WhiteHorse Finance, Inc.

Good morning. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to the White Horse Finance Third Quarter 2024 Earnings Conference Call. Our hosts for today's call are Stuart Aronson, Chief Executive Officer, and Joyce and Thomas, Chief Financial Officer. Today's call is being recorded and will be made available for replay beginning at 4 p.m. Eastern Time. The replay dial-in number is 402-220-6085. No passcode is required. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, please press star 2. It is now my pleasure to turn the floor over to Robert Ringberg of Rosen Company. Please go ahead.

Thank you, Jamie, and thank you, everyone, for joining us today to discuss Whitehorse Finance's third quarter 2024 earnings results. Before we begin, I'd 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 third quarter 2024 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, Rob. Good morning, everybody, and thank you all for joining us today. As you're aware, we issued our earnings this morning prior to market open, and I hope you've had a chance to review our results for the period ending September 30th, 2024. which can also be found on our website. On today's call, I will begin by addressing our third quarter results and current market conditions. Joyce and Thomas, our chief financial officer, will then discuss our performance in greater detail, after which we will open the floor for questions. Our results for the third quarter of 2024 were disappointing, as our investment portfolio declined this quarter due to net realized and unrealized losses, which impacted our financial performance. Q3 gap net investment income in core NII was $9.2 million, or $0.394 per share, which exceeded our quarterly base dividend of $0.385 per share and was slightly below Q2 gap in core NII of $9.3 million, or $0.40 per share. NAV per share at the end of Q3 was $1,277, representing a 5.1% decrease from the prior quarter. NAV per share was impacted by net markdowns on our portfolio, totaling 15.9 million, the majority of which related to markdowns on American Crafts and Honors Holdings, which I will discuss shortly. Turning to our portfolio activity in Q3, we had gross capital deployments of 51 million, which was partially offset by total repayments and sales of 30.2 million, resulting in net deployments of 20.8 million. Gross capital deployments of 51 million consisted of seven new originations, totaling $49 million, with the remaining 2 million used to fund four add-ons to existing investments. Of our seven new originations in Q3, three were non-sponsor and four were sponsor deals, with the average leverage of approximately 4.13 times debt to EBITDA. All of our Q3 deals were first lien loans, with an average spread of 575 basis points. and an average all-in rate of 10.8% compared to 11.8% in the second quarter of 2024. During the quarter, the BDC transferred three new deals and one add-on to the STRS-JV. At the end of Q3, the STRS-JV total portfolio had an aggregate fair value of $309.8 million and an average unleveraged yield of 11.7% compared to 12.3% in Q2. Leverage for the JV at the end of Q3 was 0.97 times compared with 1.08 times at the end of the prior quarter. We continue to utilize the STRS-JV successfully and believe Whitehorse's equity investment in the JV continues to provide attractive returns for our shareholders. At the end of Q3, 99% of our debt portfolio was first lien, senior, secured, and our portfolio mix was approximately 63% sponsor and 37% non-sponsor. In Q3, total repayments and sales were $30.2 million, primarily driven by two complete realizations and one partial repayment and one partial sale. After the effects of deployments, repayments, and STRS-JV transfers, as well as $15.9 million in net mark-to-market decreases and the $1.3 million of accretion, the total value of our investment portfolio was $654.3 million. This compares to our portfolio's fair value of $660 million at the end of the previous quarter. The weighted average effective yield on our income-producing debt investments was 13.1% at the end of Q3 compared to approximately 13.8% in the second quarter of 2024 and 13.6% in the third quarter of 2023. Transitioning to the BDC's portfolio, the challenges in this quarter generally do not relate to the overall economy, but rather are more company-specific. We are working with experts within HIG to optimize the outcomes of workout accounts. The balance of the portfolio is generally stable. During the quarter, we took a $6.6 million write-down on American crafts, and are currently seeking to either restructure or sell the company. The company's previously challenged performance was further impacted by the loss of a material customer in the quarter. While we continue to execute improvement initiatives, we believe we have the asset marked consistent where it might be sold to a strategic player. We also took a $5 million write-down on honors holdings, reflecting continued challenging industry conditions with a slowdown across many fitness concepts reflected in ongoing weak customer trends. We had previously placed the company on non-accrual status in the second quarter. We continue to work with the franchisor of the company to restructure the honors holding credit and to try to ultimately improve the company's performance. And we, as the lender, have taken control of this credit. At the end of the third quarter, we also placed Telestream on non-accrual status, which resulted in a $0.9 million write-down. We recognized approximately 557,000 of income from the credit in Q3, while reversing our approximately 300,000 in accrued interest. While the company continues to generate significant EBITDA, we are focused on restructuring Telestream, and our current expectation is that part of the loan will be back on accrual status within two quarters, and hopefully even sooner. Non-accrual investments totaled 5.6% of the total debt portfolio compared with the prior quarter of 3.6% of the total debt portfolio. Turning to the lending market in general, conditions across all sponsor segments remain very aggressive. There continues to be a shortage of new quality deal flow, and what is in the market is at very thin pricing. We've seen middle market pricing compressed down to spreads of SOFR 475 to SOFR 525, and lower mid-market spreads moved to approximately SOFR 475 to SOFR 575. From our perspective, we believe there is excessive leverage on a lot of credits that have cyclicality, and we are not participating in those transactions. There's a more attractive backdrop in the non-sponsor market, where the market continues to support leverage of only three to four and a half times, and pricing tends to be between SOFR 600 to SOFR 800. We are redoubling our efforts to focus on the non-sponsor market where there is better risk return in many cases and much less competition than what we are seeing in the on-the-run sponsor market. In the on-the-run sponsor market, we see generally very aggressive terms and therefore focusing more on the off-the-run sponsor market and the non-sponsor market. Fourth quarter volume is likely to be modest compared to other fourth quarters. Generally, supply and demand is out of balance with lender stretching too far for the better credits. For example, what we see on many of the better credits is the leverage is often so high that the cash flows are not greater than a 1.0 fixed charge coverage level. More broadly, while we continue to think there will be some declines in interest rates, we are also concerned that we could have government budgets that could put pressure on inflation based on the current policies of our new elected president. So we do not necessarily believe SOFR will come down as far as the yield curve indicates, which is probably good news for the BDC, but it means we're being careful on debt service coverages. We have also continued to see some softening in the economy based on interest rates having been high over the last several years. Subsequent to quarter end, the BDC closed one new investment and a few add-ons to existing credits, totaling approximately $7.5 million, and has had repayments of approximately $21 million, including three full realizations. The JV in the third quarter had repayments for three investments for approximately $35 million, following net repayment activity in Q3, and pro forma for several transactions in early Q4, and the special distribution we announced in October, the BDC balance sheet has approximately 45 million capacity for new assets. The JV has approximately 90 million of capacity, supplementing the BDC's existing capacity. Given the decline in pricing, we continue to expect repayment activity to remain high for the balance of this year and into 2025. While volume is lighter than we'd like it to be in all market segments, our pipeline is still at about 185 deals. We currently have seven new mandates, and are working on four add-ons to existing deals. While there can be no assurance that any of these deals will close, all of these credits would fit into the BDC or RJV should we elect to transact. With that, I'll turn the call over to Joycen for additional performance details and a review of our portfolio composition. Joycen?

