New Mountain Finance Corporation (NMFC) — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. NMFC is a business development company focused on direct lending to sponsor-backed middle-market businesses, primarily through senior secured loans, with select junior debt and equity investments. Financial statement amounts below are in U.S. dollars; figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Investment income | $94.3 | $78.4 | $281.8 | $220.5 |
| Net investment income | $40.7 | $32.8 | $119.0 | $94.4 |
| Net increase in net assets from operations attributable to NMFC | $28.7 | $7.7 | $108.1 | $59.9 |
| Basic earnings per share | $0.28 | $0.08 | $1.07 | $0.60 |
| Distributions declared and paid per share | $0.36 | $0.30 | $1.03 | $0.90 |
- Portfolio and NAV: Investments had a fair value of $3,111.9 across 109 portfolio companies at quarter-end, versus $3,221.2 across 107 companies at December 31, 2022. NMFC net assets were $1,325.0 and NAV was $13.06 per share, compared with $13.02 at year-end 2022.
- Balance sheet and liquidity: Total assets were $3,279.6, total liabilities $1,942.9, and cash $83.3, versus $71.2 at year-end. Principal borrowings totaled approximately $1,902.4; reported net borrowings after deferred financing costs were $1,889.2. Asset coverage was 182.7%.
- Cash flow: Operating activities provided $207.0 during the first nine months, compared with $8.8 used in the prior-year period. Financing activities used $195.0, including $104.0 of distributions paid. Cash increased by $12.1 to $83.3.
- Portfolio characteristics: Software, business services, healthcare, investment funds and education were the largest industry exposures. Floating-rate investments represented 89.45% of investments at fair value. Management reported weighted average yield to maturity at cost of 11.8% for income-producing investments and 10.2% for all investments; these estimates assume no defaults, prepayments or losses and exclude leverage.
- Margins: Traditional operating margins are not a principal measure for this investment company. Net investment income was $40.7 on $94.3 of investment income in Q3 and $119.0 on $281.8 for the nine-month period.
Material changes versus comparable periods
- Investment income rose 20% in Q3 and 28% in the first nine months, mainly because higher benchmark rates increased yields on floating-rate assets.
- Net investment income increased, but interest and financing expense also rose: to $31.4 in Q3 from $24.6, and to $93.9 for nine months from $64.0. Management attributed the increases chiefly to higher rates on floating-rate borrowings and interest on the 2022 Convertible Notes.
- Nine-month net realized and unrealized losses narrowed to $10.4 from $34.7 in 2022. Q3 losses were $12.0, compared with $25.3 a year earlier. The Q3 2023 loss included unrealized depreciation in Edmentum and UniTek, partly offset by gains elsewhere.
- Portfolio fair value declined by $109.3 from year-end 2022. Nine-month investment activity included $140.5 of new investments, $112.0 of debt repayments and $170.8 of securities sales.
- Borrowings declined from $1,997.8 at year-end to $1,902.4 at September 30. The company repaid the remaining $116.8 of 2018 Convertible Notes at maturity in August and repaid $140.0 of unsecured notes during the first nine months, while the NMFC Credit Facility balance increased.
Outlook, risks and unusual items
- Guidance: The filing provides no numerical earnings or investment guidance. Management said it expects current liquidity needs to be met through operating cash flows and other activities. Future distributions remain subject to board determination.
- Distributions and subsequent events: After quarter-end, the board declared a Q4 2023 distribution of $0.32 per share plus a $0.04 supplemental distribution, payable December 29, 2023. It also extended the Holdings Credit Facility maturity to October 2028; extended the DB Credit Facility to March 2027 and reduced its applicable interest rate; and extended the affiliate revolver to December 2027 while increasing its capacity from $50 to $100.
- Credit quality and non-accruals: In Q3, NMFC placed the remaining $17.9 principal amount of American Achievement Corporation first-lien loans on non-accrual; its AAC positions on non-accrual had $31.4 cost and $20.6 fair value. Ansira positions had $41.2 cost and $2.0 fair value; National HME second-lien debt had $7.9 cost and $3.0 fair value. Management reported 3 portfolio companies rated Red, 6 Orange and 8 Yellow, with the remainder Green.
- Non-cash income and valuation: For nine months, NMFC recognized $24.8 of PIK and other non-cash interest and $20.2 of PIK and other non-cash dividends. Most investment fair values are Level III and depend on unobservable inputs and management estimates; the filing notes realized proceeds may differ materially from reported values.
- Contingencies: A $30.0 collateralized resale agreement remains on non-accrual and is carried at $16.5. The guarantor hedge fund is in liquidation, breached its repurchase obligation, and NMFC has filed a claim with the Cayman Islands liquidators. A separate legacy Black Elk-related claim is carried at $8.0 fair value. The company reported no material pending legal proceedings as of September 30.
- Key risks: Credit defaults and reduced recoveries, illiquid private investments and valuation uncertainty, leverage and refinancing, interest-rate changes, industry concentration, covenant-lite loans, bank-system stress, and the transition from LIBOR to alternative reference rates. Management’s sensitivity analysis estimates net interest income would rise 6.84% with a 100-basis-point rate increase and fall 1.71% with a 25-basis-point decrease; actual outcomes may differ.
- Governance and controls: Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported. The filing identifies ongoing potential conflicts associated with the adviser’s management of other funds and related-party arrangements.
Most important facts for investors to verify
- Whether increased investment income and PIK/non-cash accruals translate into cash collections sufficient to support distributions and debt service.
- Changes in non-accrual exposures, especially AAC, Ansira, National HME, UniTek and the collateralized resale agreement, and the ultimate recoveries on those positions.
- Portfolio valuation assumptions and sensitivity, given the large Level III investment balance and the decline in portfolio fair value since year-end.
- Debt maturities, borrowing costs, covenant headroom and asset coverage, including the effect of the subsequent facility amendments.
- Whether distributions remain covered by recurring net investment income, and the eventual tax character of distributions.
- Developments in the hedge fund liquidation claims and any resulting change to the collateralized resale agreement’s value or collectability.