Earnings Labs

New Mountain Finance Corporation 8.250% Notes due 2028 (NMFCZ)

Q1 2018 Earnings Call· Tue, May 8, 2018

$25.66

+0.33%

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Transcript

Operator

Operator

Good morning and welcome to the New Mountain Finance Corporation’s First Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, that this event is being recorded. I would now like to turn the conference over to Rob Hamwee, Chief Executive Officer of New Mountain Finance Corporation. Please go ahead.

Robert Hamwee

Analyst · KBW. Please go ahead

Thank you. Good morning everyone and welcome to New Mountain Finance Corporation’s first quarter earnings call for 2018. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; John Kline, President and COO of NMFC and Shiraz Kajee, CFO of NMFC. Steve Klinsky is going to make some introductory remarks. Before he does, I’d like to ask Shiraz to make some important statements regarding today’s call.

Shiraz Kajee

Analyst · Wells Fargo. Please go ahead

Thanks Rob. 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 May 7 earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our 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. 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.newmountainfinance.com. At this time, I’d like to turn the call over to Steve Klinsky, NMFC Chairman who will give some highlights beginning on Pages 4 and 5 of the slide presentation. Steve?

Steve Klinsky

Analyst

The team 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 net investment income for the quarter ended March 31, 2018 was $0.34 per share, in the middle of our guidance of $0.33 to $0.35 per share and once again covering our quarterly dividend of $0.34 per share. New Mountain’s book value was stable at $13.60 per share as compared to $13.63 per share last quarter. We are also able to announce our regular dividend, which for the 24th straight quarter will again be $0.34 per share; an annualized yield of 10.1% based on last Thursday’s close. The company had another productive quarter of deal generation investing $238 million in growth originations versus repayments of $84 million, which keeps us fully invested. Credit quality remains strong as for the fourth consecutive quarter there were no new non-accruals. I and other members of New Mountain continue to be very large owners of our stock with aggregate ownership of 9.6 million shares, approximately 13% of total shares outstanding, an increase of over 0.5 million shares over last quarter. Finally, the broader New Mountain platform that supports NMFC continues to grow with over $20 billion of assets under management and 140 team members. In summary, we are very pleased with NMFCs continued performance and progress overall. With that, let me turn the call back over to Rob Hamwee, NMFC’s CEO.

Robert Hamwee

Analyst · KBW. Please go ahead

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 six of our presentation NMFC is externally managed by New Mountain Capital, a leading private equity firm. 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 May 3, 2018. In the seven years since our IPO we have generated a compounded annual return to our initial public investors of over 10%, meaningfully higher than our peers in the high yield index and approximately 900 basis point per annum above relevant risk free benchmarks. 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. Total cumulative return continues to be largely driven by our cash dividend, which in turn has been more than 100% covered by NII. As the bar on the far right illustrates, over the seven years we have…

John Kline

Analyst

Thanks Rob. As outlined on page 14, the state of the leverage credit markets is very similar to when we last spoke in March. Despite some equity market volatility throughout the first four months of the year, the leverage of our market has remained remarkably stable. Most deals that we evaluate have strong competitive tension between lenders and at the margin we believe that more middle market executions are being led by syndication agents to maximize the competition between capital providers. Market spreads remain lower than last year, but have remained relatively stable since our March earnings call. NMFC's biggest earnings tailwind remains the upward trend of three months LIBOR, which has increased from approximately 2% at the time of our last call in March to 2.36% today. Additionally, while Q1 is typically slow from a new deal flow perspective, we have seen promising new origination volume thus far in 2018 with a strong forward pipeline in place. Over the last month we have also added a new origination focused team member who will further enhance our client coverage in this completive market. Turning to page 15, NMFC continues to be positively exposed to future rate increases as 85% of our portfolio is invested in floating rate debt and 55% of our liabilities are locked in over the medium term at attractive fixed rates. Three months LIBOR has increased to 2.36%, which is roughly 140 basis points above the average LIBOR floor on our floating rate assets. Moving on to portfolio activity as seen on pages 16 and 17, NMFC had an active quarter with total originations of $238 million offset by $84 million of portfolio repayments and $3 million of sales proceeds, representing $151 million expansion of our investment portfolio. Our new investments were highlighted by a larger size…

