Main Street Capital (MAIN) Q4 2024 Earnings Call Transcript

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Main Street Capital (NYSE: MAIN)
Q4 2024 Earnings Call
Feb 28, 2025, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Main Street Capital fourth 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 Zach Vaughan. Thank you. You may begin.

Zach Vaughan -- Investor Relations

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's fourth 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 Ryan Nelson, chief financial officer. Also participating in the Q&A portion of the call are Jesse Morris, chief operating officer; and 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 and full year 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 7th. Information on how to access the replay was included in yesterday's release.

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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 28, 2025. And therefore, you are advised that the 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 noncash 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 noncash 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. Now, I'll turn the call over to Main Street CEO, Dwayne Hyzak.

Dwayne Louis Hyzak -- Chief Executive Officer

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 is doing well. On today's call, I will provide my usual updates regarding our performance in the fourth 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 Ryan will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and liquidity, and our expectations for the first quarter of 2025. After which, we'll be happy to take your questions. We are extremely pleased with our fourth quarter results, which closed another great year for Main Street, as highlighted by a record annualized return on equity of 25.4% for the quarter.

Our positive performance in all four quarters for the year resulted in a return on equity of 19.4% for the full year, strong levels of NII per share and DNII per share to fund our record level of annual shareholder dividends, and a new record for NAV per share for the 10th 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, the unique contributions of our asset management business, and the continued underlying overall strength and quality of our portfolio companies. Our continued positive performance allowed us to increase our total dividends paid to our shareholders in the fourth quarter by 6% over the prior year, resulting in an 11% increase for the full year. This allowed us to continue our trend of increasing the dividends paid to our shareholders over the last few years while also continuing to generate DNII per share, which exceeds the total dividends paid to our shareholders.

We continue to be encouraged by the favorable overall performance of the companies in our diversified lower middle market and private loan investment portfolios and remain confident that these strategies, together with the benefits of our asset management business, our significant available liquidity, 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 will 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, including the benefit in the quarter from the largest realized gain in our firm's history and the continued benefits from our asset management business. Ryan will discuss our NAV per share increase in more detail.

The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of strong dividend income contributions and significant net fair value appreciation in our lower middle market equity investments. The realized gain that I referenced was a $54 million realized gain on the exit of our equity investment in Pearl Meyer, which we believe is a great example of the unique benefits of our lower middle market investment strategy and which resulted in significant benefits for Main Street and our Pearl Meyer management team partners. The benefits for Main Street included significant dividend income, fair value appreciation, and the realized gain, resulting in best-in-class returns on our equity investment, in addition to the attractive interest income provided by our debt investments. This highly attractive investment also highlights one of the biggest benefits we provide to our portfolio companies through our lower middle market investment strategy, which is the ability of our portfolio companies to execute significant growth through acquisitions with the acquisitions funded 100% by debt financing from Main Street, thereby allowing the management team to execute significant value creation without experience dilution of their existing ownership percentage.

We continue these types of value-creating activities in the fourth quarter and are excited about the follow-on investments we made to finance strategic acquisitions by three 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 provide the opportunity for additional future fair value appreciation, in addition to providing us the highly attractive incremental debt investments in these high-performing portfolio companies. Consistent with my comments over the last few quarters, we also continue to see increased interest from potential buyers in certain portfolio companies that could lead to favorable realizations over the next few quarters, further highlighting the strength and quality of our portfolio companies. Our lower middle market investment activity in the fourth quarter included total investments of $168 million, including investments totaling $116 million in two new portfolio companies, which, together with the elevated repayment activity in the quarter, primarily due to the Pearl Meyer exit, resulted in a net increase in our lower middle market investments of $11 million.

