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, 2012
Business Overview: The Company is an externally managed, non-diversified closed-end investment company organized as a Business Development Company (BDC) under the Investment Company Act of 1940. It intends to qualify as a Regulated Investment Company (RIC) for tax purposes. The primary objective is to generate current income through debt and equity investments in middle market and lower middle market (LMM) companies. The Company is in the early stages of a continuous public offering of common stock at $10.00 per share.
Key Financial Metrics
| Metric | Year Ended Dec 31, 2012 | Period from Inception to Dec 31, 2011 |
|---|---|---|
| Total Interest Income | $1,873,000 | $90,000 |
| Total Expenses (Net of Waivers) | $739,000 | $34,000 |
| Net Investment Income | $1,134,000 | $56,000 |
| Net Realized Gain | $14,000 | $0 |
| Net Unrealized Appreciation | $87,000 | ($36,000) |
| Net Increase in Net Assets from Operations | $1,235,000 | $20,000 |
| Total Assets | $21,825,000 | $17,552,000 |
| Total Liabilities | $10,402,000 | $7,532,000 |
| Total Net Assets | $11,423,000 | $10,020,000 |
| Net Asset Value (NAV) per Share | $8.86 | $9.02 |
| Portfolio Investments (Fair Value) | $16,132,000 | $16,387,000 |
| Weighted Average Effective Yield | 9.9% | 9.7% |
| Debt Outstanding (Credit Facility) | $7,000,000 | $7,500,000 (Main Street Facility) |
| Cash and Cash Equivalents | $1,832,000 | $942,000 |
Material Changes vs. Prior Period
- Merger Transaction: On May 31, 2012, HMS Income LLC merged into the Company. Financial results for 2012 include the combined operations of both entities from the beginning of the period.
- Debt Financing Restructuring: The Company retired a $7.5 million facility with Main Street Capital Corporation and entered into a new $15 million senior secured revolving credit facility with Capital One, National Association. As of year-end, $7.0 million was outstanding under the new facility.
- Portfolio Composition: The portfolio shifted slightly, with the weighted average effective yield increasing from 9.7% to 9.9%. The portfolio consists of 11 private placement investments and 6 LMM investments. Approximately 90.5% of the portfolio is secured by first priority liens.
- Offering Progress: The Company raised approximately $1.4 million in gross proceeds from June 4, 2012, through December 31, 2012, selling 142,000 shares. As of March 26, 2013, 1,573,072 shares were outstanding.
- Fee Waivers: For 2012, the Advisers waived approximately $793,000 in fees (management, incentive, and administrative expenses) to prevent distributions from being classified as a return of capital.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: The Company intends to continue investing in senior secured and second lien debt securities of middle market companies. It expects to utilize leverage up to 50% of asset value as permitted by the 1940 Act. A liquidity event (listing, merger, or liquidation) is anticipated between four and six years after the completion of the offering period.
- Distributions: The Company declared distributions totaling $1,081,000 for 2012, funded entirely by net investment income. Distributions are calculated daily at an annualized yield of 7% based on the $10.00 offering price. The Company estimates $117,000 of 2012 taxable income will be distributed in 2013, subject to a 4% excise tax.
- Risks:
- Liquidity: There is no established public market for the Company's shares. Liquidity is limited to a share repurchase program (commencing September 2013) and potential future liquidity events.
- Valuation: A significant portion of the portfolio (Level 3 assets) is valued using unobservable inputs (discounted cash flow models), introducing subjectivity to the NAV.
- Regulatory: The Company requires SEC exemptive relief to co-invest with its Sub-Adviser (Main Street) in certain transactions. Failure to obtain this relief could limit investment opportunities.
- Interest Rate Risk: Approximately 73% of the portfolio contains floating interest rates. A 1% change in rates would impact interest income by approximately $118,000 and interest expense by $70,000.
- Unusual Items: The Company declared a 2.25% stock dividend in September 2012 to maintain NAV per share below the offering price. Additionally, the Company reclassified certain prior period transactions regarding the initial purchase of investments from Main Street to conform with ASC 860, though this did not materially impact total assets or NAV.
Investor Verification Checklist
- Offering Status: Verify the current number of shares sold and total capital raised, as the Company is in a continuous "best efforts" offering.
- Fee Waiver Expiration: Confirm the status of the fee waiver agreement, which was extended through September 30, 2013, and the conditions under which waived fees may be recaptured.
- SEC Exemptive Relief: Monitor the status of the application for exemptive relief to co-invest with Main Street Capital Corporation, which is critical for the Company's investment strategy.
- NAV vs. Offering Price: Note that the NAV per share ($8.86) is below the $10.00 offering price; verify if the offering price has been adjusted or if investors are currently paying a premium.
- Debt Covenants: Review compliance with the Capital One Credit Facility covenants, specifically the asset coverage ratio (2.6 to 1 as of year-end) and interest coverage ratio (4.2 to 1).