WhiteHorse Finance Q2 2024 Earnings Call Transcript

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August 8, 2024

There are 6 speakers on the call.

Operator

Good morning. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Second Quarter 2024 Earnings Conference Call. Our hosts for today's call are Stuart Aronson, Chief Executive Officer and Joyson Thomas, Chief Financial Officer. Today's call is being recorded and will be made available for replay beginning at 4 P.

Operator

M. Eastern Time. The replay dial in number is 402-220-5395. No passcode is required. At this time, all participants have been placed in a listen only mode and the floor will be open for your questions following the presentation.

Operator

It is now my pleasure to turn the floor over to Robert Bremberg of Rose and Company. Please go ahead.

Speaker 1

Thank you, operator, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's Q2 2024 Earnings Results. Before we begin, I would like to remind everyone that certain statements, which are not based on historical facts made during this call, including any statements relating to financial guidance may be deemed forward looking guidance statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward looking statements involve known and unknown risks and uncertainties, These are important factors that could cause actual results to differ materially from those expressed or implied by these forward looking statements. WhiteHorse Finance assumes no obligation or responsibility to update any forward looking statements. Today's speakers may refer to material from the WhiteHorse Finance Second Quarter 2024 Earnings Presentation, which is posted to our website this morning.

Speaker 1

With that, allow me to introduce WhiteHorse Finance's CEO, Stuart Aronson. Stuart, you may begin.

Speaker 2

Thank you, Rob, and good morning, everyone. Thank you for joining us today. As you're aware, we issued our earnings this morning prior to market open, and I hope you've had a chance to review our results for the period ending June 30, 2024, which can also be found on our website. On today's call, I'll begin by addressing our Q2 results and current market conditions. Joyson Thomas, our Chief Financial Officer, will then discuss our performance in greater detail, after which we will open the floor for questions.

Speaker 2

Our results for the Q2 of 2024 were a bit softer due to elevated repayment activity and some markdowns in our portfolio. Q2 GAAP net investment income and core was $9,300,000 or $0.40 per share, exceeding our quarterly base dividend of $0.385 per share. This represents a decrease from Q1 GAAP and core NII of $10,800,000 $0.465 per share. NAV per share at the end of Q2 was $13.45 representing a 0.4% decrease from prior quarter. NAV per share was impacted by net markdowns on our portfolio totaling $1,500,000 the majority of which related to Honors Holdings, which I will discuss shortly.

Speaker 2

Turning to our portfolio activity in Q2. We had gross capital deployments of $55,800,000 which was more than offset by total repayments and sales of $71,700,000 resulting in net repayments of 16,100,000 Gross capital deployments consisted of 7 new originations totaling $47,400,000 with the remaining $8,400,000 used to fund 9 add ons to existing investments. Our 7 new originations in Q2, 3 were non sponsor and 4 were sponsor deals with an average leverage of approximately 3.8 times debt to EBITDA. Some of these new assets were transferred to the JV during the quarter and for the deals that stayed on the BDC balance sheet, leverage was around 3.6 times. All of our Q2 deals were 1st lien loans with an average spread of 6.50 basis points and an average all in rate of 11.8%.

Speaker 2

I note that both these statistics are attractive from a historical and current market perspective. During the quarter, the BDC transferred 4 new deals and 4 add ons to the Ohio STRS JV totaling $22,000,000 in exchange for the $22,000,000 in cash. At the end of Q2, the SG or SGB's total portfolio comprised 38 issuers with an aggregate fair value of $324,800,000 and leverage as of Q2 was 1.08x compared with 0.99x at the end of the prior quarter. At the end of Q2, 99% of our debt portfolio was 1st lien senior secured and our portfolio mix was approximately 60% sponsor deals and approximately 40% non sponsor deals, roughly similar with prior quarter. In Q2, total repayments and sales were $71,700,000 primarily driven by our complete by 4 complete realizations and one partial realization.

Speaker 2

Repayments are elevated for two reasons. There are a series of accounts where performance was challenged and we asked the borrowers to refinance us out in this borrower friendly market and they've done that. This amounted to roughly 80% of our repayments in Q2. We don't expect to see many more refinancings in this category. There may be a couple of credits that we want to exit though.

