NMFC

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2011, for New Mountain Finance Holdings, L.L.C. (the "Operating Company"), New Mountain Finance Corporation (the publicly traded BDC), and New Mountain Finance AIV Holdings Corporation. The Operating Company is a Business Development Company (BDC) focused on investing in debt securities of U.S. middle-market "defensive growth" companies. New Mountain Finance completed its Initial Public Offering (IPO) on May 19, 2011, raising approximately $100 million. As of year-end, New Mountain Finance owned approximately 34.6% of the Operating Company, while AIV Holdings (owned by the private equity sponsor) owned 65.4%.

Key Financial Metrics

Debt and Liquidity: The Operating Company had total indebtedness of approximately $295 million as of December 31, 2011, consisting of $129.0 million under the Holdings Credit Facility and $165.9 million under the SLF Credit Facility. Cash and cash equivalents totaled $15.3 million. The company maintained compliance with the 200% asset coverage ratio required under the Investment Company Act of 1940.

Material Changes vs. Prior Period

• Portfolio Growth: The portfolio fair value increased by approximately 59% from $441.1 million in 2010 to $703.5 million in 2011, driven by $493.3 million in new investments and the capital raised in the May 2011 IPO.
• Investment Income: Total investment income rose 36.6% to $56.5 million, primarily due to larger invested balances and prepayment premiums.
• Operating Expenses: Total operating expenses increased significantly to $18.0 million from $3.9 million in 2010. This increase is largely attributable to the implementation of the Investment Management Agreement post-IPO, which introduced management fees ($4.9 million) and incentive fees ($3.5 million), as well as higher interest expenses on expanded credit facilities.
• Unrealized Depreciation: Unlike the net unrealized appreciation in 2010, the company recorded a net unrealized depreciation of $23.1 million in 2011, reflecting market declines and specific portfolio impairments.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary: Management highlighted the successful deployment of IPO proceeds and the expansion of the portfolio into 55 companies. The company continues to target defensive growth companies with sustainable secular growth drivers. The Operating Company declared a first-quarter 2012 distribution of $0.32 per unit/share.

Risks and Contingencies:

• Credit Risk: One portfolio company, ATI Acquisition Company, was placed on non-accrual status due to regulatory headwinds and an inability to service interest payments. Its fair value was written down significantly (cost basis $5.9 million vs. fair value $2.4 million).
• Market Risk: The company faces risks related to the downgrade of the U.S. credit rating and the European economic crisis, which could impact liquidity and borrowing costs.
• Regulatory Risk: As a BDC, the company is subject to strict asset coverage ratios (200%) and diversification requirements. Failure to maintain these could restrict distributions or borrowing.
• Valuation Uncertainty: A significant portion of the portfolio (Level III assets) consists of private securities valued using unobservable inputs, introducing estimation risk.

Important Facts for Investor Verification

• Non-Accrual Status: Verify the status and potential recovery value of the ATI Acquisition Company investment, which represents a material impairment.
• Expense Structure: Confirm the sustainability of the increased expense ratio post-IPO, specifically the management and incentive fees paid to the affiliate Investment Adviser.
• Dividend Sustainability: Assess whether the Net Investment Income of $38.5 million is sufficient to support the declared dividend rate of $0.86 per share and future distributions, considering the requirement to distribute 90% of taxable income to maintain RIC status.
• Leverage Capacity: Review the remaining capacity under the Holdings ($31 million) and SLF ($9.1 million) credit facilities to determine the ability to fund new investments without raising additional equity.
• Level III Valuations: Scrutinize the valuation methodologies for the $91 million in Level III assets, which rely on management judgment and unobservable inputs.