Imagine Print Solutions: On Non Accrual

A few days ago, when Oxford Square (OXSQ) was holding its conference call, an analyst noted that the number of non accrual companies on its books had increased from 1 to 2. When asked who the new non-performer was, management demurred, pointing to the soon-to-be-published 10-K for the answer. Now that filing has been made, we now know the new non-accruing company was Imagine! Print Solutions (aka The Imagine Group). The BDC has invested $14.9mn in the second lien debt – which has been on our underperformers list since IIQ 2018 and was rated CCR 4 most recently, as OXSQ discounted the position by (51%) as of the IIIQ 2019. In light of what we’ve learned, the company credit rating has been dropped to a 5 our our 5 point scale.

Now the 2023 Term Loan has been placed on non accrual, and the discount increased to (85%). OXSQ may have been reticent to provide information but we know Moody’s downgraded the already speculative grade company to Caa3 from Caa1 in December 2019. This extract from Moody’s report should provide a sense of what is going wrong: “The company’s revenue and profitability significantly declined in 2019, driven by the loss of a material customer and significant weakness in its Midnight Oil subsidiary. This resulted in very high financial leverage on a debt/EBITDA basis of 9.1x for the twelve months ending October 2, 2019, up from 6.1x at the end of fiscal year 2018“.

Clearly the company is highly likely to file for Chapter 11 or restructure shortly. Chances are the second lien will not survive any remaking of the company’s capital structure. OXSQ will be losing ($1.6mn) of annual investment income permanently in the most likely scenario. We should note that non-traded Audax Credit BDC has a small $1.4mn position in the company’s 2022 first lien Term Loan, discounted only (15%) at 9/30/2019. However, judging by the parlous condition of the borrower and looking at Advantage Data’s Middle Market Loans pricing module at time of writing, the current discount may be (60%).

It’s no wonder that OXSQ’s management may not have wanted to engage in any discussion of Imagine, as the final outcome for the BDC and – to a lesser degree- for Audax , seems pretty grim.

Mallinckrodt Intl Finance SA: Settlement Agreed. To File Chapter 11.

Well, that was fast. Just one day after the BDC Credit Reporter – informed by the Wall Street Journalheard Mallinckrodt was beginning negotiations with its vast array of creditors, a deal has been done. Besides agreeing a settlement with ” 47 states and U.S. territories and lawyers representing thousands of local governments”, the pharmaceutical firm at the center of the opioid crisis has also worked out a deal with its lenders. Apparently that involves swapping out existing debt for longer dated debt. Part of the overall arrangement is a trip to bankruptcy court for the U.S. subsidiary of the Dublin-based company, but the parent will not be filing.

There’s a lot to unpack here, but given the relatively small BDC exposure, we don’t have to. Suffice to say that Barings BDC (BBDC) – if it still has a position – will probably continue to accrue income on its debt after the swap occurs. Unknowable is whether the BDC will have to write-off a portion of its debt because of the maturity swap, or be able to write-up its investment given the settlement. In either case – good or bad – the impact on the BDC will be modest and a credit shadow removed.

Of course, agreeing a deal and closing a deal are two different things. Much can happen in Chapter 11 that a company might not have expected but given the buses full of creditors who’ve been involved in this negotiation, we’re more optimistic than usual. We’ll now await both BBDC latest results and the exit from bankruptcy to be able to tie this up.

Mallinckrodt Intl Finance SA: Begin Negotiations With Creditors

Apparently, controversial drug maker Mallinckrodt PLC has begun confidential discussions with its creditors. That didn’t stop “people familiar with the matter” calling up the Wall Street Journal and confiding the key elements of the company’s game plan. The Irish parent of the company is considering a bankruptcy filing for its U.S. generic drug business. That’s one potential element to find a solution to the liabilities associated with the numerous lawsuits faced relating to the opioid crisis. The BDC Credit Reporter last wrote about the subject on September 9, 2019. Even then bankruptcy was being mooted.

At the time of our last report, we surmised that the only BDC with exposure – Barings BDC or BBDC – would have to further discount its position when the IIIQ 2019 results were published. That’s just what happened, with the discount on the 2024 Term Loan being increased from (9%) to (25%), which was very close to our September 9 estimate.

We’ll be interested to see what happens when BBDC reports IVQ 2019 results. The discount already taken may be adequate at this stage. However, if the company does file for Chapter 11 – and we’re aware that there’s financial gamesmanship going on in these breathless anonymous confessions to the WSJ – income will be interrupted for the first time. On the other hand, for all we know BBDC has managed to extricate itself from what is going to be a very long and complex situation and what the ultimate resolution will be is impossible to pre-determine. We’ll find out more when those latest BBDC results come in.

