Q3 2022 WhiteHorse Finance Inc Earnings Call
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Good afternoon. My name is Shelby and I will be your conference operator today at this time I would like to welcome everyone to the Whitehorse Finance third quarter 2022 earnings Conference call.
Our hosts for today's call are Stuart Aronson, Chief Executive Officer, and Joyce Thomas Chief Financial Officer.
Today's call is being recorded and will be made available for replay beginning at four o'clock P. M Eastern time.
The replay dial in number is.
Four zero to.
220 to 655.
No pass code is required.
At this time, all participants have been placed in a listen only mode and the floor will be opened for your questions. Following the presentation.
If you would like to ask a question at that time. Please press star one on your telephone keypad, if you wish to remove yourself from the queue Press star two and its now my pleasure to turn the floor over to Robert Barnburner of Frozen company. Please go ahead.
Thank you operator.
And thank you everyone for joining us today to discuss Whitehorse Finance third quarter 2022 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, maybe 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 can cause actual results could 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 2022 earnings presentation, which was posted to our website. This morning with that allow me to introduce Whitehorse finances, CEO Stuart Aronson Stuart you may begin.
Thank you Robert.
Good afternoon, and thank you all for joining today.
As Youre aware, we issued our press release this morning prior to market open and.
And I hope you've had a chance to review our results for the period ending September 32022, which can also be found on our website.
On today's call I will begin by addressing our third quarter results and the current market conditions.
They enjoy some Thomas our Chief Financial Officer, who will discuss our performance in greater detail after which we will open the call for questions.
This afternoon I'm pleased to report solid third quarter performance for 2022.
Q3, GAAP NII was $9 8 million or <unk> 42, a share.
Core NII after adjusting for $1 1 million capital gain incentive fee reversal was approximately $8 6 million or <unk> 37, <unk> per share and more than covered our quarterly dividend of <unk> 35, and a half cents per share.
<unk> per share at the end of the Q3 was $14 76.
Presenting a 19% decrease from prior quarter.
This decline was primarily the result of mark to market reductions rather than any actual losses on investments.
Mark on our portfolio reflect market pricing that as adjusted due to disruptions in the debt markets.
Turning to our portfolio activity for the quarter.
Gross capital deployments in Q3 totaled $39 5 million of this amount $26 1 million was funded into three new originations and the remaining $13 4 million was funded into seven add ons to existing portfolio investments. In addition to the add ons there were zero point $6 million and net fundings made on <unk>.
All of our commitments.
During Q3 total repayments and sales were $36 3 million, primarily driven by three complete realizations. These largely offset the bdc's origination activity, leading to net deployments of $3 8 million for the quarter.
With originations slightly outpacing repayments net effective leveraged increased 2122 times at the end of Q3 as compared with $1. One eight times at the end of Q2.
At this level, let this leverage level, we remained slightly below our target range of $1 25 to $1 35.
As I shared on the last call. So long as our portfolio remains heavily concentrated in first lien loans, which have lower risk, but also lower returns than second lien loans. We expect to continue to run the BDC at up to 135 times leverage in order to help the BDC earn its $35.05 dividend each quarter.
Which we have Oh, and we've consistently distributed the dividend since our IPO.
Regarding the three realizations, we earned $16 3 million, including interest and fees, which generated an aggregated IRR of 12, 1%.
On the $48 1 million of aggregate capital invested into these first lien deals. This attractive return for senior secured loans demonstrates the power of our sourcing model and the lower mid market.
Confirms our diligent and conservative selection process and highlights our ability to negotiate tight covenants and strong call protections.
Third quarter realizations included Mills fleet.
Mostly pharm Nelson worldwide and Maxi transfers blocker Corp.
Following these repayments the BDC had nearly $35 million of investment capacity, thus far in the fourth quarter. There have been three four realizations.
Fourth quarter realizations included $30 million in proceeds from three portfolio companies and these realizations generated $1 7 million in prepayment penalties.
