WhiteHorse Finance, Inc.
Q4 2020 Earnings Call Transcript

Published: 2 Mar 2021

[Operator:]

Good afternoon. My name is Laurie, and I will be your conference operator today. At this time, I'd like to welcome everyone to the WhiteHorse Financial Fourth Quarter 2020 Earnings Conference Call. Our hosts for today's call are Stuart Aronson, Chief Executive Officer; and Joyson Thomas, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 5

[Sean Silva:]

Thank you, Laurie, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's fourth quarter 2020 earnings results. Before we begin, I'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 fourth quarter 2020 earnings presentation, which was posted to our website this morning. With that, allow me to introduce Whitehorse Finance's CEO, Stuart Aronson. Stuart, you may begin.

[Stuart Aronson:]

Thank you, Sean. Good afternoon, and thank you for joining us today. I hope you and your families continue to be safe and healthy as we navigate these unprecedented times. As you're aware, we issued our press release this morning prior to market open and I hope you’ve had a chance to review our results, which are also available on our website. I'm going to start by addressing our fourth quarter results and market conditions and then Joyson Thomas our Chief Financial Officer will discuss our performance in more detail. Afterwards, we will open the floor for questions. 2020 was a year unlike any other but our business remained resilient and we finished the year stronger than ever. You heard me on last quarter's call say that we were seeing the strongest pipeline in our history and I am pleased to share that our team converted on those opportunities. Our fourth quarter origination volume set a new company record with more than $160 million in gross deployments allowing us to reach our target leverage level for the BDC. I am also pleased to share positive financial performance updates including core net interest income which was $0.348 after adjusting for a $0.3 million capital gains incentive fee accrual and GAAP net investment income for the quarter was $6.9 million or $0.335 a share. NAV was $15.23 at December 31, 2020, which excluding a $0.125 special dividend, NAV would increased to $15.35 an improvement of $0.04 compared to Q3. Our quarterly record for gross deployments included 16 deals totaling $159 million and five add-ons totaling $3.5 million, which was partially offset by repayments totaling $39.1 million. Our weighted average effective yield on income-producing investments remained flat at 9.9% and as I just shared, we reached our target leverage during the quarter of one and a quarter times.

[Joyson Thomas:]

Thanks Stuart and thank you all for joining today's call. During the quarter, we recorded GAAP net investment income of $6.9 million or $0.335 per share. This compares to $5.9 million or $0.289 per share during Q3. Core NII after adjusting for the capital gains incentive fee accrual was $0.348 per share. The capital gains incentive fee was accrued as a result of net gains in the portfolio during the quarter. Our investment in the STRS JV increased to $51.2 million after the effects of transferring four new deals and one add-on totaling $32.4 million.

[Operator:]

Our first question comes in line of Mickey Schleien of Ladenburg.

[Mickey Schleien:]

Stuart, now that vaccines are obviously rolling out at a nice pace and the numbers are coming down, I am curious to understand how you would characterize the opportunity to invest in segments that are more exposed to pandemics like COVID?

[Stuart Aronson:]

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

[Mickey Schleien:]

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

[Stuart Aronson:]

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

[Mickey Schleien:]

And in terms of that Stuart, what would trends, can you give us some sense of what trends you’ve seen in either borrower's average revenue and EBITDA and what is the average revenue and EBITDA of the portfolio?

[Stuart Aronson:]

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

[Operator:]

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

[Robert Dodd:]

Congratulations on the quarter. The first one kind of tied to your comments, relatively elevated prepayments to come may be say you'll run high leverage given the limited pipeline right now, how confident are you that the payments will appear like you can go above target leverage and then if the repayments don’t happen, you're sitting above target leverage for some indefinite period of time. So can you give us any color about how high you'll need to fun for how long and the confidence is that the repayment -- I mean obviously repayments will happen eventually but the confidence about how elevated leverage could be for how long and how you feel about that?

