New Mountain Finance Corporation 8.250% Notes due 2028 (NMFCZ) Q3 2015 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the New Mountain Finance Corp. Third Quarter 2015 Earnings Call and Webcast. All participants will be in a listen-only mode [Operator Instructions] After today's presentation there will be an opportunity to ask questions [Operator Instructions]. Please also note that today's event is being recorded. At this time I'd like to turn the conference call over to Mr. Robert Hamwee, Chief Executive Officer. Sir, please go ahead.

Thank you, and good morning, everyone and welcome to New Mountain Finance Corporation's third quarter earnings call for 2015. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; and Adam Weinstein, Board member of NMFC and CFO of New Mountain Capital. Adam has been working very closely with Melody Siu, our Controller and Interim CFO, overseeing the NMFC finance function. I am pleased to report that we are very far along in our search for a new permanent CFO at NMFC, who we expect will be starting in early December, and I look forward to introducing the new CFO to you all on our next call. Steve Klinsky is now going to make some introductory remarks. But before he does, I'd like to ask Adam to make some important statements regarding today's call.

Thank you, Rob. 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 earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our November 4, 2015, press release and on page 2 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 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. Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital LLC or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisers BDC, L.L.C., where appropriate. 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.NewMountainFinanceMountainFinance.com, or call us at 212-720-0300. At this time I'd like to turn the call over to Steve Klinsky, who will give some highlights, beginning on pages four and five of the slide presentation. Steve?

Rob and Adam will go through the details in a moment, but let me start by presenting the highlights of another strong quarter for New Mountain Finance. New Mountain Finance's adjusted net investment income for the quarter ended September 30, 2015, was $0.35 per share, once again at the high end of our guidance of $0.33 to $0.35 per share. This more than covers our Q3 dividend of $0.34 per share. The Company's book value on September 30 was $13.73 per share, generally consistent with our recent offering NAV of $13.78 per share, and a decrease of $0.17 from last quarter. We are also able to announce our regular dividend for the current quarter, which will again be $0.34 per share. The Company invested $211 million in gross originations in Q3 and had only $9 million of repayments in the quarter. Additionally, since quarter-end we have had $128 million of originations against $34 million of repayments, allowing us to rapidly deploy the proceeds of our recent equity offering. I and other members of New Mountain continue to be significant buyers of our stock, purchasing over 1.4 million shares this year, bringing aggregate ownership to 6.7 million shares, more than 10% of total shares outstanding. The overall credit quality of the Company's loan portfolio continues to be strong, as once again no new loans were placed on nonaccrual. Since the inception of our debt effort in 2008, we have had only two issuers with a realized default loss, representing less than 0.2% of cumulative investments made to date. In summary, we are pleased with NMFC's continued performance and progress. With that, let me turn the call back over to Rob Hamwee, NMFC's CEO.

