Q2 2022 New Mountain Finance Corp Earnings Call
widening credit spreads in the market.
The regular dividend for Q3 2022 was again set at 30 cents per share based on estimated net investment income of at least 30 cents per share. This represents an annualized dividend yield of 9%.
As we discussed on previous earnings calls, risk controls and downside protection have always been part of New Mountain's founding mission.
Our firm as a whole now manages over $37 billion in total assets with a team of approximately 215 people.
We have never had a bankruptcy or missed an interest payment in the history of our private equity work.
We have applied that same team strength and focus on downside protection to NMFC and our credit efforts.
The great bulk of NMFC's loans are in acyclical sectors with secular tailwinds.
such as enterprise software, tech-enabled business services, and healthcare services and technology.
These are the types of defensive growth industries that we think are the right ones in all times.
and particularly attractive in the more challenging macro environment we are in today.
We believe our portfolio continues to be well positioned due to this defensive growth investment strategy, as is evidenced by an average net default loss of effectively zero since we began our credit operation in 2008.
Our portfolio company risk ratings have improved again since our last earnings call despite the addition of two small positions to our non-accrual list this quarter. Over 90% of our portfolio is now rated green and our riskiest positions continue to be reduced.
Lastly, I want to remind you that although we have not had to use it, we have not had to use it.
Our dividend protection program remains in place to the extent earnings ever fall below 30 cents per share which we do not currently expect.
Rising interest rates will continue to positively impact our earnings power, as the team will explain on this call.
Together, New Mountain professionals have invested over $700 million dollars personally into NMFC and New Mountain's credit activities.
I and management remain as NMFC's largest shareholders, and we continue to add to our positions in the most recent quarter.
With that, let me turn the call back to Rob.
Thank you, Steve.
We believe our portfolio continues to be very well positioned overall, particularly for periods of macroeconomic volatility.
The updated heat maps show the positive risk migration this quarter as summarized on page 9, with five positions representing $185 million of fair value improving in rating.
and three positions representing just $25 million worsening in rate.
As Steve mentioned, we are pleased that over 90% of our portfolio is now rated green on our risk rating scale. Conversely, our red and orange names are rated green on our risk rating scale.
which represent our most challenged position, now represent the 3.4% of the portfolio, meaningfully down from 8.4% last quarter.
Starting with the positive movers on page 10.
Four of our formerly orange names migrated positively this quarter.
Integro, an insurance and benefits business, improved to green after a publicly traded insurance broker signed a definitive agreement to acquire the business for a valuation that fully clears the first leaning debt, which represents over 85% of all positions, and likely covers at least the majority of the second leaning debt, depending on an earnout and equity performance of the acquirer. The next question Why
We felt it was prudent to place a portion of our $10 million second lien position on non-accrual to reflect the uncertainty of full collectability of the PIC interest. However, we believe the overall credit risk of our exposure has been reduced due to the finding of the transaction.
Haven, formerly known as Pennawa,
which as a reminder, ceased operations at its plant on April 14th, due to a fire migrated from orange to yellow as we further our work with insurance providers to assess coverage amounts and payout payments.
The company already received an interim payment from the insurance carriers in late July .
Permian and the distribution and logistics business also include some orange to yellow as a result stronger operating environment for both companies.
Lastly, the hospitality management business improves again from yellow to green as the impact of COVID on the travel industry further recedes.
The three negative movers are all relatively small positions and include NHME, which we placed on non-accrual this quarter due to continued top line and inflation headwinds, a specialty chemicals business, which has experienced supply chain and inflation challenges, and a business product firm that is faced with idiosyncratic demand headwinds.
combined with supply chain issues.
The updated heat map is shown on page 11.
As you can see, given our portfolio's strong bias towards defensive sectors like software, business services, and healthcare, we believe the vast majority of our assets are well positioned to continue to perform no matter how the economic landscape develops.
We continue to spend significant time and energy on our remaining red and orange names, which now represent just 2.4% of our portfolio at fair value.
We are pleased with the continued positive migration in several possible moons this quarter.
