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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 Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Mark Roberson. Thank you, you may begin.
Thank you, operator, and good morning everyone. Thank you for joining us for Main Street Capital Corporation's fourth quarter and full year 2017 earnings conference call. Joining me on the call today are Chairman and CEO, Vince Foster; President and Chief Operating Officer, Dwayne Hyzak; and Chief Financial Officer, Brent Smith.
Main Street Capital issued a press release yesterday afternoon that details the Company's fourth quarter and full year financial and operating results. This document is available on the Investor Relations section of the Company's website at mainstcapital.com. A replay of today's call will be available beginning about an hour after the completion of the call and will remain available until March 2nd. Information on how to access the replay was included in yesterday's release. We also advise you that this conference call is being broadcast live through the Internet and can be accessed on the Company's homepage.
Please note that information reported on this call speaks only as of today, February 23, 2018, and therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading.
Today's call will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may or similar expressions. These statements are based on management's estimates, assumptions and projections as of the day of this call and there are no guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties and other factors including but not limited to the factors set forth in the Company's filings with the Securities and Exchange Commission, which can be found on the Company's website or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law.
During today's call, management will discuss non-GAAP financial measures including distributable net investment income. 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 of companies was derived from third-party sources and has not been independently verified.
And now, I'll turn the call over to Vince.
Thanks, Mark, and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcement and a few other recent developments and conclude by commenting on our investment pipeline. Following my comments, Dwayne Hyzak, our President; and Brent Smith, our CFO, will comment on our first quarter and full-year financial results, recent originations and exits, our current liquidity position and certain key portfolio statistics and our operating expense ratio, after which we will take your questions.
We were pleased with our fourth quarter operating results, our lower middle market portfolio, our primary area of focus appreciated by $34 million on a net basis during the quarter, with 34 of our investments appreciating during the quarter and 14 depreciating. Our middle market loans, private loans and our other assets into the quarter collectively, essentially flat from evaluation standpoint compared to the end of the third quarter. We finished the quarter with a net asset value per share of $23.53, a sequential increase of $0.51 over the third quarter. After excluding the impact of this semi-annual supplemental dividend paid during the fourth quarter, our net asset value increased $0.79 per share during the quarter.
Our lower middle market companies collectively continue to exhibit very conservative leverage ratios on a relative basis, which Dwayne will cover in greater detail. Earlier this week, our Board declared our second quarter 2018 regular monthly dividends of $0.19 a share in each of March, April and May of 2018, maintaining our first quarter monthly payout rate. The ex-dates released dividends are March 20th, April 19th and May 18th respectively. We expect to ask our Board to declare a semi-annual supplemental dividend to be paid in June similar on amount to the $27.05 a share that we paid last December.
Earlier this year, we issued a press release to provide an update on our Board's multiyear management succession planning process. We announced that Dwayne would be named our CEO during the fourth quarter with me continuing as fulltime Chairman. This has been exciting development for our organization as we demonstrated our historical ability to promote from within. This creates additional opportunities for our people to take on grater responsibilities and accelerate their professional development. From an industry's perspective, it's important to note that the new responsibilities and positions resulting from our planning process will not involve any change to our investments strategies and process.
We have originated new lower middle market and private loan investments of roughly $60 million so far this year in 2018. As of today, I would characterize our lower middle market investment pipeline most is above average. We continue to seek and receive significant equity participation in our lower middle market investments, and as of quarter end, we owned on average a 39% fully diluted equity ownership position in the 97% of these investments in which we currently have equity exposure. Our officer director group has continued to be regular purchasers of our shares, investing approximately $800,000 during the fourth quarter.
With that, I would like to turn the call over to Dwayne to cover our performance in more detail.
Thanks, Vince, good morning everyone. We are pleased to report another quarter and another year during which we grew our total investment income and distributable net investment income, both in total and on a per share basis and again generated distributable net investment income in excess of our monthly dividends. In addition as a result of our unique focus on investments in both debt and equity in the lower middle market, we were also able to grow our net asset value per share and generate over $60 million of net realized gains on our total investment portfolio, primarily due to the successful exit of several of our lower middle market investments.
