Executive Summary / Key Takeaways

• MSC Income Fund (MSIF) is undergoing a significant transformation following its NYSE listing and equity offering in early 2025, pivoting its new investment strategy to focus solely on the Private Loan market while managing down legacy portfolios.
• The strategic shift, coupled with increased liquidity from the $90.5 million net equity raise and expanded debt capacity, provides a clear path for portfolio growth in 2025 and 2026, anticipating a doubling of regulatory leverage capacity in January 2026.
• First quarter 2025 results demonstrated solid performance with Net Investment Income (NII) of $0.38 per share, supported by lower expenses post-amended advisory agreement, despite a slight dip in total investment income and realized losses from legacy assets.
• Management expects continued favorable performance, aiming to increase NII and total dividends, targeting a Return on Equity (ROE) in the 10% range over the next six to eight quarters, contingent on market conditions and execution.
• Key factors to watch include the successful deployment of capital into the Private Loan pipeline, the impact of macroeconomic uncertainty (particularly tariffs) on portfolio performance and M&A activity, and the effective utilization of expanded leverage capacity in 2026.

Setting the Stage: A BDC in Transition

MSC Income Fund, Inc. (MSIF) operates as a Business Development Company (BDC), primarily focused on generating total return through debt investments and, to a lesser extent, equity appreciation in private companies. Formed in 2011, the fund initially pursued a dual strategy, targeting both the Private Loan market, providing debt capital to private equity-backed companies for various corporate actions like buyouts and recapitalizations, and the Lower Middle Market (LMM), offering customized debt and equity solutions, often in partnership with Main Street Capital Corporation (MAIN). Over time, MSIF also accumulated legacy portfolios in larger Middle Market syndicated debt and other miscellaneous investments.

The fund's trajectory took a significant turn in late 2024 and early 2025. Following a two-for-one reverse stock split in December 2024, MSIF successfully listed its shares on the New York Stock Exchange on January 29, 2025. This pivotal event was accompanied by a follow-on public offering that raised $90.5 million in net proceeds. Concurrently, MSIF adopted an amended advisory agreement with its external manager, MSC Adviser I, LLC, a wholly-owned subsidiary of Main Street, which included favorable adjustments to the fee structure. Most importantly, the fund strategically shifted its focus for all new platform investments solely to the Private Loan strategy, intending to manage down its legacy Middle Market and Other Portfolios while continuing to pursue follow-on opportunities within its existing LMM portfolio.

Within the competitive landscape, MSIF operates alongside larger, more established BDCs like Ares Capital Corporation (ARCC), FS KKR Capital Corp. (FSK), and Golub Capital BDC, Inc. (GBDC), as well as its affiliate, Main Street. While MSIF's scale is considerably smaller than giants like ARCC, which boasts over $25 billion in assets and demonstrates quantifiable efficiencies in deal processing and operating costs, MSIF has historically carved out a niche through its customized "one-stop" financing solutions, particularly in the LMM. This approach has aimed to provide flexibility in deal structuring and potentially higher equity returns in specific segments. However, MSIF has generally lagged behind larger peers and even MAIN in terms of overall operational efficiency, revenue growth rates, profitability margins, and key return metrics like ROE and ROIC. The strategic pivot to a singular focus on the Private Loan market for new deals represents a response to this competitive environment, seeking to leverage relationships with private equity sponsors and capitalize on opportunities in a market segment where spreads, while having tightened, have shown recent signs of stabilization. Broad industry trends, such as the subdued M&A market, significant private equity liquidity, and macroeconomic uncertainties like tariffs and inflation, continue to shape the operating environment for all players in the private lending space.

Strategic Evolution and Capital Deployment

The decision to concentrate new platform investments exclusively on the Private Loan strategy is central to MSIF's post-listing narrative. This move allows the fund to streamline its origination efforts and deepen its relationships with private equity sponsors, a key partner base in this market segment. The legacy Middle Market and Other Portfolios, deemed less strategic or inconsistent with the go-forward focus, are now in harvest mode, expected to decline over time as investments are repaid or sold. While new LMM platform deals are off the table, the fund will continue to evaluate and participate in follow-on investments within its existing LMM portfolio companies, leveraging its established partnerships with owner-operators and the SEC co-investment exemptive relief shared with Main Street.

A primary strategic imperative for 2025 is the efficient deployment of the substantial liquidity gained from the January equity offering. The $90.5 million in net proceeds, combined with the corresponding increase in available debt capacity, provides MSIF with significant dry powder. Management is focused on channeling this capital into new Private Loan investments to achieve and maintain a fully invested portfolio within its current leverage limits throughout 2025. This period is seen as crucial preparation for January 2026, when the fund's regulatory leverage capacity is set to effectively double, following the Board's approval of the modified asset coverage requirements. Optimizing the capital structure is also a priority, as evidenced by recent amendments to the Credit Facilities, including reduced interest rate spreads and extended maturities, aimed at lowering the overall cost of debt capital.

The private loan investment pipeline is characterized by management as "average" as of mid-May 2025, though it was noted as "above average" in March due to deals progressing closer to execution. Despite broad economic uncertainty, management expresses confidence in the ability to generate attractive new investment opportunities and grow the portfolio. This growth is essential to increasing net investment income and ultimately supporting higher dividends for shareholders. The strategic focus on Private Loans, where underwriting emphasizes the quality and supportiveness of private equity sponsors, is intended to provide a degree of downside protection, although risks remain, particularly in sectors sensitive to consumer spending or broader economic headwinds.

