Q3 2022 Main Street Capital Corp Earnings Call

First 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.

The impact of rising interest rates on our third quarter and future net investment income.

And our expectations for the fourth quarter.

After which we'll be happy to take your questions.

We're very pleased with main street strong third quarter results, which include another quarter with records for net investment income per share and distributable net investment income or D. NII per share and with our results exceeding the net investment income per share records, we set or matched over each of the prior four quarters.

These positive positive results included contributions from each of our core investment strategies and as a result of our strong performance D. NII per share exceeded our regular monthly dividends by 36%.

We continue to be pleased with the performance of our lower middle market portfolio companies, which resulted in another quarter of fair value appreciation in the equity investments in this portfolio.

We're also excited about the follow on investments, we made in existing lower middle market portfolio companies during the third quarter to support the growth strategies of these companies.

The new platform investments, we've made to date in the fourth quarter.

Our private credit group also continued its success with its investment activities in the third quarter.

These positive results and a favorable outlook for the fourth quarter resulted in our reclamation recommendations to our board of directors for our most recent dividend announcements, which I'll discuss in more detail later.

We continue to be pleased with the performance of our diversified lower middle market and private loan investment strategies and remain confident that these strategies combined with the benefits of our asset management business will allow us to continue to deliver superior results for our shareholders.

Our net asset value per share increased in the quarter due to the impact of mixed results in the fair value changes of the different components of our investment portfolio.

And the positive impact of our equity issuances in the quarter, which Jesse will cover in more detail.

We are pleased with the continued favorable performance of our lower middle market portfolio companies, which resulted in another quarter of fair value appreciation in this portfolio.

We also benefited from the exit of a previously restructured private loan investment, which generated a significant realized gains in the quarter and a net fair value increase between the realized gains and unrealized depreciation in this portfolio.

Quite the recent increased market volatility and uncertainty, we're very pleased that our lower middle market and private loan strategies have both continued to deliver attractive investment opportunities.

Our lower middle market investments of $112 million in the quarter resulted in a net increase in lower middle market investments after repayments of $85 million for the quarter.

Our private loan investment activities resulted in a net increase in private loan investments of $174 million for the quarter.

We believe that our third quarter operating results reflect the benefits of the growth of our investment portfolio over the last two years.

Given the continued strength and quality of our investment pipeline, we expect to have the opportunity to further grow our investment portfolio, which we expect will continue to benefit our operating results in the fourth quarter and into 2023.

Support the growth of our investment portfolio and to continue to plan for future investment portfolio growth in the <unk>.

Third quarter, we increased our activities under our aftermarket or ATM equity issuance program and completed an incremental equity offering in August .

We view these developments as positive enhancements are enhancements to our capital structure.

Which allows us to continue to execute on our attractive current and expected future investment pipeline.

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.

Non traded BDC and EMS private loan fund won a private fund.

Continue to experience favorable performance in the third quarter.

We remain excited about our plans for these funds as we execute on our investment strategies and other strategic initiatives. We are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund.

We remain excited about our strategy for growing our asset management business within our internally managed structure and are actively working to increase the contributions from Nishu. This unique benefit to our main street stakeholders.

Based upon our results for the third quarter combined with our favorable outlook in each of our primary investment strategies and for our asset management business.

And the benefits of our efficient operating structure.

Earlier this week, our board declared a supplemental dividend of <unk> 10 per share payable in December and an increase in monthly dividends for the first quarter of 2023 to <unk> 22, and a half cents per share payable in each of January February and March.

These monthly dividends represented four 7% increase from the first quarter of 2022 and.

Two 3% increase from the fourth quarter of 2022.

Supplemental dividend for December is due to our strong performance in the third quarter, which resulted in D. NII per share that was 23 and a half.

Our 36% greater than our monthly dividends paid during the quarter.

The fourth quarter represents our fifth consecutive quarter of paying a supplemental dividend.

And will result in total supplemental dividend dividends paid during 2020 to 35 per share.

Presenting an additional 13, 5% paid in excess of our monthly dividends.

Including the supplemental dividends or DNI per share for the third quarter still exceeded our total dividends paid by over $13 per share.

We're pleased to be able to deliver the significant additional value to our shareholders.

