New Mountain Finance (NMFC) CEO Robert Hamwee on Q1 2021 Results - Earnings Call Transcript

New Mountain Finance (NASDAQ:NMFC) Q1 2021 Earnings Conference Call May 6, 2021 10:00 AM ET

Company Participants

Robert Hamwee - CEO

Steven Klinsky - Chairman and CEO, New Mountain Capital

John Kline - President and COO

Shiraz Kajee - CFO

Conference Call Participants

Finian O'Shea - Wells Fargo Securities

Ryan Lynch - KBW

Bryce Rowe - Hovde

Operator

Good morning, and welcome to the New Mountain Finance Corporation First Quarter 2021 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to hand the conference over to Rob Hamwee, CEO of New Mountain Finance Corporation. Please go ahead.

Robert Hamwee

Thank you, and good morning everyone and welcome to New Mountain Finance Corporation's first quarter earnings call for 2021. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; John Kline, President and COO of NMFC; and Shiraz Kajee, CFO of NMFC.

Before diving into the business update, we do want to recognize that while significant progress has been made here in the US, we continue to live through a public health crisis that is taking a significant human toll around the globe. We hope that everyone is staying safe and that you and your families remain in good health.

Turning to business, Steve is going to make some introductory remarks, but before he does, I'd like to ask Shiraz to make some important statements regarding today's call.

Shiraz Kajee

Thanks, Rob. 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 in our May 5th earnings press release.

I'd also like to call your attention to the customary Safe Harbor disclosure in our press release and on Page 2 of the slide presentation regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections and we ask to 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 attain copies of our latest SEC filings and to access the slide presentation that we will 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 Klinsky NMFC's Chairman who will give some highlights beginning on Pages 4 and 5 of the slide presentation Steve?

Steven Klinsky

Thanks Shiraz.

It's great to be able to address all of you today as both the Chairman of NMFC and as a major fellow shareholder. I have a number of headlines to present today including in some fresh areas, which I believe should be received as very good news. It is now over a year since the COVID pandemic first hit.

As we discussed on previous earnings calls risk control has always been part of New Mountain's founding mission. Our firm as a whole now manages over $33 billion in total assets with a team of over 175 people and with over 50,000 employees at our private equity portfolio companies in the field. We have never had a bankruptcy or missed an interest payment in the history of our private equity work, while generating over $50 billion of estimated total enterprise value for all stakeholders.

We have raised over $10 billion of additional private equity capital last year despite COVID. We have applied that same team strength and focus on defensive growth industries to NMFC and our credit efforts resulting in a realized net default loss of just 12 basis points a year, each year since we began our credit operations in 2008.

Over the past decade NMFC has paid out $868 million or $13.87 of cash dividends per share, all which is $79 million of realized losses across over $8.3 billion of debt investments. To date, we've been able to offset the majority of these losses with various portfolio gains and we remain optimistic about potential gains that existing positions such as Edmentum. Overall, NMFC has delivered a 10.3% compounded annual return per share since the date of our IPO.

The great bulk of NMFC's loans are in areas that might best be described as repetitive tech-enabled business services such as enterprise software. Our companies often have large installed client bases of repeat users, who depend on their service day in and day out. These are the types of defensive growth industries that we think are the right ones at all times and particularly attractive in difficult times.

With that background, let me turn to the specifics of this earnings report on Page 4. Net investment income for the quarter ended March 31, was $0.30 per share, fully covering our dividend of $0.30 per share, and in line with our prior guidance.

The regular Q1 2021 dividend of $0.30 per share was paid in cash on March 31. Every borrower paid their interest in Q1 and no new borrowers were placed on non-accrual this quarter. We currently do not anticipate any additional portfolio companies going on non-accrual in Q2.

Our March 31, net asset value was $12.85 per share, an increase of $0.23 per share or 1.8% from the December 31 net asset value of $12.62 per share. The regular dividend for Q2 2021 was again set at $0.30 per share and will be payable on June 30, 2021, to holders of record as of June 16. We've extended our credit facilities and lowered our cost capital. NMFC has now achieved an investment grade credit rating from Moody's for the first time ever. We're implementing a dividend support program for at least the next two-years by pledging to charge no more than a 1.25% management fee on all assets.

