Q3 2023 Main Street Capital Corp Earnings Call
Greetings and welcome to the main Street Capital Corporation third quarter earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference. Please press star.
Zero on your telephone keypad.
Mind you. This conference is being recorded it is now my pleasure to introduce your host Zach Vaughan with Dennard Lascar Investor Relations. Please go ahead. Thank.
Thank you operator, and good morning, everyone. Thank you for joining us for main Street capital Corporation's third quarter 2022 earnings Conference call.
Joining me today with prepared comments are Duane Hughes, Chief Executive Officer, David Macdonald, 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 as Nik Miss or.
Managing director and head of main Street's private credit investment groups.
Main Street issued a press release yesterday afternoon that details the company's third quarter financial and operating results.
This document is available on the Investor Relations section of the company's website at 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 November 10th.
Information on how to access the replay was included in yesterday's release.
We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company's homepage.
Please note that information reported on this call speaks only as of today November three 2023, and therefore, you're 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.
Factors set forth in the company's filings with the Securities and Exchange Commission, which can be found on the company's website or S. E C 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 or NII.
The NII net investment income or NII as determined in accordance with U S generally accepted accounting principles or GAAP.
Excluding the impact of noncash compensation expenses.
Management believes that presenting D NII and the related per share amount are you.
Useful inappropriate supplemental disclosures for analyzing mainstream financial performance.
Since noncash compensation expenses did not result in a net cash impact of main street upon settlement.
Please refer to yesterday's press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.
Two additional key performance indicators that management will be discussing on this call, our net asset value or an Eva and return on equity or Roe.
N. A V is defined as total assets minus total liabilities and has also reported on a per share basis.
Main Street defines our O E as the net increase in net assets, resulting from operations divided by the average quarterly total net assets.
Please note that certain information discussed on this call, including information related to portfolio companies was derived from third party sources and has not been independently verified.
And now I'll turn the call over to main Street's CEO Dwayne he shot.
Thanks Zach.
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 updates on our asset management activities. Our recent dividend declarations are expectations for dividends going forward, our current investment pipeline.
Several other noteworthy updates.
Following my comments, David and Jesse will provide additional comments regarding our investment strategy and desperate portfolio financial results capital structure and leverage.
Our expectations for the fourth quarter, after which we'll be happy to take your questions.
We're pleased with our performance in the third quarter, which was highlighted by an annualized return on equity of 17, 9% for the quarter, which increased our return on equity for the trailing 12 months period to 18, 2%.
Our performance include the continued strength of the underlying performance of the majority of our lower middle market and private loan portfolio of companies and significant contributions from our asset management business.
We believe these results demonstrate the continued and sustainable strength of our overall platform.
The strong current investment income generating capabilities of our existing investment portfolio.
Benefits provided by the equity investments in our lower middle market investment portfolio and by our asset management business, both of which also contributed meaningful fair value appreciation in the quarter.
We're also pleased that our investment pipeline in our lower middle market investment strategy has improved and we expect higher levels of new lower middle market investment activity over the next few months.
This improved industrial pipeline together with our conservative liquidity position and capital structure, which we significantly enhanced during the quarter provide us a continued favorable outlook for the fourth quarter.
Our D NII in the third quarter exceeded the monthly dividends paid to our shareholders by 51% and the total dividends paid to our shareholders by 8%, allowing us to continue to deliver the benefits of our strong results to our shareholders.
These positive results and a favorable outlook for the fourth quarter resulted in our recommendations to our board of directors for our most recent dividend announcements, which I'll discuss in detail later.
Our NAV per share increase in the quarter due to several factors, including the impact of the fair value increases in our investment portfolio, the accretive impact of our equity issuances in the quarter.
And our retention of the excess NII per share above our total dividends paid in the quarter.
The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of net fair value appreciation and strong dividend income contributions from our equity investments in this portfolio.
As we look forward to the next few quarters, we remain excited about our expectations for our lower middle market portfolio companies and we expect to see additional fair value appreciation in this portfolio in the future.
We're also excited to have several portfolio companies in the advanced stages of strategic acquisitions, which if successful will provide the opportunity for additional fair value appreciation. In addition to providing us highly attractive incremental investments in these high performing companies.
