
11/30/2016
5,000 shares
50,000
60,000
0.02%
Madison Logic Holdings, Inc. Series A Preferred Stock
(SBIC)
(2)(4)
Equity
11/30/2016
4,500 shares
450,000
520,000
0.19%
Total
$ 5,061,449
$ 5,161,402
1.90%
Mobile Acquisition Holdings, LP
Santa Clara, CA
Class A Common Units
(4)
Equity
11/1/2016
Software
units
455,385
1,740,000
0.64%
Munch’s Supply, LLC
(20)
New Lenox, IL
Term Loan
(12)
First Lien
3M
L+6.25%
1.00%
8.35%
4/11/2019
4/11/2024
Capital
Equipment
$7,960,000
7,890,332
7,880,400
2.91%
Cool Supply Holdings, LLC Class A Common Units
(4)
Equity
4/11/2019
500,000
units
498,779
410,000
0.15%
Total
$ 8,389,111
$ 8,290,400
3.06%
National Trench Safety, LLC, et al
Houston, TX
Term Loan (SBIC)
(2)
Second Lien
11.50%
11.50%
3/31/2017
3/31/2022
Construction &
Building
$10,000,000
9,908,323
10,000,000
3.70%
NTS Investors, LP Class A Common Units
(4)
Equity
3/31/2017
2,335
units
500,000
500,000
0.18%
Total
$ 10,408,323
$ 10,500,000
3.88%
Naumann/Hobbs Material Handling
Corporation II, Inc.
(32)
Phoenix, AZ
Term Loan (SBIC II)
(9)(12)
First Lien
3M
L+6.25%
1.50%
8.20%
8/30/2019
8/30/2024
Services:
Business
$5,978,693
5,865,655
5,859,119
2.17%
Term Loan
(12)
First Lien
3M
L+6.25%
1.50%
8.20%
8/30/2019
8/30/2024
$9,480,904
9,301,650
9,291,286
3.43%
CGC NH, Inc. Common Units
(4)
Equity
8/30/2019
123 shares
440,758
400,000
0.15%
Total
$ 15,608,063
$ 15,550,405
5.75%
NGS US Finco, LLC
Bradford, PA
Term Loan (SBIC)
(2)(12)
Second Lien
1M
L+8.50%
1.00%
10.30%
10/1/2018
4/1/2026
Utilities:
Oil & Gas
$10,000,000
9,868,044
9,900,000
3.66%
NS412, LLC
Dallas, TX
Term Loan
(12)
Second Lien
3M
L+8.50%
1.00%
10.45%
5/6/2019
11/6/2025
Services:
Consumer
$7,615,000
7,474,214
7,500,775
2.77%
NS Group Holding Company, LLC Class A Common Units
(4)
Equity
5/6/2019
750 shares
750,000
810,000
0.30%
Total
$ 8,224,214
$ 8,310,775
3.07%
See accompanying notes to these consolidated financial statements.
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
NuMet Machining Techniques, LLC
Birmingham,
UK
Term Loan
(5)(35)
Second Lien
6M L+9.00%
2.00%
11.00%
11/5/2019
5/5/2026
Aerospace &
Defense
$11,700,000
11,470,017
11,470,017
4.24%
Bromford Industries Limited Term
Loan
(5)(35)
Second Lien
6M L+9.00%
2.00%
11.00%
11/5/2019
5/5/2026
$7,800,000
7,646,678
7,646,678
2.83%
Bromford Holdings, L.P. Class A Membership Units
(4)(5)
Equity
11/5/2019
1,000,000
shares
1,000,000
1,000,000
0.37%
Total
$ 20,116,695
$ 20,116,695
7.44%
Nutritional Medicinals, LLC
(24)
Centerville, OH
Term Loan
(12)
First Lien
3M
L+6.00%
1.00%
7.95%
11/15/2018
11/15/2023
Healthcare &
Pharmaceuticals
$14,845,000
14,606,657
14,399,650
5.32%
Functional Aggregator, LLC Common
Units
(4)
Equity
11/15/2018
12,500
shares
1,250,000
1,260,000
0.47%
Total
$ 15,856,657
$ 15,659,650
5.79%
PCP MT Aggregator Holdings, L.P.
Oak Brook, IL
Common LP Units
(4)
Equity
3/29/2019
Finance
750,000
shares
1,080,000
0.40%
PCS Software, Inc.
(11)(33)
Shenandoah, Tx
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+5.75%
1.50%
7.70%
7/1/2019
7/1/2024
Transportation &
Logistics
$1,990,000
$ 1,953,461
$ 1,960,150
0.72%
Term Loan
(12)
First Lien
3M
L+5.75%
1.50%
7.70%
7/1/2019
7/1/2024
$15,173,750
14,895,138
14,946,144
5.52%
PCS Software Holdings, LLC Class A Preferred Units
(4)
Equity
7/1/2019
325,000
shares
325,000
320,000
0.12%
Total
$ 17,173,599
$ 17,226,294
6.36%
Pioneer Transformers, L.P.
Franklin, WI
Term Loan (SBIC II)
(9)(12)
First Lien
1M
L+6.00%
1.50%
7.79%
11/22/2019
8/16/2024
Capital
Equipment
$4,987,500
4,901,484
4,901,484
1.81%
Premiere Digital Services, Inc.
Los Angeles, CA
Term Loan (SBIC)
(2)(13)(22)
First Lien
3M
L+5.50%
1.50%
8.73%
10/18/2018
10/18/2023
Media:
Broadcasting &
Subscription
$9,992,518
9,753,256
9,842,630
3.64%
Term Loan
(13)(22)
First Lien
3M
L+5.50%
1.50%
8.73%
10/18/2018
10/18/2023
$2,428,772
2,372,392
2,392,341
0.88%
Premiere Digital Holdings, Inc., Common Stock
(4)
Equity
10/18/2018
5,000 shares
50,000
70,000
0.03%
Premiere Digital Holdings, Inc., Preferred Stock
(4)
Equity
10/18/2018
4,500 shares
450,000
600,000
0.22%
Total
$ 12,625,648
$ 12,904,971
4.77%
Price for Profit, LLC
(17)
Cleveland, OH
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+6.50%
1.00%
8.45%
1/31/2018
1/31/2023
Services:
Business
$3,887,657
3,836,120
3,887,657
1.44%
I2P Holdings, LLC, Series A Preferred
(4)
Equity
1/31/2018
750,000
shares
750,000
2,800,000
1.03%
Total
$ 4,586,120
$ 6,687,657
2.47%
Protect America, Inc.
Austin TX
Term Loan (SBIC)
(2)(6)(12)(26)
Second Lien
3M
L+7.75%
1.00%
0.00%
8/30/2017
10/30/2020
Services:
Consumer
$17,979,749
17,851,392
5,034,330
1.86%
Skopos Financial, LLC
Irving, TX
Term Loan
(5)
Unsecured
12.00%
12.00%
1/31/2014
1/31/2021
Finance
$15,500,000
15,500,000
15,422,500
5.70%
Skopos Financial Group, LLC Series A Preferred Units
(4)(5)
Equity
1/31/2014
1,120,684
units
1,162,544
1,110,000
0.41%
Total
$ 16,662,544
$ 16,532,500
6.11%
Specified Air Solutions, LLC
Buffalo, NY
Class A Common Units
(4)
Equity
6/30/2017
Construction &
Building
3,846 shares
250,000
0.09%
SQAD, LLC
Tarrytown, NY
Term Loan (SBIC)
(2)(12)
First Lien
3M
L+6.50%
1.00%
8.44%
12/22/2017
12/22/2022
Media:
Broadcasting &
Subscription
$14,497,594
14,447,718
14,352,618
5.30%
SQAD Holdco, Inc. Preferred Shares, Series A (SBIC)
(2)(4)
Equity
10/31/2013
5,624 shares
156,001
720,000
0.27%
SQAD Holdco, Inc. Common Shares (SBIC)
(2)(4)
Equity
10/31/2013
5,800 shares
62,485
80,000
0.03%
Total
$ 14,666,204
$ 15,152,618
5.60%
TechInsights, Inc.
Ottawa, Ontario
Term Loan
(5)(13)(22)
First Lien
3M
L+6.00%
1.00%
9.33%
8/16/2017
10/2/2023
High Tech
Industries
$21,540,925
21,201,137
21,217,811
7.84%
Time Manufacturing Acquisition, LLC
Waco, TX
Term Loan
(6)
Unsecured
11.50%
10.75%
0.75%
2/3/2017
8/3/2023
Capital
Equipment
$6,385,182
6,302,784
6,385,182
2.36%
See accompanying notes to these consolidated financial statements.
Investments
Footnotes
Security
Coupon
LIBOR
floor
Cash
PIK
Investment
Date
Maturity
Headquarters/
Industry
Principal
Amount/
Shares
Amortized
Cost
Fair
Value(1)
% of
Net
Assets
Time Manufacturing Investments,
LLC Class A Common Units
(4)
Equity
2/3/2017
5,000
units
500,000
660,000
0.24%
Total
$ 6,802,784
$ 7,045,182
2.60%
TFH Reliability, LLC
Houston, TX
Term Loan (SBIC)
(2)(12)
Second Lien
3M
L+10.75%
0.50%
12.70%
10/21/2016
4/21/2022
Chemicals,
Plastics, &
Rubber
$5,875,000
5,814,371
5,875,000
2.17%
TFH Reliability Group, LLC Class A Common Units
(4)
Equity
10/21/2016
250,000
shares
231,521
220,000
0.08%
Total
$ 6,045,892
$ 6,095,000
2.25%
U.S. Auto Sales, Inc. et al
Lawrenceville,
GA
USASF Blocker II, LLC Common
Units
(4)(5)
Equity
6/8/2015
Finance
units
441,000
690,000
0.26%
USASF Blocker III, LLC Series C
Preferred Units
(4)(5)
Equity
2/13/2018
Units
125,000
200,000
0.07%
USASF Blocker LLC Common Units
(4)(5)
Equity
6/8/2015
9,000
units
9,000
10,000
0.00%
Total
$ 575,000
$ 900,000
0.33%
VRI Intermediate Holdings, LLC
Franklin, OH
Term Loan (SBIC)
(2)(12)
Second Lien
3M
L+9.25%
1.00%
11.20%
5/31/2017
10/31/2020
Healthcare &
Pharmaceuticals
$9,000,000
$ 8,949,730
$ 9,000,000
3.33%
VRI Ultimate Holdings, LLC Class A Preferred Units
(4)
Equity
5/31/2017
326,797
shares
500,000
610,000
0.23%
Total
$ 9,449,730
$ 9,610,000
3.56%
Whisps Acquisiton Corp.
