New Mountain Finance Corporation
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Good day and welcome to the New Mountain Finance Corporation Fourth Quarter 2020 Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Rob Hamwee, CEO. Please go ahead.

[Robert Hamwee:]

Thank you, and good morning everyone, and welcome to New Mountain Finance Corporation’s Fourth Quarter Earnings Call for 2020. 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.

[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 any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our February 24 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 gain 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 would like to turn the call over to Steve Klinsky, NMFC’s Chairman who will give some highlights beginning on Page 4 of slide presentation. Steve.

[Steven Klinsky:]

Thanks, Shiraz. It's great to be able to speak to all of you today as both the Chairman of NMFC and as a fellow shareholder. New Mountain as an organization has always sought to explicitly emphasize downside safety and risk controls, as well as upside returns, and therefore has emphasized defensive growth industries that can best survive unexpected market downturns. New Mountain started with private equity 20-years ago and now manages over $30 billion of assets, including both private equity and credit. Risk control was part of our founding mission. Happily, we have never had a PE portfolio company bankruptcy or missed an interest payment in the history of our private equity effort.

[Robert Hamwee:]

Thank you, Steve. While key quarterly highlights and our standard review of NMFC are detailed on Pages 5 and 6 respectively. Once again this quarter, I would like to focus my time on getting into more detail on the crisis’ impact on asset quality, net asset value and leveraged migration and net investment income.

[John Kline:]

Thanks Rob. Throughout the course of last year despite the ongoing COVID health crisis, direct lending market conditions steadily improved. While there are pockets of ongoing stress as a result of the pandemic we see robust multiples and strong prospective sponsor interest in high quality defensive companies. After a seasonally slow January we have seen the pipeline continue to build week over week leading us to believe that we will experience solid portfolio activity going into the spring. Secondary, trading levels in the broader subinvestment grade credit markets which we view as a gauge of market health have nearly returned and in some cases surpassed pre-COVID levels. Companies in our core defensive growth sectors such as software, healthcare technology technology enabled business services are performing particularly well. We believe these sectors will continue to attract significant capital in 2021 as investors seek to maximize exposure to forward-thinking companies that will be well positioned in a post COVID World. While we've seen some pressure on yields and private credit the returns in our marketplace remain highly attractive compared to most other credit asset classes. Turning to page 15. We now show how potential changes in the base rate could impact NMFC's future earnings. As you can see the vast majority of our assets are floating rate loans with our liabilities evenly split between fixed and floating-rate instruments. NMFC's current balance sheet mix offers our shareholders consistent and stable earnings even if LIBOR remains under 1%. If base rates rise above 1% as the economy normalizes post-COVID there is meaningful upside to NMFC's net investment income. For example, assuming our current asset and liability mix if LIBOR reaches 2% our annual NII would increase by 9% for $0.10 per share. At 3% LIBOR earnings would increased by 19% or 23% per share.

[Shiraz Kajee:]

Thank you John. For more details on our financial results and today's commentary please refer to the form 10K that was filed last evening with the SEC. Now I'd like to turn your attention to slide 26. The portfolio had approximately $3 billion in investments at fair value at December 31st 2020 and total assets of $3.1 billion. We had total liabilities of $1.9 billion of which total statutory debt outstanding was $1.5 billion excluding $300 million of drone SBA guaranteed diventures. Net asset value of $1.2 billion or $12.62 per share was up $0.38 on the prior quarter. At December 31, our statutory debt to equity ratio was 1.24

[Robert Hamwee:]

Thanks Shiraz. In closing, we are increasingly optimistic about the prospects for NMFC in the months and years ahead. Our long-standing focus on lending to defensive growth businesses supported by strong sponsors should continue to serve us well. While risks are more elevated than in the past and we cannot unequivocally discount more challenging scenarios we believe our model is well suited for the current environment. We once again thank you for your continuing support and interest in these difficult times 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:]

We will now begin the question-and-answer session. Our first question comes from Finian O’Shea with Wells Fargo Securities. Please go ahead.

[Finian O’Shea:]

Hi everyone. Good morning. First question on the UniTek upgrade Robert, John it felt like that was last quarter the one major situational name that you were a bit more measured on your ability to recover and so forth. So could you provide and there's all also a significant amount to be recovered there still. So I guess two-part question can you expand a little bit on what happened there and any change in outlook on recovery potential.

[Robert Hamwee:]

Yes. Absolutely. Finn I'm going to turn that one over to John as he's really more day-to-day on UniTek. John?

