New Mountain Finance Corporation
Q3 2013 Earnings Call Transcript

Published: 12 Nov 2013

[Operator:]

Good morning and welcome to the New Mountain Finance Corporation, third quarter 2013 earnings call and webcast. All participants will be in listen-only mode. (Operator Instructions). I would now like to turn the conference over to Rob Hamwee, CEO. Mr. Hamwee, please go ahead.

[Rob Hamwee:]

Thank you and good morning everyone. With me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; and Dave Cordova, CFO of NMFC. Steve Klinsky is going to make some introductory remarks, but before he does, I’d like to ask Dave to make some important statements regarding today's call.

[Dave Cordova:]

Thank you, Rob. I would like to advice 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 for the customary Safe Harbor disclosure in our November 12, 2013 press release and on page two of the slide presentation regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC 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 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.newmountainfinance.com or call us at 212-720-0300. At this time, I’d like to turn the call over to Steve Klinsky, the Chairman of New Mountain Finance Corporation, who will give some highlights beginning on page four of the slide presentation. Steve.

[Steve Klinsky:]

Thanks everybody. Before turning the call back over to Rob and Dave, I wanted to welcome you all to New Mountain Finance Corporation's third quarter earnings call for 2013. Rob and Dave will go through the details, but I'm once again pleased to present the highlights of another strong quarter for new Mountain Finance. New Mountain Finance's pro-forma adjusted net investment income for the quarter ended September 30, 2013 was $0.35 per share at the high end of our previously announced range of $0.33 to $0.35 per share and which more that covers our previously announced Q3 dividend of $0.34 per share. The company's book value on September 30 was $14.32 per share, which is unchanged from last quarter, even after paying out the $0.12 special dividend in August. We're also able to announce our regular dividend for the current quarter ending December 31, 2013. The regular dividend will again be $0.34 per share, consistent with our previously communicated view that we have reached a fully ramped steady state dividend level. The credit quality of the company’s loan portfolio continues to be strong, with once again no new loans placed on non-accrual this quarter. We have had only one issuer default since October 2008 when the debt effort began, representing less than 0.3% of cumulative investments made to-date. The company invested $87 million in gross originations in Q3 and has closed and committed another $73 million since quarter end, keeping us fully invested and leveraged. Targeted yields on new investments continue to be consistent with our previously communicated expectations. Our portfolio continues to emphasize positions in recession resistant, acyclical industries pursuant to New Mountain's overall strengths and strategy. We continue to be very pleased with the progress of New Mountain Finance to-date and we are pleased to address you as fellow shareholders, as well as management. With that, let me turn the call over to Rob Hamwee, New Mountain Finance Corporation's Chief Executive Office.

[Rob Hamwee:]

