Instituto De Banca Y Comercio Inc: IVQ 2020 Status

Instituto De Banca Y Comercio is a trade school for bank personnel in Puerto Rico, which we’ve been tracking for years. The only BDC with exposure is Ares Capital (ARCC), dating back to 2007 when the for-profit business was bought out by a PE group: Leeds Equity Partners. At one point, ARCC held a position via its joint venture with GE Capital but bought back its position – following some complex accounting – in 2016 when the company was non performing and the BDC was breaking up with its JV partner. At the end of 2020, this now 13 year relationship consisted of total exposure of $121mn in the form of debt and preferred, with a FMV of $32.3mn. $17.3mn in first lien debt is accruing at 10.5%, and there is $103.7mn in preferred. We’re not sure if ARCC is booking any income on the preferred, which only has a value of $15.0mn.

We don’t know how the business is performing but the valuation trend is unchanged between IVQ and IIIQ 2020. ARCC does not mention the company much anymore since the buyout of the GE position from the JV in 2016. Understandably, given the near ($90mn) written down already, the BDC Reporter has a CCR 4 rating on the company. Should the debt go on non accrual ARCC would forgo ($1.8mn) of annual interest income. A full realized loss of the preferred would reduce net assets by ($15.0mn). These are sizeable numbers but not especially material for a BDC of ARCC’s size.

We have no reason to believe anything is going to happen soon as the debt is not due till 2022, and the public record is bare on any details on how the company is performing, so we don’t have Instituto as Trending, but it is a Major exposure being over $100mn at cost. We’ll check back periodically to see how outstandings and valuations change on this “zombie” investment that just keeps going and going without much in the way of resolution. ARCC has extended the debt at least 4 times since 2007.

ADG, LLC: IVQ 2020 Update

ADG, LLC (dba Great Expressions Dental Centers) is a BDC portfolio company we should have written about ages ago for a number of reasons. First, BDC exposure is Major: $106mn at cost, almost all held by Ares Capital (ARCC), with New Mountain Finance (NMFC) holding a $5.9mn second lien position. Second, the company was underperforming by our standards even before the pandemic and since everyone’s been sheltering in place, has been on non accrual since IQ 2020. Finally, we’re projecting the company is Trending, i.e. likely to materially change in value in early 2021. More on that at the end. Although we’ve not written about ADG, LLC before we’ve been tracking the business in our Company Files and in our daily search for new developments.

Here’s the lie of the land: At year-end 2020, ARCC had a small first lien debt position of $7mn, half the size of the quarter before and performing, valued at a (10%) discount to par. The BDC also holds an $89mn second lien debt position due 3/1/2024 that is on non accrual but discounted only (12%). NMFC also holds a second lien debt position – maturing at the end of March 2024 – and discounted (24%). However NMFC’s debt – which may or may not be in the same facility – is not carried as non performing but its 11.0% yield is all Pay-In-Kind. Then there’s $3.0mn in equity held by ARCC (which has a very long standing relationship with the company that predates its current PE owner) , valued at zero. The total FMV for all positions and both BDCs is $89mn. ARCC is forgoing about ($7.5mn) of annual investment income due to the non accrual.

There’s no up to the minute news in the public record but the BDC valuations have been greatly improving in the last three quarters. That suggests the business is turning around. We do know that the whole dentistry sector is on the upswing after some dark months last year when dental chairs were off limits in many states due to Covid-infection fears. Sadly, neither ARCC or NMFC has mentioned ADG on their conference calls. Nonetheless, we’ll go out on a limb and suggest there’s better news ahead. That’s why we have ADG, LLC “Trending”, with the prospect of higher debt or even equity valuations and the possibility the second lien debt might return to performing status.

For the moment ADG, LLC remains rated CCR 5 but we’ll be looking out for ARCC’s disclosure about the company on April 28, 2021 when its IQ 2021 results get published.

Mississippi Resources LLC: Major Realized Loss Booked

Understandably enough BDCs are loath to discuss with their shareholders losses taken on portfolio investments gone wrong. Managers prefer to spend time on their successes; latest deployments and just about anything but setbacks. However, from the BDC Credit Reporter’s perspective investors should want to know about what did not work – and why – to better evaluate a BDC’s chosen strategy and implementation. So we’re going to spotlight the announced the ($32.2mn) realized loss booked in the IVQ 2020 by Sixth Street Specialty Lending (TSLX) on its investment in independent oil and gas producer Mississippi Resources LLC.

This investment – which began in 2014 with $44.2mn of debt and equity invested – has been an abject disaster for TSLX – far and away the worst in its history. As is so often the case in these E&P investments ,TSLX does not seem to have been willing to accept the initial reverse on its investment when oil prices crattered in the latter half of 2014. As a result the company has been restructured and essentially taken over by the Sixth Street organization (then TPG Specialty Lending) and more funds advanced.