[John Kline:]

Sure. Thanks Finn. Yes, I think as we've articulated in the past 2019, 2020 were both tough years for UniTek. We had some bad contracts and we also had a business unit that was in a perpetual state of decline and I think what's really happened in 2020 is we got out of the business that was declining and we've also completely exited the bad contract. So now at UniTek we have a collection of businesses that are focused on really one end market and that end market is fiber construction throughout the southeast and southern states of the U.S. and those business units that make up UniTek right now are all we believe in growth industries they're all healthy, they're all operating reasonably well. Some units are operating very well right now. So essentially that's really been the change in the complexion of UniTek. We've had to support the business throughout these changes with a little bit more capital but we do feel like it's a good investment to make in these markets which are growing and in the remaining businesses which are as I said healthy. Does that help?

[Finian O’Shea:]

Yes.

[Robert Hamwee:]

Yes. I think the only thing I would add to that is clearly -- UniTek was impacted on the good businesses by COVID and COVID has receded to some degree this company as well as the company has just adopted like many companies they've been able to run at a much more full utilization rate than earlier in 2020.

[Finian O’Shea:]

Sure. That's helpful. Thank you. And then just a question on outlook for activity we're hearing a lot from the market analysts and some of your peers that a REFI wave is coming. What's your take on that and in addition do you, if you see that as well can you comment on your pipeline today?

[Robert Hamwee:]

Yes sure. So I think we definitely are in the midst of a REFI wave in the syndicated market to what degree that penetrates the private credit market it certainly 2 way degree. We're not seeing it right now but I think we have to all acknowledge that if conditions stay attractive and spreads compress. We would expect to see some amount of REFI activity across the portfolio. The flip side to that is we are seeing pretty meaningful M&A activity. So from a pipeline perspective it's quite robust right now.

[Finian O’Shea:]

Okay. Awesome and just the final question that came to mind also from your market conditions slide. So some of these businesses enterprise software such as a major category of yours that's obviously been high, become a higher quality part of the market in recent years and it was accentuated by COVID. Do you see this trend like the strength in business software? Do you see that impacting your market like leveraged, private credit solutions for these businesses as they go up and become higher quality? I think you mentioned that private equity money certainly still continues to find its way there or seek those businesses but is that necessarily a good thing for you just sort of a if that's something you currently see or something down the line you see?

[Rob Hamwee:]

Listen, I think we've been seeing it for a number of years. I mean I think the notion of lending to an asset like enterprise software business has changed a lot in 10 years. So that's been an ongoing evolutionary thing that we have seen. I agree with you that COVID has even further cast light onto the quality of those business models and why they're attractive entities to lend to but I don't think soon we're seeing a step function change in the overall market from a lending perspective. I think there's for last number of years there's been plenty of guys who like to lend to those businesses. The good ones have always been competitive to lend to. We've obviously got our stake in the ground and have good share in that market and I would not expect that to change and I do think what's good for us is we will continue to see increasing capital flows into the buyouts of those business models. So our addressable market just continues to expand as private equity funds in general become larger and then dedicate large increasing percentages of their fund sizes to the industries that we like and that we focus on.

[Finian O’Shea:]

Okay Rob. Thanks so much. That's all for me.

[Rob Hamwee:]

Great. Thanks Fin.

[Operator:]

Our next question comes from Ryan Lynch with KBW. Please go ahead.

[Ryan Lynch:]

Hey, good morning. Thanks for taking my questions. First one I had I don't really anticipate you guys changing the types of businesses and sectors that you focus on going forward coming out of this downturn but one question I did have was do you anticipate changing kind of where you would potentially look to invest in the capital structures of those businesses being that we are now on kind of the upswing and coming out of the credit cycle versus two or three years ago but it was investing anticipation of a credit cycle hitting? Just any thoughts on that would be helpful.

[Robert Hamwee:]

Yes. It's a good question. I think what we're going to continue to do is really focus on bottoms up approach to businesses, specific industries and specific companies that that we know really well through PE and that we think are great credits and I think the place in the capital structure will be more function of where the opportunity is. That's risk adjusted opportunities. I wouldn't say we're going to say now we're at a different time in the cycle. We should be 10% more weighted to junior security. That is really not what we're going to do. I think we want to get exposure in the best risk-adjusted way possible to one of the best business models that we know the best. And so I would not expect us to target a a different position in the capital structure based on our read of where we may or may not be in the credit cycle.

[Ryan Lynch:]

Okay. Understood. Congratulations on the Edmentum investment. That's obviously been investment you guys have been with for a long period of time.