AAC Holdings: Forbearance Extended

Back on January 30, 2020 we wrote that troubled publicly traded AAC Holdings (aka American Addiction Centers) had negotiated an extension to its forbearance agreement with its lenders after a prior falling out. That provided some hope that borrower and lenders – who’ve been going back and forth for many months – would eventually come to some sort of modus vivendi, as opposed to ending up in court arguing.

Now we hear from a company press release that the parties “have reached an agreement to extend the deadline to enter into a restructuring support agreement with its senior secured lenders from February 21, 2020 to March 20, 2020“. Such an extension had been contemplated back in January, as we discussed at the time after reading the legal agreement:

“Even that date is not fixed, as the parties have agreed the forbearance is “subject to extension in the discretion of the Forbearing Lenders if the Company shall not have entered into agreements embodying the material terms of a consensual financial restructuring among the Company and the parties to the Credit Facilities“.

This new extension of the extension allows the company to draw another $2mn from funds committed by the lenders.

We’re not sure if the fact that this negotiation keeps going on and on is a good sign or not. Rather than draw any conclusions from what little information we have, we’ll just wait for the next chapter in this long saga. We’ve now written over 10 articles about AAC Holdings ! We can say,though, that the total amount advanced – based on Capital Southwest’s (CSWC) IVQ 2019 financials – has increased from the $66.2mn balance as of September 30, 2019. The lenders are anteing up funds to keep the business solvent. By the time all 4 BDCs involved report their exposure, the cost could be over $70mn and potentially subject to further increases. Sometimes you’ve got to spend money to save money seems to be the philosophy here.

Outdoor Voices Inc.: CEO Departs

Typically, the BDC Credit Reporter adds new companies to our underperforming company list following a write-down of the investment by 10% or more by a BDC. However, we watch the credit markets daily for any early signs that might cause us to add a company based on new publicly available information alone. After all, the earlier we can identify credit troublespots, the better. That’s what’s happened with retailer Outdoor Voices Inc., which at September 30, 2019 was fully valued by its only BDC lender TriplePoint Venture Growth (TPVG).

We were disturbed to hear from a trade article that the company’s CEO and co-founder Tyler Haney was either pushed out or voluntarily left the helm on February 22, 2020, which is rarely a good sign. (Ms Haney remains in other roles at the company; the benefit of being a founder and major shareholder). Adding to our concern is that the CEO’s departure may be associated with under-performance by the privately-held company. BizWomen said the following: “…despite initial excitement, the business failed to scale as quickly as expected and has been slow to introduce workout clothing staples like all-black attire, per BofF, and by last year was losing around $2 million a month in 2019 with annual sales of around $40 million“. That’s enough material for us to add Outdoor Voices to the underperformers list, with an initial credit rating on our five point scale of three.

TPVG only invested in the company recently – IQ 2019 – with both debt and equity at a total cost of $10.2mn. As we’ve said, the investment is valued at 100% of par, which seems hard to reconcile with those $2mn a month losses, but we only have a very partial picture. We may learn more from TPVG when the BDC reports IVQ 2019 results on a date yet to be scheduled.

Juul Labs: SEC Launches Investigation

We’ve written about Juul Labs, and it’s relationship with deep-pocketed minority investor Altria before. Now we hear from a Wall Street Journal report that the SEC is taking an interest in one of the largest melt-down in a company’s value in recent memory. According to the WSJ “E-cig makers have until May 20 [2020] to submit to the FDA applications to have their devices approved for sale on the market”, but Juul may have problems getting the nod, even with Altria’s help.

As before, we remain unclear how the ongoing uncertainty at Juul will affect the two BDCs with exposure – the two BlackRock public BDCs : Blackrock Capital Investment (BKCC) and BlackRock TCP Capital (TCPC). Neither BDC has yet reported IVQ 2019 results, so our valuation and exposure data remains from the IIIQ 2019. We shall wait and see.

Craftworks Restaurants & Breweries: To Restructure

According to the Wall Street Journal’s Bankruptcy publication, Craftworks Holdings (aka Craftworks Restaurants & Breweries) is considering a restructuring of its debt. Or filing Chapter 11. Craftworks is the owner of several well known restaurant chains, including Logan’s Roadhouse, acquired in 2018, after filing for bankruptcy in 2016. We looked around for any further information in the public record about this rumored restructuring, but found none.

