WhiteHorse Finance's (WHF) CEO Stuart Aronson on Q1 2018 Results – Earnings Call Transcript

WhiteHorse Finance (NASDAQ:WHF) Q1 2018 Earnings Conference Call May 8, 2018 10:00 AM ET


Sean Silva – IR

Stuart Aronson – CEO

Edward Giordano – Interim CFO


Mickey Schleien – Ladenburg Thalmann

Chris Kotowski – Oppenheimer


Good morning. My name is Darla, and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance First Quarter 2018 Earnings Conference Call. Our hosts for today’s call are Stuart Aronson, Chief Executive Officer; and Ed Giordano, Interim Chief Financial Officer.

Today’s call is being recorded and will be available for replay beginning at 2:00 p.m. Eastern. The replay dial-in number is 404-537-3406 and the PIN number is 4386858. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Silva of Prosek Partners.

Sean Silva

Thank you, Darla, and thank you, everyone, for joining us today to discuss WhiteHorse Finance’s First Quarter 2018 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.

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

Stuart Aronson

Thanks, Sean. Good morning, and thank you for joining us today. As you’re aware, we issued our press release this morning prior to market open, and I hope you’ve had a chance to review our results, which are also available on our website. I’m going to take you through our first quarter operating performance, and then Ed will review our financial results, after which we will take your questions.

During the first quarter, we recorded net interest income of $0.418 per share, meaningfully surpassing our dividend of $0.355. We also recorded first quarter net asset value per share of $14.30, a $0.32 increase from the fourth quarter of 2017 and a $0.50 increase from the first quarter of 2017. Additionally, our weighted average effective yield increase from 12% from — to 12% from 11.9%. We had four new originations during the quarter totaling $54 million as well as refinancings on two existing positions, five of these six transactions were non-sponsor, and all were senior secured first lien loans, and all were directly originated.

Originations range between $9 million and $20 million, which is consistent with our target range of $4 million to $20 million, and the net leverage through the positions across all six transactions was only 2.80x, which is consistent with the historical low leverage multiples of non-sponsor loans we typically target. Further, the yield on these six transactions was 10.3%, demonstrating our ability to source attractive credits while still earning double-digit yields through our extensive HIG originations infrastructure. We also recorded total repayments in sales for the quarter of $33 million compared to $26.2 million recorded during the fourth quarter of 2017. This increase was primarily driven by full paydowns on Crowne Group of $12 million, Katun Corporation of $4.4 million and Project Time & Cost of $9.1 million. Together, these refinancing repayments, combined with waiver and amendment fees, were the primary drivers of nonrecurring fee income of $2.1 million for a total fee income during the quarter of $2.2 million.

Our Q1 fee income highlights the quarterly variation we can sometimes experience in our fee income as our total fee income for all of 2017 was $2.9 million. In non-sponsor lending, it is normal to earn waiver and amendment fees and prepayment penalties due to tighter covenants and stronger prepayment protections than one achieves in sponsor deals. That said, such fees vary from quarter-to-quarter, and given this variability in our fee income, our goal is to earn our dividend on an annual basis. With a strong Q1, we’re pleased to have progressed against that goal.

I’ll now turn to our investment portfolio. As of March 31, 2018, the fair value of the portfolio was $467.7 million compared to $440.7 million reported at the end of the fourth quarter. As of that same date, our loan portfolio consisted primarily of senior secured loans to lower mid-market borrowers that are variable-rate investments primarily indexed to LIBOR. The portfolio had an average investment size of $9.7 million based on fair value and the largest investment was $26.6 million. Within the portfolio, we held 48 positions against 34 companies. At the end of the first quarter, we deployed $20.1 million more than what was repaid, resulting in leverage of 63%. While this is still under our target range of 70% to 80%, depending on the conversion rate of the six mandated transactions in our Q2 pipeline, we could finish the quarter with a fully leveraged deployment in that 70% to 80% range. I’ll elaborate on our Q2 pipeline in a moment.

