WhiteHorse Finance, Inc. (NASDAQ:WHF) Q4 2023 Earnings Call Transcript
WhiteHorse Finance, Inc. (NASDAQ:WHF) Q4 2023 Earnings Call Transcript February 29, 2024
WhiteHorse Finance, Inc. reports earnings inline with expectations. Reported EPS is $0.46 EPS, expectations were $0.46. WhiteHorse Finance, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Fourth Quarter and Full Year 2023 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 4:00 p.m. Eastern time. The replay dial-in number is (402) 220-2985. No pass code 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 Instructions] It is now my pleasure to turn the floor over to Jacob Moeller of Rose & Company. Please go ahead.
Jacob Moeller: Thank you, operator, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's fourth quarter 2023 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 Fourth Quarter 2023 earnings presentation, which was posted to our website this morning. With that, allow me to introduce WhiteHorse Finance's CEO, Stuart Aronson. Stuart, you may begin.
Stuart Aronson: Thank you, Jacob, and good afternoon, everybody. 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 December 31, 2023, which can also be found on our website. On today's call, I'll begin by addressing our fourth quarter results and current market conditions. Then Joyson Thomas, our Chief Financial Officer, will discuss our performance in greater detail after which we will open the floor for questions. This afternoon, I'm pleased to report strong performance for the fourth quarter of 2023. Q4 GAAP net investment income and core net interest income was $10.6 million or $0.456 per share, which more than covered our quarterly base dividend of $0.385 per share.
This represents a slight decline from the Q3 gap and core NII of $10.8 million or $0.465 per share. NAV per share at the end of Q4 was $13.63, representing a 1.7% decrease from the prior quarter. NAV per share was negatively impacted by a $6.8 million of net mark-to-market in our portfolio. Markdowns were related to company-specific performance and were partially offset by markups across four credits, as I will discuss shortly. Turning to our portfolio activity. In Q4, gross capital deployments totaled $56.9 million, with $54.1 million funding eight new transactions and the remaining $2.8 million funding add-ons to existing portfolio investments. This was the highest level of origination activity in 2023 but was slightly below quarters in past year fourth quarters and past years.
Origination constraints were primarily a lack of deal opportunities with a slow 2023 M&A environment, leading to a tight deal market. Half our new originations in Q4 were sponsored deals and the other half were non-sponsor deals. The sponsor deals had an average leverage of approximately 4.3x debt to EBITDA. I note that these deals were all first lien loans with spreads of 575 basis points or higher and had average all-in rate of 12%. During the quarter, the BDC transferred four of these new deals and one add-on to the Ohio STRS JV totaling $27.6 million, and that was on in exchange for cash. I will discuss activity within the JV in more detail shortly. At the end of Q4, more than 97% of our debt portfolio was first lien, senior secured and following fourth quarter originations, our portfolio mix was approximately two-third sponsor and one-third non-sponsor.
In Q4, total repayments and sales were $34.9 million primarily driven by two complete and two partial realizations. In addition, there were $0.6 million in net repayments made on revolver commitments. As addressed in our last earnings call, repayment activity remained elevated during the first half of 2020 -- sorry, relative to the first half of 2023, and we anticipate them to continue through 2024 based on a pickup in M&A activities and the ability of some companies refinance at lower rates. Currently, we have visibility into a number of likely repayments in Q1. And as of today, have already had $39 million in full repayments and sales across five investments. We will seek to redeploy this capital into attractive investments this quarter and going forward.
With repayments and JV transfers offsetting our modest deployment activity, the Company's net effect leverage remained at 1.16x, unchanged from the prior quarter. This is still below the lower end of our target leverage range. And so long as our portfolio remains heavily concentrated in first lien loans, which have lower risk than second lien loans, we expect to continue to run the BDC at up to 1.35x leverage. 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 $6.8 million in net mark-to-market changes and the $1.2 million of accretion, the fair value of our investment portfolio was $696.2 million at the end of Q4. This compares to our portfolio of fair value of $706.8 million at the end of the previous quarter.
The weighted average effective yield on our income-producing debt investments increased to 13.7% as of the end of Q4, up from 13.6% at the end of Q3. The variance was primarily driven by a slight increase in the portfolio's base rate and spread. We continue to utilize the STRS JV successfully. The JV generated investment income to the BDC of approximately $4.2 million in Q4, up from $3.9 million in Q3. As of December 31, the fair value of the JV's portfolio was $312.2 million and at the end of Q4, the JV's portfolio had an average unlevered yield of 12.4%. This compares to 12.5% at the end of Q3 and 11.3% at the end of Q4 2022. The year-over-year increase in our unlevered yield is primarily due to rising base rates. 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. Transitioning to the BDC's portfolio more broadly, there were some markdowns in the portfolio during Q4, with mark-to-market declines being driven by our investments in American Crafts, Atlas purchaser, which is also known as Aspect Software and Claridge products. These declines were partially offset by not mark-to-market increases in various portfolio investments. As we've shared before, we continue to see some pressure on our portfolio and the general economy preparedly in the consumer segment. We remain vigilant in monitoring our portfolio of companies, and we have not seen demand weakness in other sectors, including general industrial B2B, healthcare, TMT or financial services.
