Business Context and Reporting Period
Company: HMS Income Fund, Inc. (HMS Income Fund)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2018
Business Overview: HMS Income Fund is an externally managed, non-diversified closed-end management investment company organized 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. The Company closed its public offering to new investors on September 30, 2017, and currently operates a distribution reinvestment plan and a quarterly share repurchase program.
Key Financial Metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Total Portfolio Investments (Fair Value) | $1,106.6 million | $1,049.4 million |
| Total Assets | $1,147.4 million | $1,119.1 million |
| Total Liabilities | $522.1 million | $471.3 million |
| Total Net Assets | $625.4 million | $647.8 million |
| Net Asset Value (NAV) per Share | $7.96 | $8.15 |
| Weighted Average Effective Yield (Total Portfolio) | 9.5% | 8.9% |
| Net Investment Income | $58.9 million | $56.7 million |
| Net Realized Gain (Loss) | ($18.2 million) | ($2.4 million) |
| Net Change in Unrealized Appreciation (Depreciation) | ($0.4 million) | ($1.7 million) |
| Net Increase in Net Assets from Operations | $40.3 million | $52.6 million |
| Distributions Declared per Share | $0.70 | $0.70 |
| Cash and Cash Equivalents | $21.8 million | $45.8 million |
| Debt Outstanding (Credit Facilities) | $509.0 million | $430.0 million |
Material Changes vs. Prior Period
- Portfolio Growth and Yield: The total portfolio fair value increased by approximately 5.4% to $1.107 billion. The weighted average effective yield on the total portfolio increased from 8.9% in 2017 to 9.5% in 2018, driven by the deployment of capital into higher-yielding LMM and Private Loan investments.
- Net Investment Income: Increased by 3.8% to $58.9 million, primarily due to portfolio growth and higher yields. Interest income rose to $101.8 million, and dividend income increased to $7.6 million (up from $3.6 million in 2017), largely due to a full year of dividends from the HMS-ORIX investment.
- Expenses: Total expenses, net of waivers, increased to $51.5 million from $44.3 million. This was driven by a $6.5 million increase in interest expense (due to higher average borrowings and borrowing costs) and a $1.4 million increase in management fees.
- Realized Losses: The Company recognized net realized losses of $18.2 million in 2018, a significant increase from $2.4 million in 2017. These losses were primarily attributed to the exit or restructuring of Middle Market investments in four companies, including one in the oil and gas sector.
- NAV Decline: NAV per share decreased from $8.15 to $7.96, reflecting the impact of realized losses and unrealized depreciation, despite positive net investment income.
- Leverage: Borrowings under credit facilities increased from $430.0 million to $509.0 million. The asset coverage ratio remained compliant at 223% (down from 251% in 2017).
Guidance, Outlook, Risks, and Unusual Items
- Outlook and Strategy: Management intends to continue investing in proprietary LMM and Private Loan investments, which generally offer higher yields than Middle Market investments. The Company plans to maintain leverage up to the 50% limit permitted under the 1940 Act to enhance returns.
- Share Repurchase Program: The Company maintains a quarterly share repurchase program. In 2018, it repurchased approximately 4.2 million shares. The program allows stockholders to sell shares back to the Company at NAV, subject to limitations based on proceeds from the distribution reinvestment plan.
- Key Risks:
- Market Volatility: Price declines in the leveraged loan market and equity markets in late 2018 contributed to the decline in NAV. The Company notes that further price declines could materially impact its portfolio value.
- Interest Rate Risk: While most investments are floating-rate, rising interest rates increase borrowing costs. A 200 basis point increase in rates would increase net investment income by approximately $7.5 million, but a decrease would reduce it.
- Liquidity: The Company's investments are largely illiquid. There is no established public market for its common stock, and liquidity is provided primarily through the repurchase program.
- Portfolio Company Performance: Five debt investments were on non-accrual status as of December 31, 2018, representing 0.4% of the portfolio at fair value. These were primarily due to failures to make required payments.
- Unusual Items: The Company recognized $1.9 million of Payment-in-Kind (PIK) interest in 2018. Additionally, the Company incurred a $766,000 excise tax liability for the 2018 tax year due to the timing of distributions required to avoid the 4% tax on undistributed income.
Important Facts for Investor Verification
- NAV vs. Offering Price: Verify the current NAV per share ($7.96) against the price paid by investors, as the Company closed its public offering to new investors in 2017. Shares are not listed on an exchange.
- Realized Losses: Investigate the specific details of the $18.2 million in realized losses, particularly the restructuring of Middle Market investments in the oil and gas sector, to assess potential future credit risks.
- Non-Accrual Status: Review the status of the five debt investments on non-accrual (0.4% of portfolio) and the Company's recovery strategies for these assets.
- Leverage and Asset Coverage: Confirm the Company's ability to maintain the 200% asset coverage ratio required by the 1940 Act, especially given the increase in borrowings to $509 million.
- Fee Waivers: Note that the Advisers waived approximately $3.3 million in incentive fees and $2.7 million in administrative expenses in 2018. Verify if these waivers are conditional or permanent.
- Co-Investment with Main Street: Understand the extent of co-investments with Main Street Capital Corporation and the associated conflicts of interest or allocation policies.