Good afternoon. My name is Shelby, and I will be your conference operator today. At this time, I would like to welcome everyone to the WhiteHorse Finance First Quarter 2023 Earnings Conference Call. Our host for today's call are Stuart Aronson, Chief Executive Officer; and Joyson Thomas, Chief Financial Officer. Today's call is being recorded and will be made available for replay beginning at 4:00 p.m. Eastern Time. The replay dial-in is 402-220-1548. No passcode is required. [Operator Instructions]. It is now my pleasure to turn the floor over to Robert Brinberg of Rose & Company. Please go ahead.

Thank you, Shelby, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's first quarter 2023 earnings results. Before we begin, I'd 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 may be 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 can 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. Today's speakers may refer to material from WhiteHorse Finance's first quarter earnings presentation, which is posted on our website this morning. With that, allow me to introduce WhiteHorse Finance's CEO, Stuart Aronson. Stuart, you may begin.

Thank you, Rob. Good afternoon, and thank you for joining us today. As you're aware, we issued our press release this morning prior to market open, and I hope you've had a chance to review our results for the period ending March 31, 2023, which can also be found on our website. On today's call, I'll begin by addressing our first quarter results and current market conditions. Joyson Thomas, our Chief Financial Officer, will then discuss our performance in greater detail, after which we will open the floor for questions. I'm pleased to report strong performance for the first quarter of 2023. In Q1, GAAP net investment income and core NII was $10.7 million or $0.461 per share, which more than covered our previously declared dividend of $0.355 per share. Regarding dividends and as previewed on our last earnings call, the management and the Board of the BDC have closely examined whether an upward adjustment should be made to the regular dividend, given the improved earnings power of the BDC portfolio, resulting from an increase in spreads and base rates. In this regard, we are announcing several changes to our dividend structure to ensure that our shareholders benefit from our earnings momentum. I'm pleased to announce that our Board has elected to increase our regular quarterly dividend of $0.37 per share, up from $0.355 per share that we have paid consistently since our IPO. We believe that this increase in our regular dividend is both appropriate and sustainable given the increased earnings power of our portfolio. In addition, to ensure our shareholders consistently benefit from the earnings generated in excess of this regular dividend, we are introducing a new formula-based supplemental dividend. The supplemental dividend will be calculated as 50% of our NII in excess of our regular dividend rounded…

Thanks, Stuart, and thank you all for joining today's call. During the quarter, we recorded GAAP net investment income and core NII of $10.7 million or $0.461 per share. This compares with Q4 2022 GAAP NII and core NII of $11.1 million or $0.476 per share as well as our previously declared quarterly distribution of $0.355 per share. Q1 fee income decreased quarter-over-quarter to $1 million in Q1 to $1.9 million in Q4, with Q1 amounts being highlighted by amendment fees of $0.6 million generated from investments in Lift Brands, Lenny & Larry's and Brooklyn Bedding. For the quarter, we reported a net increase in net assets from operations of $7.5 million, which is an $8.7 million increase from Q4 2022. Our risk ratings during the quarter show that 73.2% of our portfolio positions carried either 1 or 2 rating, slightly lower than the 74.8% reported in the prior quarter. As a reminder, one rating indicates that the company has seen its risk of loss reduced relative to initial expectations and a 2 rating indicates the company is performing according to initial expectations. Regarding the JV specifically, we continue to grow our investment. As Stuart mentioned earlier, we transferred 3 new deals and 4 add-on transactions totaling $25.9 million in exchange for cash proceeds of $25.9 million. As of March 31, 2023, the JV's portfolio held positions in 30 portfolio companies with an aggregate fair value of $308.9 million compared to 28 portfolio companies at a fair value of $284.3 million as of December 31, 2022. Subsequent to the end of the first quarter, the company transferred 2 investments to the JV, including 1 new portfolio company. The investment in the JV continues to be accretive to the BDC's earnings, generating a mid-teens return on equity. As we have noted…

[Operator Instructions]. We'll take our first question from Mickey Schleien with Ladenburg.

Stuart and Joyson, can you hear me?

Yes, Mickey.

I just wanted to follow-up on your comments about the level of competition to make sure I understand what you were saying because we're hearing that larger commercial banks are constraining their lending, and there are obviously challenges for some lenders to access the syndicated loan market. So how do those trends play into your strategy of going upmarket within the BDC and also the opportunity in the senior loan fund?

Exactly as you said, because the syndicated markets are still in disarray for all, but the strongest to borrowers. There's more opportunity in the markets served by direct lenders and BDCs and those deals are increasingly attractive as you get to companies with EBITDA that is in the mid-market range of $30 million to $100 million. So whereas we've seen on average lower spreads on smaller deals, which is the opposite of a normal upmarket environment. Mickey, in a normal market, our lower mid-market off-the-run sponsor deals have spreads that are typically 50 to 75 basis points higher than mid-market and upper mid-market deals. And at the moment, the spreads are either aligned or the lower mid-market deals are 25 basis points lower. So from a risk return perspective, we believe that the mid-market and upper mid-market at this moment is generally not on every deal, but generally more attractive. And we've been booking deals that are generally larger EBITDA companies with $30 million of EBITDA or more.

