WhiteHorse Finance, Inc. (WHF) Q2 2019 Earnings Report, Transcript and Summary

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 Second Quarter 2019 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 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 my pleasure to turn the floor over to Sean Silva of Prosek Partners.

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.

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 lines 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 two assets. We had strong originations in the quarter and closed seven deals. Furthermore, net asset value was up to $15.38, a $0.05 increase from the prior quarter and $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, it remains a risk that we may not collect all of our remaining investment in this asset, we do expect to have more information regarding of resolution by the end of next quarter. While these two 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 seven new investments and added on to one position in Q2. Because of significant cash balances during the quarter, our adviser H.I.G. 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 this strong period of deal activity, we determine it appropriate to launch the operations of our previously formed joint venture with State Teachers Retirement System of Ohio having contributed five 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 diluted to our shareholders. The secondary offering advances our goal of addressing the offering of shares owned by the Bayside fund investors by enhancing liquidity of our public listed shares. We intend to continue managing the liquidity of our publicly listed shares in an orderly process potentially to block trades through 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 seven new first lien loans during the quarter totaling $71.4 million, the weighted average leverage multiple on these new deals was approximately 4.1 times. 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 paydown on StackPath that I mentioned earlier, as well as a paydown 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 three 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 on 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 will only underwrite assets that meet our rigorous credit standards. Turning now to our Q3 pipeline. Thus far in the third quarter, we've closed two sponsor deals and one non-sponsor transaction with an additional eight transactions that are mandated as well as one 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, our 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 and the non-sponsor market we're seeing deals between 2 to 4.5 times leverage. Normally with at least 50% equity cushions, we don't see any new competitors in the non-sponsor market. Pricing is been stable in that market for the last several quarters. In the off to run sponsor market, we continue to find attractive assets with leverage of between 3.5 to 5.5 times, normally with at least 40% equity cushions. However, we have observed the broader sponsor market continues to be very crowded, on those deals we're typically finding 10 or more competitors on transactions in that sponsor on the loan 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 a three tiered sourcing architecture at HIG, which we view is a key differentiator. As always, we're 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 management update. Ed Giordano, who is previously our Interim Chief Financial Officer, has left WhiteHorse Finance to pursue other opportunities. We thank Ed for his numerous years and dedicated service. We wish him the best moving forward. As mentioned Joyson Thomas, who’s been with the company for several years, you may have heard in previous earnings calls has been promoted from Controller to Chief Financial Officer, we look forward to Joyson’s contributions in this elevated growth. And I will now turn the call over to Joyson. Joyson?

Thanks Stuart. We reported 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 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 markdowns in the portfolio aggregating to $3.4 million. After considering our net realized and unrealized 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 two or one risk rating on a scale of 1 to 5 where an asset rate at 2 is performing according to plan in our initial expectations and asset rate of one has performed better, especially 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 roughly $15.6 million of undrawn capacity under our revolving credit facility. We continue to closely monitor asset coverage ratio and feel comparable 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 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 0.63 times 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 $0.355 per share for a total distribution of $7.3 million, 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 $0.355per 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?

[Operator Instructions] And your first question is from Tim Hayes of B. Riley FBR.

This is actually Mike on for Tim and thank you for taking my questions. So the first question is with StackPath, last quarter you mentioned that the 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?

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

And then another question on non-accruals. It’s like AG Kings was added to non-accrual this quarter and we noticed that one of your peers had placed that investment on non-accrual status a quarter earlier. So I was just wondering what actually change this quarter let you make that decision now I guess, compared to earlier?

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.

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, given things like that?

Well, we have companies that are over performing 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 in the United States. The economic wins that we read a lot about our 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 King portfolio quality with a year ago.

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?

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

Yes, the break down is roughly about 30 bps related to spread and another 10 bps let’s call it on the base rate.

Your next question is from Mickey Schleien of Ladenburg.

Actually like to follow up on that last question when we look at the impact of 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 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 what you see the portfolio yield settling?

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 plan 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 lower returning sponsor transactions that are targeted for the JV. So when you look at the average returns 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 showed an aggregate and generate 11% to 15% returns through the leverage structure of the JV. So I would indicate you that we are not experiencing spread compression, we're 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 and 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 the scope 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 one or two other players.

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

Yes, we have been putting assets on the books that are priced at LIBOR 525 to 625 and those assets – five of those assets in the third quarter early in the third quarter were transferred into the JV.

So were they transferred – was that accounted for the sale or what’s the accounting for that transfer?

Joyson I’ll give to you answer that question.

Yes, that was a sale to the JV obviously a portion of that would count as our contribution into the JV along with STRS's portion.

Okay just a couple more questions if I can, does the recent – I understand in your prepared remarks you said the Grupo HIMA improving but does the recent unrest in the government in Puerto Rico oppose any specific risk to that credit?

We have seen generally improving financial performance at Grupo HIMA the situation in Puerto Rico is as reported in the news to the 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.

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

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.

And was there any reversal for StackPath?

For StackPath went on nonaccrual at the end of May is that right Joyson.

That’s correct.

And based on the data we have at StackPath we believe that we haven't marked appropriately at 75 without having to reverse any accruals.

So accrued two months for StackPath in the current quarter?

In the quarter, yes.

[Operator Instructions] And your next question is from Rick Shane of JPMorgan.

This is actually Melissa on for Rick today. I wanted to touch on the fee income and the 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 [indiscernible] fee and prepayment income?

Melissa we can’t project prepayments or waivers or amendments but won a book that is over 50% smaller non-sponsor 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 is low. 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 labor and amendment fees on the sponsor deals because sponsors have a generally lose their 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 transaction.

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 non -- 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 with a strategy and 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 non-recurring -- non-regularly recurring income and some additional non-accruals, how do you think that bodes for dividend coverage?

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

Next question is from Robert Dodd of Raymond James.

On the spread issue which you’ve given us some color on obviously you know, this quarter down excluding LIBOR expect them call it 30 basis points, call it 50 over the last two quarters but a lot of that due to the JV assets being on board 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 those lower spread assets that are going to shift off the balance sheet?

It is a great question, Robert, I mean Joyson have you calculated that number yet or is that something we would need to generate?

We’ll need to get back to you on that Robert.

I appreciate that. Second one on Sigue, obviously I mean, the waiver in amendment fees its 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 that in terms of elevated stress in the asset and obviously I know that the fair value cost mark but am the scale of that implies a lot of work and raises an eyebrow. If you can give us any more color on it?

Sigue is generating waiver and amendment fees and at the same time the underlying performance of the company is solid and in fact it is better in the last year than it was in the prior year. The leverage on the assets 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 more changes there, otherwise we would have already taken those marks, and again the company performance is solid. So it is it is not a credit concern of the business at this time.

Thank you. 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.

Thank you.