Over the years – starting in 2017 – the BDC has been forced to book realized losses on the investment. The first write-off was ($21.8mn); the next year ($9.6mn) and ($4.2mn) in 2019. This culminated in 2020 with the ($32.2mn) realized loss. That a total of ($67.8mn). Currently, Mississippi Resources remains on the books with a $1.5mn Term loan due in 2021, which is on non accrual and has been written to zero. (In fact, none of the debt outstanding to the company has been accruing for the past 4 quarters).

The total realized loss is half as much again as the initial amount committed back in 2014 and equal to 6% of all the equity capital TSLX has raised in its history and the equivalent of 42% of its 2020 Net Investment Income. Fortunately for TSLX’s management the 2020 write-off was overshadowed by slightly larger realized losses elsewhere, which kept total net realized losses at ($2.6mn) for the year just passed.

We’d say there are three lessons learned from the Mississippi Resources story. One is a recurring theme of ours: lending/investing in commodity-driven industries like energy is highly risky and better left to speculators or specialists. Second is that TSLX – like every other lender – is at great risk when “doubling down“, continuing to advance monies when initial amounts put into play get into trouble. The flexibility BDCs have to invest in almost anything and without regulators looking over their shoulders might be a boon at times. However, at other times, such as in this instance, bad money follows bad – to coin a phrase. Third, even well regarded BDC management teams – with an excellent credit track record over long periods – like TSLX’s – are not immune from making occasional MAJOR mistakes. It’s the nature of the business. We’re only sorry the management team could not – figuratively speaking – look their shareholders and analysts in the eye and de-construct for everyone’s sake what went wrong and how any lessons learned might help future outcomes.

Sequential Brands: Lender Appoints Board Members

Sequential Brands is the BDC Credit Reporter’s Godot. We’ve written multiple articles over the past two years breathlessly warning that something bad – a bankruptcy or a forced sale – was close to happening. Then: nothing. The company and their lenders always seem to arrive at a temporary modus vivendi, but no permanent resolution. (We’re desperately trying not to use the kicking of cans down the road analogy again). At times – given the high valuations the BDC lenders have maintained – we’ve doubted ourselves and the urgency of the situation.

However, the latest developments suggest – once again – that SOMETHING is going to occur at Sequential in the near future and that there is a possibility the BDCs – with $290.5mn outstanding in debt and equity to the company – may be materially impacted. Here’s what we know: According to a March 31, 2021 regulatory filing the company and one of its lender groups – led by Wilmington Trust – extended “a waiver of existing defaults under the Credit Agreement through April 19, 2021“. Furthermore, the lender “shall have the right to appoint an independent majority of the Board of Directors of the Company“. So gone is Martha Stewart and three other less famous Board members, probably letting out a sign of relief. Also a red flag: the company has not yet filed its IVQ 2020 and full year results.

The short extension period by Wilmington suggests that whatever “strategic alternatives” the company has been exploring since December 2020 is reaching some sort of conclusion. That might involve a sale of the business – in whole or in parts – or some pre-agreed Chapter 11 filing. The public shareholders seem to be bullish about this likely outcome, with Sequential trading at $22.22 as of the close on Thursday April 1, 2021. We are less optimistic – as is our self appointed mandate.

At risk for the BDCs involved is the prospect of ($28mn) of annual investment income from their 2024 Term debt outstanding being interrupted. Then there’s a good chance – based on the most recent quarterly valuations which discounts the equity owned by (99%) – a realized loss of up to ($10mn) will be incurred. However, the most important question mark is how the second lien debt will fare in the half billion dollar of borrowings Sequential owes. FS KKR Capital (FSK) and FS KKR Capital II (FSKR) and Apollo Investment (AINV) have advanced $280.5mn– more than half the total debt outstanding.

Currently, FSK and FSKR discount their debt by only (12%) and AINV by just (4%). If we apply the more conservative discount, that would still result in ($34mn) of realized losses on the debt and ($44mn) in total. The loss could be higher, but even ($44mn) is material given the big bets placed by the FS- KKR organization and which will shortly all be held by FSK, as FSKR is about to merge into its sister BDC. (AINV’s exposure is – clearly – much more modest even adjusting for the respective BDC sizes).

We should say – to be fair and recognizing that the stock market seems to believe that there is considerable market value left in Sequential – that this could all pass as quickly and harmlessly as a summer storm. Some deep pocketed buyer could be finalizing a generous deal as we write this or some hard working lawyers could be arranging a favorable “debt for equity swap” which will leave creditors undiminished. Maybe there’s a SPAC out there who wants to own a group of consumer brands…We don’t know, but we are as confident as we’ve been in two years that a change of status is in the cards for the company in the near future.

