MSCC(MAIN) - 2022 Q4 - Annual Report

Part I Business Main Street Capital Corporation is an internally managed BDC providing debt and equity financing to LMM and Middle Market companies, focused on maximizing total portfolio return - MSCC is a principal investment firm focused on providing customized debt and equity financing to Lower Middle Market (LMM) companies and debt capital to Middle Market companies[16] - As an internally managed BDC, MSCC avoids external advisory fees, resulting in a beneficial operating expense structure, with a 1.4% ratio of total operating expenses (excluding interest) to quarterly average total assets in 2022[17][38][39] - MSCC's wholly-owned subsidiary, MSC Adviser I, LLC (the "External Investment Manager"), contributed $22.3 million to MSCC's net investment income in 2022 by providing investment management services to third parties[19][42] - The company has elected to be treated as a Regulated Investment Company (RIC) for tax purposes, generally avoiding corporate-level federal income taxes on distributed income[20] - Through its licensed Small Business Investment Company (SBIC) subsidiaries, MSCC accesses low-cost, long-term leverage from SBA-guaranteed debentures, with $350.0 million outstanding at a weighted-average interest rate of 2.9% as of year-end 2022[18][117] Organization MSCC operates as an internally managed BDC, owning SBIC funds and an external investment manager, and is taxed as a RIC - MSCC operates as an internally managed BDC, directly employing its executive officers and staff, thus avoiding external advisory fees[17] - The company wholly owns two funds licensed as SBICs by the SBA: Main Street Mezzanine Fund, LP (MSMF) and Main Street Capital III, LP (MSC III)[18] - MSC Adviser I, LLC is a wholly-owned subsidiary acting as an External Investment Manager for third parties, accounted for as a portfolio investment rather than a consolidated subsidiary[19][26] - MSCC utilizes wholly-owned Taxable Subsidiaries to hold equity investments in pass-through entities and Structured Subsidiaries for financing purposes, all consolidated in its financial statements[21][22] Overview of Our Business The company maximizes total portfolio return through LMM, Private Loan, and Middle Market strategies, benefiting from an internally managed structure and external asset management fee income Investment Strategy Focus | Strategy | Target Company Annual Revenue | Typical Investment Size | | :--- | :--- | :--- | | Lower Middle Market (LMM) | $10 million - $150 million | $5 million - $75 million | | Private Loan | Consistent with LMM/Middle Market | $10 million - $75 million | | Middle Market | $150 million - $1.5 billion | $3 million - $25 million | Operating Expense Ratios | Expense Ratio (as a % of quarterly average total assets) | 2022 | 2021 | | :--- | :--- | :--- | | Total operating expenses (excluding interest) | 1.4% | 1.5% | | Total operating expenses (including interest) | 3.3% | 3.4% | External Investment Manager Contribution to Net Investment Income | Year | Contribution (in millions) | | :--- | :--- | | 2022 | $22.3 | | 2021 | $16.5 | | 2020 | $9.9 | - The company has an SEC exemptive order permitting co-investments with funds advised by its External Investment Manager, such as MSC Income and the Private Loan Fund[44] Business Strategies Main Street's strategy focuses on maximizing total portfolio return by offering customized financing to LMM companies, growing asset management, and leveraging low-cost capital - Offer customized "one-stop" debt and equity financing solutions to LMM portfolio companies[46] - Focus on established companies with proven management teams, positive cash flow, and defensible market positions[46] - Leverage an extensive network for proprietary deal flow and grow the external asset management business to diversify income[46] - Utilize low-cost, long-term capital from SBIC licenses (SBA-guaranteed debentures) and investment-grade ratings to maintain a competitive cost of capital[46] Investment Criteria The company evaluates prospective portfolio companies based on management quality, financial performance, competitive advantages, and clear exit strategies - Management teams should be operationally-oriented, have direct industry experience, and hold a meaningful equity stake in the company[49] - Targets established companies with sound historical financial performance, typically with EBITDA of $3 million to $20 million for LMM investments[49] - Focuses on companies with competitive advantages and/or operating in industries with barriers to entry[49] - Seeks clear exit alternatives, primarily through repayment from cash flow, refinancing, strategic acquisition, or recapitalization[49] Investment Portfolio The investment portfolio primarily consists of first-lien secured debt in LMM, Private Loan, and Middle Market companies, complemented by