New Mountain Finance Corporation
Q1 2021 Earnings Call Transcript

Published: 6 May 2021

[Operator:]

Good morning, and welcome to the New Mountain Finance Corporation First Quarter 2021 Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to hand the conference over to Rob Hamwee, CEO of New Mountain Finance Corporation. Please go ahead.

[Robert Hamwee:]

Thank you, and good morning everyone and welcome to New Mountain Finance Corporation's first quarter earnings call for 2021. 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. Before diving into the business update, we do want to recognize that while significant progress has been made here in the US, we continue to live through a public health crisis that is taking a significant human toll around the globe. We hope that everyone is staying safe and that you and your families remain in good health.

[Shiraz Kajee:]

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 5th earnings press release. I'd 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 to 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 attain 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's Chairman who will give some highlights beginning on Pages 4 and 5 of the slide presentation Steve?

[Steven Klinsky:]

Thanks Shiraz. It's great to be able to address all of you today as both the Chairman of NMFC and as a major fellow shareholder. I have a number of headlines to present today including in some fresh areas, which I believe should be received as very good news. It is now over a year since the COVID pandemic first hit. As we discussed on previous earnings calls risk control has always been part of New Mountain's founding mission. Our firm as a whole now manages over $33 billion in total assets with a team of over 175 people and with over 50,000 employees at our private equity portfolio companies in the field. We have never had a bankruptcy or missed an interest payment in the history of our private equity work, while generating over $50 billion of estimated total enterprise value for all stakeholders. We have raised over $10 billion of additional private equity capital last year despite COVID. We have applied that same team strength and focus on defensive growth industries to NMFC and our credit efforts resulting in a realized net default loss of just 12 basis points a year, each year since we began our credit operations in 2008.

[Robert Hamwee:]

Thank you, Steve. Let me start by giving a little more detail on some of the positive headlines that Steve has shared. While we believe our ability to earn our $0.30 quarterly dividend remains intact as we come out of the COVID crisis, given the twin headwinds of a very low base interest rates and what we believe is a temporarily increased non-interest earning equity portfolio, we want to assure our shareholders that the dividend and the earnings base that supports it are secure. To that end, we are implementing a program whereby for at least the next two calendar years, we will effectively guarantee to reduce our incentive fee if needed to make sure earnings support the $0.30 dividend. Further in order to simplify our fee structure instead of waiving fees on a portion of certain managed assets as we historically have done for at least the next two years, we will simply charge a 1.25% management fee on all assets. We believe these two important changes even further align management's interest with those of our shareholders, an approach that has always informed our actions. Separately, we have made material progress decreasing the cost and increasing the duration and flexibility of our liabilities. Specifically, we have extended our two main asset-backed secured credit facilities to $730 million Wells Fargo facility and the $280 million Deutsche Bank facility out to 2026. At the same time, we were able to lower applicable spreads on these two facilities by 40 basis points and 25 basis points respectively. On the unsecured side, we received an investment grade rating from Moody, which will allow us to access the institutional bond market, even more effectively than in the past, which should further reduce our cost of capital. We also received an upgraded outlook from Kroll Bond Rating Service. Finally, we combine the SLP I and SLP II funds into a newly created SLP IV, the scale of which will allow for more simplified and efficient financing and execution going forward. As we emerge from the COVID crisis, we continue to have extensive conversations with both company management and sponsors and update each portfolio companies scores on our heat map using the same criteria discussed in the past and as outlined on Page 8. The updated heat maps show that risk migration was roughly neutral this quarter as summarized on Pages 9 and 10 with over $81 million of positive inter green migration and $51 million of a negative migration primarily concentrated in one insurance services business that migrated from green to yellow.