Case 12 is a view of our credit performance based on underlying portfolio company leverage relative to LPME Bata and shaded to the corresponding color of the heat map.
As you can see, the vast majority of our green-rated positions have shown results that are very consistent with our underwriting projections.
exhibiting either very minor leverage increases or in many cases leverage decreases.
on the lower right side of the page.
we show a group of nine companies that have more than two and a half tons of negative leverage the majority of which correspond to our yellow orange and red rated mean
These companies represent a small portion of our portfolio that have underperformed partially due to adverse conditions caused by the volatility in certain parts of the economy.
From a liquidity perspective, we believe that most of these companies have adequate resources
to proceed their business plan and have reasonable prospects for improved performance.
With that, I will turn it over to John to discuss market conditions and other important performance metrics. Thank you for joining us today.
Thanks, Rob. Good morning, everyone.
Since our last call in May, the overall investing environment across most asset classes has continued to be challenging.
We have seen higher interest rates, inflation, geopolitical instability, and now tangible evidence of economic softness in certain areas of the economy.
Through this period, corporate direct lending continues to be one of the most resilient asset classes across all financial markets.
Floating base rates, attractive spreads, secure debt structures, and low loan-to-value ratios have provided investors with valuable stability in an otherwise difficult investing environment.
Additionally, our strategy of making loans to non-cyclical defensive businesses provides added margin of safety compared to that of the overall lending market.
While new deal activity remains materially lower than the latter half of 2021, we continue to see compelling investment opportunities in a market where spreads are at least 100 basis points wider than they were at the beginning of the year.
The deal structures of most new direct loan investments remain attractive with sponsor equity contributions consistently in the 60 to 80 percent range.
Finally, it is important to highlight that the overall direct lending market continues to take meaningful share from the syndicated loan and high yield bond asset classes.
as our private financing solutions offer an ease of execution, price clarity, and capital certainty that is not currently available in these other markets.
offer an ease of execution, price clarity, and capital certainty that is not currently available in these other markets.
Page 14 represents an interest rate analysis that provides insight into the positive effect of increasing base rates on NMFC's earnings.
As a reminder, the NMFC loan portfolio is 89% floating rate and 11% fixed rate, while our liabilities are 54% fixed rate and 46% floating rate.
Given this capital structure mix, we are long LIBOR and thus have material positive exposure to increasing rates.
During Q2, three month LIBOR increased from about 1% on April 1st.
to about 2.3% on June 30th.
It is worth noting that many of our borrowers locked in LIBOR early in the second quarter at lower rates while our floating rate liabilities continue to reset throughout the quarter.
Given these circumstances, base rates were not a tailwind during the second quarter.
However, as our loans reset at current base rates, the portfolio yield will begin to improve.
While each of our borrowers have slightly different timing for rate resets and make slightly different choices regarding the duration of their LIBOR or SOFR contracts, we think it's valuable to provide a rough sensitivity around the earnings power of the portfolio at various static base rates.
For example, on a go-forward basis, if base rate settings average 2%, NMSE's annual net investment income will increase by 4 cents per share, all other variables being equal.
At 3% LIBOR, NMST's run rate earnings power would be approximately 11% higher, representing an incremental 14 cents per share.
Meanwhile, given the presence of LIBOR floors on our assets, which average 89 basis points, the NII downside, if rates decline, remains limited.
This positive interest rate optionality continues to offer our shareholders material potential return enhancement and provides an attractive hedge against rising rates and general inflation.
Turning to page 15, we present more detail behind the 14-cent
per share decline in our book value this quarter.
Starting on the left side of the page, we show that credit-driven fair value changes
resulted in a net NAV increase of 13 cents per share from Q1 to Q2.
This net increase was supported by positive credit catalysts for Haven and Integro and good underlying performance at Unitech, Permian, and Adventum.
Our remaining portfolio experienced 27 cents per share of depreciation.
the vast majority of which is represented by write-downs associated with general spread widening in the overall credit market.
Page 16 addresses NMSE's long-term credit performance since its inception.