Financial Performance and Portfolio Health

MSIF's first quarter 2025 financial results reflect the early impacts of its strategic transition and the benefits of the amended advisory agreement. Net Investment Income (NII) rose to $16.8 million, or $0.38 per share, compared to $14.5 million, or $0.36 per share, in the first quarter of 2024. This increase in NII occurred despite a slight decrease in total investment income, which fell by 2.0% year-over-year to $33.2 million. The decline in total investment income was primarily driven by a $1.6 million decrease in interest income (attributed to increased non-accruals and lower floating rates, partially offset by portfolio growth) and a $1.6 million decrease in fee income (lower exit/prepayment/amendment fees). However, dividend income saw a notable $2.6 million increase from certain LMM and Private Loan investments.

The key driver for the NII increase was a significant 15.0% reduction in total expenses, net of waivers, falling to $16.4 million from $19.4 million in the prior year quarter. This expense reduction was largely due to lower interest expense (driven by reduced benchmark rates and spread reductions on Credit Facilities) and a substantial decrease in incentive fees, reflecting the more favorable terms under the amended advisory agreement effective post-listing. The annualized expense ratio (excluding incentive fees) improved to 1.9% in Q1 2025 from 2.2% in Q1 2024.

Portfolio activity in Q1 2025 saw the Private Loan portfolio grow by $89 million on a cost basis (13%), reaching $790.0 million. The LMM portfolio remained relatively stable, with a net decrease of $1 million in cost basis, ending the quarter at $356.3 million cost and $439.7 million fair value. The legacy Middle Market and Other Portfolios continued their expected decline. The Middle Market portfolio decreased by $25.7 million in cost and $9.8 million in fair value, ending at $40.6 million cost and $30.8 million fair value. The Other Portfolio saw minor decreases, ending at $16.5 million cost and $22.6 million fair value.

The quarter's results included $21.1 million in net realized losses, primarily concentrated in the Middle Market portfolio from two long-term underperforming legacy names. Management noted that these losses largely reflected prior unrealized depreciation and did not significantly impact NAV beyond what was already reflected. Net unrealized appreciation across the portfolio totaled $18.8 million. Overall, the net change in fair value was a decrease of $2.3 million, driven by decreases in the Private Loan and Middle Market portfolios, partially offset by appreciation in the LMM portfolio. Portfolio asset quality saw an increase in non-accrual investments, comprising 2.8% of the total portfolio at fair value and 6.1% at cost as of March 31, 2025, up from 1.5% and 5.6% respectively at year-end 2024. This increase reflects softness, particularly in consumer-exposed names.

Capital Structure and Outlook

MSIF ended the first quarter of 2025 with a solid liquidity position, holding $39.5 million in cash and cash equivalents and $124.0 million in unused capacity under its Credit Facilities. The fund's regulatory asset coverage ratio stood at a healthy 226%. Recent amendments to the Credit Facilities have bolstered this position, including increasing the Corporate Facility commitments to $245.0 million (with an accordion to $300.0 million) and extending its maturity to May 2029, and reducing the SPV Facility interest rate spread by 80 basis points while extending its maturity to February 2030. These actions lower borrowing costs and enhance financial flexibility.

The strategic focus for 2025 is to deploy available capital to reach a fully invested state within the current leverage framework, targeting a net debt to NAV ratio between 0.85x and 0.95x, though staying below the high end until closer to the leverage expansion. The significant catalyst for future growth and enhanced returns is the planned increase in regulatory leverage capacity to 150% (from 200% asset coverage) effective January 29, 2026. This effectively doubles the fund's borrowing power and is expected to be a major driver for portfolio expansion and ROE improvement.

Management expects continued favorable performance, aiming to increase NII and total dividends in the future. The dividend policy is designed to distribute total quarterly dividends (regular plus supplemental) at or slightly below NII, with supplemental dividends used when NII exceeds the regular payout. The goal is to increase the total dividends paid over time as the portfolio grows and leverage is optimized. Management targets achieving an ROE in the 10% range over the next six to eight quarters, contingent on successful execution of the growth strategy and a supportive economic environment.

Key risks to this outlook include the impact of ongoing market uncertainty, particularly concerning tariffs, which could affect portfolio company performance, M&A activity, and potentially delay recoveries on underperforming assets. While MSIF's portfolio is weighted towards US domestic businesses, providing some buffer, it is not immune to broader economic headwinds. The execution risk associated with deploying the new capital effectively and managing the legacy portfolios also remains pertinent.

Conclusion

MSC Income Fund is at a transformative juncture, leveraging its recent NYSE listing and equity infusion to pivot towards a focused Private Loan growth strategy. The first quarter of 2025 demonstrated the initial financial benefits of this transition, with lower expenses driving NII growth despite some income headwinds and realized losses from legacy assets. The fund is well-capitalized and strategically positioned to utilize its increased liquidity and future expanded leverage capacity to grow its Private Loan portfolio significantly in the coming quarters.

The core investment thesis hinges on MSIF's ability to successfully execute this growth plan, capitalize on its relationships with private equity sponsors, and effectively manage its cost of capital. While challenges remain, including macroeconomic uncertainty and the performance of certain legacy investments, management's stated goals for increased NII, higher dividends, and an improved ROE in the 10% range provide a clear roadmap for potential enhanced shareholder returns. Investors should closely monitor the pace and quality of new Private Loan originations, trends in portfolio asset quality (particularly non-accruals), and the impact of external market factors on the fund's trajectory.