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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. If anyone should require operator assistance during the conference, [Operator Instruction]. 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 2021 earnings conference call. Main Street issued a press release yesterday afternoon that details 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 12.
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, November 5, 2021. And therefore, you are advised 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.
Mainstreet 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. Now I will turn the call over to Main Street CEO, Dwayne Hyzak.
Thanks, Zach. Good morning, everyone, and thank you for joining us today. We appreciate you taking the time to join us and we hope that everyone's doing well. Joining me today with prepared comments are David Magdol, our President and Chief Investment Officer, and Jesse Morris, our Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of our call are Vince Foster, our Executive Chairman, and Nick Meserve, our Managing Director and Head of our Private Credit Investment Group. On today's call, I will provide my normal update regarding our performance in the quarter. We're also providing updates on our asset management activities, our recent declarations of a monthly dividend increase and December supplemental dividend, our expectations for dividends going forward,
Our recent investment activities and current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments on our investment strategy, investment portfolio, financial results, and future expectations, after which we'll be happy to take your questions. We're very pleased with our third quarter results, which demonstrate the continued strength and momentum of our Mainstreet platform. The benefits of our unique investment strategies, and the quality and strong performance of our diversified group of portfolio companies. This quarter represented another quarter of sequential growth in total investment income and included a record level of dividend income from our portfolio equity investments.
In addition, primarily due to the continued favorable performance of our portfolio companies, our net asset value per share increased by 3.6% during the quarter. Our net investment income and distributable net investment income for the quarter of $0.71 and $0.76 per share are both new Main Street records. And together with the gains realized from the exit of several equity investments and the fair value appreciation on the quarter resulted in annual GAAP return on equity for the quarter of over 20% for the second consecutive quarter. Our gross lower middle-market investments of $159 million for the quarter also represented a new Main Street quarterly record. We're also very pleased with our capital markets activities in October,
which Jesse will cover in more detail, which provided further improvement to our strong capital structure and additional liquidity to fund the continued growth of our investment portfolio. portfolio. As we look forward to the fourth quarter and next year, and take into consideration the strength of our existing investment portfolio, current investment pipeline, and liquidity position, we believe we're very well-positioned to continue to provide superior results. The operating performance across most portfolio companies has continued to improve. And this strong performance, combined with our ongoing organic and acquisition growth activities at several of our high-performing portfolio companies, provide us continued optimism about our ability to generate incremental fair value and NAV per share increases over the next few quarters.
We've also continued to make progress in our asset management business. This includes progress at MSC Income Fund, the non-traded BDC we advised through our external Investment Manager, which grew its investment portfolio by over 3% and meaningfully increased its NAV per share during the third quarter and maintained its dividend to the fund shareholders in November. We also significantly improved the funds overall capital structure and liquidity position over the last several months through several activities, including the receipt of an investment-grade rating for the fund, and the execution of a new $150 million series of unsecured fixed rate long-term notes. These activities provide the fund the opportunity for continued growth and positive operating performance moving forward.
We remain excited about our plans for the fund as we continue to execute on our investment strategies and other strategic initiatives. And we are optimistic with our outlook for the future performance of the fund. At MS private loan fund 1, we have continued to grow both its capital commitments from investors and its investment portfolio through it's co-investment activities with Main Street and MSC Income Fund and our private loan investment strategy. The continued growth at both funds provides us visibility to increase future contributions from our asset management business. The growth of our asset management business has also been significantly beneficial to our ability to execute our private loan strategy. And we expect these benefits to continue to increase in the future.
We remain excited about our strategy for growing our asset management business within our internally managed structure and increase in the contributions from this unique benefit to our Main Street stakeholders. Based upon our results for the third quarter and the positive performance of our existing portfolio companies combined with our favorable outlook in each of our core investment strategies and for our growing asset management business and the benefits of our efficient operating structure and strong liquidity position, earlier this week, our Board declared another increase to our monthly dividends in the first quarter of 2022 to $21.5 per share payable on each of January, February, and March, representing a 2.4% increase from the fourth quarter and a 4.9% increase from the first quarter of 2021.
