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BDC Shareholder: WhiteHorse Finance Balks At Any Fee Concession – CORRECTION

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9/4/2018: Note From The Editor: After we wrote the article below on August 14, 2018 we received an email  from WHF’s investor relations representative pointing out – correctly – that using the June 2018 Incentive Fee number was unfairly onerous  as this included a booked Capital Gains fee (for the Aretec) transaction. As a result, annualizing the quarter’s Incentive Fee does not give a fair representation of the the BDC’s recurring compensation cost.  We’ve been asked and have agreed to publish this update  to one of the paragraphs of the article. The sentences in red were supplied by WHF:

Summed Up

In the June 2018 quarter WHF received a Management Fee of $2.067mn and a Income Incentive Fee of $3.891mn.[] [This $3.9m incentive includes the Aretec incentive accrual.  Without this incentive total annualized fees would be $3.758m, compared to their $5.958]

On an annualized basis that amounts to $23.8mn.[compared to $15.0]  [should not include the Aretec incentive accrual when annualizing NII]

As a percentage of total assets of $538.5mn at June 30, 2018, this amounted to 4.4%.[adjusted would be 2.8%]

By way of comparison, Net Investment Income in the latest quarter was $4.607mn or $18.4mn.

Of total Net Investment Income Before Compensation, the External Manager received 56% and shareholders 44%.[] When calculating % to Manager and % to Shareholders, one should also factor out the cap gains incentive fee (or normalize) when coming up with NII Before Manager Compensation.

We were also asked to make available WHF’s latest earnings press release and Conference Call transcript. Just click on the links.

Unfortunately, the communication from WHF’s investor relations representative did not address the main issues contained in the article. Namely that WHF has one of the highest compensation arrangements in the BDC Sector and that the higher leverage envisaged by the Board and Investment Advisor is likely to result in even larger payments while any increase in the BDC’s earnings or distributions remains in doubt.

Maybe these issues – critical to long term shareholder returns – will be adressed at a later stage and in a different forum.


BDC Shareholder is a new feature of the BDC Reporter which reviews how “shareholder friendly” Business Development Companies really are, using the principle of paying regard to what they do, rather than what they say. We seek out items regarding manager compensation; corporate governance and transparency; many of which may not receive much attention elsewhere but which affect shareholders. In all cases, we seek to quantify how actions taken by BDC insiders may effect – for better or worse – investor performance.

WhiteHorse Finance (WHF)

Shareholder Approval

On August 6, 2018 WHF announced that on August 1 shareholders approved “immediately becoming subject to a minimum asset coverage ratio under the Small Business Credit Availability Act of at least 150%, permitting the Company to double its amount of debt incurrence earlier than the current effective date of May 3, 2019”.

During the BDC’s IIQ 2018 Conference Call, CEO Stuart Aronson announced the results of the vote, and provided additional guidance:

..We recently held our Annual Shareholders Meeting where shareholders approved the proposal for increasing our leverage on the terms and conditions of the Small Business Credit Availability Act for the near-term we intend to manage the BDCs leverage between 1and 1¼ times based on net asset value as of June 30, 2018. The impact of these new leverage levels could increase investable assets between $61 million to $137 million.

Unchanged

However,  WHF did not make any change, either in the run-up to the shareholder vote or subsequently to the compensation paid to the BDC’s external Investment Advisor.

Currently, WHF charges 2.0% of “consolidated gross assets, including cash and cash equivalents and assets purchased with borrowed funds” on a per annum basis.

In addition, there is a 20% “Income Incentive Fee based on Pre-Incentive Fee Net Investment Income”, with a 7.00% “hurdle rate”.

The Incentive Fee includes  a 12 quarter so-called “look-back provision” intended to ensure shareholders do not pay more than 20% of “Cumulative Pre-Incentive Fee Income”.

The calculation takes into account both net investment income recognized as well as changes in Realized and Unrealized Gains. See page 26 of the 10-Q for a fuller discussion.

This can result in Incentive Fees that would otherwise be paid to the Manager being deferred and potentially available for payment for the following 12 quarter period.

Non Cash 

WHF has also agreed that any income in the form of Pay In Kind is only paid out when received in cash – along with interest thereon – “from the date of deferral to the date of payment”.

Summed Up

In the June 2018 quarter WHF received a Management Fee of $2.067mn and a Income Incentive Fee of $3.891mn.

On an annualized basis that amounts to $23.8mn.