Elgin, IL
Term Loan
(12)
First Lien
3M
L+6.00%
0.00%
7.95%
4/26/2019
4/18/2025
Beverage,
Food, &
Tobacco
$8,875,000
8,717,992
8,875,000
3.28%
Whisps Holding LP Class A Common Units
(4)
Equity
4/18/2019
500,000
shares
500,000
680,000
0.25%
Total
$ 9,217,992
$ 9,555,000
3.53%
Wise Parent Company, LLC
Salt Lake
City, UT
Membership Units
(4)
Equity
8/27/2018
Beverage,
Food, &
Tobacco
units
41,894
30,000
0.01%
Total Non-controlled, non-affiliated investments
642,707,824
628,948,077
232.45%
Net Investments
642,707,824
628,948,077
232.45%
LIABILITIES IN EXCESS OF OTHER ASSETS
(358,376,904)
(132.45)%
NET ASSETS
$ 270,571,173
100.00%
(1)
See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of the methodologies used to value securities in the portfolio.
(2)
Investments held by the SBIC subsidiaries (as defined in Note 1), which include $8,445,923 of cash and $222,009,613 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility (as defined in Note 9). The Company’s obligations to the lenders of the Credit Facility are secured by a first priority security interest in all investments and cash and cash equivalents, except for investments held by the SBIC subsidiaries (as defined in Note 1).
(3)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $669,231, with an interest rate of LIBOR plus 7.50% and a maturity of June 30, 2023. This investment is accruing an unused commitment fee of 0.375% per annum.
(4)
Security is non-income producing.
(5)
The investment is not a qualifying asset under the Investment Company Act of 1940, as amended. The Company may not acquire any non-qualifying assets unless, at the time of the acquisition, qualifying assets represent at least 70% of the Company’s total assets. Qualifying assets represent approximately 89% of the Company’s total assets as of December 31, 2019.
(6)
Represents a PIK interest security. At the option of the issuer, interest can be paid in cash or cash and PIK interest. The percentage of PIK interest shown is the maximum PIK interest that can be elected by the issuer.
See accompanying notes to these consolidated financial statements.
(7)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $666,666, with an interest rate of LIBOR plus 6.25% and a maturity of June 29, 2022. This investment is accruing an unused commitment fee of 0.50% per annum.
(8)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000, with an interest rate of LIBOR plus 5.75% and a maturity of August 8, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(9)
Investments held by the SBIC II subsidiary (as defined in Note 1), which include $477,392 of cash and $22,498,836 of investments (at cost), are excluded from the obligations to the lenders of the Credit Facility (as defined in Note 9). The Company’s obligations to the lenders of the Credit Facility are secured by a first priority security interest in all investments and cash and cash equivalents, except for cash and investments held by the SBIC subsidiaries.
(10)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $872,727, with an interest rate of LIBOR plus 5.75% and a maturity of November 1, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(11)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 5.75% and a maturity of July 1, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(12)
These loans have LIBOR floors that are lower than the applicable LIBOR rates; therefore, the floors are not in effect.
(13)
These loans are last-out term loans with contractual rates higher than the applicable LIBOR rates; therefore, the floors are not in effect.
(14)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(15)
Investment has been on non-accrual since October 31, 2017.
(16)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,000,000, with an interest rate of LIBOR plus 7.75% and a maturity of February 5, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(17)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,500,000, with an interest rate of LIBOR plus 6.50% and a maturity of January 31, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(18)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $750,000, with an interest rate of LIBOR plus 7.50% and a maturity of April 13, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(19)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $488,998, with an interest rate of LIBOR plus 6.50% and a maturity of September 26, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
(20)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $2,222,222, with an interest rate of LIBOR plus 6.25% and a maturity of April 11, 2024. This investment is accruing an unused commitment fee of 1.00% per annum
(21)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,651,515, with an interest rate of LIBOR plus 5.75% and a maturity of October 2, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(22)
This loan is a unitranche investment.
(23)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $1,662,592, with an interest rate of LIBOR plus 6.50% and a maturity of September 26, 2023. This investment is not accruing an unused commitment fee.
(24)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,000,000 with an interest rate of LIBOR plus 6.00% and a maturity of November 15, 2023. This investment is accruing an unused commitment fee of 0.50% per annum.
See accompanying notes to these consolidated financial statements.
(25)
Excluded from the investment is an undrawn delayed draw term commitment in an amount not to exceed $4,000,000, with an interest rate of LIBOR plus 5.75% and a maturity of February 8, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(26)
Investment has been on non-accrual since June 28, 2019.
(27)
Maturity date is under on-going negotiations with portfolio company and other lenders, if applicable.
(28)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $852,273, with an interest rate of LIBOR plus 6.50% and a maturity of August 28, 2025. This investment is accruing an unused commitment fee of 0.50% per annum.
(29)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $553,517, with an interest rate of LIBOR plus 5.50% and a maturity of June 24, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(30)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $2,767,584, with an interest rate of LIBOR plus 5.50% and a maturity of June 24, 2024. This investment is accruing an unused commitment fee of 1.00% per annum.
(31)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $1,875,000, with an interest rate of LIBOR plus 5.75% and a maturity of September 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(32)
Excluded from the investment is an undrawn revolver commitment in an amount not to exceed $2,644,550, with an interest rate of LIBOR plus 6.25% and a maturity of August 30, 2024. This investment is accruing an unused commitment fee of 0.50% per annum.
(33)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $3,750,000, with an interest rate of LIBOR plus 5.75% and a maturity of March 31, 2020. This investment is not accruing an unused commitment fee.
(34)
Excluded from the investment is an undrawn delayed draw term loan commitment in an amount not to exceed $1,590,909, with an interest rate of LIBOR plus 5.75% and a maturity of October 2, 2024. This investment is accruing an unused commitment fee of 1.00% per annum.
(35)
These loans have LIBOR Floors which are higher than the current applicable LIBOR rates; therefore, the floors are in effect.
Abbreviation Legend
PIK - Payment-In-Kind
L - LIBOR
Euro - Euro Dollar
See accompanying notes to these consolidated financial statements.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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. 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 December 31, 2020, the Company has issued a total of 19,486,003 shares and raised $286,629,818 in gross proceeds since inception, incurring $9,127,228 in offering expenses and sales load fees for net proceeds from offerings of $277,502,590. 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 1, Inc., SCIC - ICD Blocker 1, Inc., SCIC - Invincible Blocker 1, Inc., SCIC - FBO Blocker 1, Inc., SCIC - SKP Blocker 1, Inc., SCIC - APE Blocker 1, Inc., SCIC - Venbrook Blocker 1, 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
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 such term is defined by the SBA.
As of both December 31, 2020 and 2019, the SBIC subsidiary had $75,000,000 of regulatory capital. As of both December 31, 2020 and 2019, the SBIC subsidiary had $150,000,000 of SBA-guaranteed debentures outstanding.
As of December 31, 2020 and 2019, the SBIC II subsidiary had $40,000,000 and $20,000,000 in regulatory capital, respectively, and $26,500,000 and $11,000,000 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 11).
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 December 31, 2020, the Company’s asset coverage ratio was 223%.
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. It 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 consolidated financial statements have been prepared on the accrual basis of accounting in conformity with generally accepted accounting principles in the U.S. GAAP and pursuant to the requirements for reporting on Form 10-K 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.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
In the opinion of management, the consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the periods included herein. Certain reclassifications have been made to certain prior period balances to conform with current presentation.
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
On March 11, 2020, the World Health Organization declared COVID-19 a pandemic and recommended containment and mitigation measures worldwide. As of the year ended December 31, 2020, and subsequent to December 31, 2020, the COVID-19 pandemic has had a significant impact on the U.S. and global economy. 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. The Company believes that any such known COVID-19 pandemic impacts have been reflected in the valuation of its investments.
The global impact of the outbreak continues to evolve, and many countries have reacted by instituting quarantines, prohibitions on travel and the closure of offices, businesses, schools, retail stores and other public venues. Businesses have also implemented similar precautionary measures. Such measures, as well as the general uncertainty surrounding the dangers and impact of the COVID-19 pandemic, have created significant disruption in supply chains and economic activity. The impact of the COVID-19 pandemic has led to significant volatility in the global public equity markets and it is uncertain how long this volatility will continue. As COVID-19 continues to spread, the potential impacts, including a global, regional or other economic recession, remain uncertain and difficult to assess. 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 the Company’s portfolio companies are adversely impacted by the effects of the COVID-19 pandemic, it may have a material adverse impact on the Company’s future net investment income, the fair value of the Company’s portfolio investments and the Company’s financial condition.
Portfolio Investment Classification
The Company classifies its portfolio investments 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 December 31, 2020, cash balances totaling $109,261 did not exceed Federal Deposit Insurance Corporation insurance protection levels of $250,000. In addition, at December 31, 2020, the Company held $18,368,341 in cash equivalents that are carried at cost, which approximates the fair value of the cash equivalents. 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.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 2022 Notes (as defined in Note 11) is based on the closing price of the security (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 December 31, 2020, by circumstances and events that are not yet known.
The COVID-19 pandemic may also 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 is working 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 year ended December 31, 2020, no interest deferrals have been made; related to COVID-19 or otherwise.
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 statement 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.
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 the Company’s Credit Facility, 2022 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.
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
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
shown on the Consolidated Statement of Changes in Net Assets and Liabilities as a reduction to Paid-in-Capital. As of December 31, 2020, the Company had incurred $90,000 of costs related to the preparation of a registration statement, which were capitalized until the related offering consummated during January 2021. There were no such costs on the Consolidated Statement of Assets and Liabilities as of December 31, 2019.
Investments
As a BDC, the Company will generally invest in illiquid loans and securities including debt and equity securities of private middle-market companies. 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 median between 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.
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 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:
•
available current market data, including relevant and applicable market trading and transaction comparables;
•
applicable market yields and multiples;
•
security covenants;
•
call protection provisions;
•
information rights;
•
the nature and realizable value of any collateral;
•
the portfolio company’s ability to make payments, its earnings and discounted cash flows and the markets in which it does business;
•
comparisons of financial ratios of peer companies that are public;
•
comparable merger and acquisition transactions; and
•
the principal market and enterprise values.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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.
