Main Street Capital Corporation (NYSE:MAIN) Q3 2023 Earnings Call Transcript

Main Street Capital Corporation (NYSE:MAIN) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Greetings, and welcome to the Main Street Capital Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan at Dennard Lascar Investor Relations. Please go ahead.

Zach Vaughan: Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s third quarter 2023 earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer, and Jesse Morris, Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of the call is, Nick Meserve, Managing Director and Head of Main Street’s Private Credit Investment Group. Main Street issued a press release yesterday afternoon that details the Company’s third quarter financial and operating results. This document is available on the Investor Relations section of the Company’s website at mainstcapital.com.

A replay of today’s call will be available beginning an hour after the completion of the call, and will remain available until November 10. Information on how to access the replay was included in yesterday’s release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the Company’s homepage. Please note that information reported on this call speaks only as of today, November 3, 2023, and therefore, you are advised that time sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Today’s call will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, or similar expressions.

These statements are based on management’s estimates, assumptions, and projections as of the date of this call and there are no guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties, and other factors, including, but not limited to, the factors set forth in the Company’s filings with the Securities and Exchange Commission which can be found on the Company’s website or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law. During today’s call, management will discuss non-GAAP financial measures, including distributable net investment income or DNII. DNII is net investment income or NII as determined in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, excluding the impact of non-cash compensation expenses.

Management believes that presenting DNII and the related per share amount are useful and appropriate supplemental disclosures for analyzing Main Street’s financial performance since non-cash compensation expenses do not result in a net cash impact to Main Street upon settlement. Please refer to yesterday’s press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Two additional key performance indicators that management will be discussing on this call, are net asset value or NAV, and return on equity or ROE. NAV is defined as total assets minus total liabilities and is reported on a per share basis. Main Street defines ROE as the net increase in net assets resulting from operations divided by the average quarterly total net assets.

Please note that certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. And now, I’ll turn the call over to Main Street’s CEO, Dwayne Hyzak.

Dwayne Hyzak: Thanks, Zach. Good morning, everyone, and thank you for joining us today. We appreciate your participation on this morning’s call. We hope that everyone’s doing well. On today’s call, I’ll provide my usual updates regarding our performance in the quarter, while also providing updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, our current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and leverage, and our expectations for the fourth quarter, after which we’ll be happy to take your questions.

We are pleased with our performance in the third quarter, which was highlighted by an annualized return on equity of 17.9% for the quarter, which increased our return on equity for the trailing 12-month period to 18.2%. Our performance included continued strength in the underlying performance of the majority of our lower middle market and private loan portfolio companies and significant contributions from our asset management business. We believe these results demonstrate the continued and sustainable strength of our overall platform, the strong current investment income generating capabilities of our existing investment portfolio, and the unique benefits provided by the equity investments in our lower middle market investment portfolio and by our asset management business, both of which also contributed meaningful fair value appreciation in the quarter.

We are also pleased that our investment pipeline and our lower middle market investment strategy has improved, and we expect higher levels of new lower middle market investment activity over the next few months. This improved investment pipeline, together with our conservative liquidity position and capital structure, which we significantly enhanced during the quarter, provide us a continued favorable outlook for the fourth quarter. Our DNII in the third quarter exceeded the monthly dividends paid to our shareholders by 51% and the total dividends paid to our shareholders by 8%, allowing us to continue to deliver the benefits of our strong results to our shareholders. These positive results and our favorable outlook for the fourth quarter resulted in our recommendations to our Board of directors for our most recent dividend announcements, which I’ll discuss in detail later.

Our NAV per share increased in the quarter due to several factors, including the impact of the fair value increases in our investment portfolio, the accretive impact of our equity issuances in the quarter, and our retention of the excess NII per share above our total dividends paid in the quarter. The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of net fair value appreciation and strong dividend income contributions from our equity investments in this portfolio. As we look forward to the next few quarters, we remain excited about our expectations for our lower middle market portfolio companies, and we expect to see additional fair value appreciation in this portfolio in the future.

We are also excited to have several portfolio companies in the advanced stages of strategic acquisitions, which, if successful, would provide the opportunity for additional fair value appreciation in addition to providing us highly attractive incremental investments in these high-performing companies. We’ve also seen continued progress with the increased potential exit activities for several of our lower middle market portfolio companies that we noted last quarter, and we believe that these activities could lead to favorable realizations over the next few quarters. Our lower middle market investment activity in the third quarter was well below our expectations and goals and was limited to total investments of $20 million in existing portfolio companies.

