Good afternoon. My name is Chloe and I will be your conference operator today. I would like to welcome everyone to the WhiteHorse Finance Third Quarter 2024 Earnings Conference Call. Our hosts 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 available for replay starting at 4:00 p.m. Eastern Time. The replay dial-in number is (402) 220-2572, with no passcode required. It is now my pleasure to turn the floor over to Robert Brinberg of Rose & Company. Please go ahead.
Thank you, Chloe, and thank you, everyone, for joining us today to discuss WhiteHorse Finance's Third Quarter 2025 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 could 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 the WhiteHorse Finance Third Quarter 2025 earnings presentation, which was 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, and good afternoon, everyone. Thank you for joining us today. We released our earnings this morning before the market opened, and I hope you've had a chance to review our results for the period ending September 30, 2025, which are also available on our website. I'll start by discussing our third-quarter results and current market conditions. Our Chief Financial Officer, Joyson Thomas, will provide a more detailed analysis of our performance, after which we will open the floor for questions. Our third-quarter results for 2025 were disappointing and reflect the beginning of interest rate cuts, ongoing pressure on market spreads, and the effects of significant markdowns on some previously discussed credits. Q3 GAAP net investment income and core NII were $6.1 million or $0.263 per share, down from Q2 GAAP and core NII of $6.6 million or $0.282 per share. NAV per share at the end of Q3 stood at $11.41, marking an approximate 3.6% decline from the previous quarter.
In addition to the roughly $0.12 shortfall in NII coverage for our Q3 base distribution, NAV per share was affected by net realized and unrealized losses in our portfolio totaling $6.7 million, or about $0.29 per share, which I'll elaborate on later. Due to these earnings and current market conditions, I have three key announcements. Firstly, in light of the current earnings capacity of the BDC and our expectations for lower interest rates along with ongoing spread compression, our Board of Directors has decided to reset our quarterly base distribution to $0.25 per share. This adjusted distribution rate corresponds to an implied annualized yield of 8.8% based on the company's NAV per share at the end of Q3. This was a tough but necessary choice. We believe this reset places us in a more advantageous position to sustain our base distribution moving forward, taking into account management’s anticipated earnings capacity of the BDC, future base rate shifts, and current market dynamics.
We will maintain our previously announced distribution policy framework from our Q1 2023 earnings call, which aims to provide our base distribution and potential supplemental distributions in the future. Should we experience recoveries from our nonaccrual and troubled investments, or if market conditions improve and base rates rise, we will be ready to distribute any additional earnings to our investors through supplemental or special distributions. Joyson will explain how our supplemental distribution policy is calculated shortly. Secondly, in response to recent disappointing results and as part of our ongoing commitment to aligning the interests of the adviser with those of our shareholders, the adviser has agreed to reduce the incentive fee on net investment income from its stated annual rate of 20% to 17.5% for the next two fiscal quarters ending December 31, 2025, and March 31, 2026.
This temporary reduction of 2.5 points in our income-based incentive fee will enhance financial support for our quarterly distributions to shareholders. The adviser may extend this voluntary reduction; however, future duration and extent are uncertain and will depend on ongoing discussions with the Board. Finally, due to the company's stock price being discounted relative to its book value, the Board has authorized a share buyback program of up to $15 million. Under this program, the company may choose to repurchase its outstanding common stock in the open market at current market prices at the discretion of WhiteHorse Finance's management team. The current share price signifies a discount of over 40% compared to its book value, which we believe will lead to beneficial share repurchases. Now, regarding portfolio activity: we made gross deployments of $19.3 million in Q3, which were more than countered by high repayments and sales amounting to $50.5 million, leading to net repayments of $31.2 million.
Our gross capital deployments included two new originations totaling $14.3 million and additional amounts to fund two add-ons to existing investments. We also had $0.5 million in net funding on revolver commitments. In Q3, our new originations comprised one nonsponsor and one sponsor deal, averaging about 3.5x EBITDA. All our Q3 deals were first lien loans with an average spread of 612 basis points. Repayments and sales were driven by complete or partial realizations in five portfolio positions, including BBQGuys, Lab Logistics, Power Plant Services, Coastal TV, and Ross-Simon. By the end of Q3, 99.2% of our debt portfolio remained first lien and senior secured, with an ownership mix of approximately 65% sponsor and 35% nonsponsor. The weighted average effective yield on our income-producing debt investments dropped to 11.6% at the end of Q3 from 11.9% in Q2, mainly due to lower spreads and base rates.
