Q4 2021 Main Street Capital Corp Earnings Call
[music].
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.
Brief question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad. As a reminder, this conference is being recorded it is now my pleasure to introduce your host Zach Vaughan Dennard Lascar Investor Relations. Thank you Zach Vaughan you may begin.
Thank you operator, and good morning, everyone. Thank you for joining us for main Street capital Corporation's fourth quarter 2021 earnings Conference call.
Main Street issued a press release yesterday afternoon that details the company's fourth quarter financial and operating results.
This document is available on the Investor Relations section of the company's website at Maine S T capital Dot 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 4th.
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 February 25, 2022, and therefore, you're advised the 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 SEC dot 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 he shot Duane.
Thanks, Matt Good morning, everyone and thank you for joining us today.
We appreciate you taking the time to join US, we hope that everyone's doing well.
Joining me today with prepared comments are David Mcdowell, our president and Chief investment Officer, and Jesse Morris, Our Chief Financial Officer, and Chief operating Officer.
Also participating for the Q&A portion of our call as Nick Meserve, our managing director and head of our private credit investment group.
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. The recent declarations of our supplemental dividend in March and monthly dividends for the second quarter.
Our expectations for dividends going forward, our recent investment activities and current investment pipeline and several other noteworthy items.
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 after which we'll be happy to take your questions.
Main street delivered very strong fourth quarter results setting new quarterly records for total investment income net investment income and distributable net investment income for the second consecutive quarter, which capped off a record year for main Street Cross those same key financial metrics.
Our lower middle market and private loan strategies, both delivered record quarterly and full year investment activities, resulting in net increases and lower middle market portfolio investments of $210 million for the quarter and $349 million for the year.
And that increases in private loan portfolio investments of $290 million for the quarter and $370 million for the year.
This record investment activity together with the continued strong performance of our diversified group of portfolio companies, which generated fair value appreciation in the fourth quarter of over $42 million, which Jesse will cover in more detail increased the fair value of our total investment portfolio at year end to $3 6 billion.
As further evidence of the strength of our investment portfolio and the benefits of our unique investment strategies. We're very pleased to generate net realized gains in the fourth quarter of $35 million. Another main street quarterly record.
We thank everyone on our main street team, including our mainstream employees and the management teams and employees of our portfolio companies for their contributions to these record operating results.
As a result of our combined efforts, we generated an annual return on equity of 20% for the year, our highest level since 2012, and distributable net investment income per share, which exceeded our monthly dividends paid to our shareholders by approximately 22% for the quarter and 13% for the year.
These positive results and the continued momentum in each of our core strategies provided us with the confidence to recommend to our board of directors. The approval of two sequential quarterly increases our regular monthly dividends in the fourth quarter of 2021, and the first quarter of 2022, and the supplemental dividend payments in December 2021, and March 2000 and <unk>.
'twenty two.
We continue to believe that the strength of our differentiated investment strategies, including our highly unique lower middle market strategy combined with our diversified group of portfolio companies and a growing asset management business will allow us to consistently deliver superior results for our shareholders and we are very excited about our outlook for the first quarter and full year 2022.
The operating performance across most of our portfolio companies has continued to be strong and this strong performance combined with ongoing growth activities at several of our high performing portfolio of companies also provides us continued optimism about our ability to generate incremental fair value and net asset value per share increases over the next few quarters.
We've also continued to make considerable progress on our asset management business. This includes progress at MSC income fund the non traded BDC, we advised that our external investment manager, which grew its investment portfolio by approximately 7% during the fourth quarter we.
We also made significant progress in the fourth quarter on our efforts to optimize the mix of the Sun's existing investment portfolio.
As a result of these activities and the positive performance of MSA income fund's existing investment portfolio.
Fund generated an increased level of net investment income in the fourth quarter and this performance allowed us to earn incentive fees. In addition to our recurring base management fees.
We remain excited about our plans for the fund as we continue to execute our investment strategies and other strategic initiatives and we are optimistic with the outlook for the fund's future performance.
At Emmis private loan fund one we have continued to grow both just capital commitments from investors and its investment portfolio through its co investment activities with main Street, and MSC income fund and our private loan investment strategy and we're excited about the growing benefits we expect to receive from this relationship in 2022.
The continued growth and favorable performance at both funds provides us visibility to increase future contributions from our asset management business.
The growth of our asset management business has also been significantly beneficial to our ability to execute our private loan strategy and we expect these benefits to increase in the future.
We remain excited 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.
Based upon our results for the fourth quarter and the positive performance of our existing portfolio of companies combined with a favorable outlook in each of our core investment strategies and for our growing asset management business and.
And the benefits of our efficient operating structure and strong liquidity position.
This week, our board declared a supplemental dividend of seven five cents per share payable in March and monthly dividends for the second quarter of 2022 of 21 and a half cents per share payable in each of April may and June with the second quarter monthly dividends, representing a four 9% increase from the second quarter of 2021.
