WhiteHorse Finance (NASDAQ:WHF)
Q2 2017 Earnings Conference Call
August 8, 2017 11:00 ET
Sean Silva – Investor Relations
Stuart Aronson – Chief Executive Officer
Ed Giordano – Chief Financial Officer
Rich Shane – JPMorgan
Bryce Rowe – Baird
Good morning. My name is Paula and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance Second Quarter 2017 Earnings Conference Call. Our hosts for today’s call are Stuart Aronson, Chief Executive Officer and Ed Giordano, Chief Financial Officer. Today’s call is being recorded and will be available for replay beginning at 2 p.m. Eastern. The replay dial-in number is 404-537-3406 and the PIN number is 55184882. [Operator Instructions]
It is now my pleasure to turn the floor over to Sean Silva of Prosek Partners.
Thank you, Paula and thank you everyone for joining us today to discuss WhiteHorse Finance’s second quarter 2017 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 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. During this call, we will discuss GAAP and non-GAAP financial measures for which reconciliation can be found in our press release, which is available on our website, www.whitehorsefinance.com.
With that, allow me to introduce WhiteHorse Finance’s CEO, Stuart Aronson. Stuart, you may begin.
Good morning. Thank you for joining us today. As you are aware, we issued our press release this morning prior to the market open and I hope you have had a chance to review our results, which are also available on our website. I am going to take you through our second quarter operating performance and then Ed will review our financial results, after which we will take your questions.
Our second quarter results were strong and showed a continued commitment to our strategy of growing and protecting NAV, diversifying our portfolio and covering our dividend on an annual basis. WhiteHorse Finance was able to generate net investment income for the quarter of $0.378 per share, $0.023 higher than our dividend of $0.355. In addition, NAV per share increased by $0.03 to $13.83, and our weighted average yield remains strong at 11.9%.
We continue to maintain a pipeline of very attractive, directly originated transactions, which should allow us to continue to invest our BDC in assets that we believe are better than the assets available in the broadly syndicated market. This past quarter, as we looked to expand our portfolio in the face of many new opportunities, we deemed it appropriate to add additional capacity by raising new equity, which we did at the end of the quarter. This equity raise was supported by the BDC manager so that there was no dilution to NAV associated with the offering. We are already active in seeking to put this new capital to work, details of which I will discuss in a moment. Going forward, even as BDC’s total capitalization is now higher, the amount I intend to hold per transaction in the BDC is not expected to change. As such, new originations are expected to range between $4 million and $20 million, and thus the new capital will allow us to further diversify the BDC’s asset mix.
At the time of the equity offering, we had several deal mandates in and developing deal mandates as well. Based on scheduled closings, we plan to invest approximately 80% of the equity raised in two transactions that are expected to close by the middle of August. Our goal is to deploy the majority of the total leveraged capital within 90 days of the offering. In the interim, the offering proceeds allowed us to pay down leverage from 79% immediately prior to the offering to 65% shortly thereafter.
I will now turn to the rest of our results for the quarter. For originations, we deployed $40.1 million of capital into three accounts, two of which were new and one of which was an increase to an existing account. All three of those loans were directly originated first lien, senior secured, low leverage, non-sponsor transactions. The first, Account Control Technology Holdings, is a California-based consumer AR collection company. This asset is a first lien secured term loan of $18.4 million with an effective yield of 10.6%.
The second transaction, JVMC Holdings, is a Chicago-based agricultural trading company. This transaction included a first lien, first out secured term loan of $13.5 million with an effective yield of 9.9% and a first lien, last out secured term loan of $5 million with an effective yield of 14%. Those loans directly reflect the power and depth of the H.I.G. WhiteHorse Finance sourcing model, which allows us to access attractive opportunities at low leverage, low LTV and high returns.
