Main Street Capital CORP Q1 FY2024 Earnings Call

Greetings, and welcome to the Main Street Capital First Quarter Earnings Conference Call. As a reminder, this conference is being recorded.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's First Quarter 2024 Earnings Conference Call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer; and Jesse Morris, Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of the call is Nick Meserve, Managing Director and Head of Main Street's Private Credit Investment Group. Main Street issued a press release yesterday afternoon that details the company's first quarter financial and operating results. This document is available on the Investor Relations section of the company's website at mainstcapital.com. A replay of today's call will be available beginning an hour after the completion of the call and will remain available until May 17. Information on how to access the replay was included in yesterday's release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company's home page. Please note that information reported on this call speaks only as of today, May 10, 2024, and therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Today's call will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may or similar expressions. These statements are based on management's estimates, assumptions and projections as of the date of this call, and there are no guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties and other factors, including but not limited to the factors set forth in the company's filings with the Securities and Exchange Commission, which can be found on the company's website or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law. During today's call, management will discuss non-GAAP financial measures, including distributable net investment income, or DNII. DNII is net investment income or NII as determined in accordance with U.S. Generally Accepted Accounting Principles or GAAP, excluding the impact of noncash compensation expenses. Management believes that presenting DNII and the related per share amount are useful and appropriate supplemental disclosures for analyzing Main Street's financial performance since noncash compensation expenses do not result in a net cash impact to Main Street upon settlement. Please refer to yesterday's press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Two additional key performance indicators that management will be discussing on this call are net asset value, or NAV; and return on equity, or ROE. NAV is defined as total assets minus total liabilities and is also reported on a per share basis. Main Street defines ROE as the net increase in net assets resulting from operations divided by the average quarterly total net assets. Please note that certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. And now I'll turn the call over to Main Street's CEO, Dwayne Hyzak.

