Q3 2023 New Mountain Finance Corp Earnings Call
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Good morning, everyone and welcome to the New Mountain Finance Corporation third quarter 2023 earnings conference call.
All participants will be in listen only mode.
Should you need assistance. Please signal our conference specialist by pressing the Starkey followed by zero.
After todays presentation, there will be an opportunity to ask questions.
Please note this event is being recorded.
I would now like to turn the conference over to John Kline, President and CEO.
Oh, okay.
Thank you and good morning, everyone welcome to New Mountain Finance Corporation's third quarter 2023 earnings call.
On the line here with me today are Steve <unk>, Chairman of NMFC, and CEO of New Mountain capital and Laura Holsten, CLO and interim CFO of NMFC Steve.
Steve is going to make some introductory remarks, but before he does I'd like to ask Laura to make some important statements regarding today's call.
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 in our November 2nd earnings press release.
Also like to call your attention to the customary safe Harbor disclosure in our press release and on page two of the 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 are important factors that could cause actual results to differ materially from there.
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 we will be referencing throughout this call. Please visit our website at www Dot New Mountain finance Dot com at.
At this time I'd like to turn the call over to Steve Kaniewski, Nmfc's, Chairman, who will give some highlights beginning on page five of the slide presentation.
Thanks, Laura.
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 third quarter was 40 cents per share more than covering our 32 cents per share regular dividend that was paid in cash on September 29th.
Our earnings increased by eight cents compared to Q3 of last year and one sense sequentially over Q2 of this year.
Our net asset value per share decreased slightly to 13 O six and eight cent decline compared to last quarter demonstrating.
Demonstrating continued stable credit performance across our portfolio.
We believe our loans are well positioned overall in defensive growth industries that we think are right in all times, and particularly attractive and less certain economic times.
New mountain's private equity funds have never had a bankruptcy or missed an interest payment.
And the firm now manages over $45 billion of assets. Similarly, as shown on page 14 of this presentation.
Since inception over 12 years ago.
And I'm F. C has experienced net gains across all of its realized credit investments with only 89 million of unrealized depreciation on our books as of the end of Q3.
The higher rate environment continues to be a substantial positive for our quarterly earnings we.
We expect to continue to significantly outperform our 32 cents per share regular dividend at current interest rates. If all other factors are hold constant.
Given our earnings of <unk> 40 per share this quarter, we will make our third consecutive variable supplemental dividend payment.
The variable supplemental dividend for this quarter will be four cents per share, which is equal to half of the amount of our Q3 quarterly earnings in excess of our regular dividend of 32 cents.
This additional four cent dividend will raise the total dividend to 36 cents per share all in for this quarter, which is at the high end of our previous guidance.
NMFC will pay these distributions on December 29th to holders of record as of December 15th.
The remainder of the excess earnings will remain on our balance sheet and may be paid out in the future.
Our dividend at 36 cents represents an annualized current dividend yield of just under 12%.
Looking forward to Q4 in addition to our 32 send regular dividend, we expect to generate a variable supplemental dividend of three to four cents per share payable in the first quarter of 2024.
Incremental payout is supported by expected strong credit performance and continued elevated base rates.
We believe the strength of new mountain and of NMFC is driven by the quality of our team.
New Mountain overall now numbers 250 members and the firm has developed specialties and 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 nine months, we have continued to expand the quality of our overall team.
Finally, we as management continue as major shareholders of NMFC.
Senior management and employee share ownership has been rising over time, and we now own approximately 13% of Nmfc's total shares personally with that let me turn the call to John <unk>.
Steve Good morning again, everyone.
I would like to offer some more details on our direct lending investment strategy and track record.
Starting on page eight we highlight our disciplined industry selection.
Which shows.
Exposure to a diversified list of defensive non cyclical sectors.
These sectors and industry niches are characterized by durable growth drivers predictable revenue streams margin stability and great free cash flow conversion.
We have successfully avoided cyclical volatile and secretary challenged industries, which could be riskier areas to invest in today's higher rate environment.
Our strategy has been consistent over our 12 plus years as a public company and it allows us to operate with confidence in any economic environment.
Page nine provides a high level snapshot of our business, where we show a long term track record of delivering consistent enhanced yield by avoiding losses and distributing virtually all of our excess income to shareholders.
Since our IPO in 2011, and MFC has returned over $1 1 billion to shareholders through our dividend dividend program generating an annualized return of approximately 10%.
Our current portfolio is exposed to companies and good industries that are performing well and where our last dollar of risk is approximately 40% of the purchase price paid for the business.
We learned 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 ratings of our portfolio were relatively stable quarter over quarter with approximately 93% of our portfolio rated green.