Additionally, our portfolio includes mostly non-cyclical or light cyclical borrowers, and we have no direct exposure to oil and gas, auto, new home construction or restaurants. The vast majority of our deals have strong covenant protection, and we are finding that, in most cases, private equity firms we partnered with are supporting their credits with new cash or contingent equity as needed. No new credits were moved to non-accrual during the quarter. And at the end of Q4, investments in non-accrual totaled 2% of our total portfolio at fair value compared with 2.8% at the end of Q3. Across the portfolio, generally, we see balanced activity in terms of credit performance and remain overall pleased with the health of our debt portfolio. American Crafts remains on non-accrual status.
The turnaround of this troubled asset is taking longer than anticipated. And the investment was marked down by $7.5 million or approximately $0.32 per share in terms of our portfolio NAV in Q4. Our investments in PlayMonster, Crown Brands and Arcserve remain on non-accrual as well. Subsequent to the end of Q4, we and other leaders took control of Arcserve and we believe that the asset has potential side in the coming in to 18 to 24 months as we implement changes in management and company structure to optimize profitability. We hope to successfully exit our Crown investment this quarter. Finally, a markdown was taken on Atlas purchaser, Aspect Software, which we believe to be appropriate given the Company's ongoing restructuring. The asset remains on accrual status, and we continue to monitor the situation.
We're optimistic on our ability to effectively navigate and turn around troubled investments illustrated by the successful exit of our investment in Arcole during Q2, which generated a 1.2x return on invested capital. WhiteHorse and H.I.G. Capital have a proven ability to leverage our collective resources and expertise to turn around investments with the objective of minimizing losses and capital preservation. We are actively working with our troubled portfolio companies to improve their performance. Turning to the broader lending market. The markets in Q4 were characterized by increased liquidity from both direct lenders and banks. As a result, pricing in the market for sponsor deals fell by about 50 basis points on average. As we enter 2024, this market activity has continued to ramp up with additional liquidity becoming available in the marketplace.
We are seeing people have a more optimistic view on the economy than they had in most of 2023. And as a result, our competitors are becoming more aggressive on both leverage and price, including for companies that we see as moderate and deep cyclicals. The aggressiveness of the on-the-run sponsor market right now is reminiscent of 2021 in terms of both price and structure. Pricing on upper mid-market deals has come down to between SOFR 475 and SOFR 550. We are seeing SOFR 500 to 575 as pricing for mid-market deals and SOFR 550 to 625 for lower mid-market deals. In the lower mid-market, we're seeing deals being levered 4x to 5x, while leverage in mid-market deals is higher at 4.5x to 6x, and we're seeing deals getting done for cyclicals at 4.5x to 5.5x leverage which we view as very aggressive for a cyclical credit.
Loan-to-value, which in Q3 was typically under 50%, is now up to 55% in the lower mid-market and 60% to 65% in the mid-market and upper mid-market. In the non-sponsor sector, deals are still consistently at loan-to-value of under 50% with an average 40% to 45% loan to value. Additionally, pricing has remained stable in non-sponsor market at SOFR 650 to 850 with leverage multiples of 3x to 4.5x. In the current market environment, we are being very cautious in our deal sourcing with the on-the-run sponsors especially, and our focus remains on the off-the-run market and non-sponsor market where market terms remain comparatively more attractive. Our view on the economy in 2024 is that because unemployment remains low, and because we believe there are underlying pressures on wages and raw materials that are still raising prices.
We don't think the Fed is going to hit its 2% inflation target as quickly as other people seem to think. We maintain our perspective that the market is overly optimistic on rate cuts and expect that higher rates will slow down the economy. We don't foresee a recession, but at a minimum, we expect slower growth through 2024 and into 2025. In an elevated market environment like what we are seeing thus far in 2024, we derive particular benefit from our sourcing model, which allows us to source deals and corners of the market where there is less competition, including the off-the-run sponsor market and the non-sponsor market. Our 3-tier sourcing architecture continues to provide the BD with differentiated capabilities, and we continue to derive significant advantages from the shared resources and affiliation with H.I.G., who is a leader in the mid-market and lower mid-market.
WhiteHorse has 22 origination professionals located in 11 regional markets across North America. The strength of our origination pipeline enables us to be conservative in our selection. As a result, we believe the deals we are originating are more attractive than the general market in terms of risk and return. In general, we're seeing a continuing rebound in terms of both deal volume and quality and our pipeline activity levels remain solid. Following repayment activity in Q4, the BDC balance sheet is approximately $50 million of capacity for new assets at our target leverage range. The JV has approximately $40 million of capacity supplementing the BDC's existing capacity. With the move in the markets, deal sort are priced at SOFR 625 and below our targeted for the JV and those priced at 625 and above are targeted for the BDC balance sheet.