BDC exposure to Craftworks – according to Advantage Data’s records – is very recent, starting in the IIIQ of 2019 and includes three FS-KKR BDCs: FS-KKR Capital (FSK) and the non-traded FSIC II and FSIC III. Total exposure at cost – and all in second lien debt due 2024 – is $13.4mn. However, that’s exactly the same amount that those three BDCs advanced to Logan’s Roadhouse, so we assume there’s been some reclassification and assumption of debt. The relationship with Logan – which has been fraught – dates back to 2010.

As the above shows, the BDC Credit Reporter knows very little but we’ll speculate that whatever happens – bankruptcy or restructuring – the junior nature of the BDCs status ensures that a complete write-down or write-off is more likely than not. We may learn more when FSK reports its latest results, scheduled for February 27, 2020.

NPC International: In Forbearance Agreement With Lenders

This has been brewing for a long time (we’ve been writing about the company since June 2019) but NPC International has failed to make debt interest payments on its first and second lien debt; gone into default and been – temporarily – reprieved in the form of a “forbearance agreement” from its lenders. Furthermore, earlier in 2020, NPC received a new $35 million loan to improve liquidity. “The terms of the super-priority loan, which was provided by existing lenders, prevent the company from making payments on the second-lien term loan, the people said“.

As you’d expect Moody’s and S&P were not happy about what has happened and called a non-payment payment of interest what it is – even if the lenders chose to forebear : a default and sharply downgraded the company.

All the above comes from Bloomberg, which also reports that management and its PE sponsor are considering all options (who doesn’t ?); including a Chapter 11 filing. That would allow the company to push back against lease contracts, which would make sense.

For months, we’ve had NPC rated CCR 4 and placed on our list of companies that we expect will file bankruptcy or drastically restructure in 2020. Given the depths of the company’s troubles – very high debt; liquidity crunch; declining industry sector – there’s an aura of inevitability about this story.

For the only BDC with material exposure – Bain Capital or BCSF – that means the likely wipe-out of its second lien debt, which is currently trading at 5 cents on the dollar. BCSF also holds the first lien debt, which is trading at 48 cents on the dollar. If those discounts hold, BCSF will be taking a realized loss of ($11.5mn), out of the $14.2mn committed. Unfortunately, as of September 2019, the BDC had only reserved ($8.3mn), so there’s nearly another ($4mn) to go. Also, $1.2mn of investment income will be suspended, and most of that is unlikely to be coming back post-conclusion of any restructuring. For a huge BDC like BCSF not a major blow, but hardly immaterial either.

The collapse of NPC has happened over a relatively short period, according to Advantage Data records. BCSF signed up in the IQ of 2017. Until the IIIQ 2018, all the debt was carried at or above par. Since the IVQ 2018, though, every quarter has brought a further devaluation. We added the company to the under performers list when BCSF devalued some of its debt greater than (10%) in the IQ 2019, and has been CCR 4 – our Worry List – since the IIQ 2019. Our latest update on these pages was in August 2019 and by then the die was almost cast. In a more general sense, this chronology supports our view that we should start paying attention whenever a company’s previously stable valuation starts to erode. That may provide some false negatives, but also provide a little more lead time about credits going awry. By the time the actual default occurs – as in this case – most of the damage is done.

VIP Cinema Holdings: Files Chapter 11

Well, that’s embarrassing. For the last few weeks we’ve prided ourselves on having identified all BDC-funded companies that are under-performing. However, we’ve now learned that cinema seat manufacturer VIP Cinema Holdings has just filed Chapter 11, and that there are 3 BDCs involved and $24mn invested at cost who are about to take a haircut. VIP Holdings was not on our under performers list. All BDC exposure is in a 2023 Term Loan. We should have placed the company on the under performers list in the IIIQ 2019 (the last one reported) when the debt was discounted up to (25%), versus (8%) the prior quarter. The BDCs involved are Garrison Capital (GARS); Main Street (MAIN) and non-traded HMS Income, which is managed by MAIN.

The company appears to have a plan in place to allow a fast exit from bankruptcy: a debt-for-equity swap with the existing lenders that will see $178mn in debt extinguished out of $210mn and new capital brought in by a PE group – H.I.G. Capital. Reuters reports that the company “hopes to emerge from bankruptcy by mid-April, while preserving 373 jobs”

For the record: VIP was founded in 2008 in New Albany, Mississippi, as a residential furniture maker and reportedly has a 70% share of the U.S. market for luxury movie theater seating.

Questions have to be asked about lenders underwriting a single product company which services an industry (movie houses) whose troubles are well known. Also, when a borrower has a 70% market share the most likely direction is usually down. Still, we don’t know exactly how the BDCs involved will fare and exactly what portion of their debt will be converted to equity and what kind of realized loss – if any – will be booked. That’s likely to become evident in the IQ or IIQ 2020 results.