The overall portfolio's weighted average effective yield also slightly declined to 9.5% from around 9.8% at the end of Q2. During the quarter, the BDC transferred one new deal and four existing investments to the STRS JV. As of the end of Q3, the STRS JV portfolio was valued at $341.5 million with an average effective yield of 10.3%, down from 10.6% in Q2. We believe our equity investment in the JV continues to yield attractive returns. After accounting for net repayments and JV transfers, along with the realized and unrealized losses during the quarter, total investments fell by $60.9 million from the previous quarter to $568.4 million, compared to a fair value of $629.3 million at the end of Q2. During the quarter, we recorded $1.8 million in net realized losses and approximately $4.9 million in net unrealized losses, totaling $6.7 million in losses for Q3. Our mark-to-market losses primarily stemmed from write-downs in Alvaria and Camarillo Fitness.
Alvaria has been underperforming and struggling with its debt levels, leading us to mark down our position by about $1.7 million based on anticipated restructuring in Q4. Following the quarter, a lender group, which includes WhiteHorse, completed a restructuring that resulted in extinguishing our existing debt position for cash and equity consideration equal to our marked fair value at the end of September 30. Similarly, we marked down our position in Camarillo Fitness by approximately $4.4 million, and we are working to optimize its performance as it prepares for the new year enrollment period. As a partial offset to these markdowns this quarter, we provided an incremental add-on investment to motivational marketing after the quarter ended, helping merge that company with another portfolio company. This investment led to a significant reduction in leverage for motivational marketing and a slight markup of about $0.7 million.
The BDC also recorded $2.1 million in realized losses, which was partially mitigated by a reversal of around $1.7 million in previously recorded unrealized losses due to the restructuring of MSI Information Systems, which returned to accrual status as we anticipated. Nonaccrual investments represent now 2.7% of the debt portfolio at fair value, an improvement from 4.9% in the prior quarter. We are actively working to resolve nonaccrual deals with support from our dedicated restructuring team at WhiteHorse and H.I.G. Capital. On a more positive note, aside from the nonaccrual credits, our portfolio is performing quite well. Turning to the lending market, M&A activity has not picked up as much as anticipated, though there has been a steady improvement. Plenty of capital is still available despite the reduced supply of new financings, and the environment remains highly competitive, especially for companies with stable characteristics and limited international exposure.
Lenders in the sponsor markets are notably aggressive, while the nonsponsor markets are less competitive. In the mid-market, pricing for sponsor deals is quite solidly in the SOFR [450 to 500] range, as competition has narrowed spreads and OID typically runs 1 to 1.5 points. Lower mid-market sponsor deals range from [475 to 575] over SOFR, while leverage multiples range from 4 to 6x, with partial PIK features selectively applied for upper mid-cap and large-cap deals. The nonsponsor market remains much less competitive and attracts a significant pricing premium over the sponsor market. We typically see nonsponsor deals priced at SOFR plus [600] and above, with OID generally starting at 2 points or more compared to sponsor deals. Nonsponsor leverage levels remain consistently lower and stable compared to sponsor-backed deals. To highlight the attractiveness of the nonsponsor market, our nonsponsor mandates are currently leveraged only 3 to 5.5x, with the highest recent deal priced at SOFR [650] plus a warrant.
We continue to allocate significant resources to the nonsponsor market, which offers better risk-return profiles due to less competitive pressures, especially within the active sponsor market. Currently, we have 22 originators across 13 regional markets, focusing primarily on off-the-run sponsor deals and nonsponsor transactions in search of value and favorable risk returns amid limited deal flow. Since the end of the quarter, the BDC has completed one new deal and an add-on investment totaling $16.2 million and had one full repayment of $22.2 million. Following our deployment activities in Q4, the BDC’s remaining capacity is about $40 million, and after accounting for expected closings in the fourth quarter, our capacity for new assets is around $20 million. The STRS JV also had remaining capacity of approximately $20 million before recently mandated deals, which mean the JV’s capacity is nearing full deployment.
