Greetings and welcome to the MSC Income Fund's Second Quarter Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan. Thank you. Mr. Vaughan, you may begin.

Thank you, operator, and good morning, everyone. Thank you for joining us for MSC Income Fund's second 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 the Private Credit Investment Group; Cory Gilbert, Chief Financial Officer. MSC Income Fund issued a press release yesterday afternoon that details the Fund's second quarter 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 August 21. 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, August 14, 2025, and therefore, you are advised that any 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 2-for-1 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. And now I'll turn the call over to MSC Income Fund's CEO, Dwayne Hyzak.

Thanks, Zach. Good morning, everyone, and thank you for joining us for the MSC Income Fund second quarter conference call. We appreciate your participation on this morning's call and we hope that everyone is doing well. On today's call, Nick, David, Cory and I will provide you with the Fund's key quarterly updates, after which we'll be happy to take your questions. We are pleased with the Fund's performance in the second quarter, which resulted in a return on equity of 9% and favorable net investment income per share. We believe that the second quarter results provide visibility to the opportunity for continued favorable performance in the future, with the potential for increased net investment income and shareholder dividends as we work to expand the Fund's investment portfolio over the next several quarters. We remain confident that the Fund's increased current liquidity and path to additional debt capacity obtained through the Fund's successful listing and related equity offering earlier this year, together with the change in the Fund's investment strategy to be solely focused on its private loan strategy for investments in new portfolio companies, will strengthen the Fund's ability to deliver attractive recurring total dividends and favorable total returns to the Fund's shareholders in the future. The Fund generated NII per share of $0.35 in the quarter after excise tax and NII related income taxes of $0.02 per share, or $0.37 on a pretax NII basis, which Cory will discuss in more detail. This favorable performance gave us the confidence to recommend that our 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, which I'll discuss in more detail later. The Fund finished the quarter with an NAV per share of $15.33, which Cory will also discuss in more detail. While we are pleased with the Fund's recent results, we continue to 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 provides for additional future contractual reductions in the Fund's annual base management fee percentage as the Fund's lower middle market investments decrease as a percentage of the Fund's total investment portfolio. The listing also provided 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 capital in the future. Although we continue to be encouraged by the favorable overall performance of most of the Fund's portfolio companies, as noted on our call last quarter and as Nick will discuss in more detail, we have experienced underperformance in certain of our private loan portfolio companies, and this is having a negative impact on the contributions from the Fund's private loan portfolio. We continue to actively monitor these investments and are working with the portfolio companies to achieve the best possible outcome for each investment. Now turning to investment activity. The Fund's private loan investment activity in the quarter was slower than the expected normal quarterly activity, primarily due to lower overall levels of private equity industry investment activity, resulting in a net decrease in private loan investments of $30 million, which Nick will cover in more detail. Despite the slower-than-expected private loan activity in the quarter, we remain confident in our ability to grow this portfolio in the future with the Fund's additional liquidity and capital availability. The Fund increased its lower middle market investment portfolio in the quarter by $16 million as a result of several investments in existing portfolio companies. The Fund remains highly focused on deploying the liquidity achieved through the recent equity offering and the corresponding increase in available debt capacity into new private loan investments, maximizing the benefits from the Fund's legacy lower middle market investment portfolio and recycling existing capital into private loan investments as investments are exited or repaid. In addition to the Fund's focus on deploying its current liquidity, at the end of January 2026, the Fund will achieve expanded regulatory leverage capacity, effectively doubling the Fund's current regulatory leverage limit and providing the Fund the opportunity to deploy additional capital into new private loan investments, further grow its investment portfolio and achieve the benefits of a reduced base management fee percentage. Based upon the Fund's results for the 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 October 31 to shareholders of record as of September 30. Going forward, the Fund expects to continue 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 in line with the Fund's pretax NII. As such, we expect to recommend that our Board continue to declare future supplemental quarterly dividends to the extent the Fund's pretax NII exceeds its regular quarterly dividends paid in future quarters. Based upon the most recently declared regular and supplemental quarterly dividends and the current stock price, the Fund is currently providing its shareholders a dividend yield of approximately 10%. As the Fund executes its transition to a private loan-only investment strategy and investment portfolio and optimizes its use of leverage, our