Main Street Capital Corporation (NYSE:MAIN) Q4 2022 Earnings Call Transcript

Main Street Capital Corporation (NYSE:MAIN) Q4 2022 Earnings Call Transcript February 24, 2023

Operator: Greetings, and welcome to the Main Street Capital Corporation Fourth 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan with Dennard Lascar, Investor Relations. Thank you, sir. You may begin.

Zach Vaughan: Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s fourth quarter 2022 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 the Private Credit Investment Group. Main Street issued a press release yesterday afternoon that details the company’s fourth quarter and full year 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 March 3. 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 home page. Please note that information reported on this call speaks only as of today, February 24, 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. Please refer to yesterday’s press release for a reconciliation of these measures to the most directly comparable GAAP financial measures.

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: Thank you, Zach. Good morning, everyone, and thank you for joining us today. We appreciate your participation on this morning’s call. We hope that everyone is doing well. On today’s call, I’ll provide my usual updates regarding our performance in the quarter, while also providing a few updates on our performance for the full year. I’ll also provide updates on our asset management activities, our recent declarations of another supplemental dividend payable in March and our regular monthly dividends for the second quarter of 2023, our expectations for dividends going forward, our recent investment activities and 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 first quarter of 2023, after which we will be happy to take your questions.

We’re very pleased with our fourth quarter results, which closed a record year for Main Street across several key performance indicators, with significant positive momentum for 2023. Our results include new quarterly records for Net Investment Income or NII per share and Distributable Net Investment Income, or DNII, per share, significantly exceeding our records achieved in the third quarter and representing the sixth consecutive quarter in which we set or matched our NII per share record. This consistent strong performance demonstrates the continued and sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies and the underlying quality of our portfolio companies. We’re also pleased that the positive results included strong contributions from both our lower middle market and private loan investment strategies and our asset management business, providing us confidence about the recurring nature of these positive results in the future.

As a result of our strong performance, our quarterly DNII per share exceeded $1 per share for the first time, and we generated an annualized net income return on equity of over 20%. We’re also pleased with the strong results for the full year, which also included record NII per share and DNII per share and allowed us to end the year at a record net asset value per share. After these record-breaking results, and some meaningful capital markets activities, we entered the New Year with a strong liquidity position and a conservative leverage profile. We remain very encouraged by the continued favorable performance of our diversified lower middle market and private loan investment strategies and remain confident that these strategies, together with the benefits of our asset management business and our cost-efficient operating structure will allow us to continue to deliver superior results for our shareholders over the long-term future.

These positive results and our favorable outlook for the first quarter resulted in our recommendation to our Board of Directors for our most recent dividend announcements, which I will discuss in more detail later. Our net asset value per share increased in the quarter, due to the impact of the fair value increases in several components of our investment portfolio and the positive impact of our equity issuances in the quarter. Our lower middle market portfolio companies continued their strong performance overall, which resulted in another quarter of meaningful fair value appreciation in the equity investments in this portfolio. And we are excited about the new and follow-on investments we made in our lower middle market portfolio companies during the quarter.

We expect that these follow-on investments will drive additional fair value appreciation in these portfolio companies in future quarters. We also benefited from meaningful fair value appreciation in our private loan portfolio, and in the value of our wholly owned registered investment adviser, through a combination of portfolio company-specific and broader market-based drivers. We also continue to have favorable investment activities in the fourth quarter. Our lower middle market investments of $152 million in the quarter resulted in a net increase in lower middle market investments, after repayments of $127 million. This capped off another strong year of activity with total lower middle market investments of $373 million for the year, resulting in a net increase of $264 million.

Our private loan investment activities in the quarter included new investments of $86 million, which after aggregate repayments resulted in a net decrease in our private loan investments of $26 million. For the year, we completed $713 million of new investments, resulting in a net increase in our private loan portfolio of $335 million. Given our favorable liquidity position, after our recent capital market activities, which Jesse will address in his comments, which we achieved despite a very challenging capital markets environment, we are very well positioned to continue the growth of our investment portfolio over the next few quarters. We’ve also continued to produce positive results in our asset management business. The funds we advised through our external investment manager, including MSC Income Fund, a non-traded BDC and MS Private Loan Fund I, a private credit fund, continued to experience favorable performance in the fourth quarter.

This positive performance resulted in significant incentive fee income for our asset management business. And as a result, we received significantly higher dividends from our asset management business. We remain excited about our plans for these funds, as we execute on 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 to the investors of each fund. We are also optimistic about our strategy for growing our asset management business within our internally managed structure and are actively working to increase the contributions from this unique benefit to our Main Street stakeholders and we look forward to sharing additional details as we execute our plans for this business in 2023 and work to create additional value for the next few years.

