Msc Income Fund, Inc. Q4 FY2024 Earnings Call

Greetings, and welcome to MSC Income Fund Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan. Thank you. You may begin.

Thank you, operator. And good morning, everyone. Thank you for joining us for MSC Income Fund's fourth quarter earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer; Nick Meserve, Managing Director and Head of Private Credit Investment Group; and Cory Gilbert, Chief Financial Officer. MSC Income Fund issued a press release yesterday afternoon that details the Fund's fourth quarter and full year financial and operating results. This document is available on the Investor Relations section of the Fund's website at mscincomefund.com. A replay of today's call will be available beginning an hour after the completion of the call and will remain available until March 27th. Information on how to access the replay was included in yesterday's earnings release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the Fund's homepage. Please note that information reported on this call speaks only as of today, March 20, 2025, and therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening. Today's call may 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 Fund's filings with the Securities and Exchange Commission, which can be found on the Fund's website or at sec.gov. MSC Income Fund assumes no obligation to update any of these statements unless required by law. During today's call, management will discuss 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. MSC Income Fund defines ROE as the net increase in net assets resulting from operations divided by the average quarterly NAV. As previously announced, the Fund effectuated a two-for-one reverse stock split on December 16, 2024. All per share amounts, share data, and related information discussed on today's call reflect the effect of the reverse stock split. 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. Now, I'll turn the call over to MSC Income Fund's CEO, Dwayne Hyzak.

