Eastern Bankshares Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 4, 2023

There are 10 speakers on the call.

Operator

Greetings, and welcome to the Main Street Capital Corporation Second Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Fawn at Dennard Basker Investor Relations.

Operator

Thank you, sir. You may begin.

Speaker 1

Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's Q2 2023 earnings conference call. Joining me today with prepared comments are Dwayne Hijak, 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 and A portion of the call is Nick Mazurf, 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 Q2 financial and operating results.

Speaker 1

This document is available on the Investor Relations section of the company's website at mainstcapital.com. A replay of today's call will be available beginning an hour after the completion of the call and will remain available until August 11. Information on how to access the replay was included in yesterday's release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the company's homepage. Please note that information reported on this call speaks only as of today, August 4, 2023, and therefore, you are advised that time sensitive information may no longer be accurate at the time of any replay listening or transcript reading.

Speaker 1

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 atsec.gov. Main Street assumes no obligation to update any of these statements unless required by law.

Speaker 1

During today's call, management will discuss non GAAP financial measures, including distributable net investment income or DNII. The NII 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.

Speaker 1

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 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. 2 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 reported on a per share basis. Main Street defines ROE as the net increase in net assets Please note that certain information discussed on this call, including information Related to portfolio companies was derived from 3rd party sources and has not been independently verified.

Speaker 1

And now I'll turn the call over to Main Street's CEO, Duane Hieszak. Duane?

Speaker 2

Thanks, Zach. Good morning, everyone, and thank you for joining us today. 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 quarter, We're also providing updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, Our current investment pipeline and several other noteworthy updates. Following my comments, Our expectations for the Q3, after which we'll be happy to take your questions.

Speaker 2

We are very pleased with our performance in the 2nd quarter, which was highlighted by return on equity of 19.2% and includes new quarterly records for NII per share, DNII per share And NAV per share for the 4th consecutive quarter. Our strong performance included continued positive results from our lower middle market and private loan investment strategies And significant contributions from our asset management business. These 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 underlying strength and quality of our portfolio companies. We are also pleased that we continue to maintain investment pipeline in both our lower middle market and private loan investment strategies. And this attractive investment pipeline, Together with our conservative liquidity position and capital structure provides us a continued favorable outlook for the Q3.

Speaker 2

Our DNII in the 2nd quarter exceeded the monthly dividends paid to our shareholders by 66% And the total dividends paid to our shareholders by 24%. This strong performance allowed us to deliver significant value to our shareholders, while still conservatively retaining a meaningful portion of our income and growing our NAV per share. These positive results and our favorable outlook for the Q3 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 our retention of the excess NII per share above our total dividends paid in the quarter, the impact of fair value increases in our investment portfolio and the accretive impact of our equity issuances in the quarter. Our lower middle market portfolio companies continued their overall favorable performance, which resulted in another quarter of net fair value appreciation and strong dividend income contributions from our equity investments in this portfolio.

Speaker 2

As we look forward to the next few quarters, we remain excited about the benefits we expect certain of our lower middle market portfolio companies to realize From the acquisitions they have completed over the last 12 months, largely funded by follow on debt investments we made in those portfolio companies, and we expect to see additional fair value appreciation in these portfolio companies in the future. We call. At this time, all participants are in a listen only mode. We've also seen an increase in potential exit activities in our lower middle market portfolio that could lead to favorable realizations over the next few quarters. We are pleased with our investment activity in the Q2, which included total lower middle market investments of $131,000,000 and investments in 3 new portfolio companies.

Speaker 2

These investments were offset by increased repayments we received on several debt investments and the full exit of our investments in 2 lower middle market portfolio companies. This investment activity resulted in a net decrease in the cost basis of our lower middle market investments of $7,000,000 We were also pleased with our private loan investment activities in the quarter, which included total investments of $168,000,000 We also received increased repayments and realized a loss on a private loan investment during the quarter, resulting in a net decrease in the cost basis of our private loan investments of $11,000,000 We've also continued to attractive returns on our asset management business. The funds we manage through our external investment manager continue to experience favorable performance in the 2nd quarter. This positive performance resulted in significant incentive fee income for asset management business for the 3rd consecutive quarter. And as a result, we received a significantly higher contribution to our net investment income from our asset management business.

Speaker 2

We remain excited about our plans for these external funds that we manage as we execute our investment strategies and other strategic initiatives. We are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund. We 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 meaningful progress on our next private loan fund And we are planning to have our first closing for the fund before the end of Q3. We look forward to sharing additional details and updates on the new fund on our Conference Call.

