New Mountain Finance Corporation
Q3 2014 Earnings Call Transcript

Published: 6 Nov 2014

[Operator:]

Good morning, and welcome to the New Mountain Finance Corporation Third Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Robert Hamwee, CEO. Please go ahead sir.

[Robert Hamwee:]

Thank you and good morning everyone and welcome to New Mountain Finance Corporation’s third quarter earnings call for 2014. With me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital and Dave Cordova, CFO of NMFC. Steve is going to make some introductory remarks. But before he does, I would like to ask Dave to make some important statements regarding today's call.

[David Cordova:]

Thank you, Rob. I would like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of New Mountain Finance Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our November 5, 2014 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 to by law. Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital, LLC or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisors 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 would like to turn the call back over to Steve Klinsky who will give some highlights beginning on page four of the slide presentation. Steve?

[Steve Klinsky:]

Thank you. Rob and Dave will go through the details in a moment but let me start by presenting the highlights of another strong quarter overall for New Mountain Finance. New Mountain Finance’s pro forma adjusted net investment income for the quarter ended September 30, 2014 was $0.35 per share, the high-end of our guidance of $0.33 to $0.35 per share. This once again more than covers our Q3 dividend of $0.34 per share. The company's book value on September 30 was $14.33 per share, which is down $0.20 from last quarter after adjusting for the recent $0.12special dividend. We're also able to announce our regular dividend for the current quarter ending December 31, 2014. 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 overall credit quality of the company's loan portfolio continues to be strong. We had one new loan placed on nonaccrual this quarter, representing only our second nonaccrual since inception of our debt effort in October 2008. We have had only one issuer with the realized default loss since inception, representing less than 0.2% of cumulative investments made to date. The company invested $199 million in gross originations in Q3 and $64 million net of repayments. In addition to the positive quarterly results of the core business, we continue to execute on strategic initiatives that we believe will create meaningful shareholder value in the coming quarters. We've completed the ramp-up of our senior loan program that will generate management fees for the BDC. We’ve also begun to utilize our recently issued SBIC license. In summary, we are pleased with NMFC’s continued performance and progress. With that, let me turn the call back over to Rob Hamwee, NMFC’s CEO.

[Robert Hamwee:]

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. On Page 5, we provided some key financial highlights. As outlined on pages 6 and 7 of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm, approximately $15 billion of assets under management, and 100 staff members, including over 60 investment professionals. Since the inception of our debt investment program in 2008, we’ve taken New Mountain’s approach to private equity and applied it to corporate credit with the consistent focus on defensive growth business model 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. Additionally, I would note here that our public float is now $850 million, up from $150 million at our IPO. Turning to Page 8, you can see our total return performance from our IPO in May 2011 through November 3, 2014. In the three and half years since our IPO, we have generated a compounded annual return to our investors of 13.4%, significantly above our regular dividend yield. Page 9 breaks up the four components of this return. As you can see, the excess reflects the ongoing impact of our special dividend, increasing book value and trading multiple expansion. As outlined on Page 10, credit spreads modestly widened since our last call, driven largely by increased volatility across financial markets and, to a lesser degree, ongoing fund outflows. Although markets have recently stabilized, risk premiums remain somewhat elevated, creating a reasonably attractive environment to deploy capital. We continue to see significantly elevated credit spreads in smaller less liquid credits. Given the continued focus in the market and the possibility of future short-term and long-term rate increases, we wanted to highlight NMFC’s defensive positioning rather to this potential issue. As you can see on Page 11, 87% of our portfolio is invested in floating rate debt. Therefore, even in the face of a material rise in interest rates assuming a consistently shaped yield curve, we would not expect to see a significant change in our book value. Furthermore, as the table at the bottom of the page demonstrates, a meaningful rise in short-term rates will generally increase our NII per share with the only exception being a modest rise having a slightly negative impact as the cost of the majority of our borrowings rise while our interest income does not initially go up given the presence of LIBOR floors on our assets. Our highest priority continues to be our focus on risk control and credit performance which we believe over time is the single biggest differentiator of total return in the BDC space. If you refer to Page 12, we once again the layout the cost basis of our investments both the current 9/30/2014 portfolio and our cumulative investments since the inception of our credit business in 2008 and then show what has migrated down the performance ladder. Since inception, we have made investments of nearly $2.9 billion in 145 portfolio companies, of which only two representing just $17 million of costs have migrated to non-accrual and only one representing $4 million of costs has resulted in the default line. Over 99% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale. Pages, 13 and 14 show leverage multiples for all of our holdings above $7.5 million when we entered an investment and leverage levels for the same investment as of the end of the current quarter. 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 roughly flat or trending in the right direction with only two exceptions one of which is UniTek. Page 15 discusses UniTek in more detail. UniTek provides outsource services through three discrete operating segments