Our private loan investment activities in the quarter included total investments of $108 million, which, after repayments and other investment activity, resulted in a net increase in our private loan investments of $7 million. We've also continued to produce favorable results in our asset management business. The funds we advised through our External Investment Manager continued to experience favorable performance in the fourth quarter, resulting in significant incentive fee income for our asset management business for the ninth consecutive quarter and, together with our recurring management fees, a significant contribution to our net investment income. We also benefited from significant fair value appreciation in the value of our External Investment Manager due to a combination of the continued increase in 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 explore 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 and about our strategy for growing our asset management business within our internally managed structure. As part of our efforts to grow our asset management business, we are very pleased that in late January, MSC Income Fund, a BDC advised by our External Investment Manager and our largest asset management business initiative, successfully completed a listing on the New York Stock Exchange and a public equity offering, in which the fund raised net equity proceeds of $91 million. We were very pleased with the listing and equity offering, which resulted in the fund being able to accelerate the timing and increase the size of the offering. We are very excited about our future plans for MSC Income Fund and believe that the fund's listing and equity offering, along with the transition of its investment strategy and investment portfolio to be solely focused on co-investing with Main Street and our private loan investment strategy, provides the fund the ability to continue to provide its shareholders with a very attractive source of recurring dividend income and attractive total shareholder returns and also provides significant future benefits to Main Street through the opportunity to grow the asset management fees that our External Investment Manager receives from the fund as it executes its growth plans.

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 14th consecutive quarterly supplemental dividend; and regular monthly dividends for the second quarter of 2025 of $0.25 per share, payable in each of April, May, and June, representing a 4% increase from the second quarter of 2024. The supplemental dividend for March is a result of our strong performance in the fourth quarter and will result in total supplemental dividends paid during the trailing 12-month period of $1.20 per share, representing an additional 41% paid to our shareholders in excess of our regular monthly dividends. 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 continued favorable performance in the first quarter, we currently anticipate proposing an additional supplemental dividend payable in June 2025.

Now, turning to our current investment pipeline. As of today, I would characterize our lower middle market investment pipeline as average, with several new investments scheduled to close before quarter-end. We believe that the unique and flexible financing solutions that we can provide to lower middle market companies and their owners and management teams and our differentiated long-term to permanent holding periods represent an attractive solution to the needs of many lower middle market companies. And despite the current broad economic uncertainty, we are confident in our expectations for favorable 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 they have provided for our private loan portfolio and our asset management business. And as of today, I would also characterize our private loan investment pipeline as average. With that, I will turn the call over to David.

David L. Magdol -- President and Chief Investment Officer

Thanks, Dwayne, and good morning, everyone. Each year-end 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 highly attractive returns to our shareholders over an extended period of time. Since our IPO in 2007, we have increased our monthly dividends per share by 127% and we've declared cumulative total dividends to our shareholders of almost $45 per share or approximately three 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 16 times money invested.

This compares favorably to the 4.4 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 middle market; our private credit investment activities for the benefit of our stakeholders and for the clients of our asset management business; our internally managed structure, which allows us to maintain an industry-leading cost structure; and the strong alignment of interests between our employees and our shareholders as a result of our team's meaningful stock ownership. Most notably and uniquely, our lower middle market strategy provides attractive leverage points and income yield on our first-lien debt investments while 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 us significant downside protection through our first-lien debt investments and preferred equity positions while still providing the benefits of significant upside potential through our equity investments.

Main Street's long-term historical track record of investing in the lower middle market, coupled with our view that this market continues to be 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 predominantly family owned businesses that exist in the lower middle market has been and continues to be a strong differentiator for us. In 2024, Main Street invested $466 million in our lower middle market strategy. Two hundred and twenty-eight million of this capital was deployed in seven new lower middle market platform companies, with the remaining 238 million predominantly representing follow-on investments in existing and well-performing lower middle market companies.

Consistent with our comments in prior quarters, the majority of these follow-on investments were made to support 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 are made in support of proven management teams that we believe represent significantly less investment risk when compared to providing capital to new investment portfolio companies. Since we are significant equity owners in our lower middle market companies, we also benefit from participating alongside the proven manager in these businesses as they strive to achieve meaningful equity value creation.

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 distribution 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 a significant contributor to our results in 2025 and in the future. Additionally, this deleveraging, coupled with the attractive overall strong operating results from our lower middle market portfolio companies, allowed us to achieve $120 million in net fair value increases in 2024 for our lower middle market portfolio, including the largest realized gain in our firm's history.