The supplemental dividend for March which is our second consecutive quarter with a supplemental dividend is due to our favorable performance in the fourth quarter, which resulted in D. NII per share that was 14th.
Approximately 22% greater than our monthly dividends paid during the quarter.
As a reminder, we currently expect to recommend that our board declared future supplemental dividends to the extent D. NII significantly exceeds monthly dividends paid in future quarters, consistent with our practice for the last two quarters.
In addition, our current expectation is to retain capital from realized gains on our equity investments for future reinvestment purposes.
As a result of the combination of our first quarter and second quarter monthly dividends are recent supplemental dividends for December and March our current plans for future supplemental dividends and a favorable outlook for the year. We currently expect a significant increase in total dividends paid to our shareholders in 2022.
Now turning to our current investment pipeline after a record activities in the fourth quarter. We were pleased to maintain a number of attractive opportunities in our lower middle market strategy and as of today I'd characterize our lower middle market investment pipeline as average.
We remain excited about the quality of the investment opportunities in our current pipeline and about the prospects for follow on investments in existing portfolio companies as our companies actively look to execute on various growth strategies.
Based upon the combination of these highly attractive opportunities for follow on investments in some of our top performing companies and with some of our best management teams and.
And our position as the industry, leading partner for lower middle market companies and their management teams were very confident in our expectations for continued attractive new lower middle market originations in 2022.
We're also very pleased with the significant growth in the capabilities of our private credit team over the last two years and the significant increases they are provided for our private loan portfolio and the related latest benefits to our asset management business.
As of today I'd characterize our private loan investment pipeline as above average.
With that I will turn the call over to David.
Thanks, Dwayne and good morning, everyone.
The year end provides a good opportunity to look back at our history and recap the benefits of our unique and diversified investment strategy and discuss how these strategies have enabled us to deliver attractive returns to our shareholders over an extended period of time.
Since our IPO in 2007, we have increased our monthly dividends per share by 95% and we have declared cumulative total dividends to our shareholders over $33 per share or over two two times, our IPO price of $15 per share.
Our total return to shareholders since our IPO calculated as of December 31 significantly exceeds the returns achieved by the S&P 500, and our BDC peers over the same period of time.
As we've previously discussed we believe that the primary drivers of our long term success has been and continues to be our focus on investing in both the debt and equity investments in the underserved lower middle market growing our private credit activities in our asset management business and relief related economics, which clearly benefits our shareholders.
Our industry, leading cost structure and a strong alignment of interest that exist between our management team and shareholders through a meaningful stock ownership, we have throughout our organization.
Most notably and uniquely our lower middle market strategy provides attractive leverage points in yield on our first lien debt investments, while also creating a true partnership with the management teams of our portfolio of companies with our flexible equity ownership positions.
In short we believe that 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.
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.
Our ability to provide highly customized capital solutions for the predominantly family owned businesses that exist in our lower middle market has been and continues to be strong differentiator for us.
In 2021 main street invested a record of $561 million in our lower middle market strategy.
$352 million of this capital is deployed in 12, new lower middle market platform companies with the remaining $209 million representing follow on investments in existing seasoned and well performing lower middle market companies.
Our follow on investments are used to support multiple objectives, including acquisitions product expansion and diversification opportunities and recapitalization transactions.
Most importantly, these follow on investments support proven management teams that intrinsically pose less investment risk when compared to providing capital to new portfolio companies.
Since we have significant equity owners in our lower middle market companies, we benefit from participating alongside the proven managers in these businesses as they achieve meaningful equity value creation.
As a result of our lower middle market strategy and 2021, we were able to generate a record of $40 million of net realized gains out of a record of $45 million in realized gains achieved firm wide last year. So.
Notable realized gains on equity investments, we achieved in the fourth quarter included a $10 million realized gain and see AI software, which represented an internal rate of return of approximately 54% on our equity investment and an $11 million realized gain on J&J services, which represented an internal rate of return of approximately 59% on our equity.
Investment.
In addition to both of these notable realized gains on equity investments in the fourth quarter. Other significant realized gains. During 2021 included a $17 million gain on American trailer rental group, which had an internal rate of return on our equity investment of 61% and realized gain of $9 million in NRI clinical research group, which.
And internal rate of return on our equity investment of 39%.
Realized gains like this provide an offset against the inevitable credit losses that will be experienced when investing in predominantly non investment grade debt consistent with a debt investment strategies for bdcs and private credit funds like us.
Based upon our historical experience and current portfolio. Our expectation is that our future will feature net realized gains on lower middle market equity investments well at least offset our credit losses on our total portfolio of debt investments I'll provide us a positive credit loss result on a net basis in the future.