These investments, after repayments we received on several debt investments and return of invested equity capital, resulted in a net decrease in the cost basis of our lower middle market investments of $5 million. As I previously noted, we expect to have investment activity in our lower middle market strategy over the next few months that is more in line with our normal activities and expectations. We were pleased with our private loan investment activities in the quarter, which included total investments of $135 million and investments in two new portfolio companies. After debt repayments, sales of certain investments, and a realized loss on a private loan investment during the quarter, our investment activity resulted in a net increase in the cost basis of our private loan investments of $54 million.

We’ve also continued to produce attractive results in our asset management business. The funds we advised through our external investment manager continue to experience favorable performance in the third quarter, resulting in significant incentive fee income for our asset management business for the fourth consecutive quarter and a significant contribution to our net investment income. We remain excited about our plans for these external funds that we manage as we execute our investment strategies and other strategic initiatives, and we are optimistic about the future performance of the funds and the attractive returns we are providing for the investors of each fund. We also remain optimistic about our strategy for growing our asset management business within our internally managed structure and increasing the contributions from this unique benefit to our Main Street stakeholders.

As part of this growth strategy, we’re happy to update that we’ve made significant progress on our second private loan fund and had our initial closing of equity commitments in September. We look forward to the continued growth of this new fund over the next few quarters. Based upon our results for the third quarter, combined with our favorable outlook in each of our primary investment strategies and for our asset management business, earlier this week our Board declared a supplemental dividend of $0.275 per share payable in December, representing our ninth consecutive quarterly supplemental dividend. Our Board also declared another increase to our regular monthly dividends for the first quarter of 2024 to $0.24 per share payable in each of January, February, and March, representing a 6.7% increase from the first quarter of 2023 and representing our fifth increase to our monthly dividends in the last six quarters.

The supplemental dividend for December is a result of our strong performance in the third quarter, which resulted in DNII per share, which exceeded our regular monthly dividends paid during the quarter by $0.35, or 51%. The December supplemental dividend will result in total supplemental dividends paid during the 12-month period of $0.95 per share, representing an additional 35% paid to our shareholders in excess of our regular monthly dividends and resulting in a current yield we are providing to our shareholders of approximately 10%. After the multiple recent increases to our monthly dividend and the significant supplemental dividend, our DNII per share for the third quarter still exceeded our total dividends paid by $0.075 per share, or 8%.

We are pleased to be able to deliver this significant additional value to our shareholders while still conservatively maintaining a portion of our excess earnings to support our capital structure and investment portfolio against the risks that exist from the current economic uncertainties and to further enhance the growth of our NAV per share. We currently expect to recommend that our Board continue to declare future supplemental dividends to the extent DNII significantly exceeds the regular monthly dividends paid in future quarters and we maintain a stable to positive NAV. Based upon our expectations for continued favorable performance in the fourth quarter, we currently anticipate proposing an additional supplemental dividend payable in the first quarter of 2024.

Now turning to our current investment pipeline, as of today I would characterize our lower middle market investment pipeline as average. Despite the current broad economic uncertainty, we expect to continue to be active in our lower middle market strategy. Consistent with our experience in prior periods of broad economic uncertainty, we believe the unique and flexible financing solutions we can provide to lower middle market companies and their owners and management teams and our differentiated long-term to permanent holding periods should be an even more attractive solution in the current environment and should result in very attractive investment opportunities. We are excited about these new investment opportunities and we expect our current pipeline will be helpful as we work to maintain our positive momentum from the recent quarters in the future.

We also continue to be very pleased with the performance of our private credit team and the significant growth they have provided for our private loan portfolio and our asset management business. And as of today, I would also characterize our private loan investment pipeline as average. With that, I will turn the call over to David.

David Magdol: Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe our strong third quarter financial results continue to demonstrate the strength of Main Street’s platform, our differentiated investment approach, and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio companies continued to be positive, which contributed to our attractive third quarter financial results. As we have discussed in the past, the largest portion of our investment portfolio and the primary driver of our long-term success has been and continues to be our focus on the underserved lower middle market, and specifically our strategy of investing in both the debt and equity in lower middle market companies.

