Main Street Capital (NYSE:MAIN) Q4 2023 Earnings Conference Call February 23, 2024 10:00 AM ET
Company Participants
Zach Vaughan – Dennard Lascar, Investor Relations
Dwayne Hyzak – Chief Executive Officer
David Magdol – President and Chief Investment Officer
Jesse Morris – Chief Financial Officer and Chief Operating Officer
Conference Call Participants
Robert Dodd – Raymond James
Bryce Rowe – B. Riley Securities
Mark Hughes – Truist Securities
Eric Zwick – Hovde Group
Operator
Greetings, and welcome to the Main Street Capital Corporation Fourth 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. [Operator Instructions] 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, Mr. Vaughan. You may begin.
Zach Vaughan
Thank you, Operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation’s fourth quarter 2023 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 fourth 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 March 1. 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, February 23, 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.
Dwayne Hyzak
Thanks, Zach. Good morning, everyone, and thank you for joining us. We appreciate your participation in this morning’s call. We hope that everyone is doing well. On today’s call, I will provide my usual updates regarding our performance in the quarter, while also providing a few updates on our performance for the full-year. I’ll also provide 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 first quarter of 2024, after which we’ll be happy to take your questions.
We’re extremely pleased with our fourth quarter results, which closed another record year for us. Our fourth quarter performance resulted in a new quarterly record for NII per share, DNII per share equal to our existing quarterly record that we achieved earlier this year, a new record for NAV per share for the sixth consecutive quarter, and an annualized return on equity of approximately 23% for the quarter. Our performance in the fourth quarter continued our positive performance in the first three quarters of 2023, and resulted in new annual records for NII per share and DNII per share, and a return on equity of approximately 19% for the year.
These positive results demonstrate the continued and sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies, the unique contributions of our asset management business, and the continued underlying strength and quality of our portfolio companies. We are further pleased we were able to generate these returns while intentionally maintaining a conservative capital structure and liquidity position during 2023. The continued positive momentum across our platform during 2023 allowed us to deliver significantly increased value to our shareholders, with a 25% increase in the total dividends paid to our shareholders in 2023.
Despite this significant increase, our DNII still exceeded the total dividends paid to our shareholders by over 17%. In addition to these record-breaking results, with the continued support from our long-term lender relationships and the benefits of our recent investment-grade debt offering, in January, we entered the New Year with a strong liquidity position and a conservative leverage profile, and are excited about the prospects for significant growth in both our lower middle market and private loan investment strategies. We appreciate the hard work and efforts of the management teams and employees at our portfolio companies, and continue to be encouraged by the favorable performance of the companies in our diversified lower middle market and private loan investment strategies.
We 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. These positive results combined with our favorable outlook for the first 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 due to several factors, including the impact of the net fair value increases in our investment portfolio, the accretive impact of our equity issuances, and our retention of the excess NII above our dividends paid.
The continued favorable performance of certain of our lower middle market portfolio companies resulted in strong dividend income contributions in another quarter of significant fair value appreciation in the equity investments in those portfolio companies. As we look forward to the next few quarters, we remain excited about our expectations for our lower middle market portfolio companies, and the opportunity for continued dividend income and additional fair value appreciation from this portfolio in the future.
Our lower middle market investment activity in the fourth quarter returned to levels consistent with our normal expectations, with new investments of $92 million in the quarter, including investments totaling $68 million in two new portfolio companies, and resulting in a net increase of $66 million after repayments and other investment activity. Our private loan investment activities in the quarter included new investments of $160 million, which together with higher than expected repayment activity in the quarter, resulted in a net decrease in our private loan investments of $113 million. We’ve also continued to produce attractive results in our asset management business.
The fund we advise through our external investment manager continue to experience favorable performance in the fourth quarter, resulting in significant incentive fee income for our asset management business for the fifth consecutive quarter, and together with our recurring base management fees, a significant contribution to our net investment income. We also benefited from significant fair value appreciation in the value of the external investment manager due to a combination of increased fee income, growth in assets under management, and broader market-based drivers. We remain excited about our plans for the external funds that we manage as we execute our investment strategies and other strategic initiatives.
And we are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund. We also remain optimistic about our strategy for growing our asset management business within our internally managed structure, and increasing the contributions from this unique benefit to our Main Street stakeholders. As part of this growth strategy, we’re happy to update that we’ve made continued progress with the fundraising activities on our second private loan fund, and we look forward to the continued growth of this new fund over the next few quarters, and the related additional recurring base management fees and incentive fee opportunities.