Speaker 2

Based upon our results for the Q2 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 $0.275 per share payable in September, representing our largest An 8th consecutive quarterly supplemental dividend. Our Board also declared an increase in our regular monthly dividends for the Q4 of 20 $0.235 per share payable in each of October, November December, representing a 6.8% increase from the Q4 of 2022. The increased supplemental dividend for September is a result of our strong performance in the 2nd quarter, Which resulted in DNII per share, which exceeded our regular monthly dividends paid during the quarter by $0.445 or 66%. The September 2023 supplemental dividend will result in total supplemental dividends paid during the trailing 12 month period of $0.775 per share, representing a 22% increase over the June 2023 supplemental dividend And an additional 29% paid to our shareholders in excess of our regular monthly dividends and significantly increasing the current yield we are paying to our shareholders. Our DNII per share for the Q2 exceeded our total dividends paid by $0.22 per share or 24%.

Speaker 2

We are pleased to be able to deliver this significant additional value to our shareholders, while also maintaining a significant portion of our excess earnings to support our capital structure And investment portfolio against risks from the current economic uncertainties that may be realized in the future and to further enhance the growth of our NAV per share. We currently expect to recommend that our Board continue to declare future supplemental dividends to the extent D NII significantly exceeds the 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 3rd quarter, We currently anticipate proposing an additional supplemental dividend payable in the Q4 of 2023. Now turning to our current investment pipeline. As of today, I would characterize our lower middle market investment pipeline as average.

Speaker 2

Despite the current broad economic uncertainty, we continue to expect to be active in our rural middle market strategy. Consistent with our experience in prior periods of broad economic uncertainty, we believe the unique and flexible financing Solutions we can provide to lower middle market companies 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 for us. We are excited about these new investment opportunities and we expect our current pipeline will be helpful as we work to maintain our positive momentum from the last several quarters. 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.

Speaker 2

With that, I will turn the call over to David.

Speaker 3

Thanks, Duane, and good morning, everyone. As Duane highlighted in his remarks, we believe our strong second quarter financial results continue to demonstrate the strength of Main Street's platform, Our differentiated investment approach and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio Please continue to be positive, which contributed to our attractive second quarter financial results. As we have discussed in the past, The largest portion of our investment portfolio and the primary driver of our long term success has been and continues to be Our focus on the underserved lower middle market and specifically our strategy investing in both the debt and equity in lower middle market companies. Our view on the attractiveness of investing in lower middle market remains unchanged and we expect this to continue to be our primary area of focus in the future.

Speaker 3

Each quarter, we try to highlight key aspects of our investment strategy and differentiated approach. For today's call, we thought it would be useful to spend some time on our private loan Investment strategy, which is the 2nd largest part of our investment portfolio and is a primary driver of our asset management business. This strategy has grown significantly over the last several years and principally represents investments in the senior secured debt of private equity sponsored businesses. Our private loan investments are primarily originated directly by our internal investment professionals through strategic relationships with Private Equity Firms and Their Capital Market Intermediaries. Our private loan investments are typically 1st lien debt investments with attractive yield profiles and favorable terms.

Speaker 3

As of quarter end, 99% of our private loan secured debt investments are 1st lien loans and 98% bear interest at floating interest rates, which have an attractive weighted average yield of 12.6%. Over 6 years ago, we announced our strategic decision to dedicate significant resources towards growing our private loan portfolio, while deemphasizing our middle market portfolio, which as a reminder are typically syndicated loan investments in larger companies. We set a goal of growing our private loan portfolio to a greater percentage of our assets than our middle market portfolio, which seemed ambitious at the time since the middle market was almost double the size of our private loan portfolio. During this period of repositioning, we are also deliberate in setting a goal to maintain our emphasis on our lower middle market portfolio and growing our lower middle market portfolio to approximately 50% of our total assets at fair value. From year end 2016 through the Q2 of this year, we have increased the total fair value of our private loan portfolio by 3 37% And from 17% of our total portfolio at fair value to 35%.

Speaker 3

Over the same period of time, we The total fair value of our middle market portfolio by 53% from 32% of our total portfolio at fair value to only 7%. We also increased the total fair value of our Cornerstone Lower Middle Market portfolio by 143% and today the Lower Middle Market represents 52% of our total assets at fair value, which is above our target when we started this initiative. Our purposeful and intentional strategic shift to grow our private loan portfolio was primarily driven by our belief that an attractive and growing direct lending environment would exist in the future that private loan investments provided a more attractive risk adjusted return profile than in middle market investments. Today, the weighted average yield in our private loan portfolio is meaningfully higher than in our middle market portfolio. But even more important than higher yields, we are confident that our underwriting process and more favorable contractual terms and conditions of our private loan investments will provide significantly better returns, net returns after credit losses and in the investments available to us in the middle market investment strategy.

