Company History and Overview
WhiteHorse Finance, Inc. (NASDAQ:WHF) is a non-diversified, closed-end management investment company that operates as a business development company (BDC). The company primarily originates and invests in senior secured loans, including first lien and second lien facilities, to lower middle market companies across the United States.
WhiteHorse Finance was formed in December 2011 and commenced operations on January 1, 2012. The company was originally capitalized with approximately $176.3 million of contributed assets from two private funds that were advised by an affiliate of H.I.G. Capital, L.L.C. On December 4, 2012, WhiteHorse Finance converted from a Delaware LLC into a Delaware corporation and elected to be treated as a business development company under the Investment Company Act of 1940. Concurrent with its initial public offering, the company sold 6.67 million shares, and certain directors, officers, and related parties purchased an additional 472,670 shares through a private placement.
WhiteHorse Finance’s common stock trades on the Nasdaq Global Select Market under the symbol WHF. The company’s investment activities are managed by H.I.G. WhiteHorse Advisers, LLC, while H.I.G. WhiteHorse Administration, LLC handles its operations. Over the years, WhiteHorse Finance has faced various challenges common to business development companies, including the discontinuation of LIBOR, the transition to alternative reference rates like SOFR, and the impacts of sustained high interest rates on its portfolio companies. The company has also adapted its origination strategy to focus more on non-sponsor deals in response to changes in the competitive landscape of the lower middle market lending space.
WhiteHorse Finance’s investment objective is to generate attractive risk-adjusted returns primarily by originating and investing in senior secured loans, including first lien and second lien facilities, to performing lower middle market companies across a broad range of industries. The company’s debt investments typically carry a floating interest rate such as SOFR plus a spread and have a term of three to six years. While the company focuses principally on originating senior secured loans to lower middle market companies, it may also opportunistically make investments at other levels of a company’s capital structure, including mezzanine loans or equity interests.
As of September 30, 2024, WhiteHorse Finance’s investment portfolio consisted primarily of senior secured loans across 129 positions in 73 companies with an aggregate fair value of $654.3 million. The majority of the portfolio was comprised of senior secured loans to lower middle market borrowers, with nearly all of those loans being variable-rate investments primarily indexed to SOFR. The portfolio had an average investment size of $4.3 million based on fair value and average debt investment size of $5.6 million, with investment sizes ranging from $0 to $20.7 million and a weighted average effective yield of 10.6%.
Navigating Market Challenges
WhiteHorse Finance’s results for the third quarter of 2024 were disappointing, as the company’s investment portfolio declined due to net realized and unrealized losses, which impacted its financial performance. The company’s GAAP net investment income and core net investment income for the quarter were $9.2 million or $0.394 per share, which exceeded the quarterly base dividend of $0.385 per share but was slightly below the second quarter’s GAAP and core net investment income of $9.3 million or $0.40 per share.
The company’s net asset value (NAV) per share at the end of the third quarter was $12.77, representing a 5.1% decrease from the prior quarter. The NAV per share was impacted by net markdowns in the portfolio totaling $15.9 million, the majority of which related to markdowns on American Crafts and Honors Holdings.
During the quarter, WhiteHorse Finance had gross capital deployments of $51 million, which was partially offset by total repayments and sales of $30.2 million, resulting in net deployments of $20.8 million. The company’s weighted average effective yield on its income-producing debt investments was 13.1% at the end of the third quarter, compared to 13.8% in the second quarter of 2024 and 13.6% in the third quarter of 2023.
The challenges in the third quarter generally did not relate to the overall economy but were more company-specific. WhiteHorse Finance took a $6.6 million write-down on American Crafts and is currently seeking to either restructure or sell the company, as it was further impacted by the loss of a material customer. The company also took a $5 million write-down on Honors Holdings, reflecting continued challenging industry conditions with a slowdown across many fitness concepts, and placed Telestream on non-accrual status, resulting in a $0.9 million write-down.
Navigating the Lending Market
Regarding the lending market, conditions across all sponsor segments remain very aggressive, with a shortage of new quality deal flow and thin pricing. WhiteHorse Finance sees middle market pricing compressed down to spreads of SOFR 475 to SOFR 525, and lower mid-market spreads moving to approximately SOFR 475 to SOFR 575. The company believes there is excessive leverage on many credits that have cyclicality and is not participating in those transactions.
However, the company sees a more attractive backdrop in the non-sponsor market, where the market continues to support leverage of only 3 to 4.5 times and pricing tends to be between SOFR 600 to SOFR 800. As a result, WhiteHorse Finance is redoubling its efforts to focus on the non-sponsor market, where it believes there is better risk-return in many cases and much less competition than what it is seeing in the on-the-run sponsor market.
Subsequent to the third quarter, the company closed one new investment and a few add-ons to existing credits totaling approximately $7.5 million and had repayments of approximately $21 million, including three full realizations for approximately $35 million. Following this net repayment activity and pro forma for several transactions in early Q4, the company’s balance sheet has approximately $45 million of capacity for new assets, while the STRS JV has approximately $90 million of capacity supplementing the BDC’s existing capacity.
Financials
WhiteHorse Finance’s financial performance in the third quarter of 2024 was impacted by net realized and unrealized losses in its investment portfolio. The company reported GAAP net investment income and core net investment income of $9.2 million or $0.394 per share for the quarter. This exceeded the quarterly base dividend of $0.385 per share but was slightly below the second quarter’s figures of $9.3 million or $0.40 per share.
The company’s net asset value (NAV) per share decreased by 5.1% from the previous quarter, ending at $12.77. This decline was primarily due to net markdowns in the portfolio totaling $15.9 million, with significant write-downs on American Crafts ($6.6 million) and Honors Holdings ($5 million).