Currently, our pipeline is lower than usual for this time of year, comprising six new mandates and three add-ons to existing deals. Of our six mandates, two are nonsponsor and four are sponsor deals. While there's no guarantee that any of these will close, all credits would fit into the BDC or our JV if we proceed. The nonsponsor mandates are priced at [600] over SOFR or better, and are targeted for the BDC's balance sheet, with some larger mandates that will enhance our asset balances. The sponsor mandates offer pricing ranging from [425 to 550] over SOFR. With that, I will hand the call over to Joyson for further performance details and a review of our portfolio composition.
Thanks, Stuart, and thanks, everyone, for joining today's call. During the quarter, we recorded GAAP net investment income and core NII of $6.1 million or $0.263 per share. This compares with Q2 GAAP NII and core NII of $6.6 million or $0.282 per share, as well as our previously declared third-quarter base distribution of $0.385 per share. Q3 fee income was only approximately $0.1 million and was lower than historical quarters due to lower amendment and prepayment fee activity. For the quarter, we reported a net decrease in net assets resulting from operations of $0.6 million. Our risk ratings during the quarter showed that approximately 81.8% of our portfolio positions either carried a 1 or 2 rating, an increase from 76.8% reported in the prior quarter. Upgrades during the quarter included positions in Motivational Marketing and EducationDynamics, which were both upgraded to a 2, and positions in Telestream, which was upgraded to a 3.
As a reminder, a 1 rating indicates that a company has seen its risk of loss reduced relative to initial expectations, and a 2 rating indicates that the company is performing according to such initial expectations. Regarding the JV specifically, we continue to grow our investment. As Stuart mentioned earlier in the call, we transferred one new deal and four existing investments during the third quarter to the STRS JV, totaling $24.2 million. As of September 30, 2025, the JV's portfolio held positions in 43 portfolio companies with an aggregate fair value of $341.5 million, compared to 43 portfolio companies with an aggregate fair value of $330.2 million as of June 30, 2025. Leverage for the JV at the end of Q3 was approximately 1.24x compared with 1.16x at the end of the prior quarter. The investment in the JV continues to be accretive for the BDC's earnings, generating a mid-teens return on equity.
During Q3, income recognized from our JV investment aggregated to approximately $3.6 million, a slight increase from the $3.4 million reported in Q2. As we have noted in prior calls, the yield on our investment in the JV may fluctuate period-over-period as a result of a number of factors, including the timing and amount of additional capital investments, the changes in asset yields in the underlying portfolio, as well as the overall credit performance of the JV's investment portfolio. Turning to our balance sheet. We had cash resources of approximately $45.9 million at the end of Q3, including $36.4 million of restricted cash, and $100 million of undrawn capacity under our revolving credit facility. Following elevated repayments during the quarter, we repaid in full the $40 million of unsecured notes paying 5.375% interest that were due to mature on October 20. As of September 30, 2025, the company's asset coverage ratio for borrowed amounts, as defined by the 1940 Act, was 180.7%, which was above the minimum asset coverage ratio of 150%.
Our Q3 net effective debt-to-equity ratio after adjusting for cash on hand was approximately 1.07x compared with 1.22x from the prior quarter. Before I conclude and open up the call to questions, I'd like to discuss our distribution policy. This morning, we announced that our Board declared a fourth-quarter base distribution of $0.25 per share. To supplement Stuart's earlier comments, I note the company still has the ability under our existing distribution framework to issue supplemental distributions. Each quarter, the Board will utilize this framework to determine if a supplemental distribution should be made in addition to the regular base quarterly distribution. The framework the Board will use to determine the supplemental distribution, if any, will be calculated as the lesser of: one, 50% of the quarter's earnings that is in excess of the quarterly base distribution; and two, an amount that results in no more than a $0.15 per share decline in NAV over the current quarter and preceding quarter.