2021 also marked a record year for dividends received from our lower middle market portfolio companies of $64 million in the fourth quarter, we received $17 million of dividend income, which is the second largest amount of dividend income received in a single quarter from our lower middle market portfolio companies following the record $20 million.
Lower middle market dividend income, we recognized in the third quarter of 2021.
As we've stated in the past as our lower middle market portfolio companies perform overtime, they naturally deleverage with free cash flow generated from operations.
This allows us along with our lower middle market portfolio management team partners to benefit from distributions received from this cash flow.
Given the strength and quality of our lower middle market investment portfolio, we expect dividend income to continue to be a primary contributor to our results in 2022.
The last important area I would like to cover regarding our 2021 firm accomplishments are the impressive contributions of our private credit team have delivered.
Several years ago, we made the strategic decision to reallocate our investment portfolio away from larger often syndicated middle market credits towards sourcing smaller directly negotiated loans to high quality private equity sponsored companies, which we believe generally have better terms and return profile than larger middle market credits.
Our accomplishments in this area have been impressive.
During 2021, we increased our private loan portfolio by 54% and purposefully decreased our middle market portfolio by 11% as a result at year end, our private loan portfolio had grown to represent 32% of our total investments at fair value in the middle market portfolio declined to represent 11% of our total.
<unk> at fair value.
Our private loan capabilities and platform also support our key strategic interest in growing our asset management business as Dwayne previously discussed.
Now turning to our current portfolio as of December 31, we had investments in 185 portfolio companies spanning across more than 50 different industries.
Our largest portfolio company represented three 4% of our total investment income for the year and two 5% 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 are.
Our investment activity in the fourth quarter included total investments in our lower middle market portfolio of a record $316 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 $210 million.
During the quarter, we also made $380 million total private loan investments, which after aggregate repayments of debt investments and return of invested equity capital resulted in net increase in our private loan portfolio of $290 million.
Finally during the quarter, we had a net decrease in our middle market portfolio of $16 million.
At year end, our lower middle market portfolio included investments in 73 companies representing over $1 $7 billion of fair value, which is over 18% above our cost basis.
We had investments in 75 companies in our private loan portfolio, representing $1 $1 billion of fair value and our middle market portfolio, We had investments in 36 companies representing $395 million of fair value.
The 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 adjusted to cover our financial results capital structure and liquidity position.
Thank you David.
Turning to a summary of our financial results and echoing Duane and David's initial comments, we are very pleased with our operating results for the fourth quarter, which include a number of quarterly records and record annual total investment income investment activity and distributable net investment income per share and our highest return on equity of nine years.
Our total investment income in the fourth quarter increased by $19 7 million or.
31% over the same period in 2022, a total of $82 2 million driven by increases in interest dividend and fee income.
The fourth quarter marks our second consecutive quarter dividend income of about $20 million.
Represented accordingly record for interest income fee income and total investment income.
Of particular note the combined favorable impact of certain elevated income items in the fourth quarter, including dividends and accelerated prepayment repricing or other activity that were considered less consistent was comparable to the same period in 2020, and approximately <unk> 9 million below.
The average of the prior four quarters.
It speaks to the overall strength of our earnings in the quarter.
Our operating expenses for the fourth quarter, excluding noncash share based compensation expense.
Increased by $7 8 million over the same period of the prior year driven largely by increases in compensation expense and interest expense in the quarter.
The increase in compensation expense is primarily due to higher levels of incentive compensation accruals, which fluctuate based upon our performance and is directly attributable to our record levels of operating performance.
The ratio of our total operating expenses.
Excluding interest expense.
As a percentage of our average total assets was one 5% for the year and continues to be amongst the lowest in our industry.
The activities of our external investment manager benefited our net investment income by approximately $4 9 million during the fourth quarter, an increase of $1 7 million from the same period of the prior year through the allocation of $2 6 million of operating expenses for services we provided.
And $2 3 million of dividend income received <unk>.
Including 0.6 million incentive fees earned.
The external investment manager also ended the fourth quarter of 2021 with total assets under management of over $1 3 billion, an increase of $198 million or over 17% from the end of the third quarter.
And $403 million or 50%.
From December 31 2020.
Net investment.
<unk> income increased by $11 6 million or 29% in the fourth quarter of 2021.
While distributable net investment income increased by $11 9 million or 28% over the same period last year.
Distributable net investment income or <unk>, which is our net investment income excluding the impact of noncash share based compensation expense.
As a key measure of our performance and represents operating cash flow, which we utilized to determine our dividend for shareholders.
We recorded net unrealized appreciation on the investment portfolio of $42 8 million during the fourth quarter.
Including net depreciation of $33 5 million.
Our lower middle market portfolio.
$6 3 million in our private loan portfolio and.
And <unk> 2 million and our other portfolio.
Offset by unrealized depreciation of $10 million.
In our middle market portfolio.
All before counting for reversals for net realized gains and losses recognized during the quarter.