Speaker 3

Based on the capabilities and relationships of our private credit team, The overall growth of our private loan portfolio platform and the strength of our deal flow, Main Street has also benefited from our ability to utilize our private loan investment strategy Grow our asset management business. Through our external investment manager, our private loan strategy effectively allows Main Street to leverage our investment professionals' time and our platform to benefit from the attractive fee based income we receive from 3rd party clients, while at the same time providing highly attractive investment Now turning to the overall composition and results from our investment portfolio. As of June 30, We continue to maintain a highly diversified portfolio with investments in 195 companies spanning across more than 50 different industries among our lower middle market, Private loan and middle market portfolios. Our largest portfolio company represented 3.1% of our total portfolio fair value at quarter end and 4% of our total investment income for the last 12 months. Majority of our Portfolio investments represented less than 1% of our income and our assets.

Speaker 3

Despite the continued increases in benchmark interest rates, The vast majority of our lower middle market, private loan and middle market portfolio companies have interest rate coverage and debt service coverage ratios calculated on a pro form a basis For current interest rates as of July 1, well above 1x, and we continue to be confident in their ability to service their debt obligations today and in the future. In addition and as a reminder, our lower middle market portfolio companies are predominantly fixed rate debt investments and therefore are not impacted by increasing market index Our investment activity in the 2nd quarter included investments in our lower middle market portfolio of $131,000,000 which after Aggregate repayments on debt investments, return of invested equity capital and realized losses resulted in a net decrease in our lower middle market portfolio of $7,000,000 Driven by the capabilities and relationships of our private credit team that are previously discussed, we also completed $168,000,000 in total private loan investments, After aggregate repayments of debt investments, return of invested equity capital and realized losses resulted in a net decrease in our private loan portfolio of $11,000,000 Finally, during the quarter, we had a net decrease in our middle market portfolio of $39,000,000 as we continue to deemphasize this strategy.

Speaker 3

At the end of the Q1, our lower middle market portfolio included investments in 79 companies, representing over $2,200,000,000 of fair value, which is over 26% above our cost basis. We had investments in 88 companies in our private loan portfolio, representing $1,500,000,000 of fair value. In our middle market portfolio, we had investments in 28 companies, representing $296,000,000 of fair value. The The total investment portfolio at fair value at quarter end was 113% of the related cost basis. Additional details on our investment portfolio at quarter end are included in the press In summary, Main Street's investment portfolio continues to perform at a high level and deliver on our long term results and goals.

Speaker 3

With that, I will turn the call over to Jesse to cover our financial results, capital structure and liquidity position.

Speaker 4

Thank you, David. As Duane and David mentioned, we are very pleased with our operating results for the Q2. Our total investment income in 2nd quarter increased by $42,400,000 or 50 percent over the same period in 2022 and $7,300,000 or 6.1% over the Q1 2023 to a total of $127,600,000 and included strong performance from each of our income components. Interest income increased by 33,300,000 or 52% from a year ago and $3,900,000 or 4.2% over the Q1. We estimate that the increases in benchmark index rates drove approximately 40% of the increase from the prior quarter and about half of the increase from the prior year with the remainder driven primarily by the continued growth in our debt investments.

Speaker 4

Dividend income increased by $7,700,000 or 43 percent from a year ago and $1,400,000 or 5.7 percent over the 1st quarter. This represents the 2nd consecutive quarterly record for dividend income and demonstrates a continued strong performance of our lower middle market portfolio companies and the external investment manager. Fee income increased $1,400,000 from a year ago $2,000,000 over the Q1, driven by closing fees on new and follow on investments and repayment activity. The 2nd quarter investment income included elevated dividends and accelerated prepayment or other activity that are considered less consistent. In the aggregate, these were $2,400,000 above the average of the prior 4 quarters and $2,700,000 lower than the 1st quarter.