WhiteHorse Finance’s investment activity during the quarter included gross capital deployments of $51 million, offset by repayments and sales of $30.2 million, resulting in net deployments of $20.8 million. The weighted average effective yield on income-producing debt investments was 13.1% at the end of the third quarter, compared to 13.8% in the previous quarter and 13.6% in the same quarter of the previous year.
For the most recent quarter, WhiteHorse Finance reported total investment income of $22,851,000 and a net loss of $6,858,000. The company’s operating cash flow (OCF) and free cash flow (FCF) for the quarter were both $53,447,000. It’s important to note that as a BDC, WhiteHorse Finance’s financial metrics differ from traditional companies, with a focus on net investment income and net asset value rather than traditional revenue and profit measures.
Liquidity
As of the end of the third quarter of 2024, WhiteHorse Finance maintained a strong liquidity position. Following net repayment activity and pro forma for several transactions in early Q4, the company’s balance sheet had approximately $45 million of capacity for new assets. Additionally, the STRS JV, a joint venture partnership, had approximately $90 million of capacity, further supplementing the BDC’s existing capacity.
This liquidity position allows WhiteHorse Finance to remain active in the market and take advantage of new investment opportunities, particularly in the non-sponsor market where the company sees more favorable terms and less competition.
The company’s board of directors declared a fourth quarter distribution of $0.385 per share, consistent with the prior quarter. Furthermore, a special distribution of $0.245 per share was declared for stockholders of record as of October 31, 2024, payable on December 10, 2024. These distributions reflect the company’s ability to generate income for shareholders despite challenging market conditions.
As of the most recent quarter, WhiteHorse Finance reported cash holdings of $11,160,000. The company also had approximately $173,410,000 available to be drawn under its revolving credit facility, based on collateral and portfolio quality requirements. This substantial available credit line provides additional financial flexibility for the company to pursue investment opportunities and manage its operations.
Product Segments and Investment Strategy
WhiteHorse Finance operates in several key product segments, with its primary focus on senior secured loans. As of September 30, 2024, the company’s investment portfolio was structured as follows:
Mezzanine Loans and Equity Investments: While not the primary focus, the company opportunistically invests in mezzanine loans and equity interests. As of the latest quarter, WhiteHorse Finance had $5.00 million in second lien secured loans (0.8% of the portfolio) and $24.32 million in equity investments (3.7% of the portfolio).
STRS JV Investments: The company’s joint venture with the State Teachers Retirement System of Ohio, formed in 2019, focuses on investing in senior secured loans to lower middle market companies. As of September 30, 2024, WhiteHorse Finance’s investment in STRS JV consisted of $84.42 million in subordinated notes and $23.50 million in equity, collectively representing 12.9% of the total investment portfolio.
This diversified approach allows WhiteHorse Finance to generate current income through senior secured loans while also capitalizing on attractive risk-adjusted return opportunities through mezzanine debt and equity investments. The STRS JV further enhances the company’s exposure to the senior secured loan market and allows for portfolio diversification.
Distributions and Outlook
WhiteHorse Finance’s board of directors has declared a fourth quarter distribution of $0.385 per share, which is consistent with the prior quarter. In addition, the company has elected to declare a special distribution of $0.245 per share for stockholders of record as of October 31, 2024. The distribution will be payable on December 10, 2024. Pro forma for the special distribution, WhiteHorse Finance estimates its spillback income to be approximately $26.8 million.
While volume is lighter than the company would like it to be in all market segments, WhiteHorse Finance’s pipeline is still at about 185 deals, with seven new mandates and four add-ons to existing deals. The company currently has approximately $45 million of capacity on its balance sheet and $90 million of capacity in the STRS JV to deploy into new investments.
Given the decline in pricing, WhiteHorse Finance continues to expect repayment activity to remain high for the balance of 2024 and into 2025. However, the company believes it is well-positioned to navigate the current market challenges and deploy capital into attractive opportunities, particularly in the non-sponsor market, where it sees better risk-return characteristics.
The company will continue to evaluate its quarterly distribution going forward based on the core earnings power of its portfolio and other relevant factors. While specific forward-looking quantitative guidance was not provided, management’s focus on the non-sponsor deal market and their current pipeline suggests a cautious but opportunistic approach to new investments in the coming quarters.
Conclusion
WhiteHorse Finance is a BDC that has faced some company-specific challenges in its investment portfolio during the third quarter of 2024, leading to net markdowns and a decline in its net asset value. However, the company is taking actions to optimize the outcomes for these specific credits and is focusing its origination efforts on the non-sponsor market, where it sees more favorable terms and less competition.
With ample capacity on its balance sheet and in the STRS JV, WhiteHorse Finance is well-positioned to deploy capital into new investments, albeit in a more cautious lending environment. The company’s history of generating attractive risk-adjusted returns and its focus on senior secured loans to lower middle market companies make it a BDC worth monitoring, despite the recent setbacks.
The company’s diverse product segments, strong liquidity position, and strategic focus on the non-sponsor market demonstrate its adaptability in challenging market conditions. As WhiteHorse Finance continues to navigate through these challenges, investors should closely monitor its ability to maintain its distribution levels, manage portfolio risks, and capitalize on opportunities in the lower middle market lending space.
Disclaimer: This article is for informational purposes only. It does not constitute financial, legal, or other types of advice. While every effort has been made to ensure the accuracy of the information presented here, the author and the publisher do not make any guarantees about the completeness, reliability, and accuracy of this information.