Earnings Call Transcript
New Mountain Finance Corp (NMFC)
Earnings Call Transcript - NMFC Q1 2022
Operator, Operator
Good morning. Thank you for attending the New Mountain Finance Corporation First Quarter 2022 Earnings Call. My name is Tamia, and I will be your moderator for today. All lines will be muted during the presentation portion of the call with the opportunity for question-and-answer at the end. I would now like to pass the conference over to our host Robert Hamwee. Please proceed.
Robert Hamwee, CEO
Thank you. Good morning everyone, and welcome to New Mountain Finance Corporation's first quarter earnings call for 2022. On the line with me here today are Steve Klinsky, Chairman of NMFC and the CEO of New Mountain Capital; John Kline, President of NMFC; Laura Holson, COO of NMFC; and Shiraz Kajee, CFO of NMFC. 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, CFO
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 9th earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our press release and on page two of the slide presentation regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections and we ask you to 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 obtain 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 Steven Klinsky, NMFC's Chairman, who will give some highlights beginning on page five of the slide presentation. Steve?
Steve Klinsky, Chairman & CEO
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 will start by covering the highlights of the first quarter. Net investment income for the quarter was $0.30 per share, fully covering our dividend of $0.30 per share that was paid in cash on March 31st and in line with prior guidance. Our net asset value was $13.56 per share, a $0.07 increase from last quarter's net asset value. We generated approximately $18 million of realized gains this quarter, primarily resulting from the sale of one of our REIT assets. The regular dividend for Q2 2022 was again set at $0.30 per share based on estimated net investment income of $0.30 per share. As we discussed on previous earnings calls, risk control and downside protection have always been part of New Mountain's founding mission. Our firm as a whole now manages over $37 billion of total assets with a team of approximately 200 people. We have never had a bankruptcy or missed an interest payment in the history of our private equity work. We have applied that same team strength and focus on downside protection to NMFC and our credit efforts. The great bulk of NMFC's loans are in acyclical sectors with secular tailwinds such as enterprise software, tech-enabled business services, and healthcare services and technology. These are the types of defensive growth industries that we think are the right ones in all times and particularly attractive in the more challenging macro environment we are in today. We believe our portfolio continues to be well-positioned due to this defensive growth investment strategy and is evidenced by an average net default loss of effectively zero since we began our credit operations in 2008. Our portfolio company risk ratings have improved modestly since our last earnings call and we had no new non-accruals this quarter. Coming off of a record origination year in 2021, the first quarter represented a slower origination quarter given the seasonally slower period and the enhanced market volatility, which reduced overall deal volumes. Our sourcing capabilities are as strong as ever and we remain very selective about only lending to what we believe are the most defensive companies. Our at-the-market or ATM stock program is off to a nice start with approximately $49.5 million of net proceeds since it launched in November. Lastly, I want to remind you that, although we have not had to use it, our dividend protection program remains in place, even if earnings fall below $0.30 per share. Rising interest rates can materially improve our earnings as the team will explain on this call. Together, the New Mountain professionals have invested approximately $700 million personally into NMFC and New Mountain's other credit activities. I and management remain as NMFC's largest shareholders. With that, let me turn the call back to Rob.