Given the change in marketplace pricing, which I will discuss shortly we believe that repayment of historical investments may allow whitehorse to redeploy capital into higher yielding investments.
Of our three new originations in Q3, all were sponsor deals with an average leverage of four three times.
Which is relatively modest when compared to other lenders in the marketplace.
I note that all of these deals were first lien loans and had an average expected all in rate of nine 4% with an effective yield of 12%, which was higher than the Q2 portfolio average at.
At the end of Q3 96, 8% of our portfolio was first lien and 100% with senior secured.
With that in mind, I'll now step back to bring our entire investment portfolio and to focus.
After $7 5 million in net mark to market decreases <unk> 2 million in realized gains and $1 million of accretion.
Fair value of our investment portfolio was $764 6 million at the end of the third quarter down marginally from $766 5 billion at the end of Q2.
The weighted average effective yield on our investments was 11, 4% as of the end of the third quarter, which reflects a 150 basis point increase from Q2 level of nine 9%.
The increase was primarily driven by a rise in the portfolio's base rate as a result of rising LIBOR and sulfur rates.
Transitioning to the Crs, Ohio joint venture, we continue to continue to utilize our JV successfully the joint venture generated investment income to the BDC of approximately $3 8 million in Q3 as compared with $3 million in Q2.
This increase was driven by higher interest and dividend income from the JV in Q3.
As of September 30th.
Fair market value of the JV portfolio.
Was $289 million and at the end of Q3, the Jv's portfolio had an average unlevered yield of 10, 1% above Q2s average of eight 7%.
The increase in Unlevered yield is primarily due again to rising base rates of LIBOR in Cyprus sofa.
The JV produces annual average annual return on equity in the low teens to the BDC.
We believe white horses equity investment in the JV provides attractive returns for shareholders.
And is particularly relevant given the current market backdrop.
The Jv's return on equity, we are considering adding an additional commitment to $15 million to the JV as we seek to increase our exposure to this highly accretive earnings stream.
Returning to the Bdc's portfolio I am pleased to report that we continue to have no investments on non accrual status.
We had some markdowns in the portfolio as I mentioned earlier, but on average the portfolio was stable. Despite continued broad market volatility in Q3, our well diversified portfolio is weathering an economy experiencing a number of negative factors, including rising interest rates rising raw material prices.
Rising labor costs.
Across the portfolio revenues are up but we are seeing Margaret margin degradation on a couple of borrowers due to cost pressures.
Some of our borrowers are experiencing a slowdown in consumer demand, which has led to increases in leverage our portfolio remains mostly represented by non cyclical or like cyclical borrowers as we hold no direct exposure to oil and gas auto or restaurants, and very little exposure and construction sector.
Since we generally serve the lower mid market, we've been able to build a portfolio with conservative leverage profile by keeping our portfolio leverage low our portfolio companies are better able to cover their debt service in this rising interest rate environment.
Thus far rising interest rates have had only a modest impact on debt service coverage for our portfolio companies.
While the portfolio is holding up very well, we are keeping a careful eye on demand characteristics, especially in the consumer sector.
The modest leverage to which we underwrite our loans coupled with the fact that almost 100% of our debt portfolio is comprised of floating rate investments has allowed our portfolio to benefit from a rising interest rate environment.
We continue to monitor our portfolio companies' ability to service, our debt and with three month, LIBOR and sulfur contracts, having reset at the end of September we anticipate continued organic earnings accretion through year end.
Contrasts lenders with higher Levered portfolio companies may experience, a higher percentage of their borrowers borrowers facing much tighter debt service as interest rates continue to increase.
The market remains disrupted with lenders concerned about economic softness domestically and abroad. The credit market is largely reset to levels that one would expect to see in a downturn.
Deals for cyclical companies are no longer being underwritten at aggressive leverage levels and pricing for non cyclical assets have also seen an upward adjustment.