A presentation of the interest income we have received from portfolio companies for the years ended December 31, 2020, 2019 and 2018 is as follows:
For the year ended
December 31,
December 31,
December 31,
Loan interest
$ 51,067,006
$ 53,358,856
$ 46,501,235
PIK income
664,992
415,933
1,869,905
Fee amortization income(1)
2,389,223
1,982,868
1,636,168
Fee income acceleration(2)
1,229,560
1,138,333
1,455,725
Total Interest Income
$ 55,350,781
$ 56,895,990
$ 51,463,033
(1)
Includes amortization of fees on unfunded commitments.
(2)
Unamortized loan origination fees recognized upon full or partial realization of investment.
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-specific circumstances as well as other economic factors in determining collectability. As of December 31, 2020, we had three loans on non-accrual status, which represented approximately 4.3% of our loan portfolio at cost and 1.0% at fair value. As of December 31, 2019, we had two portfolio companies that were on non-accrual status, which represented approximately 3.6% of our loan portfolio at cost and 0.9% at fair value. As of December 31, 2020 and 2019, $7,057,415 and $3,779,593 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.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 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.
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. As of December 31, 2020, the Company had approximately $21,051,549 of undistributed taxable income that was carried forward toward distributions to be paid in 2021.
Income tax expense for the years ended December 31, 2020, 2019, and 2018 of $771,134, $903,905, and $275,106, respectively, is related to state and excise taxes.
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 December 31, 2020 and 2019, 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 years ended December 31, 2020, 2019 and 2018, 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.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 years ended December 31, 2020, 2019 and 2018, the Company recorded deferred income tax provision of $224,877, $66,760 and $67,953, respectively, related to the Taxable Subsidiaries. As of December 31, 2020 and 2019, the Company had a net deferred tax liability of $359,590 and $134,713, 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.
Distributable Earnings (Accumulated Undistributed Deficit)
The components that make up distributable earnings (accumulated undistributed deficit) on the Statement of Assets and Liabilities as of December 31, 2020 and 2019 are as follows:
December 31,
December 31,
Accumulated net realized loss from investments, net of cumulative
dividends of $24,557,535 for both periods
$ (16,388,369)
$ (6,258,510)
Net unrealized depreciation on non-controlled non-affiliated investments and cash equivalents, net of provision for taxes of $359,590 and $134,713, respectively
(5,564,061)
(13,894,460)
Accumulated undistributed net investment income
19,266,926
18,587,920
Accumulated undistributed deficit
$ (2,685,504)
$ (1,565,050)
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. Management is currently evaluating the impact of the optional guidance on the Company’s consolidated financial statements and disclosures. The Company did not utilize the optional expedients and exceptions provided by ASU 2020-04 during the year ended December 31, 2020.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Accelerated Filer and Large Accelerated Filer Definitions
The SEC recently adopted a final rule under SEC Release No. 34-88365 (the “Final Rule”), amending the Accelerated Filer and Large Accelerated Filer definitions in Exchange Act Rule 12b-2 to exclude an issuer that is eligible to be a smaller reporting company and had annual revenues of less than $100 million. The amendments include a provision under which a BDC will be excluded from the “accelerated filer” and “large accelerated filer” definitions if the BDC has (1) less than $700 million in public float, and (2) investment income of less than $100 million. In addition, BDCs are subject to the same transition provisions for accelerated filer and large accelerated filer status as other issuers, but instead substituting investment income for revenue. The amendments will reduce the number of issuers required to comply with the auditor attestation on the internal control over financial reporting requirement provided under Section 404(b) of the Sarbanes-Oxley Act of 2002. The Final Rule became effective as of April 27, 2020. As a result of the amended definitions, the Company status has changed from being an “accelerated” filer to a “non-accelerated” filer. The Company meets the requirements during the year ended December 31, 2020 such that no auditor attestation on the internal control over financial reporting is required.
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 years ended December 31, 2020, 2019 and 2018, the Company recorded an expense for base management fees of $11,084,450, $9,703,706, and $8,154,842 respectively. As of December 31, 2020 and December 31, 2019, $2,825,322 and $2,695,780 was payable to Stellus Capital, respectively.
The incentive fee has two components, investment income and capital gains, 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 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%
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
(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 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 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 incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.
For the years ended December 31, 2020, 2019 and 2018, the Company incurred $2,527,813, $5,809,672 and $5,529,376, respectively, of Investment Income Incentive Fees. As of December 31, 2020 and 2019, $681,660 and $1,618,509, respectively, of such incentive fees were payable to the Advisor, of which $559,161 and $1,463,003, respectively, were currently payable (as explained below). As of December 31, 2020 and December 31, 2019, $122,499 and $152,476, respectively, of 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 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 Gains Incentive Fees is subtracted from such Capital Gains Incentive Fee calculated.
U.S. GAAP requires that the incentive fee accrual considers the cumulative aggregate realized gains and losses and unrealized capital appreciation and depreciation of investments or other financial instruments in the calculation, as an incentive fee would be payable if such unrealized capital appreciation or depreciation were realized, even though such unrealized capital appreciation is not permitted to be considered in calculating the 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 years ended December 31, 2020, 2019 and 2018, the Company (reversed) incurred ($359,892), $799,876, and $81,038, respectively. As of December 31, 2020 and December 31, 2019, $521,021 and $880,913, respectively of Capital Gains Incentive Fees were accrued but not currently payable to the Advisor.
The following tables summarize the components of the incentive fees discussed above:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
Investment income incentive fee incurred
$ 2,527,813
$ 5,809,672
$ 5,529,376
Capital gains incentive fee (reversed) accrued
(359,892)
799,876
$ 81,038
Incentive fee expense
$ 2,167,921
$ 6,609,548
$ 5,610,414
December 31,
December 31,
Investment income incentive fee currently payable
$ 559,161
$ 1,466,033
Investment income incentive fee deferred
122,499
152,476
Capital gains incentive fee deferred
521,021
880,913
Incentive fee payable
$ 1,202,681
$ 2,499,422
Director Fees
For the years ended December 31, 2020, 2019 and 2018, the Company recorded an expense relating to director fees $394,816, $383,000 and $317,000, respectively. As of December 31, 2020 and 2019, the Company owed its independent directors no unpaid director fees.
Co-Investments
On October 23, 2013, the Company received an exemptive order (the “Prior Order”) from the SEC to co-invest with private funds managed by Stellus Capital Management 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 “Order”) that supersedes the Prior Order and permits the Company greater flexibility to enter into co-investment transactions. The Order expands on the Prior Order and allows the Company to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein. 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 Management 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 Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management 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 exemptive relief order. As of December 31, 2020 and December 31, 2019, 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 Statement of Assets and Liabilities.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 it is required to maintain and preparing reports to its stockholders and reports filed with the SEC.
For the years ended December 31, 2020, 2019 and 2018, the Company recorded expenses of $1,549,627, $1,469,706, and $1,195,174, respectively, related to the administration agreement. As of December 31, 2020 and December 31, 2019, $381,690 and $372,524, respectively, remained payable to Stellus Capital relating to the administration agreement.
Indemnification
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.
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. The Company has declared distributions of $10.91 per share on its common stock from Inception through December 31, 2020.
The following table reflects the Company’s distributions declared and paid on its common stock since Inception:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Year/Date Declared
Record Date
Payment Date
Per Share(1)
Fiscal 2012
$ 0.18
Fiscal 2013
$ 1.36
Fiscal 2014
$ 1.42
Fiscal 2015
$ 1.36
Fiscal 2016
Various
$ 1.36
Fiscal 2017
$ 1.36
Fiscal 2018
$ 1.36
Fiscal 2019
$ 1.36
Fiscal 2020
January 10, 2020
January 31, 2020
February 14, 2020
$ 0.11
January 10, 2020
February 28, 2020
March 13, 2020
$ 0.11
January 10, 2020
March 31, 2020
April 15, 2020
$ 0.11
June 30, 2020
July 15, 2020
July 31, 2020
$ 0.25
July 29, 2020
September 15, 2020
September 30, 2020
$ 0.25
September 13, 2020
December 15, 2020
December 29, 2020
$ 0.25
September 13, 2020
December 15, 2020
December 29, 2020
$ 0.06
Total
$ 10.91
The Company has adopted an “opt out” dividend reinvestment plan (“DRIP”) pursuant to which a stockholder whose shares are held in their own name will receive distributions in shares of the Company’s common stock under the Company’s DRIP unless they elect 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 our 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 issued 21,666 shares through the DRIP during the year ended December 31, 2020. No new shares were issued in connection with the DRIP during the year ended December 31, 2019.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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.
Issuance of Common Stock
Number of
Shares
Gross
Proceeds(1)(2)
Underwriting
fees
Offering
Expenses
Net
Proceeds(3)
Offering
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
-
-
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, 2015
-
-
-
-
-
-
Year ended December 31, 2016
-
-
-
-
-
-
Year ended December 31, 2017
3,465,922
48,741,406
1,358,880
307,021
47,075,505
$ 14.06
Year ended December 31, 2018
7,931
93,737
-
-
93,737
$ 11.85
Year ended December 31, 2019
3,177,936
45,862,995
1,015,127
521,715
44,326,153
$ 14.43
Year ended December 31, 2020
354,257
5,023,843
5,681
18,169
4,999,993
$ 14.18
Total
19,486,003
$ 286,629,818
$ 7,414,918
$ 1,712,309
$ 277,502,591
(1)
Net of partial share redemptions. Such share redemptions impacted gross proceeds by $94, $757, $(1,051), $(142), $(31) and $(29) in 2020, 2019, 2018, 2017, 2016 and 2015, respectively.
(2)
Includes common shares issued under the DRIP of $228,943 and $94,788 during the year ended December 31, 2020 and 2018, respectively; $0 for the years ended 2019, 2017, 2016 and 2015, and $390,505, $938,385, $113,000 for the years ended 2014, 2013, and 2012, respectively.
(3)
Net Proceeds per this equity table will differ from the Statement of Assets and Liabilities as of December 31, 2020 and 2019 in the amount of $1,456,437 and $366,375, respectively, which represents a tax reclassification of stockholders’ equity in accordance with generally accepted accounting principles. This reclassification reduces paid-in capital and increases distributable earnings (reducing the accumulated undistributed deficit).
The Company issued 332,591 shares during the year ended December 31, 2020 under the At-the-Market (“ATM”) Program, for gross proceeds of $4,794,994 and underwriting and other expenses of $23,850. The average per share offering price of shares issued in the ATM Program during 2020 was $14.42. Gross proceeds resulting from the At-the-Market (“ATM”) Program in 2019 totaled $3,262,729 and underwriting and other expenses totaled $240,040. The average per share offering price of shares issued in the ATM Program during 2019 was $14.45.
