BDC Update: WhiteHorse Finance

March 24, 2023

Update Delayed

We meant to write this Update three weeks ago, but then the press of other business intervened - including the fall of Silicon Valley Bank - and we were delayed. Now we're back and increasing our dividend projection to $1.7000 in 2023, dropping back slightly between 2024-2027 to $1.6000.

Interesting Times

As has been the case with several other BDCs - but not all - we've had a difficult time working out the impact on distributions from the higher interest rate environment and seemingly undershot what WHF might earn and pay out. This also seems to have been a challenge for the analysts covering the BDC which have raised their own 2023 EPS projections from $1.65 90 days ago to $1.76 currently. (By the way, the annualized "Core Net Investment Income Per Share" using the IVQ 2022 results came to $1.9040).

Doubts

Like us, the analysts are not so sure those earnings are sustainable and are estimating EPS will drop to $1.67 in 2024. Presumably, the analyst models are presuming lower interest rates will be in operation next year. We have the same thought but are also adjusting for potentially lower income due to credit defaults and/or losses. We're aware that about a quarter of the BDC's portfolio investments are underperforming, up from the prior quarter. That's as high a percentage as we've seen since the IIIQ 2020. It's not unreasonable to believe WHF's earnings might be dampened by a higher level of non-accruals from 2024.

Big Picture

To be clear, we don't have any grave concerns about credit quality over the long term. In the last 5 years, WHF is one of a small group of BDCs that have managed to increase their NAV Per Share. That's mostly been by keeping realized losses low and booking occasional realized gains. In fact, till the IIIQ 2022, WHF's balance sheet boasted positive "accumulated earnings" on its balance sheet. In 2022, though, net realized losses came to ($14mn), offsetting net gains in the prior two years. Chances are this might continue in the unsettled conditions we're expecting in the next two years. Down the road, though, we expect WHF 5 years from now will have,  more-or-less,  the same NAV Per Share as at the end of 2022.

Unchanged

We've made no change to our terminal dividend multiple for purposes of valuing the stock, which remains at 12.0x. That's in line with the sort of multiples reached at peak periods in the past.

Valuation

October 15, 2022

Higher

As we anticipated might occur in our earlier post on August 15, 2022 (see below) WhiteHorse Finance's (WHF) distribution level is moving up, probably due to higher interest rates. Admittedly,  the BDC did not say as much when announcing a $0.05 per share Special Dividend on October 14, 2022, to be paid in December.

Swelling

However, the analyst consensus for WHF's recurring earnings is for $0.3600 in the IIIQ and $0.3800 in the IVQ 2022, up from $0.3340 of "Core Net Investment Income Per Share" in the IIQ 2022. Furthermore, those same analysts are predicting 2023's EPS will average $0.3800, or $1.52 in total. Back in 2021, WHF's EPS was $1.4050, so the BDC is expected to increase profitability over this two-year period by a material 8%.

Small Change

We've updated the model to reflect the higher 2022 payout estimate - now $1.47 versus $1.42. That assumes WHF will maintain its "regular" distribution at $0.355 for the IVQ -  typically announced with the earnings release.

Will They?

A key question remains: will WHF increase its regular distribution given the changing economics or resort to paying out Specials like this one?  In a way, it does not matter as our model does not distinguish between different kinds of distributions. The bottom line number is what matters. We're sticking with the 2023-2026 dividend projections we made months ago, including the $1.5000 payout in 2026 and with a terminal multiple of  12x.

(Not) Popular

The Target Price remains $18.00, modestly above the all-time of $16.35 achieved back in April 2021. WHF closed at $11.69, indicating a potential 54% price increase is potentially in the cards. The yield - using the 2022 dividend level of $1.4700 - is 12.6% and should be higher next year. The price to 2023 expected earnings multiple is only 7.7x. All these numbers underscore how out of favor WHF is at the moment, trading at (22%) below net book value per share; (28%) below its 52-week high, and 11% above its 52-week low.