In addition, our external investment manager also reflect the depreciation of $12 3 million driven by the significant increase in assets under management.
Our operating results for the fourth quarter drove an increase in net asset value or NAV.
Of $104 5 million and an increase in NAV per share of.
$1 two.
Or four 2% to end the quarter with NAV per share of $25 29.
This is after the impact of <unk> 10 per share supplemental dividend paid in December .
NAV per share for the full year increased by $2.94 or 13%.
We ended the fourth quarter with nine investments on non accrual status comprising approximately 0.7% of the total investment portfolio at fair value and approximately three 3% at cost.
Our overall capitalization and liquidity remained very strong with total liquidity of $568 million as of December 31.
We continue to believe that our conservative leverage strong liquidity and continued access to capital our significant strengths and have us well positioned for the future.
In a manner consistent with our desire to maintain a flexible capital structure earlier. This week, our board of directors approved a reduction in our regulatory minimum asset coverage ratio from 200% to 150%.
Which would go into effect in the year.
Our board also approved the submission of a proposal to our shareholders to adopt the reduced minimum asset coverage ratio at main Street's 2022.
Annual meeting in April .
If approved by our shareholders to reduce minimum asset coverage ratio would take effect the day after the annual meeting.
Our primary goal in obtaining approval for the reduced minimum asset coverage ratio is two five as greater operational flexibility during times of significant macro disruptions such as those experienced during the COVID-19 global pandemic.
And additional benefit is to provide us with the flexibility to grow our investment portfolio under certain conditions.
Such as peers periods of robust net originations when market conditions may not allow us to raise additional equity capital at a pace, which keeps up with our investment activity.
In either of those cases, where we may experience higher leverage we expect to use proceeds from subsequent repayments and additional equity capital races.
To reduce our outstanding leverage while also maintaining liquidity and borrowing capacity for new investment opportunities.
The expanded leverage provides us with the operational flexibility to take advantage of new investment activities, while we bring our leverage back to our targeted leverage position over the near to midterm.
Despite this request for our shareholders' approval the expanded leverage we expect to continue to be prudent in our utilization of our level of leverage.
The increase in leverage is affected we initially intend to operate with a regulatory asset coverage ratio target range of 240% to 210% above our current minimum of 200% and well above the reduced asset coverage ratio requirement of 150%.
And the debt to equity ratio showed target range.
Calculated at senior Securities, excluding our SPX debentures divided by net asset value of <unk>.
Zero seven times to <unk> nine times.
We anticipate incurring any additional leverage through a combination of both long term and short term debt and with floating and fixed interest rates to optimize our cost of capital and the overall nature of our debt obligations and their maturities.
Coming back to our operating results DNI per share for the fourth quarter was a record 77 per share eclipsing our prior record in the third quarter of $2021 76 per share and an increase of 14 for over 22% over the same period last year.
Our <unk> per share for the quarter also exceeded our monthly dividends per share.
Paid to our shareholders by <unk> 14 per share.
We're approximately 22%.
Fifth consecutive quarter that our DNI per share has exceeded dividends paid during the quarter.
Including the December supplemental dividend dividends paid for the year were $2 57, five cents, an increase of four 7% over dividends paid during 2020.
As Dwayne mentioned in his remarks, the strength of our offerings alts provider, our board with the confidence to approve a supplemental dividend for the second consecutive quarter of.
Seven five cents per share payable in March.
As we look forward given the strength of our underlying portfolio and the robust investment environment in the second half of 2021 that Duane and David mentioned in their remarks.
We expect another strong earnings quarter in the first quarter of 2022 with expected <unk> per share of 72 per share.
More.
With that I will now turn the call back over to the operator, so we can take any questions.
Thank you we will now be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
You May press star two if you'd like to remove your question from the queue.
For participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Yes.
Our first question is from Robert Dodd with Raymond James. Please proceed with your question.
Hi, guys, congratulations on the quarter and the year.
One on the leverage.
Yeah.
Now taking the elections.
So lowered asset Jimmy.
Why did you see him partly why the decision now.
It makes sense, but to be honest it made sense, a year ago or two years ago.
So.
What is is it something you're seeing in your pipeline is it something else you're seeing that you think you're going to need.
That flexibility more going forward now than you did say in 2019 O or even during COVID-19 .
Thanks, Robert what I would say to that is there's not really a change in our expectations from a from a leverage standpoint as you heard Jesse cover in his prepared comments I think the bigger changes after having been through the impacts of COVID-19, and the impact.
The impact that had on a temporary basis on a fair value of our investments, particularly our equity investments as we look back at that and obviously, we recovered very very well, but during those time periods, our leverage did get tighter over time and when we looked at the ability to go out and obtain the expanded leverage.
We've always talked about it would be a nice insurance policy I think we've just decided it makes it makes sense to put that insurance policy in place now.
