New Mountain Finance Corporation 8.250% Notes due 2028 (NMFCZ) Q2 2018 Earnings Report, Transcript and Summary

Good morning and welcome to the New Mountain Finance Corporation’s Second Quarter 2018 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Rob Hamwee, CEO. Please go ahead.

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

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 if any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our August 7th earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our Press Release, and on Page 2 of the slide presentation regarding forward-looking statements. Today’s conference call and webcast may include forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from those statements and projections. We do not undertake to update our forward-looking statements or projections, unless required to by law. To obtain copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, please visit our website at www.newmountainfinance.com. At this time, I’d like to turn the call over to Steve Klinsky, NMFC's Chairman who will give some highlights beginning on Pages 4 and 5 of the slide presentation. Steve?

The team will go through the details in a moment. But let me start by presenting the highlights of another solid quarter for New Mountain Finance. New Mountain Finance's net investment income for the quarter ended June 30, 2018 was $0.34 per share, in the middle of our guidance of $0.33 to $0.35 per share, and once again covering our quarterly dividend of $0.34 per share. New Mountain Finance's book value was stable at $13.57 per share as compared to $13.60 per share last quarter. We're also able to announce our regular dividend, which for the 26th straight quarter will again be $0.34 per share, an annualized yield of nearly 10% based on last Friday's close. The company had another productive quarter of deal generation, investing $296 million in gross originations versus repayment of $153 million, allowing us to begin to deploy the incremental leverage approved by shareholders in the quarter. Credit quality generally remains strong. Although for the first time in over year one new asset has gone on non-accrual. I and other members of New Mountain continue to be very large owners of our stock with aggregate ownership of 9.6 million shares, approximately 13% of total shares outstanding. Finally, the broader New Mountain platform that supports NMFC continues to grow with over $20 billion of assets under management and 140 team members. In summary, we are very pleased with NMFC's continued performance and progress overall. With that, let me turn the call back over to Rob Hamwee, NMFC’s CEO.

Thank you, Steve. Before diving into the details of the quarter, as always, I’d like to give everyone a brief review of NMFC and our strategy. As outlined on Page 6 of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm. Since the inception of our debt investment program in 2008, we have taken New Mountain’s approach to private equity and applied it to corporate credit with a consistent focus on defensive growth business models and extensive fundamental research within industries that are already well known to New Mountain or more simply put, we invest in recession-resistant businesses that we really know and that we really like. We believe this approach results in a differentiated and sustainable model that allows us to generate attractive risk adjusted rates of return across changing cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource. Turning to Page 7, you can see our total return performance from our IPO in May 2011 through August 3, 2018. In the seven plus years since our IPO, we have generated a compounded annual return to our initial public investors of over 11%, meaningfully higher than our peers in the high yield index and approximately 1,000 basis point per annum above relevant risk free benchmarks. Page 8 goes into a little more detail around relative performance against our peer set, benchmarking against the 10 largest externally managed BDCs that have been public at least as long as we have. Page 9 shows return attribution. Total cumulative return continues to be largely driven by our cash dividend, which in turn has been more than 100% covered by NII. As the bar on the far right illustrates, over the seven plus years we have been public, we have effectively maintained a stable book value inclusive of a special dividend while generating a 10.4% cash-on-cash return for our shareholders. We attribute our success to; one, our differentiated underwriting platform; two, our ability to consistently generate the vast majority of our NII from stable cash interest income and an amount that covers our dividend; three, our focus on running the business with an efficient balance sheet and always fully utilizing inexpensive, appropriately structured leverage before accepting more expensive equity; and four, our alignment of shareholder and management interests. 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. While credit performance continues to be generally strong, we did experience one new non-accrual during the quarter in National HME, a $27 million second lien, where we own 100% of the tranche. National HME is a leading distributor of equipment into the hospice market. Our end market trends have been strong and consistent with our underwriting features. Execution has been lacking causing a drop in operating results. During very recent financial performance, we have valued our position at $0.50, but we are bringing our domain expertise and private equity resources to bear in order to maximize our recovery overtime. If you refer to Page 10, we once again lay up the cost bases of our investment both the current 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 over $5.8 billion into 138 portfolio companies, of which only 8 representing just $125 million of cost have migrated to non-accrual, of which only 4 representing $43 million of cost have thus far resulted in realized default losses. Further, firstly 100% of our portfolio has fair market value is currently rated 1 or 2 on our internal scale. Page 11 shows 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 most recent reporting period. While not a perfect metric, the asset by asset trend and leverage multiple is a good snapshot of credit performance and it helps to derive some degree of empirical, fundamental support for our internal ratings remarks. As you can see by looking at the table, leverage multiples are roughly flat or trending in the right direction with only a few exceptions. Only three loans showed negative migration of 2.5 turns or more, one is National HMA, and one is previously restructured and maintained. The other is a business that has had a few difficult quarters both were operating trends are expected to improve and with the sponsor has invested significant new equity capital to delever the balance sheet giving us confidence that this loan will continue to perform. The chart on Page 12 helps to track the company's overall economic performance since its IPO. At the top of the page, we show how the regular quarterly dividend is being covered at a net investment income. As you can see, we continue to more than cover 100% of our cumulative regular dividend out of NII. On the bottom of the page, we focused on below the line items. First, we looked at realized gains and realized credit and other losses. As you can see looking at the row highlighted in Green, we have had success generating real economic gains every year through a combination of equity gains, portfolio company dividends and trading profits. Conversely, realized losses including the default losses, highlighted in orange, have generally been smaller and less frequent and show that we are typically not avoiding non-accruals by selling poor credits at a material loss prior to actual default. As highlighted in Blue, we continue to have a net cumulative realized gain of $6 million. Looking further down the page, we can see that cumulative net unrealized appreciation, highlighted in gray, stands at $21 million, and cumulative net realized and unrealized loss, highlighted in yellow, is at $16 million. The net result of all of this is that in our seven plus years as a public company we get earned net investment income of $533 million, again total cumulative net losses including unrealized of only $60 million. I will now turn the call over to John Kline, NMFC's President, to discuss market conditions and portfolio activity. John?