The Company issued 2,952,149 shares during the year ended December 31, 2019 in a secondary offering on March 15, 2019 and the underwriters’ exercise of their overallotment option on April 11, 2019. Gross proceeds resulting from the secondary offering totaled $42,599,510 and underwriting and other expenses totaled $1,296,803. The per share offering price for the secondary offering was $14.43.
The Company issued 21,666 and 0 shares of common stock through the DRIP for the year ended December 31, 2020 and 2019, respectively.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
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 years ended December 31, 2020, 2019 and 2018.
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
Net increase in net assets resulting from operations
$ 20,192,441
$ 26,438,186
$ 26,194,578
Weighted average common shares
19,471,500
18,275,696
15,953,571
Basic and diluted earnings per common share
$ 1.04
$ 1.45
$ 1.64
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 December 31, 2020, the Company had investments in 66 portfolio companies. The total cost and fair value of the investments were $658,628,966 and $653,424,495, respectively. The composition of our investments as of December 31, 2020 is as follows:
Cost
Fair Value
Senior Secured - First Lien(1)
$ 508,060,059
$ 508,673,064
Senior Secured - Second Lien
93,636,285
70,720,186
Unsecured Debt
22,212,888
21,191,245
Equity
34,719,734
52,840,000
Total Investments
$ 658,628,966
$ 653,424,495
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
(1)
Includes unitranche investments, which account for 13.0% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans. Our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.
At December 31, 2019, the Company had investments in 63 portfolio companies. The total cost and fair value of the investments were $642,707,824 and $628,948,077, respectively. The composition of our investments as of December 31, 2019 was as follows:
Cost
Fair Value
Senior Secured - First Lien(1)
$ 461,107,595
$ 455,169,878
Senior Secured - Second Lien
130,600,172
111,961,013
Unsecured Debt
22,279,519
22,137,186
Equity
28,720,538
39,680,000
Total Investments
$ 642,707,824
$ 628,948,077
(1)
Includes unitranche investments, which account for 14.4% of our portfolio at fair value. Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with the second lien and subordinated loans to the extent we invest in the “last-out” tranche.
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 December 31, 2020 and December 31, 2019, the Company had 19 and 17 such investments with aggregate unfunded commitments of $28,865,204 and $37,517,784, respectively. The Company maintains sufficient liquidity to fund such unfunded loan commitments should the need arise.
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, 2020 are as follows:
Quoted Prices
in Active
Markets
for Identical
Securities
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Senior Secured - First Lien
$ -
$ -
$ 508,673,064
$ 508,673,064
Senior Secured - Second Lien
-
-
70,720,186
70,720,186
Unsecured Debt
-
-
21,191,245
21,191,245
Equity
-
-
52,840,000
52,840,000
Total Investments
$ -
$ -
$ 653,424,495
$ 653,424,495
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, 2019 are as follows:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Quoted Prices
in Active
Markets for
Identical
Securities
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Senior Secured - First Lien
$ -
$ -
$ 455,169,878
$ 455,169,878
Senior Secured - Second Lien
-
-
111,961,013
111,961,013
Unsecured Debt
-
-
22,137,186
22,137,186
Equity
-
-
39,680,000
39,680,000
Total Investments
$ -
$ -
$ 628,948,077
$ 628,948,077
The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2020 are as follows:
Senior Secured
Loans-First
Lien
Senior Secured
Loans-Second
Lien
Unsecured
Debt
Equity
Total
Fair value at beginning of period
$ 455,169,878
$ 111,961,013
$ 22,137,186
$ 39,680,000
$ 628,948,077
Purchases of investments
139,571,726
9,800,000
-
8,135,439
157,507,165
Payment-in-kind interest
80,487
506,754
77,751
-
664,992
Sales and Redemptions
(85,804,667)
(43,642,752)
-
(4,801,419)
(134,248,838)
Realized (Losses) Gains
(8,599,062)
(4,003,655)
(163,423)
2,665,177
(10,100,963)
Change in unrealized appreciation (depreciation) included in earnings﻿(1)
6,550,721
(4,276,940)
(879,310)
7,160,803
8,555,274
Amortization of premium and accretion of discount, net
1,703,981
375,766
19,041
-
2,098,788
Fair value at end of period
$ 508,673,064
$ 70,720,186
$ 21,191,245
$ 52,840,000
$ 653,424,495
(1)
Includes reversal of positions during the twelve months ended December 31, 2020.
There were no Level 3 transfers during the twelve months ended December 31, 2020.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
The aggregate values of Level 3 portfolio investments changed during the year ended December 31, 2019 are as follows:
Senior Secured
Loans-First
Lien
Senior Secured
Loans-Second
Lien
Unsecured
Debt
Equity
Total
Fair value at beginning of period
$ 292,004,982
$ 149,661,220
$ 23,697,466
$ 39,120,000
$ 504,483,668
Purchases of investments
209,966,863
26,572,699
-
9,940,714
246,480,276
Payment-in-kind interest
262,444
94,445
59,044
-
415,933
Sales and Redemptions
(48,114,716)
(51,959,386)
(5,605,908)
(22,594,613)
(128,274,623)
Realized Gains
(212,012)
-
2,364,905
17,415,227
19,568,120
Change in unrealized appreciation (depreciation) included in earnings
22,891
(12,917,767)
1,596,438
(4,201,328)
(15,499,766)
Amortization of premium and accretion of discount, net
1,239,426
509,802
25,241
-
1,774,469
Fair value at end of period
$ 455,169,878
$ 111,961,013
$ 22,137,186
$ 39,680,000
$ 628,948,077
There were no Level 3 transfers during the twelve months ended December 31, 2019.
The following is a summary of geographical concentration of our investment portfolio as of December 31, 2020:
Cost
Fair Value
% of Total
Investments at
fair value
Texas
$ 151,640,862
$ 135,146,776
20.68%
California
86,050,467
92,069,851
14.09%
Illinois
57,330,756
57,535,404
8.81%
Arizona
50,822,139
52,015,600
7.96%
New Jersey
38,228,359
37,765,139
5.78%
Ohio
34,109,657
35,827,682
5.48%
Wisconsin
22,721,856
22,827,500
3.49%
Canada
21,318,659
21,540,925
3.30%
New York
19,527,594
20,547,579
3.14%
Tennessee
19,832,576
19,959,613
3.05%
United Kingdom
20,159,650
18,727,500
2.87%
South Carolina
15,834,471
18,132,490
2.77%
Indiana
17,741,889
18,026,339
2.76%
Maryland
16,970,057
17,064,250
2.61%
Florida
12,404,739
12,299,545
1.88%
Alabama
12,252,768
12,252,768
1.88%
Washington
11,803,768
11,801,363
1.81%
Missouri
9,956,554
10,720,000
1.64%
Pennsylvania
9,884,148
9,900,000
1.52%
Virginia
7,505,287
7,759,020
1.19%
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Cost
Fair Value
% of Total
Investments at
fair value
Washington, D.C.
6,937,907
7,030,512
1.08%
Georgia
685,000
6,420,000
0.98%
North Carolina
4,979,153
2,925,000
0.45%
Puerto Rico
8,613,244
2,589,639
0.40%
Massachusetts
1,317,406
1,780,000
0.27%
Utah
-
760,000
0.11%
$ 658,628,966
$ 653,424,495
100.00%
The following is a summary of geographical concentration of our investment portfolio as of December 31, 2019:
Cost
Fair Value
% of Total
Investments at
Fair Value
Texas
$ 134,451,527
$ 120,672,985
19.19%
California
79,090,474
78,136,331
12.42%
Arizona
52,390,949
53,274,526
8.47%
New Jersey
52,548,769
51,637,750
8.21%
Ohio
48,502,609
50,092,839
7.96%
Illinois
41,869,947
44,406,252
7.06%
Canada
21,201,137
21,217,811
3.37%
New York
19,922,689
20,584,020
3.27%
United Kingdom
20,116,695
20,116,695
3.20%
Wisconsin
19,207,770
19,466,054
3.10%
South Carolina
19,935,337
19,366,716
3.08%
Tennessee
19,854,956
19,260,076
3.06%
Pennsylvania
17,408,508
17,566,213
2.79%
Maryland
17,103,044
17,325,000
2.75%
Indiana
14,064,012
13,997,251
2.23%
Florida
13,663,116
13,820,256
2.20%
Colorado
10,867,843
12,444,250
1.98%
Arkansas
14,920,694
11,989,446
1.91%
Missouri
10,078,235
10,428,223
1.66%
Georgia
575,000
5,250,000
0.83%
North Carolina
4,961,969
4,375,000
0.70%
Puerto Rico
8,613,244
3,490,383
0.55%
Utah
41,894
30,000
0.00%
Massachusetts
1,317,406
-
-%
$ 642,707,824
$ 628,948,077
100.00%
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
The following is a summary of industry concentration of our investment portfolio as of December 31, 2020:
Cost
Fair Value
% of Total
Investments at
fair value
Services: Business
$ 102,005,864
$ 109,873,364
16.82%
Healthcare & Pharmaceuticals
87,198,279
82,945,887
12.69%
Aerospace & Defense
53,615,886
52,184,338
7.99%
Beverage, Food, & Tobacco
39,339,090
41,012,620
6.28%
Media: Broadcasting & Subscription
31,889,423
34,418,869
5.27%
High Tech Industries
33,571,427
33,793,693
5.17%
Consumer Goods: Durable
27,802,124
27,780,032
4.25%
Environmental Industries
25,454,549
24,977,427
3.82%
Education
26,428,607
24,494,108
3.75%
Services: Consumer
38,026,487
22,600,924
3.46%
Media: Advertising, Printing & Publishing
21,903,057
21,348,217
3.27%
Capital Equipment
20,005,255
20,680,904
3.17%
Finance
18,016,762
19,435,000
2.97%
Transportation & Logistics
18,690,276
18,944,945
2.90%
Retail
15,834,471
18,132,490
2.77%
Containers, Packaging, & Glass
17,853,813
17,890,000
2.74%
Metals & Mining
16,970,057
17,064,250
2.61%
Consumer goods: non-durable
13,272,383
12,930,000
1.98%
Automotive
11,028,125
11,028,125
1.69%
Construction & Building
10,446,055
10,750,000
1.65%
Energy: Oil & Gas
11,015,013
9,991,177
1.53%
Utilities: Oil & Gas
9,884,148
9,900,000
1.52%
Chemicals, Plastics, & Rubber
6,605,024
6,808,125
1.04%
Software
1,772,791
4,430,000
0.66%
Hotel, Gaming, & Leisure
-
10,000
0.00%
$ 658,628,966
$ 653,424,495
100.00%
The following is a summary of industry concentration of our investment portfolio as of December 31, 2019:
Cost
Fair Value
% of Total
Investments at
Fair Value
Healthcare & Pharmaceuticals
$ 98,307,360
$ 94,000,860
14.95%
Services: Business
56,354,433
62,410,845
9.92%
Aerospace & Defense
44,970,957
46,547,324
7.40%
Consumer Goods: Durable
47,933,468
44,158,660
7.02%
Beverage, Food, & Tobacco
42,131,354
42,592,966
6.77%
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Cost
Fair Value
% of Total