For the next two years, we also pledged to reduce our incentive fee, if needed to support the $0.30 dividend. We do not anticipate needing to use this pledge, but want shareholders to have greater confidence in the current dividend. We've renewed the commitment of Rob and John to remain on as the portfolio management leaders of NMFC. Rob at age 51, will shift some of his administrative duties on to John and the team to allow a more personal time and freedom, but his commitment to the key functions of credit underwriting and investment decisions will remain unchanged. John at age 45 will be playing a more important role than ever. In total, NMFCs total team has grown to 175 from 85 at the time of NMFC's IPO, all available to support NMFC and credit decisions. A team of over 30 now report to Rob and John versus five at the time of the IPO. I remain as NMFCs Chairman.

Together New Mountain professionals have invested over $450 million personally into NMFC and New Mountain's credit activities. I and management remain as NMFC's largest shareholders. We have continued to add to our personal positions in the last 12-months, and Rob, John and I have never sold a share.

With that, let me turn the call back to Rob.

Robert Hamwee

Thank you, Steve.

Let me start by giving a little more detail on some of the positive headlines that Steve has shared. While we believe our ability to earn our $0.30 quarterly dividend remains intact as we come out of the COVID crisis, given the twin headwinds of a very low base interest rates and what we believe is a temporarily increased non-interest earning equity portfolio, we want to assure our shareholders that the dividend and the earnings base that supports it are secure.

To that end, we are implementing a program whereby for at least the next two calendar years, we will effectively guarantee to reduce our incentive fee if needed to make sure earnings support the $0.30 dividend.

Further in order to simplify our fee structure instead of waiving fees on a portion of certain managed assets as we historically have done for at least the next two years, we will simply charge a 1.25% management fee on all assets. We believe these two important changes even further align management's interest with those of our shareholders, an approach that has always informed our actions.

Separately, we have made material progress decreasing the cost and increasing the duration and flexibility of our liabilities. Specifically, we have extended our two main asset-backed secured credit facilities to $730 million Wells Fargo facility and the $280 million Deutsche Bank facility out to 2026. At the same time, we were able to lower applicable spreads on these two facilities by 40 basis points and 25 basis points respectively.

On the unsecured side, we received an investment grade rating from Moody, which will allow us to access the institutional bond market, even more effectively than in the past, which should further reduce our cost of capital. We also received an upgraded outlook from Kroll Bond Rating Service. Finally, we combine the SLP I and SLP II funds into a newly created SLP IV, the scale of which will allow for more simplified and efficient financing and execution going forward.

As we emerge from the COVID crisis, we continue to have extensive conversations with both company management and sponsors and update each portfolio companies scores on our heat map using the same criteria discussed in the past and as outlined on Page 8. The updated heat maps show that risk migration was roughly neutral this quarter as summarized on Pages 9 and 10 with over $81 million of positive inter green migration and $51 million of a negative migration primarily concentrated in one insurance services business that migrated from green to yellow.

We believe this business have improving prospects in the quarters ahead but given that one of its core verticals is brokering insurance for live events in certain areas of travel, trailing numbers have been pressured resulting in what we think is a temporary downgrade. Overall we are pleased with the asset quality and credit trends across the portfolio.

The updated heat map is shown on Page 11. As you can further see from the heat map, given our portfolio's strong buys towards defensive sectors like software, business and federal services, and tech-enabled healthcare, we believe the vast majority of our assets are very well positioned to continue to perform no matter how the public health and economic landscape develops. We continue to spend significant time and energy on our remaining red and orange names and believe as the impact of the pandemic continue to recede in the months ahead the majority of those credits will benefit materially.

Our largest orange asset Benevis continues to make significant progress towards value recovery, as the impact of our new executive chairman, new CEO, and our fully engaged PE operating team begins to be reflected in the operating metrics of the business. We have increasing confidence that the strategic plan that has been developed has a high likelihood of achieving full principal recovery and potentially even significant gains in the coming years.

Page 12 outlines the quarter's net asset value increase and the path back to pre-COVID book value. In Q1, we recovered an additional $0.23 of the dramatic decline we witnessed in Q1 of 2020. The two material drivers of this quarter's recovery representing $0.22 in total was one, the continuing market impact in our green names as spread for well performing credits in our core verticals continued to decline, and two, a further value increase in our restructured and equity portfolio, particularly in Edmentum where positive secular trends and strong execution continued to lead to a positive operating results.