We are also seeing continued progress with the increased potential exit activities for several of our lower middle market portfolio companies that we noted last quarter and.
And we believe that these activities could lead to favorable realizations over the next few quarters.
Although women to work in investment activity in the third quarter was well below our expectations and goals. It was limited to a total investments of $20 million in existing portfolio companies.
These investments after repayments, we received on several debt investments and return of invested equity capital resulted in a net decrease in the cost basis of our lower middle market investments of $5 million.
As I previously noted we expect to have investment activity in our lower middle market strategy over the next few months that is more in line with our normal activities and expectations.
We were pleased with our private loan investment activities in the quarter, which included total investments of $135 million and investments in two new portfolio companies.
After debt repayments and sales of certain investments and a realized loss on our private loan investment during the quarter.
Our investment activity resulted in a net increase in the cost bases of our private loan investments of $54 million.
We've also continued to produce attractive results for our asset management business.
As we advised through our external investment manager continued to experience favorable performance in the third quarter.
Resulting in significant incentive fee income for our asset management business for the fourth consecutive quarter.
And a significant contribution to our net investment income.
We remain excited about our plans for these external funds that we manage as we execute our investment strategies and other strategic initiatives and we are optimistic about the future performance of the funds and the attractive returns we are providing for the investors of each fund.
We also remain optimistic about our strategy for growing our asset management business within our internally managed structure and increasing the contributions from this unique benefit to our mainstreet stakeholders.
As part of this growth strategy we're.
We're happy to update that we've made significant progress on our second private loan fund and had our initial closing of equity commitments in September.
We look forward to the continued to go through this new fund over the next few quarters.
Based upon our results for the third quarter combined with our favorable outlook in each of our primary investment strategies and for our asset management business.
This week, our board declared a supplemental dividend of $27.05 per share payable in December representing our ninth consecutive quarterly supplemental dividend.
Our board also declared another increase to our regular monthly dividends for the first quarter of 2024 to 24 cents per share payable in each of January February and March representing a six 7% increase from the first quarter of 2023, and representing our fifth increase to our monthly dividends in the last six quarters.
The supplemental dividend for December as a result of our strong performance in the third quarter, which resulted in D NII per share, which exceeded our regular monthly dividends paid during the quarter by 35 or.
Our 51%.
The December supplemental dividend will result in total supplemental dividends paid during the trailing 12 month period of 95 per share.
Representing an additional 35% paid to our shareholders in excess of our regular monthly dividends and resulting in a current yield we are providing to our shareholders of approximately 10%.
After the multiple recent increases to our monthly dividend and a significant supplemental dividend R. D. NII per share for the third quarter still exceeded our total dividends paid by seven and a half cents per share or 8%.
We are pleased to be able to deliver the significant additional value to our shareholders, while still conservatively maintaining a portion of our excess earnings to support our capital structure and investment portfolio.
Against the risk that exist from the current economic uncertainties and to further enhance the growth of our NAV per share.
We currently expect to recommend that our board continue to declare future supplemental dividends to the extent D. NII significantly exceeded our regular monthly dividends paid in future quarters, and we maintain a stable to positive.
Yeah.
Based upon our expectations for continued favorable performance in the fourth quarter.
We currently anticipate proposing an additional supplemental dividend payable in the first quarter of 2024.
Now turning to our current investment pipeline.
As of today, I'd characterize our lower middle market investment pipeline as average.
Despite the current broad economic uncertainty, we expect to continue to be active in our lower middle market strategy.
System with our experience in prior periods of broad economic uncertainty. We believe we believe the unique and flexible financing solutions, we can provide to lower middle market companies and their owners and management teams and our differentiated long term to permanent holding periods should be an even more attractive solution in the current environment and should result in very attractive investment opportunities.
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We are excited about these new investment opportunities and we expect our current pipeline will be helpful. As we work to maintain our positive momentum from the recent quarters in the future.
We also continue to be very pleased with the performance of our private credit team and our significant growth. They are provided for our private loan portfolio and our asset management business and as of today I would also characterize our private loan investment pipeline as average.
With that I will turn the call over to David.
Thanks, Dwayne and good morning, everyone.
Duane highlighted in his remarks, we believe our strong third quarter financial results continued 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.
