Executive Summary / Key Takeaways

• WhiteHorse Finance's core investment thesis centers on generating income and capital appreciation through senior secured loans to U.S. lower middle market companies, leveraging a differentiated sourcing network and H.I.G. Capital affiliation.
• Recent financial performance has been impacted by increased non-accrual investments, leading to a decline in Net Investment Income ($0.294/share in Q1 2025 vs. dividend of $0.385/share) and a decrease in Net Asset Value ($12.11/share in Q1 2025).
• The company is actively addressing credit challenges with a dedicated restructuring team, focusing efforts on key non-accruals like Telestream and MSI, with the resolution of American Crafts noted.
• Strategic focus is shifting towards the less competitive non-sponsor and off-the-run sponsor markets to find better risk-adjusted opportunities amidst aggressive terms and leverage in the on-the-run sponsor segment.
• The STRS JV continues to be a valuable strategic partnership, providing accretive mid-teens returns on equity and additional deployment capacity ($35 million in Q1 2025).

A Story of Targeted Lending in the Lower Middle Market

WhiteHorse Finance, Inc. (NASDAQ:WHF) operates as an externally managed business development company (BDC), strategically focused on the U.S. lower middle market. Its journey began in late 2011, formally commencing operations in early 2012, capitalized initially with assets from private funds affiliated with H.I.G. Capital. This foundational relationship with H.I.G. remains a cornerstone of WHF's operational model, providing access to a broad network and expertise. The company's conversion to a Delaware corporation and BDC election in late 2012, coupled with its IPO, established its public identity and capital structure.

WHF's core business model revolves around originating and investing in senior secured loans, primarily first and second lien facilities, to performing companies with enterprise values typically between $50 million and $350 million. These loans generally feature floating interest rates based on indices like SOFR, plus a spread, and carry terms of three to six years. While senior debt is the focus, WHF retains flexibility to opportunistically invest in other parts of the capital structure, including mezzanine debt and equity, sometimes receiving warrants alongside debt investments. Revenue is generated through interest payments, fee income (origination, commitment, prepayment), and potential capital gains or dividends from equity holdings.

The competitive landscape in direct lending, particularly within the sponsor-backed segment, remains notably aggressive. Competitors like Ares Capital (ARCC), Golub Capital BDC (GBDC), and Main Street Capital (MAIN) operate across the middle market, often deploying larger deal sizes and benefiting from scale. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, WHF positions itself by leveraging its differentiated operational platform. This platform, arguably WHF's key "technology" in the context of a financial services firm, includes a distributed origination network comprising approximately 23 professionals located across 11 regional markets (recently expanded to 13 with Nashville). This extensive local presence, coupled with the H.I.G. affiliation, provides access to deal flow beyond the most competitive on-the-run sponsor auctions.

This operational differentiation offers tangible benefits. It enables WHF to access less competitive non-sponsor deals, which management notes typically feature lower leverage (3-4.5x EBITDA) and higher pricing (SOFR 600-800) compared to the aggressive on-the-run sponsor market (SOFR 450-600 spreads, 4-7.5x+ leverage). The strength of this network allows for selective deal participation, enabling WHF to turn down transactions deemed overly aggressive in terms of leverage or cash flow coverage, even if they are brought by sponsors. This strategic focus on sourcing quality over quantity is critical in the current market.

Another key strategic component is the STRS JV, a partnership with STRS Ohio formed in 2019. This joint venture, which is not consolidated by WHF, invests in similar senior secured loans in the lower middle market. WHF's investment in the JV, totaling $106.7 million at fair value as of March 31, 2025 ($22.3M equity, $84.4M subordinated note), provides an additional avenue for deployment and generates accretive returns to the BDC, consistently reported in the mid-teens ROE. The JV also benefits from its own credit facility, recently amended to extend maturity and reduce borrowing costs, enhancing its operational efficiency.

Performance Amidst Credit Headwinds

Recent financial performance reflects the challenging market and specific portfolio issues. In the first quarter of 2025, Net Investment Income (NII) was $6.8 million, or $0.294 per share. This fell short of the quarterly distribution of $0.385 per share and was a decrease from the $8.0 million ($0.343 per share) reported in Q4 2024.