Looking forward we would expect further positive price movement in our green yellow and orange rated loans which if our risk assessment is correct should continue to recover in coming quarters as the world normalizes. If those names return to par that would increase NAV by an additional $0.26.

While risks are clearly elevated in our red current pay securities, we still see a reasonable path towards full recovery which could account for another $0.11 per share of NAV recovery. That leaves only $0.04 per share of further improvement needed across our restructured and equity portfolio to get back to pre-COVID book value. We believe the opportunity for value creation, particularly in Edmentum Benavis and UniTek meaningfully exceeds that.

Page 13 shows that we continued to manage our statutory leverage ratio at a very comfortable level. Gross debt for the first quarter fell by $43 million while an increase in NAV of $2 million drove further reduction in our net statutory leverage ratio, which is now down to 1.15 times. We continued to have a number of portfolio companies currently in active sale processes the anticipated culmination of which will give us additional financial flexibility to either reinvest or further delever. Our intention is to manage the business at a statutory leverage ratio, of net of cash of 1.0 times to 1.25 times.

With that I will turn it over to John to discuss market conditions and other elements of the business.

John Kline

Thanks, Rob.

We are pleased to report that overall conditions in the direct lending market continued to be very healthy. Companies within most industries have very good access to capital and new sponsor-backed purchases are generally occurring at very healthy multiples across many industries. Companies within many of our core defensive growth sectors such as software, healthcare technology, field services and technology enabled business services have compelling momentum in their businesses and are attracting record purchase multiples from a diverse group of brand names sponsors.

Interest spreads on first lien and unitranche loans have returned to pre-COVID levels while second lien spreads are modestly tighter levels observed in early 2020. Despite this modest spread pressure in the second lien market returns on new loans remain attractive both on an absolute basis and relative to other credit markets that we see.

Turning to Page 15, we show how potential changes in the base rate could impact NMFCs future earnings. As you can see, the vast majority of our assets are floating-rate loans while our liabilities are 57% fixed rate and 43% floating rate. NMFC's current balance sheet mix offers our shareholders consistent and stable earnings in all scenarios where LIBOR remains under 1%.

If base rates rise above 1% as the economy normalizes or accelerates there is meaningful upside to NMFC's net investment income. For example, assuming our current investment portfolio and existing liability structure if LIBOR reaches 2%, our annual NII would increase by 9.1% or $0.11 per share. At 3% LIBOR earnings would increased by 20% or $0.24 per share.

Page 16 addresses historical credit performance, which shows NMFC's long term track record. On the left side of the page, we show the current state of the portfolio where we have $3 billion of investments at fair value with $25 million or less than 1% of our portfolio currently on non-accrual. This quarter, as mentioned earlier, we did not place any new borrowers on non-accrual.

On the right side of the page, we present NMFCs cumulative credit performance since our inception in 2008, which shows that across $8.3 billion of total investments. We have $600 million that have been placed on our watch list with $236 million of that amount migrating to non-accrual. Of the non-accruals only $79 million, have become realized losses over the course of our 12 plus year history.

Page 17 is a view of our credit performance based on underlying portfolio companies leverage relative to LTM EBITDA. As you can see the majority of our positions have shown results that are very consistent with our underwriting projections, exhibiting either very minor leverage increases or in many cases leverage decreases. We believe the strong and consistent performance across our portfolio is particularly notable in a year affected by global health crisis.

On the lower right side of the page we show a group of companies, which exclude the previously restructured benefits in Permian that have more than 2.5 turns of negative leverage drift. These companies represent a small portion of our portfolio that have underperformed partially due to adverse conditions caused by the shutdown of certain parts of the economy. From a liquidity perspective, we believe that all seven companies have adequate resources to pursue their post-COVID business plans, which all contemplate higher profits compared to those of the past 12 months.

Five of the companies have shown positive revenue and earnings momentum in the early months of 2021, which is not yet represented in the LTM calculations shown on Page 17. Two of the seven companies will require continued reopening of the economy to meet their medium-term financial targets. The first of these companies has material exposure to the travel industry and the other depends on revenues from in-person high school and college graduation ceremonies.