Thanks, Rob. As outlined on Page 13, the leverage credit market has been relatively stable throughout the year. However, recently, we observed some small pockets of volatility in the new issued market, where certain deals with aggressive debt structures and terms have need higher pricing to clear the market. As a result, there has been evolved in the wave of loan re-pricing activity that we observed earlier in the year and new issue spreads for quality deals have stabilized and some cases techs slightly wider. Still most deals that we evaluate continue to have strong competitive tension between lenders who are eager to deploy capital into the private credit market. Three months LIBOR, which has been a meaningful tailwinds for NMFC was relatively flat in this quarter at 2.34%. Deal flow and our core defensive growth sectors have been very steady throughout the late spring and summer and particularly strong in the early part of the third quarter. We attribute the strength was heavy market and good performance by our team of professionals focused on new deal flow. Looking forward, we expect this momentum to continue as we are currently evaluating a number of transactions that could become new investments for NMFC in the near future. Turning to Page 14, NMFC continues to be positively exposed the future of rate increases as 86% of our portfolio is invested in floating rate debt, and 51% of our liabilities are locked in over the medium term at attractive fixed rates. As the chart on the bottom of the page shows, given our investment portfolio and liability mix, NMFC’s earnings are positively leverage to any further increases in short term rates. Moving onto portfolio activity, as seen on pages 15 and 16, NMFC had an active quarter with total originations of $296 million offset by $153 million of portfolio repayments and $56 million of sales proceeds, representing an $87 million expansion of our investment portfolio. Our new investments were highlighted by a number of club style executions, one addition to our net lease portfolio, and the initial funding of our SLP III loan program. On Page 17, we show that since the end of Q2 we have booked $170 million of new investments offset by $182 million of sales and repayments yielding a temporary portfolio decline of $13 million. As I mentioned earlier, we have a number of committed deals in our queue and a strong pipeline of new deal opportunities. Turning to Page 18, our Q2 originations were weighted toward senior oriented investments inclusive of first lien debt net lease on our SLP III investment, while on the right side of page, we show that 80% of our Q2 repayments were second lien assets. So far in Q3, 70% of originations were first lien oriented assets, while 61% of our repayments were second lien investments. While the mix of originations and repayments varies from quarter-to-quarter, this recent portfolio activity shows that consistent with our guidance, we continue to reorient the portfolio towards a higher mix of first lien assets, which support NMFC’s higher leverage levels. As shown on Page 19, Q2 asset yields on new origination of 10.6% were somewhere lower than the average yield of the portfolio. This is due primarily to the senior heavy mix on new originations in the quarter. Overall, we continue to maintain a healthy weight average interest rate on our investment portfolio despite the competitive environment. On the top of Page 20, we show a balanced portfolio across our defensive growth oriented sectors. In the services section of the pie chart, we breakout subsectors to give better insight into the diversity within our largest sector. On the bottom of the page, we show our portfolio by asset type where we continue to maintain a balanced split between senior and subordinated investments. As you can see, first lien debt SLP investments and net lease investments represent 50% of the portfolio with non-first lien oriented investments accounting for the other half of the portfolio. The Pie chart in the lower right shows that we continue to have a clean book of investments with low exposure to underperforming loans. Finally, as illustrated on Page 21, we have a broadly diversified portfolio with our largest investment at 5.5% at fair value and the top 15 investments accounted for 44% of fair value. With that, I will now turn it over to our CFO, Shiraz Kajee, to discuss the financial statements and key financial metrics. Shiraz?

