WhiteHorse Finance Inc (WHF) 2021 Q2 法說會逐字稿

Good morning. My name is Britney, and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Second Quarter 2021 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 a replay beginning at 4:00 p.m. Eastern Standard Time. The replay dial-in number is (402)220-2330. Please note, there is no pass code required. (Operator Instructions) It is now my pleasure to turn the floor over to Nick Rust of Prosek Partners.

Thank you, Britney, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's Second Quarter 2021 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 related to financial guidance, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Before 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 Q2 Earnings Presentation, which was posted on our website this morning.

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

Thank you, Nick. Good afternoon, 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 start by addressing our second quarter results and market conditions and then Joyson Thomas, our Chief Financial Officer, will discuss our performance in more detail, after which we'll open the floor to questions.

In the second quarter, core NII was $7 million or $0.338 per share, slightly below our dividend of $0.355. GAAP net investment income was $6.1 million or $0.296 per share. NII was lower than last quarter as a result of lower fee income and accelerated interest accretion, which was higher in the prior quarter due to large volume of prepayment activity we saw in Q1. Also, as you know, asset balances were lower at the end of Q1 as a result of repayments that we got during that quarter.

We achieved modest NAV accretion in the quarter, generating $15.42 of NAV per share combined -- compared to $15.27 in Q1. This gain was driven by $4 million in mark-to-market gains that we recorded in our portfolio this quarter. When adjusting for special dividends paid in prior years, our pro forma Q2 NAV per share is highest since our December 2012 IPO. Our mark-to-market gains were highlighted by Honors Holdings at $0.7 million, BBQ Buyer at $0.7 million and LS GFG Holdings at $0.6 million.

We also experienced a strong period for capital deployments totaling $104 million, including originating 8 new transactions. This investment activity enabled us to grow the portfolio by 9% from Q1. Gross deployments of $104 million were partially offset by repayments of $31 million. We attribute the modest Q2 repayment level to timing as we're currently aware of a number of portfolio companies that are for sale and if they close before year-end, this will drive increased level of repayments.

Our 8 new originations -- of our 8 new originations, 7 were sponsor and 1 was nonsponsor, and the deals had an average leverage level of 4.05x. Additionally, 7 of these deals were first lien and 1 was second lien. At the end of the second quarter, 95% of our debt portfolio is first lien and 100% was senior secured. Sponsor loans comprise 68% of our portfolio, compared to 65% in Q1. We continue to be pleased with the pace of capital deployment throughout the first half of 2021 as compared to prior years and our weighted average effective yield on income-producing debt investments of 9.5% was just slightly below the Q1 level of 9.6%.

Now stepping back to bring our entire investment portfolio into focus. At the end of the second quarter, the fair value of our investment portfolio increased to $671 million, compared to $617 million at the end of Q1. Nonaccruals represented only 1.5% of our debt portfolio, compared to 2.5% on a fair value basis at the end of Q1. This decrease was driven by Sure Fit returning to accrual status in the quarter. Grupo HIMA remains the only nonaccrual as of June 30. We remain in restructuring negotiations with Grupo HIMA and expect that this process will extend for many months.

We continued to successfully utilize the JV, which generated income of $2.1 million in the quarter, which was at the same level of Q1. The JV's portfolio size was $210 million, with an average unlevered yield of 8.1% in Q2 '21, which was slightly above the prior year period. We remain pleased with the income contributions from the JV and believe it supports higher returns for shareholders. If we use the current full capacity of the JV, we are likely to allocate an additional $25 million or more of equity into this program to continue to drive higher net interest income for WHF.

As a result of the strong originations momentum, leverage at the end of Q2 was 1.14x within our targeted range of 1 to 1.25x. Looking ahead, our Q3 pipeline is very strong with 17 mandated deals. Eight of these deals are sponsored and split between new originations and add-ons. Of the balance, 6 deals are nonsponsor and they're nonsponsor new deals and 3 are nonsponsor add-ons. Given these mandates, we can confidently say that third quarter is on pace to produce the highest origination volume we have ever generated through our platform.

This exceptional pipeline growth and these mandated deals are enabling the BDC to drive portfolio growth and ramp the JV, which will ultimately lead to higher income levels and greater coverage of our dividend. Given that we expect high repayment activity during the balance of the year, we may choose to operate at higher than our targeted 1.25x leverage ratio in order to prepare the portfolio for expected repayments.

We have already had one repayment and refinancing in Q3. We expect some additional early repayments due to M&A and new financing events for a number of credits during the remainder of the year. This, of course, is subject to change given current market conditions. In closing, we're well positioned to continue executing our 3-tiered sourcing approach and rigorous underwriting standards in the second half of the year.

Our portfolio as a whole remains very high quality and healthy. Together with a strong pipeline of investment opportunities, we expect fee income to pick up in the second half, which should enable us to continue covering the dividend from core net interest income. That said, the increasing rates of COVID-19 infections and hospitalizations creates uncertainty and could impact both portfolio performance and the rate of new asset origination.

