New Mountain Finance Corp (NMFC) 2016 Q2 法說會逐字稿

Good morning welcome to the New Mountain Finance Corporation's Second-Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). Please note, this event is being recorded.

I would now like to turn the conference over to Rob Hamwee, CEO. Please go ahead.

Thank you and good morning, everyone. Welcome to New Mountain Finance Corporation's Second-Quarter Earnings Call for 2016. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; John Kline, President and COO of NMFC; and Shiraz Kajee, CFO of NMFC.

Steve Klinsky is going to make some introductory remarks, before he does, I'd like to ask Shiraz to make some important statements regarding today's call.

Thanks, Rob. Good morning, everyone. Before we get into the presentation, I would like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of New Mountain Finance Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our August 3rd 2016 earnings press release.

I would also like to call your attention to the customary Safe Harbor disclosures in our press release and on Page 2 of the slide presentation regarding forward-looking statements.

Today's conference call and webcast may include forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from those statements and projections. We do not undertake to update our forward-looking statements or projections unless required to by law.

Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital LLC or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisors BDC, LLC where appropriate.

To find copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, please visit our website at www.newmountainfinance.com.

At this time, I'd like to turn the call over to Steve Klinsky, NMFC's Chairman who will give some highlights beginning on Pages 4 and 5 of the slide presentation. Steve?

Rob, John and Shiraz will go through the details in a moment, but let me start by presenting the highlights of another solid quarter for New Mountain Finance.

New Mountain Finance's adjusted net investment income for the quarter ended June 30th, 2016, was $0.34 per share, in the middle of our guidance of $0.33 to $0.35 per share and once again covering our Q2 dividend of $0.34 per share.

New Mountain Finance's book value was $13.23 per share, as compared to $12.87 per share last quarter. This is a $0.36 increase per share overall despite negative performance at two of our credits, Transtar and Permian, which we have now classified as nonaccrual defaults which Rob will discuss on this call.

We're also able to announce our regular dividend for the current quarter which will again be $0.34 per share, an annualized yield in excess of 10% based on Monday's close.

The Company invested $136 million in gross originations in Q2. And had $146 million of repayments in the quarter, maintaining a fully invested balance sheet.

Finally, I would like to congratulate John Kline on his well-deserved promotion to President of NMFC. He has been with New Mountain's credit efforts since 2008 and has been a major driver behind the scenes of NMFC's success.

In summary, we are pleased with NMFC's continued performance and progress overall. With that, let me turn the call back over to Rob Hamwee, NMFC's CEO.

Thank you, Steve. Before diving into the details of the quarter, as always, I'd like to give everyone a brief review of NMFC and our strategy.

As outlined on Page 6 of the presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm with over $15 billion of assets under management and over 100 staff members, including over 60 investment professionals.

Since the inception of our debt investment program in 2008, we have taken New Mountain's approach to private equity and applied it to corporate credit with a consistent focus on defensive growth business models and extensive fundamental research within industries that are already well-known to New Mountain. Or more simply put, we invest in recession-resistant businesses that we really know and that we really like.

We believe this approach results in a differentiated and sustainable model that allows us to generate attractive, risk-adjusted rates of return across changing cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource.

Turning to Page 7, you can see our total return performance from our IPO in May 2011 through August 1st, 2016. In the five plus years since our IPO, we have generated a compounded annual return to our initial public investors of 10.2%, meaningfully higher than our peers in the high yield index and an annualized cash-on-cash return to our initial public investors of 10.6%.

Page 8 goes into a little more detail on our relative performance against our peer set, benchmarked against the ten largest externally managed BDCs that have been public at least as long as we have.

Page 9 shows return attribution. Total cumulative return continues to be driven almost entirely by our cash dividend, which in turn has been more than 100% covered by NII. As the bar on the far right illustrates, over the five plus years we have been public, we have effectively maintained a stable book value inclusive of special dividends while generating a 10% cash-on-cash return for our shareholders fully supported by net investment income.