Robert Hamwee, CEO
Thank you, Steve. While we collectively adapt to life with COVID, we have decided to expand our heat map to reflect the broader market conditions our borrowers face beyond just COVID. The revised risk rating system is outlined on page 8. The X-axis replaces COVID exposure with operating performance and reflects both business performance as well as the overall market environment. Tier 1 continues to be the most negative, reflecting severe business underperformance and/or severe market headwinds, and Tier 4 continues to be the most positive, reflecting in-line or stable performance and/or market conditions. The Y-axis is generally unchanged and as a reminder, ranks on a scale from A to C the business quality, balance sheet strength, and strong sponsor support for the company. We believe our portfolio continues to be very well positioned overall. The updated heat maps show the positive risk migration this quarter, as summarized on page nine and with four positions representing $168 million of fair value improving in rating and three positions representing $33 million worsening in rating. Starting with the positive movers on page 10, two of our formerly red names Haven, formerly known as Tenawa and Permian, migrated to orange this quarter due to significantly better execution at the companies and a stronger operating environment. After quarter end, Haven ceased operations at its plant due to a fire. Fortunately, there were no serious injuries and the company is working with a variety of experts to determine the next steps. Given expected insurance coverage and potential rebuild options, we do not currently expect this to negatively impact our carrying or ultimate value. The hospitality management business improved from orange to yellow as the impact of COVID on the travel industry receipts and KPIs show meaningful progress. Lastly, our UniTek position migrated from yellow to green this quarter, as the ongoing business building we have done has helped transform UniTek into a pure-play engineering and consulting firm with a best-in-class management team, who are delivering strong results. The three negative movers include NHME, where the company continues to face meaningful top line and inflation headwinds, an engineering and consulting firm which was modestly COVID impacted and has an impending revolver maturity, and a retail healthcare business that is experiencing a lingering COVID impact. The updated heat map is shown on page 11. As you can see, given our portfolio's strong bias towards defensive sectors like software, business services, and healthcare, we believe the vast majority of our assets are very well positioned to continue to perform no matter how the economic landscape develops. We continue to spend significant time and energy on our remaining red and orange names, which represent just 1% and 7% of our portfolio, respectively at fair value. We are pleased with the positive migration in several of the red names this quarter and are optimistic that the trend will continue. Page 12 is a view of our Credit Performance based on underlying portfolio company leverage, relative to last 12-month EBITDA and shaded to the corresponding color of the heat map. As you can see, the vast majority of our green-rated positions have shown results that are very consistent with our underwriting projections, exhibiting either very minor leverage increases or in many cases leverage decreases. On the lower right side of the page, we show a group of six companies that have more than 2.5 turns of negative leverage drift, most of which correspond to our yellow, orange, and red rated names. These companies represent a small portion of our portfolio that have underperformed partially due to adverse conditions caused by volatility in certain parts of the economy. From a liquidity perspective, we believe that most of these companies have adequate resources to pursue their business plans and have reasonable prospects for improved performance this year. With that I will turn it over to John to discuss market conditions and other important performance metrics.
John Kline, President
Thanks, Rob. Since our last call in March we have experienced sustained volatility in most areas of the equity and fixed income markets caused by rising interest rates, inflation concerns, supply chain disruptions, and geopolitical instability. Through this period, corporate direct lending has been one of the most resilient asset classes across all financial markets. Our market has benefited from continued good credit performance, particularly in defensive industries, floating interest rates, and secured debt structures. Loan-to-value ratios in many of our core industry verticals are less than 40% and in some cases under 30%. While deal flow remains materially lower than the latter half of 2021, we have seen increased activity in the large unitranche segment of the market, as equity sponsors have gravitated to the certainty and stability of direct lending versus other financing alternatives. Yields continue to be very attractive with floating rate spreads of $5.50 to $6.75 on many new unitranche loans. While we remain mindful of the overall economic environment, we continue to have high conviction in our investment strategy of lending to stable and valuable businesses within defensive growth industries that are well researched by the New Mountain platform. Page 14 presents an interest rate analysis, where we show how the current trends in the interest rate market could impact NMFC's future earnings. During Q1, three-month LIBOR increased from 21 basis points on January 1 to 96 basis points on March 31. Given the presence of floors on our assets and the lack of floors on our liabilities, this rate movement has been a