WhiteHorse Finance, Inc.

Good afternoon. My name is Lori, and I will be your conference operator today. At this time, I would like to welcome everyone to the Whitehorse Finance Fourth Quarter 2020 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 5 p.m. Eastern Time. The replay dial-in number is 404-537-3406, and the PIN number is 1860839. 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. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. If you should require operator assistance, please press star zero. We ask that you please pick up your handset to allow optimal sound quality. It is now my pleasure to turn the floor over to Sean Silva of Proceq Partners.

Thank you, Laurie, and thank you, everyone, for joining us today to discuss Whitehorse Finance's fourth quarter 2020 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 will refer them to the Whitehorse Finance Force Quarter 2020 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.

Thank you, Sean. Good afternoon, and thank you for joining us today. I hope you and your families continue to be safe and healthy. as we navigate these unprecedented times. 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 fourth quarter results and market conditions. Then Joyce and Thomas, our chief financial officer, will discuss our performance in more detail. Afterwards, we will open the floor for questions. 2020 was a year unlike any other, but our business remained resilient and we finished the year stronger than ever. You heard me on last quarter's call say that we were seeing the strongest pipeline in our history, and I'm pleased to share that our team converted on those opportunities. Our fourth quarter origination volume set a new company record with more than 160 million in gross deployments, allowing us to reach our targeted leverage level for the BDC. I'm also pleased to share positive financial performance updates, including core net interest income, which was $34.8 after adjusting for a $0.3 million capital gains incentive fee accrual, and GAAP net invested income for the quarter was $6.9 million, or $0.33 and a half cents a share. NAV was $15.23 at December 31, 2020. which excluding a 12 and a half cent special dividend, NAV would have increased to 1535, an improvement of four cents compared to Q3. Our quarterly record for gross deployments included 16 deals totaling 159 million and five add-ons totaling three and a half million, which was partially offset by repayments totaling 39.1 million. Our weighted average effective yield on income producing investments remained flat at 9.9%. And as I just shared, we reached our target leverage during the quarter of one and a quarter times. Our performance this quarter was driven by three factors. First, we benefited from a gradually recovering environment where average leverage was conservative, but pricing was higher than pre-COVID levels. Second, we made a deliberate effort to reach our target leverage level of one and a quarter times with premium price deals while maintaining our historical underwriting standards. And third, we continue to effectively use our JV to position the BDC to deliver improved earnings. On this third point, we transferred four new deals and one add-on into our JV during Q4, totaling $32.4 million. At quarter end, our JV held 20 positions with an aggregate fair value of $174.6 million. In Q1, the JV has continued to expand, as certain deals closed in Q4 have been contributed to the JV from the BDC. Based on the growth of the portfolio and the diversification of assets, the advance rate under the JV's revolving credit facility has continued to improve. As a result, the yield on the BDC's investment in the JV produced an average annualized return above 15% in Q4, which compares favorably with the underwritten levels on a fully ramped basis due to declines in LIBOR over the last 18 months and its favorable impact on the borrowing costs of the JV. Regarding credit quality, our portfolio is generally improving, but our COVID-affected accounts, which are a small piece of our portfolio, will continue to be impacted until COVID is resolved. However, once conditions normalize on our COVID-impacted positions, there is the potential for significant potential for significant recovery on these assets. Turning now to our investment portfolio. At the end of the fourth quarter, the fair value of our investment portfolio increased to 691 million compared to 595 million at the end of Q3. This was driven by our record setting 162 million in gross deployments. The average debt leverage of the new deals we added was 3.9 times EBITDA. Repayments of $39.1 million partially offset the gross deployments. Fee income of $400,000 was slightly lower than the $700,000 we recorded last quarter. And as discussed on prior calls, fee income for the BDC varies from quarter to quarter based on amendment and prepayment fees. Non-accruals continue to show strong improvement representing just 1.8% of our debt portfolio This compares to 3.3% in Q3 and 7.4% in Q2. The sale of AG Kings was consummated during Q1 and this transaction is thus not reflected in our Q4 results. At