Main Street Capital Corporation (MAIN) Q2 2024 Earnings Report, Transcript and Summary

Greetings. And welcome to the Main Street Capital Second 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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan. Thank you, Zach. You may begin.

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s second quarter 2024 earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer; and Jesse Morris, Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of the call is, Nick Meserve, Managing Director and Head of Main Street’s Private Credit Investment Group. Main Street issued a press release yesterday afternoon that details the company’s second 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 August 16. Information on how to access the replay was included in yesterday’s release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company’s homepage. Please note that information reported on this call speaks only as of today, August 9, 2024, and therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Today’s call will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, or similar expressions. These statements are based on management’s estimates, assumptions, and projections as of the date of this call, and there are no guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties, and other factors, including, but not limited to, the factors set forth in the company’s filings with the Securities and Exchange Commission, which can be found on the company’s website, or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law. During today’s call, management will discuss non-GAAP financial measures, including distributable net investment income, or DNII. DNII is net investment income, or NII, as determined in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, excluding the impact of non-cash compensation expenses. Management believes that presenting DNII and the related per share amount are useful and appropriate supplemental disclosures for analyzing Main Street’s financial performance since non-cash compensation expenses do not result in a net cash impact to Main Street upon settlement. Please refer to yesterday’s press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Two additional key performance indicators that management will be discussing on this call, are net asset value, or NAV, and return on equity, or ROE. NAV is defined as total assets minus total liabilities and is also reported on a per share basis. Main Street defines ROE as the net increase in net assets resulting from operations divided by the average quarterly total net assets. Please note that certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. And now, I’ll turn the call over to Main Street’s CEO, Dwayne Hyzak.