This new non accrual/bankruptcy is notable – besides from the fact that we missed the name in our research- for the speed at which the company went from performing to non performing. This credit dates back to IQ 2017, according to Advantage Data. As mentioned above VIP’s debt was valued close to par through IIQ 2019. Just a few months later virtually all its debt has to be written off for the business to be viable. This begs questions about the valuation process of the BDCs involved as we can’t imagine the slowdown in VIP’s sales was a very recent phenomenon. We worry that BDC lenders – and the army of valuation experts that review their investments just about every quarter – are only recognizing problems when they are right in front of them and inescapable. That’s good for manager compensation levels and keeps investors from worrying for a while, but may keep matters that should be brought into the open in the dark.

Belk Inc.: Lay-Offs Announced

This is the BDC Credit Reporter’s first article about Belk Inc., the revered North Carolina department store company. However, we’ve had Belk on our radar – and on the under performers list – since IVQ 2016. No wonder: the business of Belk is retail and you know what’s happened to that…

Furthermore – and worrying – is the large amount of BDC capital invested in the debt and equity of the company. Mostly the former. At 9/30/2019 there were 6 BDCs involved with a combined $170mn invested at cost in various debt tranches and a sliver of common stock. The FMV was $128mn, and may go lower when IVQ 2019 results get published. According to Advantage Data, which keeps a list of all BDC funded companies by capital committed, Belk was the 103rd largest investment, out of 4,000 or more companies out there.

The BDC with the most to lose is FS-KKR Capital (FSK), which has committed $122mn, or 72% of the total – all in junior debt or equity. In the IIIQ 2019, there was an amendment made to the debt, and the second lien was split into two. One tranche is carried at par and the second – larger – amount was discounted in value even more than before. See the discussion on FSK’s Conference Call.

As far back as June of 2019 S&P was on the record with a downgrade to CCC, and the contention “a debt exchange that we would view as distressed could occur over the next 12 months”. For our part – not to be outdone – we long ago added the retailer to our list of companies that we expect to default or be restructured in 2020.

All the above is to explain why we’re writing about what might be – or might not – a minor development (except to the individuals involved) at the company: the lay-off of 80 personnel at headquarters. This seems to be yet another sign that all is not well in North Carolina and there may be other shoes to drop. We’ll be keeping close tabs – including those fourth quarter 2019 BDC valuations and any color coming from conference call.

APTIM Corp: Lawsuits Filed Against Company-UPDATED

On February 13, 2020, we heard that APTIM Corp – an engineering services – company was “slapped” with two new lawsuits. The company is accused of not paying for the work of sub-contractors related to the clean-up after two recent hurricane disasters. The BDC Credit Reporter does not typically write an article every time a BDC portfolio company is sued because we would be posting constantly. However, this is a good opportunity to review our concerns about APTIM and its possible impact on the 5 BDCs involved. The public funds are Main Street Capital (MAIN) and Great Elm Corporation (GECC) and non-listed FS Investment III and IV and HMS Income Fund, which is managed by a MAIN subsidiary. Total exposure – all in the 6/1/2025 Term Loan – is $30.8mn at cost. The latest valuation was at September 30, 2019, and the FMV was just under $25mn. Income involved is approximately $2.7mn annually.

We’ve noticed that the value of the 2025 Term Loan has been declining. According to Advantage Data’s records, the debt was most recently discounted by (43%), suggesting the BDC values of last September will shortly be adjusted downward when year end 2019 results are published. Moreover, it’s worth remembering that the debt has been rated Caa2 by Moody’s since mid-2018.

At this stage we don’t have enough information to predict the company might file for Chapter 11 or restructure or default, but given the above context we would hardly be surprised. We will circle back – if need be – after MAIN reports on February 28, 2020. (GECC does not have an earnings release date yet).

UPDATE: (February 20, 2020) We’ve since heard S&P Global Ratings affirmed its CCC+ rating on the company, but revised its outlook to “Negative” from “Stable”. Seems to confirm that we were right to flag APTIM at this time.

J.C. Penney: Sales Down. Debt “Untenable” ?

Just a brief update about highly troubled J.C. Penney’s. (We’ve already written six times previously about the famous retailer). A Seeking Alpha article on February 13, 2020 reports same-store sales over the Christmas/New Year period were down (7.5%). The article’s author – using company numbers for projected 2020 EBITDA – estimates debt to EBITDA could reach 8.8x. Debt is called “untenable”. Notes that the stock price has “broken the buck”. As of today the stock closed at $0.71.

