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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Main Street Capital Corporation Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan with Dennard Lascar Investor Relations. Thank you, Mr. Vaughan. You may begin.
Thank you, operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's third quarter 2019 earnings conference call.
Main Street issued a press release yesterday afternoon that detailed the company's third quarter financial and operating results. This document is available on the Investor Relations section of the company's website at mainstcapital.com. A replay of today's call will be available beginning an hour after the completion of the call and will remain available until November 15th. 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 home page.
Please note that information reported on this call speaks only as of today, November 8, 2019, and therefore, you're advised that time-sensitive information may no longer be accurate at the time of 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 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. Please refer to yesterday's press release for a reconciliation of these measures to the most directly comparable GAAP financial measures. Certain information discussed on this call, including information related to portfolio companies, was derived from third-party sources and has not been independently verified.
And now I'll turn the call over to Main Street's CEO, Dwayne Hyzak. Dwayne?
Thanks, Zach, and thank you all for joining us today. Joining me for the call today with prepared comments are David Magdol, our President and Chief Investment Officer; and Brent Smith, our CFO. Also joining us for the Q&A portion of our call are Vince Foster, our Executive Chairman; and Nick Meserve, our Managing Director and Head of our Middle Market Investment Group.
On today's call, I will start by providing a recap of our overall performance in the third quarter, commenting on the performance of our investment portfolio, discussing our recent dividend announcement and other recent developments and I will conclude by commenting on our investment activities and pipeline. Following my comments, David and Brent will provide additional comments on our financial results, our current liquidity position and certain key portfolio stats, after which we'll be happy to take your questions.
We were pleased with our operating results for the third quarter, a quarter during which the performance quality and diversity of our investment portfolio, and the leverage of our efficient low cost operating structure facilitated favorable operating performance and financial results.
During the quarter, we continued to focus our efforts on sourcing transactions that are consistent with our historical investment profile and on the aspects of our business where we have more control and influence. As a result of our performance, we again generated distributable net investment income or DNII per share in excess of our regular monthly dividends, exceeding the monthly dividends paid during the quarter by approximately 7%.
We believe that the advantages of our differentiated investment strategy, diversified investment portfolio and efficient operating structure, combined with our conservative capital structure and liquidity position, have us very well positioned for continued future success.
Looking specifically at the performance of our investment portfolio in the third quarter, our lower middle market portfolio appreciated by $2.7 million on a net basis with 27 of our investments appreciating and 17 depreciating. Our lower middle market companies collectively continue to exhibit very conservative credit profiles on a relative basis, which David will cover in his comments.
Our middle market and private loan portfolios collectively depreciated by $10.7 million on a net basis, primarily due to the impact of depreciation from certain investments with specific credit issues that we have been working through in our middle market portfolio.
Earlier this week, our Board declared our first quarter 2020 regular monthly dividends of $0.205 per share payable in each of January, February and March, an amount that is unchanged from our monthly dividends for the fourth quarter, and representing a 5.1% increase from the first quarter of 2019. Consistent with our prior guidance and our previously announced plan for transitioning, our semi-annual supplemental dividend into our monthly dividends over several years, we also recently declared a supplemental dividend payable in December of $0.24 per share a decrease of $0.01 from our June supplemental dividend.
We continue to expect that our dividend transition will take several years with the ultimate timing of this transition impacted by the performance of our investment portfolio, the overall economy and changes in the overall interest rate environment. And we remain confident that by the end of the transition period, we will be successful in delivering on our long term goal of growing our total annual dividends.
Now turning to our investment activities in the quarter and our current investment pipeline, we completed lower middle market investments of approximately $25 million in the quarter. And as of today, I would characterize our lower middle market investment pipeline, as above average. Our third quarter activity and our current pipeline as a result of our maintenance of a disciplined and selective approach to new investment opportunities. And we remain confident in our future ability to continue to originate new investments consistent with our historical investment profile.
And our comments over the last few quarters, we noted that we're experiencing increased third party interest in several of our existing lower middle market portfolio companies. And this interest resulted in two attractive exits in the third quarter. We believe that these ongoing activities should result in additional attractive exits over the next two quarters. We continued our success in focusing our non-lower middle market investment portfolio growth on our private loan portfolio, with this portfolio growing by approximately $32 million on a net basis in the quarter.