Investments at
Fair Value
Media: Broadcasting & Subscription
32,353,301
33,218,991
5.28%
Finance
27,776,880
29,562,500
4.70%
Education
26,594,771
25,661,125
4.08%
Media: Advertising, Printing & Publishing
22,425,972
21,965,124
3.49%
High Tech Industries
21,201,137
21,217,811
3.37%
Capital Equipment
20,093,379
20,237,066
3.22%
Retail
19,935,337
19,366,716
3.08%
Metals & Mining
17,103,044
17,325,000
2.75%
Transportation & Logistics
17,173,599
17,226,294
2.74%
Automotive
17,151,902
17,221,213
2.74%
Software
15,807,191
15,516,250
2.47%
Containers, Packaging, & Glass
14,306,286
14,564,570
2.32%
Environmental Industries
15,256,675
14,410,327
2.29%
Energy: Oil & Gas
12,624,269
13,582,102
2.16%
Services: Consumer
26,075,606
13,345,105
2.12%
Chemicals, Plastics, & Rubber
11,880,825
11,857,228
1.89%
Consumer goods: non-durable
14,973,711
11,770,000
1.87%
Construction & Building
10,408,323
10,750,000
1.71%
Utilities: Oil & Gas
9,868,044
9,900,000
1.57%
Hotel, Gaming, & Leisure
-
540,000
0.09%
$ 642,707,824
$ 628,948,077
100.00%
The following provides quantitative information about Level 3 fair value measurements as of December 31, 2020:
Description:
Fair Value
Valuation Technique
Unobservable Inputs
Range (Average) (1)(3)
First lien debt
$ 508,673,064
Income/Market(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-3.78% to 1.84% (-0.15)%
-2.95% to 0.14% (-1.68)%
7x to 48x (13x)(4)
Second lien debt
$ 70,720,186
Income/Market(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-1.71% to 3.83% (0.54)%
-2.65% to 0.08% (-1.44)%
8x to 14x (11x)(4)
Unsecured debt
$ 21,191,245
Income/Market
approach(2)
HY credit spreads,
Risk free rates
Market multiples
-0.25% to 0.34% (-0.03)%
-1.92% to -1.62% (-1.78)%
1x to 24x (6x)(4)
Equity investments
$ 52,840,000
Market approach(5)
Underwriting
multiple/
EBITDA Multiple
1x to 24x (12x)
Total Long Term Level 3
Investments
$ 653,424,495
(1)
Weighted average based on fair value as of December 31, 2020.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
(2)
Inclusive of but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3)
The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for a first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -3.78% (-378 basis points) to 1.84% (184 basis points). The average of all changes was -0.15%.
(4)
Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5)
The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple (the “Multiple”). Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.
The following provides quantitative information about Level 3 fair value measurements as of December 31, 2019:
Description:
Fair Value
Valuation Technique
Unobservable Inputs
Range (Average) (1)(3)
First lien debt
$ 455,169,878
Income/Market(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-2.19% to 6.98% (0.57)%
-1.48% to 0.52% (-0.68)%
6x to 29x (12x)(4)(4)
Second lien debt
$ 111,961,013
Income/Market(2)
approach
HY credit spreads,
Risk free rates
Market multiples
-0.69% to 5.94% (1.19)%
-1.34% to 0.48% (-0.42)%
7x to 34x (14x)(4)(4)
Unsecured debt
$ 22,137,186
Income/Market
approach(2)
HY credit spreads,
Risk free rates
Market multiples
-0.39% to 0.00% (-0.35)%
-0.45% to -0.42% (-0.43)%
2x to 20x (4x)(4)(4)
Equity investments
$ 39,680,000
Market approach(5)
Underwriting
multiple/
EBITDA multiple
2x to 17x (10x)
Total Long Term Level 3
Investments
$ 628,948,077
(1)
Weighted average based on fair value as of December 31, 2019.
(2)
Inclusive of but not limited to (a) the market approach which is used to determine sufficient enterprise value, and (b) the income approach which is based on discounting future cash flows using an appropriate market yield.
(3)
The Company calculates the price of the loan by discounting future cash flows, which include forecasted future LIBOR rates based on the published forward LIBOR curve at the valuation date, using an
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
appropriate yield calculated as of the valuation date. This yield is calculated based on the loan’s yield at the original investment and is adjusted as of the valuation date based on: changes in comparable credit spreads, changes in risk free interest rates (per swap rates), and changes in credit quality (via an estimated shadow rating). Significant movements in any of these factors would result in a significantly lower or higher fair value measurement. As an example, the “Range (Average)” for a first lien debt instruments in the table above indicates that the change in the HY spreads between the date a loan closed and the valuation date ranged from -2.19% (-219 basis points) to 6.98% (698 basis points). The average of all changes was 0.57%.
(4)
Median of LTM (last twelve months) EBITDA multiples of comparable companies.
(5)
The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the Multiple. Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiple, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.
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 December 31, 2020, the Company had $28,865,202 of unfunded commitments to provide debt financing to nineteen existing portfolio companies. As of December 31, 2019 the Company had $37,517,784 of unfunded commitments to provide debt financing to seventeen existing portfolio companies. As of December 31, 2020, 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.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
NOTE 8 - FINANCIAL HIGHLIGHTS
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
Per Share Data:(1)
Net asset value at beginning of year/period
$ 14.14
$ 14.09
$ 13.81
$ 13.69
$ 13.19
Net investment income
1.13
1.23
1.42
1.21
1.39
Change in unrealized appreciation (depreciation)
0.44
(0.85)
(0.11)
-
1.49
Realized gain (loss)
(0.52)
1.07
0.35
0.31
(1.05)
Provision for taxes on realized gains
-
-
(0.02)
-
-
(Provision) benefit for taxes on unrealized appreciation
(0.01)
-
-
-
0.03
Total from investment operations
1.04
1.45
1.64
1.52
1.86
Sales Load
-
(0.06)
-
(0.09)
-
Offering Costs
-
(0.03)
-
(0.02)
-
Stockholder distributions from:
Net investment income
(1.15)
(0.54)
(1.03)
(1.20)
(1.36)
Net realized capital gains
-
(0.82)
(0.33)
(0.16)
-
Other(3)
-
0.05
-
0.07
-
Net asset value at the end of year/period
$ 14.03
$ 14.14
$ 14.09
$ 13.81
$ 13.69
Per share market value at end of year/period
$ 10.88
$ 14.23
$ 12.95
$ 13.14
$ 12.06
Total return based on market value (4)
(13.73)%
21.97%
8.68%
20.29%
42.83%
Weighted average shares outstanding at the end
of period
19,471,500
18,275,696
15,953,571
14,870,981
12,479,959
Ratio/Supplemental Data:
Net assets at the end of year/period
$ 273,360,649
$ 270,571,173
$ 224,845,007
$ 220,247,242
$ 170,881,785
Weighted average net assets
$ 253,034,571
$ 259,020,507
$ 223,750,302
$ 195,211,550
$ 165,189,142
Annualized ratio of operating expenses to net assets﻿(7)(8)
13.75%
14.11%
13.72%
11.10%
13.20%
Annualized ratio of interest expense and other fees to net assets﻿(2)
6.29%
5.78%
5.51%
4.02%
4.84%
Annualized ratio of net investment income to net assets﻿(7)(8)
8.58%
8.64%
10.09%
9.21%
10.71%
Portfolio Turnover(5)
21%
23%
32%
48%
16%
Notes Payable
$ 48,875,000
$ 48,875,000
$ 48,875,000
$ 48,875,000
$ 25,000,000
Credit Facility Payable
$ 174,000,000
$ 161,550,000
$ 99,550,000
$ 40,750,000
$ 116,000,000
SBA-guaranteed debentures
$ 176,500,000
$ 161,000,000
$ 150,000,000
$ 90,000,000
$ 65,000,000
Asset Coverage Ratio(6)
2.23x
2.29x
2.51x
3.46x
2.21x
(1)
Financial highlights are based on weighted average shares outstanding as of year/period ended.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
(2)
Excludes debt extinguishment costs of $416,725 for the year ended December 31, 2017. Including these costs, this ratio would be 4.24%.
(3)
Includes the impact of different share amounts as a result of calculating certain per share data based on weighted average shares outstanding during the period and certain per share data based on shares outstanding as of the period end.
(4)
Total return on market value is based on the change in market price per share since the end of the prior quarter and includes dividends paid, which are assumed to be reinvested. The total returns are not annualized.
(5)
Calculated as the lesser of purchases or paydowns divided by average portfolio balance and is not annualized.
(6)
Asset coverage ratio is equal to total assets less all liabilities and indebtedness not represented by senior securities over the aggregate amount of the senior securities. SBA-guaranteed debentures are excluded from the numerator and denominator.
(7)
These ratios include the impact of the (provision) benefit for income taxes related to net unrealized (gain) loss on certain investments of $(224,877), $(66,760), and $(67,953) for the years ended December 31, 2020, 2019 and 2018 respectively, which are not reflected in net investment income, gross operating expenses or net operating expenses. The (provision) benefit for income taxes related to net realized loss or unrealized loss (gain) on investments at taxable subsidiaries to net assets for the years ended December 31, 2020, 2019 and 2018 is less than (0.09)%, (0.03)% and (0.03)%, respectively.
(8)
Deferred offering costs of $261,761 for the year ended December 31, 2016 are not annualized.
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 September 18, 2020 with ZB, N.A., dba Amegy Bank and various other lenders (the “Credit Facility”).
The key changes in the amended and restated Credit Facility are as follows:
Prior agreement
As amended and restated
Maturity Date
October 10, 2021
September 18, 2025
Commitment termination date
March 10, 2021
September 18, 2024
LIBOR floor
None
0.25%
Prime rate floor
None
3.00%
Asset coverage ratio
Minimum of 1.75 to 1.00 (maximum leverage of 1.33x)
Minimum of 1.67 to 1.00 (maximum leverage of 1.5x)
Refinancing of 2022 Notes(1)
Not required
Required by March 15, 2022
(1)
See Note 14 for discussion about 2022 Notes subsequent to December 31, 2020
The Credit Facility, as amended and restated, provides for borrowings up to a maximum of $230,000,000 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.