modest earnings headwind during Q1. However, since quarter end, LIBOR has moved even higher to 1.4% and is expected to continue to increase throughout the rest of the year. If this rate trajectory continues, we expect to experience a material positive change in NMFC's earnings power during the back half of the year. For example, if base rates rise to 2%, which could occur within the next three to six months, annual earnings per share could increase by $0.08 or 6%. At 3% LIBOR, NMFC's run rate earnings power could be 14% higher, representing an incremental $0.17 per share. This positive interest rate optionality continues to offer our shareholders material potential return enhancement and provides an attractive hedge against rising rates and general inflation. Turning to Page 15. We present our book value performance since the COVID pandemic began, where we showed that the portfolio has steadily appreciated over the course of the last two years. Today our book value is more than 2% higher than it was in the quarter preceding the health crisis. This recovery has been driven by an increase in the fair value of our core debt holdings, strong contributions from our REIT portfolio, and appreciation of certain equity positions. The largest of which are shown on the right side of the page. Going forward, assuming solid operating performance and a supportive valuation environment, we believe these equity positions could continue to increase in value. Page 16 addresses NMFC's long-term credit performance since its inception. On the left side of the page, we show the current state of the portfolio where we have $3.2 billion of investments at fair value with $30 million or less than 1% of our portfolio currently on non-accrual. On the right side of the page, we present NMFC's cumulative credit performance since our inception in 2008, which shows that across $9.4 billion of total investments only $276 million have been placed on non-accrual. Of the non-accruals, only $79 million have become realized losses over the course of our 13-plus year history. As we will discuss on the next page, these default losses have been offset by realized gains elsewhere in the portfolio. Limiting losses over a long period of time is perhaps the most important metric for a credit manager. We remain committed to transparently disclosing these metrics to our investors. The chart on Page 17 tracks the company's overall economic performance since its IPO in 2011. As you can see at the top of the page since our initial listing, NMFC has paid $962 million of regular dividends to our shareholders, which have been fully supported by $969 million of net investment income. On the lower half of the page, we focus on below-the-line items, where we show that since inception, highlighted in blue, we have a cumulative net realized gain of $2.3 million, which is a $17.6 million improvement compared to last quarter as a result of the partial sale of the Arctic Glacier position from our real estate portfolio. This cumulative realized gain is offset by $19.2 million of cumulative unrealized depreciation in our portfolio, which nets to a cumulative net realized and unrealized loss of just $16.9 million. This aggregate loss stands at the lowest level since 2018 and remains a fraction of total dividend payouts to date. As we look forward, our team remains very focused on reversing this small cumulative loss while maintaining credit quality throughout the remainder of the portfolio. Page 18 shows a stock chart detailing NMFC's equity returns since its IPO nearly 11 years ago. Over this period, NMFC has generated a compound annual return of 10.4%, which represents a very strong cash flow-oriented return in an environment where risk-free rates have averaged less than 1%. NMFC's performance has materially exceeded 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. Additionally, in recent months during a challenging environment for risk assets, NMFC has performed very well compared to the equity and fixed income markets that we track. Finally on Page 19, I would like to provide a brief update on NMFC's REIT subsidiary, which invests in mission-critical commercial properties with long-term tenants. We entered the asset class with the thesis that net lease offered a very nice complement to our corporate debt portfolio given the critical nature of the properties, long lease duration, attractive cap rates, and annual rent escalators. Additionally, one of the key aspects of the investment process involves a detailed credit analysis of the property's tenant, which represents a core competency of the New Mountain platform. Overall, the real estate portfolio has performed very well, as we have experienced both attractive current cash yield and principal appreciation aided by the strong commercial real estate environment since the date of our first investment in 2016. Given the very low cap rates on certain seasoned assets in Q4 of 2021, we made the strategic decision to sell a meaningful portion of the portfolio, which has yielded sales in Q1 and Q2 of approximately $67 million creating a realized gain of approximately $43 million. Depending on market conditions, we may sell a handful of incremental net lease assets with an aggregate fair value of approximately $50 million. The remaining portfolio valued at $120 million consists of more recent originations, which we plan to hold for the foreseeable future. While we continue to like this asset class, we have decided to reduce overall exposure with the goal of reinvesting sales proceeds into our core strategy of a floating rate defensive growth-oriented private credit. I will now turn the call over to our COO, Laura Holson to discuss more details on our recent originations and current portfolio construction.
