Q1 2020 Earnings Call

Thursday Thursday, good morning, and welcome to the new Mountain Finance Corporation first quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialist by pressing the star key followed by zero after today's presentation. There will be an opportunity to ask questions to ask you a question. You may press * then one on your telephone keypad to withdraw your question, please press * then two.

Please note. This event is being recorded. I would now like to turn the conference over to Rob Hamley, please go ahead.

Thank you and good morning everyone and welcome to New Mountain Finance Corporation. First quarter earnings call for 20 20 on the line with me here today are Steve Quincy Home chairman of nfb and CEO of new Mountain Capital Don Kleine president and CEO of NSC and Shiraz catchy CFO of NXT month before diving into the business update. We do want to recognize that we are living in a Public Health crisis that is taking a significant human call on our community across country and around the globe. We hope that everyone is saying say and that you and your families remain in good health turning to business sequence e is going to make some introductory remarks, but before he does I'd like to ask the Shiraz to make some important statements regarding today's call.

Thanks a lot of good morning everyone before we get into the presentation. I would like to advise everyone to today's call and webcast are being recorded. Please note that they are the home of new Mountain Finance Corporation and any unauthorized broadcasts in any form is strictly prohibited information about the audio replay of this call is available in our May 6th earnings address, please

I would also like to call your attention to the customary Safe Harbor disclosure, you know, press release and on page two of the slide presentation regarding forward-looking statements today's conference call in web page may include forward-looking statements and projections and would ask that you refer to our most recent filings with the SEC. So important factors that could cause actual results to differ materially from those statements and projections month. We do not undertake to update forward-looking statements or projections. Unless required to Bi-Lo.

cocaine copies, how latest

D filings and to access the slide presentation that we will be referencing throughout this call. Please visit our website at ww.w amount and finance.

At this time, I'd like to turn the call over to Steve krinsky and I'm actually chairman will give some highlights beginning on page four slide presentation Steve.

Thanks your eyes. It's great to be able to speak to all of you today as both the manager of NFC and as a fellow shareholder.

The code that pandemic has caused a great crisis for the nation both the human and economic terms. I want to First Express all of our hopes that you and your own families are safe on a second. I want to summarize the overview charts on page four or five and six to explain how nmfc itself is working to stay safe and secure throughout this.

As a bit of personal background my own career began at Goldman Sachs in 1981 and has included the 1987 crash the recession of nineteen eighty-five the 1990 fall of Drexel and the junk bond crash the Russian Nation crashes of the 1990s the first internet crash and mm mm the 2008 Great Recession and now this Copa crisis given these experiences new Mountain as an organization has always sought to explicitly emphasized downside safety and risk control as well as upside returns and therefore has explicitly emphasized defensive growth industries that can best survive unexpected. Knock it down terms.

New Mountain Started With Private Equity twenty years ago and now manages over twenty billion dollars of assets including both private equity and credit risk control was part of life. I found ignition happily. We have never had a PE portfolio Company bankruptcy or missed an interest payment in the history of our private Equity effort. Similarly, as of December Thirty One two thousand and nineteen. We had only $43 million of realized bought losses or just a 0.4% loss rate on the more than eight billion dollars of table that we have bought since beginning our credit arm in 2008. Meanwhile, we have had significant gains both in private equity and credit and I'm FC has paid $752 million of total cash dividend since and went public in 2011 or about $12.67 dividends per share in all.

As investment managers are General belief is that the greatest mistakes in private Equity our credit come when the industry melts Beneath You For example along to a toy store in the mall fighting Amazon may not be salvageable. However, a loan to a company that provides a necessary service in a high-quality way such as the the quality of, tree or dental practice is in a position to recover. It is even better positioned. If a top-quality PE sponsor has tens of millions or even hundreds of millions of equity dollars in the capital structure beneath us.

I believe nmfc was.

Built with the fence of growth industries and risk control in mind long before covid-19.

About 12% of the portfolio is currently heavily impacted by covid-19 home close Downs. However, these cheaply consists of dental Dermatology and I care practices which we believe are ultimately necessary Services position to recover as the country reopens.

The great bulk of these loans are in areas that might best be described as repetitive Tech enabled business services such as enterprise software are companies often have a large installed client basis of repeat users who depend on their service day in and day out. These are the types of defensive growth industries that we think are the right ones and all time and particularly attractive in difficult times with that background. Let me turn to slide five and the specifics of this earning report.