We are very happy to be able to deliver this performance over a period of time where risk-free rate has been effectively zero and will strive to continue this performance. We attribute our success to one, our differentiated underwriting platform. Two, our ability to consistently generate the vast majority of our NII from stable cash interest income. Three, our focus on running the business with an efficient balance sheet and always fully utilizing [inexpensive] appropriately structured leverage before accepting more expensive equity. And four, our alignment of shareholder and management interest.

Our highest priority continues to be our focus on risk control and credit performance which we believe over time gives us the single biggest differentiator of total return [with] the BDC [states.]

If you refer to Page 10, we once again lay out the cost basis of our investments, both the current portfolio and our cumulative investment since the inception of our credit business in 2008 and then show what has migrated down the performance ladder. Since inception, we have made investments of $3.9 billion in 179 portfolio companies, of which only six, representing just $78 million of cost, have migrated to nonaccrual and only two, representing $6 million of cost, have thus far resulted in realized default losses.

Approximately 97% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale.

Page 11 shows leverage multiples for all of our holdings above $7.5 million when we entered in investment and leverage levels for the same investment as of the end of the current quarter. While not a perfect metric, the asset by asset trend in leverage multiples is a good snapshot of credit performance and helps provide some degree of empirical, fundamental support for our internal ratings and marks.

As you can see by looking at the table, leverage multiples are roughly flat or trending in the right direction with only a few exceptions.

Of the four loans that show negative migration of two and a half turns or more, one is to a business that is completing a [sale] process that we expect to pay off our loan in full by the end of Q3.

The second one is a first lien loan to an energy services business, that while cyclically challenged continues to have substantial liquidity and which we expect to be current in the foreseeable future.

The final two, Transtar and Permian, have been placed on nonaccrual this quarter. As we reported last quarter, Transtar has been challenged by several operational mishaps, while Permian, an energy service business, continues to be challenged by a downturn in its end-market.

As a result of these business challenges, it has become clear that it's necessary to restructure both company's balance sheets, for which conversations are currently ongoing. We expect the restructuring to be completed prior to our next earnings call and we'll provide an update at that time.

The chart on Page 12 helps track the Company's overall economic performance since its IPO. At the top of the page, we show as a regular quarterly dividend being covered out of net investment income. You can see we continue to more than cover 100% of our cumulative regular dividend as NII.

On the bottom of the page, we focus on below the line items. First we look at realized gains and realized credit and other losses. You can see looking at the row highlighted in green, we've had success generating real economic gains every year through a combination of equity gains, portfolio company dividends and trading profits.

Conversely, realized losses, including default losses, highlighted in orange, have been significantly smaller and less frequent and show that we are typically not avoiding nonaccruals by selling poor credits and material loss prior to actual default.

The net cumulative impact of this success to date is highlighted in blue which shows cumulative net realized gains of $44.7 million since our IPO.

Next we look at unrealized appreciation and depreciation. As you see highlighted in gray, we have $77 million of cumulative net unrealized appreciation, an improvement of $22 million since last quarter. This improvement is largely driven by broad market gains across the portfolio. Credit specific gains also contributed to some degree with additional markdowns at Transtar and Permian more than offset by significant improvement at UniTek and a few others.

As you may recall, UniTek underperformed in 2014 and was [subsequently] restructured at the end of that year. During the restructuring, New Mountain and another leading lender took ownership of the company and controls the board. Over the course of the last two years, EBITDA has improved from approximately $25 million to a current run rate in the low 40s.

We've installed a new management team that has effectively exited unprofitable businesses and cut extraneous costs [while immediately] improving core operating performance. We believe that New Mountain's private equity operating expertise and board oversight has been highly valuable to UniTek.

I will now turn the call over to John Kline, NMFC's President, to discuss market conditions and portfolio activities. John?

Thanks, Rob. As outlined on Page 13, since our last call on May 5th, we have seen continued strong performance in the credit markets driven by positive fund flows into leveraged credit, limited new issue supply, and an increased desire for yield in the current low rate environment.