Thanks, Zach. Good morning, everyone. And thank you for taking the time to join us for the MSC Income Fund fourth quarter and full year 2024 conference call. We appreciate your participation on this morning's call and we hope that everyone is doing well. Before we provide our normal quarterly updates, we want to start by thanking the investors that participated in the Fund's recent equity offering in January. This equity offering and the listing of the Fund's shares on the New York Stock Exchange was a culmination of our multiyear efforts to provide both a path to liquidity for the Fund's existing shareholders who desire such an option and a positive outcome for the Fund and all of its shareholders in the future. We are very pleased with the outcome, which resulted in both an upsized and accelerated offering, and we appreciate the support of the Fund's shareholders who allowed for this positive outcome. Now turning to our normal updates. On today's call, I will provide a few highlights regarding the Fund's operating performance in the fourth quarter and for the full year, followed by updates on the Fund's investment activities and current investment pipeline, dividend plans, future outlook, and several other noteworthy items. Following my comments, Nick will provide comments on the Fund's private loan investment strategy, investment activity, and investment portfolio. David will provide comments on the Fund's lower middle market investment activity and investment portfolio, and the Fund's total investment portfolio. And Cory will cover the Fund's financial results, capital structure, and liquidity position. Now turning to our most recent operating results, we are pleased with the Fund's performance in the fourth quarter and the full year, which closed another good year for the Fund in its final full year as an unlisted BDC. We believe that the fourth quarter and full year performance provide visibility to significant opportunities in the future after the completion of the Fund's successful listing and equity offering in January, which provided the Fund increased liquidity and a clear path to additional debt capacity. These benefits, together with the change in the Fund's investment strategy to focus solely on its private loan strategy for investments in new portfolio companies, provide significant opportunities to achieve meaningful growth in 2025 and 2026 and strengthen the Fund's ability to deliver attractive, recurring, and growing total dividends and favorable total returns to the Fund's shareholders in the future. The Fund generated net investment income per share of $0.35 in the fourth quarter, which Cory will discuss in more detail. This performance provided us with the confidence to recommend that the Fund's Board of Directors declare a regular quarterly dividend of $0.35 per share and a supplemental quarterly dividend of $0.01 per share, both payable on May 1st, which I'll discuss in more detail later. The Fund finished the year with an NAV per share of $15.53, an increase of $0.15 from the prior quarter, which Cory will also discuss in more detail. The Fund's financial results represent an annualized return on equity or ROE of 13.2% for the fourth quarter and an ROE of 9.1% for the full year. While we are pleased with the Fund's recent results, we believe that the Fund has the opportunity to increase its ROE in the future through several post-listing changes and activities, including the favorable changes to the Fund's fee structure, which among other changes, provided for an immediate reduction in the Fund's annual base management fee percentage upon the listing and additional future contractual reductions in the fee percentage as the Fund's lower middle market investments decrease as a percentage of the Fund's total investment portfolio in the future. The listing also provides the Fund the opportunity to expand its utilization of debt capital, and we believe gives the Fund the opportunity to achieve a lower cost of debt capital in the future. During the fourth quarter, we maintained our focus on executing new investments in the Fund's private loan strategy and legacy lower middle market strategy, keeping the Fund fully invested and working to maximize the returns from the Fund's existing investment portfolio. Based upon the Fund's net investment activities in the quarter, the Fund's private loan investment portfolio decreased by $6 million on a cost basis while the lower middle market portfolio increased by $16 million on a cost basis, which Nick and David will cover in more detail. Looking forward to 2025, the Fund is highly focused on deploying the liquidity achieved in the recent equity offering, including both the equity proceeds raised and the corresponding increase in available debt capacity into new private loan investments and recycling existing capital into private loan investments as investments in the other investment portfolios are exited or repaid. The Fund will maintain its focus on deploying its available liquidity and will then focus on maintaining its investment portfolio in a fully invested position through the end of January 2026. At which point, the Fund will achieve expanded regulatory leverage capacity, effectively doubling the Fund's regulatory leverage limit and providing the Fund the opportunity to deploy additional liquidity into new private loan investments and further grow its investment portfolio. Based upon the Fund's results for the fourth quarter, we are pleased that we are in a position to recommend that the Fund's Board of Directors declare a regular quarterly dividend of $0.35 per share and a supplemental quarterly dividend of $0.01 per share, both of which are payable on May 1st. Going forward, the Fund expects to maintain a dividend policy that provides for its total quarterly dividends, which are expected to include a regular quarterly dividend and a supplemental quarterly dividend to be set at an amount equal to or at a slight discount to the Fund's net investment income. As such, we expect to recommend that our Board continue to declare future supplemental quarterly dividends to the extent the Fund's NII exceed its regular quarterly dividends paid in future quarters. Based upon the most recently declared regular and supplemental quarterly dividends, the Fund is currently providing its shareholders a dividend yield of approximately 8.5%. As the Fund executes its transition to a private loan-only investment strategy and investment portfolio and optimizes its use of leverage, our goal and current expectation is for the Fund to be able to increase the total dividends paid to its shareholders in the future. As we look forward to the Fund's near-term investment activities, we are pleased with the size and quality of our investment pipeline. The Fund has continued to be very active in its private loan investment strategy since quarter-end, and as of today, I would characterize the private loan investment pipeline as above average. We remain highly confident in our ability to continue to generate attractive new investment opportunities over the next few quarters. And through these investment activities, we remain confident in our ability to grow the Fund's net investment income in future periods and provide its shareholders with an attractive recurring and growing quarterly total dividend. The last update I wanted to provide was regarding the continued support the Fund has received from Main Street Capital Corporation. Since Main Street's wholly owned subsidiary was appointed the sole advisor to the Fund in October 2020, Main Street has purchased over $21 million of equity in the Fund, over $4 million of which was purchased as part of the Fund's public equity offering in January. In conjunction with the offering, Main Street also entered into an open market share purchase plan to purchase up to $20 million of the Fund's shares for a 12 month period following the offering at times when the Fund's shares are trading at predetermined levels below the Fund's NAV per share, with the terms of such plan being identical to the Fund's open market share repurchase plan to purchase up to $65 million of the Fund shares, with any open market share purchases being split by the Fund and Main Street on a pro-rata basis. We believe Main Street's significant ownership position in the Fund and its participation in the post-listing share purchase plan demonstrates Main Street's commitment to the future success of the Fund and reinforces Main Street's positive views regarding the strength and quality of the Fund's investment portfolio and investment strategy. With that, I will turn the call over to Nick.