We're also pleased that our operating results represent a GAAP return on equity or ROE of 13.3% for the full year and 18.1% on an annualized basis for the fourth quarter. Returns are in line with our stated long term goal of producing an ROE percentage in the low to mid teens. We believe that these results illustrate the significant benefits of our investment strategy of investing our debt and equity in the lower middle market, which combines our efficient operating structure and other complement investments and asset management activities continue to provide a value proposition that differentiates Main Street from other yield oriented investment options and generates a premium total returns realized by our shareholders, as a result of the growth in our dividends per share, our net asset value per share and our stock price.
At each year in period, we want to take a few minutes to look back at our history and re-cap the benefits that our unique investment strategy and efficient operating structure have enabled us to deliver to our shareholders. Since our IPO over 10 years ago through the end of 2017, our operating performance has allowed us to grow our recurring monthly dividends per share by 73% and paid cumulative total dividends to our shareholders of over $21 per share or over 140% of our IPO price of $15 per share. Our shareholders have also benefitted from significant back price appreciation. These benefits for our shareholders represent an annual rate of return of approximately 20% per year during the 10-year period since our IPO through the end of 2017, which we believe compares very favorably to other investment options over this time period.
As we discussed in our prior conference calls, we believe 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 investment strategy of investing in both debt and equity in the lower middle market, and acting as a sponsor and a partner to the management teams of our lower middle market companies and not just the financing source. Without this primary focus on the lower middle market, it will be very difficult to produce these returns for our shareholders. Given our view of the significant value associated with our focus on the lower middle market, we are pleased that despite the competitive market conditions that most of our peers are facing in the current environment, we've continued to find attractive new investment opportunities in the lower middle market that match our historical investment profile.
Now turning back to our most operating results, consistent with prior quarters the contributions from our lower middle market portfolio continue to be well diversified with 44 of our 68 lower middle market companies with equity investments having unrealized appreciation at year end and with 26 of these companies that are flow-through entities for tax purposes are 52% of our total investments in these types of entities, contributing to our dividend income during 2017. We also have several equity investments in few corporations which have contributed to our dividend income.
In addition to the positive contributions from our equity investments in 2017, in the first two months of 2018, we successfully exited our investments in two companies generating total realized gains on these equity investments of approximately $30 million. We believe that the diversity of our lower middle market portfolio is very important when analyzing the benefits from our lower middle market strategy and we believe that this diversity provides visibility to the recurring nature of these benefits in the future.
Now turning specifically to our investment activity in the fourth quarter and our investment portfolio at year end, our investment activity in the fourth quarter included total investments in our lower middle market portfolio of approximately $14 million, which after aggregate a repayment on debt investments and return of invested equity capital resulted in a net decrease in our lower middle market portfolio of approximately 29 million.
We had a net decrease in our middle market portfolio of approximately $6 million and a net decrease in our private loan portfolio of approximately $18 million. As a result, at December 31st, we had investments in 186 portfolio companies that are more than 50 different industries across the lower middle market, middle market and private loan components of our investment portfolio.
The largest portfolio company represents 4.6% of our total investment income for the year and 4.1% of our total investment portfolio of fair value at year-end, with the majority of our portfolio investments representing less than 1% of our income and our assets. Additional details on our investment portfolio at year-end are included in the press release that we issued yesterday, but I will touch on a few highlights.
Our lower middle market portfolio included investments in 70 companies, representing approximately $948 million of fair value, which is approximately 22% above our cost basis. At the lower middle market portfolio level, the portfolio's median net senior debt to EBITDA ratio was a conservative 2.8 to 1 or 3.3 to 1 including portfolio company debt, which is junior in priority to our debt position.
As a complement to our lower middle market portfolio and our middle market portfolio, we had investments in 62 companies, representing approximately $609 million of fair value. In our private loan portfolio, we had investments in 54 companies, representing approximately $468 million of fair value. The total investment portfolio fair value at year-end was approximately 108% of the related cost basis and we had five investments on non-accrual status, which comprised approximately 0.2% of the total investment portfolio at fair value and 2.3% at cost.
In summary, Main Street's investment portfolio continues to perform at a high level and continues to deliver on our long-term goals.
With that, I will turn the call over to Brent to cover our financial results, capital structure and liquidity position.