Borrowings under the Credit Facility bear interest, subject to the Company’s election, on a per annum basis equal to (i) LIBOR 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) with a 0.25% LIBOR 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
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
rate based on the highest of the Prime Rate, Federal Funds Rate plus 0.5% or one month LIBOR plus 1.0%. The Company pays unused commitment fees of 0.50% per annum on the unused lender commitments under the Credit Facility. Interest is payable 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. 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.
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 1.0, (iii) maintaining a minimum shareholder’s equity, and (iv) maintaining a minimum interest coverage ratio of at least 2.00 to 1.00. As of December 31, 2020, the Company was in compliance with these covenants.
As of December 31, 2020 and December 31, 2019, the outstanding balance under the Credit Facility was $174,000,000 and $161,550,000, respectively. 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 $3,636,707 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 December 31, 2020 and 2019, $2,271,595 and $1,039,367 of such prepaid loan structure fees and administration fees had yet to be amortized, respectively. These prepaid loan fees are presented on our consolidated statement 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:
December 31,
December 31,
Credit Facility payable
$ 174,000,000
$ 161,550,000
Prepaid loan structure fees
2,271,595
1,039,367
Credit facility payable, net of prepaid loan structure fees
$ 171,728,405
$ 160,510,633
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 years ended December 31, 2020, 2019, and 2018:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
For the years ended
December 31,
December 31,
December 31,
Interest expense
$ 5,837,905
$ 5,112,499
$ 3,737,735
Loan fee amortization
619,658
485,017
415,179
Commitment fees on unused portion
228,953
405,438
387,601
Administration fees
28,214
34,978
40,972
Total interest and financing expenses
$ 6,714,730
$ 6,037,932
$ 4,581,487
Weighted average interest rate
3.2%
4.8%
4.7%
Effective interest rate (including fee
amortization)
3.7%
5.7%
5.7%
Average debt outstanding
$ 181,943,716
$ 106,244,521
$ 79,818,493
Cash paid for interest and unused fees
$ 6,284,516
$ 5,217,832
$ 4,158,382
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 December 31, 2020 and 2019, the SBIC subsidiary had $75,000,000 in regulatory capital and $150,000,000 of SBA-guaranteed debentures outstanding.
As of December 31, 2020 and 2019, the SBIC II subsidiary had $40,000,000 and $20,000,000 in regulatory capital and $26,500,000 and $11,000,000 of SBA-guaranteed debentures outstanding, respectively.
On August 12, 2014, the Company obtained exemptive relief from the SEC to permit it to exclude the SBA-guaranteed debentures from its asset coverage test under the 1940 Act. The exemptive relief provides the Company with increased 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 collectively held $277,440,338 and $240,109,144 in assets at December 31, 2020 and 2019, respectively, which accounted for approximately 41.1% and 37.0% of our total consolidated assets at December 31, 2020 and 2019, 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 SBA-guaranteed 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 U.S. Treasury Note rate plus a spread at each pooling date.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
The following table summarizes the SBIC subsidiary’s SBA-guaranteed debentures as of December 31, 2020:
Issuance Date
Licensee
Maturity Date
Debenture
Amount
Interest
Rate
SBA
Annual
Charge
October 14, 2014
SBIC
March 1, 2025
$ 6,500,000
2.52%
0.36%
October 17, 2014
SBIC
March 1, 2025
6,500,000
2.52%
0.36%
December 24, 2014
SBIC
March 1, 2025
3,250,000
2.52%
0.36%
June 29, 2015
SBIC
September 1, 2025
9,750,000
2.83%
0.36%
October 22, 2015
SBIC
March 1, 2026
6,500,000
2.51%
0.36%
October 22, 2015
SBIC
March 1, 2026
1,500,000
2.51%
0.74%
November 10, 2015
SBIC
March 1, 2026
8,800,000
2.51%
0.74%
November 18, 2015
SBIC
March 1, 2026
1,500,000
2.51%
0.74%
November 25, 2015
SBIC
March 1, 2026
8,800,000
2.51%
0.74%
December 16, 2015
SBIC
March 1, 2026
2,200,000
2.51%
0.74%
December 29, 2015
SBIC
March 1, 2026
9,700,000
2.51%
0.74%
November 28, 2017
SBIC
March 1, 2028
25,000,000
3.19%
0.22%
April 27, 2018
SBIC
September 1, 2028
40,000,000
3.55%
0.22%
July 30, 2018
SBIC
September 1, 2028
17,500,000
3.55%
0.22%
September 25, 2018
SBIC
March 1, 2029
2,500,000
3.11%
0.22%
October 17, 2019
SBIC II
March 1, 2030
6,000,000
2.08%
0.09%
November 15, 2019
SBIC II
March 1, 2030
5,000,000
2.08%
0.09%
December 17, 2020
SBIC II
March 1, 2031
9,000,000
0.54(1)
0.09%
December 17, 2020
SBIC II
March 1, 2031
6,500,000
0.54(1)
0.27%
Total SBA-guaranteed debentures
$ 176,500,000
(1)
Interest rate of the SBA-guaranteed debentures will be set as determined by the SBA when pooled on March 24, 2021.
As of December 31, 2020 and 2019, 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 values 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 December 31, 2020 and 2019, the SBA-guaranteed debentures would be deemed to be Level 3, as defined in Note 6.
As of December 31, 2020, the Company has incurred $6,182,775 in financing costs related to the SBA-guaranteed debentures since receiving our licenses, which were recorded as prepaid loan fees. As of December 31, 2020 and 2019, $3,332,504 and $3,456,147 of prepaid financing costs had yet to be amortized, respectively. These prepaid loan fees are presented on the consolidated statement 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:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
December 31,
December 31,
SBA- guaranteed debentures payable
$ 176,500,000
$ 161,000,000
Prepaid loan fees
3,332,504
3,456,147
SBA-guaranteed debentures, net of prepaid loan fees
$ 173,167,496
$ 157,543,853
The following table summarizes the interest expense and amortized fees on the SBA-guaranteed debentures for the years ended December 31, 2020, 2019 and 2018:
For the years ended
December 31,
December 31,
December 31,
Interest expense
$ 5,385,661
$ 5,166,475
$ 3,982,658
Debenture fee amortization
701,069
623,900
623,989
Total interest and financing expenses
$ 6,086,730
$ 5,790,375
$ 4,606,647
Weighted average interest rate
3.3%
3.4%
3.2%
Effective interest rate (including fee
amortization)
3.8%
3.8%
3.7%
Average debt outstanding
$ 161,635,246
$ 151,893,151
$ 125,390,411
Cash paid for interest
$ 5,346,231
$ 5,007,832
$ 3,107,218
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. The 2022 Notes will mature with a balance of $48,875,000 on September 15, 2022 and may be redeemed in whole or in part at any time or from time to time at the Company’s option at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly.
As of both December 31, 2020 and 2019, the aggregate carrying amount of all Notes was $48,875,000 and the fair value of the Notes was approximately $49,168,250 and $49,715,650, respectively. The 2022 Notes are listed on New York Stock Exchange under the trading symbol “SCA”. The fair value of the 2022 Notes is based on the closing price of the security, which is a Level 2 input under ASC 820 due to sufficient trading volume.
In connection with the issuance and maintenance of the 2022 Notes, we have incurred $1,688,961 of fees which are being amortized over the term of the 2022 Notes, of which $567,482 and $900,798 remained to be amortized as of December 31, 2020 and 2019, respectively. These financing costs are presented on the consolidated statement of assets and liabilities as a deduction from the debt liability.
The following table summarizes the interest expense and deferred financing costs on the 2022 Notes for the years ended December 31, 2020, 2019, 2018:
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
For the year
ended
December 31,
For the year
ended
December 31,
For the year
ended
December 31,
Interest expense
$ 2,810,312
$ 2,810,312
$ 2,810,312
Deferred financing costs
333,316
332,403
332,404
Administration fees
5,000
5,000
7,905
Total interest and financing expenses
$ 3,148,628
$ 3,147,715
$ 3,150,621
Weighted average interest rate
5.7%
5.8%
5.8%
Effective interest rate (including fee amortization)
6.4%
6.4%
6.4%
Average debt outstanding
$ 48,875,000
$ 48,875,000
$ 48,875,000
Cash paid for interest
$ 2,810,312
$ 2,810,312
$ 2,810,312
The following is a summary of the Notes Payable, net of deferred financing costs:
December 31,
December 31,
Notes payable
$ 48,875,000
$ 48,875,000
Deferred financing costs
567,482
900,798
Notes payable, net of deferred financing costs
$ 48,307,518
$ 47,974,202
The indenture and supplements thereto relating to the 2022 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.
NOTE 12 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the results of operations for the years ended December 31, 2020, 2019, and 2018. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.
Qtr. 1
Qtr. 2
Qtr. 3
Qtr. 4
Total Investment Income
$ 15,261,045
$ 13,841,278
$ 14,016,749
$ 13,539,242
Net Investment Income
$ 6,239,462
$ 5,435,615
$ 5,328,945
$ 4,987,881
Net (Decrease) Increase in Net Assets from operations
$ (43,939,732)
$ 39,812,674
$ 7,508,680
$ 16,810,819
Total Investment Income per share(1)
$ 0.79
$ 0.71
$ 0.72
$ 0.69
Net Investment Income per share(1)
$ 0.32
$ 0.28
$ 0.27
$ 0.26
Net (Decrease) Increase in Net Assets from Operations per share﻿(1)
$ (2.26)
$ 2.04
$ 0.39
$ 0.86
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Qtr. 1
Qtr. 2
Qtr. 3
Qtr. 4
Total Investment Income
$ 13,834,929
$ 14,170,255
$ 15,515,227
$ 15,391,478
Net Investment Income
$ 4,333,659
$ 5,415,400
$ 5,798,659
$ 6,891,091
Net Increase in Net Assets from Operations
$ 10,142,443
$ 5,994,683
$ 8,468,254
$ 1,832,807
Total Investment Income per share(1)
$ 0.85
$ 0.75
$ 0.82
$ 0.81
Net Investment Income per share(1)
$ 0.27
$ 0.29
$ 0.31
$ 0.36
Net Increase in Net Assets from Operations per
share﻿(1)
$ 0.62
$ 0.32
$ 0.45
$ 0.10
Qtr. 1
Qtr. 2
Qtr. 3
Qtr. 4
Total Investment Income
$ 10,911,781
$ 12,619,657
$ 14,487,623
$ 15,247,277
Net Investment Income
$ 4,475,379
$ 4,727,236
$ 5,609,974
$ 7,823,948
Net Increase in Net Assets from Operations
$ 7,343,929
$ 7,603,246
$ 8,884,517
$ 2,362,886
Total Investment Income per share(1)
$ 0.68
$ 0.79
$ 0.91
$ 0.96
Net Investment Income per share(1)
$ 0.28
$ 0.30
$ 0.35
$ 0.49
Net Increase in Net Assets from Operations per
share﻿(1)
$ 0.46
$ 0.48
$ 0.56
$ 0.14
(1)
Per share amounts are calculated using weighted average shares outstanding during the period.