Turning now to repayments, during the quarter we received paybacks of roughly $35.5 million related to American Gaming Systems and Coastal Sober Living, which we have also in the past referred to as Origins. Our exit of American Gaming resulted from a downward re-pricing of that credit that we found to be unattractive. American Gaming was a broadly syndicated credit, and as we shared with our investors going forward, we are seeking to focus on proprietary originated assets instead of broadly syndicated assets. This is because we think that it’s a very difficult time to find attractive risk return in the broadly syndicated market.
I would like to spend a moment discussing Grupo HIMA, a portfolio company of the BDC where we hold $14.3 million of senior first lien loan and $1 million of second lien loan. Grupo HIMA, which is an owner and operator of hospitals in Puerto Rico, has come under pressure due to macro issues in that commonwealth. The lenders are working closely with management of the company to do what’s right for the business. First lien leverage remains reasonable at below 4x cash flow, and we have marked the first lien and second lien loans according to what we believe is a conservative valuation for those assets.
Turning now to our broader investment portfolio, as of June 30, 2017, the fair value of the portfolio was $437.9 million, which is above the $431.7 million reported at the end of the first quarter. As of that same date, our loan portfolio consisted primarily of senior secured loans to lower mid-market borrowers, which are variable rate investments primarily indexed to LIBOR. All loans in our lending portfolio continue to be on an accrual basis as of the end of the quarter. The portfolio had an average investment size of $11.2 million based on fair value, with the largest investment being $26.1 million. The portfolio’s weighted average effective yield stood at 11.9%. Within the portfolio, we held 39 positions across 30 companies. Immediately prior to the equity offering, the portfolio was effectively fully invested with leverage of 79%.
I would like to highlight that we have marked up the value of our equity position in Aretec Group, which has exhibited strong financial performance. We recognize that the equity of Aretec, because it has no cash yield, puts a drag on the BDC’s net investment income. That said, based on the performance of the company to date, it is the opinion of management that shareholders are best served if we keep that equity in our balance sheet at this time. We do hope that the equity position can be converted to investable cash in the next 12 to 24 months. Looking ahead during the third quarter, we hope to close no fewer than 3 new mandates, and the pipeline continues to reflect attractive, directly sourced opportunities. As shared in prior calls, we will seek to keep the ratio of first lien loans at over 50% of the BDC.
Turning now to our macro outlook, the markets continue to be aggressive, particularly the sponsor markets. As a result, our firm continues to focus on the smaller, less covered sponsors and on entrepreneur and family-owned borrowers trying to create a pipeline of attractive transactions. At this time, the majority of our current pipeline is in non-sponsored opportunities, focused on first lien loans at lower relative leverage ratios and LTVs of under 50%. As we close transactions and build our portfolio, we will endeavor to keep the BDC leverage at approximately 80%. Lastly, as always, management’s goal is to earn the dividend on an annual basis and protect and grow NAV.
With that, I will turn the call over to Ed.
Thanks, Stuart. Before I turn to our second quarter results, I’d like to note that during the quarter we amended the terms of an existing JPMorgan credit facility to, among other things, one, extend the reinvestment period and maturity date and two, amend and lower the interest rate spread applicable on outstanding borrowings to LIBOR plus 2.75. In connection with the credit facility, WhiteHorse Credit pledged securities with a fair value of approximately $379.6 million as of June 30, 2017 as collateral. The credit facility has a final maturity date of December 29, 2021. As of June 30, 2017, WhiteHorse had $162.3 million in outstanding borrowings and $37.7 million undrawn under the credit facility.
I will now summarize our financial highlights for the quarter. NII was $6.9 million for the quarter or $0.378 per share. This compares to $6.5 million or $0.356 per share in the prior quarter. Our investment income continues to consist primarily of recurring cash interests. We reported a net increase in net assets from operations of $7.3 million or $0.39 per share for the second quarter. As of June 30, 2017, net asset value was $283.8 million or $0.1383 per share, up from $252.5 million or $0.138 per share as reported for Q1.
Switching over to portfolio and investment activity, the risk ratings on our portfolio remain mostly unchanged. We continue to maintain a 3 rating on our energy holdings to reflect the current macroeconomic market conditions. As a reminder, we continue to have low exposure to the energy sector overall, with approximately 3% of our portfolio representing energy or energy-related investments.