Thanks, Zach. Good morning, everyone, and thank you for joining us. We appreciate your participation on this morning's call, and we hope that everyone is doing well. On today's call, I will provide my usual updates regarding our performance in the quarter, while also providing updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, our recent investment activities and current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and leverage, and our expectations for the second quarter of 2024, after which we'll be happy to take your questions. We are pleased with our first quarter results, which were highlighted by an annualized return on equity of 17.2% for the quarter, a new record for NAV per share, and NII per share and DNII per share that significantly exceeded the dividends paid to our shareholders. In addition, our positive performance in the quarter increased our return on equity for the trailing 12-month period to an impressive 19.3%. Our DNII per share in the first quarter exceeded the monthly dividends paid to our shareholders by 54% and the total dividends paid to our shareholders by 9%, representing a significant level of dividend coverage. This is after increasing the total dividends paid to our shareholders in the first quarter by 20% as compared to the same period of last year. We believe that these positive results demonstrate the continued and sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies, the unique contributions of our asset management business and the continued underlying strength and quality of our portfolio companies. We are also very pleased that we generated growth in both our lower middle market and private loan investment portfolios and ended the quarter with attractive pipelines in both strategies, which we believe will be helpful as we work to maintain our positive momentum from the last few quarters into the future. We remain encouraged by the continued favorable performance of our diversified lower middle market and private loan investment strategies, and we are confident that these strategies, together with the benefits of our asset management business and our cost-efficient operating structure, will allow us to continue to deliver superior results for our shareholders in the future. Additionally, with the continued support of our long-term lender relationships and the benefits of our January investment-grade debt offering, we continue to maintain strong liquidity, a conservative leverage profile and more than adequate flexibility to fund our current prospects for growth in both our lower middle market and private loan investment strategies. These positive results, combined with our favorable outlook for the second quarter, resulted in our recommendations to our Board of Directors for our most recent dividend announcements, which I'll discuss in more detail later. Our NAV per share increased in the quarter, primarily due to the impact of net fair value increases in our investment portfolio and our retention of excess NII above our total dividends paid, which Jesse will discuss in more detail. The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of significant net fair value appreciation in the equity investments in the lower middle market portfolio, and we are excited about the follow-on investments we made in several of our high-performing lower middle market portfolio companies. During the quarter, we supported three lower middle market portfolio companies in completing strategic acquisitions, each of which was funded by follow-on debt investments by Main Street for a total of $52 million of incremental debt investments in these portfolio companies. We expect that these follow-on investments will help drive additional fair value appreciation in these portfolio companies in future quarters, in addition to the highly attractive interest income provided by these debt investments. We've also seen increased interest from potential buyers in several of our lower middle market portfolio companies that could lead to favorable realizations over the next few quarters and which we believe highlights the strength and quality of our portfolio companies. We were pleased with our investment activity in the first quarter. This activity included total lower middle market investments of $92 million, resulting in a net increase in lower middle market investments of $67 million after repayments and other investment activity. Our private loan investment activities in the quarter included new investments of $155 million and slightly moderated repayment activity as compared to the significant level of repayment activity experienced in the fourth quarter, resulting in a net increase in our private loan investments of $55 million. As a result of our favorable investment activity, our total investment portfolio grew by approximately 6% on a cost basis. Given our conservative capital structure and strong liquidity position, we remain very well positioned to continue the growth of our investment portfolio over the next few quarters. We've also continued to produce positive results in our asset management business. The funds we advise through our external investment manager continued to experience favorable performance in the first quarter, resulting in significant incentive fee income for our asset management business for the sixth consecutive quarter, and together with our recurring base management fees, a significant contribution to our net investment income. We also benefited from significant fair value appreciation in the external investment manager due to a combination of the continued increase in fee income, growth in assets under management and broader market-based drivers. We remain excited about our plans for the 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 to the investors of each fund. We remain optimistic about our strategy for growing our asset management business within our internally managed structure and are actively working to increase the contributions from this unique benefit to our Main Street stakeholders. As part of this growth strategy, we continue to focus on the near-term growth of our assets under management and the related additional recurring base management fee and incentive fee opportunities as we work to create additional value for both the investors in these funds and Main Street in the future. Based upon our results for the first quarter, combined with our favorable outlook in each of our primary investment strategies and for our asset management business, earlier this week, our Board declared a supplemental dividend of $0.30 per share payable in June, representing our 11th consecutive quarterly supplemental dividend and an increase to our regular monthly dividends for the third quarter of 2024 to $0.245 per share, our sixth increase to our monthly dividends over the last 8 quarters. The third quarter regular monthly dividends are payable in each of July, August and September and represent a 6.5% increase from the third quarter of 2023. The supplemental dividend for June is a result of our strong performance in the first quarter and will result in total supplement dividends paid during the trailing 12-month period of $1.15 per share, representing an additional 41% paid to our shareholders in excess of our regular monthly dividends and a current total yield we are providing to our shareholders of over 8%. After multiple increases to our monthly dividend and the significant supplemental dividend paid in March, our DNII per share for the first quarter still exceeded our total dividends paid by $0.09 per share or 9%. We are pleased to be able to deliver significant additional value to our shareholders while still conservatively retaining a portion of our excess earnings to support our capital structure and investment portfolio against the risks associated with the current general economic uncertainty and to further enhance the growth of our NAV per share. We currently expect to recommend that our Board continue to declare future supplemental dividends to the extent DNII significantly exceeds our regular monthly dividends paid in future quarters and we maintain a stable to positive NAV. Based upon our expectations for continued favorable performance in the second quarter, we currently anticipate proposing an additional supplemental dividend payable in September 2024. Now turning to our current investment pipeline. As of today, I would characterize our lower middle market investment pipeline as above average. Consistent with our experience in prior periods of broad economic uncertainty, we believe that the unique and flexible financing solutions that we provide to our lower middle market companies and our owners and management teams and our differentiated long-term to permanent holding periods represent an even more attractive solution in the current environment, and we are confident in our expectations for strong lower middle market investment activity over the remainder of 2024. We also continue to be very pleased with the performance of our private credit team and the significant growth they have provided for our private loan portfolio and our asset management business. As of today, I would also characterize our private loan investment pipeline as above average.