Thanks, Zach. Good morning, everyone, and thank you for joining us. We appreciate your participation on this morning's call and we hope that everyone's doing well. On today's call, I will provide my usual updates regarding our performance in the quarter, while also providing updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, our recent investment activities and current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and leverage, and our expectations for the third quarter of 2024, after which we'll be happy to take your questions. We are pleased with our second quarter results, which were highlighted by an annualized return on equity of 16.1%, DNII per share, that continue to exceed the dividends paid to our shareholders, and a new record for NAV per share for the eighth consecutive quarter. We believe that these continued strong results demonstrate the sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies, unique contributions of our asset management business, and the continued underlying strength and quality of our portfolio companies. We are also pleased that we generated significant growth in both our low-income market and private loan investment portfolios and into the quarter with attractive investment pipelines in both investment strategies, which we expect will be beneficial in the future. We remain encouraged by the continued favorable performance of our diversified lower-middle market and private loan investment strategies, and remain confident that these strategies, together with the benefits of our asset management business and our cost-efficient operating structure, will allow us to continue to deliver superior results for our shareholders in the future. Additionally, with the continued support of our long-term lender relationships, as evidenced by our recent extension and expansion of our Corporate Facility, and the benefits of our second investment-grade debt offering of the year in June, we continue to maintain strong liquidity and a conservative leverage profile, which we believe is important in the current economic environment and we remain excited about the current opportunities in both our lower middle market and private loan investment strategies. These positive results for the second quarter, combined with our favorable outlook for the third quarter, resulted in our recommendations to our board of directors for our most recent dividend announcements, which I'll discuss in more detail later. Our NAV per share increased in the quarter primarily due to the impact of net fair value increases in our investment portfolio and the accretive impact of our equity issuances, which Jesse will discuss in more detail. The continued favorable performance of the majority of our lower middle market portfolio companies resulted in strong dividend income contributions and another quarter of significant net fair value appreciation in the equity investments in the lower middle market portfolio. We are also excited about the following investments we made to finance strategic acquisitions by two of our high-performing lower middle market portfolio companies, each of which were funded by follow-on debt investments by Main Street for a total of over $36 million of incremental debt investments in these portfolio companies. We expect that these follow-on investments will help drive additional fair value appreciation in these portfolio companies in future quarters in addition to the highly attractive interest income provided by these incremental debt investments. In the second quarter, we were also pleased to have recognized a meaningful realized gain upon the combination of one of our lower middle market portfolio companies with a strategic acquirer, which resulted in the full exit of our debt investments and a partial exit of our equity investment in the company while retaining an equity investment in the combined company and the related future upside from the strategic combination. We are excited that we continue to see increased interest from potential buyers in several of our lower middle market portfolio companies that could lead to favorable realizations over the next few quarters in which we believe highlights the strength and quality of our portfolio companies. We were very pleased with our investment activity in the second quarter. This activity included total lower middle market investments of $155 million, including new investments totaling $88 million, resulting in a net increase in our lower middle market investments of $69 million after repayments and other investment activity. Our private loan investment activities in the quarter included new investments of $324 million, which after repayments and other investment activity resulted in a net increase in our private loan investments of $225 million. Given our conservative capital structure and strong liquidity position, we remain very well positioned to continue the growth of our investment portfolio over the next few quarters. We've also continued to produce positive results in our asset management business. The funds we advise through our External Investment Manager continue to experience favorable performance in the