New Mountain Finance Corporation (NASDAQ:NMFC) Q1 2024 Earnings Call Transcript

New Mountain Finance Corporation (NASDAQ:NMFC) Q1 2024 Earnings Call Transcript May 2, 2024

New Mountain Finance Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the New Mountain Finance Corporation First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would like now to turn the conference over to John Kline, President and CEO of New Mountain Finance. Please go ahead.

John Kline : Thank you, and good morning, everyone. Welcome to New Mountain Finance Corporation’s first quarter 2024 earnings call. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; Laura Holson, COO of NMFC; and Kris Corbett, CFO and Treasurer of NMFC. Laura is a little under the weather today, so she will not be making prepared remarks but will be available for Q&A. Now, Steve is going to make some introductory remarks, but before he does, I’d like to ask Kris to make some important statements regarding today’s call.

Kris Corbett : Thanks, John. Good morning, everyone. Before we get into the presentation, I would like to advise everyone that today’s call and webcast are being recorded. Please note that they are the property of New Mountain Finance Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available on our May 1 earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our press release and on Pages 2 and 3 of our slide presentation regarding forward-looking statements. Today’s conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from those statements and projections.

We do not undertake to update our forward-looking statements or projections unless required to by law. To obtain copies of our latest SEC filings and to access the slide presentation that will be referencing throughout this call, please visit our website at www.newmountainfinance.com. At this time, I’d like to turn the call over to Steve Klinsky, NMFC’s Chairman, who will give us some highlights beginning on Page 5 with a slide presentation. Steve?

Steve Klinsky : Thanks, Kris. It’s great to be able to address you all today, both as NMFC’s Chairman and as a major fellow shareholder. Adjusted net investment income for the quarter was $0.36 per share, in line with our implied guidance, and more than covering our $0.32 per share regular dividend that was paid in cash on March 29. Our net asset value per share decreased slightly to $12.77, a $0.10 decline compared to last quarter. NMFC experienced strong core credit performance offset by a decrease in value of one of our equity positions, which John will discuss later in the presentation. Given our earnings of $0.36 per share this quarter, we will make our fifth consecutive variable supplemental dividend payment. The variable supplemental dividend for this quarter will be $0.02 per share, which is equal to half of the amount of our Q1 quarterly earnings in excess of our regular dividend of $0.32.

NMFC will pay these distributions on June 28 to holders of record as of June 14. The remainder of the excess earnings will remain on our balance sheet and may be paid out in the future. Our dividend at $0.34 represents an annualized current distribution yield of 11%. Looking forward to Q2, in addition to our $0.32 regular dividend, we expect to again generate a variable supplemental dividend of $0.02 per share, or $0.34 in total payable in the third quarter of 2024. We also continue to keep our dividend protection program in place and are committed to reduce our incentive fee if and is needed to fully support the $0.32 per share quarterly regular dividend. We do not anticipate utilizing this pledge given our strong credit performance and current earnings power.

We believe the strength of New Mountain and of NMFC is driven by the consistency of our strategy and the quality of our team. New Mountain overall, now numbers over 245 members and the firm has developed specialties in attractive defensive growth that is a cyclical growth sectors such as life science supplies, healthcare information technology, software, infrastructure services and digital engineering. When pursuing our credit investing efforts, we utilize our extensive group of industry experts to provide unique knowledge and expertise that allows us to make very informed high conviction underwriting decisions. Over the last year, we have continued to expand the quality of our overall team. New Mountain’s private equity funds have never had a bankruptcy or missed an interest payment, and the firm now manages over $50 billion of assets.

Similarly, NMFC has experienced only 5 basis points of average annualized net realized losses in its 13 years as a public company, while paying out nearly $18 per share of cumulative ordinary supplemental and special dividends. We believe our loans today are well positioned overall in defensive growth industries that we think are right at all times and particularly attractive in less certain economic times. Finally, we as management continue as major shareholders of NMFC, I and NMC’s other senior management employees currently own approximately 12% of NMFC’s total shares personally. With that, let me turn the call to John.