We are maintaining our CCR 4 rating on the company – as an eventual loss seems more likely than repayment in full. We are also adding Sequential to our Trending list because of the expectation that whatever is in the company’s future in the weeks ahead will be reflected in the BDC valuations and income – most probably in the IIQ 2021. For FSK especially this could either be a body blow, or not. We’ll be tracking the situation daily and will report back when something material occurs.

Currency Capital LLC: Placed On Non-Accrual

Over at the BDC Reporter we’ve been undertaking systematic reviews of several public BDCs following the end of IVQ 2020 BDC earnings season. Most recently we tackled Capitala Finance (CPTA) which happens to be the sole BDC lender to Currency Capital, LLC. The company bills itself on its website as “an exciting FinTech company specializing in transaction enablement“. As far as we can tell, this involves providing equipment financing.

Till the IIIQ 2020, the $16.3mn invested at cost in the company’s first lien debt was carried at only a (1%) discount, although a small preferred stake was valued at half its cost. In the IVQ 2020, though, CPTA placed the debt on non-accrual, resulting in the interruption of over $2.0mn of annual interest income. The debt was written down to just $3.75mn. The preferred was written to zero. We have downgraded Currency Capital (now known as Currency Finance apparently) from CCR 2 to CCR 5 in one fell swoop.

What’s gone wrong ? CPTA did not say on its most recent earnings conference call and the public record is moot on the company’s troubles, so we won’t speculate. However, this is clearly a major reverse for CPTA, and we’ll continue to monitor both publicly available information and any update that CPTA offers.

Integro Parent Inc: Downgraded By Moody’s

Integro Parent Inc. (aka Tyser’s) is a London-based specialty insurance broker and has just seen its corporate credit rating and debt tranches downgraded by Moody’s. The outlook is “Negative”. Apparently, the pandemic has impacted business conditions in many markets, leaving the company in a classic highly leveraged state, with weak liquidity and cash flow. The company rating has been lowered to a speculative Caa1.

That was enough for the BDC Credit Reporter to add the company to our underperformers list – the first addition in some time – with an initial rating of CCR 3. There are two BDCs with material exposure up and down the company’s capital structure : New Mountain Finance (NMFC) and Crescent Capital (CCAP). Total exposure at cost was $48.5mn at year-end 2020, most of which is held by NMFC, as this table from Advantage Data shows:

Both BDCs are valuing both first and second lien debt at or above par. The first lien is priced at 6.75% and the second lien at 10.25%. (CCAP holds a non-material equity position as well). We have also added Integro to our Trending list because it’s possible that with the Moody’s downgrade, the BDCs involved might reduce the value of their positions in the upcoming IQ 2021 results. Just a 20% overall discount could reduce the FMV by ($10mn) or so. We’ll check back when we hear from CCAP and NMFC in the next few weeks.

Bioplan USA Inc. : Moody’s Downgrades

On March 24, 2021 Moody’s downgraded BioPlan USA Inc. (also known as Arcade Beauty) to “D-PD from Caa2-PD, following the recent restructuring of the company’s first-lien and second-lien credit facilities“. By its standards, Moody’s considers the just completed restructuring at the company as a “distressed exchange and thus a default“. Here’s a link to a Moody’s press release with much more information.

The basic issue is that the lenders to the company appear to have “kicked the can down the road“, extending the maturity of all outstanding debt, and adding a payment-in-kind (“PIK”) requirement which will effectively increase the balance owed. Although the sponsor – Oaktree Capital Management – kicked in another $20mn of equity capital, Moody’s still believe the company’s capital structure is “unsustainable“. As the press release makes clear BioPlan has plenty of challenges including negative free cash flow; a slow return to “normal conditions“; very high leverage and much more.Still, the lenders and the sponsor seem to believe there’s a way out given enough time

There are two BDCs with exposure to the beauty products company: publicly traded Investcorp Credit Management (ICMB) and non-traded Guggenheim Credit, with total exposure at cost – all in the just restructured first lien 2021 Term Loan – of $18.2mn. The former BDC is on the record on its conference calls as being optimistic about the company’s prospects and has discounted its debt by (22%). Guggenheim is more conservative and has a (37%) discount.

We have had a CCR 4 rating for the company since the IQ 2020 when the onset pandemic sharply cut foot traffic at malls and the demand for fragrance sprays. We are adding Bioplan to our Trending list because we expect that with the restructuring there might be a change – probably upward – in the debt’s valuation. This should show up in the IQ or IIQ 2021 results of the two BDCs involved and – for the moment – reduces the risk of the debt going on non accrual. We cannot say whether in the long run this will result in a loss for the BDCs involved. Most at risk – but only modestly so – is ICMB, which could see nearly $0.7mn of annual investment income interrupted should the debt go on non accrual. Ironically, in the short term, the BDC’s income (and Guggenheim’s ) could increase thanks to the new PIK pricing…

We’ll circle back when ICMB and Guggenheim report 2021 results.