Thanks Dwayne. We are pleased to report that our total investment income increased by 19% for the fourth quarter over the same period in 2016 to a total of $55.8 million primarily driven by an increase in interesting income of approximately $7.1 million, an increase in dividend income of $2.4.
The total investment income includes an increase of $2.7 million related to interest income that as considered to be either a less consistent on a recurring basis or non-recurring when compared to the same period in 2016 and an increase of $1.1 million primarily related to higher accelerated prepayment reprising and other activity for certain debt investments when compared to the same period in 2016.
Fourth quarter 2017 operating expenses excluding non-cash share based compensation expense increased by $1.8 million over the fourth quarter of the prior year to a total of $15.8 million. The increase was primarily related to a $1 million increase in interest expense, a $0.5 million increase in comp efficient expense, and a $0.5 million increase in general and administrative cost. These increases were partially offset by an increase of $0.2 million in cost we allocated to the external investment manager for services provided to it.
The ratio of our total operating expenses excluding interest expense as a percentage of our average total asset, which we believe is the key metric in evaluating our operating efficiency was 1.5% on an annualized basis for the fourth quarter, unchanged from the same period in the prior year. Our increased total investment income and the continued leverage of our efficient operating structure resulted in a 22% increase in distributable net investment income for the fourth quarter of 2017 to a total of 40 million or $0.69 per share, which exceeded our recurring monthly dividends paid for the quarter by approximately 21%.
Our external investment manager’s relationship with the HMS Income Fund benefited our net investment income by approximately 2.5 million in the fourth quarter of 2017, through a 1.6 million reduction of our operating expenses for cost we allocated to the external investment manager for services we provided to it and 0.9 million of dividend income from the external investment manager.
We reported a net realized loss of 11.7 million during the fourth quarter, primarily related to the net realized losses on two middle market debt investments along with a net realized loss on the exit of the lower middle market investment. And as Vince discussed, we reported net unrealized appreciation on the investment portfolio of 36.4 million in the fourth quarter, primarily related to 34.2 million of net appreciation on our lower middle market portfolio, 1.6 million of net appreciation on our other portfolio, and 2.5 million of appreciation on our external investment manager. This net unrealized appreciation was partially offset by 1 million of net unrealized depreciation on our middle market portfolio, and 0.9 million of net depreciation on our private loan portfolio.
We estimate that approximately 15 million of the net appreciation relating to our lower middle market portfolio was a result of the impact of the tax reform passed at the end of 2017 on our equity valuations. In addition, approximately 18 million of the net appreciation relating to our lower middle market portfolio was due to the increase in the value of our equity investment in CBT Nuggets. This unrealized appreciation was primarily due to an increase in the value of certain cryptocurrencies that CBT owns. Additional details for the change in our net unrealized appreciation can be found in our earnings release.
Our operating results for the fourth quarter of 2017 resulted in a net increase in net assets of 61.4 million, or $1.05 per share. On the capital resources front, our liquidity and overall capitalization remained strong. At the end of the fourth quarter, we had 51.5 million of cash, 521 million of unused capacity under our credit facility and approximately 54 million of incremental SBIC debenture capacity, for total liquidity of approximately 600 million.
Currently, we have approximately 68 million of cash, 472 million of unused capacity on our credit facility and 44 million of incremental SBIC debenture capacity. In November, we issued a 185 million of investment grade unsecured notes with the five-year term and a fixed 4.5% coupon. We believe providing additional long-term fixed rate debt capital in a rising interest environment significantly enhanced our capital structure and has us well positioned for 2018 and 2019.
We also continue to be pleased with the execution of our ATM equity issuance program. During the fourth quarter, we raised nearly 33 million in net proceeds with an average sales price of $40.22 per share. As we look forward to the first quarter of 2018, and taking into account the impact from two fewer days of interest income during the first quarter when compared to the fourth quarter, which we estimate has a $0.01 to $0.02 per share negative impact to net investment income.
We currently expect that we would generate distributable net investment income of $0.63 to $0.64 per share during the quarter. This estimated $0.06 to $0.07 per share or approximately 10% to 12% above our previously announced monthly dividends for the first quarter of $0.57 per share, maintaining our conservative approach to our monthly cash dividends.
With that, I will now turn the call back over to the operator, so we can take any questions.