goal is for the Fund to increase the total dividends paid to shareholders in the future. As we look forward to the Fund's near-term investment activities, given the continued slower overall private equity industry investment activities, I would characterize the private loan investment pipeline at slightly below average. Despite this lower market environment, we continue to have a positive view of the current investment opportunities and we remain confident in our ability to generate attractive new private loan investment opportunities in the future and grow the Fund's investment portfolio over the next several quarters. My last comment is a reminder on the continued support the Fund has received from Main Street Capital Corporation. Since Main Street's wholly-owned subsidiary was appointed the sole adviser 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 beginning in March 2025 at times if and 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, and 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 equity ownership 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 confidence in 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. As Dwayne highlighted in his remarks, we are pleased with the performance of the Fund's private loan investment portfolio in the second quarter. The overall operating performance for most of the Fund's private loan portfolio companies continue to be positive, which contributed to the Fund's favorable second quarter financial results. The Fund has continued to see softness in certain private loan portfolio companies, particularly those with consumer exposure, and we are working on maximizing recoveries on those specific investments over the next few years. We have been and continue to work with the private equity owners and management teams of the Fund's private loan portfolio companies to understand their current tariff exposures and mitigation plans. Based upon those discussions and activities to date and the overall diversity of the private loan portfolio, we are comfortable with the Fund's estimated tariff exposure. The largest portion of the Fund's investments continues to be in its private loan strategy, which, as a reminder, is now the Fund's sole focus with respect to new portfolio company investments. At quarter-end, 93% of private loan portfolio was comprised of secured debt investments, over 99% of which were first lien and 97% of which were floating rate loans. The portfolio had an attractive weighted average yield of 11.5%, which was down 50 basis points from the end of 2024, primarily as a result of decreases in the SOFR rates for these floating-rate debt investments. During the second quarter, the Fund invested $44 million in the private loan portfolio, which after aggregate investment activity resulted in a net decrease of $30 million. The Fund ended the second quarter with investments in 82 private loan portfolio companies, totaling $742 million at fair value and representing 60% of the Fund's total investment portfolio at fair value. As Dwayne mentioned, our private loan pipeline is below average at the moment. As we all know, M&A activity overall, and especially within the private equity industry, has been lower than historical averages and the market's general expectations. While we expect activity to pick up in the second half of the year, we have also expected this activity to have been busier in the first half of the year. Another reason for the Fund's lower investment activity has been market pricing on new deals. A portion of the market we focus on, the lower end of the middle market, has come in some over the last 2 quarters of 2025, and as a result, we missed out on a few opportunities. The good news is we are not seeing other terms become more aggressive on transactions, and we are encouraged that we have closed a few deals since quarter-end and are starting to see the pipeline build. 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. As a reminder, these 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 shop debt and equity financing solutions provided by Main Street's lower middle market investment strategy. After the listing of the Fund's shares on the New York Stock Exchange at the end of 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 existing lower middle market portfolio companies. We are pleased to report that the overall operating performance for most of the Fund's lower middle market portfolio companies continues to be positive, which contributed to the attractive second quarter financial results. These contributions included both strong dividend income and continued fair value appreciation. Despite the continued heightened level of concern and uncertainty in the overall economy, we remain confident in the ability of the Fund's lower middle market portfolio companies to continue to navigate the current climate. During the second quarter, the Fund had follow-on investment activity related to its existing lower middle market investments, which resulted in a net increase in the lower middle market portfolio of $15.9 million. At quarter-end, the lower middle market portfolio had investments in 57 portfolio companies totaling $458 million at fair value and representing 37% of the Fund's total investment portfolio. The lower middle market portfolio at fair value was comprised of 54% debt investments and 46% 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 expect these investments will continue to provide significant 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 companies. Turning to the Fund's total investment portfolio as of June 30. The Fund continued to maintain a highly diversified portfolio with investments in 147 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 3.5% of total investment income for the trailing 12 months ended June 30, with most portfolio investments representing less than 1% of the Fund's income and assets. With that, I will turn the call over to Cory.