That investment income for the first quarter of 2020 ending march Thirty $1.20 was thirty-five cents per share exceeding our dividend of $34 per share and at the high end of our guidance of $0.33 to $0.35 per share.

Every one of our borrowers paid their cash interest for q1 2020 only two assets have been placed on non-accrual both of which are junior tranches of previously wage structure positions. Only one additional asset is currently anticipated to be placed on non-accrual 420.

The regular Q 12020 dividend of $0.34 per share was paid in cash on March 27th 2020.

Our March $31 net asset value is $11.14 per share a decrease of $2.12 per share from the December 2019 nav of $13.26 per share. Notably the change in Book value was primarily driven by interest rate movements and Company valuations in the economy overall and not by underlying credit problems in the portfolio itself.

The regular dividend 420 was set at thirty cents per share based on estimated net investment income of $0.27 to $0.31 per share wage will be payable on June Thirty $20.20 to Holders of record as of June 16th, 2020. The majority of the change in quarterly income is expected to be driven by the deleveraging of NFC Zone balance sheet by lower transaction fee income and by lower base interest rates for the economy, generally rather than by significant amount of rules.

and

He's liquidity position remains strong as we currently have approximately 130 million of cash and immediately available liquidity to handle future needs.

New Mountain as the manager has been highly supportive of NFC. We have provided a $50 million-dollar unsecured revolving credit facility to NFC may have purchased approximately eleven million dollars of nfc's common stock in the Reit at a premium to nfc's original cost.

We have also deferred both Q4 2019 and 220 management and incentive fee payments new Mountain has significant resources to further support including a strong balance sheet at new Mountain the manager itself. I and MSC management team continue to be the largest shareholder of the company with ownership of approximately 11% I feel a very deep personal commitment to nfc's long-term success as a Founder manager and shareholder.

in conclusion I had no way want to minimize the cobit crisis along with its tragic medical issues coping maybe the worst financial crisis I have seen in my career because the returns traditional day-to-day life is still so unpredictable with that said I remain proud of the work that our credit team did and carefully building a portfolio to withstand a crisis I remained home about internet feeds own competitive advantages and future prospects with that let me turn the call back to Rob him we CEO of NFC

Thank you. Steve Wilke quarterly highlights and our standard review of NFC are detailed on pages seven and eight respectively this quarter. I would like to focus my time on getting into more detail on the crisis's impact on asset quality net asset value and leverage migration liquidity and net investment income.

As detailed in page nine in order to assess how the crisis is impacting our borrowers and the last eight weeks. We have had extensive conversations with both company management and sponge based on those discussions. We have assigned each portfolio company scores on two metrics to generate an overall risk rating the first metric tons of exposure ranks from 1 to 4 the degree to which a company has been directly impacted by coding the second metric overall company strength is a combination of three sub metrics pre-performance liquidity and balance sheet strength and sponsor support which we rank on a scale of a to see

Based on our rankings for the two metrics and the resulting risk rating for each company. We then plotted the overall portfolio accordingly to create the risk rating heatmaps. You can find on pages ten and eleven.

The heat map chart out the Covetous posure on the x-axis ranging from least impacted on the left to the most impact on the right against the overall Comfort company strength on the y-axis ranging from highest quality at the bottom to the lowest quality of the top the circles represent the size of the exposure in that quadrant, which are coded to reflect the overall risk rate with green being the least risk followed by yellow orange and then red.

Both heatmap or for the 331 portfolio with the only difference being page ten utilizes 12/31 pricing to show our exposure pre-crisis off while page eleven used 331 prices to show our current exposures.

As you can see on page eleven over 90% of the portfolio is rated green or yellow and only 6% of the portfolio is red.

I'd like to get a little more detail on a few of the yellow orange and red quadrant.

Starting with three see you can see four of our previously restructured companies. We have discussed in the past and Menton Unity National Bank and PPA.

Well, each is only modestly impacted by covid-19 is in the prior restructuring. They by definition have weaker balance sheets and no remaining third party sponsorship. The other magery quadrant 1A is almost exclusively comprised of retail Healthcare specifically dental care. I care and dermatology practices. These offices are heavily impacted by covid-19 in the short and medium-term as many of their office locations are closed, but they all have solid balance sheets significant liquidity to an operating losses in debt service even in a very lengthy private driven shut down and well-capitalized sponsors behind them with very significant cash Equity Investments comprising of 50% of total capitalization.