Our most challenged names within the Orange and red categories represent only approximately 2% of NMFC as fair value.
And we have Derisked, our book by marking our Red names.
To 11% of face value in our orange names to 68% of face value.
At these valuation levels are weaker names do not represent material future downside risks risk to our book value.
The updated heat map has shown in its entirety on page 11, given our portfolio's orientation towards defensive sectors like software business services and health care. We believe our assets are well positioned to continue to perform no matter, how the economic landscape develops.
We did have two names representing only 1% of total fair value migrate negatively this quarter.
Both companies are experiencing short term operational headwinds, but we remain optimistic about the long term value proposition and and prospects for a full recovery on our first lien positions.
On the positive side, we are pleased to report the Eagle picture second lien, which was previously a yellow name marked at 70 cents was moved to green during the quarter.
And subsequently repaid at par in October.
Overall as we reflect on the prospects of our yellow names. We are optimistic that we may have more positive outcomes like this one in the future.
Turning to page 12, we provide a graphical analysis of any new changes during the quarter star.
Starting on the left credit specific movements represented a 20 cent decrease in book value driven by relatively minor equity markdowns, reflecting the more challenging valuation environment for mid cap companies.
Broad credit market movements were at eight book value tailwind as credit spreads tightened during Q3 due to the modest new issue supply.
And as Steve mentioned earlier, we over earned the regular and supplemental dividends by four cents per share, which accrued to our book value.
Combined these changes netted to an 8% decline in book value for the quarter.
It is important to note that if we were to value all of our green rated loans at par and continue to value the balance of the portfolio at current fair value. Our book value would be 13 50 compared to our actual NAV of 13 O six at 930.
Page 13 addresses Nmfc's nonaccrual performance on the left side of the page we show the current state of the portfolio, where we have $3 1 billion of investments at fair value with $48 million or one 5% of the portfolio currently on non accrual.
The number of companies on nonaccrual decreased this quarter as we moved Integra second lien back to accrual status due to our increased conviction of a full recovery in the next 12 months.
Of the name to remain on nonaccrual most are from older vintages had 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 NFC has made $9 2 billion of investments and cheap net gains on all realized positions of $15 million.
This is consistent with our value proposition.
Preserving principal value and distributing nearly all of our net investment income through predictable quarterly dividends.
Yeah.
On page 14, we present Nmfc's overall economic performance since IPO, showing that we have delivered consistent and compelling returns cube.
Cumulatively NMFC has earned $1 2 billion in net investment income will generate $15 million of cumulative net realized gains and only 89 million of net unrealized depreciation netting to over $1 1 billion of value created for our shareholders.
Page 15 shows a stock chart detailing nmfc's equity returns since IPO over this period NMFC has generated a compound annual return of approximately 10%, which represents a very strong cash flow oriented return well in excess of both high yield index and an index of BDC peers, who have.
Been public at least as long as we have.
I will now turn the call over to our Chief operating officer, and interim Chief Financial Officer, Laura Halston to discuss our current portfolio construction and financial results.
Thanks, John we continue to believe the outlook for the rest of 2023, and 2024 and the sponsor backed direct lending market and positive.
Deal flow continues to be down overall as valuation expectations reset in a world of higher base rates, but there are pockets of activity in our defensive growth verticals, where we have the opportunity to make loans at attractive yields while remaining very selective.
Deal structures remain compelling with leverage levels meaningfully 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, given the magnitude of dry powder for private equity and the ongoing need to return capital to Lps as well as the general maturity wall facing borrowers.
We saw a bit of a flurry of deal activity post labor day, including some opportunistic issuance, but it continues to be episodic at the moment.
Given our large portfolio of over 100 unique borrowers we continue to see good opportunities to make incremental loans to existing well performing portfolio companies seeking to pursue accretive M&A.
Despite lower overall deal volume the direct lending market remains the primary market for sponsors while the syndicated market has reopened it was practically only opened for select issuers with higher ratings.
Ongoing market volatility continues to push borrowers toward the more certain execution of a direct lending deal.
Page 17 presents an interest rate analysis. It provides insight into the positive effect of increasing base rates on Nmfc's earnings.
As a reminder, the NMFC loan portfolio is 88% floating rate and 12% fixed rate, while their liabilities are 50% fixed rate and 50% floating rate.
Moving on to page 18 in Q3, we continued our focus on modest deleveraging towards the middle of our one to 1.25 times debt to equity range.
Results outside of some modest C V gel jobs, we actually experienced net repayment activity and several borrowers repaid due to refinancings or M&A.
