New Mountain Finance (NASDAQ:NMFC) is a business development company with a growing and well-managed portfolio, floating exposure that indicates higher portfolio income as interest rates rise, and a low non-accrual rate.
Furthermore, the business development company covers its dividend payments with net investment income, and the stock currently trades at a 13% discount to book value. The stock is appealing to dividend investors seeking high recurring dividend income, while NMFC’s low valuation relative to book value leaves room for upside.
Buying A 10% Yield At A Discount
Under the Investment Company Act of 1940, New Mountain Finance is classified as a Business Development Company. The BDC is managed externally, which means it pays another company for management services. New Mountain Finance primarily invests in middle-market companies with EBITDA of $10 to $200 million.
The majority of New Mountain Finance’s investments are senior secured debt (first and second lien) in industries with defensive characteristics, which means they have a high likelihood of performing well even in recessionary environments. New Mountain Finance’s core business is middle market debt investments, but the company also invests in net lease properties and equity.
As of March 31, 2022, New Mountain Finance’s portfolio was composed of 54% first lien debt and 19% second lien debt, with the remainder spread across subordinated debt, equity, and net lease investments. In the first quarter, almost all new loan originations (92%) were first lien debt.
The total exposure of New Mountain Finance to secured first and second lien debt was 73%. As of March 31, 2022, the company’s total portfolio, including all debt and equity investments, was $3.27 billion.
Interest Rate Exposure
New Mountain Finance has taken care to invest primarily in floating rate debt, which guarantees the investment firm a loan rate reset if the central bank raises interest rates. The central bank raised interest rates by 75 basis points in June to combat rising inflation, which hit a four-decade high of 8.6% in May. An increase in benchmark interest rates is expected to result in a significant increase in net interest income for the BDC.
The credit performance of New Mountain Finance is excellent. As of March, five of 107 companies were non-accrual, representing a $30 million fair value exposure. Since the BDC’s total portfolio was worth $3.27 billion in March, the non-accrual ratio was 0.9%, and the company has yet to recognize a loss on those investments.
NII Covers $0.30 Per Share Quarterly Dividend Pay-Out
New Mountain Finance’s dividend of $0.30 per share is covered by adjusted net investment income. In the previous year, New Mountain Finance had a pay-out
ratio of 98.4%, indicating that it has consistently covered its dividend with the income generated by its loan investments.
Even though New Mountain Finance currently covers its dividend with NII, a deterioration in credit quality (loan losses) could cause the BDC to under-earn its dividend at some point in the future.
On March 31, 2022, New Mountain Finance’s book value was $13.56, while its stock price was $11.84. This means that New Mountain Finance’s investment portfolio can be purchased at a 13% discount to book value.
In recent weeks, BDCs have begun to trade at greater discounts to book value, owing to concerns about rising interest rates and the likelihood of a recession in the United States.
Why New Mountain Finance Could See A Lower Valuation
Credit quality and book value trends in business development companies show investors whether they are dealing with a reliable or untrustworthy BDC. Companies that report poor credit quality and book value losses are often forced to reduce their dividends. In a downturn, these BDCs should be avoided.
The credit quality of New Mountain Finance is strong, as measured by the level of non-accruals in the portfolio. Credit quality deterioration and book value losses are risk factors for New Mountain Finance.
New Mountain Finance is a well-managed and inexpensive business development company to invest in.
Currently, the stock price is lower than the NMFC’s book value, implying that the BDC can be purchased at a 13% discount to book value.
Furthermore, New Mountain Finance’s overall credit quality appears to be favorable, and the business development company covers its dividend payments with net investment income.