John Kline: Thank you, Steve. I would like to begin by offering some more details on our direct lending investment strategy and track record. Starting on Page 8, we highlight our exposure to a diversified list of defensive non-cyclical sectors. These sectors mapped industries where New Mountain has made successful private equity investments and where our firm’s knowledge is the strongest. We seek to make investments in companies with durable growth drivers, predictable revenue streams, margin stability, and great free cash flow conversion. As you can see from the industry pie chart on Page8, we have virtually no exposure to cyclical, volatile, and secularly challenged industries, which could be riskier areas to invest in given today’s higher rate environment.

Our strategy has been consistent over our 13 years as a public company, and it allows us to operate with confidence in any economic environment. Page 9 provides a high-level snapshot of our business, where we show a long-term track record of delivering consistent enhanced yield to our shareholders by minimizing credit losses and distributing virtually all of our excess income to shareholders. Since our IPO in 2011, NMFC has returned over $1.2 billion to shareholders through our dividend program, generating an annualized return of approximately 10%. This represents a very strong cash flow oriented return well in excess of the high yield index. Our current portfolio invest in companies within high quality industries that are performing well and where our last dollar of risk is approximately 40% of the purchase price paid for the business.

We lend primarily to businesses owned by financial sponsors who are sophisticated and supportive owners with significant capital that is junior to the loans that we make. Turning to Page 10, the internal risk rating of our portfolio improved quarter-over-quarter with 96.5% of our portfolio rated green compared to 94.5% last quarter. This represents the highest level of green rated assets since we began using the heat map rating system during COVID. Our most challenged names within the orange and red categories represent less than 1.5% of NMFC’s fair value, making them a negligible part of our portfolio. We have de-risked our book value by marking our red names to just 8% of face value and our orange names to 67% of face value. Overall, when we consider the very high proportion of green names compared to our non-green names, our portfolio is as healthy as it has been in recent history.

The update heat map is shown in its entirety on Page 11. Given our portfolio’s orientation towards defensive sectors like software, business services and healthcare, we believe our assets are well-positioned to continue to perform no matter how the economic landscape develops. We did not have any negative risk rating migrations during the quarter. We also received full repayment of our $37.5 million second lien position in Franklin Energy, a yellow rated name marked at $0.91 as of 12/31. As Franklin Energy and other material pay downs in recent quarters demonstrate, we continue to believe that many of our non-green names have the ability to migrate back to green and achieve exits at par. Turning to Page 12, we provide a graphical analysis of NAV changes during the quarter resulting in a book value of $12.77.

Overall, the quarter benefited from very good core credit performance in a supportive market environment. However, we did reduce the carrying value of our equity stake at Edmentum. As a reminder, Edmentum is a leading provider of K-12 online learning programs. We have been a minority owner since the restructuring in 2015 and have since recovered our cost basis while maintaining a residual equity position in the company. During Covid, Edmentum and certain other players in the education technology market benefitted from an accelerated shift to virtual learning. As the market normalizes post-Covid, we have seen a slowdown in performance and therefore reversed some of the unrealized gain we had previously recognized. We believe the market is stabilized, Edmentum remains well-positioned and the value proposition of the company’s products remains strong.

Page 13 addresses NFMC’s non-accrual performance. On the left side of the page, we show the current state of the portfolio where we have approximately $3.1 billion of investments at fair value with $49 million or 1.6% of the portfolio currently on non-accrual. As we mentioned on our Q4 earnings call, charismatic brands a red name with a current fair market value of just $0.4 million filed for bankruptcy and was placed on non-accrual. The other names on non-accrual are from much older vintages, have been written down materially and have a good chance of exiting the portfolio in the medium term. On the right side of the page, we show our cumulative credit performance since IPO, where NMFC has made $9.5 billion of investments while realizing losses of only $37 million.

This represents an annualized net realized loss rate of approximately 5 basis points since IPO. This is consistent with our value proposition of preserving principal value and distributing nearly all of our net investment income through predictable quarterly dividends. On Page 14, we present NMFC’s overall economic performance since IPO, showing that we have delivered consistent and compelling returns. Cumulatively, NMFC earned nearly $1.3 billion in net investment income while generating only $37 million of cumulative net realized losses and only $58 million of net unrealized depreciation resulting in $1.2 billion of value created for shareholders. Moving to general market commentary, we continue to believe the outlook for the remainder of 2024 in the sponsor-backed direct lending market is positive.