On the chart on Page 18 tracks the company's overall economic performance since its IPO. At the top of the page, we show that our net investment income has always cumulatively covered our regular quarterly dividend on the lower half of the page, we focus on. below the line items where we show that since inception highlighted in the blue box NMFC has experienced $20 million of net realized losses, and in gray we show that NMFC has total unrealized portfolio markdowns of $65 million. Combined, these two numbers represent $85 million of cumulative net realized and unrealized losses.

This bottom line number represents a $23 million improvement compared to last quarter driven by the positive change in our portfolio marks that we discussed in detail earlier in the presentation. Since the Q1 2020 low point in NMFC's fair value we have recovered $168 million of unrealized losses. As Rob discussed, we continue to believe that most of the remaining cumulative net unrealized loss can be recovered over time if certain performing positions return to par. Historically troubled names continue to recover and the overall value of our equity positions appreciate modestly.

Page 19 shows a stock chart detailing NMFC's equity returns since IPO. While the performance of our stock was impacted by fears around the pandemic recently we have seen material improvement in our share price as investors have become comfortable with the trajectory of the US economy and gain confidence in the stability, attractive yield and upside of our portfolio. Since our IPO nearly 10 years ago NMFC has a compounded annual return of 10.3% which materially exceeds that of the high-yield index as well as an index of BDC peers that have been public at least as long as we have.

Page 20 provides a final look at NMFC's cumulative return compared to the individual returns of our peers. As you can see NMFC has been the second best performer amongst the peer group that we have tracked since the IPO. We continue to build this on this total return performance with our $0.30 per share dividend, which is based on the current stock price represents an annualized dividend yield of approximately 9.1%.

Turning to our investment activity tracker on Page 21, this quarter our total originations were $219 million highlighted by five new sponsor-backed club deals, the expansion of our net lease REIT and the continued investment in the SLP III joint venture. These new investments were offset by $196 million of loan repayments and sales yielding $23 million of net originations. This balanced activity is reflective of continuing to operate well within the range of our new leverage guidance.

Page 22 details a group of new investments that we have made so far this quarter, which included several new club deal financings, size to accommodate our balance sheet availability. It is worth noting that we do have a long list of companies on our repayment watch list, which we believe could be exiting our portfolio in the next quarter. These loan repayments would represent a material source of cash for new deals.

Turning to Page 23, as shown on the left side of the page, our origination mix by asset type in Q1 was heavily oriented towards senior assets including first-lien loans, SLP investments and net lease real estate investments.

Overall these senior oriented assets represented 67% of our total new deal flow in the quarter. Repayments were weighted approximately 60% towards first lien assets and 40% towards second lien assets resulting in the current portfolio of mix shown on the right side of the page, which remains heavily weighted towards senior and secured assets.

On Page 24, we show the average yield of NMFC's portfolio was stable from Q4 to Q1 at approximately 8.8%. For the quarter, we were able to originate a group of assets with a weighted average yield of 8.7%, which is roughly consistent with the portfolio average. As we mentioned earlier, while the current environment is competitive, the available spreads in the marketplace remain supportive of our NII targets.

On Page 25, we have detailed breakouts of NMFC's industry exposure. The center pie chart shows overall industry exposure while the surrounding pie charts give more insight into the very significant diversity within our healthcare software and services portfolio. As you can see, we have successfully avoided nearly all of the most troubled sectors while maintaining high exposure to the most defensive sectors within the US economy.

Finally, as illustrated on Page 26, we have a diversified portfolio with our largest single name investment at 3.9% of fair value in the top 15 investments accounting for 37% of fair value.

And with that I will now turn it over to our CFO, Shiraz Kajee to discuss the financial statements and key financial metrics. Shiraz?

Shiraz Kajee

Thank you, John. For more details in our financial results and today's commentary, please refer to the Form 10-Q that was filed last evening with the SEC.