Turning to our balance sheet, we had cash resources of approximately $43.7 million as of June 30, 2017, including $4 million of restricted cash and approximately $37.7 million of undrawn capacity under our revolving credit facility. We continue to closely monitor our asset coverage ratio and feel comfortable with our leverage as of June 30, 2017. The company’s asset coverage ratio for borrowed amounts as defined by the 1940 Act was 247.6% at the end of the second quarter, well above the statute’s requirement of 200%. Our net effective debt-to-equity ratio, after adjusting for cash on hand, was 0.52x.
Last, I’d like to highlight our quarterly distribution. On June 2, we declared a distribution for the quarter ended June 30, 2017, of $0.355 per share for a total distribution of $6.5 million to stockholders of record as of June 19, 2017. The distribution was paid to stockholders on July 6. This marks the company’s 19th 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’ll now turn the call to the operator for your questions. Operator?
[Operator Instructions] Your first question comes from Rich Shane of JPMorgan.
Hey, guys. Thanks for taking my questions this morning. One of the observations we have seen is that there seems to be in the private equity space a drift towards the larger sponsors in terms of being able to raise capital and new funds. I am curious how you are seeing that impact your business and what feedback you are getting from the smaller sponsors that you are working with?
The relative beauty of the smaller sponsor market, especially what I will call the less covered sponsors, is that you don’t have the industry titans beating down their door. And as a result, while there is competition in the sponsor market, you never get a noncompetitive deal. The competition is less and the behavior of the smaller sponsors is more what I’m going to term old-fashioned, where they do value reliability, they value insight, they generally capitalize their deals a little more favorably than what we see among the larger sponsors and we do, on all of those transactions, we work on getting covenants. So there is not an excess of business coming out of that market, to your point, but we are working on a solid number of smaller sponsor transactions at the moment and we do find those transactions to be lower leveraged, better capitalized and modestly better priced than what we see going on in the more populated mid-market space where there is more competition. So, the pipeline is solid. That said, as I mentioned, the majority of our pipeline at the moment continues to be non-sponsor deals and we are in most cases finding the non-sponsor transactions to have a more attractive risk reward than the sponsor transactions just based on the relative competition in that marketplace.
Got it. That makes sense. And again, I think the H.I.G. relationship there really gives you an advantage in finding those non-sponsored deals. I would like to just make sure we understand sort of the context of the pipeline. You talked about two deals that represent 80% of the proceeds. That’s about $25 million. You talked about being fully deployed on the capital, fully levered on the capital, target 90 days. That would suggest probably $50 million of originations. You also talked about three deals at least during the quarter and I am assuming sort of midpoint of the range for you guys, about $15 million. Are we looking $45 million, maybe $50 million of originations or fundings this quarter? Is that the target?
The goal would be that within 90 days of having raised the money, the majority of the money on a leveraged basis would be deployed, whether that would be, call it $45 million or $55 million, there is still too much uncertainty. I can tell you that two transactions are going through their closing process right now, which is why I feel comfortable publicly disclosing that we expect that to happen. And you are correct the actual amount that we are deploying into the BDC for those two transactions is $24 million. I also have other mandated transactions, but they are not in the closing process yet. And so I can’t have as high a degree of confidence on those. Frankly, it’s two transactions that are mandated. And then behind those two, there are two more that are very active. So we have visibility into getting the majority of the capital deployed, but again with the uncertainty that happens in a closing process, just too early to say whether that number is $40 million, $45 million, or $55 million. But I do feel comfortable that if things proceed as they are right now, it will be the majority deployed within 90 days.
Got it. And then one last question, given any potential repayments you are comfortable with that sort of target leverage within roughly 90 days? And again, I realize things slip and all of the variables, but when you are talking about that target leverage, you are accounting for any expected repayments?