Thank you, Steve. As always I’d like to start with a brief review of NMFC and our strategy. As outlined on page five of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm with more than $9 billion of assets under management and approximately 100 staff members, including nearly 60 investment professionals. NMFC takes New Mountains approach to private equity and applies it to corporate credit with a consistent focus on defensive growth business models and extensive fundamental research. Some of the key hallmarks of defensive growth business models include acyclicality, sustainable secular growth drivers, high barriers to competitive entry, niche market dominant, repetitive revenue, variable cost structures, and strong free cash flow. With this historically successful, business model focused approach in mind, our mandate since the inception of New Mountains debt investment program in 2008 has been to primarily target what we believe to be high quality businesses that demonstrate most or all of the defensive growth attributes that are important to us, and to do so with an industry that are already well researched by New Mountain or more simply put, we invest in recession resistant businesses that we really know and that we really like it. We believe this approach results in a differentiated and sustainable model that will allow us to generate attractive risk adjusted rates of return across change in cycles and market condition. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource. Turning to page six, you can see our total return performance from our IPO in May 2011 to November 8, 2013. We continue to be very pleased with both our absolute and relative return performance. As outlined on page seven, credit spreads were generally tighter since our last call. As the market looked past the budgetary impact from Washington, long term rates stabilized and loan and bond funds had material cash inflows. For the most part, the compression in market spread has not been a significant and smaller less liquid credits. Recent history has shown that market conditions can change quickly, so I’d like to reemphasize that New Mountain Capital and accordingly NMFC have always been proactively focused on defensive acyclical business models and that our financing has turned out until late 2016 and not subject to traditional mark-to-market margin goal. Given the renewed focus in the market on the possibility at future short-term and long-term rate increases, we wanted to highlight NMFC's defensive positing relative to this potential issue. As you can see on page eight, 88% our portfolio is invested in floating rate debt. Therefore, even in the phase of the 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 drive, having a slightly negative impact as the cost of our borrowing rise, while our interest income does not initially go up given the presence of LIBOR floors on our asset. Our single 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 nine, we once again layout the cost basis of our investment about the current 9/30/13 portfolio and our accumulative investments since the inception of our credit business in 2008 and then show what, if anything has migrated down the performance ladder. In Q3 once again no assets had negative credit migration. We continue to have one SLF asset with a cost of $13.5 million and a fair market value of $8.8 million that previously migrated from internal rating of two, to an internal rating of three, indicating operating performance materially below our expectations, but no near or medium term expectation for non-accrual. We continue to have only one portfolio company in non-accrual, representing a cost of 0.6% of our total portfolio and under 0.1% of fair market value. Since the inception of our credit efforts in 2008 we have made investments in 119 portfolio companies, of which only one has migrated to non-accrual. Over 99% of our portfolio at fair market value is currently rated one or two on our internal scale. Pages 10 and 11 show that the operating company and SLF respectively leverage multiples for all of our holdings above $7.5 million when we entered in an investment and leverage level for the same investment as of the end of the current quarter. Well not a perfect metric, the asset-by-asset trend and 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 two tables, leverage multiples are in almost all cases roughly flat or trending in the right direction. On page 12 we show a table depicting our NMFC’s publicly traded float has increased by over four times based on the equity offerings we have competed since our IPO. We now have 45.2 million shares in our float, representing 94% of the total shares outstanding and liquidity and daily trading volume have increased commensurately. As you can see, only 2.7 million shares are now held by AIV Holdings, our private equity funds. The chart on Page 13 helps track the company’s overall economic performance since its IPO. At the top of the page we sure have a regularly quarterly divined that’s being covered out of net investment income. As you can see, we continue to 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 credits and other losses. As you can see looking at the row highlighted in green, we have had success generating real economic gains nearly every quarter through a combination of equity gains, portfolio company dividends and trading profits. Conversely we had no material realized losses as evidence by the numbers highlighted in orange, which shows that we are not avoiding non-accruals by selling poor credits at a loss prior to actual default. The net cumulative impact of the success to-date is highlighted in blue, which shows cumulative net realized gains of $22.5 million since our IPO. Next we look at unrealized appreciation and depreciation. As you can see highlighted in gray, we had a cumulative net unrealized appreciation of $15.8 million. For clarity, our mark-to-market loss on our one defaulted investment ATI of $5.5 million is reflected in this number, along with various other mark-to-market gains and losses reflected on our schedule of investments. Finally, we combined net realized with unrealized appreciation to derive the final line on the table, which in the yellow box shows the current cumulative net realized and unrealized appreciation of $38.2 million. The point her is to show that on both the realized and combined realized, unrealized basis, we have offset any credit losses or impairments with below the line gains elsewhere in the portfolio. In fact by this mythology we have now built a $38 million cushion to offset any future credit losses, some of which we have paid out as special dividends. 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 Page 14, in Q3 we made significant investments in four portfolio companies and had total growth originations of $87 million. Repayments in Q3 were broadly consistent with prior quarters totaling $112 million. As Steve briefly mentioned earlier and as shown on Page 15, we have had a busy start to Q4 with originations and commitments of $73 million. All of the investments in keeping with our strategy are in industries and businesses that are well known to us through our historical private equity activities. Pages 16 and 17 show the impact of Q3 investment and disposition activity on asset type and yields respectively, both asset originations and repayments from modestly skewed towards first lien investments. Yields on originations were slightly higher than those on disposals. The modest increase in the portfolio yield to maturity from 10.7% to 10.8% was a function of a slight decrease in the forward LIBOR curve and a modest increase on average asset yield noted above. As you can see, we continue to collectively find attractive opportunities to deploy capital. We continue to operate with our credit facility fully deployed, allowing for an optimized level of earnings. Give current market conditions, we would expect not to issue primary equity in the near term as expected repayments are likely to be sufficient to fund the current pipeline of attractive investment opportunities. In terms of the portfolio review on Page 18, the key statistics as of 9/30 was very similar to 6/30. The asset mix remains roughly evenly split between first lean and non-first lean. As always, we maintain a portfolio comprised on companies in the defensive growth industry like business services, software, education and healthcare that we believe will outperform in an uncertain economic environment. Finally, as illustrated on Page 19, we have a broadly diversified portfolio with our largest investment at 4.4% of fair value and the top 15 investments accounting for 46% of fair value consistent with past quarters. With that, I will now turn it over to our CFO, Dave Cordova, to discuss the financial statements and key financial metrics. David.