Our view on the attractiveness of investing in the lower middle market remains unchanged, and we expect this to continue to be our primary area of focus in the future. Each quarter, we try to highlight key aspects of our investment strategy and differentiated approach. For today’s call, we thought it would be useful to spend some time on the support we provide to our lower middle market portfolio companies. In addition to our normal ongoing activities to support our lower middle market portfolio companies, we specifically want to highlight an annual event we host for the leaders of our lower middle market portfolio companies, our seventh annual Main Street Presidents’ Meeting. For those of you who are not familiar with our Presidents’ Meeting, it is an annual event Main Street hosts for which we invite our lower middle market portfolio company leaders to Austin for a two-day event to network and relationship build, share best practices, learn from each other, and benefit from being part of Main Street’s portfolio.

Based on post-event feedback we receive from our lower middle market portfolio company executives, the event is highly valued by the participants, and the event improves each year as we refine our agenda based on the feedback we receive. Topics covered in the most recent meeting included sales generation techniques, executive coaching and culture building, cyber-security best practices, operational optimization, and industry-oriented breakout groups. When Main Street went public 16 years ago, we could not have imagined we would be able to bring such a large and high-caliber group of leaders and build this type of collaborative community event which brings robust benefits to our portfolio companies. As a result of this annual event, our portfolio companies have done business together, referred business to each other, utilized each other as operational resources, and made friendships that are invaluable.

Provide more context, one panel we received very positive feedback on this year was focused on best practices for optimizing your operations. The panel was comprised of a peer group of our lower middle market portfolio company leaders who led a discussion on lean manufacturing techniques, the use of KPIs throughout their operations, effective incentive compensation programs, and top-grading talent. Another valuable topic we covered was best practices for defining effective B2B sales strategies for an organization. For this session, we had an industry expert present on how to bring clarity and purpose to a selling organization. Presentation explored how to gain better insights in the customer needs, creating a shared vision on a company’s selling proposition, and how to proactively guide a prospective customer through the buying process.

The engagement from the audience for both presentations was robust and led to several post-event discussions, including the sharing of key third-party resources and operating best practices that we believe will ultimately improve the financial results and operating performance for our portfolio companies. Given our focus on the lower middle market strategy and the unique benefits it can provide, we are excited to bring together the key leadership from our lower middle market portfolio companies in this highly effective annual president’s meeting and event, in addition to certain other Main Street programs where we can provide value. And selfishly for our benefit at Main Street, we always leave this event very excited about the quality of the individuals leading our lower middle market portfolio companies and the future value creation we can expect they and their teams can generate for our mutual benefit in the future.

We left this year’s event even more excited than ever. Now, turning to the overall composition and results from our investment portfolio, as of September 30th, we continue to maintain a highly diversified portfolio with investments in 195 companies spanning across more than 50 industries across our lower middle market, private loan, and middle market portfolios. Our largest portfolio company represented 3.2% of total investment portfolio fair value at quarter end and 3.7% of our total investment income for the last 12 months. Majority of our portfolio investments continue to represent less than 1% of our income and our assets. Despite the increases in benchmark interest rates, the vast majority of our lower middle market, private loan, and middle market portfolio companies have interest rate and debt service coverage ratios calculated on a pro-forma basis for the current interest rates as of October 1st greater than one times, and we continue to be confident in their ability to service their debt obligations today and in the future.

In addition, and as a reminder, our lower middle market portfolio companies are predominantly fixed rate debt investments and therefore are not impacted by fluctuations in market index rates. Our investment activity in the third quarter included total investments in our lower middle market portfolio companies of $20 million, which, after aggregate repayments on debt investments and return of invested equity capital, resulted in a net decrease in our lower middle market portfolio of $5 million. Base of lower middle market originations this quarter was slower than we expect to achieve in any given quarterly period of time. That said, our origination volume can be lumpy in the lower middle market, and to reiterate what Dwayne mentioned in his opening remarks, as of today we would characterize our current lower middle market pipeline as average.

