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New Mountain Finance: Shareholders Approve Higher Leverage

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NEWS

On June 11, 2018 New Mountain Finance (NMFC) reported in an 8-K filing that shareholders had voted to approve the lower asset coverage provision allowed under the Small Business Credit Availability Act.

See the filing attached.

The provision passed by a 2:1 margin.


ANALYSIS

Under the provisions of the Act, given that shareholder approval has been added to Board approval, the new asset coverage limit will apply immediately.

Currently NMFC has $1.977bn of investment assets and total borrowings of $0.975mn and Net Assets of $1.033bn.

By our calculation, the BDC can – on a pro forma basis – add $1.091bn in assets.

That would bring total investments assets to $3.068bn, total debt to $2.066, and asset to debt coverage to 1.5x.

Assuming NMFC – which historically has maintained debt at very close to the regulatory limit – chooses a target leverage of 1.9x, the likely increase in assets/debt is likely to be $0.988mn.

Let’s just say $1.0bn…

Bigger Picture

We’ve been undertaking a similar analysis of likely asset and debt increase on any BDC which has announced its intention to leverage up and where we have a rough idea as to how much.

So far, we’ve completed these first pass calculations for 10 BDCs.

Aggregate extra investment assets that are likely to be eventually generated has reached $4.068bn.

Given that several major BDCs are not yet included on our list, we still estimate the extra investment assets will eventually exceed $20.0bn.

Assuming average management fees and Incentive Fees equal to 2.5% of those incremental assets, External Managers will be earning an additional half a billion dollars a year.


VIEWS

We wrote a generally favorable article about the economics of NMFC’s proposed higher leverage back in April.

If we understand the BDC’s approach to how fees will be charged – and we don’t know that we do –  recurring earnings per share may get a boost from the new assets added.

However, there’s no denying – whatever NMFC invests in – that the credit risk will be increased by adding up to $1.0bn of new investments to the same capital base as before.

Uncertain 

Despite doing our homework and making many calculations on the backs of envelopes a great deal of uncertainty accompanies this move.

The BDC – and all those who follow in its footsteps – will have to radically change their liability management to take full advantage of the new leverage freedoms

Much remains unknown about how NMFC – and others – will tackle the existence of their already highly leveraged Joint Ventures and how generous the debt markets might be in terms of advance rates, terms and pricing.

Not to mention how S&P will opine on all this extra debt getting loaded onto the broad backs of BDCs.

(We’re still guessing in the stand-off between issuers and ratings group, the former wins in the end).

Yet shareholders know very little about how NMFC, CGBD and the other 24 BDCs that have already pledged to adopt the new rules – sooner or later – will tackle these and a myriad related issues.

Confession

From our standpoint – and given we are in the Views section of this reportage – we’re in a Wait And See mode about investing with so much unknown.

The Market Speaks

This seems to be the reaction of the BDC market more generally.

NMFC’s stock price – as this 1 Year chart shows – has increased in the last few weeks, but remains below the levels of 2017.

Laggard

Likewise, Carlyle’s TCG BDC (CGBD) – which was the first BDC to get shareholder approval for the higher leverage – has not been exactly on fire since opting to leverage up.

As this Year To Date chart shows, the market has been punishing the stock in the last couple of days.

At time of writing, the stock price is just 4% off its 52 Week Low, and 14% away from its 52 Week High.

Eye On The Big Prize

Of course, these two external managers may be less concerned about what happens to the stock price of the BDC they manage than in the tens of millions of dollars in higher incentive compensation coming their way in the years ahead come rain or shine.

Shareholders and manager interests have rarely been so far apart, and it’s reflected in that perpetual voting machine: the stock price.

 

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