Thank you, Steve. Before diving into the details of the quarter, as always I'd like to give everyone a brief review of NMFC and our strategy. As outlined on page 6 of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm with over $15 billion of assets under management and 100 staff members, including over 60 investment professionals. Since the inception of our debt investment program in 2008 we have taken New Mountain's approach to private equity and applied it to corporate credit, with a consistent focus on defensive growth business models and extensive fundamental research, within industries that are already well known to New Mountain. Or, more simply put, we invest in recession-resistant businesses that we really know and that we really like. We believe this approach results in a differentiated and sustainable model that allows us to generate attractive risk-adjusted rates of return across changing cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource. Turning to page seven, you can see our total return performance from our IPO in May 2011 through November 2, 2015. In the four and a half years since our IPO, we have generated a compounded annual return to our investors of 11.4%, significantly above our regular dividend yield and dramatically higher than our peers and the high-yield index. Page eight goes into a little more detail around relative performance against our peer set, benchmarking against the 10 largest externally managed BDCs that have been public at least as long as we have. Page nine shows return attribution. We attribute our success to, one, our differentiated underwriting platform; two, our ability to consistently generate the vast majority of our NII from stable cash interest income in an amount that covers our dividend; three, our focus on running the business with an efficient balance sheet and always fully utilizing inexpensive, appropriately structured leverage before accessing more expensive equity; and four, our alignment of shareholder and management interests. As outlined on page 10, since August, we have witnessed significantly increased market volatility and a widening of credit spreads. This has been a function of global economic growth [trends], uncertainty around the direction of interest rate, and general investor risk aversion. We also believe technical factors are at play, as regulated banks and investment banks continue to pull away from middle market leverage credit. While spreads have reduced modestly in recent weeks, the environment for deploying capital remains attractive. Given the continued focus in the market on the possibility of future short-term and long-term rate increases, we wanted to highlight NMFC's defensive positioning relative to this potential issue. As you can see on page 11, 83% of our portfolio is invested in floating-rate debt. Therefore, even in the face of a material rise in interest rates, assuming a consistently shaped yield curve, we would not expect to see a significant change in our book value. Furthermore, as the table at the bottom of the page demonstrates, a meaningful rise in short-term rates will generally increase our NII per share, with the only exception being a modest rise having a slightly negative impact as the cost of the majority of our borrowings rise while our interest income does not initially go up, given the presence of LIBOR floors on our assets. Our highest priority continues to be our focus on risk control and credit performance, which we believe over time is the single biggest differentiator of total return in the BDC space. If you refer to page 12, we once again lay out the cost basis of our investments, both the current 9/30/15 portfolio and our cumulative investment since the inception of our credit business in 2008, and then show what has migrated down the performance ladders. Since inception, we have made investments of $3.5 billion in 167 portfolio companies, of which only four -- representing just $36 million of cost -- have migrated to nonaccrual; and only two -- representing $6 million of costs -- have thus far resulted in a realized default loss. Approximately 97% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale. Page 13 shows leverage multiples for all of our holdings above $7.5 million when we entered an investment, and leverage levels for the same investment as of the end of the current quarter. While not a perfect metric, the asset-by-asset trend in leverage multiple is a good snapshot of credit performance and helps provide some degree of empirical, fundamental support for our internal ratings and marks. As you can see by looking at the table, the leverage multiples are roughly flat or trending in the right direction, with only a few exceptions. Of the four loans that show negative migration of twp turns or more, one is to a business that is under contract to be sold, resulting in a full repayment; one is to a business that is currently in the early stage of a sale process, expected to either pay off the loan in full or yield a modest loss; and the final two are first-lien loans to energy service businesses that, while cyclically challenged, have significant liquidity. These last three loans are rated 3 on our internal scale and are carried at meaningful discounts to par, reflecting the degradation in earnings and prospects, although none are likely near-term nonaccrual candidates and all have a reasonable chance, in our judgment, of continuing to make full and timely payments of interest and principal through maturity. The chart on page 14 helps track the Company's overall economic performance since its IPO. At the top of the page, we show how the regular quarterly dividend is being covered out of net investment income. As you can see, we continue to more than cover 100% of our cumulative regular dividend out of NII. On the bottom of the page we focus on below-the-line items. First, we look at realized gains and realized credit and other losses. As you can see, looking at the row highlighted in green, we have had success generating real economic gains every year through a combination of equity gains, portfolio company dividends, and trading profits. Conversely, realized losses including default losses, highlighted in orange, have been significantly smaller and less frequent and show that we are typically not avoiding nonaccruals by selling poor credit at a material loss prior to actual default. The net cumulative impact of this success to date is highlighted in blue, which shows cumulative net realized gains of $43.1 million since our IPO. Next we look at unrealized appreciation and depreciation. This quarter, small mark-to-market gains on underlying assets were outweighed by mark-to-market losses, primarily reflecting broad-based market weakness for asset prices in the third quarter. As you can see highlighted in grey, we have cumulative net unrealized depreciation of $43 million, of which approximately $30 million relates to unrealized mark-to-market losses on our historical nonaccruals, primarily UniTek and Edmentum. Finally, we combine net realized with unrealized appreciation to derive the final line on the table, which in the yellow box shows current cumulative net realized and unrealized appreciation of just under $1 million. The point here is to show that on both a realized and combined realized/unrealized basis we have consistently and methodically offset any credit losses or impairments with below-the-line gains elsewhere in the portfolio. While market-driven volatility around unrealized appreciation and depreciation may cause the bottom-line number to vary, over time true economic gains and losses will accumulate in the realized bucket, where we will strive to retain a positive balance. Moving on to portfolio activity, as seen on pages 15, 16, and 17, originations in the quarter ran at a strong pace, totaling $211 million. Additionally, repayments were unusually small at $9 million. This trend has continued in the current quarter to date, as we have had $128 million of origination so far against $34 million of repayments. This large net origination activity led us to raise equity in September, which I am pleased to say we have effectively deployed. We sit here today with a statutory debt-to-equity ratio of 0.72 times and an economic debt-to-equity ratio of 0.85 times. Pages 18 and 19 show the impact of Q3 investment and disposition activity on asset type and yields, respectively. Both asset originations and repayments were heavily weighted towards first-lien investments. Given that weighting, yields on originations were moderately lower than those on the portfolio as a whole, but meaningfully higher than quarterly dispositions. The bigger change in effective portfolio yield came from a flattening of the forward LIBOR curve in light of diminished expectations around a potential Fed rate increase. The net impact is that portfolio yield overall is down modestly to 10.4%. In terms of the portfolio review on page 20, the key statistics as of 9/30 look very similar to 6/30. The asset mix has shifted modestly back towards first-liens. As always, we maintain a portfolio comprised of companies in the defensive growth industries like software, business services, and education that we believe will outperform in an uncertain economic environment. Finally, as illustrated on page 21, we have a broadly diversified portfolio with our largest investment at 3.4% of fair value and the top 15 investments accounting for 37% of fair value. With that I will now turn it over to Adam Weinstein to discuss the financial statement and key financial metrics. Adam?