In addition, our middle market portfolio grew by approximately $26 million. As of today, I would characterize our private loan investment pipeline, as above average. And in closing, our officer and director group has continued to be regular purchasers of our shares, investing approximately $500,000 during the quarter and owning Main Street's shares valued at over $154 million at quarter end.
With that, I will turn the call over to David.
Thanks, Dwayne, and good morning everyone. We're pleased to report another quarter during which we grew our net total investment income and distributable net investment income while continuing to generate distributable net investment income in excess of our monthly dividends. We believe that our result illustrates the significant benefits of our unique investment strategy in the lower middle market, which, when combined with our complimentary first lien debt investment strategies and our asset management activities, provides a value proposition that positively differentiates Main Street among our BDC peers.
This has been demonstrated through our consistent ability to generate premium total returns for our shareholders to the growth in our dividends per share, our increased net asset value per share and our stock price appreciation. The primary driver of our long term success continues to be our focus on the underserved, lower middle market. We see significant benefits from investing in both the debt and the equity securities in this segment of our business.
Our equity investments closely align our interest with our portfolio company management teams and allow us to share in the equity upside as our portfolio companies perform. While our first lien debt investments provide an attractive yield profile and significant downside protection. Each quarter we try to highlight different aspects of our unique investment strategy. This quarter, we'd like to highlight several points related to the benefit of our lower middle market investment strategy, as illustrated by several recent exits of equity investments.
During 2019, we fully exited four of our lower middle market equity investments. All of these exits resulted in realized gains in which - which in aggregate totaled approximately $14 million. When you compare our realized gains on these exits, to the fair value mark two quarters and four quarters prior to exit, the actual value achieved on exit of these investments exceeded the fair value marks by approximately 5% two quarters prior to exit, and by over 40% four quarters prior to exit.
In the third quarter of 2019, we exited two of our lower middle market equity investments. Both exits resulted in realized gains with these gains totaling almost $8 million. The exit from our investment and land ventures during this past quarter generated a realized gain of approximately $6 million and a cumulative 11% internal rate of return and a 2.2 times money invested on our cumulative debt and equity investments. The full exit of our equity investment in Condit during this past quarter generated realized gains over the life of the investment of $2.6 million and a cumulative 22% internal rate of return at a 2.8 times money invested on our cumulative debt and equity investments.
Despite both investments experiencing volatility and profitability and valuation over our 11 year investment period, we ultimately achieved very attractive return profiles. We believe these examples support our competitive advantage of being long-term investors participating in both the debt and the equity in our lower middle market companies, and the advantage of being able to hold investments for extended periods of time, despite market volatility. We also believe the related comparison of these realized gains to our prior fair value estimates are helpful when evaluating the current fair value estimates for our overall portfolio.
Finally, as Dwayne mentioned earlier, we continue to get inbound interest in various lower middle market companies. We currently have several other attractive potential portfolio company exit opportunities that we hope to complete in the next two quarters. By size and scope, our lower middle market investments are a primary driver behind both our historical NAV per share growth and our significant pre-tax net unrealized appreciation at September 30th, contributing approximately $212 million or $3.35 per share.
Our lower middle market investments also support growth in our total dividends paid to our shareholders through the dividend income we received and the periodic realized gains upon the exit from these equity investments. In addition, the unrealized appreciation and realized gains from these equity investments provide an offset against the inevitable credit losses that will be experienced when making investments in non-investment grade debt securities.
Turning back to our most recent operating results, the contributions from our lower middle market portfolio continues to be well diversified, with 40 of our 67 lower middle market companies with equity investments having unrealized appreciation at quarter end. 66% of our companies that are pass through entities for tax purposes contributed to our dividend income in the last 12 months. And our total dividend income received from our lower middle market investments was approximately $33 million during this period of time, representing a 28% compounded annual growth rate since the year ended 2017.
We believe the diversity of our lower middle market portfolio is critical when analyzing the benefits from this strategy. And we believe that this diversity provides visibility to the recurring nature of these benefits in the future. At September 30th, we had investments in 182 portfolio companies spanning across more than 50 industries. Our largest portfolio company represented 2.6% of our total investment portfolio, fair value at quarter end, and 4.9% of our total investment income for the last 12 months.
