Morningstar DBRS Confirms WhiteHorse Finance, Inc.'s Long-Term Credit Ratings at BBB (low) With Stable Trends

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

KEY CREDIT RATING CONSIDERATIONS
The credit ratings reflect WhiteHorse's sound franchise underpinned by its advisory relationship with H.I.G. WhiteHorse Advisers, LLC (the Adviser), which is an affiliate of H.I.G. Capital, a global alternative asset manager with $64 billion of capital across multiple investment funds. WhiteHorse has a long-standing track record and established lower-middle market lending platform which generates sufficient earnings from its predominantly floating-rate investment portfolio. The Company's funding profile is also well-diversified and includes a material portion of unsecured debt, with well-laddered maturities. The credit ratings also consider the Company's sizeable portion of non-sponsored investments and lower middle market focus which increases the potential for credit risk which is partially mitigated by its highly diversified, first lien focused investment portfolio. Moreover, 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 has been historically strong with low leverage at the portfolio companies and strong risk-adjusted yields.

The Stable trend reflects Morningstar DBRS's expectation that WhiteHorse will continue to generate acceptable operating results despite potential earnings pressures should base rates decline over the medium-term, which would be offset by the recent 0.25% decrease in the base management fee. The Stable trend also incorporates a modest deterioration in credit performance as non-accruals continue to increase from specific portfolio company issues, including broad weakness in consumer demand.

CREDIT RATING DRIVERS
Over the longer-term, sustained earnings growth and lower leverage while maintaining a similar risk profile would result in a credit ratings upgrade. Conversely, should operating performance materially worsen, including notable losses that erode net asset value, or significant credit deterioration, the credit ratings would be downgraded. Should the Company's capital buffer to regulatory requirements materially decrease for a sustained period, the credit ratings would also be downgraded.

CREDIT RATING RATIONALE

Franchise Building Block (BB) Assessment: Good / Moderate
WhiteHorse has a sound franchise in lower middle market lending, that is underpinned by its relationship with H.I.G. Capital. The Company focuses on debt investments to both sponsor-backed (63.4% of investment portfolio at fair value at 1Q24) and non-sponsored lower middle market U.S. companies across industries. The Company also utilizes a joint-venture with State Teachers Retirement System of Ohio (STRS JV) to syndicate lower-yielding assets in order to enhance its profitability and manage portfolio concentrations. At March 31, 2024, the Company's investment portfolio totalled 120 investments across 71 companies with a fair value of $697.9 million.

Earnings Building Block (BB) Assessment: Moderate
WhiteHorse has sufficient earnings generation that is supported by relatively strong investment yields which generate consistent investment income through primarily recurring interest income. The Company has generated an annual net profit over the last seven years, with a net increase in net assets resulting from operations (net income) of $20.4 million in 2023, up from $15.7 million in 2022, as base rates remained at relatively high levels. For 1Q24, net income was $6.0 million, down modestly from $7.5 million for 1Q23, driven by realized losses in two portfolio companies. With credit spreads tightening due to increased direct lending competition, the Company's weighted average effective yield on the total portfolio totalled 12.1% at 1Q24, down from 12.4% in 4Q23 and down from 12.6% at 1Q23. We expect WhiteHorse will continue to generate sufficient earnings in 2H24supported by the Company's focus in originating loans in the off-the-run sponsor market as well as in the non-sponsor market where spreads have remained attractive.

Risk Building Block (BB) Assessment: Good / Moderate
WhiteHorse's risk profile is considered acceptable, even with an increase of non-accruals to 3.3% of the debt investments at cost as of 1Q24, up from 0.5% at 1Q23, driven by consumer-related portfolio companies and others idiosyncratic portfolio company challenges. The Company's exposure to non-sponsored portfolio companies (36.6% at 1Q24) carries some additional risk from a lack of other institutional financial support in times of crisis; however, this channel provides a differentiated set of origination opportunities with better pricing and lower leverage than traditional sponsor-originated transactions. Smaller hold sizes and the Company's diversified portfolio also helps mitigate potential credit risk, and keeps concentration risks minimal.

Funding and Liquidity Building Block (BB) Assessment: Moderate
WhiteHorse's funding profile is fairly diverse, with a capital stack that is more unsecured than other BDCs of its size, with approximately 49% of its debt financing in unsecured form. As of March 31, 2024, WhiteHorse had $394.5 million of debt outstanding with a weighted average cost of 6.5%, comprised of $194.5 million of unsecured notes and $200.0 million drawn on its revolving credit facility. 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 as the Company has approximately $135 million of capacity remaining under its credit facility. Additionally, the Company had $10.7 million of cash on its balance sheet, which combined with its revolver capacity is more than sufficient to meet the $20.7 million of unfunded commitments at 1Q24.

Capitalization Building Block (BB) Assessment: Moderate / Weak
Capitalization is considered acceptable, though the Company's target of 1.35x debt-to-equity is somewhat elevated for lower middle market assets which includes both non-sponsored and sponsor-backed portfolio companies. At 1Q24, gross debt-to-equity was at 1.26x, which is still well inside the regulatory limits of 2.0x. Morningstar DBRS estimates that WhiteHorse would need to incur losses of $116 million, or 17% of its investment portfolio at fair value, to breach the cushion to the asset coverage ratio (ACR).

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (15 April 2024) https://dbrs.morningstar.com/research/431187. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

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

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

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

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

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit 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. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.
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