UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2021 OR ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-35730 STELLUS CAPITAL INVESTMENT CORPORATION (Exact Name of Registrant as Specified in Its Charter) Maryland 46-0937320 (State or other Jurisdiction of Incorpo ...

Stellus Capital Investment Corporation (NYSE:SCM) Q2 2021 Earnings Conference Call August 3, 2021 12:00 PM ET Company Participants Robert Ladd - Chief Executive Officer Todd Huskinson - Chief Financial Officer Conference Call Participants Bryce Rowe - Hovde Group Christopher Nolan - Ladenburg Thalmann Matt Tjaden - Raymond James Ryan Lynch - KBW Operator Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Stellus Capital Investment Corpora ...

OR ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-35730 STELLUS CAPITAL INVESTMENT CORPORATION (Exact Name of Registrant as Specified in Its Charter) UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2021 (I.R.S. Employer Identification No.) 4400 Post Oak Parkway, Suit ...

Financial Data and Key Metrics Changes - For Q1 2021, the company reported GAAP net investment income of $0.26 per share, covering the dividend of $0.25 per share, with core net investment income at $0.28 per share [6][10] - Net asset value per share remained stable at $14.03 [6] - The investment portfolio at fair value increased to $714.5 million from $653 million at year-end, with a growth of approximately $60 million for the quarter [10][12] Business Line Data and Key Metrics Changes - The company funded $93 million in new investments during the quarter, with $33.6 million in repayments, resulting in a net increase in the portfolio [10] - The portfolio is heavily weighted towards secured lending, with 95% of loans secured and 93% at floating rates [11] - 86% of the loan portfolio consists of first lien or unit tranche loans, indicating a focus on lower-risk investments [11] Market Data and Key Metrics Changes - The company has identified potential fundings of approximately $75 million that could be executed by the end of the current quarter [13] - The company continues to see an increase in investment opportunities, with a solid pipeline of actionable investments [13] Company Strategy and Development Direction - The company has maintained a stable asset quality rating, with 17% of the portfolio rated ahead of plan and only 8% rated below plan [12] - The investment strategy focuses on maintaining a high percentage of first lien investments, which is expected to remain the norm moving forward [40][42] - The company is leveraging its SBIC licenses to draw low-cost debentures, enhancing its capital structure [7][33] Management's Comments on Operating Environment and Future Outlook - Management expressed confidence in the stability of asset quality and the ability to cover dividends, indicating a positive outlook for the upcoming quarters [5][6] - The company anticipates a robust second quarter, driven by increased activity and a strong pipeline of investments [32][34] Other Important Information - Since its IPO in November 2012, the company has invested approximately $1.7 billion across over 135 companies, with a total of $164 million in dividends paid to investors [9] - The company completed a $100 million institutional bond offering to refinance existing debt and strengthen its balance sheet [6][10] Q&A Session Summary Question: What will the company do with excess cash in the second quarter? - Management indicated that most of the cash will be reinvested through SBIC licenses, with expectations to fully invest by June 30 [20] Question: What is the outlook for Grupo HIMA, which has non-accrual investments? - Management acknowledged the troubled situation with Grupo HIMA but noted that it represents a small position in the overall portfolio [22] Question: Is the non-accrual status of a commercializing company due to COVID-related issues? - Management clarified that the non-accrual status is more related to structural issues rather than COVID, and they expect to resolve it positively [28] Question: How has the portfolio construction changed over the years? - Management confirmed that the current focus on first lien debt investments is part of their long-term strategy and is not expected to change significantly [40][42] Question: What are the company's targets for leverage post-COVID? - Management reiterated targets of one-to-one regulatory leverage and up to two-to-one total leverage, with potential for slight increases due to the nature of the portfolio [44]

PART I. FINANCIAL INFORMATION [Item 1. Financial Statements](index=3&type=section&id=Item%201.%20Financial%20Statements) This section includes Stellus Capital Investment Corporation's unaudited consolidated statements of assets and liabilities, operations, changes in net assets, cash flows, and schedules of investments as of March 31, 2021, and December 31, 2020, with detailed notes covering operations, accounting policies, related party transactions, dividends, equity offerings, investment portfolio and fair value, commitments and contingencies, financial highlights, credit facilities, and SBA debentures [Consolidated Statements of Assets and Liabilities](index=3&type=section&id=Consolidated%20Statements%20of%20Assets%20and%20Liabilities) As of March 31, 2021, total assets increased significantly to $747.8 million, up 10.8% from $674.9 million on December 31, 2020, driven by increases in non-controlled, non-affiliated investments and cash, with total liabilities rising to $474.3 million, while net assets remained stable at $273.4 million, and NAV per share at $14.03 Consolidated Statements of Assets and Liabilities | Metric | March 31, 2021 (Unaudited) | December 31, 2020 | Change | | :----------------------------------- | :------------------------- | :---------------- | :------- | | Total Assets | $747,758,576 | $674,910,157 | +10.8% | | Non-controlled, non-affiliated investments (fair value) | $714,464,472 | $653,424,495 | +9.3% | | Cash and cash equivalents | $30,449,635 | $18,477,602 | +64.8% | | Total Liabilities | $474,329,691 | $401,549,508 | +18.1% | | Notes payable | $97,765,674 | $48,307,518 | +102.4% | | SBA-guaranteed debentures | $205,285,585 | $173,167,496 | +18.5% | | Net Assets | $273,428,885 | $273,360,649 | +0.02% | | Net Asset Value Per Share | $14.03 | $14.03 | 0% | [Consolidated Statements of Operations](index=4&type=section&id=Consolidated%20Statements%20of%20Operations) For the three months ended March 31, 2021, net investment income decreased by 19.0% to $5.06 million from $6.24 million in the prior year, primarily due to lower interest income, while the net increase in net assets from operations significantly improved to $4.94 million, compared to a $43.94 million decrease in the prior year, driven by unrealized appreciation Consolidated Statements of Operations | Metric | Three months ended March 31, 2021 (Unaudited) | Three months ended March 31, 2020 (Unaudited) | Change | | :------------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | :------- | | Total Investment Income | $13,987,864 | $15,261,045 | -8.3% | | Total Operating Expenses | $8,927,233 | $9,021,583 | -1.0% | | Net Investment Income | $5,060,631 | $6,239,462 | -19.0% | | Net realized gain on investments | $462,228 | $1,296,793 | -64.3% | | Loss on debt extinguishment | $(539,250) | $0 | N/A | | Net change in unrealized appreciation (depreciation) | $121,983 | $(51,504,946) | N/A | | Net Increase (Decrease) in Net Assets from Operations | $4,937,788 | $(43,939,732) | N/A | | Net Investment Income Per Share | $0.26 | $0.32 | -18.8% | | Net Increase (Decrease) in Net Assets from Operations Per Share | $0.25 | $(2.26) | N/A | | Distributions Per Share | $0.25 | $0.34 | -26.4% | [Consolidated Statements of Changes in Net Assets](index=5&type=section&id=Consolidated%20Statements%20of%20Changes%20in%20Net%20Assets) For the three months ended March 31, 2021, net assets increased by $68,236 to $273.4 million, a significant improvement compared to a $45.65 million decrease in the prior year, primarily due to the net increase in net assets from operations offsetting distributions to shareholders Consolidated Statements of Changes in Net Assets | Metric | Three months ended March 31, 2021 (Unaudited) | Three months ended March 31, 2020 (Unaudited) | Change | | :------------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | :------- | | Net Increase (Decrease) in Net Assets from Operations | $4,937,788 | $(43,939,732) | N/A | | Total Distributions | $(4,869,552) | $(6,619,297) | -26.4% | | Net Increase in Net Assets from Capital Share Transactions | $0 | $4,906,521 | N/A | | Total Increase (Decrease) in Net Assets | $68,236 | $(45,652,508) | N/A | | Net Assets at End of Period | $273,428,885 | $224,918,665 | +21.6% | [Consolidated Statements of Cash Flows](index=6&type=section&id=Consolidated%20Statements%20of%20Cash%20Flows) For the three months ended March 31, 2021, operating activities used $57.1 million in cash, primarily for investment purchases, while financing activities provided $69.0 million, mainly from new notes and SBA debentures, resulting in a $12.0 million net increase in cash Consolidated Statements of Cash Flows | Metric | Three months ended March 31, 2021 (Unaudited) | Three months ended March 31, 2020 (Unaudited) | Change | | :------------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | :------- | | Net Cash Used in Operating Activities | $(57,052,324) | $(27,884,098) | +104.6% | | Net Cash Provided by Financing Activities | $69,024,357 | $46,776,029 | +47.6% | | Net Increase in Cash and Cash Equivalents | $11,972,033 | $18,891,931 | -36.6% | | Cash and Cash Equivalents Balance at End of Period | $30,449,635 | $35,025,246 | -13.1% | | Cash paid for interest expense | $4,166,438 | $5,291,684 | -21.3% | [Consolidated Schedules of Investments](index=7&type=section&id=Consolidated%20Schedules%20of%20Investments) As of March 31, 2021, the fair value of the investment portfolio increased to $714.5 million across 70 portfolio companies, up from $653.4 million (66 companies) on December 31, 2020, primarily comprising senior secured first lien debt (79%) and concentrated in business services, healthcare, and aerospace & defense, with unfunded commitments decreasing to $22.8 million Total Investments | Metric | March 31, 2021 (Fair Value) | December 31, 2020 (Fair Value) | Change | | :----------------------------------- | :---------------------------- | :----------------------------- | :------- | | Total Investments | $714,464,472 | $653,424,495 | +9.3% | | Number of Portfolio Companies | 70 | 66 | +4 | | Senior Secured – First Lien | $564,335,624 (79%) | $508,673,064 (78%) | +10.9% | | Senior Secured – Second Lien | $61,483,486 (9%) | $70,720,186 (11%) | -13.0% | | Unsecured Debt | $32,155,362 (4%) | $21,191,245 (3%) | +51.7% | | Equity | $56,490,000 (8%) | $52,840,000 (8%) | +6.9% | - **Geographical Concentration (March 31, 2021):** Primarily concentrated in **Texas (19.69%)**, **California (13.00%)**, and **Illinois (8.88%)**[160](index=160&type=chunk)[247](index=247&type=chunk) - **Industry Concentration (March 31, 2021):** Primarily concentrated in **Business Services (22.74%)**, **Healthcare & Pharmaceuticals (11.60%)**, and **Aerospace & Defense (9.09%)**[170](index=170&type=chunk)[249](index=249&type=chunk) - **Unfunded Commitments:** Decreased from **$28.9 million** (19 companies) on December 31, 2020, to **$22.8 million** (22 companies) on March 31, 2021[174](index=174&type=chunk)[251](index=251&type=chunk) [Notes to Unaudited Financial Statements](index=26&type=section&id=Notes%20to%20Unaudited%20Financial%20Statements) This section details the company's operations, significant accounting policies, related party transactions, dividends, equity offerings, investment portfolio and fair value measurement, commitments and contingencies, financial highlights, credit facilities, SBA debentures, and the potential impact of COVID-19 on operations and investments [NOTE 1 — NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES](index=26&type=section&id=NOTE%201%20%E2%80%94%20NATURE%20OF%20OPERATIONS%20AND%20SIGNIFICANT%20ACCOUNTING%20POLICIES) Stellus Capital Investment Corporation operates as an externally managed BDC and RIC, focusing on debt and equity investments in middle-market companies, utilizing wholly-owned taxable subsidiaries and SBIC subsidiaries for investments and leverage, with its asset coverage ratio reduced to 150% in 2018, and continuously assessing COVID-19 impacts - **Company Status:** An externally managed, closed-end, non-diversified investment management company, regulated as a Business Development Company (BDC) under the 1940 Act and treated as a Regulated Investment Company (RIC) under the Internal Revenue Code of 1986, as amended[55](index=55&type=chunk)[58](index=58&type=chunk) - **Investment Objective:** To maximize total shareholder return through current income and capital appreciation by investing in debt and related equity of middle-market companies, typically with **EBITDA between $5 million and $50 million**[59](index=59&type=chunk) - **SBIC Subsidiaries:** Stellus Capital SBIC, LP ("SBIC Subsidiary") was formed in 2013, and Stellus Capital SBIC II, LP ("SBIC II Subsidiary") in 2018, both licensed by the U.S. Small Business Administration (SBA) to operate as Small Business Investment Companies (SBICs) and issue SBA-guaranteed debentures[60](index=60&type=chunk)[65](index=65&type=chunk) - **Asset Coverage Ratio:** The company's applicable asset coverage ratio test was reduced from 200% to **150%** on June 29, 2018, following board and shareholder approval, with the ratio standing at **203%** as of March 31, 2021[66](index=66&type=chunk)[67](index=67&type=chunk) - **COVID-19 Impact:** The company is assessing the impact of the COVID-19 pandemic on investment valuations and portfolio company liquidity, anticipating that the pandemic may have a significant adverse effect on future net investment income, fair value of investments, and financial condition[72](index=72&type=chunk)[74](index=74&type=chunk) SBIC Regulatory Capital and Debentures | Metric | March 31, 2021 | December 31, 2020 | | :------------------------------------------------- | :------------- | :---------------- | | SBIC I Regulatory Capital | $75,000,000 | $75,000,000 | | SBIC II Regulatory Capital | $60,000,000 | $40,000,000 | | SBIC I SBA-guaranteed debentures outstanding | $150,000,000 | $150,000,000 | | SBIC II SBA-guaranteed debentures outstanding | $60,000,000 | $26,500,000 | [NOTE 2 — RELATED PARTY ARRANGEMENTS](index=34&type=section&id=NOTE%202%20%E2%80%94%20RELATED%20PARTY%20ARRANGEMENTS) The company has agreements with its investment adviser, Stellus Capital, including an investment advisory agreement with a 1.75% base management fee and incentive fees (subject to a 2.0% hurdle and total return requirements for investment income, and 20% of cumulative realized capital gains), an administration agreement, and a name license agreement, also engaging in co-investments with affiliated funds under an SEC exemptive order Related Party Fees and Expenses | Fee Type | Three Months Ended March 31, 2021 | Three Months Ended March 31, 2020 | | :--------------------------------- | :-------------------------------- | :-------------------------------- | | Base Management Fees | $2,963,861 | $2,719,054 | | Investment Income Incentive Fees | $0 | $1,339,637 | | Capital Gains Incentive Fee (reversed) | $83,281 | $(880,913) | | Total Incentive Fee Expense | $83,281 | $458,724 | | Administrative Services Expenses | $381,050 | $399,599 | | Director Fees | $91,500 | $132,250 | - **Investment Income Incentive Fees:** Based on net investment income before incentive fees, subject to a **2.0% (8.0% annualized)** hurdle rate and a cumulative total return requirement, with no incentive fee paid if net investment income before incentive fees does not exceed the hurdle[118](index=118&type=chunk)[119](index=119&type=chunk) - **Capital Gains Incentive Fee:** Equal to **20.0%** of cumulative realized capital gains since inception, less cumulative realized capital losses and cumulative unrealized capital depreciation[123](index=123&type=chunk) - **Co-Investments:** Under an SEC exemptive order, the company can co-invest with private funds managed by Stellus Capital or its affiliates to access more investment opportunities and achieve greater diversification[129](index=129&type=chunk) [NOTE 3 — DISTRIBUTIONS](index=37&type=section&id=NOTE%203%20%E2%80%94%20DISTRIBUTIONS) The company typically declares quarterly dividends and plans to distribute at least its net realized income annually to maintain RIC qualification, with total common stock dividends declared since inception reaching $11.16 per share as of March 31, 2021, operating an "opt-out" dividend reinvestment plan that may increase total assets and associated management fees - **Dividend Policy:** Dividends are typically declared quarterly, with plans to distribute at least its net realized income annually to maintain RIC qualification[137](index=137&type=chunk) - **Dividend Reinvestment Plan (DRIP):** Operates an "opt-out" DRIP where shareholders receive dividends in company common stock unless they elect to receive cash, with participation increasing total assets and consequently impacting base management and incentive fee calculations[141](index=141&type=chunk) Total Distributions Per Share | Fiscal Year | Total Distributions Per Share | | :---------- | :---------------------------- | | 2012 | $0.18 | | 2013 | $1.36 | | 2014 | $1.42 | | 2015 | $1.36 | | 2016 | $1.36 | | 2017 | $1.36 | | 2018 | $1.36 | | 2019 | $1.36 | | 2020 | $1.15 | | 2021 (Q1) | $0.25 (3 x $0.0833) | | **Total (Inception - Mar 31, 2021)** | **$11.16** | [NOTE 4 — EQUITY OFFERINGS AND RELATED EXPENSES](index=39&type=section&id=NOTE%204%20%E2%80%94%20EQUITY%20OFFERINGS%20AND%20RELATED%20EXPENSES) Since inception, the company has issued 19,486,003 shares of common stock, raising $286.6 million in gross proceeds, with no shares issued in Q1 2021, but 332,591 shares issued in Q1 2020 through an ATM Program for $4.795 million Equity Offerings (Inception) | Metric | Total (Inception) | | :--------------------------------- | :---------------- | | Number of Shares Issued | 19,486,003 | | Gross Proceeds | $286,629,818 | | Underwriting Fees | $7,414,918 | | Offering Expenses | $1,712,309 | | Net Proceeds | $277,502,591 | - **Q1 2021 Issuance:** No shares were issued[148](index=148&type=chunk) - **Q1 2020 ATM Program:** **332,591 shares** were issued, generating **$4,794,995** in gross proceeds at an average price of **$14.42 per share**[149](index=149&type=chunk) - **DRIP Issuance:** **0 shares** issued in Q1 2021, compared to **9,910 shares** in Q1 2020[149](index=149&type=chunk) [NOTE 5 — NET INCREASE (DECREASE) IN NET ASSETS PER COMMON SHARE](index=40&type=section&id=NOTE%205%20%E2%80%94%20NET%20INCREASE%20(DECREASE)%20IN%20NET%20ASSETS%20PER%20COMMON%20SHARE) For the three months ended March 31, 2021, the net increase in net assets per share was $0.25, a significant improvement compared to a $2.26 decrease per share in the prior year Net Increase (Decrease) in Net Assets Per Common Share | Metric | Three Months Ended March 31, 2021 | Three Months Ended March 31, 2020 | | :------------------------------------------------- | :-------------------------------- | :-------------------------------- | | Net increase (decrease) in net assets from operations | $4,937,788 | $(43,939,732) | | Weighted average common shares | 19,486,003 | 19,429,480 | | Net increase (decrease) in net assets from operations per share | $0.25 | $(2.26) | [NOTE 6 — PORTFOLIO INVESTMENTS AND FAIR VALUE](index=40&type=section&id=NOTE%206%20%E2%80%94%20PORTFOLIO%20INVESTMENTS%20AND%20FAIR%20VALUE) As of March 31, 2021, the fair value of the investment portfolio increased to $714.5 million across 70 companies, up from $653.4 million (66 companies) on December 31, 2020, primarily comprising senior secured first lien debt (79%) with equity investments at 8%, all classified as Level 3 fair value, and unfunded commitments decreasing to $22.8 million Total Investments | Metric | March 31, 2021 (Fair Value) | December 31, 2020 (Fair Value) | Change | | :----------------------------------- | :---------------------------- | :----------------------------- | :------- | | Total Investments | $714,464,472 | $653,424,495 | +9.3% | | Number of Portfolio Companies | 70 | 66 | +4 | | Senior Secured – First Lien | $564,335,624 (79%) | $508,673,064 (78%) | +10.9% | | Senior Secured – Second Lien | $61,483,486 (9%) | $70,720,186 (11%) | -13.0% | | Unsecured Debt | $32,155,362 (4%) | $21,191,245 (3%) | +51.7% | | Equity | $56,490,000 (8%) | $52,840,000 (8%) | +6.9% | - **Fair Value Hierarchy:** All investments are classified as **Level 3**, indicating their valuation relies on significant unobservable inputs[153](index=153&type=chunk) - **Unfunded Commitments:** Decreased from **$28.9 million** (19 companies) on December 31, 2020, to **$22.8 million** (22 companies) on March 31, 2021[160](index=160&type=chunk) - **Geographical Concentration (March 31, 2021):** Primarily concentrated in **Texas (19.69%)**, **California (13.00%)**, and **Illinois (8.88%)**[170](index=170&type=chunk) - **Industry Concentration (March 31, 2021):** Primarily concentrated in **Business Services (22.74%)**, **Healthcare & Pharmaceuticals (11.60%)**, and **Aerospace & Defense (9.09%)**[174](index=174&type=chunk) Aggregate Portfolio Value | Metric | March 31, 2021 | December 31, 2020 | | :--------------------------------------- | :------------- | :---------------- | | Aggregate cost of portfolio securities | $719,546,960 | $658,628,966 | | Gross unrealized appreciation | $29,436,962 | $28,143,621 | | Gross unrealized depreciation | $(34,519,450) | $(33,348,092) | | Aggregate fair value | $714,464,472 | $653,424,495 | [NOTE 7 — COMMITMENTS AND CONTINGENCIES](index=49&type=section&id=NOTE%207%20%E2%80%94%20COMMITMENTS%20AND%20CONTINGENCIES) The company is not currently involved in any material legal proceedings, and unfunded commitments for debt financing to portfolio companies decreased to $22.8 million as of March 31, 2021, from $28.9 million on December 31, 2020, with sufficient liquidity maintained to meet these obligations - **Legal Proceedings:** The company is not currently involved in any material legal proceedings, nor has it received any threats of such[183](index=183&type=chunk) - **Unfunded Commitments:** As of March 31, 2021, the company had **$22,838,727** in unfunded commitments to **22** existing portfolio companies, down from **$28,865,202** to **19** companies on December 31, 2020[185](index=185&type=chunk) - **Liquidity:** The company maintains sufficient liquidity through cash on hand and available borrowings under its credit facility to address unfunded loan commitments[185](index=185&type=chunk) [NOTE 8 — FINANCIAL HIGHLIGHTS](index=50&type=section&id=NOTE%208%20%E2%80%94%20FINANCIAL%20HIGHLIGHTS) Net asset value per share remained stable at $14.03, while net investment income per share decreased to $0.26 from $0.32 year-over-year, but total return based on market value significantly improved to 19.1% from (47.8)%, reflecting recovery from COVID-19 impacts, and the asset coverage ratio increased from 1.87x to 2.03x Financial Highlights | Metric | March 31, 2021 | March 31, 2020 | Change | | :------------------------------------------------- | :------------- | :------------- | :------- | | Net asset value at beginning of period | $14.03 | $14.14 | -0.8% | | Net investment income per share | $0.26 | $0.32 | -18.8% | | Net increase (decrease) in net assets from operations per share | $0.25 | $(2.26) | N/A | | Net asset value at end of period | $14.03 | $11.55 | +21.5% | | Per share market value at end of period | $12.70 | $7.29 | +74.2% | | Total return based on market value | 19.1% | (47.8)% | N/A | | Weighted average shares outstanding | 19,486,003 | 19,429,480 | +0.3% | | Asset coverage ratio | 2.03x | 1.87x | +8.6% | | Annualized ratio of net investment income to net assets | 7.45% | 9.28% | -19.7% | | Portfolio Turnover | 4.91% | 5.14% | -4.5% | [NOTE 9 — CREDIT FACILITY](index=51&type=section&id=NOTE%209%20%E2%80%94%20CREDIT%20FACILITY) The company's senior secured revolving credit facility, with a maximum of $230 million (expandable to $280 million) and maturing on September 18, 2025, had an outstanding balance of $165.5 million as of March 31, 2021, down from $174 million, bearing interest at LIBOR plus 2.50% (or 2.75% under certain conditions) with a 0.25% LIBOR floor, and the company remains compliant with all covenants, including the 1.67:1 asset coverage requirement - **Credit Facility Terms:** Senior secured revolving credit agreement with a maximum borrowing amount of **$230 million**, expandable to **$280 million**, with the commitment period expiring on September 18, 2024, and all borrowings due on September 18, 2025[189](index=189&type=chunk) - **Interest Rate:** Borrowings bear interest at **LIBOR plus 2.50%** (or 2.75% during certain periods if the asset coverage ratio is less than or equal to 1.90:1.00), with a **0.25% LIBOR floor**, and an unfunded commitment fee of **0.50% per annum**[192](index=192&type=chunk) - **Covenants:** Includes covenants to maintain minimum liquidity of at least **$10 million**, an asset coverage ratio of at least **1.67:1**, and minimum shareholder equity, all of which the company was in compliance with as of March 31, 2021[193](index=193&type=chunk) Credit Facility Outstanding Balance | Metric | March 31, 2021 | December 31, 2020 | Change | | :----------------------------------- | :------------- | :---------------- | :------- | | Outstanding Balance | $165,500,000 | $174,000,000 | -4.9% | | Credit facility payable, net of prepaid loan structure fees | $163,342,988 | $171,728,405 | -4.9% | Credit Facility Interest and Debt | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :---------------------------------- | :-------------------------------- | :-------------------------------- | | Total interest and financing expenses | $1,209,600 | $1,993,793 | | Weighted average interest rate | 2.8% | 4.1% | | Effective interest rate | 3.5% | 4.5% | | Average debt outstanding | $140,666,667 | $175,812,088 | [NOTE 10 — SBA-GUARANTEED DEBENTURES](index=53&type=section&id=NOTE%2010%20%E2%80%94%20SBA-GUARANTEED%20DEBENTURES) SBIC subsidiaries (SBIC I and SBIC II) issue SBA-guaranteed debentures, benefiting from an SEC exemption that excludes this debt from the 1940 Act's asset coverage test, with $150 million outstanding for SBIC I and $60 million for SBIC II as of March 31, 2021, these debentures feature fixed rates (10-year Treasury plus market spread) and 10-year terms, with upfront fees amortized over their life - **Exemptive Relief:** The company obtained SEC exemptive relief allowing SBA-guaranteed debt issued by its SBIC subsidiaries to be excluded from the 1940 Act's asset coverage test, increasing flexibility[198](index=198&type=chunk) - **Debenture Terms:** SBA-guaranteed debentures have fixed interest rates (equal to the prevailing 10-year U.S. Treasury rate plus a market spread), a **ten-year maturity**, and interest paid semi-annually, with principal not due until maturity but prepayable at any time without penalty, and upfront fees (**3.425% or 3.435%**) amortized over the debentures' life[199](index=199&type=chunk)[200](index=200&type=chunk) - **Regulatory Capital:** As of March 31, 2021, the SBIC Subsidiary had **$75 million** in regulatory capital, and the SBIC II Subsidiary had **$60 million** in regulatory capital[202](index=202&type=chunk) SBA-Guaranteed Debentures Outstanding | Metric | March 31, 2021 | December 31, 2020 | Change | | :----------------------------------- | :------------- | :---------------- | :------- | | Total SBA-guaranteed debentures outstanding | $210,000,000 | $176,500,000 | +18.9% | | SBA Debentures, net of prepaid loan fees | $205,285,585 | $173,167,496 | +18.5% | SBA-Guaranteed Debentures Interest and Debt | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :---------------------------------- | :-------------------------------- | :-------------------------------- | | Total interest and financing expenses | $1,619,647 | $1,512,958 | | Weighted average interest rate | 3.0% | 3.3% | | Effective interest rate | 3.5% | 3.8% | | Average debt outstanding | $190,211,111 | $161,000,000 | [NOTE 11 — NOTES](index=55&type=section&id=NOTE%2011%20%E2%80%94%20NOTES) The company redeemed all $48.875 million of its 5.75% fixed-rate 2022 Notes on February 12, 2021, recognizing a $539,250 loss on debt extinguishment, while simultaneously issuing $100 million of 4.875% fixed-rate 2026 Notes on January 14, 2021, with proceeds used to redeem the 2022 Notes and repay a portion of the credit facility - **2022 Notes Redemption:** The company redeemed all **$48,875,000** of its 5.75% fixed-rate 2022 Notes on February 12, 2021, resulting in a **$539,250** loss on debt extinguishment[209](index=209&type=chunk)[210](index=210&type=chunk) - **2026 Notes Issuance:** The company issued **$100,000,000** of 4.875% fixed-rate 2026 Notes on January 14, 2021[212](index=212&type=chunk) - **Use of Proceeds:** Net proceeds from the 2026 Notes were used to fully redeem the 2022 Notes and repay a portion of the outstanding amount under the credit facility[213](index=213&type=chunk) Notes Interest and Debt | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | | :---------------------------------- | :-------------------------------- | :-------------------------------- | | **2022 Notes:** | | | | Total interest and financing expenses | $357,295 | $785,452 | | Loss on debt extinguishment | $539,250 | $0 | | Weighted average interest rate | 5.7% | 5.8% | | Average debt outstanding | $48,875,000 | $48,875,000 | | **2026 Notes:** | | | | Total interest and financing expenses | $1,136,936 | $0 | | Weighted average interest rate | 4.9% | 0% | | Average debt outstanding | $100,000,000 | $0 | [NOTE 12 — SUBSEQUENT EVENTS](index=57&type=section&id=NOTE%2012%20%E2%80%94%20SUBSEQUENT%20EVENTS) Subsequent to March 31, 2021, the company received a $14 million term loan repayment, made new investments totaling $18.3 million in two new portfolio companies (HVAC/plumbing and catalyst products), committed an additional $2.1 million in unfunded revolving credit/delayed draw term loans, increased its credit facility balance to $186 million and SBA debentures to $220 million, made an additional $15 million capital contribution to SBIC II, and declared regular monthly dividends of $0.0833 per share for April, May, and June 2021 - **Investment Repayment:** On April 22, 2021, the company received a **$14 million** full repayment of an unsecured term loan from Skopos Financial, LLC[219](index=219&type=chunk) - **New Investments:** On April 26, 2021, the company invested **$10.8 million** in a first lien term loan and committed **$0.1 million** in unfunded revolving credit and delayed draw term loans to an HVAC and plumbing design, installation, and service provider[319](index=319&type=chunk) On April 28, 2021, the company invested **$7.5 million** in a first lien term loan and committed **$2 million** in unfunded revolving credit, along with a **$0.8 million** equity investment, in Unicat Catalyst, LLC[320](index=320&type=chunk) - **Credit Facility:** As of May 6, 2021, the outstanding balance on the credit facility was **$186 million**[321](index=321&type=chunk) - **SBA-Guaranteed Debentures:** As of May 6, 2021, the total outstanding balance of SBA-guaranteed debentures was **$220 million**[322](index=322&type=chunk) - **SBIC II Subsidiary:** On April 13, 2021, the company made an additional **$15 million** capital contribution to its SBIC II Subsidiary, bringing its total contributed capital to **$50 million**[323](index=323&type=chunk) - **Dividend Declaration:** On April 19, 2021, the Board of Directors declared regular monthly dividends of **$0.0833 per share** for April, May, and June 2021[323](index=323&type=chunk) [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=59&type=section&id=Item%202.