[Unidentified Company Representative:]

Yes. Thank you.

[Ryan Lynch:]

– supported it and it's turned out to be a really good investment. I'm just curious on kind of the outlook of that business and based on this transaction you guys kind of recommitted to that business and recommitted to that business at kind of bottom of the capital structure first exposure with your equity obviously you have some preferred and some debt as well. So can you just talk about why you decided to recommit to that business and also felt comfortable committing in some of the riskier and obviously higher return opportunity portions of that capital structure?

[Robert Hamwee:]

Yes. So Edmentum has been a strong performer the last two or three years, prior to COVID as we really kind of revamped management particularly the CEO who's just been a superstar. And as we've gotten to just really get our arms around the business it was a business that had some pretty strong secular trends and then when COVID came it just put virtually all of those trends on steroids. So we see a multi-year outlook for Edmentum of you never want to say yes also you can't say guaranteed growth but when you look at all the factors that drive the company's prospects they're all about as green as one can be. So we think some of the best growth is really ahead of Edmentum despite the fact that it's had incredible growth the last year and solid growth the last three years and we just want to, we've done so much work and we frankly if we didn't have a maturing capital structure at Edmentum in 2021 we just would have waited on a transaction generally but we had to do something either REFI the debt or bring in new equity and given the valuations we thought it was a good time to take some chips off the table but we wanted to recommit the bulk of our exposure because we just believe there is, you want to ride your winners in the investment world. We've had very good success with that as a firm and we think this is one of the best potential winners that we have exposure to and we don't think this is not going to take five years to play out. I don't want to give specific time frames but we think there's an opportunity more in the medium term to show that that future value creation.

[Ryan Lynch:]

Understood. Yes obviously a business yes. You have deep knowledge and deep experience with fundamentals there. You sounded somewhat what positive on even some of your more stressed businesses ability to recover in 2021 depending on kind of the kind of the economic recovery and kind of the reopening. Do you guys have any sort of baseline that a baseline of reopening a recovery that you guys used to make those comments and what would that look like?

[Robert Hamwee:]

I think it's really more around the narrower issue around COVID because if you think of some of those remaining stressed assets whether it's getting to full utilization and dental because of COVID kind of getting significantly reduced or whether it's an education based business not like it mentioned but one that is more levered to in-person education or whether it's a hotel exposed business those are our few remaining red and orange names. All those things will benefit materially all else equal by vaccination and by ultimately the font the COVID, the final COVID exposed name getting recovered. So the handful of things we have there it's more about that versus whether it's GDP up two or up five. So the optimism and we're not smarter than anyone else about epidemiology but we're just reading the same things you and everybody else are that vaccines are happening and that vaccine optimism is increasing and so it's not crazy to think about a second half of 2021 where those COVID induced headwinds reduced materially and that should help those few remaining businesses that are on our heat map. So really Ryan I guess it's the COVID relative to where we were a quarter ago that's driving that tone changed

[Ryan Lynch:]

Okay. Understood. I appreciate that Rob. Those are my questions I appreciate the time this morning.

[Robert Hamwee:]

Great. Now we appreciate your interest thank you.

[Operator:]

Our next question comes from Arthur Winston with Pilot Advisors. Please go ahead.

[Arthur Winston:]

Okay. Thanks for the excellent results and the amount of transparency and disclosure. It's excellent.

[Robert Hamwee:]

Thank you.

[Arthur Winston:]

The originations had a higher level of interest rate and of course overall interest rates are rising yet it sounds like because of prepayments and whatever he yield in the portfolio is definitely going to go down for the foreseeable future. Is that fact?

[Robert Hamwee:]

I'm not sure that totally fact. I think we're originating a similar yields as we have been. They come down that somewhat. I think the bigger driver is really the leverage coming down and we're committed to that. I think we're, where we should be relatively stable from here as from leverage perspective. So I think the question is on the one hand like you say rates are going up now. They are really going up more on the long end of the curve. We're not really exposed to that. So we are more tied to the short end of the curve, where rates are not going up. Certainly as John articulated if the short end at some point whether it's this year or next year or whenever if the short end does start to go up some more historically normalize levels, that would be a big tail win for us. And then it really comes down to what's going to happen with credit spread across someone this this year so far, but we've seen that before and then they've gone back up. So I think we're going to be tracking that very carefully and that will really be the driver in the next couple of quarters as to overall asset level yields if that makes sense.