[Dave Cordova:]

Thank you Rob. For more details on the financial results and today's commentary, please refer to the Form 10-Q that was filed this morning with the SEC. Before we turn to Slide 20, I want to mention that we have included a structured chart as Appendix A in the presentation. Similar to prior calls, I will spend a moment reviewing the company’s structure as a brief refresher. The structure was set up similar to an UPREIT structure, whereby the public company Pubco has no direct operations of its own and its sole asset is its units of our operating business OpCo. The other units of OpCo are held by a private BDC owned by New Mountain’s private equity fund, AIV Holdings. This structure is a master feeder, whereby the financial statements for OpCo are allocated pro rata to Pubco and AIV Holdings based on their respective ownership. All discussion throughout this call and presentation is focused on OpCo and its operations. Additionally, OpCo owns the equity of a non-recourse vehicle, the SLF. This vehicle originates lower yielding first lien loans, but with greater leverage at 2

[Rob Hamwee:]

Thanks Dave. Well, once again we do not plan to give explicit forward guidance. 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 extremely pleased with our performance to-date. Most importantly, from a credit perspective our portfolio 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:]

Thank you. We will now begin the question-and-answer session. (Operator Instructions). And your first question comes from Troy Ward with KBW.

[Troy Ward:]

Great, thank you and good morning gentlemen.

[Rob Hamwee:]

Hey Troy.

[Troy Ward:]

Hey Rob, I’ve got a couple of questions for you and then Steve, I’d like to actually ask you some brief kind of overarching question about what your seeing in private equity. Rob quickly on, you made the comment that you don’t anticipate near term equity as you expect portfolio repayments to cover originations. Can you give a little more specificity there on what you consider near term? Is that kind of just a look into the fourth quarter?

[Rob Hamwee:]

I mean, I think that extends into the first quarter as well Troy, unless there was a meaningful change in the market tone and then also just some hideous and crowded things we have in terms of repayment looking into late Q4 and early Q1. So I would extend near term into Q1 and we’ll have to see where the market goes from there. January is seasonally a very slow month as well, so we’ll have a better sense probably February and March of where we’re at. We’re very focused on just staying fully ramped, fully levered and continuing to be very selective in what we invest in.

[Troy Ward:]

I’m sorry, I didn’t mean to cut of there. So is the expectation for the repayments, in the last couple of quarters they’ve been very steady, but it looks like, you don’t call it a $100 million, $115 million, is the expectation that that’s going to be increasing a little bit here in the fourth and first quarter or…

[Rob Hamwee:]

No, its sort of going to be, continue to be consistent. So it’s more a question of the origination flow that we find appropriate and acceptable and not dilutive to the yield.

[Troy Ward:]

Okay, and then one more. When you talk about the predecessor asset, obviously they are winding down. Is there any expectation of or desire on your part to wind that up and if not, when do you think that progression would be and the predecessor assets will go away.

[Rob Hamwee:]

Yes, I mean like you can see, they are mostly gone at this point. I mean I think that there is $100,000 of delta between the stepped up basis and the non-stepped up basis. So the combination of them continuing to wind up over the next couple of quarters, as well as you know we had just the 2.7 million shares left in the private equity fund and those shares get monetized, that will allow it to collapse the up being the C structure, which will also sort of happen. At that point will sort of accelerate for that final accounting and that would also allow it go away. So I think it wouldn’t surprise me if the first half of next year, that the whole concept just goes away, which obviously would greatly simplify our accounting reporting, etcetera.

[Troy Ward:]

Yes, we currently look forward to that simplicity.

[Rob Hamwee:]

Yes, you and David as well in the staff.

[David Cordova:]

Yes, absolutely.

[Troy Ward:]

Steve real quick here and I’ll hop back in the queue and let others ask, but Steve, we don’t get a great chance on some of these BDC calls to get a good great look in the private equity. So I’d appreciate some insight that you have. What are you seeing out there from a private equity angle, the multiples on private equity buyout, how much leverage? Where’s the leverage points and covenants and things like that you’re seeing in the private equity world right now?

[Steve Klinsky:]

Yes, I mean I think it’s a bit of a bifurcated market. For loans that are large enough to be syndicated broadly to not just BDC buyers, but all types of buyers. It continues to be a very friendly market for borrowers and credit is quite available, low covenants or no covenants are available and so I mean it’s a good debt market from a private equity buyers point of view. What we’re seeing, because what we’re seeing has been very good deal flow for our own firm, because we have a large team now that proactively chooses sectors and dives down into sectors sometimes for years to find specific companies. So we just announced an acquisition of a company called Alexander Mann Solutions last week. There’s another one that we signed up, but haven’t announced and so we find good opportunity flow. I think other firms are – I think it depends whether you can avoid auctions or not. I think the auction environment is not particularly attractive for private equity firms, but if you can find proactive things its still quite attractive. And the multiples are – the strong S&P and the strong stock market raises multiples in general, but I think there’s still good acquisitions out there.