American Achievement Corp: Exits Chapter 11

We hear from S&P Global Market Intelligence that “the bankruptcy court overseeing the involuntary bankruptcy petition filed against American Achievement Group Holding Corp. on March 16 has dismissed the case, according to a court order, ending the company’s brief encounter with Chapter 11“. The BDC Credit Reporter had written about the involuntary bankruptcy (which occurred January 14, 2021) back on February 20, 2021. We won’t go back into the whys and wherefores that caused the bankruptcy filing. However, we don’t know the full details of how matters have been patched up except that the parties have agreed to an out-of-court restructuring which will “would leave all creditors unimpaired“. Another $35mn Revolver is contemplated to provide the company with liquidity.

We can’t say when all this will come together but the news seems to be good for the only BDC with exposure: Sixth Street Specialty Lending (TSLX). The BDC had placed its $23.8mn in senior debt to the company on non accrual in the IVQ 2020 and discounted its position by ($2.2mn), or (9%). Presumably the debt will shortly return to accrual status and – we assume – accrued interest will be collected.

The company is rated CCR 5 and remains there for the moment. However we are adding American Achievement to our Trending list because we expect in the IQ or IIQ 2021 for a significant change in status (from non performing to performing) and the resumption of interest income, which amounts to $2.2mn a year, not to mention a rating upgrade. We will circle back when we receive confirmation from TSLX that all is well.

Avanti Communications: IVQ 2020 Update

We’ve just heard from Great Elm (GECC) regarding its IVQ and full year 2020 results. This includes an update on the BDC’s valuation of its largest investment : Avanti Communications. According to the BDC, the values attached were depressed by the then-uncertainties regarding the refinancing of the satellite company’s debt, which has been subsequently extended for a year. The total investment in debt and equity by GECC is now $105.6mn and the FMV $29.3mn. This compares to $103.0 at cost in the prior quarter and FMV of $39.3mn. That’s a (25%) decrease in the FMV of the BDC’s investment in the IVQ 2020.

The BDC Credit Reporter continues to believe that a complete loss is possible where Avanti is concerned, and that’s increasingly reflected in the valuation. All the debt instruments the BDC holds are accruing interest on a non-cash basis while the other BDC with exposure – BlackRock TCP Capital (TCPC) – has its loans showing as non performing. Effectively, despite $118mn invested at cost between the two BDCs – of which $62.4mn is in the form of debt – no cash income is being received already.

We maintain our CCR 5 rating and have Avanti on our Trending List. Next quarter we expect to see the total amount invested increase due to the previously mentioned refinancing. GECC will be adding $3.7mn to one of the debt facilities – as disclosed in its 10-K. TCPC may also invest further funds, but on a smaller scale. The valuation may increase as a result of the refinancing achieved but that will not necessarily continue in future quarters. We will revert back when the IQ 2021 results come out for GECC and TCPC or if something new transpires at Avanti.

Roscoe Medical: Debt Back On Accrual Status

We’ve not written about Roscoe Medical since October 16, 2019 when its junior debt and equity were being deeply discounted by its BDC lenders and some debt tranches were on non accrual. As recently as November 2020 Saratoga Investment (SAR) continued to carry its 3/28/2021 second lien Term Loan as non accruing. However, we hear from Portman Ridge Financial (PTMN) – also a lender and investor – that the debt has been removed from non accrual. (SAR admits the company is back to paying interest but still carried the loan as non performing through November). Furthermore, both BDCs have reduced the discount on their equity stakes from 100% to (55% to 75%), suggesting fundamental improvements in the business.

Overall, BDC exposure is $13.9mn and the current FMV $12.7mn. We have added Roscoe to our Trending list as we expect there is likely to material changes to value and income when the next set of PTMN and SAR earnings come out in the IQ 2021. If SAR begins to accrue its share of investment income again in future quarters like PTMN is doing that will increase investment income by close to $0.5mn annually. Furthermore, there could be further increases in the value of the smallish equity positions both SAR and PTMN hold in the company.

We are ready to upgrade Roscoe from CCR 5 to CCR 3 – based on the IVQ 2020 results but will wait till those first quarter 2021 valuations are published. At this point the medical devices company looks like a real turnaround given that the FMV of those debt and equity assets – despite one loan on non accrual – has doubled since the IQ 2020.

Production Resource Group LLC: IVQ 2020 Update

A reader wrote to ask for an update on Production Resource Group, LLC which we wrote about on May 27, 2020, just after the debt went on non accrual. This is a fair question and reminds us to set up a more formal regular credit follow-up system, especially for larger amounts at risk. In this case the advances by the three BDCs involved were huge – $511mn – as of the IQ 2020.

The current amount outstanding at year-end 2020 from two of the BDCs involved – FS KKR Capital II (FSKR) and Ares Capital (ARCC) – is high but has decreased, as we’ll explain – to $267mn. (No word yet from non-traded TCW Direct Lending VII, which had advanced $30.2mn as of IIIQ 2020).