Speaker 4

Our offering expenses increased by $11,400,000 over a year ago, largely driven by increases in interest expense and compensation related expenses, partially offset by an increase in expenses allocated to the external investment manager. Interest expense increased by $9,500,000 over the prior year, driven primarily by increases in benchmark index rates And from the addition of new debt obligations at higher interest rates, combined with an increase in average outstanding borrowings to fund our investment activity and support the growth of our investment portfolio. Cash compensation expenses increased by $1,600,000 over a year ago, driven primarily by increases in incentive compensation accruals as a result of our positive operating performance and increased headcount to support higher levels of investment Activity and assets under management. Non cash compensation expenses increased by $2,200,000 from a year ago, including increases in share based compensation and deferred compensation expenses. The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets Was 1.4% for both the quarter and the trailing 12 month period and continues to be amongst the lowest in our industry.

Speaker 4

Our external investment manager contributed $8,500,000 to our net investment income during the quarter, an increase of $3,400,000 from a year ago and $500,000 over the Q1. The manager earned $3,700,000 in incentive fees during the quarter, An increase of $3,600,000 from a year ago and $400,000 over the Q1 as a result of the positive performance of the assets under management and ended the quarter with total assets under management of $1,400,000,000 During the quarter, we recorded net Fair value appreciation, including net realized losses and net unrealized appreciation on the investment portfolio of 29,400,000 We recorded net fair value appreciation of $22,700,000 in our lower middle market portfolio, which as Duane mentioned, which is driven by the continued positive performance of our portfolio companies. We recorded net fair value appreciation in our private loan portfolio of $600,000 A net fair value appreciation of $4,500,000 in our middle market portfolio with a positive contribution from changes in market spreads and quoted market prices, Improved performance from certain historically underperforming companies, offset by depreciation due to underperformance of certain portfolio companies. We also recognized $1,300,000 of appreciation in the fair value of our external investment manager, driven by increased revenues, partially offset by a decline in peer multiples.

Speaker 4

We recognized net realized losses of $75,500,000 in the quarter. The realized losses recognized were primarily the result of the exit or restructuring of several long standing underperforming investments, partially offset by realized gains on the exits of lower middle market investment and a private loan investment. The vast majority or approximately 90% of the unrealized depreciation related to the investments for which we realized a loss in the second quarter was recognized prior to this year and approximately 45% of the unrealized depreciation was recognized in 2021 or prior. When looking specifically at the impact of the Q2, these realized losses were completed at a net realized Fair value $2,300,000 greater than the fair value for such investments at the end of the Q1 of 2023. We ended the Q1 with 9 investments on nonaccrual status, comprising approximately 0.3% of the total investment portfolio at fair value and approximately 1.7 percent at cost, which represented a meaningful reduction from the 13 investments on nonaccrual status, Comprising approximately 0.6 percent of the total investment portfolio at fair value and approximately 3.2% at cost as of the end of the Q1.

Speaker 4

NAV per share increased by $0.46 or 1.7 percent Over the end of the Q1 and by $2.32 or 9.1 percent when compared to a year ago To a record $27.69 at June 30, 2023. 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. Our regulatory debt to equity leverage calculated as total debt excluding our SBIC debentures divided by net asset value respectively. During the quarter, we continue to be active in our at the market program, raising a net $43,000,000 from equity issuances. We ended the quarter with strong liquidity, including cash and availability under our credit facilities of 726,000,000 We believe that this provides us with ample liquidity to continue to be opportunistic and pursue attractive investment opportunities throughout 20 23, while continuing to maintain a conservative leverage profile.

Speaker 4

In July, we expanded the commitments on our corporate facility About $15,000,000 to $995,000,000 under the same terms and conditions as the existing commitments. The expanded commitment came from an existing lender in the facility, which we greatly appreciate and believe it was a strong vote of confidence. Return on equity for the Q1 6 months ended June 30 were 19.2% and 17.1% on an annualized basis, respectively. For the trailing 12 month period, ROE was 16.7%. All of these are above our long term targets, which we believe represent strong results compared to the industry.

Speaker 4

The NII per share for the quarter was a record $1.12 per share, an increase of $0.05 or 4.7 percent over the 1st quarter and $0.34 or 30 percent over the same period a year ago. The combined impact of certain investment income considered less considered, Less consistent, our non recurring nature to DNI was $0.03 per share, above the average of the last 4 quarters and $0.04 per share about the same quarter a year ago. The impact to NII, which include these items together with deferred compensation expense, per share paid to our shareholders in the 2nd quarter by $0.445 or 66 percent and our total dividends per share by $0.22 or 24%. As Duane mentioned, given the strength of our operating results and the outlook for 2023, Our Board approved an increase to our monthly dividends to $0.235 per share for the Q4 2023, The second increase this year and a supplemental dividend of $0.275 per share payable in September 2023, Our 8th consecutive and largest quarterly supplemental dividend. The total monthly and supplemental dividends declared for the Q3 2023 For $0.965 per share, representing a 7.2% increase over the total dividends paid in the Q2 of 2023 and a 30% increase over the total dividends paid in the Q3 of the prior year.