Thanks, Stuart, and thank you, everyone, for joining today's call. During the quarter, we recorded GAAP net investment income and core NII of $9.2 million, or 39.4 cents per share. This compares with Q2 GAAP NII and core NII of $9.3 million each, or 40.5 cents per share, as well as our previously declared quarterly distribution of 38.5 cents per share. Q3 fee income was lower quarter over quarter at approximately $0.3 million, compared with $0.4 million from the prior quarter. Q3 amounts were primarily comprised of prepayment and amendment fees. For the quarter, we reported a net decrease in net assets resulting from operations of 6.9 million. Our risk ratings during the quarter show that approximately 75.1% of our portfolio positions either carried a 1 or 2 rating, slightly higher than the 74.4% reported in the prior quarter. As a reminder, a 1 rating indicates that a company has seen its risk of loss reduce relative to initial expectations. and a 2 rating indicates the company is performing according to such initial expectations. Regarding the JV specifically, we continue to grow our investment. As Stuart had mentioned earlier, in the third quarter, we transferred three new deals and one add-on to the SGRS JV, totaling $15.1 million. As of September 30, 2024, the JV's portfolio held positions in 38 portfolio companies with an aggregate fair value of approximately $309.8 million, compared to 38 portfolio companies at an aggregate fair value of $324.8 million as of June 30, 2024. The investment in the JV continues to be accretive to the BDC's earnings, generating a mid-teens return on equity. During Q3, total investment income recognized for more investments in the JV aggregated to approximately $4 million during the quarter, which compares with approximately $3.9 million in Q2. As we have noted in prior calls, the yield on our investment in the JV may fluctuate period over period as a result of a number of factors, including the timing and amount of additional capital investments, the changes in asset yields in the underlying portfolio, as well as the overall credit performance of the GAB's investment portfolio. Turning to our balance sheet now, we had cash resources of approximately 20.7 million at the end of Q3, including 9.5 million in restricted cash, excuse me, 9.5 million in restricted cash, and approximately 173 million of undrawn capacity available under a revolving credit facility. As of December 30, 2024, the company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 183.4%, which was above the minimum asset coverage ratio of 150%. Our Q3 net effective debt-to-equity ratio, after adjusting for cash on hand, was approximately 1.13 times, compared with 1.09 times from the prior quarter. Before I conclude and open up the call to questions, I'd again like to highlight our distributions. This morning, we announced that our board declared a fourth quarter distribution of 38.5 cents per share, which is consistent with the prior quarter. The upcoming regular distribution, the 49th consecutive quarterly distribution paid since our IPO in December 2012, with all distributions at or above a rate of 35.5 cents per share per quarter, will be payable on January 3rd, 2025. The stockholders record has a December 20th, 2024. In addition to our quarterly distribution, we elected to declare a special distribution of 24.5 cents per share for SOC holds a record as of October 31st, 2024. The distribution will be payable on December 10th, 2024. Pro forma for this special distribution, we estimate our spillback income to be approximately 26.8 million. As we said previously, we will continue to evaluate our quarterly distribution both in the near and medium term based on the core earnings power of our portfolio. in addition to other relevant factors that may warrant consideration. With that, I'll now turn the call over to the operator for your questions. Operator?

