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Edited Transcript of WHF earnings conference call or presentation 7-Aug-19 2:00pm GMT

Q2 2019 WhiteHorse Finance Inc Earnings Call

New York Aug 30, 2019 (Thomson StreetEvents) -- Edited Transcript of WhiteHorse Finance Inc earnings conference call or presentation Wednesday, August 7, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joyson Thomas

WhiteHorse Finance, Inc. - CFO

* Stuart D. Aronson

WhiteHorse Finance, Inc. - CEO & Director

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Conference Call Participants

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* Melissa Marie Wedel

JP Morgan Chase & Co, Research Division - Analyst

* Michael Edward Smyth

B. Riley FBR, Inc., Research Division - Research Analyst

* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

* Sean Silva

Prosek LLC - Associate VP

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Presentation

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Operator [1]

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Good morning. My name is Christy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance's Second Quarter 2019 Earnings Conference Call. Our host 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 available for replay beginning at 1 p.m. Eastern Standard Time. The replay dial-in number is (404) 537-3406 and the pin number is 4389314. (Operator Instructions)

It is now a pleasure to turn the floor over to Sean Silva of Prosek Partners.

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Sean Silva, Prosek LLC - Associate VP [2]

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Thank you, Christy, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's Second Quarter 2019 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 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 2019 earnings presentation, which was posted to our website this morning at www.whitehorsefinance.com.

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

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [3]

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Thank you, Sean. Good morning, and thank you for joining us today. As you're aware, we issued our press release this morning prior to market open, and I hope you've had a chance to review our results, which are also available on our website. I'm going to take you through our second quarter operating performance, and then Joyson Thomas, our newly appointed Chief Financial Officer, will review our financial results before we open the line for questions. I'll provide more detail on Joyson's appointment at the end of my prepared remarks.

Our second quarter results were mixed. It was an otherwise strong quarter but was impacted, we hope temporarily, by the markdown of 2 assets. We had strong originations in the quarter and closed 7 deals. Furthermore, net asset value was up to $15.38, a $0.05 increase from prior quarter and a $0.51 increase from Q2 of 2018.

GAAP net investment income for the quarter was $7.2 million or $0.352 a share and core net investment income was $0.362 per share covering our $0.355 dividend. Although our weighted average effective yield on income-producing investments was 11.3% as of the end of the second quarter, the weighted average effective yield on our total portfolio declined to 10.7% due to the impact of AG Kings and StackPath, both of which we placed on nonaccrual during the quarter as they faced challenging dynamics.

I'll now provide further detail on these positions. As reported in the prospectus published ahead of the secondary offering announced in June, we placed AG Kings on nonaccrual and marked our position down to $0.75 on the dollar. The position affected not only our yield for this period, but the reversal of previously accrued interest from the prior period impacted our earnings as well. We, the sponsor, and the company's advisers are working hard to resolve the challenges facing this company as quickly as possible. Also based on data we saw at quarter end, we placed our investment in StackPath on nonaccrual and marked the position to $0.75 down from $0.82 in Q1.

We continue to work closely with the sponsor of this company as they take action to reduce debt. As I mentioned last quarter, as a result of these efforts, the sponsor reduced debt at the company which resulted in a $3.8 million of our loan being repaid at par this quarter and the remaining loan converting to a first-lien facility. However, there remains a risk that we may not collect all of our remaining investment in this asset. We do expect to have more information regarding a resolution by the end of next quarter. While these 2 investments meaningfully impact our results, we were able to partially offset these markdowns thanks to other operational highlights from the quarter, which I'll now address in more detail.

As mentioned, we experienced strong deal flow during the quarter and able to source high-quality deals and continue deploying proceeds from the Aretec sale. We made 7 new investments and added on to 1 position in Q2. Because of significant cash balances during the quarter, our adviser HIG WhiteHorse Advisers agreed to waive management fees on the cash portion of our assets for the quarter so as to not disadvantage our shareholders while these proceeds are reinvested. Given those balances are now largely deployed, we do not anticipate the need for future waivers based on the data we have at this time. Further, as a result of the strong -- of this strong period of deal activity, we determined it appropriate to launch the operations of our previously formed joint venture with State Teachers Retirement System of Ohio, having contributed 5 assets at the beginning of the third quarter. The JV will allow us to efficiently invest in more senior secured assets with the goal of achieving a leverage yield of 11% to 15% on our investment.