second quarter, resulting in significant incentive fee income for our asset management business for the seventh consecutive quarter, and together with our recurring base management fees, a significant contribution to our net investment income. We remain excited about our plans for the external funds that we manage as we execute our investment strategies and other strategic initiatives. We are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund. We remain optimistic about our strategy for growing our asset management business within our internally managed structure, and are actively working to increase the contributions from this unique benefit to our mainstream stakeholders. As a result of these continued efforts, a few weeks ago, MSE Income Fund, a non-listed BDC that is advised by our External Investment Manager, filed a preliminary proxy statement that contains certain proposals intended to position the fund to listed shares on a national securities exchange. The preliminary proxy statement also details additional activities and changes at MSE Income Fund, including a transition of the fund's investment strategy to be solely focused on its private loan investment strategy and a potential amendment to the investment advisory agreement between the external investment advisor and the fund, both of which would become effective upon a listing of the fund shares. We're very excited about these potential changes at MSE Income Fund, which we believe represents significant catalyst to the future growth of the fund and the opportunity for significant future benefits to both the MSE Income Fund shareholders and our asset management business. Based upon our results for the second quarter, combined with our favorable outlook in each of our primary investment strategies and for our asset management business, earlier this week, our board declared a supplemental dividend of $0.30 per share, payable in September, representing our 12th consecutive quarterly supplemental dividend to go with the aid increases to our regular monthly dividends since the fourth quarter of 2021. Our board also declared regular monthly dividends for the fourth quarter of 2024, of $0.245 per share, payable in each of October, November and December, representing a 4% increase from the regular monthly dividends paid in the fourth quarter of 2023. The supplemental dividend for September is a result of our strong performance in the second quarter and will result in total supplemental dividends paid during the trailing 12-month period of $1.175 per share, representing an additional 41% paid to our shareholders in excess of our regular monthly dividends and total dividends for the trailing 12-month period of over $4 per share and a current total yield we are providing to our shareholders of over 8%. We currently expect to recommend that our board continue to declare future supplemental dividends to the extent DNII significantly exceeds our regular monthly dividends paid in future quarters and we maintain a stable to positive NAV. Based upon our expectations for the continued favorable performance in the third quarter, we currently anticipate proposing an additional supplemental dividend payable in December 2024. Now turning to our current investment pipeline, as of today, I characterize our lower middle market investment pipeline as well above average. We believe that the unique and flexible financing solutions that we can provide to lower middle market companies and their owners and management teams in our differentiated long-term to permanent holding periods represent an attractive solution to the needs of many lower middle market companies. We are confident in our expectations for strong, new lower middle market investment activity over the next few months. We also continue to be very pleased with the performance of our private credit team and the significant growth that they have provided for our private loan portfolio and our asset management business. As of today, I characterize our private loan investment pipeline as average. My last update relates to our activities to expand and improve our finance accounting and treasury functions to match the growth and investing class performance of our investment teams, investment portfolio, and asset management business. As part of these activities, yesterday we announced several promotions and changes in these areas, including a change in Main Street's CFO position. We are excited about these changes and what they mean for our company and for these specific individuals in the future. In conjunction with these changes, personally and on behalf of our executive management team and our board of directors, I want to thank Jesse for his significant contributions over the last few years as our CFO while also serving as our Chief Operating Officer and managing a lower middle market investment portfolio. We are very excited to have his focus back solely on our investment and operations activities where we know that he will continue to add significant value to our firm and we appreciate his significant contributions over the last few years as our CFO. With that, I will turn the call over to David.

