NEW MOUNTAIN FINANCE CORPORATION
Fitch Ratings has affirmed
The Rating Outlook has been revised to Stable from Negative.
KEY RATING DRIVERS
IDRs AND SENIOR DEBT
The Outlook revision reflects the recent decline in leverage and reduction in NMFC's target leverage range, decline in non-accruals, recognition of unrealized portfolio appreciation in 1H21 and low realized loss rate over the past year. Fitch believes the improvements in leverage and asset quality reduce the downside risk to NMFC's asset coverage cushion. Net investment income (NII) coverage of dividends declared has also improved in recent quarters.
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 the BDC sector include the market impact on leverage, given the need to fair-value the portfolio each quarter, dependence on access to the capital markets to fund portfolio growth and a limited ability to retain capital due to dividend distribution requirements. Additionally, the competitive underwriting environment has yielded deterioration in terms in the middle market, including fewer/looser covenants and higher underlying leverage.
Non-accrual investments accounted for 1.0% of the debt portfolio at fair value at 2Q21 and 3.1% at cost; down from recent peaks of 2.9% and 4.7%, respectively, at 2Q20. Net realized losses as a percentage of the average portfolio at value were 0.1% in 2020 and averaged 0.7% from 2017 through 2020, which were below the rated BDC peer averages. Net realized losses were slightly above-average in 1H21 driven by a loss on a restructured energy investment, but remained low at 0.3%.
NMFC's portfolio has shifted more toward first lien positions in recent years. However, first lien exposures as a percentage of the total portfolio at value were 51.6% at 2Q21, below the rated peer average. Fitch would view continued rotation into first lien positions more favorably.
Core earnings have been pressured by low interest rates and the recent portfolio rotation into lower-yielding senior investments. Annualized NII was 3.8% of the average portfolio at cost for 1H21, which was unchanged from a year ago and below peers. The weighted average yield on the income producing portfolio was 8.8% at 2Q21, up from 8.6% a year ago.
Statutory leverage, as measured by par debt-to-equity excluding SBA borrowings, was 1.19x as of
Unsecured debt amounted to 38.7% of NMFC's outstanding debt at 2Q21, which remains within Fitch's 'bbb' category quantitative benchmark range of 35%-50% for BDCs. In
NII coverage of dividends declared was 100.2% in 1H21, up from 97.7% in 2020. NMFC recently implemented a dividend support program, which will 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 17.7% of interest and dividend income in 1H21, which was well above the peer average. Fitch believes NMFC's cash dividend coverage metrics would improve if adjusted for non-cash income accruals, which are not publicly reported. Still, failure to improve cash NII dividend coverage would be viewed negatively.
The alignment of the unsecured and secured debt ratings with the Long-Term IDR reflects solid collateral coverage for all debt classes given that NMFC is subject to a 150% asset coverage requirement.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A decline in the asset coverage cushion to below 11%, 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, a sustained increase in non-cash income at or above the current level, weaker cash-based NII coverage of the dividend and/or a sustained decline in unsecured debt to below 35% of total debt outstanding.
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. Positive rating action would also be conditioned upon an improvement in cash earnings and dividend coverage metrics, the maintenance of leverage levels commensurate with the risk profile of the portfolio, sufficient liquidity and continued access to the unsecured debt markets. Although not envisioned, a material reduction in leverage which was not accompanied by an offsetting increase in the portfolio risk profile could also contribute to positive rating momentum.
The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a 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.
RATING ACTIONSENTITY/DEBT RATING PRIOR
New Mountain Finance Corporation LT IDR BBB- Affirmed BBB-
senior unsecured
LT BBB- Affirmed BBB-
senior secured
LT BBB- Affirmed BBB-
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
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