We already have a CCR 4 rating on the company and recently added Penney’s to companies we expect to file to Chapter 11 and go on non accrual in 2020. We reiterate our opinion based on the most recent data. Not helping the situation is that the retailer’s liquidity – as mentioned in the article – is very modest so matters could go south very fast.

BDC exposure remains at what we knew last time we wrote, back on November 19, 2019. When we hear from the 4 BDCs involved about IVQ 2019 results the exposure numbers could change.

Akorn, Inc.: Lenders Extend Standstill, Company To Be Sold

Akorn, Inc. has been in trouble ever since a proposed sale to a third party fell through last year for all the wrong reasons. Since mid-2019, the company has been operating under a “standstill agreement” with its lenders, and much negotiation has been happening behind the scenes. We last wrote about the company and its troubles back on December 18, 2019. At that point, we had a rating of CCR 4 on Akorn, suggesting we believed that a bankruptcy or restructuring, and some sort of realized loss, was more likely than not.

Now we hear – thanks to a February 12, 2020 press release – that certain lenders have agreed to an indefinite extension of the” standstill agreement”. More importantly – and the reason for the lenders apparent patience – is an agreement that the company will immediately seek a buyer. There’s even an agreed schedule and provisions for a “pre-packaged” Chapter 11. If no sale occurs then a default will occur and we’ll be potentially back in bankruptcy court, but under different conditions. The lenders goal: ensuring Akorn is sold to ensure their debt is paid in full. As of September 2019, Akorn reported $835mn in debt, all due the minute the borrower and the lenders cannot agree. All of the above suggests the Akorn story will come to a conclusion of some sort in 2020, and sooner rather than later if matters go well.

From a BDC perspective there’s only BDC with exposure – and not much at that. Garrison Capital (GARS) has $2.0mn invested in the 2021 Term Loan, marked at a modest (7%) discount. The BDC – and the market if we are to believe what the debt is trading for – seem to believe the lenders will “get out” without any material loss. Not so the shareholders of the company who have seen their stock price drop in the last two years from $33 a share to $1.36. That suggests there is not much room for any further decline in Akorn before lenders join common stockholders to share the financial pain. Still, with annual investment income at risk of only $0.166mn and a modest potential book value loss, GARS is unlikely to be much affected one way or another.

Hudson Technologies Company: Update

We last wrote about refrigerants distributor Hudson Technologies back in mid-2019, and we were not optimistic about the outlook for the business. We had rated Hudson CCR 4 and anticipated that a restructuring or bankruptcy filing was possible. Since then, the underlying business of the company has continued to deteriorate; the existing working capital lender (PNC) has been replaced by a new one (Wells Fargo) ; the Term debt covenants have been reset and the common stock of this public entity may shortly be de-listed from NASDAQ. Not to mention that Hudson ended the IIIQ 2019 with a “Going Concern” anvil above its head.

Nonetheless – and to their credit – Hudson is still with us. Thanks to the new facility and the amendment/waivers from its Term Lenders, the company lives to fight another day. On Seeking Alpha at least one author is projecting that “great days lie ahead” for shareholders.

We’re sorry to throw cold water on all this, but our review of the Term Loan Amendment and the attendant measures agreed between the company and its lenders does not reassure us. It’s true that the lenders – in the short term – have agreed to an incredibly high new leverage level (16.57x this quarter), but that quickly ramps down to “just” 10.67x in the following three months. Moreover – and ominously – lenders have required the appointment – at a cost of $120,000 a month – of a Chief Restructuring Officer (CRO) brought in from Grant Thornton. He took up his post on January 2, 2020. There’s much more besides that causes us to believe this is more a transition to an eventual bankruptcy or major restructuring than a good odds rescue effort within the current capital and ownership structure. This provision in the amendment illustrates what we mean:

The Fourth Amendment also adds a new covenant providing that in the event of a breach of a financial covenant contained in the Term Loan Facility or any failure to make a required principal repayment (a “Trigger Event”), then on or prior to six months after a Trigger Event, the Company shall commence a process to (x) sell its businesses and/or assets, and/or (y) consummate a refinancing transaction with respect to the Term Loan Facility (a “Transaction”), in each case, subject to enumerated time milestones contained in the Fourth Amendment, and which requires that Transaction shall, in any event, be consummated on or prior to the eighteen (18) month anniversary of the Trigger Event.