Now I'd like to turn your attention to Slide 27. The portfolio had over $3 billion in investments at fair value at March 31, 2021 and total assets of $3.1 billion, where total liabilities of $1.9 billion of which total statutory debt outstanding of $1.5 billion, excluding $300 million of drawn SBA guaranteed debentures. Net asset value of $1.2 billion or $12.85 per share was up $0.23 from the prior quarter. At March 31, our statutory debt to equity ratio was 1.18:1 and as mentioned, net of available cash on the balance sheet, the proforma leverage ratio would be 1.5:1.

On Slide 28, we show our historical leverage ratios, and our historical NAV adjusted for the cumulative impact of special dividends.

On Slide 29, we show our quarterly income statement results. We believe that our adjusted NII is the most appropriate measure of our quarterly performance. This slide highlights that while realized and unrealized gains and losses can be volatile below the line, we continue to generate stable net investment income above the line. Focusing on the quarter ended March 31, we earned total investment income of $67.4 million in line with the prior quarter. Total net expenses were approximately $37.9 million, a slight decrease quarter-over-quarter.

As discussed, the Investment Adviser has committed to capital management fees for the next two calendar years such that the effective annualized management fee this quarter was 1.25%. It is important to note that the investment advisor cannot recoup fees previously waived. This results in first quarter adjusted NII of $29.5 million or $0.30 per weighted average share which covered our Q1 regular dividend of $0.30 per share. As a result of the net unrealized appreciation in the quarter, for the quarter ended March 31st 2021 we had an increase in net assets resulting from operations of $52.3 million.

As Slide 30 demonstrates our total investment income is recurring in nature and predominantly paid in cash. As you can see 91% of total investment income is recurring and cash income remained strong at 80% this quarter. We believe this consistency shows the stability and predictability of our investment income.

Turning to Slide 31, as briefly discussed earlier, our adjusted NII for the first quarter covered our Q1 dividend. Based on preliminary estimates we expect our Q2 2021 NII will be approximately $0.30 per share prior to the impact of any fee waivers under our new dividend gets support program. Given that our Board of Directors has declared a Q2 2021 dividend of $0.30 per share which will be paid on June 30-2021 to holders of record on June 16, 2021.

On Slide 32 we highlight our various financing sources. Taking into account SBA guaranteed debentures we had almost $2.3 billion of total borrowing capacity at quarter end with over $500 million available on our revolving lines subject to borrowing base limitations. From March 25th we amended and extended our Deutsche Bank Credit facility pushing out our maturity to 2026 while decreasing our applicable spread. Post quarter end, we also successfully amended and extended through 2026 our Wells Fargo credit facility resulting in a significant spread reduction.

Both these actions left in a majority of our secured debt for five years while bringing down our overall cost of capital. As a reminder, both our Wells Fargo and Deutsche Bank Credit Facilities covenants are generally tied to the operating performance of the underlying businesses that we lend to rather than the marks of our investments at any given time.

Finally on Slide 33, we show our leverage maturity schedule. As we've diversified our debt issuance we've been successful at laddering our maturities to better manage liquidity. We have no near-term maturities, and as mentioned, have pushed out the maturities and our two largest credit facilities to 2026, we expect to extend our other revolving lines in the coming months. Also, given our recent investment grade rating from Moody's we will continue to explore the unsecured debt markets to further ladder our maturities and the most cost effective manner.

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

Robert Hamwee

Thanks Shiraz.

In closing, we are optimistic about the prospects for NMFC in the months and years ahead. Our long-standing focus on lending to the defensive growth businesses supported by strong sponsors should continue to serve us well. We once again thank you for your continuing support and interest, wish you all good health and look forward to maintaining an open and transparent dialogue with all of our stakeholders in the days ahead.

I will now turn things back to the operator to begin Q&A. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Finian O'Shea with Wells Fargo Securities.

Finian O'Shea

First question on the I suppose new outlook Rob you said this was sort of the twin approach on rates and then equity. Is it, I was going to start with the equity does this reflected a new view that you'll be holding this portfolio for a much longer time or just this portfolio will produce less income to you or how do you describe your change in view there given that more or less looks the same?

Robert Hamwee

Yes, know, I want to be super clear, you're right, it looks the same we're just highlighting as we think about our earnings profile that we do in fact have a larger than average over the last five years. Equity portfolio with things like Edmentum, Benevis and UniTek and we actually believe there is tremendous potential in those names to create real economic value, but of course for every dollar that's in a non-yielding piece of equity at non-cash and non-income yielding piece of equity that obviously is a dollar that's not earning NII in the quarter.