Apparently – according to FSKR – a “debt for equity ” swap occurred in the fall of 2020:

We have reached a definitive agreement to recapitalize the Production Resource Group balance sheet and bolster liquidity. In exchange for our term loan position we will receive a package of take-back securities that are comprised of a reinstated term loan, preferred equity and common equity. The consensual restructuring transaction provides for a substantially reduced debt and interest burden while maintaining a path for a substantial recovery of our original par balance along with significant upside beyond that.

FSKR CC – 8/11/2020

In the IVQ 2020 this was reflected on the BDCs balance sheets and P&L. ARCC booked a realized loss of ($60mn) and its total exposure at cost dropped from $104mn at cost/$38.4mn at FMV in IIIQ 2020 to $45.6mn/$45.8mn. Exposure consisted of two Term Loans maturing in 2024, but with much lower pricing than before. Our rough estimate is that ARCC’s investment income will have dropped from $9.0mn annually to $3.9mn – a ($5.1mn) loss of income. The BDC also has Class A common stock units with a cost of $4.9mn and an FMV of $5.2mn.

FSKR’s exposure at cost just before the non-accrual was $381mn – a large amount even for a BDC its size. As of year end 2020 FSKR has $221mn invested between 4 term loans and two preferred stock holdings. We suppose – but cannot confirm – that the ($160mn) difference was booked as a realized loss. Unlike ARCC, FSKR does not call out Production Resources Group in its 10-K, with its ($872mn) of net realized portfolio losses in 2020. FSKR currently values its multiple holdings at a combined $199.7mn.

We have upgraded the restructured company from CCR 5 to CCR 3 – after three quarters of non performance – from IVQ 2020. Given the very little information we have about the new financial structure and the still challenged business of sports broadcasting, the company remains on the BDC Credit Reporter’s underperforming companies list. We’ll update our Company file when we hear from TCW Direct Lending VII and write a new update when all the IQ 2021 results are out.

For both ARCC and FSKR, this has been a material set-back, permanently reducing both income and capital and illustrates the danger of taking very large positions (especially in the case of FSKR, which is half the size of ARCC but took on more than twice the exposure). For ARCC, this was the second largest realized loss of 2020, out of total net realized losses of ($148mn). Nor was being at the senior level in the capital structure much protection against loss. Judging from ARCC’s write-offs, some 60% of capital advanced when things turned sour has been lost. All the BDCs involved will have to hope their equity stakes in the reorganized company provide some eventual offset. Maybe Production Resource Group will be bought by a SPAC ?

Sundance Energy: Files Chapter 11

Despite a higher oil price, there’s still plenty of credit trouble in the energy sector as reflected in the just-announced voluntary Chapter 11 filing of Sundance Energy Inc. (NASDAQ: SNDE) and its affiliates. As you might expect, the company and its major lenders have a plan already in place to restructure the balance sheet and exit from bankruptcy. The second lien Term Loan lenders seem to be ready to convert all or most of the $250mn owed to them into equity. Moreover, the press release suggests “certain of its Term Loan lenders” will provide $45mn in debtor-in-possession (“DIP”) financing to keep the business running. When this is all said and done:

Upon emergence, the Company’s recapitalized balance sheet will include (i) $137.5 million of funded indebtedness comprising a senior secured reserve-based revolving credit facility, a senior secured second out term loan, and, if necessary, a senior secured third out term loan, in each case provided by the existing RBL Facility lenders and (ii) new common equity interests issued in exchange for DIP financing claims and Term Loan claims, subject to dilution by new common equity interests granted under a new management incentive plan“.

The only BDC with exposure is Ares Capital (ARCC) with $58.6mn invested at cost (par value is slightly higher) in the second lien Term loan. The debt has been non-performing since the IIIQ 2020, and was already discounted (37%) as of IVQ 2020. Before the debt went on non accrual ARCC was earning $6.7mn on an annual basis of investment income. We now expect there will be both a realized loss booked in the IQ or IIQ 2021 associated with the restructuring and – most likely – new capital advanced.

We won’t try to estimate the extent of ARCC’s loss, especially as this restructuring is just a way station in the BDC’s relationship with Sundance Energy, which began in IIQ 2018. Frankly, we don’t understand why ARCC – which often makes a great deal of its modest energy exposure – would have invested second lien capital in a “independent oil and natural gas company focused on the development, production and exploration of large, repeatable resource plays in North America“. To be blunt, given what has happened to a multitude of similar companies in recent years this seems unwise credit underwriting.

We’ll circle back once the restructuring plan is approved and when we discover how stage two of ARCC’s relationship with Sundance Energy looks like. This could be an investment we’ll be writing about for years to come.