The majority of our portfolio investments represented less than 1% of our assets and our income. Additional details our investment portfolio quarter end are included in the press release that we issued yesterday, but I'll note a few highlights. Our lower middle market portfolio included investments in 68 companies representing approximately $1.2 billion of fair value, which is over 20% above our [technical difficulty] at the lower middle market portfolio level, the portfolios median net senior debt to EBITDA ratio was a conservative 3.1 to 1 or 3.2 to 1, including portfolio companies' debt, which is junior and priority to acquisition. And the total EBITDA to senior interest ratio was 2.9 to 1.
In our private loan portfolio, we had investments in 62 companies representing approximately $630 million of fair value. And in our middle market portfolio, we had investments in 52 companies representing approximately $550 million of fair value. The total investment portfolio fair value at quarter end was approximately 108%, the related cost basis, and we had 7 investments on nonaccrual status, which comprise approximately 1.6% of the total investment portfolio at fair value and 4.4 at cost.
With that, I'll turn the call over to Brent to cover our financial results, capital structure and liquidity position.
Thanks, David. We are pleased to report that our total investment income increased over the same period in 2018 to a total of $60.1 million, primarily driven by an increase in dividend income and partially offset by a decrease in fee income. The change in total investment income includes a decrease of $1.9 million related to lower levels of accelerated income for certain debt investments when compared to the third quarter of last year. Our operating expenses excluding non-cash share based compensation expense increased by $0.4 million over the same period of the prior year to a total of $18.5 million, primarily related to an increase in interest expense and partially offset by a decrease in compensation expense.
The ratio of our total operating expenses excluding interest expense, as a percentage of our average total assets was 1.2% for the third quarter on an annualized basis and 1.3% for the trailing 12 month period. A combination of our unique investment strategy and leverage of our efficient operating structure resulted in distributable net investment income of $41.6 million or $0.66 per share, which exceeded our monthly dividends paid for the quarter by approximately 7%.
The activities of our external investment manager benefitted our net investment income by approximately $2.6 million to the allocation of $1.7 million of operating expenses for services we provided to it and $1 million of dividend income. We recorded a net realized loss of $5.9 million primarily relating to the realized losses from the restructure and exit of two middle market investments, partially offset by realized gains, related to the exit of two lower middle market investments.
And as Dwayne discussed, we recorded net unrealized depreciation on the investment portfolio of $7.7 million, primarily resulting from $12.2 million net depreciation relating to our middle market portfolio, partially offset by $2.7 million of net appreciation on our lower middle market portfolio, $1.5 million of net appreciation on our private loan portfolio and $0.8 million of appreciation relating to our external investment manager.
Our operating results for the third quarter resulted in a net increase in net assets of $33.9 million or $0.54 per share. Our overall capitalization liquidity remained strong as our total liquidity was approximately $650 million at the end of the third quarter. As we previously discussed falling our investment grade debt issuance in April of this year, we will reborrow under our revolving credit facility to repay the $175 million investment grade notes that mature in December.
Due to our elevated liquidity, we were again less active under our ATM equity issuance program during the third quarter, raising approximately $9.3 million in net proceeds with an average sale price exceeding $42 per share. As we look forward to the fourth quarter of 2019 and taking into account the impact from the recent interest rate cuts, which we estimate will have a negative impact of approximately $0.02 per share during the fourth quarter, based on our floating rate loan portfolio as of September 30th.
We expect that we will generate distributable net investment income of $0.63 to $0.65 per share. This estimate is $0.015 to $0.035 per share or approximate 2% to 6% above our previously announced monthly dividends for the fourth quarter of $61.05 per share.
With that I will now turn the call back over to the operator, so we can take any questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Robert Dodd with Raymond James. Please proceed with your question.
Hi guys. On the lower middle market portfolio can you give us any color on kind of growth that you’re seeing I know we see a lot of portfolio companies, revenue or EBITDA or anything like that in terms of trends that you’re seeing there and if there are any weaker industry areas. And then sort of semi related to that I think that tone change Dwayne I think last quarter your lower middle market pipeline was about average, this quarter it’s above average. Any color on what the drivers were there? And if there’s any industries that have become more attractive or more active?
Sure, thanks Rob. I’ll give a couple of comments and I’ll let David add on. I’d say when you look at the existing lower middle market portfolio, it continues to perform at a favorable level. If you look at revenue and EBITDA performance with increases or decreases at the portfolio level, I’d say it’s consistent with what it’s been for a long time, so that’s continued positive performance in the actual results.