Thank you, David, and thank you to everyone who has joined us today. The Fund's total investment income for the second quarter was $35.6 million, an increase of $1.7 million or 5% from the second quarter of 2024, and 7.3% higher compared to the first quarter. The second quarter included income considered less consistent or non-reoccurring in nature of $0.9 million. As we previously discussed, these non-reoccurring items vary quarter-to-quarter and can include dividend income from equity investments and interest and fee income from accelerated prepayment, repricing, and other activity related to debt investments. For the second quarter, these items were $0.1 million lower than the average of the prior 4 quarters, $0.7 million lower than the second quarter of 2024, and consistent with the first quarter. Dividend income for the second quarter increased by $0.9 million from a year ago and decreased by $0.2 million from the first quarter. The increase in dividend income from the prior year was primarily due to an increase in dividends from lower middle market and private loan equity investments. The decrease in dividend income from the first quarter was due to a decrease in dividends from lower middle market equity investments. As we've 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. Interest income increased by $0.5 million from the second quarter of 2024 and by $1.9 million from the first quarter. The increase from prior year was primarily due to higher average levels of income-producing investment portfolio debt investments, partially offset by an increase in investments on non-accrual status and a decrease in the interest rates on floating-rate debt investments primarily resulting from decreases in benchmark index rates. The increase in interest income from the first quarter was primarily due to higher average levels of income-producing investment portfolio debt investments, primarily driven by investments made late in the first quarter. Fee income for the second quarter increased by $0.3 million from a year ago and increased by $0.7 million from the first quarter. The increase in fee income from both the prior year and the first quarter was primarily due to changes in investment activities. The Fund's expenses for the second quarter decreased by $1.2 million from the prior year and increased by $1.9 million from the first quarter of 2025. The decrease from the prior year was primarily driven by a $0.9 million decrease in interest expense and a $0.3 million decrease in base management fees. The decrease in interest expense from a year ago was largely driven by decreases in weighted average interest rates on the Fund's credit facilities due to decreases in benchmark index rates and reductions to contractual spreads, partially offset by an increase in weighted average outstanding borrowings used to fund a portion of the growth of the investment portfolio. The $1.9 million increase in expenses from the first quarter was primarily driven by a $1.4 million increase in incentive fees and a $0.4 million increase in interest expense. The increase in incentive fees was primarily due to a lower incentive fee in the pre-listing first quarter period under the pre-listing incentive fee structure. The $0.4 million increase in interest expense from the first quarter was largely driven by an increase in weighted average outstanding borrowings used to fund a portion of the growth of the investment portfolio, partially offset by decreases in weighted average interest rates on the Fund's credit facilities due to reductions to contractual spreads. The Fund's expense ratio, calculated as the Fund's total operating expenses net of any waivers and excluding interest expense as a percentage of the Fund's average total assets, was 3% on an annualized basis for the second quarter, compared to 3.4% for the prior year and 2.6% for the first quarter. Excluding incentive fees, the Fund's expense ratio was 1.9% on an annualized basis for the second quarter, a decrease from 2.2% in the prior year and consistent with the first quarter. These variances were primarily due to changes to the base management fee and incentive fees under the amended advisory agreement after the listing on January 29, 2025. The Fund's NII before taxes in the second quarter was $17.3 million or $0.37 per share, increasing from $14.4 million or $0.36 per share from the prior year. The Fund's NII in the second quarter was $16.3 million or $0.35 per share, increasing from $13.4 million or $0.33 per share from the prior year. During the quarter, the Fund recorded a net increase in the fair value of its investments of $0.9 million, representing the combined impact of $4.8 million of net realized gains, partially offset by $3.9 million of net unrealized depreciation. The net fair value increase was attributable to an increase of $2.9 million in the lower middle market portfolio, partially offset by decreases of $1.5 million in the private loan portfolio and $1 million in the middle market portfolio. Overall, the Fund's operating results for the second quarter resulted in a net increase in net assets of $16.3 million and an NAV per share of $15.33, a $0.02 decrease from the first quarter. As of quarter-end, the Fund had non-reporting investments comprising 2.6% of the total investment portfolio at fair value and 6.3% at cost. As of quarter-end, the Fund's regulatory asset coverage ratio was 2.34 and its net debt to NAV ratio was 0.71. This remains below the Fund's targeted leverage levels. As Dwayne mentioned, the Fund's focus remains on achieving a fully invested portfolio within its current leverage limits through January 2026, at which point the Fund will benefit from expanded regulatory leverage capacity as previously approved by the Fund's Board in January 2025. With that, I will now turn the call back over to the operator so we can take any questions.

