This article uses my ‘optimal leverage’ analysis to assess dividend coverage for New Mountain Finance.
The BDC industry is experiencing yield compression and 7 out of the 26 BDCs that I cover have recently cut dividends.
I will use this series to project which BDCs are less likely to cut dividends in the future.
Over the next few weeks I will be assessing dividend coverage for most of the 26 BDC that I cover in an effort to uncover companies that have the potential to sustain or increase current dividends. I will also be using this information to update my latest "BDC Rankings: May 2014". For more details regarding this series and for the dividend coverage results for Ares Capital (NASDAQ:ARCC), TCP Capital (NASDAQ:TCPC), THL Credit (NASDAQ:TCRD) and Medley Capital (NYSE:MCC) please see:
New Mountain Finance
New Mountain Finance (NYSE:NMFC) recently announced an offering of $100 million of senior unsecured convertible notes due 2019. These notes will be used to pay down some of the outstanding balances of its credit facilities and increase its overall borrowing capacity. Earlier this year NMFC also announced that it had receive a 'green light' letter from the SBA to continue its application process to obtain a Small Business Investment Company (SBIC) license. This will give the company access to attractive long-term financing with many advantages including increased amounts of leverage that is excluded from BDC leverage requirements.
Over the last five quarters NMFC has been able to maintain its portfolio yield of around 9.9% and is currently lower than the average BDC (closer to 11.5%). During Q1, NMFC received onetime dividend income of $1.9 million but I have not assumed dividend income for the coming quarters.
NMFC is an externally managed BDC that pays its Investment Adviser a base management fee of 1.75% of total assets less cash and the amount borrowed under its SLF Credit Facility. As far as I know this is the only BDC that does not include a portion of debt in the calculation of these fees and it is a very investor friendly bonus. Incentive fees are a standard 20% of pre-incentive fee income and gains, but for projection purposes I use core net investment income ("NII") that excludes both income and incentive fees related to capital gains.
The following table shows the results for the most recent quarter along with projections at various levels of leverage and using a stable yield of 9.9% to determine the impacts on dividend coverage. Each of these scenarios assumes a full quarter of benefit from interest income but also a full quarter of interest expense, management and incentive fees.
These scenarios assume the highest level of efficiency and actual results could be lower because there will always be some turnover in the portfolio (that could drive higher fee income). This analysis implies that the current dividend is sustainable. Keep in mind that the most recent quarter had the benefit of $1.9 million in onetime dividend income that helped to cover dividends as well as lower its operating cost ratio for the quarter.
The following table is used by NMFC to track its dividend coverage with NII and is included in each investor presentation. If you look at the 2014 NII of $17.6 million (same as the table above) and divide by the regular dividends paid of $16.3 million it comes out to the same 108% coverage for the quarter. However the company is showing the cumulative coverage since the IPO at 102%.
Side by Side Comparison:
For the side by side comparison I will be using the amount of equity as of March 31, 2014 (or most recent) along with a debt-to-equity ratio of 0.80 and current portfolio yield to project income and expenses, tracking the following metrics:
- Dividend coverage (using a debt-to-equity 0.80)
- BDC expenses (as a % of available income)
'Available income' is total interest and fee income less interest expense from borrowings and is the amount of income that is available to pay management expenses and shareholder distributions. BDCs with lower expenses can pay higher amounts to shareholders without investing in riskier assets.
The following table compares the results for NMFC to TCRD, TCPC, ARCC and MCC. As you can see NMFC, TCPC and ARCC have lower cost structures and higher dividend coverage than TCRD and MCC. I will continue to add BDCs in the following articles.
For more details including some of the potential variances to this methodology for assessing dividend coverage please see "Part 1" of this series. Investors should only use this information as a starting point for due diligence. See the following for more information:
Disclosure: I am long FSIC, HTGC, MAIN, TCPC, ARCC, NMFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.