As we've discussed in the past the largest portion of our investment portfolio and the primary driver of our long term success has been and continues to be our focus on the underserved lower middle market and specifically our strategy of investing in both the debt and equity and lower middle market companies.
Our view on the attractiveness of investing in the lower middle market remains unchanged and we expect this to continue to be our primary area of focus in the future.
Each quarter, we try to highlight key aspects of our investment strategy and differentiated approach for.
For today's call, we thought it would be useful to spend some time on the support we provide to our lower middle market portfolio companies.
In addition to our normal ongoing activities to support our lower middle market portfolio companies, we specifically want to highlight an annual event, we host for the leaders of our lower middle market portfolio companies, our seventh annual main Street President's meeting.
But those of you who are not familiar with our Presidents' meeting. It is an annual event mainstreet hosts for which we invite our lower middle market portfolio company leaders to Austin for a two day event to network and relationship built.
Sure best practices.
Learn from each other and benefit from being part of main street portfolio.
Based on post event feedback, we received from our lower middle market portfolio company executives.
That is highly valued by the participants and the event improves each year as we refine our agenda based on the feedback we received.
Topics covered in the most recent meeting included sales generation techniques executive coaching and culture building cyber security best practices.
Operational optimization and industry oriented breakout groups.
When <unk> went public 16 years ago, we could not have imagined we would be able to bring such a large and high caliber group of leaders and build this type of collaborative community event, which brings robust benefits to our portfolio of companies.
As a result of this annual event our portfolio companies have done business together referred business to each other utilize each other's operational resources and made friendships that are invaluable.
To provide more context, one panel panel we received very positive feedback on this year was focused on best practices for optimizing your operations.
The panel was comprised of a peer group of our lower middle market portfolio company leaders, who lead a discussion on lean manufacturing techniques. They use of kpis throughout their operations.
<unk> incentive compensation programs and top grading talent.
Another valuable topic, we covered with best practices for defining effective b to b cell strategies for an organization.
For this session, we had an industry expert present on how to bring clarity and purpose to our selling organization.
The presentation explored how to gain better insights into customer needs, creating a shared vision on a company selling proposition and how to proactively guide a prospective customer through the buying process.
The engagement from the audience for both presentations was robust and led to several post event discussions, including the sharing of key third party resources and operating best practices that we believe will ultimately improve the financial results and operating performance for our portfolio companies.
Given our focus on the lower middle market strategy and the unique benefits that can provide we're excited to bring together the key leadership from our lower middle market portfolio companies in this highly effective annual President's meeting and event. In addition to certain other mainstream programs, where we can provide value.
And Selflessly for a benefit at main street, we always leave this event very excited about the quality individuals leading our lower middle market portfolio companies and the future value creation, we can expect they and their teams can generate for our mutual benefit in the future.
We left this year's event, even more excited than ever.
Now turning to the overall composition of the results from our investment portfolio as of September 30th we continued to maintain a highly diversified portfolio with investments in 195 companies spanning across more than 50 industries across our lower middle market private loan and middle market portfolios.
Our largest portfolio company represented three 2% of total investment portfolio fair value at quarter end and three 7% of our total investment income for the last 12 months.
Majority of our portfolio investments continue to represent less than 1% of our income and our assets.
Despite the increases in benchmark interest rates, the vast majority of our lower middle market private loan and middle market portfolio companies have interest rate and debt service coverage ratios calculated on a pro forma basis with current interest rates as of October one greater than one times and we continue to be confident in their ability to service their debt obligations.
Patients today and in the future.
In addition, and as a reminder, our lower middle market portfolio companies are predominantly fixed rate debt investments and therefore are not impacted by fluctuations in market index rates.
Our investment activity in the third quarter included total investments in our lower middle market portfolio companies of $20 million, which after aggregate repayments on debt investments and return of invested equity capital resulted in a net decrease in our lower middle market portfolio of $5 million.
The pace of lower middle market originations this quarter was slower than we expect to achieve in any given quarterly period of time.
That said, our origination volume can be lumpy in the lower middle market and to reiterate with Dwayne mentioned in his opening remarks as of today, we would characterize our current lower middle market pipeline as average.