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe that our strong first quarter financial results continue to demonstrate the strength of Main Street's platform, our differentiated investment approach and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio companies continues to be positive, which contributed to our attractive first quarter financial results. Each quarter, we try to highlight key aspects of our differentiated investment strategy. This quarter, we'd like to revisit several reasons why we believe that our structure as a publicly traded BDC with the significant benefits of permanent capital is a great match with our focus on investing in both the debt and equity capital in lower middle market businesses. First, on a new lower middle market investment side, we believe that our permanent capital structure allows us to be an ideal long-term to permanent partner for the owners of privately held businesses. One of the challenges of a typical limited-term-specific private equity fund is that they cannot represent a long-term partnership solution for a retiring business owner or their management teams. Our permanent capital structure and long-term to permanent investment strategy in the lower middle market allows us the flexibility to compete for new investments by providing significantly more beneficial structural consideration as opposed to relying solely on price to gain a competitive advantage. Ultimately, we believe this can generate highly attractive investment structures that more traditional private equity funds cannot provide. In addition, our ability to be a long term to permanent partner to the companies we invest in allows the long-term owners of these businesses and their management teams the ability to maintain the identity and independence of their companies while also achieving the best long-term outcomes for all of their company's stakeholders. Second, our long-term holding periods also helped generate a diversified portfolio of mature companies that typically have lower relative leverage, since they've generally used free cash flow from operations to deleverage over time. As our companies deleverage, we work proactively with our portfolio company executives and individual equity owners to decide how they can generate the best returns for the equity owners of these businesses. This tends to create 3 attractive opportunities for our high-performing lower middle market portfolio companies: the opportunity for long-term equity capital appreciation through the reinvestment of cash flows or through deleveraging; the opportunity to pay significant dividends to the shareholders of the business; and the opportunity to effectively take advantage of internal and external growth strategies and initiatives as they arise. In our more high-performing situations, we often see our portfolio company executives and equity owners take advantage of multiple value creation opportunities. We are well aligned with our portfolio company operating partners to evaluate and pursue the best alternatives to create shareholder value, since we share in the benefits of equity ownership with them. Alternatively, should our portfolio company face difficult industry headwinds or other challenges, since they have lower relative leverage profiles, they tend to be well positioned to work through any negative economic cycles as they arise, and they have the added benefit of a highly aligned partner in Main Street to help them work through a potential rough patch. The first quarter of 2024 represented another strong period for add-on investments for our lower middle market companies, whereby we supported five portfolio companies with additional capital for growth or recapitalization initiatives. Because of Main Street's strong capital availability and ability to provide both debt and equity capital to our portfolio companies, we are well situated to move quickly to support our portfolio companies, not only on the initial transaction but also when they identify growth initiatives. Today, the environment for add-on acquisitions by our portfolio companies remains strong. We welcome the opportunity to make incremental investments in our most successful lower middle market companies as we strive to create long-term value for Main Street shareholders alongside the other equity owners at the portfolio companies. Our lower middle market portfolio is currently comprised of 47 companies which have been in our portfolio for greater than five years, and 22 of which who have been in our portfolio for greater than a decade. We are excited about our partnerships with companies that have proven long-term track records at Main Street. A recent example of our supporting a seasoned portfolio company management team in executing their growth strategies took place when Main Street supported our portfolio company Gulf Manufacturing, or GMI, in a highly strategic acquisition. We made our original investment in GMI over 16 years ago, and in the first quarter, Main Street was pleased to provide 100% of the cash needs for GMI to complete a strategic acquisition. This acquisition provides the combined company and its owners, including management, the opportunity to benefit from the significant equity value creation opportunities produced through combined cross-selling prospects, economies of scale and other synergies that are expected to exist from the larger combined platform. GMI's acquisition is representative of the attractive opportunities we believe exist within our existing lower middle market portfolio to put incremental capital to work, supporting both internal and external growth initiatives at the portfolio company level. We believe our seasoned lower middle market portfolio will continue to provide attractive follow-on investment opportunities in the future. Now turning back to our lower middle market portfolio. The contributions from this portfolio continue to be well diversified, with 49 of our 81 lower middle market companies with equity investments having appreciation at quarter end and with 48 of these companies contributing to our dividend income over the last 12 months. Additionally, more than half of our lower middle market companies experienced increases in their trailing 12-month EBITDA in the first quarter of this year when compared to the fourth quarter of last year, which we believe demonstrates the underlying strength of our lower middle market portfolio. Now turning to the overall composition results from our investment portfolio. As of March 31, we continue to maintain a highly diversified portfolio with investments in 191 companies spanning across numerous industries and end markets. Our largest portfolio companies, excluding our external asset manager, represented only 3.5% of our total investment income for the trailing 12-month period and 3.5% of our total investment portfolio fair value at quarter end. The majority of our portfolio investments represented less than 1% of our income and our assets. Our investment activity in the first quarter included total investments in our lower middle market portfolio of approximately $92 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 $67 million. Driven by the capabilities and relationships of our private credit team, we also made $155 million in total private loan investments, which after aggregate investment activity resulted in a net increase in our private loan portfolio of $55 million. Finally, during the quarter, we had a continued net decrease in our middle market portfolio of $22 million. At the end of the first quarter, our lower middle market portfolio included investments in 81 companies representing $2.4 billion of fair value, which is 28% above our cost basis. We had investments in 88 companies in our private loan portfolio, representing $1.5 billion of fair value. And in our middle market portfolio, we had investments in 22 companies representing $239 million of fair value. The total investment portfolio at fair value at quarter end was 115% of the related cost basis. In summary, Main Street's investment portfolio continues to perform at a high level and deliver on our long-term goals. Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday. With that, I will turn the call over to Jesse to cover our financial results, capital structure and liquidity position.

