MSC Income Fund, Inc. — Q2 2023 Form 10-Q
Business context and reporting period. MSC Income Fund is an externally managed business development company (BDC) investing primarily in secured debt and, to a lesser extent, equity of lower middle-market, middle-market and private-loan companies. This unaudited filing covers the quarter and six months ended June 30, 2023; balance-sheet comparisons are with December 31, 2022.
Financial and portfolio highlights
| Metric | Q2 2023 / June 30, 2023 | Comparable period / prior date |
|---|---|---|
| Investment income | $33.2 million for the quarter | $24.3 million in Q2 2022; up 37% |
| Net investment income | $14.4 million; $0.18 per share | $12.9 million; $0.16 per share in Q2 2022 |
| Net change in assets from operations | $19.3 million; $0.24 per share | $1.8 million; $0.02 per share in Q2 2022 |
| Six-month results | Investment income $64.3 million; net investment income $28.5 million ($0.36 per share); operations increased net assets by $31.5 million ($0.39 per share) | For first-half 2022: $47.7 million, $25.6 million ($0.32 per share), and $18.0 million ($0.23 per share), respectively |
| Net realized investment result | Loss of $28.9 million for Q2; $25.4 million for first half | Q2 2022 gain of $0.4 million; first-half 2022 gain of $0.6 million |
| Net unrealized investment change | Appreciation of $35.8 million for Q2; $31.6 million for first half | Q2 2022 depreciation of $10.7 million; first-half 2022 depreciation of $7.0 million |
| Cash flows | First-half operating cash flow $19.0 million; financing cash used $10.3 million; cash increased $8.7 million to $30.1 million | First-half 2022 operating cash flow $10.4 million; cash fell $15.8 million to $10.0 million |
| Investments and NAV | Investments at fair value $1.086 billion; NAV $613.8 million, or $7.67 per share | At Dec. 31, 2022: $1.068 billion and $609.7 million, or $7.61 per share |
| Debt and liquidity | Total debt outstanding $487.7 million face amount; $30.1 million cash and $152.3 million unused credit-facility capacity; BDC asset coverage 226% | Debt face amount was $471.7 million at Dec. 31, 2022 |
- Higher floating benchmark rates and spreads on newer investments lifted interest income. However, first-half net interest expense rose 75% to $17.2 million, and total expenses net of waivers rose 61% to $35.8 million. Q2 incentive fees were $3.6 million; none were incurred in the 2022 comparable period.
- Portfolio effective yields at June 30 were 12.9% for Private Loan, 12.9% for lower middle-market and 12.1% for middle-market debt, excluding non-accrual investments. These portfolio yields are not equivalent to shareholder returns.
- First-half net realized losses included losses associated with restructurings and exits; unrealized appreciation more than offset these losses in reported operating results. The filing notes that Q2 restructurings were completed at a net realized fair value $2.9 million above the investments’ prior-quarter-end fair value.
Material changes, outlook and risks
- Non-accrual investments declined to four, representing 0.3% of portfolio fair value and 2.8% of cost, from seven investments, 0.8% of fair value and 4.8% of cost at year-end 2022.
- Management provided no specific earnings or investment-growth forecast. It expects to fund investments, expenses, distributions and repurchases with existing cash, operating cash flows, investment repayments and available credit-facility borrowings. Future dividends remain subject to quarterly board decisions.
- On August 10, 2023, the board declared a $0.175-per-share quarterly dividend payable November 1, 2023. It also approved a repurchase offer tied to 90% of proceeds from shares issued in lieu of cash distributions for that dividend. Subsequent to quarter-end, the company repurchased 545,206 shares at $7.74 per share for $4.2 million.
- The Q2 modified Dutch auction repurchased 406,904 shares at $5.50 per share for $2.2 million. This price was below the June 30 NAV of $7.67 per share.
- Material risks include portfolio-company credit deterioration, inflation and other macroeconomic pressures, leverage and refinancing, and interest-rate exposure. At June 30, 82% of debt investments (at cost) bore floating rates, while 31% of debt obligations bore fixed rates; the company had no interest-rate hedges. A hypothetical 100-basis-point rate increase was estimated to raise annualized net investment income by about $4.0 million ($0.05 per share), while a 100-basis-point decrease was estimated to reduce it by the same amount.
- All investment fair values were classified as Level 3, relying on significant unobservable inputs. Management cautions that actual realizations may differ materially from estimated values. First-half PIK interest, which is not currently paid in cash, was 3.6% of investment income.
- Outstanding unfunded investment commitments were $67.8 million. The company stated it manages liquidity to fund these commitments. It reported compliance with its credit-facility and note covenants and said current legal matters were not expected to materially affect results, while noting outcomes cannot be assured.
Important facts for investors to verify
- Whether portfolio-company performance and the $31.6 million first-half unrealized appreciation support the carrying values, given the all-Level-3 portfolio and valuation sensitivity.
- Credit quality and recoveries for restructured, non-accrual and materially marked-down investments; also monitor changes in the four non-accrual positions.
- Whether higher investment yields continue to exceed rising funding costs, incentive fees and other expenses, and how rate movements affect net investment income.
- Available borrowing capacity after borrowing-base and leverage limits, the $67.8 million unfunded commitments, and maturities of the JPM SPV Facility in 2025 and other debt in 2026.
- The sustainability and cash coverage of quarterly distributions, including the effect of non-cash PIK income, share repurchases and DRIP issuances on NAV per share.