[David Cordova:]

Thank you, Rob. For more details on the financial results in today's commentary please refer to the Form 10-Q that was filed last evening with the SEC. Now I would like to turn your attention to Slide 24. The portfolio had just over $1.35 billion investment at fair value at September 30, 2014 and total assets of just under $1.4 billion. We had total liabilities of $650.7 million of which total debt outstanding was approximately $600.8 million. Net asset value of $747.5 million or $14.33 per share was down $0.20 from the previous quarter pro forma for the $0.12 special dividend paid during the quarter, primarily due to net unrealized depreciation. As of September 30, our debt-to-equity ratio was 0.8 to 1 which exceeded the high-end of our target range. The weighted-average debt-to-equity ratio during the quarter was approximately 0.74 to 1. On Slide 25, we show the historical NAV per share and leverage ratios, which are probably consistent with our target leverage between 0.65 to 0.75 to 1. We also show the NAV adjusted for the cumulative impact of special dividends which portrays a more accurate reflection of true economic value creation and highlights the general upward trend in NAV per share since inception. On Slide 26, we show our quarterly income statement results. We believe that adjusted NII which excludes the capital gains incentive fees is the most appropriate measure of our quarterly performance. This slide highlights that while realizations and unrealized appreciation, depreciation can be volatile below the line, we continue to generate stable net investment income above the line. Focusing on the quarter ended September 30, 2014 we earned total investment income of approximately $34.7 million. This represents an increase of 1 million or 3% from the prior quarter, largely attributable to an increase in interest income from a larger asset base offset by a modest decrease in prepayment fees. Total net expenses of $16.6 million increased $1.5 million or 10% due to an increase in management fees associated with the asset growth as well as an increase in interest expense associated a higher average debt balance. Net administrative, professional and other general and administrative expenses were roughly flat with the prior quarter. This results in third quarter adjusted NII of $18.1 million or $0.35 per weighted average share, which is at the high-end of our guidance provided on August 7, 2014 of $0.33 to $0.35 per share and more than covers our Q3 regular dividend of $0.34 per share. Shifting to below the NII line, we had adjusted net realized gains of $0.6 million. Adjusted unrealized losses of $14 million were largely driven by the write-down of our positioning UniTek of approximately 11.5 million and lower marks in the broader portfolio of approximately $7 million which was offset by an increase in unrealized appreciation on one of our equity positions of approximately $4.6 million. As a result of the net unrealized appreciation in the quarter, we reduced our capital gains incentive fee accrual by approximately $2.7 million. In total, for the quarter ended September 30, 2014 we had a net increase in net assets resulting from operations of $7.4 million. As Slide 27 demonstrates, our total investment income is predominantly paid in cash. Though the amount of prepayment fees vary from quarter-to-quarter based on repayments, our historical earnings have consistently shown some material prepayment fee income. Therefore we show total interest income as a percentage of total investment income both with and without prepayment fees which is one measurement of the stability and predictability of our investment income. Turning to Slide 28, as briefly discussed earlier, our adjusted NII for the third quarter more than covered our Q3 dividend. Given our belief that our Q4 NII will fall within the previously declared expected range of $0.33 to $0.35 per share, our Board of Directors has declared a Q4 2014 dividend of $0.34 per share in line with the past 10 quarters. The Q4 2014 quarterly dividend of $0.34 per share will be paid on December 30, 2014 the holders of record on December 16, 2014. On Slide 29, we highlight our various financing sources, including the convertible notes issued in corporate revolving credit facility that closed earlier this year. Taking into account SBIC debentures from our recently announced SBIC license, we now have 810 million of total pro forma borrowing capacity. As a reminder, our Wells Fargo credit facility covenants are generally tied to the operating performance of the underlying businesses that we lend to rather than the marks of our investments at any given time. We are also currently documenting extensions of our Wells Fargo credit facilities. At this time I would like to turn the call back over to Rob.