Thank you. At this time, if you would like to ask a question, please press star 1 on your telephone keypad. You may remove yourself from the queue at any time by pressing star 2. Once again, that is star 1 to signal for a question and star 2 to remove yourself. We will pause for just a moment to assemble the question queue. We'll take our first question from Melissa Weddle with JP Morgan. Please go ahead.

Good morning. Thanks for taking my questions. I wanted to follow up. Hi. Wanted to follow up on your comments about the deal environment and specifically you mentioned that this fourth quarter may not be as robust as typically seen. in that seasonally busy quarter, though repayments are expected to be elevated. I think you said in the coming quarters. It sounds like we should be thinking about modest portfolio deleveraging over the next few quarters. Is that, am I hearing you correctly there?

I would tell you that based on the mandates that we have, without clarity as to whether they'll all close, If most of them do close, they should match up in balance with any repayment activity that we currently see. So I don't see leverage getting lower. That said, we have a lot of undeployed capacity, both on the BDC balance sheet, which is targeted for assets priced at so for 600 and greater, and on the JV where there's 90 million of capacity. Those are for assets that are priced under SOFR 600, which would typically be the sponsor deals in today's market. And I'm not sure given the relative balance of deal volume that we're going to be able to deploy much of that excess capacity here in Q4. But I don't think based on what we see right now that we would have shrinkage of portfolio size, I would personally estimate based on current volume stability.

I appreciate that. I know it's difficult to estimate that with any degree of accuracy really looking ahead. I understand there are a lot of moving parts. I think one of the second question, you know, there's been a lot of focus on you know, the quality of investment income across the industry and the percentage of PIC income in particular as a function of total revenue. You know, when you look across the portfolio, we've seen sort of a gradual increase over time over the last four quarters, maybe in PIC income as a percentage of total revenue. And just want to understand how you're thinking about that, how it informs new deals that you put on the balance sheet. and how you manage any investments that are opting for PIC income and what that means for value marks or engagement with management. Thank you.

Yes. As it regards new deals, we generally seek either 100% cash income or the vast majority being cash income. As an example, the Westinghouse deal that we put in a couple of quarters ago had a little bit of PIC, but it was still for 550 cash. plus 100 basis points a pick. Most of the pick that we have in portfolio relates to troubled accounts that we're looking to turn around. And we try to be very realistic. If we are picking interest, but a company is moving in the wrong direction, and the likelihood of collecting that interest is in debt, we take the asset on the non-accrual as we did with Telestream. As I highlighted in my prepared remarks, TeleStream still has a significant amount of EBITDA, but the amount of EBITDA is not supportive of the current debt load. So the lenders are likely to take over that credit, restructure the debt, and most of that debt or the debt, either all or most of the debt that would come back onto the balance sheet would come on as cash pay debt would be our expectation. or at least it would be cash pay debt within a quarter or two.