the end of the fourth quarter, Kings accounted for 1.2% of our non-accruals at fair value and 1.3% at cost. On a pro forma basis, If you were to account for the exit of AG King's last out term loan position, our Q4 non-accruals would be reduced to only 0.6% of the debt portfolio at fair value. Lastly, in Q4, 96% of our debt portfolio loans were senior secured first lien and 58% of our portfolio was comprised of sponsor loans as compared to 94% and 52% in Q3 respectively. Looking ahead, our robust Q4 momentum has carried over into Q1, into the pipeline, which is stronger than it was at the same time last year. We currently have 11 mandated deals in our pipeline, eight of which are new originations and three are add-ons. Of the eight new originations in our pipeline, six are sponsor and two are non-sponsor. Within our three add-ons, two are sponsor and one is non-sponsor. As always, there can be no assurance that any of these mandated deals will close. A potential offset to this strong origination activity is that we have identified that over the next four quarters, we may experience a higher level of repayment than our portfolio's historical average. We're monitoring a number of these loans which have an increased likelihood of repayment. However, the good news is that our pipeline inflow is strong, and knowing that we have repayments coming, we will seek to prudently invest more capital, potentially operating at higher leverage than one and a quarter times on a temporary basis so that we can maintain the earnings power of the BDC. This potential higher leverage is purely anticipatory and does not change our long-term leverage target. Further, if increased repayment activity does materialize, we would expect a higher level of prepayment fees that will boost fee income and net interest income. As we look to deploy capital, I'll note that the broadly syndicated loan market is incredibly aggressive right now and unattractive to us. The on-the-run sponsor market is almost back to pre-COVID levels in terms of pricing and leverage and is moderately attractive. On the other hand, the non-sponsor and off-the-run sponsor businesses which we focus on remain above pre-COVID levels with pricing 50 to 75 basis points higher and leverage between a quarter turn to a half a turn lower, as evidenced by our Q4 statistics. Before turning the call to Joyce, I'll provide a few company updates. First, as was publicly reported, in December, funds affiliated with the HIG Capital agreed to sell their collective ownership interests in Whitehorse Finance to HIG Bayside Loan Opportunity Fund IV, another LP affiliated with and managed by HIG Capital. This share transfer was executed because the legacy Bayside funds were reaching the end of their terms. Since Q1 of 2019, the funds affiliated with HIG Capital, Whitehorse Finance's largest shareholder, have sold over half of their position in Whitehorse Finance to the public markets, reducing their holdings from 51.25% of shares outstanding to 23.67% as of December 31st, 2020. While the share transfer does not preclude the fund from selling additional shares of Whitehorse Finance into the public markets in the future, there is no timing pressure to do so as this new fund has at least three to five years of remaining life. Second, I hope that our results in my commentary illustrate our commitment to seeking to cover our dividend on an ongoing basis. We're encouraged by our record-setting finish to the year as our three-tiered sourcing infrastructure was built for cyclicality and market downturns has flourished. We've heard our investors and analysts loud and clear that dividend coverage is critical. We believe that reaching our target leverage of one and a quarter times is an important milestone in achieving this goal. Additionally, we have declared special dividends at the end of both 2019 and 2020 And if fee income leads to earnings above the dividend level at the end of 2021, the Board of the BDC will continue whether another special dividend is warranted. We are entering 2021 with strong momentum. NII was strong and NAV adjusted for the special dividend increased. Robust new deal flow showed strong pricing and reasonable leverage. And almost our entire portfolio is first lien, which is rare for BDCs with a dividend yield as high as ours. We've increased asset deployment up to our target leverage, which will help us earn our dividend on a quarterly basis. Q4 was a record-breaking quarter for Originations, and while we cannot guarantee the pipeline activity, Q1 so far is shaping up to be our first best quarter ever. Despite this record activity, we have not sacrificed on credit quality, non-accruals are down, and our mix of sponsor and non-sponsor assets is still balanced. We have delivered these results amidst the year, with unprecedented challenges, speaks to our commitment to navigating this cycle and continuing to perform for our shareholders. We are pleased to be providing these types of updates to you. We look forward to continuing our dialogue and answering any questions. I'll turn the call now to Joycen, after which we will take your questions.