[John Kline:]

Thanks, Rob. We are pleased to report that overall conditions in the direct lending market continued to be very healthy. Companies within most industries have very good access to capital and new sponsor-backed purchases are generally occurring at very healthy multiples across many industries. Companies within many of our core defensive growth sectors such as software, healthcare technology, field services and technology enabled business services have compelling momentum in their businesses and are attracting record purchase multiples from a diverse group of brand names sponsors. Interest spreads on first lien and unitranche loans have returned to pre-COVID levels while second lien spreads are modestly tighter levels observed in early 2020. Despite this modest spread pressure in the second lien market returns on new loans remain attractive both on an absolute basis and relative to other credit markets that we see. Turning to Page 15, we show how potential changes in the base rate could impact NMFCs future earnings. As you can see, the vast majority of our assets are floating-rate loans while our liabilities are 57% fixed rate and 43% floating rate. NMFC's current balance sheet mix offers our shareholders consistent and stable earnings in all scenarios where LIBOR remains under 1%. If base rates rise above 1% as the economy normalizes or accelerates there is meaningful upside to NMFC's net investment income. For example, assuming our current investment portfolio and existing liability structure if LIBOR reaches 2%, our annual NII would increase by 9.1% or $0.11 per share. At 3% LIBOR earnings would increased by 20% or $0.24 per share. Page 16 addresses historical credit performance, which shows NMFC's long term track record. On the left side of the page, we show the current state of the portfolio where we have $3 billion of investments at fair value with $25 million or less than 1% of our portfolio currently on non-accrual. This quarter, as mentioned earlier, we did not place any new borrowers on non-accrual.

[Shiraz Kajee:]

Thank you, John. For more details in our 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 27. The portfolio had over $3 billion in investments at fair value at March 31, 2021 and total assets of $3.1 billion, where total liabilities of $1.9 billion of which total statutory debt outstanding of $1.5 billion, excluding $300 million of drawn SBA guaranteed debentures. Net asset value of $1.2 billion or $12.85 per share was up $0.23 from the prior quarter. At March 31, our statutory debt to equity ratio was 1.18

[Robert Hamwee:]

Thanks Shiraz. In closing, we are optimistic about the prospects for NMFC in the months and years ahead. Our long-standing focus on lending to the 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 operator to begin Q&A. Operator?

[Operator:]

The first question comes from Finian O'Shea with Wells Fargo Securities.

[Finian O'Shea:]

First question on the I suppose new outlook Rob you said this was sort of the twin approach on rates and then equity. Is it, I was going to start with the equity does this reflected a new view that you'll be holding this portfolio for a much longer time or just this portfolio will produce less income to you or how do you describe your change in view there given that more or less looks the same?

[Robert Hamwee:]

Yes, know, I want to be super clear, you're right, it looks the same we're just highlighting as we think about our earnings profile that we do in fact have a larger than average over the last five years. Equity portfolio with things like Edmentum, Benevis and UniTek and we actually believe there is tremendous potential in those names to create real economic value, but of course for every dollar that's in a non-yielding piece of equity at non-cash and non-income yielding piece of equity that obviously is a dollar that's not earning NII in the quarter. So, nothing has changed, and in fact, our outlook continues to brighten for those names, and from a timing perspective, it's not the case that we think we're going to own them any longer than we would have thought last quarter. It's just the timing of those uncertain right like will you because it's a lumpy will you exit one of those and convert that into cash, that's redeployed in NII generative traditional debt securities we just don't know. So, we want to just make sure that the new explicit NII per action program has enough runway to make sure we can recycle those proceeds.

[Finian O'Shea:]

On the new leverage guidance, is that sort of tied to equity or is that does that reflect your view of debt market conditions, and I guess tied that into the other part of the program as you described on lower returns. Is that more through leverage or just your view of the market is not going to recover the loss base rates or you're going to be more cautious just whatever you would expand on that front?