Based upon our results for the fourth quarter, combined with our favorable outlook in each segment of our business and the benefits of our efficient operating structure, earlier this week, our Board declared a supplemental dividend of $0.175 per share payable in March, representing our largest and sixth consecutive quarterly supplemental dividend. Our Board also declared regular monthly dividends for the second quarter of 2023 at $0.225 per share payable in each of April, May and June, representing a 4.7% increase from the second quarter of 2022. The increased supplemental dividend for March is a result of our strong performance in the fourth quarter, which resulted in DNII per share that was $0.37 or 56% greater than our monthly dividends paid during the quarter.

The March 2023 supplemental dividend will result in total supplemental dividends paid during the trailing 12-month period of $0.45 per share, representing an additional 17% paid to our shareholders in excess of our regular monthly dividends. Including these supplemental dividends, our DNII per share for the fourth quarter exceeded our total dividends paid by $0.20 per share. We are pleased to be able to deliver the significant additional value to our shareholders, while also maintaining a significant portion of our excess earnings to support our capital structure and investment portfolio against risks from the current economic uncertainties that maybe realized in 2023 and to further enhance the growth of our NAV per share. As we’ve previously mentioned, we currently expect to recommend that our Board declare future supplemental dividends to the extent DNII significantly exceeds regular monthly dividends paid in future quarters, and we maintain a stable to positive net asset value.

Based upon our expectations for continued favorable performance in the first quarter, we currently anticipate proposing an additional supplemental dividend payable in June 2023. Now turning to our current investment pipeline. As of today and after our robust activity for the fourth quarter, I would characterize our lower middle market investment pipeline as below average. While the near-term pipeline is currently below average, we remain highly confident in our ability to generate significant new lower middle market investment opportunities in 2023. 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’d 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. Year-end provides a good opportunity to look back at our history and highlight the benefits of our unique and diversified investment strategy and discuss how this has enabled us to deliver attractive returns to our shareholders over an extended period of time. We believe looking back at our history also supports our intent to continue to execute our unique and highly differentiated strategy in the future. Since our IPO in 2007, we have increased our monthly dividends per share by 105%, and we have declared cumulative total dividends to our shareholders of $36.65 per share or over 2.4 times our IPO price of $15 per share. Our total return to shareholders since our IPO calculated using our stock price as of yesterday’s close and assuming reinvestment of all dividends received since our IPO was 8.6 times money invested.

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This compares very favorably to 2.5 times money invested for the S&P 500 over the same period of time and is significantly higher when compared to our BDC peers. As we’ve previously discussed, we believe that the primary drivers of our long-term success have and will continue to be our focus on making both debt and equity investments in the underserved lower middle market. Growing our private credit activities for the benefit of our balance sheet and for the clients of our Asset Management business, which clearly benefits our shareholders and our industry-leading cost structure, which provides for a strong alignment of interest between our management team and shareholders through our team’s meaningful stock ownership and incentive compensation plan, which is tied to our ability to achieve superior financial results for our shareholders.

Most notably and uniquely, our lower middle market strategy provides attractive leverage points and yields on our first lien debt investments, while also creating a true partnership with the management teams of our portfolio companies through our flexible equity ownership structures. This approach provides significant downside protection through our first lien debt investments, while still providing the benefits of alignment and significant upside potential with our equity investments made alongside our portfolio company management team partners. Our long-term historical track record of investing in the lower middle market, coupled with our view that this market continues to be underserved gives us confidence that we will be able to continue to find attractive new investment opportunities in this important cornerstone of our business in the future.

In 2022, Main Street invested $373 million in our lower middle market strategy. $137 million of this capital is deployed in five new lower middle market platform companies with the remaining $236 million represented follow-on investments in existing fees and lower middle market companies. Consistent with our comments in prior quarters, these follow-on investments were made to support the growth strategies in some of our highest performing portfolio companies, which makes this aspect of our lower middle market investment activity very exciting for us. Consistent with our guidance in prior quarters, 2022 represents the strongest year of add-on investments in our lower middle market companies in Main tree’s history. Our follow-on investment investments are typically used to support multiple objectives, including acquisitions, diversification opportunities, product or geographic expansion and recapitalization transactions.

These follow-on investments support proven management teams that intrinsically plus less investment risk when compared to providing capital to new portfolio companies. Since we are significant equity owners in our lower middle market companies, we benefit from participating alongside the proven managers in these businesses as they strive to achieve meaningful equity value creation. As we’ve stated in the past, our lower middle market portfolio companies perform over time to naturally deleverage with free cash flow generated from operations. This also allows us, along with our lower middle market portfolio management team partners to benefit from the distributions received from this cash flow. Given the strength and quality of our lower middle market portfolio, we expect dividend income to continue to be a primary contributor to our results in 2023.