Based upon our results for the fourth 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 March, representing our 10th consecutive and largest to date quarterly supplemental dividend. Our Board also declared regular monthly dividends for the second quarter of 2024, of $0.24 per share, payable on each of April, May, and June, representing a 6.7% increase from the second quarter of 2023. The supplemental dividend for March is a result of our strong performance in the fourth quarter, which resulted in DNII per share which exceeded our regular monthly dividends paid during the quarter by $0.42 per share or 59%.
The March 2024 supplemental dividend will result in total supplemental dividends paid during the trailing 12-month period of $1.075 per share, representing an additional 39% paid to our shareholders in excess of our regular monthly dividends, and implying a current total yield to our shareholders of approximately 9%. After multiple increases to our monthly dividends during 2023, and the significant supplemental dividend paid in December, our DNII per share for the fourth quarter still exceeded our total dividends paid by $0.14 per share or 14%.
We are pleased to be able to deliver this significant additional value to our shareholders, while still conservatively retaining a portion of our excess earnings to support our capital structure and investment portfolio against the risks associated with the current continued general economic uncertainty, and to further enhance the growth of our NAV per share. As we’ve previously mentioned, we currently expect to recommend that our Board 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 first quarter, we currently anticipate proposing an additional supplemental dividend payable in June, 2024.
Now turning to our current investment pipeline, as of today, I would characterize our lower middle market investment pipeline as average. Despite the current board economic uncertainty, we expect to continue to be active in our lower middle market strategy. Consistent with our experience in prior period of broad economic uncertainty, we believe that the unique and flexible financing solutions that we can provide to our lower middle market continues and their owners and management teams, and our differentiated long-term to permanent holding periods should be an even more attractive solution in the current environment, and should result in very attractive investment opportunities.
We are excited about these new investment opportunities. And we expect that our current pipeline will be helpful as we work to maintain our positive momentum from 2023 into the future. We also continue to be very pleased with the performance of our private credit team and the results they have provided for our private loan portfolio and our asset management business. And as of today, I would characterize our private loan investment pipeline as average.
With that, I would turn the call cover to David.
David Magdol
Thanks, Dwayne, and good morning, everyone. Each yearend provides a good opportunity to look back at our history and highlight the results of our unique and diversified investment strategies and discuss how these strategies have enabled us to deliver attractive returns to our shareholders over an extended period of time. Since our IPO in 2007, we have increased our monthly dividend per share by 118%. And we have declared cumulative total dividend for shareholders of $40.56 per share or over 2.7 times our IPO price of $15 per share.
Our total return to shareholders since our IPO calculated using our stock price as of yesterday’s close and assuming reinvestment of all dividends received since our IPO, was 11 times money invested. This compares very favorably to the 3.4 times money invested for the S&P 500 over the same period of time, and is significantly higher when compared to other BDCs. As we previously discussed, we believe that the primary drivers of our long-term success have been and will continue to be our focus on making both debt and equity investments in the underserved lower and middle market supporting our private credit activities to the benefit of our stakeholders and for the clients of our asset management business which also benefits our stakeholders, our internally managed structure which allows us to maintain an industry-leading cost structure and a strong alignment of interest between our employees and our shareholders as a result of team’s meaningful stock ownership.
Most notably and uniquely, our lower middle market strategy provides attractive leverage points and income yields on our first linen debt investments are also creating a true partnership with the management teams and other equity owners of our portfolio companies through our flexible and highly aligned equity ownership structures. This approach provides significant downside protection through our first lien debt investments and preferred equity positions while still providing the benefits of alignment and significant upside potential through these equity investments which we make alongside our portfolio company management team partners.
Main Street’s long-term historical track record of investing in a lower middle market coupled with our view that this market continues to underserved, gives us confidence that we will be able to continue to find attractive new investment opportunities in this primary area of investment focus for our business.
Our ability to provide highly customized and differentiated capital solutions for the predominately family-owned businesses that exist in the lower middle market has been and continues to be a strong differentiator for us. In 2023, Main Street invested $301 million in our lower middle market strategy. A $197 million of this capital was deployed in six new lower middle market platform companies with the remaining $104 million predominately representing follow-on investments in existing, seasoned, and well-performing lower middle market companies.
Consistent with our comments in prior quarters, these follow-on investments were made to support the growth strategies in some of our highest performing portfolio companies, which makes this aspect of our lower middle market investment activity very exciting for us. Our follow-on investments are typically used to support multiple objectives including acquisitions, product or geographic expansion opportunities, and recapitalization transactions.
Most importantly, these follow-on investments support proven management teams that we believe intrinsically pose less investment risk when compared to providing capital to new portfolio companies. Since we are significant equity owners in our lower middle market companies, we benefit from participating alongside the proven managers needs businesses as they strive to achieve meaningful equity value creations.