Thanks, Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe our strong second quarter financial results continue to demonstrate the strength of Main Street's platform, our differentiated investment approach, and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio companies continued to be positive, which contributed to our attractive second quarter financial results. However, we did experience some continued softness in certain portfolio companies with consumer discretionary-focused products or services, which we have been monitoring for several quarters, and we are actively working to maximize our recoveries on those specific investments. As we have discussed in the past, the largest portion of our investment portfolio and the primary driver of our long-term success has been and continues to be our focus on the underserved lower middle market, and specifically our strategy of investing in both the debt and equity in lower middle market companies. Our view on the relative attractiveness of investing in the lower middle market remains unchanged, and we expect that this will continue to be our primary area of focus in the future, and as Dwayne noted, we are excited about our current lower middle market investment pipeline. Each quarter, we try to highlight key aspects of our investment strategy and differentiated approach. For today's call, I am going to spend some time discussing our private loan investment strategy, which is the second largest part of our investment portfolio and is the primary driver of our asset management business. We have grown our private loan strategy significantly over the last several years, both on Main Street's balance sheet and for the third-party client funds that we manage through the External Investment Manager. As a reminder, our private loan strategy principally represents investments in the senior secured debt of private equity sponsored businesses. These investments are primarily originated by our internal investment professionals through strategic relationships they cultivate and maintain with a select group of private equity firms and their capital market intermediaries. Our private loan investments are typically first lien debt investments with attractive yield profiles and favorable terms. As of quarter end, 99% of our private loans secured debt investments were first lien loans and 97% had floating rate interest rates, which had an attractive weighted average yield of 12.8%. Over seven years ago, we announced our strategic decision to dedicate significant resources towards growing our private loan strategy while de-emphasizing our middle market strategy. Our desire to make this significant shift was driven by our intention to focus on investing in companies that were smaller than those typically accessing the traditional syndicated loan market. We believe that the opportunity existed to lead or co-lead the vast majority of our private loan investments whereby we were able to directly manage the due diligence, the loan documentation, and the post-investment process. We believe this approach allows us to maximize our net returns on capital invested in private loans from Main Street and the investment portfolios we manage in our asset management business. While the overall market competition for private credit products has increased over the last few years, we believe our niche focus on the smaller end of the market is less competitive and allows us to earn more attractive risk-adjusted returns for Main Street's investors and the investors in the funds we manage. During the time of our intentional and purposeful repositioning in the market from 2016 year end through the second quarter of this year, we increased the total fair value of our private loan portfolio at Main Street from 17% of our total portfolio at fair value to 37%. Based on the capabilities and relationships of our private credit team, the overall growth of our private loan platform, and the strength of our investment pipeline, Main Street has also benefited from our ability to utilize our private loan investment strategy to grow our asset management business. Through our External Investment Manager, our private loan strategy effectively allows Main Street to leverage our investment professionals' time and our platform to benefit from the attractive fee-based income we receive from third party clients, while at the same time providing highly attractive investment opportunities and returns for those clients. We look forward to the continued future benefits to our overall platform as we pursue additional ways to grow our private loan platform and third party asset management business in the future. Now, turning to the overall composition and operating results from our investment portfolio as of June 30th, we continue to maintain a highly diversified portfolio with investments in 194 companies spanning across numerous industries and end markets. Our largest portfolio company, excluding our External Investment Manager, represented only 3.7% of our total investment income for the trailing 12-month period and 3.3% of our total investment portfolio fair value of quarter end. The majority of our portfolio investments represented less than 1% of our income and our assets. Our investment activity in the second quarter included total investments in our lower middle market portfolio of $155 million which after aggregate repayments on debt investments, return of invested equity capital, and realized losses, resulted in a net increase in our lower middle market portfolio of $69 million. We completed $324 million in total private loan investments, which after aggregate repayments of debt investments, resulted in a net increase in our private loan portfolio of $225 million. Finally, during the quarter, we had a net decrease in our middle market portfolio of $66 million as we continued to de-emphasize this strategy, resulting in a remaining middle market investment portfolio of less than 4% of the total fair value of our investment portfolio. At the end of the first quarter, our lower middle market portfolio included investments in 83 companies representing over $2.4 billion of fair value, which is over 27% above our cost basis. We had investments in 92 companies in our private loan portfolio representing $1.7 billion of fair value. In our middle market portfolio, we had investments in 19 companies representing $184 million of fair value. The total investment portfolio at fair value at quarter end was 115% of the related cost basis. In summary, Main Street's investment portfolio continues to perform at a high level and deliver on our long-term results and goals. Additional details on our investment portfolio at quarter end are included in the press release that we issued yesterday. With that, I will turn the call over to Jesse to cover our financial results, capital structure, and liquidity position.

