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…

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…

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…

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…

[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.