Experiencing the impact of the COVID-19 pandemic.
I appreciate that do you think it will have any impact on.
Your ego.
Financing costs are and I don't mean that in terms of negative impact I mean potentially positive right. It gives more cushion.
So.
Do you think did that have any influence on the decision that was there any.
<unk> may not be the right word for it but but but.
Any indications from the rating agencies or the the the unsecured.
On secured investors yes.
Yes, I would say that the primary reason was the insurance policy concept that I talked about earlier I think.
It remains to be seen how the EV investment grade investors will view. This as you know and as I think most people that track the industry know, we're one of the only bdcs that did not have the expanded leverage so we do not expect.
Have a negative impact on us, particularly with our guidance that we expect to continue to manage the business in a conservative manner, but I would say it remains to be seen how the investment grade universe will respond to it I do think to your point, we hope that they view it as a positive because it gives us more cushion.
From a restriction from a regulatory standpoint that as you can see from the other bdcs hasnt really impacted anyone from a and.
And actual leverage standpoint, it but it's just a negative in terms of if something bad really something really bad happened you could have a football from a regulatory compliance standpoint, and we just wanted to take that risk off the table.
Understood. Thank you.
A different topic I mean, you you see.
With your lower middle market portfolio, I mean, you see.
A lot of industries and a lot of.
Smaller businesses, I mean mom and pop corner stores, but smaller than some of the huge bdcs and then there'll be actually you're seeing middle market and private loan portfolio as well.
<unk>.
With the environment with inflation et cetera are you seeing any differences between the ability of small versus small within the context of your portfolio businesses versus medium sized business in say the ability to.
Pass on.
Pricing increases or are there any differences between industries.
<unk> ability to pass those those pricing increases.
Increased cost Sultan.
To maintain margins.
Yes, Robert I'll give a quick response to that and I'll, let David add on I would say that.
Clearly the portfolio companies across all of the investment segments that we invest in they've been impacted by the issues you're referring to I.
I would not say that there has been a consistent pattern, where smaller companies or larger companies have been kind of universally are from a kind of an overall standpoint impacted differently I do think different companies different industries have been able to respond to inflation the ability to either just deal with supply chain issues and labor issues and then pass on cost incurred.
<unk> to their customers I would say, it's been more company specific industry specific as opposed to Big company. We're a small company, but I'll, let David add on any additional color there, but he is yes, Robert I would agree with Duane.
The one benefit we get from our portfolio being smaller with our equity investments as we're talking to our management teams regularly and there is a ability to be nimble and to move quickly relative to price increases, whereas some of the larger companies have a more challenging time pushing out those price increases. So it's top of mind, both a diverse portfolios. We have it's just a different call.
<unk>, depending on the industry segment and the end market.
Got it I appreciate that and one last one if I can one on the asset manager I mean, obviously it's.
A great risk adjusted return.
Because obviously, you're not putting capital at risk.
<unk>.
Yes.
Do you have a target.
Pool pool what percentage.
Our long term target.
Maybe what percentage of earnings at main you'd like to come from asset management versus.
Okay.
Explicit capital investing.
Yes, Robert I would say, we don't have a specific target I do think that we have been.
Kind of indicating or directing that we expect the asset management business to grow both in terms of the amount of assets under management and then the contributions to main street that continues to be the case today and we do expect as you understand the previous comments or the prepared comments that we expect the asset management business to be a larger contributor in 2022 than it was in 'twenty one.
We have a number of initiatives in place to continue to grow the asset management business, but in terms of setting a specific percentage of main street's overall investment income or net investment income, we don't have a long term target on that front.
Other than you are trying to continue to focus on growing the asset management business overall as part of our platform.
Okay I appreciate that thank you and yes, congratulations on the yoga Thanks Robert.
Thank you. Our next question is from Kenneth Lee with RBC capital markets. Please proceed with your question.
Hi, good morning, and thanks for taking my question.
Wondering if you could talk a little bit more about.
Hello potential interest rate increases could could impact earnings from main street, what what kind of benefits could you see over the near term. Thanks sure. Thanks, Ken what I would say is we expect that given the impact or the nature of our current investment portfolio and then our liabilities at main street, but the impact from a downside.
Standpoint.
Minimal we do think that there's more opportunity from an upside risk and I'll, let let Jesse give a few more details on that.
Thanks Duane.
Kind of tagging onto what Duane said, if you look at our.
Main street's obligations, 82% of our outstanding debt obligations at the end of the year or had fixed interest rates.
And then if you look at our on our investment side.
<unk>, 71% of our investments were used at floating rate.
Interest rates in the majority of which had a tad interest rate floors.
On average of about 100 basis points, so as Dwayne mentioned it.
Interest rates rise.
I'd say kind of within that zero to 100 basis points, we would have some impact.
On our results.
Around a penny a share but as they continue to increase beyond that.