The benefit from realized gains on our lower middle market equity investments is unique to us among our BDC peers and provides the opportunity to offset losses which will naturally incur when investing in non-investment-grade asset classes. As our lower middle market equity investments perform, they also provide us the opportunity for unrealized appreciation, which allows us to continue to grow our [Technical difficulty] which is an opportunity that the investment strategies of other BDCs simply do not have. A great example of a lower middle market equity investment that highlights the benefits of our unique investment strategy was the exit from our portfolio company Pearl Meyer that Dwayne mentioned in his remarks. We completed the exit in our investment in Pearl Meyer in the fourth quarter, which resulted in a realized gain of $54 million.

In addition to the realized gain achieved upon exit, Pearl Meyer also distributed total dividends to us of $32 million over the lifetime of our investment. As a result, on a cumulative basis, since our initial investment in April 2020 and taking the realized gain and dividends into consideration, we realized an annual internal rate of return of 69% and 7.7 times money invested return on our equity investment. Including all debt and equity investments in Pearl Meyer, Main Street realized an IRR of 33%. The last important area I'd like to cover regarding our 2024 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 toward growing the private loan segment of our business, which we believe provides a very attractive risk-adjusted return profile for us and for the clients of our asset management business. During 2024, we completed gross investments of approximately $900 million in our private loan strategy and grew the cost basis of our private loan investment portfolio by $449 million. As a result of these investment activities, our private loan portfolio represented 46% of our total investments at cost at year-end and our middle market portfolio declined to represent less than 5% of our total investments at cost. As Dwayne discussed earlier, our private loan capabilities are also the primary driver of our strategic objective to continue to grow our asset management business.

As of December 31st, we had investments in 190 portfolio companies, spanning across numerous industries and end markets. Our largest portfolio company, excluding the External Investment Manager, represented only 3.3% of our total investment income for the year and only 3.8% 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 $168 million, including investments of $116 million in two new lower middle market portfolio companies, which, after aggregate repayments on debt investments, return of invested equity capital from several equity investments, and a decrease in the cost basis due to realized losses on certain portfolio investments, resulted in a net increase in our lower middle market portfolio of $11 million. During the quarter, we also completed $108 million in total private loan investments, which, after aggregate repayments of debt investments and a decrease in cost basis due to a realized -- to realized losses on several portfolio investments, resulted in a net increase in our private loan portfolio of $7 million. At year-end, our lower middle market portfolio included investments in 84 companies, representing 2.5 billion of fair value, which is 29% above our related cost basis. We had investments in 91 companies in our private loan portfolio, representing $1.9 billion of fair value.

The total investment portfolio at fair value at year-end was 16% above our related cost basis. Additional details on 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 Ryan to cover our financial results, capital structure, and liquidity position.

Ryan Nelson -- Chief Financial Officer

Thank you, David. To echo Dwayne's and David's comments, we are pleased with our operating results for the fourth quarter, which included a number of quarterly records and capped the year in which Main Street achieved records for net investment income and distributable net investment income and net assets -- net asset value per share. Our total investment income for the fourth quarter was $140.4 million, increasing by $11.1 million or 8.6% over the fourth quarter of 2023 and by $3.6 million or 2.6% from the third quarter of 2024. The positive momentum we experienced during the first three quarters continued into 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.

Interest income increased by $9.3 million from a year ago and decreased $0.6 million when compared to the third quarter. The increase over the prior year was driven primarily by the impact of increased net investment activity over last year, partially offset by the impact of an increase in investments on nonaccrual status and a decrease in interest rates on our floating rate debt investments, primarily resulting from decreases in benchmark index rates. The decrease from the third quarter was primarily driven by the impact of decreases in interest rates on our floating rate debt investments, partially offset by an increase in net investment activity. Dividend income increased by $0.7 million or 3.1% when compared to a year ago, including a $0.2 million increase in unusual or nonrecurring dividends, and increased by $1.3 million or 5.5% from the third quarter, including a $0.3 million increase in unusual or nonrecurring dividends.