We look forward to making press announcements in the fourth quarter about some exciting new investments that we are currently in the process of completing.
Driven by the capabilities and relationships of our private credit team. We also completed a $135 million in total private loan investments, which after aggregate repayments of debt investments and sale of several private loan portfolio investments resulted in a net increase in our private loan portfolio of $54 million.
Finally during the quarter, we had a net decrease in our middle market portfolio of $11 million as we continue to deemphasize this strategy.
At the end of the third quarter, our lower middle market portfolio included investments in 79 companies, representing approximately $2 $2 billion of fair value, which is 28% above our cost basis.
We had investments in 89 companies in our private loan portfolio, representing $1 $5 billion of fair value.
In our middle market portfolio, we had investments in 27 companies representing $291 million of fair value.
The total investment portfolio at fair value at quarter end was 113% of the related cost basis additional.
Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday.
In summary main streets investment portfolio continues to perform at a high level and deliver on our long term results and goals.
With that I will turn the call over to Jesse to cover our financial results capital structure and liquidity position.
Thank you David.
Dwayne and David mentioned, we are pleased with our operating results for the third quarter.
Our total investment income for the third quarter was $123 2 million, representing an increase of $24 9 million or 25% over the third quarter 2022, and a decrease of $4 3 million.
Or three 4% from the second quarter 2023.
As we highlighted in our earnings release total investment income for the third quarter did not include meaningful levels of dividends and accelerated prepayment for other activities that are considered less consistent or nonrecurring.
In the aggregate these items were $4 six selling below the average of the prior four quarters.
Were comparable to the third quarter last year and.
And were $6 1 million lower than the second quarter of 2023.
Interest income increased by $24 4 million or 32% over a year ago, and $2 1 million or two 2% over the second quarter.
The increase in interest income over the second quarter was driven primarily by increases in benchmark index rates and that investment activity, partially offset by reduced accelerated OID income and the impact of an increase in non accrual investments.
The increase in interest income over the prior year was driven primarily by increases in benchmark interest rates and net investment activity.
Dividend income increased by $1 8 million or nine 1% over a year ago.
Dividend income decreased by $4 4 million or 17% from the second quarter largely from a reduction in elevated nonrecurring dividend income.
Fee income decreased $1 3 million from a year ago and $2 million from the second quarter, driven by reduced closing fees, resulting from lower investment activity in our lower middle market portfolio and in the quarter.
Our operating expenses increased by $5 1 million over a year ago, largely driven by increases in interest expense and compensation related expenses, partially offset by an increase in expenses allocated to the external investment manager.
Interest expense increased by $5 2 million over the prior year.
Driven primarily by increases in benchmark.
Rates and.
And from the addition of new debt obligations at higher interest rates.
Partially offset by a decrease in average outstanding borrowings.
Cash compensation expenses increased by $1 million over a year ago, driven by increased based compensation rates decreased cash incentive compensation accruals.
As a result of our positive operating performance and increased head count to support our growing investment portfolio and asset management activities.
Noncash compensation expenses increased by 0.7 million from a year ago.
Including increases in share based incentive compensation.
And deferred compensation expenses.
The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets was one 3% for the quarter on an annualized basis and one 4% for the trailing 12 month period.
Continues to be amongst the lowest in our industry.
Our external investment manager contributed $7 6 million to our net investment income during the quarter.
An increase of $2 6 million from a year ago.
And a decrease of 1 million from the second quarter.
The manager earned $2 6 million in incentive fees during the quarter as a result of the positive performance of the assets under management.
Ended the quarter with total assets under management.
A $1 5 billion.
During the quarter, recognizing that for value appreciation, including net realized gains and net.
Unrealized appreciation.
On the investment portfolio of $27 $7 million.
This increase was driven by $24 2 million and net fair value appreciation in our lower middle market portfolio, resulting.
Resulting from the continued positive performance of certain of our portfolio companies.
$12 2 million appreciation in our external investment manager.
Driven by increased revenues and an increase in peer multiples.
$4 1 million net fair value appreciation in our middle market portfolio as.
As a result of increases in quoted market prices and specific company performance improvements.
This appreciation was partially offset by net fair value depreciation at 14 million in our private loan portfolio largely due to the underperformance of certain portfolio companies.