Speaker 2

And then there are some other accounts with a much lower interest rate environment and the more aggressive credit environment has led borrowers to be able to push up leverage and push down price. On some of those deals, we just felt the resulting transactions are too aggressive and we're letting these go. We expect that the borrower friendly market combined with eventually declining base rates will likely lead to a continued flow of refinancings into the latter part of the year, especially as call protection on the deal steps down or expires. We expect refinancings to remain heavy through the balance of the year. Thus far in Q3, there have been no full repayments or sales though.

Speaker 2

With that in mind, I'll now step back to bring our entire investment portfolio into focus. After the effects of net repayments and the STRS JV transfers as well as $1,500,000 in net mark to market decreases, $200,000 of realized losses and $800,000 of accretion, the fair value of our investment portfolio was $660,000,000 at the end of Q2. This compares to our portfolio's fair value of $697,900,000 at the end of the previous quarter. The weighted average effective yield on our income producing debt investments was 13.8% at the end of Q2, a 40 basis point improvement compared to 13.4% in the Q2 of 2023 and up slightly from 13.7% in the Q1 of 2024. We continue to utilize the STRS JV successfully.

Speaker 2

The JV generated investment income to the BDC of approximately $3,900,000 in Q2 compared to $4,800,000 in Q1. As of June 30, the fair value of the JV's portfolio was $324,800,000 and the portfolio had an average unlevered yield of 12.3% compared to 12.4% in Q1. The JV is currently producing an average annual return on equity in the mid teens to the BDC. We believe WhiteHorse's equity investment in the JV provides attractive returns for our shareholders. Traditionally transitioning to the BDC's portfolio more broadly, there were some markdowns in the portfolio during Q2.

Speaker 2

Most notably, there was a $2,200,000 mark down to our investment in Honors Holdings, which was placed on non accrual status in the middle of the quarter, resulting in a decrease of approximately $125,000 of interest compared to expectations at the start of the quarter. Honors was a company that was heavily impacted by COVID. After that, a private equity firm contributed additional equity to Honors to help it navigate the pandemic and to further execute on its growth strategy in the face of a weak market. However, the company has been experiencing weaker customer trends in recent quarters. Now we're taking action to position the company for remediation and we're working with both the franchisor and of the concept who currently and the current owners of the company.

Speaker 2

We expect to improve and resolve that investment over the next 12 to 24 months. Honors meaningfully contributed to the increase in non accrual investments, which totaled 4.2% of the total debt portfolio compared with 1.3% at Q1 excluding investments in the SDR S JV. In regard to American Crafts and Arcserve, we continue to execute turnaround plans to maximize the value of both of these companies, working alongside our restructuring resources and private equity resources. And we remain optimistic that we would seek exits on those in 18 to 30 months. We otherwise see balanced activity in terms of credit performance across the portfolio generally and remain overall pleased with the health and relative stability of our debt portfolio with cash flow coverages holding up in a high interest rate environment.

Speaker 2

Turning to the broader lending market, there continues to be a supply demand imbalance in favor of borrowers. As a result, market conditions across all of the sponsor segments remain very aggressive. In the upper mid cap and large cap markets, we're seeing leverage of anywhere between 5 to 7.5 times. We also see lenders putting PIK leverage on companies for an additional 1 to 2 turns beyond that 5 to 7.5 times. PIK leverage occurs in the market from time to time, but we are generally avoiding it.

Speaker 2

Pricing in the upper mid cap and large cap markets is SOFR 450 to SOFR 500 with an original issued discount of between 98 99. We have been avoiding doing any deals in the upper mid cap and large cap markets due to the aggressive natures of these deals. The mid market is 1 step less aggressive. We are seeing leverage typically between 4.5x and 6x. Pricing in the mid market is so for $500,000,000 to so for $550,000,000 for the most part with OID also between $98,000,000 to $99,000,000 The lower mid cap market is again 1 step less aggressive with leverage generally running 4 to 5 times and pricing in the lower mid cap market ranging from SOFR 500 to SOFR 600 with an OID typically of 98 to 98.5.

Speaker 2

The non sponsor market has not moved much at all with leverage remaining at 2.5 to 4.5 times and pricing in the range of $600,000,000 to $800,000 over SOFR with an OID of $98,000,000 or lower. Given the relative attractiveness of the non sponsor market, we are focusing heavily on originating deals in the non sponsor sector. We are seeing more evidence of competitors accepting heavily adjusted EBITDAs as they are trying to win new volume in a market that is short of assets. We've seen bankers bringing out many refinancings on troubled credits where they're trying to adjust the capital structure often on highly adjusted EBITDA. Many of those deals that have come in front of us we think are negative cash flow deals.