Additionally, this deleveraging, coupled with the attractive underlying operating results at our floor middle market portfolio companies allowed us to achieve $75 million in fair value appreciation in realized activities. This benefit in our lower middle market equity investments is unique among our BDC peers with value appreciation along with realized gains serving to offset losses we will naturally incur in our investing activities. Our unrealized equity appreciation also provides potential upside to Main Street’s net asset value that other BDCs simply do not have. The last important area I’d like to cover regarding our 2022 accomplishments are the impressive contributions that our private credit team delivered during the year. Our private credit team continued to execute on our strategy to dedicate significant resources towards growing the private loan segment of our business, while deemphasizing our middle market portfolio, which, as a reminder, typically includes investments in larger syndicated loans.

Our purposeful and intentional strategic shift over the last five years to grow our private loan portfolio is primarily driven by our belief that an attractive and growing direct lending environment exists, and that private loan investments provide an attractive risk-adjusted return profile for Main Street. During 2022, Main Street invested $713 million in our private loan strategy, which helped increase our private loan portfolio by 29% and purposely decreased our middle market portfolio by 17%. As a result, at year-end, our private loan portfolio has grown to represent 36% of our total investments at fair value and the middle market portfolio declined by 300 basis points to represent 8% of our total investments at fair value. As Dwayne discussed earlier, our private loan capabilities also support our key strategic intention to continue growing our asset management business.

Now turning to our current portfolio. As of December 31, we had investments in 194 portfolio companies spanning across more than 50 different industries. Our largest portfolio company represented 3.4% of our total investment income for the year and 3.2% of our total investment portfolio fair value at year-end. The majority of our portfolio investments represented less than 1% of our income and our assets. Our investment activity in the fourth quarter included total investments in our lower middle market portfolio of $152 million, which after aggregate repayments on debt investments and return of invested equity capital resulted in a net increase in our lower middle market portfolio of $127 million. During the quarter, we also made $86 million in private loan investments, which after aggregate repayments of debt investments and return of invested equity capital resulted in a net decrease in our private loan portfolio of $26 million.

Finally, during the quarter, we had a net decrease in our middle market portfolio of $19 million. At year-end, our lower middle market portfolio included investments in 78 companies representing over $2.1 billion of fair value, which is over 20% above our cost basis. We had investments in 85 companies in our private loan portfolio, representing $1.5 billion of fair value. In our middle market portfolio, we had investments in 31 companies representing $329 million at fair value. Total investment portfolio at fair value at year-end was 109% of the related cost basis. Additional details on our investment portfolio at year-end are included in the press release that we issued yesterday. 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. To echo Dwayne’s and David’s comments, we are pleased with our operating results for the fourth quarter, which included a number of quarterly records and capped the year with Main Street achieving records for net investment income, distributable net investment income and net asset value, all on a per share basis. Our total investment income for the fourth quarter represented another consecutive quarterly record, increasing by $31.7 million or 38.6% over the same period in 2021 to a total of $113.9 million. The fourth quarter surpassed our most recent quarterly record for total investment income flat in the third quarter of 2022 by $15.5 million or 15.7%, including meaningful increases in interest, dividend and fee income, which demonstrates the continued strength and momentum of our investment and asset management strategies.

Interest income increased by $32.5 million from a year ago and $11.3 million over the third quarter. We estimate the continued benefit from increases in benchmark index rates, drove a little over half of the increase over the third quarter, with the remainder driven primarily by the continued growth in our portfolio debt investments. In addition, the combined favorable impact of certain elevated income items in the fourth quarter, including dividends and accelerated prepayment, repricing or other activities that are considered less consistent was approximately $2 million or $0.02 per share by the average of the prior four quarters and was comparable to such income amounts earned in the fourth quarter of 2021. Our operating expenses for the quarter increased by $7 million over the fourth quarter of 2021, largely driven by increases of $7.1 million in interest expense, $1.5 million in general and administrative expenses and $0.7 million in share-based compensation, partially offset by a decline of $1.5 million in cash compensation related expenses and an increase of $0.8 million in expenses allocated to the External Investment Manager.

The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.4% for the year and continues to be amongst the lowest in our industry. Our external investment manager contributed $7 million to our net investment income for the fourth quarter, an increase of $2.1 million from the same period of the prior year primarily due to a $1.9 million increase in incentive fees earned. During the quarter, we recorded net fair value appreciation, including net realized losses and net unrealized appreciation on the investment portfolio of $36.2 million, including net fair value appreciation of $24.2 million in our lower middle market portfolio, $9.2 million of our private loan portfolio and $10.4 million in our external investment manager.

