New Mountain Finance Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2024

There are 9 speakers on the call.

Operator

2024 Earnings Call. All participants will be in a listen only mode. Please note this event is being recorded. I would now like to turn the conference to John Klein, President and CEO of New Mountain Finance Corporation. Please go ahead.

Speaker 1

Thank you, and good morning, everyone. Welcome to New Mountain Finance Corporation's Q2 2024 Earnings Call. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital Laura Holson, COO of NMFC and Chris Corbett, CFO and Treasurer of NMFC. Steve is going to make some introductory remarks, but before he does, I'd like to ask Chris to make some important statements regarding today's call.

Speaker 2

Thanks, John. 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 on our July 31 earnings press release.

Speaker 2

I would also like to call your attention to the customary Safe Harbor disclosures in our press release and on Pages 23 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. To obtain copies of our latest SEC filings and to access the slide presentation that we'll 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 Kalinski, NMFC's Chairman, who will give some highlights beginning on Page 5 of the slide presentation.

Speaker 2

Steve? Thanks, Chris. It's great to

Speaker 3

be able to address you all today, both as NMFC's Chairman and as a major fellow shareholder. Adjusted net investment income for the quarter was $0.36 per share, in line with our implied guidance and more than covering our $0.32 per share regular dividend that was paid in cash on June 28. Our net asset value per share of $12.74 was roughly flat with only a $0.03 decline or 0.2 percent, demonstrating continued stable credit performance across our portfolio. Given our earnings of $0.36 per share this quarter, we will make our 6th consecutive variable supplemental dividend payment. The variable supplement supplemental dividend for this quarter will be $0.02 per share, which is equal to half of the amount of our Q2 quarterly earnings in excess of our regular dividend of $0.32 NMFC will pay these distributions on September 30 to holders of record as of September 16.

Speaker 3

The remainder of the excess earnings will remain on our balance sheet and may be paid out in the future. Our dividend at $0.34 represents an annualized current distribution yield of 11%. For Q3, in addition to our $0.32 regular dividend, we expect to generate a variable supplemental dividend of at least $0.01 per share payable in the Q4 of 2024. As we look ahead, the continuation of variable supplemental dividend payments will be dependent on the direction of base rates, financing spreads and other factors. While there is uncertainty around these variables, we would like to announce some shareholder friendly changes to our fee structure.

Speaker 3

First, we plan to permanently reduce our base management fee to 1.25% from 1.4%. 2nd, we are announcing the extension of our dividend protection program. While the current program will remain unchanged for the remainder of the year, for calendar years 20252026, we commit to reduce our incentive fee to 15% if and as needed to help support the $0.32 per share quarterly regular dividend. Specifically, during 20252026, if we are in quarterly NII below $0.32 per share, we would reduce our incentive fee to the higher of 15% or the percentage needed to achieve NII of $0.32 per share. We believe these changes reflect our commitment to delivering stable yield and a well protected dividend.

Speaker 3

We believe the strength of New Mountain and of NMFC is driven by the consistency of our strategy and the quality of our team. New Mountain overall now numbers over 250 members and the firm has developed specialties and attractive defensive growth that is a cyclical growth sectors such as life science supplies, healthcare information technology, software, infrastructure services and digital engineering. When pursuing our credit investing efforts, we utilize our extensive group of industry experts to provide unique knowledge and expertise that allows us to make very informed high conviction underwriting decisions. Over the last year, we have continued to expand the quality of our overall team. New Mountain's private equity funds have never had a bankruptcy or missed an interest payment and the firm now manages over $55,000,000,000 of assets.

Speaker 3

Similarly, NMFC has experienced only 12 basis points of average annualized net realized losses in its 13 years as a public company, while paying out over $18 per share of cumulative dividends. We believe our loans today are well positioned overall in defensive growth industries that we think are right in all times and particularly attractive in less certain economic times. Finally, we as management continue as major shareholders of NMFC. I and NMC's other senior management employees currently own around 12% of NMFC's total shares personally. With that, let me turn the call to John.