Brexit, once perceived as a risky event for market participates, instead acted as a further catalyst for investors to put more dollars to work in leveraged credit.

Looking forward, we expect that the strong credit market combined with a significant private equity [dry powder] will create a robust yield environment in the fall.

Turning to Page 14, NMFC is well-positioned in the event of future rate increases as 85% of our portfolio is invested in floating rate debt. Therefore, even in the face of a materially rising interest rate, assuming a consistently shaped yield curve, we would not expect to see a significant change in our book value.

Furthermore, as the table at the bottom of the page demonstrates, a rise in short-term rates will generally increase our NII per share.

Moving on to portfolio activity, as seen on Pages 15 and 16, investment activity increased significantly from Q1. Total originations were $136 million, offset by $146 million of repayments and $12 million of sale proceeds yielding a modest net source of cash of $22 million.

Our new originations consisted of a balanced mix of new platform investments, opportunistic purchases in the secondary market, and add-on investments to existing portfolio companies.

Additionally, as mentioned on our last call, we invested $28 million into SLP II, which continues to ramp at a consistent pace.

Since the end of the quarter, we have maintained our origination momentum with a total of $80 million in new originations, offset by $43 million of repayments and sales, resulting in a $37 million use of cash.

As we stand today, we are fully invested, with our future originations expected to be funded by cash proceeds from certain near-term portfolio exits as well as from availability in our SBIC programs.

Page 17 shows that during the quarter our originations by asset type are consistent with our rough historical mix of 50% second lien and 50% first lien, inclusive of the SLP facilities. Meanwhile, our sales and repayments were 66% first lien and 34% second lien.

Asset yields, as shown on Page 18, remain consistent with last quarter at 10.3%. Despite the stronger market which has pushed spreads modestly lower, we continue to have success finding portfolio investments with attractive yields in our core defensive growth industries like software, healthcare, distribution logistics, and business services that we believe will perform well in various economic environments.

On Page 19, we show our balanced portfolio across defensive growth oriented sectors and our continued balance between first and second lien investments. On the lower right, it's important to note the vast majority of our portfolio continues to perform at or above our expectations.

Finally, as illustrated on Page 20, we have a broadly diversified portfolio with our largest investment at 3.7% of fair value and the top 15 investments accounting for 39% of fair value.

With that, I will now turn it over to our CFO, Shiraz Kajee, to discuss the financial statements and key financial metrics. Shiraz?

Thank you, John. More details on our financial results and today's commentary, please refer to our form 10-Q that was filed last evening with the SEC.

Now I would like to turn your attention to Slide 21. The portfolio had approximately $1.53 billion in investments at fair value at June 30th, 2016. And total assets of just over $1.58 billion. Total liabilities $741.3 million of which total statutory debt outstanding was $600 million, excluding $121.7 million of drawn SBA guaranteed debentures.

Net asset value of $843.3 million, $13.23 per share, was up $0.36 from the prior quarter. As of June 30th, our statutory debt to equity ratio was 0.71 to 1.0.

On Slide 22, we show the historical NAV per share and leverage ratios which are broadly consistent with our current target statutory leverage between 0.7 and 0.8 to 1.0. We also show the NAV adjusted for the cumulative impact of special dividends which portrays a more accurate reflection of true economic value creation.

On Slide 23, we show our quarterly income statement results. We believe that our adjusted NII is the most appropriate measure of our quarterly performance. This slide highlights our realizations and unrealized appreciation depreciation can be volatile below the line. We continue to generate stable net investment income above the line.

Focusing on the quarter ended June 30th, 2016, we had total investment income of approximately $41.5 million. This represents an increase of $0.6 million or 1.5% from the prior quarter, largely attributable to an increase in [prepayment] income.

Total net expenses of $19.7 million are up slightly from the prior quarter.

Mentioned on prior calls, [a majority of our] Wells Fargo credit facilities is consistent with the methodologies since IPO. The investment advisor will continue to waive management fees on the leverage associated with those assets which share the same underlying yield characteristics with investments leveraged under the legacy SLF credit facility. This results in an effective annualized management fee of 1.4% for the quarter which is in line with prior quarters.

