WhiteHorse Finance, Inc.

Good morning, 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 First Quarter 2021 Earnings Conference Call. Our hosts for today's call are Stuart Arson, Chief Executive Officer, and Joyston Thomas, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 5 o'clock p.m. Eastern. The repay dial-in number is 404-537-3406, and the PIN number is 428-7043. 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 telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you please pick up your headset to allow optimal sound quality. If you should require operator assistance, please press star zero. It is now my pleasure to turn the floor over to Sean Silva of Plastic Partners.

Thank you, Angela, and thank you, everyone, for joining us today to discuss Whitehorse Finance's first quarter 2021 earnings results. Thank you for your patience as we work through a minor technical issue that caused this brief delay. 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 first quarter 2021 earnings presentation, which was posted to our website this morning. With that, allow me to introduce Whitehorse Finance's CEO, Stuart Arrington. Stuart, you may begin.

Thank you, Sean. Good afternoon, everyone, 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 first quarter results and market conditions. Joyce and Thomas, our Chief Financial Officer, will then discuss our performance in more detail After which we will open the floor to questions. Our first quarter results were defined by an improving economic backdrop, supporting both COVID impacted and non-COVID impacted credits. This delivered some of the recovery in our portfolio, but also led to elevated repayments, both of which we had forecasted on prior calls. As a result, our outlook for 2021 remains unchanged. GAAP net investment income was $7.6 million, or 37 cents a share. Core net investment income was $7.7 million, or 37.5 cents per share. Covering our dividend, NAV was $15.27 per share compared to $15.23 per share in Q4. Gross deployments of $58 million were offset by repayments of $110 million. Our weighted average effective yield on income producing debt investments modestly decreased to 9.6% compared to 9.9% in Q4. Leverage at the end of Q1 was 1.1 times within our targeted range of one to one and a quarter times. Activity in our JV remained stable. At quarter end, the JV held 22 positions at a fair value of 174.6 million in Q4. I'm sorry. At quarter end, the JV held 22 positions with an aggregate fair value of 185.7 million compared to 20 positions at a fair value of 174.6 in Q4. The return to our BDC on our investment in the JV at the end of Q1 was 14.8%. We continue to believe that our JV is accretive to the BDC's earnings. Turning now to our investment portfolio, At the end of the first quarter, the fair value of our investment portfolio decreased to $617 million compared to $691 million at the end of Q4. Gross deployments of $58 million resulted from five new originations and a number of add-ons. Comparatively to first quarters and prior years, this year's Q1 origination level was stronger. Gross deployments were more than offset by $110 million of repayments, which is consistent with the projected outlook we provided during our last call. The timing of some of these transactions resulted in a higher Q1 repayment level than expected, but it does not change our overall projections for the year. Non-accruals represented 2.5% of our debt portfolio compared to 1.8% in Q4. We are disappointed to share that Group Ohima failed to make its interest payment during Q1. This Puerto Rican hospital company, like other hospital companies, is being impacted by COVID. As a result, we wrote off two months of current accrued interest previously recorded in Q4 and placed the first lien loan on non-accrual. This reversal had a negative impact of 1.4 cents to net interest income. We are actively engaged in restructuring negotiations with Group Ohima and will provide updates as they become available. Regarding our other non-accrual, We're pleased to report that subsequent to quarter end, Sure-Fit merged with Hollander Sleep Products. Both Sure-Fit and Hollander are owned by the same sponsor. As a result of this merger, our loan investment in Sure-Fit will be back on accrual in Q2 and all past due interest and fees have been paid. At the end of the first quarter, Sure-Fit had accounted for 0.8% of our non-accruals at fair value. After giving effect for Sure-Fit going back on accrual, On a pro forma basis, our Q1 non-accruals would have been only 1.7% of the debt portfolio at fair value. We are pleased that even with the markdown on HEMA, NAV was still up during Q1 as the rest of our COVID impacted accounts improved. We've seen emerging strength in our fitness concepts investments as the economy begins reopening. Our restaurant exposure, while a small part of our portfolio, has also improved. This account represents 1.8% of our debt portfolio as of March 31st, 2021. At the end of the first quarter, 85% of our debt portfolio is first lien, senior and secured. Sponsor loans comprise 65% of our portfolio compared to 58% in Q4. Also subsequent to quarter end, Honors Holding had a significant equity investment made by a PE firm which will provide additional equity cushion to our loan and will have a materially positive impact on the mark for honors in Q2. Looking ahead, our Q2 pipeline is strong. We already have 11 mandated deals, 10 of which are new originations. Of the 10 new originations in our pipeline, six are sponsor and four are non-sponsor. As always, there can be no assurance that any of these mandated deals will close. Turning to the market outlook, in Q1 we saw a notable increase in supply-demand imbalance in favor of borrowers. This was most true in the on-the-run sponsor market, which is right now comparatively less attractive than the off-the-run sponsor market and the non-sponsor market. Pricing and structures in the on-the-run sponsor market have returned to pre-COVID levels. But in the off-the-run sponsor market, there is still a slight premium on pricing to pre-COVID, and the same is true for the non-sponsor market. In closing, I'm encouraged by the directionally positive trends we're seeing in our business. The improving economic backdrop is benefiting our portfolio, and we have a healthy pipeline going into Q2. Many of our COVID-impacted credits are beginning to deliver the economic upside that we've been projecting on prior calls as the vaccine rollout program improves. This improving momentum brings particular significance to our three-tiered sourcing architecture, which is foundational to our strategy. It includes 24 deal professionals dedicated to origination in 12 locations across North America, a 20-plus person business development team leveraging HIG Capital's proprietary prospect database of over 21,000 names, and sourcing at the HIG level by over 400 investment professionals overall. As a result, we believe we are optimally positioned to capture the economic recovery in a way that benefits our business and our shareholders. With that, I'll turn the call to Joyson, after which we'll take your questions.