As we have stated in the past as our lower middle market portfolio companies perform over time, they naturally deleverage with free cash flow generated from operations. This allows us along with our lower middle market portfolio management team partners to benefit from a larger portion of the portfolio company’s cash flow after debt service which can be available for distributions to the equity owners.
Given the strength and quality of our lower middle market portfolio and the long-term holding period for many of our companies, we expect dividend income to continue to be significant contributor to our results in 2024. Additionally, this deleveraging coupled with the attractive overall strong underlying operating results of our lower middle market portfolio companies allowed us to keep $72 million in net fair value appreciation in 2023 to the lower middle market portfolio.
This benefit from our lower middle market equity investments is unique among BDCs with our fair value appreciation available to offset losses which we will naturally incur in our investment strategies given the fact that we are investing in non-investment grade asset classes. Our unrealized equity appreciation also provides potential upside to Main Street’s net asset value that the investment strategies of other BDCs simply do not have. The last important area I’d like to cover regarding our 2023 accomplishments are the impressive contributions that our private credit team delivered during the year.
Our private credit team continued to execute on our strategy to dedicate significant resources towards growing the private loan segment of our business while deemphasizing our middle market portfolio, which, as a reminder, includes investments in larger syndicated loans.
Our purposeful and intentional strategic shift over the last six years to grow our private loan portfolio is primarily driven by our belief that an attractive and growing direct lending environment exists and that the private loan investments provide a very attractive risk-adjusted return profile for Main Street and for the clients of our asset management business.
During 2023, Main Street invested $507 million in our private loan strategy while decreasing our middle market portfolio by 27% on a cost basis. As a result of these investment activities during the year, our private loan portfolio represented 39% of our total investments at cost at year end, and our middle market portfolio declined by 300 basis points to represent only 8% of our total investments at cost.
As Dwayne discussed earlier, our private loan capabilities also support our key strategic objective to continue to grow our asset management business. As of December 31st, we had investments in 190 companies spanning across more than 50 different industries. Our largest portfolio companies, excluding the external investment manager, represented only 3.7% of our total investment income for the year and 3.5% of our total investment portfolio fair value at year end. The majority of our portfolio investments represented less than 1% of our income and our assets.
Now, turning to our investment activity in the fourth quarter, we made total investments in our lower middle market portfolio of $92 million, including investments of $68 million in two new lower middle market portfolio companies, which after aggregate repayments on debt investments and return of invested equity capital and a decrease in cost basis due to a realized loss, resulted in a net increase in our lower middle market portfolio of $66 million.
During the quarter, we also completed $160 million in total private loan investments, which after aggregate repayments and sales of debt investments and a decrease in cost basis due to a realized loss, resulted in a net decrease in our private loan portfolio of $113 million.
Finally, during the quarter, we had a net decrease in our middle market portfolio of $50 million as a result of our continued focus to de-emphasize this strategy and portfolio. At year-end, our lower middle market portfolio included investments in 80 companies, representing $2.3 billion of fair value, which is 27% above our related cost basis. We had investments in 87 companies in our private loan portfolio, representing $1.5 billion of fair value.
In our middle market portfolio, we had investments in 23 companies, representing $244 million of fair value. The total investment portfolio at fair value at year-end was 15% above our related cost basis. Additional details in our investment portfolio at year-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.
Jesse Morris
Thank you, David. To echo Dwayne’s and David’s comments, we are pleased with the operating results for the fourth quarter, which included a number of quarterly records and capped a year in which Main Street achieved records for distributable net investment income and net asset value, each on a per share basis. Our total investment income for the fourth quarter was $129.3 million, increasing by $15.4 million or 13.6% over the fourth quarter of 2022, and by $6.1 million or 4.9% from the third quarter of 2023.
The positive momentum we experienced during the first three quarters continued in the fourth quarter and culminated in a year with strong levels of interest, dividend, and fee income, which again demonstrated the continued strength of our differentiated investment and asset management strategies. The fourth quarter included elevated levels of certain income considered less consistent or nonrecurring in nature, including dividends from our equity investments and accelerated prepayment, repricing, and other activity related to our debt investments. In the aggregate, these items totaled $5.3 million and were comparable to the average of the prior four quarters were 1.1 million higher than such items in the fourth quarter of 2022 and 4.7 million higher than the third quarter of 2023.
