NMFC

Business Context and Reporting Period

Company: New Mountain Finance Corporation (New Mountain Finance) and its operating subsidiary, New Mountain Finance Holdings, L.L.C. (NMF Holdings).

Reporting Period: Quarter ended September 30, 2011. This is the first quarter following the company's Initial Public Offering (IPO) on May 19, 2011.

Structure: New Mountain Finance is a closed-end, non-diversified business development company (BDC) and a holding company. Its sole asset is an ownership interest in NMF Holdings. As of September 30, 2011, New Mountain Finance owned approximately 34.6% of NMF Holdings, while New Mountain Finance AIV Holdings Corporation (AIV Holdings) owned the remaining 65.4%.

Investment Strategy: The company focuses on sourcing and originating debt securities (first and second lien debt, notes, bonds, mezzanine) and equity interests in defensive growth companies.

Key Financial Metrics

Material Changes vs. Prior Period

Operational Status: The company commenced operations on May 19, 2011, following its IPO. Therefore, there is no direct comparable prior period for New Mountain Finance Corporation itself. Comparisons are made against NMF Holdings' pre-IPO performance (September 30, 2010).

• Revenue Growth: Total investment income for NMF Holdings increased by 9% to $15.1 million for the quarter ended September 30, 2011, compared to $13.9 million in the same period in 2010. This was driven by larger invested balances from IPO proceeds and the formation of the SLF Credit Facility.
• Expense Increase: Total operating expenses for NMF Holdings surged to $5.1 million in Q3 2011 from $0.7 million in Q3 2010. This increase is primarily due to the new Investment Management Agreement (management and incentive fees) and interest expenses on the new SLF Credit Facility, which did not exist in the prior year.
• Market Performance: The portfolio experienced a net loss of $21.3 million in realized and unrealized gains/losses for the quarter, compared to a net gain of $5.6 million in Q3 2010. This decline was attributed to an overall drop in market prices.
• Portfolio Expansion: The portfolio grew from 43 companies (fair value $441.1 million) at December 31, 2010, to 50 companies (fair value $604.3 million) at September 30, 2011.

Guidance, Outlook, Risks, and Unusual Items

Dividends and Distributions:

• The company declared a fourth-quarter 2011 distribution of $0.30 per unit/share, payable December 30, 2011.
• Total distributions paid since the IPO (May 19, 2011) amount to $0.86 per share.
• The company intends to distribute approximately all of its adjusted net investment income quarterly to maintain Regulated Investment Company (RIC) status.

Outlook and Management Commentary:

• Management expects liquidity to be generated through periodic follow-on equity offerings and cash flows from operations.
• The company is actively monitoring credit profiles; as of September 30, 2011, all investments were rated 1 or 2, with the exception of ATI Acquisition Company (rated 3 due to regulatory headwinds).

Risks and Contingencies:

• U.S. Credit Rating Downgrade: The filing highlights the risk associated with the August 2011 downgrade of the U.S. credit rating by S&P, which could increase borrowing costs and impact the credit risk perception of the portfolio.
• Interest Rate Risk: The portfolio contains floating-rate loans (LIBOR-based). A sensitivity analysis indicates that a 100 basis point increase in interest rates could result in a 3.8% decrease in net interest income, while a 25 basis point decrease could result in a 1.1% increase.
• Valuation Uncertainty: A significant portion of the portfolio ($53.3 million or 8.8%) is classified as Level III (unobservable inputs), requiring significant management judgment for valuation.

Unusual Items:

• Cost Basis Step-Up: The IPO did not step up the cost basis of existing investments to fair market value for GAAP purposes. This results in higher amortization of purchase discounts and different realized gain/loss recognition compared to an adjusted basis used for incentive fee calculations.

Investor Verification Checklist

• Expense Cap Compliance: Verify if the $3.0 million expense cap for the first year of operations under the Administration Agreement was exceeded (Note 5 indicates $1.3 million in excess expenses were incurred, partially receivable from affiliates).
• Level III Valuations: Review the specific valuation methodologies and unobservable inputs for the $53.3 million in Level III assets, particularly the $24.0 million in second lien debt.
• ATI Acquisition Company: Investigate the specific regulatory headwinds affecting ATI Acquisition Company, which holds a fair value of $1.4 million against a cost basis of $4.3 million.
• Debt Covenants: Confirm continued compliance with asset coverage ratios and other covenants for the Holdings and SLF Credit Facilities, especially given the market volatility.
• Dividend Sustainability: Assess whether the declared $0.30 distribution is fully supported by Adjusted Net Investment Income or if it includes a return of capital.