NMFC

Business Context and Reporting Period

Company: New Mountain Finance Corporation (NMFC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2014
Business Overview: NMFC is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The company focuses on generating current income and capital appreciation through debt securities (first and second lien) and equity interests in defensive growth companies. Top industry concentrations include Education, Software, and Business Services.

Organizational Restructuring: Effective May 8, 2014, NMFC completed a restructuring. It now owns 100% of New Mountain Finance Holdings, L.L.C. (NMF Holdings), which serves as a special purpose vehicle for existing credit facilities. Prior to this date, NMFC and NMF Holdings operated under a master-feeder structure.

Key Financial Metrics

Material Changes vs. Prior Period

• Investment Income: Total investment income for the six months ended June 30, 2014, was $64.1 million, a 6% increase compared to $60.5 million in the prior year period. This was driven by larger invested balances from equity offerings and leverage, offset by lower dividend and other income due to the absence of a large warrant distribution received in the prior year.
• Net Expenses: Net expenses increased to $30.8 million for the six months ended June 30, 2014, from $25.3 million in the prior year. This increase is primarily due to higher management fees and interest expenses resulting from increased asset balances and debt utilization.
• Realized and Unrealized Gains: The company reported a net gain of $13.8 million from realized and unrealized gains for the six months ended June 30, 2014, compared to a net gain of $4.2 million in the prior year. This improvement was driven by increased market prices of investments and a $5.6 million gain from the sale of warrant investments.
• Debt Levels: Average debt outstanding increased significantly. The Holdings Credit Facility average debt rose to $228.7 million (from $193.9 million), and the SLF Credit Facility remained fully utilized at approximately $215.0 million.

Guidance, Outlook, and Risks

Capital Markets Activity:

• Convertible Notes: On June 3, 2014, NMFC issued $115.0 million in senior unsecured convertible notes due 2019 with a 5.0% coupon.
• Equity Offerings: In April 2014, the company completed a public offering of 3.5 million shares, raising net proceeds of approximately $51.0 million.
• Credit Facilities: NMFC established a new $50.0 million senior secured revolving credit facility (NMFC Credit Facility) in June 2014, which was undrawn as of period end.

Dividends and Distributions:

• The company declared a regular quarterly distribution of $0.34 per share for the second quarter of 2014.
• Subsequent to the period end, the board declared a special distribution of $0.12 per share and a third-quarter distribution of $0.34 per share.

Risks and Contingencies:

• Credit Risk: The portfolio consists primarily of below-investment-grade debt. Two super priority first lien positions in ATI Acquisition Company are on non-accrual status due to the portfolio company's inability to service interest payments.
• Liquidity: The company relies on revolving credit facilities and cash flows from operations. As of June 30, 2014, there were $39.3 million in unfunded commitments to portfolio companies.
• Valuation: A significant portion of the portfolio (Level III assets) is valued using unobservable inputs, requiring significant management judgment.

Investor Verification Checklist

• Non-Accrual Status: Verify the status and potential recovery value of the ATI Acquisition Company investments, which are on non-accrual and rated as Investment Rating 4.
• Expense Cap Expiration: Confirm the impact of the expired expense cap (March 31, 2014) on future administrative expense reimbursements to the Administrator.
• Convertible Note Dilution: Assess the potential dilution impact of the $115 million convertible notes, which have an initial conversion price of approximately $15.93 per share.
• Asset Coverage Ratio: Monitor the asset coverage ratio (234.23% as of June 30, 2014) to ensure compliance with the 1940 Act requirement of at least 200%.
• Level III Valuations: Review the sensitivity of the $312.3 million in Level III assets to changes in unobservable inputs such as EBITDA multiples and discount rates.