Speaker 1

Thank you, Steve. I would like to begin by offering a broader review of our direct lending investment strategy and long term track record. Starting on Page 8, we highlight our exposure to a diversified list of defensive non cyclical sectors. These sectors map to the industries where New Mountain has made successful private equity investments and where our firm's knowledge is the strongest. We seek to make investments in companies with durable growth drivers, predictable revenue streams, margin stability and great free cash flow conversion.

Speaker 1

As you can see from the industry pie chart on Page 8, we have virtually no exposure to cyclical, volatile and secularly challenged industries, which could be riskier areas to invest in given today's higher rate environment. Our strategy has been over our 13 years as a public company and it allows us to operate with confidence in any economic environment. Page 9 provides key performance statistics showing a long term track record of delivering consistent enhanced yield to our shareholders by minimizing credit losses and distributing virtually all of our excess income to shareholders. Since our IPO in 2011, NMFC has returned approximately $1,300,000,000 to shareholders through our dividend program, generating an annualized return of approximately 10%. Our current portfolio invests in companies within high quality industries that are performing well and where our last dollar of risk is approximately 40% of the purchase price paid for the business.

Speaker 1

We lend primarily to businesses owned by financial sponsors who are sophisticated and supportive owners with significant capital that is junior to the loans that we make. Turning to Page 10, the internal risk ratings of our portfolio improved quarter over quarter with 97% of the portfolio rated green compared to 96.5% last quarter. This represents the highest level of green rated assets since we began using the Heat Map rating system in 2020. Our most challenged names within the orange and red categories represent only 1.2% of NMFC's fair value, making them a negligible part of our portfolio. The updated heat map is shown in its entirety on Page 11.

Speaker 1

Given NMFC's orientation towards defensive sectors like software, business services and healthcare, we believe our assets are well positioned to continue to perform no matter how the economic landscape develops. Similar to Q1, we did not have any negative risk rating migrations during the quarter. In fact, the majority of our investments continue to experience both top and bottom line growth consistent with our underwriting. Additionally, we remain optimistic about the prospects of many of our non Green names, many of which have the ability to migrate back to Green over time and one of which we expect to partially repay in Q3 at par. Turning to Page 12, we provide a graphical analysis of NAV changes during the quarter resulting in a book value of $12.74 a $0.03 decline in book value compared to last quarter.

Speaker 1

Overall, the quarter benefited from very good core credit performance, a supportive market environment, which was offset by declines in the value of a delay in the expected timing of realization resulted in a write down this quarter. Additionally, we again modestly reduced the carrying value of our equity stake in Momentum. As a reminder, Momentum is a leading provider of K-twelve online learning programs that benefited from an accelerated shift to virtual learning during the pandemic. As we discussed last quarter, the market continues to normalize post COVID and therefore we have reversed some of the unrealized gain that we previously recognized. Consistent with last quarter, we believe the market is stabilizing, Vadmentum remains well positioned and the value proposition of the company's products is strong.

Speaker 1

Page 13 addresses NMSD's non accrual performance. On the left side of the page, we show the current state of the portfolio where we have approximately $200,000,000 of investments at fair value with $44,000,000 or 1.4 percent of the portfolio currently on non accrual. Of the names on non accrual, most are from much older vintages, have been written down materially and have a good chance of exiting the portfolio in the medium term. We now show an adjusted non accrual box on the bottom left of the page, which excludes $54,000,000 of certain older Unitech preferred classes that are on non accrual. These preferred positions suffered dilution in 2020 when New Mountain led an incremental capital round during the pandemic.

Speaker 1

The investment came with significant equity participation, which meaningfully diluted the preferred stock tranches. Today, the current value of this equity largely offsets the original face value of the non accruing preferreds. We believe that showing these non accruing Unitek positions with the offsetting equity appreciation without the offsetting equity appreciation is misleading and that this new disclosure more accurately reflects our overall non accrual performance. Moving to the right side of the page, we show our cumulative credit performance since IPO where NMFC has made approximately $10,000,000,000 of investments while only realizing losses of $69,000,000 This represents an average annualized net realized loss rate of approximately 12 basis points since IPO. This loss rate increased compared to last quarter as we recorded realized losses as a result of the restructurings of Charismatic Brands and Transcendia.