We currently expect to recommend that our board declare future supplemental dividends to the extent D. NII significantly exceeds monthly dividends paid in future quarters, and we maintain a stable to positive net asset value.

Based upon our current expectations for continued favorable performance in the fourth quarter. We currently anticipate proposing an additional supplemental dividend in the first quarter of 2023.

Now turning to our current investment pipeline.

We were pleased to maintain attractive opportunities in our lower middle market and private loan strategies.

As of today and after recently closing several new investments in the fourth quarter I would characterize our lower middle market investment pipeline as average.

We remain excited about the quality of the investment opportunities in our current pipeline and specifically about the prospects for future follow on investments in existing portfolio companies.

We also continue to be very pleased with the performance of our private credit team and a significant growth. They are 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.

Thanks, Dwayne and good morning, everyone.

Duane highlighted in his remarks, we believe our strong third quarter financial results continue to demonstrate the strength of main street's platform, our differentiated investment approach and our unique operating model.

We're pleased to report that the overall operating performance for most of our portfolio of companies continue to be positive, which contributed to our attractive third quarter financial results and main street.

Another contributor to our strong results during the quarter was our robust lower middle market and private loan investment activity.

In addition, we've seen repayment activity for both our lower middle market and private loan portfolios slow significantly over the last few quarters, a trend which continued in the third quarter.

Significance of these net investment activities in the quarter positively impacted our investment income.

As it relates to the current investment environment, we are excited about the opportunity to thoughtfully deploy capital.

As availability of debt financing has declined and the relating borrowing costs have increased from prospective purchasers of businesses.

Creasing, the hearing from intermediaries and others that purchase price multiples have moderated as private equity and strategic acquirers can no longer rely on inexpensive readily available debt capital to achieve their expected leverage returns.

This change to apparel available leverage has created an environment similar to what we've seen in the past whereby main street has been able to put capital to work at attractive risk adjusted return profiles.

Our lower middle market businesses, our ability to speak for the entire capital structure puts us in an enviable position as compared to private equity investors, who need to raise debt capital on a deal by deal basis.

Our private loan business, we are seeing attractive opportunities with lower ltvs and higher yields.

In the past during times of market dislocation main street has continued to thoughtfully deploy capital and we intend to do the same in today's environment.

In 2020, we experienced similar although harsher market dynamics during the COVID-19 pandemic when many investors halted are significantly slowed their investment activity.

We carefully continue to invest during this uncertain time and with the benefit of hindsight. We are fortunate to have completed several investments that are key to acceptable results, which we would have otherwise missed had we paused our investment activity. During these uncertain times.

As we've discussed in the past the primary driver of our long term success has been and continues to be our focus on the underserved lower middle market and specifically our strategy of investing in both debt and equity and lower middle market companies.

Thus far in 2022, we've had attractive origination activities, particularly related to that follow ons for existing lower middle market investments.

When evaluating new lower middle market platform investments, we continue to target our combined first lien debt and equity investments to achieve a blended internal rate of return in the mid to high teens range.

From an underwriting standpoint, we achieved these targets by maintaining a disciplined mix of debt and equity investments with a typical initial investment comprised of approximately 75% to 80% debt and 20% to 25% equity.

We are confident that our long term proven success of investing in the lower middle market comprised with our prudent use of low to modest leverage at main street will continue to allow us to deliver attractive financial results for our investors in the future.

Now turning to the overall composition of our investment portfolio as of September 30, we continued to maintain a highly diversified portfolio with investments in 195 companies between our lower middle market private loan and middle market portfolios spanning across more than 50 different industries.

Our largest portfolio company represented three 2% of our total investment portfolio fair value at quarter end and three 3% of our total investment income over the last 12 months.

The majority of our portfolio investments represent less than 1% of our income and our assets.

Our investment activity in the third quarter included total investments in our lower middle market portfolio of $112 million.

Which after aggregate repayments on debt investments and return of invested equity capital resulted in net increase in our lower middle market portfolio of approximately $85 million on a cost basis.

Driven by the capabilities and relationships of our private credit team, we completed approximately $234 million in total private loan portfolio investments during the quarter, which after aggregate repayments of debt resulted in net increase in our private loan portfolio of approximately $174 million.