The increases in dividend income are a result of the continued underlying strength of our portfolio companies. Fee income increased by $1.1 million or 23.3% from a year ago and increased by $2.9 million or 96.6% from the third quarter of 2024. The increase in fee income from the prior year was primarily driven by higher closing fees on new and follow-on investments, partially offset by a decrease from accelerated amortization and an exit prepayment and amendment fees, driven by investment activity. The increase in fee income over the third quarter was primarily driven by higher closing fees on new and follow-on investments during the fourth quarter and increased prepayment and amendment fees, driven by investment activity.

Prepayment and other fee income considered nonrecurring decreased by $0.2 million compared to a year ago and increased by $1.1 million compared to the third quarter of 2024. The fourth quarter included reduced levels of income considered less consistent or nonrecurring in nature in comparison to the fourth quarter of 2023 and elevated levels of income considered less consistent or nonrecurring in nature in comparison to the third quarter of 2024, including dividends from our equity investments and accelerated prepayment, repricing, and other activity related to our debt investments. In the aggregate, these items totaled $3.7 million and were $1.3 million or $0.02 per share lower compared to the average of the prior four quarters or $1.6 million or $0.02 per share lower than such items in the fourth quarter of 2023, and $1.5 million or $0.02 per share higher than the third quarter of 2024. Our operating expenses increased by $10.9 million over the fourth quarter of 2023, largely driven by increases in interest rate expense and compensation-related expenses, partially offset by an increase in expenses allocated to the External Investment Manager.

The increase in interest expense from a year ago was primarily driven by an increase in average borrowings to fund a portion of growth of our investment portfolio and an increase in the weighted average rate on our debt obligations. The ratio of our total operating expenses excluding interest expense as a percentage of our total -- of our average total assets was 1.3% for the quarter on an annualized basis and for the year and continues to be among the lowest in our industry. Our External Investment Manager contributed $8.7 million to our net investment income during the fourth quarter, representing a decrease of $0.5 million from the same quarter a year ago, which resulted in a total of $34.3 million for the year, representing an increase of $1 million or 3% over the prior year. The manager earned $3.4 million in incentive fees during the quarter and $13.7 million for the year, representing a decrease of $0.5 million and an increase of $0.3 million, respectively, over the same periods in the prior year.

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 $80.8 million. This increase was driven by net fair value appreciation in our lower middle market portfolio and our External Investment Manager, partially offset by net fair value depreciation in our private loan portfolio and certain of our other portfolio investments. 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 depreciation in our private loan portfolio was driven by the impact of specific portfolio company underperformance, partially offset by decreases in market spreads. The fair value appreciation of our External Investment Manager was a result of a combination of increases in the valuation multiples of publicly traded peers, which we use as one of the benchmarks for valuation purposes, and an increase in the fee income generated by the External Investment Manager. We ended the fourth quarter with investments on nonaccrual status comprising approximately 0.9% of the total investment portfolio at fair value and approximately 3.5% at cost. Net asset value, or NAV, increased by $1.08 per share over the third quarter and by $2.45 or 8.4% when compared to a year ago to a record NAV per share of $31.65 at year-end.

Our regulatory debt to equity leverage calculated as total debt excluding our SBIC debentures divided by net asset value was 0.64 times, and our regulatory asset coverage was 2.56 times. And these ratios continue to be more conservative than our long-term target ranges of 0.8 to 0.9 times and 2.1 to 2.25 times, respectively. Given our current liquidity position, we were less active during the fourth quarter in our at the market, or ATM, program, raising net proceeds of $8.9 million from equity issuances. After giving effect to the capital activities in 2024, we entered 2025 with strong liquidity, including cash and availability under our credit facilities in excess of $1.4 billion with one near-term debt maturity of $150 million in December of 2025.

We continue to believe that our conservative leverage, strong liquidity, and continued access to capital are significant strengths that are proven to benefit us historically and have us well positioned for the future, allowing us to continue to execute our attractive investment strategies. As discussed last quarter, with this current level of liquidity, we currently expect to fund our new net investment activity in 2025 through a greater portion of debt financing. And as such, we would expect leverage to continue to increase during this time to be closer to our long-term stated targets. However, we expect to continue to operate throughout 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 25.4% on an annualized basis and 19.4% for the year. DNII per share for the quarter of $1.08 decreased from DNII per share for the fourth quarter of last year by $0.04 or 3.6% and exceeded DNII per share for the third quarter by $0.02 per share or 1.9%. The combined impact of certain investment income considered less consistent or nonrecurring in nature on a per-share basis was $0.02 per share below the average of the last four quarters, $0.02 per share below the same quarter a year ago, and $0.02 per share above the third quarter. For the year, these items were $0.05 per share below 2023 levels.