Thank you, Rob. For more details on the financial results and today's commentary please refer to the Form 10-Q that was filed last evening with the SEC. Now I'd like to turn your attention to slide 22. The portfolio had about $1.5 billion in assets -- in investments at fair value at September 30, 2015, and total assets of just under $1.6 billion. We had total liabilities of $691.3 million, of which total statutory debt outstanding was $568 million, excluding $103.8 million of drawn SBA guaranteed debentures. Net asset value of $878.7 million or $13.73 per share was broadly consistent with our recent offering NAV as of September 21 of $13.78 per share, and down $0.17 from the prior quarter. As of September 30, our statutory debt-to-equity ratio was 0.65-to-1. Taking into account investment activity since quarter-end, our statutory pro forma debt-to-equity ratio is 0.72-to-1. On slide 23 we showed the historical NAV per share and leverage ratios, which are broadly consistent with our current target leverage of between 0.70- and 0.80-to-1. We also show the NAV adjusted for the cumulative impact of special dividends, which portrays a more accurate reflection of true economic value creation. On slide 24, we show our quarterly income statement results. We believe that our pro forma adjusted NII is the most appropriate measure of our quarterly performance and removes one-time adjustments related to items such as changes in tax or other accruals that would otherwise cause inconsistency in our reported results. This slide highlights that while realizations and unrealized appreciation and depreciation can be volatile below the line, we continue to generate stable net investment income above the line. Focusing on the quarter ended September 30, 2015, we earned total investment income of approximately $37.9 million, steady versus the prior quarter. Total net expenses of $17.5 million are roughly in line with the prior quarter as well. As mentioned on prior calls, due to the merger of our Wells Fargo credit facilities and consistent with the methodology since IPO, the investment advisor will waive management fees on the leverage associated with those assets that share the same underlying yield characteristics with investments leveraged under the legacy SLF Credit Facility. This results in an effective management fee of 1.4% for the third quarter, which is broadly in line with the prior quarters. It is expected, based on our current portfolio construct, that the 2015 effective management fee will be broadly consistent with the prior years. It is important to note that the investment adviser cannot recoup management fees previously waived. In total, this results in third-quarter pro forma adjusted NII of $20.4 million or $0.35 per weighted average share, which is at the high end of our guidance provided on August 6, 2015, of $0.33 to $0.35 per share, and more than covers our Q3 regular dividend of $0.34 per share. In total, for the quarter ended September 30, 2015, we had an increase in net assets resulting from operations of $9.6 million. As slide 25 demonstrates, our total investment income is predominantly paid in cash. As you can see, total interest income as a percentage of total investment income remains strong at 92% this quarter. We believe this consistency is one measurement of the stability and predictability of our investment income. Turning to slide 26, as briefly discussed earlier our pro forma adjusted NII for the third quarter more than covered our Q3 dividend. Given our belief that our Q4 2015 NII will fall in the previously declared expected range of $0.33 to $0.35 per share, our Board of Directors has declared a Q4 2015 dividend of $0.34 per share, in line with the past 14 quarters. The Q4 2015 quarterly dividend of $0.34 per share will be paid on December 30, 2015, to holders of record on December 16, 2015. Finally, on slide 27 we highlight our various financing sources. Taking into account SBA guaranteed debentures related to our SBIC license, we have $855 million of total borrowing capacity today, and we have no maturities until 2019. As a reminder, our Wells Fargo credit facility's covenants 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. At this time I'd like to turn the call back over to Rob.