Speaker 1

Charismatic is currently held at a negligible fair value relating to out of the money warrants received in the restructuring. The position has almost no downside, but meaningful upside if the company returns to past earnings levels. Transcendia was recapitalized by a new sponsor during Q2, which led to a restructuring of our 2nd lien position, but no meaningful change in fair value relative to Q1. We now own 2 tranches of preferred securities and common equity alongside the new owner of the business. We are optimistic about Transcendia's current trajectory and operational improvement plans and are hopeful the value of our new securities will increase over time.

Speaker 1

On Page 14, we present NFFC's overall economic performance since IPO showing that we have delivered consistent and compelling returns. Cumulatively, NMFC has earned nearly $1,300,000,000 of net investment income, while generating only $69,000,000 of cumulative net realized losses and only $30,000,000 of net unrealized depreciation, resulting in $1,200,000,000 of value created for shareholders. I'll now turn the call over to our Chief Operating

Speaker 4

Thanks, John. Sponsor backed M and A continued to pick up in the Q2, but still remains below normal levels. There are pockets of activity in our defensive growth verticals where we have the opportunity to make loans that attach $1 in the capital structure at attractive double digit yields, while staying very selective. Deal structures remain compelling with leverage below peak levels and significant sponsor equity contributions representing the vast majority of the capital structures. We remain bullish on the medium and long term outlook for M and A activity, given the magnitude of dry powder for private equity, the ongoing pressure to return capital to LPs as well as attractive financing markets for borrowers.

Speaker 4

The timing of that pickup in M and A remains a question. However, general sentiment feels more likely 2025 rather than the second half of twenty twenty four. Syndicated markets are open and we continue to see modest spread compression related to the increased competition. However, we expect the supply demand imbalance to normalize as soon as we see a more regular deal flow environment return. While the syndicated markets are open, the direct lending market generally remains the financing market of choice for sponsors as the majority of sponsors still recognize the benefits of the direct lending solution, including more certain execution, more flexibility around creating a bespoke capital structure and the ability to hand select lenders.

Speaker 4

In addition to new activity, we've seen an increased volume of opportunistic refinancings and add on opportunities within our large portfolio of over 120 unique borrowers. This provides an ongoing opportunity set to make incremental loans to existing well performing portfolio companies seeking to pursue accretive M and A. Page 16 presents an interest rate analysis that provides insight into the effective base rates on NMFC's earnings. The NMFC loan portfolio is 86% floating rate and 14% fixed rate, while our liabilities are 48% fixed rate and 42% floating rate as of quarter end. As a reminder, during Q1, we fully swapped our investment grade bond issuance from fixed to floating rates.

Speaker 4

As we access the investment grade market in the future, we would expect to hedge interest rate risk in this manner. We highlight our sensitivity to interest rates on the bottom chart. While we would expect to see some earnings pressure in the scenario where base rates decrease, we believe we have some opportunities to offset that by optimizing our liability stack and potentially refinancing some shorter dated higher cost fixed rate debt. Specifically, our 7.5% converts mature in October 2025 and our 8.25% baby bonds are callable at par in November of 2025, both of which represent opportunities to hopefully refinance at lower rates. Moving on to Page 17, in Q2, we saw strong portfolio velocity.

Speaker 4

We originated $437,000,000 of assets and had nearly $300,000,000 of repayments. Our originations consisted of investments in our core defensive growth power alleys, including niches of enterprise software and business services. I'd highlight that 5 of our repayments during the Q2 were second lien positions, 2 of which completed opportunistic refinancings where we participated in the new first lien. Turning to Page 18, we continue to show good momentum in rotating our asset mix more senior, where approximately 75% of our investments, inclusive of 1st lien, SLPs and net lease are senior in nature, up from 69% last quarter. 2nd lien positions decreased from 18% in Q2 of last year and 14% last quarter to just 9% this quarter.