So, nothing has changed, and in fact, our outlook continues to brighten for those names, and from a timing perspective, it's not the case that we think we're going to own them any longer than we would have thought last quarter. It's just the timing of those uncertain right like will you because it's a lumpy will you exit one of those and convert that into cash, that's redeployed in NII generative traditional debt securities we just don't know. So, we want to just make sure that the new explicit NII per action program has enough runway to make sure we can recycle those proceeds.

Finian O'Shea

On the new leverage guidance, is that sort of tied to equity or is that does that reflect your view of debt market conditions, and I guess tied that into the other part of the program as you described on lower returns. Is that more through leverage or just your view of the market is not going to recover the loss base rates or you're going to be more cautious just whatever you would expand on that front?

Robert Hamwee

Yes, I mean, I think we've been talking about the 1.0 to 1.25 target for a while now. I think our view is that's probably the prudent level for the foreseeable future, I think that's where the intersection of leverage levels and maximizing the efficiency of the rate our debt capital is best. I think we, actually saw that with the Moody's rating recently which is a function of that range and we think that will allow us over time to further reduce the cost of debt capital. So it's just a question of finding the sweet spot where we can minimize the cost of our debt capital, but still get the return on the balance sheet that we're looking for, obviously over long periods of time that can continue to evolve, but I'd expect us to operate there for the foreseeable future.

Finian O'Shea

Okay, thanks. And just one more on the newer JVs. Is there anything I think it's a different kind of partner. Is this a different kind than your previous JVs, which was seemingly mostly your origination pretty uniform with your strategy and so forth, this is kind of fallen in that progression or is there anything new or about different about this one?

Robert Hamwee

No, we'll be doing absolutely the same thing we've been doing from an asset side in the SLPs, that's worked incredibly well for us. If I think you know, we've never had a credit issue, material credit issue, let alone or default or default loss in the SLPs and whatever it's been five or six years, and that's again that strategy of investing in the business as we know intimately through our private equity work in our defensive growth sectors. So, that's absolutely going to remain unchanged.

Operator

[Operator Instructions] Your next question comes from Ryan Lynch with KBW.

Ryan Lynch

Thanks for taking my questions. First, congrats on the Moody's rating. One kind of question on that you guys already had another investment grade rating from Fitch version major rating agency then also we had some rating investment grades from Egan Jones in Kroll. So I'm just curious how much do you think that this new Moody's rate will be able to increase or lower your cost of debt on a new issuance, you guys already issuing pretty low from your issuance in January, so just any thoughts on that?

Robert Hamwee

Yes, I think what it really allows us is to tap into the more I'll cover the more traditional institutional market. We've been historically constrained even with that, the Fitch rating, which has been great, but we've been historically constrained to more of the narrower insurance company, institutional market and adding the Moody's rating on top of the Fitch rating and the other ratings now allows us to pretty materially widen in the pool of investors that we can go to.

I don't want to necessarily speculate on exactly in basis points six months from now, what that will mean but I just I think if you look at some of our peers who access that wider institutional market, they've issued materially 20 to 50, 75 basis points inside of us in that market pending on the time et cetera, et cetera. But on a like-for-like basis I think those types of savings are obtainable over time as we access that wider market. Now obviously that's relative to whatever happens with the 5-year, 7-year, et cetera, but on a spread basis, I think that's realistic given that much broader depth of that market relative to our current market.

Ryan Lynch

That makes sense. That's good to hear that we are open up to a whole new and bigger investor set and you guys debts are positive. I have a question regarding, I see you guys focus on defensive growth businesses you guys do a lot in the software sector which is obviously a very in-favor sector for direct lending today. I'm just curious as competition has been increasing in that market pretty substantially recently, what percentage you don't even have to give me a percentage, but the deals that you guys are working and closing on, is they're starting to become a much bigger prevalence of direct lenders in a lending based on annual recurring revenue opposed EBITDA multiples for some of these recurring businesses, and how comfortable are you are doing on ARR based lending compared to kind of the more traditional cash flow or EBITDA based lending?