Thanks, Dwayne. And good morning, everyone. As Dwayne highlighted in his remarks, we are pleased with the overall performance of the Fund's private loan investment portfolio in the fourth quarter. The overall operating performance for most of the Fund's private loan portfolio companies continued to be positive, which contributed to the Fund's favorable fourth quarter financial results. The Fund did, however, experience continued softness in certain private loan portfolio companies with consumer discretionary focused products or services, which we've been monitoring for several quarters, and we are actively working to maximize recoveries on those specific investments. As a result, we experienced some depreciation on these investments that resulted in net fair value depreciation for the quarter in the private loan portfolio. The largest portion of the Fund's investments continues to be in its private loan strategy, which is now the Fund's sole focus with respect to new portfolio company investments. The Fund's private loans are typically made to private equity owned businesses whereby the private equity firms have substantial cash equity investments in those businesses. These equity investments are by definition junior to the first lien senior secured debt investments made by the Fund. Due to specific private loan portfolio company underperformance, the general practice and expectation is that the private equity owner of the company will support the business with new equity to protect its existing investment. As a result, a key factor in underwriting is the historical track record and quality of the private equity sponsor, as well as the reputation for supporting their portfolio companies with both managerial assistance and additional equity capital in the event of underperformance. At year-end, 94% of the private loan portfolio was comprised of secured debt rate investment, over 99% of which were first lien and 98% of which were floating loans. The portfolio had an attractive weighted average yield of 12%, which was down 110 basis points from the end of 2023, primarily as a result of decreases in the SOFR rates for these floating rate debt investments. During the fourth quarter, the Fund invested around $30 million in the private loan portfolio, which after aggregate principal repayments and a decrease in cost basis due to a realized loss resulted in a net decrease from investment activity of $6 million. The Fund ended the fourth quarter with investments in 84 private loan portfolio companies totaling $678 million of fair value, representing 58% of the Fund's total investment portfolio at fair value. With that, I'll turn the call over to David.

Thanks, Nick. And good morning, everyone. In addition to the private loan portfolio that Nick just covered, the Fund also maintains a portfolio of legacy lower middle market investments. These investments are combined debt and equity investments in smaller privately held companies whereby the Fund partnered directly with the company's existing business owners and management team through co-investments with Main Street Capital Corporation, utilizing the customized one-stop debt and equity financing solutions provided in Main Street's lower middle market investment strategy. As a reminder, after the listing of the Fund shares on the New York Stock Exchange in January, the Fund will not make any investments in new lower middle market portfolio companies but will continue to participate in follow-on investments in its existing lower middle market portfolio companies. During the fourth quarter, the Fund made total lower middle market investments of $30 million, including investments in two new portfolio companies, which after aggregate debt repayments and a decrease in cost basis due to a realized loss resulted in a net increase in the lower middle market portfolio of $16 million. At year-end, the lower middle market portfolio had investments in 57 portfolio companies totaling $436 million of fair value and representing 37% of the Fund's total investment portfolio. The lower middle market portfolio at fair value was comprised of 53% debt investments and 47% equity investments. These debt investments had an attractive weighted average yield of 13%, consistent with the prior year, and over 99% were first lien loans. The Fund had equity ownership positions in all of its lower middle market portfolio companies, representing a 9% average ownership position. We continue to be pleased with the performance of the majority of the Fund's lower middle market portfolio companies and expect these investments to continue to provide benefits in the future, including the opportunity for continued dividend income, fair value appreciation, and eventually meaningful realized gains upon the future exit of these lower middle market portfolio company investments. Turning to the Fund's total investment portfolio. As of December 31st, the Fund continued to maintain a highly diversified portfolio with investments in 151 portfolio companies spanning across numerous industries and end markets. The Fund's largest portfolio companies represented less than 4% of the total investment portfolio fair value at quarter-end and less than 3% of the total investment income for 2024, with most portfolio investments representing less than 1% of the Fund's income and assets. With that, I'll turn the call over to Cory.