Thanks, Stuart, and thank you all for joining today's call. During the quarter, we recorded a gap net investment income of $7.6 million, or 37 cents per share. This compares to $6.9 million, or 33.5 cents per share, in Q4 2020. Core NII was 37.5 cents per share, which covered our quarterly dividend. Our investment in the STRS-JV increased by $4.3 million after the effects of transferring four new deals, totaling $28.9 million. As of March 31, 2021, we held 22 positions in the JV with an aggregate fair value of $185.7 million. Q1 fee income was approximately $0.8 million, compared with $0.4 million in the prior quarter. largely a result of prepayment fees collected from the elevated repayment levels during the quarter. We reported a net increase in net assets resulting from operations of $8.2 million. Our risk ratings during the quarter showed that 84.3% of our portfolio positions carried either a 1 or 2 rating, compared to 83.3% in Q4. Turning to our balance sheet, we had cash resources of approximately $24.5 million as of March 31, 2021, including $16.8 million in restricted cash. As of March 31st, we had approximately $70.4 million undrawn under our revolving credit facility. As of March 31st, 2021, the company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 192.6%. These are a requirement under the statute of 150%. Our Q1 net effective debt to equity ratio, after adjusting for cash on hand, was just above one times. Next, I'd like to highlight our distributions. On March 2, 2021, we declared distribution for the quarter ended March 31, 2021, 35.5 cents per share for a total distribution of $7.3 million to stockholders of record as of March 26. The dividend was paid on April 5, 2021. This marks the company's 34th consecutive quarterly distribution paid since our IPO in December 2012, with all distributions at the rate of 35.5 cents per share per quarter. Finally, this morning we announced that our board declared a second quarter distribution 35.5 cents per share to be payable on July 2, 2021 to stockholders of record as of June 18. Consistent with what we have said in prior quarters, 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. I'll now turn the call back over to the operator for your questions. Operator?

If you would like to ask a question at this time, please press star 1 on your telephone keypad. Your first question comes from the line of Robert Dodd with Raymond James. Please go ahead.

Hi, guys. So some moving parts. A question on Group Ohima, for example. that the 1.4 cent impact that looks about $300,000. Um, is that correct? That was reversed out of, um, interest income during, during Q1. That's correct. Got it. Um, then just on gripping him, obviously Puerto Rico, um, suffered another, uh, COVID spike, um, uh, earlier, um, and just a couple of months ago. Um, Do you have any expectation or belief that the failure to pay the coupon payment was related to that or other issues that have been ongoing at the business for a while?

We're led to understand that the vast majority of hospitals across the country and the world have been very heavily impacted by COVID-19. in terms of normal activity that would go on. And that has been true for Group OHIMA since COVID hit. And the company's liquidity, including support from the government, was not enough to bring the company through this period. So with great questions about what's going to be the timing of the recovery from COVID, and also questions around the levels of government support. We felt it was prudent, given that the company did not pay its interest to put the loan on non-accrual, and it'll stay there until and unless we get data that would suggest that the company would be able to service its debt properly. And at the moment, we're in active negotiations with the company around the potential for restructuring.