Earnings for the purpose of measuring the excess over the quarter's base distribution is net investment income. The NAV decline measurement is inclusive of the supplemental distribution calculated, and to be clear, is measured over the two most recently completed quarters. We believe this formulaic supplemental distribution framework allows us to maximize distributions to our shareholders while preserving the stability of our NAV, a factor that we do believe to be an important driver of shareholder economics over time. The upcoming $0.25 distribution will be payable on January 5, 2026, to stockholders of record as of December 22, 2025. As we've said previously, we will continue to evaluate our quarterly distribution, both in the near and medium term based on the core earnings power of our portfolio, in addition to other relevant factors that may warrant consideration. In addition to our quarterly distribution, we elected to declare a special distribution of $0.035 per share for stockholders of record as of October 31, 2025.
The distribution will be payable on December 10, 2025. This distribution was related to undistributed taxable income that was earned last year, which would have otherwise been taxable. With that, I'll now turn the call over to the operator for your questions.
And we will take our first question from Melissa Wedel with JPMorgan.
I wanted to start with the dividend and understand how you're approaching it with the announcement for the 4Q level of $0.25 a share. Should we be thinking about that as the new base level? Or is this going to be something that will fluctuate a little bit more quarter-to-quarter outside of the supplemental component?
Melissa, we took a look at where interest rates are, what interest rates are supposed to do in the future, where deployments are, what the current market spreads are, and the earnings power of the BDC given some losses on accounts that we've taken, both realized and unrealized losses. We came up with a sensitivity analysis that caused us to work with the Board to set a new base dividend that should be a long-term dividend if our projections as to market conditions and interest rates are correct. We set that at a level that we believe we can earn on a quarterly basis reliably even if interest rates do continue to decline in alignment with the current yield curve.
Okay. Appreciate that. And then as a follow-up, wanted to touch on the fee waiver. I'm curious about, I guess, two aspects of it, the level going to 17.5% from 20%, and the two quarters for 4Q and 1Q that that will apply to. I guess the question behind both is why that level and why that timeframe? Is there a longer-term consideration the Board is taking under advisement?
Thank you, Melissa. The Board and the manager discussed how to provide some cushion to the earnings capability of the BDC, and it was agreed that we would waive the 2.5% amount for the next two quarters. Moving forward, it will depend on discussions between the Board and the manager and will be tied to the results of the BDC.
And we'll take our next question from Robert Dodd with Raymond James.
Regarding the BDC and the joint venture, it seems you're nearing full investment capacity unless there are recoveries from some of the distressed assets. I appreciate the insights you've provided on these businesses. Can you share any additional thoughts on the timeline for turnarounds? As you mentioned, it might stretch into the first quarter before we see a resurgence in activity. What are your long-term expectations for fair value recovery of these troubled assets? This is important as it could influence potential reinvestments, a possible increase in the dividend, or additional capacity for the BDC. What can you tell us about the actual prospects in this regard?
Yes. Robert, the deals that are on nonaccrual right now, as I indicated in the prepared remarks, are likely to remain on nonaccrual for at least the next 12 to 24 months. In a number of cases, we have taken over the management of those companies, and our five-person restructuring team works cooperatively with H.I.G. private equity operating professionals to make sure that we're getting optimal management teams into those companies, cutting costs where appropriate, and driving growth strategies. The turnaround of those credits for the most part is a multiyear effort. In certain circumstances, as it regards to credits like Playmonster, we have taken it, and that was a credit where there was fraud originally, and we found out that the EBITDA of the company was actually pretty strongly negative. We have turned that company around, and the EBITDA is now positive. We believe we have a good management team, and we're hoping for improved results, not only this year but heading into next year.
So that would be a good example of an account that's heading in the right direction. But in order for us to get to a markup and a cash realization, we need to continue to turn that account around more than has already occurred so far. And the same is true for credits like Camarillo Fitness, which we're still working on. In all the cases, except for Alvaria and Camarillo, we're seeing stabilization to improvement in the performance of the company. But we do think it's going to be a significant period of time, again, at least 12 to 24 months before those assets that are on a nonaccrual come back on to accrual.
Could you provide insight on the performance difference between sponsor and nonsponsor deals? As you mentioned, sponsor deals typically have significantly higher spreads and lower leverage. However, in the event of issues, the responsibility falls on us to resolve them rather than the sponsor dealing with it. While the income returns are better for sponsors, what is the track record of the outcomes for these two different investment strategies?