Thank you, David. To echo Dwayne's and David's comments, we are very pleased with our operating results for the first quarter. Our total investment income for the first quarter was $131.6 million, increasing by $11.4 million or 9.4% over the first quarter of 2023 and by $2.3 million or 1.8% from the fourth quarter of 2023. The positive momentum we experienced during 2023 continued in the first quarter and resulted in strong levels of investment income, which we believe, as Dwayne and David touched on, demonstrates the continued strength of our differentiated investment and asset management strategies. The first quarter included elevated levels of certain income considered less consistent or nonrecurring in nature, which include dividends from our equity investments and accelerated prepayment, repricing and other activity related to our debt investments. In the aggregate, these items totaled $7.5 million and were $2.1 million higher than the average of the prior four quarters, $2.2 million higher than the fourth quarter and $1.8 million lower than the first quarter of 2023. Interest income increased by $6.7 million from a year ago and decreased $0.6 million from the fourth quarter. The increase over the prior year was driven primarily by increases in benchmark index rates and increased net investment activity. The decrease from the fourth quarter was primarily driven by a decrease in accelerated OID income, partially offset by increased net investment activity. Dividend income decreased by $1.4 million or 5.9% when compared to a year ago, driven primarily by a $5.3 million decrease in less consistent or nonrecurring dividends. The $3.9 million increase in dividends deemed recurring is a result of the continued underlying strength of the majority of our portfolio companies and the recurring benefits from our asset management business. Dividends decreased by $1 million or 4.2% from the fourth quarter and included a $1.7 million increase in dividends we characterize as less consistent or nonrecurring in nature. Fee income increased by $6.1 million from a year ago and $3.9 million from the fourth quarter. These increases were driven primarily from an increase in fees received from refinancing and prepayment of debt investments and fees related to higher portfolio investment activity. Prepayment and other fee income considered nonrecurring increased by $3.8 million from a year ago and by $2.1 million from the fourth quarter. Our operating expenses increased by $2.5 million from 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. The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.3% for the quarter on an annualized basis and continues to be among the lowest in our industry. Our External Investment Manager contributed $8.6 million to our net investment income during the first quarter, an increase of $0.5 million from a year ago and a decrease of $0.6 million from the fourth quarter. The Manager earned $3.9 million in incentive fees during the quarter, increasing by $0.6 million over a year ago as a result of the positive performance of the assets under management. The Manager ended the quarter with total assets under management of $1.5 billion. During the quarter, we recorded net fair value appreciation, including net realized losses and net unrealized appreciation on the investment portfolio, of $28.3 million. This increase was driven by net fair value appreciation in our lower middle market portfolio and in our External Investment Manager, partially offset by net fair value depreciation in our private loan portfolio. The net fair value appreciation on our lower middle market portfolio was driven by the continued positive performance of certain of our portfolio companies. The fair value appreciation in the External Investment Manager was a result of a combination of an increase in the fees generated by the manager, driven by continued strong performance of our asset management business and an increase in the valuation multiples of publicly traded peers, which we use as one of the benchmarks for valuation purposes. The net fair value depreciation on our private loan portfolio was