Speaker 4

Looking forward, given the strength of our underlying portfolio, we expect continued strong performance in the Q3 Of 2023, with expected DNII per share of $0.98 to $1 per share, with the opportunity to exceed this level driven by the level of dividend income and portfolio investment activities during the quarter. With that, I will now turn the call back over to the operator, so we can take any questions.

Operator

Thank you. Our first question comes from Bryce Roe with B. Riley. Please proceed.

Speaker 5

Thanks a lot. Good morning. Let's see, wanted to maybe start On the supplemental, Duane, I mean, you all highlighted the record level for the supplemental here In the next quarter, just curious how you're thinking about kind of formulaically coming to that level And thinking about kind of future quarters, how to size it up To what you've paid out over the last few quarters?

Speaker 2

Sure, Bryce. Good morning and thanks for the question. What I would say is that when you look at it, I think we've given some of this guidance before, we are funding the supplement or determining the supplemental based On the excess DNII above the monthly, obviously, as you know, when you look at the numbers, we're still retaining a significant amount of the excess For our NAV and for just for conservatism purposes. So I think we feel really good about where we set the supplemental in terms of it being a conservative number relative to performance as well as something that going forward we have good visibility and confidence that we'll continue to pay a meaningful supplemental not guaranteeing it's $0.275 per share going forward because that is the second quarter is a really, really good quarter. But we do have confidence that it will continue to be a meaningful contribution To our shareholders from a dividend standpoint.

Speaker 5

Okay. That's great. And then maybe kind of changing gears here a little bit, just your comment around potential exits And exit activity, can you help us kind of think about maybe just The pace and maybe what's driving some of the exit activity, I don't know if we've seen or heard That type of comment from other BDCs, maybe it's the fact that you play in smaller markets and some of the Exit activity is not necessarily kind of market driven. It's going to be company specific.

Speaker 2

Sure, Bryce. We wanted to highlight it because we agree with you that it's probably a little bit of An anomaly or an outlier versus what others may be saying. We do believe that we've got a very, very high quality portfolio of companies, Equity investments in the lower middle market. So part of it is we have these companies performing well and several of the companies have gotten some interest from 3rd parties and those 3rd party interest they've gotten has caused us and the other equity owners, the management teams of those businesses to take a look at it. So we're Obviously, it's a very uncertain environment both on the capital market side and just on the overall economy side of things.

Speaker 2

So we can't We don't really predict whether any of those transactions will move forward and close, but we are seeing more activity than we had seen in the last couple of quarters, which is why we wanted Highlighted in our prepared comments.

Speaker 5

Great. And then last one for me. A bit of cleanup activity with some of the longer standing underperformers. Was that kind of a matter of just Of timing things kind of happened when they did or would you describe that as more kind of intentional and trying to again Clean up some of the non performers.

Speaker 2

Yes. I would say it's more the former, Bryce. Some of these transactions, When you look at the legacy underperforming investments, several of those were transactions where we are not the lead or even the most significant investor. So to some extent, we're along for the ride in terms of determining how and when a restructure or an exit happens. There are a couple of transactions Where we did have more influence, but I'd say that when you look at most of those items, they were things that were Largely out of our control where we had involvement, but not control over it.

Speaker 2

So we just had to wait for some process, whether it was a sale process or restructuring or some other Transaction to work its way through to a final transaction before we could recognize those realized losses. But I think Jesse highlighted it In his comments, most of the depreciation was taken not just in prior quarters, but really in prior years. So these were some long standing under companies that we finally you've got to resolution on in the quarter.

Speaker 5

Okay. Great. Well, I'll jump back in queue. Appreciate the

Operator

The next question comes from Robert Dodd with Raymond James. Please proceed.

Speaker 6

Hi, guys, and congrats on the quarter. On The lower middle market pipeline, which you characterized as the average, can you give us any color on that pipeline? Kind of how much It's looking like it's add on acquisitions, which you have capital, these small companies may be looking to make acquisitions. And is that a Greater than average share of the average pipeline? Or is it just kind of ticking on kind of normal mix for add ons versus new platforms?