Within this environment the broadly syndicated market remains effectively shut for new issues. Nonetheless, there are residual credits there were underwritten and are being leaked out at significant discounts. We believe some of these provide attractive opportunities for making investments of larger non cyclical or marginally cyclical business.
As we diligently review these loans for suitability.
And with our deal flow pipeline at a record high remain highly selective and opportunistic about which credits we pursue.
Across the mid to lower end of the market segments. We are most focused on in addition to rising prices loans are being written to more conservative credit terms with tighter documentation and tighter covenants are.
Our primary lower mid market is still competitive with pricing more variable than the mid to upper mid market, while the risk return.
Is as good as I've seen really since 2015, we are approaching the environment with increased scrutiny and remain focused on credits with compelling risk return characteristics.
We are being cautious in the face of a weakening economy. Our base case assumptions are that we will see recessionary conditions in 2023 and 2024.
We want to ensure that the companies we invest in can weather the storm.
And our existing portfolio as I mentioned earlier, our investments are well positioned as they were underwritten at low leverage levels and Ken generally withstand even another 200 basis points of rate increases broadly speaking, we've already underwritten to an extreme downside scenario.
Our pipeline activity remains high and we have been selectively taking advantage of market conditions.
Whitehorse maintains its differentiated sourcing capabilities through our three tiered architecture.
Our pipeline has increased to approximately 200 deals for the first time, the BDC history, and we continue to derive significant advantages from the shared resources and affiliation with HIV, who is a leader in the mid market the.
The strength of the pipeline enables us to be meticulous in our deal selection.
And the current primary limiting factor for originations is the bdc's investing capacity.
As such and as I mentioned earlier, we are considering increasing our investment in the str's JV by $15 million.
Our strategy and competitive advantages continue to result in momentum in our originations business. Thus far in Q4. The company has closed five new deals and add on transactions and currently has visibility for 10 additional mandated new deals and add on transactions. Although there can be no assurance that any of these deals will close nor can.
There'd be assurance that the BDC will have capacity for these deals.
We anticipate utilizing the capacity provided by the repayments to continue to rotate into higher yielding assets that combined with portfolio growth and the potential for increasing our investment in the JV should ultimately lead to higher income and greater coverage of our dividend.
At the conclusion of the third quarter, we are cautiously optimistic for the first quarter and new year, while we remain concerned about cyclical industries and various economic headwinds. We believe we have built a very strong team and a solid sourcing and underwriting process.
With that I'll turn the call over to Joyce for additional performance details and a review of our portfolio composition.
Thanks, Stuart and thank you all for joining today's call during.
During the quarter, we recorded GAAP net investment income of $9 8 million or <unk> 42 per share. This.
This compares to $7 9 million or <unk> $33 <unk> per share in the second quarter.
Core NII was approximately $8 6 million or $37 <unk> per share after adjusting for $1 1 million capital gains incentive fee reversal.
This compares with Q2 core NII of $10 8 million or $33 <unk> per share and a quarterly distribution of $35 <unk> per share.
Q3 fee income decreased slightly quarter over quarter to <unk> 4 million from <unk> 7 million in Q2.
The decline was due to lower prepayment and amendment activities during the current quarter.
In the third quarter, we reported a net increase in net assets, resulting from operations of $3 8 million a decrease of $3 5 million when compared to Q2, which was driven by unrealized mark to market losses on the overall portfolio.
Our risk ratings during the quarter showed the 83, 5% of our portfolio positions carry either a one or two rating slightly lower than 84, 8% in the prior quarter.
As a reminder, a one rating indicates that the company has seen its risk of loss reduced relative to initial expectations.
Two rating indicates the company's performing according to your initial expectations.
Regarding the JV, specifically no new assets were transferred during the third quarter. However, subsequent to quarter end, we have transferred one new portfolio company already in Q4.
As of September 32022, the Jv's portfolio held positions in 28 portfolio companies with an aggregate fair value of $289 million compared to 32 portfolio companies at a fair value of $318 8 million as of the end of Q2.