Yes, I am. The beauty of having a directly originated portfolio where you are in direct dialogue with the borrowers and the management teams is that there is normally pretty good visibility to a refinancing process. That’s not to say there are situations that arise where you get surprised, but we believe we have a pretty good optic. There is very little syndicated credit left in our BDC portfolio and those are the ones that tend to be less predictable. So, we are doing our very best to keep track of what the likelihood is of repayments and we work very diligently to try to time the redeployment of capital to be fairly shortly after repayment would occur. And at the moment, based on the information we have our goal would be to be as I mentioned around an 80% leverage ratio, if not 90 days after the raising of the new equity as soon as possible after that. Again, I should highlight we will not do a deal just to get deployed. We will only do the deal if we think the risk return is a good balance for our shareholders, but we have a very good pipeline right now and I do feel optimistic that we will get well deployed over that 90-day period.
Great. Thank you for taking all my questions this morning.
No problem. Thank you, Rich.
Your next question comes from Bryce Rowe of Baird.
Hi, good morning. Thanks for taking the questions Stuart and Ed. I wanted to just maybe follow-up on the transactions here that are expected to close in mid-August, you guys have laid out well the benefits of the directly originated investments, I am curious what you are seeing from a kind of pricing perspective, are you able to maintain the level of pricing you have in the portfolio or at least the level you have seen with recent investments with these two and then with those that are in the pipeline? Thanks.
My general observation would break into sponsor market versus non-sponsor market. There is no question that pricing is lower overall in the sponsor market, but that’s always been true, to be honest with you. We are continuing to put loans on the book that are first lien non-sponsor loans that have coupons of LIBOR 800 and above, which is profoundly higher than what you see in the general mid-market, sponsor mid-market or broadly syndicated market. Those senior secured loans continue to be low leverage, consistent with our history, which is public data at this point. And the loans to value continue to be at 50% or less and in the deals that we are closing right now, both of them are well less than 50% loan to value. We then balance the overall yield on the senior deals, which are a little bit lower, by doing some second lien assets and we are working on some second lien assts right now. Those second lien assets generally will have yields that are several hundred basis points higher than the first lien assets. And that is the mechanism whereby we create a balanced risk portfolio that has a yield that allows us to earn the dividend on an annual basis. The non-sponsor market has not seen nearly as much pricing pressure or competitive pressure as the sponsor market and we do continue to find transactions that are in our opinion, very attractive risk returns and very conservative on their structures. Did that answer your question?
It does Stuart, that’s great, that’s a great answer. And maybe just one question for Ed on the income statement, any help you can give us from a fee income perspective, maybe breaking that down between what might have been non-recurring versus what may be considered recurring going forward?
Well, the – from a recurring perspective, it somewhat depends on how you define it. But recurring, truly recurring is a relatively small number in any given quarter for us. So these are amendment fees and other types of fees that occur naturally throughout our portfolio.
I will highlight Bryce, that particularly in our non-sponsored book, covenants are set very tightly to the expected performance of the company. Many non-sponsored borrowers plan on growing significantly over the first couple of years. And when they grow either more slowly or don’t grow, they have covenant violations. Those covenant violations are not, in our opinion, a credit issue or at least normally they are not. But they do result in amendment and waiver fees and those amendment and waiver fees are a very natural part of what we collect on a quarterly basis. So while they may not be recurring the same way our interest income is due and recurring, it is in most quarters true that we are collecting waiver fees, amendment fees and prepayment penalties on transactions. And on our non-sponsor book, it is normal to get 3 years to 4 years of prepayment protection. So when many of those non-sponsor loans pay off, there is in fact a fee associated with those loans paying off.
Great, that’s helpful. And maybe to ask the question a better way, the fee income you have this quarter, any way to break that down between amendment, waiver versus prepayment, if any?
We have two amendments and one prepayment, the largest being the prepayment fee, so the $0.5 million.
$0.5 million, okay. Thank you, Ed. I appreciate it.
Thank you. This concludes today’s conference call. Thank you for your participation. All participants may disconnect at this time.
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