I would say if we’re seeing any increased uncertainty or pessimism, it’s more in the outlook. I think if you talk to a subset of our companies particularly those that are a more cyclical industries, they’re probably more pessimistic about the outlook today than they would have been three or six months ago. We just haven’t seen that come through in our actual results yet to a significant extent, and the portfolio continues to perform at a positive level. Anything to add to that David or?
Just to your point about the pipeline. It is a lumpy business. And last year we closed 10 portfolio companies, new investments, because there are only 10, it’s lumpy in how it falls in the quarter. So at any one time we might see more or less activities. Right now, it says the pipeline like Dwayne characterized it’s above average and we’re optimistic about closing some deals in the near term.
Okay got it, thank you. And then just one more, on the HMS, if I remember right from prior quarters, I think the dividend was a little lower this quarter than it has been. Was there anything related to incentive fees HMS or anything like that, that are flowing to you and maybe paying a slightly smaller dividend this quarter? It’s marginal so…
Yeah, Robert, I would say that the vast majority of that variance is all incentive fees. We had a nice incentive fee that we recognized and recorded in Q2 and that decreased on a relative basis quarter-over-quarter in Q3.
Got it, thank you.
Thank you.
[Operator Instructions] Our next question comes from the line of Bryce Rowe with National Securities. Please proceed with your question.
Great, thanks good morning.
Good morning.
Dwayne and David, I wanted to ask about dividends within the income statement. Obviously, it’s taking a nice share of total revenue. And it’s been pretty consistent so far throughout 2019. You’ve got from what I can tell one company that’s accounted for maybe a quarter 20% to a quarter of those dividends so far this year. So I wanted to understand kind of what visibility you might have into dividend payments coming from those lower middle market equity investments, and if you can kind of foresee when we might have a shift from one company taking growth over the large portion of that dividend income to another company kind of stepping in to provide that dividend income?
Yeah. Bryce, what I would say in response for that question is as these lower middle market companies mature and de-lever, as long as they're continuing to perform, they naturally have more cash flow that's available for dividend or distribution purposes. So we have - we do have one company that has contributed, to a significant amount of dividend income in the year to date period.
But we also have a number of companies that are contributing to dividend income on a consistent basis. And that's the thing that we really take a lot of comfort in is that there's a group of companies that have continued to delever and perform and are now becoming consistent, meaningful contributors to our dividend income on a recurring quarterly basis. And that's what gives us a lot of comfort when we look at the portfolio as a whole and the sources of that dividend income each quarter going forward.
Okay, that's helpful. Maybe a question on the nonaccrual flows. Obviously, you stated total number of nonaccrual investments at 7. I was curious if there is change within the 7 quarter to quarter if he had one come in and one or two go out?
Yes, that's correct. The count stays the same, but we had one move out and one move in. So [indiscernible] was on non-accrual at the end of last quarter, but it went through a restructuring so it was removed from the nonaccrual this. And then American addiction centers was added to nonaccrual during the third quarter.
Okay. And then maybe one more for you, Brent. Just you made note of the lower incentive compensation accrual here in the third quarter. They push compensation expense down a bit quarter-over-quarter. Is that a function of weaker volumes, weaker credit quality trends, what's driving that? And any kind of forward look on what that might look like, in the fourth quarter would be helpful? Thanks.
Yes, what I would say is that there was a number of factors that contribute to the incentive fee declining; part of it is, impact of interest rates; part of it is specific names that you have had performance issues, namely, the nonaccrual that Brent touched on. So those are your contributing factors. I think when we look forward, it's always hard to predict, how much incentive fee income you will have. I think when you look forward - I'm sorry, the comp, I'm sorry. Go ahead. I'm sorry. I misunderstood the question.
Yeah. Okay. That incentive compensation accrual, basically, when we accrue that every quarter and we look at the overall financial results, obviously, this year, we haven't quite met our ROE target and other factors to do some middle market credit specific issues as well as lower originations in the lower middle market. So we adjust our incentive accrual each quarter based on year-to-date performance.
So looking forward the fourth quarter ultimately will depend how the fourth quarter shakes out and how the full year shakes out. Generally speaking, I would expect our compensation level. It might be a little bit higher than the third quarter, but it should not be materially higher.
Okay, exactly what I needed. Thank you.
Sure.
Thanks, Bryce.
This concludes today's question-and-answer session. I'd like to turn the call back to management for closing remarks.
I just want to thank everyone for joining us today and we look forward to talking to everyone again in late February.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.