%20Management%27s%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) This section discusses Stellus Capital Investment Corporation's financial condition and operating results as of March 31, 2021, covering the company overview, COVID-19 impact, portfolio composition and activities, asset quality, operating results, financial condition, liquidity and capital resources, off-balance sheet arrangements, RIC status and dividend policy, recent accounting pronouncements, and critical accounting policies [Overview](index=59&type=section&id=Overview) Stellus Capital Investment Corporation, established in 2012, is an externally managed BDC and RIC aiming to maximize total returns through debt and equity investments in U.S. middle-market companies, adhering to BDC regulations including maintaining at least 70% qualified assets and RIC tax requirements, with its asset coverage ratio reduced to 150% in 2018 and standing at 203% as of March 31, 2021 - **Company Formation:** Formed on May 18, 2012, and commenced operations on November 7, 2012[229](index=229&type=chunk) - **Investment Objective:** To maximize total shareholder return through current income and capital appreciation by investing in debt and related equity of middle-market companies[230](index=230&type=chunk) - **Regulatory Status:** Elected to be regulated as a BDC under the 1940 Act and treated as a RIC under Subchapter M of the Code[231](index=231&type=chunk) - **Qualified Assets:** As a BDC, it is required to have at least **70%** of its total assets at the time of acquisition as "qualifying assets"[232](index=232&type=chunk) - **Asset Coverage Ratio:** The company's applicable asset coverage ratio was reduced from 200% to **150%** on June 28, 2019, following board and shareholder approval, with the ratio standing at **203%** as of March 31, 2021[234](index=234&type=chunk) [COVID-19 Developments](index=60&type=section&id=COVID-19%20Developments) The COVID-19 pandemic has significantly impacted the U.S. and global economies, causing widespread market disruptions, and while the company has assessed its investment valuations to reflect these impacts, uncertainties regarding vaccine distribution and economic recovery persist, potentially leading to significant adverse effects on future net investment income, portfolio fair value, and financial condition - **Economic Impact:** COVID-19 was declared a pandemic on March 11, 2020, causing significant disruptions in global supply chains and economic activity[235](index=235&type=chunk) - **Valuation Impact:** Each portfolio company has been individually assessed, and the pandemic's effects are reflected in investment valuations[236](index=236&type=chunk) - **Future Uncertainty:** The extent of the pandemic's impact on financial performance remains uncertain, depending on the duration, spread, related recommendations and restrictions, and the health of financial markets and the economy, with a prolonged recession potentially having a significant adverse effect on the company's net investment income, fair value of investments, and financial condition[237](index=237&type=chunk) [Economic outlook](index=60&type=section&id=Economic%20outlook) The economic outlook remains uncertain due to the evolving COVID-19 pandemic, particularly regarding vaccine distribution and the timeline for achieving "herd immunity," with prolonged self-isolation and reduced economic participation potentially leading to continued adverse economic and market conditions, posing significant risks to the company's business, financial condition, and cash flows - **Vaccine Distribution Uncertainty:** The pace of vaccine distribution nationally and globally, and when "herd immunity" will be achieved, remains unclear[238](index=238&type=chunk) - **Prolonged Economic Slowdown:** Delays in vaccine distribution could lead to continued self-isolation and prolonged non-participation in economic activity, resulting in a sustained global economic slowdown[238](index=238&type=chunk) - **Significant Risks:** The COVID-19 pandemic presents significant uncertainties and risks to the potential value of portfolio companies and the company's business, financial condition, operating results, and cash flows[238](index=238&type=chunk) [Operations](index=61&type=section&id=Operations) Since March 16, 2020, Stellus Capital's partners and employees have primarily worked remotely without operational disruption and are prepared to continue remote work as necessary to ensure the health and safety of all personnel - **Remote Operations:** Since March 16, 2020, Stellus Capital's partners and employees have primarily worked remotely, with no disruption to operations[240](index=240&type=chunk) - **Preparedness:** Partners and employees are prepared to continue remote work as necessary to ensure the health and safety of all personnel[240](index=240&type=chunk) [Our COVID-19 response](index=61&type=section&id=Our%20COVID-19%20response) Since the pandemic's onset, the company has maintained regular contact with all portfolio companies and their sponsors to assess operational capabilities, liquidity, covenant compliance, and employee/customer health in the new environment, aiming to mitigate COVID-19 impacts - **Continuous Monitoring:** Regular contact is maintained with all portfolio companies and their sponsors to assess their operational capabilities, liquidity positions, anticipated covenant compliance, and the health of their employees and customers in the new environment[241](index=241&type=chunk) - **Mitigation Efforts:** Ongoing efforts are in place to mitigate the impact of the COVID-19 pandemic[241](index=241&type=chunk) [Financial impact](index=61&type=section&id=Financial%20impact) The company will continue to closely monitor the financial condition of its portfolio companies to mitigate the impact of the COVID-19 pandemic, recognizing that historical financial information may no longer adequately reflect future performance - **Continuous Monitoring:** The financial condition of portfolio companies will continue to be closely monitored[242](index=242&type=chunk) - **Historical Data Relevance:** Historical information may be relatively less relevant[242](index=242&type=chunk) [Portfolio Composition and Investment Activity](index=61&type=section&id=Portfolio%20Composition%20and%20Investment%20Activity) As of March 31, 2021, the investment portfolio's fair value increased to $714.5 million across 70 companies, primarily comprising first lien debt (79%), with key industries including business services, healthcare, and aerospace & defense, unfunded commitments decreased to $22.8 million, and in Q1 2021, the company invested $93.4 million in new and existing portfolio companies while receiving $33.6 million in investment repayments Portfolio Composition | Metric | March 31, 2021 (Fair Value) | December 31, 2020 (Fair Value) | Change | | :----------------------------------- | :---------------------------- | :----------------------------- | :------- | | Total Investments | $714.5 million | $653.4 million | +9.3% | | Number of Portfolio Companies | 70 | 66 | +4 | | Senior Secured – First Lien | 79% | 78% | +1% | | Senior Secured – Second Lien | 9% | 11% | -2% | | Unsecured Debt | 4% | 3% | +1% | | Equity | 8% | 8% | 0% | - **Unfunded Commitments:** Decreased from **$28.9 million** (19 companies) on December 31, 2020, to **$22.8 million** (22 companies) on March 31, 2021[247](index=247&type=chunk) - **Q1 2021 Investment Activity:** Total investments of **$93.4 million** (3 new companies, 11 existing companies) and investment repayments of **$33.6 million**[253](index=253&type=chunk) - **Debt Investment Interest Rates:** As of March 31, 2021, and December 31, 2020, **93%** of debt investments were at floating rates (subject to interest rate floors), and **7%** were at fixed rates[254](index=254&type=chunk) - **Weighted Average Yield:** As of March 31, 2021, the weighted average yield on all debt investments was **8.3%**, and approximately **7.8%** on all investments, including non-income producing equity positions[256](index=256&type=chunk) [Asset Quality](index=67&type=section&id=Asset%20Quality) The company employs a five-tier numerical rating system to monitor the credit quality and expected return levels of its investments, with 92% of the portfolio (by fair value) rated 1 or 2 (performing as expected or better) as of March 31, 2021, and five loans on non-accrual status, representing 5.3% of the loan portfolio at cost and 1.8% at fair value, an increase from three loans on non-accrual as of December 31, 2020 - **Investment Rating System:** A five-tier numerical rating system (1-5) is used to assess and monitor the credit quality and expected return levels of each investment in the portfolio, where **1** indicates performance exceeding expectations; **2** indicates performance meeting expectations (all new loans are initially rated 2); **3** indicates performance below expectations, requiring close monitoring but no expected loss of return or principal; **4** indicates performance significantly below expectations with substantially increased risk, expecting some loss of return but no principal; and **5** indicates performance significantly below expectations with substantially increased risk, expecting some loss of return and principal[258](index=258&type=chunk) - **Non-Accrual Loans (March 31, 2021):** **Five loans** were on non-accrual status, representing **5.3%** of the loan portfolio at cost and **1.8%** at fair value[260](index=260&type=chunk) - **Non-Accrual Loans (December 31, 2020):** **Three loans** were on non-accrual status, representing **4.3%** of the loan portfolio at cost and **1.0%** at fair value[262](index=262&type=chunk) - **Unaccrued Income:** Unaccrued income on non-accrual investments was **$8.2 million** as of March 31, 2021, and **$7.1 million** as of December 31, 2020[262](index=262&type=chunk) Investment Category by Fair Value | Investment Category | March 31, 2021 (Fair Value) | % of Total Portfolio | Number of Portfolio Companies | December 31, 2020 (Fair Value) | % of Total Portfolio | Number of Portfolio Companies | | :------------------ | :---------------------------- | :------------------- | :---------------------------- | :----------------------------- | :------------------- | :---------------------------- | | 1 | $119.4 million | 17% | 14 | $87.3 million | 14% | 12 | | 2 | $538.8 million | 75% | 48 | $496.5 million | 76% | 45 | | 3 | $44.6 million | 6% | 4 | $61.3 million | 9% | 6 | | 4 | $3.6 million | 1% | 1 | $0 | 0% | 0 | | 5 | $8.1 million | 1% | 3 | $8.3 million | 1% | 3 | | **Total** | **$714.5 million** | **100%** | **70** | **$653.4 million** | **100%** | **66** | [Results of Operations](index=67&type=section&id=Results%20of%20Operations) Net investment income for Q1 2021 decreased by 19.0% to $5.1 million year-over-year, primarily due to lower LIBOR rates, while total operating expenses remained stable, and the net increase in net assets from operations significantly improved to $4.9 million compared to a $43.9 million decrease in Q1 2020, largely driven by a positive change in unrealized appreciation versus a significant depreciation in the prior year Results of Operations | Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | Change | | :------------------------------------------------- | :-------------------------------- | :-------------------------------- | :------- | | Total Investment Income | $14.0 million | $15.3 million | -8.5% | | Total Operating Expenses | $8.9 million | $9.0 million | -1.1% | | Net Investment Income | $5.1 million | $6.2 million | -18.0% | | Net Realized Gain | $0.5 million | $1.3 million | -61.5% | | Net Change in Unrealized Appreciation (Depreciation) | $0.1 million | $(51.5) million | N/A | | Provision for Taxes on Unrealized Appreciation | $(0.2) million | $0.03 million | N/A | | Net Increase (Decrease) in Net Assets from Operations | $4.9 million | $(43.9) million | N/A | - **Decrease in Interest Income:** Primarily due to lower LIBOR rates and the recognition of previously reserved interest in Q1 2020[266](index=266&type=chunk) - **Decrease in Operating Expenses:** Primarily due to lower income incentive fees, partially offset by an increase in capital gains incentive fees[269](index=269&type=chunk) - **Change in Unrealized Appreciation:** A significant improvement compared to the unrealized depreciation in Q1 2020, which was primarily due to the onset of the COVID-19 pandemic[276](index=276&type=chunk)[279](index=279&type=chunk) [Financial condition, liquidity and capital resources](index=71&type=section&id=Financial%20condition,%20liquidity%20and%20capital%20resources) The company's liquidity is derived from its credit facility, 2026 Notes, SBA debentures, and operating cash flow, with Q1 2021 operating activities using $57.1 million while financing activities provided $69.0 million, primarily from the issuance of 2026 Notes and SBA debentures, offsetting the redemption of 2022 Notes and credit facility repayments, maintaining a 150% asset coverage ratio (203% as of March 31, 2021) and benefiting from an SEC exemption for SBA debt - **Cash Flow (Q1 2021):** Operating activities used **$57.1 million** in net cash; financing activities provided **$69.0 million** in net cash[280](index=280&type=chunk) - **Liquidity Sources:** Credit facility, 2022 Notes, 2026 Notes, SBA-guaranteed debentures, and cash flow from operations[282](index=282&type=chunk) - **Capital Raising:** Anticipates funding portfolio growth through future public and private equity offerings and senior securities or future borrowings, which may be limited if common stock trades below net asset value per share (equity offerings below NAV require shareholder approval, with current approval expiring June 25, 2021)[283](index=283&type=chunk)[284](index=284&type=chunk) - **Asset Coverage Ratio:** Stood at **203%** as of March 31, 2021, well above the **150%** requirement, with the company having obtained SEC exemptive relief to exclude SBA-guaranteed debentures from the asset coverage test[289](index=289&type=chunk) - **Credit Facility:** As of March 31, 2021, the credit facility had an outstanding balance of **$165.5 million**, with a maximum capacity of **$230 million** and an incremental feature to increase it to **$280 million**[292](index=292&type=chunk) - **SBA-Guaranteed Debentures:** As of March 31, 2021, **$210 million** of SBA-guaranteed debentures were outstanding[293](index=293&type=chunk) - **2026 Notes:** **$100 million** of 2026 Notes were issued in January 2021, used to redeem the 2022 Notes and repay a portion of the credit facility[303](index=303&type=chunk) [Off-Balance Sheet