Thank you, David. And thank you to everyone that has joined us today. The Fund's total investment income for the fourth quarter was $33.5 million, a decrease of $1.3 million or 3.8% from the fourth quarter of 2023 and relatively consistent with the third quarter of 2024. The fourth quarter included income considered less consistent or non-recurring in nature of $0.9 million. As we previously discussed, these non-recurring items vary quarter to quarter and can include dividend income from equity investments, interest and fee income from accelerated prepayment, repricing, and other activities related to debt investments. For the fourth quarter, these items were $0.5 million lower than both the average of the prior four quarters and the fourth quarter of 2023, and $0.4 million higher than the third quarter of 2024. Interest income decreased by $0.5 million from a year ago and by $0.6 million from the third quarter. The decrease from the third quarter was primarily driven by lower interest rates on floating rate debt investments, primarily due to lower market index rates, partially offset by the impact of increased net investment activity. Dividend income for the fourth quarter decreased by $0.7 million from a year ago and increased by $0.2 million from the third quarter. As we previously discussed, dividend income will fluctuate quarter-to-quarter based on the underlying performance, cash flows, and capital allocation activities of the Fund's portfolio companies. Fee income for the fourth quarter decreased by $0.1 million from a year ago and increased by $0.3 million from the third quarter. The Fund's expenses for the fourth quarter net of waivers decreased by $0.5 million over the prior year and decreased by $0.1 million from the third quarter. The $0.1 million decrease from the third quarter was primarily driven by a $0.8 million decrease in interest expense and a $0.3 million decrease in general and administrative expenses, partially offset by a $1 increase in incentive fees. The $0.5 million decrease from the prior year was primarily driven by a $0.5 million decrease in incentive fees and a $0.3 million decrease in interest expense, partially offset by a $0.3 million increase in base management fees. The Fund's expense ratio excluding incentive fees was 2.1% on an annualized basis for the fourth quarter, a decrease from 2.2% in both the prior year and the third quarter. Post-listing, the Fund amended its advisory agreement to, among other things, reduce its annual base management fee from 1.75% to 1.5% with additional future contractual reductions based upon changes to the Fund's investment portfolio composition and reduced the NII incentive fee from 20% to 17.5%, subject to a unique 50-50 catch-up feature. The Fund's NII in the fourth quarter was $14.2 million or $0.35 per share, decreasing from $15 million or $0.37 per share from the prior year. During the quarter, the Fund recorded a net change in fair value resulting from net unrealized depreciation and net realized losses on the investment portfolio of $1.2 million, driven by net fair value increases of $5 million in the lower middle market portfolio and $0.6 million in the middle market portfolio, partially offset by net fair value decreases of $4.1 million in the private loan portfolio and $0.4 million in the other portfolio. The Fund's operating results for the fourth quarter resulted in a net increase in net assets of $20.5 million and an NAV per share of $15.53, a $0.15 increase from the third quarter and a $0.01 decrease from a year ago. As of year-end, the Fund had non-accrual investments comprising 1.5% of the total investment portfolio at fair value and 5.6% at cost. As of year-end, the Fund's regulatory asset coverage ratio was 2.1 and its net debt to NAV ratio was 0.86. As Dwayne mentioned, the Fund's focus in 2025 is on achieving and maintaining its investment portfolio in a fully invested position based upon its current debt to equity leverage limit through January 2026 when the Fund will achieve expanded regulatory leverage capacity based upon the previously announced approval of the modified regulatory asset coverage requirements by the Fund's Board of Directors. As a result of the increased regulatory leverage capacity that the Fund achieved from its equity offering, the Fund amended its corporate facility earlier this month to increase its total commitments by $80 million to allow the Fund to achieve and maintain a fully invested position based upon its current leverage limit. Consistent with our goal to improve the Fund's ROE, partially by achieving a lower cost of debt capital, the Fund amended its corporate facility in November to reduce its interest rate by 45 basis points to SOFR plus 2.05% and also extend the maturity date. We continue to work on other opportunities to lower the Fund's cost of debt capital and look forward to providing additional announcements in the future. With that, I will now turn the call back to the operator so we can take questions.

