This is the kind of good news - bad news article that will potentially shine some light on the fact that nothing is simple when it comes to BDCs (or Business Development Companies). This article takes the recent news on the bond offering, puts it into some context, then reaches a valuation assessment. This logical order of presentation does 'bury the lead' - because the lead (or the most important component) is the ending valuation assessment.
From yesterday's press release:
"New Mountain Finance Corporation (NYSE:NMFC) announced today the pricing of $35 million in aggregate principal amount of additional 5.00% unsecured convertible notes due 2019. In addition, the Company has granted the underwriters of the Notes an option to purchase up to an additional $5.25 million in aggregate principal amount of the Notes. The closing of the offering is subject to customary closing conditions and is expected to take place on September 30, 2016. The Notes constitute a further issuance of, rank equally in right of payment with, and form a single series with the $115 million in aggregate principal amount of the 5.00% unsecured convertible notes due 2019 that the Company issued on June 3, 2014. The Notes were priced at 100.75% of par value, plus accrued interest from June 15, 2016."
The good news - BDCs can sell debt at 5.0%. The bad news - it is relatively short term, debt - maturing in 2019 and - it does not cost 5.0%. What???
From the Q2-16 10-Q: NMFC had $115 million of senior unsecured convertible notes with a coupon of 5% that mature on June 15, 2019. For Q2-16 the interest expense was $1.438 million and the amortization expense was $0.185 million - resulting in an effective interest rate of 5.7%.
Let's look at the full 'debt story' where that last bit is repeated. The acronym NAV is for Net Asset Value and PWAY is for Portfolio Weighted Average Yield:
|New Mountain Finance||Q2-16||Q1-16||Q4-15||Q3-15||Q2-15||Q1-15||Q4-14||Q3-14||Q2-14||Q1-14|
|Debt/share to NAV||75.23%||77.85%||83.12%||81.89%||62.55%||73.29%||83.61%||54.59%||56.97%||67.27%|
|Annualized Int exp/Debt||3.83%||3.70%||3.58%||3.12%||3.94%||3.30%||3.28%||4.52%||3.53%||2.91%|
|PWAY - Int exp/Debt||647 bps||670 bps||712 bps||728 bps||686 bps||730 bps||742 bps||618 bps||717 bps||799 bps|
NMFC has a regular Holdings credit facility and a senior loan credit facility. The regular facility has a cost of LIBOR + 1.75. For Q2-16, the interest expense was $2.643 million; the non-use fee was $0.125 million and the amortization of financing costs was $0.402 million. The weighted average interest rate was 2.6% while the effective interest rate was 3.2%.
The senior loan facility cost LIBOR + 200 for first lien loans and LIBOR + 2.75% per annum for second lien loan. For Q2-16, the interest expense was $0.686 million; the non-use fee was $0.03 million and the amortization of financing costs was $0.089 million. The weighted average interest rate was 2.9% while the effective interest rate was 3.4%.
NMFC had $115 million of senior unsecured convertible notes with a coupon of 5% that mature on June 15, 2019. For Q2-16 the interest expense was $1.438 million and the amortization expense was $0.185 million - resulting in an effective interest rate of 5.7%.
NMFC had $117.745 million of SBA debentures with a weighted average rate of 3.0% that mature in 2025 and 2026. For Q2-16 the interest expense was $0.883 million and the amortization expense was $0.098 million - resulting in an effective interest rate of 3.4%.
The good news - an interest expense to TII ratio of 16% is lower than the sector average of roughly 20%. The bad news - the ratio was already growing. More bad news - the new offering will make it grow more
Sizing the problem - The good news is this problem is small. It is a two or three straws on the back of a camel small. The bad news - the camel is already stressed. NII is not covering the dividend. The data (reminder - the dividend is $0.34/quarter):
(Note: The following stats uses the diluted share count - and that produces per/share numbers that I now believe are in error.)