The decline in NII was primarily driven by lower interest income, a result of slightly lower portfolio yields, a decrease in portfolio size, and notably, an increase in non-accrual investments. PIK income also decreased compared to the prior year period, contributing to the lower revenue.

The company's Net Asset Value (NAV) per share declined to $12.11 at the end of Q1 2025, a 1.6% decrease from $12.31 in the prior quarter. This was impacted by $2.6 million in net realized and unrealized losses on investments. This follows a 3.6% NAV decrease in Q4 2024, partly due to a special dividend but also impacted by $4.9 million in net losses and markdowns.

Credit quality remains a key area of focus and challenge. Non-accrual investments increased to 8.8% of the debt portfolio at fair value as of March 31, 2025, up from 7.2% at the end of Q4 2024 and 5.0% at the end of Q3 2024. These challenges are described as primarily company-specific rather than indicative of a broad economic downturn impacting the entire portfolio. Key non-accrual positions include Telestream (3.5% of debt portfolio fair value), which management hopes to return partially to accrual status soon, and MSI Information Services, which was placed on non-accrual in Q1 2025. Honors Holdings was placed on non-accrual in Q2 2024 due to weaker customer trends. The company has established a dedicated five-person restructuring team to work on these troubled accounts, aiming to optimize outcomes and execute turnarounds. While American Crafts was resolved, it was not with the initially expected outcome, highlighting the difficulties in workout situations.

Liquidity remains adequate, supported by the Credit Facility with JPMorgan (JPM). As of March 31, 2025, WHF had $19.6 million in cash ($8.2M restricted) and approximately $164.9 million available under the Credit Facility. The Credit Facility terms were recently amended in January 2025, extending maturity and reducing borrowing costs, providing enhanced financial flexibility. Despite unfunded commitments totaling $31.9 million as of Q1 2025, management believes it has sufficient resources to meet these obligations.

Strategic Responses and Outlook

In response to the aggressive lending environment and portfolio challenges, WHF is strategically pivoting its origination efforts. Management is redoubling its focus on the non-sponsor and off-the-run sponsor markets, where competition is less intense and terms are more favorable. This approach allows WHF to maintain its disciplined underwriting standards, prioritizing deals with positive free cash flow, limited cyclicality, and strong ownership, even if it means passing on volume in the on-the-run market.

The pipeline stands at approximately 175 deals, slightly below the typical range. Management anticipates slower closure rates due to the lower quality of deals in the overall market and their selective approach. A relatively quiet period for new deal closures is expected from Q2 into Q3 2025. However, Q2 2025 has started solidly with one deal closed and several mandates and add-ons in progress.

Looking ahead, management expects elevated repayment activity in the second half of 2025, driven by borrowers seeking to refinance as call protection on existing loans expires. This borrower-friendly market, combined with potentially declining base rates, could lead to continued portfolio churn. While the visible repayment pipeline is currently light, this dynamic could offset new deployments.

A critical near-term factor for earnings is the resolution of non-accrual investments, particularly Telestream. Management hopes to complete the Telestream restructuring by the end of May 2025, expecting a portion of the debt to return to cash-paying accrual status, which would be accretive to NII. The dedicated restructuring team is central to these efforts across the challenged portfolio.

The dividend remains a key consideration for the board, evaluated quarterly based on the core earnings power of the portfolio. The current non-accrual levels compromise this earning power. While the company holds a significant spillover income balance ($28.4 million estimated at the end of 2024 pro forma for the special dividend), providing a cushion, the board is monitoring the success of non-accrual resolutions and deployment of available capacity before making decisions on the dividend rate.

Conclusion

WhiteHorse Finance operates in a competitive direct lending market, leveraging its relationship with H.I.G. Capital and a geographically distributed origination network to target the less competitive segments of the lower middle market. While the core strategy of senior secured lending provides a stable foundation, recent performance has been impacted by company-specific credit issues, leading to increased non-accruals, lower NII, and a decline in NAV.

The company's strategic response, focusing on rigorous underwriting in non-sponsor and off-the-run sponsor markets and actively managing troubled assets with a dedicated restructuring team, is crucial for navigating current headwinds. The STRS JV remains a valuable contributor to earnings and deployment capacity. Investors should closely monitor the resolution of key non-accrual positions, the success of new originations in target markets, and the impact of potential elevated repayments on portfolio size and composition, as these factors will significantly influence future earnings power and dividend sustainability.