Speaker 2

Sure, Robert. Thanks for the question and good morning. I would say that when you look at the pipeline, we're excited about the pipeline, one, because we think The volume or the size of pipeline, both in terms of number of companies and dollar amounts of potential investment are both strong and our Your numbers are in line with what we would want them to be. To your point on the follow on versus new investments, I think this has been a trend we talked about the last couple of years really going back to 2019 2020 and to some extent it's intentional on our side. We are seeing a consistent amount of that pipeline Represented by follow on investment opportunities in our existing portfolio companies, which as you've heard us say in the past, from a risk reward standpoint, we really value Those opportunities because they're with our better performing companies, management teams and industries that we know well having been an investor in those companies For some period of time, so when we have an opportunity to deploy additional capital, one, we value it significantly because we think it's a really good investment.

Speaker 2

And then when you look at our equity investment in those same companies, it gives us an opportunity for significant fair value appreciation in the future, which has been one of the things we've seen for Couple of quarters for the companies that have made acquisitions over the last 12 or 18 months. So we think it's a good high quality pipeline in terms of the types of companies and to your point, it is a good mix from our perspective in terms of new investments as well as follow ons. Steve, David wants to add anything to that commentary on the pipeline.

Speaker 3

Yes. The only thing I'd add is that certainly we're pleased with some of the increased activity And our add ons over time, but we also have a nice mix of platform opportunities here and the platforms today make the add ons in the future. So we do have a nice mix and consistent with our strategy, the minority equity portion of that has really taken some steam in today's market conditions and Those transactions fit us particularly well. And I'd say last thing is just on the one stop shop type of opportunity that we provide. The intermediaries are really appreciative of knowing that we've got non contingent financing in this environment.

Speaker 3

So we feel like it's a really good way to lead.

Speaker 6

Got it. I appreciate the color on that. And then on the leverage, I think Jesse said that it's intentionally conservative Versus your target at 0.75 right now. I mean, could you give us any color on why you're being intentionally conservative right now? I mean, I would think it would be either because the pipeline was really strong, but since average and you were reserving capital or you were worried about the economy, but neither of those things seem to be The case.

Speaker 6

So why are you intentionally conservative right now?

Speaker 2

Sure, Robert. I'll give some initial comments and then Jesse can add on If you have some additional points to make to it, what I would say is we're always we've always valued a conservative capital structure and strong liquidity positions. We do expect even though we gave guidance that both the lower middle market and private loan pipelines are average. We do expect to be Not just in the next quarter, but for the next couple of quarters. So we're preparing for that opportunity from an investment standpoint.

Speaker 2

We also do acknowledge that we have a maturity in May of 2024. So we're intentionally making sure that we have as much Flexibility and as many options as possible to deal with that maturity in 2024. So those would be the key factors. I'll let if you have some other comments you want to add on?

Speaker 4

Yes. I mean, I think you covered Duane. I mean, it's as you said, just having the flexibility and core, as you know, Our comments just having a very strong balance sheet has been a core strategy for us, particularly in these times.

Speaker 6

Got it. Thank you.

Speaker 2

Thank you, Robert.

Operator

The next question comes from Mark Hughes with Churys. Please proceed.

Speaker 7

Yes. Thank you. Good morning.

Speaker 2

Good morning, Mark.

Speaker 7

In the Asset Management business, you Say how you're going to be closing the private loan fund pretty shortly. Could you kind of refresh me on the cadence you expect to Grow the size of this fund, kind of how it compares to earlier funds, You expect that cadence to accelerate the deal flow, deal market opens up?

Speaker 2

Sure, Mark. I'll give you a couple of reference points just as reminders and it will help guide our expectations for the 2nd fund, so the 1st private loan fund that we have, we raised just over $100,000,000 of limited partner equity capital. When you take that $100,000,000 you put some leverage on it, you get to just over $200,000,000 from a maximum investment capacity. That fund is performing very, very well as we gave in our earnings release and in our commentary. When you look at Fund 2, our goal is to have it be at least the same size from an equity standpoint with the goal being that we increase the size To be larger than the $100,000,000 of LP equity capital.

Speaker 2

Obviously, today's environment is there's a lot of uncertainty and a lot of moving parts. So I think that Our ability to increase above the $100,000,000 level of equity will be somewhat impacted by the overall markets, but we feel confident that we're going to be able to Achieve that goal and then our other big catalyst will be how much institutional investor interest and participation can we get in that new fund and that will really drive You drive the upside opportunity to be significantly larger than the $100,000,000 level. Let me know if that answers your

Speaker 7

If you could tell me a little about the future, that would be a great 2 kind of how you See it progressing. Is this an annual event? How should we think about it?