Speaker 2

We don't believe many of the adjustments and we think the leverage is too heavy and we're turning down all of those deals. In the current market environment, we're taking a cautious stance and focused on transactions that have positive free cash flow, limited cyclicality and strong owners behind them. The on the run sponsor market is clearly more aggressive than the off the run sponsor market and also more aggressive than the non sponsor market. As a result, we are spending most of our time focused on the off the run sponsor market and the non sponsor market. With respect to the broader economy, we are seeing signs of weakening that is showing up in lower consumer demand and in some sectors lower demand in the business to business segment.

Speaker 2

Given the gradual slowdown in the economy, we do believe that the Fed will begin to reduce interest rates in the Q4 of 2024. Following net repayment activity in Q2, the BDC balance sheet has approximately $60,000,000 of capacity for new assets. The JV has approximately $30,000,000 of capacity supplementing the BDC's existing capacity. Deals that are priced at sulfur plus $600 and above will generally put on the BDC's balance sheet and deals priced below this level will generally go into the STRS joint venture. While volume is lighter than we expected to be in all market segments, we're actively working on 6 new mandated deals split evenly between sponsor and non sponsor.

Speaker 2

While there can be no assurance that any of these deals will close, all of these mandates would fit into the BDC or our JV should we elect to transact. Subsequent to quarter end, we have closed 3 new originations totaling approximately $18,000,000 with several more pending. Of the new originations, 2 are expected to be transferred to the JV during the Q3. So far, there have been no asset transfers to the JV in the Q3. Our pipeline is still running about 180 deals, but the portion of the pipeline that we call active pipeline is lower than it would normally be this time of year.

Speaker 2

In addition, our 3 tier sourcing architecture continues to provide the BDC with differentiated capabilities. We derive significant advantages from the shared resources and affiliation with H. I. G, who is a leader in the mid market, lower mid market. WhiteHorse has approximately 23 origination professionals located in 11 regional markets across North America.

Speaker 2

The strength of this originations pipeline enables us to be conservative in our deal selection. Based on current market terms and conditions, we are taking a very cautious stance and focused on doing deals that have positive free cash flow, limited cyclicality and strong owners. Despite continued concerns regarding economic softening, we believe we are well positioned to continue to source attractive opportunities and navigate economic challenges through our strong originations capabilities and rigorous underwriting standards. With that, I'll turn the call over to Joyson for additional details and a review of our portfolio composition. Joyson?

Speaker 3

Thanks, Stuart, and thanks everyone for joining today's call. During the quarter, we recorded GAAP net investment income and core NII of $9,300,000 or $0.40 per share. This compares with Q1 GAAP NII and core NII of $10,800,000 or $0.465 per share and our previously declared quarterly distribution of $0.385 per share. Q2 fee income was lower quarter over quarter at $400,000 compared with $600,000 from the prior quarter. Q2 amounts were primarily comprised of approximately $300,000 of amendment fees.

Speaker 3

For the quarter, we reported a net increase in net assets resulting from operations of $7,800,000 Our risk ratings during the quarter showed that 74.4 percent of our portfolio positions carried either a 1 or 2 rating, slightly lower than the 76.6% reported in the prior quarter. As a reminder, a 1 rating indicates that a company has seen its risk of loss reduced relative to such initial expectations and a 2 rating indicates the company is performing according to such initial expectations. Regarding the JV specifically, we continue to grow our investment. As Stuart mentioned earlier, in the Q2, we transferred 4 new deals and 4 add ons to the Ester S JV totaling $22,000,000 in exchange for cash proceeds of the same amount. As of June 30, 2024, the JV's portfolio held position in 38 portfolio companies with an aggregate fair value of $324,800,000 compared to 34 portfolio companies at a fair value of $309,400,000 as of March 31, 2024.

Speaker 3

Investment in the JV continues to be accretive to the BDC's earnings, generating mid teens return on equity. During Q2, income recognized from our JV investment aggregated to $3,900,000 during the quarter as compared with approximately $4,800,000 in Q1. As a reminder, and as reported in the prior call, in Q1, there was an elevated amount of income recognized from a JV investment, largely attributable to non occurring events that had occurred in the JV's portfolio during Q1. As we have noted in the prior calls, the yield on our investment in the JV may fluctuate period over period as a result of a number of factors, including the timing and amount of additional capital investments, the changes in asset yields in the underlying portfolio as well as the overall credit performance of the JV's investment portfolio. Turning to our balance sheet.