equity investments for capital appreciation - LMM debt investments are generally first-lien, single tranche loans with 5-7 year terms and interest rates between 10% and 14%[48][50] - Private Loan and Middle Market debt investments are also typically first-lien secured loans with 3-7 year terms and floating interest rates[52][53] - In connection with LMM debt, the company often receives equity warrants or makes direct equity investments, targeting a 5% to 50% fully diluted equity position[54][56] Investment Process The company employs a seven-stage investment process, from deal generation and due diligence to post-investment monitoring and exit, managed by its investment committee - The investment process is managed by an internal investment committee and follows seven stages: Deal Generation, Screening, Term Sheet, Due Diligence, Document and Close, Post-Investment, and Exit/Refinancing[58] - Due diligence for LMM investments is comprehensive, including site visits, financial reviews, and interviews with customers and suppliers; Private Loan and Middle Market due diligence relies more on external resources and internal assessment[63] - Post-investment, the company actively monitors its portfolio companies, offering managerial assistance and often taking board representation or observation rights in its LMM investments[69][70] - An internally developed rating system is used to monitor the performance and expected returns of each portfolio company[72] Determination of Net Asset Value and Investment Portfolio Valuation Process The company determines its NAV quarterly, with the illiquid investment portfolio valuation being the most significant estimate, following ASC 820 and SEC Rule 2a-5 - NAV is determined quarterly, and the valuation of the investment portfolio is the most significant estimate in the financial statements[74][75] - The valuation process adheres to ASC 820 and SEC Rule 2a-5, with the Board designating an executive group as the Valuation Committee[75][80] - The quarterly valuation process is a multi-step procedure involving an internal valuation team, the investment team, the Valuation Committee, and rotational review by an independent financial advisory firm[81] Human Capital Main Street's success relies on attracting and retaining talent through competitive compensation, development opportunities, and a diverse, inclusive culture - The company emphasizes attracting, developing, and retaining employees through competitive compensation, benefits, and a strong corporate culture[84][87] - As of December 31, 2022, Main Street had 91 employees, including 53 investment and portfolio management professionals[91] - Maintains initiatives to promote a diverse and inclusive work environment, including a Women's Initiative and a Community Building Committee[87][88] Regulation Main Street is subject to comprehensive regulation as a BDC, including asset composition and leverage limits, and as a RIC, requiring specific income and distribution tests - As a BDC, the company must maintain at least 70% of its assets in "qualifying assets," primarily securities of private or thinly traded U.S. companies[94] - Effective May 3, 2022, the company's required asset coverage ratio was reduced from 200% to 150%, allowing for increased leverage[98] - Its SBIC funds are regulated by the SBA, which provides access to up to $350 million in SBA-guaranteed debentures but imposes specific investment and operational restrictions[110][112][117] - To maintain its RIC status, the company must meet a 90% income test, asset diversification tests, and distribute at least 90% of its investment company taxable income annually[123][126] Risk Factors Investing in the company involves significant risks related to business operations, investment performance, leverage, regulatory compliance, and general market conditions - Business and Structure Risks: The portfolio is recorded at fair value, which involves subjective estimates; the company's success depends on its ability to manage and deploy capital, attract and retain key personnel, and navigate increasing competition[137][143][154] - Investment Risks: Investments in LMM companies carry significant risks, including limited financial resources and lack of liquidity; economic downturns, rising interest rates, and inflation could impair portfolio companies' performance and lead to defaults[139][162][164] - Leverage Risks: The use of borrowed money magnifies the potential for both gains and losses; a decline in asset value would cause NAV to decline more sharply, and default on debt obligations could lead to foreclosure on assets[140][189][196] - Regulatory and Tax Risks: Failure to comply with BDC regulations could reduce operating flexibility; failure to meet RIC qualification requirements would subject the company to corporate-level income tax, substantially reducing net assets and