Finally, during the second quarter, we announced that private funds managed by H.I.G. Capital, also known as the Bayside Funds, conducted a secondary offering of shares at an offering price of $14 per share. As a result, approximately 2.6 million shares were sold, which reduced the Bayside Funds total share ownership of WhiteHorse Finance to under 39%. It is important to note that this was a secondary offering and so no new shares were issued nor did we receive any proceeds from this offering and therefore this offering was not dilutive to our shareholders. The secondary offering advances our goal of addressing the overhang of shares owned by the Bayside Fund investors by enhancing liquidity of our publicly listed shares. We intend to continue managing the liquidity of our publicly listed shares in an orderly process, potentially through block trades or additional secondary offerings in addition to exploring other options such as an aftermarket offering program, understanding that the timing of any sales will be determined by many factors which are beyond our control.

I'll now turn to our investment portfolio. The fair value of our portfolio in Q2 grew by 14% to $534.8 million compared to $468.4 million as of the previous quarter. The increase in portfolio balances was mainly attributable to net deployments made during the quarter. We originated 7 new first-lien loans during the quarter totaling $71.4 million. The weighted average leverage multiple on these new deals was approximately 4.1x. We also made one small add-on during the quarter, which was a secondary purchase of $3.9 million principal amount at 93.5% at face on our first-lien loan to Grupo HIMA, whose performance continues to improve. Repayments and sales during the quarter totaled $12.3 million, which included the pay down on StackPath that I mentioned earlier as well as a pay down on our remaining position in ACT, as discussed on our prior earnings call. Fee income from the quarter was very strong and totaled approximately $2.9 million and was primarily driven by prepayment fees on ACT of $0.9 million as well as wavering amendment fees generated from Sigue of $1.8 million.

Our portfolio had an average debt investment size of $8.8 million based on fair value with all the 3 of our current portfolio companies falling below the upper range of our target investment size of $20 million. Elevated origin activity during the quarter drove an increase in our leverage ratio to 79%, up from 57% last quarter. This advances our objective of carefully ramping up investments to manage our portfolio at leverage levels between 1 and 1.25x. The timing of this ramp-up is dependent on market conditions and as always, we will only underwrite assets that meet our rigorous credit standards.

Turning now to our Q3 pipeline. Thus far in the third quarter, we have closed 2 sponsor deals and 1 non-sponsor transaction with an additional 8 transactions that are mandated as well as 1 other additional add-on transaction to an existing account, which would increase funding. As always, there can be no assurance that any of these mandated transactions will close. I should also mention that all the deals that closed in Q2, all the deals that have closed so far in Q3 and all the mandated deals in Q3 are first-lien transactions. As of the end of Q2, our portfolio is up to 85% first-lien transactions and 15% other.

More broadly, market conditions remain largely unchanged from last quarter. In the non-sponsor market, we are seeing deals between 2 to 4.5x leverage, normally with at least 50% equity cushions. We don't see any new competitors in the non-sponsor market. Pricing has been stable in that market for the last several quarters. In the off the run sponsor market, we continue to find attractive assets with leverage of between 3.5 to 5.5x, normally with at least 40% equity cushions. However, we have observed the broader sponsor market continues to be very crowded. On those deals, we are typically finding 10 or more competitors on transactions in that sponsor on the run market, although pricing has been generally stable over the last several quarters. Our strong deal flow despite this competitive market underscores the value of our direct origination infrastructure backed by our three-tiered sourcing architecture at H.I.G., which we view as a key differentiator. As always, we are staying true to our disciplined approach to sourcing and underwriting throughout this process by maintaining our rigorous credit standards, diversifying our portfolio to prevent customer concentrations and avoiding binary outcome risk.

In closing, I will now share a management update, Ed Giordano, who was previously our Interim Chief Financial Officer, has left WhiteHorse Finance to pursue other opportunities. We thank Ed for his numerous years of dedicated service and wish him the best moving forward. As mentioned, Joyson Thomas, who has been with the company for several years and who you may have heard in previous earning calls has been promoted, from Controller to Chief Financial Officer. We look forward to Joyson's contributions in this elevated role.

And I will now turn the call over to Joyson. Joyson?