Speaker 3

We had cash resources of approximately $21,800,000 at the end of Q2, including $8,900,000 restricted cash and approximately $167,000,000 of undrawn capacity available under our revolving credit facility. As of June 30, 2024, the company's asset coverage ratio for borrowed amounts as defined by the 1940 Act was 186.2%, which was above the minimum asset coverage ratio of 150%. Our Q2 net effective debt to equity ratio after adjusting for cash on hand was 1.09 times compared with 1.19 times from the prior quarter. Before I conclude and open up the call to questions, I'd again like to highlight our distributions. This morning, we announced that our Board declared a 3rd quarter distribution of $0.385 per share, which is consistent with the prior quarter.

Speaker 3

The upcoming distribution, the 48th consecutive quarterly distribution paid since our IPO in December 2012 with all distributions at or above the rate of $0.355 per share per quarter will be payable on October 2, 2024 to stockholders of record as of September 18, 2024. As we said previously, we will continue to evaluate our quarterly distribution both in the near and medium term based on the core earnings power of our portfolio in addition to other relevant factors that may warrant consideration. With that, I'll now turn the call over to the operator. Operator?

Operator

Thank We'll go first with Bryce Roe from B. Riley. Please go ahead.

Speaker 4

Thanks a bunch. Good morning.

Speaker 2

Good morning, Bryce.

Speaker 4

Hey, Stuart. I really appreciate some of the market commentary and your cautious approach. I think it's probably the more one of the more cautious kind of messages that I've heard throughout the earnings season. Wanted to ask kind of about the flows in and out of the BDC from an investment perspective. Leverage is coming down.

Speaker 4

It sounds like that cautious approach could lead to a more kind of muted activity as we think about the second half of this year and into next. Can you talk about kind of where you're comfortable with leverage in terms of how low leverage could go on the balance sheet? Do you think you can maintain here or a good chance that it continues to move lower?

Speaker 2

Bryce, we're lucky to have a HIG supplement origination capability that when the on the run markets get really aggressive like they are right now, we can scroll down into the off the run markets and non sponsor markets and find deals that we feel are a better risk return. When the markets were very favorable, we completely filled up the BDC and for a period of time the BTC had no capacity and we were doing deals that couldn't go into the BTC. As I highlighted, we now have about 60,000,000 dollars of availability on the BDC balance sheet, which given the average allocation would be about 6 deals of incremental capacity plus an incremental 2 to 3 deals in the JV. Q3 is a decent but relatively slow quarter so far. But in general, we tend to see Q4 as a stronger quarter.

Speaker 2

And even in a very slow M and A year like 2023, Q4 had volume that was about double of what Q3 was. So I don't expect that we're going to use up the unused capacity in Q3, but we are hopeful that we will put most of the unused capacity to work in Q4 if we see a normal upswing in economic activity. With the expectation of interest rate cuts in Q4 and many private equity firms being pressured by LPs to have realizations and bankers telling us that their pipelines are reasonably robust. We're hoping that after the August slowdown in September, October, we'll see robust M and A flow and be able to use up some of that capacity.

Speaker 4

Okay. That's helpful. And then in terms of kind of repayments, appreciate the commentary around repayment activity in the quarter. Can you help us kind of handicap, if there are more portfolio companies in that leave category or ask to leave category? And then maybe on the flip side help us understand or maybe handicap that other category you mentioned of companies coming to refinance and you all don't want to participate because the terms are not up to your standards?

Speaker 2

Yes. In general, at the moment, there's only one company I can think of that I would put in the desired exit category. And so that category is going to slow down because I think we had 3 of them in the last quarter where we had the opportunity to stay with the credits, but we wanted to exit because of performance issues that our credit teams felt warranted a termination of the relationship. As it regards to the refinancings, in 20222023, we were adamant about getting strong call protection. And we got call protection on our deals that was generally 2 years on the sponsor deals and 3 to 4 years on the non sponsor deals.