Thank you. At this time, we would be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Robert Dodd with Raymond James. Please go ahead with your question.
On the tax, last quarter Vince you gave us a lot of color on what the tax implications could be for the business. Obviously, we've seen the NAV benefit already. The bill obviously passed after that call. Were there any surprises in that bill versus what you are expecting and anything that changes the color? Or we should just take what you told us last quarter as pretty the lack of better term definitive of what you think the impacts are?
I would say nothing material. The equipment expensing of new and used equipment that I think was retro to like September 27th of last year, that something we had factored in. So in other words, if we do a new asset deal, Robert, as opposed to a stock deal where it's taxable and we give a step up, we can expense on day 1 any of the equipment that gets placed in service as appreciable, and it's all used when you do an asset deals in existing company. And that's a pretty amazing result, that’s mostly going to impact our new deals as opposed to our old deal. So I would say nothing material.
And then on the after the end of the quarter, you mentioned the $13 realized gain onto low middle market investments. As far as the GST order led you have a senior position in this some other BDCs that have junior debt you have a senior position in. That as far as I know there has been restructuring or a resolution of that. You had marked to 80 last quarter I remember roughly we obviously don’t have the K yet. The story that I've seen is the final dissolution is more like 20 for the senior. So any color on that and is that going to have any -- how they going to offset would that be against the 13 million used generated in gains so far this year?
Nick Meserve is on plan on that. He's going to respond.
So GST, this is a mid-2014 transaction for us. Like you said, we are in the senior debt the short-term formally expected and really ran some liquidity issues in late '17 and then file for bankruptcy, everyone to the process, we were dealing in long-term value for our positions with that dealing some other vendor in January right around mark for 12/31 and also little above our mark for 9/30. The end result really up to date $3 million realizable loss, our cash-on-cash basis were basically flat and it could be the interest we've received from 2014 compare to zero percent IRR there [indiscernible].
But the 20% number was end up being bad number they got reported.
It's technically an accurate number based on some banks filing, but I would not expect it was the long-term recovery for the senior debt will be 20. Based on range of the bankruptcy filing of what the end evaluation was.
And it was materially different than what our actual realized came out [indiscernible]
So, we make this program [indiscernible] the first week of January.
On small business optimism, has just -- based I mean January, another high facility, higher outlook, is an all time high and that data goes back for the FYB to the 70. And I know point or two it's a good time to expand, none on -- in that index nobody seems particularly worried about labor cost flow inflation. What's the tone you're hearing for your existing obviously you can do the deals, but is there increased appetite for your lower middle market business to be expanding and doing add-on expanding time, expanding headcount and anything like that?
Yes, I would say Robert that the view that our portfolio company has is generally consistent with what you described. So I think we continue to see good opportunities there. Clearly, you got to be cautious about some of the items that you referred to, but we continue to work with our company to maximize the opportunities. If you looked at our fourth quarter new activity in the lower middle market while it was smaller than what we would have hoped, two of the companies that were involved in that both were existing lower middle market companies had completed acquisitions. So, I think that when you look at it both we and our portfolio companies are optimistic about what should come to bear in 2018 and '19 and we're trying to help them take advantage of those opportunities.
Got it. Appreciated. One final. On CBT nuggets, you mentioned cryptocurrency so. Is it possible to give an idea how much of the fair value mark of the equity, obviously, the appreciation was due to the crypto, but how much of the equity value in that would be a essentially result of the crypto that they own?
So, Robert, I think Brent in his comments gave the fourth quarter impact and I would say that that fourth quarter impact represented the vast majority of the value they had in the valuation. So clearly, it's something that has a lot of volatility and we benefitted from that volatility in the fourth quarter, but there's not a lot of additional value in their valuation from cryptocurrency above the 17 million, but I think Brent covered in his comments.
That's correct.
Our next question comes from the line of Doug Mewhirter with SunTrust Robinson Humphrey. Please proceed with your question.
First bigger picture question, Vince or Dwayne or both. So it seems like in the BDC space, no one really wants to be kind of in the middle anymore and maybe they want to be like really big and do bank deals type deals. But also seeing sort of increased sentiment and this is just all sort of baked on secondary conversations about the lower middle -- how the lower middle market looks attractive because it's less efficient, and I am sure you've heard these same conversations 100 times. I mean, are you seeing any more push in the lower middle market, especially from these smaller private funds and from the sponsors and SBIC funds because it seems like it's sort of the last bastion of low competition and nice spreads? Or is it been relatively steady?