Thanks, Stuart, and thank you all for joining today's call. During the quarter, we recorded GAAP net investment income of $6.9 million, or 33.5 cents per share. This compares to $5.9 million, or $0.289 per share, during Q3. Core NII, after adjusting for the capital gains incentive fee accrual, was $0.348 per share. The capital gains incentive fee was accrued as a result of debt gains in the portfolio during the quarter. Our investment in the STRS-JV increased to $51.2 million after the effects of transferring four new deals and one add-on, totaling $32.4 million. As of December 31, 2020, we held 20 positions in the JV with an aggregate fair value of $174.6 million. Q4 fee income was approximately $0.4 million compared with $0.7 million in the prior quarter. We reported a net increase in net assets resulting from operations of $8.2 million. Our risk ratings during the quarter showed that 83.3% of our portfolio positions carried either a 1 or 2 rating. compared to 76.5% in Q3. 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 that the company's performing according to our initial expectations. Turning to our balance sheet, we had cash resources of approximately $15.9 million as of December 31st, 2020, including $7.9 million in restricted cash. During Q4, we exercised the first $35 million available under our accordion of our JPMorgan revolving credit facility. As of December 31st, we had approximately $20 million undrawn under our revolving credit facility, which excludes the remaining $65 million accordion under the revolver. As of December 31st, 2020, the company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 180.2%, which exceeds our requirement under the statute of 150%. Our Q4 net effective debt to equity ratio, after adjusting for cash on hand, was 1.2 times. During Q4, we successfully raised additional unsecured debt at attractive rates to support our growing pipeline. This was done through a private notes offering as discussed on our last call, as well as through a follow-on offering towards the end of the quarter. That original private notes offering, which closed on October 20th, was for an aggregate principal amount of $40 million of 5.375% unsecured notes maturing in 2025. In connection with his unsecured offering, on December 4th, we subsequently issued a follow-on offering totaling $20 million in aggregate principal amount of notes. The first set of notes was comprised of 10 million of 5.375% notes maturing in 2026, while the second set consisted of 10 million of 5.625% notes maturing in 2027. The proceeds from these issuances were used to repay outstanding balances on our revolving credit facility, as well as help facilitate the growth in our portfolio during the quarter. Looking at the composition of our debt capital resources after these offerings, unsecured debt now makes up approximately 30% of our total debt, excluding the unexercised accordion option under a revolving credit facility. Next, I'd like to highlight our distributions. On November 9th, we declared distribution for the quarter ended December 31st, 2020 of 35.5 cents per share for a total distribution of $7.3 million to stockholders of record as of December 21st, 2020. The dividend was paid on January 5th, 2021. This marks the company's 33rd consecutive quarterly distribution paid since our IPO in December 2012, with all distributions at the rate of 35.5 cents per share per quarter. Additionally, on December 10th, 2020, we paid a special distribution of 12.5 cents per share to stockholders of record as of October 30th, 2020. Finally, this morning we announced that our board declared our first quarter distribution of 35.5 cents per share to be payable on April 5, 2021, to stock hold as a record as of March 26, 2021. Consistent with Stuart's remarks earlier, our robust momentum has not only allowed us to reach our target leverage levels, but we believe it also better positions us for ongoing dividend coverage via higher deployment volumes. With that said, and as we've always done, we will continue to evaluate our quarterly distribution based on the core earnings power of the BDC's portfolio, in addition to other relevant factors that may warrant consideration. I will now turn the call back over to the operator for your questions. Operator?