I'd highlight that two of the repayments were second lien positions whereby strong performance enables both companies to take out the second lien with incremental first lien.
Given the high base rate environment, the impact of my or deleveraging has not impeded our ability to significantly out earn our regular dividend.
As I discussed in the market overview, we continue to see compelling opportunities in post quarter end have received a few additional repayments that should provide some available capital for deployment into our highest conviction deals.
In addition to the $10 8 million dollar Eagle picture repayment that John mentioned, we also received a post quarter and repayment of our 67 and a half million dollar position and find it a dermatology practice management business.
Turning to page 19, we show that our asset mix is consistent with prior quarters. We're about two thirds of our investments inclusive of first lien SLP and net lease are senior in nature.
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 and the medium term and rotate those dollars into cash yielding assets.
Our net lease portfolio, while only 4% of the portfolio continues to be a strong performer and we thought it was worth a brief refresher on our strategy.
We enter into sale leaseback transactions for operationally critical properties with credit worthy tenants in our core defensive growth verticals.
Like the longer duration nature of the asset class the annual rent escalators as well on the downside protection associated with owning the physical real estate.
We've generated $41 million of realized gains to date and the strategy and a weighted average cash yield of approximately 11%.
Page 20 shows the current portfolio at a glance, we owned 70 operationally essential and geographically diversified properties, including manufacturing facilities pharmaceutical manufacturing and packaging facilities and warehouses that are leased to 13 tenants, we have no office or retail exposure.
Page 21 shows that the average yields of Nmfc's portfolio has increased from 11, 6% in Q2 to 11, 8% from Q3, primarily due to the higher for longer shift in the base rate curve.
Generally speaking spreads remain attractive and support our net investment income targets.
Page 22 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 a $147 million.
Well, we first and foremost concentrate on how an opportunity knocks against our defensive growth criteria and internal 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 been consistent over the last several quarters.
Loan to values continue to be quite compelling in the current portfolio has an average loan to value of 42%.
From an interest coverage perspective, we've continued to see modest compression as base rates rise.
Weighted average interest coverage on the portfolio declined slightly to one five times from one six times last quarter.
We expect interest coverage ratios to stabilize and note that we've seen sponsors continuing 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 that are able to attract additional investment at healthy evaluation.
Finally, as illustrated on page 23, we have a diversified portfolio across 110 portfolio companies.
The top 15 investments inclusive of our F. L. P funds and that lease account for about 42% of total fair value and represent our highest conviction names.
I will now cover our financial results for more details. Please refer to our quarterly report on Form 10-Q that was filed yesterday with the SEC.
As shown on slide 24, the portfolio had approximately $3 $1 billion in investments at fair value on September 30th and total assets of $3 $3 billion with total liabilities of $2 billion of which total statutory debt outstanding was $1 $6 billion, excluding $300 million of draw.
Non SBA guaranteed debentures.
Net asset value of $1 $3 billion or $13.06 per share was down slightly compared to the prior quarter.
At quarter end, our statutory debt to equity ratio was 121 times to one and 1.16 times net of available cash on the balance sheet consistent with the balance sheet deleveraging I mentioned previously.
On Slide 25, we show our quarterly income statement results.
So the current corner, we earned total investment income of $94 $1 million.
A 20% increase over prior year.
Total net expenses were approximately $53 $7 million, an 18% increase over prior year.
As a reminder, the investment advisor has committed to a management fee of 1.25% for the 'twenty to 'twenty, three and 'twenty four calendar years.
The investment advisor has also pledged to reduce its incentive fee if and as needed. During this period to fully support the 32 cents per share regular quarterly dividend.
It is important to note that the investment advisor cannot recoup fees previously waived.
Our adjusted NII for the quarter was 40 cents per weighted average share, which meaningfully exceeded our Q3 regular dividend of 32 cents per share.
As slide 26 demonstrates 99% of our total investment income is recurring this quarter given the minimal fees earned in Q3.
You'll see historically that over 90% of our quarterly income is recurring in nature and on average over 80% of our income is irregularly paid in cash.
We believe this consistency shows the stability and predictability of our investment income.
Importantly over 99% of our quarterly noncash income is generated from our green rated names.
Turning to slide 27, the Red line shows the coverage of our regular dividend.
This quarter adjusted NII exceeded our Q3 regular dividend by eight cents per share.
For Q4 2023, our board of Directors again declared a regular dividend of 32 cents per share as well as a supplemental dividend of four cents per share.
On slide 28, we highlight our various financing sources and diversified leverage profile.
Taking into account SBA guaranteed debentures, we had $2 $2 billion of total borrowing capacity at quarter end was $313 million available on our revolving lines subject to borrowing base limitations.