Looking forward, we expect headwinds on top-line earnings related to the decrease in floating market index rates, but given the strength of our underlying portfolio, we expect another strong earnings quarter in the first quarter of 2025, with expected DNII of at least $1.05 per share, with potential for upside, driven by 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.

Questions & Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator instructions]Our first questions come from the line of Robert Dodd with Raymond James. Please proceed with your questions.

Hey, Robert, can you check if you're self-muted, please?

Robert Dodd -- Analyst

I am self-muted. I apologize. Congratulations on the quarter and Pearl Meyer, in particular. Just maybe segueing from that, can you give us any color on exposure in the portfolio to potential tariff issues or government efficiency initiatives? I mean, it's not their first rodeo with tariffs and adapted pretty well before, but can you just give us any thoughts on that given the economic environment and what's coming out of D.C.

at the moment?

Dwayne Louis Hyzak -- Chief Executive Officer

Sure, Robert. We're happy to do that. So, good morning and thanks for the question. I'd say, on the tariff topic, clearly, we're in some very interesting times here.

And I think our view is that if the tariffs are implemented and maintained the way that they're being discussed right now, that there's many businesses and industries in the U.S. that are going to have some issues or some exposure, just given the global nature of the business world today. And I'd say when you look at our portfolio, I'd say we're no different. You know, there are certain companies in our portfolio that will definitely have an impact.

But as you probably heard us say in the past, you know, we do have a very, very diverse portfolio. We think that's a benefit in all periods. We think it would also be a benefit when you look at the potential impact of tariffs going forward. We also, you know, look at the companies that we have.

As you've heard us say in the past, particularly in the lower middle market, you know, these are largely U.S. domestic-focused businesses. You know, both customers and vendors are going to be more focused from a, you know, U.S. domestic standpoint.

So, while we will be impacted, if we compare our expected impacts to the broader U.S. economy, we do think that our impacts will be less. So, not that we won't be impacted, but we think it will be a favorable comparison relative to other parts of the U.S. economy.

But despite that view, as I think you would probably expect, I'd say we have been and we are actively working with our portfolio companies to make sure that they're being diligent in looking at, you know, their plans or playbooks to deal with the issues that could come about. As you just said in your comments, you know, they've dealt with this kind of thing before, you know, both with COVID-19, supply chain issues, and then tariffs historically; and then more recently, the kind of high inflation period. So, we think that our, you know, companies and their management teams have dealt with these types of issues in the past. And when we look at our performance, you know, since COVID, we think they've done a really good job of dealing with the uncertainty that has existed in a number of different fronts, and we would be hopeful that they can continue to navigate things in a positive manner.

But we are clearly focused on it, spending time on it, and we'll continue to focus on that with our management teams and our companies. You've heard us also say this before, but, you know, one of the things we've always loved about the lower middle market is that we do think we have best-in-class management teams. I think we've proven that over the last five to 10 years with the performance in the lower middle market. So, these are great operators.

They're also very, very much aligned with us, much more focused on their equity ownership position as opposed to just a paycheck or a bonus. So, we think that they manage their businesses in a very productive manner. And because of the size of the companies, when they execute a plan, that plan can actually have an impact very, very quickly. So, we think those are all positives.

So, I think it'll be interesting to see how this plays out, not just for us, but for the, you know, more broad U.S. economy. But I think we feel that we're in good shape relative to others and are confident in the abilities of our teams to manage it. On your second question or topic about the impacts from a government efficiency standpoint, I'd say we have some limited exposure there.

You know, there's a couple of companies that we can think of that have significant exposure. And obviously, we're -- you know, just like we are on the tariff topic, we're talking to those companies and those management teams frequently to, one, you know, stay up to date on what's going on, but also you do what we can to help them plan and navigate it. One of those companies, I would say, has a lot more impact. You know, the other one, I think, is actually continuing to do exceptionally well.