Arrangements](index=75&type=section&id=Off-Balance%20Sheet%20Arrangements) As of March 31, 2021, the company's off-balance sheet arrangements included $22.8 million in unfunded commitments to 22 portfolio companies, a decrease from $28.9 million on December 31, 2020, with sufficient liquidity maintained to meet these commitments - **Unfunded Commitments:** As of March 31, 2021, the company had **$22.8 million** in unfunded commitments to **22** portfolio companies, down from **$28.9 million** to **19** companies on December 31, 2020[307](index=307&type=chunk) - **Liquidity:** The company maintains sufficient liquidity through cash on hand and available borrowings under its credit facility to meet unfunded commitments[307](index=307&type=chunk) [Regulated Investment Company Status and Dividends](index=75&type=section&id=Regulated%20Investment%20Company%20Status%20and%20Dividends) The company maintains RIC status by distributing at least 90% of its taxable income, thereby avoiding corporate-level federal income tax, with $21.1 million in undistributed taxable income carried forward to 2021, though covenants in the credit facility may restrict dividend distributions, potentially impacting RIC compliance, and the company may retain net taxable capital gains as deemed distributions, allowing shareholders to claim tax credits - **RIC Qualification:** The company maintains RIC qualification by distributing at least **90%** of its investment company net taxable income annually[308](index=308&type=chunk) - **Undistributed Taxable Income:** As of December 31, 2020, the company had **$21,051,549** of undistributed taxable income carried forward to 2021[310](index=310&type=chunk) - **Distribution Restrictions:** Covenants in the credit facility may prohibit the company from making distributions to shareholders, potentially hindering its ability to meet distribution requirements[311](index=311&type=chunk) - **Deemed Distributions:** The company may retain a portion of its net taxable capital gains and treat them as deemed distributions to shareholders, who may be eligible for a tax credit equal to the tax paid by the company[314](index=314&type=chunk) - **Dividend Policy:** The company currently has no intention to pay dividends in stock form under U.S. Treasury Regulations or private letter rulings but continuously monitors its liquidity position and the overall economy to assess what is in the best interest of the company and its shareholders[314](index=314&type=chunk) [Recent Accounting Pronouncements](index=76&type=section&id=Recent%20Accounting%20Pronouncements) The company refers to Note 1 of the consolidated financial statements for recent accounting pronouncements, including ASU 2020-04 (reference rate reform), and believes these standards will not materially impact the consolidated financial statements upon adoption - **ASU 2020-04 (Reference Rate Reform):** This standard provides optional practical expedients and exceptions for contracts, hedging relationships, and other transactions affected by reference rate reform, effective through December 31, 2022, which the company did not elect to adopt during the quarter ended March 31, 2021[113](index=113&type=chunk)[114](index=114&type=chunk) - **Impact:** Management believes that recently issued pronouncements will not have a material impact on the company's consolidated financial statements upon adoption[315](index=315&type=chunk) [Critical Accounting Policies](index=76&type=section&id=Critical%20Accounting%20Policies) The company refers to Note 1 of the consolidated financial statements for a description of its critical accounting policies - **Reference:** Critical accounting policies are described in Note 1 to the consolidated financial statements[316](index=316&type=chunk) [Subsequent Events](index=77&type=section&id=Subsequent%20Events) Subsequent to March 31, 2021, the company received a $14 million term loan repayment, made new investments totaling $18.3 million in two new portfolio companies (HVAC/plumbing and catalyst products), committed an additional $2.1 million in unfunded revolving credit/delayed draw term loans, increased its credit facility balance to $186 million and SBA debentures to $220 million, made an additional $15 million capital contribution to SBIC II, and declared regular monthly dividends of $0.0833 per share for April, May, and June 2021 - **Investment Repayment:** On April 22, 2021, the company received a **$14 million** full repayment of an unsecured term loan from Skopos Financial, LLC[318](index=318&type=chunk) - **New Investments:** On April 26, 2021, the company invested **$10.8 million** in a first lien term loan and committed **$0.1 million** in unfunded revolving credit and delayed draw term loans to an HVAC and plumbing design, installation, and service provider[319](index=319&type=chunk) On April 28, 2021, the company invested **$7.5 million** in a first lien term loan and committed **$2 million** in unfunded revolving credit, along with a **$0.8 million** equity investment, in Unicat Catalyst, LLC[320](index=320&type=chunk) - **Credit Facility:** As of May 6, 2021, the outstanding balance on the credit facility was **$186 million**[321](index=321&type=chunk) - **SBA-Guaranteed Debentures:** As of May 6, 2021, the total outstanding balance of SBA-guaranteed debentures was **$220 million**[322](index=322&type=chunk) - **SBIC II Subsidiary:** On April 13, 2021, the company made an additional **$15 million** capital contribution to its SBIC II Subsidiary, bringing its total contributed capital to **$50 million**[323](index=323&type=chunk) - **Dividend Declaration:** On April 19, 2021, the Board of Directors declared regular monthly dividends of **$0.0833 per share** for April, May, and June 2021[323](index=323&type=chunk) [Item 3. Quantitative and Qualitative Disclosures About Market Risk](index=78&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) The company faces interest rate market risk, with 93% of its loan portfolio at floating rates (subject to LIBOR floors), where a 200 basis point increase in interest rates would annually increase net interest income by $3.5 million, while a 100 basis point increase would decrease it by $0.2 million, primarily due to interest expense impacts, and no hedging activities were undertaken in Q1 2021 or Q1 2020 - **Interest Rate Risk Exposure:** As of March 31, 2021, and December 31, 2020, **93%** of the company's loan portfolio was at floating rates (referencing LIBOR and subject to interest rate floors)[324](index=324&type=chunk) - **Weighted Average Interest Rate Floor:** Stood at **1.19%** as of March 31, 2021, and **1.21%** as of December 31, 2020[326](index=326&type=chunk) - **Hedging Activities:** No hedging activities were undertaken during the three months ended March 31, 2021, or March 31, 2020[326](index=326&type=chunk) Annual Impact on Net Interest Income | Change in Basis Points | Annual Impact on Net Interest Income ($ in millions) | | :------------------- | :------------------------------------------------- | | Up 200 | $3.5 | | Up 150 | $1.3 | | Up 100 | $(0.2) | | Up 50 | $(0.3) | | Down 25 | $0.0 | [Item 4. Controls and Procedures](index=78&type=section&id=Item%204.%20Controls%20and%20Procedures) The CEO and CFO affirm the effectiveness of the company's disclosure controls and procedures as of March 31, 2021, with no material changes to internal controls over financial reporting identified during the quarter - **Disclosure Controls:** The Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were effective as of March 31, 2021[327](index=327&type=chunk) - **Internal Controls over Financial Reporting:** No changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting were identified during the quarter ended March 31, 2021[328](index=328&type=chunk) PART II. OTHER INFORMATION [Item 1. Legal Proceedings](index=80&type=section&id=Item%201.%20Legal%20Proceedings) The company is not currently involved in any material legal proceedings, nor has it received any threats of such, and routine legal actions that may arise in the ordinary course of business are not expected to materially impact its financial condition or operating results - **Current Status:** The company is not currently involved in any material legal proceedings, nor has it received any threats of such[330](index=330&type=chunk) - **Expected Impact:** Routine legal actions that may arise in the ordinary course of business are not expected to materially impact the company's financial condition or operating results[330](index=330&type=chunk) [Item 1A. Risk Factors](index=80&type=section&id=Item%201A.%20Risk%20Factors) No material changes have occurred in the risk factors disclosed in the company's annual report on Form 10-K for December 31, 2020, beyond the information provided in this report - **No Material Changes:** No material changes have occurred in the risk factors disclosed in the company's annual report on Form 10-K for December 31, 2020, beyond the information provided in this report[331](index=331&type=chunk) [Item 2. Unregistered Sales of Equity Securities and Use of Proceeds](index=80&type=section&id=Item%202.%20Unregistered%20Sales%20of%20Equity%20Securities%20and%20Use%20of%20Proceeds) For the three months ended March 31, 2021, the company did not issue any shares through its dividend reinvestment plan (DRIP), whereas in the prior year period, 9,910 shares of common stock were issued under DRIP, totaling approximately $135,472 - **Q1 2021 DRIP:** No shares were issued through the dividend reinvestment plan (DRIP)[332](index=332&type=chunk) - **Q1 2020 DRIP:** **9,910 shares** of common stock were issued through the DRIP, totaling approximately **$135,472**[332](index=332&type=chunk) [Item 3. Defaults Upon Senior Securities](index=80&type=section&id=Item%203.%20Defaults%20Upon%20Senior%20Securities) This item is not applicable for the reporting period - **Status:** Not applicable[333](index=333&type=chunk) [Item 4. Mine Safety Disclosures](index=80&type=section&id=Item%204.%20Mine%20Safety%20Disclosures) This item is not applicable for the reporting period - **Status:** Not applicable[333](index=333&type=chunk) [Item 5. Other Information](index=80&type=section&id=Item%205.%20Other%20Information) No other information is disclosed for this reporting period - **Status:** None[334](index=334&type=chunk) [Item 6. Exhibits](index=80&type=section&id=Item%206.%20Exhibits) This report includes certifications from the Chief Executive Officer and Chief Financial Officer as exhibits - **Exhibits:** Includes certifications from the Chief Executive Officer and Chief Financial Officer (31.1, 31.2, 32.1, 32.2) filed with this report[335](index=335&type=chunk)

Financial Data and Key Metrics Changes - The net asset value per share increased by $0.86 during the fourth quarter, rising from $13.17 to $14.03, attributed to the early declaration of the fourth quarter dividend and net appreciation on the investment portfolio [12] - The company reported a net realized loss of $7.7 million, primarily related to one investment, offset by unrealized gains of $19.6 million during the quarter [13] - The company’s liquidity and capital position improved significantly, with an increase in the bank facility by $10 million to $230 million and an institutional bond offering of $100 million completed in January 2021 [14][15] Business Line Data and Key Metrics Changes - The investment portfolio at fair value was $653 million across 66 portfolio companies, up from $629 million across 63 companies a year ago [20] - The company invested $152 million in 10 new and 20 existing portfolio companies during 2020, receiving $129 million in repayments, resulting in a net portfolio growth at cost of about $23 million for the year [20] Market Data and Key Metrics Changes - The company maintained a diversified portfolio, with the largest industry sector accounting for 17% of the total, and 97% of loans were secured while 93% were priced at floating rates [21][22] - The asset quality remained stable, with a rating of 2.0 on the investment rating system, and only 1% of the total loan portfolio was marked as non-accrual [23] Company Strategy and Development Direction - The company’s strategy includes investing in the equity of portfolio companies modestly to generate realized gains sufficient to offset losses over time [24] - The company aims to grow its portfolio to approximately $800 million by the end of the year, with a focus on SBIC financings [42] Management's Comments on Operating Environment and Future Outlook - Management noted an increase in investment opportunities, with $158 million invested on a cost basis in the first quarter of 2021 [9] - The investment philosophy remains unchanged, focusing on companies that can survive economic downturns, with a preference for businesses with low maintenance capital expenditures [57] Other Important Information - The company has reduced unfunded commitments from $37.5 million at the beginning of the year to $24.2 million [15] - The company continues to commit equity capital to its second SBIC subsidiary, allowing for low-cost debentures [16] Q&A Session Summary Question: Status of a previously non-accrual loan - Management confirmed that a preferred equity position has been written up and the loan amount has gone back on accrual [31][32] Question: Future debt offerings and leverage ratios - Management indicated that while the bond offering was attractive, the current mix of fixed and floating rate liabilities is deemed appropriate, with potential for modest additional bond offerings if yields decrease [33][35] Question: Pipeline of investment opportunities - Management stated that the pipeline is consistent, with expectations for continued opportunities and a significant portion of new investments qualifying for SBIC financing [39][40] Question: Quality of deals and leverage trends - Management noted that most deals are first lien unitranche, with leverage ratios remaining stable and covenants in place [45][47] Question: Breakdown of unrealized gains - Management provided a breakdown indicating that approximately $10 million of unrealized gains were due to reversals of previous losses, with the remainder primarily from equity portfolio gains [52][54] Question: Changes in investment philosophy post-COVID - Management confirmed that the investment philosophy has not changed, focusing on companies that can withstand downturns, while noting an increase in SBIC-qualifying investments [57][60]