These were partially offset by a net fair value depreciation of $8.8 million in our middle market portfolio. Net asset value or NAV per share increased by $0.92 over the third quarter and by $1.57 or 6.2% when compared to a year ago, to a record NAV per share of $26.86 at year end. We ended the fourth quarter with 12 investments on non-accrual status, comprising approximately 0.6% of the total investment portfolio at fair value and approximately 3.7% at cost. While not material to our NAV expectations for the next quarter, we did resolve a large and very long-standing non-accrual in the first quarter of 2023, which will impact these non-accrual stats at March 31, 2023. We continue to believe that our conservative leverage, strong liquidity and continued access to capital or significant strengths that have us well positioned for the future.

Given our belief of the importance of liquidity and a conservative capital structure, as we indicated on our third quarter conference call, we continue to explore additional sources of debt financing. During the fourth quarter, we were active on the capital front, including the execution of a new SPV credit facility with commitments of $255 million, the execution of a $100 million unsecured private placement notes, the repayment of the $185 million due on our 2022 notes at maturity and a net $71 million raised from equity issuances under our at-the-market program. As a result of these actions, we ended the year with strong liquidity, including cash and availability under our credit facilities of $617 million. Taken together with an additional $110 million provided by additional capital activities in January 2023, including the issuance of $50 million additional unsecured private placement notes and the expansion of commitments under our corporate credit facility by $60 million, we believe this provides us with the liquidity necessary to continue to be opportunistic and pursue attractive investment opportunities in 2023 while continuing to maintain a conservative leverage profile and healthy liquidity in these uncertain periods.

Our regulatory debt-to-equity leverage calculated its total debt, excluding our SBIC debentures, divided by net asset value was 0.79, and our regulatory asset coverage ratio was 227%, both of which are improvements from the third quarter and are intentionally slightly below the conservative end of our target ranges of 0.8 to 0.9x and 210% to 225%, respectively. Coming back to our operating results. Our return on equity for the fourth quarter was 20.8% on an annualized basis and 12.6% for the year. C&I per share for the quarter was a record $1.03 per share exceeding the total regular monthly dividends per share paid to our shareholders in the fourth quarter by $0.37 per share or approximately 56%. The NII per share for the quarter eclipsed our prior record in the third quarter of 2022 by $0.15 per share or 11.7%, an increase by $0.25 or 32.1% over the same period last year.

Total dividends paid in 2022 were $2.945 per share, including $0.35 per share in supplemental dividends, an increase of 14.4% over total dividends paid during 2021. As Dwayne mentioned, given the strength of our operating results and the outlook for 2023, our Board approved a supplemental dividend of $0.175 per share payable in March 2023. With this supplemental dividend, total declared dividends for the first quarter of 2023 are $0.85 per share, representing an 11.8% increase over the total monthly and supplemental dividends paid in the fourth quarter of 2022 and a total annualized yield of approximately 8.5%. As we look forward, given the strength of our underlying portfolio, we expect another strong top line and earnings quarter in the first quarter 2023 with expected DNII per share of at least $0.98 per share and with the potential for upside 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: At this time, we will be conducting a question-and-answer session. Our first question comes from Robert Dodd with Raymond James. Please proceed with your question.

Robert Dodd: Hi. Good morning. Congratulations on another really good quarter.

Dwayne Hyzak: Thanks Robert.

Robert Dodd: On dividend income, if I can, I know it’s hard to not just predict. But in this quarter, if I take out the dividend from the asset manager out to I-45, it was still a really strong dividend quarter just from the portfolio companies. I mean, 2021 was crazy, but still really strong. Can you give us any color you’ve given us some color in the past about, how much the concentration of what portion of the portfolio that income comes from? Can you give us any updates on that, or even maybe, how much of that income comes from portfolio companies you’ve held for

Dwayne Hyzak: Yeah.

Robert Dodd: five years or more or any breakdown you can give us for kind of the types, age concentration of the portfolio of companies is coming from?

Dwayne Hyzak: Sure, Robert. Thanks for the question. We’re happy to give you those details. As you said, and you’ll be able to see this when you see the 10-K, the contributions on the dividend income side are pretty broad-based. If you take out MSC Income Fund, it would take another 12 companies, on the lower middle market side before you got to 50% of the remaining dividend income. So we think it’s a nice diversity, contributions from a broad base of companies. Once you get past that 12, there’s a very large number of other companies that are meaningful contributors. So as you heard us say in our comments, we feel good about how the lower middle market companies are performing. You see that in both the appreciation we recognized in the quarter, but you also see it to the question you raised here to the point, you raised here with the broad-based dividend income that we saw from the portfolio in the fourth quarter.

Robert Dodd: Got it. Got it. Thank you for that. I mean, and then, the other question is, the lower middle market pipeline, you said, it’s below average. I mean, you also gave a lot more. But can you give me what — why currently, is it below average? Do you think is it a function of the outlook on the economic environment or for it to get to back to average or above average, do we need more certainty in kind the economy because, obviously, sellers with business owners, right? It’s not sponsors we got on the middle market deal, right? So they may have different views on the economy. Any color on, what it takes to get a rebound in the pipeline on that side of the business?