Our first question is coming from Robert Dodd of Raymond James.

First question, on kind of the shrinking private loan book in the quarter. Obviously, lower M&A activity, etc., but Nick talked about missing out because of lower pricing. So with the optimism kind of that you seem to have into the second half, do you expect to hold the line on what you view as appropriate pricing? Or do you think you're going to move lower on those deployment spreads given where the market is on pricing terms at the moment?

Sure, Robert. Thanks for the question. I'll give a quick answer and then I'll let Nick add on if he has any additional color he thinks is appropriate to add. I'd say most of our view of the better second half is more driven by an expectation that there is more activity. That would be one component. I think as we sit here today, we've already seen some of the activity increasing here recently. So that also drives optimism. And then I think we've talked about this before, but as we have a larger existing portfolio on the private credit, private loan side, those companies are doing well. There's more of those that have had an opportunity to grow through acquisitions. Those acquisitions need financing. We love providing follow-on or additional financing to those types of companies. So we've also seen some increase on that side and we expect to see continued activity there in the second half. So I'd say that's the primary driver of the optimism. When you look at rates, I think, from my perspective, for a high-quality deal, would we go inside by 25 basis points of what we would have done in the first half? We probably would. But I think we're going to continue to try and maintain as much consistency on pricing as possible. But Nick, you add on any additional color.

Yes, I'd echo that. I think one thing in the first half of the year, and really it's always the case, but pricing is a little bit more of an art than a science. I think there are a few deals, we've talked about it in the past, we're not trying to do 75 or 80 deals per year; we're shooting for 15 to 25 per year. And if we miss on a couple of pricing, we're off by 25 basis points and they go somewhere else, we probably have more of that in the first half of the year than we have historically. And so I think we rightsize that a little bit and maybe we do dip down for better deals on 25 basis points in the second half of the year; that's kind of where we think we'll hit our numbers for the total year. Does that make sense, Robert?

Yes, it does. To that point, before year-end, there might be an opportunity to reach leverage in the 90s before the leverage limit changes. How do you feel about that considering your current position and the expectations for increased activity? Do you think it’s realistic to assess portfolio size and leverage by year-end?

Sure, Robert. I'd say that our view of our ability to get there today versus where it would have been 6 or 9 months ago, obviously is a little less confident just purely because of the activity that we've had in the first 2 quarters of the year. But I think when you look at our expectations, I think we still feel optimistic about our ability to grow the portfolio significantly and head in that direction. I don't know if we'd get all the way to that level by year-end or even by January, but it's largely going to be dictated or determined by the overall market activity in the industry. But I think we still feel very confident about where we are. And I think we've got multiple drivers, just the overall investment activity, the existing portfolio growing through acquisitions and add-on financing for us, they can still get us to a level that's very, very good for us.