Interest income increased by $14.4 million from a year-ago, and $1.3 million over the third quarter. The increase over the prior year was driven primarily by increases in benchmark index rates, net investment activity and $2.3 million in increased accelerated OID income. The increase over the third quarter was primarily driven by $3.1 million increase in accelerated OID income, partially offset by decreased levels of interest bearing debt investments at quarter end as a result of elevated levels of repayments, offsetting new and follow-on investments.
Dividend income increased by $1.4 million or 6.1% over a year ago, including a $1.2 million decrease in unusual or nonrecurring dividends and increased by $2.6 million or 12.2% from the third quarter, including a $0.5 million increase in unusual or nonrecurring dividends. The increases in dividend income are a result of the continued underlying strength of our portfolio companies and the benefits from our asset management business. Fee income was comparable to a year ago and increased by $2.2 million from the third quarter driven by closing fees resulting from an increased investment activity and our lower middle market investment strategy and increased prepayment fees driven by repayment activity in our private loan portfolio.
Prepayment and other fee income considered nonrecurring was comparable to a year ago and increased by $1.2 million from the third quarter of 2023. Our operating expenses increased by $1.2 million over the fourth quarter of 2022, largely driven by increases in interest expense and compensation related expenses, partially offset by an increase in expenses allocated to the external investment manager. The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, was 1.3% for both the quarter on an annualized basis and the year 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 fourth quarter, an increase of $2.2 million from the same quarter a year ago, which resulted in a total of $33.4 million for the year, representing an increase of $11.1 million or 50% over the prior year. The manager earned $3.8 million in incentive fees during the quarter and $13.4 million for the year, increasing by $1.4 million and $10.9 million respectively over the same periods in the prior year as a result of the positive performance of the assets under management.
The manager ended the quarter with total assets under management of $1.5 billion. During the quarter, we recorded net fair value appreciation, including net realized losses and net unrealized appreciation on the investment portfolio of $48.2 million. This increase was driven by net appreciation across each of our investment strategies, largely driven by the continued positive performance of certain of our portfolio companies and the impact from changes in market spreads.
The increase in the fair value of our external investment manager was a result of a combination of increases in the fees generated by the external investment manager and the valuation multiples of publicly traded peers, which we use as one of the benchmarks for evaluation purposes.
We ended the fourth quarter with investments on non-accrual status comprising approximately 0.6% of the total investment portfolio fair value and approximately 2.3% of costs. Net asset value or NAV increased by $0.87 per share over the third quarter and by $2.34 or 8.7% when compared to a year ago to a record NAV per share of $29.22 at year end. Our regulatory debt-to-equity leverage calculated as total debt excluding our SBIC debentures divided by net asset value was 0.59 and our regulatory asset coverage ratio was 2.69, both intentionally more conservative than our long-term target ranges of 0.8x to 0.9x and 2.1x to 2.25x.
During the fourth quarter, we expanded our total commitments under the SPB facility from $255 million to $430 million and raised $38 million from equity issuances under our aftermarket program. In January of this year, we issued $350 million of unsecured notes with a coupon rate of 6.95%, maturing in March 2029 and utilized the proceeds to repay outstanding borrowings under our credit facilities. We currently intend to fund the repayment of our May 2024 notes at maturity, primarily through borrowings under the credit facilities.
After giving effect to the capital activities in 2023, the issuance of the March 2029 notes and the upcoming repayment of our May 2024 notes, we entered 2024 with strong liquidity including cash and availability under our credit facilities in excess of $1 billion. We continue to believe that our conservative leverage, strong liquidity and continued access to capital are significant strengths that have us well positioned for the future and allow us to continue to execute our investment strategy and growth of our investment portfolio.
With this current level of liquidity, we 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 increase during the course of the year. However, we expect to continue to operate through the year at leverage levels more conservative than our long-term targets.
Coming back to our operating results, as a result of our strong performance for the quarter and year, our return on equity for the fourth quarter was 22.9% on an annualized basis and 18.8% for the year. DNII per share for the quarter of $1.12 exceeded the DNII per share for the fourth last year by $0.09 or 8.7% and exceeded the DNII per share for the third quarter by $0.08 or 7.7%. The combined impact of certain investment income considered less consistent are non-recurring in nature on a per share basis was comparable to the average of last four quarters, $0.01 per share above the same quarter a year ago and $0.06 per share above the third quarter.
For the year, these items were $0.15 per share above 2022 levels. DNII per share for the quarter exceeded total regular monthly dividends per share paid to our shareholders in the fourth quarter by $0.415 per share or approximately 59%. Total dividends paid for the year were $3.695 per share, including $0.95 per share in supplemental dividends, an increase of 25% over our total dividends paid during 2022.