H.I.G. with $45 billion of capital under management empowers us to continue to benefit from the shared resources of a leader in the mid-market. This includes 63 deal professionals dedicated to direct lending a 20-plus person business development team leveraging H.I.G. Capital's proprietary prospect database and sourcing at the H.I.G. level by over 400 investment professionals overall.

Our WhiteHorse team spans 12 locations across North America and includes non-gateway markets that face less deal sourcing competition than large investment centers like New York and Chicago. As a result, we believe our combined platform is poised to drive continued portfolio growth and ultimately higher returns to our shareholders across our established direct lending business.

With that, I'll turn the call to Joyson, after which we'll take your questions. Go ahead, Joyson.

Thanks, Stuart, and thank you all for joining today's call. During the quarter, we recorded GAAP net investment income of $6.1 million or $0.296 per share. This compares to $7.6 million or $0.37 per share in Q1 2021. Core NII was $0.338 per share after adjusting for a $0.9 million capital gains incentive fee accrual. Our investment in the JV continues to ramp up, increasing by $6.6 million after the effects of transferring 4 new deals and 3 add-ons that totaled $31.8 million in Q2. As of June 30, we held 25 positions in the JV with an aggregate fair value of $209.5 million, compared to 22 positions at a fair value of $185.7 million in Q1.

Investment in the JV continues to be accretive to the BDC's earnings as our return on our investment in the JV at the end of Q2 was approaching 14%. Q2 fee income was approximately $0.3 million compared to $0.8 million in the prior quarter. The decline was largely due to higher prepayment fees collected during the first quarter. We reported an increase in net assets resulting from -- a net increase in net assets resulting from operations of $10.5 million. Our risk ratings during the quarter showed that 90% of our portfolio positions carried either a 1 or 2 rating compared to 84.3% in Q1.

Turning to our balance sheet. We had cash resources of approximately $17.8 million as of June 30, 2021, including $7.4 million in restricted cash. At quarter end, we had approximately $46.5 million undrawn under our revolving credit facility. We also have the flexibility to increase the line to $350 million under our existing accordion feature.

As of June 30, 2021, the company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 187.9%, 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 1.08x. Since the end of the quarter, we have completed an amendment and refinancing on our existing JPMorgan Bank credit facility. The impact will extend the non-call period to November '22, or will short the reinvestment period to November 2024 and reduced the applicable interest spread from 250 to 235 basis points beginning in Q3 2021.

We anticipate this will result in annual cost savings of approximately $0.4 million, assuming the line continues to be utilized at our historical levels. Next, I'd like to highlight our distributions. On May 10, 2021, we declared distribution for the quarter ended June 30, 2021, of $0.355 per share for a total distribution of $7.4 million to stockholders of record as of June 18. The dividend was paid on July 2, 2021, and marks the company's 35th consecutive quarterly distribution paid since our IPO in December 2012, with all distributions consisting at the rate of $0.355 per share per quarter.

Finally, this morning, we announced that our Board of Directors declared a third quarter distribution of $0.355 per share to be payable on October 4, 2021, to stockholders of record as of September 20. 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 back over to the operator for your questions. Operator?

(Operator Instructions) And we will take our first question from Bryce Rowe with Hovde Group.

Stuart. So you noted that you're expecting possibly the highest ever origination quarter here in the third quarter. I guess it could move into the fourth quarter as well. But looking back, it looks like $176 million was the best quarter for originations to date. So if you could kind of help us -- help frame the pipeline relative to that. And then from a repayment perspective, I know it's hard to predict, but do you expect originations in the back half of this year to outpace repayment activity?

So our originations activity across our entire WhiteHorse direct lending is higher than it's ever been, which is strange for Q3 because Q3 is normally the second slowest quarter after Q1. And that bodes well for Q4, absent disruptions in the economy or something else that we're not projecting. How much of that origination activity ends up in the BDC will come down to suitability for the BDC and allocation percentages, but it should be significant. I would say based on what we know right now, we will have net -- significant net additions to the portfolio in Q3.

And then we have a number of sale processes on companies, again we're not selling them, the owners are selling them, but we have our loans that will get repaid as a part of that, that will probably hit in Q4. So Bryce, what we're hoping to do is ramp-up originations, potentially get the total leverage above 1.25x in Q3, preparing for what we expect to be more pay downs in Q4 and we're going to try to manage to about 1.25x leverage with assets of around $700 million for year-end if we can get there.

There are always repayments that pop up that we don't know about. But the thing that's different right now is how many of those repayments are visible because we know that the companies that those loans are made to are either already in the market or are coming to market in Q4.

That's good detail. Maybe one more for me, and then I'll jump back in the queue. But Joyson, I noticed the dividend income not related to the JV was a bit elevated here in the quarter. Can you speak to what drove that? And maybe trying to get an understanding for what that might be here going forward?

Yes. Outside of the JV's dividend, we did receive some dividend income primarily related to Oracle Holdings. As you know, that is an equity investment, as that investment continues to have some excess cash flows, again, from their perspective, the underlying portfolio company had made a dividend out to its equity owners. So we did recognize a dividend this quarter related to that.