Over 100 basis point increase.
Actually it would result and be accretive to our earnings.
Overtime.
So again I think when you look at it we look at it two ways. One is looking at it purely on.
Our income statement as a result of the assets and liabilities that Jesse touched on I think the long term answer.
In relation to both our reserve results in just the marketplace overall would be.
<unk> portfolio of companies would perform if there was a significant rise in rates when I say significant something north of that.
150 to 200 basis point increase I think that's where you.
It remains to be seen kind of how the overall marketplace would respond to that type of a rate rise in interest rates.
Got you very helpful. There.
And one of one follow up if I may.
In the current environment and it sounds like the private loan.
The pipeline you mentioned it was above average just wondering if you could talk a little bit more about what's driving the activity there and as well in the current environment. How do you think about the potential risk and return.
For private loans versus some of the opportunities are there opportunities you might have thanks.
Sure. So on the private loan side I think you heard both.
David and I say that we're very pleased at how our private credit team.
Has grown its capabilities over the last two years the team that we have today.
<unk> is in position to execute on transactions that we honestly just weren't in a position to execute on three or four years ago.
<unk> continue to grow their capabilities and their activities.
Continue to see more and more opportunities both from existing sponsors that we've transacted with historically, but also with new sponsors that we're developing relationships with so I think our activities. There are directly the result of their their positive activities and we're just continuing to see that business and our position in the marketplace grow over time.
When you look at kind of relative attractiveness, I think as you've always heard us say the lower middle market.
It has been and will continue to be our primary focus, but we really like the asset class. That's represented by the private loan strategy and Youll see us continue to execute on that as a compliment to the to the primary strategy in the lower middle market.
Yeah.
Got you that's very helpful. Thanks again, thank you.
Thank you. Our next question is from Bryce Rowe with Holt. Please proceed with your question.
Thanks, Good morning, guys.
Wanted to.
Maybe start.
On on yields within the within the portfolio.
Really encouraging to see yields stability in the lower middle market portfolio, and then relative stability in our private loan portfolio, despite very heavy volume.
Volume here here in the quarter. So maybe if you could just speak to what youre seeing from a pricing perspective from a competitive perspective, and how that may play out in terms of what youre seeing in the pipeline now.
Sure. Thanks, Thanks Bryce.
What I would say on a little bit of market and you've probably heard US say this in the past is you do see some movement and lower middle market rates, but over the long term we have in the past and continue to expect to see more stability. There when you see our yields overall in the portfolio change quarter to quarter or year to year.
It's less about the initial investment, we're making because our rates and our expectations from initial investment standpoint have always been and continue to be very consistent.
Low teens type of percentage, but as our portfolio companies continue to perform well grow and delever.
Increasingly provided decreases in rates through either an interest rate grid based upon leverage or just discussions with the company where we allow the.
The initial rates have come down as the company continues to perform long term because our view is if we have a good performing lower middle market investment with the management team that we're.
Having a really good relationship with that.
It is worthy of a lower interest rate. So that's really where you see some movement on lower middle market rates over time, the private loan segment I would say that we were very happy with the investments we made in the fourth quarter and the rates that we were able to achieve there that part of the marketplaces. I think you would probably expect is more rate sensitive and it is more of a challenge too.
To maintain the rates and to your point, that's why we're very happy to see the rate stability there.
I would say longer term remains to be seen kind of how rates in the broader market and specifically our private loan strategy will perform to date, we're continuing to see good activity and good kind of terms and attractive rates on what we're executing in the first quarter.
But longer term that is part of the marketplace that has been and continues to be more competitive.
Okay. That's helpful. Duane I appreciate it.
Maybe maybe you want to talk a little bit about the expense side.
Employee base side of the of the House, obviously, one 5% expense to assets ratio is best in the industry.
Kind of curious, how you or how youre thinking about that.
Going forward, especially as the the external advisor continues to contribute and then as it relates to the employee base I assume theres been some growth within the employee base to support all the portfolio activity that you've seen can you speak to maybe any level of growth.
In your lower middle market teams or in that private credit team and kind of what you expect from a.
From an employee growth perspective going going forward here.
Sure so.
As you know, Brian we've grown our portfolio significantly over the last couple of years, both in the lower middle market and the private loan or private credit categories, and you've seen us invest in additional resources in both of those strategies and Youll see us continue to do that.
As we go forward, both both the lower middle market team and the private credit team. When you look at both of those teams and the expectations for 2022.
Theres definitely expectations to continue to add both junior and mid level personnel.
It's a complement or to support the activities we have across the firm with that being said I think as we look at our platform and our ability to grow assets and have the asset management would be a big part of our growth strategy. I think we continue to be very comfortable with the long term target of one 5% from an expense to asset ratio has been.