Deal flow is picking up in real time, but still remains depressed versus historical levels. There are pockets of activity in our defensive growth verticals where we have the opportunity to make loans at attractive yields while staying very selective. Yield structures remain compelling with leverage levels below peak levels and significant sponsor equity contributions representing the vast majority of the capital structures. We remain bullish on the medium and long-term outlook for M&A activity given the magnitude of dry powder for private equity and the increasing pressure to return capital to LPs, as well as more attracting financing markets for borrowers. Syndicated markets are open and we continue to see modest spread compression related to the increased competition.

However, we expect the supply demand imbalance and normalize as soon as we see more regular deal flow environment return. While the syndicated markets are open the direct lending market remains that the financing market of choice for sponsors, as the majority of our sponsors still recognize the benefits of direct lending solutions, including more certain execution, more flexibility around creating bespoke capital structures and the ability to hand select lenders. In addition to new activity, we have seen an increased volume of opportunistic refinancing and add-on opportunities within our large portfolio of over 100 unique borrowers. This provides an ongoing opportunity set to make incremental loans to existing well performing companies seeking to pursue accretive M&A.

Page 16 presents an interest rate and analysis that provides insight into the effect of base rates on NMFC’s earnings. As a reminder, the NMFC loan portfolio is 88% floating rate and 12% fixed rate. While our liabilities are 54% fixed rate and 46% floating rate as of quarter end. During Q1, we fully swapped our investment grade bond issuance from fixed to floating rate. As we access the investment grade market in the future, we would expect to hedge interest rate risk in this manner again. Moving on to Page 17. In Q1, we saw continued portfolio velocity. We originated $192 million of assets, partially offset by $145 million of repayments. Our originations consisted of investments in our core defensive growth power alleys, including niches of enterprise software and business services.

I’d highlight that three of our repayments during the first quarter were second lien positions. And turning to Page 18, subsequent to quarter end, we received four additional second lien repayments. We believe this uptick in second lien repayments is a function of credit selection. We generally reserve our second lien capacity for our highest conviction opportunities. These companies have largely performed well and have been able to take advantage of the current market environment to either sell or refinance their capital structures. These refinancings, combined with our incumbency position, often provide a mechanism for us to rotate from second lie to first lien, as you can see in the case of OEConnection and TriTech. Turning to Page 19, we show our asset mix where approximately 69% of our investments inclusive of first lien SLPs and net lease are senior in nature.

As I mentioned, this continues to skew more senior over time. Second lien positions decreased from 18% in Q1 of last year to 14% this quarter, and only 10% pro forma for the post quarter end second lien repayments. Approximately 8% of the portfolio is comprised of our equity positions, the largest of which are shown on the right side of the page. As mentioned in prior quarters, we hope to monetize certain of these equity positions in the medium term and rotate those dollars into cash yielding assets. Page 20 shows the average yield on of NMFC’s portfolio has increased from 10.9% in Q4 to 11.1% for Q1, primarily due to the higher for longer shift in the base rate curve. Generally speaking, even though spreads are tighter, as evidenced by lower yields on our originations compared to our repayments, yields remain attractive and support our net investment income target.

Page 21 highlights the scale and credit trends of our underlying borrowers. As you can see, the weighted average EBITDA of our borrowers has increased over the last several quarters to $179 million. This is primarily attributable to our originations of some larger companies as well as growth at individual portfolio companies that we lend to. While we first and foremost concentrate on how an opportunity maps against our defensive growth criteria and internal New Mountain knowledge, we believe that larger borrowers tend to be marginally safer, all else equal. We also show the relevant leverage and interest coverage stats across the portfolio. Portfolio company leverage has decreased slightly over the last several quarters, loan to values continue to be quite compelling, and the current portfolio has an average loan to value of 43%.

Interest coverage ratios have stabilized as expected, and the weighted average interest coverage on the portfolio actually increased slightly to 1.7x this quarter. We see our sponsors continue to proactively support company liquidity and continued M&A activity. This is a great indication that our portfolio consists of companies that are performing well and are able to attract additional investments at healthy valuation. Finally, as illustrated on Page 22, we have a diversified portfolio across 115 portfolio companies. The top 15 investment inclusive of our SLP funds and net lease account for approximately 42% of total fair value and represent our highest conviction names. I will now turn the call over to our Chief financial Officer, Kris Corbett, to discuss our financial results.