NOTE 13 - INCOME TAXES
As of December 31, 2020 and December 31, 2019, the Company had $21,051,549 and $22,548,941, respectively, of undistributed ordinary income.(1) Undistributed capital gains were $0 and $2,053,494 for the periods ended December 31, 2020 and December 31, 2019, respectively. All of the undistributed ordinary income as of December 31, 2020 will have been distributed within the required period of time such that the Company will not have to pay corporate-level U.S. federal income tax for the year ended December 31, 2020. We will be subject to a 4% nondeductible U.S. federal excise tax on our undistributed income to the extent we did not distribute an amount equal to at least 98% of our net ordinary income plus 98.2% of our capital gain net income attributable to the period. The Company has accrued $828,684 and $900,000 of U.S. federal excise tax for the tax years ended December 31, 2020 and December 31, 2019, respectively, independent of prior year adjustments. See Note 1 for further discussion of tax expense in each year.
Ordinary dividend distributions from a RIC do not qualify for the reduced maximum tax rate on qualified dividend income from domestic corporations, except to the extent that the RIC received the income in the form of qualifying dividends from domestic corporations and qualified foreign corporations. The tax character(2) of distributions paid in the years ended December 31, 2020 and 2019 was as follows:
December 31,
December 31,
Ordinary income
$ 20,154,524
$ 10,000,000
Qualified dividends
-
103,080
Distributions of long-term capital gains(2)
2,248,435
14,935,093
Total distributions accrued or paid to common stockholders
$ 22,402,959
$ 25,038,173
(1)
The Company’s taxable income for each period is an estimate and will not be finally determined until
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
the Company files its tax return for each year. Therefore, final taxable income earned in each period, and the undistributed ordinary income and capital gains for each period carried forward for distribution in the following period, may be different than this estimate.
(2)
Distributions of long-term capital gains of $2,248,435 as of December 31, 2020 differ from distributions of net capital gains on the Consolidated Statement of Changes in Net Assets because it represents the completion of distribution of long-term capital gains recognized in 2019 for tax purposes. The qualified dividend amount in 2019 is derived from qualified dividends received by the Company from a portfolio company. Additional differences arise because certain prepayment gains are characterized differently for tax reporting purposes.
Listed below is a reconciliation of “Net increase in net assets resulting from operations” to taxable income and total distributions declared to common stockholders for the years ended December 31, 2020, 2019 and 2018:
Net increase in net assets resulting from operations (includes NII, realized gain/loss, unrealized gain/loss and taxes)
$ 20,192,441
$ 26,438,186
$ 26,194,578
Net change in unrealized (appreciation) depreciation
(8,555,274)
15,499,766
1,646,549
Income tax provision
224,877
66,760
67,953
Pre-tax (income) expense, (gain) loss reported at Taxable Subsidiaries, not consolidated for tax purposes
65,484
(5,819,114)
416,203
Long term capital loss carryover
4,896,643
-
-
Book income and tax income differences, including debt origination, interest accrual, income from pass-through investments, dividends, realized gains (losses) and changes in estimates
2,840,954
3,791,081
1,524,556
Estimated taxable income
$ 19,665,125
$ 39,976,679
$ 29,849,839
Taxable income earned in prior year and carried forward for distribution in current year
22,434,805
7,496,299
(662,990)
Adjustment for cumulative effect of distributions carried forward
1,354,578
-
-
Taxable income earned prior to period end and carried forward for distribution next period
(21,051,549)
(24,602,435)
(9,303,869)
Distribution payable as of period end and paid in following period
-
2,167,630
1,807,570
Total distributions accrued or paid to common
stockholders
$ 22,402,959
$ 25,038,173
$ 21,690,550
The aggregate gross unrealized appreciation and depreciation, the net unrealized appreciation, and the aggregate cost of the Company’s portfolio company securities for U.S. federal income tax purposes as of December 31, 2020 and December 31, 2019 were as follows:
Aggregate cost of portfolio securities for federal income tax purposes
$ 658,628,966
$ 643,573,873
Gross unrealized appreciation of portfolio company securities
28,143,621
17,587,984
Gross unrealized depreciation of portfolio company securities
(33,348,092)
(31,347,731)
Net unrealized appreciation of portfolio company securities
$ (5,204,471)
$ (13,759,747)
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
As of December 31, 2020, the Taxable Subsidiaries had unrealized losses in investments, net operating loss (“NOL”) carryovers, and capital loss carryovers creating a net deferred tax liability equal to $12,779 as reflected below. As of December 31, 2020, for U.S. federal income tax purposes, the Taxable Subsidiaries had capital loss carry forward of $1,382,978, which, if unused, will expire in the taxable year 2021. As of December 31, 2020, for U.S. federal income tax purposes, the Taxable Subsidiaries had net operating loss carryforwards totaling $3,313,794 of which $1,615,912 will expire during the tax years 2033 through 2037 if unused. Due to the nature of the Taxable Subsidiaries’ holdings, a valuation allowance was established when management determined it is more likely than not that some of the deferred tax assets will not be realized prior to expiration. Although our future projections indicate that we may be able to realize a portion of these deferred tax assets, due to the degree of uncertainty of these projections, management has recorded a deferred tax asset valuation allowance of $346,811.
Deferred tax asset
$ 2,729,651
$ 2,189,818
Deferred tax liability
(2,742,430)
(2,043,021)
Total deferred tax asset (liability) before valuation allowance
$ (12,779)
$ 146,797
Deferred tax valuation allowance
$ (346,811)
$ (281,510)
Net Deferred Tax Liability
$ (359,590)
$ (134,713)
The Company has recorded a tax reclassification of stockholders’ equity in accordance with U.S. GAAP to reduce paid-in capital and increases distributable earnings (reducing the accumulated undistributed deficit) for book to tax differences that it has determined to be permanent. For the years ended December 31, 2020 and 2019, this reclassification was $1,090,062 and $366,375, respectively. The total adjustment on the Statement of Assets and Liabilities as of December 31, 2020 and 2019 was $1,456,437 and $366,375, respectively.
Although the Company files federal and state tax returns, its major tax jurisdiction is federal. The 2017, 2018 and 2019 federal tax years for the Company remain subject to examination by the Internal Revenue Service.
NOTE 14 - SENIOR SECURITIES
Information about the Company’s senior securities is shown in the following table for the fiscal years ended December 31, 2012 through 2020.
Class and Year
Outstanding
Exclusive of
Treasury
Securities(1)
Asset
Coverage per
Unit(2)
Involuntary
Liquidating
Preference
per Unit(3)
Average
Market Value
per Unit(4)
(In thousands, except per unit amounts)
SBA-guaranteed debentures
Fiscal 2014
$ 16,250
N/A(6)
-
N/A
Fiscal 2015
$ 65,000
N/A(6)
-
N/A
Fiscal 2016
$ 65,000
N/A(6)
-
N/A
Fiscal 2017
$ 90,000
N/A(6)
-
N/A
Fiscal 2018
$ 150,000
N/A(6)
-
N/A
Fiscal 2019
$ 161,000
N/A(6)
-
N/A
Fiscal 2020
$ 176,500
N/A(6)
-
N/A
Original Credit Facility(7)
Fiscal 2012
$ 38,000
$ 3,090
-
N/A
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Class and Year
Outstanding
Exclusive of
Treasury
Securities(1)
Asset
Coverage per
Unit(2)
Involuntary
Liquidating
Preference
per Unit(3)
Average
Market Value
per Unit(4)
(In thousands, except per unit amounts)
Fiscal 2013
$ 110,000
$ 2,470
-
N/A
Fiscal 2014
$ 106,500
$ 2,320(6)
-
N/A
Fiscal 2015
$ 109,500
$ 2,220(6)
-
N/A
Fiscal 2016
$ 116,000
$ 2,210(6)
-
N/A
Credit Facility
Fiscal 2017
$ 40,750
$ 3,460(6)
-
N/A
Fiscal 2018
$ 99,550
$ 2,520(6)
-
N/A
Fiscal 2019
$ 161,550
$ 2,286(6)
-
N/A
Fiscal 2020
$ 174,000
$ 2,230(6)
-
N/A
5.75% Notes due 2022
Fiscal 2017
$ 48,875
$ 3,460(6)
-
$ 25.34
Fiscal 2018
$ 48,875
$ 2,520(6)
-
$ 25.18
Fiscal 2019
$ 48,875
$ 2,286(6)
-
$ 24.43
Fiscal 2020
$ 48,875
$ 2,230(6)
-
$ 23.64
6.50% Notes due 2019(8)
Fiscal 2014
$ 25,000
$ 2,320(6)
-
$ 25.41
Fiscal 2015
$ 25,000
$ 2,220(6)
-
$ 25.27
Fiscal 2016
$ 25,000
$ 2,210(6)
-
$ 25.11
Short-Term Loan(5)
Fiscal 2012
$ 45,000
$ 3,090
-
N/A
Fiscal 2013
$ 9,000
$ 2,470
-
N/A
(1)
Total amount of senior securities outstanding at the end of the period presented.
(2)
Asset coverage per unit is the ratio of the carrying value of the Company’s total assets, less all liabilities and indebtedness not represented by senior securities, in relation to the aggregate amount of senior securities representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness.
(3)
The amount to which such class of senior security would be entitled upon the involuntary liquidation of the issuer in preference to any security junior to it. The “- “ indicates information which the SEC expressly does not require to be disclosed for certain types of senior securities.
(4)
Average market value per unit for the 2022 Notes and the 6.50% Notes due 2019 represents the average of the daily closing prices as reported on the NYSE during the period presented. Average market value per unit for our SBA-guaranteed debentures, the Original Credit Facility and the Credit Facility are not applicable because these are not registered for public trading.