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Kenneth Lee with RBC Capital.

Just one on the originations pipeline. You mentioned characterization of an above-average private loan pipeline there. Just wondering if you could just provide a little bit more color, especially given the macro environment there, what are you seeing in terms of the pipeline?

I'll give a couple of comments. I'll let Nick, who leads our private credit group, add on to it. But I'd say here in the last couple of weeks, we've seen significant positive progress with our pipeline. So I'd say the pipeline is always full of a number of different opportunities. But just over the last couple of weeks, I'd say we've seen a number of those opportunities move more in Main Street's direction in terms of being an executable transaction and also more in the direction of the private equity group that we're looking to support in terms of them being the potential winning party. So we just had some good movement here in the last couple of weeks that drove that characterization to be above average, but I'll let Nick add on anything else he wants to add.

The only thing I'll add is it's still probably too early to see if this is actually increased activity or just more of the transactions we're seeing and the sponsors we're dealing with winning those transactions versus losing those transactions. But it feels like it's picked up a little bit from where we were 30 to 45 days ago.

And just one related question around the private loan investment side. Wondering if you could just provide a little bit more color around what you're seeing in terms of spreads on some recent investments and wonder if you could just talk a little bit more about expectations for how spreads could potentially trend over the near term?

On the spread side, we previously mentioned that spreads have tightened over the last year by approximately 75 to 150 basis points in transactions. Since the end of the year, we may have tightened another 25 basis points. However, we’ve also observed some fluctuations in the syndicated markets due to recent tariff news. Overall, the direct side, particularly in the lower end, has remained quite stable year to date, and I anticipate that this trend will continue for the remainder of the year.

Our next question comes from Robert Dodd with Raymond James.

I have a couple of questions, one follow-up regarding the pipeline for Main Street. Three weeks ago, it was described as average. Has the likelihood of winning those deals changed significantly over the past few weeks as the processes have progressed? Is that why there has been a change in terminology? Are those deals potentially closing in Q1, or are we still looking at closer to Q2 for that activity? Can you provide any additional details?

I would say that you're right in the view or the characterization of the change from a couple of weeks ago with Main Street. So we've had the pipeline. I'd say it's built. Obviously, as I said earlier, a number of transactions have moved, both in our direction and in the direction of the private equity sponsors. I'd also say I think the front end of the funnel has also improved. It's hard to tell how many of these transactions will close between now and the end of the quarter. But we think there's a number that could and we think there's also some that will fall into April or even later in the month of April, that's out of our control, to a large extent. Obviously, we're going to be as responsive as we can to the opportunity and to the private equity firm that we're supporting. But they and the company they're investing in will ultimately decide the timing of that transaction. But we feel good about where we are from a pipeline standpoint and neither you nor Ken asked about it. But I'd say even with the stuff that we still have in the pipeline, we've also had what we think is a very productive quarter in terms of gross originations, closed to date about $100 million of new originations. We've had some repayments so that's not a 100% change from an investment standpoint on a net basis, but we feel good about what we've executed so far to date in the quarter. And as we noted in our above-average comment, we feel good about the pipeline.

And one more if I can. On the question of like full leverage, obviously, your leverage limit kicks up in January next year. I think I've been expecting it to get quite close to the current limit as we went through the course of this year. But as Nick mentioned, I mean, the market is more volatile and there's been some more noise going on. Has that affected how you would characterize full leverage through the course of this year while it's still a one to one until the two to one comes into play?