Furniture Factory Outlet: Post Mortem

Now that Stellus Capital (SM) has reported IVQ 2020 results, we know the final outcome of bankrupt retailer Furniture Factory Outlet (FFO) that we’ve written about 3 times before. Unfortunately, despite booking a major final realized loss on the investment, SCM’s external manager was tight lipped about many of the details and was even shy of mentioning the company by name. However, from what we can tell the $13.1mn invested at cost as of September 2020 and valued at $2.1mn was written off in this most recent quarter, resulting in a ($10.1mn) realized loss. Virtually all that exposure – and loss – was in the form of first lien debt.

For SCM this means the permanent loss of about ($0.750mn) – taking into account the $2.1mn recovery – of annual investment income. However, the debt has been on non accrual since IIQ 2020 so the impact has already been reflected in the BDC’s most recent results. The company has now been fully removed from SCM’s books.

This has been a material credit set-back for SCM, equal to 3.7% of the BDC’s equity capital at par and more than three quarters of the funds advanced to FFO. From a post-mortem, Monday Morning Quarterback credit perspective this was probably an avoidable loss. As we explained in our prior article – which we’ll quote below – the choice of industry from the outset was problematic and the first lien position in the balance sheet afforded little protection:

The furniture business – as old credit hands like the BDC Credit Reporter will tell you – is a notoriously difficult industry to lend into, even if the bulk of your exposure – as with SCM – is nominally in first lien debt. This investment by SCM dates back to 2016, before the general “retail apocalypse” became crystal clear to all. However, as recently as IQ 2018, the BDC doubled its exposure, just when mall vacancies in the U.S. reached a six year high. In retrospect, SCM may have wished they had headed in the opposite direction“.

Paper Source Inc. : Files Chapter 11

On March 2, 2021 stationery retailer Paper Source Inc. filed Chapter 11. According to Bloomberg: “The company intends to hand control of the business to an affiliate of MidCap Financial, a lending arm of Apollo Global Management, in exchange for debt forgiveness, court papers show. Paper Source owes about $103 million to lenders, including more than $55 million under a first-lien term loan“.

This is no great surprise to the BDC Credit Reporter, which has had the company on its underperformer list with a CCR 3 rating since IIQ 2017. A further downgrade occurred in April 2020 tro CCR 4 and will now be moved to a CCR 5 – non performing. The principal BDC lender is Apollo Investment (AINV) , which has invested $14.2mn in the company, principally in the form of first lien debt, which was valued at $11.4mn at year-end 2020, a (20%) discount. Presumably some ($1.2mn) of annual interest income will be forgone as Paper Source is sorted out.

From what is being said in court papers, the Apollo Global owned lender Mid-Cap Financial – with whom AINV participated – envisages some sort of debt for equity swap. This will make the lenders owner/lenders going forward and reduce the company’s debt. Here is an outline of the plan, according to the Chicago-Tribune, quoting from court papers:

Paper Source said MidCap Financial agreed to serve as an initial bidder, or “stalking horse,” to purchase the company’s assets for up to $88.8 million, which includes $16.5 million in financing to help the company continue operating… A sale is expected to close in about 90 days”.

AINV only arrived on the scene as a lender in June 2019 when Paper Source was already underperforming, possibly as part of a “lend-to-own” strategy or just in a case of bad timing. Chances are now high that the BDC will be advancing additional monies; restructuring debt and the like and extending indefinitely its relationship with the retailer.

For AINV, whose credit troubles have been mostly concentrated in “legacy assets” booked some time ago under a different management team, this is a rare setback for loans booked by Mid-Cap Financial, the principal source of the BDC’s current new investment activity. We’re adding Paper Source to our Alert List because both income and investment values should be substantially different in the IQ 2021 results.

FDS Avionics Corp: Company Sold

Increasingly Business Development Companies are “turning around” their own under-performing portfolio companies. This drastically changes the profile of an investment – usually both increasing the capital put at risk and extending the holding period. Furthermore the ultimate prospective return changes as equity stakes taken from a turn-around can range widely in value over time. With that in mind, the BDC Credit Reporter is very interested in chronicling every instance of a BDC seeking to tackle a distressed asset. In this case, Fidus Investment (FDUS) took charge of FDS Avionics in 2014, investing $7.2mn of subordinated debt and equity.

By 2017, the company was in trouble and FDUS booked a ($2.4mn) realized loss and invested another $750,000 “along with certain co-investors and management, giving us a controlling interest”. In 2019 FDUS – on a conference call – explained its approach: “This is an aerospace parts company, it’s primarily electronics. It serves the general aviation, the commercial and the military end markets, so there’s some diversity there. It’s been lumpy historically. And it also was in need of a product refresh whereby customers really wanted to wait for certain new products versus buying some of the legacy products. We continue to believe in, I’d say, the value proposition of the business. And as such, we made a control equity investment probably 20 months ago now.”