In addition, due to the favorable performance in the third quarter, which resulted in DNII per share that was $14.50 greater than our monthly dividends paid during the quarter. Our board also declared a supplemental dividend of $0.10 per share payable on December 2021. While we may recommend that our board declare future supplemented dividends to the extent DNII significantly exceeds monthly dividends paid in future quarters, our current expectations to retain capital from realized gains on our equity investments for future reinvestment purposes, as opposed to paying these realized gains out as supplemental dividends. Now, turning to some additional details on our investment activities to date in the fourth quarter and our current investment pipeline, since September 30th, we have completed total lower middle-market investments of over $60 million.
As of today, I would characterize our lower middle-market investment pipeline as well above average. We remain very active in our lower middle-market strategy, and we're excited about the investment opportunities in the current pipeline. Consistent with our activities over the last 2 years, our recent investments in the current investment pipeline, includes several follow-on investments in existing portfolio companies. As we and our companies actively look to execute on various growth opportunities. We view these follow-on investment opportunities as very attractive, as they allow us to make follow-on investments in some of our top performing companies and with some of our best management teams. And provide the opportunity for meaningful future equity value creation through these accretive acquisitions and continued fair value appreciation on these investments going forward.
As we've previously noted in prior quarters, we believe that several factors are driving a significant increase in activity in our current pipeline. These factors included an increased focus on financial and estate planning priorities by many entrepreneur owners after the difficult environment experienced broadly across the economy's since early 2020. Combined with the significant uncertainty and concern regarding increasing future tax rates, particularly taxes on capital gains, consistent with our historical experiences over the last few decades as the industry-leading partner for lower middle market companies and their management teams. We believe that our unique combined debt and equity investment offering and our ability to be a long-term to permanent partner for the companies we invest in positions us as the favorite investment partner for these business owners.
We expected this position will continue to result in attractive new lower middle-market originations for our Main Street platform going forward. Due to the strength and quality of our lower middle-market portfolio companies, we are also continuing to experience robust third-party interest in a number of these portfolio companies. These activities have resulted in realized gains on exits of lower middle-market investments in both the third quarter and the fourth quarter, and based upon ongoing activities could result in additional exit and realized gain opportunities in the near-term future. We've also continued to grow our private loan portfolio. And as of today, our characterized, our private loan investment pipeline is about average. With that, I will turn the call over to David.
Thanks, Dwayne. And good morning, everyone. As Dwayne highlighted in his remarks, we believe our strong third quarter financial results demonstrate the strength of Mainstreet platform, our differentiated investment approach, and our unique operating model. We're excited that our performance during the quarter resulted in several all-time highs, including our net investment income and lower middle-market originations. Were also pleased to report that the overall operating performance for the majority of our portfolio companies is so strong in the quarter, resulting in both a significant increase in our NAV per share and the highest level of dividend income from our lower middle-market portfolio in our firm's history.
As a result of our strong performance, our third quarter operating results achieved a GAAP return on equity, or ROE of over 20% on both an annualized and trailing 12-month basis, which we believe is very attractive in comparison to the majority of our BDC peers. As we've discussed in the past, the primary driver of our long-term success has been and continues to be our focus on the underserved lower-middle market. And specifically our strategy of investing in both the debt and equity in lower middle-market companies. Given the unique benefits of our lower middle market portfolio, we've periodically provided comments on different attractive aspects of this strategy.
Today, I will review how our lower middle-market strategy has enabled us to achieve attractive ROEs over the long term for our shareholders. Firstly, we believe that some BDC investors have historically overemphasized monthly dividends when evaluating their overall expected return in the BDC industry. As most sophisticated investors appreciate, this approach can be misleading in situations where either their dividends are not covered by net investment income or when underwriting issues caused NAV per share to decline. When we evaluate new lower middle-market investments, we target our combined first-lien debt and equity investments to achieve a base case blended annual return at or above mid to high teens percentage with targeted returns on equity investments consistent with private equity industry standards.
From an underwriting standpoint, we achieved these targets by maintaining a disciplined mix of debt and equity investments with a typical initial investment comprised of approximately 75% to 80% debt and 20% to 25% equity, which provides a strong alignment of interest with the managers of the businesses we partner with. We're confident that our long-term proven success of investing in the lower middle market combined with our prudent use of conservative leverage at Main Street will continue to allow us to deliver very attractive ROE results for our investors in the future. It's also important to note that as our individual lower middle market investments mature in our portfolio, they tend to deleverage which increases their ability to pay dividends and generate both unrealized equity appreciation and realize gains.