On the topic of leverage, today we announced that our Board of Directors approved the reduced asset coverage requirements proposed by the enactment of the Small Business Credit Availability Act in March of 2018, which reduces asset coverage requirements from 200% to 150%. We also recommended the shareholders vote in favor of the reduced asset coverage requirements at our upcoming 2018 Annual Shareholders Meeting. As a result, we expect these changes to take place on May 3, 2019, unless earlier approved by our shareholders. Based on management discussions, any increase in leverage for the rest of the year would be moderate, and our goal would be to accompany this increase in leverage with an increase in senior secured deals that we believe will perform through a potential cyclical downturn. I’ll now briefly touch on our positions in Aretec and Grupo HIMA.

Several media outlets during the quarter reported that Aretec is for sale. The mark on that asset has increased based on third-party bids for the equity. We are closely monitoring the situation, given its potential positive impact on our position. As shared last quarter, when WhiteHorse was able to convert equity positions into cash, we can redeploy that cash into investments which earn interest income, which helps create coverage for our dividend. In general, for every $2 million of cash we receive and invest in a 10% yield with leverage, we increase net interest income by approximately $0.01 per share on an annual basis.

Now regarding Grupo HIMA, we placed our second lien position on nonaccrual and net asset. However, at a position size of only $1 million, it is a small part of our portfolio. With that said, based on the leverage multiple and the cash flows on the transaction, we are optimistic that the $14 million of first lien debt in Grupo HIMA will have a full recovery.

Turning to our pipeline; during the second quarter we have already closed on two transactions: one sponsor deal and one non-sponsor deal, both are directly originated and both are senior secured, first lien loans. We also have mandates on four additional transactions, and as always, these transactions are subject to due diligence, and we do not know how many will actually close. More broadly, our originations pipeline is more robust than it’s ever been. We are currently evaluating over 100 deals, but we’re also turning down more deals than ever before, which speaks to our diligence and discipline. We pursue companies with limited cyclicality, high free cash flow conversion and no binary outcome risk. We also subject all our companies through a recession analysis, where we only make the loan if we believe that 100% of our money can be recovered in a down cycle.

Further, our direct sourcing model enables us to uncover off-the-run transactions in a lower mid-market, where there’s less competition to our local network of lawyers, accountants, wealth managers, boutique bankers, off-the-run sponsors and family offices. The ability to source so effectively speaks to the power of our three-tiered H.I.G. sourcing architecture, where we can be prudent and conservative in our credit assessment but ample in our canvassing for opportunities. We believe these factors to be a meaningful differentiator, which is validated by our results from this quarter.

Turning briefly now to our macro outlook, where general market conditions remain very aggressive. We have been shown a number of complicated syndicated credits that we thought deserved very significant pricing premiums that weren’t being accounted for in the market, so we’ve declined all of these opportunities. We believe that many market participants are undertaking higher risk by focusing on EBITDA instead of net cash flow by placing too much leverage on cyclical companies and by lending to companies that have too much binary outcome risk, such as customer concentrations or regulatory risk. We continue to avoid these types of risks in transactions that we evaluate. This reinforces the importance of the three Tier direct origination architecture at H.I.G., allowing WhiteHorse Finance to see a broad range of transactions without relying on large intermediaries.

WhiteHorse also benefits from the credit knowledge and insights that come from the 350-plus investment professionals across H.I.G., who are available to assist in the credit underwriting process. We access this cross-H. I.G. knowledge on virtually all the deals we underwrite.

With that, I will now turn the call over to Ed.

Edward Giordano

Thanks, Stuart. Starting with our first quarter results from operations. NII was $8.6 million for the quarter or $0.418 per share. This compares to $6.8 million or $0.331 per share in the prior quarter. Our investment income continues to consist primarily of recurring cash interest. We reported a net increase in net assets resulting from operations of approximately $13.9 million or $0.68 per share for the first quarter. As of March 2018, the net asset value was $293.5 million or $14.3 per share, up from $287 million or $13.98 per share, as reported for Q4. As it pertains to our portfolio and investment activity, the risk ratings on our portfolio remains mostly unchanged.