|Total investment income||41.490||40.976||41.967||37.447||37.905||36.536||36.748||34.706||33.708||30.439||26.783|
|Net investment income||21.832||21.567||22.521||20.487||20.253||19.062||25.919||20.800||17.289||16.058||14.826|
|Adjusted Net investment income||21.832||21.567||22.521||20.487||20.253||19.062||19.200||18.100||18.500||17.800||16.400|
|Investments @ fair value||1.528||1.520||1.542||1.478||1.309||1.435||1.455||1.354||1.311||1.180||1.116|
|Wt Av Share Count||71.117||71.211||66.968||66.002||65.313||65.218||57.998||59.290||54.293||47.968||42.933|
|NII/share before incentive fees||$0.46||$0.40||$0.34||$0.34||$0.33|
|NII/share after incentive fees||$0.3070||$0.3029||$0.3363||$0.3104||$0.3101||$0.2922||$0.34||$0.35||$0.36||$0.37||$0.35|
|Wt Av Yield||10.3%||10.4%||10.7%||10.4%||10.8%||10.6%||10.7%||10.7%||10.7%||10.9%||11.0%|
|Portfolio company Debt/EBITDA||x||x||5.0x||5.0x||4.8x||4.5x||5.0x||4.7x||4.6x||4.8x|
|Incentive fees subtracted from NII in the earnings release starting in Q1-15 - Q1 also the first Q with higher diluted shares|
A safe dividend for NMFC based on the NII performance would be $0.29/quarter compared to the current $0.34. Is NMFC selling at a price that indicates the market expects a future dividend cut? No. With a 9-27-16 closing price of $13.83, the yield is (136/1383) 9.83% compared to a PWAY of 10.3% and a sector average yield around 11.45%.
Let's look at the current valuation and performance numbers for the full sector:
Yield in the spreadsheet below is based on the Q2-16 'regular' dividend. Spreadsheet header abbreviations: Div = dividend; EPS = earnings per share; LTM = last twelve months; YTD = year to date. The dividend to EPS ratio is a measure of dividend safety. Due to calendar and fiscal years failing to overlap, I also include a dividend to the sum of the last four quarters of NII - in the Div/NIIltm column. After the Price/NAV ratio, the next column displays the percent change in price YTD. The next display price change plus YTD dividends accrued on the payment date - not the earned date. For the last four columns - the first measures the percentage change in the 2016 EPS projection since the beginning of the year; the second measures the change in the price target since the beginning of the year; the third measures the change in the Q2-16 dividend from the Q2-15 dividend; and the last measures the change in NAV between Q1-16 and Q1-15. Special dividends are not included in this data. ARCC, FDUS, MAIN and TCPC have paid special dividends on a near regular schedule. Full announced 6-24 it will merge with Great Elm Capital Corp to form net yet traded GECC. On 9-22 CPTA announced a 17% cut in its Q4-16 dividend to $0.13/month.
|Share Price||Div/||Div/||Div/||Div/||Q1-16||Price||YTD Percent Change||LTM %||LTM %|
|Alcentra Capital Corporation||(NASDAQ:ABDC)||11.60||13.32||10.21||87.2||93.2||86.8||9.6||14.16||0.94||14.83||23.62||9.09||-8.20||0.00||-5.79|
|American Capital Senior Floating||(NASDAQ:ACSF)||9.83||10.07||11.52||92.8||99.1||94.6||9.3||12.45||0.81||2.44||11.29||1.63||-13.46||0.00||-14.37|
|Apollo Investment Corporation||(NASDAQ:AINV)||5.22||5.83||10.29||71.4||89.6||77.6||8.7||6.90||0.84||11.69||20.31||0.00||-19.30||-25.00||-13.86|