Shiraz Kajee

Analyst · Wells Fargo. Please go ahead

Thank you, John. For more details on our financial results in today's commentary please refer to our Form 10-Q that was filed last evening with the SEC. Now I would like to turn your attention to slide 23. Portfolio had approximately $2 billion in investments at fair value at March 31, 2018 and total assets of $2.1 billion. We had total liabilities of $1 billion, of which total statutory debt outstanding was $841 million excluding $150 million of growing SBA guaranteed debentures. Net asset value of $1 billion or $13.60 per share was down $0.03 from the prior quarter. As of March 31 our statutory debt to equity ratio was 0.821 at the high end our target range. Slide 24, we show historical leverage ratios which are broadly consistent with our current target statutory leverage of between 0.7 and 0.821. On this slide we also show the historical NAV adjusted for the cumulative impact of special dividends, which portrays a more accurate reflection of true economic value creation. On slide 25, we show our quality income statement results. We believe that our NII is the most appropriate measure of our quarterly performance. This slide highlights that while realized and unrealized gains and losses can be volatile below the line, we continue to generate stable net investment income above the line. Focusing on the quarter ended March 31, 2018 we earned total investment income of $52.9 million and total net expenses were approximately $27.2 million. As in prior quarters, the investment advisor continues to waive certain management fees such that the effective annualized management fee is 1.46%. It is important to note that the investment advisor cannot accrue fees previously waved. This results in first quarter NII of $25.7 million or $0.34 per weighted average share, which is within our guidance…

Robert Hamwee

Analyst · KBW. Please go ahead

Thanks Shiraz. 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 expectations. In closing, I would just like to say that we continue to be pleased with our performance to date, most importantly from a credit perspective our portfolio overall continues to be 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

Operator

Thank you. [Operator Instructions] The first question will come from Paul Johnson of KBW. Please go ahead.

Robert Hamwee

Analyst · KBW. Please go ahead

Hey Paul.

Paul Johnson

Analyst · KBW. Please go ahead

Hey guys. Guys, thanks for taking my question. My first question was on your investment in Edmonton. I know you guys provided some more capital. I saw the press release that I think it was $25 million or so between you and some other investors extended to the company. My question is how much of that funding went into the BDC and the also what was the rational for the investments, just kind of dividends have been struggling, the investment of your.

Robert Hamwee

Analyst · KBW. Please go ahead

Yeah, and so we talked a little bit about this last quarter, but that money went in about 12 and change, about half of it from us, half of it from another investor and as well as we’ve seen this maturity and the rational is pretty simple. It’s a business that you know seems to be kind of taking control over it, has done okay and we think it’s now positioned with a little bit of incremental capital to do significantly better than okay. We as I think again, I mentioned in the past, we brought in a very talented new CEO in the summer of last year and based on her plan and execution to-date we have really you know a lot of confidence in where that company is going and so are inclined to be supportive of it if we possibly can be.

Paul Johnson

Analyst · KBW. Please go ahead

Okay, thanks for that. And then my other question was on the third SLF, it’s sort of the side question that you guys formed. I am just kind of curious here, given its you know the same partner and virtually the same FB split as the SLF II, which is why you chose to open up a new JV as opposed to kind of simply just expanding the second one. Is there any sort of advantage to doing that?

Robert Hamwee

Analyst · KBW. Please go ahead

Yeah, actually it’s a different credit provider. Wells Fargo is the credit provider for SLP II and as John mentioned Citi is the credit provider for SLP III and we think it’s you know good to have more than one credit provider for these vehicles over time.

Paul Johnson

Analyst · KBW. Please go ahead

Sure, that makes sense, that makes sense. And then lastly I just on your origination to this isolated quarter for you guys, leverage is probably about as high as its been in the BDC. I am just kind of curious, is that an anticipation for the increased leverage that you guys have done. I think the shareholder vote in June or is that more just kind of a timing issue on the strong originations for the quarter?

Robert Hamwee

Analyst · KBW. Please go ahead

Yeah, it’s really more of a timing issue. You know the – I mean we didn’t – I don’t think we found out about the change in legislation from late March and you know a lot of it will be too late to influence our behavior in terms of you know what would have been closed by the end of March. So it’s really more idiosyncratic around timing of originations and repayments. You know obviously as we navigate this quarter you know depending on how the process goes around the proxy, that may have an influence on exactly where we wind up at 630.

Paul Johnson

Analyst · KBW. Please go ahead

Okay, that’s all I have. Thanks for taking the questions.

Robert Hamwee

Analyst · KBW. Please go ahead

Yeah, anytime. Thank you.

Operator

Operator

[Operator Instructions] The next question comes from Jonathan Bock of Wells Fargo. Please go ahead.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Good morning and thank you for taking my questions.

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

Hey Jonathan.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Hey Rob. So if we are able to maybe breakout some things, one you know the credit to you and the board and Steve as you guys are approaching this leverage discussion, what we want to understand is lets imagine that regulatory constraints were no longer an issue today. How quickly would it take to perhaps lever the senior secured assets to a level beyond one-to-one? Do you have current availability to do that and flexibility in your borrowing base and just give us a sense of timing given than folks generally don’t ask for votes unless they believe it to be a positive MPV proposition you know over the next 12 months.