Turning to our balance sheet; we had cash resources of approximately $18.6 million as of March 31, 2018, including $6.6 million of restricted cash and approximately $45 million of undrawn capacity on our revolving credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of March 31, 2018. The company’s asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 258.7% at the end of the first quarter, well above our existing requirements under the statute of 200%. Our net effective debt-to-equity ratio, after adjusting for cash on hand, was 0.57x.

Last, I’d like to highlight our quarterly distribution. On March 12, we declared a distribution for the quarter ended March 31, 2018, of $0.355 per share for a total distribution of $7.3 million to stockholders of record as of March 31, 2018. The distribution was paid to stockholders on April 2. This marks the company’s 22nd distribution since our IPO in December 2012, with all distributions at the rate of $0.355 per share per quarter. We expect to be in a position to continue our regular distributions.

I will now turn the call over to the operator for your questions. Operator?

Question-and-Answer Session


[Operator Instructions] Your first question is from Mickey Schleien with Ladenburg.

Mickey Schleien

Perhaps you can remind us how your origination team provides you the opportunity to find these deals that have attracted risk-adjusted returns. And I’d also be interested in understanding how your underwriting differs between sponsored and unsponsored deals in terms of protecting your downside risk.

Stuart Aronson

We benefit from a very robust three tiered origination mechanism. It starts with the fact that we have 17 investment professionals who are spread out across 10 cities, physically located in 10 cities across the U.S. These investment professionals typically have 15 to 25 years of experience. To the extent they are sourcing non-sponsored transactions, these are people who generally were born in these communities, grew up in these communities, went to school in these communities and are socially active in these communities, which means they are tapped into the local business architecture. We have found that non-sponsor deals are best sourced not from big investment banks but instead from the people who entrepreneurs rely on for advice, and those people are the accountants, the wealth managers, the lawyers and the single shingle bankers that occur — that exist across these local communities in the U.S. So those are sort of the network that we seek to source from.

We also source from the smaller off-the-run sponsors that exist in these local communities across the U.S. These are typically sponsors that have fund sizes of less than $500 million or, in some cases, are working with non-dedicated funds. We also source from family offices. So 17 investment professionals in 10 cities directly originating. That is supplemented by 25 people in the H.I.G. business development group. That business development group serves all of H.I.G., with a team that is based mostly in Miami, that is doing telephonic sales into a database of over 21,000 names that H.I.G. has created. It’s a proprietary database that H.I.G. has created over its 25-year history. And that is a database of, again, lawyers, accountants, wealth managers, family offices, single shingle bankers, boutique bankers who exist across the U.S. in those smaller communities where we don’t have the physical presence. And then telephonic sales force is quite unique in the debt side of the lower mid-market to give us access into a network of potential deal sources that we believe, in many cases, no one else is talking to.

The third tier — so that’s Tier 2., the third tier of originations comes from the fact that H.I.G. has over 350 investment professionals, many of them focused on private equity. Those investment professionals are looking to source organic deal transaction situations, and they regularly run across entrepreneurs who are not ready to sell their companies but who need growth capital or capital to cash out minority shareholders or to make acquisitions, and those transactions are passed by our private equity professionals — H.I.G.’s private equity professionals over to our originations professionals for debt opportunities. So we have a massive architecture in the lower mid-market that reflects the fact that H.I.G. is, what we believe, the largest player in the lower mid-market that gives our BDC, we believe, unparalleled origination capability compared to anyone else in the market.