I would say it hasn't changed our view that much. Obviously, you're always trying to manage new investment activity and repayments. So you're trying to balance that change in investment activity with the change in liquidity that we have today from the proceeds of the equity offering plus the incremental debt capacity. So you're always trying to balance each of those components. But as we look at the balance of 2025 and then heading into January of 2026 when we get the benefit of the expanded leverage that the Board has already approved. So it's just a matter of time for us to get that expanded leverage then obviously we have to go and execute to finding lenders that will provide us the capital, but we feel confident about our ability to do that. So as we go through the balance of 2025, as we sit here today, we would expect the leverage to tick up closer to full capacity knowing that in early 2026 we're effectively going to double our regulatory leverage capacity. So I think that's the way we're looking at it. Obviously, if there was a significant change in the economy or significant change in our portfolio specifically, we'd have to revisit that and become a little more conservative. But as we sit here today, that would be our plan for the balance of 2025 and into 2026.

Our next question comes from Mark Hughes with Truist Securities.

Dividend income down a little bit in the quarter year-over-year. Any change in expectations on how that will trend in coming quarters?

Not anything significant. Mark as you probably heard us say before, both on the MSC Income Fund side and on the Main Street side, there's always going to be a fair amount of volatility quarter-to-quarter in dividend income just because it moves around quite a bit just based upon what the actual portfolio companies are executing to both in terms of their performance and their capital allocations and capital management. But I think we feel really good about how the lower middle market portfolio companies have been performing and what their current outlook is. So all things being equal, I think we would expect at least the next one to two quarters we should continue to see positive favorable contributions from the dividend income component of our overall investment income. Obviously, that can change based upon the overall economy. But right now, we feel pretty good about the actual performance we're seeing and the near-term visibility to future performance that we're hearing from the portfolio companies.

And then the consumer discretionary, I think you described a little bit of pressure there and you're looking to maximize recoveries. Can you do that internally or do you need the economy to give you more of a tailwind to really maximize that and so maybe a longer-term initiative?

I would say it's a longer-term initiative. A strong economy, particularly one that benefits consumers, will be crucial for the results of our investments in the consumer sector, especially those that have not performed well. Each investment will have its unique circumstances, and it will ultimately depend on the decisions we and other lenders make, as well as how the market perceives the value of these opportunities. There will be some adjustments in how each of these investments progresses. However, at this moment, we are optimistic about the fair value assessments in most situations and confident about our future recovery expectations. Nick, if you have anything else to add, feel free to share.

The only thing I'd add there is, I think, our role now when the consumer is weaker is to really position that company to when it does bounce back it benefits from that. So make sure the company is structured well, operating very efficiently. And that way when the consumer does bounce back they can pick up the full pick up in that upside.

And then you've already discussed the private loan pipeline shifting to above average. Anything from the lower middle market equity portfolio, I think you've talked about some opportunities to do some monetization there. Is that still consistent with your earlier comments or is that pace picked up or decelerated perhaps?

I would like to make a few comments regarding that topic. Firstly, we did not address the MSC Income Fund specifically. The lower middle market portfolio for MSC Income Fund tends to be smaller than that of Main Street, and there isn't always a consistent allocation between the two. This inconsistency can be attributed to the historical liquidity of MSC Income Fund at various times when we were making new investments or follow-on investments in the lower middle market. Thus, the two portfolios do not completely overlap. Therefore, the near-term M&A activity we discussed concerning Main Street is less significant for MSC Income Fund, which is why we did not highlight it specifically.

Our next question comes from Brian McKenna with Citizens JMP.

So it's great to see that the IPO was upsized and the 15% green shoot was also exercised, that resulted in MSIF raising an incremental $20 million of equity capital with leverage. You'll have an incremental $40 million plus of capital to invest relative to your expectations ahead of the IPO. So how are you thinking about this incremental capacity to invest? I'm assuming there's no real change to the strategy for this incremental capital, but any thoughts here would be helpful.