Robert Hamwee

Yes, it's a really good question and you're right, we've definitely seen an expansion of that market over the last three or four years in particularly the last one or two years. And so we are seeing just in our industry generally much more capital flowing into that on both the equity side and the credit following it. We do and will participate in those loans, we're quite selective and the key attributes that we focus on for the loans and that's in that area that we will get involved with our are really one very, very large equity cushions. So we will typically look at loan to values sub 35% and often sub 25%. So really, really large cash equity cushions.

Two, as always, but particularly in those deals just businesses we know intimately. So it's going to be businesses that we've have a very high level of conviction based on our own private equity activities and the views of our network, right. Steve touched on this 50,000 employees in the field of our PE portfolio companies, many of whom are in that space and getting a readout from the CEO of one of our related companies is incredibly important and valuable there.

And three, we look at companies that they're only reason they're not profitable today is not something inherent about the business model, they operate at very high gross margin, 70% to 80% gross margins, but they're making a conscious decision to redirect those gross margins into sales to support a very high growth rate, and when we can underwrite that and we say listen if they wanted to tomorrow they could be materially profitable just at a much lower growth rate, which is okay for the debt definition for the equity.

So those are some of the way you think about those loans, and listen those loans when some of the absolute best I know John touched on this in the past, those loans are some of the absolute best performers in our portfolio through the COVID crisis.

Ryan Lynch

That's helpful color on that, especially, their recent performance due to COVID. Can you provide an update on Edmentum obviously there is capital injection into that business late last year. You guys wrote that investment pretty meaningfully this quarter. So I'd just love to hear an update on how that business is doing and kind of the outlook, it seems to be performing really well?

Robert Hamwee

Yes, I mean you're right, we obviously sold. It wasn't really capital injection into the business. It was sale of half of the capital stock effectively to Victory, a education-focused private equity firm, but the business really continues to do incredibly well. They ended their fiscal year, which ends Jan 31 at well more than 100% growth year-over-year at the operating profit line and are on a trajectory over the next three years, we believe and then management believe to continue to grow quite significantly, and I would say we are even at the current valuation, which is obviously up from the last quarter in the last couple of quarters, we are holding it at a very material discount to private and public comparables just because listen that we want to continue to see the prospects, turn into results, but we are seeing that and we expect to continue to see that and we do think it is very significant. There's always risk, but it's very significant upside in that position from here, and the reasons are pretty obvious, right? We're all kind of living it with the trends that are sustainable right? Obviously there is a bump through COVID for digital education tools, but the sustainable elements are;

One, there has been an incredible learning loss well documented that's going to take years to repair and Edmentum is one of the leading provider of the tools to deal with that challenge. Two, there is no going back particularly in the high school level that schools are going to have to offer a some sort of virtual option for some types of learners who want to need a hybrid approach going forward. And again Edmentum was one of the leading provider of those tools. And three, were related to one and two, we are seeing just tremendous and sustainable dollar flows at both the state and federal level into the areas that Edmentum service.

So, we're incredibly bullish about that. We also have a great CEO there who has proven herself, and we think it is an execution intensive area and we think we have a great in plus person to deliver the execution. So, it always worry about things, but we are very, very optimistic about the prospects for that one over the next one to 2 years.

Ryan Lynch

That's good to hear. And I know that's and that's investment you got to work with for a long time. So that does, that great.

Robert Hamwee

Yes, definitely out of cash - project. I've been on the Board there now for whatever it's been six, seven years and it's taking time, but I think we really got it, got it right now and I think the best is yet to come there.

Ryan Lynch

So that was it. I just wanted to make one more last comment. I appreciate the all the commentary you guys gave around, the ability you guys data eventually and full year and the dividend, but I also very much appreciate you guys putting in the support as necessary to cover that if there are some bumps along the way. So I think shareholders really do appreciate those measures you put in, but those are all my questions. I appreciate the time this morning.

Robert Hamwee

Great. Thanks, Ryan. We appreciate the questions and the comments, so thank you.

Operator

Your next question comes from Bryce Rowe with Hovde.

Bryce Rowe

So, first comment, I think you should probably trademark the NII protection program as a statement that's a good one.

Robert Hamwee

Yes. Thank you, We like it.