We ended the third quarter with investments on non accrual status comprising approximately 1.0% of the total investment portfolio at fair value and approximately three 1% of cost.
And NAV per share increased by 64.
Our two 3% over the second quarter and by $2 39 for.
Nine 2% when compared to a year ago to a record $28 33.
At September 32023.
We continue to believe that our conservative leverage strong liquidity and continued access to capital are significant strengths that have us well positioned for the future.
Our regulatory debt to equity leverage calculated as total debt, excluding our <unk> debentures divided by net asset value was 0.7.
Our regulatory asset coverage ratio was two five at quarter end.
Both ratios are intentionally more conservative than our target ranges and 0.8, <unk> nine and $2 one to 2.25, respectively.
Continue to be active during the quarter with our aftermarket or ATM program.
Raising a net $81 million from equity issuances.
We ended the quarter with strong liquidity, including cash and availability under our credit facilities of $834 million.
In addition in October we expanded the commitments under our SPV facility by 175 million to $430 million, increasing our current liquidity to over 1 billion.
We believe this provides us with ample liquidity to continue to pursue attractive investment opportunities for the remainder of 2023 and into 2020 for Lockheed.
While continuing to maintain a conservative leverage profile and significant capital structure flexibility.
As Dwayne indicated our operating performance resulted in a return on equity for the quarter 17, 9% on an annualized basis.
At 18, 2% for the trailing 12 month period.
All of these are above our long term targets.
Do you believe that these represent strong results compared to the industry.
The NII per share for the quarter was $1 <unk> per share.
A decrease of eight.
Or 7% from the second quarter and an increase of 16.
Or 18% over the same period a.
A year ago.
As I mentioned earlier, the combined impact of certain investment income considered less consistent or nonrecurring in nature.
Was not significant in the <unk>.
Third quarter.
It was <unk> <unk> per share below the second quarter of <unk>.
<unk> per share below the average of the last four quarters.
And was consistent with the same quarter a year ago.
C&I per share exceeded the total regular monthly dividends per share paid to our shareholders in the third quarter by 35.
We're 51% and our total dividends per share by sentiment has since were 8%.
That's the way you mentioned given the strength of our offer results and the outlook for 2023.
Our board approved a supplemental dividend of 27 five cents per share payable in December 2023, our ninth consecutive quarterly supplemental dividend.
Total monthly in supplemental dividends declared for the fourth quarter 2023, or <unk> 98 per share representing a one 6% increase over the total dividends paid in the third quarter and a 29% increase or the total dividends paid in the fourth quarter last year.
Additionally, given the continued momentum of our operating results. Our board also approved an increase to our monthly dividends to <unk> 24 per share for the first quarter of 2024.
The third consecutive quarterly increase to our regular monthly dividends.
Looking forward given the strength of our underlying portfolio. We expect continued strong performance in the fourth quarter of 2023.
With expected <unk> per share of at least $1.04.
And with the opportunity to significantly exceed this amount driven by the level of dividend income and portfolio investment activities during the quarter.
With that I will now turn the call back over to the operator, so we can take any questions.
Thank you we will now be conducting a question and answer session.
You would 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 would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
First question comes from Bryce Rowe with B Riley Securities. Please go ahead.
Thanks, Good morning.
What it wanted to Duane first just kind of ask about your comments around.
The more muted lower middle market portfolio growth in the third quarter, and then prospects for Q4.
For some improvement.
In portfolio of activity lower middle market portfolio activity.
Whats driving that.
The increased pipeline.
If you could comment on that.
Sure Bryce good morning, and thanks for the question and thanks for joining US today I would say when you when you look at the lower middle market and you've heard US say this in the past.
We find that part of our market or our investment strategies by far the most attractive but the negative about the market as it can be lumpy in the third quarter. We had some of that Lumpiness come through we had a number of transactions. We were working on that for one reason or another.
It did not make it through to a closing and so that resulted in the muted activity in the quarter, we continue to be.
Do you have a favorable view optimistic view about our expectations long term for the lower middle market I think we tried to give guidance in our comments.
You should expect to see some near term investment activity as well as more normal investment activity over the next couple of months as you look at it is closing out the fourth quarter and moving into the first quarter. So not anything from our standpoint to be overly concerned about but it was a.
