WhiteHorse Finance, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. WhiteHorse Finance is an externally managed business development company (BDC) and regulated investment company that primarily originates floating-rate senior secured loans to lower-middle-market businesses. Financial statement amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Investment income | $21.6 | $18.4 | $61.6 | $53.7 |
| Net investment income after excise tax | $9.8 | $7.6 | $26.2 | $21.3 |
| Net realized and unrealized gains (losses), including foreign currency | $(5.9) | $0.6 | $(9.3) | $5.6 |
| Net increase in net assets from operations | $3.8 | $8.3 | $16.9 | $27.0 |
| Basic and diluted earnings per share | $0.17 | $0.40 | $0.73 | $1.30 |
- Investment income and expenses: Q3 investment income increased $3.2 million year over year, principally from larger investments and higher base rates. Q3 net investment income increased $2.1 million. Higher borrowing rates and balances raised Q3 interest expense to $5.6 million from $3.8 million; nine-month interest expense rose to $15.4 million from $11.5 million. Nine-month base management fees were $11.7 million, versus $10.2 million.
- Portfolio and NAV: At September 30, portfolio investments had $764.6 million fair value, versus $819.2 million at December 31, 2021. The portfolio comprised 107 positions in 68 companies, compared with 127 positions in 76 companies at year-end. Weighted average effective yield was 11.0%, up from 9.0%; yield on income-producing debt investments was 11.4%. NAV was $14.76 per share, down from $15.10, and net assets were $343.0 million, down from $349.8 million.
- Credit quality: No loans were on non-accrual at September 30, 2022; non-accrual investments had fair value of $10.0 million at December 31, 2021. Investments rated 3 or 4 on the company’s risk scale increased to 16.5% of the portfolio from 9.9% at year-end; none were rated 5.
- Cash flow and liquidity: Nine-month operating activities provided $64.1 million of cash, compared with $22.6 million in 2021. Financing activities used $67.5 million, mainly for debt repayments and shareholder distributions. Cash, cash equivalents and restricted cash totaled $19.3 million at quarter-end, including $9.4 million restricted. The company had $88.9 million available under its JPMorgan credit facility, subject to collateral and portfolio requirements.
- Debt and leverage: Debt carrying value was $431.0 million; principal outstanding was $436.1 million, down from $481.6 million at December 31, 2021. Asset coverage was 178.7%, above the 150% statutory minimum. Credit-facility borrowings were $246.1 million at a 5.61% quarter-end rate; the facility had a $335 million borrowing capacity and $88.9 million available. The company reported compliance with its facility covenants.
- Distributions: The company declared $0.355 per share for Q3 and $1.065 per share for the first nine months. A further special distribution of $0.05 per share was declared October 14, payable December 9, 2022.
Material changes and unusual items
- Despite higher investment income and net investment income, Q3 operating results fell year over year because of $6.2 million of net unrealized depreciation on investments and foreign currency, versus $0.7 million of unrealized appreciation in Q3 2021.
- Nine-month results included $15.9 million of net realized losses, compared with $7.5 million of realized gains in 2021. The filing attributes a $6.9 million combined realized and unrealized loss to the Grupo HIMA San Pablo realization; the reported realized loss on that investment was $18.3 million. The period also included a $1.7 million recovery gain from RCS Capital.
- In January 2022, the company restructured its PlayMonster exposure, converting prior loan investments into a new first-lien loan and preferred and common equity. The related equity fair values were reduced during the period.
- In February 2022, WhiteHorse increased its STRS JV commitment by $25 million; its economic ownership rose from 60% to approximately 66.67%. At September 30, its STRS JV investment included an $80 million subordinated note and $22.1 million of equity at fair value.
- The company’s own weighted average borrowing cost and portfolio yields rose in the higher-rate environment. Nearly all performing floating-rate investments have floors, so income benefits from rate increases only when the benchmark exceeds applicable floors.
Outlook, risks and contingencies
- The filing provides no specific earnings, revenue, or distribution guidance. Management expects some non-recurring fee income in most quarters but states that results may vary substantially across periods.
- Management identifies portfolio-company credit risk, inflation, rising interest rates, market spread and valuation changes, COVID-19 effects, and geopolitical uncertainty—including the Russia-Ukraine war and China lockdowns—as risks. Higher rates may increase income but can also raise borrower debt-service burdens, defaults and the company’s financing costs.
- Fair values are especially judgment-sensitive: substantially all investment fair value is Level 3, using significant unobservable inputs. Private investments may be illiquid, and realized proceeds may differ materially from reported fair values.
- The company has $37.0 million of unfunded portfolio-company commitments, down from $53.1 million at year-end. These may be conditional and may expire without being drawn. The filing says the company believes it has sufficient assets to meet them.
- Senior debt is subject to a 150% asset-coverage requirement and credit-facility borrowing-base, market-value and other covenants. Falling asset values or covenant breaches could restrict borrowing or distributions and could accelerate repayment obligations.
- Management reported effective disclosure controls and no material legal proceeding. The filing states that COVID-19 impacts on portfolio companies could continue, but their future magnitude cannot be quantified.
Investor verification priorities
- Review portfolio-company performance, the increase in risk-rated 3 and 4 exposures, and the status of the Grupo HIMA and PlayMonster restructurings.
- Validate Level 3 valuations, especially assumptions for discount rates, market quotes, and exit multiples, and compare them with subsequent borrower performance and recoveries.
- Monitor asset coverage, borrowing-base availability, credit-facility rates and covenants, and the approaching August 2023 maturity of the $30 million 6.00% notes.
- Assess whether higher floating-rate income can continue to exceed increased financing costs without materially impairing borrowers’ repayment capacity.
- Confirm future distribution coverage from taxable earnings and cash generation; distributions may include return of capital, and the declared special distribution is payable after the reporting date.
- Check subsequent SEC filings for changes in credit quality, liquidity, valuation marks, unfunded commitments, and LIBOR transition arrangements.