On the left side of the page, we show the current state of the portfolio, where we have 3.3 billion of investments at fair value, with 45 million, or less than 1.5% of our portfolio currently on non-accrual.
As mentioned earlier, we did put both NHME and a portion of Integro-Second Lean on non-accrual, which represent only 10.9 million, or 0.3%, of our current book value.
NMFC's cumulative credit performance, shown on the right side of the page, remains strong.
Since our inception in 2008, we have made $9.6 billion of total investments, of which only $306 million have been placed on non-accrual.
Of the non-accruals, only 79 million have become realized losses over the course of our 13-plus year history.
As shown on the next page, default losses have been more than offset by realized gains elsewhere in the portfolio.
The chart on page 17 tracks the company's overall economic performance since its IPO in 2011.
As you can see at the top of the page, since our initial listing, MFC has paid $992 million of regular dividends to our shareholders, which have been fully supported by $1 billion of net investment income.
On the lower half of the page, we focus on below the line items, where we show that since inception highlighted in blue, we have a cumulative net realized gain of $17.2 million.
which is an approximately $15 million improvement compared to last quarter as a result of certain opportunistic sales in our net lease portfolio that we disclosed last quarter.
This cumulative realized gain is offset by 49.5 million of cumulative unrealized depreciation on our portfolio, which increased this quarter by about $30 million.
due primarily to general mark to market declines associated with widening risk spreads in the general market.
On the bottom right, in yellow, we show the cumulative net realized and unrealized loss stands at just 32 million dollars.
which remains a tiny fraction of the $1 billion of NII that we have generated since our IPO.
As we look forward, our team remains very focused on reversing the small cumulative loss and maintaining best-in-class credit quality throughout the portfolio.
Page 18 shows a stock chart detailing NMFC's equity returns since its IPO over 11 years ago.
Over this period, NMFC has generated a compound annual return of 10.2%, which represents a very strong cash flow-oriented return in an environment where risk-free rates have averaged less than 1%.
This year, NMFC's performance has compared favorably to most equity indexes and has materially exceeded that of the high-yield index as well as the index of BDC peers that have been public at least as long as we have.
I will now turn the call over to our COO, Laura Holson, to discuss more details.
on our recent originations and current portfolio construction.
Thanks, John . As shown on page 19, we originated over $220 million in Q2 in our core defensive growth verticals, including enterprise software, healthcare services and technology, and business services.
We primarily funded these originations with repayments and a modest amount of sales.
keeping us fully invested and at the high end of our target leverage range.
We continue to have great success targeting and sourcing high quality deals within niches of the economy where we have the highest conviction.
Since quarter end, overall deal activity has been steady, but more borrowers continue to migrate to the direct lending market as the syndicated market remains somewhat closed to new issue.
As always, we remain extremely selective on credit and are focusing on the highest quality opportunities in a widening opportunity set.
We expect to remain fully invested in our target leverage range as our deal flow absorbs any proceeds from ordinary course loan repayments as well as any incremental capital raised through our ATM program.
Turning to page 20, we show that our asset mix is consistent with prior quarters. We're slightly more than two-thirds of our investments, inclusive of first lien, SLPs, and net lease are senior in nature.
Approximately 7% of the portfolio is comprised of our equity positions, the largest of which are shown on the right side of the page.
Assuming solid operating performance and a supportive valuation environment, we believe these equity positions could continue to increase in value and drive book value appreciation.
We hope to monetize certain of these equity positions in the medium term and rotate those dollars into yielding assets.
Page 21 shows that the average yield of NMFC's portfolio increased from 9.8% in Q1 to 10.3% for Q2, largely due to the benefit of the increasing forward LIBOR curve.
Post quarter end, we've seen spreads widen approximately 75 basis points as well as higher fees for direct lending opportunities, which help support our net investment income target.
Turning to page 22, we show detailed breakouts of NMFC's industry exposure.
The center pie chart shows overall industry exposure. The surrounding pie charts give more insight into the significant diversity within our software, services, and healthcare sectors.