[Robert Hamwee:]

Yes, I mean, I think we've been talking about the 1.0 to 1.25 target for a while now. I think our view is that's probably the prudent level for the foreseeable future, I think that's where the intersection of leverage levels and maximizing the efficiency of the rate our debt capital is best. I think we, actually saw that with the Moody's rating recently which is a function of that range and we think that will allow us over time to further reduce the cost of debt capital. So it's just a question of finding the sweet spot where we can minimize the cost of our debt capital, but still get the return on the balance sheet that we're looking for, obviously over long periods of time that can continue to evolve, but I'd expect us to operate there for the foreseeable future.

[Finian O'Shea:]

Okay, thanks. And just one more on the newer JVs. Is there anything I think it's a different kind of partner. Is this a different kind than your previous JVs, which was seemingly mostly your origination pretty uniform with your strategy and so forth, this is kind of fallen in that progression or is there anything new or about different about this one?

[Robert Hamwee:]

No, we'll be doing absolutely the same thing we've been doing from an asset side in the SLPs, that's worked incredibly well for us. If I think you know, we've never had a credit issue, material credit issue, let alone or default or default loss in the SLPs and whatever it's been five or six years, and that's again that strategy of investing in the business as we know intimately through our private equity work in our defensive growth sectors. So, that's absolutely going to remain unchanged.

[Operator:]

Your next question comes from Ryan Lynch with KBW.

[Ryan Lynch:]

Thanks for taking my questions. First, congrats on the Moody's rating. One kind of question on that you guys already had another investment grade rating from Fitch version major rating agency then also we had some rating investment grades from Egan Jones in Kroll. So I'm just curious how much do you think that this new Moody's rate will be able to increase or lower your cost of debt on a new issuance, you guys already issuing pretty low from your issuance in January, so just any thoughts on that?

[Robert Hamwee:]

Yes, I think what it really allows us is to tap into the more I'll cover the more traditional institutional market. We've been historically constrained even with that, the Fitch rating, which has been great, but we've been historically constrained to more of the narrower insurance company, institutional market and adding the Moody's rating on top of the Fitch rating and the other ratings now allows us to pretty materially widen in the pool of investors that we can go to. I don't want to necessarily speculate on exactly in basis points six months from now, what that will mean but I just I think if you look at some of our peers who access that wider institutional market, they've issued materially 20 to 50, 75 basis points inside of us in that market pending on the time et cetera, et cetera. But on a like-for-like basis I think those types of savings are obtainable over time as we access that wider market. Now obviously that's relative to whatever happens with the 5-year, 7-year, et cetera, but on a spread basis, I think that's realistic given that much broader depth of that market relative to our current market.

[Ryan Lynch:]

That makes sense. That's good to hear that we are open up to a whole new and bigger investor set and you guys debts are positive. I have a question regarding, I see you guys focus on defensive growth businesses you guys do a lot in the software sector which is obviously a very in-favor sector for direct lending today. I'm just curious as competition has been increasing in that market pretty substantially recently, what percentage you don't even have to give me a percentage, but the deals that you guys are working and closing on, is they're starting to become a much bigger prevalence of direct lenders in a lending based on annual recurring revenue opposed EBITDA multiples for some of these recurring businesses, and how comfortable are you are doing on ARR based lending compared to kind of the more traditional cash flow or EBITDA based lending?

[Robert Hamwee:]

Yes, it's a really good question and you're right, we've definitely seen an expansion of that market over the last three or four years in particularly the last one or two years. And so we are seeing just in our industry generally much more capital flowing into that on both the equity side and the credit following it. We do and will participate in those loans, we're quite selective and the key attributes that we focus on for the loans and that's in that area that we will get involved with our are really one very, very large equity cushions. So we will typically look at loan to values sub 35% and often sub 25%. So really, really large cash equity cushions. Two, as always, but particularly in those deals just businesses we know intimately. So it's going to be businesses that we've have a very high level of conviction based on our own private equity activities and the views of our network, right. Steve touched on this 50,000 employees in the field of our PE portfolio companies, many of whom are in that space and getting a readout from the CEO of one of our related companies is incredibly important and valuable there. And three, we look at companies that they're only reason they're not profitable today is not something inherent about the business model, they operate at very high gross margin, 70% to 80% gross margins, but they're making a conscious decision to redirect those gross margins into sales to support a very high growth rate, and when we can underwrite that and we say listen if they wanted to tomorrow they could be materially profitable just at a much lower growth rate, which is okay for the debt definition for the equity. So those are some of the way you think about those loans, and listen those loans when some of the absolute best I know John touched on this in the past, those loans are some of the absolute best performers in our portfolio through the COVID crisis.

