MSC INCOME FUND, INC. annual report, Q4 FY2017

SEC Filing Summary: HMS Income Fund, Inc. (10-K)

Business Context and Reporting Period

Company: HMS Income Fund, Inc. (HMS Income Fund)

Reporting Period: Fiscal year ended December 31, 2017

Structure: Externally managed, non-diversified closed-end management investment company organized as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC).

Strategy: Primary objective is to generate current income through debt and equity investments in Lower Middle Market (LMM) and Middle Market companies. Secondary objective is long-term capital appreciation. The portfolio consists of secured and unsecured debt, equity, and warrants. The Company co-invests with Main Street Capital Corporation affiliates and manages a joint venture, HMS-ORIX, with ORIX Funds Corp.

Capital Markets Status: The Company closed its public offering to new investors on September 30, 2017. There is no established public market for its shares; liquidity is provided via a quarterly share repurchase program.

Key Financial Metrics (Year Ended Dec 31, 2017)

Metric 2017 Value 2016 Value
Total Portfolio Investments (Fair Value) $1,049.4 million $989.2 million
Total Assets $1,119.1 million $1,033.6 million
Total Liabilities $471.3 million $435.7 million
Net Assets (NAV) $647.8 million $597.8 million
NAV Per Share $8.15 $8.15
Total Investment Income $103.7 million $89.4 million
Net Investment Income $58.7 million $51.3 million
Net Realized Gain (Loss) ($4.4 million) ($22.9 million)
Net Change in Unrealized Appreciation (Depreciation) ($1.7 million) $38.2 million
Net Increase in Net Assets from Operations $52.6 million $66.6 million
Weighted Average Effective Yield (Total Portfolio) 8.9% 8.9%
Debt Outstanding (Credit Facilities) $430.0 million $413.0 million
Cash and Cash Equivalents $45.8 million $23.7 million
Distributions Declared Per Share $0.70 $0.70

Material Changes vs. Prior Period

  • Portfolio Growth: Total portfolio fair value increased by approximately 6.1% ($60.2 million) from 2016 to 2017, driven by new investment purchases of $551.8 million offset by sales and repayments of $525.0 million.
  • Income Growth: Total investment income rose 16.0% to $103.7 million, primarily due to portfolio growth and increased accretion of unearned income ($15.1 million in 2017 vs. $11.9 million in 2016).
  • Expense Increase: Net expenses increased to $44.3 million from $37.8 million, driven by higher interest expense ($18.3 million vs. $15.1 million) and increased management fees due to higher average gross assets.
  • Realized Losses: Net realized losses narrowed significantly to $4.4 million in 2017 compared to $22.9 million in 2016. The 2016 losses were largely driven by restructurings in the oil and gas sector. 2017 losses were primarily related to exits/restructurings in the oil and gas sector, partially offset by gains on equity exits.
  • Unrealized Performance: The portfolio experienced a net unrealized depreciation of $1.7 million in 2017, a reversal from the $38.2 million unrealized appreciation recorded in 2016.
  • Capital Structure: The Company closed its public offering to new investors in September 2017, raising approximately $184.1 million in the offering (including reinvested distributions) through year-end.

Guidance, Outlook, Risks, and Unusual Items

  • Outlook: Management intends to continue employing leverage (up to 50% of assets) to enhance returns. The Company expects to fund future investments through existing cash, borrowings, and the distribution reinvestment plan.
  • Share Repurchase Program: The Company maintains a quarterly repurchase program allowing stockholders to sell up to 2.5% of outstanding shares per quarter at NAV. In Q4 2017, the Company repurchased 1.1 million shares at an average price of $8.10.
  • Key Risks:
    • Interest Rate Risk: Approximately 87.2% of the debt portfolio contains floating rates. Rising rates increase interest income but also increase borrowing costs. A 100 basis point increase in rates would increase net investment income by approximately $4.3 million.
    • Liquidity Risk: Investments are primarily illiquid private securities. There is no public market for the Company's stock.
    • Valuation Risk: The majority of the portfolio (Level 3 assets) is valued using unobservable inputs (e.g., discounted cash flows, broker quotes), introducing subjectivity.
    • Concentration Risk: While diversified, the portfolio has exposure to specific industries (e.g., Commercial Services, Hotels/Restaurants) and geographic regions (Midwest, Southwest).
    • Adviser Dependency: The Company relies entirely on HMS Adviser LP and MSC Adviser I, LLC (Main Street Capital) for investment management.
  • Unusual Items:
    • Non-Accrual Status: As of Dec 31, 2017, four debt investments in three portfolio companies were on non-accrual status, representing 0.2% of the portfolio at fair value.
    • Fee Waivers: The Advisers waived approximately $3.0 million in incentive fees and $3.0 million in internal administrative expenses during 2017.
    • Tax Legislation: The "Tax Cuts and Jobs Act" was enacted in December 2017, reducing the corporate tax rate. The Company accounted for the effects as of year-end, though the impact on RIC status and distributions remains subject to monitoring.

Investor Verification Checklist

  • NAV Accuracy: Verify the fair value of Level 3 assets (100% of portfolio) given the reliance on unobservable inputs and the recent shift from unrealized appreciation to depreciation.
  • Asset Coverage Ratio: Confirm the Company maintains the required 200% asset coverage ratio under the 1940 Act to continue paying distributions and issuing debt (reported at 236% as of Dec 31, 2017).
  • Distribution Sustainability: Assess whether the $0.70 per share distribution is fully covered by Net Investment Income ($0.76 per share) or if it relies on capital gains or borrowings.
  • Portfolio Quality: Review the specific details of the four non-accrual investments and the $4.4 million realized losses to understand credit deterioration trends.
  • Leverage Costs: Monitor the cost of funds on the EverBank and Deutsche Bank credit facilities, as rising rates will compress the spread between borrowing costs and portfolio yields.
  • Offering Status: Note that the public offering to new investors is closed; future capital growth depends on the distribution reinvestment plan and potential follow-on offerings.