Dwayne Hyzak: Sure, Robert. So that statement we provide each quarter is always highly judgmental. So you’ve heard

Robert Dodd: Yeah.

Dwayne Hyzak: us get for a long time. I’d say, it’s below average today, largely because, the third quarter and fourth quarter were both very, very active, very robust time periods. As I said in my comments, while it is below average today, it’s not a concern. I think we feel very confident, very good about the ability of our platform to consistently generate lower middle market opportunities over the long term. Just as we sit here at this point in time, it’s a little bit slower, but it’s not a big concern for us. I think, we expect to be active. That’s why we’ve prepared ourselves from a capital structure standpoint to continue to be active and continue to grow in that area. And we just need the market to reset a little bit and see the sellers’ expectations go back into being in line with where we need them to be from an execution standpoint. I’ll let David add any additional comments he has there.

David Magdol: Hey Robert. So, when we think about the comment on how we characterize it, the near-term outlook is really mostly impacted by Q1 ’23 and how we see our closing is taking place in that period of time. But I’d say, the lower middle market has always been lumpy. The medium term, Q2 and beyond, we have a better visibility towards the pipeline growing. So, I wouldn’t be concerned relative to the overall market and taking — making too many assumptions about it being unattractive or not being able to surface our type of opportunities. We’re very confident that the year will play out well relative to the opportunity set. We’re still dealing with family-owned businesses, it still need to transact, and we’ve got a very active kind of medium-term pipeline that’s out there.

Robert Dodd: Got it. Thank you, and again, congratulations on the quarter.

Dwayne Hyzak: Thank you, Robert. We appreciate it.

Operator: Our next question comes from Bryce Rowe with B. Riley. Please proceed with your question.

Bryce Rowe: Thanks, so much. Good morning guys.

Dwayne Hyzak: Good morning, Bryce.

Bryce Rowe: Let’s see, I just wanted to kind of dive into the fair value marks here in the quarter. Nice to see NAV up and obviously, contribution from the ATM, but also unrealized or net gain type of activity, you highlight in the press release that some, I guess, 33 lower middle market portfolio companies saw net appreciation and then 27 depreciation. Can you — kind of similar to Robert’s question around dividend breadth, can you talk about — is there a portfolio company that’s having an outsized impact from a mark perspective here in the quarter?

Dwayne Hyzak: Sure, Bryce. I would say that when you look at our depreciation on the lower middle market side, there’s a number of companies that continue to outperform significantly. And we see it to Robert’s prior question on the dividend income side. And on your question here, you also see it on the unrealized appreciation. And just looking at schedule here, I would say, there’s kind of six or seven companies that contributed significantly to the unrealized appreciation during the quarter. What I’ll also tell you, and I won’t give you numbers by names, but I would say that those same companies are also a lot of the primary contributors to the dividend income. So we just got some companies that despite the challenges we see in the economy with inflation, supply chain, quality labor, et cetera.

These companies, as you’ve heard us say in the past, are excellent new managers, excellent teams, and they’ve been able to navigate the challenges, not just navigate them, but continue to excel. And you’re seeing that come through in the continued appreciation on the fair value side and on the dividend income contributions.

Bryce Rowe: Okay. Okay. That’s helpful. And then maybe on the asset management activities and the dividend into the BDC here in the quarter. Obviously, nice uptick in the dividend, it looked like the incentive fee income kind of ticked up pretty meaningfully in the fourth quarter. Is that a sustainable level? Is there anything in that income that wouldn’t be considered kind of recurring?

Dwayne Hyzak: Yes. Bryce, I would say there was one transaction in the quarter that benefited both Main Street directly. It also benefited MSC Income Funds. So that transaction will not be recurring. But even without that transaction, we would have seen some incentive fee income at MSC Income Fund. So it’s very, very difficult to predict what happens in the future, even one quarter out. I would say, as we sit here today, we would expect to have some incentive fee contribution from our asset management business, it may just be down a little bit from where it was in the fourth quarter, primarily are directly attributable to that one transaction that I referenced.

Bryce Rowe: Okay. Okay. And then maybe last one for me. You all highlight where nonaccruals are today. Obviously, not a meaningful piece of the portfolio, but — can you talk about kind of the puts and takes quarter-on-quarter? I guess you have 12 nonaccruals today versus 11 last quarter. And you did highlight some realized loss activity. Just curious if those nonaccruals generated some of that?