Moving on to the more significant orange quadrant 1B, we find a similar story to one a in terms of primarily retail Healthcare exposure with the only significant difference being modestly less liquidity and balance sheet strength, but still enough to get through all but the most Draconian scenarios and still with a strong sponsorship behind them.

Finally in tier-one see in the upper right hand corner. We have our most impacted companies. Once again retail Healthcare is the largest exposure with two material or businesses representing ninety, six million of the $99 million total. We expect one of these to borrowers to go on partial non-accrual in Q2 and restructure.

Despite that giving new mountains expertise as a sponsor and dental and our access to talk to your operating and managerial talent and the expectation that even in a severe recession following the pandemic people will still want and need to get proper dental care. We believe there is reasonable potential for a full recovery in this investment.

Yep.

On retail Healthcare, the other two names in red are our Legacy previously restructured Energy Service name Permian and Sierra Hamilton the collapse and energy prices Palm Oil patch activity has significantly impacted these business models and we have decreased valuations accordingly one final point of the $239 million dollars with current life reading of orange and red all but fifteen million dollars are in first lien loans.

Page twelve attempts to describe what we believe is to a significant degree a temporary decline in net asset value driven largely by market spread movement and comparing a company valuation not underlying credit problems.

$99 or roughly half of the quarters net asset value decline is yield driven price movement in our green and yellow rated loan, which if our risk assessment is correct should recover over some period of time as the world normalizes even in our orange and red current pay Securities representing another thirty million dollars off potential energy recovery while risks are clearly elevated. We would expect the significant majority of those to continue to pay full interest and principal finally of the remaining roughly $75 million dollar value changed in previously and prospectively restructured securities. The both of the value change is in it mentions unitech and Company to get results remain while risk to remain for these businesses in this environment. There's also ample opportunity for Value recovery.

Page thirteen shows had a decline nav this quarter somewhat offset by a modest reduction in statutory debt as we took initial asset-sale actions beginning in March translate into what we believe to be a temporarily elevated leverage ratio, while future asset values are difficult to predict giving market-driven inputs into our valuation process. We are taking off will continue to take meaningful steps to get back down to our Target leverage ratio of 1.2 to 1.3 as soon as practical.

In terms of liquidity as you can see, I'm Pages 14 and 15. We currently have approximately 130 million dollars of cash and immediately available quiddity and based on visibly payment and net interest income less are expected to to Dividend that balance is expected to grow to approximately 150 million dollars by early July.

This liquidity is available to support the needs of the business going forward which primarily include one further unfunded revolver and delayed draw Term Loan draws, which have largely took it in recent weeks to incremental needs to support portfolio companies and three any need to support the borrowing base of our credit facility.

if needed

Have multiple ways to generate incremental liquidity in the weeks to come we maintain a healthy and transparent dialogue with the credit the credit rating agencies and our leverage providers who continued to be supportive partner 816 compares the debt outstanding on our three credit facilities with the fair market value of the assets that support these facilities with a sense of the credit enhancement embedded in each facility is further shows the risk rating percentages for the asset pools. And as you can see the underlying collateral is largely composed of Loans To What We believe to be strong companies that are expected to be only modestly impacted by code.

Walmart, first priority in this crisis has been to focus on our assets quiddity and leverage. We also want to continue to maximize net investment income or pre-owned know the Enterprise safety throughout the current prices. However long it may last.

Page Seventeen is a bridge from our q1 net investment income of $34 or $0.35 per share to our current preliminary estimate of $20,000 or $27.31 per share. You can see the largest decrease in nii is from prepayments and asset sales which we believe on a student in this period of uncertainty followed by lower projected income in an environment characterized by de minimis origination and repayment activities lower base rates off automatically decreased nii as to the current and anticipated non-accrual.

Well, the first three factors are likely to remain earnings headwinds during the length of the crisis. They should moderate and ultimately reverse and become Tailwinds whenever the environment begins to deal with that. I will turn it over to John Klein to discuss market conditions and other elements of the business John.

Thanks, Rob, covid-19 has dramatically changed the sub and investment-grade leveraged lending market after years of steady deal volume. We have experienced a virtual shutdown of sponge back by us.

Secondary trading levels have also declined reflecting an increase in stressed borrowers and higher risk premiums across the board while government stimulus optimism around her infection rates and line-of-sight towards partial reopening have caused material improvements in the market from the lowest levels and March many loans still trade at meaningful discounts to their issue prices. In fact over 35% of the loan Market is currently quoted below ninety cents on the dollar.