Thank you, David. To echo Dwayne's and David's comments, we are pleased with our operating results for the second quarter. Our total investment income for the second quarter was $132.2 million, increasing by $4.6 million, or 3.6% over the second quarter, 2023, and by $0.5 million, or 0.4% from the first quarter, 2024. Our results for the second quarter, 2024, included strong performance across our lower middle market and private loan investment portfolios and our asset management business resulting in strong levels of investment income, which is Dwayne and David touched on, demonstrates the continued strength of our differentiated investment and asset management strategies. Interest income increased by $2.8 million from a year ago and was comparable to the first quarter. The increase for the prior year was driven primarily by the impact of increase in net investment activity over the last year and increases in benchmark index rates, partially offset by the impact of an increase in investments on non-accrual. When compared to the first quarter, the second quarter benefited from the increase in net investment activity during the first and second quarter offset by an increase in investments on non-accrual. Dividend income increased by $1.1 million or 4.3% when compared to a year ago. With this increase after the impact of a $1.6 million decrease in unusual or non-recurrent dividends, an increase by $3.9 million or 17.1% from the first quarter, including a comparable level of unusual or non-recurrent dividends between the quarters. The continued underlying strength of the majority of our lower middle market portfolio companies together with the unique benefits of our asset management business drove the strong level of dividend income in the quarter. Fee income increased by $0.7 million from a year ago and decreased by $3.3 million from the first quarter. The first quarter of this year included elevated levels of refinancing and prepayment fees considered non-recurring. The aggregate amount of these items for the second quarter decreased by $2.7 million from the first quarter and were comparable to the prior year. For the second quarter, the impact of certain income considered less consistent or non-recurring in nature, including dividends from our equity investments and accelerated prepayment, re-pricing and other activity related to our debt investments, as I mentioned earlier, totaled $5.1 million. In the aggregate, these items were consistent with the average of the prior four quarters and $1.6 million lower than the prior year and $2.5 million lower than the first quarter. Our operating expenses increased by $3 million from a year ago, largely driven by increases in interest expense, share-based compensation expense, and general administrative related expenses. The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.3% for the quarter on an annualized basis and continues to be amongst the lowest in our industry. Our External Investment Manager contributed $9.2 million to our net investment income during the second quarter, an increase of $0.7 million from a year ago and $0.6 million from the first quarter. The manager earned $4.1 million in incentive fees during the quarter, increasing by $0.5 million from the prior year and $0.3 million from the first quarter, primarily as a result of the positive performance of the assets under management. The manager ended the quarter with total assets under management of $1.6 billion. During the quarter, we recorded net fair value appreciation, including net realized gains and net unrealized appreciation on the investment portfolio of $26.5 million. We recorded net fair value appreciation in our lower middle market portfolio, our other portfolio, our middle market portfolio, and in our External Investment Manager, partially offset by net fair value appreciation in our private loan portfolio. The net fair value appreciation in our lower middle market portfolio was largely driven by the continued positive performance of certain of our portfolio companies. The net fair value appreciation in our other portfolio was driven by positive performance in certain investments. The net fair value appreciation in our middle market portfolio was driven by the exit of a portfolio company at a favorable value compared to its fair value at the end of the first quarter. The fair value appreciation of our External Investment Manager was a result of an increase in the fees generated by the External Investment Manager, driven by the continued strong performance of our asset management business, partially offset by a decrease in the valuation multiples of public trade peer, which we use as one of the benchmarks for valuation purposes. The net fair value appreciation in our private loan portfolio was driven by the net impact of specific portfolio company underperformance, partially offset by the impact of decreases in market spreads. We ended the second quarter when investments on non-accrual comprising approximately 1.2% of the total investment portfolio at fair value and approximately 3.6% of costs. As David indicated, the new investments on non-accrual for the second quarter largely relate to underperforming companies with significant exposure to consumer end markets. Net asset value or NAV increased by $0.26 per share over the first quarter and $2.11 or 7.6% when compared to a year ago to a record NAV per share of $29.80 at the end of the second quarter. Our regulatory debt-to-equity leverage calculated its total debt excluding our SBIC debentures divided by net asset value was 0.74 and our regulatory asset coverage ratio was 2.33 and these ratios continue to be slightly more conservative than our long-term target ranges of 0.8x to 0.9x and 2.1x to 2.25x respectively. We continue to be active this quarter on capital activities aided by our strong relationships. In May, we repaid the $450 million due on our May 2024 notes at maturity. In June, we issued $300 million of unsecured notes maturing in June 2027 with a coupon rate of 6.5%. We also amended our corporate credit facility in June, increasing commitments by $115 million to $1.1 billion with a diversified group of 19 lenders and extended the maturity to June, 2029 for $1.035 billion of the commitments. We were also active in our at-the-market or ATM program, raising net proceeds of $42.2 million during the quarter. After giving effect to the investment and capital activities in the first and second quarter of this year, we continue to maintain strong liquidity including cash and availability under our credit facilities and one of our SBIC funds of approximately $1 billion. We continue to believe that our conservative leverage, strong liquidity and continued access to capital are significant strengths that have proven to benefit us historically and have as well positioned for the future, allowing us to continue to execute our attractive investment strategy. As we discussed last quarter, with this current level liquidity, we currently expect to fund our net new investment activity in 2024 through a greater proportion of debt financing, and as such, we would expect leverage to continue to increase during the course of the year to be more in line with our long-term stated targets. Coming back to our operating results, as a result of our strong performance for the quarter, our return on equity for the second quarter and the first six months of the year was 16.1% and 16.6% on an annualized basis, respectively. DNII per share for the quarter of $1.07 was $0.05 or 4.5% lower than the record DNII per share for the second quarter last year and was $0.04 cents or 3.6% lower than the DNII per share for the first quarter. The combined impact of certain investment income considered less consistent or non-recurring nature on a per share basis was in line with the average of the last four quarters, $0.02 per share lower than the same quarter a year ago, and $0.03 per share lower than the first quarter accounting for most of the declines in DNII. Total dividends paid in the second quarter were $1.02 per share, including a supplemental dividend of $0.30 per share and the increase of 13% over our total dividends paid during the same period in the prior year. Given the strength of our operating results and the outlook for the rest of the year, our board approved a supplemental dividend of $0.30 per share payable in September 2024. With a supplemental dividend, total declared dividends for the third quarter of 2024 were our $1.035 per share, representing a 7.3% increase over the total dividends paid in the third quarter of last year. Our board also approved recurring monthly dividends of $0.245 cents per share for a total of $0.735 per share for the fourth quarter of 2024. Looking forward, given the strength of our underlying portfolio, we expect another strong top line in earnings quarter in the third quarter with expected DNII of at least $1.07 per share, with the potential for upside driven by the actual level of dividend income and portfolio investment activities during the quarter. With that, I will now turn the call back over to the operator so we can take any questions.