Speaker 4

Approximately 7% of the portfolio is comprised of our equity positions, the largest of which are shown on the right side of the page. We continue to dedicate meaningful time and resources to business building at these companies, all of which we believe are making positive progress in advance of potential medium term exits. Our ability to own and operate businesses is a key differentiator. We leverage the full operating capabilities of our private equity team and approach our credit equity positions like any other New Mountain Capital owned business. Page 19 shows that the average yield of MMFC's portfolio remained consistent at 11.1% for Q2.

Speaker 4

Generally speaking, even though spreads are tighter as evidenced by lower yields on our originations compared to on our repayments, yields remain attractive and support our net investment income target. Page 20 highlights the scale and credit trends of our underlying borrowers. As you can see, the weighted average EBITDA of our borrowers has increased over the last several quarters to $180,000,000 This is primarily attributable to originations of some larger companies as well as growth at the individual companies we lend to. While we first and foremost concentrate on how an opportunity maps against our defensive growth criteria and internal New Mountain knowledge, we believe that larger borrowers tend to be marginally safer, all else equal. We also show the relevant leverage and interest coverage stats across the portfolio.

Speaker 4

Portfolio company leverage has decreased slightly over the last several quarters. Loan to values continue to be quite compelling and the current portfolio has an average loan to value of 44%. Interest coverage ratios have stabilized as expected and the weighted average interest coverage on the portfolio was flat at 1.7 times this quarter. We've seen sponsors continue to proactively support company liquidity and continued M and A activity. This is a great indication that our portfolio consists of companies that are performing well and are able to attract additional investment and healthy valuations.

Speaker 4

Finally, as illustrated on Page 20 1, we have a diversified portfolio across 123 portfolio companies. The top 15 investments, inclusive of our SLP funds and net lease, account for approximately 41% of total fair value and represent our highest conviction name. I will now turn the call over to our Chief Financial Officer, Chris Corbett to discuss our financial results.

Speaker 2

Thank you, Laura. For more details, please refer to our quarterly report on Form 10 Q that was filed yesterday with the SEC. As shown on Slide 22, the portfolio had approximately $3,200,000,000 in investments at fair value on June 30 and total assets of $3,400,000,000 with total liabilities of $2,000,000,000 of which total statutory debt outstanding was 1,700,000,000 dollars Net asset value of $1,400,000,000 or $12.74 per share was down slightly compared to the prior quarter. At quarter end, our statutory debt to equity ratio was 1.21:one and 1.14:one net of available cash on the balance sheet, continues to be within our target range. While we ended the quarter at the higher end of our range, our average leverage during the quarter was in the middle of our target range.

Speaker 2

On Slide 23, we show our quarterly income statement results. For the current quarter, we earned total investment income of $94,300,000 a 1% decrease over prior year. Total net expenses of approximately $56,100,000 increased 1% versus prior year. As a reminder, the investment advisor is committed to a management fee of 1.25 percent for the 2024 calendar year and as mentioned earlier, we expect to permanently reduce our fee to this level on a go forward basis. The investment advisor has pledged to reduce its incentive fee to fully support the $0.32 per share regular dividend through the end of 2024.

Speaker 2

In 20252026, it pledges to reduce its incentive fee to the higher of 15% or the percentage needed to achieve an adjusted NII of $0.32 if and as needed to support the quarterly regular dividend. It is important to note that the investment advisor cannot recoup fees previously waived. Our adjusted net investment income for the quarter was 0.36 dollars per weighted average share, which meaningfully exceeded our Q2 regular dividend of $0.32 per share. As slide 24 demonstrates, 93% of our total investment income is recurring in Q2. We saw higher non recurring income during the quarter due to increased portfolio velocity and a one time dividend following the strong performance of one of our equity positions.