Through IVQ 2020, FDUS exposure at cost was $8.4mn in first and second lien debt, preferred and common. At one point FMV had dropped as low as $4.0mn. Now we learn the following: ” On February 12, 2021, we [FDUS] exited our debt and equity investments in FDS Avionics Corp. (dba Flight Display Systems).  Flight Display Systems was acquired and combined with Calculex Inc. and Argon Corporation under a new holding company, Spectra A&D Holdings (“Spectra”). We received payment in full of $5.1 million on our second lien and revolving debt. We sold our preferred and a portion of our common equity investments for a realized gain of approximately $1.0 million. In conjunction with the transaction, we invested $8.0 million in first lien debt and $4.1 million in preferred equity, of which $2.0 million was rolled over from our original common equity investment in Flight Display Systems”.

So FDUS is clawing back $1.0mn of the ($2.7mn) lost in 2017 but has actually increased its exposure by one third. The BDC will be accruing income on the loan (terms not yet revealed) and -possibly – on the preferred (unlikely). For a time consuming investment that was fraught with problems this is a successful interim resolution, but far from the final word. We may be years away from a final tally.

We are upgrading the company – now Spectra A&D Holdings – to CCR 3 from CCR 4 and we will periodically revisit how the new owners are performing.

Accent Food Services LLC: Restructured

This is the third article we’ve written about Accent Food Services, LLC. We started out in September 2020, basing ourselves on what Fidus Investment (FDUS) was willing to tell us about the vending machine company’s troubles. Even then, we were bracing for the worst: “We know too little – even the identity of the first lien lender and its payment status – so we can’t estimate whether Accent will pull out of this valuation dive or not. Given the second lien status, though, a complete write-off is possible.” 

Roll forward to the most recent FDUS reporting for IVQ 2020 and we learn that “In Q4, we realized a loss of $36.1 million on Accent Food Services. That’s 100% of the total cost of the funds FDUS advanced to the company. Just before Accent began to deteriorate – IIIQ 2019 – FDUS had the investment valued at $35mn. The BDC was receiving about $3.5mn in annual investment income before Accent went on non accrual late in 2019. As recently as September 2020, FDUS still valued its debt at $5mn.

Not unreasonably, a BDC analyst asked for a recap of what went wrong at Accent and to his credit, the CEO of FDUS gave a fulsome answer, albeit after the horse has left the barn. We are re-publishing the full discussion from the February 26, 2021 FDUS conference call:

What I would say, look, Accent was on nonaccrual prior to COVID-19. Having said that, it had a positive outlook and had real market presence. I mean revenues were growing. It just — it needed to clean up its act, which is actually now done, and COVID created the opportunity for the company to do that and get their cost structure in line and whatnot.

But — so the — what happened was the shelter-in-place orders, and in particular, the work-from-home orders greatly impacted the business, right? The most of any company in our portfolio, no question. So our one nonaccrual got hit the hardest.

Secondly, I’ll go — say the senior debt providers and, quite frankly, the equity group were not helpful to put it mildly. And the senior group played loan-to-own ball and — as opposed to work together, which most people do. And so given the status of the company at the second half of the year, which were very different, quite frankly, than the projections we were getting throughout the COVID period, we chose not to double down, and basically, take a controlling stake in the company. We have that opportunity. And it would have required a very large equity investment. And so it’s very unfortunate all around, but that’s how it played out.

And the company has a solid medium-term outlook and a good management team. And so we supported the company with actually a small equity investment in the new restructured company. So that’s the situation. It’s very unfortunate. But we didn’t have — other than owning the company and writing a very big equity check, we didn’t have the cards given the — given COVID. And that’s what happened“.

There’s a lot to unpack there, including the reminder that BDCs like FDUS have the ability to walk away or “double down” (the very language underlining the uncertainty involved). Generally speaking, it’s hard for a second lien lender to control a situation like this one and the large amount already invested might actually have been a deterrent to putting even more money to work. We find it amusing that FDUS invested $2mn in the newly restructured/owned company but – maybe – that will provide some partly offsetting return one day.

Otherwise, though, this was a major loss for the BDC, far and away the biggest write-off taken in a difficult year and a reminder of how vulnerable junior debt capital can be, especially in the lower middle market. (BTW, FDUS also booked multiple realized gains in 2020, leaving the BDC with a net realized loss of just ($1mn) for the year.

In terms of our ratings, we are upgrading Accent Food Services from CCR 5 to CCR 3. Even though the amount FDUS has invested is now small – barely material by our standards – we’ll continue to update the company’s progress to the best of our ability.

Swipe Acquisition Corp: Restructuring Completed

Swipe Acquisition Corp is a manufacturer of gift cards and hotel key cards and – unsurprisingly – was badly impacted by Covid-19. As recently as the IQ 2020 the company was marked as performing to plan but quickly downshifted to underperforming and then to non performing by the IIIQ 2020. We now learn that the business has been taken over by its lenders in a debt for equity swap, which occurred in the IVQ 2020. One of those lenders – Owl Rock Capital (PRCC), on its February 24, 2021 outlined what has happened in recent weeks :

In order to best position the company in the near term, we rightsized the outstanding debt amount and equitize the remainder of the debt balance.”