|Ares Capital Corporation||(NASDAQ:ARCC)||14.25||15.50||9.81||99.3||93.8||95.4||9.1||16.62||0.93||8.77||16.77||-3.77||-5.17||0.00||-1.07|
|BlackRock Capital Investment||(NASDAQ:BKCC)||9.40||8.22||10.22||81.6||89.4||80.9||9.2||9.13||0.90||-12.55||-5.85||1.98||-17.29||0.00||-13.54|
|CM Finance Inc||(NASDAQ:CMFN)||10.02||9.12||15.22||95.1||121.8||96.2||11.7||11.90||0.77||-8.98||1.41||15.87||-26.67||0.00||-17.42|
|Capitala Finance Corp.||(NASDAQ:CPTA)||12.08||13.11||14.34||100.5||101.6||99.3||11.5||16.28||0.81||8.53||20.20||-2.60||-12.42||0.00||-9.30|
|Fidus Investment Corporation||(NASDAQ:FDUS)||13.69||15.87||9.83||107.6||97.5||97.9||10.1||15.52||1.02||15.92||24.47||-13.17||-5.04||0.00||2.24|
|Fifth Street Finance Corp.||(NYSE:FSC)||6.38||5.77||12.48||98.6||96.0||102.1||8.8||8.15||0.71||-9.56||-1.10||-5.19||-15.91||0.00||-10.73|
|Fifth Street Senior Floating Rate||(NASDAQ:FSFR)||8.57||8.60||10.47||103.4||97.8||100.2||8.2||10.99||0.78||0.35||8.23||-12.12||-6.86||0.00||-10.14|
|Franklin Square Investment Corp||(NYSE:FSIC)||8.99||9.44||9.45||101.4||103.7||95.5||9.7||9.18||1.03||5.01||12.45||-12.00||-11.59||0.00||-7.18|
|Full Circle Capital Corporation||(FULL)||2.47||2.66||15.79||120.0||85.7||113.7||11.6||3.61||0.74||7.69||20.45||-16.67||2.18||0.00||-18.51|
|Gladstone Investment Corporation||(NASDAQ:GAIN)||7.67||8.77||8.55||96.2||97.4||102.5||7.6||9.84||0.89||14.34||21.68||8.33||6.06||0.00||6.49|
|Garrison Capital Inc.||(NASDAQ:GARS)||12.17||10.34||13.54||95.9||101.4||86.6||10.8||12.94||0.80||-15.04||-6.41||-7.01||-22.23||0.00||-15.37|
|Golub Capital BDC, Inc.||(NASDAQ:GBDC)||16.63||18.71||6.84||100.0||100.0||104.0||8.1||15.88||1.18||12.51||18.28||-3.76||3.35||0.00||0.89|
|Gladstone Capital Corporation||(NASDAQ:GLAD)||7.31||8.02||10.47||100.0||100.0||94.3||10.6||7.95||1.01||9.71||18.33||0.00||-16.38||0.00||-16.23|
|Goldman Sachs BDC||(NYSE:GSBD)||19.00||22.26||8.09||86.5||88.2||79.3||9.8||18.41||1.21||17.16||24.26||0.97||-5.05||0.00||-5.40|
|Harvest Capital Credit||(NASDAQ:HCAP)||11.73||12.20||11.07||95.7||97.1||82.8||9.8||13.71||0.89||4.01||12.64||-0.70||-3.39||0.00||-5.25|
|Share Price||Div/||Div/||Div/||Div/||Q1-16||Price||YTD Percent Change||LTM||LTM|
|Horizon Technology Finance Corp||(NASDAQ:HRZN)||11.73||13.60||10.15||95.2||97.9||93.6||10.4||13.27||1.02||15.94||24.77||2.11||-1.65||0.00||-5.15|
|Main Street Capital Corporation||(NYSE:MAIN)||29.08||34.23||6.49||102.8||99.1||100.9||10.5||21.11||1.62||17.71||23.44||-8.09||1.82||2.78||-3.34|
|Medley Capital Corporation||(NYSE:MCC)||7.52||7.66||11.49||91.7||95.7||84.0||9.0||9.76||0.78||1.86||10.64||-21.95||-21.96||-26.67||-15.35|
|Monroe Capital Corporation||(NASDAQ:MRCC)||13.09||15.47||9.05||83.8||87.5||85.6||9.7||14.50||1.07||18.18||26.20||3.73||2.90||0.00||2.26|
|New Mountain Finance Corporation||(NYSE:NMFC)||13.02||13.83||9.83||100.0||97.8||106.9||10.3||13.23||1.05||6.22||14.06||-4.90||-6.67||0.00||-4.82|
|OFS Capital Corporation||(NASDAQ:OFS)||11.48||13.17||10.33||93.2||85.5||87.7||9.2||14.76||0.89||14.72||23.61||-1.35||2.61||0.00||0.68|
|Oak Hill Advisors||(NASDAQ:OHAI)||3.80||3.17||15.14||129.7||111.6||107.9||10.0||4.80||0.66||-16.58||-7.11||-13.95||0.00||0.00||-32.96|
