Business Context and Reporting Period
Company: New Mountain Finance Corporation (NMFC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2015
Business Model: NMFC is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). It targets current income and capital appreciation by investing in debt securities (first and second lien, mezzanine) and equity of U.S. middle-market "defensive growth" companies.
Key Financial Metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Total Assets | $1,602.1 million | $1,514.9 million |
| Total Net Assets | $836.9 million | $802.2 million |
| Net Asset Value (NAV) per Share | $13.08 | $13.83 |
| Portfolio Fair Value | $1,512.2 million | $1,424.7 million |
| Number of Portfolio Companies | 75 | 71 |
| Total Investment Income | $153.9 million | $135.6 million |
| Net Investment Income | $82.5 million | $80.1 million |
| Net Realized Gains (Losses) | ($12.8 million) | $0.4 million |
| Net Change in Unrealized Appreciation (Depreciation) | ($35.3 million) | ($43.9 million) |
| Net Increase in Net Assets from Operations | $33.0 million | $45.6 million |
| Dividends Declared per Share | $1.36 | $1.48 |
| Weighted Average Yield to Maturity at Cost | 10.7% | 10.7% |
Debt and Liquidity
- Total Indebtedness: $742.0 million outstanding as of December 31, 2015.
- Holdings Credit Facility: $419.3 million outstanding (Weighted Avg Rate: 2.6%).
- NMFC Credit Facility: $90.0 million outstanding (Weighted Avg Rate: 2.7%).
- Convertible Notes: $115.0 million outstanding (Fixed Rate: 5.0%).
- SBA-Guaranteed Debentures: $117.7 million outstanding (Weighted Avg Rate: 2.4%).
- Cash and Cash Equivalents: $30.1 million.
Material Changes vs. Prior Period
- Investment Income Growth: Total investment income increased by approximately $18.3 million (13%) compared to 2014, driven by larger invested balances from a September 2015 equity offering and increased leverage.
- Net Realized Losses: The company reported a net realized loss of $12.8 million in 2015, compared to a net gain of $0.4 million in 2014. This was primarily due to $29.7 million in realized losses from debt restructuring extinguishments (Edmentum, EDMC, and UniTek) partially offset by sales of investments with fair values exceeding prior valuations.
- Unrealized Depreciation: Net unrealized depreciation was $35.3 million in 2015, an improvement from $43.9 million in 2014, reflecting market price fluctuations.
- Expense Increases: Net operating expenses increased by $15.8 million to $71.4 million, primarily due to higher management and incentive fees resulting from a larger asset base and increased interest expenses from new debt facilities.
Guidance, Outlook, and Risks
- Dividend Policy: NMFC intends to distribute approximately all Adjusted Net Investment Income quarterly to maintain RIC status. A quarterly distribution of $0.34 per share was declared for Q1 2016.
- Share Repurchase Program: On February 4, 2016, the Board authorized a program to repurchase up to $50.0 million of common stock, effective until December 31, 2016, citing potential undervaluation due to market volatility.
- Portfolio Concentration: The portfolio is concentrated in Software (24.5%), Business Services (24.4%), and Education (11.0%).
- Credit Quality: As of December 31, 2015, 94.1% of the portfolio (by fair value) was rated Investment Rating 1 or 2 (performing in-line or above expectations). Only 2.1% was rated Rating 3 and 0.1% was rated Rating 4.
- Key Risks:
- Leverage: High leverage magnifies potential gains and losses; asset coverage ratios must be maintained under the 1940 Act.
- Interest Rate Risk: Approximately 86.3% of the portfolio consists of floating-rate investments, while debt facilities are also floating-rate, creating sensitivity to LIBOR changes.
- Valuation Uncertainty: A significant portion of the portfolio (Level III assets) relies on unobservable inputs and management judgment for fair value determination.
- Regulatory Compliance: Failure to maintain RIC status would subject the company to corporate-level income taxes.
Investor Verification Checklist
- Asset Coverage Ratio: Verify compliance with the 200% asset coverage requirement under the 1940 Act, excluding SBA-guaranteed debentures.
- Restructuring Outcomes: Monitor the performance of restructured portfolio companies (Edmentum, EDMC, UniTek) to ensure they remain income-producing and do not require further write-downs.
- Debt Maturities: Review the maturity schedule of the Holdings Credit Facility (2019), NMFC Credit Facility (2019), and Convertible Notes (2019) to assess refinancing risks.
- Dividend Sustainability: Confirm that cash flow from operations and interest income is sufficient to cover the $0.34 quarterly dividend without relying on return of capital or new borrowings.
- Level III Valuations: Scrutinize the fair value adjustments for Level III assets, which comprised approximately 46.3% of the total portfolio fair value.