PART I [ITEM 1. BUSINESS](index=3&type=section&id=ITEM%201%2E%20BUSINESS) Stellus Capital is an externally managed BDC investing in middle-market companies, aiming for total stockholder return under BDC/RIC regulations and SBIC leverage, while managing COVID-19 impacts - Stellus Capital Investment Corporation is an externally managed BDC, organized on May 8, 2012, and commenced operations on November 7, 2012. It invests primarily in private middle-market companies (typically **$5.0 million to $50.0 million EBITDA**) through first lien, unitranche, second lien, and unsecured debt, often with equity co-investments[14](index=14&type=chunk) - The company's investment objective is to maximize total return to stockholders through current income and capital appreciation, achieved by accessing extensive origination channels, investing in companies with strong fundamentals across diverse sectors (business services, energy, healthcare, software, specialty finance), focusing on directly originated transactions, applying disciplined underwriting, and actively monitoring investments[15](index=15&type=chunk)[16](index=16&type=chunk) - The company has elected to be treated as a Regulated Investment Company (RIC) for U.S. federal income tax purposes, requiring compliance with source-of-income and asset diversification rules to avoid corporate-level taxes on timely distributed income[20](index=20&type=chunk) - Effective June 29, 2018, the company's asset coverage ratio requirement decreased from **200% to 150%** following approval by its board and stockholders, allowing it to borrow **$2.00 for every $1.00 of investor equity**. As of December 31, 2020, the asset coverage ratio was **223%**[21](index=21&type=chunk)[22](index=22&type=chunk) - Two wholly-owned subsidiaries hold Small Business Investment Company (SBIC) licenses, enabling them to obtain SBA-guaranteed debentures up to **$175.0 million** (subject to capitalization and approval) with fixed, attractive interest rates and ten-year maturities. Exemptive relief from the SEC allows these debentures to be excluded from the company's asset coverage test, providing increased borrowing flexibility[24](index=24&type=chunk)[25](index=25&type=chunk) - The COVID-19 pandemic has severely impacted global economic activity and financial markets, creating disruption in supply chains and adversely affecting industries. The company is actively monitoring portfolio companies' liquidity, covenant compliance, and workforce health to mitigate impacts, acknowledging that historical information may be less significant[26](index=26&type=chunk)[28](index=28&type=chunk)[29](index=29&type=chunk) Portfolio Investments Summary (December 31, 2020) | Category | Fair Value ($ millions) | % of Portfolio at Fair Value | | :------------------------- | :---------------------- | :--------------------------- | | First Lien Debt | $508.67 | 77.8% | | Second Lien Debt | $70.72 | 10.8% | | Unsecured Debt | $21.19 | 3.3% | | Equity | $52.84 | 8.1% | | **Total** | **$653.42** | **100.0%** | - Stellus Capital Management, the investment adviser, is responsible for managing investment activities, including opportunity analysis, due diligence, structuring, origination, and monitoring. Its senior investment professionals have an average of over **31 years of experience** and maintain extensive networks for sourcing investments[39](index=39&type=chunk)[40](index=40&type=chunk)[41](index=41&type=chunk) - The company identifies attractive market opportunities in middle-market lending due to robust demand for debt capital from private equity firms, a strong U.S. economy supporting middle-market companies, attractive deal pricing and structures with stronger covenant packages and higher interest rates, and specialized lending requirements that favor experienced lenders[43](index=43&type=chunk)[44](index=44&type=chunk)[45](index=45&type=chunk)[46](index=46&type=chunk) - Competitive strengths include an experienced investment team, a rigorous investment and monitoring process, demonstrated ability to structure investments creatively (e.g., commitment fees, OID, PIK interest, equity participation), and access to the broad resources and relationships of the Stellus Capital Management platform[48](index=48&type=chunk)[49](index=49&type=chunk)[50](index=50&type=chunk)[51](index=51&type=chunk) - The investment strategy is opportunistic and flexible, focusing on direct origination of first lien (including unitranche), second lien, and unsecured debt, often with equity co-investments, in middle-market companies with **$5.0 million to $50.0 million EBITDA**. The strategy emphasizes capital preservation, downside protection through conservative structures, and diversification across industries[52](index=52&type=chunk)[53](index=53&type=chunk)[54](index=54&type=chunk)[56](index=56&type=chunk) - Transaction sourcing relies on the senior investment team's long-standing relationships with private equity firms, investment banks, senior lenders, management teams, and other intermediaries, providing a continuous flow of investment opportunities and market intelligence[58](index=58&type=chunk)[59](index=59&type=chunk)[61](index=61&type=chunk) - Investment structuring involves tailoring terms based on the portfolio company's business, credit profile, industry outlook, and management. Investments typically include high cash pay interest, with potential return-enhancing mechanisms like commitment fees, OID, early redemption premiums, PIK interest, and equity participation (preferred/common stock, warrants). Debt investments usually have a **5-7 year term**[62](index=62&type=chunk)[63](index=63&type=chunk) - The investment process is highly involved and interactive, designed to identify attractive risk/reward characteristics. It includes initial informal review, weekly senior investment professional meetings, detailed due diligence (financials, industry, management, sponsor track record), and a multi-stage approval process by the investment committee, requiring unanimous approval for new and follow-on investments[73](index=73&type=chunk)[74](index=74&type=chunk)[75](index=75&type=chunk)[76](index=76&type=chunk)[77](index=77&type=chunk) - Investment monitoring is active, involving quarterly financial performance reviews, regular discussions with management, periodic written updates, and a comprehensive quarterly portfolio review by the Chief Investment Officer and Chief Compliance Officer. Valuations of non-publicly traded investments are reviewed by an independent third-party firm at least **twice annually** and determined in good faith by the Board[80](index=80&type=chunk)[81](index=81&type=chunk)[82](index=82&type=chunk) - The company uses a five-level numeric investment ranking system to monitor credit profile and expected returns: Category 1 (above expectations), Category 2 (within expectations, initial rating for new loans), Category 3 (below expectations, closer monitoring, no loss expected), Category 4 (substantially below expectations, work out, some return loss expected), and Category 5 (substantially below expectations, work out, some principal loss expected)[84](index=84&type=chunk)[85](index=85&type=chunk)[86](index=86&type=chunk)[87](index=87&type=chunk)[88](index=88&type=chunk) - Net asset value (NAV) per share is determined quarterly by dividing total assets minus liabilities by outstanding shares. Investments with readily available market quotations are valued at market prices; others are valued at fair value by the Board, with independent firm review at least **twice annually**. Valuation factors include market data, yields, multiples, collateral, cash flow, and peer comparisons[90](index=90&type=chunk)[91](index=91&type=chunk)[92](index=92&type=chunk)[94](index=94&type=chunk) - The company's primary competitors include public and private funds, other BDCs, commercial and investment banks, commercial financing companies, and private equity/hedge funds. Many competitors are larger, have greater resources, and are not subject to the same regulatory restrictions as BDCs or RICs[98](index=98&type=chunk) - The company has no direct employees; day-to-day operations are managed by Stellus Capital Management. Officers are employees of Stellus Capital Management, and their allocable costs are reimbursed under an administration agreement[100](index=100&type=chunk) - Under the investment advisory agreement, Stellus Capital Management determines portfolio composition, identifies/evaluates investments, executes transactions, and monitors the portfolio. The company pays a base management fee (**1.75% of gross assets**, excluding cash) and an incentive fee (**20.0% of pre-incentive fee net investment income** above an **8.0% annualized hurdle**, subject to a total return requirement and capital gains component)[102](index=102&type=chunk)[103](index=103&type=chunk)[104](index=104&type=chunk)[105](index=105&type=chunk)[111](index=111&type=chunk) - The administration agreement outlines services provided by Stellus Capital Management, including office facilities, clerical, bookkeeping, and other administrative functions, for which the company pays an allocable portion of overhead and expenses. A license agreement grants the company non-exclusive, royalty-free use of the 'Stellus Capital' name[131](index=131&type=chunk)[132](index=132&type=chunk)[134](index=134&type=chunk) - As a BDC, the company must invest at least **70% of its total assets** in 'qualifying assets,' primarily private operating companies or certain public companies with market capitalization under **$250 million**. It also offers managerial assistance to portfolio companies to meet regulatory requirements[19](index=19&type=chunk)[139](index=139&type=chunk)[142](index=142&type=chunk) - To maintain RIC status, the company must meet a **90% income test** (at least **90% gross income from investments**) and diversification tests (at least **50% of assets** in cash, government securities, other RICs, and other securities not exceeding **5% of assets** or **10% of issuer's voting securities**; no more than **25% of assets** in one issuer or related businesses)[168](index=168&type=chunk) - The company's SBIC licenses allow its subsidiaries to issue SBA-guaranteed debentures, which are non-recourse, interest-only, ten-year maturity debentures with fixed interest rates. SBICs are subject to SBA regulations regarding investment limitations (e.g., maximum **30% of regulatory capital** in one company), eligible small business criteria (tangible net worth < **$19.5 million**, avg. net income < **$6.5 million**), and prohibitions on certain industries[179](index=179&type=chunk)[180](index=180&type=chunk)[181](index=181&type=chunk) SBIC Regulatory Capital and Debentures (December 31, 2020) | Subsidiary | Regulatory Capital ($) | SBA-Guaranteed Debentures Outstanding ($) | | :------------------- | :--------------------- | :---------------------------------------- | | SBIC subsidiary | $75,000,000 | $150,000,000 | | SBIC II subsidiary | $40,000,000 | $26,500,000 | [ITEM 1A. RISK FACTORS](index=35&type=section&id=ITEM%201A%2E%20RISK%20FACTORS) Investing in the company's securities involves significant risks from business structure, operations, economic conditions, and specific investments, including personnel dependence, conflicts of interest, leverage, COVID-19, and regulatory compliance [Risks Relating to our Business and Structure](index=35&type=section&id=Risks%20Relating%20to%20our%20Business%20and%20Structure) The company faces risks from economic uncertainty, COVID-19, dependence on Stellus Capital Management personnel, conflicts of interest from fees, BDC/RIC regulatory compliance, and potential cybersecurity failures - Political, social, and economic uncertainty, including the COVID-19 pandemic, creates and exacerbates risks such as increased market volatility, difficulty in valuing assets, higher default risks for obligors, and potential for global economic slowdowns. The pandemic has led to business disruptions, increased draws on credit lines, and requests for loan amendments, impacting the company's ability to originate loans and achieve investment objectives[188](index=188&type=chunk)[190](index=190&type=chunk)[191](index=191&type=chunk)[192](index=192&type=chunk) - The company is highly dependent on the diligence, skill, and network of Stellus Capital Management's senior investment professionals. The loss of key personnel, including members of the investment committee, could significantly harm the company's ability to achieve its investment objective and operate effectively[204](index=204&type=chunk)[205](index=205&type=chunk) - Significant potential conflicts of interest exist due to Stellus Capital Management's multiple roles (officers, directors, managers of other funds with similar strategies) and its incentive fee structure. The base management fee, calculated on gross assets, may incentivize the use of additional leverage, potentially leading to more speculative investments. The incentive fee on net investment income, subject to a hurdle, and the capital gains incentive fee, without a hurdle, could also encourage riskier investment decisions[209](index=209&type=chunk)[212](index=212&type=chunk)[213](index=213&type=chunk)[215](index=215&type=chunk)[216](index=216&type=chunk) - Maintaining RIC tax treatment requires distributing at least **90% of net ordinary income and net short-term capital gains** annually. Debt covenants and asset coverage ratios under the 1940 Act can restrict distributions, potentially leading to corporate-level income tax or default under credit facilities. Recognizing income before receiving cash (e.g., PIK interest) can also create distribution difficulties[220](index=220&type=chunk)[222](index=222&type=chunk)[223](index=223&type=chunk) - The company's use of leverage magnifies potential gains and losses. As a BDC, it must maintain a **150% asset coverage ratio** (down from **200%** since June 2018). Failure to meet this or other debt covenants could restrict additional borrowing, limit distributions, or lead to default and foreclosure on assets, which are substantially pledged as collateral[227](index=227&type=chunk)[229](index=229&type=chunk)[232](index=232&type=chunk)[235](index=235&type=chunk) - Most portfolio investments are illiquid and valued at fair value by the Board, which involves significant management judgment and unobservable inputs (Level 3 under ASC Topic 820). This introduces uncertainty, and actual realized values may differ materially from recorded fair values, potentially impacting net asset value[249](index=249&type=chunk) - The company is highly dependent on information systems and faces cybersecurity risks, including cyber-attacks, system failures, and data breaches. Such incidents could disrupt business, lead to financial losses, litigation, regulatory penalties, and reputational damage, with heightened risks in remote working environments[290](index=290&type=chunk)[291](index=291&type=chunk)[292](index=292&type=chunk)[293](index=293&type=chunk)[295](index=295&type=chunk)[296](index=296&type=chunk)[298](index=298&type=chunk) - Non-compliance with SBA regulations for its SBIC subsidiaries could lead to limitations on debenture use, acceleration of outstanding debentures, or license revocation, negatively impacting the company's operations and financial condition[263](index=263&type=chunk)[264](index=264&type=chunk)[265](index=265&type=chunk) [Risks Related to Our Operations](index=50&type=section&id=Risks%20Related%20to%20Our%20Operations) Operational risks include capital raising challenges due to RIC rules, affiliate transaction restrictions, conflicts of interest in valuation, reliance on Stellus Capital Management, fluctuating results, strategy changes, and anti-takeover provisions - The company requires additional capital for growth but is limited by RIC distribution requirements (**90-100% taxable income**) and BDC asset coverage tests (**150%**). If common stock trades below NAV, raising equity capital is restricted without stockholder approval, potentially impairing growth or forcing disadvantageous asset sales[266](index=266&type=chunk)[267](index=267&type=chunk) - SBIC subsidiaries' ability to make distributions to the company may be limited by SBA regulations, potentially hindering the company's ability to maintain RIC tax treatment and leading to entity-level taxes[268](index=268&type=chunk) - Restrictions under the 1940 Act limit transactions with affiliates, including co-investments, which may narrow investment opportunities. The involvement of interested directors and Stellus Capital Management's investment professionals in the valuation process creates potential conflicts of interest, as management fees are tied