And we think despite what's going on from a federal efficiency standpoint, we expect they'll continue to do well. But we think we have limited exposure on that front when you look at the portfolio we have.

Robert Dodd -- Analyst

Got it. Appreciate that. If can I have one more, still tied to D.C. There's obviously the -- can you hear me?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, we can hear you.

Robert Dodd -- Analyst

Can you hear me?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah. Robert, can you hear us?

Robert Dodd -- Analyst

Hi. Just on taxes, right? There's the perspective -- I can hear you, yes, now. So, there's potential that capital gains taxes come down maybe this year, maybe next year. Who knows? Is -- are you hearing anything from -- on the front of new platform acquisitions where -- you know, is there any slowdown in expected activity as people are like waiting for clarity on taxes? Because obviously, a lot of these entrepreneurs that potentially have pretty significant tax exposure if they sell their business, depending on a variety of factors.

But is that entering anybody's mind at the moment or is that just not a big deal?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, Robert, I'll give my views, and I'll let David add on if he has any additional comments. But I'd say, as we look at, you know, the first quarter, I think you probably heard this from other BDCs or management teams that you've talked to, I think activity both lower middle market and private loan or private credit has been a lot slower than we expected it to be. But I don't think it's related to any potential, you know, changes from a capital gains rate standpoint. I think there is some reluctance or caution just given everything that's going on in the U.S.

economy with the topics that you touched on earlier. So, I do think that that is probably, you know, kind of dampened some of the expectations from an M&A standpoint. But I don't think I've heard people talking about the capital gains stuff. And David is, you know, kind of shaking his head here saying that he hasn't either.

So, we have not seen that, you know, pop up. Obviously, if there was a positive change there, that could be a positive catalyst. But we just haven't -- you know, we haven't heard that enter the discussions of the companies we've been talking to.

Robert Dodd -- Analyst

Got it. Got it. Thank you.

Dwayne Louis Hyzak -- Chief Executive Officer

Thank you, Robert.

Operator

Thank you. Our next questions come from the line of Kenneth Lee with RBC Capital Markets. Please proceed with your questions.

Kenneth Lee -- Analyst

Hey. Good morning. Thanks for taking my question. Just one on leverage.

So, still below target ranges, and it sounds like the expectation is a little bit of conservatism for this year. I just want to dig into that a little bit more. Is this based on any kind of macro factors, and do you see there being enough origination activity to be able to bring up the leverage meaningfully over the near term? Thanks.

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah. Ken, good morning. Thanks for the question. I would say that the views we've given on leverage are really -- you know, we're -- we enter the year in a pretty significantly under-levered position.

You know, I'd say that's driven by a couple of different things. One is, you know, less-than-expected investment activity both on the lower middle market and private loan side of our business as we exited the fourth quarter. And that's continued to be the case, as I said a few minutes ago, as we look at the first couple of months of the year. But I think Ryan covered this in his prepared comments, but we do expect and are focused on trying to get our leverage up, and the way we're going to do that will be driven by two things.

One is just actual investment activity on a net investment activity basis. That's going to be the biggest driver of where we end the year from a leverage standpoint. And then the other side of that is just given where we're at today from a leverage position, we expect to be less active under the ATM. So, as we do grow our investment portfolio and grow our capital structure alongside that, you should expect it to be much more heavily weighted toward the debt capital side of the capital structure.

And, Ryan, if there's anything else you would add on, feel free to add on there.

Ryan Nelson -- Chief Financial Officer

No, I think that about covers. I mean, one thing I would mention is -- was called out in the prepared remarks was the exit of Pearl Meyer happened at the very end of December, and that was a sizable check that was written, which is great for us but obviously had an impact on those leverage ratios as we hit year-end. So, that also has a little bit of interplay there.

Kenneth Lee -- Analyst

Gotcha. Very helpful there. And then within the lower mid market portfolio there, and I think you mentioned in the prepared remarks seeing increasing interest and there could be some potential realizations at some point, wonder if you could just go a little bit more details around that, what's sort of the nature of these kind of discussions? And is the level of interest increasing based on macro factors, regulatory outlook, or any other specific factors there? Thanks.

