MSC's Q3 2025 Earnings Call: Contradictions Emerge on Private Loan Pipeline, Spreads, Tariff Exposure, Dividend Income, and ROE Strategy

Guidance:

• Expanded regulatory leverage capacity becomes effective end of January 2026 (~+$250M), enabling higher deployment.
• Management expects to grow the private-loan portfolio to increase net investment income and support higher dividends in 2026.
• Dividend policy to target pretax NII; Board declared regular $0.35 and supplemental $0.01 (payable Jan 30, 2026); current yield ~12%.
• Plan to transition toward a private-loan-only portfolio and benefit from contractual adviser fee step-down as lower middle market weight declines.
• Pipeline described as "above average" with anticipated increased originations over the next 2 quarters.

Business Commentary:

• Investment Activity and Pipeline:
• The fund's private loan investment activity resulted in a net decrease of $6.7 million in the third quarter, indicating slower-than-expected activity.
• However, the fund's private loan investment pipeline is currently described as above average, suggesting expected improvements in deal flow.
• 

• The slower investment activity is attributed to market conditions and volume, while the optimistic pipeline outlook is driven by increased interest from private equity sponsors and improving market conditions.

• Dividend Strategy and Performance:

• MSC Income Fund declared a regular quarterly dividend of $0.35 per share and a supplemental quarterly dividend of $0.01 per share, payable on January 30, 2026.
• This decision reflects the fund's strategy to align dividends with pretax net investment income and aims to provide a dividend yield of approximately 12%.

• The dividend strategy is supported by the fund's investment performance, favorable net investment income, and expectations of increased investment income from an expanding leverage capacity.

• Portfolio Composition and Exit Opportunities:

• The fund exited a private loan portfolio company equity investment, representing approximately $15 million or $0.30 per share in expected realized gains at a premium to fair value.
• The fund is actively working on maximizing recoveries from specific private loan investments and expects favorable realizations from lower middle market portfolio companies.

• The realization of these gains and potential future exits are crucial for redeploying capital into more private loans with contractual interest income, enhancing dividend growth.

• Earnings and Financial Performance:

• The fund reported a return on equity of 14.6% and a net increase in net assets of $26.5 million for the third quarter.
• The operating results showed a net increase in net assets per share of $15.54, reflecting a $0.21 increase from the previous quarter.
• These performance metrics are attributed to the fund's favorable net investment income, strong dividend income from the lower middle market portfolio, and strategic execution of the investment portfolio.
  

  Sentiment Analysis:

  Overall Tone: Positive

  • Management highlighted 14.6% ROE, NAV per share $15.54 (up $0.21 QoQ), NII $0.35 per share ($0.36 pretax), declared $0.35 regular + $0.01 supplemental dividend (yield ~12%), and described the private-loan pipeline as "above average" with confidence in growing NII and dividends.

Q&A:

• Question from Robert Dodd (Raymond James): All of the private loan book slower this quarter, but looking like it's ramping up... can you give an update there? Was pricing the issue again in the third quarter and you've moved a little bit on pricing in the fourth, or what's created that transition to acceleration?
  Response: Slowdown was driven more by lower deal volume than by competitiveness; pricing is somewhat inside prior-year levels but the pipeline and volume have meaningfully picked up and should drive closings into Q4.

• Question from Robert Dodd (Raymond James): In terms of sectors attractive into '26/'27 — with consumer being a problem area, what sectors are you particularly focused on now?
  Response: We're largely risk-off on consumer; primary focus is B2B sectors (industrials, manufacturing, aerospace & defense) and select consumer only when high-bar opportunities exist.

• Question from Brian Mckenna (Citizens): Assuming pipelines continue to build into year-end, what acceleration can we see in funding next year and the base/bull case for portfolio growth in 2026? How does this play into earnings/dividend trajectory and how should we think about the ~$0.30 per share of expected realized gains and their redeployment or dividend use?
  Response: We have ~ $100M leeway today and expect ~ +$250M expanded capacity in Jan 2026 to deploy into private loans; plan is to rotate realized equity gains into higher-yielding private loans to grow recurring NII and create the opportunity for higher dividends in 2026, with retention or redeployment decided case-by-case.

• Question from Kenneth Lee (RBC Capital Markets): Any further color on the above-average private loan pipeline — what drivers or segments are you seeing?
  Response: Renewed activity largely reflects more active private equity sponsors, improved sentiment and dry powder; pipeline feels more likely to transact now versus prior periods.

• Question from Kenneth Lee (RBC Capital Markets): Regarding the realized gain you mentioned, what delivered such a favorable outcome on those positions?
  Response: One exit came from a consistently high-performing company; the other was a restructured COVID-impacted company that recovered through patient capital, management execution and restructuring work, producing a premium realization.