Speaker 2

Sure. So maybe to give some color to 1st fund, because I think if we achieve our goals, we would expect to have similar performance from a ramp standpoint as the 1st fund. So the first one fund, we closed the fundraising in February, March of 2022 and we're effectively fully So if you look at that type of a timeframe, if we're successful and again there could be movement obviously based on market conditions and Our ability to be successful in sourcing new investment opportunities, but I think we have a high level of confidence in our private credit team's ability to We would expect to be having a cadence of a new fund every 18 to 36 months. I know that's a pretty wide range, but that'll be You're really impacted by the marketplace as well as how large of a capital raise are we successful in raising with the second fund. If it's larger, that time period could get a little bit extended.

Speaker 2

If it's more similar in size to the first fund, we would be on the front end of that from a timeline standpoint.

Speaker 7

And then maybe just a big picture question. A lot of BDC peers talk about their The corporate structure, the parent related companies that give them very good deal flow, can you talk about how you compete with your Private loan strategy, in that context, how you're able to differentiate and be successful?

Speaker 2

Sure. I'll give a few comments and I'll let Nick Meserve, who's in the room with us, who leads our private credit investment strategy and our private credit team give some additional But I would say when you compare us to the really large platforms, we are in different parts of the marketplace from our So do we see some of those players from time to time? We might, but they are not the regular competitors when we're looking at our private loan strategy or Frankly, we view it as a positive from our perspective because the types of transactions that we're executing In our private loan strategy, they fit us really, really well from a size standpoint and they wouldn't fit some of the other players well. So when you look at it From a competitive landscape standpoint, even if the big guys were interested, they're going to be interested in a much larger investment than we are. So they may pay some attention to the transactions we're We're participating in, but it's not going to be their priority from a competitive standpoint.

Speaker 2

But I'll let Nick give any additional color he wants

Speaker 8

The thing I'd add to that would be also how we source our transactions. We're not bringing them in from either wealth advisors or banking relationships. It's mainly direct from the sponsors Or 3 intermediaries they hire to find financing. Those 2 are our main channels of finding activities with direct to sponsor being preferred and The intermediaries of there's 5 or 6 that kind of run most of the smaller in the market, and you were conjugate them on a weekly basis to source new transactions. And so that's an avenue that we have that it doesn't really necessarily matter whether you've got a bigger platform, sourcing different transactions because we're really focused on A certain size and a certain type of transaction that fits us.

Speaker 7

Thank you. Appreciate it.

Speaker 2

Thanks, Mark.

Speaker 6

The next

Operator

question comes from Bitesh Abraham with UBS. Please proceed.

Speaker 9

Hey, everybody. Thanks for the question. Just to begin a little bit more on that 50% target on the lower middle market portfolio, can you put any kind of timeframe Around that and I think the private loan portfolio is about 35% to 40% now. Is there a level that you Want to see that grow to over a certain amount of time as well?

Speaker 2

Sure. So I'll take a stab at answering the question. You can tell me if we don't cover Completely. But our long term goal is to have the lower middle market portion of our investment portfolio be above 50%. I think realistically moving it to 55 or 60 over a long period of time is a good goal.

Speaker 2

Over time when you look at the private loan and middle market portfolios, We have been and will continue to shrink the middle market as a percentage of the total portfolio as well as just an absolute dollar. And that portion of our portfolio will move to growth of both low and middle market and private loans. So in a perfect world, Whatever time period you want to pick out 5 or 10 years into the future, middle market will be there'll be something there, but it'll be less than what it is today and you'll The increases in both the lower middle market and the private loan portions or percentages of the overall portfolio. But let me know if that gives you what you were looking for.

Speaker 9

Okay. So then the message that like leaning into private loan right now is more tactical and then kind of long term, You guys are still where you have been in terms of how you're thinking about that?

Speaker 2

So we the private loan investment strategy for us It's very important to our business as a whole, both for our balance sheet and for our Asset Management business. When you look at our Asset Management business today, It's not exclusively private loan, but if you look at the growth, the growth of the asset management business is, if not exclusively Private loan, it's the vast majority of it. So when you look at the Main Street platform as a whole, private loan is and will continue to be a big part of Our investment strategy and activities, but when you look at Main Street's investment portfolio and our balance sheet specifically, you're going to continue to see more lower middle market than you would Private loan. But I would say the private loan portion of our balance sheet going forward, we do not expect that to shrink. The piece that we expect Due to decline or decrease going forward is the middle market portion of our existing portfolio and both the lower middle market and private loan portions of the Main Investment portfolio on our balance sheet will both continue to increase going forward.