We look forward to making press announcements in the fourth quarter about some exciting new investments that we are currently in the process of completing. Driven by the capabilities and relationships of our private credit team, we also completed $135 million in total private loan investments, which, after aggregate repayments of debt investments and sale of several private loan portfolio investments, resulted in a net increase in our private loan portfolio of $54 million. Finally, during the quarter we had a net decrease in our middle market portfolio of $11 million as we continue to deemphasize this strategy. At the end of the third quarter, our lower middle market portfolio included investments in 79 companies, representing approximately $2.2 billion of fair value, which is 28% above our cost basis.

We had investments in 89 companies in our private loan portfolio, representing $1.5 billion of fair value. In our middle market portfolio, we had investments in 27 companies, representing $291 million of fair value. The total investment portfolio at fair value at quarter end was 113% of the related cost basis. Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday. In summary, Main Street’s investment portfolio continues to perform at a high level and deliver on our long-term results and goals. With that, I will turn the call over to Jesse to cover our financial results, capital structure, and liquidity position.

Jesse Morris: Thank you, David. As Dwayne and David mentioned, we are pleased with our offering results for the third quarter. Our total investment income for the third quarter was $123.2 million, representing an increase of $24.9 million, or 25%, over the third quarter of 2022, and a decrease of $4.3 million, or 3.4%, from the second quarter of 2023. As we highlighted in our earnings release, total investment income for the third quarter did not include meaningful levels of dividends and accelerated prepayment or other activity that are considered less consistent or non-recurring. The aggregate, these items were $4.6 million below the average of the prior four quarters, comparable to the third quarter last year, and were $6.1 million lower than the second quarter of 2023.

Interest income increased by $24.4 million, or 32%, over a year ago, and $2.1 million, or 2.2%, over the second quarter. The increase in interest income over the second quarter was driven primarily by increases in benchmark index rates and net investment activity, partially offset by reduced accelerated OID income and the impact of an increase in non-accrual investments. The increase in interest income over the prior year was driven primarily by increases in benchmark index rates and net investment activity. Dividend income increased by $1.8 million, or 9.1%, over a year ago. Dividend income decreased by $4.4 million, or 17%, from the second quarter, largely from a reduction in elevated non-recurring dividend income. The income decreased $1.3 million from a year ago and $2 million from the second quarter, driven by reduced closing fees resulting from lower investment activity in a lower middle market portfolio in the quarter.

Our operating expenses increased by $5.1 million, over a year ago, largely driven by increases in interest expense and compensation-related expenses, partially offset by an increase in expenses allocated to the external investment manager; Interest expense increased by $5.2 million, over the prior year, driven primarily by increases in benchmark index rates and from the addition of new debt obligations at higher interest rates, partially offset by a decrease in average outstanding borrowings. Cash compensation expenses increased by $1 million, over a year ago, driven by increased base compensation rates, increased cash and sound compensation accruals as a result of our positive operating performance, the increased headcount to support our growing investment portfolio and asset management activities.

Non-cash compensation expenses increased by $0.7 million from a year ago, including increases in share-based incentive compensation and deferred compensation expenses. Ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.3% for the quarter on an annualized basis and 1.4% for the trailing 12-month period and continues to be amongst the lowest in our industry. Our external investment manager contributed $7.6 million to our net investment income during the quarter, an increase of $2.6 million from a year ago and a decrease of $1 million from the second quarter. Manager earned $2.6 million in incentive fees during the quarter as a result of the positive performance of the assets under management and ended the quarter with total assets under management of $1.5 billion.

During the quarter, we recognized net fair value appreciation, including net realized gains and net unrealized appreciation on the investment portfolio of $27.7 million. This increase was driven by $24.2 million of net fair value appreciation in our lower middle market portfolio, resulting from the continued positive performance of certain of our portfolio companies, $12.2 million appreciation in our external investment manager, driven by increased revenues and an increase in peer multiples, $4.1 million net fair value appreciation in our middle market portfolio as a result of increases in quoted market prices and specific company performance improvements. This appreciation was partially offset by net fair value depreciation of $14 million in our private loan portfolio, largely due to the underperformance of certain portfolio companies.