Dwayne Hyzak: Yes. I’ll let Jesse add on any additional detail that he has here. But I’d say that during the quarter, from memory, we had on net add. So not a lot of movement, as you said. I think the portfolio as a whole continues to perform well. We do have some names that have underperformed. And when they underperform, if it’s on the private loan or middle market side, the first thing we do is look for the private equity sponsor in terms of what they’re going to do in relation to supporting the company. And I’d say that we’ve seen in most situations, the private equity sponsors continue to be very, very supportive, which obviously is a good thing and a big part of our investment strategy in the private loan segment. But we have had a couple where the performance was such that the private equity firms either were not supportive, but we needed to do a restructure that either caused the nonaccrual or the realized loss activity.

But I’ll let Jesse give any additional specifics he can add on.

Jesse Morris: I think this is — we have one that came on, that was the movement. And I think you probably heard it in my commentary, but we expect to have another one come off in the first quarter of this year.

Bryce Rowe: Got it. Okay. I think I’ll leave it there. Appreciate it.

Dwayne Hyzak: Thanks a lot, Bryce

Bryce Rowe: Thank you.

Operator: Our next question comes from Kenneth Lee with RBC Capital Markets. Please proceed with your question.

Kenneth Lee: Hi, good morning. Thanks for taking my questions. Just one on the Asset Management business. You mentioned briefly, in the prepared remarks about actively working on growing the business. I realize that’s still a little early days, but I wonder if you could just talk a little bit more about what sort of activity you’re working on? And also maybe I could wonder if you could just comment upon what you’re seeing in terms of either fundraising or investor demand for the product there? Thanks.

Dwayne Hyzak: Sure. Thanks for the question, Ken. While it is early because we haven’t launched anything. I’d say consistent with our messaging for the last year or longer, our desire is to grow the asset management business. I think it would be natural that our next step there would be another private fund or a private vehicle similar to MS Private Loan Fund I. I think the good news for us, and you could see it in my comments, you can also see it in the incentive fees we earned during the quarter. That fund has performed really well. So I think the LPs or the investors there are very pleased or excited about that performance. So we are somewhat confident that once we launch another vehicle, there will be a significant amount of interest from those existing LPs and the outcome, the eventual outcome to how much success we have there will be how successful we are at bringing new LPs in, specifically on the institutional side.

So I’d say that’s the big question in terms of how large would that next vehicle be, but I think we’ve got a high level of confidence that we’ll have a new vehicle in the near term and that, that new vehicle will have strong reception at least from the existing LPs in our first private vehicle.

Kenneth Lee: Got you. Very helpful there. And just one follow-on, if I may. Just on the liquidity position, wondering if you’re comfortable with the liquidity position as it is, or do you see a further boost in the liquidity position over the near term there? Thanks.

Dwayne Hyzak: Thanks, Ken. I think you probably heard us say over a long period of time that one of the big things that we value is liquidity. We always want to be in a position where we can not only be defensive, but we can be on offense. So we always want to be in a position to support our lower middle market companies, whether that’s in good times or bad. We also want to make sure that when the market is most attractive, which is when no one else has capital that we can be on offense. You’ve seen us do that through each of the big step backs in the economy, whether it was the great recession or more recently here during COVID. And if you look at some of the best performing companies, specifically on the low middle market side that we touched on earlier, in response to some of the other questions.

Several of those investments were made right in the middle COVID, and we wouldn’t have been able to do that. Have we not had our very conservative capital structure and significant liquidity position? So we’re always focused on maintaining significant liquidity. I think we’ve done a great job over the last two or three months of really enhancing our liquidity and our capital structure. But you’re going to see us always focus on being in a conservative position, so we can do what I just touched on. But I’ll let Jesse, add any additional comments he wants to add.

Jesse Morris: I think you covered it.

Dwayne Hyzak: Okay.

Kenneth Lee: Got you. Great. Very helpful there. Thanks again.

Dwayne Hyzak: Thank you, Ken.

Operator: Our next question is from Mark Hughes with Truist Securities. Please proceed with your question.

Mark Hughes: Yeah. Thanks. Good morning.

Dwayne Hyzak: Good morning, Mark.

Mark Hughes: Why is the private loan pipeline average? This is kind of a slow deal environment. You seem pretty optimistic about that. Just interested in your thoughts on what’s driving that?

Dwayne Hyzak: Sure. I do think, overall, for the last couple of months, you have seen a slowdown in the overall market. From my standpoint, there’s purely my personal opinion. I think that’s because the private equity firms have been, needing to reset their expectations, given the significantly higher cost of capital that exists in today’s marketplace. I think to some extent, that’s happening. So I do think that you’ll see that part of the marketplace from an activity standpoint starting to improve. And I think we’ve already seen that here more recently, but I’ll give credit to our private credit team over the last couple of years, including during COVID, largely because of what we just talked about, us having liquidity and having a capital structure that allowed us to continue to be active.