This week, our board approved a supplemental dividend of $0.30 per share payable in March 2024. With the supplemental dividend, total declared dividends for the first quarter of 2024 were $1.02 per share, representing a 4.1% increase over the total dividends paid in the fourth quarter of 2023 and a 20% increase over the total dividends paid in the first quarter of last year.
As we look forward, given the strength of our underlying portfolio, we expect another strong top line and earnings quarter in the first quarter of 2024 with expected DNII of at least $1.06 per share with the potential upside driven by the level of dividend income and portfolio investment activities during the quarter and we would also expect that we would recommend to our board that it declare another supplemental dividend in the second quarter.
With that, I will now turn the call back over to the operator so we can take any questions.
Question-and-Answer Session
Operator
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Robert Dodd
Hi, guys. Congratulations on the quarter. First question on the asset management business, and I mean, the largest contributor to that is still MSE Income Fund. Can you give us any update on your thought process regarding that business? You don’t control it, but in terms of how shareholders there might end up with liquidity? The question there is, I think, you’ve discussed it before, one of the possibilities eventually could be a fee cut there in connection with other things. Do you think that’s a likely or unlikely event during 2024 that the fee structure and the financial relationship there could change, or is that if anything happens there, it’s longer term?
Dwayne Hyzak
Sure, Robert, thanks for the question. I would say on MSC Income Fund, like you’ve heard us say before, we’re obviously the advisor there, but the Board of MSC Income Fund will have a huge part in determining what the outcome is there. We are encouraged by some of the more recent activity here, in 2024, with several funds going public through new IPOs. Obviously that’s an opportunity from a space or an industry standpoint that hasn’t been there for the last couple of years, so it’s very encouraging to see that activity. And we will be having conversations with the MSC Income Fund Board about that activity in our next Board Meeting to contemplate what it may mean for MSC Income Fund.
To your point on fees, I do think that the market, as evidenced by these more recent IPOs, has been requiring a lower base management fee than what we currently charge to MSC Income Fund. I will remind you that the strategy for MSC Income Fund is consistent with Main Street’s, so it can — it includes a accommodation of private credit, private loan activities that is more consistent with what you see from most others in the BDC industry, but it also includes a health amount of lower middle market investment activity that we think is more akin or more consistent with a private equity investment strategy that would warrant, in the marketplace, a higher fee structure, both on the base annual fee as well as the incentive fee.
So, I think the conclusion on the fee will be driven by our conversations with the MSC Income Fund Board, what the market would tell us if there was a desire to seek an IPO or another liquidity event. And then how we look at the overall composition of that portfolio today, and what we think the composition would be going forward, that those would be drivers of what we think happens long-term with the fee structure.
Robert Dodd
Got it, I appreciate that color. Thank you. Changing track completely, you mentioned the low middle market pipeline is average. It is an election year. It’s possible the White House could [technical difficulty] Senate, House, everything could flip. There are currently tax rules that sunset in ’25. Any of the — because a lot of what you do there is assisting in tax planning option for people looking to transition, do you think the — it being an election year and potential tax flow changes, do you think that’s going to have an effect on the lower middle market business’ demand and pipeline and maybe in the second-half of the year?
Dwayne Hyzak
Yes, Robert, I’d say it’s always hard to predict what impacts activities in Washington, whether it’s an election or tax rate changes or other changes, it’s really hard to predict what those activities, what impact they’ll have on lower middle market activity. We can make arguments for those types of activities driving increased demand for individual owner-operators, families or partners that own a business, could drive them to be more active or have a stronger desire for a transaction. But it could also result in more uncertainty in the marketplace and a view that if someone goes to market they’re not going to realized full valuation, so they may be more compelled to wait until after an election or after any of those changes take place to see what the impact on the marketplace is.
As you’ve heard us say in the past, we do think that what we provide from a financing standpoint and a partnership standpoint to our lower middle market companies is very, very different. We think the solution can and should be and, in the past, has been applicable to all types of markets, whether it’s a very good productive market or if it’s a market that’s got more uncertainty, whether that’s economic uncertainty, tax rate change uncertainty or political uncertainty. So, we continue to be confident that our lower middle market strategy will be applicable in all those markets. But it’s really hard to predict what happens in Washington and what impact that’ll have on overall deal flow activity, and specifically deal flow activity in the lower middle market strategy.
David, I covered a lot. I don’t know if you would add anything to that?
David Magdol
Yes, all I’d add is that, Robert, when we think about the landscape, it’s — yes, the election has an impact on outcome, as does last year when we had rising interest rates and concerns about visibility towards that. So, we always have some — various environmental issues that we’re looking at any one moment in time. But I’d say that interest rates stabilizing a bit as they have probably has a positive impact that might — we are hoping will offset any concerns relative to election year.