We believe these sectors are well positioned in an inflationary environment given the pricing power and margin profile that comes along with the largely tech and services nature of these industries.
The sectors we focus on have innately attractive cash flow characteristics such as high EBITDA margins, minimal CAPx and working capital needs, and flexible cost structures.
As a result, as interest rates rise, we believe most of our borrowers have sufficient free cash flow to cover the increasing interest burden.
We have successfully avoided nearly all of the most troubled industries, while maintaining high exposure to the most defensive sectors within the U.S. economy.
that we believe can perform well in more volatile macro environments.
Finally, as illustrated on page 23, we have a diversified portfolio.
Our largest single obligor, Edmentum, now represents 4.4% of fair value as the company continues to appreciate in value due to the strong underlying business performance and secular tailwinds in the education technology space.
The top 15 investments, inclusive of our SLP funds, account for 37% of total fair value.
With that I will now turn it over to our CFO , Sharaz Kaji to discuss the financial statements. Sharaz.
Thank you, Laura. For more details on our financial results and today's commentary, please refer to the form 10Q that was filed last evening with the SEC.
Now I'd like to turn your attention to slide 24. Portfolio had over $3.3 billion in investments at fair value at June 30th and total assets at $3.4 billion.
with total liabilities of $2.1 billion, of which total statutory debt outstanding was $1.7 billion, excluding $300 million of drawn SBA-guaranteed debentures.
Net asset value of $1.4 billion or $13.42 per share was down 14 cents or 1% from the prior quarter.
At quarter end, our statutory debt-to-equity ratio was 1.27 to 1. However, net of available cash on the balance sheet net leverage is 1.25 to 1 within our target leverage range.
Slide 25, we show historical leverage ratios and our historical NAV adjusted for the cumulative impact of special dividends.
Consistent with our goal of minimizing credit losses and maintaining a stable book value over the long term, you will see that current NAV adjusted for special dividends is in line with NAV from our IPO over 11 years ago.
Slide 26, we show quarterly income statement results.
We believe that our NII is the most appropriate measure of our quarterly performance.
The slide highlights.
While realized and unrealized gains and losses can be volatile below the line, we continue to generate stable net investment income above the line.
For the current quarter, we earn total investment income of $72.8 million, a $4.2 million increase from the prior quarter.
This was due to higher interest income from initial base rate resets and higher fee income in the quarter.
Total net expenses were approximately $41.4 million, a $2.4 million increase quarter over quarter, due primarily to higher costs and offloading rate debt.
As discussed, the investment advisor is committed to a management fee of 1.25% for the 2022 and 2023 calendar years.
We have also pledged to reduce our incentive fee if and as needed during this period to fully support the 30 cent per share 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.
This results in quarterly NII of $31.4 million, or 31 cents per weighted average share, which exceeded our Q2 regular dividend of 30 cents per share.
As a result of the net unrealized depreciation in the quarter, with an increase in net assets resulting from operations of $15.8 million.
Slide 27 demonstrates 90% of our total investment income is recurring in nature.
We believe this consistency shows the stability and predictability of our investment income.
Turning to slide 28, the red line shows our dividend coverage.
While NII exceeded our Q2 dividend, the Dividend Protection Program could have provided additional coverage if needed.
Based on preliminary estimates, we expect our Q3 NII will be at least
Given that, our Board of Directors has declared a Q3 dividend of 30 cents per share, which will be paid on September 30 to hold us a record on September 16.
On slide 29, we have our various financing sources.
Taking into account SBA-guaranteed benches, we had over $2.3 billion of total borrowing capacity at quarter-end, with over $330 million available on our revolving lines subject to borrowing-based limitations.
As a reminder, both our Wells Fargo and Deutsche Bank Card facilities covenants are generally tied to the performance, the operating performance of the underlying businesses that we lend to rather than the marks of our investments at any given time.
Finally, on slide 30, we show our leverage maturity schedule. As we've diversified our debt issuance, we have been successful at laddering our maturities to better manage liquidity and over 75% of our debt matures after 2025.
Our $55 million 2022 maturity was repaid on July 15th.