Well I think, if there's an attractive $7 million visibly growing EBITDA company, I think it's fair to say, Dwayne, you're closed to this than I am, but you are attracting, if there is well run auction, you are attracting more bids now than you were a few years ago. If it's a slow growing kind of value oriented $7 million EBITDA company, there is not much more appetite because these funds have temporarily capital and they have to buy stuff that their confidence, they can add-on to and sell.
So where we have a competitive advantage as we can come in, pay a lower valuation for this slower growth company, and not have much competition, if any. Because we don’t have to worry about existing in 48 or 60 months, we can hold forever used the cash and enjoy the deleveraging power to cash flow to have our equity appreciate.
So that's what were focused on, we're not going to be competitive. We find a nice company recently that wasn’t about that size and EBITDA, and we came in about seven times and it was a growth oriented company, and we were told and this bodes well for our existing companies. We were told it needed to be at 10 multiple to make the next round. So, we just don’t spend much energy on those deals. We will participate given the indication briefly, but we're not going to chase them.
And if the other thing I would add and you heard us talk about this in the past, so that's not just being active in the lower middle market, our combined approach of debt and equity and being a very willing partner in a minority basis really is different. When you look at other people in the marketplace, so that the deal that fit us, fit us extremely well, and there was not many other people in the U.S. that can provide the combination of debt and minority equity. So for the right transaction, we continue to see great opportunities and our structure give us a significant advantage as opposed to just having to compete on valuation.
Maybe a financial question or balance sheet type question. In your stocks come-off the peak a little bit as of all BDCs, I know you have an active ATM at the market program. Have you I guess adjusted your algorithms or your trading instructions at all, because the stock has been slightly less attractive valuation? Or is it still so far above the threshold that you basically sell as much stock as you need to based on your investment pipeline and the valuation zone really isn’t in an area where you would make any of those kind of adjustments?
So, we absolutely take that equation to account. So, we -- it's a tool we think it's important and important part of our strategy. In an ideal situation, we're issuing our shares in a year to replicate the dividends that we paid and would be able to synthetically retain our earnings, using that as about how we usually could have sold, we could have sold a lot more. Brent gives the desk daily instructions and a typical day might be within certain valuation parameters 5% of the volume. And would you add more color to that? I mean the answer, I forget definitely modulate based upon where the stocks are trading and we've done that and we've been on the market for several days and we didn’t like where the stock was trading.
The good thing is that we've talked about before. We control when we sell, so it's very easy to start or stop and change any parameters, and we've been very active in that regard. So, I think obviously as we have said the stock price will determine how much we're willing to sell, but long term we still do believe in the benefit of the permanent capital especially as it relates to our lower middle market strategy. And we do expect to be in the ATM program, but we'll do so on a very guarded and carefully thought out process.
My last question relating to interest rates, a lot of your lower middle market first lien loans and some of them are fixed or sort of semi fixed, but a relatively high coupon. So you get a pretty nice spread off of LIBOR even if LIBOR being up, but that being said now that LIBOR has crept up and your funding costs have crept up a little bit. Is that sort of feeding back into the lower middle market, debt conversations? Or is sort of the clearing rate of your first lien coupons still in that sort of 10% to 12% range?
I would say in general we'll still on that range, what I would say that we've done in the last couple of years which you would not have seen doing four to five years ago was that just from a negotiating standpoint with our companies, as we look at new investments is giving them an option as a fixed versus floating, and letting them pick between the two. We look at that as something that was good from a market competition standpoint, but at the same time as you said, it allowed us to have some of our lower middle market debt portfolio being floating rates given the current interest rate environment and the outlook going forward. But outside of that change, I would not say that we've seen a significant shift in our strategy or approach as it relates to the interest rates on our lower middle market debt investments.
Thanks. [Operator Instructions] And it seems that we have no questions at this time, I would like to turn the floor back to management for closing comments.
Great, thanks for joining us. And we'll talk to you again in a couple of months.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.