Kris Corbett: Thank you, John. For more details, please refer to our quarterly report on Form 10-Q that was filed yesterday with the SEC. As shown on Slide 23, the portfolio had approximately $3.1 billion in investments at fair value on March 31, and total assets of $3.3 billion with total liabilities of $1.9 billion, of which total statutory debt outstanding was $1.5 billion. Net asset value of $1.4 billion or $12.77 per share was down slightly compared to the prior quarter. At quarter end, our statutory debt to equity ratio was 1.08x to 1x and 1.03x to 1x net of available cash on the balance sheet. This represents the lower end of our target range and is meaningfully lower than Q1 of the prior year. On slide 24, we show our quarterly income statement results.

For the current quarter, we are in total investment income of $90.3 million, a 2% decrease from prior year. Total net expenses of approximately $53 million decreased 1% versus prior year. As a reminder, the investment advisor has committed to a management fee of 1.25% for the 2024 calendar year. As mentioned earlier, the investment advisor has also pledged to reduce its incentive fee if and is needed during this period to fully support the $0.32 per share regular quarterly dividend. Based on our forward view of the earnings power of the business, we do not expect to use this pledge. It is important to note that the investment advisor cannot recoup fees previously waived. Our adjusted net investment income for the quarter was $0.36 per weighted average share, which has meaningfully exceeded our Q1 regular dividend of $0.32 per share.

As Slide 25 demonstrates, 98% of our total investment income is recurring this quarter given the minimal fees earned in Q1. You will see historically that over 90% of our quarterly income is recurring in nature and on average over 80% of our income is regularly paid in cash. We believe this consistency shows the stability and predictability of our investment income. Importantly, over 99% of our quarterly non-cash income is generated from our green rated names. Turning to Slide 26, the red line shows the coverage of our regular dividend. This quarter adjusted NII exceeded our Q1 regular dividend by $0.04 per share. For Q1 2024, our Board of Directors has again declared regular dividend of $0.32 per share, as well as a supplemental dividend of $0.02 per share.

On Slide 27, we highlight our various financing sources and diversified leverage profile. Taken into account the SBA-guaranteed debentures, we have $2.6 billion of total borrowing capacity with $787 million available on a revolving line subject to borrowing base limitations. This represents our most significant availability since the inception of our business and highlights our strong liquidity. As a reminder, covenants under both our Wells Fargo and Deutsche Bank credit facilities are generally tied to the operating performance of the underlying businesses that we lend to, rather than the marks of our investments at any given time, which we think is particularly important during more volatile times. Finally, on Slide 28, we show our leverage maturity schedule.

During the quarter, we issued a $300 million five-year investment grade bond with very strong execution for NMFC’s first issuance of this kind. In the future, we plan to be repeat issuers in the investment grade debt markets to further ladder our maturities in the most cost-efficient manner. Notably, nearly 70% of our debt matures in or after 2027. With that, I’d like to turn the call back over to John.

John Kline : Thank you, Kris. As we look forward over the remainder of 2024, we remain confident in a continued strong performance of NMFC’s portfolio and believe we are on track to continue to deliver great risk adjusted returns to our shareholders. We once again would like to thank all of our stakeholders for the ongoing partnership and support and look forward to maintaining our dialogue throughout the year. I’ll now turn things back to the operator to begin Q&A. Operator?

Operator: [Operator Instructions] Our first question comes from Bryce Rowe of B. Riley.

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Q&A Session

Bryce Rowe : Maybe just wanted to start on some of the origination versus repayment dynamic in terms of pricing, and I think you noted it in your prepared remarks as well, is going to show it on Slide 20. So, it looks like some of the repayment activity is coming off at a higher yield and the originations are coming on at a lower yield. Can you talk about that dynamic and kind of what your expectations are, especially considering, maybe increased competition and tighter spreads that we’re starting to see here?

John Kline : Sure. I think, that’s undoubtedly true. When you look at the numbers, we did have particularly some second lien positions repay, and those definitely had attractive spreads. Now, we think that the primarily unitranche loans that we’re originating right now, also very good spreads, but they are a little lower. I think my own view is this is a moment in time and we alluded it to this in our prepared remarks where, there’s not quite enough deal activity to satisfy the demand in the lending community. But I think it’s our belief that, that could normalize over the rest of the year and we would expect to see spreads at least stabilize and potentially get a little better. I think when we look at the originations we’ve made, we really like the risk adjusted returns that those new loans afford us and think they’re smart loans to make and feel very good about it.