Furthermore, our multiple investment-grade credit ratings provide us access to various unsecured debt markets that we continue to explore to further ladder our maturities in the most cost-efficient manner.
With that, I would like to turn the call back over to Rob.
Thanks, Shiraz.
In closing, we are optimistic about the prospects for NMFC in the months and years ahead. Our longstanding focus on lending to defensive growth businesses supported by strong sponsors should continue to serve us well.
We once again thank you for your continuing support and interest, wish you all good health, and look forward to maintaining an open and transparent dialogue with all of our stakeholders in the days ahead.
I will now turn things back to the operators to begin Q&A.
Operator?
Thank you. If you'd like to ask a question, please press start followed by 1 on your telephone keypad.
If for any reason you'd like to remove your question, please press start followed by 2. Again, to ask your question it is start followed by 1. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking a question.
So our first question comes from the line of Jordan Wafum of Wells Fargo. Your line is now open, please go ahead.
Just a question on Admentum. Obviously you guys have chosen to hold onto this one and you've added more over time. The results have been pretty impressive with some capital gains. How are you guys thinking about that asset today and is there a point at which it becomes too big as a percentage of the portfolio where it becomes something that you feel like you have to move rather than something that's just nice to have?
Yeah, hey Jordan. So, fortunately, Admentum has become as big as it has for a good reason, right, as the value has just grown so significantly. And also, we've taken a fair amount of cash off the table on Admentum as we've sold down our position there. You may recall, at one point, we owned over 40% of the company.
and through a series of sales, we now own closer to 10% of the company. And so it's just that the enterprise value of the company has continued to grow so strongly that that's reflected despite the decreasing ownership percentage, the valuation continues to rise. All that said, you know, I can't speak to exact specifics. It's certainly our intention to broadly...
monetize the equity portfolio over time. Admentum's obviously a critical part of that. And I think, you know, there's certainly a reasonable chance that we'd see, you know, Admentum monetized in the quarters to come. Obviously, no guarantees there, but that is certainly a real possibility. Okay, thank you. And we noticed the new pick preferred you have.
we expect our sponsor clients to be very active in the market.
Generally, as I mentioned, the pricing for loans has gotten much more attractive, which is great. Structures are better, equity contributions are big. And as you can see, we've been participating mostly on the Unitronch side, but selectively down the capital structure on PIC preferreds. And I think that's going to continue over the course of this year and next. Unitronch will be our bread and butter, but when we see just really great, compelling situations where we can buy a...
And also a.
There's a new question registered from Ryan Grinch of KBW. Your line is now open. Please go ahead.
Hey, good morning.
First question, well, I also actually just wanted to first get a compliment on the slide deck. A ton of, I think, helpful information both on the movements of some of the stressed investments, you know, improvements and declines. Very helpful. And then also slide 15 actually showing the movement to NAV related to credit versus the NAV movements related to broad race spread.
Movements was incredibly helpful. So it's really well done with the slide deck. My first question though, I wanted to talk about, you gave some commentary on movements from interest rates and it's kind of broad-based commentary. I was wondering if you guys had run any sort of analysis, you may or may not have, but on what you guys expect the potential impact for rising rates.
For the third quarter just because rates, you know, they're moving so quickly Recently and they reset kind of on this lag And so as you mentioned rates were very high in the second quarter but but you and most PDCs haven't really gotten much of a benefit from that because they're they're They're kind of resetting on this lag And so I wonder if you guys have done an analysis of of the potential impacts For rising rates as they reset at the beginning of the third quarter what you expect
John , you touched on that a little bit. Do you want to give a little more detail on that?
Sure, it's something that we're constantly looking at and as I tried to allude to Ryan, it's a little bit of a, it's constantly moving because when we think about all the different floating rate exposures we have, our liabilities, in some cases we'll move every day where we get a reset every day to whatever the day one month live or is. Different facilities are slightly different with regards to the resets. And then on the asset side, while companies tend to cluster at
To be a real tailwind for us and something that every month that we re, evaluate and look at and and I can just tell you it is very positive. It's just difficult to put a precise number of cents per share. Just given some of the movements that I tried to articulate, but it is it is positive. And as long as LIBOR goes up. Our companies are going to be our assets, our loans are going to be forced to to reset at those higher rates, which is a good thing just given our, our asset liability mix that we discussed on page 14.