We ended the third quarter with investments on non-accrual status comprising approximately 1.0% of the total investment portfolio at fair value and approximately 3.1% of cost; NAV per share increased by 64 cents or 2.3% over the second quarter and by $2.39 or 9.2% when compared to a year ago to a record $28.33 at September 30, 2023. We continue to believe that our conservative leverage, strong liquidity, and continued access to capital are significant strengths that have us well-positioned for the future. Regulatory debt to equity leverage calculated as total debt excluding our SBFC debentures divided by net asset value was 0.7 and our regulatory asset coverage ratio was 2.5. Both ratios are intentionally more conservative than our target ranges of 0.8 to 0.9 and 2.1 to 2.25, respectively.

We continue to be active during the quarter with our At-the-Market for ATM program, raising a net $81 million from equity issuances. We ended the quarter with strong liquidity, including cash and availability under our credit facilities of $834 million. In addition, in October, we expanded the commitments under our SPV facility by $175 million to $430 million, increasing our current liquidity to over $1 billion. We believe this provides us with ample liquidity to continue to pursue attractive investment opportunities for the remainder of 2023 and into 2024 while continuing to maintain a conservative leverage profile and significant capital structure flexibility. As Dwayne indicated, our offering performance resulted in a return on equity for the quarter of 17.9% on an annualized basis and 18.2% for the trailing 12-month period.

All of these are above our long-term targets and we continue to believe that these represent strong results compared to the industry. The NII per share for the quarter was $1.04 per share, a decrease of $0.08 or 7% from the second quarter and an increase of $0.16 or 18% over the same period a year ago. As I mentioned earlier, the combined impact of certain investment income considered less consistent or nonrecurring in nature is not significant in the third quarter. It was $0.08 per share below the second quarter, $0.06 per share below the average of the last four quarters, and was consistent with the same quarter a year ago. The NII per share exceeded the total regular monthly dividends per share paid to our shareholders in the third quarter by $0.35 or 51% and our total dividends per share by $0.075 or 8%.

As Dwayne mentioned, given the strength of our offering results and the outlook for 2023, our Board approved a supplemental dividend of $0.275 per share payable in December 2023, our ninth consecutive quarterly supplemental dividend. Total monthly and supplemental dividends declared for the fourth quarter 2023 are $0.98 per share, representing a 1.6% increase over the total dividends paid in the third quarter and a 29% increase over the total dividends paid in the fourth quarter last year. Additionally, given the continued momentum of our offering results, our Board also approved an increase to our monthly dividends to $0.24 per share for the first quarter of 2024, a third consecutive quarterly increase to our regular monthly dividends. Looking forward, given the strength of our underlying portfolio, we expect continued strong performance in the fourth quarter 2023 with expected DNI per share of at least $1.04 with the opportunity to significantly exceed this amount driven by the level of dividend income and portfolio investment activities during the quarter.

With that, I will now turn the call back over to the operator so we can take any questions.

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Q&A Session

Operator: Thank you. [Operator instructions] First question comes from Bryce Rowe with B. Riley Securities. Please go ahead.

Bryce Rowe: Thanks. Good morning. I wanted to, Dwayne, first just kind of ask about your comments around the more muted lower middle market portfolio growth in the third quarter and then prospects for some improvement in portfolio activity, lower middle market portfolio activity. What’s driving the increased pipeline, if you could comment on that?

Dwayne Hyzak: Sure, Bryce. Good morning and thanks for the question. Thanks for joining us today. I would say when you look at the lower middle market, and you’ve heard us say this in the past, we find that part of our market, our investment strategies, by far the most attractive, but the negative about the market is it can be lumpy. In the third quarter, we had some of that lumpiness come through. We had a number of transactions we were working on that, for one reason or another, did not make it through to a closing. So, that resulted in the muted activity in the quarter. We continue to have a favorable view, optimistic view about our expectations long-term for the lower middle market. I think we try to give guidance in our comments that you should expect to see some near-term investment activity as well as more normal investment activity over the next couple of months as you look at us closing out the fourth quarter and moving into the first quarter.

So, not anything from our standpoint to be overly concerned about, but it was a lower than expected amount of investment activity originations in the third quarter specifically.

Bryce Rowe: Okay, that’s helpful. You also kind of commented on potential exit activity within the lower middle market portfolio picking up here. What’s driving that? Is it M&A? Is it kind of idiosyncratic based on a lower middle market portfolio company owner seeking liquidity? Just curious on that.

