Business Context and Reporting Period
HMS Income Fund, Inc. (the "Company") is an externally managed, non-diversified closed-end investment company organized as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The reporting period covers the three and nine months ended September 30, 2012. During this period, the Company completed a merger with HMS Income LLC on May 31, 2012, and commenced its public offering of common stock in June 2012, raising $110,000 in gross proceeds as of the quarter-end.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2012 | Nine Months Ended Sep 30, 2012 |
|---|---|---|
| Total Investment Income | $464,000 | $1,288,000 |
| Net Investment Income | $262,000 | $871,000 |
| Net Realized Gain | $12,000 | $12,000 |
| Net Unrealized Appreciation | $33,000 | $187,000 |
| Net Increase in Net Assets from Operations | $307,000 | $1,070,000 |
| Net Asset Value (NAV) per Share | $8.90 | $8.90 |
| Total Portfolio Investments (Fair Value) | $16,603,000 | |
| Weighted Average Effective Yield | 10.4% | |
| Cash and Cash Equivalents | $527,000 | |
| Total Debt Outstanding | $7,000,000 | |
| Asset Coverage Ratio | 2.4 to 1.0 |
Material Changes vs. Prior Period
- Merger Transaction: On May 31, 2012, HMS Income LLC merged into HMS Income Fund, Inc. The results of operations for the nine-month period include the combined operations of both entities from the beginning of the period.
- Investment Classification Reclassification: Investments acquired from Main Street Capital Corporation were reclassified from "Non-Control/Non-Affiliate" to "Affiliate Investments" (accounted for as a secured loan to Main Street) for the period June 1, 2012, through September 30, 2012. This was due to provisions in the Servicing Agreement. Management determined this change was not material to total assets or NAV.
- Debt Restructuring: The Company retired a $7.5 million facility with Main Street Capital Corporation in May 2012 and replaced it with a $15 million revolving credit facility with Capital One, borrowing $7.0 million initially.
- Portfolio Turnover: The Company sold four investments for approximately $5.5 million and acquired seven new investments totaling approximately $7.2 million, diversifying geographic and industry exposure.
Guidance, Outlook, and Risks
Outlook and Capital Resources: The Company intends to continue funding investments through its ongoing public offering, existing cash, and its Credit Facility. As of September 30, 2012, the Company had approximately $3 million in available debt financing capacity after accounting for BDC asset coverage requirements. The Company declared a 2.25% stock dividend in September 2012 to maintain NAV below the offering price.
Distributions: The Company declared cash distributions of $0.18 per share for the quarter ended September 30, 2012. Distributions are funded primarily by net investment income. The Company has not established a limit on using borrowings or offering proceeds to fund distributions.
Risks and Contingencies:
- Interest Rate Risk: Approximately 73% of the portfolio contains variable interest rates. A 1% change in rates would impact interest income by approximately $122,000 and interest expense by $70,000.
- Valuation Risk: Portfolio investments are illiquid and valued using unobservable inputs (Level 3) for LMM investments, involving significant management judgment.
- Related Party Transactions: The Company has significant relationships with its Adviser (Hines affiliate) and Sub-Adviser (Main Street Capital Corporation), including fee waivers and investment transfers.
Investor Verification Checklist
- Fee Waivers: Verify the duration and conditions of the fee waiver agreement, which currently waives management and incentive fees to prevent distributions from being a return of capital.
- Debt Covenants: Confirm continued compliance with the Capital One Credit Facility covenants, specifically the 2.0x asset coverage ratio and 2.0x interest coverage ratio.
- Offering Progress: Monitor the pace of the public offering, as only $110,000 had been raised as of September 30, 2012, limiting the ability to deploy capital.
- Investment Classification: Review the amended Servicing Agreement with Main Street Capital Corporation to confirm future investments will be classified as sales rather than secured loans.
- Portfolio Quality: Assess the weighted average rating of the LMM portfolio (2.2 as of Sep 30, 2012) and monitor for any downgrades to Rating 4 or 5.