Speaker 2

You will see historically that over 90% of our quarterly income is recurring in nature and on average over 80% of our income is regularly paid in cash. We believe this consistency shows the stability and predictability of our investment income. Importantly, over 98% of our quarterly non cash income is generated from our green rated names. Turning to slide 25, the red line shows the coverage of our regular dividend. This quarter, adjusted net investment income exceeded our Q2 regular dividend by $0.04 per share.

Speaker 2

For Q3 2024, our Board of Directors has again declared a regular dividend of $0.32 per share as well as a supplemental dividend of $0.02 per share. On Slide 26, we highlight our various financing sources and diversified leverage profile. Taking into account SBA guaranteed debentures, we have $2,600,000,000 of total borrowing capacity with $587,000,000 available on our revolving lines, subject to borrowing base limitations. Our significant borrowing capacity continues to highlight our strong liquidity position. Subsequent to quarter end, we successfully negotiated a repricing on our Wells Fargo credit facility, which reduced our spread from SOFR plus 2.50 to SOFR plus 2.15.

Speaker 2

The successful repricing will partially mitigate the aforementioned spread tightening seen in the market and we believe this represents very strong execution for a facility of this nature. As a reminder, covenants under both our Wells Fargo and Deutsche Bank Credit Facilities are generally tied to the operating performance of the underlying business that we lend to rather than the marks of our investments at any given time, which we think is particularly important during more during volatile market conditions. Finally, on Slide 27, we show our leverage maturity schedule. As we've diversified our debt issuance, including through our inaugural investment grade bond issuance earlier this year, we successfully we've been successful at laddering our maturities to manage liquidity. Notably, nearly 70% of our debt matures in or after 2027 with near term maturities representing an opportunity to continue to access the investment grade bond market.

Speaker 2

With that, I would like to turn the call back over to John.

Speaker 1

Thank you, Chris. As we look forward over the remainder of 2024, we are confident in the continued strong performance of NMFC's portfolio and believe we are on track to continue to deliver great risk adjusted returns to our shareholders. We once again would like to thank all of our stakeholders for the ongoing partnership and support and look forward to speaking to you again on our next quarterly call in October. I will now turn things back to the operator to begin Q and A. Operator?

Operator

Thank The first question comes from Finian O'Shea with Wells Fargo. Please go ahead.

Speaker 5

Hey, everyone. Good morning. Good morning. How are you? First question on capital raising, it looks like you may have only hit book value intraday a little bit.

Speaker 5

So, 1, was there any ATM capital raise below NAV? And 2, what sort of posture should we expect if and when the stock reaches NAV again?

Speaker 1

Sure. Yes, so when we issue shares in our ATM program, we always make sure that the company nets NAV. So there was there were small subsidies that we paid to make sure the company netted NAV on any new ATM shares. And then the posture around growing through the ATM is one of, I think, of a focus. We do want to continue to grow NMFC.

Speaker 1

We think there's a huge opportunity for us to grow our direct lending franchise in general. As you know, more of a midsized lender and we stay long ideas and always a little bit short capital. So when we issue ATM shares, we have no problem investing those proceeds into our core direct lending loans that we make. So to the extent the stock trades well, we continue we'll continue to utilize the ATM program.

Speaker 5

Okay. It's helpful. Thanks. And a second one on the color ratings you provided, which are very helpful. I think you said there are no changes this quarter.

Speaker 5

And in the Q, it says Transcendia is on green. So assuming it was on green last quarter with the comments like so are the color ratings market value adjusted or something like that? Or if this was the case, like why was Transcendia on green last quarter?

Speaker 4

Yes. So when we anytime when one of the portfolio companies restructures, we kind of reset kind of the color mapping from a heat map perspective. So Transcendia was technically not on green last quarter. I believe it might have been an orange last quarter. But because it was kind of a new transaction effectively post restructuring, we kind of reset the expectations.

Speaker 4

We're resetting our underwriting cases, all of that. And therefore, it's on now on green kind of post restructuring. Does that help clarify?

Speaker 5

Absolutely. Thanks so much.

Operator

Next question comes from Bryce Roe with B. Riley. Please go ahead.