Thank you. Once again, ladies and gentlemen, that is star one. If you would like to signal for a question, we'll hear next from Robert Dodd with Raymond James.

Hi, guys. You gave us the spillover number. I wrote down 26, but I think I might have written down the wrong number. Can you repeat what...

That is Robert 26.8 million pro forma for this.

Yeah, got it. Got it. Thank you. Then, then, I mean, still your, your comments about how, how aggressive the market is. Um, I mean, talking about deals being done at origination for, for, for middle market, low market companies at fixed charge coverage ratios below one. I mean, How long do you think that competitive environment can sustain itself? I mean, is it that the U.S. is just betting on growth? Underlining on those kind of terms seems somewhat problematic.

Yeah, I mean, Melissa's point about pick interest in general really gets to that point, Robert, where people are structuring deals that have the ability to pick part or all of the coupon of the deal in order to accommodate the fact that the cash flows of the company can't service the debt load. I would say, yes, you're right, that people are predicting growth. which is one of the ways that they'll dig themselves out of the less than 106 charge coverage hole. But more than that, people are very much expecting SOFR to decline. Candidly, we are, as I highlighted, more skeptical of the yield curve right now, given what we understand to be pressures that are likely to be on the economy that will be reinflationary. That's not to say we don't think there'll be some more small cuts from the Fed in the near term, but we are skeptical that a year to two years from now, SOFR is as low as the yield curve is indicating. And I would say that the move in the 10-year treasuries yesterday was an indication that the market is starting to see some of the same things that we are seeing. We are sticking to our knitting. The catch-22 is on the stronger non-cyclical credits, the leverage levels and fixed charge coverage levels are very challenged. On the more cyclical credits, the leverage levels are obviously lower, but we get very nervous putting more than three and a half or four times leverage on a cyclical credit. And the market at the moment is, in many cases, well in excess of that. So we have turned down, walked away from or lost a lot of deals in the market right now because we just think people, it's not so much a price issue because we don't think we're going to walk away from a good deal based on price. But it is the fact that people are putting anywhere from a half a turn to, in some cases, a turn and a half too much leverage on credits. And that's why we've redoubled our efforts in the non-sponsor sector, where leverage is much lower. And we hope to book a higher ratio of non-sponsor deals while the markets remain this aggressive.

Thank you for that, Colin. Very helpful. One more if I can. On American Crafts, your historic track record has been to try and stay with a troubled credit long term and work it out, turn it around, and hopefully get a full recovery. Sounds like American Crafts obviously lost a material customer, but it sounds like you've taken another look at that credit and decided that's not a viable strategy and a sooner exit might be might be better. So, I mean, is it just the change of, I mean, just the loss of the material customer? Is there something else that's changed there in terms of your decision-making of maybe not sticking with it and working it out further versus a quick sale?

Yeah, Robert, you're exactly right. We have a very strong crack record of taking over credits and turning them around and getting to full recovery. When we had to take over American Crafts because it ran into liquidity problems, we did inject additional capital into the company to bring the trade current and to get products shipped and to increase our fill rates. But given the challenges the company was facing, which we were addressing, the loss of the major customer took the revenue base of the company down low enough that we don't see a path for a real recovery of that company as a standalone entity. And it would take an injection of more capital into the company to have a shot to turn it around. And at this point, we don't think that that would be money that would be well invested. So we are exploring a sale of the company. to strategic players who are the logical ones to own it, given that we don't think the company is going to be able to be significantly profitable on a standalone basis. So it is not consistent with our history of successful turnarounds. This would be, unfortunately, a failed turnaround. And that is why I characterized the NAV for the quarter as disappointing. And we are very disappointed. And we are on other accounts, including Telestream, Honors, working very hard to turn those around and get to what we've done historically, which is not only getting our money back, but getting a gain on many of these credits that we have to take control of. And we do work with HIG private equity resources to make sure that we execute on management changes, cost cuts, and revenue growth opportunities on those turnaround accounts.

Got it. Thank you.

We'll turn now to Bryce Rowe with B. Reilly. Please go ahead.

Good morning, Bryce. Hi there. How are you, Stuart? Doing well.

Good.

Hey, I wanted to ask about your comment around redoubling on the non-sponsor effort. And you guys have talked quite a bit about over the years, you know, the resources you have, you know, across the country on within different markets to drive deal flow. When you talk about redoubling, I mean, what exactly does that mean?