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Joyson Thomas, WhiteHorse Finance, Inc. - CFO [4]

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Thanks, Stuart. We recorded GAAP net investment income of $7.2 million or $0.352 per share. This compares to $7.6 million or $0.37 per share in the prior quarter. Core NII, after adjusting for $0.2 million capital gains incentive fee accrual, was approximately $7.4 million for the quarter, translating to $0.362 per share. This compares to $7.5 million or $0.365 per share in the prior quarter. We reported net mark-to-market gains of approximately $1 million driven by markups in the portfolio aggregating to $4.4 million that were partially offset by markdown in portfolio aggregating to $3.4 million. After considering our net realized, nonrealized gains in the portfolio, we reported net increase in net assets, resulting from operations, of approximately $8.2 million or $0.41 per share for the second quarter. As of June 30, 2019, net asset value was $315.9 million or $15.38 per share, up from $350 million or $15.33 per share as reported in Q1.

As it pertains to our portfolio investment activity nearly 85% of our portfolio carries either a 2 or 1 risk rating on a scale of 1 to 5. Where an asset rated a 2 is performing according to plan in our initial expectations and an asset rated a 1 has performed better, such that the risk of loss has been reduced relative to those initial expectations.

Turning to our balance sheet. We had cash resources of approximately $50.4 million as of June 30, 2019, including $33.8 million of restricted cash and approximately $15.6 million of undrawn capacity under our revolving credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of June 30, 2019. The company's asset coverage ratio for borrowed amounts as defined by the 1940 Act was 226.7% at the end of the second quarter. Well above our requirement under the statute of 150%.

Our net effective debt to equity ratio, after adjusting for cash on hand, was 0.63x as of the end of the quarter.

Next, I'd like to highlight our quarterly distribution. On June 10, we declared distribution for the quarter ended June 30, 2019, of $0.355 per share for a total distribution of $7.3 million to stockholders of record as of June 20, 2019. The distribution was paid to stockholders on July 3, 2019. This marks the company's 27th distribution since our IPO in December 2012 with all distributions at the rate of $0.355 per share per quarter. We expect to be in a position to continue our regular distributions.

I will now turn the call over to the operator for your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from Tim Hayes of B. Riley FBR.

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Michael Edward Smyth, B. Riley FBR, Inc., Research Division - Research Analyst [2]

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This is actually Mike on for Tim. So the first question is with StackPath. Last quarter you mentioned a private equity sponsor was investing in the company and you kind of reiterated that today. I was just wondering what drove the markdown this quarter. And what's the outlook here looking forward?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [3]

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The change in the mark was driven by an update in the financial results that we got at the end of June. The financial results were disappointing, which in our mind lowered the value of the asset, and we are -- the sponsor has injected equity and is very actively involved in seeking to reduce the debt at the company, and we expect to -- we are in multi-times-a-week dialogue with them and expect to have a significant information by the time we get to next quarter's update.

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Michael Edward Smyth, B. Riley FBR, Inc., Research Division - Research Analyst [4]

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That's helpful. And then another question on nonaccruals. Looks like AG Kings was added to nonaccrual this quarter. And we noticed that one of your peers had placed that investment on nonaccrual status a quarter earlier. So I was just wondering what actually changed this quarter that led you to make that decision now, I guess compared to earlier?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [5]

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We got, again, more information on the performance of the credit and that information on the performance of credit led to more understanding of the value on the credit, and we determined that the likelihood of recovering that interest was lower than we thought before, and we did reverse the accrual that we took in the prior quarter. So we have corrected that and that is included in our earnings results for the quarter.

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Michael Edward Smyth, B. Riley FBR, Inc., Research Division - Research Analyst [6]

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Got you. And then just a follow-up. I guess in terms of the overall portfolio, how would you characterize the health of your portfolio companies compared to maybe a year ago? Are you seeing any material changes in EBITDA growth, interest coverage, different things like that?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [7]

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No. We have companies that are overperforming, companies that are underperforming and companies that are performing on plan. We are not seeing any systemic change in the performance of the lower mid-market economy of the United States. The economic wins that we've read a lot about, resulting from trade wars and other macro issues, do not seem to be impacting our portfolio. So I would say with the exception of StackPath that is a specific issue and Kings, which is dealing with issues in that sector, we are consistent in portfolio quality with a year ago.