BDC exposure to Hudson is major – just over $100mn – and the debt involved (the 2023 Term Loan referenced above) was discounted (44%) at September 30, 2019, according to Advantage Data. When we hear from the FS-KKR organization about IVQ 2019 results, we’ll be interested to see if the valuation has been increased in light of the amendment. Even if it has, we will continue to be highly skeptical of the company’s odds of survival in its current form. For the BDC lenders involved – including publicly traded FS-KKR Capital (FSK) with $38.5mn at cost – there is a large amount of investment income at risk: about $12mn a year. Given that the company is public and FSK will shortly be reporting its valuations, expect to hear back from us with yet another update sooner rather than later.

VPROP Operating LLC: In Default

Ares Capital (ARCC) reported its IVQ 2019 results on February 12, 2020 and held a Conference Call. Included in the latter was substantial disclosure about a new non-accruing loan: VPROP Operating LLC (also known as Vista Proppants and Logistics). At some point in the last three months of 2019, the company’s debt became non-performing. According to Advantage Data records and ARCC’s 10-K , total BDC exposure – all ARCC’s – was $158.400mn at cost. At the end of 2019, an equity investment of $9.7mn had been written to zero and the 2021 Term Loan,in which the rest of the exposure lies, was discounted (25%). Fair market value dropped to $111.1mn, from $150.8mn the quarter before. ARCC has lost for the time being ($17.3)mn of annual investment income.

VPROP has been an Ares investment since the IVQ 2017 in an almost unchanged amount. Till the IIQ 2019 there were no signs of strain in the quarterly valuations. Then, the equity investment – which had been trading at a premium – moved to a (22%) discount. In the IIIQ 2019, the equity discount doubled and the 2021 Term Loan was ever so slightly written down. Now the equity is fully written down and the debt is deeply discounted and no income is being received.

ARCC’s manager let listeners know that the company was hurt in 2019 by oversupply in the business of selling sand to Texas fracking companies, which led to the default. The company is working with its creditors – including ARCC – on an unspecified “restructuring”. We’d guess that means some sort of “debt for equity swap” where lenders such as ARCC receive all or some of the stock in the privately held company. Unfortunately, the general state of the oil services industry – in which VPROP neatly fits – is poor. So patching together a structure that gives the company a chance to succeed with a new capital structure is tough. However, there’s very little information about the company in the public record so we may have to rely on ARCC for further updates on the progress of the reshaping of VPROP.

For our part, we have downgraded the company from a Corporate Credit Rating of 3 on our scale to a 5, which means non performing. There’s plenty of room for the valuation to drop further yet, but we have no way of evaluating which way performance might go. It should be noted, though, that the amounts “lost” so far, both in book value and income, are some of the highest we’ve seen inflicted on a single BDC, even one with over $14bn in portfolio investments. We will revisit the company whenever we gain additional information.

Maxus Capital Carbon: Restructured

There are numerous portfolio companies that BDCs finance which are privately-held and for which there is little or no public information. We are reliant on whatever the BDC involved is willing to divulge about what is going on. A prime example is Maxus Capital Carbon (aka Carbonfree Chemicals), a chemical plant that was financed by Apollo Investment (AINV) starting back in 2013. The initial funding was a $60mn Term Loan, due in 2019, and with a 13.0% interest rate.

Something seems to have gone wrong with Maxus/Carbonfree (aka Skyonics) as AINV had to ante up a $6mn Subordinated Loan as well in late 2017 and more capital in 2018. As far as we can tell the obligations have been extended and or increased or repriced at least 4 times up until September 2019. At that point, AINV had $63mn in debt to the company and $9mn invested in equity. The debt had an interest rate of 5%, which was being paid in PIK form and had a 2021 maturity. The equity was written to zero. In round numbers, AINV had $72mn invested and an FMV of $56mn.

Now we learn – if only in a response to a question from an analyst on the latest AINV Conference Call – that Maxus has been restructured again. The debt has been extended to 2024 – still at the same rate- but has been reduced in amount to $30mn and valued at par. AINV now has equity in an affiliated company as well in Carbonfree Chemicals SA, with a cost of $14.3mn and an FMV of $10.2mn. Here’s how AINV’s CEO Howard Widra explained the various trade-offs associated with this Brave New World for Maxus:

Basically what was running this project both to produce profit as well as to build off an IP value of sort of a carbon-free technology. Our restructure basically changed our deal to sort of align us directly with that equity investor. So we had — we both had debt on our operating company, if you will, and we had ownership in the IP that is monetizable in other places, we believe, and has raise money at a good valuation. And so what we have done in terms of sort of the stability of the — so one, we’ve diversified our collateral, if you will. So we basically, the position now has both the previous collateral had before, which is this plant, and it also has this IP, which is separately — has separate value. That’s one. And two, because of that and because of allocating a portion of the value to that equity, the debt that the operating company is forced to carry is now much lower. So the cash flow profile of that entity is — it’s easy for it to service that debt. It’s still driven by a commodity price. So it can still have some variability on its ability but it now has less debt, so it has a much lower burden of debt. Also, no PIK, you don’t want to accrue anymore. So it’ll be — it’ll have something like $33 million of debt that will pace steadily that it could cover, which is far less than it had covered before. And then we have the separate pool of value. And so we view it as meaningfully de risked from where it was before. Obviously, we’re rolling down as well. So there’s let debt. There’s less debt to service and there’s more collateral”.