We did a great job, and we built some what we think are some really good high-quality relationships with private equity firms that we want to be doing business with. So we continue to see good deal flow. I do think we, just like everybody else, is being very prudent in how we approach the market. But from our standpoint, when a private equity firm is transacting in this marketplace, we think the quality of that transaction is likely better, because it survived what’s going on in the broader economy. And that private equity firm is excited about moving forward with that investment despite the fact that they’re going to pay a higher cost of capital, at least on the debt capital side. So we think it’s a good environment to be investing for those reasons.

And obviously, as we touched on earlier, you have the ability to continue to be active and be selective where it makes sense given our conservative capital structure and our liquidity position. But I’ll see if Nick wants to add any additional comments on that point.

Nick Meserve: I think, Dwayne got nailed the overall theme. I think the other one is repayments are down, specifically, across the industry. And so with lower repayments, our need to respin that money is lower. And so our total transactions might be down, but the dollar amount was spent in total on a net basis will be where we target for the year.

Mark Hughes: Yes. Thank you for that. And then just to kind of step back, the lower middle market, if we do run into a slower economy, is that going to perform from a credit perspective, refresh me on the kind of the dynamics there?

Dwayne Hyzak: Sure. So I’ll provide a couple of comments, and then if David wants to add on, he can. But I’d say the key points we look at. One is most of our lower middle market portfolio is fixed rate debt as opposed to floating. So they’re not being impacted by the rising rate environment. That’s one of the big positives we see in that part of our strategy. The management team is there, they obviously are dealing with inflation, supply chain, labor, et cetera, but they are not worried about their capital structure because they’ve got a very well-capitalized, strong investor in Main Street in the capital structure, and they are not seeing, at least for the majority of that portfolio are not seeing their interest expense changes as market rates have improved.

So we think that’s a big positive today, and we think it will be — continue to be a big positive going forward. The reason we’ve always valued are kind of really favored our lower middle market investment strategy is our primary strategy is that we are directly aligned with the people that run that business day to day. The individuals that are the management teams that are typically the majority owners of these businesses, they’re living with that company day-to-day with the customers, vendors, employees’. So when we’ve seen them execute in times of stress, again, whether it’s COVID, great recession, whatever time period you want to pick, clearly, they’re dealing with challenges just like everybody else is. But in our opinion, and just our opinion, our experience long-term over the last 20 years, is that they will outperform the market just because they are making changes on a real-time basis.

These businesses are not large. So when they make a strategic decision to pivot to address what’s going on in the marketplace, it has an impact almost immediately. So that’s something that we’ve always viewed as a big positive, and they’re doing that one because it’s the right thing to do, but they’re also doing it because they’re the majority owner of the business in most situations. So those are the two biggest things I’d highlight, but I’ll let David add any additional color.

David Magdol: I think, Dwayne covered most, but just a couple of additional points. One is that for the most part, we’re backing existing managers that have been in the business for a lengthy period of time have seen cycles up and down in the past, and they know what to do. They’re proactively looking at their operating expenses, looking where they can cut. They’re very nimble as small businesses and look ahead very proactively. They also have leverage on the front end that we’d see in a normal private equity type of transaction, just total leverage, so their coverage is better. And the overall portfolio is very seasoned at this point. So if you look at the 75 companies we have, many of them have been in the portfolio for an extended period of time and have naturally deleveraged. So they’re really well-situated for a tougher economic climate if we happen to be there in their individual industry segment.

Mark Hughes: Appreciate that. Thank you.

Dwayne Hyzak: Thanks, Mark.

Operator: Our next question comes from Vilas Abraham with UBS. Please proceed with your question.

Vilas Abraham: Hi, everyone. Thanks for the question. Just a bit of finer point on some of the capital structure commentary. So leverage regulatory — leverage dropped down to $0.79 in I believe. So is the message here that you guys are comfortable running at the bottom or below the range? And how are you thinking about timing on when that could go up? And also, just how do you couple that with the equity issuance that you’re able to do here?

Dwayne Hyzak: Thanks for the question, and thanks for joining us this morning on the call. Yeah, I’d say we’re very comfortable being above or below the range. Obviously, we’re a little bit more on the conservative side today. I’d say that is very much intentional just given the current economic environment, kind of the overall backdrop that we’re dealing with. In terms of when will it move the other direction, it will all be driven primarily by the pace of opportunities in our lower middle market strategy and then secondarily, our private loan strategy. But we’re comfortable, and you can see it in our quarterly results. We’re comfortable that we can deliver best-in-class returns, not just from an industry standpoint, but compared to other public companies without running it at higher levels of leverage.

And we think that’s a huge part of the benefit that a shareholder or an investor gets from investing in Main Street. You’re getting a very, very good return, and we think you’re getting it on a very positive or favorable risk-adjusted basis.

Vilas Abraham: Got it. Okay. And then just maybe on the dividend. Just how are you guys thinking about the base versus the supplemental dividend? And what would it take to get a bump up in the base at some point?