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Michael Edward Smyth, B. Riley FBR, Inc., Research Division - Research Analyst [8]

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That's helpful. And then one last question for me. Looks like the all-in yield declined 40 basis points quarter-over-quarter, so I was just wondering how much of this decline was driven by LIBOR? And then how much of it was driven by competition, if any?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [9]

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Joyson, do you happen to have a breakdown of those numbers?

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Joyson Thomas, WhiteHorse Finance, Inc. - CFO [10]

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Yes. The breakdown is roughly about 30 bps related to spread and another 10 bps, let's call it, on the base rate.

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Operator [11]

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Your next question is from Mickey Schleien of Ladenburg.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [12]

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Actually, I'd like to follow up on that last question, when we look at the impact of spread and spread compression as capital has come into the market, seems pretty clear looking at your portfolio yield on Page 11 that, that's been a major trend. When you think about the potential for the Fed to continue to loosen with the economy looking to slow down and taking into account the floors in your loans, which I assume are well below the current LIBOR rate, how do you think about -- how do you think competitors will behave in this sort of developing environment and where do you see the portfolio yields settling?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [13]

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Let me just highlight that we continue to be booking first-lien loans and not second-lien loans, so everything booked in Q2, so far in Q3 and planned for Q3 are first lien. Secondly, we continue to book assets that we would not have booked in the BDC before that are modestly levered, low-returning sponsor transactions that are targeted for the JV. So when you look at the average returns, it is not apples-to-apples to compare it with periods of time before we had the JV because with the JV, we're knowingly taking on assets that price from LIBOR 525 to LIBOR 625 that we did not take on before. Those assets when contributed to the JV should, in aggregate, generate 11% to 15% returns through the leverage structure of the JV.

So I would indicate to you that we are not experiencing spread compression, we are not seeing a change in pricing in the market over the last several quarters, but we are having a change in yield based on the composition of the assets we're taking, both in terms of them being senior secured first-lien assets and the fact that we're doing what we believe are low-leverage, low-LTV, senior secured assets that do not have the lofty yields on them that historically we would be putting in the BDC. That's one of the reasons that the originations in the BDC have been so strong.

In terms of how the market will react to a declining interest rate environment, that would be a prediction of future market behavior that I just don't have any insight to, but we will gauge the markets and sticking with our credit standards, do the right things that we can do for the BDC. The beauty of our model continues to be, we have 19 originators in 11 cities across North America. We are not competing toe to toe with all those people who are buying deals off of sales desks of the major banks and regional banks. We are doing, in general, bespoke transactions where the majority of deals that we do, we as an organization are holding all of that asset or in some cases clubbing those deals together with just 1 or 2 other players.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [14]

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Stuart, just to make sure I understand given that we haven't seen the Q yet, you, I guess, effectively warehouse some lower yielding loans that will be contributed to the JV in this current quarter, is that correct?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [15]

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Yes. We have been putting assets on the books that are priced at LIBOR 525 to 625. And those assets -- 5 of those assets in the third quarter, early in the third quarter, were transferred into the JV.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [16]

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So were they transferred -- was that accounted for as a sale? Or what's the accounting for that transfer?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [17]

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Joyson, I'll pivot to you to answer that question.

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Joyson Thomas, WhiteHorse Finance, Inc. - CFO [18]

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The accounting was a sale to the JV, obviously, a portion of that would account as our contribution into the JV, along with SGRs' portion.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [19]

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Okay. Just a couple of more questions, if I can. The recent -- I understand in your prepared remarks you said the Grupo HIMA's improving, but does the recent unrest in the government in Puerto Rico pose any specific risk to that credit?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [20]

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We've seen generally improving financial performance at Grupo HIMA. The situation in Puerto Rico is, as reported in the news to best of our knowledge, but it does not seem to be having any material impact on the need of the residents of Puerto Rico for hospital care. And the company seems to be managing itself better and their balance sheet situation has improved over the past 3 to 6 months.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [21]

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Okay. And on AG Kings, I just want to confirm, you said you reversed the entire interest accrued from the previous quarter, was that correct?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [22]

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Yes. That had an impact, I believe, of $0.03 a share. So earnings would have been $0.03 higher had we not needed to take that reversal.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [23]

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And was there any reversal for StackPath?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [24]

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StackPath went on nonaccrual at the end of May. Is that right, Joyson?

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Joyson Thomas, WhiteHorse Finance, Inc. - CFO [25]

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That's correct.