[Operator Instructions] Our first question comes from the line of Robert Dodd with Raymond James.

Hi guys, congratulations for the quarter. I mean, a quite a few question about the pipeline. Dwayne, I'm trying to recall the last time you characterized the low and middle market as well above average. That sounds quite positive. So can you give us any incremental try on what that is? Because that seems like the lower middle market pipeline keeps getting stronger. So are there any common characteristics in that? Obviously, every deal is unique, but I mean, anything that's really driving the incremental activity of business owners kind of coming to the table.

Good morning, Robert. Thanks for the question. I don't know if I'd point to anything specific that's driving owners to come to the table. I think our teams here internally at Main Street are doing a better job of proposing what we think is unique to the intermediaries that we deal with, and then eventually to the business owners. And I think we're having a lot of success there. We are trying to give you guidance that the lower middle market pipeline is very, very strong. We expect to have good originations this quarter. Some of it may end up moving into the fourth quarter, but we feel really good about the pipeline, which is why we gave the guidance. As you've heard us say in the past, we always have to get through due diligence and legal documentation so things can always change. The economy can also change, but right now we feel really, really good about the pipeline and we expect to have robust lower middle market originations over the next couple of months, next couple of quarters. I'll let David add any additional comments that he might have on his side.

I think Dwayne hit on it. We're just resonating quite well with our referral network. The only other observation I'd make is our incoming deal volume is up and it's in part as a result of interest rates having more visibility and not having a rising interest rate kind of outlook like we had a year ago, quite as unclear, and that led intermediaries to advise their clients it's a good time to go to market where as we think there were some that were hitting pause a year ago and the like.

Got it. Thank you for that. On the private loan side, I mean average, all the private loan side, is it that you're seeing average number of deals or that you're seeing maybe a better than average number of deals, but the price asks. I mean, I've seen lots of talk from people about straight compression, et cetera, and the number of BDCs who are just like rejecting deals because the pricing is too tight. So is that something that's having any impact on private loan or is the pricing consideration that comes in later rather than in pipeline characteristics?

Yes, Robert, I'll give you a few comments and I'll let Nick Meserve add any additional commentary he has on his side. But just to be clear on our guidance, the well above average was on the low market side. The guidance for private loan was average. We did have a really, really --

Yes, that's, sorry, that's what I meant. I mean, the fact that the private loan is only average, is that because of pricing or inflow versus the lower middle market, which was well above average. Sorry, if I didn't characterize that.

That's okay, no problem. I just want to make sure we kind of got the question right. As you'll see, as you saw in our press release, you'll see in our 10-Q, the second quarter was a very, very robust quarter for us on the private loan side. So we had a lot of success, both on the front end of the pipeline, but more importantly on the backend, working through the process, diligence, legal documentation, et cetera, and getting to a closing. So part of the reason that we think that the pipeline is average today is that the second quarter was so robust. I do think that the broader market, I don't think we see this as much on the lower middle market side, but the broader market, just from a seasonal standpoint, you typically see a slowdown in August, September. People are on vacation. They're doing other things other than focusing on transactions. And I think you see some of that seasonality. We continue to view our part of the market, which again, as you've heard us say in the past, just to make sure we clarify it, it's a different part of the market than what you see most other BDCs participate in. These are the smaller part of the private equity world, or the kind of the private credit world. We continue to see what we think are very attractive opportunities, both from an underwriting risk standpoint, leverage standpoint, and a pricing standpoint. But I'll let Nick give any additional comments or color that he thinks is helpful.