I would say that there's no real change. It provides us with a bit more liquidity in the short term, both through the equity and the debt capacity mentioned. After the offering, we quickly extended our credit facility to ensure we have the necessary debt capacity. We are confident about our position regarding the available leverage or debt capacity. However, I wouldn't say that the additional funds from the equity offering, along with the increased debt, alter our expectations regarding the pace or activities we'll undertake or the allocations to MSC Income Fund. We clearly want to deploy those proceeds as soon as possible. Having additional equity can be a downside because it may lead to dilution if we cannot deploy it in the near term. Nonetheless, we are optimistic about our pipeline and the activities we've seen in Q1, so we have no concerns there. Overall, I wouldn't say that we have made any significant changes because of the incremental equity raise.

And then with respect to the NII ROE, it's been tracking just north of 9% the last several quarters. I know this is set to move notably higher into 2025 and beyond. But can you just remind us about the trajectory of the ROE throughout 2025 and into 2026 and then ultimately where you think this can settle in at longer term on a normalized basis?

I think our objective is clearly to enhance the NII ROE percentage. Our initial approach will involve adjusting the base management fee downwards. In a positive scenario with the incentive fee, this will lead to higher incremental returns benefiting shareholders rather than advisors. Both of these strategies will yield favorable outcomes. Additionally, if we can boost leverage, which is expected to happen more significantly in 2026 rather than 2025, this will serve as another major catalyst for improving return on equity. However, we should anticipate seeing these benefits approximately 12 to 18 months from now. We are also committed to actively managing our debt costs to ensure they remain as favorable as possible. We have already made progress in reducing our cost of capital and anticipate further success ahead. These efforts will positively impact our ROE as well. Looking ahead, our aim is to elevate the ROE from below 9% to the 10% range over the next six to eight quarters. Of course, the overall economic environment and portfolio performance need to remain strong, as any significant downturn could hinder our progress. Nevertheless, we feel optimistic about the aspects we can control, which should contribute positively to our ROE.

And then one more on the portfolio and some of your sector exposures. How much of the book today has exposure to tariffs? And then do you have any portfolio companies that might be impacted by a reduction in government spending?

So I'll take the second question first. When you look at specific companies that would be impacted by the federal activity, I'd say we don't have anything that we think is significant in the MSC Income Fund portfolio. We have one company that we look at on the lower middle market side that has very specific, very direct exposure from that standpoint. But they're actually doing really well, and we don't see any negative impacts or headwinds at least as of today. So we don't have anything there on the tariff side. This is a more generic response. But I think we've always viewed one of the biggest benefits that the Fund has is a very diverse portfolio. So that diverse portfolio has some companies that will be impacted more than others. Some companies could actually benefit from the activity. So we like the fact that you've got that diversity that gives us some protection for broad impacts like you could see from the tariffs. But I think we would characterize the impact of tariffs as obviously broadly would not be a good thing for our portfolio. We think that'd be the case for anybody that has an investment portfolio whether it's private companies or public companies. So we don't think we're any different in that respect. We do think, from a positive standpoint, if you look specifically at the lower middle market portfolio and then maybe to a lesser extent the private loan portfolio, we think our portfolio relative to the overall US economy is more weighted towards US domestic businesses doing business with US domestic companies and US domestic vendors. So net-net, that should make us a little bit less impacted than the overall broader economy. But that being said, just like anybody else, we would expect to have some negative impacts if the tariffs are implemented the way that they're being discussed and if those tariffs are in place for a long period of time.

Our next question comes from Paul Johnson with KBW.

In terms of the realized losses this quarter. How much of that, I guess, was associated with the reduction in non-accruals and how much of that was already basically reflected in that? Was there any additional depreciation on the realized losses this quarter?

Yes, I would say that the realized losses did not have a significant impact if any impact on the non-accruals. So there's not a big impact there. And the second part of your question, Paul, just to make sure I got it right. So I think you were asking about the impact on non-accruals. What was the second piece, you were saying did those non-accruals have incremental depreciation in the quarter?

Yes. More from just the realized losses this quarter. I mean, was that primarily driven from a reduction in the non-accruals, any realizations there? And then was that already previously reflected in NAV?

I would say the vast majority of it was two investments primarily, and most of that realized loss had already been reflected in the previous unrealized depreciation.