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

Yeah, no it’s a good question Jonathan. I mean I think – and we can get behind the math a little bit. I think the short answer though is that its quarters, it’s not months, but it’s not years either and of course to go with the hand-on prevailing market conditions and we you know the pipeline of opportunities. But if I had to handicap it, I would say its quarters, because when we think about it right, we have roughly a little over $1 billion equity base. So for every 0.1 of leverage increase you’re talking about a net increment of $100 million or so of assets above our replacement rate. So to go from 0.8 to 1.2, I’ll make that up, is a net increase of $400 million of assets just to put it into context, right. So it’s a decent amount, but it’s not insane in the context of the scale of the market, our footprint in that market, our deal flow and our ability to…

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

That would make sense. Rob I have no questions about your ability to deploy the capital effectively. I think the question is just in terms of adjusting with your leverage facilities, how long does that typically take?

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

Yeah, so we are in dialogue around that. I expect that well it’s very doable. I don’t want to get too far you know ahead of those conversations. I would not expect that to be the constraint.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Okay, great. Then maybe one item I know folks appreciate it and are trying to understand kind of incremental math and clearly with the 60 to 80 basis point fee discussion on the new incremental senior secured assets, that’s very helpful and also very attractive. Can you walk us through what you think onboarding yields generally are and financing costs?

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

Sure, sure. So let’s just to keep the math simple, let’s assume we’re going to onboard $100 million of incremental assets, and that’s also to assume that all those assets are senior assets, lower yielding to higher advance rate. So let’s think about the return side of the equation and let’s think about the cost side of the equation. So for 100 of assets let’s assume that they are going to be – again we make this up, but its ballpark L550. L is you know close to 250, just again to make the math simple. So let’s assume that its 250 base rate, 550 spread, so 8% assets. So on $100 million, that’s $8 million of marginal revenue.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Yep.

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

On the cost side obviously the first one is the interest expense. So let’s assume those assets has a 60% advance rate on our senior facility and our senior facility is advancing capital at L plus 200. So it’s the same math; that’s $60 million of borrowings at 4.5% and then lets says we borrowed in the unsecured market at some higher price because now we are more levered, but we recently borrowed at just under 5%, so let’s assume its again, I’m going to make this up, but 50 basis point more. I thought I’ll make the math simple, because the treasury rates have going up, less the senior borrowing in the unsecured market on the incremental $40 million at 6%, again its total making these numbers up for illustrative purposes, and I’m doing the math in real time so bear with me. So $60 million at 4.5% is 2.4, 2.7 of costs and 2.4 on the 40, so roughly $5 million of incremental interest expense, right.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Yep.

Shiraz Kajee

Analyst · Wells Fargo. Please go ahead

And on the management fee side, again use the midpoint of that range 70 bips on the $100 million, so another $700,000. So now you are $5.7 million of cost. Interestingly virtually all of our other costs are fixed, right. So maybe a couple, you know $50,000 or $100,000, but you are dropping more than $2 million to the bottom line using this math, which again is illustrative here. And that’s there to effectively allow one to take an average lower yielding asset across the portfolio to the tune of $2 million and/or offset general market spread compression. So that’s the accretive nature of the math given our cost to borrow and given the way our management seeds works, that is a tool.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Right, I appreciate that and that math is – that illustrative math is compelling. Then would you be able to walk us through the next step, which will be – if you look at your off balance sheet JVs, does two-to-one leverage alter your thinking on the net attractiveness that those JVs kind of offer in today’s environment, given while they are a little bit more levered than what you traditionally have on balance sheet. I’m wondering if two-to-one kind of changes that dynamic and their relative attractiveness to something you could put on the balance sheet at a higher leverage.

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

I think the short answer is no Jonathan because those are fundamentally different assets. Those are the broadly syndicated first liens that today are yielding, L350 and L375 and we are using three-to-one leverage there to make that math work for us in a double-digit return, and we still think that’s the place where we want to be able to active in, because if you remember the original industrial logic all the way to back LOS 1[ph], whatever it was four years ago, is that again – our core competency is our knowledge of businesses that we know really well through private equity. Sometime those businesses are financed, where the only actionable part of the capital structure is an L+375 regular way syndicated loan and we want to have a bucket for that, because again we have such high convection around those businesses that we want to make sure we can express that convection somewhere as long as the return math makes sense which in today’s world is still does.

Jonathan Bock

Analyst · Wells Fargo. Please go ahead

Yes, yes. Guys, thank you for answering my questions. Thank you.

Robert Hamwee

Analyst · Wells Fargo. Please go ahead

Thank you Jonathan.

Operator

Operator

[Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Rob Hamwee for any closing remarks.

Robert Hamwee

Analyst · KBW. Please go ahead

Great, thank you. And thank you everyone. We appreciate the time and attention and look forward to speaking again in the weeks ahead. Bye-bye now.

Operator

Operator

Thank you, sir. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.