[Robert 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 as long as the adjusted NII covers the dividend in line with our current expectation. In closing, I would just like to say that we continue to be extremely pleased with our performance to date. Most importantly, from a credit perspective our overall portfolio continues to be very healthy. Once we like to thank you for your support and interest and at this time I will turn things back to the operator to begin the Q&A. Operator?

[Operator:]

(Operator Instructions) And our first question today will come from Ryan Lynch of KBW.

[Ryan Lynch:]

First one is regarding the senior loan program. Now that’s closed and fully funded, are you guys in discussions with other partners about possibly signing up a senior secured loan program too and any time from around that closing will be really helpful to us?

[Robert Hamwee:]

Yeah I would say we are in some preliminary discussions. From a timeframe perspective, I wouldn't expect anything in the first half of next year, perhaps in the second half of next year.

[Ryan Lynch:]

And are you targeting with an SLP number 2, similar size, similar management fees and expected returns?

[Robert Hamwee:]

Yes.

[Ryan Lynch:]

And then to touch on UniTek for a second. First, I just wanted to confirm that there was $27 million of UniTek that is still making interest payments to you guys. Is that correct?

[David Cordova:]

Yes, some of it’s making payment in cash, some of it which continues to be growing. Yes.

[Ryan Lynch:]

So how should we think about those payments as UniTek officially files for bankruptcy this week? Are those going to continue or how should we think about those?

[David Cordova:]

So the payments I am referring to is on the new securities that are outlined in the reorganization plan. So again there will be some that are paid in cash, some that will accrue and since we control the whole capital structure, we and the other lenders, we will be taking out cash as appropriate once we get the business where we want it to be.

[Ryan Lynch:]

And then one more in regards to the SBIC, it looks like you guys have kind of funded maybe two loans in the SBIC which is a small sample size but just looking at those two loans, looks like they are subordinated debt and they have kind of double digits midteens yield on those. Is that kind of what we should be expecting to go into the SBIC kind of more subordinated debt and maybe a little bit higher-yielding loans versus what you guys have kind of historically done to your portfolio?

[Robert Hamwee:]

It will be a mix. I think over time it will broadly mirror the big portfolio at the BDC. So I think like you said it’s small size and I would expect as the program is fully ramped up you will see a mix of junior and senior with yields consistent with our broader yield profile.

[Ryan Lynch:]

And then just one more I was just looking through, looks like about 77% of your portfolio is kind of in energy investments. I just kind of quickly looked through a couple on them, looked like they had pretty good fair value marks on them in the quarter, but I was just wondering how -- are any of those businesses kind of tied to the oil and gas industry and if they are, are they feeling any effects of the recent downturn in energy prices?

[Robert Hamwee:]

Yes, the answer is some are, none of them are through a direct commodity exposure E&P type investment. Some are first or second derivative, we specifically target the investment that we do not expect to correlate, because we have no idea where oil and gas prices are going. So businesses that are – have models that you would not expect to be meaningfully impacted by the price movements and price volatility in the underlying commodity.

[Operator:]

And the next question comes from Greg Nelson of Wells Fargo Securities.

[Greg Nelson:]

Just hitting back on UniTek per a second. Does the mark at end of the quarter – does that include everything that was going on with the bankruptcy, because I know 40% of your debt has been converted to equity and you’re holding the entire position on the books at about $0.72 on the dollar. Is that mark reflective of the entire prepack?

[Robert Hamwee:]

Yes, absolutely.

[Greg Nelson:]

And I'm assuming that the amount you put on that accrual is what you assume will be converted into equity?

[Robert Hamwee:]

Yes, well it’s consistent with the amount that is going to flow through from a mark-down perspective which is broadly consistent with the equity movement. Well, at the end of the reorganization process which we hope and expect will be at the end of this quarter, we will break out the new securities that we are converting into the new debt pieces and the equity piece and show individual marks and that will sort of add back up to the $0.71.

