Whitehorse Finance, Inc. 2018 Annual Report (10-K) Summary
Business Context and Reporting Period
Company: Whitehorse Finance, Inc. (Whitehorse Finance)
Reporting Period: Fiscal year ended December 31, 2018
Business Model: Whitehorse Finance is an externally managed, non-diversified, closed-end management investment company operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). It targets debt investments, primarily senior secured loans (first and second lien), in privately held lower middle-market U.S. companies with enterprise values between $50 million and $350 million.
Management: Investment activities are managed by WhiteHorse Advisers, an affiliate of H.I.G. Capital. The company has no direct employees; administrative services are provided by WhiteHorse Administration.
Key Financial Metrics (Year Ended Dec 31, 2018)
| Metric | 2018 Value | 2017 Value |
|---|---|---|
| Total Investment Income | $63.2 million | $54.8 million |
| Net Investment Income (after excise tax) | $25.0 million | $26.2 million |
| Net Realized Gains | $32.7 million | $0.1 million |
| Net Change in Unrealized Appreciation/Depreciation | ($0.4 million) | $8.1 million |
| Net Increase in Net Assets from Operations | $57.3 million | $34.4 million |
| Total Assets | $514.1 million | $485.5 million |
| Total Debt Outstanding | $180.0 million | $185.0 million |
| Net Assets | $315.3 million | $287.0 million |
| Net Asset Value (NAV) per Share | $15.35 | $13.98 |
| Portfolio Fair Value | $469.6 million | $440.7 million |
| Weighted Average Effective Yield (Total Portfolio) | 11.8% | 11.4% |
Material Changes vs. Prior Period
- Realized Gains Surge: Net realized gains increased significantly from $0.1 million in 2017 to $32.7 million in 2018. This was primarily driven by the sale of the company's equity investment in Aretec Group, Inc., which generated a realized gain of approximately $33.0 million.
- Unrealized Depreciation: Unlike the $8.1 million unrealized appreciation in 2017, the company recorded $0.4 million in unrealized depreciation in 2018. This was largely due to fair value decreases in investments in StackPath, LLC and AG Kings Holdings Inc., partially offset by increases in Caelus Energy Alaska O3, LLC.
- Expense Increases: Total expenses (net of waivers) rose to $37.3 million from $28.6 million. Interest expense increased to $11.6 million due to rising LIBOR rates. Performance-based incentive fees more than doubled to $12.1 million, reflecting higher pre-incentive net investment income and the capital gains component from the Aretec sale.
- Debt Restructuring: The company refinanced its capital structure by redeeming the $30 million 2020 Notes and issuing $30 million of Private Notes (due 2023) and $35 million of 2025 Notes. Outstanding borrowings under the Credit Facility decreased from $155 million to $115 million.
- Portfolio Growth: The portfolio expanded to 53 positions in 39 companies (from 43 positions in 32 companies in 2017), with a weighted average effective yield increasing to 11.8%.
Guidance, Outlook, Risks, and Unusual Items
- Outlook & Strategy: Management continues to focus on originating senior secured loans to lower middle-market companies. The company expects to generate current income through interest and fees, with capital appreciation from opportunistic equity investments.
- Recent Developments: In January 2019, the company entered a joint venture with the State Teachers Retirement System of Ohio (STRS Ohio) to co-manage a new senior loan fund with up to $125 million in committed capital.
- Key Risks:
- Leverage: The company utilizes significant leverage (asset coverage ratio of 275.2% as of year-end). While the Small Business Credit Availability Act (SBCAA) allows for a maximum debt-to-equity ratio of 2.0x, leverage magnifies the potential for loss.
- Interest Rate Sensitivity: Most portfolio loans are floating-rate (LIBOR-based). While rising rates increase investment income, they also increase borrowing costs. The company has interest rate floors on 100% of its floating-rate investments.
- Valuation Uncertainty: The majority of the portfolio (Level 3 assets) is valued using unobservable inputs, requiring significant management judgment. Fair value may differ materially from realized values.
- Concentration Risk: The portfolio is non-diversified. Specific risks include the Puerto Rico economic situation affecting Grupo HIMA San Pablo, Inc. (approx. $12.1 million exposure) and regulatory challenges in the healthcare sector.
- Unusual Items: The $33.0 million realized gain from the Aretec Group sale is a non-recurring event that significantly boosted 2018 earnings and the incentive fee calculation.
Investor Verification Checklist
- Aretec Gain Sustainability: Verify the extent to which future earnings will rely on recurring investment income versus one-time realized gains like the Aretec sale.
- Debt Covenants: Review the specific borrowing base and market value tests under the Credit Facility to ensure the company maintains compliance and distribution capabilities.
- Portfolio Quality: Monitor the "watch list" positions and the specific performance of Grupo HIMA San Pablo, Inc., given the macroeconomic risks in Puerto Rico.
- Incentive Fee Structure: Understand how the capital gains component of the incentive fee impacts net investment income, particularly in years with large realized gains.
- Interest Rate Floors: Confirm the impact of the 100% interest rate floor coverage on the portfolio's ability to benefit from further LIBOR increases.