Laura Holson, COO
Thanks, John. As Steve previewed, Q1 was a seasonally slower origination quarter for our direct lending platform overall. Page 20 aligns the diverse origination within NMFC in our core defensive growth verticals, including two veterinary services businesses and an add-on for an existing software business and a healthcare technology business. $154 million of gross originations less $74 million of repayments and sales effectively deployed the ATM proceeds, keeping us fully invested and within our target leverage range. We continue to have great success targeting and sourcing high-quality deals, within niches of the economy, where we have the highest conviction. Since quarter end, deal activity has picked up and we have committed to several larger deals that we expect to fund over the course of Q2 and Q3. We expect to remain fully invested in our target leverage range, as our deal flow absorbs any proceeds from ordinary course loan repayments, as well as any incremental capital raised through our ATM programs. Turning to page 21, we show that in Q1, our originations were heavily weighted towards first lien loans, due to continued sponsor adoption of the unitranche product. We plan to maintain an asset mix that is consistent with our quarter-end portfolio, or slightly more than two-thirds of our investments, inclusive of the first lien SLPs and net lease are senior in nature. Page 22 shows that the average yield of NMFC's portfolio increased from 9.1% in Q4 to 9.8% for Q1, largely due to the benefit of the increasing LIBOR curve. While the environment is competitive, the market spreads for high-quality deals remain supportive of our net investment income target. Turning to page 23, we show 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 significant diversity within our software, services, and healthcare sectors. We believe these sectors are well positioned in an inflationary environment, given the pricing power and margin profile that comes along with the largely tech and services nature of these industries. The sectors we focus on have attractive cash flow characteristics such as high EBITDA margins, minimal CapEx, and working capital needs, and flexible cost structures. As a result, as interest rates rise, we believe most of our borrowers have sufficient free cash flow to cover the increasing interest burden. As further protection, it is important to note that for our top 20 borrowers, the incremental interest expense associated with a 1% increase in rates represents on average just approximately 1.5% of the sponsored cash equity check. We have successfully avoided nearly all of the most troubled industries while maintaining high exposure to the most defensive sectors within the U.S. economy that we believe can perform well in a more volatile macro environment. Finally, as illustrated on page 24, we have a diversified portfolio. Our largest single obligor Edmentum now represents 4.4% of fair value as the company continues to appreciate in value due to the strong underlying business performance and secular tailwinds in the education technology space. The top 15 investments, inclusive of our SLP funds, account for 36% of total fair value. With that, I will now turn it over to our CFO, Shiraz Kajee to discuss the financial statements.
Shiraz Kajee, CFO
Thank you, Laura. For more details on 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 25. The portfolio had approximately $3.3 billion in investments at fair value at March 31, and total assets of $3.4 billion, with total liabilities of $2 billion, of which total statutory debt outstanding was $1.7 billion, excluding $300 million of drawn SBA guaranteed debentures. Net asset value of $1.3 billion or $13.56 per share was up $0.07 from the prior quarter. At quarter end, our statutory debt-to-equity ratio was 1.23:1, and net of available cash on the balance sheet, the pro forma leverage ratio would be 1.21:1. On slide 26, we show historical leverage ratios and our historical NAV adjusted for the cumulative impact of special dividends. Consistent with our goal of minimizing credit losses and maintaining a stable book value over the long term, you will see that current NAV adjusted for special dividends has surpassed NAV from our IPO, almost 11 years ago. On slide 27, we show our quarterly income statement results. We believe that our 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. For the current quarter, we earned total investment income of $68.6 million, a slight decrease from the prior quarter. Total net expenses were approximately $39 million, a slight increase quarter-over-quarter. As discussed, the investment adviser has committed to a management fee of 1.25% for the 2022 and 2023 calendar years. We have also pledged to reduce our incentive fee if and as needed during this period to fully support the $0.30 per share quarterly dividend. It is important to note that the investment adviser cannot recoup fees previously waived. This results in quarterly NII of $29.6 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 depreciation in the quarter, we had an increase in net assets resulting from operations of $36.2 million. Slide 28 demonstrates 94% of our total investment income is recurring in nature. We believe this consistency shows the stability and predictability of our investment income. Turning to slide 29. The red line shows our dividend coverage. While NII fully covered our Q1 dividend, our dividend protection program could have provided an additional $0.04 of coverage if needed. Based on preliminary estimates, we expect our Q2 NII will be approximately $0.30 per share. Given that our Board of Directors has declared a Q2 dividend of $0.30 per share which will be paid on June 30 to holders of record on June 16. On slide 30, we highlight our various financing sources. Taking into account SBA guaranteed benches we had almost $2.3 billion of total borrowing capacity at quarter end with over $330 million available on our revolving lines subject to borrowing base limitations. 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 31, 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 and over 75% of our debt matures after 2025. To address our $55 million unsecured note maturing in July, we recently priced $75 million of additional unsecured notes at 5.9% to maintain a stable mix of secured and unsecured borrowings. Furthermore, our multiple investment credit ratings provide us access to various unsecured debt markets that we continue to explore to further ladder our maturities in the most cost-efficient manner. With that, I would like to turn the call back over to Rob.