Speaker 6

Thanks a bunch. Good morning.

Speaker 1

Good morning. How are you, Bryce?

Speaker 6

I'm good, John. So maybe I'll start with a kind of an income statement question. And Chris, you called out the one time dividend. I was hoping maybe you could help size that one up for us. And then also it looked like the other income line might have been a little elevated in the quarter, just trying to get a feel for what's recurring and what isn't?

Speaker 2

Yes. So that yes, the dividend that we received during the quarter was approximately $2,000,000 for that line. And then as far as the uptick in other income, again, that was due to the increased velocity with the increase in originations during the quarter. I think that was the bulk of the that increase in the other income line item.

Speaker 6

Got it. Okay.

Speaker 1

Yes. Bryce, as you know, for quite a long period of time, we just didn't have a lot of portfolio velocity. And we're really in Q2, we just saw that change and that does change the nature of our income a little bit.

Speaker 6

Yes. Okay. That makes sense. And then you guys made a comment about and we've seen some other BDCs do this in swapping the fixed rate on some of the unsecured into floating. Did I get the read that maybe that will be kind of an ongoing strategy even in maybe a different interest rate environment, do you expect to try to match the assets and liabilities from, I guess, an ALM perspective, asset liability management perspective?

Speaker 4

Yes. I think that's right. I mean, as we said, we did fully swap the investment grade bond issuance that we did earlier this year. And we think that was appropriate to do based on the interest rate environment that we're in. And I think going forward, we would probably expect to operate in that same manner, but we'll continue to evaluate on a case by case basis.

Speaker 6

Okay. That's helpful. Last one for me, just kind of thinking about activity in the back half of the year and certainly heard your comments about M and A activity or percolating M and A activity might be more of a 'twenty five event than 'twenty four. But curious how you're kind of seeing the back half of the year from maybe a net perspective? What's the pipeline look like origination wise?

Speaker 6

What's the visibility into repayments? And then maybe a follow-up to that is around the 2nd lien activity that you've noted here. Has that kind of continued into the Q3? I guess we're a month into it

Speaker 4

now. Sure. Yes. So as we think about kind of just overall activity, I think what we've demonstrated in Q2 is that even in a somewhat depressed M and A environment, granted it was a little bit better than Q1, we've still been very active from an origination and just velocity perspective. And I attribute that to the incumbency position that we have in a lot of the portfolio and just a lot of portfolio activity when we think about incrementals, opportunistic refis, kind of all of that type of thing.

Speaker 4

So the pipeline remains decent for the back half of the year, despite what I said about M and A activity seemingly not totally unlocking maybe until 2025, we're still seeing a handful of new deals taking place and then a lot of continued portfolio activity. So, velocity wise, we're not seeing maybe quite the pace of repayments that we saw in Q2, at least quarter to date, but we're still seeing some velocity there. And I think the second on the second lien side, that is a trend that I would expect to continue. I'm not sure if it will be at that same pace that we saw just the migration over the last couple of quarters. But as you know, the unitranche really has taken market share from the 1st lien, 2nd lien capital structures.

Speaker 4

And so most of what we're looking at in terms of new deal activity tends to be more 1st lienunitranche.

Speaker 6

Okay. All right. That's all for me. Appreciate the answers.

Speaker 1

Thank you.

Operator

The next question comes from Robert Dodd with Raymond James. Please go ahead.

Speaker 7

Hi, congrats on the quarter and the management fee permanence. On the go back to kind of the top of the price, I mean, a third of your second lien basically repaid in the quarter. I mean the market has shifted. What do you think could change that to go back, right? You have generated pretty attractive returns historically in the second one.

Speaker 7

And the fact that they keep repaying means the credit risk pretty decent. So

Speaker 6

what do you

Speaker 7

need to see in balance? What do you think the market needs to see for the second lien to get more appealing market wide and more appealing to you to maybe increase that mix, maybe not back up to the highs, but back out of the single digits? So it's just that something that's just not on the cards for you anymore?