[Ryan Lynch:]

That's helpful color on that, especially, their recent performance due to COVID. Can you provide an update on Edmentum obviously there is capital injection into that business late last year. You guys wrote that investment pretty meaningfully this quarter. So I'd just love to hear an update on how that business is doing and kind of the outlook, it seems to be performing really well?

[Robert Hamwee:]

Yes, I mean you're right, we obviously sold. It wasn't really capital injection into the business. It was sale of half of the capital stock effectively to Victory, a education-focused private equity firm, but the business really continues to do incredibly well. They ended their fiscal year, which ends Jan 31 at well more than 100% growth year-over-year at the operating profit line and are on a trajectory over the next three years, we believe and then management believe to continue to grow quite significantly, and I would say we are even at the current valuation, which is obviously up from the last quarter in the last couple of quarters, we are holding it at a very material discount to private and public comparables just because listen that we want to continue to see the prospects, turn into results, but we are seeing that and we expect to continue to see that and we do think it is very significant. There's always risk, but it's very significant upside in that position from here, and the reasons are pretty obvious, right? We're all kind of living it with the trends that are sustainable right? Obviously there is a bump through COVID for digital education tools, but the sustainable elements are; One, there has been an incredible learning loss well documented that's going to take years to repair and Edmentum is one of the leading provider of the tools to deal with that challenge. Two, there is no going back particularly in the high school level that schools are going to have to offer a some sort of virtual option for some types of learners who want to need a hybrid approach going forward. And again Edmentum was one of the leading provider of those tools. And three, were related to one and two, we are seeing just tremendous and sustainable dollar flows at both the state and federal level into the areas that Edmentum service. So, we're incredibly bullish about that. We also have a great CEO there who has proven herself, and we think it is an execution intensive area and we think we have a great in plus person to deliver the execution. So, it always worry about things, but we are very, very optimistic about the prospects for that one over the next one to 2 years.

[Ryan Lynch:]

That's good to hear. And I know that's and that's investment you got to work with for a long time. So that does, that great.

[Robert Hamwee:]

Yes, definitely out of cash - project. I've been on the Board there now for whatever it's been six, seven years and it's taking time, but I think we really got it, got it right now and I think the best is yet to come there.

[Ryan Lynch:]

So that was it. I just wanted to make one more last comment. I appreciate the all the commentary you guys gave around, the ability you guys data eventually and full year and the dividend, but I also very much appreciate you guys putting in the support as necessary to cover that if there are some bumps along the way. So I think shareholders really do appreciate those measures you put in, but those are all my questions. I appreciate the time this morning.

[Robert Hamwee:]

Great. Thanks, Ryan. We appreciate the questions and the comments, so thank you.

[Operator:]

Your next question comes from Bryce Rowe with Hovde.

[Bryce Rowe:]

So, first comment, I think you should probably trademark the NII protection program as a statement that's a good one.

[Robert Hamwee:]

Yes. Thank you, We like it.

[Bryce Rowe:]

So I wanted to, I guess you guys commented on the repayment watch list and it being relatively long and a possible source of cash flow for newer investments going forward. Maybe you could help us think about kind of the size of that repayment watchlist and what the yield looks like on it relative to maybe where you're investing today?

[Robert Hamwee:]

Yes, I'm going to turn that one over to John. John, you want to maybe comment on that?