driven by the net impact of specific portfolio company underperformance, partially offset by the impact of decreases in market spreads. We recognized net realized losses in our private loan middle market and other portfolio of a combined $12.8 million in the quarter, which were related to long-standing underperforming investments. The majority of the unrealized depreciation related to these investments was taken in prior periods, and as a result, the net impact of these realized losses in the quarter, after taking into account the accounting reversals of previously recognized unrealized depreciation, was a net fair value decrease of $1.2 million. We ended the first quarter with investments on non-accrual status comprising approximately 0.5% of the total investment portfolio at fair value and approximately 2% at cost. Net asset value, or NAV, increased by $0.34 per share over the fourth quarter and by $2.31 or 8.5% when compared to a year ago, to a record NAV per share of $29.54 at the end of the first quarter. Our regulatory debt-to-equity leverage, calculated as total debt, excluding our SBIC debentures, divided by net asset value, was 0.7, and our regulatory asset coverage ratio was 2.4, and were intentionally more conservative than our long-term target ranges of 0.8x to 0.9x and 2.1x to 2.25x. In January of this year, we issued $350 million of unsecured notes maturing in March 2029 with a coupon rate of 6.95%. We utilized the proceeds to repay outstanding borrowings under our credit facilities. On May 1 of this year, we repaid the $450 million due on our May 2024 notes at maturity through borrowings under our credit facilities. After giving effect to the investment capital activity thus far this year, we continue to maintain strong liquidity, including cash and availability under our credit facilities of over $900 million. We continue to believe that our conservative leverage, strong liquidity and continued access to capital are significant strengths that have proven to benefit us historically and have us well positioned for the future while allowing us to continue to execute our investment strategy. With this current level of liquidity, we currently expect to fund our net new investment activity in 2024 through a greater proportion of debt financing, and as such, we would expect leverage to increase during the course of the year. Coming back to our operating results. As a result of our strong performance for the quarter, our return on equity for the quarter was 17.2% on an annualized basis. DNII per share for the quarter of $1.11 exceeded the DNII per share for the first quarter of last year by $0.04 or 3.7%, and was $0.01 or 0.9% lower than the record DNII per share for the fourth quarter. The combined impact of certain investment income considered less consistent and nonrecurring in nature on a per share basis was $0.03 per share above the fourth quarter, $0.02 above the average of the last four quarters and $0.03 below the same quarter a year ago. Total dividends paid in the first quarter were $1.02 per share, including a supplemental dividend of $0.30 per share, an increase of 20% over the total dividends paid during the same period in the prior year. As Dwayne mentioned, given the strength of our operating results and the outlook for the rest of the year, our Board approved a supplemental dividend of $0.30 per share payable in June 2024. With this supplemental dividend, total declared dividends for the second quarter were $1.02 per share, representing a 13% increase over the total dividends paid in the second quarter of last year. The Board also approved an increase of our recurring monthly dividends to $0.245 per share or a total of $0.735 per share for the third quarter. As we look forward, given the strength of our underlying portfolio, we expect another strong top line and earnings quarter in the second quarter, with expected DNII per share of at least $1.03, with the potential for upside driven by the level of dividend income and portfolio investment activities during the quarter. With that, I will now turn the call back over to the operator so we can take any questions.