It is expected, based on our credit portfolio construct, that the 2016 effective management fee will be broadly consistent with the prior years and it is important to note that the investment advisor cannot recruit management fees previously waived.

In total, this results in second-quarter adjusted NII of $21.8 million or $0.34 per share which is in line with guidance and covers our future regular dividend of $0.34 per share.

In total, for the quarter ended June 30th, 2016, we had an increase in net assets resulting from operations of $44.7 million.

Slide 24 demonstrates our total investment income is recurring in nature and predominantly paid in cash. As you can see, 89% of total investment income is recurring and cash income remains strong at 94% this quarter. We believe this consistency shows the stability and predictability of our investment income.

Turning to Slide 25, as we discussed earlier, our adjusted NII for the second quarter covered our Q2 dividend. Given our belief that our Q3 adjusted NII will fall within our guidance of $0.33 to $0.35 per share, our Board of Directors has declared a (technical difficulty) of $0.34 per share in line with the past 17 quarters. (inaudible)

As mentioned in our last call, during (inaudible) our credit facility, $110 million to $123 million. We also issued $50 million of five year senior unsecured notes at a fixed rate of 5.313%. Taken into account SBA guaranteed debentures, we had $933 million of total borrowing capacity at June 30th, 2016.

As a reminder, our Wells Fargo credit facilities covenants are generally tied to the operating performance of the underlying businesses that we lend to, rather than the [marks] of our investments at any given time.

At this time, I would like to send the call back over to Rob.

Thanks, Shiraz. It continues to remain our intention to consistently pay the $0.34 per share on a quarterly basis for future quarters so long as the adjusted NII covers the dividend in line with our current expectations.

In closing, I would just like to say that we continue to be pleased with our performance to date. Most importantly, from a credit perspective, our portfolio overall continues to be healthy. Once again, we'd like to thank you for your support and interest and at this point, turn things back to the operator to begin the Q&A. Operator?

++ q-and-a

(Operator Instructions).

Jonathan Bock, Wells Fargo Securities.

One small item as we were making a read-through. Rob, related to SLF II where we saw an equity commitment both yourself and your partner roughly $35 million. Debt outstanding to the vehicle of $71 million. Yet the fair value of assets at $167 million.

And I'm just curious because either I can't read, which is certainly possible, but is there another piece or debt part outstanding that's allowing you to hold that asset level above both the debt and equity commitment to the vehicle?

No, there's nothing strange going on. So, either there's a typo in something that we put out, which I hope is not the case, or Jonathan, you're maybe conflicting two different things?

Where are you seeing the $167 million?

We'll take it offline. It's probably certainly our mistake. But we do understand that the SLFs are important growth avenues, which kind of gets to our next question. In terms of the ability to attack the senior secured marketplace, where are you seeing most of the deal flow coming through that channel?

You could either A, move to your more syndicated type markets, or B, participate as passive investors alongside perhaps a direct originator doing the L550 stretch, right? Whether it's a [Nonteris] or a Golub, etcetera. Knowing that you're part of that process, how are you looking at sourcing opportunities there? Because both can be attractive based on your views of the industries it's being originated in, but it gives us a sense of how to model where we should think about yields will be going in that portfolio.

It's a good question, Jonathan. And I think, again, not to beat a dead horse here, but we do start with the industry and the business. And only then think about the scale of the capital structure and whether it's broadly syndicated or clubbed up or in some instances a direct origination led by us.

So, those are really all [outputs] so we could see three great businesses that we underwrote for private equity and that somebody else purchased and they all three could be, pick a category, club deals, that would be three club deals in a row. But they could just as easily be three syndicated deals or three direct originations for us. So, it's really a function, Jonathan, of the flow that falls into that box that we focus on which is defensive growth businesses that we know and like through our private equity effort.

So, it's very hard for me to say because we're not selecting for those categories, the categories of type. We selecting for business and industry.