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [26]

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And based on the data we have at StackPath, we believe that we have it marked appropriately at 75 without having to reverse any accruals.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [27]

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Okay. So you accrued 2 months for StackPath in the current quarter?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [28]

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In the quarter, yes.

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Operator [29]

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(Operator Instructions) And your next question is from Rick Shane of JPMorgan.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [30]

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This is actually Melissa on for Rick today. I wanted to touch on the fee income and debt prepayments, income that you guys received that I think you identified as sort of onetime in this quarter. I'm wondering about your outlook is headed into the back half of '19 on some of our certain nonrecurring or lumpy fee and prepayment income?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [31]

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Melissa, we can't project prepayments or waivers or amendments, but we won a book that is over 50% smaller non-sponsored companies and those companies over the entire life of the BDC have regular defaults on covenants, which result in waivers and amendment fees. So that is a very natural piece of our income. As I reported in prior quarters, it varies from quarter-to-quarter. In some quarters, it's high, like last quarter. In some quarters, it's slow. But it is a normal part of our income stream and always has been and will be, primarily in the non-sponsor transaction flow. We do get some waiver in amendment fees on the sponsor deals, but because sponsors have a generally looser covenants than non-sponsor deals, the sponsors violate those covenants less frequently and so we don't see as many fees generally coming from the sponsor deals. The highlight, both ACT and Sigue, who are the key contributors to fees in the quarter are both non-sponsor transactions.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [32]

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Okay. I'm also looking at the press release that you guys put out on June 13, where you talked about that $0.13 per share of what you guys classified as nonrecurring fee and other nonrecurring investment income from prepayments and amendments and other items? When I look -- when we look at the lower yield that I think you've described really well what the strategy is in terms of bringing on lower yields and investments onto the balance sheet before they're transferred into the joint venture. But if you look at that impact combined with perhaps lower or nonrecurring -- non-regularly recurring income and some additional non-accruals, how do you think that bodes for dividend coverage?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [33]

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Again, we never get into projecting forward results. StackPath and Kings, until they are resolved, will be a drag on earnings. Fees and -- waiver fees, amendment fees and prepayment penalties, we expect to have continue to come in, but we can't predict the levels, but the nonaccruals will put pressure on our ability to earn or generate net interest income and it's all a function of deployment resolution of those issues and what waiver and amendment fees we get.

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Operator [34]

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Our next question is from Robert Dodd of Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [35]

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On the spread issue, which you've given us some color on, obviously, this quarter down, excluding LIBOR -- spreads down, call it 30 basis points, call it 50 over the last 2 quarters, but a lot of that due to the JV assets being onboarded that you've talked about before. When -- obviously, that went live at the beginning of the third quarter so you transferred them. So how much of that spread should we expect to come back in -- all other things being equal, obviously, in the third quarter given that those lower spread assets are going to shift off the balance sheet?

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [36]

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It's a great question, Robert. I mean, Joyson, have you calculated that number yet? Or is that something we'd need to generate?

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Joyson Thomas, WhiteHorse Finance, Inc. - CFO [37]

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We need to get back to you on that, Robert.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [38]

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Okay. I appreciate that. Second one on Sigue, obviously, the wavier and amendment fees, it's great income, but that implies to me some fairly material adjustments needed to be made with the debt structure of that asset. So I mean is there anything that we should be concerned about there in terms of elevated stress in that asset? And obviously, I know the fair value of the cost mark, but the scale of that implies a lot of work and raises an eyebrow. If you can give us any more color on if there is any issues there, that could become apparent in the next few quarters or anything like that.

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [39]

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Again, very good question. Sigue is generating waiver and amendment fees and at the same time, the underlying performance of the company is solid. In fact, it is better in the last year than it was in the prior year. The leverage on the asset that we have is very modest, but the company has been in default on other issues that do not relate to the core financial performance. We do not anticipate any mark changes there, otherwise we would have already taken those marks, and again, the company performance is solid. So it is not a credit concern of the business at this time.

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Operator [40]

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There are no further questions at this time. We thank you for joining today's WhiteHorse Finance Second Quarter 2019 Earnings Conference Call. You may disconnect your lines at this time, and have a wonderful day.

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Stuart D. Aronson, WhiteHorse Finance, Inc. - CEO & Director [41]

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Thank you.