NEW MOUNTAIN FINANCE CORPORATION
Fitch Ratings has affirmed
The Rating Outlook is Stable.
Today's rating actions have been taken as part of a broader review of business development companies (BDCs), which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Completes 2023 BDC Peer Review' available at www.fitchratings.com.
Key Rating Drivers
The rating affirmation reflects NMFC's solid historical credit performance, experienced management team, shift toward first-lien investments in recent years, demonstrated access to the debt and equity markets over time, and access to deal flow and investment resources, given its affiliation with
Rating constraints include a greater reliance on non-cash income, higher-than-peer exposure to second-lien and equity investments, including
Rating constraints for BDCs more broadly include the market impact on leverage, given the need to fair-value the portfolio quarterly, dependence on access to the capital markets to fund growth and a limited ability to retain capital due to distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid higher interest rates and slower growth at portfolio companies.
NMFC's non-accrual investments accounted for 2.4% of the debt portfolio at value at YE 2022 and 6.5% at cost, both of which were above the rated peer average. However, NMFC generated net realized gains as a percentage of the average portfolio at value of 1.7% in 2022 and realized gains have averaged 0.4% between 2019-2022, both of which were above the rated BDC peer average. The firm's cumulative net realized gains since inception compare favorably to the rated peer average, which Fitch believes demonstrates the platform's solid deal selection and ability to work through underperforming investments.
NMFC's portfolio has shifted more toward first-lien positions in recent years, however, the firm's allocation remained below the peer average at YE 2022, at 54.2% of the portfolio. Fitch would view continued rotation into first-lien positions favorably.
NMFC's net investment income (NII), defined as NII as a percentage of the average portfolio at cost, amounted to 3.7% in 2022, which was slightly lower than 3.8% a year ago, and remained below the rated peer average. The weighted average yield on the income producing portfolio was 11.3% at YE 2022, up from 9.1% a year ago given higher rates. Fitch believes NMFC's NII should benefit further from rising interest rates in 2023, given the floating-rate nature of the majority of its investments and its meaningful fixed-rate funding component, although the potential for credit deterioration in the portfolio will be a headwind.
Leverage, as measured by par debt to equity, was 1.52x at
Unsecured debt accounted for 42.5% of NMFC's outstanding debt at YE 2022, which was below the rated peer average but exceeds the firm's four-year average of 37.2% between 2019-2022. Assuming the firm utilizes available capacity under their secured credit facilities to refinance upcoming unsecured debt maturities in June and August of 2023, pro forma unsecured funding mix is estimated to drop to 32.6%, which falls below Fitch's 'bbb' category funding benchmark range of 35%-50%. Fitch views the firm's ability to economically access the unsecured debt markets over time favorably but a sustained decline in unsecured debt below 35% of total debt could lead to negative rating action.
NII coverage of dividends declared was 97.7% in 2022, down from 102.1% in 2021. NMFC extended its dividend support program, which will now continue until at least
NMFC's cash earnings coverage of the dividend remains weaker than peers given a high reliance on non-cash income. Paid-in-kind income amounted to 13.5% of investment income in 2022, which was well-above the peer average. Fitch believes NMFC's cash dividend coverage would improve if adjusted for collections of non-cash income accruals, which are not publicly reported. However, failure to improve cash NII dividend coverage would be viewed negatively.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A sustained decline in unsecured debt to below 35% of total debt, a sustained increase in leverage above the targeted range, a sustained increase in non-accrual levels, meaningful realized losses, a material change in the firm's risk profile, including a decline in first-lien positions or a shift in focus toward subordinated debt and/or equity investments without a commensurate decline in leverage would be negative for ratings. Additionally, a sustained increase in non-cash income at or above the current level, net of collections, and/or weaker cash-based NII coverage of the dividend could also yield negative rating momentum.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Strong and differentiated credit performance of recent vintages, which will be evaluated in combination with the consistency of NMFC's operating performance, asset quality metrics, investment valuations, and underlying portfolio metrics could yield positive rating momentum. Additionally, an improvement in cash earnings and dividend coverage metrics, the maintenance of the asset coverage cushion commensurate with the risk profile of the portfolio, sufficient liquidity and a sustained increase in unsecured debt to at least 40% of total debt outstanding would be positive for ratings. Although not envisioned, a material reduction in leverage that was not accompanied by an offsetting increase in the portfolio risk profile could also contribute to positive rating momentum.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
The equalization of the secured and unsecured debt ratings with the Long-Term IDR reflects solid collateral coverage for all classes of debt given that NMFC is subject to a 150% asset coverage requirement.
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a material reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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