To the second part of your question on the risk underwriting. We don’t have direct insight into what other competitors are doing. But based on the transactions we see closing, that we are turning down the vast majority of, we do believe that we have a very differentiated risk process. It starts from the fact that there are 32 investment professionals in our business and we tap into. This is the WhiteHorse direct lending business so dedicated to doing just direct lending. And those 32 investment professionals bring their knowledge and wisdom to bear in the credit underwriting of transactions. We do organic forensic credit work on all the transactions that we do. That involves not only meeting and spending significant time with company management, but we do background checks, we read customer contracts, supplier contracts, we do forensic work on the financials of the company, and we, in addition to that, on every transaction we work on, subject the company to a downside case that typically looks like what the Great Recession looked like, with intention of understanding how we could recover all of our money in a downside case if that downside case looked like the Great Recession.

We do not believe that most credit shops in the market are exercising these rigorous due diligence processes. If they did, we think a lot of the deals that are getting done in the marketplace would not be getting done. And again, these are a lot of the deals that we are turning down. The other thing I mentioned on the call, we actively tap into the knowledge that extends beyond our 32 people. There are over 350 investment professionals in H.I.G. who have owned over 300 companies and have worked on and bid on thousands of companies. There’s an enormous amount of knowledge resident in the H.I.G. system that we tap into on virtually every transaction that we underwrite. So we speak to the private equity professionals, or we speak to the distressed debt professionals to understand the credits and the sectors and the risk that’s associated with those companies. That does cause us to decline a lot of transactions, but it gives us an awful lot of credit insight.

And then, I’ve spoken a lot, but the final thing I’ll share with you is that the investment committee for WhiteHorse Finance is a 10-person investment committee that includes the founders of H.I.G., Sami Mnaymneh and Toni Tamer. They bring the knowledge of the entire 25-year history of H.I.G. to bear in credit decisions. That credit committee, with 10 people on it, has over 280 years of experience, and we require unanimous consent of our credit committee to do a deal. So if 6 out of 10 people or 7 out of 10 people want to do the deal, but 2 or 3 or 4 don’t, that transaction does not get consummated. It is a unanimous consent process, which results in a very conservative credit philosophy applied to the transactions that are done in our BDC.

Mickey Schleien

And if I add just one more follow-up question. How do you define a mandated transaction?

Stuart Aronson

A mandated transaction is where a customer has executed a letter of intent with us, and a mandated transaction in the non-sponsor world typically would also involve a cash deposit has been made, which means that our expenses are being paid for by that customer as we work on doing the due diligence on the transaction. I’ll also mention, you didn’t ask directly, but it has come up with some others, we talk a lot about both non-sponsor and off-the-run sponsor. In our BDC, our ratio of non-sponsored transactions to sponsor transactions at the moment is about 66% non-sponsor and 34% sponsor; so we do both types of transactions.

But a majority of the things we do in our BDC are the non-sponsor transactions, which then gets reflected in the very low leverage multiples-type documents, strong covenants, that leads to the waiver and amendment fees that give us a quarter like the quarter we just experienced.


Your next question is from Chris Kotowski, Oppenheimer & Co.

Chris Kotowski

I realized it’s still very early days in the higher-leverage limits that are available to the industry now. And I was just wondering, what would your approach to that be? I know you said near term, you’re staying with the 70% to 80% guideline, but — target range. But in the longer run, are you thinking about opening the box to other kinds of investments, more liquid traded credit? Or do you plan to stay close to your knitting with a kind of lower middle market, non-sponsor and sponsor transactions that you’ve been doing in the last five, six years?

Stuart Aronson

Chris, my opinion is that in the current market environment, the liquid traded transactions offer less risk return value than the directly originated transaction situations that we are bringing to the BDC. There is a lot less competition when you directly originate. And as a result, we are originating and have always originated low-leverage transactions that have double-digit yields. At the moment, we have not seen an ability to get that good a risk return out of the syndicated market. Now it is, of course, possible that at any point in time, there will be a retrenchment in that market. And in that moment in time, opportunities could arise where it would be a good move for our shareholders to have us take advantage of either short-term or medium-term situations in the syndicated market. So we could and would do that, but we’re not doing it at the moment. All the transactions that we have closed, all the transactions that are mandated and the vast majority of transactions in our broad pipeline are directly originated credits.