Speaker 9

Okay. That's helpful. And can you talk a little bit about EBITDA growth trends, your portfolio companies? Where are you seeing things now versus, say, a year ago? And are there certain industries that may be decelerating Little bit more than others.

Speaker 9

Any color there would be great.

Speaker 2

I'll give some comments and then David can add on if he wants to add some additional comments. But I'd say We continue to view that the performance of our companies broadly or kind of across the portfolio is very good. And you can see that in our appreciation, changes in fair value appreciation. You can also see it in the dividend income. When you look at individual industries or companies, I would Our view, which is consistent with what I think you probably heard us say in the past, is it's more company specific than it is industry specific.

Speaker 2

We have some companies and some management teams that They're doing an exceptional job and you see that come through in their fair value appreciation and in their contributions to dividend income. So I wouldn't say we're seeing anything specific by industry or any other specific vertical. I think we do have some industries that You may be showing a little bit of your slowdown and I think is what you would see from the broader economy. I think we're taking a little bit more of a risk off approach on certain Consumer type industries, but by and large, the portfolio as a whole is performing very, very well. And in certain situations, the companies are performing well or performing About as well as they've ever performed in any market environment, which gives us a lot of comfort and gives us a positive view towards Both future fair value appreciation and dividend income contributions from those high performing companies.

Speaker 2

But David, I don't know if there's anything you want to add to that.

Speaker 5

I think you've covered it.

Speaker 9

Okay. And if I could just squeeze one more in. Just on the DNII for Q3, a little bit of a step down Yes. Should we think of that as a combination of lower dividend income and slightly smaller portfolio? Just Some of the drivers there, any color you can give would be great.

Speaker 9

Thank you.

Speaker 2

Sure. So I'll let Jesse come back with some numbers. But I think When you look at it, we try to highlight, as we do each quarter, some portion of DNII or NII that's nonrecurring. So it's items that Elevated for some reason. Some of that is dividend income, some of it could be accelerated income from repayments and we had a combination of those 2, which we have that every So what I would say, the biggest change between Q2 actual and Q3 projections is you don't have those elevated items And just to highlight one other thing is those elevated items not only impact Main Street, but they impact Some of our asset management clients that would be in those same investments.

Speaker 2

So as you see us benefit at Main Street directly from those Elevator or accelerated income items, you see it also come through the asset management business as those same asset management clients Generate or receive the same benefit from an accelerated income standpoint. But I'll let Jesse maybe give a few numbers to add on to that.

Speaker 4

Yes. No, that's right, Duane. Thank you. And what we call is elevated items that as a reminder, those come from accelerated Income, prepayment fees and then certain dividend items that are that we consider elevator are less consistent. At the beginning of the quarter, those are hard to predict and can drive the outperformance, as I think I indicated in my comments, And drove a lot of the outperformance in terms of the initial guidance in the Q2 to where we ended at.

Speaker 4

For the second quarter, We had $0.08 per share or about $6,500,000 of those items that drove The results for the Q2 and we have not included much or at all that into our guidance For the Q3 as we said here today.

Speaker 9

Great. That's it for me. Thank you very much.

Speaker 2

Thank you.

Operator

Our next question comes from Eric Schmidt with Hovde Group. Please proceed.

Speaker 5

Thanks. Good morning. Most of my questions have been So just kind of one final one here for me. We heard from another BDC this morning who recently increased Was it fairly straightforward given that it was a relatively small increase in the fact that it was kind of already allowed under the accordion feature? Or were there any Negotiations that accompanied it.

Speaker 2

Yes. I'd say it was pretty straightforward. We didn't have a lot of detailed negotiations or trouble getting there, which is we I think Jesse said in his comments, we really appreciate the support of all the banks in our credit facilities and the addition that we received in the most recent It's just a further, kind of further reason why we really value those relationships. I think our bank group as a whole based upon the feedback we get from them Very happy with the performance, very happy with the relationship across the board. And I think we saw that come through with the ease at which we were able to add the $15,000,000 of So again, Justin wants to add anything, I'm happy to let you jump in there.

Speaker 4

Thank you, guys.

Speaker 5

I appreciate the color. Thanks for taking my question.

Speaker 2

Thanks, Eric. Appreciate it.

Operator

This concludes our question and answer session. I would like to turn I'll go back over to management for closing comments.

Speaker 2

Thank you everyone for joining us again this morning and we look forward to speaking to you again in early November.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this

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Earnings Conference Call
Eastern Bankshares Q2 2023
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