We have a valuable mix of fixed and floating rate debt and the 50% of fixed rate debt continues to be an earnings tailwind.
As a reminder, covenants under both of 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 29, we show our leverage maturity schedule.
As we've diversified our debt issuance, we've been successful at ladder, our maturities to manage liquidity.
Post quarter end, we have successfully amended both of our wells Fargo and Deutsche Bank credit facilities to extend maturities to 2028 and 2027, respectively.
Additionally, upsized and extended our management company revolvers maturity to 2027.
Pro forma for that over 60% of our debt matures in or after 2027.
Our multiple investment grade credit ratings provide us access to various unsecured debt markets and we continue to explore to further ladder, our maturities and the most cost efficient manner.
With that I would like to turn the call back over to John.
Thank you Laura as we look out over the balance of 2023, we remain confident in the quality of our investment portfolio and believe we are on track to continue to deliver great risk adjusted returns for our shareholders.
We once again, thank you for your support and look forward to maintaining an open and transparent dialogue with all of our stakeholders I will now turn things back to the operator to begin Q&A operator.
Yeah.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two.
At this time.
I'll ask momentarily to assemble our roster and again to enter the queue star one.
Yeah.
Our first question comes from Finian O'shea from Wells Fargo opinion. Please go ahead.
Thanks, everyone. Good morning.
Good morning.
How are you.
Can you expand on the advisor revolver upsize post quarter.
And how might that play into.
As the remaking of your capital structure, if it's applicable thank you.
Sure Yeah, So post quarter end, we Upsized, our management company revolver from 50 to 100 million and also extended maturity mm three years to December 27 from December 24, and it still remains a relatively small portion of our overall liability stack, but we do think.
You know, it's an important signal from just the commitment from you know from the investment advisor, but also just generally help support liquidity historically not you know not ever drawn on this facility, but again, it's good to have as just incremental liquidity and it was just part of I would say a series of things that we did.
Ed on the liability side post quarter end to try to just put out my push out maturities, which continues to be a big focus for us.
Right that's helpful and just to drill down a touch more as you pointed out you don't really use it.
So does the upsize indicate that you might use it or is it more of a show of support to.
You know for your other lending facilities that this is a sort of.
Supplemental liquidity you might need.
I view this somewhat as a show of force I mean, we have really strong relationships with all of our key providers and as Laura said, we extended many of those facilities. Just recently and you know as we as we get bigger and as we're in an uncertain environment.
Why wouldn't we try to maximize liquidity with you know with all available tools that we have so as always said, we don't expect it to use it but we just really wanted to show every avenue for liquidity and balance sheet strength, the strength that we could and the manager was worth more than happy to do that.
Okay, great. Thank you just a follow up you touched on the hub.
The fee waiver and your commentary I know that was the last quarter events the extension.
But we've seen more bdcs are going that way to sort of the $1 25.
Based fee rate.
So are your.
Discussions are leading to.
To keep it that way at the end of 'twenty four.
And if so why not sort of permanent is it.
So people can.
Of course model it.
With more confidence long term it gives you that that credit.
Just any.
Understanding this is still a private matter more or less but just.
Just color on how you were thinking about it would be helpful. Thank you.
Sure you know I I think I hope I think with a lot of investors, we do get credit for being at 1.25, we've been there for a while we've extended it.
No eight quarters, and a and I think it's fair to say that it is a topic of discussion, but when I think about our our base management fee and I know there's been some activity on base management fees around the industry I think we're still you.
Top quartile when we when you look at the base management fee. So we do feel good about where we're at where we're at we do have a track record of being shareholder friendly we'd been at 1245 for awhile that said, we're always going to maintain dialogue with our advisors and our board just around around around that fees and other.
Other aspects to.
Our management agreement.
Thanks, so much.
And our next question comes from Bryce Rowe from B Riley.
Please go ahead.
Thanks, a lot good morning.
Good morning Bryce.
Hey, John.
Let's see one or two.
Maybe maybe start on some of the origination activity and you know how it plays into repayment activity and how it plays into the.
The balance sheet leverage we talked about this last quarter.
But oh.
It feels like you're taking a slightly more conservative approach in terms of balance sheet leverage and we've seen it come down for a couple of quarters.
ROE now you just highlighted the repayment activity here subsequent to third quarter and so I guess the question is do you think we'll see that trend continue in terms of balance sheet leverage I'm kind of working lower and then as far as the activity for the third quarter.
Really muted origination activity is that is that kind of work with this this whole discussion around leverage or is it more just a kind of a view of all of the macro environment and what youre seeing in terms of investment opportunities.