As regard to your leverage question, we’ve just demonstrated in this quarter that we can comfortably earn our dividend or more. At some point, Aretec, hopefully, will be sold as is rumored, hopefully it will be sold at a price that’s consistent with what the market is indicating, and that will result in a very positive cash outcome for the BDC. We will then have additional cash that we can both invest and leverage, that will provide even more support for our ability to earn the dividend on a comfortable basis. And it’s really coming off of all of that, that we will enjoy the flexibility to use increased leverage as appropriate, with the ongoing stated goal being that we want to earn the dividend of the BDC on an annual basis and protect and grow NAV. And if we can do that in a safe manner, by booking more first lien senior secured assets and changing the ratio of first lien to second lien to be more towards first lien, if those opportunities arise, that could be a very good outcome for the BDC, and we would take some higher leverage.

But as I shared in our comments, at least for the balance of the year, the — any increase in leverage, we would expect to be modest.

Chris Kotowski

And then I know you’re limited in what you can say on such things. But you indicated confidence in a full recovery on the Grupo HIMA senior loan. And I’m wondering, is that based on — is there anything you can share there in terms of, like, the EBITDA coverage through those senior loan or asset values? Or what’s that confidence based on, if you can say?

Stuart Aronson

I can’t share specific numbers for reasons of confidentiality. I can tell you that the leverage multiple through the senior debt, in our opinion, is well inside of the franchise value of the business operation, which is a mission-critical hospital system in Puerto Rico. And we do believe, even though we have marked it down in conservatism, we do believe that, that ultimately has a good likelihood of being a part of recovery. That said, we try to consistently apply conservative mark-to-market values and notwithstanding our belief that, that will be a part of recovery. Given the noise around the situation in Puerto Rico, we have marked down very significantly the second lien loan that we think has a risk of real impairment.

And we’ve also marked down the first lien loan, which, if it does have a full recovery, obviously has an upside that will occur at that time.


[Operator Instructions] Your next question is from George [ph] with Deutsche Bank.

Unidentified Analyst

In the prepared remarks, you had mentioned two transactions that have closed subsequent to March 31. Can you disclose the size of those transactions?

Stuart Aronson

I don’t mind doing that. I don’t have the numbers in front of me. I’m going to see if Ed has those numbers that are handy for him.

Edward Giordano

$12.7 million on the first one and $15.6 million on the second.

Unidentified Analyst

And do you have a sense for any — you may not disclose this, any repayment activity subsequent to 3/31?

Stuart Aronson

Again, Ed, are we able to share anything that has repaid already since the end of the quarter?

Edward Giordano

We had — we’ve had one so far — I’m sorry, two so far. They are Pay-O-Matic and Pre-Paid Legal.

Stuart Aronson

Do you have the dollar amounts on those?

Edward Giordano

$11.8 million and $19 million of phase [ph].

Unidentified Analyst

And just broadly, with regard to any credit-related issues that you may be looking at year-to-date in the portfolio, do you continue to review it? Or is it largely in line with what it was like at the beginning of the year?

Stuart Aronson

We are always reviewing the credits in the portfolio. And again, we try to take a very realistic and conservative view to the marks on our assets. And therefore, I would say, wherever you see any type of credit stress as in Grupo HIMA, you see the assets are then marked that way, and our risk ratings reflect that as well. But overall, our portfolio is performing well. And other than that $1 million loan on HIMA, everything we have is on accrual.


And there are no further questions at this time.

Stuart Aronson

Great. Thank you very much. I appreciate everybody’s attention, and we will talk to you next quarter.


This concludes the WhiteHorse Finance First Quarter 2018 Earnings Conference Call. You may now disconnect.

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