Lower than expected amount of investment activity originations in the third quarter specifically.
Okay. That's helpful.
And he also kind of commented on potential.
Potential exit activity within the lower middle market portfolio of picking up here.
Yes.
What's driving that is it M&A is it kind of idiosyncratic based on.
Our lower middle market portfolio company owner.
<unk> liquidity, just just just curious on that.
I'd say it would be more of the latter it would be things that are specific to the individual portfolio company as you've heard us say in the past and you can see it in our results both in the dividend income that our lower middle market companies are producing as well as the free b.
Fair value increases that we're having the companies are performing at a high level. So when you look at that type of performance. They will attract interest from third parties that could lead them to explore an exit opportunity or there could be other activities specific to the portfolio company or to its existing ownership its management team.
Lead them to take a look at it and exits I'd say, there's nothing specific that applies to all the opportunities, but as we started noting last quarter and I wanted to reiterate this quarter. We are seeing more activity there and we do expect that a number of those initiatives are those activities could result of some favorable access over the next couple of months.
Got it Okay and one last one for me.
On the on the closing of the <unk>.
Second private loan fund can you can you help size this size that up for us.
Sure Brian when you look at it our goal is that our second private sign would be larger than the first just as a reminder, the first one.
$100 million of equity you can effectively double that with leverage to get to $200 million to $215 million total portfolio size, we with our first closing here were successful in closing with about $65 million of equity capital, where we're going to continue to raise capital in that fund going forward just like we would would've done on the first.
So we hope to define long term wind up being greater than $100 million, but the process will play out over the next couple of quarters and kind of determine how much success. We are with the size on the equity commitments and then just like fund one.
Our plan is to put leverage in place that are effectively double the assets relative to your equity bye bye bye the use of <unk>.
A data our leverage facility.
Got it okay. Thanks, so much. Thank you I appreciate it.
Yep.
Next question, Robert Dodd with Raymond James Please go ahead.
Hi, guys and congrats on the quarter excuse me thanks Robert.
When you look your comment about some.
Some of the deals.
In the quarter I mean, you said there wasn't anything you were concerned about but what does that have any kind of.
Theme was it what was it.
Final due diligence seen that kind of fell through all people to match you to help to ask on the on the price. So any any kind of color you can give us on what the trigger points, where on the ones that fell through.
Sure Robyn I'll give some color then I'll, let David add on anything that he has from his perspective, but I would say it wasn't anything consistent across the transactions that didn't make it across the finish line, but as you've heard us say in the past we're dealing with individuals not not institutions in terms of the counterparty of nice transactions and you know they can and will have stuff that changes on their side.
From a personal standpoint in my view of one of the transactions that's exactly what it was but he had a view of what a transaction.
Desirable transaction would be and I'd say that view over time changed as we went through our process the other.
Difficulties, we've had no big surprise I think to people, we continue to be very disciplined in our underwriting approach not not anything different than what we've done in the past, but we always maintain a very disciplined approach and in this current environment. When you look at the economic uncertainty whether it's actual historical results as we go through due diligence or if it's the visibility to the future expectations.
Future results Youre seeing more volatility and as we go through the diligence process, we have to deal with that volatility in terms of how we value and structure of the final transaction and that could lead the transaction not to move forward. So those would be the two two examples I would point to I'll, let David add any additional comments. He has on his side yeah Robert I.
We're always conscious about our origination budget and trying to.
Closings in this quarter, we had some lumpiness couple of examples where one had a safety issue that came up during our diligence. Another one had some financial diligence relative to historical and projections that.
Ultimately, we couldnt get comfortable underwriting too so when we see those things while we're anxious to have closings and put more more assets on the books, we're just going to be disciplined about making sure. We're making good prudent investments like we have historically and that leads to some quarters that are lumpier than others, but nothing to take away as far as things.
Got it got it. Thank you that's what I was kind of a.
One of them.
What are you hearing preliminarily if anything on budget outlooks for 24, obviously these are smaller base, but actually that's 10 years ago and I think most of your portfolio companies had budget so to speak but you've been much more vigorous over the years in terms of.
Encouraging those kind of those processes, so I E.
And anything on that front about 2020 for more moderate more of the same anything that's coming through so far.
