DBRS Morningstar Assigns Long-Term Ratings of BBB (low) to WhiteHorse Finance, Inc. with a Stable Trend

DBRS, Inc. (DBRS Morningstar) has assigned a Long-Term Issuer Rating of BBB (low) and Long-Term Senior Debt rating of BBB (low) to WhiteHorse Finance, Inc. (WhiteHorse or the Company). The trend on the ratings is Stable. The Company’s Intrinsic Assessment (IA) is BBB (low), while its Support Assessment is SA3, resulting in WhiteHorse’s final ratings positioned in line with its IA.

KEY RATING CONSIDERATIONS
The ratings reflect WhiteHorse’s established lower-middle market lending platform and track record, as it benefits from higher overall base rates and generates acceptable earnings from its predominantly floating-rate investment portfolio. The Company has a diversified funding profile, including a material portion of unsecured debt, with well-laddered maturities. WhiteHorse is managed by H.I.G. WhiteHorse Advisers, LLC (the Adviser) an affiliate of H.I.G. Capital, a global alternative asset manager with $55 billion of capital across multiple investment funds. While WhiteHorse does not benefit from an explicit guarantee from H.I.G. Capital, the ratings are underpinned by the Adviser’s expertise, broad scale and deal sourcing capabilities. The ratings also consider the Company’s sizeable portion of non-sponsored investments whose risk is partially mitigated by its highly diversified, first lien focused investment portfolio. We consider the Company’s leverage target of 1.35x debt-to-equity as somewhat elevated for the underlying assets, but note that the performance of the non-sponsored investments have been historically strong with low leverage and strong risk-adjusted yields.

The Stable trend considers the turmoil in the U.S. banking system and the potential for a worsening macroeconomic environment. While the recent bank failures had no direct impact on WhiteHorse, overall bank stress and financial market volatility may pressure middle market and lower middle market companies with limited access to capital. The lender-friendly private credit market with higher spreads and better documentation is balanced by WhiteHorse’s constrained origination capacity as gross leverage remains near target levels combined with the slowdown in traditional M&A transactions that have historically driven deal flow.

RATING DRIVERS
Over the longer-term, solid profitability and operating performance along with sound credit fundamentals would lead to a ratings upgrade. Conversely, the ratings would be downgraded if there is a sustained reversal of earnings performance that erodes net asset value or if dividend distributions are not covered by net investment income for an extended period. A material increase in non-accrual investments or a sizable loss that significantly reduces the Company’s capital buffer to regulatory requirements would also result in a ratings downgrade.

RATING RATIONALE
WhiteHorse's sound franchise is based on the Company’s long-standing track record through multiple economic cycles and underpinned by its relationship with H.I.G. Capital, a global alternative asset manager with $55 billion of assets under management.

WhiteHorse focuses on directly originated investments to privately held, lower middle market U.S. companies (enterprise value of $50 million to $350 million) across a broad range of industries with investment sizes of $5 million to $25 million. WhiteHorse benefits from H.I.G. Capital’s investment capabilities and deep knowledge of the lower middle market. The Company has co-investment exemptive relief from the SEC which allows for the WhiteHorse and H.I.G. Capital platform to underwrite larger transactions of more than $25 million and for assets to be syndicated across H.I.G. Capital’s other managed vehicles, including a WhiteHorse joint-venture with State Teachers Retirement System of Ohio (STRS JV). The Company’s investment portfolio was $728.4 million at 2Q23, and we expect it to remain similarly sized until capacity constraints are relieved, as WhiteHorse has limited access to new equity capital and is already at its leverage target.

Positively from a credit perspective, WhiteHorse has shifted its investment focus from junior capital investments and non-sponsored portfolio companies into senior secured (first lien) investments backed by financial sponsors. At 2Q23, 81% of the investment portfolio (95% including the STRS JV) was invested in first lien investments and 65% were sponsor-backed, compared with 52% first lien investments and 32% sponsor-backed at 4Q17. Overall, WhiteHorse’s investment portfolio consisted of 70 portfolio companies at 2Q23.

WhiteHorse’s top line revenue has benefitted from a 300 basis point rise in base rates over 2022 and net investment income has strengthened despite a smaller investment portfolio. The Company has generated an annual net profit over the last six years, with a net increase in net assets resulting from operations (net income) of $15.7 million in 2022 compared to $30.1 million in 2021. The reduction in earnings for 2022 was driven by a realized loss in a legacy non-accrual investment in a syndicated loan. For 1H23, net income was $11.4 million, down modestly from $13.1 million for 1H22. We note that the Company’s only losses have been from the syndicated loan market, and WhiteHorse no longer invests in these loans, instead pursuing its own direct, private credit opportunities. The all-in weighted average portfolio yield was 12.5% at 2Q23, up from 9.0% at 4Q21.

WhiteHorse’s risk profile is considered acceptable, as non-accruals increased to 4.0% of the cost of debt investments at 2Q23 driven by consumer-related portfolio companies and others that had operational challenges due to market pricing, independent of current economic conditions. We note that the exposure to non-sponsored portfolio companies (35% at 2Q23) carries some additional risk from a lack of other institutional financial support in times of crisis. In our view, financial sponsors are incentivized to protect their equity investments by investing additional capital when a business turnaround is necessary and view sponsor support as a first line of defense. As the Company’s loans are substantially all floating rate with interest rate floors, earnings will continue to benefit from any further interest rate hikes.

WhiteHorse’s funding profile is fairly diverse, with a capital stack that is more unsecured than other BDCs of its size, with approximately 44% of its debt financing in unsecured form, and 56% from its secured revolving credit facility at 2Q23. The Company has successfully tapped the public and private debt capital markets with a number of smaller issuances, with well-laddered maturities out through 2028. Liquidity is adequate, considering unfunded commitments of $38.8 million, compared with available capacity on the credit facility of $66 million, along with $10.4 million of cash, proforma for the $30 million repayment of 6.0% senior notes that matured on August 7, 2023.

Capitalization is considered acceptable, though the Company’s target of 1.35x debt-to-equity is somewhat elevated for lower middle market assets which are a mix of non-sponsored and sponsor-backed. At 1.32x gross debt-to-equity at 2Q23, the Company was still well inside of regulatory limits of 2.0x. DBRS Morningstar estimates that WhiteHorse would need to incur losses of $113 million, or 16% of its investment portfolio at fair value to breach the cushion to the asset coverage ratio (ACR).

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (July 4, 2023).

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions: https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions. (September 2, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings: https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors (July 4, 2023).

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The primary sources of information used for this rating include Morningstar, Inc. and Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com

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