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, Ken. Just like we are with [Inaudible] we're going to be a little, you know, limited on what we say there. Obviously, if there's activities going on, it's under a confidential kind of situation in terms of, you know, having a transaction that may be in process that is not public. But as we said in the past, we think we've got some fantastic companies in our lower middle market portfolio, similar to what you saw with Pearl Meyer.

And at some point, you know, they -- those companies may be called on by either a strategic or a larger private equity firm because just like we find these companies very attractive, they may also find them attractive, and that may lead to, you know, dialogue, could lead to a process being run by our portfolio company with Main Street's assistance to maximize the value of those transactions. I'd say that's, you know, similar to what happened on the Pearl Meyer side. You know, we don't mandate anything. As you've heard us say in the past, we absolutely view our relationships with our lower middle market companies and their management teams as partnerships.

So, there's got to be something that both we and the management team views as an attractive opportunity. But when that happens, we're going to support them in maximizing the value. And we think we will consistently have really good outcomes in that type of a scenario, just like we had on Pearl Meyer. David, if you want to add anything to that, feel free to add on.

David L. Magdol -- President and Chief Investment Officer

I think you covered it.

Kenneth Lee -- Analyst

Great. Well, that's --

Dwayne Louis Hyzak -- Chief Executive Officer

Ken, anything else on that?

Kenneth Lee -- Analyst

No, that's very helpful. Thanks again.

Dwayne Louis Hyzak -- Chief Executive Officer

Thank you, Ken.

Operator

Thank you. [Operator instructions] Our next questions come from the line of Mark Hughes with Truist Securities. Please proceed with your question.

Mark Hughes -- Analyst

Yeah. Thanks. Good morning.

Dwayne Louis Hyzak -- Chief Executive Officer

Good morning, Mark.

Mark Hughes -- Analyst

Good appreciation in the quarter in the External Investment Manager. Anything we can anticipate related to the public offering or was that appreciation in 4Q already factoring that in?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah. I would say, Mark, the appreciation in Q4 didn't really have anything to do with the listing and the offering. It was more based upon continued growth with the consistent incentive fees we've been earning and receiving there, as well as just the market. You know, we have a number of different factors that go into our valuation approach.

One of those factors, not the only factor, but one of those factors is a publicly traded peer set. And I just think that peer set has been trading exceptionally well, not just in Q4, but for the last couple of quarters. You see some benefit there from a valuation approach standpoint.

Mark Hughes -- Analyst

And then when we think about the public offering, just the increase in assets, will that kind of logically trigger more value for the external manager or is that still looking at the peer group and other inputs?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, I think when you look at the changes that happened in conjunction with the listing and offering, you know, the changes are such that the benefit to Main Street or through the External Investment Manager to Main Street are going to be fairly limited unless there's a significant change to the operating results at MSC Income Fund. What I mean there is we lowered the base management fee so that, you know, that change in the percentage will reduce the base management fees we get. We also, you know, changed the incentive fee structure to be more consistent with what you see from other externally managed BDCs. And those two at a -- you know, at consistent operating results would be close to breakeven.

The structure was intended to provide MSC Income Fund shareholders additional benefits as we grow and have better performance both at the net investment income line and the ROE line. So, if we do that, you know, there will be a lower incentive fee relative to performance. But overall, when you look at the growth of assets and an increasing level of performance, we still think it's a really good outcome for Main Street as well when we look at the relationship that we have with MSC Income Fund.

Mark Hughes -- Analyst

Very good. From a regulatory standpoint, Dwayne, I think you've mentioned a time or two you've lost some lending opportunities to local banks. Any prospects you think for looser regulation on banks to get them more active? Would that be a competitive impact or, you know, hard to see? But any thoughts there?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, I'll give a few thoughts, and I'll let Nick add on if he has a different view because I think where we see, you know, most of the pressure over the last two, three, four years and from that angle, it's not on the lower middle market side, it's on the private credit side. And I'd say, in the last quarter, we had another, you know, attractive company performing well. I wouldn't say it was knocking the cover off the ball in terms of, you know, their performance versus our original underwriting expectations, but a bank came in and took us out of that at a significant reduction in the spread. So, you're still seeing some of that.