Evaluating whether the restructuring is fair or foul is impossible for us to do. Too complicated. We feel we’re on stronger ground with the following assertions of fact: First, interest income from Maxus will be greatly reduced going forward given the smaller amount of debt outstanding, costing the lender about ($1.6mn) of annual investment income. Second, AINV booked a Realized Loss of ($9mn) in the IVQ 2019 on this investment. The BDC also booked unrealized depreciation of ($2.9mn).

Notwithstanding all the above, it’s not clear that the underlying business is viable or capable of generating a return, so we are retaining Maxus on the Under Performers List – where it’s been since IVQ 2016 – and with a CCR rating of 4 (Worry List). With $55.2mn remaining in value, and $1.6mn of investment income still in doubt, this complex tale is far from over.When we learn more – and what – will probably be dependent on what AINV is willing to divulge.

Oliver Street Dermatology: Defaults On Debt

Right up front we have to warn that the BDC Credit Reporter is playing the “name game” here. Here’s the background: Bloomberg reported on February 5, 2020 that “U.S. Dermatology Partners has defaulted on a $377 million financing provided by a group of investment firms, according to people with knowledge of the matter“. The article went on to say the debt was funded – at least in part – by BDC offshoots of Golub Capital (GBDC); Carlyle Group (CGBD) and Ares Management (ARCC). The rub ? No such company name exists in the Advantage Data records, nor even the prior name of the business: Dermatology Associates.

After much rifling through virtual files, we’ve worked out that GBDC carries its portion of the unitranche debt – which is nominally publicly traded – as Oliver Street Dermatology and has a $27.5mn investment at cost, all but $0.2mn of which is in the May 2022 unitranche loan. At September 30, 2019 that debt was discounted between (12%) and (18%). CGBD’s exposure is even bigger ($73mn) and goes under the name Derm Growth Partners III. Like ARCC, CGBD has a sliver of equity in the company ($1mn), valued at zero. The debt – in that same 2022 unitranche loan – was discounted (30%). We’ve not been able to clarify if ARCC has any exposure to the troubled company under yet another name.

What we do know is that we placed the company on the Under Performers List with a CCR 3 rating in the IQ 2019, when the equity stake was written down by CGBD by (86%), after being carried at a 45% premium the quarter before. That kind of valuation change is what draws our attention to previously performing companies.

The rating was dropped to CCR 4 when the debt – as mentioned above – was discounted (30%), compared to (13%) in the IIQ 2019. Now, with the default, we’ll be downgrading the company by whatever name to CCR 5.

We know a little about what’s ailing the privately-held company from CGBD’s last Conference Call: “We’re working through some operational and financial performance challenges with the sponsor and the company“. CGBD, though, waxed optimistic about any ultimate outcome because “this is a first lien tranche“. Still, if we read the filings right, the interest rate on the debt has been upped by 1.0% recently and was entirely on PIK through September 2019 – typical signs of credit weakness.

Now we seem to be looking at yet another “debt for equity swap” – a favored resolution in these situations amongst leveraged lenders, who move from lender to owner, or some hybrid thereof. We’ll wait for further details before drawing any grandiose conclusions but, given the $100mn of public BDC exposure to the business – owned by ABRY Partners since 2016 – this is a story worth following.

Commercial Barge Line: To File Chapter 11

All the way back on January 18, 2020 we added Commercial Barge Line (aka American Commercial Lines) to our Bankruptcy Imminent list, based on news reports that a restructuring was in the offing. Rarely does a peaceful restructuring these days omit a quick side trip to bankruptcy court along the way. On February 4, 2020 the Wall Street Journal reported the company will shortly file for Chapter 11 protection for a “pre-packaged” transaction. In this case, the company has negotiated a $1.0bn “debt for equity swap” with its lenders and a $690mn in new financing, mostly asset-based.