Got it. And then if there are a couple more questions. Nick, you mentioned in the prepared remarks, but this is for anyone, are you comfortable with the current level of tariff exposure in the portfolio? Can you provide any additional insights? Has there been any change in the amount of exposure? The tariffs are continually changing as well. Can you elaborate on what gives you this comfort? Is it adjustments on the portfolio company side or the way tariffs are evolving? What is the dynamic at play here?

Yes, like you said, it is moving around and shifting week by week. I think where I'd say where we feel comfortable is it's a combination of where the management teams have led. We don't have a lot of portfolio companies that have exposure to 1 country or have no options to outsource elsewhere. And so we think most companies have some flexibility to move around. It might take a little bit of time to get there. And then also what they can do to work around different tariffs; have some exemptions, etc. I think as we look at the portfolio in whole and as it moves around week by week, we do track that and see what we're exposed to. But right now, I think we feel overall comfortable it's not going to be a massive impact to the portfolio.

Got it. And then one final question for housekeeping. Of the $912,000 in federal and state income taxes, not including the excise tax, could you give a rough estimate of how much of that was related to dividend income at the blockers? Is the majority of that amount from the tax on your dividend income held in blockers, or do you have any comments on that?

Yes. Sure, Robert. I'd say that when you look at the amount of tax that's up in the NII-related section, I would say that the vast majority of that, outside of excise tax, the vast majority of that is going to be taxed on the dividend income from flow-through companies that are held by the blockers. So that's the driver. Obviously, you've got to split it between current and deferred in terms of what's payable versus something that will be paid at some point in the future. But the vast majority of it would be related to dividend income from the flow-through entities.

The next question is coming from Brian Mckenna of Citizens.

So maybe just another question here on origination activity. Appreciate the detail on where the pipeline stands today and then also just kind of what you're seeing in the market more broadly. But in terms of activity in the second quarter, I'm assuming April was pretty slow. I mean it was an air pocket broadly just given Liberation Day. But how did fundings trend in May and June? And then, any more detail you can share just on quarter-to-date activity or even how July fundings compare to May or June?

Brian, you are correct. April, following the tariff announcements, was a really slow month, and everything was delayed. Most of the activity for the quarter likely happened in June. For the deals we did finalize in that quarter, repayments were significantly higher in June compared to April. Year-to-date, or quarter-to-date, we’ve added a few to our existing portfolio and one new platform. Overall, we feel positive about what we’ve achieved so far. This has contributed to the below-average pipeline because we closed some existing deals, and we are currently working on rebuilding that pipeline. Regarding the pipeline status, when we say it’s below average, it’s only slightly below average. Dwayne mentioned it’s slightly below average, but it’s fluctuating as we are making progress. Right now, we are indeed below average.

And Brian, just to give a little more kind of color or granularity, when you look at our activity to date in the third quarter, the net activity on the private loan side is just over $50 million of net investment activity.

Yes. Okay. That's helpful. And then just in terms of credit quality, we talked about this a little bit the last couple of quarters, if I look at the Q2 dynamics, nonaccruals, that cost increased a little bit to 6.3% from 6.1%. So can you just talk about some of the puts and takes here in the quarter? And then where are we in the process of working through some of these nonaccruals? And then, I mean, is there any expectation on the timeline when some of these could get resolved or even nonaccruals can start to move lower again?

Sure, Brian. I'll provide a brief response and then Nick can give additional insights if he has any. In this quarter, we had a balance of positive and negative changes. One investment that was in nonaccrual status was resolved, and another joined the group. As we evaluate the nonaccruals, we believe we're making progress on a few of them. We're hopeful that at least one, if not more, will transition back to accrual status. If any of these are restructured, they may not return to full accrual but could involve some portion being on accrual moving forward. Overall, we feel optimistic about our current situation. Negotiating these transactions can be complex due to the interactions between us as the lender, the private equity sponsor, and the portfolio company. However, we remain confident about several ongoing discussions and believe that some nonaccruals will be resolved in either Q3 or Q4. Nick, feel free to add anything.