Robert Dodd
Got it. Thank you for the color. And then one more if I could sneak one in. To that point with stabilizing interest rates, you indicated you’re planning to take up leverage somewhat this year. I mean you’ve been running it intentionally low, still producing high returns. But is the indication that you expect leverage to drop, is that an indication of comfort that you just feel better about the interest rate environment where the economy is, or if there’s some other factor that drove that decision to maybe increase leverage a little bit from the low level currently?
Dwayne Hyzak
Sure, Robert. As you’ve heard us say in the past, we’ve always viewed our ability to produce shareholder returns is driven more based upon investment strategy and our approach to the marketplace, and less on financial engineering through leverage. So, we’ve always wanted to and have always consistently maintained a very conservative leverage profile and a significant liquidity position. And we don’t expect that to change going forward, whether that’s in 2024 or any time after that. We have been intentionally more conservative for the last 12 months or so, and that was really less driven by the overall economy or other kind of portfolio-related issues, and more based upon the fact that we had a May of 2024 — have a May of 2024 maturity, that we wanted to create maximum flexibility to deal with that.
And obviously we’ve dealt with that here in the first part of 2024, with the new unsecured debt issuance. I’d say that pressure is a lot less than it would have been over the last 12 months. So, that that would really be the driver for us taking leverage up some, but still being conservative and still likely ending the year below our leverage targets.
Robert Dodd
Got it, thank you.
Dwayne Hyzak
Thank you.
Operator
Thank you. Our next question, it comes from the line of Bryce Rowe with B. Riley Securities. Please proceed with your question.
Bryce Rowe
Thanks a bunch. Good morning.
Dwayne Hyzak
Morning.
Bryce Rowe
Hey, Dwayne, just maybe a follow-up to some of Robert’s questioning around the external manager. I know you all, in the pretty recent past, have run some tender processes to try to give those particular shareholders some liquidity. Have you continued to do that here at the end of 2023?
Dwayne Hyzak
Yes, Bryce, to your point, we have introduced that over the last 12 months, and continue to be active in providing liquidity options to the shareholders of MSC Income Fund. Those liquidity options have been through the consistent quarterly redemption that is funded by the fund’s DRIP proceeds. And then we’ve added the Dutch auction that I think we’re now on our — or we’re executing our fourth iteration of that. So, we think those activities have been productive. We continue to think it’s a good activity for us to try and provide additional liquidity options for those shareholders who have a heightened need or desire for liquidity.
So, that was the intent or the goal behind those activities, and we think they’ve been successful or productivity from our perspective.
Bryce Rowe
Okay, and that’s helpful. And then as we think about the valuation, obviously you’ve seen a material increase in the external manager’s valuation in ’23, and even in the fourth quarter. And in your prepared remarks, you talked about kind of a breakdown of increased assets under management, increased fee income, and then market-based approach to that valuation. Can you help us think about what’s driving the valuation? Of those three factors, what’s the biggest factor or is it fairly well split between the three?
Dwayne Hyzak
I would say all three of those drivers are factors contributing to the increase in Q4. But if you were to go look at the publicly traded performance for asset managers, I would say that, in the fourth quarter, there was a significant increase in those valuations. And that would have been a significant contributor to the increase in our valuation in the fourth quarter. Just as a reminder, we obviously don’t use that as the only benchmark to drive our valuations, it’s one of the inputs. But it is an input, so when you see those publicly traded peers increase significantly in value; we’re going to see that come through our valuation.
Bryce Rowe
Got it, okay. You mentioned continued progress with private loan fund number two. Can you give us some numbers around that progress?
Dwayne Hyzak
Sure. So, the numbers at year-end, it was about $80 million of total LP equity commitments, so still not a huge number. But relative to where we were at this point in time on PLF, it is a significant increase. And we continue to have what we think are very productive conversations with additional LPs. So, our goal, just to remind everyone, is that we want that fund from an LP equity commitment standpoint to be somewhere between 100 and 300 — as a reminder, at $100 million and $300 million of LP equity. As a reminder PLF 1 is just over $100 million. We hope to be something north of 150 or 200 with the max being 300, and our activities over the next couple of quarters as we continue to execute the fundraising activities for that fund. They obviously will dictate how large we end up being from a LP equity commitment standpoint. And then, just as a reminder, we think the marketplace will continue to allow kind of a one-to-one debt-to-equity leverage level. So, if we’re successful at 150 million of equity, that’s 300 million of assets. Obviously, if you go up to 300 million of equity, then it’s 600 million of assets. But that’s the goal and intent. And we’ll continue to work on that as we move through the next couple of quarters.