[Arthur Winston:]

But why is it that your that is on the leverage side rather than taking the opportunity to expand a little bit with the better environment we're supposed to be seeing.

[Robert Hamwee:]

Well I think there's a couple of things. I think until we get the true-true all clear that there's no new mutation that's gonna screw things up again or what it may be we still want to be somewhat defensively pastured and then I think what we're seeing is there may be an opportunity if we keep our leverage at a slightly lower level than what we were running at pre-COVID there may be an opportunity to more materially reduce our borrowing expenses. So we're monitoring that and trading off those that math as well. So those are the things kind of driving right now where we think the leverage makes sense.

[Arthur Winston:]

Okay. Thank you.

[Robert Hamwee:]

Yes. You're welcome.

[Operator:]

Our next question comes from Chris with Oppenheimer. Please go ahead.

[Unidentified Analyst:]

Yes. Good morning and thank you. I liked your slide 11 about the net recovery process and I was trying to kind of mentally draw an equivalent map of what the path would be for a recovery of your distribution to the pre-COVID level of 34 and I mean the obvious candidates would be rising short rates, I guess and then also converting equity investment into yielding investments, but I mean is there a corresponding map to be drawn? And what would be the key elements of that?

[Robert Hamwee:]

Yes. You hit dead center. Those are the two drivers that get us back to where we were which is LIBOR going from 25 bips to 2% not like it needed to go to 6% but 25 bips is tough. So that's driver one and driver two is exactly what you said, it's recycling some of this equity exposure that has no yield but is still compounding ultimately monetizing that and re-plowing that back into yielding assets. And that math is very powerful. If you took, you know, just stuff you to round numbers over time. You recycled a hundred million dollars of equity exposure into assets yielding 8% that $8 million that really blows the bottom line right? Because there's no more extra management fee on that. There is no more extra leverage that you need for that. So that's pretty powerful. And so it really is a combination of those two things obviously making sure there is no future deterioration in earnings on future default would be offsetting that. So that's that that is the rough, those are the factors that will drive. It will drive. So I think you're dead on that.

[Unidentified Analyst:]

Okay. Alright, that's it for me. Thank you.

[Robert Hamwee:]

Yes, you're welcome.

[Operator:]

Our next question comes from Bryce Rowe with group, please go ahead.

[Unidentified Analyst:]

Thanks. Good morning everyone.

[Robert Hamwee:]

Hello.

[Unidentified Analyst:]

Hi, can you hear me okay?

[Robert Hamwee:]

Yes Bryce we can hear you well.

[Unidentified Analyst:]

Okay. Sorry. Rob I wanted to just kind of follow up on that comment you made about potentially being able to you know further reduce some of your interest costs and clearly we saw the issuance here recently at a nice rate and so I'm curious kind of where that comment is kind of targeted? Is it targeted to some of the unsecured debt that is is on the balance sheet now or do you see some potential for spreads coming down within the revolving facilities, within the capital structure.

[Robert Hamwee:]

Yes. I think it's predominantly the former on the unsecured side but we do think there's room on the secured side as well as we come out of obviously what was a tough year and we've seen the the dramatic decline in AAA CLO liabilities and the secured market tends to benchmark off of that market. So yes we think there is there's a potential opportunity there. So it's both sides but I think for the long term the more dramatic opportunity potentially is on the unsecured side.

[Unidentified Analyst:]

Okay and can you remind us what the opportunity is to refinance some of those unsecured notes. I mean obviously the next maturity is July of 22 and so just trying to think about kind of when you might look to pay those down if there is in fact an opportunity to prepay?

[Robert Hamwee:]

Yes. I mean it's the timing gets into call provisions which are a little bit different across the board and magnitude right. I mean if the gap in rate is big enough you can you can prepay early and make that math work but you can see you know maturity wall is in 2023 but there may be the ability to pull some of that forward like we're doing with the baby bonds for instance now. So it's that timing would be or that the next 6 to 18 months would be I think the way to think about it.

[Unidentified Analyst:]

Okay. Great. That's all for me. I appreciate the comments.

[Robert Hamwee:]

Yes. Absolutely.

[Operator:]

As there are no questions this concludes our question and answer session. I would like to turn the conference back to Rob Hammwe for any closing remarks.

[Robert Hamwee:]

Thank you and thanks to everyone. I appreciate again as always the time and the attention and look forward to talking to everybody in a couple of months to talk about Q1 and in the interim of course we're always available people know where to find us. So thank you and have a great rest of the day. Bye-bye.

[Operator:]

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