It means that we have regular dialogue with our originators and our 12 regional locations. James Rattling Leafs, Indicating to them that chasing on the run sponsor deals in today's market is likely to be low productivity. James Rattling Leafs, and asking them to work on developing more of the non sponsor opportunities that involves talking to CEOs CFOs deal brokers lawyers accountants wealth managers, in fact. in support of that non-sponsor marketing activity, I find myself in Denver this morning where I joined our new Denver originator last night for a non-sponsor origination effort that was targeted at about 35 or 40 deal professionals in this Denver market. And so things like that that I did last night, along with a number of efforts being taken by other members of the team have resulted in us doing a higher percentage of non-sponsored deals than we did in 2022 or 2023. So in a normal market environment, we see somewhere between 20% to 30% of our deals being non-sponsored. But in this market environment, any given quarter, 30% to 50% of our deals are non-sponsored.

And, I mean, if you look across, at least in the deck that you have here, pretty consistent, you know, two-thirds, one-third, you know, sponsored versus non-sponsored. Over time, you know, kind of assuming some of these competitive dynamics don't really shift, and certainly they likely will, but is there maybe a renewed effort to, you know, permanently take that non-sponsored level higher within the portfolio, especially thinking about the better pricing and better terms that you get with it?

Yes, I would say that is likely. At the moment, virtually all sponsored deals are priced below SOPR 600. So the sponsored deals that we're doing will almost all, not necessarily 100%, but almost all be targeted for the JV. And it will be primarily non-sponsored deals that will be going on to the BDC balance sheet. So if market conditions persist in their current manner, I would expect to see the ratio of non-sponsor deals on our portfolio rise over the next quarter to five quarters.

Okay. And, and one more for me in terms of that non-sponsor market, you know, who, who, who are you, what, what's the competitive dynamic like there? Are you running into other public BDCs or, you know, different, you know, I guess different, different capital providers?

If you get into the upper mid-market and large cap market on non-sponsor deals, you see a number of sponsor, historically sponsor-oriented players seeking volume because of how the markets are, and in some cases, underpricing those deals. But in the core mid-market and lower mid-market, where sourcing non-sponsor deals is a very organic and labor-intensive effort because the big banks don't intermediate those deals. We see very limited competition. There are other players who participate in the sponsor mid-market and lower mid-market. They include names like Comvest, MGG, and Goldman to name three. But there is no one competitor that we see consistently in that market. And a lot of the mid-market and lower mid-market non-sponsor deals that we work on, we are working on a negotiated basis without any direct competition on the transactions. That's not to say there's not a recognition of those clients as to what market pricing is, but there is again, very limited competition in the non-sponsor space for organic origination as compared to the sponsor space. In fact, I tell you there are 20 times more players in the sponsor space than there are in the non-sponsor space.

Okay. Last one for me, when we're looking at the yield compression for the quarter, it looks like 70 basis points, 7-0 basis points. Any sense for how to think about that spread compression versus interest rate or lower base rates, what the impact is?

Joseph Baeta, Supt of Schools, um lower base rates mean Joyce and you can confirm it, I think they were about 50 basis points of the 70 compression, but we are seeing a combination of lower base rates and lower spreads. Joseph Baeta, Supt of Schools, We on both our sponsor and non sponsor deals have during favorable market environments always seek to maximize our call protection, and so we typically get. at least two years of call protection on sponsor deals and three to four years of call protection on non-sponsor deals. And that has been protecting some of our higher spread deals in portfolio. But as time passes, you know, you've got an entire year now where market pricing has been lower. And so as those call protections either roll off or step down, we are going to see increased pressure to reprice deals to the current market level. And that market level is down 100 to 150 basis points from where it was in mid 2022 and mid 2023. That's not just for us. I believe that is true across the market, both sponsor and non-sponsor, where pricing has fallen more in the sponsor market. than it has in the non-sponsor market. And I believe that all of our competitors are dealing with a similar dynamic.

Yep.

Okay.

Appreciate all the commentary. Thank you.

Once again, ladies and gentlemen, that is star one on your telephone keypad if you'd like to signal for a question. And we will pause for just a moment. there are no further questions at this time ladies and gentlemen that will conclude our question and answer session and the white horse finance third quarter 2024 earnings call thank you for your participation you may disconnect your line at this time and have a wonderful rest of your