Bryce Rowe
Got it. That’s helpful. And then, maybe last one from me, you all called out non-accrual levels, having come down quarter-over-quarter, and then also some of the realized exit activity in the lower middle market and private loan portfolios. Can you kind of — I assume those kind of marry up together with lower non-accruals being driven by some of that exit activity. If not, can you help me think about that?
Dwayne Hyzak
Sure. So, may be I’ll give a couple of comments, and if Nick, who leads our private credit activities, if he wants to add on, he can add on here. So, I would say the non-accrual activity, obviously, it’s an improvement when you look at a quarter-over-quarter. I would say we’re not super excited about it because it improved because of a realized loss in the quarter. So, most of that movement was driven by, I think, it was about a $15 million realized loss on an investment that we restructured, and it came off non-accrual in the quarter. I think the repayment activity, specifically on the private credit side, as you’ve heard us say in the past, we think we’ve got a very, very attractive, high-quality portfolio.
And despite the continued uncertainty in the marketplace, we just saw a number of names, some of which, frankly, we hadn’t even been in that long, 12 or 18 months, a number of names that had performed really, really well that either went through an M&A transaction or just went out and refinanced us with a significantly lower cost of capital from that replacement lender. So, it’s kind of — it’s good and bad. It shows the very high quality of our portfolio, but obviously you had elevated repayments, which is not good from an interest income standpoint when we look at the portfolio going forward. But Nick, I don’t know if you’d add anything to that.
Nick Meserve
Yes, Bryce. So, let me add there is most of those repayments really came in late in the quarter. And so, from an average perspective, we were where we wanted to be for the fourth quarter. And I said those names were names we had targeted to get repaid in ’24. We just moved into kind of late December, early December versus in the first or second quarter of ’24. And so, I think from where we want to be, I think we just need to spend some money here in the first quarter, we’ll be back to where the balance should be.
Bryce Rowe
Got it. I mean, I think we’ve heard on other BDC calls that the expectation is for increased activity from a prepayment perspective or repayment perspective in ’24. Do you all share that sentiment?
Dwayne Hyzak
We do. I think if you look at our total repayments on the private loan side of the business, for the first three quarters, we were, I’d say, well under average, what you’d usually see. The fourth quarter picked that up, and so for the year, we probably hit our average repayment level we’ve seen in the last decade. But we’d expect that to continue more on that average level, basically a one-third repayment rate on an annual basis.
Bryce Rowe
Got it. Okay. Thanks for taking the questions. I appreciate it.
Dwayne Hyzak
Thanks, Bryce.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.
Mark Hughes
Yes, thank you. Good morning.
Dwayne Hyzak
Good morning, Mark.
Mark Hughes
On the private loan portfolio, the assets were down in the quarter, more repayments, I think we’ve been talking about that. What’s your feeling about early 2024? Is that going to be back into the positive territory?
Nick Meserve
I appreciate the question, Mark. This is Nick. I think where we’re at to date, for the quarter, we’d be close to flat from third quarter. So, we’re up for the first quarter, and so we’d expect that to continue to grow and really be back to a flat from third quarter to up from third quarter.
Mark Hughes
Very good. And then, the follow-on investment activity, how are you seeing that trending? Is that a reasonable indicator of underlying economic health? Does that tend to — I’m sure it varies in terms of rationale. But are you seeing any trends there that are worth noting, and does it imply anything about the broader picture. Again, this is a follow-on investment activity with your existing portfolio company?
Nick Meserve
Sure, Mark. When you look at our lower middle market portfolio, you’ve heard us say this. We have a number of companies in that portfolio that have been and continue to perform very, very well. When you look at some of those companies, they also have had an increased appetite to grow through acquisitions to supplement or compound their organic growth. So, we had one portfolio company in the fourth quarter that was a meaningful follow-on.
Probably 80% or 90% of the total follow-ons were in that one portfolio company that executed what we think is a highly attractive, very strategic acquisition. If you look at the pipeline today, one of the things that makes us feel good about that investment pipeline is that we have a number of companies, multiple companies in the low and middle market portfolio, again, most of them being in the upper end of our portfolio from a performance standpoint, that are actively executing on acquisition opportunities that would require additional debt financing for Main Street. We expect those to close in the fourth quarter, but obviously there’s a lot of pieces that have to come into place that we don’t always control in order for that to happen, but we’re encouraged by that activity. And if we’re successful there, we think it will benefit us significantly in Q1, but even more importantly over the next 12 or 24 months as we really see the benefits of those acquisitions flow through the portfolio company’s results and are fair value changes and hopefully additional dividend income in the future.
