Business Context and Reporting Period
HMS Income Fund, Inc. (the "Company") is an externally managed, non-diversified closed-end management investment company organized as a Business Development Company (BDC) under the Investment Company Act of 1940. The Company's primary objective is to generate current income through debt and equity investments in lower middle market and middle market companies. This report covers the quarterly period ended March 31, 2020.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net Investment Income | $12.46 million | $13.90 million |
| Net Realized Loss on Investments | $(3.37) million | $(7.14) million |
| Net Change in Unrealized Appreciation (Depreciation) | $(94.91) million | $12.06 million |
| Net Increase (Decrease) in Net Assets from Operations | $(85.82) million | $18.82 million |
| Net Asset Value (NAV) per Share | $6.50 | $8.03 |
| Total Portfolio Investments (Fair Value) | $894.86 million | $1,027.60 million |
| Cash and Cash Equivalents | $16.25 million | $21.85 million |
| Total Credit Facilities Outstanding | $403.00 million | $445.00 million |
| Asset Coverage Ratio | 226% | 237% |
Material Changes vs. Prior Period
- Significant NAV Decline: NAV per share decreased from $7.77 at the beginning of the period to $6.50 at the end, a decline of approximately 16.3%. This was primarily driven by a net change in unrealized depreciation of $94.9 million, largely attributed to the impact of the COVID-19 pandemic on leveraged loan market values.
- Investment Income Reduction: Total investment income decreased by approximately $5.2 million (17.7%) compared to Q1 2019. This was due to a decrease in interest income ($4.4 million) and dividend income ($0.9 million), driven by a lower weighted average effective yield (8.3% vs. 9.6%) and an increase in non-accrual investments.
- Expense Reduction: Total expenses, net of waivers, decreased by $3.7 million to $11.5 million. This reduction was primarily due to the elimination of the subordinated incentive fee on income ($1.4 million) and lower interest expense ($1.9 million) resulting from reduced borrowing rates and lower average borrowings.
- Portfolio Valuation: The fair value of the portfolio decreased by approximately $132.7 million from December 31, 2019, to March 31, 2020. The Company reported 10 investments in seven portfolio companies on non-accrual status as of March 31, 2020, up from eight investments in five companies at year-end 2019.
Guidance, Outlook, Risks, and Unusual Items
- COVID-19 Impact: Management explicitly states that the pandemic has had a material adverse effect on results of operations and expects this to continue. The pandemic has caused a steep decline in leveraged loan market values, increased the risk of defaults, and may necessitate investment restructurings or permanent impairments.
- Share Repurchase Suspension: On March 31, 2020, the Board of Directors approved a temporary suspension of the share repurchase program commencing with the second quarter of 2020 to preserve financial flexibility and liquidity.
- Debt Facility Amendment: On April 24, 2020 (subsequent to the period end), the Company amended its Deutsche Bank Credit Facility to terminate the revolver commitments and begin the amortization period. No further advances or reinvestments are permitted under this facility during the amortization period.
- Interest Rate Risk: The Company is exposed to interest rate fluctuations. A decrease in LIBOR reduces gross investment income, though many investments have floors. Conversely, rising rates would increase interest expense on floating-rate borrowings.
- Distributions: The Company declared distributions of $0.17 per share for the quarter. Management noted that distributions may exceed earnings and could be funded from sources other than net realized income, including borrowings or return of capital.
Investor Verification Checklist
- Non-Accrual Status: Verify the specific portfolio companies placed on non-accrual status and the magnitude of write-offs or potential future impairments.
- Debt Covenants: Confirm continued compliance with asset coverage ratios (200% requirement) and other covenants under the TIAA and Deutsche Bank Credit Facilities given the decline in asset values.
- Liquidity Position: Assess the sufficiency of cash ($16.3 million) and undrawn commitments ($177 million) to meet unfunded loan commitments ($39 million) and operational needs during the pandemic.
- Valuation Methodology: Review the significant unobservable inputs (Level 3) used to value the portfolio, particularly the risk-adjusted discount rates and expected principal recovery percentages, which were adjusted in response to market volatility.
- Subsequent Events: Monitor the impact of the April 24, 2020 amendment to the Deutsche Bank Credit Facility on the Company's ability to deploy capital and manage leverage.