Thank you. At this time, I would like to remind everyone, if you would like to ask a question, please press star to the number one on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. We ask that while posing your question that you please pick up your handset to allow optimal sound quality. Our first question comes from the line of Mickey Shlian of Lattenburg.

Good morning. I'm sorry. Good afternoon, Stuart and Joyce. Stuart. Hey, Mickey. Hi. Now that vaccines are obviously rolling out at a nice pace and the numbers are coming down, I'm curious to understand how you would characterize the opportunity to invest in segments that are more exposed to pandemics like COVID?

Mickey, we are taking a very conservative stance on that. We have done some investments in the medical sector that was impacted by COVID primarily in March, April, May, but we've seen those companies spring back strong and are performing for the most part even during this COVID period, as well as they did pre-COVID. But I would say any company that has significant COVID exposure, we're not interested in taking the variant risk or any other type of risk. So really what we're doing right now is underwriting non-cyclical businesses and businesses that we believe have either light or no COVID exposure.

Okay, I understand. And speaking of cyclical versus non-cyclical, we're starting to see meaningful wholesale price inflation. And I do understand that most of your portfolio is non-cyclical, but you must have some borrowers that are exposed to wholesale inflation. I'm curious how you think about their ability to pass on those price increases.

At the moment, we are seeing... people having reasonably strong pricing power and the performance of the majority of our accounts is either stable or upward. There is a small grouping of heavily COVID impacted accounts in areas like serving restaurants or fitness that continue to be heavily impacted. But companies that are exposed to the general economy outside of COVID, Mickey, are performing, frankly, very strongly.

And in terms of that, Stuart, what trends, can you give us some sense of what trends you've seen in your borrowers' average revenue and EBITDA, and what is the average revenue and EBITDA of the portfolio?

I don't have those numbers handy, but I can try to get that together and share it in the future with you, Mickey.

All right. Thank you, Stuart.

Our next question comes from the line of Robert Dodd of Raymond James.

Hi, guys. Congratulations on the quarter. The first one kind of ties to your comments, Stuart. I mean, relatively elevated prepayments to come, maybe, say you'll run higher leverage given a really good pipeline right now. How confident are you that the repayments will appear. You can go above target leverage and then if the repayments don't happen, you're sitting above target leverage for some indefinite period of time. So can you give us any color about how high you're willing to run for how long and what the confidence is that the repayment, I mean, obviously repayments will happen eventually, but the confidence about how elevated leverage could be for how long and how you feel about that.

Yes. Robert, I can tell you that we have information flows from our portfolio that a number of the companies that we lend to are either performing so strongly that they're going to get repriced in the marketplace. In some cases, they've already been repriced in the marketplace, and those loans will repay because we're not going to chase pricing down. We also have a number of companies that are strong performers where the owners of the company might have sold them in 2020 if it hadn't been for COVID, and they've indicated to us that they have every intention of selling those companies in 2021. For the most part, those are expected to be Q2, Q3, or Q4 events, but given the number of companies that are potentially for sale, we're not relying on any one or two of those sales to happen, but instead there's probably about six to ten companies that are targeted for sale, and we are pretty sure, given the performance of some of those companies, that they will transact and that those repayments will happen. In the interim, we will run the BDC at leverage up to one and a half times, so nothing too high or too edgy, with an intention that the paydowns will take us from one and a half times down back to one and a quarter times. If we don't manage ahead of those repayments, then we will find ourselves below our target leverage and our ability to earn the dividend on the reliable basis that we're trying to get to will be compromised. So again, we've run the math and while there can be no assurances of what the dividend earnings will be or what the earnings on the shares will be at one and a quarter leverage, we are much better positioned to be able to deliver at least 35 and a half cents a quarter with prepayment penalties, waiver fees, amendment fees, and accretion of early payoffs potentially generating incremental income to the BDC. And as I shared in my prepared remarks, if we have incremental income at the end of the year in excess of what was dividended out, we will speak to the Board about considering an additional special dividend both in 2021 and also in any year where we generate those excess earnings.