Mark Hughes
And then, the external investment manager, assuming things go as they have been and there’s no material change. You described a 50% increase in the positive impact on NII. With what you have in line of sight, can you give us some sense of what the marginal effect is going to be here in 2024?
Dwayne Hyzak
Mark, I may not have fully followed your question. Can you give me a little more detail on what you’re looking for?
Mark Hughes
Yes, just the NII impact from the external investment manager. I think you said it was up. You went from 22 million to 33 million in 2023, if I heard that properly.
Dwayne Hyzak
Yes.
Mark Hughes
I was just trying to get some sense of how you think that’s going to trend in 2024.
Dwayne Hyzak
Sure. Thanks, Mark. And I apologize, I want to make sure I answered the question correctly on our side. So, if you look at 2023 as a whole and just give you kind of the highs and lows from a quarterly NII contribution standpoint, the low was just over $7.5 million. The high was $9.2 million, which that high was in the fourth quarter. The variability quarter-to-quarter is really driven by the incentive fees. Probably not a big surprise, the base management fees, one of the reasons we find the asset management business so attractive is those base management fees don’t really move much quarter-to-quarter. Obviously, as we grow additional clients and we grow additional AUM, they will move over time, but quarter-to-quarter, they just don’t move that much.
So, the real driver, the real volatility is all driven by the incentive fees. So, to the extent we continue to have favorable performance, you heard Jesse’s comments about our expectations at Main Street for the first quarter. As I said earlier, there is a lot of overlap between our portfolio and MSC Income Fund’s portfolio. It is not 100%, but you can apply a little bit of a read-through from our results and our expectations to MSC Income Funds.
So, given that, we expect MSC Income Fund to continue to perform well and continue to generate positive contributions to us from an incentive fee standpoint. But the real productivity or growth year-over-year versus that $33 million number that you referenced is really going to be more dictated by the incentive fee coming off the performance of not just MSC Income Fund, but also the private loan funds that we manage. Our ability to continue to produce positive results there is going to really be the driver of that outcome.
Mark Hughes
Great. Thank you.
Dwayne Hyzak
Thank you.
Operator
Thank you. Our next question comes from the line of Eric Zwick with Hovde Group. Please proceed with your question.
Eric Zwick
Good morning, everyone. Just one question for me this morning, given the fact that both the Fed and the futures market are projecting declines in short-term interest rates at some point during 2024, obviously the timing and magnitude remain up for debate. But I’m wondering, can you provide an update on your interest rate sensitivity, maybe in terms of the potential impact to DNII per share for each 25 basis point reduction?
Dwayne Hyzak
Sure, Eric. Thanks for the question, and thanks for joining us this morning. We, like other — I think all the other BDCs, you’ll provide what we think is a pretty granular table, both in our SEC filings and in our investor presentation. So, you’ll see that when we post all that later this morning. But in general, we have historically and continue to view our position to be a little less sensitive than other BDCs as purely attributable to the fact that our lower middle market strategy is predominately fixed rate as opposed to floating whereas most the spaces as you know is a 100% if not 100% or close to 100% floating.
So, we do think we have a little bit less sensitivity. So, we’ve — you are not seeing the same benefits that this space may have seen over the last 12 or 18 months. But, if rates come down, we should see less of an impact going forward. But for your benefit, if you look at our portfolio and our obligations of 12/31/2023, so as of yearend a 25 basis point change would be just over $0.04 a year.
I think it’s about $0.045. So, if you look at that and annualize it, you kind of get $0.18 a year. Just remember that assumption is a very, very aggressive calculation because it assumes those rate change day one of the year. Obviously given the curve as you know, that wouldn’t happen. And in practice, it also likely wouldn’t happen. It will happen kind of on a curve basis over the balance of the quarter and the year. So, the impact will likely be lower than that. But that’s the best way that we and I think the other BDCs have been able to deliver that interest rate sensitivity historically and continue to provide it today.
Eric Zwick
Great. Thanks, Dwayne. I appreciate the color. That’s all from me today.
Dwayne Hyzak
Thank you, Eric. Appreciate it.
Operator
Thank you.
Dwayne Hyzak
I think guys that would be the last question there. So, again, we appreciate everyone’s participation. I really appreciate the questions. We love responding to questions. So, we appreciate the individuals that joined and asked us questions. And, we’ll look forward to talking to everyone again in May after our first quarter 2024 results are released.
Operator
And ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines. And have a wonderful day.
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