Bryce Rowe

So I wanted to, I guess you guys commented on the repayment watch list and it being relatively long and a possible source of cash flow for newer investments going forward. Maybe you could help us think about kind of the size of that repayment watchlist and what the yield looks like on it relative to maybe where you're investing today?

Robert Hamwee

Yes, I'm going to turn that one over to John. John, you want to maybe comment on that?

John Kline

Sure, absolutely. So I wouldn't say that our repayment watch list, a lot of the names that we're seeing are just our core names we've owned that are in sale processes right now or we believe are in sale processes and when we think about the yield on those names it's generally consistent and I think this dovetails in my comments earlier in the call, but it's generally consistent with what we think we can underwrite in the in the prospective new deal market.

So what we think it's just good loans being repaid and will find good loans in the market that that we can re-underwrite and put back in the portfolio. So I don't think it's a degradation of yield, I don't think it's going to be a big yield enhancement, but we just, as I mentioned, you view this environment is as one where we can continue to meet the dividend targets and with very good safety in the portfolio.

Bryce Rowe

Okay, that's helpful. Maybe one follow-up here on the conversation around the Edmentum, looks like they paid a dividend here in the first quarter and was curious if you expect that dividend to be stable on a going-forward basis or how should we think about just the level of that dividend coming in from Edmentum?

Robert Hamwee

Yes, that's really more a truing up of some elements from the fourth quarter transaction. So we do not expect Edmentum to be a regular payer of dividends. So it was more of a one-time post transaction settling than it was a policy of paying dividends, I think Edmentum is going to be more of a growth entity than a dividend payer.

Bryce Rowe

Okay and then did want to ask about the, the NII protection program and what you've put in there, as I guess you recall it a temporary solution for the next couple of a years to support and $0.30 level for the dividend. So, I assume that there was some talk around making that temporary versus permanent. So any thoughts around why not make it permanent beyond just these next two years?

Robert Hamwee

Yes. Listen, I think it's open-ended. So we're not saying it's two years for sure and then we said at least two years and that's important. I also think even today, we feel pretty good about just naturally earning the $0.30, but we recognize there are some post COVID headwinds and we want to make sort of explicit what's been frankly implicit, and we just don't want anyone to be worrying about the $0.30 dividend and the sustainability and the coverage it through NII and I think in a listen two years as we've all seen in the world is a very long time and we'll be readdressing if and as needed, but I think our hope and expectation is that two years from now the things that have hurt the dividend, the base rate going down and the larger equity portfolio.

We'll have made progress and there'll be just much more fulsome coverage to give people that more traditional confidence in the dividend. And of course, if there is not, we are going to be, I think you've seen as we've always been very supportive. I would be shocked if we weren't, we needed to extend it, we will likely extend it.

Bryce Rowe

Yes, I agree with that. And then maybe one more question just around the liability structure. Obviously you've highlighted getting a Moody's investment-grade rating, and done a good job in laying out what you're maturities are. So with the unsecured market of being as favorable as it is now, is there an inclination to try to shift even more so the liability structure from a fixed versus floating perspective on your debt? And I guess, by that I mean do you eliminate some of the revolving credit facilities and replace them with unsecured fixed-term debt?

Robert Hamwee

Yes, it's a really good question and it's something we obviously spend a lot of time thinking about as managers and exactly where is the sweetest spot in the mix, I think as we show on the presentation today. We're still pretty heavily skewed towards fixed for 57% to 43% floating on the drawn debt. We feel pretty good about that, but to the extent that migrated probably will migrate a little bit more in terms of takes.

I don't see us going to like 80/20 because there is always you feel like rates are pretty low right now, and you'd like to lock that in, but you could be wrong right? Rates could go the other way. So we want some of it matched, but we do like in general that the asymmetry and it's really just a question of fine tuning around the edges. And, then as we continue to grow the business my guess is we'll probably see the growth kind of probably skewed more towards fixed and floating.

Operator

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference over back to Rob Hamwee for any closing remarks.

Robert Hamwee

Thank you. Just want to thank everybody. As always, we appreciate the interest and the support. Obviously, we're you know where to find us, any follow-up questions we're always around, and then, of course, look forward to speaking with everybody next quarter. Thank you, operator.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.