Which has proved very well in the past. So, then maybe attacking it in a different way. John, I think you mentioned there's opportunity for, given private equity capital and sidelines, business activity, eventually is likely to pick up.

Do you see more of an opportunity to work on privately negotiated second liens? In which case you benefit from substantial covenant and pricing premiums. Is that private second lien options really come into the fray? Or are the transactions that you would expect coming on the wave of new deal activity this year, is it going to be more of a dealer brought type of transaction that produces high yield that you know well? But might actually come at a bit of a lower spread than if you were able to do it as part of a privately negotiated club deal?

There's a lot there. I would say that we think deal activity is going to go up across the board, both on more private club deals and also broadly syndicated deals brought by dealers.

I think you bring up a really important point on the second lien market. And that market is definitely evolving. I think one or two years ago, I think larger investment banks were probably more active in that business. And I think as you and a lot of other market watchers know, that market is evolving to really become more of a private market.

And so we're finding a way, we feel we have good sourcing avenues no matter where the market goes.

Credit is a question that has entered into a lot of investors' minds and certainly how it ties to dividend policy, etcetera. And we've seen that you've been certainly able to more than maintain earnings as well as do so by focusing on acyclical types of industries and investments.

And the question is, Rob, is now really a period where your investors should expect earnings growth? And no can actually be a good answer because it allows them to look at the dividend yield in a different light as much more sustainable for a manager who is happy running in place instead of continually trying to grow earnings or reach for yield which might present NAV issues down the road.

Jonathan, I think I've been very consistent about this for some time now which is we are absolutely not focused on growing NII and growing the dividend in this interest rate environment. We believe getting a 10% ROE is pretty attractive and we want to do that while taking as little risk from a credit perspective as possible.

So, unless we have a material change in the underlying interest rate environment, our focus is to continue to deliver what we believe is a tremendous amount of excess spread while keeping the credit profile as high quality as possible.

And how would you define the impact? Clearly LIBOR has gone from 30 to 60 to 78 or so now. One of the questions, you largely absorb the impact of that higher LIBOR but still have been able to maintain ROE. In terms of the pain that perhaps could come to the extent LIBOR creeps up a little bit more, how should we think about your ability to mitigate that remaining negative earnings impact?

It's almost down to zero, Jonathan. We've got a slide on Page 14 that as far as the point of maximum pain is plus or minus 50 more bps. And that's $0.01 a share annually.

So, we, like you say, we absorb most of it and we're comfortable if we happen to reach that point of maximum pain and stop right there, we're comfortable we can handle that again, $0.01 out of $1.36.

And then the final question, we noticed that portions of Permian Tank and Transtar were placed on nonaccrual. And while the portions placed on nonaccrual were really the majority of the loan, can you walk us through why some get put on nonaccrual? Why the others wouldn't? And really what, the credit situation there, how it unfolds and the impact? Would you expect more to come? Or you can isolate it to a certain business division, etcetera. More color on those credits would be very helpful.

From a policy perspective, and historically, to the extent there's debt being reinstated in a proposed restructuring, and that debt is either cash pay or [it's picked] but we believe that it's highly likely to be collectible. GAAP requires us to put that into the nonaccrual.

That's what we've done at UniTek. It works and makes sense. [And at Menson.] And we're doing the same thing with Permian and Transtar. Based on our current best information and belief as to how those restructurings, which are very much in progress, will play out.

And then once the restructuring is finalized, we have final numbers which could be higher or lower. So, in terms of the underlying things going on in the business, as I said in the prepared remarks Jonathan, because they're both private companies with private restructurings, until they're finalized, I really can't go into any further detail based on confidentiality issues and constraints. But I will expect both of those to be completed by our next call and we'll go through all the gory details.

(Operator Instructions).

Jeff Greenblatt, Monarch Capital.

I had a quick question and I'm trying to, again, on a big picture basis, look through your portfolio past the NAV number. And by the way, it's nice to see that rise this quarter as some of the credit markets have stabilized. But as effectively a debt substitute, in my mind the most important number is always sort of been what is the par value if your underwriting is good and you get paid off on time.

