Business Context and Reporting Period
Company: HMS Income Fund, Inc. (a Maryland corporation)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2016
Business Overview: HMS Income Fund 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.
Capital Structure: As of December 31, 2016, the company had 73,382,971 shares of common stock outstanding. It is conducting a continuous public offering of common stock, with a current offering price of $9.30 per share (as of March 3, 2017).
Key Financial Metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Total Assets | $1,033.6 million | $893.4 million |
| Total Portfolio Investments (Fair Value) | $989.2 million | $853.0 million |
| Net Investment Income | $51.3 million | $36.5 million |
| Net Realized Gain (Loss) | ($22.9 million) | ($5.5 million) |
| Net Unrealized Appreciation (Depreciation) | $38.2 million | ($38.0 million) |
| Net Increase in Net Assets from Operations | $66.6 million | ($7.0 million) |
| Net Asset Value (NAV) per Share | $8.15 | $7.88 |
| Total Borrowings (Notes Payable) | $413.0 million | $380.0 million |
| Cash and Cash Equivalents | $23.7 million | $24.0 million |
| Weighted Average Effective Yield (Total Portfolio) | 8.9% | 8.3% |
Material Changes vs. Prior Period
- Portfolio Growth: Total portfolio investments increased by approximately 16% (from $853.0 million to $989.2 million) driven by new investment activity and capital raised.
- Income Growth: Net investment income increased by 40.5% to $51.3 million, primarily due to portfolio growth, increased accretion of unearned income ($11.9 million vs. $4.4 million), and a higher weighted average yield.
- Realized Losses: The company recognized net realized losses of $22.9 million in 2016, a significant increase from $5.5 million in 2015. This was primarily driven by a $20.3 million loss related to the restructuring of four Middle Market investments and a $2.4 million loss from the exit of one Middle Market investment.
- Unrealized Gains: The portfolio swung from a $38.0 million unrealized depreciation in 2015 to a $38.2 million unrealized appreciation in 2016. This recovery was attributed to improved leveraged loan market conditions and appreciation in LMM and Private Loan equity investments.
- Expense Increases: Total expenses (net of waivers) rose to $37.8 million from $28.8 million, driven by higher interest expense ($15.1 million vs. $11.2 million) and increased management fees due to higher average gross assets.
Guidance, Outlook, and Risks
Management Commentary & Outlook:
- The company intends to continue investing in LMM and Middle Market companies, with a focus on generating current income.
- The board extended the continuous public offering until September 30, 2017, with the closing of the offering to new investors authorized for that date.
- Management expects to continue employing leverage as market conditions permit, subject to the 50% asset coverage limit under the 1940 Act.
Risks and Contingencies:
- Market Volatility: The company remains exposed to disruptions in capital markets, which could impact asset valuations and the ability to raise capital.
- Portfolio Concentration: While diversified, the portfolio includes exposure to the energy sector, which has faced challenges due to declining oil prices. As of year-end, three investments were on non-accrual status (0.2% of portfolio fair value).
- Liquidity: There is no established public market for the company's shares. Liquidity is provided through a quarterly share repurchase program (limited to 2.5% of outstanding shares per quarter) and potential future listing or liquidation events.
- Regulatory Constraints: As a BDC and RIC, the company faces strict asset coverage and distribution requirements that may limit investment flexibility or force asset sales to meet distribution obligations.
Unusual Items:
- The company incurred a 4% nondeductible federal excise tax liability of approximately $246,000 for 2016 due to spillover taxable income distributed in 2017.
- Significant realized losses were recognized due to the restructuring of specific Middle Market investments.
Investor Verification Checklist
- Offering Status: Verify the current status of the continuous public offering and the specific terms of the anticipated closing in September 2017.
- Non-Accrual Assets: Review the specific details of the three investments on non-accrual status and the recovery strategies employed by management.
- Realized Loss Drivers: Examine the specific restructuring terms of the four Middle Market investments that resulted in $20.3 million in realized losses.
- Fee Waivers: Confirm the current status of fee waivers and expense support payments, as these significantly impact net investment income and distributions.
- Debt Covenants: Verify compliance with asset coverage ratios (minimum 200% under the 1940 Act) and specific covenants under the Capital One and Deutsche Bank credit facilities.
- Distribution Sources: Analyze the source of distributions to determine the portion derived from net investment income versus return of capital or borrowings.