Thank you for that very thorough answer. I appreciate that a lot. The follow-on to that, obviously, is if you're running higher in the near term, you have, obviously, you've got $20 million available on the Revolver. Obviously, there's an accordion. Would you be looking to utilize the Revolver to fund those more near-term leverage, or should we expect... more unsecured and congratulations again to 30% of the debt stack being unsecured as well. You know, obviously the public markets for unsecured BDC debt are pretty attractive still. But what's going to be the debt strategy to fund those incremental investments if you do get up towards 150 leverage?

We view the unsecured market as being attractive at this moment, and if we had a need for incremental debt, we would very openly explore more unsecured debt to take our number up from 30 percent. But if that market is not attractive, our senior secured line is very attractive at LIBOR 250, and we would exercise the accordion as needed. But we have not made a decision yet as to whether we go unsecured or secured. But we have explored and been communicated to by the banking community as to what they could do on incremental unsecured debt. And the numbers that they're quoting us do sound very attractive.

Got it. I appreciate that answer. Thank you. And congratulations on a really good 2020.

Thank you so much, Robert. Have a great day.

Your next question comes from the line of of the Riley Securities.

Thank you for taking my question here. I certainly appreciate the comments on higher repayment activity in this environment. If you can maybe help us with the cadence of deployments or repayments through fiscal 21. Do you think you'll be able to grow the book through 21 inclusive of the repayments?

Well, we don't want to grow the book really anymore. We're at one and a quarter times leverage. So asset deployment or total assets of around 700 million is the right number. But again, we may take it up by 25 to 50 million in the face of the coming repayments. Some of those repayments are already occurring in Q1, which is a good sign for fee income in Q1. And we have, again, visibility into a pattern of payments in Q2, Q3, and Q4, depending on the timing of sale of some of the companies that we're lending to. At the moment, we have a very strong pipeline for Q1. As I mentioned, it's stronger than any other Q1 we've had before. And our forward pipeline, not just the mandated deals, but our forward pipeline is is as strong right now as it was prior to COVID. So we do believe that we're going to be able to keep pace with the repayments, and we will be very careful about not getting leverage too high. Again, we'll take it up to a maximum of one and a quarter times as we stagger into the repayment schedule that we expect to see in the rest of Q1 and Q2.

Thank you for that. Certainly helpful. And if I touch on the fee income that you expect for this year, you know, if I look at 2019, pretty healthy level of fee income there. And if I look at 2018, you know, about $5 million in fee income. I guess, where do you expect fee income to land, just kind of given the pipeline of repayment activity you're seeing?

It's too early to tell. Some of the deals that are getting sold It depends on which quarter they get sold in, in terms of what our prepayment penalty will be. I have one deal that's got to remain nameless at the moment, but it has a make-hole prepayment penalty, and the company may be sold very soon at an excellent price. And if that happened, our prepayment penalty would be, in that case, very large, or that sale of that company could get delayed, six months and then that prepayment penalty would be much lower. So, there's really no way of knowing exactly where that will come out other than the fact that the prepayments that we're getting in many cases will involve prepayment penalties and other cases will involve the acceleration of fee accretion and all of those things will be positive for NII. So, the rotation of the accounts is a positive earnings indicator but it's too early to tell exactly what those numbers will look like.

Understood. Thank you. I'll hop back into queue.

Our next question comes from the line of Melissa Liddell of J.P. Morgan.

Good morning, guys. Hi. Thanks for taking my questions this afternoon. Looking at the really robust activity in 4Q. I'm wondering about the cadence of both the originations and the repayments in 4Q, and specifically whether or not there were any timing impacts to consider there. For example, did the portfolio benefit from a full quarter of earnings? I suspect that's not the case, but can you give us some context around that?