I think that pretty much covers it. I think the big one for 2Q is obviously a large quarter for us. Part of that was pulling through some third quarter transactions. They closed right at the end of the quarter for 2Q. They could have moved into 3Q. But overall, I think that the portfolio feels good. I think it's not a spread necessarily question on whether it's average or above average. Spreads have condensed a little bit, like Dwayne said, not as much on the smaller market that we play in.

Got it. Thank you. One more, if I can. I mean Dwayne, you talked about obviously you've seen some headwinds on the consumer facing side for a while. I've been talking about it a while. Are there any new segments of the economy or where there are any emerging signs of credit concern that are maybe not consumer direct?

Yes, Robert, I think to your point, we've been talking about consumer risk or concerns for a while, not just a couple quarters, but for longer than that, we've been risk off from a new investment standpoint in that area for a very specific reason. I think we have been wrong for a while, but I think you're seeing it, not just in our portfolio, but I think broader across the U.S. economy, you're seeing that same feedback everywhere and that those headwinds from an overall industry standpoint with the challenges that some of these companies already had internally, you just got to the point in this quarter where we had an increase in the non-accruals, but hopefully for you and others, it shouldn't have been a surprise because we've been trying to communicate that for the last couple of quarters. When you look at the broader parts of the economy, we feel good about it. The rest of the portfolio by and large is doing well. You see that in our dividend income from the lower middle market. You see that in the fair value changes. So we feel good about it. We continue to say if a portfolio company is struggling, it's probably more of a portfolio company specific issue than it is something more broad based from an economic or an industry standpoint outside of that consumer segment.

Our next question comes from the line of Bryce Rowe with B. Riley Securities.

Thanks much. Maybe a couple of follow-ups to Robert's questioning there. Dwayne, in terms of the lower middle market pipeline, I agree. I don't know if I've heard you guys describe it as well above average before, maybe you have, but it's certainly been a long time. Can you talk about the mix within that pipeline in terms of kind of add-ons versus new? So incumbent type relationships versus new?

Yes, Bryce, so just to reiterate some of the second quarter, we did have two really nice add-ons from an investment standpoint into existing portfolio companies to help finance what we think are very, very attractive strategic acquisitions for two of our high-performing portfolio companies. As we look forward to the current pipeline, I would say it's much more weighted towards new platforms. There might be one or two potential add-ons that are in the earlier stages, but we're not really counting that in the pipeline guidance today. This pipeline guidance is more new platforms. The good news from our perspective is these platforms, when you look at your type of transaction, mix of debt equity leverage, valuation, kind of pricing everything else that you would take into consideration, it's all consistent with what we've done consistently on a long-term basis, which is what gets us so excited about the pipeline being as favorable as it is today.

Okay. That's helpful. And then maybe one more on the private loan activity, any sense for kind of where maybe leverage attachment points are within private loan, just curious if it's consistent with what you've done in the past?

Yes, Bryce, it hasn't really changed from where we've been in the last few years. So we're still kind of at 3.5x and 4.5x range, usually that’s in 3.5x to 4x.

Okay. Good deal. Let's see, on non-accruals, it's certainly not a surprise to hear you guys talk about some weakness in consumer discretionary. You certainly have talked about it for quite some time. If we look at maybe the non-accrual bucket, just in general, and maybe some of the newer inflows, are they coming from lower middle market, private loan middle market, just what portion of the investment portfolio are creating the non-accrual inflows?

These are mostly on the lower middle market side.

Okay. In terms of the middle market, clearly a de-emphasis again here in the second quarter. Is that more of a kind of proactive approach or reactive approach, just given a lot of the refinance activity we saw in the second quarter?

