New Mountain Finance Corp quarterly report, Q2 FY2023

New Mountain Finance Corp. (NASDAQ: NMFC) — Q2 2023 Form 10-Q

Business context and period. NMFC is a business development company (BDC) focused primarily on lending to sponsor-backed middle-market companies. This unaudited quarterly report covers the three and six months ended June 30, 2023; financial amounts below are in U.S. dollars unless stated otherwise.

Financial performance and position

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Investment income	$95.5 million	$73.1 million	$187.4 million	$142.1 million
Net investment income	$39.9 million	$31.7 million	$78.3 million	$61.6 million
Net realized and unrealized gains (losses)	$(4.9) million	$(16.6) million	$1.6 million	$(9.4) million
Net increase in net assets from operations attributable to NMFC	$34.8 million	$16.0 million	$79.4 million	$52.1 million
Basic / diluted EPS	$0.35 / $0.32	$0.16 / $0.16	$0.79 / $0.71	$0.52 / $0.50
Distributions declared and paid per share	$0.35	$0.30	$0.67	$0.60

• At June 30, the portfolio had a fair value of $3.179 billion across 113 companies; NMFC net assets were $1.326 billion and NAV was $13.14 per share, versus $13.02 at December 31, 2022.
• Cash and cash equivalents were $45.9 million, down from $71.2 million at year-end. Six-month operating cash flow was positive $119.9 million, compared with negative $79.1 million in the prior-year period; cash distributions paid were $67.6 million.
• Borrowings were $1.923 billion at principal value ($1.908 billion net of deferred financing costs), compared with $1.998 billion and $1.981 billion, respectively, at year-end. Asset coverage was 181.7%, above the 150% statutory minimum; the company reported compliance with applicable debt covenants.
• Investment income grew 31% in Q2 and 32% for the six-month period. Net investment income was 41.8% of investment income in both 2023 periods, versus approximately 43.4% in the comparable 2022 periods.

Changes versus comparable periods

• Higher floating-rate asset yields, primarily from increased LIBOR and SOFR rates, drove higher interest income. The company also cited increased PIK dividends and cash dividends from its Senior Loan Programs III and IV.
• Financing expenses rose $11.0 million in Q2 and $23.2 million for the six months, mainly due to higher rates on floating-rate borrowings and the 2022 Convertible Notes. This partly offset stronger investment income.
• Six-month realized and unrealized results improved to a $1.6 million net gain from a $9.4 million net loss in 2022. Q2 still recorded a $4.9 million net loss, although smaller than the prior-year quarter’s $16.6 million loss.
• Portfolio fair value declined $41.8 million from December 31, 2022. New investments were $124.6 million, compared with $397.1 million in the prior-year period; sales and paydowns also differed from the prior-year activity.
• The six-month total return was 6.04% based on market value and 6.09% based on NAV; the comparable 2022 returns were negative 9.00% and positive 3.95%, respectively.

Outlook, risks and unusual items

• No quantitative earnings or investment guidance is provided. The company said it expects current liquidity needs to be met through operating cash flows and other activities. It cautioned that interim results are not necessarily indicative of full-year results.
• On July 27, 2023, the board declared a Q3 distribution of $0.32 per share plus a $0.04 supplemental distribution related to Q2 earnings, payable September 29 to holders of record September 15.
• At June 30, 89.13% of investments by fair value carried floating rates. Management noted that rising rates can boost asset income but also increase funding costs; modeled net interest income, before incentive fees and other expenses, would rise 7.77% for a 100-basis-point increase and fall 1.94% for a 25-basis-point decrease.
• Credit concerns include non-accrual or impaired holdings. Ansira had $41.2 million cost basis and $3.5 million fair value on non-accrual; other non-accrual positions included National HME, American Achievement, UniTek and Education Management. Risk ratings placed $9.0 million of portfolio fair value in Red, $51.1 million in Orange and $142.8 million in Yellow categories.
• A collateralized resale agreement remains on non-accrual, with $30.0 million cost and $16.5 million fair value. The guarantor, a private hedge fund in Cayman Islands liquidation, breached its repurchase obligation; NMFC has filed a claim and says it does not have full rights and title to the collateral.
• Unfunded revolving and delayed-draw commitments totaled $197.4 million, with a further $4.9 million of investment purchase commitments. Most portfolio investments are privately held and valued using significant unobservable inputs: $3.096 billion of $3.179 billion in investments was Level III.
• Debt-related items to monitor include the $116.8 million 2018 Convertible Notes due August 15, 2023, and $233.3 million of total contractual obligations due within one year as listed at June 30. The filing reports the notes’ status as of June 30, not their subsequent repayment or refinancing.
• Additional risks cited include recession and market volatility, bank-system stress, covenant-lite loans, illiquidity and uncertainty in fair-value estimates, leverage, and the transition from LIBOR to replacement rates.

Important facts for investors to verify

1. How the August 2023 maturity of the 2018 Convertible Notes was funded or refinanced, and the resulting cost and maturity profile of debt.
2. Whether the rise in floating-rate investment income continues to exceed increases in borrowing costs, and how rates affect borrowers’ ability to pay.
3. Developments in non-accrual, Red/Orange-rated and impaired investments, particularly Ansira, National HME, AAC, UniTek and the resale agreement claim.
4. Changes in NAV, Level III valuation assumptions, portfolio concentration and the amount of PIK/non-cash income relative to cash receipts.
5. Liquidity after distributions and unfunded commitments, and continued compliance with asset-coverage, facility and other debt covenants.