In the current quarter, our lower middle-market investments were the primary driver behind our significant pre -tax net unrealized appreciation with these investments representing appreciation of over $0.40 per share, or approximately $28 million in the quarter. Additionally, our lower middle-market equity investments were responsible for realized gains of over $13 million in the third quarter, following gains of approximately $15 million realized in the second quarter and $11 million of gains to date in the fourth quarter. Based upon ongoing activities, we are hopeful that we could achieve additional exit and realize gain opportunity in the near-term future.
A good example of our typical lower middle-market investments strategy playing out, is a minority equity and debt investment we recognized this quarter in our lower middle-market portfolio Company, National Research Institute or NRI. We initially invested in NRI in 2011 to support a change of controlled transaction. We fully exited our investment in the third quarter, which provided us an $8.8 million realized gain. On a cumulative basis, including both our debt and equity investments, we achieved a total annual internal rate of return of 20% and 2.6 times money invested. As we've mentioned in the past, realized gains like this provides the offset to the inevitable credit losses that will be experienced in making investments in non-investment grade investments as we do for the vast majority of the investments in our portfolio.
Now turning to the overall composition results from our investment portfolio, the contributions from our lower middle-market portfolio continued to be well diversified with 64% of our lower middle-market companies with equity investments having appreciation at quarter-end and with 54% of these companies contributing to our dividend income over the last 12 months. Our investment activity in the third quarter included total investments in our lower middle-market portfolio of approximately $159 million, which after aggregate repayments on debt investments and return of invested equity capital resulted in a net increase in our lower middle-market portfolio of approximately $135 million. It's also important to note that on a year-to-date basis, we've been able to invest $118 million in our existing lower middle-market portfolio companies to support acquisitions, recapitalizations, and other growth initiatives.
We view this as notable and we believe that investing in our existing portfolio companies provide less risk from compared to investing in new portfolio companies which have not yet proven financial and operational success to us over an extended period of time. During the quarter, we also made $118 million in total private loan investment, which after aggregate repayments of debt result in net decrease in our private loan portfolio of approximately $20 million. On a year-to-date basis, this portfolio continues to grow, which is consistent with our long-term commitment to this important strategic part of our business.
Finally, we had a net decrease in our middle market portfolio of approximately $17 million. As of September 30th, we had investments in a 177 portfolio companies spanning across over 50 different industries. Our largest portfolio Company represented approximately 2.5% of our total investment portfolio fair value of quarter-end and 3.2% of our total investment income for the last 12 months. The vast majority of our portfolio investments represented less than 1% of our assets and our income. At quarter end, our lower middle market portfolio included investments in 70 companies representing over $1.5 billion of fair value, which is over 20% above our cost basis.
As of September 30th, Mainstreet 's private loan portfolio included total investments of approximately $846 million of fair value across 69 unique companies. In our middle-market portfolio, we had investments in 38 companies representing approximately $421 million of fair value. The total investments portfolio at fair value [Indiscernible] was approximately 110% of the related cost basis. In summary, Main Streets investment portfolio continues to perform at a high level and deliver on our long-term goals. With that, I'll turn the call over to Jesse to cover our financial results, capital structure and liquidity position.
Thank you, David. Turning to a summary of our financial results and echoing Dwayne 's and David 's initial comments, we are very pleased with our operating results for the third quarter, which included a number of quarterly records. Our total investment income in the third quarter increased by $24.8 million or 48% over the same period in 2020 to a total of $76.8 million, driven by increases in interest, dividend, and fee income. A particular note, total investment income in the third quarter of 2021 included the favorable impact of certain elevated income items, including dividends and accelerated pre -payment, repricing, or other activities are considered less consistent. While these income items occur frequently, practically every quarter, we fill it is worthwhile to highlight them because of their variability on a quarter-to-quarter basis.
In the third quarter, the combined impact of these items was approximately 8.2 million or $0.12 per share greater than the same period in 2020 and approximately 5.4 million or $0.08 per share above the average of the prior four quarters. Our operating expenses for the third quarter, excluding non-cash share-based compensation expense, increased by 5.7 million over the same period of the prior year, driven largely by increases in compensation expense, and interest expense in the quarter. The increase in compensation expense is primarily due to high levels incentive compensation accruals, which is directly attributable to the high levels of operating performance and to a lesser extent, investments in additional personnel to grow our investment teams. We continue to have industry-leading operating expense management.