Yes, we expect a couple of those transactions to be completed by the end of the third quarter, and then one or two more by the fourth quarter. For the consumer-focused companies, we have mostly transitioned and restructured the ones where we have seen weakness. We anticipate that things will return to a normal flow going into 2026.

The next question is coming from Arren Cyganovich of Truist Securities.

Could you provide some insight into your ability to exit certain equity positions in the lower middle market and reinvest those into private loans? Also, could you clarify how much control you have in these situations and give us an expected timeframe for when these actions might take place?

Sure. Happy to do that. Thank you for the question and thanks for joining us this morning. I would say that similar to the comment we gave last week on the Main Street side, we had a couple of exits in the lower middle market portfolio for the Main Street platform over the last 9 months. Unfortunately, for MSC Income Fund, those were investments that they had not been invested in. Despite those exits, the guidance we gave last week was that we're continuing to see kind of elevated or some activity from an exit standpoint. In the case of those names that we referenced last week, MSC Income Fund is invested. If you recall, most of the investments historically on the lower middle market side would have been an 80-20, 80% Main Street, 20% MSC Income Fund, split. So you have to take that split into consideration. But I think we feel good about those investments. And if we were to exit, I think we would feel really good about where the realized event would compare to our historical or our current fair value. In terms of control, our approach on the lower middle market is always about partnership. So even if we had equity ownership control, we're not going to exit something without the support of our partners and the management team. So I would say in each of those situations where we're looking at a potential exit, it's kind of a joint decision fully supported both by us and the management team. And I think it's supported because, if we decide to seek an exit, we expect to have a really good outcome.

Okay. Yes, that makes sense. And then in terms of the leverage getting higher over time, can you just remind me where your target range is there and what that represents to the extent that you still have some of the LMM in the portfolio? I'm assuming you carry a lower leverage on that than you would on the private loan side.

Yes. I think when you look at our leverage, we look at it on a combined basis. Obviously, as we shift to the private loan portfolio and have lower middle market decrease, that naturally will make you more comfortable in having a higher leverage. But as we've said in the past, the transition from lower middle market to private loan is going to take a long time. We take a long term to permanent holding period on the lower middle market investment, so it won't be a quick switch or transition. But despite that, we do expect to take leverage up over the next couple of quarters. I'll let Cory kind of give a reminder on our current leverage targets and then how those leverage targets would move once we have the expanded BDC regulatory leverage.

Yes. Thanks, Dwayne. Our current leverage targets are below where we want them as of June 30. We aim to leverage the portfolio between 0.75 and 0.95. As mentioned in this and previous calls, our Board of Directors approved an increase in leverage that will take effect in January 2026, allowing us to leverage the portfolio between 1.15 and 1.25 times.

The next question is coming from Paul Johnson of KBW.

On just the weaker consumer trends that you're sort of noticing, what is, I guess, your assessment of kind of the total underlying consumer exposure within the portfolio?

Sure, Paul. Thanks for joining us. Thanks for the question. I'd say when you look at our view of the consumer weakness, just as a reminder, I'd say that's not something that's new. I think we've been talking about it, at least on the Main Street side when we're having quarterly conference calls prior to MSC Income Fund going public, probably talking about it for probably 2 years. We had kind of seen it coming, had expected that there'd be some pain. And I'd say over that time period, you've seen a number of companies that have been able to deal with it fine, but you've seen some companies, as evidenced by the fair value depreciation and the nonaccruals, seen some companies that have had more stress on their performance, which has resulted in the stress on the nonaccrual side. I think Nick may have said this earlier; I'll let him kind of clarify if my memory is wrong, but I think as we look at it, we feel pretty good about the exposure today. I think we've taken most of the pain both in terms of nonaccrual, fair value depreciation, whether that's unrealized or if it's gone through a restructuring and it's already been realized, I think we feel pretty good about the downside that we've taken. Now we're just trying to maximize the recovery on those names. But I think that's the way that I would categorize it. I don't think we have a disproportionate exposure. It just has been a disproportionate amount of our underperforming companies for the last couple of years.