|Prospect Capital Corporation||(NASDAQ:PSEC)||6.98||8.26||12.11||97.1||101.0||96.0||10.4||9.62||0.86||18.34||29.08||0.98||-12.14||0.00||-6.69|
|PennantPark Floating Rate Capital||(NASDAQ:PFLT)||11.25||13.18||8.65||111.8||99.1||128.5||8.3||13.75||0.96||17.16||24.76||0.99||-2.68||0.00||-4.05|
|PennantPark Investment Corp||(NASDAQ:PNNT)||6.18||7.53||14.87||108.7||113.1||107.4||12.5||8.94||0.84||21.84||35.44||1.98||-9.46||0.00||-10.96|
|Saratoga Investment Corp.||(NYSE:SAR)||15.42||17.96||9.13||85.9||85.0||80.6||7.4||22.11||0.81||16.47||24.45||-2.05||-8.75||24.24||-2.81|
|Stellus Capital Investment||(NYSE:SCM)||9.64||11.28||12.06||102.3||100.7||110.2||10.4||13.12||0.86||17.01||27.59||0.00||-4.18||0.00||-6.35|
|Solar Capital Ltd.||(NASDAQ:SLRC)||16.43||20.36||7.86||92.0||86.5||96.2||7.4||21.51||0.95||23.92||31.22||0.00||1.89||0.00||-1.87|
|Solar Senior Capital Ltd.||(NASDAQ:SUNS)||14.90||16.12||8.75||100.0||101.4||99.9||8.4||16.76||0.96||8.19||15.29||0.00||1.52||0.00||-4.50|
|Medallion Financial Corp.||(NASDAQ:MFIN)||7.04||4.06||24.63||128.2||138.9||56.7||8.8||11.41||0.36||-42.33||-31.68||-39.06||-40.26||0.00||1.33|
|Triangle Capital Corp||(NYSE:TCAP)||19.11||19.32||9.32||106.5||90.9||94.2||12.1||14.82||1.30||1.10||8.16||-26.20||-6.90||-16.67||-4.20|
|TCP Capital Corp.||(NASDAQ:TCPC)||13.93||16.37||8.80||95.4||92.3||91.4||9.8||14.74||1.11||17.52||25.27||-7.93||-0.47||0.00||-2.38|
|THL Credit, Inc.||(NASDAQ:TCRD)||11.70||9.59||14.18||96.5||105.4||92.9||11.4||11.88||0.81||-18.03||-9.32||0.71||-16.78||0.00||-10.61|
|TICC Capital Corp.||(NASDAQ:TICC)||6.08||5.81||19.97||246.8||223.1||279.7||17.7||6.54||0.89||-4.44||9.87||-33.80||-37.50||0.00||-23.95|
|TriplePoint Venture Growth||(NYSE:TPVG)||11.96||10.70||13.46||101.4||94.7||105.7||11.0||13.05||0.82||-10.54||-1.51||-15.48||-24.60||0.00||-10.25|
|TPG Specialty Lending||(NYSE:TSLX)||16.22||18.30||8.52||91.8||90.7||88.6||10.0||15.55||1.18||12.82||20.04||1.19||-0.11||0.00||-1.83|
|With the 10 Treasury at 1.54% and sector average yield on Q2 dividends at 11.38% - the spread is 984 bps.|
|The cap weighted ETF BDCS has a price change of 8.19% year to date - with dividends its total return is 14.90%.|
|The SPY or S&P 500 EFT is 5.74% year to date. - and with unreinvested dividends is 6.78% year to date.|
Summation: NMFC has failed to cover the dividend with net investment income for several consecutive quarters (based on using the wrong share count). This is an indicator that the current level of dividend payments is in danger of being cut. The dividend/NAV ratio is higher than the Portfolio Weighted Average Yield (or PWAY) - and this is a second danger sign. At the same time, NMFN is priced at a lower than sector average yield and higher than sector average Price/NAV ratio. This means that there is no risk of a dividend cut being priced into the stock. The yield for NMFC is below the PWAY - which is another valuation signal that NMFN is priced as if it were low risk.
It is the combination of metrics that signal risk plus a valuation that shows no risk is being priced into the stock that lead to my conclusions that NMFC is a sell.
Disclosure: I am/we are long AINV, ARCC, FDUS, MRCC, PFLT, PNNT, TCPC.
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.