Greetings, and welcome to the Main Street Capital Corporation First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan with Dennard Lascar Investor Relations. Thank you, Zach. You may begin.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's first quarter 2022 earnings conference call. 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 13. 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 6, 2022. 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. Please refer to yesterday's press release for a reconciliation of these measures to the most directly comparable GAAP financial measures. 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. Dwayne?

Thanks, Zach. Good morning, everyone, and thank you for joining us today. We appreciate you taking the time to join us. We hope that everyone is doing well. Joining me today with prepared comments are David Magdol, our President and Chief Investment Officer; and Jesse Morris, our Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of our call is Nick Meserve, our Managing Director and Head of our Private Credit Investment Group. 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 declarations of our supplemental dividend in June and monthly dividends for the third quarter our expectations for dividends going forward, our recent investment activities and current investment pipeline and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, Investment portfolio, financial results, capital structure and leverage, the impact of rising interest rates on our future net investment income and our expectations for the second quarter after which, we'll be happy to take your questions. We are pleased that Main Street delivered very strong first quarter results with net investment income per share and distributable net investment income, or DNII, and per share amounts that matched our quarterly record set in the fourth quarter and with the DNII per share that exceeded the monthly dividends paid to our shareholders during the quarter by over 19%. The continued strong performance of our underlying portfolio of companies resulted in additional fair value appreciation of our investments in these companies. And when combined with our continued success in executing new lower middle market and private loan investments increased the fair value of our total investment portfolio at quarter end to $3.7 billion…

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe our strong first quarter financial results demonstrate the strength of Main Street's platform, our differentiated investment approach and our unique operating model. We're excited that our performance during the quarter resulted in a record level of interest income earned which is a direct result of our strong lower middle market and private loan originations in the fourth quarter. We're also pleased to report that the overall operating performance for the majority of our portfolio companies continued to be strong in the first quarter resulting in both a significant increase in our NAV per share and attractive dividend income received from our lower middle market portfolio companies during the quarter. As a result of our strong performance, our first quarter operating results achieved a GAAP return on equity or ROE of 14.2% on an annualized basis for the quarter and 19.9% for the TTM period, which we believe is very attractive. Each quarter, we try to highlight key aspects of our differentiated investment strategy and/or discuss relevant trends in our business that we believe our shareholders would be interested in learning more about. We have generally focused these discussions on our lower middle market strategy, which continues to be the largest and most profitable segment of our investment portfolio. For today's call, we thought it would be useful to spend some time on the second largest segment of our investment focus, which is our private loan portfolio. This strategy has grown significantly over the last 5 years and invest primarily in the senior secured debt of private equity-sponsored businesses. Our private loan investments are generally originated either directly by our internal investment professionals or through strategic relationships with other investment funds. Our private loan investments are typically…

Thank you, David. And now turning to a summary of Main Street's financial results. As Duane and David commented, we're very pleased with our operating results for the first quarter. Total investment income increased by $16.6 million or 26% over the same period in 2021 to a total of $79.4 million driven by increases in interest and fee income, which were partially offset by a decline in dividend income. Interest income for the quarter represents a new quarterly record and is a result of our record investment activity in 2021. Included in the total investment income for the quarter is a reduction of $2.1 million and the net impact of certain income items considered less consistent or nonrecurring when compared to the first quarter of 2021. These items were also $3.9 million lower than the average of the prior 4 quarters, which speaks to the overall strength and quality of the earnings in the quarter. Operating expenses excluding noncash share-based compensation expense increased by $3.6 million or 18% over the same period of the prior year, largely driven by increases in interest expense and compensation expense. The increase in interest expense was driven by higher borrowing levels to support the increase in portfolio investments, partially offset by a lower weighted average interest rate on borrowings as compared to a year ago. The increase in compensation expense is primarily due to increased headcount, higher base compensation and increased incentive accruals. These increases were partially offset by a reduction to compensation expense resulting from changes in the fair value of deferred compensation plan assets and corresponding liabilities. The ratio of total operating expenses, excluding interest expense as a percentage of average total assets was 1.5% for the trailing 12 months and 1.1% for the quarter on an annualized basis, which continues to…

. Our first question is from Robert Dodd with Raymond James.

Congratulations on the quarter. I guess on dividend income from portfolio companies, obviously, the asset manager was up year-over-year, , I don't know yet but it's not . It looks like -- so it looks like from the lower middle market portfolio companies, the dividend income was down double-digit percentages, that point is still higher than any quarter other than the quarters last year. But is there anything thematic there in terms of, is it just because the quarters of last year were perhaps outsized? Or is there any segments, particular industry segments, where the dividend income from the lower middle market was down more than others. Any color you can give us there?