It is very limited. But my view would be I would not expect you to see there being significant enough changes in the banking regulations to change that. I think you'll still see some of that from time to time, but I think it's less, you know, specific or related to changes in the bank regulatory environment and more a bank decides they want to do something, they can't explain why they do it, but they go out and do something that we think is fairly aggressive, but it's beneficial for the company that they end up giving that loan to. Nick, feel free to add on.

Nicholas T. Meserve -- Managing Director and Head of Private Credit Investment Group

I'd say the usual case for that is it's not a fresh LBO, it's a transaction that happened maybe 12 or 18 months before and maybe the bank had been a banking partner before the sponsor bought the business. They couldn't get there on the first transaction. Usually, it's either speed or timing and leverage issue. So, as a company performs better, a lot of times, that regional or local bank will step back in again with a lower rate to try to get reinvolved in that business.

Mark Hughes -- Analyst

Understood. Thank you.

Nicholas T. Meserve -- Managing Director and Head of Private Credit Investment Group

From a -- I'd say from a fresh LBO perspective, we don't see them really as competition there.

Mark Hughes -- Analyst

Yeah, yeah. OK. Very good. Thank you.

Dwayne Louis Hyzak -- Chief Executive Officer

Thank you, Mark.

Operator

Thank you. Our next questions come from the line of Douglas Harter with UBS. Please proceed with your questions.

Cory Johnson -- UBS -- Analyst

Hi. This is Cory Johnson on for Doug. I just have a question, just sticking with the competition for a second. You know, just given the success that you've had in your lower middle market strategy, you know, in that portfolio, do you have any -- I guess, you know, what are your thoughts in regards to perhaps concerns from competition regarding other BDCs possibly moving down market or perhaps even imitating the lower middle market strategy? You know, just what are your thoughts on competition in general?

Dwayne Louis Hyzak -- Chief Executive Officer

Yeah, thanks for the question. I'd say we haven't seen a change there. Definitely not a change from the BDC industry in terms of being more competitive with our lower middle market strategy or approach. I think when you look at it -- and that's why we have two very distinct and different teams at Main Street.

You know, a team that looks like what I expect most BDCs investment team to look like. It's going to be very consistent with what Nick and his team at Main Street do. They're credit-focused. That's their history, that's their experience, and that's their approach.

Our lower middle market team is much more, you know, a private equity-type focus. We're underwriting the transaction the exact same way that a private equity sponsor or fund would or that a strategic acquirer would. And those are just two very, you know, different approaches and very distinct skill sets. So, you know, we haven't seen anybody trying to come in and duplicate or become competitive with us in our lower middle market strategy.

We also don't expect them to, given that dynamic in terms of the differences in the skill set and experience. Could they? They could. I think over the last 20 years of being in the industry, we have seen some people do it a long time ago, probably 10, 15 years ago. And I'd say that those companies, they're not around anymore, and they did not fare very well because you had, you know, kind of -- you know, lenders or credit guys trying to do private equity and it just -- it's a totally different skill set.

Cory Johnson -- UBS -- Analyst

Thank you.

Dwayne Louis Hyzak -- Chief Executive Officer

Thank you.

Operator

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

Dwayne Louis Hyzak -- Chief Executive Officer

Thank you very much. And just from our side, just thank you to everyone again for joining us today, and we look forward to talking to everyone again in a few months after our first quarter earnings release. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Zach Vaughan -- Investor Relations

Dwayne Louis Hyzak -- Chief Executive Officer

David L. Magdol -- President and Chief Investment Officer

Ryan Nelson -- Chief Financial Officer

Robert Dodd -- Analyst

Dwayne Hyzak -- Chief Executive Officer

Kenneth Lee -- Analyst

Ken Lee -- Analyst

David Magdol -- President and Chief Investment Officer

Mark Hughes -- Analyst

Nicholas T. Meserve -- Managing Director and Head of Private Credit Investment Group

Nick Meserve -- Managing Director and Head of Private Credit Investment Group

Cory Johnson -- UBS -- Analyst

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