Our first question comes from Bryce Rowe with B. Riley Securities.

Dwayne, I wanted to maybe start on the comments Jesse made around using more debt to fund growth here in '24. Maybe you could help us think about that relative to where the regulatory leverage is now and where your target is. Do you expect to try to get back into that target range? Or will you still run conservatively below that target range?

Sure, Bryce. I'll give you a few comments there, and then I'll let Jesse remind everyone what our long-term new target expectations are for leverage. I'd start off just saying we've been well below our targets for a while. That was really in anticipation of the May 1, 2024 maturity that we just had that we repaid here over the last week or so. So we intentionally were being more conservative in advance of that because the markets, as you've heard us say before, have been very uncertain, and we weren't sure what we would be able to accomplish from an unsecured IG issuance standpoint. So we had intentionally built more cushion, more conservatism in that ratio over the last 12 months or so than what we would have otherwise executed on from a leverage and overall capital structure standpoint. But as you've heard us say in the past, we're always going to be more conservative in this space. We view our ability to generate best-in-class, best-in-industry ROE as fundamental. It's a different investment strategy. It's good underwriting. It's a long-term to permanent approach. So we really look at focusing on the fundamental investment strategies that we have to produce our return on equity and not use excessive leverage or financial engineering to get there. So we'll always be more conservative in the space, and we don't think anything would change there. That being said, because we have been in a more conservative position for a while, what Jesse is trying to indicate or message in his comments was that we will be moving from our current position towards our long-term targets over the next 12 to 24 months as we continue to execute the growth of our investment portfolio. But maybe I'll let Jesse remind everybody what those long-term targets are.

Sure. Thanks, Dwayne. As I said on the call, our leverage targets are 0.8x to 0.9x. As a reminder, the way we define that, we exclude our SBIC debentures due to our exemption there. At the end of the quarter, we had moved closer to that, as you probably saw, Bryce, to 0.7x. So we made the same comment in the last quarter. We made some movement closer to those targets. We're still more conservative to those, and we're expecting to continue to move closer to those.

It seems that the SBA debenture has decreased. Did you all prepay some, or was that just related to an existing maturity?

Yes, Bryce, those are just activities in relation to existing maturities. So we had 2 tranches that we paid off, and we'll be in the process of requesting new debentures to replenish that capacity from the SBA. We started that process. It just takes a while for us to get through the process with the SBA, but that's in process. It's just a matter of time before we hopefully have access to the full $350 million again.

Okay. All right. And then I'll ask one more and maybe jump back in queue if others don't ask other questions. So in terms of kind of the nonrecurring or less recurring income, especially on the fee side, is that more prepayment type of activity or amendment activity? Just help us think about that and kind of curious if it is prepayment type activity, what's driving that? Is that the tighter spreads that we've seen here recently, getting opportunity for refinance opportunities for your borrowers?

Sure, Bryce. When you consider that long-term metric, it includes all the items you mentioned. In the first quarter, we experienced two repayments that came with protections or benefits allowing us to gain additional advantages in fee income. Therefore, the first quarter was somewhat unusual, which is reflected in the numbers. Each quarter will show fluctuations in those figures, influenced by the typical investment repayment or prepayment activities happening across the entire portfolio.

Okay. And those were in the private loan portfolio, Dwayne, or lower middle market?

The two bigger ones that I'm referencing were both in the private loan portfolio.

Our next question comes from Robert Dodd with Raymond James.

On the dividend income from the portfolio companies, not the asset management, it was down a little bit this quarter, which you did highlight. It looks kind of like a 5.9% yield on portfolio company equity, down from last year, but the same as first quarter '22, I think, right, from a yield perspective. So I think Jesse said something about the vast majority are doing fine. Where they are at the margin, a couple of portfolio companies that are now deciding to reserve a little cash rather than distribute, is that becoming an emerging theme in the portfolio? Or is it just one of those random things that happens?

Thank you for the question, Robert. I would attribute the changes more to a random quarterly fluctuation. The companies contributing to our dividend income continue to be a diverse group, similar to previous quarters. There hasn't been a material increase in concentration, nor a significant change in the composition of these companies contributing to dividend income on a quarterly basis. Occasionally, we encounter nonrecurring items, which we always aim to identify. However, if you compare the fundamental performance of the companies contributing to dividend income now to what it has been over the last few quarters, particularly the last 6 to 8 quarters, I wouldn't say there has been a significant change. Fluctuations from quarter to quarter do drive that dividend income.

Got it. Regarding the asset manager, can you provide any updates on how you plan to manage MSC or other initiatives you are considering? You also have the two private loan funds in play. Any insights into the outlook for that high return on risk-adjusted capital business within Main over the next few years would be appreciated.

Certainly, Robert. We consider the asset management business to be extremely appealing, distinguishing it from other BDCs. It has significantly contributed to our return on equity and recurring net investment income, which we highly value, and we believe our stakeholders do as well. As we mentioned in previous quarters, we are focused on growing this segment. We have a couple of growth avenues, one being our private loan activities. While we don't intend to double the growth in this area, our approach will be deliberate, resulting in moderate growth. In the long term, if we can find a mutually beneficial solution with the shareholders of MSC Income Fund, we see this as a major opportunity. We continue to explore various strategic initiatives to ensure good returns for their shareholders and to provide additional benefits to Main Street through this fund's growth. Although I don't have specifics to share today, we are actively working on it and remain optimistic about achieving a positive outcome for everyone involved.