Sure I'm happy to cover that so in terms of just the you know the deleveraging and kind of where we are and so we do have you know we continue to have our stated range of one to 1.25 times.
That's where we are comfortable operating within that range from a leverage perspective, but you know as we tried to highlight I think we are focused on trying to get more to the middle of that range. Because I think there had been several quarters in a row, where we had been at the very high end of that range and so just given the macro environment. We're in we thought it made sense to kind of come down.
A little bit more towards the middle of the range. So that that is what is reflected in our Q3 results here.
I think you know.
It's obviously hard to hard to predict it does bounce around a little bit depending on kind of repayments that we get them, but I think that the repayments that we received after quarter end I think we're comfortable redeploying those proceeds and continuing to operate kind of more in the middle of the leverage range.
So in terms of the Q3 originations yeah. They they definitely were more muted.
That was that was intentional I don't think it's necessarily reflective of the overall market you know as we have been you know continue to be.
Active in and see good opportunities in some other pockets of capital and we have them, but we did want to make that conscious decision to get a little bit more conservative from a leverage profile for.
For the for NMFC.
Kind of in the market commentary, we do continue to see some good opportunities, but you know, it's not as fast and furious as it might have been you know a couple of years ago, but we are still things almonds. So I do think we'll be able to redeploy some of those repayments that we received post quarter end some attractive opportunities.
That's good stuff. Thanks, Thanks, a lot.
And then one more for me John I think you highlighted.
The elevated name.
I'm getting getting repaid at par.
From a mark around 70 cents.
And you made the comment that there were prospects for possibly.
Possibly more yellow rated name is following that same path can you can you maybe speak to that.
And a little bit more detail.
Sure and I don't have any specific yellow names names as I'm looking at the list of yellow names I don't have any specific names that I know we're gonna repay.
But in general I wanted to make the point that just because the name is yellow it doesn't mean that it can't go back to Green now it doesn't mean that it's on a one way trip to red and when we look at our our yellow names. We do we do see names on that list that we do have some some pretty good optimism around there.
They're not yet performing the way we want them to perform.
But then as I mentioned I think there's a good chance that we could see some good outcomes. So every time a yellow gets repaid we're very excited in and particularly a yellow that that we had marked to.
Fair value of 71 that gets repaid at par even though it was a small position it does feel very good.
Absolutely, it's a great outcome alright, that's all I had that's all I had thank you so much.
And again, if you would like to answer the question queue Press Star one.
And we have a question now from Paul Johnson from K B W.
Paul You May proceed.
Yeah, Thanks for taking my.
This morning.
I have a few on the mark for them.
13th sensor so on the slide So you guys gave on what drove the mark or was that just comp valuations or anything specific with business.
Yeah, No I meant them overall continues to be a good performer or Australia, particularly when you think about just the the history of that business and so I would say the markdown. This quarter is a little bit more consistent with just the overall M&A environment that we're in where valuations. We think have come down for some of the more you know for some some industries.
And so we're just kind of taking it down in sympathy a little bit with that just as we looked at fair value all of our physicians every quarter.
Got it thanks.
And then just for the S. L piece for all the joint ventures.
And as far as kind of future quarters go.
I don't know when it comes to that obviously growing from those investments but is this a good you know around $8 6 million or so it was kind of what I have for third quarter or is that it.
Decent run rate, what do you think you'd be getting off the a J b's or you know is there any sort of one time stuff in there.
Expect it to be slightly lower.
Yeah, there's no there's no massive one time items, obviously, you know we've seen no good benefits from the Asphaltenes in particular, just the benefit of the rising rate environment. Given you know all of those underlying assets are floating rate.
But as rates start to stabilize it seems a little bit I do think that's a reasonably good estimate you know all the you know the JV yeah, that's all tiers and all of sudden that leaves they do move around a little bit just naturally quarter over quarter, but I think it's a relatively good indications.
One thing that's been going on in the in the L. F. J vs is because those are first lien syndicated loan assets are over the course of the year, we have been able to trade out of lower spread names and by higher spread names at a similar dollar price.
And that's been very very helpful in driving better yields. So we feel very good about what we're doing you know in in that funding. We continue to see good opportunities to enhance the yield of the portfolio without taking increased credit risk. So.
These are exciting little many funds within NMFC.
Got it thanks for that that's all the questions for me.
Yeah.
And this concludes our question and answer session.
I'd like to turn the conference over to John Kline.
Great well, thanks, everyone for joining our third quarter earnings conference call and we look forward to speaking with you next year.
Thank you.
Yeah.
Yeah.
The conference has now concluded.
Thank you so much for attending today's presentation you may now disconnect.
Yeah.