income available for distribution[140][209][234] - General Risks: Events outside of the company's control, such as public health crises, supply chain disruptions, inflation, and capital market instability, could negatively affect portfolio companies and overall operations[145][242][244] Unresolved Staff Comments The company reports that there are no unresolved staff comments - None[256] Properties The company does not own any real estate or other material physical properties, leasing its corporate headquarters in Houston, Texas - The company leases its corporate headquarters in Houston, Texas and does not own any material real estate[257] Legal Proceedings The company may be involved in litigation in the normal course of business but does not expect any current legal matters to materially affect its financial condition or results of operations - The company is not currently involved in any legal proceedings that are expected to have a material adverse effect on its financial condition or results of operations[258] Mine Safety Disclosures This item is not applicable to the company - Not applicable[259] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Main Street's common stock trades on the NYSE, consistently at a premium to NAV, with a dividend reinvestment plan, and has significantly outperformed market indices since its IPO Common Stock Price Range and Premium to NAV (2022) | Quarter | NAV per Share | High Price | Low Price | Premium of High to NAV | Premium of Low to NAV | | :--- | :--- | :--- | :--- | :--- | :--- | | Q1 2022 | $25.89 | $44.88 | $39.94 | 73% | 54% | | Q2 2022 | $25.37 | $43.65 | $34.59 | 72% | 36% | | Q3 2022 | $25.94 | $45.28 | $33.23 | 75% | 28% | | Q4 2022 | $26.86 | $39.50 | $32.57 | 47% | 21% | - The company has a dividend reinvestment plan (DRIP) where stockholder dividends are automatically reinvested into additional shares unless they opt out[269] - During 2022, 625,196 shares of common stock were issued under the DRIP, with an aggregate value of $24.1 million[270] - The stock performance graph indicates that Main Street's total return since its IPO has substantially exceeded that of major market indices, including the S&P 500 and the S&P BDC Index[273][274] Management's Discussion and Analysis of Financial Condition and Results of Operations In 2022, Main Street experienced significant growth in investment income and NII, despite a net realized loss and lower unrealized appreciation, maintaining strong liquidity Key Financial Results Comparison (2022 vs. 2021) | Metric | 2022 | 2021 | % Change | | :--- | :--- | :--- | :--- | | Total Investment Income | $376.9M | $289.0M | 30% | | Net Investment Income (NII) | $245.3M | $182.7M | 34% | | Distributable NII | $257.5M | $194.7M | 32% | | NII per Share | $3.29 | $2.65 | 24% | | Distributable NII per Share | $3.46 | $2.82 | 23% | | Net Realized Gain (Loss) | ($5.2M) | $45.3M | NM | | Net Unrealized Appreciation | $24.8M | $135.6M | NM | - The increase in interest income was primarily due to higher average levels of debt investments and higher floating interest rates[307] - Total expenses increased by 24% to $131.5 million, mainly due to higher interest expense from increased borrowings and higher compensation costs[309][310] - As of December 31, 2022, the company had $49.1 million in cash and $568.0 million of unused capacity under its credit facilities[330] Investment Portfolio Summary As of December 31, 2022, the company's investment portfolio grew across LMM, Private Loan, and Middle Market segments, with increased weighted-average effective yields reflecting rising interest rates Portfolio Summary as of December 31, 2022 | Portfolio | of Companies | Fair Value (M) | Cost (M) | Wtd-Avg Yield | | :--- | :--- | :--- | :--- | :--- | | LMM | 78 | $2,060.5 | $1,719.9 | 12.3% | | Private Loan | 85 | $1,471.5 | $1,500.3 | 11.6% | | Middle Market | 31 | $329.1 | $401.7 | 11.0% | Portfolio Summary as of December 31, 2021 | Portfolio | of Companies | Fair Value (M) | Cost (M) | Wtd-Avg Yield | | :--- | :--- | :--- | :--- | :--- | | LMM | 73 | $1,716.4 | $1,455.7 | 11.2% | | Private Loan | 75 | $1,141.8 | $1,157.5 | 8.2% | | Middle Market | 36 | $395.2 | $440.9 | 7.5% | - The investment in the External Investment Manager had a fair value of $122.9 million as of December 31, 2022, down from $140.4 million at year-end 2021[285] Critical Accounting Policies The company's critical accounting policies involve significant judgment, particularly in the valuation of its investment portfolio at fair value and the recognition of interest and dividend income - The valuation of the Investment Portfolio is the most significant accounting estimate, representing 97% of total assets, determined at fair value following ASC 820 and SEC Rule 2a-5[289][291] - Interest and dividend income are recorded on an accrual basis; loans are generally placed on