Thanks, John. For more details in our financial results in 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 22. In the portfolio we had approximately $2.1 billion in investments at fair value at June 30, 2018, and total assets of $2.2 billion. We have total liabilities of $1.2 billion of which total statutory debt outstanding was $931 million, excluding $163 million of drawn SPA guarantee debentures. Net asset value of $1 billion, a $13.57 per share, was down $0.03 from the prior quarter. As of June 30, our statutory debt-to-equity ratio was 0.9 to 1. On Slide 23, we show our historical leverage ratios. We expect to increase leverage overtime given the shareholders approval we received in Q2. In the slide, we also show the historical NAV adjusted for the cumulative impact of special dividends, which would trade the more accurate reflection of true economic value creation. On Slide 24, we show our quarterly income statement results. We believe that our net investment income is the most appropriate measure of our quality performance. This slide highlights that our realized and unrealized gains and losses can be volatile below line, we continue to generate stable net investment income above the line. Focusing on the quarter ended June 30, 2018, we earned total investment income of $54.6 million, a $1.7 million increase from the prior quarter, primarily due to an increase in interest income from a higher asset base. Total net expenses were approximately $28.8 million, a $1.6 million increase from the prior quarter due to higher borrowing costs. As in prior quarters, the investment advisor continues to raise certain management fees such that the effective annualized management fees of 1.45%. It is important to note that the investment advisor capital group fees previously weighed. This results in second quarter NII of $25.8 million, a $0.34 per weighted average share, which is within guidance and covered our Q2 regular dividend of $0.34 per share. In total, for the quarter-ended June 30, 2018, where an increase in net assets resulting from operations of $23.2 million. As Slide 25 demonstrates how total investment income is recurring in nature and predominantly fading cash. As you can see, 93% of total investment income is incurred and cash income remains strong at 83% of this quarter. We believe this consistency shows the stability and predictability of our investment income. Turning to Slide 26, as briefly discussed earlier, our NII from the second quarter covered our Q2 dividend. We now believe that our Q3, 2018 NII before within our guidance of $0.33 to $0.35 per share. Our Board of Directors has declared the Q3 2018 dividend of $0.34 per share, which will be paid on September 28, 2018, to hold as of record on September 14, 2018. Finally, on Slide 27, we highlight our various financing sources. Taking into account SBA guaranteed debentures, we had approximately $1.3 billion of total borrowing capacity at quarter-end of which $1.1 billion was outstanding. Additionally, first quarter end, we issued $50 million 5-year unsecured notes at an attractive rate of 5.36%. As a reminder, Wells Fargo credit facilities covenants are generally tied to the operating performance, the underlying businesses that we lend to rather than the marks for our investments at any given time. With that, I’d like to turn the call back over to Rob.

Thanks Shiraz. It continues to remain our intention to consistently pay the $0.34 per share on a quarterly basis for future quarters, so long as the adjusted NII covers the dividend in line with our current expectations. In closing, I would just like to say that we continue to be pleased with our performance to date, most importantly from a credit perspective our portfolio overall continues to be healthy. Once again, we’d like to thank you for your support and interest and at this point turn things back to the operator to begin Q&A. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] First question comes from [indiscernible] with Wells Fargo Securities. Please go ahead.

Just first question on the leverage. I think, I know, you said you want to forgive me for long last quarter expanded the holdings facility that you know has about $100 million in capacity left. But any color in terms of -- should we see maybe that grow in size and commitment or something else?

Yes, I think it will be a combination of that growing as well as utilizing the other elements of the financing structure including some unsecured. We always looking at trade-offs between are in stakes, given the flat yield curve interest rate versus floating on a secured basis. But I think the mix will continue to be utilized in such way to optimize all the various elements of the liability strategy.

And high technology, can you give some color on the appreciation there. Is that a market yield base component or is there some maybe convert or equity kicker in there that reflects that appreciation?

So we were actually market at the accreted value at a contractual value. At this moment that is not showing any impact of the convertibility. We’re really sort of right at the cost though. So we continue to monitor the enterprise value map that drives the share price there could be further upside if that seem to be in the money.

And then just one final, more high level question, touching on HME, but not specifically zeroing on it understanding it's a specific name. We're seeing some similar sharper declines kind of across the space this quarter even with the benign environment and strong economy et cetera, but as active folks in the market such as yourselves, if you look at these high level, can you give kind of a feel on how much is say your synchronic one-off versus the impact of declining structures that we often hear about in the ladder of which I would find more broadly concerning. But if you kind of want to touch on there, are we seeing perhaps market-wide, are we kind of paying the price now for the structural impacts across direct lending?

We are certainly not seeing that at all. Any issues we're seeing in HME would be a good example. It's completely idiosyncratic and irrespective of some of the structural weaknesses that have been introduced into credit agreements in the last few years. One or two years from now might those structural weaknesses impact things that certainly possible. But to date, that has -- there is no tearful evidence at least that we're seeing in terms of portfolio impacts.

Very well guys. Thanks so much for taking the questions.

Yes. Thank you.

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

Well, thanks everyone. We appreciate the interest, the support and look forward to speaking to everyone in the months ahead. And enjoy the rest of the summer. Thank you. Good bye.

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