Business context and reporting period
MSC Income Fund, Inc. is an externally managed business development company (BDC) focused on debt and equity investments in U.S. lower middle-market, middle-market and privately held companies. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2022; comparisons are to the corresponding 2021 periods unless noted. The company is managed by an adviser wholly owned by Main Street Capital Corporation.
Key financial metrics
Amounts below are in millions except per-share data and where otherwise stated.
| Metric | Three months ended June 30, 2022 | Six months ended June 30, 2022 |
|---|---|---|
| Investment income | $24.3 | $47.7 |
| Expenses, net of waivers | $11.4 | $22.2 |
| Net investment income | $12.9; $0.16 per share | $25.6; $0.32 per share |
| Net realized gains | $0.4 | $0.6 |
| Net unrealized depreciation | $(10.7) | $(7.0) |
| Net increase in net assets from operations | $1.8; $0.02 per share | $18.0; $0.23 per share |
At June 30, total assets were $1,131.4 million, investments at fair value were $1,105.7 million, net assets were $606.9 million and NAV was $7.58 per share. Cash and cash equivalents were $10.0 million. Gross debt was $501.7 million: $351.7 million drawn under credit facilities and $150.0 million of Series A Notes; the notes’ carrying value after issuance costs was $148.7 million. Unused capacity under the credit facilities was $138.3 million, subject to borrowing-base and asset-coverage restrictions.
For the six months, operating activities provided $10.4 million of cash, while financing activities used $26.2 million; cash declined $15.8 million. The company paid or accrued dividends of $0.325 per share for the six months. The board subsequently declared a $0.16-per-share quarterly dividend payable November 1, 2022.
Material changes versus comparable periods
- Second-quarter investment income rose 8% to $24.3 million, but net investment income fell 9% to $12.9 million. For the first half, investment income rose 12% to $47.7 million while net investment income declined 2% to $25.6 million.
- Expenses net of waivers increased 39% in the quarter and 34% for the six months. Higher interest expense and management fees were key factors; management attributed higher interest costs to larger average debt balances and higher floating rates.
- Interest income increased, reflecting a larger debt investment portfolio. Dividend income fell as prior-year income included elevated amounts management characterized as less consistent or non-recurring. Fee income increased, principally from amendment and prepayment fees in the quarter and management fees from equity investments over six months.
- Quarterly operations fell to $1.8 million from $23.5 million in 2021, principally reflecting the swing from unrealized appreciation to depreciation. First-half operations were $18.0 million, down from $36.1 million, with $7.0 million of unrealized depreciation versus $13.0 million of appreciation in 2021.
- NAV per share decreased from $7.68 at December 31, 2021 to $7.58 at June 30, 2022. Portfolio fair value increased from $1,077.1 million to $1,105.7 million.
Outlook, risks, contingencies and unusual items
- The filing provides no earnings or investment-income guidance. Management says investment activity, portfolio-company performance, repayments, dividends, non-accruals and market conditions can cause results to fluctuate; interim results are not necessarily indicative of full-year results.
- Management cites ongoing exposure to COVID-19-related disruption, supply-chain constraints, labor and materials availability and cost increases, inflation, rising interest rates and recession risk. These factors may weaken portfolio-company earnings and debt-service capacity and reduce investment valuations.
- All $1,105.7 million of investments were categorized as Level 3, relying on significant unobservable valuation inputs. Management cautions that estimated fair values may differ materially from realizable values. Second-quarter unrealized depreciation was driven primarily by increased market spreads in the Private Loan portfolio.
- Four investments were on non-accrual at quarter end, representing 0.6% of portfolio fair value and 2.7% of cost. A majority of variable-rate loans have contractual floors; 85% of debt investments at cost were floating-rate, and 93% of those were subject to rate floors. A hypothetical 100-basis-point rate increase was estimated to increase annualized net investment income by about $4.6 million, or $0.06 per share, assuming no changes in balances or other factors.
- Unfunded investment commitments totaled $67.9 million, including $61.4 million of loan commitments and $6.5 million of equity commitments. The company expects to fund these using cash, operating cash flows and borrowing capacity.
- The company reported no known covenant noncompliance for its credit facilities or Series A Notes. It does not expect current legal matters to materially affect results, while noting that outcomes cannot be assured. No material changes to previously disclosed risk factors were reported.
- All portfolio investments are generally restricted from resale, and most are pledged as collateral for credit facilities. The company also identifies a potential allocation conflict in co-investments with Main Street-affiliated funds; it says policies and independent-board oversight address the conflict.
- After quarter end, the company repurchased 527,508 shares for $4.0 million at $7.64 per share. Separately, it repurchased 536,065 shares during the quarter at an average $7.77 per share.
Important facts for investors to verify
- Confirm the debt reconciliation: the balance sheet and debt note show $501.7 million of gross debt, while one MD&A passage describes $351.7 million as total borrowings under credit facilities and Series A Notes. The latter appears to reflect credit-facility borrowings only.
- Assess whether higher interest income can outpace rising funding costs, given the increase in interest expense and the portfolio’s floating-rate exposure.
- Review the largest valuation declines, non-accrual exposures and assumptions underlying Level 3 valuations, including market spreads, discount rates and expected principal recovery.
- Evaluate dividend coverage against net investment income, the amount of non-cash PIK and cumulative dividend income, and the company’s available liquidity and unfunded commitments.
- Check the credit-facility borrowing-base limits, required asset-coverage ratios and remaining availability; stated unused capacity is not necessarily fully drawable.