New Mountain Asset Sale Shapes Up as a Test of Private Credit Market

Steven Klinsky, founder of New Mountain Capital, is shown during a 2019 Bloomberg Television interview in New York. (Christopher Goodney/Bloomberg)

Key Points

• New Mountain Finance is exploring a $500 million asset sale to diversify its portfolio, enhance financial flexibility, and reduce its exposure to pay-in-kind loans.
• The potential sale, representing about 15% of New Mountain’s portfolio, is a key test for the business-development company and the private-credit market.
• New Mountain Finance has a debt-to-equity ratio of 1.4 and approximately 15% of its income from pay-in-kind loans, both higher than industry averages.

A potential sale of $500 million of assets by New Mountain Finance shapes up as an important test for the business-development company and private credit, a $1 trillion market that is already under scrutiny.

The company said in conjunction with its third-quarter earnings report in November that it was “exploring” a $500 million sale in the secondary market that would diversify its portfolio, enhance “financial flexibility” and reduce its exposure to pay-in-kind loans. So-called PIK loans pay interest with additional debt rather than cash.

New Mountain said it would provide an update at its fourth-quarter earnings report in February, or sooner. Nothing has been announced yet.

It is unusual to see a BDC sell a chunk of its assets. Private-credit loans, unlike junk bonds and syndicated loans to larger companies, generally don’t trade.

PitchBook has reported that Evercore is advising New Mountain on the sale. New Mountain declined to comment on the potential sale.

New Mountain is one of a few dozen public business-development companies that invest in private credit, which consists of high-rate loans of around 10%, mostly to private companies valued at $5 billion or less that were taken private in leveraged buyouts.

New Mountain is a midsize player among private-credit BDCs with about $3 billion in assets and a market value of under $1 billion. The industry’s largest participants include Ares Management, Blue Owl, Blackstone, and Apollo Global Management.

Private credit has been the hottest area of the alternative asset business because of high yields and historically strong credit quality. Proponents see private credit as an appealing alternative to the public junk-bond market. Both retail and institutional investors have been allocating more money to the sector.

But investors this year have increasingly focused on the quality of private-credit loans and how problems with repayment could affect the BDCs that invest in them. As a result, BDCs have come under pressure in the stock market: The VanEck BDC Income ETF, which has broad exposure to the sector, is down 15% this year to $14.35.

While private-credit quality generally is strong, there has been some weakness this year. The worry is that there will be more widespread credit problems in the industry, including in technology, where artificial intelligence poses a threat to software providers. Critics say that problem loans get extended or turned into PIK structures to disguise or postpone trouble.

A second issue is lower short-term interest rates, which are pressuring the dividends BDCs can pay because most private credit loans are pegged to short rates.

If the sale goes well, it likely would boost New Mountain’s stock, which is down close to 20% this year to around $9 and yields 14%.

While New Mountain has had excellent credit quality since it went public in 2011, investors are showing concern about the health of its portfolio of loans and other assets, including equity positions. The stock trades for a roughly 25% discount to the company’s quarter-end net asset value of just above $12 a share.

New Mountain classifies 95% of its portfolio as carrying a green risk weighting, its highest internal credit-quality mark. Most private-credit loans aren’t rated by Moody’s or S&P Global.

A successful sale of some $500 million, or about 15% of the New Mountain portfolio, at prices where the company has been valuing those assets, would be a validation of its marks. Unloading the assets at those levels could buttress both the BDC and private-credit markets because New Mountain owns some loans in common with other firms in the market.

Based on New Mountain’s discounted stock price and debt leverage, equity investors now appear to be valuing the New Mountain portfolio at about 90 cents on the dollar, Barron’s estimates. That is why a portfolio sale at New Mountain’s carrying values would be viewed favorably.

On the flip side, if the New Mountain sale doesn’t generate high prices or if the company decides not to proceed after getting bids in the secondary market, it could be negative for its stock price and outlook. Investors elsewhere in private credit would take note.

Nearly all of New Mountain’s portfolio is now valued at very close to its overall cost, as is typical for private credit. Lower sales proceeds would be a sign it has valued the portfolio too favorably.

Private credit borrowers typically carry high leverage with debt of around six times annual earnings before interest, taxes, depreciation, and amortization, higher than many junk-grade public companies. Many pay half or more of their annual Ebitda in interest, a burdensome expense.

New Mountain has a strong credit record, but the BDC has higher-than-average leverage and a higher proportion of PIK loans than its peers. Both are viewed negatively by investors.

There is higher risk in PIK loans. Many companies that use them can’t currently make cash interest payments as they scale up their businesses, or face financial trouble.

New Mountain’s debt-to-equity ratio is 1.4, compared with an industry average of 1.2, according to KBW analysts. The company likes to focus on a regulatory measure that excludes some debt and results in a lower leverage ratio of 1.2.

New Mountain gets about 15% of its income from PIK loans, roughly double the industry average.

On the company’s third-quarter earnings conference call, Steven Klinsky, the chairman of New Mountain Finance, said the portfolio sale would increase “financial flexibility” and “provide us with an opportunity to evaluate debt paydowns and/or increase the size of our stock buyback program.” He also said the sale could also reduce PIK income.

Klinsky is the billionaire founder of the privately held asset manager New Mountain Capital. The firm manages about $60 billion, mostly in private equity ($46 billion) and credit ($13 billion), including the New Mountain Finance BDC.

He owns about 10% of New Mountain Finance, while other insiders and employees own another 4%. Klinsky emphasized the high insider ownership as a sign of confidence in the company.

Write to Andrew Bary at andrew.bary@barrons.com