Okay. So and that's more episodic? Or is it distributed to cover tax distribution or tax expense?

Yes, that's a great question. The way I would look at it is, I think there is a little bit of Canadian taxes at play there, but we do envision future income streams to come from the company prior to a realization. So what I'd say is that this isn't kind of a one-off event.

Yes. Just to highlight, Oracle is doing well generating cash flow, and they're dividending that cash flow out as equity distributions. And ultimately, we will continue to operate that company until we deem it an appropriate market environment to sell into, which probably be -- well, it will be in the future. We don't know what the date would be.

And we will take our next question from Robert Dodd with Raymond James.

On the portfolio today and kind of the outlook and thank you for telling on that. I mean right now, I guess, what, sponsor is about 2/3 now and nonsponsor about 1/3. Obviously, that has not been the kind of historic mix and you gave some color on what the mandated deals are in Q3. But I mean, would you expect, I guess, that to come down over time and when obviously nonsponsors' deals take longer to structure. But I mean any color on whether is that -- if that is a permanent shift in the mix, sponsor, nonsponsored or just a timing kind of issue in a very active market?

I would say that broadly, while it will vary quarter-to-quarter in terms of new originations, our portfolio is likely to stay about 2/3 sponsor and about 1/3 nonsponsor. The sponsor deals are harder to find, harder to underwrite, more frequently on the nonsponsor deals, the underwriting doesn't support the credit. And even though we get mandates, we don't close on the deals. That happened on a couple of nonsponsor deals last quarter, frankly.

But we have a very healthy pipeline of nonsponsor deals in Q3. As I highlighted, I think of our 17 deal opportunities that are mandated, I think 9 of them are either new sponsor deals or -- sorry, either new nonsponsor deals or nonsponsor add-ons. So in any given quarter, it could be anywhere from 90-10 to 50-50 where sponsor makes up the larger number typically. But overall, we'd expect the portfolio to remain similar to where it is now.

Got it. Got it. On -- just to that point, I mean, you said -- I mean -- so you've got 17 mandated deals, roughly half sponsor. How -- you just said a couple of sponsor mandates kind of fell through last quarter.

Nonsponsor. Nonsponsor mandates fell through last quarter.

Nonsponsor. Sorry, nonsponsor. Yes. How confident are you I mean just looking at Q2, Q3, obviously, leverage going up and then leverage going back down again. I mean what would you say your comfort level is on being at that $700 million or so and 1.25x at year-end, given there are a lot of moving parts. Have you got higher confidence in originations than repayments, which are more difficult to predict or vice versa?

I have more confidence in Q3 because we're in the middle of it, and we have the mandated deals, and I can look at each of the deal names and sort of handicap the likelihood of them getting done. And I think our asset balances are likely to rise for our total asset portfolio to $700 million or greater in Q3. And then in Q4 we don't yet have visibility into originations. There's only one deal mandated right now that would be a Q4 close, and we know a lot of deals are repaying in Q4.

So we're going to need to look at the portfolio of pipeline deals, develop over the next 6 to 8 weeks to have more insight into Q4. But all I can tell you, historically, as I mentioned earlier, Q3 is the second slowest quarter. So with a Q3 this strong, absent is something happening in the marketplace, we'd expect a similarly strong Q4, and that would bode very well for the JV and the core BDC portfolio balances and set us up to, hopefully, comfortably earn our dividend unless there are other things that go on that we don't know about yet.

Understood. I appreciate that. One housekeeping quick one, if I can. The tax expense this quarter was a little bit elevated. Was that related to the dividend income? You mentioned that some Canadian tax considerations. I mean was -- and should we expect that excise tax to -- or that tax, not just excise tax, to pop up if there's increased dividend income or was it unrelated to that?

Robert, I think the way to think about it is, listen, with any year, when you look at our taxable income, which takes into account all the book tax timing differences. Ultimately, distributions are going to be paid out of taxable earnings. So when you put all that in a blender effectively, we currently estimate the earnings of the BDC to be excess -- in excess of our distributions at a slightly higher run rate than where we were earlier in the year or last year for that matter, based on not only kind of the investment income, but also some of the net gains that we're realizing this year. So as you're aware, year-to-date, we have a large realized gain from our realization. So that also came into play there.

(Operator Instructions) And we'll take our next question from Sarkis Sherbetchyan with B. Riley.

Just a quick question. If you expect second half '21 repayments to remain elevated, how does this impact the fee income expectations?

There should be either more prepayment penalties or more fee sweeps associated with faster repayments which all things being equal, will be accretive to NII. We saw that last quarter where fee suites and prepayment penalties helped us generate an NII number in excess of the dividend.

And we have no further questions on the line at this time. I will turn the call back over to management for any additional or closing remarks.

I appreciate everyone's time and attention today. As always, if there are questions that people would like to see addressed in future calls please alert us prior to the call so we can add that into the prepared remarks. And with that, I hope everybody has a good afternoon. Thank you.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.