[Stuart Aronson:]

Yes Robert, I can tell you that we have information flows from our portfolio that a number of the companies that we lend to are either performing so strongly that they're going to get repriced in the marketplace. In some cases, they've already been repriced in the marketplace and those loans will repay because we're not going to chase pricing down. We also have a number of companies that are strong performers where the owners of the company might have sold them in 2020 if it hadn’t been for COVID and they've indicated to us that they had every intention of selling those companies in 2021. For the most part those are expected to be Q2, Q3 or Q4 events, but given the number of companies that are potentially for sale, we're not relying on any one or two of those sales to happen, but instead there's probably about 6 to 10 companies that are targeted for sale and we're pretty sure given the performance of some of those companies that they will transact if those repayments will happen. In the interim, we will run the BDC at leverage up to 1.5 times. So nothing too high or too edgy with an intention that the pay downs will take us from 1.5 times down back to 1.25 times. If we don't manage ahead of those repayments, then we will find ourselves below our target leverage and our ability to earn the dividend on a reliable basis that we're trying to get to will be compromised. So again, we've run the math and while there can be no assurances of what the dividend earnings will be or what the earnings on these shares will be at 1.25 leverage, we are much better positioned to be able to deliver at least $0.355 a quarter with prepayment penalties, waiver fees, amendments fees and accretion of early payoffs potentially generating incremental income to the BDC and as I shared in my prepared remarks, if we have incremental income at the end of the year in excess of what we've dividend it out, we will speak to the board about considering an additional special dividend both in 2021 and also in any year where we generate those excess earnings.

[Robert Dodd:]

The follow-on to that obviously is if you're running higher in the near term you have obviously you’ve got $20 million available on the revolver without it obviously says there's an accordion. Would you be looking to utilize the revolver to fund those more, the near-term leverage or should we expect more unsecured and congratulations again to 30% of the debt that were on schedule as well. Obviously the public markets were unsecured BDC that are pretty attractive, but what's going to be the debt strategy to fund those incremental investments if you do get up towards 150 leverage?

[Stuart Aronson:]

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

[Robert Dodd:]

Got it, I appreciate the answer. Thank you and congratulations on a very good 2020.

[Operator:]

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

[Unidentified Analyst:]

Certainly appreciate the comments on higher repayment activity in this environment. If you can maybe help us with the cadence of deployments or repayments through fiscal '21, do you think you'll be able to grow the book through '21 inclusive of the repayments?

[Stuart Aronson:]

Well we don't want to grow the book really anymore. We're 1.25 times leveraged. So asset deployment or total assets of around $700 million is the right number, but again we may take it out by $25 million to $50 million in the face of the coming repayments. Some of those repayments are already occurring in Q1, which is a good sign for fee income in Q1 and we have again visibility into a pattern of payments in Q2, Q3 and Q4, depending on the timing of sale of some of the companies that we're leading to. At the moment, we have a very strong pipeline for Q1. As I mentioned it's stronger than any other Q1 we've had before and our forward pipeline, not just the mandated deals, but our forward pipeline is as strong right now as it was prior to COVID. So we do believe that we're going to be able to keep pace with the repayments and we will be very careful about not getting leverage too high. Again we'll take it up to a maximum of 1.25 times as we stagger into the repayment schedule, that we expect to see in the rest of Q1 and Q2.

[Unidentified Analyst:]

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

[Stuart Aronson:]

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

[Operator:]

Your next question comes from the line of Melissa Liddell of JPMorgan.

[Melissa Liddell:]

Looking at the really robust activity in 4Q, I am wondering about the cadence of the both the originations of payments in 4Q and specifically whether or not there were any timing impacts to consider there? For example, did the -- put differently, did the portfolio benefit from a full quarter of earnings? I expect that's complicated, but can you give us some context around it?

[Stuart Aronson:]

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

[Melissa Liddell:]

And then on the repayment activity, was that fairly evenly distributed throughout the quarter or was that similarly queued in one direction or the other?

[Stuart Aronson:]

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

[Joyson Thomas:]

Yeah Melissa what it says the full exit Invesco happened shortly after Q3, so that was early in Q4. The remaining payments and sales part which spread out throughout the quarter.

[Melissa Liddell:]

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

[Stuart Aronson:]

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

[Operator:]

Your next question comes from the line of Chris Kotowski of Oppenheimer.

[Chris Kotowski:]

A most of mine were asked, but just I noticed the dividend income relatively high, was that -- is that just because of the joint venture is ramping up and then we should expect that to continue or is it just a one-off or unusual thing that happened?

[Stuart Aronson:]

Chris, that's correct. It's related to the early contribution from the JV.

[Chris Kotowski:]

Okay. So we shouldn't view this as necessarily as an extraordinary level.

[Stuart Aronson:]

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

[Chris Kotowski:]

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

[Stuart Aronson:]

I believe it pays it out all quarterly, is the right Joyson?

[Joyson Thomas:]

That's correctly. The intent is to distribute it currently on a quarterly basis.

[Operator:]

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

[Stuart Aronson:]

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

[Operator:]

Thank you for participating in the WhiteHorse Finance fourth quarter 2020 earnings conference call. You may now disconnect your lines and have a wonderful day.