Stuart, if I can follow-up. I mean you're absolutely right. I mean I can't recall a situation where spreads in upper middle market or middle market are better than lower middle market. Is that being caused by some players that are acting irrationally or new entrants or is it some specific deals that are getting done at numbers that aren't attractive to you? But that's a really unusual situation. Is there anything you can tell us about what precipitated that?

There are a couple of lenders in the lower mid-market marketplace who continue to underprice deals versus the mid-market. When we see that happen, we just let those deals go, and we reallocate our resources into the more attractive risk-return transactions. There was more of that going on in 2022. There were more lenders who had not adjusted to the market price. But we're not concerned by it. We just think the market dynamics are abnormal right now, and we do expect over time that the lower mid-market deals will once again command a premium to the mid-market deals. It's just with the shortage of liquidity in the mid-market, those mid-market deals are being priced up to find adequate liquidity.

And we'll take our next question from Robert Dodd with Raymond James.

Congratulations on the quarter and the variable -- supplemental formulaic dividend that [indiscernible] Essentially following up to Mickey's, on this mid-upper versus lower, are you seeing, I mean, obviously the 3 deals, you did with [indiscernible] were sponsored transactions. And typically, as we move further up market, I think that's less and less non-sponsored. So is this going to result in a further mix shift away from non-sponsored transactions in the portfolio? And is that part of the deliberate calculus or that just a side-effect of where you're seeing the risk return in the upper market right now?

Robert, I should have been clear and I wasn't clear. I apologize for that. The dislocation in the lower mid-market is almost entirely on sponsor deals. So we see that lower price on lower mid-market sponsor deals. We have a deal mandated right now that we hope to close in mid-June. That is a non-sponsored transaction with pricing of $750 over at leverage of under 3x EBITDA. So the non-sponsored market continues to be robust, low-priced, conservative leverage, conservative terms, and we're working on a number of non-sponsored transactions. So I would not expect, in general, a change for the balance of the year between sponsor and non-sponsor. It was just the luck of the draw that in this past quarter, all 3 deals that we closed were sponsor deals.

Got it. So we would see a little bit of a bifurcation like the most continued sponsor deals, but those probably in the lower market and then the more sponsor deals in the upper end of the market, is that fair?

I think what you'll see is the non-sponsor deals will be both lower mid-market and mid-market. The deal that I was making reference to that is mandated that should close in June actually has more than $30 million of EBITDA. So it's a mid-market size deal. So our non-sponsor pipeline is reasonably strong right now with both lower mid-market and mid-market opportunities. And all of those opportunities are either priced very attractively or we have one deal where the leverage is extremely low, like 1x leverage and the pricing would be about 6.25. And that would go into the JV.

Got it. Got it. I appreciate that. And then last one, obviously, your portfolio leverage, to your point, you can handle higher rates given the relatively lower portfolio leverage and your spreads aren't super high, they're attractive, but they're not super high. So that tends to imply pretty decent interest coverage. Is there a -- at what point would you actually be worried for lack of a better term, how high -- and again, forward curve is indicating down, but how high would the Fed have to go for you to feel concerned from the perspective of coverage that you may be needing to provide more support or sponsors needing to provide meaningful support just from a kind of an interest coverage from a rate perspective?

Robert, our interest coverage ratio on average across the portfolio is greater than 2x. Individual credits vary much more significantly. We ran an analysis in the face of a yield curve that is predicting lower rates, and we ran the assumption that rates went up by 100 basis points, and there was no material additional stress in the portfolio even if rates went up another 100 basis points. So that's the best sensitivity I can give you right now. Again, we expect interest rates to be peaking out, but if they went up 100 basis points more, we would not, on most accounts see an interest coverage problem or a debt service problem.

And we'll take our next question from Eric Zwick with Hovde Group.

Wanted to start just on the STRS joint venture, and I know you referenced you've made a greater commitment to it and continues to grow and you added some new investments here in the first quarter, and it sounds like a couple more slated for 2Q. So just curious, longer term, how you think about its concentration in your total portfolio and if you have a target range or potentially even a cap on how large it could become?

Well, I wouldn't say it's cap, but I would tell you that the size that we have it at currently with the recent increase at the moment is probably as large as we plan to go. We don't want to get too heavy into the 30% bucket of concentration. And we've grown the JV nicely. It's generating very positive returns for our investors. And with the deployment of the remaining 25, 15 from us and 10 from our Ohio STRS partner, the JV should be at its target levels.

That's helpful. And then just looking at Slide 12 and the improvement in the net investment spread certainly took a nice leg up in the middle to second part of '22 and it seems to have flattened out here a little bit in Q1. If the Fed transitions from its hiking cycle to a holding it at higher for longer strategy, which, I guess as you referenced or maybe that Robert referenced before, the future curve is actually pointing towards down, but if the Fed were to hold higher for longer, what are your expectations for your ability to hold or potentially even improve the net investment spread at this point?