to gross assets and incentive fees to realized/unrealized gains[269](index=269&type=chunk)[270](index=270&type=chunk)[271](index=271&type=chunk)[272](index=272&type=chunk) - The investment advisory and administration agreements were not negotiated at arm's length, potentially making terms less favorable. Stellus Capital Management and its affiliates are not prohibited from managing other entities with similar investment strategies, which could divert resources and create competition for investment opportunities[274](index=274&type=chunk)[275](index=275&type=chunk) - Stellus Capital Management can resign as investment adviser or administrator with **60 days' notice**, and finding a suitable replacement quickly may be difficult, leading to operational disruption and adverse effects on financial condition and stock price[278](index=278&type=chunk) - Failure to maintain BDC status or invest a sufficient portion of assets in qualifying assets would subject the company to greater regulatory restrictions, significantly reducing operating flexibility and potentially preventing follow-on investments[279](index=279&type=chunk)[280](index=280&type=chunk)[281](index=281&type=chunk)[282](index=282&type=chunk) [Risks Related to Economic Conditions](index=57&type=section&id=Risks%20Related%20to%20Economic%20Conditions) Global economic, political, and market conditions, including Brexit and U.S. policy changes, can adversely affect the company's business, liquidity, and earnings, increasing volatility and hindering attractive returns - Global economic, political, and market conditions, including Brexit and U.S. policy changes, can adversely affect the company's business. Downgrades to the U.S. credit rating, government shutdowns, or geopolitical unrest could negatively impact liquidity, financial condition, and earnings, increasing market volatility and economic uncertainty[300](index=300&type=chunk)[301](index=301&type=chunk)[304](index=304&type=chunk)[305](index=305&type=chunk) [Risks Related to our Investments](index=58&type=section&id=Risks%20Related%20to%20our%20Investments) Investment risks include economic recessions, illiquidity, non-diversification, lack of control, defaults, prepayments, interest rate changes (LIBOR transition), industry-specific regulations, and subordination in bankruptcy - Economic recessions or downturns can impair portfolio companies, increasing non-performing assets and decreasing portfolio value. Leveraged, private, and middle-market companies are particularly susceptible due to limited financial resources, unpredictable operating results, and reliance on a small management team, increasing the risk of losing all or part of the investment[306](index=306&type=chunk)[308](index=308&type=chunk)[309](index=309&type=chunk)[311](index=311&type=chunk) - Most assets are illiquid loans and securities, making them difficult to sell quickly and potentially leading to significant losses if liquidation is required. Price declines and illiquidity in corporate debt markets can result in substantial net unrealized depreciation, reducing net asset value[312](index=312&type=chunk)[313](index=313&type=chunk)[314](index=314&type=chunk) - As a non-diversified investment company, the company is not limited in the proportion of assets invested in a single issuer, increasing exposure to individual company or industry-specific risks[315](index=315&type=chunk) - The company generally does not hold controlling equity interests, limiting its ability to influence portfolio company decisions and prevent actions adverse to its interests. Defaults by portfolio companies can trigger cross-defaults and jeopardize obligations, while prepayments of debt investments can reduce net investment income and ability to make distributions[319](index=319&type=chunk)[320](index=320&type=chunk)[321](index=321&type=chunk) - Floating-rate loans are subject to interest rate changes, which could increase borrowing costs, reduce net investment income, or cause portfolio companies to default. The planned phase-out of LIBOR by the end of **2021** introduces uncertainty regarding alternative reference rates and potential market disruptions[322](index=322&type=chunk)[323](index=323&type=chunk)[324](index=324&type=chunk)[325](index=325&type=chunk)[326](index=326&type=chunk)[327](index=327&type=chunk) - Investments in subordinated loans carry greater default risk. Portfolio companies may incur debt ranking equally with or senior to the company's investments, meaning senior creditors would be repaid first in insolvency, potentially leaving no assets for the company. Intercreditor agreements may also limit the company's control over collateral enforcement[330](index=330&type=chunk)[331](index=331&type=chunk)[332](index=332&type=chunk)[333](index=333&type=chunk)[335](index=335&type=chunk)[340](index=340&type=chunk) - Industry-specific risks, such as changes in healthcare laws and regulations or technological developments in business services, can adversely affect portfolio companies' ability to offer products/services, increase costs, or render offerings obsolete, impacting investment value[344](index=344&type=chunk)[345](index=345&type=chunk)[346](index=346&type=chunk)[347](index=347&type=chunk) [Risks Relating to Our Common Stock](index=66&type=section&id=Risks%20Relating%20to%20Our%20Common%20Stock) Common stock risks include distribution uncertainty, dilution from DRIP non-participation, trading at a NAV discount, and significant market price fluctuations due to speculative investments and external factors - There is no assurance of specific cash distribution levels or year-to-year increases, as distributions depend on earnings, financial condition, RIC status, and BDC/SBA compliance. A portion of distributions may be a non-taxable return of capital[350](index=350&type=chunk)[351](index=351&type=chunk)[352](index=352&type=chunk) - Stockholders not participating in the dividend reinvestment plan may experience dilution over time. Shares may trade at unsustainable premiums or discounts from net asset value, a risk distinct from NAV decline, particularly for short-term investors[353](index=353&type=chunk)[354](index=354&type=chunk)[355](index=355&type=chunk)[356](index=356&type=chunk) - Investing in the company's securities involves an above-average degree of risk due to speculative investments. The market price and liquidity of securities can fluctuate significantly due to factors like volatility in BDC sector, regulatory changes, operating performance, and general economic trends[357](index=357&type=chunk)[358](index=358&type=chunk) [Risks Relating to Our Debt Securities](index=67&type=section&id=Risks%20Relating%20to%20Our%20Debt%20Securities) Debt securities risks include subordination, limited indenture protection, illiquidity, default on other debt, optional redemption, credit rating downgrades, and inability to repurchase upon change of control - The **2026 Notes** are unsecured and effectively subordinated to secured indebtedness and structurally subordinated to all indebtedness and liabilities of the company's subsidiaries. This means that in liquidation, secured creditors and subsidiary creditors have priority claims over **2026 Note** holders[359](index=359&type=chunk)[360](index=360&type=chunk) - The indenture for the **2026 Notes** provides limited protection, not restricting the company's ability to incur additional debt (including secured or structurally senior debt), pay dividends on junior securities (subject to 1940 Act and specific exceptions), sell assets, or enter into affiliate transactions. This lack of covenants could adversely affect the **2026 Notes'** value[361](index=361&type=chunk)[362](index=362&type=chunk)[363](index=363&type=chunk)[364](index=364&type=chunk)[365](index=365&type=chunk) - There is no active trading market for the **2026 Notes**, and the company does not intend to list them. This illiquidity means holders may not be able to sell them at a favorable price or at all, and their market value could decline based on interest rates, credit ratings, and economic conditions[367](index=367&type=chunk) - Default on other indebtedness (e.g., Credit Facility) could prevent payments on the **2026 Notes**, leading to acceleration of all debt and potential bankruptcy. The company may also redeem the **2026 Notes** at its option when prevailing interest rates are low, forcing reinvestment at lower rates[368](index=368&type=chunk)[369](index=369&type=chunk) - A downgrade, suspension, or withdrawal of the credit rating for the company or the **2026 Notes**, or changes in debt markets, could significantly reduce their liquidity or market value. The company may not be able to repurchase the **2026 Notes** upon a Change of Control Repurchase Event due to insufficient funds or restrictions in other debt agreements[370](index=370&type=chunk)[371](index=371&type=chunk)[372](index=372&type=chunk)[373](index=373&type=chunk) [ITEM 1B. UNRESOLVED STAFF COMMENTS](index=71&type=section&id=ITEM%201B%2E%20UNRESOLVED%20STAFF%20COMMENTS) There are no unresolved staff comments from the SEC - No unresolved staff comments are applicable to the registrant[374](index=374&type=chunk) [ITEM 2. PROPERTIES](index=71&type=section&id=ITEM%202%2E%20PROPERTIES) The company does not own any material real estate or physical properties. Its headquarters are in Houston, TX, with additional offices in Charlotte, NC, and the Washington, D.C. area, all provided by Stellus Capital Management under an administration agreement - The company does not own any material real estate or physical properties. Its headquarters are in Houston, TX, with additional offices in Charlotte, NC, and the Washington, D.C. area, all provided by Stellus Capital Management under the administration agreement[375](index=375&type=chunk) [ITEM 3. LEGAL PROCEEDINGS](index=71&type=section&id=ITEM%203%2E%20LEGAL%20PROCEEDINGS) Neither the company, Stellus Capital Management, nor its subsidiaries are currently subject to any material legal proceedings, nor are any threatened. The company may be involved in ordinary course legal proceedings, but these are not expected to materially affect its financial condition or results of operations - Neither the company, Stellus Capital Management, nor its subsidiaries are currently subject to any material legal proceedings, nor are any material legal proceedings threatened against them. Any ordinary course legal proceedings are not expected to have a material effect on financial condition or results of operations[376](index=376&type=chunk) [ITEM 4. MINE SAFETY DISCLOSURES](index=71&type=section&id=ITEM%204%2E%20MINE%20SAFETY%20DISCLOSURES) Mine Safety Disclosures are not applicable to the company - Mine Safety Disclosures are not applicable[377](index=377&type=chunk) PART II [ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES](index=71&type=section&id=ITEM%205%2E%20MARKET%20FOR%20REGISTRANT%27S%20COMMON%20EQUITY%2C%20RELATED%20STOCKHOLDER%20MATTERS%20AND%20ISSUER%20PURCHASES%20OF%20EQUITY%20SECURITIES) The company's common stock (SCM) trades on the NYSE, with nine stockholders of record as of January 31, 2021, and a history of monthly/quarterly distributions. In 2020, it issued shares via DRIP and ATM for $4.77 million, while its stock often traded at a discount to NAV with high volatility - The company's common stock is traded on the New York Stock Exchange (NYSE) under the symbol **'SCM'**. As of January 31, 2021, there were **nine stockholders of record**[379](index=379&type=chunk) - The company generally intends to pay distributions to stockholders. From January 2014 through March 2020, monthly distributions were **$0.1133 per share**. For April-December 2020, quarterly distributions were **$0.25 per share**[380](index=380&type=chunk) Equity Securities Activity (Year Ended December 31, 2020) | Activity | Shares | Proceeds/Cost ($) | | :-------------------------------- | :------- | :------------------ | | DRIP Issuances (unregistered) | 21,666 | $228,943 | | ATM Program Sales (registered) | 332,591 | $4,771,144 | | DRIP Purchases (open market) | 117,687 | $1,127,500 (Avg. $9.58/share) | - The company's common stock has historically traded at times at a discount to its net asset value (NAV) per share, a risk distinct from NAV decrease[388](index=388&type=chunk) Common Stock Price Range and NAV (Fiscal Year Ended December 31, 2020) | Quarter | NAV Per Share ($) | High Sales Price ($) | Low Sales Price ($) | Premium or Discount of High Sales NAV (%) | Premium or Discount of Low Sales NAV (%) | | :---------------- | :------------------ | :------------------- | :------------------ | :---------------------------------------- | :--------------------------------------- | | 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 | [ITEM 6. SELECTED FINANCIAL DATA](index=75&type=section&id=ITEM%206%2E%20SELECTED%20FINANCIAL%20DATA) This section provides a five-year financial overview (2016-2020), highlighting fluctuating investment income, stable net investment income, increasing portfolio fair value, and a downward trend in weighted average debt investment yield from **11.0% to 8.3%** Selected Financial Data (2016-2020) | Metric | 2020 ($) | 2019 ($) | 2018 ($) | 2017 ($) | 2016 ($) | | :------------------------------------ | :--------- | :--------- | :--------- | :--------- | :--------- | | **Statement of Operations Data:** | | | | | | | 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 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 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 Dec 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 | 66 | 63 | 57 | 48 | 45 | | Weighted average yield on debt investments | 8.3% | 9.2% | 10.9% | 10.8% | 11.0% | [ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS](index=75&type=section&id=ITEM%207%2E%20MANAGEMENT%27S%20DISCUSSION%20AND%20ANALYSIS%20OF%20FINANCIAL%20CONDITION%20AND%20RESULTS%20OF%20OPERATIONS) This section analyzes the company's financial condition, liquidity, and operations for 2020, covering COVID-19 impacts, portfolio, investment activity, asset quality, revenues, expenses, debt, RIC status, and subsequent events [Forward-Looking Statements](index=76&type=section&id=Forward-Looking%20Statements) This section notes the report contains forward-looking statements about future operations, investments, and regulatory compliance, which involve COVID-19 related risks and uncertainties, with no obligation to update unless legally required - The report contains forward-looking statements about future operating results, business prospects, investment effects, contractual arrangements, conflicts of interest, economic dependence, portfolio company objectives, use of borrowed money, financing adequacy, cash flow timing, Stellus Capital Management's ability to locate and monitor investments, RIC/BDC qualification, and regulatory changes[395](index=395&type=chunk) - Forward-looking statements involve risks and uncertainties, including those related to the COVID-19 pandemic, and actual results could differ materially from anticipated outcomes. The company does not undertake to revise or update these statements unless required by law[395](index=395&type=chunk)[397](index=397&type=chunk) [Overview](index=76&type=section&id=Overview) Stellus Capital, an externally managed BDC formed in **2012**, aims to maximize stockholder returns through middle-market debt and equity, complying with **70%** qualifying asset rules and RIC status, with a **150%** asset coverage ratio, while navigating COVID-19 impacts - Stellus Capital Investment Corporation, organized on May 18, 2012, and commenced