Robert, in general, the leverage on the nonsponsor deals is anywhere from one turn to 1.5 turns lower than on the sponsor deals. Our track record historically has been that we see fewer defaults, sorry, fewer payment defaults on the nonsponsor deals. During COVID, we had a number of sponsor deals that went into payment default and needed equity support, but we did not have any nonsponsor deals that went into payment default during that COVID period. We've had one nonsponsor deal that has resulted in a significant loss. That was American Crafts, which is now fully resolved. But as I think through the nonaccruals, I believe all of the nonaccrual accounts at this point are actually deals that were sponsored deals, and none of them currently are nonsponsored deals, which speaks to the relative strength of what we do in the nonsponsor market.
Stuart, I think if we're considering perhaps non-income-producing restructured assets, Lift Brands might be one that we are looking at. I don't remember if it's a sponsor or nonsponsor deal.
No, no, no. Lyft Brands was a sponsor deal. That was a deal that during COVID, the private equity firm injected a significant amount of equity into turning around the company.
Let me double-check on the others and I'll come back on that. But I think that is correct. And the only other one I could think of is potentially Sklar, again, another non-income-producing or a portion of the equity, which is non-income producing.
But I believe Sklar, which is nonsponsor, is on accrual. Yes, so Sklar is also a company that we had to take control of. We have dramatically improved the performance of that credit since taking control of it. That is a credit that if it hits its projected numbers for next year based on new customers that have been signed up and additional EBITDA we expect to be earning, that is a credit, again, it's on accrual right now. The debt is paying interest in cash, but we own the equity and there is potential for an equity gain upon the sale of that credit next year if we are able to hit our projected numbers.
I understand, thank you for that. I have one more question. Regarding pricing, it seems that even in the lower middle market for sponsor deals, pricing is relatively tight compared to historical standards. Is that a result of increased competition from larger market players entering this space due to a lack of activity at the higher end, or is it simply your long-term competitors becoming more aggressive in their approach?
It's a really good question, Robert. The compression of mid-market spreads is largely due to major market players not having sufficient volume and entering the mid-market, which increases the supply of capital. In the mid-market, we're generally seeing pricing around 450 to 500. This has certainly been influenced by the larger players moving down market. In the lower mid-market, we aren't really seeing these larger players, but several new organizations have emerged without established relationships in the industry. Some of these firms are attempting to gain market share by reducing prices and/or using higher leverage on deals. Therefore, the lower mid-market, where there are numerous private equity firms operating, is much more variable, with pricing ranging from 475 to 575 depending on the level of competition for specific deals and the complexity of the credit. However, I don't think that lower mid-market spreads have been significantly affected by the larger firms. When I mention lower mid-market, I'm referring to EBITDA below $30 million.
And we will take our next question from Christopher Nolan with Ladenburg Thalmann.
And it really revisits the incentive fee reduction. Once we're beyond first quarter '26, if the EPS continues to underperform, what's the, I guess, state of mind or headspace in terms of lowering that incentive fee or continuing it?
So the Board of Directors has provided us a perspective that the forgiveness of the incentive fee or the temporary reduction of the incentive fee is aligned with trying to make sure that we are earning the dividend. If there is underperformance in terms of core dividend earnings, I would expect that the Board would take a view that they would seek additional forgiveness or additional waiver of that 2.5% for additional quarters. But six months is a significant amount of time in the market, and we all need to see what is going on with M&A volume, spreads in the marketplace, and core interest rates in terms of what the Fed is doing to have a better sense of what earnings will be out in three or four quarters or more from now.
Understood. And I guess on the share repurchases, if I were to read your comments earlier, it seems like deal flow seems to be slow. Should we read into that, that the company will be aggressive on share repurchases?
Chris, we're trading at a very significant discount to NAV, even off of the reduced NAV that I showed you today of $11.41. Buying back shares at levels anywhere around today's price is highly accretive for shareholders, both in terms of NII and NAV. Given limitations in how many shares we can purchase in any given day or week, we felt a $15 million allocation made a lot of sense to recapture shareholder value if the shares did not materially trade higher. So we, as a manager, are going to try to act in the interest of the shareholders and repurchase shares so long as there is a material benefit to the shareholders in doing so.
And it does appear there are no further questions at this time. This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful afternoon.
Thank you.