Speaker 1

Well, I would say well, first of all, hi, Robert, and welcome to the call. I would first of all say that second lien is just a little bit of an out of favor classification of debt. I think one reason is because unitranche just is widely accepted and I think really widely liked by sponsors and folks that are financing their companies. 2nd, there's 2nd liens typically are cash oriented yielding securities and there's not a lot of extra cash after 1st lien cash obligation. So typically 2nd liens are being pushed out in favor for of preferred tranches or non cash pay debt related debt like instruments.

Speaker 1

And so I just think that when we look at the market, it's just it's a unit tranche market and if folks want to stretch beyond that, it's a unitranche and pref market. In some cases, we do see 1st lien, 2nd lien structures more on the larger companies where you have a syndicated first and perhaps a second lien. And right now, just given the competitive environment in that larger more syndicated market, the 2nd lien that do exist are being priced at extremely tight levels. In many cases in the low to mid 500s on a spread basis, which I think when you compare that relative value to even the 1st lien and unitranche market, I think that relative value is pretty poor. So those are really the reasons and I don't know what the impetus for the 2nd lien market sort of improving will be.

Speaker 1

It could be lower base rates and things always change in our market, so you never know. When we look at whether it's 1st lien, 2nd lien, pref positions, we evaluate credit risk in the same way. And to the extent that market comes back, we could be open to investing if we think there's great value in that second lien market.

Speaker 7

Got it. Thank you. And just one if I can. On Lloyd, comment on kind of the pipeline, maybe it's more 2025 than the second half of this year. I mean, how soon will you know?

Speaker 7

I guess the question obviously, I mean, rates might move in September, the market might liven up, but it might not. There's an election. I mean, given that the time it takes to underwrite, I mean, are you basically hitting the cutoff now for closing deals this year? Or what's the timeframe you think about?

Speaker 1

No, I mean, I think Laura expressed her view that and I think it's a good view that 'twenty five will be really busy, but the back half of 'twenty four, I think, could be pretty busy. Deals can pop up very quickly. And so we're not giving up on the back half of 'twenty four. If we were to look at our private equity deal pipeline, there are plenty of deals that our private equity team is looking at and that would be, I think an interesting data point when we think about other sponsors in the market. So, 2024 is looking just fine, but I think we do have the view that the pent up demand will really hit in 2025.

Speaker 1

That said, it just is hard to know with great precision.

Speaker 7

Got it. Thank you.

Speaker 1

Thank you.

Operator

The next question comes from Finian O'Shea of Wells Fargo with a follow-up. Please go ahead.

Speaker 5

Hey, everyone. Thanks for the follow-up. Just curious on for like platform design and workout when you have a name where you've taken the keys and invent them a unit tech so forth, is that then fully run by the private equity side or do you still have your, say, origination point person or some or a group on the in the credit business that Thanks.

Speaker 1

Sure. I mean, it's exactly as I think you said, which is, we would have a credit deal shepherd involved in the deal, but the restructured equity position would really be run and driven by the private equity team. And that is what we think is a really big competitive advantage for getting great outcomes on positions that turn from debt to equity. So that is the way we do it. Credit is still involved, but the decision making, the effectuation of affecting positive operating change in the business is really driven by our private equity team and our operating partners.

Speaker 5

Great. Thanks, John.

Operator

The next question comes from Paul Johnston with KBW. Please go ahead.

Speaker 8

Hey, good morning. Thanks for taking my question. On the high level of origination activity this quarter, how much, if any, of those originations is just due to PIK accruing?

Speaker 4

So I think in today's environment, we're seeing a decent amount of new deal activity have some form of PIK flexibility, but it tends to be still pretty small percentage of the overall yield. So in a typical deal, what we might see is a SOFR 500 or 525 type pricing in terms of the overall spread and the ability for the borrower to pick 100 or 200 basis points of the spread for a 25 or 50 basis point premium. So I would say that's kind of the typical new market deal for Unitranche right now. So of our new originations, I would say certainly, probably a good handful of them have that kind of PIK flexibility, but it's still pretty small in the context of the overall yield. And importantly, I think it is one of the reasons why again, back to my comments about why direct lending kind of still remains the market of choice.