Dwayne Hyzak: Yeah, I’d say, Bryce, it’d be more the latter. It’d be things that are specific to the individual portfolio company. As you’ve heard us say in the past, and you can see in our results, both in the dividend income that our lower middle market companies are producing, as well as the fair value increases that we’re having, the companies are performing at a high level. So, when you look at that type of performance, they will attract interest from third parties that could lead them to explore an exit opportunity, or there could be other activities specific to the portfolio company or to its existing ownership, its management team that lead them to take a look at an exit. So, I’d say there’s nothing specific that applies to all the opportunities.

But as we started noting last quarter and wanted to reiterate this quarter, we are seeing more activity there, and we do expect that a number of those initiatives or those activities could result in some favorable exits over the next couple of months.

Bryce Rowe: Got it. Okay. And one last one for me. On the closing of the second private loan fund, can you help size that up for us?

Dwayne Hyzak: Sure, Bryce. So, when you look at it, our goal is that our second private fund would be larger than the first. Just as a reminder, the first one was $100 million of equity. You can effectively double that with leverage to get to a $200 to $215 million total portfolio size. We, with our first closing here, were successful in closing with about $65 million of equity capital. We’re going to continue to raise capital in that fund going forward, just like we would have done on the first fund. So, we hope that the fund long-term will end up being greater than $100 million, but the process will play out over the next couple of quarters and determine how much success we are with the size on the equity commitments. And then just like fund one, our plan is to put leverage in place that will effectively double the assets relative to equity by the use of a debt or a leverage facility.

Bryce Rowe: Got it. Okay. Thanks a bunch. Thank you. Appreciate it, Bryce.

Operator: Next question, Robert Dodd with Raymond James. Please go ahead.

Robert Dodd: Hi, guys, and congrats on the quarter. When you look, you’re concerned about some of the deals not closing in the quarter. I mean, you said there wasn’t anything you were concerned about, but was there any kind of theme? Was it final due diligence kind of fell through or people latched it up, the ask on the price or any kind of color you can give us on what the trigger points were on the ones that fell through?

Dwayne Hyzak: Sure, Robert. I’ll give some color, then I’ll let David add on anything that he has from his perspective. But I’d say it wasn’t anything consistent across the transactions that didn’t make it across the finish-line. But as you’ve heard us say in the past, we’re dealing with individuals, not institutions in terms of the counterparty transactions. And they can and will have stuff that changes on their side from a personal standpoint. In my view of one of the transactions, that’s exactly what it was. He had a view of what a transaction, a desirable transaction would be. And I’d say that view over time changed as we went through our process. The other difficulties we’ve had, no big surprise, I think, to people, we continue to be very disciplined in our underwriting approach, not anything different than what we’ve done in the past.

But we always maintain a very disciplined approach. And in this current environment, when you look at the economic uncertainty, whether it’s actual historical results as we go through due diligence, or if it’s the visibility to the future expectations and future results, you’re seeing more volatility. And as we go through the diligence process, we have to deal with that volatility in terms of how we value and structure the final transaction. And that could lead the transaction not to move forward. So those would be the two examples I’d point to. I’ll let David add any additional comments he has on his side.

David Magdol: Yeah, Robert, we were always conscious of our origination budget and trying to drive towards closings. In this quarter, we had some lumpiness. A couple of the examples were one had a safety issue that came up during our diligence. Another one had some financial diligence relative to historical and projections that ultimately we couldn’t get comfortable underwriting to. So when we see those things, while we’re anxious to have closings and put more assets on the books, we’re just going to be disciplined about making sure we’re making good prudent investments like we have historically. And that leads to some quarters that are lumpier than others, nothing to take away as far as themes.

Robert Dodd: Got it. Got it. Thank you. This one’s kind of sort of what would you hearing preliminarily, if anything, on budget outlooks for ’24? Obviously, these are small, but if I’d asked you this 10 years ago, I don’t think most of your portfolio companies had budgets, so to speak. But you’ve been much more rigorous over the years in terms of encouraging those kind of those processes. So are you hearing on anything on that front about 2024, more moderate, more of the same, anything that’s coming through so far?