(5)
Refers to short-term loans that the Company obtained from Raymond James & Associates, Inc. and repaid in full on January 2, 2013 and January 2, 2014, respectively.
(6)
The Company has excluded its SBA-guaranteed debentures from the asset coverage calculation as of December 31, 2020, 2019, 2018, 2017, 2016, 2015 and 2014 pursuant to the exemptive relief granted by the SEC in August 2014 that permits it to exclude such SBA-guaranteed debentures from the definition of senior securities in the 150% asset coverage ratio we are required to maintain under the 1940 Act.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
(7)
On November 13, 2012, the Company entered into a senior secured revolving credit agreement, by and among us, as the borrower, SunTrust Bank, as the administrative agent, various lenders that are parties thereto from time to time (the “Original Credit Facility”). The Company terminated the Original Credit Facility on October 11, 2017.
(8)
On September 20, 2017, the Company redeemed all of the issued and outstanding 6.50% Notes due 2019.
NOTE 15 - SUBSEQUENT EVENTS
Investment Portfolio
On January 14, 2021, the Company received full repayment on the first lien term loan and revolver of BFC Solmetex, LLC. for total proceeds of $13,613,967. The Company also received full repayment on the first lien term loan of Bonded Filter Co. LLC, a subsidiary of BFC Solmetex, LLC, for total proceeds of $1,193,460.
On January 29, 2021, the Company invested $11,250,000 in the first lien term loan of NuSource Financial, LLC, a provider of technology integration and installation of Automated Teller Machines / Integrated Teller Machines (“ATM” / “ITM”), maintenance services, and security solutions. Additionally, the Company invested $4,750,000 in the subordinated debt and warrants of the company.
On February 1, 2021, the Company invested $41,018 in the equity of Tailwind Core Investor, LLC, an existing portfolio company.
On February 11, 2021, the Company invested $7,194,811 in the first lien term loan of Time Manufacturing Acquisition, LLC, an existing portfolio company. Additionally, the Company invested $53,600 in the equity of the company.
On February 19, 2021, the Company invested $13,500,000 in the first lien term loan and committed $100,000 in the unfunded revolver of CEATI International, Inc., a provider of intellectual content, technical trade programs, research groups, and conferences for utility companies. Additionally, the Company invested $250,000 in the equity of the company.
On March 1, 2021, the Company invested $10,787,208 in the first lien term loan and committed $100,000 in the unfunded revolver of TAC LifePort Purchaser, LLC, a provider of aerospace products for the U.S. military / government, air medical, and high-end VIP aircraft end markets. Additionally, the Company invested $500,000 in the equity of the company.
On March 2, 2021, the Company invested $10,000,000 in the first lien term loan and $100,000 in the unfunded revolver of TradePending, LLC, a provider of vehicle trade-in and merchandising intelligence solutions for auto dealerships, primarily flagship dealerships. Additionally, we invested $750,000 in the equity of the company.
2026 Notes
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 is payable semi-annually beginning September 30, 2021. The Company used all of the net proceeds from this offering to fully redeem the 2022 Notes and repay a portion of the outstanding amount under the Credit Facility.
STELLUS CAPITAL INVESTMENT CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2020
Redemption of 2022 Notes
On February 12, 2021, the Company redeemed all $48,875,000 in aggregate principal amount of the 2022 Notes. The 2022 Notes were redeemed at 100% of their principal amount, plus the accrued and unpaid interest thereon through the redemption date.
Credit Facility
The outstanding balance under the Credit Facility as of March 3, 2021 was $164,500,000.
SBA-guaranteed Debentures
The outstanding balance of SBA-guaranteed debentures as of March 3, 2021 was $210,000,000.
SBIC II Subsidiary
On January 21, 2021, the Company contributed $15,000,000 to the SBIC II subsidiary, bringing the total contributed capital to $35,000.000. On January 25, 2021, the Company increased committed capital to $60,000,000.
Distributions Declared
On January 15, 2021, the Company’s Board changed the frequency of distributions from quarterly to monthly and declared a regular monthly distribution for each of January, February and March 2021 as follows:
Declared
Ex-Dividend Date
Record Date
Payment Date
Amount per Share
1/15/2021
1/28/2021
1/29/2021
2/16/2021
$ 0.0833
1/15/2021
2/25/2021
2/26/2021
3/15/2021
$ 0.0833
1/15/2021
3/30/2021
3/31/2021
4/15/2021
$ 0.0833

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9.
Changes in and Disagreements with Independent Registered Public Accounting Firm on Accounting and Financial Disclosure
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A.
Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2020 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the 1934 Act). Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
(b) Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f), and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2020. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2020 based upon the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment, management determined that our internal control over financial reporting was effective as of December 31, 2020.
(c) Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal control over financing reporting that occurred during the fourth fiscal quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
Item 9B.
Other Information.
None.
PART III
We will file with the Securities and Exchange Commission (the “SEC”) a definitive Proxy Statement for Stellus Capital Investment Corporation’s (“we”, “us”, “our” and the “Company”) 2021 Annual Meeting of Stockholders, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to the Annual Report on Form 10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are incorporated by reference.

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by Item 10 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2021 Annual Meeting of Stockholders, to be filed with the SEC within 120 days following the end of the Company’s fiscal year.
We have adopted a code of business conduct and ethics that applies to our directors, officers and employees. This code of ethics is published on our website at www.stelluscapital.com . We intend to disclose any future amendments to, or waivers from, this code of conduct within four business days of the waiver or amendment through a website posting.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11.
Executive Compensation
The information required by Item 11 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2021 Annual Meeting of Stockholders, to be filed with the SEC within 120 days following the end of the Company’s fiscal year.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2021 Annual Meeting of Stockholders, to be filed with the SEC within 120 days following the end of the Company’s fiscal year.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2021 Annual Meeting of Stockholders, to be filed with the SEC within 120 days following the end of the Company’s fiscal year.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14.
Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from the Company’s definitive Proxy Statement relating to the Company’s 2021 Annual Meeting of Stockholders, to be filed with the SEC within 120 days following the end of the Company’s fiscal year.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits, Financial Statement Schedules
a. Documents Filed as Part of this Report
The following financial statements are set forth in Item 8:
Page
Report of Independent Registered Public Accounting Firm
Statements of Assets and Liabilities as of December 31, 2020 and December 31, 2019
Statements of Operations for the years ended December 31, 2020, 2019, and 2018
Statements of Changes in Net Assets for the years ended December 31, 2020, 2019, and 2018
Statements of Cash Flows for the years ended December 31, 2020, 2019, and 2018
Schedule of Investments as of December 31, 2020 and December 31, 2019
Notes to Financial Statements
b. Exhibits
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:
 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).
 3.3 
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).
 4.1 
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).
 4.2 
Form of Indenture (Incorporated by reference to Exhibit (d)(2) to the Registrant’s Registration Statement on Form N-2 (File No. 333-189938, filed January 29, 2014).
 4.4 
Second Supplemental Indenture between the Registrant and U.S. Bank National Association, date August 21, 2017, (Incorporated by reference on exhibit (d)(6) to the Registrant’s Registration Statement on Form N-2 (File No. 333-216138), filed on August 23, 2017).
 4.5 
Third Supplemental Indenture between the Registrant and U.S. Bank National Association, date January 14, 2021 (Incorporated by reference Exhibit 1.1 to the Registrant’s Current Report on Form 8-K (File No 814-00971), filed on January 14, 2021).
 4.6 
Form of Global Note with respect to the 5.75% Note due 2022 (Incorporated by reference to Exhibit 4.4).
 4.7 
Form of Global Note with respect to the 4.875% Note due 2026 (Incorporated by reference to Exhibit 4.5).
 4.8*
Description of Securities
10.1 
Form of Investment Advisory Agreement between Registrant and Stellus Capital Management, LLC (Incorporated by reference to Exhibit (g)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.2 
Custody Agreement between Registrant and ZB, National Association (Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File No. 814-00971), filed on November 7, 2017).
10.3 
Administration Agreement between Registrant and Stellus Capital Management, LLC (Incorporated by reference to Exhibit (k)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.4 
Dividend Reinvestment Plan (Incorporated by reference to Exhibit (e) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.5 
Form of License Agreement between the Registrant and Stellus Capital Management (Incorporated by reference to Exhibit (k)(2) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.6 
Form of Indemnification Agreement between the Registrant and the directors (Incorporated by reference to Exhibit (k)(3) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
10.7 
Form of Guarantee and Security Agreement, the Registrant, ZB, N.A., dba Amegy Bank, as administrative agent, and ZB, N.A. dba Amegy Bank, as collateral agent (Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (File No. 814-00971), filed on October 13, 2017).
10.8 
Consent and Waiver, dated March 28, 2018, between the Registrant, as a borrower, the lenders party hereto and ZB, N.A. dba Amegy Bank, as administrative agent
10.9 
First Amendment to Senior Secured Revolving Credit Agreement and Commitment Increase, dated March 28, 2018, between the Registrant, as a borrower, the lenders party thereto and ZB, N.A. dba Amegy Bank, as administrative agent
14.1 
Code of Ethics (Incorporated by reference to Exhibit (r)(1) to the Registrant’s Registration Statement on Form N-2 (File No. 333-184195), filed on October 23, 2012).
21.1 
Subsidiaries of the Registrant and jurisdiction of incorporation/organizations:
Stellus Capital SBIC, LP - Delaware
Stellus Capital SBIC GP, LLC - Delaware
Stellus Capital SBIC II, LP - Delaware
SCIC-SKP Blocker 1, Inc. - Delaware
SCIC-ERC Blocker 1, Inc. - Delaware
SCIC-Consolidated Blocker 1, Inc. - Delaware
SCIC-CC Blocker 1, Inc. - Delaware
SCIC-APE Blocker 1, Inc. - Delaware
SCIC-Hollander Blocker 1, Inc. - Delaware
SCIC-Invincible Blocker 1, Inc. - Delaware
SCIC-FBO Blocker 1, Inc. - Delaware
SCIC-ICD Blocker 1, Inc. - Delaware
SCIC-Venbrook Blocker 1, Inc. - Delaware
23.1*
Consent of Grant Thornton LLP
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended.
31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended.
32.1*
Certification of Chief Executive Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
32.2*
Certification of Chief Financial Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002.
*
Filed herewith.
c. Financial statement schedules
No financial statement schedules are filed herewith because (1) such schedules are not required or (2) the information has been presented in the aforementioned financial statements.