Got it. I appreciate that, Kala. And then just another one on the front, SureFit. You said back on accrual and is paid all past due interest. Will that be recognized as interest income in Q2, or is it going to get some other kind of special treatment like return of capital or anything like that?

Robert, that's correct. So now that we're current in Q2, all that back due interest that was received would be recorded as interest income in the Q2 period.

Got it. Thank you. And then just one more, if I can. Obviously, the repayments were very strong in Q1. If I look at your book, it looks like you may be continuing to expect a pretty high level of repayments. Obviously, you also have a lot of mandates already for Q2. So just You said your expectations for the year aren't really changed, but could you reiterate for us exactly what that expectation is in terms of do you expect the book at, say, the end of 21 to be above the size at the end of 20? Or can you give us any color on where you expect that relatively to be? Not quarter to quarter is hard to predict, but maybe by the end of the year you can give us some color.

Yeah, Robert, there are a good number of companies in our portfolio that are either currently in the market for sale or we believe will be coming to market in Q3 or Q4. So we have visibility into a number of accounts that are likely to repay, some of which have significant prepayment penalties that will be accreted to the BDC. What we can't predict is beyond what we have as our current pipeline, how many new deals we will win and how many new deals we will close, especially in Q3 and Q4, given that we're distant from those and don't have mandates for those quarters yet. So the goal is to be operating at about one and a quarter times leverage with about 700 million of assets. And it's just, not possible at the moment to know where we'll be at the end of the year, other than the fact that we have a very strong pipeline. As of this morning, there were 133 deals in pipeline, whereas prior to COVID, the norm was typically 100 to 120 deals. So we're above what our pre-COVID pipeline was. And if we can win our fair share of transactions, which we've historically done, that should position us to operate in the direction of the total leverage and asset picture that we want to be at.

Got it. I really appreciate that, Carla. Thank you.

Your next question is from the line of Sarkees Sherbert Cheyenne with B Reilly Securities. Please go ahead.

Hey, good morning, and thank you for taking my question here. Good morning. Last quarter, You mentioned one particular deal that had a large make-hole prepayment penalty. Did that sale occur in the first quarter or should we expect that yet to come?

We had deals that had prepayment penalties occur in Q1, but there is a transaction that has, as you correctly discussed it, a make-hole prepayment penalty that is currently expected to close in June. although, again, there can be no assurance that will occur. And so there is the possibility that we'll get a significant prepayment penalty on that transaction if the acquisition of the company is consummated by the end of the quarter.

Thanks for that. And, you know, in the last call, you mentioned, you know, potentially expecting the BDC to run at interim leverage of up to 1.5x, you know, given the elevated prepayment levels. And it sounds like the repays, the expectations there are continuing. So is that still the right way to think about it? And then as those repays come in, you'll kind of go back to your target leverage of 1.25 times, or should we think about that differently?

So there were more repayments in Q1 than we knew about on the last call, which have resulted in lower assets and lower leverage. We have visibility into Q2, Q3, and Q4 of companies that are intended to be sold. And so if we could originate enough business to take the leverage up above one and a quarter to up to one and a half times, we would do that in anticipation of the pay downs of these deals. That said, given the repayments that were above our expectations in Q1, the likelihood of getting above one and a quarter in the near future is low.

Thanks for that. One more for me. I'll hop back in the queue. You know, seeing the first leans kind of dominate the mix here. I think in prior calls, you were targeting more of an 85-15 mix there between first lean and seconds. Any comments or updates on kind of pricing and where you're finding more value for the portfolio or any changes to those longer term objectives?

Sure. The markets are aggressive, especially in the large cap and upper mid cap market. We have looked at a number of second lien loans, but have only found one that we've been willing to do so far. and of the 11 mandated transactions, one of them is in fact a second lien loan. As you know, our second lien loan portfolio has continued to shrink over several years now, and it's actually lower. The number and amount of second lien loans that we have is lower than our targeted level. So we do intend to bring in a second lien loan for $15 million. That loan is priced at LIBOR plus 900. and should be accretive to the portfolio. And we do in our pipeline that I mentioned of 133 deals, three of those 133 are second lien loans. So there's still some more second lien that we're working on, although the vast majority of our pipeline is first lien lending. Did that fully answer your question?