The ratio of our total operating expenses, excluding interest expense, as a percentage of our average total assets was 1.5% for the trailing 12 months and continues to be amongst the lowest in our industry. The activities of our external investment manager benefited our net investment income by approximately $4.2 million during the third quarter through the allocation of $2.7 million of operating expenses for services we provided to it and $1.5 million of dividend income, an increase of $1.1 million from the same period of the prior year. This increase is largely attributable to Main Street taking over the sole advisor responsibilities of the, MSC Income Fund in October 2020, plus growth in the overall assets managed by the external investment manager. Net investment income, increased by $18.8 million or 62% in the third quarter of 2021 over the same period last year.
A key measure of our performance is distributable net investment income, or DNII, which is our net investment income excluding the impact of non-cash share-based compensation expense. DNII increased by $19.2 million or 58% in the third quarter of 2021 over the same period last year. As a percentage of total investment income, DNII increased by over 80 basis points to 67.4% for the first 9 months of the year when compared to the same period last year, which demonstrates the continued benefit of the operating leverage underlying Main Street 's overall results. We recorded net unrealized appreciation on the investment portfolio of $49.7 million during the third quarter with contributions from all segments and including net appreciation of 27.9 million in our lower middle-market portfolio, 3.2 million in our private loan portfolio, 2.9 million in our middle-market portfolio, and $9.3 million in our other portfolio.
All before accounting for reversals for net realized gains and losses recognized during the quarter. In addition, our external investment manager also reflected appreciation of $6.4 million, primarily driven by the increase in assets managed by the manager. Our operating results for the third quarter resulted in an increase in net asset value or NAV of 84 million and an increase in NAV per share of $1.22 to end the quarter with NAV a $24.27 per share. We ended the third quarter with 8 investments on non-accrual status, comprising approximately 0.9% of the total investment portfolio at fair value, and approximately 3.5% at costs.
We had one middle-market investments that was previously on non-accrual, moved to accrual during the quarter after a successful restructuring. Our overall capitalization and liquidity remained very strong with total liquidity in excess of $700 million as of September 30th. We're also very pleased to have further enhanced our capital structure through the issuance of an additional $200 million of fixed rate long-term investment-grade debt at an effective rate of 2.6% in October.
We continue to believe that our conservative leverage, strong liquidity and continued access to capital of significant strengths, that have us well-positioned for the future. Coming back to our offering results, DNII per share for the third quarter was $0.76 per share, an increase of $0.26 or over 50% on the same period last year. And the $0.10 or 14.7% increase over the second quarter 2021. Our DNII per share for the quarter, exceeded the dividends per share paid to our shareholders by $14.5 per share.
The fourth consecutive quarter that our DNII per share has exceeded dividends paid during the quarter. Including the December supplemental dividend, which Dwayne mentioned in his remarks, in the monthly dividends declared for the fourth quarter, dividends paid for the year will be $2 and 57.5 cents, an increase of 4.7% over dividends paid to our in 2020. As we look forward, given the strength of our underlying portfolio and the robust investment environment that Dwayne and David mentioned in the remarks, we expect another strong earnings quarter in the fourth quarter with expected DNII per share in excess of $0.66 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]. One moment please while we pause for questions. Our first question is from Robert Dodd with Raymond James. Please proceed with your question.
Hi, guys, and congratulations on a great quarter. On the Co-op portfolio, is seems to be performing great. The variability from an investment perspective, I guess, comes from the dividend income. Now, Jesse gave some numbers, but can you go through -- again what's -- any -- identify maybe the scale of any one-time dividends that flowed from portfolio companies this quarter, looking at what the earnings was here and obviously what the guidance that the fourth quarter would tend to imply that with some one-time factors in that.
Yeah, Robert. Thanks for the question. So as we've said before, there's always going to be quarter-to-quarter volatility in the dividends. So to your point as Jesse outlined in his comments, we had just under $5 million of dividend income that we would characterize as one-time. When you look at the fourth quarter guidance because it's so hard to predict the dividend income going forward, I would say that we've been more conservative in the dividend income side of that projection, when you look at the $0.66 per share projection for Q4. So obviously, if we had significant increased volatility on the dividend income side, good to the upside of the benefit, then you could see upside to that 66 set number.