Yeah, we did not benefit from a full quarter of earnings as is so often the case in a Q4. Most of the transactions close in the second half of the quarter and some number of the deals close in the last week or two of the quarter. So we have positioned ourselves with the Q4 volume to have very solid earnings in Q1 and going forward. but we only got a modest portion of the benefit of that in Q4.

Got it. And then, excuse me, on the repayment activity, was that fairly evenly distributed throughout the quarter, or was that similarly skewed one direction or the other?

Joycen, I'd need to lean on you to let me know. I don't remember when the payoffs during the quarter occurred.

Yeah, Melissa, what I'd say is the full exit in Vesco happened shortly after Q3, so that was early in Q4. The remaining payments and sales probably were just spread out throughout the quarter.

Okay. So as we think about the portfolio yield going forward, certainly note that that was flat sequentially. Is that consistent with sort of what you're seeing in terms of new deals and what could be rolling on?

So we had very strong pricing on our deals in Q4 as it regards first lien pricing. But as you'll note that the concentration of second lien deals in our portfolio has continued to contract. So the reduction of second lien assets has been offset by the higher pricing we're getting on the first lien assets. which is why our overall pricing is stable. As I've shared in prior calls, we really would like the BDC to be balanced about 85 percent first lien and 15 percent second lien. We just haven't been able to find second lien assets that fit our credit standards, so we've got an over concentration right now of first lien assets. Or said another way, the BDC is overall a safer and more stable portfolio, than we even expected to be in. But what we're seeing so far in Q2, sorry, Q1 is pricing in our non-sponsor and off the run sponsor is largely equivalent to what it was in Q4. Pricing in anything that's more on the run sponsor is down a little bit from Q4, down 25 or 50 basis points. But the deals that we're mandated on and the deals that we're trying to close are all priced anywhere between LIBOR 600 and LIBOR 1100. So pricing in general is holding up. And I'm hoping that our performance in Q1 will continue to keep pricing across the portfolio at least stable.

Got it. Thank you so much.

Once again, if you'd like to ask a question, please press star one. Your next question comes from the line of Chris Katowski of Oppenheimer.

Yeah, good afternoon. Hey, most of mine were asked, but I noticed the dividend income looked relatively high. Is that just because the joint venture is wrapping up and we should expect that to continue, or is it just a you know, a one-off or unusual thing that happened.

Joyston? Chris, that's correct. It's related to Ernie's contribution from the JV.

Okay, so we shouldn't view this as necessarily as an extraordinary level. That's correct. Okay.

The JV is doing very well and is functioning, frankly, a little better than even projected. where I think we indicated that the expected returns on the JV would be 12 to 15%. And right now the JV is operating at better than 15%. So as we continue to move forward to fill the JV, and we still have some room to grow that, that should have a incremental positive effect on earnings. And once again, try to set us up to be able to earn the dividend on a reliable basis quarter to quarter with upside.

All right. And is the JV able to retain any of its earnings or is it paying it all out on a quarterly basis?

I believe it pays it out all quarterly. Is that not right, Joyce?

No, that's correct. The intent is to distribute it currently on a quarterly basis. Okay. All right. Great.

That's it for me. Thank you. Thank you, Chris.

At this time, there are no further questions. I'll now return the call to management for any additional or closing comments.

Thank you, operator. I just want to highlight that we continue to be a highly credit-focused organization. We now have 20 originators in 12 locations across North America. We are directly originating a bespoke grouping of assets for the BDC and are utilizing the resources across HIG to optimize origination and optimize underwriting. We'll work very hard to earn the dividend on a reliable quarterly basis, and hopefully we will have earnings in excess of the dividend that will position us to be able to offer supplemental dividends at the discretion of the board in the future. So I appreciate everybody's time and look forward to speaking with you next quarter.

Thank you for participating in the Whitehorse Finance Fourth Quarter 2020 Earnings Conference Call. You may now disconnect your lines and have a wonderful day.