operations on November 7, 2012, is an externally managed, non-diversified, closed-end investment company regulated as a BDC and treated as a RIC[398](index=398&type=chunk)[399](index=399&type=chunk) - The company's investment objective is to maximize total return to stockholders through current income and capital appreciation from debt and related equity investments in middle-market companies[398](index=398&type=chunk) - As a BDC, the company must ensure at least **70% of its total assets** are 'qualifying assets' (investments in eligible portfolio companies). It also maintains RIC tax status, requiring compliance with source-of-income and asset diversification rules to avoid corporate-level taxes on distributed income[400](index=400&type=chunk)[401](index=401&type=chunk) - Following stockholder approval in **2018**, the company's asset coverage ratio requirement decreased from **200% to 150%**, increasing its leverage capacity. As of December 31, 2020, the asset coverage ratio was **223%**[402](index=402&type=chunk)[403](index=403&type=chunk) [COVID-19 Developments](index=77&type=section&id=COVID-19%20Developments) The COVID-19 pandemic, declared in **March 2020**, has significantly impacted the economy and portfolio valuations, with ongoing uncertainty regarding vaccine distribution and potential recession posing material risks to future net investment income and financial condition - The COVID-19 pandemic, declared in **March 2020**, has significantly impacted the U.S. and global economy, leading to widespread disruptions, quarantines, and business closures. The company has assessed the pandemic's impact on each portfolio company's valuation[404](index=404&type=chunk)[405](index=405&type=chunk) - Uncertainty regarding vaccine distribution and the timeline for achieving 'herd immunity' means a prolonged period of self-isolation and reduced economic participation is possible. This could lead to a sustained recession, materially adversely affecting the company's business, operations, net investment income, portfolio fair value, and financial condition[405](index=405&type=chunk)[406](index=406&type=chunk)[407](index=407&type=chunk) [Economic outlook](index=78&type=section&id=Economic%20outlook) The economic outlook remains uncertain due to the COVID-19 pandemic, posing material risks to portfolio company values, financing, operational costs, and regulatory policy, potentially triggering a global economic slowdown - The economic outlook is uncertain due to the COVID-19 pandemic, with potential for prolonged self-isolation and reduced economic participation despite vaccine authorizations. This presents material uncertainty and risks to portfolio company values, financing arrangements, operational costs, and regulatory policy, potentially triggering a global economic slowdown[408](index=408&type=chunk) [Operations](index=78&type=section&id=Operations) Stellus Capital Management's partners and employees have operated remotely since **March 16, 2020**, without disruption, prepared to continue as needed for safety - All partners and employees of Stellus Capital Management have been operating remotely since **March 16, 2020**, without disruption, and are prepared to continue as long as necessary for health and safety[409](index=409&type=chunk) [Our COVID-19 response](index=78&type=section&id=Our%20COVID-19%20response) Since the pandemic's onset, the company has maintained regular contact with portfolio companies and sponsors to assess liquidity, covenant compliance, and workforce/customer health - Since the onset of the COVID-19 pandemic, the company has been in regular contact with all portfolio companies and/or their sponsors to assess liquidity, expected covenant compliance, and the health of their workforce and customers[410](index=410&type=chunk) [Financial impact](index=78&type=section&id=Financial%20impact) The company will closely monitor portfolio companies' financial condition to mitigate COVID-19 impacts, noting historical data may be less relevant - The company will continue to closely monitor the financial condition of its portfolio companies to mitigate the impact of the COVID-19 pandemic, with historical information being relatively less significant[411](index=411&type=chunk) [Portfolio Composition and Investment Activity](index=78&type=section&id=Portfolio%20Composition%20and%20Investment%20Activity) As of December 31, 2020, the portfolio held **$653.4 million** across **66 companies**, primarily **78%** first lien debt with an **8.3%** weighted average yield, concentrated in Texas, California, Business Services, and Healthcare, with **$28.9 million** unfunded commitments and **$152.0 million** in 2020 investments - As of December 31, 2020, the company had **$653.4 million** (fair value) invested in **66 companies**. The portfolio was composed of approximately **78% first lien debt** (including unitranche), **11% second lien debt**, **3% unsecured debt**, and **8% equity investments** at fair value[413](index=413&type=chunk) - As of December 31, 2020, **93% of debt investments** bore interest based on floating rates (subject to interest rate floors), and **7%** bore interest at fixed rates. The weighted average yield on all debt investments was approximately **8.3%** (down from **9.2% in 2019**), and on all investments (including non-income producing equity) was approximately **7.9%** (down from **8.8% in 2019**)[420](index=420&type=chunk)[421](index=421&type=chunk) Portfolio Composition by Investment Type (Fair Value) | Investment Type | Dec 31, 2020 ($) | Dec 31, 2020 (%) | Dec 31, 2019 ($) | Dec 31, 2019 (%) | | :------------------------ | :--------------- | :--------------- | :--------------- | :--------------- | | Senior Secured – First Lien | $508,673,064 | 77.8% | $455,169,878 | 72.4% | | Senior Secured – Second Lien| $70,720,186 | 10.8% | $111,961,013 | 17.8% | | Unsecured Debt | $21,191,245 | 3.3% | $22,137,186 | 3.5% | | Equity | $52,840,000 | 8.1% | $39,680,000 | 6.3% | | **Total Investments** | **$653,424,495** | **100.0%** | **$628,948,077** | **100.0%** | Top Geographical Concentrations (Fair Value, Dec 31, 2020) | Geography | Fair Value ($) | % of Total Investments | | :---------- | :------------- | :--------------------- | | Texas | $135,146,776 | 20.68% | | California | $92,069,851 | 14.09% | | Illinois | $57,535,404 | 8.81% | | Arizona | $52,015,600 | 7.96% | | New Jersey | $37,765,139 | 5.78% | Top Industry Concentrations (Fair Value, Dec 31, 2020) | Industry | Fair Value ($) | % of Total Investments | | :---------------------------- | :------------- | :--------------------- | | Services: Business | $109,873,364 | 16.82% | | Healthcare & Pharmaceuticals | $82,945,887 | 12.69% | | Aerospace & Defense | $52,184,338 | 7.99% | | Beverage, Food, & Tobacco | $41,012,620 | 6.28% | | Media: Broadcasting & Subscription | $34,418,869 | 5.27% | - As of December 31, 2020, unfunded commitments to **19 portfolio companies** totaled **$28.9 million**, a decrease from **$37.5 million** across **17 companies in 2019**. The company had sufficient liquidity to fund these commitments[415](index=415&type=chunk) - In 2020, the company made **$152.0 million** in investments (**ten new, twenty existing portfolio companies**) and received **$128.8 million** in proceeds from prepayments and amortizations. Investment activity slowed in early 2020 due to COVID-19 but increased later in the year, with **$76.7 million** invested in **seven new companies** since July 2020[423](index=423&type=chunk)[426](index=426&type=chunk) [Asset Quality](index=83&type=section&id=Asset%20Quality) The company uses a five-level investment rating system; as of December 31, 2020, **76%** of the portfolio was Category 2 (within expectations), **14%** Category 1 (above expectations), and only **1%** Category 5 (expected loss) - The company uses a five-level numeric investment rating system to characterize and monitor the credit profile and expected returns of each investment. Category 1 indicates performance above expectations, Category 2 is within expectations (initial rating for new loans), Category 3 is below expectations but no loss of return/principal expected, Category 4 is substantially below expectations with some return loss expected, and Category 5 is substantially below expectations with some loss of return and principal expected[427](index=427&type=chunk) Investment Category Summary (Fair Value) | Investment Category | Dec 31, 2020 ($ millions) | Dec 31, 2020 (%) | Dec 31, 2019 ($ millions) | Dec 31, 2019 (%) | | :------------------ | :------------------------ | :--------------- | :------------------------ | :--------------- | | 1 | $87.3 | 14% | $70.4 | 11% | | 2 | $496.5 | 76% | $492.2 | 78% | | 3 | $61.3 | 9% | $49.3 | 8% | | 4 | — | —% | $12.0 | 2% | | 5 | $8.3 | 1% | $5.0 | 1% | | **Total** | **$653.4** | **100%** | **$628.9** | **100%** | [Loans and Debt Securities on Non-Accrual Status](index=84&type=section&id=Loans%20and%20Debt%20Securities%20on%20Non-Accrual%20Status) As of December 31, 2020, **three loans** were on non-accrual status, representing **4.3%** of the loan portfolio at cost and **1.0%** at fair value, with **$7.1 million** in unaccrued income Loans on Non-Accrual Status | Metric | Dec 31, 2020 | Dec 31, 2019 | | :-------------------------------- | :----------- | :----------- | | Number of portfolio companies | 3 | 2 | | % of loan portfolio at cost | 4.3% | 3.6% | | % of loan portfolio at fair value | 1.0% | 0.9% | | Unaccrued income ($) | $7.1 million | $3.8 million | [Results of Operations](index=84&type=section&id=Results%20of%20Operations) In 2020, net investment income was **$22.0 million** (**$1.13 per share**), down from **$22.4 million** in 2019, driven by lower interest income and operating expenses, with net realized losses of **$10.1 million** and **$8.6 million** in unrealized appreciation, resulting in a **$20.2 million** net increase in net assets from operations Investment Income Breakdown ($ millions) | Income Type | 2020 | 2019 | 2018 | | :---------------- | :---- | :---- | :---- | | Interest Income | $54.7 | $56.5 | $49.6 | | PIK Income | $0.7 | $0.4 | $1.9 | | Miscellaneous fees| $1.3 | $2.0 | $1.8 | | **Total** | **$56.7** | **$58.9** | **$53.3** | - Interest income decreased from 2019 to 2020 primarily due to a decline in market indices for floating rate loans, subject to interest rate floors. Non-recurring income from early repayments, previously reserved income, and loan amendments was **$2.1 million** in 2020, **$2.8 million** in 2019, and **$3.4 million** in 2018[433](index=433&type=chunk)[434](index=434&type=chunk) Operating Expenses Breakdown ($ millions) | Expense Type | 2020 | 2019 | 2018 | | :-------------------------------- | :---- | :---- | :---- | | 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** | **$30.6** | - Operating expenses decreased in 2020 primarily due to lower income incentive fees (due to lower LIBOR rates) and a reversal of capital gains incentive fees from realized losses. This was partially offset by increased management fees (due to portfolio growth) and higher interest expense (due to increased debt balances)[438](index=438&type=chunk) Net Investment Income and Net Assets from Operations | Metric | 2020 ($) | 2019 ($) | 2018 ($) | | :---------------------------------------- | :---------- | :---------- | :---------- | | Net investment income | $21,991,903 | $22,438,809 | $22,636,537 | | Net investment income per common share | $1.13 | $1.23 | $1.42 | | Net increase in net assets from operations| $20,192,441 | $26,438,186 | $26,194,578 | | Net increase in net assets from operations per common share | $1.04 | $1.45 | $1.64 | - Net investment income decreased in 2020 compared to 2019 due to lower interest income, offset by lower operating expenses. Net realized losses totaled (**$10.1 million**) in 2020, primarily from a loan disposition, partially offset by equity investment gains. This contrasts with net realized gains of **$19.6 million** in 2019 and **$5.5 million** in 2018[440](index=440&type=chunk)[443](index=443&type=chunk) - Net change in unrealized appreciation was **$8.6 million** in 2020, primarily due to portfolio company-specific performance on equity investments. This is a reversal from net unrealized depreciation of (**$15.5 million**) in 2019 and (**$1.6 million**) in 2018[445](index=445&type=chunk)[446](index=446&type=chunk) - A deferred tax provision of **$224.9 thousand** was recognized in 2020 (vs. **$66.8 thousand in 2019** and **$68.0 thousand in 2018**) related to unrealized appreciation on equity investments in Taxable Subsidiaries[448](index=448&type=chunk) [Financial condition, liquidity and capital resources](index=88&type=section&id=Financial%20condition%2C%20liquidity%20and%20capital%20resources) Liquidity stems from the Credit Facility, SBA debentures, and operations; 2020 saw **$3.5 million** net cash used in operations and **$5.8 million** provided by financing. The Credit Facility was amended in **September 2020**, lowering the asset coverage ratio to **1.67 to 1.0**, with **$174.0 million** outstanding on the Credit Facility and **$176.5 million** on SBA debentures, and **$48.9 million** in **5.75% notes** due 2022 Cash Flows Summary ($ millions) | Activity | 2020 | 2019 | 2018 | | :------------------------------------ | :----- | :----- | :----- | | Net Cash Used In Operating Activities | ($3.5) | ($93.3)| ($102.4)| | Net Cash Provided by Financing Activities | $5.8 | $92.0 | $94.8 | - The decrease in net cash used in operating activities in 2020 was primarily due to reduced new investments during the first half of the year, influenced by the COVID-19 pandemic[453](index=453&type=chunk) - Liquidity and capital resources are derived from the Credit Facility, **2022 Notes**, SBA-guaranteed debentures, and cash flows from operations. The company expects to fund growth through future equity offerings and senior securities issuances, but faces limitations if common stock trades below NAV[456](index=456&type=chunk)[457](index=457&type=chunk) - As of December 31, 2020, the company's asset coverage ratio was **223%** (vs. **229% in 2019**), well above the **150% requirement**, providing flexibility for leverage. Cash and cash equivalents were **$18.5 million** in 2020 (vs. **$16.1 million in 2019**)[459](index=459&type=chunk) - The Credit Facility was amended and restated on **September 18, 2020**, extending the maturity to **September 18, 2025**, and the commitment termination date to **September 18, 2024**. It includes a LIBOR floor of **0.25%** and a minimum asset coverage ratio of **1.67 to 1.0** (maximum leverage of **1.5x**)[460](index=460&type=chunk) Credit Facility Key Terms (Amended and Restated) | Feature | Prior Agreement | As Amended and Restated | | :------------------------ | :-------------- | :---------------------- | | Maturity Date | Oct 10, 2021 | Sep 18, 2025 | | Commitment Termination Date | Mar 10, 2021 | Sep 18, 2024 | | LIBOR Floor | None | 0.25% | | Prime Rate Floor | None | 3.00% | | Asset Coverage Ratio | Min 1.75 to 1.00| Min 1.67 to 1.00 | - As of December 31, 2020, the outstanding balance under the Credit Facility was **$174.0 million** (vs. **$161.6 million in 2019**). The weighted average interest rate was **3.2%** in 2020 (vs. **4.8% in 2019**)[464](index=464&type=chunk)[465](index=465&type=chunk) - SBA-guaranteed debentures outstanding were **$176.5 million** in 2020 (vs. **$161.0 million in 2019**). These debentures have fixed interest rates (10-year Treasury + spread) and a ten-year maturity, with no prepayment penalty. The SBIC subsidiaries held **41.1% of total consolidated