Business Context and Reporting Period
Company: HMS Income Fund, Inc. (MSC Income Fund, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2020
Business Overview: An externally managed, non-diversified closed-end management investment company operating as a Business Development Company (BDC). The Company invests primarily in illiquid debt and equity securities of lower middle market (LMM) and middle market companies. It is managed by HMS Adviser LP, with MSC Adviser I, LLC (a subsidiary of Main Street Capital Corporation) serving as the Sub-Adviser.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 |
|---|---|---|
| Total Investment Income | $46.2 million | $57.8 million |
| Net Investment Income | $24.4 million | $27.8 million |
| Net Realized Gain (Loss) | $(17.7) million | $(6.9) million |
| Net Change in Unrealized Appreciation (Depreciation) | $(70.9) million | $9.7 million |
| Net Increase (Decrease) in Net Assets from Operations | $(64.2) million | $30.6 million |
| Net Asset Value (NAV) per Share | $6.60 | $8.00 |
| Total Portfolio Investments (Fair Value) | $877.6 million | $1,027.6 million |
| Total Assets | $927.9 million | $1,066.1 million |
| Total Liabilities | $404.6 million | $456.8 million |
| Credit Facilities Outstanding | $384.9 million | $445.0 million |
| Cash, Cash Equivalents, and Restricted Cash | $27.9 million | $20.7 million |
Material Changes vs. Prior Period
- Portfolio Valuation Decline: Total portfolio investments at fair value decreased by approximately $150 million (14.6%) from December 31, 2019, to June 30, 2020. This was driven primarily by a net unrealized depreciation of $70.9 million and net realized losses of $17.7 million.
- Investment Income Reduction: Total investment income decreased by $11.6 million (20.1%) year-over-year. This decline was attributed to a decrease in the weighted average annual effective yield (from 9.4% to 7.6%), interest income write-offs due to increased non-accrual investments, and a reduction in the aggregate par value of debt investments.
- Expense Reduction: Total expenses, net of waivers, decreased by $8.2 million (27.3%) compared to the prior year period. This was primarily due to lower interest expense (resulting from reduced average borrowings and lower rates), a decrease in base management fees (due to lower average gross assets), and the absence of subordinated incentive fees on income in the current period.
- Non-Accrual Status: The number of debt investments on non-accrual status increased from 8 (in five companies) at December 31, 2019, to 10 (in seven companies) at June 30, 2020. These investments represented 1.8% of the total portfolio at fair value.
- NAV Decline: NAV per share decreased from $7.77 at the beginning of the period to $6.60 at the end of the period, a decline of 15.1%.
Guidance, Outlook, Risks, and Unusual Items
- Distribution Suspension: On June 29, 2020, the Board of Directors unanimously approved the suspension of all distributions to stockholders, effective immediately after the payment of previously declared distributions through June 30, 2020. This decision was made to preserve financial flexibility and liquidity given the prolonged impact of the COVID-19 pandemic.
- Share Repurchase Suspension: The Company's share repurchase program was temporarily suspended commencing with the second quarter of 2020 for the same reasons as the distribution suspension.
- COVID-19 Impact: The pandemic has caused a steep decline in leveraged loan market values and has adversely affected the operations of many portfolio companies, particularly in retail, travel, hospitality, leisure, and oil & gas sectors. The Company expects continued financial distress and potential defaults among portfolio companies.
- Advisory Agreement Change: On June 26, 2020, the Adviser entered into an asset purchase agreement to assign the Investment Advisory Agreement to the Sub-Adviser (MSC Adviser I, LLC). If approved by stockholders, the Sub-Adviser will become the sole investment adviser, and the base management fee rate is expected to be reduced from 2.00% to 1.75%.
- Debt Facility Amortization: The Deutsche Bank Credit Facility was amended in April 2020 to terminate revolver commitments and begin an amortization period. No further advances or reinvestments are permitted on this facility; proceeds are applied to outstanding advances.
- Interest Rate Risk: Approximately 86% of the debt portfolio contains floating interest rates. A decline in LIBOR has reduced gross investment income, though many investments have contractual floors (typically 100-150 basis points).
Important Facts for Investor Verification
- Distribution Status: Verify the current status of distributions, as they were suspended in June 2020. Future distributions are subject to Board reevaluation.
- Portfolio Quality: Review the list of 10 investments on non-accrual status and the specific portfolio companies affected by the COVID-19 pandemic to assess credit risk.
- Advisory Transition: Monitor the progress of the proposed transaction to make MSC Adviser I, LLC the sole adviser and the potential reduction in the management fee.
- Liquidity Position: Confirm the Company's ability to meet unfunded commitments ($40.7 million) and service debt obligations ($384.9 million outstanding) given the suspension of distributions and share repurchases.
- Asset Coverage Ratio: Verify the Company remains in compliance with the 200% asset coverage requirement under the 1940 Act (reported as 236% as of June 30, 2020).