A good metric for us and one that we think we can continue to achieve and continue to provide that benefit to our shareholders. Given the unique nature of our strategies and also the very very beneficial impact that we have from that asset management business. If you recall.
Bryce when we look at executing that asset management business one of the things that we've always found very attractive about it.
Whether it's the activities we are performing for MSC income ponder if it's for any of the other activities. We have we're not having to go out and hire people specifically for those activities. The nature of the assets that are being invested in through those different vehicles that we manage the exact same assets that we're investing in at main street. So there is.
Investment activities across each of the vehicles that we manage and that approach to the asset management business really gives us a lot of operating leverage from a from a management standpoint in terms of how we manage not only the assets on main street balance sheet and in our portfolio, but also in the investment portfolios of those those other vehicles.
Okay and then.
Maybe one related to that Duane.
You guys called out the AUM at the external manager.
Just curious if the private.
Loan fund contributed.
Contributed to management fees.
At the external manager here this quarter and then any any update in terms of where.
AUM is at the private loan funding and what the timeframe is for that.
The capital commitments to to come to a close here.
Sure Bryce on the private loan funds.
It has been ramping significantly over the balance of 2021, So we started the year.
Just in fund raising mode with no assets and then we started deploying some capital towards the end of the first quarter and had been growing that pool.
Over the balance of the year as we went to went through 2021.
Nearing the end of our capital raised there. So we continue to add additional <unk>.
Well commitments both from limited partners. We also put in place a new credit facility that will allow us to continue to grow the assets under management at the private loan funds.
And we expect that to be a significant benefit to us as we look at the expectations for the asset management business.
In 2022, just to put a number on it.
Private loan fund had approximately $85 million of assets under management at year end that number has continued to grow and we will continue to grow in the first quarter and our goal long term when we get the get the fund closed and then have it fully deployed is to be somewhere in the $200 million to $250 million of assets under management.
Okay.
Okay. That's it for me I appreciate.
The answers thanks, a lot Bryce.
Okay.
As a reminder, if you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
Our next question is from David Miyazaki with confluence investment. Please proceed with your question.
Hi, good morning, and congratulations on the way that she made it through the pandemic in a recovery.
You guys did a really good job of controlling both the risk and addressing the return opportunity.
A question for you is that you know one of the the messaging challenges I think that BDC managers have is.
If you ask them where to invest and it always happens to be where they have the most capability and I think you guys are a little unique and that you have the latitude to go.
Up and down the <unk>.
<unk> scale, the large guys keep telling us that.
EBITDA of 75 million to $100 million is the place to be because theres shifts.
Out of the BSL and into the middle market and the upper middle market as the place to be because the risk is better.
At the same time, the small guys say that you get the pricing and the terms and the lower side.
And obviously you guys are shifting.
And focusing more on the little lower middle market and the private loan side, but if you can kind of.
Give us.
A little more detail on the detail on the specifics of the risk in the pricing between the two choices that you have I think it's kind of a unique perspective, because you can choose whereas others are too large to be in the small side are too small to be in the beach side.
Sure sure.
We appreciate the comments first on.
The way we performed through the pandemic. It's much appreciate it because we know you spent a lot of time.
Tracking the space and investing across different platforms, we really really appreciate those comments, what I always say and you've heard us say this before but I'll just kind of repeat some of the views we have in our lower middle market.
So the aluminum market has always been main streets primary focus area and kind of the core of what we do and it always will be.
There's a couple of reasons why that's the case as you can see from the rates that we achieved there and then the results from our equity investments, we think we're able to return.
Percentages from a return on asset standpoint that are far superior in our opinion really anywhere else in the marketplace that you can you can achieve those returns. We also really like the fact that we think it's even more attractive on a risk adjusted basis. So we are.
Not investing with other private equity firms in that lower middle market practice, we're investing directly and in alongside the owner operators of those businesses and the people that run that business day to day.
After having done it for two decades plus.
While there are some risk associated with smaller businesses, we really think that the alignment of interest between.
Our interest at main street with the individuals that are running that business day to day that are talking to customers employees and vendors. We really think that that alignment of interest is a significant positive for us and we'll trade that the risk of a smaller business for the benefit of that alignment of interest with the people that run the business All day long every day the issue or the only.
Negative we've seen in the past with the lower middle market strategy is that it can be lumpy from quarter to quarter. Obviously the last few years. When you look at 2020 in 2021, they've been very very good years for us from an origination standpoint, but if you look at the longer term history, you will have some volatility or variability in the origination activities from a.
Quarter to quarter standpoint, but again, that's really the only negative we have when we look at the lower middle market strategy and.
<unk> has been and as I said earlier, we will continue to be their primary focus area for us as we as we look at the main street platform from a long term standpoint overtime as you probably know we've invested in other areas as we've grown our private credit team over the last 10 years or so we started off spin spend more time initially kind of into <unk>.