Sure Robert as you said our companies all of them will go through some level of budgeting process for next year and most of them will go through a multi year outlook or expectation planning process. Most of our companies are likely right in the middle of that process for 2024 today. So we don't really have information of points, you're coming out of those Budd.
2020 for budget discussions, but what I would point you to you and David talked about this in and.
In his comments not specifically the 'twenty 'twenty four expectations, but the fact that we just hosted our Presidents' meeting for our lower middle market companies and the data point I would give you is that coming out of that meeting the overall.
<unk> sentiment expectations from the group broadly is very positive I think companies are doing well despite.
Despite all the challenges and all the headwinds that you hear about in the broader <unk>.
Community or just the overall economy. These companies are doing well and they're concerned about the same uncertainties that everybody else is but if you look at their.
Their expectations in terms of discussions with customers and their ability to drive operational improvements or efficiencies and manage all the parts of their business. They drive value I would say that they all have a fairly optimistic view, which is why we look at it and we always leave that meeting very very encouraged but I would say this year. We left the meeting you may be more encouraged than we had in the pack.
And again I'll, let David if he has any comments he wants to add as a.
Response, there as it is in terms of what we heard from Presidents' meeting.
I'd say the only thing that.
It's always interesting to talk to a portfolio company exact about it there are specific drivers.
Within each industry, because we have so many industries represented as a <unk>.
Generally what youre hearing in the economy, probably overlays with our portfolio of companies that the great news is that because they are small they can be nimble and react quickly to the changes that they're seeing so there was a lot of discussion with those that might have some headwinds in the industry, what theyre doing proactively to position themselves and others are still seeing good robust activity in capital.
On that.
Got it thank you and Uh huh.
The color congratulations on the.
Good quarter. Thanks.
Thanks, Robert we appreciate it.
Next question Mark Hughes withdrew its securities. Please go ahead.
Yeah. Thanks, Good morning, good morning, Mark.
The incentive fee income from the fund management business, I think up nicely year over year.
What are is that a reasonable run rate was there something unusually good this quarter or.
It kind of it.
If the market stays in a.
The group this will be a decent.
Our run rate for you.
Sure market. If you look at our asset management business one of the things that I would remind that the group is that that business from an investment strategy standpoint is primarily focused on our private loan strategy. So when you look at main Street results you can kind of read through to the results that we're seeing in the funds or the declines we have on the asset management business.
So if you if you look at our results at main Street and this quarter you did not see a lot of nonrecurring unusual one time items. It was a from our perspective, a very clean quarter from that perspective. So I would say that you should expect the results that we had in our asset management business would follow the same the same nature of income and earnings so when we look.
At the third quarter, the incentive fees were down a little bit from the second quarter, but we feel like it's a really good base level of.
Incentive fees, assuming the market continues to perform the way it has and we don't see degradation or issues across the portfolio, which we're not seeing today. So we feel really good about the quarter and we feel feel good about what that means from a look through standpoint into the incentive fees, we're getting off the asset management business.
And then did you give any indication of kind of the underlying EBITDA or revenue growth or your portfolio companies the lower middle market company.
We did Margaret that's not our staff that we typically publish.
Okay very good. Thank you I'm not sure whether you were touching on your pipeline.
Pipeline in terms of potential new investments, but I think you would also suggest that the true opportunity for fair value appreciation through maybe some domestic activity.
That was.
Elevated could you talk a little bit more about that.
What needs to happen for that to.
Come through.
Sure Marc if you look broadly at our changes in fair value both in this quarter and I'd say for the last couple of quarters. We're seeing the result of a number of companies that are just performing at a high level specifically in the lower middle market.
Some of those companies have completed acquisitions over the last 12 or 18 months as you may recall I was saying in prior quarters and those acquisitions have been integrated well, they're performing well they are realizing the synergies and youre seeing the results of those strategic valuable acquisitions come through the company's quarterly results and then Youll see it come through on a fair value so that that would be a big driver.
When you look at the exit activity I would say one thing from our perspective, which we may not control the outcome because we're just one of the equity owners, we're not we don't own controller or drive all the final decisions of these individual lower middle market portfolio companies, but in general.