Robert Hamwee, CEO
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 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, Operator
Absolutely. We will now begin the question-and-answer session. The first question comes from John Rowan with Janney. Your line is open.
John Rowan, Analyst
Good morning.
Robert Hamwee, CEO
Hi, John.
John Rowan, Analyst
So I appreciate the information you provided regarding your earnings sensitivity to the potential increase in base rates. I just want to make sure that's a parallel shift assumption, or I just want to make sure that that target that you provided does not account for slope shift of the yield curve?
Robert Hamwee, CEO
The sensitivity we have is primarily related to LIBOR and increasingly to SOFR, which we expect to move similarly to LIBOR for now. Our focus is on the one and three-month LIBOR, so we are not affected by changes further out on the yield curve. The shape of the yield curve does not have much significance for us; it's the short end, specifically the one to three-month LIBOR, that matters. Does that make sense?
John Rowan, Analyst
Sure. Lastly, is there any potential for volatility in noncontrolling interest due to market fluctuations? Does market volatility have any effect on noncontrolling expenses?
Robert Hamwee, CEO
I'm sorry. Does it impact?
John Rowan, Analyst
The noncontrolling interest?
Robert Hamwee, CEO
The noncontrolling interest in our equity positions?
John Rowan, Analyst
In the lease corp.
Robert Hamwee, CEO
Oh okay. I'm sorry. Hey John do you want to?
John Kline, President
We value the full net lease program and report this value in our financials. The value reflects the full net lease subsidiary, and there is a noncontrolling interest of approximately 10%, which is noted in the footnotes. In the financials, you will see 100%, of which NMFC owns 90%. Shiraz, please correct me if I’m mistaken.
Shiraz Kajee, CFO
That's correct John. Yes.
John Kline, President
Does that answer your question? Okay. Thank you.
John Rowan, Analyst
Sure. Yes.
Operator, Operator
Thank you. The next question comes from Bryce Rowe with Hovde Group. Please proceed.
Bryce Rowe, Analyst
Good morning. Thank you for the question, Rob. It's interesting to see the actions taken regarding the real estate portfolio. I'm curious if this will lead to a special dividend that we might see later this year or early next year. I'm trying to understand how you plan to manage those gains.
Robert Hamwee, CEO
Yes. I mean it's a good question, obviously, we'll have to see how the rest of the year plays out and what if any losses we might have to offset against that. But that is something very much on our radar screen. I think we'll have a better sense of it as we get a little later in the year August and certainly on our November call. But it is something we're focused on and it's a great point.
Bryce Rowe, Analyst
Okay. That's helpful, Rob. Laura, you mentioned an increase in rates and how it affects your borrowers, as well as its relationship to the size of the equity checks sponsors are writing. Could you clarify that for us again and help us understand it better?
Laura Holson, COO
Sure. Yes. I think the statistics that we looked at was what does the 1% change in rates, how does that compare to the overall cash equity check that sponsors have in top 20 borrowers. We thought that it was a relevant statistic because fundamentally, if the business is performing well and obviously given the very attractive loan to values that John talked about in the market section, sponsors are not going to walk away in our view generally speaking of hundreds of millions or billions of dollars of cash equity over what is a relatively small dollar amount for 1%, 2% change in interest burden. So we thought that was a relevant analysis. So the statistic that I quoted was that for the top 20 borrowers, a 1% increase in rates represents on average about 1.5% of the overall sponsor cash equity check. So it was kind of one component of the analysis and then we've obviously run some sensitivities on free cash flow coverage etcetera. And again, given the attractive cash flow characteristics of our borrowers we think we're relatively well positioned there as well.
Bryce Rowe, Analyst
Okay. Okay. And when you look at that coverage interest coverage, where does it sit maybe right now? And if you think about the analysis that you're running how does an increase in rates kind of impact that statistic?
