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, 2013
Business Overview: The Company is an externally managed, non-diversified closed-end 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 middle market and lower middle market (LMM) companies. The Company is managed by HMS Adviser LP, with Main Street Capital Corporation (and its subsidiary MSC Adviser I, LLC) serving as the Sub-Adviser. As of December 31, 2013, the Company was in an ongoing public offering of common stock at $10.00 per share.
Key Financial Metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Total Assets | $77.6 million | $21.8 million |
| Total Portfolio Investments (Fair Value) | $66.9 million | $16.1 million |
| Net Investment Income | $1.7 million | $1.1 million |
| Net Increase in Net Assets from Operations | $2.2 million | $1.2 million |
| Net Asset Value (NAV) per Share | $8.91 | $8.86 |
| Weighted Average Effective Yield (Total Portfolio) | 7.5% | 9.9% |
| Debt Outstanding (Credit Facility) | $14.0 million | $7.0 million |
| Cash and Cash Equivalents | $6.4 million | $1.8 million |
| Expense Ratio (Total Expenses) | 4.23% | 7.05% |
Material Changes Versus Prior Period
- Portfolio Growth: Total portfolio investments increased by approximately 314% (from $16.1 million to $66.9 million) due to the investment of new equity capital raised and increased borrowings. The number of portfolio investments grew from 11 to 64.
- Yield Compression: The weighted average effective yield on the total portfolio decreased from 9.9% in 2012 to 7.5% in 2013. This decline is attributed to the repayment of higher-yielding LMM investments and a lower interest rate environment.
- Expense Management: While gross expenses increased due to portfolio growth, the net expense ratio improved significantly from 7.05% to 4.23%. This was driven by significant fee waivers (management, incentive, and administrative fees) and an expense support payment of $153,000 from the Adviser.
- Leverage: Borrowings under the Credit Facility doubled from $7.0 million to $14.0 million. The Company expanded the facility capacity from $15 million to $30 million during the year.
- Asset Quality: The weighted average rating of LMM portfolio investments improved from 2.0 to 1.5. No investments were in default as of December 31, 2013.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: The Company intends to continue investing in senior secured and second lien debt securities. It anticipates further increases in investment income as the portfolio base grows. The Company is seeking SEC exemptive relief to co-invest with its Sub-Adviser in LMM transactions, which is currently restricted.
- Distributions: The Company declared distributions totaling $0.70 per share in 2013. Distributions are calculated to target an annualized yield of 7% based on the $10.00 offering price. A portion of distributions may represent a return of capital.
- Fee Waivers: The Adviser waived all base management fees, incentive fees, and administrative expenses for 2013. The waiver period for the Adviser was extended through December 31, 2014, while the Sub-Adviser's waiver expired on December 31, 2013.
- Risks:
- Liquidity: There is no established public market for the Company's shares. Liquidity is limited to a quarterly share repurchase program.
- Regulatory: Failure to obtain SEC exemptive relief may limit the Company's ability to co-invest with Main Street, potentially restricting deal flow.
- Valuation: A significant portion of the portfolio (Level 3 assets) is valued using unobservable inputs, introducing subjectivity to the reported NAV.
- Interest Rate Risk: While most assets are floating-rate, rising rates increase borrowing costs. A 1% increase in rates would increase interest expense by approximately $140,000.
- Unusual Items: The Company recognized $80,000 in Payment-in-Kind (PIK) interest income in 2013 related to an investment that experienced a technical default but was subsequently sold.
Investor Verification Checklist
- Fee Waiver Sustainability: Verify the terms and expiration dates of the fee waivers and expense support agreements, as the Sub-Adviser's waiver expired at year-end 2013.
- Capital Raise Progress: Confirm the current status of the ongoing public offering and the total capital raised to date, as the Company's ability to deploy capital depends on this.
- SEC Exemptive Relief: Check for updates on the application for exemptive relief to co-invest with Main Street Capital Corporation, which is critical for the LMM investment strategy.
- Share Repurchase Program: Review the limitations on the quarterly share repurchase program, as it is the primary source of liquidity for shareholders.
- Portfolio Concentration: Assess the concentration of the portfolio in specific industries or geographies, noting that the largest single investment represented approximately 3% of the portfolio.