But it’s something we have to watch as we consider just our ROE. But you can see that based on the results and the earnings power that the portfolio has, we’re still in very good shape and feel good throughout the rest of the year.

Bryce Rowe : Maybe one question on the income statement, dividends from the SLPs look to be a little bit larger, than you’ve seen here recently. Anything specifically going on and just trying to, trying to get a feel for, you know, how sustainable those dividend levels are?

John Kline: Sure. The SLP funds have been great for us over the last 10 years, and I really think that over the course of the last, you know, two to three years we’ve accumulated positions in really well performing loans that have very nice spreads. And I think we’re reaping the benefits of that right now. I think the SLPs will continue to produce great income for NMFC. It is possible that there’ll be a little bit of spread pressure on those funds. But as far as I can see over the next few quarters, I think the distribution yields from the SLPs will be very strong.

Bryce Rowe: Okay. Last one from me and not — just around the capital structure. You know, you’ve got some SBA debentures that are starting to approach maturity I guess in ‘25. Just curious how you’re thinking about the SBIC licenses that you have? Is there an opportunity to re-up and apply for a third or have you guys’ kind of out outrun those SBIC licenses and expect them just to level off here?

John Kline: Sure. So I think the SBA program has been a really great program for us for a long period of time. SBA-1 has done very well, but as you mentioned, it is heading towards maturity. Right now, our mindset is to try to replace that with a third license. But we don’t have anything to report with regard to achieving that third license. And so that, that’s sort of where things stand. So we’re very aware of the March ‘25 first maturity and of course we still have SBA-2, which has longer maturity. So generally, we feel really good about the SBA program, and we’ve been able to populate it with good conforming loans. I guess I’d also note that we have some other debt that’s coming due over the next year or so, that is actually at much higher rate. So there could potentially be an opportunity, depending on what the overall rate environment looks like. There could be an opportunity to refinance those at attractive rates.

Operator: Our next question comes from Finian O’Shea of Wells Fargo.

Finian O’Shea: Hey, everyone. Good morning. Could we go back to the commentary on the potential incentive fee waivers? Appreciate that, of course, but gleaning out the remarks, it sounded like this is for a specific period or maybe insuring against a specific ROE headwind factor for a specific period. Can you outline that again? Like what for, you know, for how long and again is it for spreads or whatnot? What you anticipate the headwind might be and for how long?

John Kline: Sure. So thanks for that question. We’ve had this program for a while. The whole intent of the program is to provide our investors with great confidence that if for any reason our earnings dip below the $0.32 base dividend, that we will support it through waiving incentive fee and applying those dollars back to the company such that we meet — we make sure that the NII is covering our dividend. And I think that’s really powerful and I think it gives a lot of our stakeholders a lot of comfort that even if NII does ever dip below $0.32, that they can feel good about their $0.32 dividend. That’s a really powerful thing. It’s been in place for a while. We haven’t talked about it may be quite as much because, the NII has been so high.

It’s still meaningfully above — our NII is still meaningfully above the $0.32. But we just want to have investors just continue to keep that in mind. It’s set to expire at the end of this year. Although my expectation would be that we’ll talk to our Board in very short order to extend that. It’s a program that we feel very strongly about and again, I think a lot of our shareholders really like it.

Finian O’Shea: Absolutely. That would include, like, what’s going through my head sort of is if base rates relapse, New Mountain and many other BDCs, of course, would probably be facing dividend cuts. So would it — in that sort of new environment that may eventually come, would it still apply then?

John Kline : Yes, the way we’ve done it in the past is we’ve always set the Dividend Protection Program to be absolute over a certain period of time. And so, my mindset would be to talk to our Board about extending it for one to two years. And then if it’s in place, we would live up to that Dividend Protection Program pledge. So that’s our mindset. I think we show — in our deck, we do show sensitivities around what happens at different base rates. And of course, there are different things that if in a lower base rate environment, there’s some positive changes that can occur as well. For example, on the previous question I mentioned the fact that we have some pretty high-cost debt maturing in ‘25. So if base weights rates, for example, were to plummet into ‘25, we would lose yield on our assets.