Our next question comes from Mark Hughes with Truist Securities.

Yes. Dwayne, you talked about the you're seeing more interest from several buyers. You also categorized your pipeline as above average compared to average last quarter. Could you expand on that a little bit more? Uptick clearly in deal activity that you're seeing, do you think that's broader? What's driving all that?

Sure, Mark. Thanks for your questions. Addressing them in reverse order, we have noticed a significant increase in activity in both the lower middle market and private loan sectors. As mentioned in our script and reflected in the numbers, our investment activity in both strategies was strong in the first quarter. My previous comments indicate that the pipeline in both areas remains positive. It’s unclear whether this uptick is due to the market becoming busier overall or specific actions we've taken; it’s likely a mix of both. You might have heard similar sentiments from other BDCs or private equity and private debt investors recently noting increased market activity, which we have also observed at the beginning of the funnel. Recently, we have experienced greater success in both our lower middle market and private loan strategies, with more opportunities progressing through the funnel and leading to actionable items for us. There’s nothing particularly significant to note, just an improved market and our effective execution in seizing these opportunities. Regarding your first question on the rise in potential realizations, this activity tends to fluctuate. It doesn't necessarily lead to an exit since several factors need to align for us and our portfolio companies to achieve a successful exit. However, we have seen increases, particularly from at least one company where our partners are more eager to pursue liquidity, and a few others responding to unsolicited interest from third parties. We will continue to work on achieving the best outcomes for us and our partners in the lower middle market portfolio companies and remain hopeful for positive results. If we don’t exit, the companies in reference are strong, high-performing entities, and we are happy to maintain our long-term investment in them.

Any observation about the kind of valuations? Are you seeing perhaps more attractive valuations that would prompt more realizations?

I wouldn't say there's a significant change. The market has become a bit more competitive. Overall, current valuations are likely slightly higher than they were 12 or 18 months ago. However, I wouldn't describe it as materially different. It's a healthy and productive market, but we don't perceive any significant increase. Dave, do you have anything to add?

Yes. Only thing I'd add is that if you look at the longer term for our size transactions, there has not been a material change in the recent past. We did see some reluctance for sellers to come to market when interest rates ticked up kind of more suddenly and there was concerns about the financing. So we saw some degradation in valuation multiples. Now that there's some normalcy in the new interest rate environment, it's stabilized, which puts us back to historical norms for our lower middle market investment portfolio.

Our next question comes from Erik Zwick with Hovde Group.

First, just wanted to start on the second private loan funds. If you could just provide maybe an update on activity there in the first quarter? And then also, I think you've previously indicated that you're targeting between $100 million and $300 million. I'm curious if you've kind of narrowed that range or set a more precise target? And then ultimately, what factors do you consider in determining when to do the final closing? Is it just timing or size or a change in market activity?

Sure, Erik. Thanks for the question. When you look at the current activity in the first quarter, I said we didn't have a huge increase in equity commitments from LPs. We had some slight kind of moderate increase there, but continue to have active dialogue with new investors about either joining the fund or existing investors about increasing their commitments. So we hope to continue to add onto that over the next year or so. Just to give you a number, we're probably at about $80 million or just over $80 million of LP commitments in that second fund. When you look at the range we provided, which was $100 million to $300 million as you indicated, today I would say we're probably expecting to be somewhere closer to the $150 million would be more realistic. Unless we have significant success with some institutional investors coming in, it's unlikely we get to $300 million, but we still think it will be larger than the first fund. And if we are successful in increasing it, when you put leverage on top of that, it is a nice increase to our asset management business long term. So we continue to be excited about the fund and continue to work on those fundraising activities. In terms of the timeline that you asked about, that's contractual. Like any other fund, when we go out and we start the fundraising period or process, you typically set a date for how long that fundraising period will last. So we're no different. And when we set it, we set it for 18 months. So the fundraising process will continue for that 18-month duration. We started, I believe, in September of last year, off the top of my head. So it will last through March of 2025, at least directionally. I think that's if that's not exactly right, that's pretty close to what time period is.