Dwayne Hyzak: Sure, Robert. As you said, our companies, all of them will go through some level of budgeting process for the next year. Most of them will go through a multi-year outlook or expectation planning process. Most of our companies are likely right in the middle of that process for 2024 today. So we don’t really have information to point to coming out of those budget, 2024 budget discussions. But what I would point you to, and David talked about this in his comments, not specifically the 2024 expectations, but the fact that we just hosted our president’s meeting for our lower middle market companies. And the data point I would give you is that coming out of that meeting, the overall mood, sentiment, expectations from the group broadly is very positive.

I think companies are doing well, despite all the challenges and all the headwinds that you hear about in the broader business community or just the overall economy, these companies are doing well. And they’re concerned about the same uncertainties that everybody else is. But if you look at their expectations in terms of discussions with customers and their ability to drive operational improvements or efficiencies and manage all the parts of their business that drive value, I would say that they all have a fairly optimistic view, which is why we look at it. And we always leave that meeting very, very encouraged. But I’d say this year we left the meeting maybe more encouraged than we had in the past. And again, I’ll let David, if he has any comments he wants to add as a response there, as in terms of what we heard from president’s meeting.

David Magdol: I’d say that the only thing that is always interesting to talk to our portfolio company execs about is their specific drivers within each industry, because we have so many industries represented. It is a, generally what you’re hearing in the economy probably overlays with our portfolio companies. The great news is because they’re small, they can be nimble and react quickly to the changes that they’re seeing. So there was a lot of discussion with those that might have some headwinds in their industry, what they’re doing proactively to position themselves, and others are still seeing good, robust activity and capitalizing on that.

Robert Dodd: Got it. Thank you. And I really appreciate the call. And again, congratulations on the government of this quarter.

Operator: Next question, Mark Hughes with Truist Securities. Please go ahead.

Mark Hughes: Yeah, thanks. Good morning. The incentive fee income from the fund management business, I think, up nicely year over year. Is that at a reasonable run rate? Was there something unusually good this quarter? Or is this kind of if the market stays in a particular groove, this will be a decent run rate for you?

Dwayne Hyzak: Sure, Mark. If you look at our asset management business, one of the things that I would remind the group is that that business from an investment strategy standpoint is primarily focused on our private loan strategy. So when you look at Main Street’s results, you can kind of read through to the results that we’re seeing in the funds or the clients we have on the asset management business. So if you look at our results at Main Street in this quarter, you did not see a lot of non-recurring, unusual one-time items. It was, from our perspective, a very clean quarter from that perspective. So I would say that you should expect the results that we had in our asset management business would follow the same nature of income and earnings.

So when we look at the third quarter, the incentive fees were down a little bit from the second quarter, but we feel like it’s a really good base level of incentive fees, assuming the market continues to perform the way it has and we don’t see degradation or issues across the portfolio, which we’re not seeing today. So we feel really good about the quarter and we feel good about what that means from a look-through standpoint into the incentive fees we’re getting off the asset management business.

Mark Hughes: And then did you give any indication of kind of the underlying EBITDA or revenue growth for your portfolio companies, the lower middle market companies?

Dwayne Hyzak: We didn’t, Mark. That’s not a stat that we typically publish.

Mark Hughes: Okay, very good. And I think you — I’m not sure whether you were touching on your pipeline in terms of potential new investments, but I think you would also suggest that your opportunity for fair value appreciation through maybe some divesting activity, that that was elevated. Could you talk a little bit more about that? What needs to happen for that to come through?

Dwayne Hyzak: Sure, Mark. If you look broadly at our changes in fair value, both in this quarter, and I’d say for the last couple of quarters, we’re seeing the results of a number of companies that are just performing at a high level, specifically in the lower middle market. Some of those companies have completed acquisitions over the last 12 or 18 months, as you may recall us saying in prior quarters, and those acquisitions have been integrated well, they’re performing well, they’re realizing the synergies, and you’re seeing the results of those strategic, valuable acquisitions come through the company’s quarterly results, and then you see it come through our fair value. So that would be a big driver. When you look at the exit activity, I would say one thing from our perspective, which we may not control the outcome because we’re just one of the equity owners, we don’t own control or drive all the final decisions of these individual lower middle market portfolio companies, but in general, if we’re going to be motivated or inclined to sell, it’s likely going to be at a premium to our fair value.