The decrease in the number of portfolio companies quarter over quarter was a result of full realizations of positions in four portfolio companies during the third quarter.
The investment in the JV continues to be accretive to the Bdc's earnings.
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 and changes in asset yields in the underlying portfolio as well as the overall credit performance of the Jv's investment portfolio.
Turning to our balance sheet, we had cash resources of approximately $19 3 million at the end of Q3, including $9 4 million of restricted cash.
As of September 32022, the company's asset coverage ratio for Bart amounts as defined by the 940 Act was 178, 7%, 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 one to two times as compared to $1. One eight times in the prior quarter.
Before I conclude and open up the call to questions I'd like to highlight our distributions.
On August 10, 2022, we declared distribution for the quarter ended September 32020 to $35 <unk> per share to stockholders of record as of September 20 of them.
The dividend was paid on October 4th marking the companys 14th consecutive quarterly distribution. This speaks to both the consistent strength of the platform as well as our resilient deal sourcing capabilities and be able to create a well balanced portfolio generating consistent current income.
In addition to our quarterly distribution last month, we declared a special distribution of <unk> <unk> per share to be payable on December nine 2022 to stockholders of record as of October 31 2022.
Distribution was related to undistributed taxable income that was earned last year, which would have otherwise been taxable.
Finally, this morning, we announced that our board declared a fourth quarter distribution $35 five per share to be payable on January four 2023 to stockholders of record as of December 21, 2022.
This one month this will mark the company's 41 consecutive quarterly distribution since our IPO in December 2012, with all distributions consistent with the rate of $35.05 per share per quarter.
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 turn the call over to the operator for questions operator.
Thank you at this time, if you'd like to ask a question. Please press the star and one on your Touchtone phone.
You may remove yourself from the queue at any time by pressing star two.
Once again that is star one to ask a question, we'll pause for a moment to allow questions to queue.
And we'll take our first question from Bryce Rowe with B Riley.
Hi, Thanks, good afternoon.
Good afternoon, Bryce how are you.
Stuart.
Let's see one maybe I'll start on the dividend, obviously, great to see dividend coverage here in the third quarter, and what kind of project that with with base rates continuing to rise.
You will likely continue to turn to earn the dividend all else being equal.
Can you can you kind of talk about this.
How you think about.
Distributing any kind of excess dividend, our excess earnings above that $35 five right. If we do in fact see that.
See that emerge.
Yes price you've seen for the past three years, where we have.
Excess income that would be subject to taxation. We have made the decision we and the board has made the decision to distribute that income to shareholders with.
With rising interest rates there is an increased likelihood.
That we will in fact have earnings.
That would be.
Undistributed and subject to taxation.
Each year, we will carefully consider whether it makes sense to do a supplemental dividend.
As we did for the <unk> this year.
But that will be based on performance over the course of the year.
That's helpful. Thanks.
And then maybe just a question around credit and internal risk ratings.
Highlighted.
Essentially a stable portfolio, maybe a slight increase in what youre seeing.
And.
Three rated three rated credits.
So can you can you kind of walk us through what's happening within those particular companies.
And just to help us help us get some level of comfort with that with what's going on from a credit perspective. Thanks.
Yes, Bryce there is a clear slowdown in consumer demand and there is a equally clear slowdown in <unk>.
Retailers.
Restocking inventory.
We do believe that inventory levels got inflated.
During the latter half of the covered period.
Where people were not confident in supply chain and so we're getting as much stuff on their shelves as they could.
Retailers are now looking to deplete that inventory.
And so between.
Consumer softness and too much inventory on store shelves are consumer facing accounts have seen a.
Real and significant slowdown in demand.
Uniformly they all expect that as inventory levels get down to more appropriate levels.
The retailers will start a more normal ordering pattern again.
But we are very careful about what we're seeing in consumer demand.
We are not seeing.