• Question from Arren Cyganovich (Truist): With higher expected pipeline activity, do you expect repayment activity to increase as well? And what are your leverage targets and what do you need to see to get there?
  Response: Elevated repayments occurred in recent quarters and some repayments are expected in Q4, but repayments should normalize as originations pick up (likely into H1'26); current leverage target was 0.85–0.95 (we ran ~0.72) and will move to a 1.15–1.25 target range after expanded regulatory leverage in Jan 2026.

• Question from Paul Johnson (KBW): Do you have an objective to cut consumer exposure or accelerate exits of specific names, is that exposure primarily in private loans or lower middle market, and what about the second private fund's mandate and overlap with MSIF?
  Response: We're conservative on new consumer exposure and manage existing underperformers case-by-case with co-investors; consumer exposure exists in both private loan and lower middle market portfolios; the second private fund shares MSIF's private-loan mandate but there is no plan today to merge those funds into MSIF.

• Question from Douglas Harter (UBS): The adviser waived some incentive fee this quarter — how should we think about that going forward and under what situations might that happen again?
  Response: Main Street has shown voluntary support (equity purchases and a modest waiver) and may provide discretionary support again, but waivers are not contractual—it's ad hoc and intended to support the fund.

• Question from Mickey Schein (Clear Street): What's your sense of the direct lending supply/demand balance and outlook for spreads?
  Response: Near-term outlook (Q4 and Q1) is productive; fundraising has focused on larger deals leaving smaller-sized direct lending with healthier demand for providers like us; spreads have tightened over 12 months but appear to have found some stability/a floor on smaller deals.

Contradiction Point 1

Private Loan Pipeline and Market Activity

It involves contradicting statements regarding the state of the private loan pipeline and market activity, which is crucial for investors to understand the company's growth and investment strategy.

Can you update us on private loan activities and whether pricing is a factor this quarter? - Robert Dodd (Raymond James)

20251114-2025 Q3: Activity levels are more significant than pricing changes. The market remains competitive, but we're seeing an uptick in pipeline volume. - Dwayne Hyzak(CEO)

When do you expect the M&A recovery to occur? Is it expected to be weighted toward late 2025 or extend into 2026? - Unidentified Analyst (Raymond James)

2025Q1: We believe there should be a fair amount of pent-up demand with resolution to the tariff situation. We expect significant M&A activity once certainty returns. - Dwayne Hyzak(CEO)

Contradiction Point 2

Spreads and Market Stability

It involves contradicting statements regarding the stability of spreads and market conditions, affecting investors' understanding of the company's investment strategy.

How do you see the supply-demand balance and spreads evolving? - Mickey Schein (Clear Street)

20251114-2025 Q3: Positive outlook for Q4 and Q1 2026. Market shows stability, and although spreads have compressed, there's been less movement in recent months. - Dwayne Hyzak(CEO)

What are the spreads on new investments? - Kenneth Lee (RBC Capital Markets)

2025Q1: Spreads have stabilized, but some widening is expected due to market uncertainty. The investment activity is muted, and current activity is more follow-on. We expect stable to slightly wider spreads. - Dwayne Hyzak(CEO)

Contradiction Point 3

Tariff Exposure and Impact on Portfolio Companies

It involves differing assessments of the impact of tariffs on portfolio companies, which could affect the diversification and risk profile of the fund's investments.

How much of the portfolio's gains are related to tariffs? - Mickey Schein (Clear Street)

20251114-2025 Q3: Minimal impact from tariffs on portfolio companies, with companies effectively navigating risks. - Dwayne Hyzak(CEO)

Can you detail the comfort level with tariff exposure? - Dwayne Hyzak

2025Q2: We feel comfortable due to the diversity of portfolio companies and their ability to adapt. We monitor exposure, and while it's moving week by week, we believe it will not have a massive impact. - Nicholas Meserve(Managing Director)

Contradiction Point 4

Dividend Income and Expectations

This contradiction involves projections for dividend income, which could affect shareholder expectations and financial planning.

How should we view future adviser fee waivers? - Douglas Harter (UBS)

20251114-2025 Q3: We foresee positive contributions from the lower middle market portfolio performance. Outlook has positive near-term visibility. - Dwayne Hyzak(CEO)

Has dividend income declined year-over-year? Are expectations for future quarters changing? - Mark Hughes (Truist Securities)

2024Q4: Volatility in dividend income is expected, but we foresee positive contributions from the lower middle market portfolio performance. - Dwayne Hyzak(CEO)

Contradiction Point 5

ROE Improvement Strategy

This contradiction refers to the company's plans for improving the return on equity, a critical financial metric for investors.

How much of the portfolio gains are related to tariffs? - Mickey Schein (Clear Street)

20251114-2025 Q3: The goal is to increase ROE to the 10% range over the next six to eight quarters. - Dwayne Hyzak(CEO)

What is MSC's tariff exposure, and how might spending cuts impact your portfolio? - Brian McKenna (Citizens JMP)

2024Q4: ROE is expected to improve due to reduced management fees and incentive fee structures. - Dwayne Hyzak(CEO)