Otherwise, all things being equal, we’re likely going to be more inclined to hold the investment. We have permanent capital, our desire is to have a very, very mature, diversified, broad portfolio. So all things being equal, if we had control over everything, we would maintain our best companies forever, unless somebody was going to pay us a significant premium to what we think is worth as of today. So that may not directly answer your question, but I think we feel good about where we have our portfolio companies valued overall. We specifically feel good about where we have them valued in the context of them going through an exit or sell process.

Mark Hughes: Thank you. Appreciate it.

Operator: [Operator instructions] Next question comes from Vilas Abraham with UBS. Please go ahead.

Vilas Abraham: Hey, everyone. Thanks for the question. Maybe just to follow on Mark’s question a little bit. On these add-on acquisitions that are driving some of the fair value appreciation through the realization of synergies, is the momentum for that dynamic going to continue for the foreseeable future? And one of the key drivers here as you think about your fair value marks for the next few quarters?

Dwayne Hyzak: Sure, I’ll give you a couple of comments. I’ll let either David or Jesse add on, because they’re involved in a couple of the companies that are executing acquisition growth strategies. But just to kind of go backwards a little bit, if you had been looking at us, talking to us five, six years ago, acquisition growth strategies for our portfolio companies, while we had some, it was not a significant activity for most of our companies. It’s something that we long had viewed as an opportunity. And we started in our president’s meeting five, six years ago, really talking about the opportunity to pursue growth through acquisitions and started educating our companies on how and why they should at least consider it, clearly not forcing them to do it, but at least should consider it.

As a result of that, and as a result of the just the high quality of the companies and management teams that we have in the portfolio over the last couple of years, really, COVID was a time period where it really accelerated. We started seeing more of our companies embrace acquisition growth opportunities. So when we look at it, we’ve got a number of companies that, as I said, have been executing those acquisitions, not just closing the acquisition, but integrating and optimizing the synergies. And they’ve done a lot of that. And we continue to have some of those same companies continue to explore additional acquisitions. But we also have a broader group, some companies that have not executed acquisitions in the past that have very attractive strategic acquisitions that we’re helping them work through.

And we hope to have a closing again, sometime over the next one to three months. And if we’re successful there, we wouldn’t execute that acquisition both for our benefit or for the portfolio company, without the viewpoint that it’ll be a significant value creator from a fair value standpoint and an ultimate equity valuation for when that company’s ever sold. So I know that’s a lot there, but I’d say it’s just, we have been and continue to encourage our companies to pursue that. And we’ve seen really, really good results over the last couple of years from that initiative.

David Magdol: So I’ll just add one thing on the fair value comment. There are two big inputs that Dwayne talked about. One are the accretive acquisitions. The second are the exit activities. When we’re doing our fair value marks, we’re marking them to what we think is a fair value at that moment in time. When we do run a process, the job on a process, if there is an intermediary involved, is to go out there and find the outlier and to get to the top of a range of expected outcomes. As time goes on, we get further through that and we have incoming calls, we hope to exceed the fair value marks that we have. So when we see activity, we’re hopefully able to appreciate and get that outlier type of valuation that also helps obviously with the fair value.

Vilas Abraham: Okay. And then that final mark will happen after the transaction closes?

Dwayne Hyzak: At closing. Yeah. When you see the realized transaction, go through the financial statements.

Vilas Abraham: Okay. Okay. Great. That’s all very helpful, color. Can you guys talk about the, just to pick up there, non-accruals for the quarter? Any color around what was happening there with that credit or credits that I think were in the private loan book?

Jesse Morris: Yeah. There were two that off the top of my head were private loan. One was middle market. I’d say these are companies that we had been writing down from a fair value standpoint the last couple of quarters as those companies had dealt with specific operating company performance issues to the credit of the sponsors. They continue to be supportive and we continue to work with the private equity sponsors in each of those transactions and the other participants in the capital structure. But the non-accrual status and the fair value depreciation that we’ve recorded just represents the underlying operating performance challenges that those companies have had specifically. So nothing that’s systematic or broad-based. It’s very, very specific to the operating performance of those companies in this quarter that were moved to non-accrual.

Vilas Abraham: Okay. Thank you, guys. I’ll hop back in the queue.

Operator: This concludes our question and answer session. I would like to turn the floor back over to management for closing comments.

Dwayne Hyzak: We just want to thank everyone again for joining us this morning and we’ll look forward to talking to everyone again in mid to late February. Ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines and have a wonderful day.