non-accrual status when 90 days or more past due and collectability is doubtful[292] - The company recognizes non-cash income from Payment-in-Kind (PIK) interest and cumulative dividends, which comprised 1.4% and 0.5% of total investment income in 2022, respectively[295] Investment Portfolio Composition The combined LMM, Private Loan, and Middle Market portfolios are predominantly composed of first-lien debt, with equity investments making up a significant portion at fair value due to unrealized appreciation Portfolio Composition by Investment Type (at Cost) | Investment Type | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | First lien debt | 85.0% | 82.5% | | Equity | 14.2% | 16.2% | | Second lien debt | 0.3% | 0.6% | | Other | 0.5% | 0.7% | Portfolio Composition by Investment Type (at Fair Value) | Investment Type | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | First lien debt | 75.2% | 74.3% | | Equity | 24.1% | 24.6% | | Second lien debt | 0.3% | 0.5% | | Other | 0.4% | 0.6% | Portfolio Asset Quality The company monitors portfolio asset quality using an internal rating system, with a slight increase in non-accrual investments by number, though a decrease as a percentage of fair value Non-Accrual Investments | Metric | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Number of Investments | 12 | 9 | | % of Portfolio (at Fair Value) | 0.6% | 0.7% | | % of Portfolio (at Cost) | 3.7% | 3.3% | Discussion and Analysis of Results of Operations For 2022, total investment income and net investment income significantly increased due to higher interest income, while net realized and unrealized gains decreased, leading to a lower net increase in net assets Results of Operations (Year Ended Dec 31) | (in thousands) | 2022 | 2021 | Change | | :--- | :--- | :--- | :--- | | Total investment income | $376,860 | $289,047 | $87,813 | | Total expenses | ($131,533) | ($106,382) | ($25,151) | | Net investment income | $245,327 | $182,665 | $62,662 | | Net realized gain (loss) | ($5,212) | $45,336 | ($50,548) | | Net unrealized appreciation | $24,816 | $135,624 | ($110,808) | | Net increase in net assets | $241,606 | $330,762 | ($89,156) | - The 30% increase in total investment income was driven by a 47% rise in interest income, partially offset by a 6% decrease in dividend income[306][307] - The 24% increase in total expenses was primarily due to a 33% increase in interest expense and a 15% increase in cash compensation[309][310] Liquidity and Capital Resources In 2022, financing activities provided significant cash, primarily from credit facilities and equity offerings, while operating activities used cash for investments, maintaining strong liquidity and a healthy asset coverage ratio - Net cash provided by financing activities was $263.4 million in 2022, while net cash used in operating activities was $246.9 million[324][325][326] - As of December 31, 2022, liquidity consisted of $49.1 million in cash and $568.0 million of unused capacity under its Credit Facilities[330] - In 2022, the company raised $212.4 million in gross proceeds from its at-the-market (ATM) equity program and $55.1 million from a public equity offering[338][339] - The company's BDC asset coverage ratio was 227% as of December 31, 2022, well above the required 150%[345] Quantitative and Qualitative Disclosures About Market Risk The company faces market risk primarily from interest rate changes, with a majority of its debt investments at floating rates and debt obligations at fixed rates, leading to a positive sensitivity to rising rates - As of December 31, 2022, 73% of the debt investment portfolio (at cost) had floating interest rates, while 70% of the company's debt obligations had fixed interest rates[361] Interest Rate Sensitivity Analysis (as of Dec 31, 2022) | Basis Point Change | Change in Net Investment Income (in thousands) | Change in NII per Share | | :--- | :--- | :--- | | +200 | $33,681 | $0.43 | | +100 | $16,755 | $0.21 | | -100 | ($17,098) | ($0.22) | | -200 | ($34,024) | ($0.43) | Consolidated Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2022, including balance sheets, statements of operations, cash flows, and detailed notes, with an unqualified audit opinion - The independent auditor, Grant Thornton LLP, issued an unqualified opinion on the financial statements and on the effectiveness of the company's internal control over financial reporting[369][370][380] - The critical audit matter identified was the fair value of Level 3 investments, due to the significant management judgments and estimation uncertainty involved in their valuation[374] Consolidated Financial Statements The consolidated financial statements show total assets of $4.24 billion and net assets of $2.11 billion as of December 31, 2022, with total investment income of $376.9 million and a net increase in net assets of $241.6 million for the year