We're actively working on 12 new mandates and add-on acquisitions, of the new platform mandates all are non-sponsor deals. And while there can be no assurance that any of these deals will close, all these mandates fit within the BDC or our JV should we elect to transact. Subsequent to quarter end, we have closed five new originations and three add-ons to existing portfolio of companies with several more pending. Of the new originations, one investment was transferred to the JV during the first quarter. In short, activity continues to pick up, and we remain cautiously optimistic that market conditions remain conducive for WhiteHorse. Despite sustained concerns of economic softening, we believe we are well positioned to continue to source attractive opportunities, navigate economic challenges due to our rigorous underwriting standards and continue delivering to our shareholders.
As a result, in our Q3 earnings release, we announced that the Board of Directors of the BDC approved an increase to our quarterly base dividend from $0.37 per share up to $0.385 per share starting in Q4 of this year. The Board approved the decrease in the base management fee rate paid to H.I.G. WhiteHorse Advisers, the BDC adviser from 2% to 1.75%, effective January 1, 2024. This will have a further positive effect on our financial results and our ability to cover the increased base dividend on a go-forward basis. Before I conclude, I'd like to take a moment to address the recent passing of our friend and fellow board member, Kevin Burke. Kevin provided invaluable counsel throughout his tenure on the Board, and we are grateful for his dedication and service to WhiteHorse Finance.
It was truly a privilege to have worked alongside Kevin and we are deeply saddened by his passing. With that, I'll turn the call over to Joyson for additional performance details and a review of our portfolio composition. Joyson?
Joyson Thomas: Thanks, Stuart, and thank you, everyone, for joining today's call. During the quarter, we recorded GAAP net investment income and core NII of $10.6 million or $0.456 per share. This compares with Q3 GAAP NII and core NII of $10.8 million or $0.465 per share and our previously declared quarterly distribution of $0.385 per share. Q4 fee income increased quarter-over-quarter to approximately $0.6 million in Q4 from $0.4 million in Q3. Q4 amounts are highlighted by a $0.4 million prepayment fee generated from the full realization of our investment in Aeyon and a small amendment fee from motivational marketing. For the quarter, we reported a net increase in net assets resulting from operations of $3.4 million. Our risk ratings during the quarter showed that 77.7% of our portfolio positions carried either one or two rating, slightly lower than 78.2% in the prior quarter.
As a reminder, a one rating indicates that a company has seen its risk of loss reduced relative to initial expectations and a two rating indicates the Company is performing according to initial expectations. Regarding the JV specifically, we continue to grow its portfolio. As Stuart mentioned earlier, we transferred four new deals and one add-on transaction totaling $26.6 million. As of December 31, 2023, the JV's portfolio helped positions in 34 portfolio companies with an aggregate fair value of $322.2 million compared to 32 portfolio companies at an aggregate fair value of $313 million as of December 30, 2023. Subsequent to the end of the fourth quarter, the Company transferred three investments to the JV, including one new portfolio company.
The investment in the JV continues to be accretive to the BDC's earnings, generating a mid-teens return on equity. As we have noted in 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 the 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. We had cash resources of approximately $24.5 million at the end of Q4, including $13.7 million in restricted cash and approximately $138 million of undrawn capacity available under our revolving credit facility. As of December 31, 2023, the Company's asset coverage ratio for borrowed amounts as defined by the 1940 Act, was 181% which was above the minimum asset coverage ratio of 150%.
Our Q4 net effective debt to equity ratio after adjusting for cash on hand was 1.16x consistent with the prior quarter. Before I conclude and open up the call to questions, I'd like to again highlight our distributions. This morning, we announced that our Board declared a first quarter 2024 distribution of $0.385 per share, which is consistent with the previous quarter. As mentioned earlier by Stuart, in the fourth quarter of 2023, we increased our quarterly base distribution to $0.385 per share, which represents a cumulative increase of 8.5% as compared with the inaugural $0.355 per share dividend that was declared at the BDC's IPO. These actions speak to both the consistent strength of the platform as well as our resilient deal sourcing capabilities and being able to create a well-balanced portfolio generating consistent current income.
As was announced in the beginning of 2023, our Board also implemented a formulaic supplemental quarterly distribution. For the fourth quarter, the Board did not declare a supplemental distribution, which is consistent with our formulaic supplemental distribution framework. We believe this framework allows us to maximize distributions to our shareholders while preserving the stability of our NAV, a factor that we believe to be an important driver of shareholder economics over time. In assessing distributions, we also consider a taxable income relative to amounts that we have distributed during the year when setting our overall dividend. Our current estimate of undistributed taxable income, sometimes referred to as our spillover as of the end of Q4 2023 is approximately $32 million.
We continue to believe that having a healthy level to the lower income is beneficial to the long-term stability of our base dividend. We continue to monitor our undistributed earnings and balance these levels against prudent capital management considerations. The upcoming distribution, the 46th consecutive quarterly distribution paid since our IPO in December 2012, with all distributions at or above a rate of $0.355 per share per quarter will be payable on April 2, 2024, to stockholders of record as of March 22, 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 for your questions. Operator?
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