Sure, Robert. Thanks for joining us again. What I would say on the dividend income is it is down quarter-over-quarter, particularly when you look at the last couple of quarters, which we had highlighted work quarters of elevated income. I think we always try to call out items that could be either unusual or nonrecurring. And I would say that the last couple of quarters, we did have higher amounts of dividend income at that category this quarter. We really don't have any of that type of income. So it's a much more stable recurring level of dividend income. If you look at the companies that contributed, I'd say that it's -- no surprise, our best-performing companies. And if you look at the top 10 companies in the first quarter, it would be very, very consistent with what you would have seen for the top 10 companies in the fourth quarter of last year as well as the full year. So I wouldn't say there's anything there that is kind of a trend or anything that's troubling to us. Obviously, we'd like dividend income to be as high as possible, but we still view the level that we achieved in the first quarter to be a healthy level of dividend income. If I was to point at anything, it could be just given the environment we're in, which obviously includes a lot of uncertainty. I do think you're seeing some of our companies kind of tend to be a little more conservative in the kind of the uncertain backdrop we have, and that could have contributed to the number being down slightly in the first quarter versus the last couple of quarters. But overall, I think we're still very pleased with how the operating companies are performing as a whole, and we're happy with that level of dividend income.

Got it. Yes. And that relates to the next question. I mean, obviously, you have great relationships with these lower middle market portfolio companies. I mean what are you hearing from them now say on labor cost, raw material cost per se. I mean, obviously, we all know the macro. But has anything changed over the last few months or versus 6 months ago in terms of what they're telling you about concerns on the macro front? Or are they just dealing with it and carrying on?

Sure, Robert. I'll give some comments, and I'll let David add on to the extent he has some additional comments that he'd add on. But I'd say just like they have for the last couple of quarters, the portfolio companies are dealing with challenges across the board on each of the items that you touched on labor, cost of material, supplies and then just availability of both of those, and it's not just a cost issue, but it's just actually finding availability of both labor and supplies and materials. So that has continued to be a challenge, and we expect will continue to be a growing challenge going forward. We're fortunate at least to date, that our companies have been able to navigate that. I think you've always heard us say that we really like our position in the lower middle market being partners for individuals that have owned these companies and manage these companies for decades, not years. And we really think they do a great job of managing opportunities as well as challenges. And we continue to see them do a really, really good job here in the current environment, just like they have for the last couple of quarters and the last couple of years going back to the COVID kind of environment and dealing with those challenges. But I'll let David add on if he has any additional comments there.

No, I think you covered it Dwayne.

And then last question for me. On the asset management side, I mean, obviously, revenue is up another -- again, I think it was the dividend was $2.3 million in the fourth quarter. $2.3 million again, which is more than double what it was in the first quarter last year. So significant. And that's not including the OpEx offset. What I won't want to say expectations, but hopes. I mean it's been a good performer for you. You've now got obviously the MSC Income Fund that contributes to that. You've got the private fund. Any incremental initiatives that you can talk about on growing that asset management business because obviously, it's a great return to shareholders without having to put additional capital risk?

Sure, Robert. So what I would say is, obviously, for the last year or so, we've been focused on both the changes we've been implementing at MSC Income Fund after becoming the sole adviser at the end of 2020 and then more recently, on raising and growing MS Private Loan Fund I which, as I've indicated in my comments, we finalized the fundraising process and have been actively investing in that portfolio. So while we don't have an answer for what the next generation of the asset management business growth initiatives will be. It is something that we have now turned our attention to see what is that next evolution? Is it a another private fund? Or is there something else in the asset management business, largely focused on our private loan strategy that we can look to execute on. So we're in the stages of working on that, but it's too early to really announce anything. I'll give you much more color than it's in process, and we expect to have success on something in the next kind of 6 to 12 months.

Our next question comes from Bryce Rowe with The Hovde Group.

I wanted to maybe start -- maybe as a follow-up to one of Robert's questions there. He asked about the impact of the current environment on the lower middle market portfolio in some of those borrowers. Was -- you all have a diverse portfolio and get looks into larger companies, smaller companies, and that's certainly a bit a bit different and unique for the space. Are you seeing any divergence in terms of borrower health between those lower middle market and then the larger private loan and middle market companies?

Bryce, I wouldn't say that we've seen a big divergence. I think similar to the lower middle market, the private loan companies in our portfolio have performed well. I think that as you said, we are closer to the lower middle market, just given our position as a significant equity owner versus the primary lending relationship we have in that private loan portfolio, but all the feedback we get both from the companies and the sponsors and then what we see come through from a quarterly and monthly reporting standpoint on their financials has continued to be positive. So I think they are similarly dealing with all the challenges that exist in the marketplace. But to date, we haven't seen anything that was kind of a broad trend across the board. You do, as we always have had in the past, you have certain companies in the portfolio that are performing higher or better than others. And that's always been the case. But I'd say those are more company-specific issues than anything that's more broad-based from an overall economy or kind of supply chain inflation standpoint.