As I mentioned earlier repayments in our private loan portfolio slowed in 2022.

When compared to our private loan investment portfolio at the beginning of the year. The 2022 year to date repayment rate has decelerated by approximately 25% of the repayment rate experienced in the comparable period of 2021.

Slowdown was even more significant in the third quarter with repayment with a repayment rate in 2022 down approximately 70% from the same quarter in the prior year.

Given the current status of the debt capital markets. We expect this trend will continue for the next couple of quarters.

During the quarter, we had a net decrease in our middle market portfolio of approximately $1 million as we continued to strategically deemphasize this portfolio.

Our total investment portfolio grew six 9% during the third quarter to approximately $4 billion at fair value at September 30.

At quarter end, our lower middle market portfolio included investments in 75 companies, representing $1 9 billion of fair value, which is about 20% above our cost basis.

We had investments in 87 companies in our private loan portfolio, representing $1 $5 billion of fair value and our middle market portfolio, We had investments in 33 companies representing $354 million of fair value.

Total investment portfolio at fair value at quarter end was approximately 108% of the related cost basis.

In summary main streets investment portfolio continues to perform at a high level and deliver on our long term results.

Details on our investment portfolio at quarter end are included in the press release that we issued yesterday.

With that I'll turn the call over to Jesse to cover our financial results capital structure and liquidity position.

Thank you David and good morning, everyone.

Our total investment income in the third quarter increased by $21 6 million or 28% over the same period in 2021.

$13 2 million or 15, 4% over the second quarter of 2022 to a total of $98 4 million.

Interest income increased by $24 6 million from a year ago and $11 million over the second quarter, which was a direct result of the continued growth in our portfolio debt investments.

And the impact of higher market index interest rates on our floating rate debt investments.

We estimate that the increase in market index rates drove about a quarter of the increase over the same period a year ago.

And then a little over half of the increase in interest income over the second quarter.

Dividend income was $3 6 million lower than the same period a year ago. This decrease was driven by a comparison to a meaningful levels of less consistent nonrecurring dividends.

<unk> in the third quarter of 2021.

Further supporting the overall strength of our third quarter results, the combined impact of certain income items, including dividends accelerated OID and prepayment fees that.

What are considered less consistent or nonrecurring in the quarter decreased by $8 million for about <unk> 12 per share when compared to a year ago.

And was $3 9 million or <unk> <unk> per share below the average of the prior four quarters.

Expenses for the quarter increased by $8 5 million over the prior year.

Largely driven by increases of $6 5 million and interest expense.

And $1 6 million compensation related expenses.

We offset by an increase of <unk> 6 million in expenses allocated to the external investment manager.

Our operating expenses to assets ratio was one 5% for the quarter on an annualized basis.

This continues to be amongst the lowest in our industry.

Our external investment manager contributed five new into our net investment income during the quarter.

An increase of <unk> 8 million or 19% when compared to a year ago and ended the quarter with total assets under management of $1 4 billion.

During the quarter, we recorded net fair value decrease, including the impact of realized gains and unrealized depreciation on the investment portfolio of $5 1 million, which included decreases of $8 4 million and our middle market portfolio, and $5 8 million and our external investment manager.

These were partially offset by net fair value increases of $4 1 million in our lower middle market investment portfolio, and $1 8 million and our private loan portfolio.

Net asset value or NAV.

<unk> increased by $114 3 million or <unk> 57 per share to ended the third quarter with <unk> of $25 94 per share.

Our record level of NAV per share.

We added two investments to non accrual status, resulting in a total of 11 investments on nonaccrual status at quarter end.

Representing <unk>, 8% of the total investment portfolio at fair value and three 7% on a cost basis.

We continue to believe that conservative leverage strong liquidity and continued access to capital are important components of our capital allocation strategy.

Our regulatory debt to equity leverage.

<unk> total debt, excluding our Sps debentures divided by net asset value was <unk> 86, and our regulatory asset coverage ratio was two six times, both of which are within our target ranges.

Our liquidity as we ended the quarter, including cash and availability under our credit facility was $420 million, which provides ample liquidity to fund our near term funding requirements.

