Business Context and Reporting Period
Company: HMS Income Fund, Inc. (HMS Income Fund)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2019
Business Overview: HMS Income Fund is an externally managed, non-diversified closed-end management investment company organized as a Business Development Company (BDC) and a Regulated Investment Company (RIC). Its primary objective is to generate current income through debt and equity investments in Lower Middle Market (LMM) and Middle Market companies. The Company is managed by HMS Adviser LP, with MSC Adviser I, LLC (a subsidiary of Main Street Capital Corporation) serving as the Sub-Adviser. As of December 31, 2019, the Company held 210 investments in 124 companies.
Key Financial Metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Total Portfolio Investments (Fair Value) | $1,027.6 million | $1,106.6 million |
| Total Assets | $1,066.1 million | $1,147.4 million |
| Total Liabilities | $456.8 million | $522.1 million |
| Total Net Assets | $609.3 million | $625.4 million |
| Net Asset Value (NAV) per Share | $7.77 | $7.96 |
| Total Investment Income | $111.8 million | $111.4 million |
| Net Investment Income | $55.1 million | $58.9 million |
| Net Realized Gain (Loss) | ($18.4 million) | ($18.2 million) |
| Net Change in Unrealized Appreciation (Depreciation) | $3.0 million | ($0.4 million) |
| Net Increase in Net Assets from Operations | $39.6 million | $40.3 million |
| Weighted Average Effective Yield (Total Portfolio) | 8.7% | 9.5% |
| Credit Facilities Outstanding | $445.0 million | $509.0 million |
| Cash and Cash Equivalents | $21.8 million | $21.8 million |
Material Changes vs. Prior Period
- Portfolio Size: The total portfolio fair value decreased by approximately $79.0 million (7.1%) from 2018 to 2019. This was driven by net repayments and sales of $357.3 million exceeding new investment purchases of $282.0 million.
- Yield Compression: The weighted average effective yield on the total portfolio declined from 9.5% in 2018 to 8.7% in 2019, attributed to a reduction in total debt investments and a lower yield environment.
- Realized Losses: The Company recorded net realized losses of $18.4 million in 2019, primarily due to $21.8 million in losses from the exit or restructuring of Middle Market debt investments in five portfolio companies. This was partially offset by a realized gain on the exit of one Private Loan equity investment.
- NAV Decline: NAV per share decreased from $7.96 at December 31, 2018, to $7.77 at December 31, 2019. Management attributed this to net realized losses, unrealized depreciation in specific investments (particularly in oil and gas and retail sectors), and a declining interest rate environment.
- Expense Increase: Total expenses, net of waivers, increased to $55.9 million from $51.5 million, primarily due to a $3.9 million increase in incentive fees (which were not waived in 2019, whereas $3.3 million was waived in 2018).
Guidance, Outlook, and Risks
Management Commentary: Management noted that while the portfolio experienced net realized losses and unrealized depreciation due to underperformance in specific sectors (oil and gas, retail), these were offset by net unrealized appreciation in LMM equity investments. The Company continues to focus on generating current income and long-term capital appreciation.
Liquidity and Capital Resources: As of December 31, 2019, the Company had $125.0 million in aggregate capacity available under its credit facilities (TIAA and Deutsche Bank), subject to borrowing base limitations. The Company maintains sufficient cash and available borrowings to fund unfunded commitments of $46.3 million.
Key Risks and Contingencies:
- Market Volatility: The filing highlights risks associated with capital market disruptions, including the potential impact of the novel coronavirus (COVID-19) which surfaced in December 2019, potentially affecting portfolio company operations.
- LIBOR Transition: The Company faces operational challenges and uncertainty regarding the transition from LIBOR to alternative reference rates (e.g., SOFR) by the end of 2021.
- Non-Accrual Status: As of December 31, 2019, eight debt investments (1.5% of the portfolio at fair value) were on non-accrual status due to defaults or significant credit deterioration.
- Leverage: The Company utilizes leverage to enhance returns, which magnifies the potential for loss. The asset coverage ratio was 237% as of December 31, 2019, well above the 200% regulatory requirement.
- Illiquidity: The Company's shares are not listed on an exchange, and there is no established secondary market. Liquidity is provided through a quarterly share repurchase program, which is subject to limitations.
Investor Verification Checklist
- NAV Trend: Verify the continued decline in NAV per share ($7.77 in 2019 vs. $8.15 in 2017) and the specific portfolio companies contributing to realized losses.
- Yield Sustainability: Assess the impact of the declining weighted average yield (8.7%) on future distribution coverage, especially given the rising expense ratio (9.11% of average net assets).
- Credit Quality: Review the specific details of the eight investments on non-accrual status and the Company's recovery strategies for these distressed assets.
- Liquidity Event: Confirm the status of the Company's plan to explore a liquidity event (listing or liquidation) between four and six years following the closing of its Offering (which closed to new investors in September 2017).
- Fee Waivers: Monitor the Advisers' incentive fee waiver policies, as the lack of waivers in 2019 significantly impacted net investment income compared to 2018.