If rates stay where they are, as we rotate into new deals that have higher spreads from deals that were sourced in 2019 or 2021 that had lower spreads, we will get a gentle upward movement in our earnings capability. But again, I think everyone knows, a lot of the increase in the income has come from the higher base rates, as I shared in the prepared remarks. And our expectation is that most of that benefit is showing up in the numbers that you saw this quarter might get a little bit better just because people choose SOFR periods that often run 3 months. So we convert quarter-to-quarter into new SOFR periods. So there should be some upward momentum next quarter. But I think you've seen most of it already roll into the numbers. Joyson, if you disagree with that, please share your thinking.

No, I think that's exactly what we're seeing.

That makes sense. And last one for me. I think you have some 2023 notes coming due. I'm just curious about your thoughts on that and the source of funds to redeem those and potentially replace that capital or if you would just use the revolver. Curious, any thoughts there?

We've spoken to firms in the marketplace. Treasury rates themselves are not that unattractive right now, at least in our opinion if go out the curve. But spreads are very high right now. And frankly, we can do a lot better by drawing down on our JPMorgan facility than we can by issuing unsecured. So we will keep an eye on the unsecured market. And as that market moderates back to more normalized spreads, we will consider issuing a new round of unsecured, but at the moment, given market conditions, we're more inclined to fund that $30 million under our JPMorgan line.

Great.

Thank you, Erik.

We'll take our next question from Bryce Rowe with B. Riley.

Stuart, I wanted to ask about the kind of the internal performance ratings, not too terribly surprised to see some shift with some of the dynamics you discussed in your prepared remarks. But I just wanted to get a sense from you. What's driving some of the movements into the 3 rated credits. And then you also saw some movement into the 1 rating there, which may or may not be surprising given the macro backdrop?

Yes. We have a number of credits where the ability to increase price has not kept up with rising raw material and labor prices and those companies are working with lower margins. So as a result of that, the companies are in most cases, slightly underperforming to our original budgets, which is why you've seen a move down a little bit in average rating. But 3 is not particularly concerning. It just means it's underperforming where it was originally. And as I think I shared about half our portfolio is seeing increased EBITDA and lower leverage. And the other half of the portfolio is seeing decreases in EBITDA and higher leverage. And so that's balancing out to, on average, slightly higher, like 0.1 or 0.2 turns higher leverage across the portfolio.

Okay. Maybe a couple more for me. The Arcole transaction that you noted in the prepared remarks, assuming you monetized that or exited that around the fair value that we saw as of March 31?

I believe we did. Joyson?

Bryce, yes, we did exit it at the price that was marked at 3 31. And as Stuart had mentioned in the prepared remarks, overall, like to-date that equated to about 1.2x on our invested capital.

Okay. Last one around rates. A lot of discussion around higher rates or lower rates, I would assume that there was quite a bit of consternation in taking the regular dividend up $0.015 with the prospects of maybe seeing lower rates at some point in the future. So if you could just talk about sensitivity to lower rates and how comfortable you are earning that $0.37 even in a lower rate environment?

So we assume that the yield curve is correct. We assume that SOFR will come back down under 3% in a couple of years. We ran our sensitivities based on that. And based on the advice of our shareholders and analysts, we only raised the regular dividend by an amount that we felt was sustainable. And so if the yield curve is correct, the dividend should be sustainable, absent unforeseen circumstances at the $0.37 level. And that's why we took everything above $0.37 and linked that to the variable mechanism that Joyson described in depth.

[Operator Instructions]. We'll take our next question from Melissa Wedel with JPMorgan.

Sorry to drill in on the dividend, the supplemental, but I want to make sure that we are thinking about that and accounting for that properly in our model. As I heard you articulate on the call today, if I'm understanding you correctly, there is a threshold at which if NAV would be lowered by $0.15 a share between both net income and the supplemental dividend, there would be no supplemental dividend at all? Stuart Is that right?

That's right. To think about this is that inclusive of the supplemental dividend, the decrease in NAV over the current and the preceding quarter would be limited to $0.15 per share. So we would factor in not only with the supplemental dividend, but then to the extent that we do have maybe unrealized mark-to-market declines in NAV that would also limit it in any particular quarter.

Okay. And just to make the distinction, we're talking about, it's either that 50% of excess earnings as declared or if it would trip that $0.15 decline threshold, there would be none at all. It wouldn't be just reduced to limit.

It would be reduced. As an example, if inclusive of the proposed $0.05 per share supplemental dividend that would have caused a NAV decline of $0.17 per share, then that proposed $0.05 supplemental dividend would have been reduced by $0.02 such that the supplemental dividend would have been $0.03 per share.

Okay. Got it. Very helpful.

That was for illustration purposes only. Yes.

And it appears that we have no further questions at this time. I will now turn the program back over to our presenters for any additional or closing remarks.

I appreciate everybody taking the time to join us this afternoon. We continue to work hard to generate sustained predictable results and to give transparency. And as I always invite our analysts and shareholders, if there are things you'd like us to share on upcoming calls, please let us know before those calls, so we can try to make sure we give you all the information you want to have about WhiteHorse. Thank you very much.

That concludes today's teleconference. Thank you for your participation. You may now disconnect.