MSC INCOME FUND, INC. quarterly report, Q2 FY2015

Business Context and Reporting Period

Company: HMS Income Fund, Inc. (a Business Development Company and Regulated Investment Company)
Reporting Period: Quarter and six months ended June 30, 2015
Business Model: Externally managed closed-end fund investing primarily in debt and equity securities of middle market and lower middle market companies. The fund is advised by HMS Adviser LP and sub-advised by MSC Adviser I, LLC (an affiliate of Main Street Capital Corporation).

Key Financial Metrics

MetricSix Months Ended June 30, 2015Six Months Ended June 30, 2014
Total Portfolio Investments (Fair Value)$754.2 million$248.7 million
Net Investment Income$15.1 million$2.7 million
Net Increase in Net Assets from Operations$23.1 million$3.1 million
Net Asset Value (NAV) per Share$8.69$8.85
Total Distributions Declared per Share$0.35$0.35
Weighted Average Effective Yield8.5%7.1%
Total Borrowings (Notes Payable)$303.0 million$182.9 million (Dec 31, 2014)
Cash and Cash Equivalents$17.2 million$12.3 million

Material Changes vs. Prior Period

  • Portfolio Growth: The portfolio fair value increased by approximately 203% year-over-year, driven by significant capital raising ($178.8 million in proceeds) and increased leverage. The number of portfolio investments grew by 16 (14.7%) compared to the prior year-end.
  • Revenue Expansion: Total investment income surged from $4.9 million to $27.2 million, primarily due to the larger asset base and higher weighted average yield (8.5% vs. 7.1%).
  • Expense Increase: Total expenses (net of waivers) rose from $2.2 million to $12.1 million. This was driven by a $5.9 million increase in management/incentive fees and a $3.8 million increase in interest expense due to higher average borrowings ($250.0 million vs. $41.5 million).
  • Fee Waivers: The Adviser waived subordinated incentive fees of $1.3 million for the six months ended June 30, 2015. Administrative services expenses of $0.9 million were also waived.
  • Asset Quality: Two investments in Clarius BIGS, LLC (approx. 0.3% of portfolio) were placed on non-accrual status due to default, representing a deterioration from the prior period where no investments were in default.

Guidance, Outlook, and Risks

  • Outlook: Management expects further increases in investment income due to a growing portfolio base. The fund anticipates funding future investments through existing cash, capital raised from the ongoing public offering, and borrowings under credit facilities.
  • Liquidity: As of June 30, 2015, the fund had $157.0 million of remaining capacity available under its Credit Facilities (Capital One and Deutsche Bank), subject to asset coverage ratios. The asset coverage ratio was 230%.
  • Distributions: Distributions are declared daily ($0.00191781 per share per day). The fund may fund distributions from sources other than net realized income, including offering proceeds and borrowings, which may result in a return of capital for tax purposes.
  • Risks:
    • Interest Rate Risk: Approximately 83.6% of debt investments have floating rates. While most have floors (1.0%–1.5%), rising rates could increase borrowing costs faster than investment income if the spread narrows.
    • Credit Risk: Investments in lower middle market companies carry higher risk of default. The fund holds unsecured and second-lien debt which is subordinated to senior claims.
    • Concentration: The largest single investment represented 2.5% of the portfolio fair value.

Investor Verification Checklist

  • Capital Raise Status: Verify the current status of the public offering and the ability to deploy the $178.8 million raised in the first half of 2015.
  • Fee Waiver Expiration: Confirm the terms of the fee waiver agreement, which is extended through December 31, 2015, and the conditions under which previously waived fees might be reimbursed.
  • Non-Accrual Assets: Monitor the recovery status of the Clarius BIGS, LLC investments ($4.4 million principal) currently on non-accrual.
  • Debt Covenants: Review compliance with the 200% asset coverage ratio requirement under the 1940 Act, which limits future borrowing capacity.
  • Distribution Sources: Analyze the tax characterization of distributions (ordinary income vs. return of capital) based on the fund's taxable income estimates.