Business Context and Reporting Period
Company: HMS Income Fund, Inc. (MSC Income Fund, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2015
Business Overview: HMS is an externally managed, non-diversified closed-end investment company operating 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.
Key Financial Metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Total Investment Income | $65.4 million | $19.2 million |
| Net Investment Income | $36.5 million | $11.2 million |
| Net Realized Gain (Loss) | ($5.5 million) | $20,000 |
| Net Unrealized Appreciation (Depreciation) | ($38.0 million) | ($14.2 million) |
| Net Increase (Decrease) in Net Assets from Operations | ($7.0 million) | ($3.0 million) |
| Total Portfolio Investments (Fair Value) | $853.0 million | $473.9 million |
| Total Assets | $893.4 million | $506.2 million |
| Total Liabilities | $401.8 million | $246.2 million |
| Net Assets | $491.7 million | $260.1 million |
| Net Asset Value (NAV) per Share | $7.88 | $8.40 |
| Weighted Average Effective Yield | 8.3% | 8.1% |
| Notes Payable (Debt) | $380.0 million | $182.9 million |
| Cash and Cash Equivalents | $24.0 million | $19.9 million |
Material Changes vs. Prior Period
- Portfolio Growth: The portfolio fair value increased by approximately 80% from 2014 to 2015, driven by significant capital raising ($306 million in gross proceeds in 2015) and increased leverage. The number of portfolio investments grew by 38.
- Unrealized Depreciation: The company recorded a significant unrealized depreciation of $38.0 million in 2015, compared to $14.2 million in 2014. Management attributes this to broad price declines in the high yield bond and leveraged loan markets and the impact of declining oil prices on energy sector investments.
- Realized Losses: A realized loss of $5.5 million was recognized in 2015, primarily due to the conversion of a Private Loan debt investment in Relativity Media, LLC into equity and warrants following the company's bankruptcy declaration.
- Expense Structure: Total expenses (net of waivers) increased to $28.9 million from $8.0 million, driven by higher management fees (due to increased assets) and interest expense (due to higher average borrowings of $305 million vs. $90 million).
- NAV Decline: NAV per share decreased from $8.40 to $7.88, reflecting the impact of unrealized losses and realized losses on the portfolio.
Guidance, Outlook, Risks, and Unusual Items
- Offering Status: The Initial Offering terminated on December 1, 2015. A new Registration Statement (Form N-2) was declared effective on January 5, 2016, allowing for the sale of up to $1.5 billion of shares. The offering price was reduced multiple times in early 2016, settling at $8.50 per share as of February 18, 2016, to ensure shares were not sold below NAV.
- Liquidity and Capital Resources: As of December 31, 2015, the company had $105.0 million available under its Capital One Credit Facility and $85.0 million available under its Deutsche Bank Credit Facility, subject to asset coverage ratios. The company maintains a share repurchase program allowing for the repurchase of approximately 10% of outstanding shares annually.
- Risk Factors:
- Market Volatility: Continued price declines in the leveraged loan market and energy sector could further reduce NAV.
- Leverage: The company utilizes leverage (borrowings) to finance investments, which magnifies potential gains and losses. Asset coverage ratios must be maintained to avoid restrictions on distributions and borrowing.
- Illiquidity: Investments are primarily in private companies with no established trading market, limiting the ability to sell assets quickly without potential loss.
- Adviser Dependency: The company relies heavily on the Adviser and Sub-Adviser for deal flow and management; their departure could materially harm operations.
- Unusual Items: The conversion of the Relativity Media debt investment into equity/warrants resulted in a significant realized loss. Additionally, the company anticipates a 4% nondeductible excise tax liability of approximately $108,000 for the 2015 taxable year due to undistributed taxable income.
Important Facts for Investor Verification
- NAV vs. Offering Price: Verify the current offering price relative to the most recent NAV per share ($7.88 as of Dec 31, 2015) to assess potential dilution or discount.
- Fee Waivers Expiration: Confirm the status of fee waivers and expense support agreements, as the 2015 Fee Waiver Amendment expired on December 31, 2015, potentially increasing future expense ratios.
- Portfolio Concentration: Review the exposure to the energy and oil/gas sector, which contributed significantly to unrealized depreciation.
- Debt Covenants: Monitor compliance with asset coverage ratios (200% required under the 1940 Act; 219% as of Dec 31, 2015) and interest coverage ratios to ensure continued ability to borrow and pay distributions.
- Distribution Sources: Verify the source of distributions, as a portion may represent a return of capital rather than earnings, particularly given the net decrease in net assets from operations.