[Troy Ward:]

And then one final question Steve is thinking back, one of the questions we get a lot is are the BDC’s more relevant to the private equity players today than they were say five or definitely 10 years ago. When you build a capital structure inside a private equity buyout, where do you typically source your senior or your subordinated debt today versus where you sourced it five years ago? Has that changed at all?

[Steve Klinsky:]

Well again, I think it’s a two part market where we’re doing things that are pretty large loans in the multi $100 million size that are easily syndicated to CLO’s and broadly I think it’s the same sources of capital. I mean it’s the major investment banks, the major commercial banks doing it. I think the sort of loans that our BDC is sourcing are usually smaller, nicher, more specialized type loans and New Mountain itself hasn’t played as much in that size as a buyer, but we study those industries as a lender, so it helps us on the lending side. So I would say it’s the same. I mean BDC’s have grown, but there’s still a very small part of the total debt market, so I think it’s pretty much the way it was seven years ago.

[Troy Ward:]

Good color. Thank you guys.

[Rob Hamwee:]

Thank you. Operator?

[Operator:]

Yes. Again thank you. (Operator Instructions) And the next question comes from (Inaudible) from Wells Fargo Securities.

[Unidentified Analyst:]

Good morning and thank you for taking my questions. It looks like purchase levels were up just slightly at the OpCo facility. Are quarter-to-date originations more or less in line with those leverage levels on the portfolio today?

[Rob Hamwee:]

Yes.

[Unidentified Analyst:]

Alright, and then another question on the quarter-to-date originations. Originations this quarter were more or less first, secondly mix that you guys traditionally have focus on. But the largest investment quarter-to-date is Crowley I believe.

[Rob Hamwee:]

Yes.

[Unidentified Analyst:]

And the preferred equity position, 12.5 yield I believe. What kind of attracts you guys to that investment and how did you source it, given that it kind of stays from your traditional focus?

[Rob Hamwee:]

Sure. Well, it does not stray from our traditional focus from a business and industry standpoint. We’ve known Crowley, which is a very large family owned logistics, shipping and logistics business through a portfolio company on our private equity side called Intermarine, which competes in the Jones market, the protected Jones shipping and logistics market, the same what Crowley does. So our private equity team member who are involves the Intermarine, got to know the Crowley management team, including the senior Crowley family member who runs the business quite well over a period in the last three or four years and we actually looked at different ways to do things on the private equity side, Intermarine, vis-à-vis our (inaudible) with Crowley. We got to know their market position very well; we got to know the team and their capability really from the inside out. So this is a perfect example of how the synergies between the private equity side and debt side work and when Crowley was looking to raise some subordinated capital to support the growth of their business, they turned to us and we actually really led the structuring and ultimate syndication of that, what turned out to be a $200 million raise for them, of which we funded $35 million and we are very pleased with the way that was able to be structured. It is a preferred stock because of some capital treatment issues they were trying to deal with, but it really had many of the characteristics of a more senior security and according to them to get the right accounting treatment. Of course important to us to get the right protection, so we were able to structure that in a way that makes sense. But again, in business we know very well, with the team we got to know very well not just in three weeks of diligence, but over literally years of talking about doing different things.

[Unidentified Analyst:]

Alright, that’s great color. And then just one last question; from the release, the 0.71 pro-forma debt-to-equity, is that for everything with the equity raised portfolio growth and kind of a normalizing of the investments payable?

[Rob Hamwee:]

No, so that’s things that were as of 09/30. So with literally just commitment and purchases that did not – that were on the books but did not fund at 09/30. So it excludes stocks that happen every month including deals that we signed up post 09/30 and including the equity rate. But because you pro-forma even further for that, we kind of right back I think in the high sixes with a few things that should fund doing that to get us right back to that point, plus or minus.

[Unidentified Analyst:]

Alright. Thanks for taking my questions and congrats on the quarter.

[Rob Hamwee:]

Great, thank you.

[Operator:]

Thank you. And there are no more questions at the present time, so I’d like to turn the call back over to management for any closing remarks.

[Rob Hamwee:]

Okay great, thank you. Well again, happy to have another strong quarter. I appreciate everyone’s time and interest and look forward to talking to people either offline or certainly in our next quarterly call in 2014. Thank you very much.

[Operator:]

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