You show a cumulative depreciation number of $77 million, I think, on one of the slides, which has improved somewhat since the last quarter. I'm trying to, if I can roughly figure out, how do I look at that $77 million? Because on 64 million shares, that's hypothetically $1.20 above the NAV that could be recouped if effectively you ignore the market-to-markets. But I guess some of that is stuff that's gone on nonaccrual, correct?

That is correct.

Is there a way to sort of, obviously the extent that that can be paid off at par, not all of it will because it's on nonaccrual. But [if] that $77 million paid off at par that's what we hypothetically could look forward to in terms of a rise of NAV over time, correct?

That is correct. And we've done the math there for you. I think the number is, that you're looking at, if you take the restructured equity components and anything that's troubled, like a Transtar or a Permian or CR Hamilton, anything rated three, etcetera. Leave all that stuff at the mark, right? But take all the not troubled stuff at par.

Exactly, the stuff that you're reading one or two that you expect to pay off.

That basically gets you to a 1390 NAV. So, effectively covers 60% of that number on a dollar basis.

So, that's as compared to your 1320 or whatever --

1323, exactly.

So, aside from the continuation of the 10% yield which I agree with you is almost perplexing why it's so high in this environment. You still have that element of potential NAV appreciation as your investments pay off, assuming you have no further defaults.

That is correct. And of course, on the other stuff, the troubled stuff, could go up, like the UniTek could go down depending on how some of these restructurings play out etcetera.

(multiple speakers)

As a follow up to that, I took note of a statement you made which I am tremendously supportive of, which is you said you prefer to continue a favorable use of well-structured and efficient debt financing over the more expensive equity component of selling stock.

And I know in the past you've said you will not sell stock below NAV which obviously is important, but I also view it important not selling stock below the 1390 number hypothetically. Biggest to me, as an investor, I've written, and moved down in the unrealized and I'd like to write it back without getting diluted.

So, to what extent can I look at the $200 million of future availability it looks like you have on all your debt lines combined and think about to the extent that effectively your portfolio is trading at a discount to par as we discussed that you'll focus more on using that debt than doing subsequent equity raises.

Are you looking at that the same way I am? Or are there different factors you're looking at?

I think it's similar. I think we are, in our own minds, constrained on the debt, less by the $200 million of availability than the statutory constraint. We've always talked about obviously we don't want to get too close to the 1.0 to 1.0 statutory constraint. So, we've always talked about running the business 0.75 plus or minus.

So, it will never use that full $200 million. It's good to have a liquidity cushion. But the constraint will be around how much more debt to get to that plus or minus 0.75. It could be 0.78, it could be 0.72. And of course, using the SBA debt does not impact the statutory. So, we'll use that to the maximum capacity.

When we think about equity issuances, we do look at things other than just stated book value. Because I agree with you. That 1390 is an important marker. Frankly, the 1375 that we went public at is another important marker. So, all of those are markers beyond just looking at book value.

And last question, I noticed a slight trend, which I'm not sure is significant, but maybe you can comment, on the percentage of the portfolio that's of companies, I believe, under $100 million of EBITDA. I think over the last few quarters it's moved up from the 60s to close to 70s.

I assume that's because the opportunities there makes it easier for you to negotiate one-off with the borrower rather than being part of a club deal where you're subject to terms imposed by others. Is that the right way to look at that? Or how should I look at that, if it means anything at all?

I think there's two elements to that. I think what you just said is one element. And I think the other element is our ramping up of the SBA facility, which trends to smaller businesses. So, those are the two components to that trend.

Thanks for the answers to the questions and congratulations on another good quarter.

Thank you and thanks for your support. We appreciate it.

This concludes our question and answer session. I would like to turn the conference back over to Rob Hamwee for any closing remarks.

Thank you, Operator. Thank you everyone for taking the time to join us this morning. And we look forward to speaking again next quarter. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.