Any particular slowdown in <unk>.
It is at the moment to consumer led slowdown based on the evidence that we're seeing in our portfolio.
But.
In general, where we have seen slowdowns in where they had been covenant defaults.
The owners of the company have been supportive of the company.
In the case of sponsor owned companies.
In every situation the owners who've been willing to support those companies as needed.
Cash or contingent equity.
That's great I'll jump back in queue and give others a chance. Thank you.
Thank you Bruce.
We'll take our next question from Erik Zwick with healthcare.
Good afternoon guys.
Good afternoon.
First question for me from the prepared comments I think you mentioned that you've had five new deals closed in <unk> and potentially 10 more.
And the works no guarantee that those will close or that you'll have capacity, but I guess my question is around kind of the second part of that comment.
Do you have any.
Investments that seem to be good for the portfolio have attractive underwriting and attractive yields how do you think about the potential too.
Either not close those and or take on.
Additional borrowings to potentially fund those I know youre kind of getting towards the top end of your targeted a range now, but just curious how you think about portfolio growth.
Going forward, maybe just in general, but also in a period of economic uncertainty like we are in now.
Yes.
<unk>.
Are very skeptical of the repayment pipeline.
So we are.
Trying to manage the portfolio so that we're not above the 135 times leverage.
That means we have about $35 million of capacity of.
Which we are thinking 15 million will be committed into the JV.
The JV will invest in assets that are priced at less than so for 700 for the most part.
The JV used to be focused on deals that were priced primarily.
So for $5 50 to 600 over the shifts in the market environment.
The yield on those assets is now going to be targeted more like 625 to $6 75.
In terms of the remaining 20, sorry $20 million of capacity on the BDC balance sheet.
We are reserving that for assets that are priced at so for 700 or above.
And we are regularly seeing so for 700 on assets that are.
Modest leverage.
50% or less LTV and first lien senior secured first lien. So just to give you a flavor for how much the markets have moved.
Back about a year ago second lien loans were yielding in the range of $6 50 to 750 <unk>.
And now we're able to book first lien loans with returns of 700 and put them on the balance sheet.
So we are very pleased that we did not jump into that overheated market a year ago.
Take on a lot of second lien assets at spreads that today would look very very unattractive.
I'll also mention that we are keeping our eyes open.
For good second lien investments in this market environment, where people are being more conservative.
On EBITDA adjustments more conservative on leverage levels more conservative on loan to value.
And we think this is the type of environment for a good non cyclical company.
Where it makes sense to book second lien loans. So while our portfolio is currently I think its 97% first lien.
And our pipeline candidly is majority first lean right now.
Would not be surprised over the next quarter or two if we were able to find a couple of good second lien investments in non cyclical companies that we thought presented compelling risk return for our investors.
That's great detail I really appreciate it.
And then just looking at your funding profile it looks like you have.
Some notes coming due in 2023.
Could you remind me I guess what month those come due and just your thoughts are on how you would replace those.
Eric those notes come roll off in August of next year.
$30 million of unsecured paper the way to think about it is we'll obviously be monitoring to see market environment, but in regards to the GPM credit facility that facility has capacity up to $335 million and so we can comfortably.
Replace that $30 million with the GPM facility and still be.
Within our one in the quarter to 135 times target profile.
Got it thank you and last one for me just in terms of the unrealized losses that you recorded in the quarter curious if you could split that between how much was market spread related versus company specific performance.
I don't have that split, but just working the numbers in my head.
It was largely I would say Stuart it was largely due to mark to market write I would've said one.
One third one third credit related and two thirds mark to market.
Sounds about right Jason.
Sorry, if I come back to you in terms of the breakdown between the two yes.
Okay. Okay. So it sounds like definitely more market spread versus company specific so that's helpful.
Yes, the mark to market spread was broad based whereas the company specific was only in a couple of accounts.
That makes sense. Thank you for taking my questions.
No problem. Thank you.