That's fair enough. I understand it's a complicated and kind of fluid situation, but I appreciate the commentary. You gave a lot of comments on kind of the broader environment for deploying and lending money, which is very consistent with what we've heard other direct lenders talk about how it's certainly become more favorable from a lending standpoint. I'm just curious.
You guys have this equity co-investment program that you guys announced a while ago. Does this environment, which has become certainly more lender friendly, but I would also assume purchase price multiples are also lower, which could theoretically mean it's a decent time to be making some equity investments. I'm just curious, in this current environment, do you see any sort of changes in your appetite to participate in the equity co-investments more or less than...
And we'll always do it in small dollars. I do think our goal of building a really high-graded portfolio of equity co-invests to further build book value over the long term is still very much on topic for us. And I would expect to see, you know, selective additions to that program in the quarters ahead.
But I don't think, Ryan, we're trying to make a call and say, oh, gosh, the lows are in, or no, we're going to wait because we think the lows will be six months. I think it's really more idiosyncratic from the bottom up. When we see something that really fits well with the program, we'll add that. That said, we are seeing some very interesting things. I would expect to see a couple of additions in the next couple of quarters.
So nothing really accelerating or decelerating from the broader market. It's just more balanced up.
today.
The other question I had and it looks like your guys' core income has come a long way from you guys implementing sort of those willingness to do those potential fee waivers of incentive fees. It looks like over the next couple of quarters given the trajectory of interest rates, of course things could change. I would think you guys are going to have pretty meaningful dividend coverage and actually over earning the dividend. I'm just curious.
Do you guys have, can you remind me of what is the stated policy that you guys choose to set the dividend at? Would you guys... A question... Yeah!
Is there a policy that you guys are fine, you know, meaningfully over earning the dividend and potentially growing a little bit of book value a quarter if you guys do have core earnings well above the dividend or would you guys ever anticipate either raising the dividend or paying out that extra earnings in the form of like some sort of supplemental dividend which you've seen some other BBC just trying to get a sense because I think we could be approaching a new territory that we haven't seen a while where there could be some meaningful things. So with that, I think that's it for today.
percent and therefore we're going to you know over earn the dividend for the next ten years by X we would we would consider raising the dividends that to match that you know the problem of course is you know we don't know what interest rates are going to be in 18 months or two years it's obviously a very volatile thing so so while you know I want I don't want to say we've never raised a dividend you know at some point that could happen I think our our median term plan is is probably to over earn
potentially either book, build book value and or over distribute in the form of special, but continuously reevaluate. And if we feel we've gotten to a new plateau that is consistent in all, in virtually all cases, then we agree evaluate. But I think what we don't want to do is raise and then cut because the Fed reverses direction 18 months from now. pentruED,
library back at, you know, or so forth back at 50 basis points. So that's the tension we're navigating against. But I do think, Ryan, philosophically, yes, we want to distribute you know, our NIR in a wholesome way. And we do feel good about having a little more cushion for sure.
Yes, I think that makes a ton of sense. You certainly don't want to get over your schemes and really just dependent on, you know, with a broader market and the Fed does with rates in order for you to earn the dividends of that, that makes sense. That's all for me today. I appreciate the time.
Great, thank you Ryan, to share your interest.
Thank you. As there are no further questions, registered this time I'd like to turn the call back over to Robert for Clasier remarks.
Thank you, operator. Well, thank you, everyone. As always, we appreciate the time and the interest, and again, we're always here to talk to and we look forward to communicating again next quarter and into the months ahead, and I hope everyone has a great end of the summer.
Thank you.
Thank you. Ladies and gentlemen, that now concludes today's New Mountain Finance Corporation earnings call. I'd like to wish you a great day ahead. You may now disconnect your lines.
So.