August 15, 2022

Old Dependable

When we projected WhiteHorse Finance's (WHF) likely distributions in 2021 for the years 2022-2026, coming up with an annual payout was a straightforward affair. After all, the mid-sized, lower middle market-focused BDC has been paying the same quarterly dividend of $0.355/$1.42 annually since going public in 2012. In fact, WHF has the longest track record of paying the same-same dividend of any public BDC. It was easy to fill in the 5-year projection, and we did. After all, consistency has been a hallmark of WHF, whose NAV Per Share is almost unchanged since the level of its earlier days, even as the portfolio has grown.

Interesting Times

However, after reviewing WHF's IIQ 2022 results; and annotating the conference call and looking through the 10-Q, we realized the times might be a-changing. Admittedly, in the quarter, adjusted Net Investment Income Per Share was a just OK $0.334 and the dividend paid was - again - $0.355. Nonetheless, management was clear that in the second half of 2022, there is a very good chance the BDC's earnings might explode, or at the very least take a big step forward. Looking even further down the road, these better results should continue, as we'll discuss.

Easy Enough

Of course, the main reason is that the Fed's raising of short-term rates is working its way through the pricing arrangements WHF has with its borrowers, which is expected to boost EPS significantly. Moreover, like so many of its peers, much of WHF's debt financing is fixed rate, so interest expense will not grow by much. On a very pro-forma basis, WHF's net investment income could increase by as much as 25%, going by the disclosures in the 10-Q and if you assume rates will increase by 200 basis points.

Bonus

Also, WHF has not been shy to indicate market conditions for new loans - in terms of pricing and structures - are at their best in years. Spreads are up; leverage levels are lower and documentation is tighter.  Over time, if more and more of these Goldilocks loans are booked, the BDC's overall yield on its income-producing investments will increase, regardless of rates.

A Smidgeon More

Finally, although WHF is close to its target leverage, there is a little room to increase the size of the portfolio - which mostly consists of first-lien loans - which could provide another nudge to earnings. The current net debt to equity is 1.2x and WHF is willing to push up to 1.35x.

Going Our Own Way

We'd love to tell you what the analysts are projecting in the next couple of quarters and years, but our regular source at Yahoo Finance shows nothing - probably because their models are being revised. We forged ahead and revisited our own projections - which focus only on actual distributions.

Hard

It's a bit of a mug's game trying to pinpoint what might happen too specifically as there are many moving parts here. Overall, though, we conservatively assumed WHF would pay out $1.42 in 2022, just like in the years before and as we initially assumed. However, by 2023, we expect the dividend to jump up to $1.5000 as those higher rates and spreads and larger portfolio kick in, and even if there are losses of income from credits gone bad. In 2024, we expect an even higher payout of $1.5500. After that, we expect rates to come off the boil and through 2025-2026 to level out at $1.5000. It's only a 6% increase in 2026 that we had projected before, but material enough for an update. Baked into these numbers are material levels of realized losses and an eventual return to narrower spreads - all of which should temper the upward swing in profits.

Standing Firm

We're not changing the price/dividend multiple we've been using - which is mostly based on how high WHF has traded historically - and that remains at 12.00x. As a result, our target price for WHF has increased to $18.00. At the moment, the BDC is at $15.04 and has been as high as $16.22 in the past 52 weeks. That means there's a 20% price upside from here if we're right, and an 11% jump over the prior price record.

By The Numbers

At $18.00, WHF would trade at a 23% premium to its latest net book value per share, and that 2023 dividend (given that 2022 is almost behind us with 3 quarters of distributions already paid or announced) of $1.5000 amounts to a yield of 10.0% - which seems reasonable. As we write this, the total return we project for WHF is 69% or 13.9% per annum. 71% of the return will come from dividend payouts (which may include specials in the future). In the past 5 years, Seeking Alpha indicates the BDC's total return has been 87%.

Good. Not Great?

Comparisons are odious we're told but our model indicates the projected WHF return through 2026 is just about average amongst the 43 names we track. What the numbers don't fully reflect for investors is the unusually high level of reliability about distributions that has, and should continue, to come with investing in WHF.