Got it. And then if I can on the advisor, I mean, you've made a lot of progress. Investment grade NAV grew, et cetera, doesn't look like it paid an incentive fee to -- MSC advisors this quarter. I mean, what's the outlook both for that fund in terms of additional work you've still got to do and how fast you think you can get that done. And the potential for incentive fee is to start flowing to your advise and thus dividend income to the BDC.
Sure, Larry. You are correct. There is no incentive fee that was recorded in the quarter from our relationship with MSC Income Fund, as we continue to execute on our strategies, there. As you said, we've really been focused on the capital structure side of things, getting either capital structure improved and getting them additional liquidity so they can continue to be a consistent co-investor with Main Street across both the lower middle market and pilot launch strategy. So we've achieved that over the last year, and obviously now we're continuing to focus on optimizing their portfolio and returns from that portfolio. So we are close to earning an incentive fee, but we did not do it this quarter, but there is that opportunity for additional benefits from that relationship through the incentive fee as we look at the next couple of quarters.
I appreciate that. And if I can just get one more, might as well. All the low middle market obviously grew, the lower market segment of portfolio partly because of appreciation on those assets, but grew again as a percentage of the overall mix of the portfolio. Where -- do you feel this is the right level for that? Obviously, quarter-to-quarter things move around. But long term, do you think this mix is about right, or would you continue to hope to get the lower middle market to represent a greater portion of the overall assets on the books? And that's the last one for me.
Thanks for the questions, Robert. So if you recall last couple of years, going back 4 or 5 years ago, we've been focused on -- you're looking at your repositioning our portfolio with lower middle market being the primary focus. So we're very, very pleased here to see how the portfolio on the lower middle market side has continued to grow. And we are optimistic about the expectations for Q4 and Q1, as we look at continued new origination or growth activity, and a lower middle markets.
So I would say all things being equal, we would like that lower middle market portion of the portfolio to be as large as possible and would be happy to see it continue to grow over the next couple of quarters. We're also really focused on growing the private loan portion of our portfolio at our private credit team has done a great job on that side of the business as well. So when you look at the growth of lower middle market, it's really coming at the expense or the decrease of the middle market portfolio. As we continue to focus primarily on lower market growth and then secondarily on private long growth.
Thank you.
Thank you, Robert.
As a reminder, if you'd like to ask a question, please [Operator Instructions] Our next question is from Kenneth Lee with RBC Capital Markets. Please proceed with your question.
Hi. Thanks for taking my question. Just one on where you talked about in the prepared remarks about reinvesting any future equity realizations rather than paying out a supplemental dividend. I wonder if you could just further elaborate upon that. What kind of potential reinvestment opportunities are you thinking of there? Thanks.
Thanks, Kenneth. What I would say on that point is to the extent we have significant excess DNII above the monthly dividend like we did here most recently, that's -- that would really be the source of our potential for our opportunities on the supplemental incomes -- our supplemental dividends going forward. If you recall, a number of years ago prior to the COVID-19 pandemic, we had made the decision strategically to move away from our supplemental dividends and move more to focusing on increasing the monthly and to the extent we had significant realized gains due to the extent we can given our tax structures, retaining those gains for future growth of the portfolio. So there's not a reinvestment opportunity that we're focused on is different than our main strategies. But as we have those realized gains and we can retain that capital, the expectation would be to redeploy it into the lower middle market and private loan strategies that we have as our primary investment strategies.
Got you. Got you. And one follow-up if I may, in terms of the dividend income and portfolio, is there still a potential benefit from any kind of catch-up dividends from the portfolio companies in the current quarter. Thanks.
Hey Kenneth, I think it's hard to really tie down the source or the driver of dividend income and every business, but I would say, in general, I would say most of the dividend income today is more the benefit of increased operations or increased profits that they're generating as opposed to being an overhang or carried forward from there conservatism back in COVID time periods.
Got you. Very helpful. Thanks again.
Thank you.
This now concludes our question-and-answer session. I would like to turn the floor back over to management for closing comments.
Thank you again everyone for joining us this morning, and we'll look forward to talking to you again in late February when we report our year-end results for the year. Thank you.
Ladies and gentlemen. Thank you for participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.