Once again, if you'd like to ask a question. Please press star and one on your Touchtone phone.
We'll take our next question from Melissa Wedel with JP Morgan.
Good afternoon, Thanks for taking my question.
And.
I'm not sure if I missed this one I know that you did talk about some of the activity to date.
With five new deals and then also expecting from realizations I believe did you quantify that in terms of dollars.
I don't think we did.
I don't have those numbers handy choice MDU.
Melissa in terms of the deals that we had originated in Q4.
They related to about three new deals and then several add ons right. So in terms of the total quantum.
What I'd say is it probably would have been.
No more than somewhere between 25% and $30 million.
And then as regards to the realizations. We had noted three exits during Q4 already.
And proceeds aggregated to $30 million with respect to that.
Okay.
Thank you I appreciate that clarification.
Yes.
And given your comments about the JV and seen opportunity.
With an additional transfer in fourth Q.
Potential additional investment $15 million.
And to that.
Baroness.
The growth that you've seen any income from that vehicle.
Sure.
Should sort of continue on that trajectory in the near term.
Yes, if we invest more in the JV and the assets going into the JV have higher yield both the existing assets and new assets.
The JV should continue to throw off.
Returns in the low to mid teens and.
Again this market environment is extremely attractive and historically deals that were priced at $6 50, or 60 75, we were putting on the BDC balance sheet.
But now based on the shift in the market, we're able to put those higher price deals in the JV and reserve the BDC balance sheet for deals that are priced at 700 or greater.
So when you take that in combination with the rising base rates we have.
A very.
Positive trend line in the core earnings of the BDC.
That could change of course always but right.
Right now the trend lines are very positive, which is not unique to us I think the <unk>.
C community broadly is benefiting from the higher spreads and the higher base rates.
That makes sense.
Just one last question from me are you seeing anything any.
Thanks.
Sort of metrics around payments.
Any borrowers.
Kind of edging towards that as things get a little bit tighter.
Thanks, so much.
Our problem Melissa.
As we reported.
Last year and for several years.
We've observed in the marketplace that a lot of people.
We're lending at leverage multiples of six to eight times EBITDA.
Off of adjusted Synergize the EBITDA.
And we thought not taking account of.
Cash flow multiples, so so EBITDA minus capex.
That we saw many deals.
Where we believed that the operating cash flow leverage.
Between 10% and 14 times.
With LIBOR and sulfur under 1%.
Those deals worked in terms of cash flows despite the very high cash flow leverage.
But with so far having increased 400 basis points LIBOR as well.
Our belief based on what we've seen because we've been shown some of those deals again.
Is that a lot of companies that were done at higher leverage.
Are now running into.
Trouble servicing their debt on an operating cash flow basis.
And we believe those companies are more likely to start having to pick.
Some of their payments.
We did not do.
Many or any of the deals at those high leverage levels.
And as a result, we are particularly well positioned compared to others, who did that.
To keep our deals on cash pay interest.
So.
For the vast majority of our accounts.
We continue to be cash pay on either.
All where the vast majority of.
The interest payments and again with average leverage.
In around four times on the deals that we've done.
Even with sulfur at 4% to 5% or even if silver goes up to 6%.
We believe the majority of our portfolio companies will continue to be able to pay cash interest to us and we will not have to resort to pack.
Thank you.
Thank you.
And it appears that we have no further questions at this time I will turn the program back over to our presenters for any additional or closing remarks.
Yes.
I appreciate everybody taking the time as always we are happy to provide as much transparency.
Into our portfolio and management as we can.
We invite shareholders or analysts to communicate with US ahead of these public earning calls.
Let us know what type of information you would like to see.
And we do make ourselves available to the analyst community.
To answer your questions outside of this call.
So again, thank you very much and we hope to Usher part.
<unk> performance in Q4.
Pending on what happens over.
The next couple of months. Thank you much.
Okay.
That concludes today's teleconference. Thank you for your participation you may now disconnect.
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