Dwayne Hyzak: Sure. So I think we’ve been trying to be fairly consistent for the last year or so in terms of setting our policy. And I’d say that we’re not planning on making changes there. So our long-term goals, when we say long-term goals, three to five years, not kind of two to three quarters, is to deliver a consistent, recurring and growing monthly dividend. Historically, it’s been kind of 3% plus or minus. I think in this environment, most recently, we’ve been above that, closer to 5%. And I think near term, we would expect that to continue to be the case. On the supplemental, that’s going to be directly attributable to how much distributable net investment income, or DNII, are we able to generate in a quarter in relation to the monthly.

So our dividend for March is based upon the fourth quarter’s results were as I think I may have touched on in the prepared comments, but we exceeded the monthly dividend by a very wide margin. I think it was $0.37 off the top of my head, and we paid out about half of that, a little bit less than half of that in the supplemental. So that’s the approach we’ve taken in the last couple of quarters. I think we’ll continue to take that conservative approach. And the reason we’re not paying out more is though, even though we feel really good about the portfolio and it’s performing at a super, super high level, there is additional risk in the economy, and we think it’s prudent to reserve some of that just in case things take a step back. We would not think it would be prudent to be paying out 100% of your dividend, 100% of your earnings and dividends today because there’s a number of factors that would say there’s risk in the economy that would support not doing that.

So that’s why you see us taking a fairly conservative approach in how we’re paying that supplemental dividend.

Vilas Abraham: Got it. Makes sense. And maybe one last quick one. You mentioned that six or seven companies contributed materially to the appreciation this quarter. Were those in any specific sector or was that kind of cross sector?

Dwayne Hyzak: When you say sector, you mean industry or you mean by investment strategy?

Vilas Abraham: Yeah, yeah, industry. Yeah.

Dwayne Hyzak: Yeah, I would not say that they’re specific to an individual industry or sector. I think if you look at it, our portfolio in the lower middle market continues to be very, very diverse. And when you look at the top contributors there, I’d say that they are across a wide range of different industries.

Vilas Abraham: Got it. Thank you.

Dwayne Hyzak: Thank you.

Operator: Our next question comes from Eric Zwick with Hovde Group. Please proceed with your question.

Eric Zwick: Thank you. Good morning. There have been a number of comments this morning with regard to credit quality and still some excess risk in the economy and the outlook. And I’m curious, from what you track and the data that you have. Are you seeing any early signs of deterioration or concerns about credit quality, either in heightened amendment requests or internal watch list growing or any companies that are maybe getting close to the covenant which is anything along those lines at this point?

Dwayne Hyzak: Yeah. Erik, I would say that when you look at changes there, I wouldn’t say that we’ve seen a huge change. I think when we look at underperformance at a specific portfolio company level or more broad-based, I think it continues to be very company-specific and not something that is driven by the broader economy. And David, Nick, Jesse, you guys jump in here, but we’re not seeing a systematic or thematic kind of issue across the portfolio. Just like any environment, some companies perform better, some companies underperform, but I would say that the relative over performance, underperformance has not changed dramatically here in the most recent months. But you guys add on if you have a different view or a different opinion on it.

David Magdol: The only thing I’d add is that if you look at our diversification, we’re very purposefully and intentionally diverse across a lot of different industry segments, some of which are countercyclical. So we do feel like, we’re well positioned, as well positioned as we can be. Obviously, if you have a major change in the overall economy, we’ll feel that impact. But right now, we’re pretty comfortable with where we sit.

Eric Zwick: Thanks. I appreciate the commentary there. Just one more for me, just with regard to the strategy to deemphasize the middle market portfolio, I think you mentioned it’s about 8% at fair value of the total portfolio now. Is the goal to bring that down to zero, or do you still occasionally see attractive opportunities to invest within that portion of the portfolio?

Dwayne Hyzak: Sure, Erik. We’ve been trying to emphasize, we’re not trying. We have been deemphasizing the middle market strategy for a number of years. So five, six years ago, we said publicly that we were going to be working to deemphasize that and pivot to the private loan strategy. And I think we’ve been highly successful in doing that. And I think it’s been a significant contributor to our success over the last couple of years, and you’ll see us continue to do that. We don’t expect it to go to zero. We do want to maintain that capability because there could be stuff that comes up from time-to-time where it makes sense to continue to be active there. But I think you’ll see us continue to minimize those activities going forward.

Eric Zwick: Got it. Thanks for taking my questions today.

Dwayne Hyzak: Thank you, Eric. We appreciate it.

Operator: We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Dwayne Hyzak, for closing comments.

Dwayne Hyzak: Thank you, Maria. Thank you again to everybody for joining us this morning for our call. We really appreciate your interest in and support of Main Street. And we look forward to talking to you again in early May.

Operator: This concludes today’s conference. Thank you for your participation. You may now disconnect your lines.