That's very helpful. I'd like to ask a second question. Considering the diversity in your current portfolios and pipelines, there seems to be some uncertainty regarding the economic trends and how different sectors or industries are performing. Can you provide any insights from your activities on sectors where the economy may be underperforming? Are there any specific industries or sectors that you believe have weakened and that you are avoiding at this time?

Sure, Erik. There's no change in what we've been saying over the past 12 to 24 months. Looking at the industries and the companies in our portfolio, we currently have more companies performing well than those that are underperforming. The overperformance is quite broad, spanning industrials, B2B, and even businesses targeting higher-end consumers. We have been cautious and are avoiding companies focused on the consumer, particularly those targeting the lower end. It's become apparent across the U.S. economy that lower-income consumers are being cost-conscious and are selecting cheaper products and purchasing less. We experienced strong performance across our portfolio this quarter, but a few companies with significant exposure to the lower-end consumer faced considerable underperformance, leading us to recognize substantial unrealized depreciation in those investments. This trend of risk has been a concern for a couple of years and has noticeably impacted our results over the past 3 to 6 months. Beyond that, there's not much more to highlight, but this has been a recent challenge.

Our next question is from Bryce Rowe with B. Riley Securities.

Told you I'd be back. Dwayne, maybe just a couple more for me. Can you talk about some of the yield dynamics within the three portfolios? You laid out in the press release, it looks like there was a bit of compression in the lower middle market in the private loan. Just assuming that is reflective of where spreads have gone over the last three months or so?

Sure, Bryce. Thank you for joining us again and for your follow-up question. I will provide some insight into the lower middle market segment, and then I have Nick Meserve here, who heads our private credit group, to share additional insights on the private loan aspect. Regarding the lower middle market, I would not say the interest rate environment or our capacity to secure good yields on new investments has changed. We remain very disciplined in this area and have not observed any significant impact. If there’s been a decrease in our lower middle market rates, it mainly stems from our existing portfolio companies, especially those performing exceptionally well. It is common for these companies to have an interest rate pricing grid, and as they succeed, grow, and reduce leverage, they benefit from moving down that grid. Therefore, any reduction in rates pertaining to our lower middle market portfolio should be viewed in that light. We are committed to maintaining a balanced approach, believing that we possess quality companies that we prefer to keep in our portfolio for the long term rather than rushing them to exit, so we don’t view that as a negative outcome. On the private loan and private credit front, I believe, as you may have heard from others, there is some pressure. This pressure seems to be more related to rates rather than structure and leverage, but I will let Nick elaborate further.

Yes, Bryce, I'd say we're probably back to '21, '22 spreads after kind of the spread widening of last year. And so we're probably in sort of between 50 and 75 basis points over the last 6 to 9 months as the market has gotten a little more competitive and people are out there trying to put more money to work. I'd say it's more really focused on spreads so far and less on incremental debt leverage or deal terms.

Okay. Yes, and I think that's pretty consistent with what we've heard throughout or from the other BDCs. Maybe another one for Jesse. You guys have clearly outearned the dividend even with the supplementals. Jesse, do you have a good, maybe an estimate of where spillover is sitting at this point?

Yes, Bryce. I think from memory, spillover was around $70 million to $80 million. I can pull that up for you and get back to you.

Okay. Okay. And then last one for me. It looked like non-accruals were down for the quarter on a cost basis. Any color there? Is it just normal ebbs and flows of non-accruals in and out of that bucket?

Yes. There's, Bryce, on the non-accruals, nothing significant. We had one company that we had a realized loss on. Obviously, that company, when it was on non-accrual, comes off non-accrual. And then we had one new addition, a small addition to the non-accrual, which is why you saw that stat go down when you look at it on a percentage basis. Going back to Jesse's, your question for Jesse, we're just under 80 million, I'm sorry, just under $80 million of spillover. So right at a buck a share from a spillover income standpoint at the end of the quarter.

This concludes our question-and-answer session. I'd like to turn the floor back over to management for closing comments.

We just want to say thank you again, everyone, for joining us this morning, and thank you for your continued long-term support of Main Street, and we look forward to talking to you again in early August after our second quarter results.

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