WhiteHorse Finance, Inc. 10-Q

Item 1A. Risk Factors In addition to the below risk factor and other information set forth in this report, you should carefully consider the “Risk Factors” discussed in our annual report on Form 10-K for the year ended December 31, 2020, which could materially affect our business, financial condition and/or operating results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially affect our business, financial condition and/or operating results. We intend to continue to finance our investments with borrowed money, which will magnify the potential for gain or loss on amounts invested and may increase the risk of investing in us. The use of leverage, including through the issuance of senior securities, magnifies the potential for gain or loss on amounts invested. We have incurred leverage in the past and currently incur leverage through credit facilities and issuance of public and private notes. From time to time, we intend to incur additional leverage to the extent permitted under the 1940 Act. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. In the future, we may borrow from, and issue senior securities, to banks, insurance companies and other lenders. Holders of these senior securities will have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such holders to seek recovery against our assets in the event of a default. WhiteHorse Credit has pledged, and expects to continue to pledge, all or substantially all of its assets. WhiteHorse Credit has granted, and may in the future grant, a security interest in all or a portion of its assets under the Credit Facility. In addition, under the terms of the Credit Facility, we must use the net proceeds of any investments that we sell to repay amounts then due with respect to our debt and certain other amounts owing under the Credit Facility before applying such net proceeds to other uses, such as distributing them to our stockholders. We may pledge up to 100% of our assets and may grant a security interest in all of our assets under the terms of any debt instruments into which we may enter. In addition, under the terms of any credit facility or other debt instrument we enter into, we are likely to be required by its terms to use the net proceeds of any investments that we sell to repay a portion of the amount borrowed under such facility or instrument before applying such net proceeds to any other uses. If the value of our assets decreases, leverage would cause our net asset value to decline more sharply than it otherwise would have had we not leveraged, thereby magnifying losses or eliminating our equity stake in a leveraged investment. Similarly, any decrease in our revenue or income will cause our net income to decline more sharply than it would have had we not borrowed. Such a decline would also negatively affect our ability to make distributions on our common stock or preferred stock. Our ability to service our debt will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. In addition, our common stockholders will bear the burden of any increase in our expenses as a result of our use of leverage, including interest expenses and any increase in the management fee payable to WhiteHorse Advisers. ​ 79 ​ As a business development company, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock that we may issue in the future, of at least 150%, subject to certain disclosure requirements, as is specified in the 1940 Act. If this ratio declines below 150%, we cannot incur additional debt and could be required to sell a portion of our investments to repay some debt when it is disadvantageous to do so. This could have a material adverse effect on our operations, and we may not be able to make distributions to our stockholders. As of September 30, 2021, our total outstanding indebtedness was $384.6 million and our asset coverage was 184.2%. The amount of leverage that we employ will depend on WhiteHorse Advisers’ and our board of directors’ assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that we will be able to maintain our borrowings under our existing indebtedness or to obtain other credit at all or on terms acceptable to us. For information regarding a reduction in the asset coverage ratio applicable to us, see Item 1A. Risk Factors -- “ The SBCAA allows us to incur additional leverage, which may increase the risk of investing with us ” in our most recent Annual Report on Form 10-K. In addition, the terms governing our existing indebtedness and any indebtedness that we incur in the future could impose financial and operating covenants that restrict our business activities, including limitations that may hinder our ability to finance additional loans and investments or make the distributions required to maintain our ability to be subject to tax as a RIC. The instruments governing our existing indebtedness contain terms and conditions for senior unsecured notes issued in a private placement, including minimum stockholders’ equity, minimum asset coverage ratio, maximum debt to equity ratio and prohibitions on certain fundamental changes of the Company or any subsidiary guarantor. These instruments also contain customary events of default with customary cure and notice periods, including, without limitation, nonpayment, incorrect representation in any material respect, breach of covenant, cross-default under other indebtedness of the Company or certain significant subsidiaries, certain judgements and orders, and certain events of bankruptcy. The breach of any of the covenants or restrictions, unless cured within the applicable grace period, would result in a default under the applicable indebtedness arrangement that would permit the lenders thereunder to declare all amounts outstanding to be due and payable. In such an event, we may not have sufficient assets to repay such indebtedness. As a result, any default could have serious consequences to our financial condition. An event of default or an acceleration under these arrangements could also cause a cross-default or cross-acceleration of another debt instrument or contractual obligation, which would adversely impact our liquidity. We may not be granted waivers or amendments to these arrangements if for any reason we are unable to comply with them, and we may not be able to refinance such arrangements on terms acceptable to us, or at all. The reduction of our asset coverage requirement from 200% to 150% increases the amount of debt that we are permitted to incur, such that the Company’s maximum debt to equity ratio increased from a prior maximum of 1.0x (equivalent of $1 of debt outstanding for each $1 equity) to a maximum of 2.0x (equivalent to $2 of debt outstanding for each $1 of equity). Increased leverage could amplify the risks associated with investing in the Company. For example, if the value of the Company’s assets decreases, although the asset base and expected revenues would be larger because increased leverage would permit the Company to acquire additional assets, leverage will cause the Company’s net asset value to decline more sharply than it otherwise would have without leverage or with lower leverage. Any decrease in the Company’s revenue would cause its net income to decline more sharply, on a relative basis, than it would have if the Company had not borrowed or had borrowed less. ​ 80 ​ The following table illustrates the effect of leverage on returns from an investment in our common stock as of September 30, 2021, assuming that we employ leverage such that our asset coverage equals (1) our actual asset coverage as of September 30, 2021 and (2) 150%, each at various annual returns, net of expenses and as of September 30, 2021. The purpose of this table is to assist investors in understanding the effects of leverage. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below. ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Assumed Return on Our Portfolio (Net of Expenses) ​ -10% -5% 0% 5% 10% Corresponding return to common stockholder assuming actual asset coverage (1) (25.5) % (14.9) % (4.3) % 6.3 % 16.9 % Corresponding return to common stockholder assuming 150% asset coverage (2) ​ (35.6) % (20.9) % (6.2) % 8.4 % 23.1 % (1) Assumes $729.6 million in total assets, $384.6 million in debt outstanding and $323.7 million in net assets as of September 30, 2021, and an average cost of funds of 3.6%, which is our weighted average borrowing cost as of September 30, 2021. (2) Assumes $992.4 million in total assets, $647.4 million in debt outstanding and $323.7 million in net assets as of September 30, 2021, and an average cost of funds of 3.1%, which would be our weighted average borrowing cost assuming 150% asset coverage as of September 30, 2021. Based on our outstanding indebtedness of $384.6 million as of September 30, 2021 and an average cost of funds of 2.47%, 6.00%, 6.50%, 5.375%, 5.375% and 5.625%, which were the effective annualized interest rates of the Credit Facility, 2023 Private Notes, 2025 Public Notes, 2025 Private Notes, 2026 Private Notes and 2027 Private Notes, respectively, as of that date, our investment portfolio must experience an annual return of at least 2.0% to cover annual interest payments on our outstanding indebtedness. Based on our outstanding indebtedness of $647.4 million on an assumed 150% asset coverage ratio and an average cost of funds of 2.47%, 6.00%, 6.50%, 5.375%, 5.375% and 5.625%, which were the effective annualized interest rates of the Credit Facility, 2023 Private Notes, 2025 Public Notes, 2025 Private Notes, 2026 Private Notes and 2027 Private Notes, respectively, as of that date, our investment portfolio must experience an annual return of at least 2.1% to cover annual interest payments on our outstanding indebtedness. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Mine Safety Disclosures Not applicable.