From Advantage Data’s records we know that the Owl Rock organization – which includes non-traded Owl Rock Capital II – had $176mn advanced in senior debt to Swipe as of September 2020. We don’t have yet have ORCC II’s results, but we can see that ORCC’s own investment at cost in Stripe debt has dropped from $156mn in debt to $52mn in the post-restructuring IVQ. We know that the BDC took a realized loss of ($51mn), virtually all Swipe related.

In addition, $48mn is booked from the IVQ 2020 under “New PLI Holdings” as a common stock investment. That’s where the debt for equity swapping occurs. All of that does not recognize to the last dollar but indicates ORCC has roughly already written off one-third of its initial capital and reduced its investment income by two-thirds. That’s ($8.5mn) of annual investment income forgone.

This is a big move for Owl Rock – according to management on its conference call – making the move to owner/lender from solely a lender. Only time will tell if i) the company requires additional capital; ii) the asset manager is successful at effecting a turnaround. Still, this is an example of what we’ve been calling out for some time: the ever increasing willingness of BDCs of all stripes to turn around their own failed investments. (That must be frustrating to all those “distressed” investments funds waiting around for opportunities like Swipe). For investors in BDCs the increasing number of “control” investments created in this way make evaluating BDC value and performance more difficult than in the past.

For the moment, the BDC Credit Reporter has upgraded Swipe/PLI to CCR 3 from CCR 5, given the restructuring and the return to accrual status. We’ll continue to offer updates in the quarters ahead.

NGL Energy Partners LP: Suspends Dividends

We learn from a recent Seeking Alpha article (Trapping Value on February 21, 2021) that NGL Energy Partners LP (ticker: NGL) has recently refinanced its debt. As part of the agreement with the public company’s new lenders, all common and preferred dividends have been suspended. Admittedly, the suspension is supposedly only temporary and the payouts will resume once a target leverage is met. Still, given the pressures in the oil patch, we don’t suggest shareholders should hold their breath.

For the only BDC with exposure – FS Energy & Power – this looks like a body blow from what we can tell. That’s because the BDC has $173mn invested at cost in equity and preferred, of which $166mn is in the latter and yielded 14.3% from distributions. Our calculator indicates that’s ($23.7mn) of annual dividend income lost. A glance at the non-traded’s BDC IIIQ 2020 financial statements indicates that’s equal to 13% of total investment income and over 50% of Net Investment Income.

We had already rated NGL CCR 4 but now downgrade the company to CCR 5, given this was a yield producing investment. If this settled out today we’d expect the BDC to lose (25%-50%) of its investment, but that’s not happening, giving NGL – buoyed by its debt refinancing – the chance to fight on. However, this is a Major investment by our standards (over $100mn) and will be of concern to the manager of the BDC and its shareholders.

American Achievement Corp: Debt On Non Accrual

We learn from Sixth Street Specialty Lending (TSLX), following IVQ 2020 results, that a new portfolio company has been placed on non-accrual: American Achievement Corp. The company “manufactures and supplies yearbooks, class rings and graduation products, and as a result of COVID, underperformed for the 2020 sales season“. TSLX added: “We are currently working with the company on a potential restructuring to keep our term loan outstanding and to receive a majority of the equity in the business as a lender group. We expect to reach resolution on this in the near term“.

What TSLX failed to say is that the company “filed for involuntary Chapter 11 bankruptcy protection January 14, 2021, in the Northern District of Texas“, according to public records. In addition, TSLX did not mention that the near half a billion dollar in debt owed by the company is the subject of heated disputes, which adds an element of uncertainty to the outcome. This article by S&P describes some of the maneuverings underway.

TSLX seems to be (unduly ?) optimistic, writing down its $23.8mn first lien loan by only (9%). Furthermore, if a debt for equity swap – as mentioned above – seems the likeliest resolution, it seems unlikely that the debt will not be subject to a major haircut, which will impact long term income. At the moment, with the non-accrual TSLX has temporarily lost ($2.2mn) of annual investment income.

We have downgraded the company from CCR 2 to CCR 5 in one fell swoop. (As of the IIIQ 2020 TSLX valued its investment at a modest discount of (7%) and no mention was made by TSLX – the only BDC lender – of any challenges at the company). We are also adding AAC – as its known – to our Alerts list because it’s likely that the income, value and outstandings involved will be subject to substantial change in the next couple of quarters.

Frankly, we’re a little disappointed by the transparency of TSLX at this stage. Maybe with so much ill feeling between the parties involved with the company, the BDC did not want to stir up the pot on its February 18, 2021 conference call, but investors are left with an incomplete picture. This a company that bears watching and which we’ve added to our daily review for any new developments.