New Mountain Finance Corporation (NASDAQ: NMFC) — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet figures are as of March 31, 2023 unless stated otherwise. NMFC is a business development company (BDC) focused primarily on lending to middle-market companies in defensive-growth industries. Dollar amounts below are in millions unless noted.
Key financial results and position
| Metric | Q1 2023 | Prior comparable period / year-end |
|---|---|---|
| Investment income | $92.0 | $69.0 in Q1 2022; up 33% |
| Net investment income (NII) | $38.4; $0.38 per share | $29.9; $0.30 per share in Q1 2022 |
| Net increase from operations attributable to NMFC | $44.6; $0.44 basic EPS and $0.40 diluted EPS | $36.2; $0.37 basic EPS and $0.34 diluted EPS in Q1 2022 |
| Net realized and unrealized gains | $6.4 | $7.1 in Q1 2022 |
| Distributions | $0.32 per share declared and paid | $0.30 per share in Q1 2022 |
| Net asset value (NAV) | $1,326.7; $13.14 per share | $1,314.5; $13.02 per share at December 31, 2022 |
| Investments at fair value | $3,270.3 across 111 portfolio companies | $3,221.2 across 107 companies at December 31, 2022 |
| Cash and cash equivalents | $46.4 | $71.2 at December 31, 2022 |
| Net cash from operating activities | $(3.5), cash used | $(45.2), cash used in Q1 2022 |
| Borrowings | $2,010.4 principal; $1,994.1 net of deferred financing costs on the balance sheet | $1,997.8 principal at December 31, 2022 |
| Asset coverage ratio | 177.6% | 181.3% in Q1 2022 |
The filing does not present a conventional operating margin. NII was about 41.8% of investment income, compared with about 43.4% in Q1 2022. Interest and other financing expense rose to $30.8 million from $18.6 million. The weighted-average yield to maturity at cost was 10.9% for income-producing investments and 9.8% for all investments; these estimates exclude leverage and assume no prepayments or losses.
Material changes versus Q1 2022 and year-end 2022
- Investment income increased by $23.0 million, primarily from higher portfolio interest rates and larger invested balances. Higher floating-rate borrowing costs and additional notes issuance contributed to the increase in financing expense.
- Net investment income rose by $8.5 million, while net realized and unrealized gains declined by $0.7 million. Q1 2023 gains included realized gains associated with Haven Midstream and unrealized appreciation in UniTek, partly offset by losses in National HME and unrealized depreciation in Ansira and ADG.
- Fair value of investments increased $49.1 million from year-end. The portfolio’s fair value remained below its $3,302.6 million cost basis.
- Principal borrowings increased $12.6 million from year-end. NMFC issued $60.0 million of additional 7.50% convertible notes in March and repaid $90.0 million of unsecured notes in January.
- Portfolio activity included $94.2 million of new investments, $31.5 million of debt repayments, and $36.2 million of securities sold. New investment volume was lower than the $153.8 million reported in Q1 2022.
Liquidity, portfolio risks and outlook
- Liquidity and leverage: The company reported $46.4 million of cash. At quarter-end it also reported capacity of approximately $115.3 million under the Holdings Credit Facility, $93.6 million under the DB Credit Facility, and $110.6 million under the NMFC Credit Facility. Capacity is subject to facility terms and borrowing-base requirements. The company reported compliance with applicable debt covenants.
- Near-term maturities: The contractual-obligations table lists $50.0 million of unsecured notes due June 2023 and $116.8 million of 2018 convertible notes due August 2023, unless earlier converted, repurchased, redeemed or refinanced. The filing says the company repaid the $90.0 million 2018A unsecured notes in January 2023.
- Credit quality and non-accruals: In Q1, NMFC placed its ADG second-lien loan on non-accrual; its $7.4 million cost basis was valued at $2.7 million. Other disclosed non-accrual positions include Ansira, Integro, National HME, American Achievement, Sierra Hamilton, UniTek and Education Management. ADG, Ansira and National HME were among the portfolio companies rated Red; the filing reports most portfolio value in the Green category.
- Valuation and concentration: $3,184.4 million of portfolio investments were Level III, approximately 97% of investment fair value, relying on significant unobservable inputs and valuation judgment. Software, business services and healthcare represented 28.6%, 17.7% and 17.1% of investments, respectively. Approximately 89.1% of investments were floating rate, exposing income and portfolio companies to interest-rate changes.
- Contingencies: A $30.0 million-cost collateralized resale agreement was valued at $16.5 million and is on non-accrual. The hedge-fund counterparty is in Cayman Islands liquidation, allegedly breached its repurchase obligation, and NMFC has filed a claim. Separately, the company continues to pursue a $16.0 million claim under a restored agreement related to the historic Black Elk transaction; the related investment had a $14.5 million cost basis and $8.0 million fair value.
- Funding commitments: Unfunded revolving commitments were $107.1 million and delayed-draw or other future commitments were $109.1 million, totaling about $216.2 million. Additional investment-purchase commitment letters had aggregate par of $4.9 million.
- Management outlook and risks: Management expects current liquidity needs to be met through operating cash flows and other activities, but provides no quantified earnings or portfolio guidance. It notes that rising rates may increase investment income as well as funding costs, and that a recession could affect borrowers and credit quality. The filing added banking-system strain and dependence on bank relationships as a risk. Other stated risks include leverage, illiquidity, below-investment-grade credit exposure, valuation uncertainty, industry concentration and potential conflicts with the affiliated adviser.
- Subsequent events: On April 25, 2023, the board declared a $0.32 regular Q2 distribution plus a $0.03 supplemental distribution related to Q1 earnings, payable June 30, 2023. A director resigned effective April 25; the filing reports no disagreement with the company.
Investor verification priorities
- Confirm the repayment, refinancing or conversion plan for the $50.0 million June 2023 note maturity and $116.8 million August 2023 convertible-note maturity.
- Review non-accrual exposures, especially ADG, Ansira, National HME, American Achievement and the impaired resale agreement; verify recoveries, collateral rights and any subsequent valuation changes.
- Assess how higher borrowing costs affect NII and distribution coverage, given the rise in financing expense and the 177.6% asset coverage ratio.
- Examine Level III valuation assumptions and the effect of changes in portfolio-company performance, valuation multiples and discount rates.
- Verify that the $0.35 per-share Q2 distribution is supported by recurring cash income, distinguishing cash earnings from PIK and other non-cash income.
The independent accountant performed a review of the interim financial information and reported no material modifications needed for GAAP conformity; this was a review, not an audit.