New Mountain Finance (NASDAQ:NMFC) is a high-quality business development company (“BDC”) which recently experienced stock price deterioration.
Because the business development company has a conservative-leaning investment portfolio, solid portfolio health, and variable rate exposure, I believe the dip is a terrific chance to buy or double down on New Mountain Finance.
Because inflation remained high in August, at 8.3%, New Mountain Finance is unquestionably a business development company whose passive income is worth considering on the drop.
A Safe And Well-Managed Business Development Company
New Mountain Finance is a safety-focused business development firm that focuses on First and Second Liens. In the second quarter, First Liens accounted for 56% of the BDC’s portfolio investments, while Second Liens, which are slightly riskier than First Liens but offer a higher return, accounted for 18% of portfolio investments.
Secured assets accounted for 74% of all portfolio investments. Other instruments in which New Mountain Finance invests include common and preferred equity, which account for 12% of the BDC’s interests.
In 2Q-22, the total value of New Mountain Finance’s investments was $3.3 billion.
The portfolio value of New Mountain Finance climbed by $43.2 million in the third quarter, owing mostly to a substantial number of new originations. The business development company originated six new first liens to portfolio companies and one new investment in preferred shares. Total gross originations were $220.4 million, up from $153.7 million in the first quarter.
Unfortunately, New Mountain Finance’s non-accruals increased in the second quarter. A total of 7 out of 107 investments were non-accrual, indicating that certain borrowers are under financial difficulties and are not paying regular interest payments.
The overall value at risk is $45 million (up from $30 million in the previous quarter), representing a 1.4% non-accrual ratio.
Non-accrual investments accounted for 0.9% of total investments in the first quarter. So, while there has been some decline in credit quality, it is not yet significant.
Floating Rate Exposure
New Mountain Finance has aggressively invested in floating-rate loans, which promise to provide greater interest income if the Fed hikes interest rates further.
So far in 2022, the market has seen two 75-basis-point interest rate increases, with more possible. With inflation remaining high in August at 8.3%, the central bank has a strong case for another large interest rate hike at the end of September. This would be a positive development for New Mountain Finance, whose portfolio comprises of 89% variable rate loans.
This floating rate upside may help New Mountain Finance’s dividend coverage metrics in the future. The BDC’s dividend coverage ratio has been reasonably constant at about 100-101% since the company’s IPO in 2011, but increased net investment income from resetting loan rates in a rising interest rate environment might improve the coverage and contribute to a higher margin of safety.
Net Asset Value
New Mountain Finance’s net asset value was $13.42 per share as of June 30, 2022, a 1.0%, or $0.14, decline from the previous quarter. The BDC’s net asset value has declined nearly 5% since the company’s IPO more than a decade ago, according to its long-term record.
New Mountain Finance is trading at a 5% discount to net asset value based on the most recent net asset value. As long as the stock is trading at a discount to net asset value, I recommend purchasing New Mountain Finance.
Why New Mountain Finance Could See A Lower Valuation
New Mountain Finance is a well-managed business development firm with a portfolio that prioritizes safety while maintaining acceptable credit quality. However, deterioration in credit quality, loan losses, and changes in monetary policy by the central bank could result in a higher discount to net asset value.
Your next opportunity to purchase New Mountain Finance’s 9.4% dividend has arrived. The stock has experienced some unwarranted stock price downturn in recent days, but investors should concentrate on what is truly important here.
In the second quarter, New Mountain Finance paid its dividend with net investment income, and the business development has significant variable rate exposure, which implies investors may see an increase in NII if the central bank continues to raise interest rates.
Last but not least, I view the valuation of New Mountain Finance’s stock (5% discount to net asset value) as attractive.