Yes, I'd say, Bryce, you've heard us talk about the middle market being an area that we've been de-emphasizing for a while. I think when you look at quarter to quarter change, we're down to less than 20 names. I forget if it's 18 or 19 individual portfolio companies. The movement of that portfolio is just going to be lumpy, and it's really going to come down to either a maturity date or refinancing opportunity. I think we were happy with what happened in the second quarter, but it's going to be lumpy quarter to quarter just based upon what's going on. I do think the current environment, you should be constructive or conducive to continued repayments, which we will welcome those opportunities as we continue to shrink that portfolio and move those kind of assets or capital into the lower middle market and private loan strategies.

Okay. And then maybe last one for me, Dwayne, you talked about as part of the possible take public of the MSC Income Fund converting to a simply private loan strategy. Can you talk about why just go straight to private loan and kind of lose the lower middle market piece of that?

Sure, Bryce, as you've heard us say in the past, we've been working with the MSC Income Fund Board for a while to try to determine what we collectively thought was the right long-term answer for the fund. So we've come up with something that we think is a really attractive opportunity both for Main Street, but also for the shareholders of MSC Income Fund. And when you look at our ability to produce what we think are really, really attractive returns in our private loan strategy and couple that with what we think will be a best-in-class kind of fee structure, both from a base management fee and an incentive fee structure going forward for the shareholders of MSC Income Fund, that was, from our perspective, the best way to deliver a really good long-term outcome when I say long-term, not one or two years, but 5, 10 years plus a really good outcome for the shareholders of MSC Income Fund. Well, again, at the same time, providing what we think is a really, really attractive outcome for Main Street. So we just think it's the right answer. We think it'll be something that's going to be very different than what you see from other publicly traded BDCs, given the areas that Nick and Sami and our private credit team focus on. And to be able to deliver that different asset class with best-in-class fee structure, we think that's going to be a positive outcome.

Our next question comes from the line of Mark Hughes with Truist Securities.

Yes, thank you. Good morning. What will be the impact of the listing of the external advisor on the fee income? Is there going to be any kind of near-term volatility, maybe some increased expenses or reduced fees that may have some flow-through impact, presumably in the short term? I hear what you're saying, that it will be very profitable in the long term.

Sure, Mark. So just to try and give some color to the fees, we are proposing a decrease in the base management fee from 1.75% to 1.5%, so there will be a little bit of an impact there. Obviously, long-term, if we're in position between what we're doing here at Main Street and what we do at MSC Income Fund, if we're in position to grow the assets, you should have a catalyst that goes the other direction. If we continue to have really good performance, you also get the benefit of the incentive fee. So we think there's potentially a little bit of a drag day one just with the fee going from 1.75% to 1.5%, but we think it's a minimal change, and we think it's the right answer for the long term when you look at what we think the outcome can be several years down the road with the growth of assets and growth of capital, access to debt capital markets, et cetera, the positives that should come out of the listing of the fund and the subsequent growth.

Yes, thank you. And then the markdowns related to the exposure to consumer, and you might have just addressed this a couple of minutes ago, but if there's a broader rebound of the economy, gets on a better footing, would you see the investment marks rebound there, or is it company-specific? And I'm sorry if you addressed this.

Yes, no, Mark, it's a good question. I think it's both. I mean, these companies have faced some headwinds from an industry standpoint. Clearly, that's what we've been communicating for the last couple of quarters, so that has not been a positive, but these companies also have company-specific issues or challenges that they've been working through, at least several of them do. So I think it's a combination of the two. When we look at the fair value marks going forward, you should not expect those fair value marks to rebound significantly next quarter. This will be a long-term path of us working with the portfolio companies and their management teams to figure out what the right long-term path is, and that's just going to take a while for that to play out, and it'll take a while before you see a significant improvement or recovery of fair value on those specific names.

Thank you. And this now concludes our question and answer session. I would like to turn the floor back over to management for closing comments.

I just want to say thank you again everyone for joining us this morning. And we'll look forward to talking to you again after our third quarter earnings release in early November. Thank you.

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