Speaker 4

In today's base rate environment, I think sponsors like to have a little bit of that flexibility and one of the reasons why sponsors still choose the direct lending solution over the syndicated market. And what the other thing I would note is just because the deal is structured with a little bit of that PIK flexibility doesn't mean that all borrowers are using that flexibility. It's kind of a nice to have and then they make a kind of quarter by quarter decision whether to use that.

Speaker 8

Got it. That's good color. But within the 4 $37,000,000 of originations this quarter, I mean, is there any PIK accrual included in that number at all?

Speaker 4

No, it's not. That's just pure new deal activity in DDTL draws.

Speaker 6

Got you. Thanks. Thanks. And

Speaker 8

just generally on pick utilization rates in the quarter, I mean, how did that trend this quarter, higher or lower, kind of what did you see there?

Speaker 4

Yes, I would say no material change. The borrowers that have been utilizing a little bit of their pick flexibility probably continue to do so, but we haven't seen any material uptick in that. And if anything, maybe slightly going the other way that as people kind of grow into their capital structures, they're swapping to kind of all cash.

Speaker 8

Got you. That makes sense. And then, I mean, not to belabor the point, but going forward on new origination activity, I mean, how do you factor in, I guess, the higher utilization rate in the portfolio today to just managing PIK income going forward? I mean, it probably isn't reasonable to expect that a new issue loan is going to be paying pick income so soon after origination. But how do you kind of factor that into new deals that you fund today?

Speaker 1

Sure. So our strategy is really to try to invest in the best direct lending credit within our core industries as we can find. The fact of the matter is this PIK flexibility is a term that is a it's a market standard term. And if we want access to the best deals that we see in direct lending market within our core industries, we have to accept that. So when we think about managing our overall PIK portfolio, I think we're going to accept this partial PIK feature on great loans with really creditworthy borrowers.

Speaker 1

And on the and the way that we plan to reduce the overall pick in the portfolio is some of the older names that we think are coming up for refinancing in the very near future that we think that may have 100% pick, they may be preferred investments and we can think of a couple of catalysts over the next four quarters where we do we really think we can exit some of those larger 100 percent PIK positions. And so the goal would be to actually be able to reduce the PIC over the next year. Although as you're noting and as you're alluding to, I think the headwind is just the PIK component that is just in existence on these unitranche loans.

Speaker 8

Got it. Thanks. It's very helpful. And then last one for me, it sounded like a lot of the activity this quarter was driven kind of by add on opportunities within the portfolio. Is that those type of add on deals, are those mainly M and A driven or are there other things that they're using the capital for?

Speaker 4

Yes, I think it's largely M and A driven. Certainly, kind of the buy and build strategies we've talked about in the past is, I think, key to a lot of sponsors' thesis for post acquisition of an additional or an initial portfolio company. So I think most of it's M and A related. There's a handful of cases where it could have been for specific investments that the sponsor has identified. And then the other category would be the refi activity that I mentioned where maybe there was a 1st lien, 2nd lien capital structure that the sponsor refinanced into an all first lien or a 1st lien pref, as John talked about.

Speaker 4

So those would be kind of the nature of, the originations in the quarter that related to existing portfolio companies?

Speaker 1

We like making loans to companies that we know well and have performed well for us. So when we see the sort of activity that Laura is talking about, we think that's just a healthy sign and indicates that we're picking good credit and we're sticking with those companies.

Speaker 8

That makes sense. Thanks for taking my questions and congrats on the good quarter and as well as the protection of the dividend extension.

Speaker 6

Great. Thank you.

Operator

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

Speaker 1

Great. Well, thank you for your interest in New Mountain Finance Corporation. Thank you for the great questions on the call today, and we look forward to speaking with you again very soon. Have a great day.

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Earnings Conference Call
New Mountain Finance Q2 2024
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