Speaker 2

To the extent that that call protection is starting to roll off, especially on the 2022 deals, we are seeing people come back and look to do refinancings. In many cases, based on the strength of the market, those refinancings include dividends as well. And so where borrowers are taking up leverage, taking down equity in the company and taking down price, we're only sticking with the stronger non cyclical borrowers and there are several transactions that have gone on where we just felt that the underlying leverage and price made it imprudent to stick with the borrowers. There's no way to know how much of that we will see in the balance of Q3 and Q4, But there is no doubt in my mind with interest rates or interest spreads as low as they are right now that there will be continued refinancing pressure. If the credits are okay, we will adjust the pricing on those deals to the current market, which in many cases will take pricing from $600,000,000 to $650,000,000 down to pricing of $500,000,000 to $550,000,000 But the thing that will make us exit is if the performance of the borrower combined with the leverage that they're trying to put on the borrower leaves us questioning the stability of that credit in the ongoing period, especially because we have a view that the economy really is softening.

Speaker 2

We're not necessarily predicting a recession, but we are predicting into 2025 a weaker economy and we think it's imprudent to overly leverage companies into a weaker economy and we're making our decisions on that basis.

Speaker 4

Good stuff. Two quick ones for you, Joyson. Do you have an estimated UTI balance as of the end of June? And then did I hear that there was an interest reversal in the quarter?

Speaker 3

In relation to your second question, Bryce, the $125,000 was not recognized in Q2. It wasn't necessarily a reversal of an accrual from the prior quarter. But when we put the Honors holding position on non accrual in Q2, essentially, we didn't recognize an additional $125,000 that we would have as compared to Q1. Okay.

Speaker 4

And then do you have a UTI balance or estimate for us?

Speaker 3

I don't have the UTI balance handy for me right now. Let me see if I can just pull that up. I think it's about $32,000,000 Actually, I just pulled it up, dollars 32,000,000 Okay, awesome. Thank

Operator

you, guys. We'll go next to Sean Paul Adams with Raymond James. Please go ahead.

Speaker 5

Hey, guys. Good morning. On the portfolio risk ratings, it seems like the uptick in risk ratings 45 was likely due to the new non accrual. Am I correct in that?

Speaker 2

Yes, I believe that is the case.

Speaker 5

Okay. So but in aggregate over the last 6 months, there has been a somewhat large shift in ratings just downward within the portfolio. At the beginning of January, risk ratings 1 were somewhere around 18%. Now they're sitting around 12.8. So it just seems like there's a somewhat large waterfall effect going downward within the portfolio.

Speaker 5

And it looks like you guys are really paying large attention to the new deals on the market and really focusing on credit quality and leverage. What kind of aspects are you guys thinking about in regards to your existing portfolio companies? And is there any isolated sectors that are really experiencing the largest material weaknesses?

Speaker 2

Yes. Jean Paul, in regard to the ones, what generally happens with credits that are over performing is the companies get sold or the companies get refinanced. So there's a natural effect that ones tend to go away, and that happens in all market, but especially true in a strong market environment. That said, as I indicated in my prepared statements, we are seeing a slowdown in the economy as recently has been indicated by data that's been released into the marketplace and has led to some equity gyrations recently. We are spending a significant amount of time focused on existing portfolio.

Speaker 1

Most of

Speaker 2

our existing portfolio accounts are comfortably paying their interest burden and their debt burden. But we do have a number of situations that are not related to the general economy like Honors Holdings where it is a company specific issue that has led to the weakness in the performance. And actually it's a fairly recent issue as well. The company was only levered about 3.5 times about a year ago and the company has experienced weakness over the past 12 months. We have a 5 person restructuring team that gets involved in all the deals that need covenant waivers and that restructuring team includes private equity professional who on owned accounts helps us put the right management teams in place, helps us come up with growth strategies for the company and helps us cut costs.

Speaker 2

And on Arcserve and American Crafts in particular, which are both owned assets, We are working with that restructuring team and with our private equity expertise to execute turnarounds that we hope will take hold and allow us to get strong exits in 18 to 30 months. So there is a lot of attention being paid to portfolio. And in today's market where we think competitors are being overly aggressive, we are committed to trying to not add any marginal credits to our portfolio.

Speaker 5

Okay. Thank you so much. And I believe you remarked earlier in the call that Honors Holdings probably had a timeline of 12 to 24 months of a resolution process. And I believe you also mentioned ArtServe would probably be around an 18 to 30 month timeline as well?

Speaker 2

Yes.

Speaker 5

Okay. Okay. That's perfect. I just needed to clarify that. Thank you so much for the color.

Speaker 2

No problem. Thank you.

Operator

And ladies and gentlemen, as there are no further questions in queue at this time, that will conclude our question and answer session and the WhiteHorse Finance Second Quarter 2024 Earnings Call.

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