Notably for our portfolio loans to mission-critical recurring technology-enabled businesses have performed materially better than the broader Market the timing of new sponsorship deals remains highly uncertain and is predicated on decreases and infection rates and resumption of more normal business activity Across the Nation.

Turning to page. Nineteen. We show how potential changes in the base rate could impact nmsc future earnings, as you can see the vast majority of our assets are floating-rate loans with our liabilities evenly split between fixed and floating-rate instruments at 3:31. Libor was artificially High given the market dislocation off since then 3 month Libor has declined from 1.45% to .54% as of last Friday, which we expect to result in annual headwind approximately $0.03.

Given the presence of 1% live where floors on 73% of our floating-rate assets as well as our unplugged floating-rate borrowings. We don't expect earnings to be fairly impacted with Libor between 0 and 1% limiting further downside exposure to lower rates.

To the extent Libor increases above one. We are well positioned to benefit from rising rates.

Page twenty addresses historical credit performance on the left side of the page. We show the current state of the portfolio where we have about three billion dollars of investment at fair value pack $44 million of which are on non-accrual.

This quarter we had two additions to our non-accrual including a single tranche of unitech Junior pick preferred stock representing nineteen point five million up their values While most of the unit tax capital structure continues to perform the valuation of the company and no longer supports future accrual of quarterly dividends on this specific Security Office additionally our investment in Permian pick notes worth 2.8 million at fair value was also placed on non-accrual.

On the right side of the page we show cumulative credit performance which notably shows total realized default losses since infection of $74, which is $31 million dollar increase since last quarter and reflective of the impact of covid-19.

Page Twenty-One is a view of our credit Performance Based on underlying portfolio company and leverage relative to LTM ebitda while we feel this slide has been and will continue to be very useful for investor. It is too backward-looking to give real-time insights into the effects of covid-19 on our underlying portfolio companies. What it does show is that the majority of our thoughts entered the Health crisis either around or below closing leverage with a couple of notable exceptions.

the three names

Have more than 2 and 1/2 turns of negative leverage drift are the aforementioned Permian as well. As you know, Tech elementum both unitech internet and have been discussed on prior calls and a reasonably solid business models in the current covid environment.

The chart on page twenty-two tracks the company's overall economic performance since its IPO.

At the top of the page, we show that our net investment income has always covered our regular quarterly dividend on the lower half of the page. We focus on below-the-line items first wage realized gains and realized credit and other losses as you can see looking at the real highlighted in green. We've had success generating a real economic gains every year through a combination of equity gains portfolio company dividends and trading profits moving down the page the orange section of the chart shows an increase in realized losses of 32.3 million dollars, which relates to permanent realized losses on Permian and Seattle as a result of these new realized losses. We now have cumulative realized losses by life in blue of Thirteen million dollars. This is the first time since our IPO where we have more cumulative realized losses than cumulative realized games.

It is worth noting that over the long-term. We do expect to incur realized credit losses on our Investment Portfolio our goal as a management team is to limit realized losses check these losses only represent a small fraction of our cumulative net investment income.

Looking further down the page. We show a material impact from unrealized portfolio markdowns of $172 in q1 and cumulative on realized losses off of $249. We believe that most of the q1 mark-to-market loss is reflective of temporary market conditions and will recover in time.

Page twenty-three shows a stock chart detailing mfc's performance. And while the performance of our stock inclusive of our quarterly dividend has historically been a very strong compared to relevant benchmarks over the past two months and MSD has experienced an outsized downward move relative to the various index comparables as well as the dispatch index C. Have been public at least as long as we have

we break down this under performance on page twenty-four. We're on the right side of the page. We show the largest component of our under performance has been the $4 per share decline driven by the contraction of our book value multiple since our IPO.

Additionally as noted earlier, we had experienced a decline in the market to market value of our investments of $2.94 per share. Most of it relates to the impact from covid-19 on the positive side. The chart shows that cumulatively MFC has generated $12.67 per share in cash dividend payments supported by interest payments from our defense of growth-oriented lending portfolio.

page twenty-five provide provide a final look at the stock price performance compared to the individual stocks of our peers that have been public at least as long as we have

turning to our origination tracker on page twenty-six we highlight that before the cobit related shutdowns MFC experienced a relatively normal quarter with Club deal origination LF extension and portfolio company add-ons modestly outpacing sales and repayments representing a $23 portfolio expansion

on page twenty-seven we show that when the magnitude of the covid-19 crisis became apparent we pivoted from expansion of our investment book to a strategy of