If we're gonna be motivated inclined to sell it's likely going to be at a premium to our fair value otherwise all things being equal we're likely going to be more inclined to hold the investment we have permanent capital. Our desire is to have a very very mature diversified broad portfolio, so all things being equal.
If we had control over everything we would maintain our best companies forever unless somebody who's going to pay a significant premium to what we think is worse as of today. So that that may not directly answer your question, but I think we feel good about.
Where we have our portfolio companies valued overall, we specifically feel good about where we haven't valued in the context of them going through an exit or sale process.
Thank you I appreciate it thank you.
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Hey, everyone. Thanks for the question, maybe just to follow on Mark's question, a little bit.
And these are add on acquisitions that that are driving some of the.
Fair value appreciation through them.
Realization of synergies is that the momentum for that.
Dynamic going are going to continue for the foreseeable future and one of the key drivers here as you think about.
Your fair value marks for the next few quarters.
Sure I'll get a couple of comments and I'll, let either David or Jesse add on because they're involved in a couple of the companies that are executing acquisition growth strategies, but just to kind of go backwards a little bit. If you had been looking at is talking to US five six years ago acquisition growth strategies for our portfolio companies. While we had some it was not a significant.
<unk> activity for most of our companies and it's something that we we long head had viewed it as an opportunity and we started in our Presidents' meeting five six years ago really talking about the opportunity to pursue growth through acquisitions and started educating our companies on how and why they should at least consider it clearly not forcing them to do it but at least should.
Should consider it as a result of that and as a result of the just the high quality of the companies and management teams that we have in the portfolio over the last couple of years really Covid was a time period, where it really accelerated we started seeing more of our companies embrace acquisition growth opportunities.
So when we look at it we've got a number of companies that as I said have been executing those acquisitions not not just closing the acquisition integrating and optimizing the synergies and they've done a fantastic job and we continue to have some of those same companies continuing to explore additional acquisitions, but we also have a broader group some companies that have not executed.
Acquisitions in the past that have very attractive strategic acquisitions that we're helping them work through and we hope to have a closing again sometime over the next one to three months and if we're successful there.
Wouldn't execute that acquisition, both for our benefit or for the portfolio company without the viewpoint that it'll be a significant value creator from a fair value standpoint, and an ultimate equity valuation if or when that company has ever sold so I know that's a lot there, but I'd say, it's just we have been and continue to encourage our companies to pursue that and we've seen seen really really good results.
Over the last couple of years from that from that initiative.
Add one thing on the on the fair value a comment or two big inputs that Duane talks about one are they accretive acquisitions, the second or the exit activities. When we're doing our fair value marks work.
We're marketing them to what we think is a fair value at the at that moment in time, when we do run a process the job on a process. If there is an intermediary involved is to go out there and find the outlier and to get to the top of our range of expected outcomes as time goes on and we get further through that and we have incoming calls we hope to exceed the fair value marks that we have.
So we see activity, we're hopefully able to appreciate and get that outlier type of valuation that also helps obviously with the fair value.
Okay, and then that final Mark will happen after the transaction closes.
At closing.
Yes, when you see the realized the realized transaction go go through the financial statements.
Okay. Okay, great. That's all very helpful.
Color.
Can you guys talk about the just a tick up there in non accruals.
For the quarter any any color around what.
What is happening there with that credit or credits that I think we're in the private our private loan book.
There were two.
To that off the top of my head, where where private loan one was middle market I'd say these are companies.
We had been writing down from a fair value standpoint, the last couple of quarters as those companies had dealt with specific operating company performance issues.
The credit of the sponsors they they continue to be supportive and we continue to work with the private equity sponsors in each of those transactions and the other participants in the capital structure, but the non accrual status in the fair value depreciation that we've recorded just represents that.
The underlying operating performance challenges that those companies have had specifically so nothing systematic.
Systematic abroad base, its very very specific to the operating performance of those of those companies in this quarter that were moved to nonaccrual.
Okay. Thank you guys I'll hop back in the queue.
Thanks, a lot.
This concludes our question and answer session I would like to turn the floor back over to management for closing comments.
I just want to thank everyone again for joining us. This morning, and we will look forward to talking to everyone again in mid to late February.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.
Okay.
Hum.
Hum.