And then just on the tax expenses, were slightly larger this quarter. Just wondering if you can give any color there in terms of was that all primarily excise tax, was there any additional, different tax expenses in there this quarter? And what should we kind of expect going forward? Was that more of kind of a seasonal sort of true-up in the tax expense or should we expect taxes to be kind of running in this range going forward?

I would say the answer on the taxes, Paul, is I think that fourth quarter was higher than what we would expect to have on an ongoing basis going forward. There's a lot of moving parts and pieces that go into that calculation largely driven by the impact of the tax blockers we have and how those tax blockers get impacted from a fair value change standpoint, realized gains, losses, etc. So there's a lot of moving parts there that resulted in the number for Q4. But I would say that when we look at the expectations going forward, we would expect that number to be less significant from a dollar standpoint. On the other piece you asked about was excise tax, it does include the excise tax in that current expense. And Cory, I don't know if you know what that excise tax amount was for Q4. I'm trying to find it here but I'm not having luck on my side.

We'll get back to you on that.

We'll come back to you, Paul. There is an excise tax in the numbers, and I found it. It was about $850,000 for the year, with a couple of hundred thousand dollars in Q4 related to the excise tax.

Our next question is from Cory Johnson with UBS.

Having reported a little later in Q1 than some other BDCs, can you provide guidance on how prepayments are progressing for the quarter? Additionally, coming into this year, there was an expectation that capital markets activity might increase. Can you share any updates on what you are observing in the capital markets as we approach Q2 and Q3? Do you have any visibility into that?

Cory, I'd say that we don't have a lot of visibility as we look out to Q2 and Q3 outside of the guidance we gave on the more near term or current pipeline. I think we and others, and you've heard this from everybody including if you listen to the Main Street conference call a couple of weeks ago, you heard a pretty consistent theme that I think people post the election expected 2025 to be a very, very robust M&A and capital markets activity period. Clearly, that has changed significantly over the last month or two. I'd say that continues to probably be the case where people's overall expectations for '25 are probably still a little more modest or cautious compared to what it would have been three or four months ago. So I don't think we've seen a big change there. We have, as I said earlier, just had more success on the specific items we've been working on and that our partners on the private equity side have been working on, which has led to the improvement in the pipeline. But I wouldn't say that we've seen a significant change to the positive in the overall expectations. And if anything, maybe it got a little more cautious because it's really hard for anyone, specifically investors making a large investment as a new investment in a company they're buying, to have a lot of comfort about where things might be next month or next quarter. So I think you continue to have that uncertainty weigh negatively on overall activity. So that'd be my broader view. When you look specifically at prepayment activity, I would say that we have seen some increased activity on that side as well. It hasn't really come through our actual results to date. We've got about $20 million of repayments on the private loan side to date in the quarter. But I do think we're seeing more repayment activity, which is something we'll have to balance as we look at the new investment activity and try to target what we want the net number to be long-term.

My last question is about the credit quality of your current portfolio and the new deals you are evaluating. How do you feel about the quality of those deals?

I think on the new stuff, I think we feel really good about it. I mean, I think it goes without saying we wouldn't be executing if we didn't feel really good about it. But I'd say that the quality of the stuff is good. Obviously, you're having to look at things maybe a little differently than you may have in the past from a due diligence standpoint but we feel good about the quality. And I would say that's the case not just for the stuff that we expect to execute here in the next couple of weeks or next month or so, I think the front end of the pipeline also looks good from a quality standpoint. I think both Nick and David covered it outside of the consumer side, both the private loan and lower middle market existing portfolios, I think we feel good about both of those portfolios when you look at the overall performance. And for the most part each of the companies, again, you've always got some underperformance with a large diversified portfolio like we have. But outside of the consumer space, you're not seeing anything that's more broad-based or systemic.

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

We just want to say thank you again, everyone, for joining us here for the first conference call we've had as a public company. And we'll look forward to having another call with you in early to mid-May after the release of our results for the first quarter.

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