Introduction

I own several Business Development Corporations, though currently New Mountain Finance Corporation (NASDAQ:NMFC) is not one of them, but was years ago. With the belief that interest rates might be near a cyclical peak, I discovered the New Mountain Finance Corporation NT 28 (NASDAQ:NMFCZ) while screening for Notes that matured in 2028 thru 2030, where my Fixed Income ladder is light. After a brief overview of the issuer, NMFC, I review NMFCZ in more detail. With no preferreds outstanding, this Note offers investors a second tradeable means of exposure to New Mountain Finance Corporation.

My original ratings were Buy versus NMFC and a Strong Buy compared to the CD. After the price jump since first submitting this article, both are now only a Hold. I will return to my higher ratings once the YTM exceeds 7.5%.

New Mountain Finance Corporation overview

“New Mountain Finance Corporation (NMFC), a business development company is a private equity / buyouts and loan fund specializes in directly investing and lending to middle market companies in “defensive growth” industries. The fund prefers investing in buyout and middle market companies. It also makes investments in debt securities at all levels of the capital structure including first and second lien debt, unsecured notes, and mezzanine securities. In some cases, its investments may also include equity interests. The fund seeks to invest in United States of America. It seeks to invest between $10 million and $125 million per transaction. NMFC was founded in 2010.”

Source: seekingalpha.com NMFC

NMFC has a market cap of $1.3b, with a Forward yield near 10%. The next slide gives a summary of the portfolio and important data points.

The Balance sheet looks very strong, with the debt/equity ratio continuing to decline.

Total Assets stand at 1.7X Total Liabilities, with NAV being over 50% of the value of all the Notes outstanding. Considering how interest rates have climbed over the past year, just a $0.14 decline in NAV/share shows that NMFC’s portfolio was well-positioned to handle that change in the interest rate environment.

Another Hoya Capital Income Builder contributor, Gen Alpha, gave NMFC a Buy rating in late September (article link). Readers can get a more in-depth review of NMFC there. I agree with the others who recently reviewed NMFC and the Seeking Alpha ratings, that New Mountain is a solid company in the Business Development Company World.

While things can change in five years, steady results over the past decade give me confidence that Note holders have no worries despite the rating agencies’ opinions.

New Mountain Finance Corporation NT 28 review

NMFC issued 4.6m shares of the NMFCZ Note. According to the IPO Prospectus, the Company intends to use all of the net proceeds to repay outstanding indebtedness under the NMFC Credit Facility. The first trade I saw for NMFCZ was on November 27th, when it closed at $25.39. The Baa3 is the lowest investment-grade rating on the Moody’s scale. The Note is Callable in two years, when rates should be lower than today, thus increasing the odds that NMFC might exercise that option. As expected, the payments are not covered by the 15% tax rules.

While not listed on Quantumonline.com, the Preliminary Prospectus for NMFCZ lists other issued Notes that NMFCZ has equal standing with:

• $116.5 million principal amount of 5.494% fixed-rate notes due 2024
• $200 million principal amount of 3.875% notes due 2026
• $75 million principal amount of 5.900% notes due 2027
• $260 million principal amount of 7.50% unsecured convertible notes due 2025

The last two Notes were issued in 2022. Notice the coupon difference due to all rates climbing since then. When checking Fidelity for prices, I only found a price for 2025 Notes, which a 3rd party was asking $101 for.

Portfolio strategy

Here I will compare the NMFC common stock, the 2028 Note, and a 5-year CD (12/1/23 data).

Factor NMFC NMFCZ 5Yr CD Yield 9.98% 7.87% 5.50%* YTM NA 7.09% 5.50% Risk factor A- via SA rankings Baa3 Insured Click to enlarge

* via Fidelity.com While that is FDIC insured, the best rate from a major bank was only 4.6%.

Investors get an extra 159bps in return over the best 5-Yr CD available, another 90bps if they want to avoid a non-regional bank they might not have heard of. In my risk/reward analysis, the current spread yields a Hold rating versus the CD, maybe a Buy if avoiding the higher rate offered by the regional banks.

They give up 211bps in yield for what should be greater price certainty I consider the Note having over the common stock. I did see that Carlyle Secured Lending (CGBD), another BDC, just issued its own Note that matures at the same time, Carlyle Secured Lending, Inc. NT 28 (CGBDL) with an 8.2% coupon, also trading slightly above Par. To me, that helps gauge how the market views both BDCs. As a reference, NMFC has a CAGR of around 11.4% if dividends were reinvested since inception. More recent results 5/10 years) were both near 8.7%. If that occurs over the next years, NMFC common stock investors would net about 161bps above the Note. Using that analysis, I rate the Note as a Hold compared to the common stock.

Risk analysis

To put all that in Cliff Notes format:

• I see no risk to NMFC folding as a company before the Notes come due.
• Cash flows are adequate enough to cover all dividends and interest payments. In 2023, NMFC gave shareholders $.11 in special distributions as a sign of that ability.
• History across all economic situations has such Baa/BBB rated bonds (lowest rated investment grade bond), with a 1.60% expected probability of default over a 5-year period.
• During COVID, the common stock payment was only reduced by $.04 and not counting the special payments, half of that reduction has been restored. That shows NMFC is prudent in its cash management.
• Assuming the YTM occurs (I am investing as it will), the extra return offsets the natural added risks of holding a Note over a CD. A Note has less risk than the common stock as payouts and redemption would require NMFC to file for bankruptcy, and the data currently says there is little risk of that happening.

Conclusion

With such low default rates for bonds/notes rates as NMFCZ is, my view is that that risk is so small that NMFCZ will get a Strong Buy rating versus a similar CD or the common stock when the YTM breaks 8%, a Buy rating at 7.5%.

When the price jumped on 11/30 and then again on 12/1, it caused me to rethink the better ratings I had when first submitting this article for Seeking Alpha review. Deciphering how much of the movement was due to first-week trading or belief that interest rates have peaked based on Chairman Powell’s comments are above my pay grade, as a former US president liked to say. I apologize if my ratings seem confusing or wishy-washy for you Charlie Brown fans. In short, buy at 7.5% YTM, a Strong Buy at 8% YTM. As this week showed, price matters a lot!