Yes, I don't have much to add there. I would mention that none of these are truly consumer product businesses. The end user ultimately becomes the consumer. We're taking a broad approach with our definition of consumer. However, the main factor is the consumer's financial situation, whether it's a service or a product that eventually reaches the consumer. As Dwayne mentioned, I think we are optimistic that we've addressed most of the challenges from a market and fair value standpoint, and now we are focusing on how to drive recovery through the restructuring process.

I understand, thank you. My final question is whether there is a relationship between overall M&A activity, especially in the lower middle market, and the dividend income generated from your portfolio. Specifically, does a slowdown or stagnation in M&A activity lead to higher-than-average dividend income from those companies over time as they seek to realize some of their value? What are your thoughts on this?

Yes. Paul, the way I would respond to that is our dividend income across the lower middle market portfolio, because that's where it's heavily concentrated, is going to come from companies that have been in the portfolio for a while, that have performed well and have delevered. And as a result, they have the same or greater amounts of free cash flow compared to what we underwrote, but they just don't have the same leverage. So there's less interest expense, there's more free cash flow. If they don't have a use for it, i.e., an acquisition or a significant CapEx, then that cash likely will be paid out in the form of dividends. So that's really the key driver for our dividend income contributions. When we have high-performing companies and those companies exit, clearly, we would lose that dividend income. But I wouldn't say it's a direct correlation with the M&A market. I think today, obviously, we've said the M&A market, from a private equity standpoint, and I would say probably in general just given the uncertainty in the environment or the economy for the last couple of quarters, has been less than kind of average, or at least historical average. But we've got a bunch of great companies and those companies continue to perform. They get on the radar of every private equity group that's out there. And if they want to kind of acquire those companies and we and our partners decide that it makes sense to pursue that exit, we're going to end up in a really good situation. So we'll lose dividend income on those, but I wouldn't say that there's a direct correlation between the 2, if I understand your question.

The next question is a follow-up coming from Brian Mckenna of Citizens.

Okay. Great. So just on the dividend, looking out over the next 12 to 18 months, there's a few variables within that just in terms of base rates and credit quality from here, but you're in a position to grow the portfolio. So I mean, in the event earnings are flat to up over the next 12 to 18 months, you'll have some more capacity on the dividend. So I mean, how are you going to pay that? I mean would you look to increase the regular or would you pay that kind of step-up in earnings if that exists through the supplemental?

Yes, Brian, you might not like this answer, but it will depend on the quality of the income. The more we perceive that income as recurring and sustainable over several quarters, the more likely we are to increase the monthly dividend. Conversely, if it's a one-time income or less certain to recur, we might opt to either increase the supplemental dividend or retain some for growth purposes. We are confident in our ability to maintain several levers that could foster NII growth and increase the dividend moving forward. As you know, this involves effectively using our significant leverage capacity now and especially after the end of January. Additionally, as we continue to grow our private loan portfolio and see some transition from lower middle market to private credit, we expect the lower middle market to decrease below 20% of fair value. When that happens, the contractual adjustment reducing the base management fee from 1.5% to 1.25% will effectively add about $0.02 per share each quarter. We believe there are positive catalysts ahead, and our goal is to execute our strategy and provide that benefit to shareholders over the next few quarters. Whether that is within 2, 4, or 6 quarters, we are confident in our capacity to deliver results in the future.

Thank you. At this time, I would like to turn the floor back over to management for closing comments.

Thank you, operator, and thank you again to everyone for joining us today. We appreciate the support of MSC Income Fund. And we look forward to talking to you again in November after our third quarter earnings release.

Ladies and gentlemen, this concludes today's event. You may disconnect your lines or log off the webcast at this time. And enjoy the rest of your day.