Okay. That's helpful, Dwayne. And then maybe just around some of the pipeline comments, you described lower middle market as average. Private loan is above average. On the other side of originations, I guess there's prospects that you'll see slowing repayment activity with higher rates. Just curious if that affects lower middle market and private loan equally. And if that is in fact the case, is there some potential for maybe stronger net portfolio growth as repayments possibly slow?

Yes. Bryce, I would say when you look at the impact of the current rate environment on repayments, if there's going to be an impact, I would say, would be on the private loan segment. With that being said, I would say that so far in the quarter, we've had a couple of our investments pay off. So we haven't seen a significant impact on the repayment expectations purely because of the rate environment. But I do think longer term, as you see rates increase, if there's going to be a bigger impact. It's most likely on that private loan and middle market segments for that matter as opposed to lower middle market. As that's always been our view, the lower middle market companies are going to repay us. much more based upon just free cash flow from operations or some type of an exit transaction as opposed to a more traditional refinancing where the private loan portfolio would be more based upon kind of market activity trends. And if they see an opportunity to refinance at a lower rate, you could see that refinancing activity happen more in that portfolio than you would in the lower middle market. But we haven't seen that impact happen to date. And as I referenced earlier, did see a couple of our private loan investments, repay through a refinancing here in the most recent couple of months.

Okay. All right. Maybe one more for me. On the right side of the balance sheet, you've got a debt maturity, notes maturity coming up here in '22. Just curious how you're thinking about that especially with higher base rates and possibly wider spreads in that notes market? Are you comfortable perhaps taking the outstandings on the credit facility a bit higher? Or you kind of approach that in a different way?

Sure, Bryce. I think what she said is the way we're looking at it. As Jesse mentioned in his comments, we were active in 2021, specifically near the end of 2021. In October, when we went out and raised an additional $200 million of IG debt, obviously, with hindsight, that timing was really good, probably should have done more, but that was kind of all we had capacity for at the time. But that was intentionally done to set us up to make sure we had enough liquidity and kind of flexibility to deal with that pending maturity as well as the very significant growing pipeline that we had seen developing for the fourth quarter. So we feel like we've got our capital structure and balance sheet in good position to deal with that maturity. We also, as you know, have the option to continue to issue equity under the ATM. So as we continue to see good portfolio activity, you'll likely see us utilize the combination of the ATM issuance and the revolver to fund our needs, including the potential needs in December. But obviously, if there is an opportunity where there's an opportunity in the IG market, to take advantage of an issuance, then we'll continue to monitor that. But I think that's the approach that we're taking when we look at that pending maturity.

. Our next question comes from Kenneth Lee with RBC Capital Markets.

Just one on the private loan side. I really appreciate the additional disclosures there. Wonder if you could just give us a little bit more color into what's driving the above-average pipeline there? And how you think about the potential growth there this year?

Sure. I don't know if I can point to anything other than our private credit team has done a great job the last couple of years of forming new relationships across the private equity sponsor universe. And we're seeing their efforts, not just here recently, but over the last couple of years, kind of come to fruition with a number of really attractive recurring opportunities from some of the sponsors I've got it here with me, Nick, if there's anything else that you'd want to add in terms of the pipeline we're seeing.

Yes. Our current pipeline is above average. I would say overall, the market does feel softer than last year. But last year was a record-breaking year across the board, both in private credit and M&A. And so I think looking at '22, it still feels above average if you look at the long-term cycle, but it's definitely a little slower than last year.

Got you. Very helpful there. And then in terms of a follow-on question, if I may. You mentioned remarks how rising rates could have an impact on valuation and investments. I wonder if you could just further expand upon this. I presume that this is specifically within the equity investments but just wanted to get a little bit more details on that.

Sure. I think it's hard to give much detail there, Ken, other than when Jesse provided that comment, I think what we're communicating is that all things being equal, a rising rate environment, while it would be good for our income statement will not be good for our balance sheet. And that's purely based upon valuation methodologies, which will include kind of cost of capital as part of the valuation process and as cost of capital goes up, particularly on the debt side, that net-net will be a negative factor for equity valuations. And if you look at our debt investments, if the marketplace today allows the opportunity to invest in new debt investments that have a higher yield on your existing portfolio than just on a relative comparable basis, your existing investments, the value of those investments from a valuation process will be negatively impacted. So that's what Jesse was referring to when we talked about that. But other than kind of those broad brushed comments, it remains to be seen what the long-term impact is. And then if you look at kind of the rising rate environment and inflation as a whole, if those issues continue to persist and get worse, then it's expected that's not a good thing for the economy, which, again, long term is not a good thing for equity valuation. So at a macro level, that's what Jesse was referring to in his comments.

There are no further questions at this time. This now concludes our question-and-answer session. I'd like to turn the floor back over to management for any closing comments.

Thank you again to everyone for joining us this morning. We appreciate your interest in Main Street, and we'll look forward to talking to you again in early August.

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