As a percentage of total assets of $538.5mn at June 30, 2018, this amounted to 4.4%.

By way of comparison, Net Investment Income in the latest quarter was $4.607mn or $18.4mn.

Of total Net Investment Income Before Compensation, the External Manager received 56% and shareholders 44%.


IMPACT OF HIGHER LEVERAGE

Should WHF – as projected above by management –  add another $137mn in assets, its Management Fee should increase annually by $2.74mn.

How much the Incentive Fee might increase is harder to calculate.

We estimate an incremental $1.1mn per annual.

Comparisons

Recently two BDCs have announced their intention to charge a flat 1.0% Management Fee on all assets.

These are Goldman Sachs BDC (GSBD), which made the offer subject to shareholders approving the higher leverage rule, which they subsequently did.

Barings, BDC (BBDC) – as part of taking over as External Manager of Triangle Capital – agreed to charge a 1.0% Management Fee for a finite period, and has also received shareholder approval of the higher leverage.

PennantPark Floating Rate (PFLT) and Solar Senior Capital (SUNS) both have charged a 1.0% Management Fee since going public, but are also targeting higher leverage.

PFLT has received Board approval and will increase its leverage limit in 2019. SUNS is seeking shareholder approval shortly.

Moreover, a number of BDCs increasing their leverage limit have chosen to reduce their Management Fee to 1.0% (typically from 1.5%) on all assets OVER the historical limit.

Currently several BDCs have adopted this stance, which will result in a much smaller benefit to shareholders: typically between one fifth and one third compared to a 1.0 MF from dollar one.

The WhiteHorse Stance

When asked on its Conference Call about the fee policy, WHF’s answer was as follows:

We have certainly noted the announcements that have been made by a number of other BDCs in regard to lower fees on assets that are invested at leverage at over one times and that will be an active discussion point among the management of the company, but no decisions on that have been reached at this time.


QUANTIFICATION

If WHF were to reduce its Management Fee to 1.0% from dollar one of assets, the annual savings – assuming the extra $137mn on top of existing assets – would be $3.375mn.

That would increase Net Investment Income Per Share by $0.16 annually.

However, that number would be reduced by a higher Income Fee that might total $0.03, leaving the pro-forma benefit of $0.13.

Currently, Core Net Investment Income Per Share is $1.324 annualized.

If WHF were to only offer the discounted Management Fee on assets acquired over the historic limit, the savings for shareholders would be $0.69mn annually.

This savings would likely be offset by 20% by a higher Net Incentive Fee, leaving the pro-forma benefit at $0.55mn.

On a per share basis that would result in higher earnings per share for shareholders of under $0.03 per annum.


BDC SHAREHOLDER VIEW

Long Way To Go

WHF already charges one of the highest Management Fees of any BDC, and is one of a rare number who charge a fee on assets held in the form of cash.

Just to be in the middle of the pack of BDCs for a base fee, WHF would need to cut its fee by 25% and remove the charge on cash.

On the other hand, the Look-Back feature on Incentive Income and the hold back on paying fees on Pay-In-Kind Income is more “shareholder friendly”.

Note, though, that the BDC has very little PIK income and from the filings we cannot detect that any material fee holdback is occurring.

However, we have little illusion that the Board or the External Manager are considering a change of any kind to the Base Management Fee.

Guesswork

More likely – but with no certainty – WHF might concede to charge a lower MF (0.5% ?) on assets acquired over the historical limit.

As we’ve seen in the Quantification section, this will provide shareholders only a very modest benefit if implemented and only if WHF fully utilizes its new self imposed leverage limit.

Payout Change

Nor should shareholders necessarily expect that distributions (which have been very steady at $0.355 per quarter for 23 periods in a row) will increase based on the larger asset size.

Management has announced its intention to use the greater borrowing power to reduce the risk in the portfolio (current yield 12.0%) by investing in lower-risk, lower yield assets.

The extra leverage may improve the sustainability of the distribution but might not result in a higher payout.

As a result, if WHF remains on the current course, the absolute dollars received by the External Manager may increase with the higher leverage but the amounts paid to shareholders stay the same.


CONTACT INFO

WHF shareholders with a view to express may contact the BDC in the following manner, which we’ve copied from the website:

For WhiteHorse Finance Investor Relations inquiries, please contact us at:
1450 Brickell Avenue
31st Floor
Miami, FL 33131
Directions and map
Phone: (305) 381-6999
Fax: (305) 379-2013
investorrelations@whitehorsefinance.com

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