Business Context and Reporting Period
Company: HMS Income Fund, Inc. (a Business Development Company and Regulated Investment Company)
Reporting Period: Quarter and six months ended June 30, 2016
Business Overview: The Company invests primarily in illiquid debt and equity securities of lower middle market and middle market companies. It is externally managed by HMS Adviser LP and MSC Adviser I, LLC (Main Street Capital Corporation affiliate). As of June 30, 2016, the portfolio consisted of 164 investments in 125 companies with a fair value of $930.4 million.
Key Financial Metrics
| Metric (Six Months Ended June 30, 2016) | Amount (in thousands) |
|---|---|
| Total Investment Income | $42,460 |
| Net Investment Income | $24,288 |
| Net Realized Gain (Loss) | $(10,015) |
| Net Unrealized Appreciation (Depreciation) | $1,153 |
| Net Increase in Net Assets from Operations | $15,426 |
| Total Assets | $973,957 |
| Total Liabilities | $445,214 |
| Notes Payable (Debt) | $407,000 |
| Cash and Cash Equivalents | $17,949 |
| Net Assets | $528,743 |
| Net Asset Value (NAV) per Share | $7.77 |
| Distributions Declared per Share | $0.35 |
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased to $42.5 million for the six months ended June 30, 2016, compared to $27.2 million in the prior year period. This was driven by portfolio growth funded by equity capital and borrowings.
- Expense Increase: Total expenses (net of waivers) rose to $18.2 million from $12.1 million year-over-year, primarily due to higher management fees ($2.4 million increase) and interest expense ($2.8 million increase) resulting from increased average borrowings ($394.0 million vs. $250.0 million).
- Realized Losses: The Company reported a net realized loss of $10.0 million, contrasting with a gain of $147,000 in the prior year. Losses were primarily attributed to a $6.8 million restructure of a Middle Market investment and a $2.4 million exit from another Middle Market investment.
- NAV Decline: NAV per share decreased from $7.88 at December 31, 2015, to $7.77 at June 30, 2016, largely due to realized losses and unrealized depreciation driven by high-yield bond market declines and lower oil prices affecting the energy sector.
- Non-Accrual Status: Investments on non-accrual status increased to six investments in five companies (1.3% of portfolio fair value) from three investments in two companies at the end of 2015.
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management expects investment income to grow with the portfolio base. The weighted average effective yield on the portfolio increased slightly to 8.4%.
- Capital Raising: The Company is in a continuous public offering (Form N-2). As of June 30, 2016, it had raised $54.8 million in the current offering. The board authorized closing the offering to new investors on or about March 31, 2017, though they retain the right to accelerate or continue it.
- Fee Waivers: The Advisers waived subordinated incentive fees on income of $493,000 and administrative services expenses of $1.1 million for the six months ended June 30, 2016. Administrative expense waivers are not subject to future reimbursement.
- Liquidity: The Company had $103.0 million of remaining capacity under its credit facilities (Capital One and Deutsche Bank), subject to asset coverage ratios. Cash and cash equivalents were $17.9 million.
- Risks: Significant exposure to interest rate fluctuations (84.2% of debt portfolio is floating rate) and credit quality deterioration, particularly in the oil and gas sector. The Company anticipates a $108,000 excise tax liability for the 2015 taxable year.
- Unusual Items: A change in accounting treatment for offering costs was implemented effective January 1, 2016, capitalizing costs as deferred offering costs to be amortized over 12 months.
Investor Verification Checklist
- Realized Loss Drivers: Verify the specific details and future outlook of the Middle Market investments that generated $9.2 million in realized losses.
- Non-Accrual Portfolio: Review the credit status and recovery prospects of the six investments currently on non-accrual status, particularly the four in the oil and gas industry.
- Debt Covenants: Confirm continued compliance with asset coverage ratios (currently 221%) required under the 1940 Act to maintain borrowing capacity.
- Distribution Sustainability: Assess the source of distributions, noting that 37% of distributions for the six months ended June 30, 2016, were funded from sources other than net realized income (e.g., offering proceeds, borrowings, or fee waivers).
- Offering Closure: Monitor the status of the continuous public offering and the board's decision regarding the March 31, 2017 closing date.