Syndicated middle market segment overtime, as we kind of experienced that part of the segment and learn more about the evolving kind of private credit we define it as private loan segment, we just determined on our side and others clearly may have different views, but we determined that the smaller end of kind of the private equity sponsor universe.
And the ability to be directly originating either just at main street or alongside a small group of peers that we have really good relationships to be directly originating negotiating diligence diligence seeing those transactions as opposed to doing that you're kind of through a third party in the syndicated market with just a better view for March.
Standpoint have the ability to underwrite.
<unk> provided a better risk return opportunity for us and for our shareholders in that segment. So that's why you've seen us over the years really migrate from the syndicated.
Middle market segment into the into the directly originated private loan segment and you've seen our portfolio rotation that over the last three or four years, which we've tried to do our best job to signal what we were doing over the long term and then explain to people at least in our opinion why while we thought that was it was a was the right approach. So I don't know if that addressed your car.
Comments, but that would be kind of the views of how we look at lower middle market and universe private loan I can't really speak to the broadly syndicated larger middle market. Because we honestly just don't don't play in that space and as we sit here today really don't have an expectation too. So I wouldn't be the right person to really talk about the positives or negatives about that part of the marketplace.
No. That's very helpful. I think it's great that you've been able to increase your assets under management, but still keep a focus on.
Smaller borrowers and smaller sponsor relationships.
If I if I think about what you just said it sounds like what you're saying is that the underwriting.
Diligence is.
It's something that can offset the risk of having borrowers that are smaller with fewer resources.
Clearly from our standpoint in the lower middle market that that's been the case for for two decades. It's also as I said earlier, just a direct alignment of interest with the individuals running the business day to day I think on the private loan. It is what you are describing there we feel like we are able to get closer to the business from an underwriting standpoint and from a documentation.
And what we were able to achieve historically in the in the in the syndicated marketplace. This is David if I can just add one point on the lower middle market strategy.
Very unique in the sense, we do this barbell approach first lien debt coupled with the equity. So wallets are riskier credit as far as the size of the investment we can protect our interest to the extent that something.
It's a challenge, but we also get the opportunity for the upside which is why we in our prepared remarks, we talked about some of the gains we booked they really do provide an offset to some of the losses elsewhere in the portfolio that are naturally.
Going to occur over time so.
The approach, we talk to our management teams and the family owned businesses, we invest with that they don't like the cost of our capital that is market based it's higher rate, but overtime. If they perform really well, we're going to be able to like Dwayne said reduce our rates and we benefit both on that from an equity perspective. So it really is a barbell approach.
We talked about it a lot with.
The management teams and family owned businesses that we partner with and it does allow them to grow which is another positive aspect that there are companies perform we're able to put more capital to work that's accretive to both of us on an equity perspective with doing things like expansion and acquisitions within the portfolio.
Yeah, No I think that that first lien equity barbell. Its been something that has really stood the test of time and creating value in the trust risk if I could.
Shifting gears completely on you wondering what your thoughts are with regard to <unk> and others.
It's just the topic that starts and stops all the time.
It goes in different specific directions, even if the general direction is trying to get some reform in place and you guys have been.
Involve quite a bit over the years so just.
I'm wondering if you have any update on that and if you have any.
If you could direct the industry.
In a particular strategy or particular way of engaging with the SEC or <unk> Congress what are your thoughts on those fronts.
Sure David We've got somebody else here with this is Jason <unk>, who is our general counsel.
As in the room and he sits in a leadership position in one of the industry groups I'll, let Jason kind of give the latest color or background. We have on that David that Unfortunately is not a lot to report on the F&B. We've been pushing this for a long time as you know with Spi a and other bdcs.
The proposed rule is a while back there's not been much movement. Since then we're past the comment period I think the general thought is those rules as proposed don't generally work we don't think.
Funds will include the the data that we think there'll still included in the table.
The purpose of the rule and so we're still pushing on this with SBA and other bdcs, but to date, there's really not been much.
Much to report.
Okay, Yeah, I mean I'm in agreement with you that I don't think the footnote really.
Is it going to change anything.
Perhaps progress and nothing happens all at once in Washington, and I understand that but.
I was kind of disappointed in general to see that.
Now moving into footnote direction, Yes, we agree and we also are pushing on the legislative side as well, but as you know being a midterm election year. It's it's difficult it has been difficult to pushing anything too far from that perspective.
Okay, well those are my questions. Thank you very much gentlemen, okay. Thank you we appreciate the questions.
As always we greatly appreciate everyone that joined US This morning for the call and for the great questions. We had after our prepared remarks, and we will look forward to speaking to everyone again here in a few months in early may.
Thank you.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines have a wonderful day.
Okay.
Yes.
[music].
Okay.
[music].
Yes.
Yes.
[music].
Yeah.
[music].
Yes.
[music].
Yes.
Okay.
Okay.
[music].