Laura Holson, COO
Yes. So the weighted average interest coverage today is kind of a little bit above 2.5x across the portfolio overall. And we think that we continue again for most of the borrowers to be well covered as we took up rates 1%, 2%, 3%, etcetera.
Bryce Rowe, Analyst
Okay, all right. That's good information. I appreciate it. And then, maybe one more for me, as you think about being fully levered here and maybe an increase in volatility, slowing some level of repayment activity. It sounds like you've got a decent pipeline behind you. Can you talk about, being able to stay fully levered, not go too much higher here from a leverage perspective and possibly deal with slowing level of repayment activity?
Robert Hamwee, CEO
Certainly. We are always working to maintain a balance. Ultimately, we size our commitments based on our available resources, which are influenced by repayments that can be unpredictable. However, we have good visibility in the near term due to several businesses in our portfolio that are set to be sold. This gives us insight into the proceeds we can expect. Additionally, we benefit from proceeds from our ATM program. These factors collectively guide how we size our commitments, and we are committed to operating within our established leverage profile. The positive aspect is that we have a substantial deal flow that can support any repayment needs without difficulty, allowing us to be selective. Consequently, we anticipate maintaining our fully leveraged position without exceeding it. Furthermore, we closely monitor our net asset value, which is critical to our leverage calculations, especially during periods of high volatility.
John Kline, President
Hi Bryce, this is John. The only thing I'd add is, while we're fairly fully invested in NMFC which we consider our flagship credit fund, we do have multiple other funds that are private funds and are active in raising more capital. So, even if NMFC is fully invested, we remain open for business and open to support our clients in pursuing transactions that they want to pursue. So we feel comfortable holistically, just about our ability to be in business and be very relevant in the financing market.
Bryce Rowe, Analyst
Got it. Thank you all for your time this morning.
John Kline, President
Yeah. Thank you.
Operator, Operator
Thank you. The next question comes from Ryan Lynch with KBW. Your line is open.
John Kline, President
Hey, Ryan.
Ryan Lynch, Analyst
Hey, good morning. I had a couple of questions. First, you've gotten this compliment in the past, but I really appreciate your guys' slide deck. And I also appreciate you guys, I think updating your rating system to kind of reflect the environment we're in today with less focus on COVID and just more focus on overall business strength. So thanks for providing that update. I did have a question on some of your commentary on the net lease update. You obviously talked about selling some of those assets which have been incredibly successful, but I was interested to hear that you said a lot of those proceeds are going to go back into your core lending strategy. So to me, that feels like you're pulling back a little bit from that strategy, which has been incredibly successful. Obviously, you get high cash returns on it. You've exited those investments at very nice gains, and it seems like you may have some nice gains in the future. So, it would be helpful if you could just educate me on why you guys are pulling back, because I'm just not as familiar with the whole net leasing space. I'm not sure if rising rates have something to do with the decision to kind of pull back some of the air, because again it's been so successful in the past?
Robert Hamwee, CEO
It's a great question, and you've touched on an important point. The main issue is related to interest rates. We really like this space and have a successful private fund focused on it, where market volatility isn't a concern. In the public sector, we entered during a time with attractive cap rates, and we could foresee a possible compression of those rates, which has indeed occurred. However, we're not trying to predict rates specifically. We're aware that there's likely to be more volatility in rates moving forward, and we want to avoid introducing significant volatility into the public vehicle regarding net asset value. We were fortunate to make some successful exits before rates started changing, which we didn't foresee. Now, as rates fluctuate more, we want to maintain a substantial net lease portfolio, but we don't want to further invest heavily in that sector due to the rate volatility. This is the only area where we have significant duration, and we prefer to have less duration now, considering the current uncertainty surrounding inflation and interest rates.
John Kline, President
And Ryan, this is John. The only thing I would add is, as Rob mentioned, we do have a positive view on the asset class. We are enhancing our net lease capabilities at New Mountain. Rob effectively highlighted the timing aspect that influences our decisions. We genuinely believe that, at this point, prioritizing long floating rates in NMFC is in the best interest of our shareholders, and that is our current inclination.