We continue to actively pursue additional capital to continue to fund our investment opportunities.

During the quarter, we amended our credit facility to extend its maturity 2027, and expand the total commitments to $920 million.

Duane mentioned, we raised equity capital with 100 105 million proceeds rates both.

Through our aftermarket equity program and our equity offering in August .

We also continue to evaluate additional sources of debt financing.

Coming back to our operating results NII per share increased to 83 cents per share and D. NII per share increased to 88 per share with each representing an increase of 12 from the same period last year.

Dividends paid during the quarter were $74.05 per share, which includes the Sept September supplemental dividend of <unk> 10.

Ah represents an increase of 21% or with the dividends paid in the third quarter of 2021.

As a result of a strong earnings the NII per share exceeded our regular monthly dividends per share paid to our shareholders by 36% and the total dividends paid per share paid to our shareholders by 18%.

Turning to the impact to our financial results related to changes in interest rates.

As of the end of the third quarter, 73% of our outstanding debt obligations maintain fixed interest rates.

And 76% of our debt investments for interest at.

At floating rates.

As a result, and as rising interest rate environment. Our third quarter. Operating results include an estimated net benefit of $5 million or <unk> <unk> per share to our net investment income when compared to a year ago and two the second quarter.

If we assume that market index rates at September 30th remain in place for the fourth quarter.

Assuming no changes to our existing portfolio investments and borrowings from September 30, we estimate a similar additional benefit to our results for the fourth quarter when compared to the third quarter.

Finally, as we look forward.

Given the strength of our underlying portfolio and the investment environment, thus far in 2022.

We expect another strong top line and earnings quarter in the fourth quarter.

With expected to NII per share in excess of 90%.

With the opportunity to meaningfully exceed this level based upon the amount of dividend income and portfolio investment activities during the quarter.

With that I.

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

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First question comes from Kenneth Lee with RBC capital markets. Please go ahead.

Hey, good morning, Thanks for taking my question.

Just want to dig into a little bit more on that on the lower middle market portfolio and specifically wondering if you can just talk a little bit more about what drove the unrealized.

Gains in the quarter and more specifically the appreciation in the equity investments.

Jordan portfolio. Thanks.

Sure. Thanks, Ken So I would say that in the low middle market Theres nothing that I would say as unusual or special this quarter, we had a number of companies that continue to perform well.

And also delever or improve their capital structure, both of which impact our valuations to the positive.

I have a number of companies that are up in a quarter and a number of companies that are that are going to be down just based upon their performance or their operating results and this quarter. We just had more of the companies.

We're up at bigger changes than the companies that had depreciation and have netted to that into that increase we had across the lower middle market portfolio from an unrealized appreciation standpoint.

Got you.

And one follow up if I may.

You mentioned.

There could be some opportunities around follow on investments within the lower middle market portfolio.

I was curious whether you could see a pickup in such opportunities even in this current macro environment.

Just want to get a better sense of that thanks.

Sure. Thanks, again, Ken I would say you've heard US say this before I think all things being equal.

We have the opinion of the view that our existing lower middle market companies are very very strong companies.

We typically have good long term relationships with those companies and their management teams that we have the opportunity.

It's a complete follow on investments to support their growth or other activities that they have at the portfolio company level, we really favor those investments.

More so than anything else and if you look at our activities in the third quarter. The vast majority of our investment activity in the third quarter was in existing portfolio companies, where we supported the growth of those companies specifically to companies that completed large acquisitions and when you look at our current pipeline route of things. We're very excited about is that a healthy portion of that.

<unk> would also be follow on investments in existing companies. We have four companies that were working on now.

If things go as planned you could see us complete additional investments in those companies that were excited about that just like we always have been.

And welcome the opportunity for additional investments in our existing companies.

Great very helpful. Thanks again.

Great. Thank you again.

Thank you I would now like to turn the call over to management for closing remarks.

So thank you again to everyone for joining US today, we'll look forward to talking to everyone again in a few months in February when we cover our fourth quarter results and last thing is go Astros.

Ladies and gentlemen, thank you for your participation. This does concludes today's teleconference. You may disconnect your lines and have a wonderful day.

Okay.

Okay.

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Right.