Yeah, that's very helpful. Thank you very much. I'll hop back in the queue. No problem.

Your next question is from the line of Melissa Waddell with JP Morgan. Please go ahead.

Good morning, guys. Thanks for taking my questions. I think first question for you would be about sort of expected portfolio yield trends. It did come down a bit quarter over quarter. And I'm wondering if that's related to you talked about the sponsor or certainly on the run sponsor deals. pricing pretty competitively. I've also noticed that the, I think in your slide, Doug, you had the share of sponsored deals increasing sort of over time. I'm wondering if that's related. Should we expect that to continue?

Non-sponsored deals price higher than sponsored deals, despite the fact that the non-sponsored deals generally have lower leverage. As I've shared with the market before and will reiterate, sourcing of non-sponsored deals is much tougher than sourcing of sponsor deals there's much less competition but it's hard to find those deals there's no centralized point you can go to to directly originate non-sponsored transactions our non-sponsored deals are typically levered only two and a half to four and a half times with an average more in the low to mid threes And most of our non-sponsored deals are priced at LIBOR 700 and above. Sometimes priced as high as 800, 900, or 1,000 over. A number of the repayments we took in Q1 were, in fact, non-sponsored repayments. And that's one of the reasons that you see the ratio of sponsored and non-sponsored deals shifting and the average yield shifting a bit as well. We work very, very hard to optimize and maximize our sourcing in the non-sponsor market. And as I mentioned, of the 10 new platforms that we have mandates for in the quarter, four of them are non-sponsor deals. So we continue to have a good participation from that piece of the market. But it would be directionally true that the more non-sponsored deals that we source, that will generate, in a normal scenario, a higher average return on the assets. And then the other thing, of course, that will help the average return on assets is if we successfully get our second lien concentration back in the range to 10% to 15% of the overall portfolio, which would be very modest and is much, much less than we were a couple years ago. You've seen our second lien concentration decrease markedly over time.

Okay, thanks for that. Second question is around the JV. How are you guys thinking about the sort of level and trajectory of dividend income from that vehicle? Thank you.

Our goal is to successfully deploy all the capital we have in the JV, which would be $75 million of junior capital from the BDC. The 14.8% is actually, I think, either at the high end of the range or above the high end of the range of what we projected for the JV IRR as evidenced by strong originations of well-priced deals. If we deploy the $75 million into the JV, we would actively consider, based on what we're seeing in the market, increasing the allocation to the JV by another $25 million because we do believe that that return at anywhere from 13% to 15% is very accretive to the BDC shareholders.

Okay. Thanks so much.

Have a good day, Melissa.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from the line of Chris Kotolsky with Oppenheimer. Please go ahead.

Yeah, good afternoon. Thank you. Most of mine have been asked, but it's kind of an interesting case study. I'm looking at the 8.16 million of net realized gains and, you know, 7.6 million of unrealized depreciation. And I'm wondering if that is related mainly to AG Kings. And if it is, it just seems to me, I've lost track of it a little bit, but it's, and the cost and the par have moved around over the last two years since it's been on Anacol. But it seems to me like that it kind of implies that you've got a more or less full recovery on that loan after having marked it. Is that the right way to read that?

I'll have Jason share them. Go ahead, Jason.

Yeah, no worries. So Chris, you're absolutely right there. That's the way to think about it. As you know, we last year had done a secondary trade to buy a portion of the debt at a deep discounted price. And as a result of that, The cost basis was lower than essentially what we had marked it at, and essentially the realization that occurred in the quarter was at that marked value. So the $7.5 million of unrealized losses really is from just the reversal of those unrealized gains that now have transferred over into realized gains, and then the additional amounts mainly related to sales that we had in barrel parent, also known as sink sort, during the quarter.

Okay. And it does pretty much imply a pretty complete recovery of your original loan, right?

Yes. We recovered more than our original principal amount, yes.

Correct. Great.

Okay.

All right. That's it for me. Thank you. No problem.

And I'm showing no further questions at this time. I would like to turn the call back to management for closing remarks.

I am pleased that things continue to go well at the BDC. We will continue to seek to give transparency to our investors. And I encourage investors or analysts who cover us to let us know prior to these calls any questions that you'd like to see addressed. And I hope everybody has a good day and a good week.

And this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect your line.