Ryan Lynch, Analyst
That's helpful. It makes sense based on the explanation and the timing of the exits you have. I have another question regarding the revaluation of purchase prices and business valuations today. In the public sector, we see that those businesses, particularly high-quality ones, have been affected significantly due to higher valuations. Businesses with strong profitability, especially those in the tech and enterprise sectors that you focus on, like Adobe, Salesforce, or ServiceNow, have seen their multiples drop considerably. I believe this trend will extend to the private markets, as it is already happening or will in the future. I'd like to hear your thoughts on what you have observed regarding private market valuations for high-growth, defensive-oriented businesses. This is an area of focus for you at NMFC, and New Mountain Capital does this on the private equity side too. Additionally, if you have lent to a strong business that is performing well but its multiples have decreased by 20%, 30%, or even 40%, what implications does that have for you as a lender? I know you've made investments with relatively low loan-to-values, which has been beneficial, but how do those reduced multiples affect their ability to service debt and ultimately repay you in the long run?
Robert Hamwee, CEO
It's a great question and something we discuss frequently, especially when considering new underwriting commitments. The public markets have adjusted quickly, but we haven't yet seen a significant impact on our private equity side. We anticipate that this change will occur since the two markets cannot remain vastly disconnected for extended periods. Currently, the private markets remain quite lively, with some notable large transactions announced at appealing multiples from a public to private perspective. However, we should expect considerable multiple compression in the private market, which we always factor in. This raises questions when a business is acquired at 25 times EBITDA, yet we are comfortable lending at six or seven times, as that approach prepares us for potential compression. If the multiple drops by 20% or 30%, it would be 18 or 16 times, which still provides a significant buffer against our average attachment point for repayment. This isn't a debt service concern since it's tied to cash flows, not asset values. Repayment is crucial, and we always consider this possibility. We do not perceive that we have shifted to a very low-cost environment; rather, we may be moving towards a more normalized environment from a previously high pricing level, with the possibility of further swings. That's why, particularly for higher multiple businesses, we're looking at loan to values in the 20s or 30s, providing substantial cushioning to navigate the current and potentially more challenging environment ahead.
Ryan Lynch, Analyst
Yes, that's helpful commentary and color. And obviously, it's a lot of unpredictability and tough to really see, how it all plays out but that's helpful. The other question I had was, your business is built on a lot of the defensively positioned characteristics of your borrowers. I'm just curious, have you gotten any feedback on, how your overall portfolio is dealing with and managing through the inflationary and labor pressures? Or is it really even too early to really know, because they just really started kind of late last year early this year. I'm sure you don't have financials, yet probably even for Q1, for a lot of these companies. So do you have a sense of that yet, or is it just too early in the process to really know?
John Kline, President
Sure. I can take that one, Ryan. This is John. In some cases, it's too early to know, while in others, we have good visibility. We've seen budgets and Q1 results in many cases, allowing us to gather information on how companies are navigating the current economic challenges. Overall, we're quite pleased with our direct lending portfolio. We focus on avoiding investments in companies that are overly reliant on their input costs or have tight margins that could be disrupted by slight labor shifts. When we carefully consider our core positions, we believe they are well-prepared for environments of input inflation and labor inflation. Generally, we feel optimistic, but we remain attentive and are monitoring the situation closely.
Robert Hamwee, CEO
Yes. I would add that a key aspect in an inflationary environment is pricing power. One of our core strengths is our dominance in niche markets, where we are a leading player, which generally allows for pricing power. Additionally, having unique technology or skills that are not easily replicated enhances this position. As we review budgets and early Q1 numbers, we can see our ability to increase prices in line with wage inflation, which is significant. We're maintaining our margins through our competitive positioning. While it's still early, we feel confident about how the portfolio is set up. There may be challenges ahead, but overall, the portfolio is in a strong position.
Ryan Lynch, Analyst
Yes. Okay. Understood. John, Rob I appreciate the insights and dialogue today.
Robert Hamwee, CEO
Yes. Thank you.
John Kline, President
Thanks, Ryan.
Operator, Operator
Operator, are there any other questions? Well, we're not sure what happened to our operator, but we don't see any questions on our board. So I think, we're going to go ahead and thank everybody as always, for their time and interest. And look forward to speaking with you all in the weeks and months ahead. So thank you.