For the two BDCs involved, that will actualize the losses already booked through September 2019 ($7.0mn in total of unrealized) and more. The discount in the IIIQ 2019 was (38%-41%). At the moment, the 2020 syndicated Term Loan, in which both BDCs are invested, is trading at a (55%) discount. That suggests another ($2.7mn) could be written off, or close to ($10mn) in all. However, just how Great Elm Corporation (GECC) and FS-KKR Capital (FSK) value the equity that they’re likely to receive remains to be seen. (GECC has much the bigger exposure).

Also unknown is whether the two BDCs have signed up for the new financing as well, which might see their total exposure to the company from a cost standpoint rise rather than reduce after the trip through bankruptcy court is completed. The most likely outcome, in the short term, is that no more investment income will be recognized on the 2020 Term Loan, and a great deal less when the restructuring is completed.

This could be just a way station for one or both BDCs if they retain equity in the company. For the moment, we are downgrading the company to CCR 5 from CCR 4 and waiting to learn more when GECC and FSK report results for the year end 2019 and IQ 2020. Most likely – if and when the restructuring occurs – the company will emerge with new owners and a CCR 3 rating.

KLO Acquisition: Closes Plant

We don’t have the full picture on KLO Acquisition (aka Hemisphere Design Works). As always with privately-held companies with financial difficulties, information is doled out unevenly. We most recently wrote about the company – which boasted of being the largest manufacturer of kayaks over several brands – back on November 24, 2019.

Now we hear from local publications that the manufacturer is preparing to close a third – and final – manufacturing plant in Muskegon, Michigan. As required by law, the company informed its employees and the state, on January 27, 2020 of the projected closure of a plant at Remembrance Road in Muskegon. In October 2019 two other plants in the town were officially slated for closure.

That does not mean the company is out of business. Management may be retrenching to other facilities in other areas. However, the news does suggest that the troubles that have plagued the company – a combination of of Muskegon-based KL Outdoor and Montreal, Canada-based GSC Technologies – have not abated.

The public debt in which the two BDCs with $16.6mn of exposure at cost continues to be on non-accrual and discounted by two-thirds in value. We hope to hear more – and get fresh valuations – when Apollo Investment (AINV) and sister non-traded BDC Cion Investment report results in the next few weeks. At the moment, though, this “first lien” loan investment in KLO looks like a bust, with likely realized losses of ($11mn) or more. That’s twice the amount provided for at September 30, 2020 so chances are we’ll see further write-downs in the IVQ 2019 results.

Bluestem Brands: Drops Rating and Downgraded

Just in case you didn’t know, it’s the companies themselves who pay for their credit ratings from groups like Moody’s and S&P. (That’s different than at the BDC Credit Reporter, whom nobody pays). We were reminded of this economic fact of life on hearing that Moody’s has “withdrawn’ the ratings of retailer Bluestem Brands. The rating firm – usually prone to long discussions in its regular credit reports – was succinct on this occasion: “Moody’s has decided to withdraw the ratings because of inadequate information to monitor the ratings due to the issuer’s decision to cease participation in the rating process“. No other explanation was given.

Apparently S&P Global has not been any kind of succor. That rating group downgraded the company on January 28, 2020 to CCC- from CCC..Here’s the crux of the matter as S&P sees it: “

Bluestem’s revolver and term loan are due this year and we believe the likelihood that the company will undertake a restructuring in the near term has increased.  The company’s $200 million asset-based lending (ABL) facility matures in July and its term loan (roughly $400 million outstanding) comes due on Nov. 7, 2020. In our view, Bluestem does not have a clear refinancing plan and we believe it is increasingly likely that the company will pursue a holistic debt restructuring to address its maturities given its weak operating performance. If the company pursues a restructuring or exchange that provides its lenders with less than they were originally promised under the security, we would view it as distressed and tantamount to a default”.

We’ve written on three earlier occasions about Bluestem, starting back in the spring of 2019. As far back as June 2019, we had a Corporate Credit Rating of 4 on the company – on our five point scale. More recently, when we began projecting out which BDC-financed under-performing companies were most likely to default in 2020, Bluestem was one of our first additions. Now there seems to be a consensus building that the company will not be able to avoid either a “distressed debt exchange” or a Chapter 11 filing in the months ahead.

For the 4 BDCs involved – all in the 2020 Term Loan, which is structurally subordinated to the Revolver (as far as we can tell) – that’s bad news. Not helping is that S&P is only projecting a 45% recovery rate in event of default. That implies ultimate losses of over ($15mn) over cost, or about ($6mn) more than already provided for at September 30, 2019. Then there’s the $2.7mn of annual investment income at risk of interruption…

We expect to be revisiting Bluestem – and its intractable balance sheet inside a retail sector in seemingly permanent crisis – before long.