[Greg Nelson:]

And then on SBIC facility, I don’t believe you guys – you started funding and you didn’t draw-down on the SBIC or SBI debt, yet, what’s your outlook for timeframe that you expect to start pulling on the facility and drawing some debt?

[Robert Hamwee:]

Yes, we are expecting to drawdown some debt to fund two new investments this quarter, so this month actually, in the coming days we expect to make our first borrowings under the facility and I would expect , if I had to guess by the end of the quarter we would be maybe half- drawn on the first 75 tranche and then moving up from there in the coming quarters.

[Greg Nelson:]

And then last question just on -- obviously this quarter was pretty robust from an origination standpoint but also kind of robust from a repayment standpoint, but then looking at the quarter, activity repayments were little bit lower. Just kind of get a sense of how you’re thinking of net portfolio growth here and then as it relates to equity issuance going forward?

[Robert Hamwee:]

Sure, I would – if I had to guess it’s always so hard, right, because the repayments tend to be pretty lumpy. We feel very good about the origination, the pipeline is very strong today. So I would expect from an origination perspective, Q4s look very similar to Q3, always plus or minus because the deals can move meaningfully. And then the repayments it’s tougher to see – I certainly wouldn’t expect it to be greater repayments than we saw in Q3, potentially somewhat less but we have a few meaningful ones that we know are coming – well, one that we know is upcoming this quarter and one that may happen end of this quarter and may leak into January. So as always we will manage our balance sheet first and foremost to be fully levered, take advantage of the attractively priced financing that we have, including the SBA leverage that we don't think about, when we think about our target range, when we talk about our target range to that 0.75 number, we exclude the SBA leverage from that. So as we use – as we drawdown on the SBA to fund some deals this quarter, that sort of incremental buying power that would push any future equity issuance further into the future but it’s always the timing around any further equity issuances will be driven by first our ability to be fully levered and capitalized, and then secondly, incremental attractive deal flow that we see in excess of repayments.

[Greg Nelson:]

And then just touch on that point briefly for a second. So you are still targeting 0.75 times leverage regardless of SBA debt. So no matter where economic leverage goes, you still target 0.75 from a regularly perspective?

[Robert Hamwee:]

We are comfortable up to 0.75, we always see our range is 0.65 to 0.75, but we're clearly comfortable up to 0.75 on a steady state basis. And yes, we are focused on the regulatory perspective, not the financial perspective, it looks t be somewhat higher once we start drawing down on the SBA debt.

[Operator:]

And our next question will come from Arthur Winston of Pilot Advisors.

[Arthur Winston:]

As becoming a long term investor, we are appreciative of the credit – the great credit you guys are doing and the fact that there is inside ownership by the people who collect the fees. But the thing I can’t figure out is that with the current leverage -- your projection from leverage how these incremental equity offerings can result in higher dividends or net investment income to the existing shareholders, it seems like – with the returns you get a new investments you’re more like on a treadmill in terms of – with the net investment income to be and we’re appreciative of the capital gains distributions which have been terrific.

[Robert Hamwee:]

I mean again we raise equity when we have the attractive new investment pipeline in terms of the other obviously covenant we have with the investor bases to always raise equity on a net basis, at least the book value. And then the benefits -- so they are at least – like you say breakeven right, we do think they are accretive to the extent that we are continuing to use some of that equity for instance to fund our equity investments in the SBA where returns to the shareholders are considerably higher than our existing return on equity. There is also benefits to scale relative to amortizing fixed costs across the broader platform and there is some benefits to scale in terms of securing deal flow, I think given our scale today we're doing some very interesting unit tranche financing that we couldn’t do in the past. So I do think over time there – you could argue that it works to its neutral but I do actually think that as our scale grows, we do get benefits to that, that get passed along to the shareholders.

[Operator:]

And this will conclude our question-and-answer session. I would like to turn the conference back over to Robert Hamwee for any closing remarks.

[Robert Hamwee:]

Great, thank you. Again we appreciate everyone’s time this morning and ongoing support of the company and look forward to talking to you in the new year. Thank you very much.

[Operator:]

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