MSC INCOME FUND, INC. annual report, FY2023

MSC Income Fund, Inc. — 2023 Form 10-K

Business context and reporting period. MSC Income Fund is an externally managed business development company (BDC) focused on debt and equity investments in U.S. lower middle-market and middle-market businesses. This filing covers the fiscal year ended December 31, 2023; comparisons are primarily with 2022. Its common stock is not exchange-listed, and the filing says no public market is expected to develop.

Financial and portfolio highlights

Metric	2023	2022
Total investment income	$131.4 million	$103.8 million
Net investment income	$57.7 million; $0.72 per share	$52.9 million; $0.66 per share
Net realized investment gains (losses)	$(34.0) million	$(3.9) million
Net unrealized appreciation (depreciation)	$46.3 million	$(1.7) million
Net increase in net assets from operations	$66.2 million; $0.82 per share	$45.6 million; $0.57 per share

Balance sheet and liquidity at December 31, 2023: total assets were $1.140 billion, investments at fair value were $1.093 billion, cash and cash equivalents were $30.8 million, and NAV was $622.3 million, or $7.77 per share (up from $7.61 at year-end 2022).
Debt: total borrowings were $485.7 million, compared with $471.7 million at year-end 2022. BDC asset coverage was 228%. Reported unused capacity under the two credit facilities was $129.3 million, subject to borrowing-base, leverage and covenant limits. The Series A Notes carry a fixed 4.04% rate and mature in 2026; revolving facilities have floating rates.
Cash flow: operating activities provided $50.2 million and financing activities used $40.8 million; cash increased $9.5 million during the year. The company funded $236.4 million of investments and received $238.7 million from investment sales, repayments and returns of capital.
Portfolio: Private Loan, LMM and Middle Market portfolios had fair values of $595.3 million, $387.0 million and $86.0 million, respectively. Weighted-average effective yields at cost were approximately 13.0%–13.1% by strategy, excluding non-accrual investments. Non-accrual investments represented 1.1% of portfolio fair value and 4.0% of cost, versus 0.8% and 4.8% in 2022.
Distributions: $0.70 per share was paid or accrued for 2023, versus $0.645 in 2022. The board subsequently declared a $0.185-per-share quarterly dividend payable May 1, 2024.

Material changes versus 2022

Investment income rose 27%, mainly as higher benchmark rates increased income on floating-rate loans, partly offset by lower average income-producing debt balances. Dividend income also increased.
Net investment income increased 9%, but expenses rose 45% to $73.7 million. Higher interest expense (up 49%) reflected increased benchmark rates; incentive fees rose to $12.6 million from $2.1 million as pre-incentive-fee income improved.
The $34.0 million realized loss was substantially larger than in 2022, including $30.7 million of losses on restructurings. Higher unrealized appreciation, largely in the LMM portfolio, more than offset the realized loss in reported operating results.
Portfolio fair value increased to $1.093 billion from $1.068 billion. First-lien debt declined as a share of the combined Private Loan, LMM and Middle Market portfolio’s fair value, from 81.4% to 78.4%; equity increased from 17.9% to 21.5%.
Interest expense increased to $36.5 million from $24.4 million. The average borrowing rates on the Corporate and SPV facilities rose to 7.54% and 8.09%, respectively, in 2023.

Outlook, risks and unusual items

The filing provides no specific earnings or investment guidance. Management says activity and results depend on investment opportunities, portfolio performance, liquidity and economic conditions, and intends to manage costs and liquidity accordingly.
Management highlighted inflation’s continuing pressure on portfolio-company labor, materials and service costs, which could weaken cash flows, debt-service capacity, distributions and investment valuations. Rising rates can increase borrower stress and the fund’s own floating-rate borrowing costs; falling rates may reduce income on floating-rate assets.
Valuation is a key uncertainty: all $1.093 billion of investments were classified as Level 3 at year-end, and approximately 95% of those investments had no readily available market values. Fair values rely on significant estimates and unobservable assumptions. The auditor identified Level 3 investment valuation as a critical audit matter but issued an unqualified opinion on the financial statements.
Other significant risks include borrower defaults, illiquid investments, leverage and pledged collateral, limited capital-raising options, potential conflicts in allocating opportunities with Main Street and affiliated funds, and the risk of failing to maintain regulated investment company (RIC) status. About 3.8% of 2023 investment income was PIK interest, recorded before cash collection.
The company had $70.8 million of unfunded investment commitments at year-end. Its SPV facility was amended in August 2023: the revolving period was extended to February 2027, maturity to February 2028, and commitments reduced from $325 million to $300 million.
Share repurchases totaled $24.4 million in 2023, including $7.8 million through Dutch auction tenders. Repurchases are subject to program limits; shares are not publicly traded, so investor liquidity is limited. Subsequent to year-end, the company repurchased shares at $7.81 and $7.00 per share in separate offers.
Management reported effective disclosure controls and internal control over financial reporting at December 31, 2023. The auditor was not engaged to audit internal controls.

Important facts for investors to verify

Review the $34.0 million realized investment loss, especially restructurings, and assess whether the improved unrealized marks are supported by portfolio-company performance.
Check non-accrual exposures, unfunded commitments and subsequent borrower developments against the detailed investment schedule and later filings.
Assess borrowing costs, facility availability, covenants, maturities and the 228% asset-coverage ratio under different interest-rate and valuation scenarios.
Examine Level 3 valuation assumptions and the extent of independent valuation review; these valuations affect NAV and may differ from amounts ultimately realized.
Confirm whether investment income and cash generation support distributions, given PIK income, dividend obligations and the company’s restricted share liquidity and repurchase program.