Consolidated Balance Sheet Highlights (as of Dec 31) | (in thousands) | 2022 | 2021 | | :--- | :--- | :--- | | Total Investments (Fair Value) | $4,102,177 | $3,561,831 | | Total Assets | $4,241,885 | $3,694,802 | | Total Liabilities | $2,133,299 | $1,905,956 | | Total Net Assets | $2,108,586 | $1,788,846 | | NAV per Share | $26.86 | $25.29 | Consolidated Statement of Operations Highlights (Year Ended Dec 31) | (in thousands) | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Total Investment Income | $376,860 | $289,047 | $222,614 | | Net Investment Income | $245,327 | $182,665 | $137,945 | | Net Increase in Net Assets | $241,606 | $330,762 | $29,383 | Notes to Consolidated Financial Statements The notes detail critical accounting policies, particularly the valuation of Level 3 investments, portfolio composition, debt structure, dividend policy, unfunded commitments, and related party transactions - As of December 31, 2022, $4.10 billion of the $4.102 billion investment portfolio was categorized as Level 3 in the fair value hierarchy, indicating reliance on unobservable inputs[615] - The External Investment Manager contributed $22.3 million to Main Street's net investment income in 2022 through a combination of allocated expenses and dividend income[654] - Total debt outstanding as of December 31, 2022, was $2.007 billion, consisting of SBIC debentures, credit facilities, and three series of unsecured notes[658] - As of December 31, 2022, the company had $274.4 million in outstanding unfunded commitments, primarily for revolving loans and equity capital[742] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure This item is not applicable to the company - Not applicable[798] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2022, with no material changes reported - Management concluded that disclosure controls and procedures were effective as of the end of the period[799] - Management concluded that internal control over financial reporting was effective as of December 31, 2022, which was attested to by the independent auditor[800][801] Other Information This section provides updated annual expense estimates, totaling 8.92% of net assets, and announces a new Vice President, Chief Accounting Officer, and Assistant Treasurer appointment Annual Expenses (as a % of net assets) | Expense Category | Percentage | | :--- | :--- | | Operating expenses | 3.14% | | Interest payments on borrowed funds | 4.41% | | Income tax expense | 1.11% | | Acquired fund fees and expenses | 0.26% | | Total annual expenses | 8.92% | - On February 21, 2023, the Board appointed Ryan R. Nelson as Vice President, Chief Accounting Officer, and Assistant Treasurer, effective March 13, 2023[810] Disclosure Regarding Foreign Jurisdictions that Prevent Inspections This item is not applicable to the company - Not applicable[814] Part III Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance is incorporated by reference from the company's 2023 Proxy Statement - Information is incorporated by reference from the 2023 Proxy Statement[816] Executive Compensation Information on executive and director compensation, including the Compensation Discussion and Analysis, is incorporated by reference from the company's 2023 Proxy Statement - Information is incorporated by reference from the 2023 Proxy Statement[818] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of December 31, 2022, over 5.2 million securities were available for future issuance under approved equity compensation plans, with additional securities under unapproved plans Equity Compensation Plan Information (as of Dec 31, 2022) | Plan Category | Securities to be Issued Upon Exercise | Securities Remaining Available for Future Issuance | | :--- | :--- | :--- | | Approved by security holders | — | 5,281,165 | | Not approved by security holders | 165,248 | — | | Total | 165,248 | 5,281,165 | Certain Relationships and Related Transactions, and Director Independence Information concerning related party transactions and director independence is incorporated by reference from the company's 2023 Proxy Statement - Information is incorporated by reference from the 2023 Proxy Statement[820] Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's 2023 Proxy Statement - Information is incorporated by reference from the 2023 Proxy Statement[821] Part IV Exhibits and Consolidated Financial Statement Schedules This section lists all documents filed as part of the Annual Report, including financial statements, schedules, and a comprehensive index of exhibits - This section contains the index to the Consolidated Financial Statements and the Schedule of Investments in and Advances to Affiliates[823][824] - A comprehensive list of exhibits is provided, including corporate governance documents, debt indentures, credit agreements, equity incentive plans, and required certifications[824][825][826]