Thanks, Adam. It continues to remain our intention to consistently pay the $0.34 per share on a quarterly basis for future quarters so long as the adjusted NII covers the dividend, in line with our current expectation. In closing, I would just like to say that we continue to be extremely pleased with our performance to date. Most importantly, from a credit perspective our portfolio overall continues to be very healthy. Once again, we'd like to thank you for your support and interest and at this point, turn things back to the operator to begin Q&A. Operator?

[Operator Instructions] And our first question today comes from Ryan Lynch from KBW. Please go ahead with your question.

Hey, good morning and thanks for taking my questions.

Hey Ryan.

Hey, so my first one just relates to that commend you had made about market conditions, that you said smaller deals continued to be priced at a premium. Can you just elaborate on what size EBITDA and loan sizes you're talking about, and also just expand on what is driving the better pricing on some of the larger deals?

So two things, right? So the smaller deals and this is consistent over recent quarters, is the liquidity premium that's built in and just a smaller addressable market of potential investors. When I talk about smaller deals in the middle market I'm defining -- let's say, broadbrush strokes -- EBITDA, $10 million to $25 million, right, that can't really access the more syndicated market. So, depending on a lot of other factors you're talking about incremental spread of 50 to 250 depending on where you are in the capital structure, etc., all else being equal for those deals. In terms of the broader market, it's just some of the things we talked about, right? The broader stepping back from risk of people; I think the banks and investment banks stepping away from the middle market; and just the general concern around the macro-environment and outlook.

All right. One other comment you made, you talked about credit spreads increasing since the last call. I'm just trying to reconcile a couple things. Your Q3 originations came in at about 9.4%, which was much lower than the prior quarter's originations of 11.1%. You guys also had a robust quarter of originations in Q3. So the robust originations would tell us that it's a good time to -- it would indicate to us that you guys think it's a good time to be deploying capital. However, you guys are now focusing on lower yielding, more first-lien loans, which is why the origination yield came down significantly, which that would tell us that there is some caution around credit quality. So how do we just balance out those two factors: that you guys are deploying a lot of capital, but you guys are deploying them into lower yielding, more senior assets?

Yes, as you point out, it's really a mix issue, right? So it's not that the asset-to-asset comparison yields are lower. Yields are higher. Obviously the blended yield looks lower because of the mix. So in terms of our focus, we're not focused one way or the other. As always, we're looking for the opportunities in businesses that we really know and like. It's a little bit of a -- where those opportunities fall. So the fact that we can deploy capital more safely in our judgment and still maintain the appropriate portfolio yield to support the dividend is what we're focused on. I've said this to my Board and to others: in a widening spread environment, I'd rather increase safety and keep the yield the same, than stretch for excess yield and keep safety the same. So that's really our mantra, but part of it is also just idiosyncratic to the specific opportunities that were available this quarter.

Okay. Great. Those were all the questions for me.

Great. Thanks Ron.

[Operator Instructions] We do have an additional question from Fin O'Shea from Wells Fargo. Please go ahead with your question.

Hi, guys. Good morning and thanks for taking my question. First, with a larger portfolio now and what appears to be a fairly well ramped SLP, should we expect additional commitments or growth in that? And to what extent, if you could provide any color?

Yes, as I've mentioned I think on previous calls, we're investigating some additional opportunities in that area. But really until we have firm commitments in place we're really just not able to talk about it.

Okay, very well and another portfolio question that caught my ear on this call. You've done very well in your industry expertise. With the concentration in -- or to the extent you're concentrated in the education sector, we've seen a few BDCs at least with potential problem assets in those education names exposed to the broader themes of for-profit and gainful employment stuff. Would you say you have any exposure to those broader themes?

Yes; no, no, we have no exposure to post secondary. So our education bucket is, just to give you a sense, it's pretty broadly defined. We have corporate training in there; we have K-12 private schools in there. But there is no -- and a bunch of other things, but there's no material exposure to post-secondary, which have those issues you've talked about.

Okay, very well. That's helpful, and thank you very much.

You're welcome. Thank you.

And ladies and gentlemen, at this time, we've reached the end of the question-and-answer session. I'd like to turn the conference call back over to management for any closing remarks.

Great; thank you. Well thanks, everyone. Appreciate it. Look forward to speaking with everyone again next quarter.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.