New Mountain Finance Corp quarterly report, Q3 FY2022

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New Mountain Finance Corporation — Q3 2022 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2022. NMFC is a business development company focused on middle-market lending and related investments. Unless otherwise noted, dollar amounts below are in millions.

Business context and portfolio

At quarter-end, NMFC held investments with a fair value of $3,234.4 across 107 portfolio companies. The portfolio was concentrated in software (27.4% of investments at fair value), business services (15.3%), and healthcare services (14.9%). First- and second-lien investments represented 54.7% and 17.7% of portfolio fair value, respectively; equity and other investments represented 25.3%. Approximately 87.6% of investments were floating-rate.

Financial performance and position

  • Investment income: Q3 income was $78.4, up 15% year over year; nine-month income was $220.5, up 9%. Management attributed the increase mainly to higher interest rates and larger invested balances.
  • Net investment income: $32.8 in Q3 versus $30.6 a year earlier; $94.4 for nine months versus $88.8. Earnings per share were $0.08 for Q3 and $0.60 for nine months, compared with $0.23 and $1.54, respectively.
  • Realized and unrealized results: NMFC-attributable net increase in net assets from operations was $7.7 in Q3 versus $21.8 a year earlier, and $59.9 for nine months versus $149.1. Nine-month realized and unrealized results were a net loss of $34.7, compared with a $65.1 net gain in 2021, primarily reflecting portfolio valuation declines.
  • Expenses and financing costs: Q3 net expenses were $45.7, up from $37.8; nine-month net expenses were $126.1, up from $113.9. Interest and other financing expenses increased to $24.6 in Q3 and $64.0 for nine months, reflecting higher rates, increased borrowings on certain facilities, and issuance of new notes.
  • NAV and liquidity: NMFC net assets were $1,332.0 and NAV was $13.20 per share at September 30, versus $1,321.2 and $13.49 at year-end 2021. Cash was $48.9, down from $58.1. Operating cash flow was negative $8.8 for the nine months, versus positive $84.7 in the prior-year period.
  • Debt and coverage: Borrowings were approximately $1,980 principal amount at quarter-end. Asset coverage was 179.3%, down from 184.0% at year-end 2021; the statutory minimum is 150%. NMFC reported compliance with applicable facility covenants. The company paid $0.90 per share in distributions for the first nine months.

Material changes versus comparable periods

  • Higher base rates and larger invested balances supported investment-income growth, but borrowing costs rose materially and offset part of the benefit.
  • Valuation performance weakened: nine-month net realized and unrealized results shifted from a gain in 2021 to a loss in 2022. Fair value of investments was $3,234.4 versus $3,174.4 at year-end, while cost increased to $3,258.9 from $3,126.5.
  • Portfolio activity included $526.6 of new investments and $466.5 of sales and paydowns during the nine months. NMFC also raised $40.0 net through its at-the-market share program.
  • NAV per share declined $0.29 from year-end, despite nine-month net investment income of $0.94 per share and distributions of $0.90 per share.

Outlook, risks, contingencies, and unusual items

  • Outlook: No quantified earnings or portfolio guidance is provided. Management said current liquidity needs are expected to be met through operating cash flows and other activities. It cautioned that results depend on economic conditions, interest rates, portfolio performance, and market developments.
  • Credit quality: Three portfolio companies were rated Red, three Orange, and eight Yellow; the remainder were Green. Ansira was placed on non-accrual in Q3, with $41.3 cost and $19.7 fair value. National HME, Integro, AAC, UniTek, Sierra Hamilton, and Education Management exposures also include non-accrual positions. These investments can reduce income and NAV.
  • Valuation and concentration: Approximately $3,155.2, or about 97.5% of portfolio investments, were Level III fair-value assets using significant unobservable inputs. Software is the largest sector, and fair values may be sensitive to portfolio-company performance and valuation assumptions.
  • Rate exposure: Management estimated that a 100-basis-point increase in rates would raise net interest income, net of interest expense, by 6.31%; a 100-basis-point decrease is not presented, but the filing estimates a 25-basis-point decrease would reduce it by 1.58%. Actual results may differ.
  • Contingencies: A $30.0 collateralized resale agreement with a private hedge fund in liquidation was on non-accrual and valued at $19.4. The fund allegedly breached its repurchase obligation; NMFC has filed a claim with the Cayman Islands liquidators. Separately, the Black Elk-related claim has a $14.5 cost basis and $9.4 fair value. The filing reports no material pending legal proceedings.
  • Subsequent events: NMFC issued $200.0 principal amount of 7.50% convertible notes due 2025 after quarter-end, intending to fund a tender offer for up to $201.3 of its 2018 convertible notes and then repay other debt or use proceeds for general purposes. The board declared a Q4 distribution of $0.32 per share. The CEO transition to John R. Kline is effective January 1, 2023.
  • Other: The investment adviser’s base management fee waiver was extended through Q4 2023. Management identified no material change in internal control over financial reporting; disclosure controls were deemed effective.

Important facts for investors to verify

  • Whether non-accrual and distressed holdings—particularly Ansira, National HME, AAC, and UniTek—recover, and how their valuations and income recognition evolve.
  • Whether portfolio cash income can continue to cover financing costs and distributions as rates and borrowing costs change; verify the reported rate-sensitivity assumptions.
  • Asset coverage, covenant headroom, and refinancing needs, including unsecured notes maturing in 2023–2024 and the existing convertible notes due in 2023.
  • The outcome and recovery prospects for the PPVA resale agreement and Black Elk-related claim, including any further valuation changes.
  • Terms and completion of the 2022 convertible-note offering and 2018-note tender offer, and resulting interest expense, dilution, and debt levels.
  • Portfolio valuation assumptions and concentration risks, given the high proportion of Level III assets and exposure to software and other concentrated industries.