[John Kline:]

Sure, absolutely. So I wouldn't say that our repayment watch list, a lot of the names that we're seeing are just our core names we've owned that are in sale processes right now or we believe are in sale processes and when we think about the yield on those names it's generally consistent and I think this dovetails in my comments earlier in the call, but it's generally consistent with what we think we can underwrite in the in the prospective new deal market. So what we think it's just good loans being repaid and will find good loans in the market that that we can re-underwrite and put back in the portfolio. So I don't think it's a degradation of yield, I don't think it's going to be a big yield enhancement, but we just, as I mentioned, you view this environment is as one where we can continue to meet the dividend targets and with very good safety in the portfolio.

[Bryce Rowe:]

Okay, that's helpful. Maybe one follow-up here on the conversation around the Edmentum, looks like they paid a dividend here in the first quarter and was curious if you expect that dividend to be stable on a going-forward basis or how should we think about just the level of that dividend coming in from Edmentum?

[Robert Hamwee:]

Yes, that's really more a truing up of some elements from the fourth quarter transaction. So we do not expect Edmentum to be a regular payer of dividends. So it was more of a one-time post transaction settling than it was a policy of paying dividends, I think Edmentum is going to be more of a growth entity than a dividend payer.

[Bryce Rowe:]

Okay and then did want to ask about the, the NII protection program and what you've put in there, as I guess you recall it a temporary solution for the next couple of a years to support and $0.30 level for the dividend. So, I assume that there was some talk around making that temporary versus permanent. So any thoughts around why not make it permanent beyond just these next two years?

[Robert Hamwee:]

Yes. Listen, I think it's open-ended. So we're not saying it's two years for sure and then we said at least two years and that's important. I also think even today, we feel pretty good about just naturally earning the $0.30, but we recognize there are some post COVID headwinds and we want to make sort of explicit what's been frankly implicit, and we just don't want anyone to be worrying about the $0.30 dividend and the sustainability and the coverage it through NII and I think in a listen two years as we've all seen in the world is a very long time and we'll be readdressing if and as needed, but I think our hope and expectation is that two years from now the things that have hurt the dividend, the base rate going down and the larger equity portfolio. We'll have made progress and there'll be just much more fulsome coverage to give people that more traditional confidence in the dividend. And of course, if there is not, we are going to be, I think you've seen as we've always been very supportive. I would be shocked if we weren't, we needed to extend it, we will likely extend it.

[Bryce Rowe:]

Yes, I agree with that. And then maybe one more question just around the liability structure. Obviously you've highlighted getting a Moody's investment-grade rating, and done a good job in laying out what you're maturities are. So with the unsecured market of being as favorable as it is now, is there an inclination to try to shift even more so the liability structure from a fixed versus floating perspective on your debt? And I guess, by that I mean do you eliminate some of the revolving credit facilities and replace them with unsecured fixed-term debt?

[Robert Hamwee:]

Yes, it's a really good question and it's something we obviously spend a lot of time thinking about as managers and exactly where is the sweetest spot in the mix, I think as we show on the presentation today. We're still pretty heavily skewed towards fixed for 57% to 43% floating on the drawn debt. We feel pretty good about that, but to the extent that migrated probably will migrate a little bit more in terms of takes. I don't see us going to like 80/20 because there is always you feel like rates are pretty low right now, and you'd like to lock that in, but you could be wrong right? Rates could go the other way. So we want some of it matched, but we do like in general that the asymmetry and it's really just a question of fine tuning around the edges. And, then as we continue to grow the business my guess is we'll probably see the growth kind of probably skewed more towards fixed and floating.

[Operator:]

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

[Robert Hamwee:]

Thank you. Just want to thank everybody. As always, we appreciate the interest and the support. Obviously, we're you know where to find us, any follow-up questions we're always around, and then, of course, look forward to speaking with everybody next quarter. Thank you, operator.

[Operator:]

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