assets** in 2020[469](index=469&type=chunk)[470](index=470&type=chunk) - The company issued **$48.9 million** in **5.75% fixed-rate notes** due **September 15, 2022** (the '**2022 Notes**'). As of December 31, 2020, the carrying amount was **$48.9 million**, with a fair value of approximately **$49.2 million**. The weighted average interest rate was **5.7%** in 2020[474](index=474&type=chunk)[475](index=475&type=chunk)[477](index=477&type=chunk) Contractual Obligations (Principal Amounts, as of Dec 31, 2020) | Obligation | Total ($ thousands) | 2021 ($ thousands) | 2022 ($ thousands) | 2023 ($ thousands) | 2024 ($ thousands) | 2025 ($ thousands) | 2026 and thereafter ($ thousands) | | :------------------------ | :------------------ | :----------------- | :----------------- | :----------------- | :----------------- | :----------------- | :-------------------------------- | | Credit Facility payable | $174,000 | — | — | — | $58,000 | $116,000 | — | | Notes payable | $48,875 | — | $48,875 | — | — | — | — | | SBA-guaranteed debentures | $176,500 | — | — | — | — | — | $176,500 | | **Total** | **$399,375** | **$—** | **$48,875** | **$—** | **$58,000** | **$116,000** | **$176,500** | [Off-Balance Sheet Arrangements](index=92&type=section&id=Off-Balance%20Sheet%20Arrangements) As of December 31, 2020, off-balance sheet arrangements included **$28.9 million** in unfunded commitments to **19 portfolio companies**, a decrease from **$37.5 million** for **17 companies in 2019**, with sufficient liquidity maintained - As of December 31, 2020, the company had **$28.9 million** in unfunded commitments to **19 portfolio companies**, down from **$37.5 million** for **17 companies in 2019**. The company maintains sufficient liquidity to fund these commitments[479](index=479&type=chunk) [Regulated Investment Company Status and Dividends](index=92&type=section&id=Regulated%20Investment%20Company%20Status%20and%20Dividends) The company maintains RIC status by distributing at least **90%** of taxable income, carrying forward **$21.1 million** to 2021, and aims for **90-100%** annual distribution, though debt covenants may restrict it; the IRS temporarily reduced the cash distribution requirement to **10%** in 2020 - The company maintains RIC tax status by distributing at least **90% of its investment company taxable income** to stockholders, avoiding corporate-level taxes. As of December 31, 2020, **$21.1 million of undistributed taxable income** was carried forward for 2021 distributions[480](index=480&type=chunk)[483](index=483&type=chunk) - The company intends to distribute **90-100% of its annual taxable income**, but Credit Facility covenants may restrict distributions. Stockholders are not assured of specific distribution levels[484](index=484&type=chunk)[485](index=485&type=chunk) - In 2020, the IRS temporarily reduced the minimum cash distribution requirement for stock dividends to **10%** (from **20%**) for distributions declared between April 1 and December 31, 2020, to enhance liquidity during economic disruption. The company has no current intention to pay dividends in stock but continues to assess its liquidity and the economic environment[486](index=486&type=chunk)[487](index=487&type=chunk)[488](index=488&type=chunk) [Recent Accounting Pronouncements](index=93&type=section&id=Recent%20Accounting%20Pronouncements) FASB issued ASU 2020-04, Reference Rate Reform, in **March 2020**, offering optional expedients for contracts and hedging relationships through **December 31, 2022**, which the company is evaluating but did not use in 2020; other pronouncements are not expected to materially impact financials - In **March 2020**, FASB issued ASU 2020-04, Reference Rate Reform, offering optional expedients for contracts and hedging relationships affected by reference rate reform, effective through **December 31, 2022**. The company is evaluating its impact but did not use these expedients in 2020[606](index=606&type=chunk) - Other new accounting pronouncements are not expected to have a material impact on the company's consolidated financial statements upon adoption[609](index=609&type=chunk) [Critical Accounting Policies](index=94&type=section&id=Critical%20Accounting%20Policies) Critical accounting policies are detailed in Note 1 to the Consolidated Financial Statements - Critical accounting policies are described in Note 1 to the Consolidated Financial Statements[490](index=490&type=chunk) [Subsequent Events](index=94&type=section&id=Subsequent%20Events) Post-December 31, 2020, the company received **$14.8 million** in repayments, made **$48.8 million** in new investments, issued **$100.0 million** in **4.875% notes** due 2026 to redeem **2022 Notes** and repay Credit Facility, increased SBIC II capital by **$15.0 million**, and declared **$0.0833 per share** monthly dividends - On **January 14, 2021**, the company received full repayment of **$13.6 million** on the first lien term loan and revolver of BFC Solmetex, LLC, and **$1.2 million** from its subsidiary, Bonded Filter Co. LLC[491](index=491&type=chunk)[719](index=719&type=chunk) - New investments post-year-end include **$11.3 million** in first lien term loan and **$4.8 million** in subordinated debt/warrants of NuSource Financial, LLC (**Jan 29, 2021**); **$0.4 million** in equity of Tailwind Core Investor, LLC (**Feb 1, 2021**); **$7.2 million** in first lien term loan and **$0.1 million** in equity of Time Manufacturing Acquisition, LLC (**Feb 11, 2021**); **$13.5 million** in first lien term loan, **$0.1 million** unfunded revolver, and **$0.3 million** equity of CEATI International, Inc. (**Feb 19, 2021**); **$10.8 million** in first lien term loan, **$0.1 million** unfunded revolver, and **$0.5 million** equity of TAC LifePort Purchaser, LLC (**Mar 1, 2021**); and **$10.0 million** in first lien term loan, **$0.1 million** unfunded revolver, and **$0.8 million** equity of TradePending, LLC (**Mar 2, 2021**)[492](index=492&type=chunk)[493](index=493&type=chunk)[494](index=494&type=chunk)[495](index=495&type=chunk)[496](index=496&type=chunk)[720](index=720&type=chunk)[721](index=721&type=chunk)[722](index=722&type=chunk)[723](index=723&type=chunk)[724](index=724&type=chunk) - On **January 14, 2021**, the company issued **$100.0 million** in **4.875% fixed-rate notes** due 2026. Proceeds were used to fully redeem the **2022 Notes** (**$48.875 million**) on **February 12, 2021**, and repay a portion of the Credit Facility[497](index=497&type=chunk)[498](index=498&type=chunk)[725](index=725&type=chunk)[727](index=727&type=chunk) - As of **March 3, 2021**, the outstanding balance under the Credit Facility was **$164.5 million**, and SBA-guaranteed debentures totaled **$210.0 million**[499](index=499&type=chunk)[500](index=500&type=chunk)[728](index=728&type=chunk)[729](index=729&type=chunk) - On **January 21, 2021**, the company contributed an additional **$15.0 million** to the SBIC II subsidiary, bringing total contributed capital to **$35.0 million**. Committed capital was increased to **$60.0 million** on **January 25, 2021**[501](index=501&type=chunk)[730](index=730&type=chunk) - On **January 15, 2021**, the Board changed the distribution frequency from quarterly to monthly and declared a regular monthly dividend of **$0.0833 per share** for January, February, and March 2021[502](index=502&type=chunk)[731](index=731&type=chunk) [ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK](index=95&type=section&id=ITEM%207A%2E%20QUANTITATIVE%20AND%20QUALITATIVE%20DISCLOSURES%20ABOUT%20MARKET%20RISK) The company faces interest rate risk; **93%** of loans are floating-rate with a **1.21%** weighted average LIBOR floor in 2020, where a **50 basis point increase** could decrease net interest income by **$0.4 million**, though hedging was not used in 2019 or 2020 - The company is subject to financial market risks, including changes in interest rates. A prolonged low interest rate environment, particularly with reduced LIBOR, could compress net interest income and adversely affect operating results[503](index=503&type=chunk) - As of December 31, 2020 and 2019, **93% of the company's loan portfolio** bore interest at floating rates (typically LIBOR-indexed with floors). The weighted average interest rate floor on floating rate loans was **1.21%** in 2020 (vs. **1.13% in 2019**)[503](index=503&type=chunk) Annual Impact on Net Interest Income from Interest Rate Changes (Dec 31, 2020) | Change in Basis Points | Interest Income ($ millions) | Interest Expense ($ millions) | Net Interest Income ($ millions) | | :--------------------- | :--------------------------- | :---------------------------- | :------------------------------- | | Up 200 | $11.4 | ($3.5) | $7.9 | | Up 150 | $7.6 | ($2.6) | $5.0 | | Up 100 | $2.9 | ($1.7) | $1.2 | | Up 50 | $0.5 | ($0.9) | ($0.4) | | Down 25 | — | — | — | - The company may hedge against interest rate fluctuations using instruments like futures, options, and forward contracts, but did not engage in hedging activities for the years ended December 31, 2020 and 2019[505](index=505&type=chunk) [ITEM 8. AUDITED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA](index=95&type=section&id=ITEM%208%2E%20AUDITED%20FINANCIAL%20STATEMENTS%20AND%20SUPPLEMENTARY%20DATA) This section presents the audited consolidated financial statements for 2018-2020, including the independent auditor's report, primary financial statements, schedule of investments, and comprehensive notes detailing operations, accounting policies, related parties, distributions, equity, NAV, fair value, commitments, financial highlights, debt, taxes, senior securities, and subsequent events [Report of Independent Registered Public Accounting Firm](index=97&type=section&id=Report%20of%20Independent%20Registered%20Public%20Accounting%20Firm) Grant Thornton LLP issued an unqualified opinion on the company's 2019-2020 consolidated financial statements, confirming U.S. GAAP conformity, with the critical audit matter being the fair value of Level 3 investments due to unobservable inputs and management judgment - Grant Thornton LLP issued an unqualified opinion on the company's consolidated financial statements for the periods ended December 31, 2020 and 2019, confirming fair presentation in conformity with U.S. GAAP[508](index=508&type=chunk) - The critical audit matter identified was the fair value of investments, specifically Level 3 assets, due to the use of significant unobservable inputs and high management judgment in valuation. Audit procedures included testing controls over management's valuation process and evaluating data, methods, and assumptions with internal valuation specialists[513](index=513&type=chunk)[514](index=514&type=chunk)[515](index=515&type=chunk) [Statements of Assets and Liabilities](index=99&type=section&id=Statements%20of%20Assets%20and%20Liabilities) As of December 31, 2020, total assets we

Financial Data and Key Metrics Changes - The company generated net investment income of $0.27 per share, exceeding the regular distribution of $0.25 per share for Q3 2020 [10] - Core net investment income, including taxes, was reported at $0.29 per share [10] - Total earnings for the quarter amounted to $0.39 per share, with a net asset value (NAV) decline to $13.17 per share at the end of the quarter [11][13] Business Line Data and Key Metrics Changes - The portfolio valuation increased by approximately $2.1 million, or $0.11 per share, with realized gains contributing an additional $0.01 per share [11] - Non-accrual loans represented only 1.5% of the total loan portfolio's fair value, with no new loans added to non-accrual status since April 1 [17] - The investment portfolio at fair value decreased to $622.4 million across 66 portfolio companies, down from $641 million at the end of Q2 2020 [18] Market Data and Key Metrics Changes - The company noted that 90% of its portfolio is rated at two or better on a one-to-five investment rating system, indicating stable asset quality [16] - The largest industry sector represented 18% of the total portfolio at fair value, with an average investment per company of about $9.4 million [17] Company Strategy and Development Direction - The company is focusing on investing in first lien unitranche debt and is unlikely to participate in mezzanine financing, indicating a strategic shift towards safer investments [35] - The company plans to utilize both cash in SBIC 1 and debentures in SBIC 2 to fund new investments, reflecting a proactive approach to capital management [26] Management's Comments on Operating Environment and Future Outlook - Management expressed confidence in the stability of the portfolio and noted that most portfolio companies are managing well in the current environment [15] - The company anticipates new investments in Q4 2020 to at least match the amount of repayments and equity realizations, potentially reaching $30 million [21] - Management highlighted a robust pipeline of over 10 companies under consideration, indicating a return to pre-COVID levels of activity [45][55] Other Important Information - The company declared a regular dividend of $0.25 per share and a special dividend of $0.06 per share for Q4 2020, totaling $1.15 per share for the year [22] - The company has extended the revolving period of its $230 million bank facility to September 2024, enhancing its liquidity position [19] Q&A Session Summary Question: What is the current cash position in SBIC and plans for debentures? - The company has approximately $25 million in cash in SBIC 1 and plans to use this along with debentures from SBIC 2 for new investments [26] Question: Thoughts on the redemption of 2022 baby bonds? - The company has $49 million of unsecured notes maturing in September 2022 and is considering a new fixed income offering to address this requirement [29][30] Question: Trends in portfolio favoring first lien debt? - The company has been shifting towards first lien debt over the past 2-2.5 years and expects this trend to continue [35] Question: Drivers of stable interest income despite lower investment volumes? - The stability in interest income is attributed to fee income from payoffs during the quarter [37] Question: Insights on market activity and deal quality? - The company is seeing strong activity in business-to-business sectors and technology-related companies, with a robust pipeline of quality transactions [44][46] Question: Anticipated changes in investment philosophy? - The company remains selective in its investments, focusing on companies that can withstand economic downturns, while also being cautious about the impact of COVID-19 on performance [58][62]

Stellus Capital Investment Corporation (NYSE:SCM) Q2 2020 Earnings Conference Call July 31, 2020 11:00 AM ET Company Participants Robert Ladd – President and Chief Executive Officer Todd Huskinson – Chief Financial Officer Conference Call Participants Ryan Lynch – KBW Bryce Rowe – National Securities Christopher Nolan – Ladenburg Thalmann Robert Dodd – Raymond James Operator Good morning, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Stellus Capit ...

Stellus Capital Investment Corporation (NYSE:SCM) Q1 2020 Results Earnings Conference Call May 12, 2020 11:00 AM ET Company Participants Robert Ladd - Chief Executive Officer Todd Huskinson - Chief Financial Officer Conference Call Participants Christopher Nolan - Ladenburg Thalmann Bryce Rowe - National Securities Paul Johnson - KBW Matt Tjaden - Raymond James David Miyazaki - Confluence Investment Management Kevin Tripp - Oppenheimer & Company Operator Good morning ladies and gentlemen and thank you for s ...