Only two days ago, the BDC Credit Reporter warned Quorum Health – a major hospital chain – was getting to ready to file chapter 11. Now the company – in a press release – indicates that a bankruptcy filing has occurred as part of a restructuring plan with its lenders. As is now routine in so many similar situations, lenders will become owners; a Debtor-In-Possession financing will be put into place and – not always the case – the new lender-owners will be injecting additional equity into the restructured company. We’ve not had time to dig into the full terms of the restructuring agreement so we won’t go beyond what was said in the press release.
As we wrote last time, there are just two BDCs involved with $17.6mn invested in first lien and subordinated debt. We expect the latter to be greatly written down and converted into equity. At the moment, that debt is trading at 75 cents on the dollar in Advantage Data’s market module. That seems still high, but we’ll see. FS KKR Capital (FSK) and sister BDC non-traded FSIC II have $10mn in the junior debt. At the very least, interest income of nearly $1.2mn a year will stop.
The remaining $7.6mn is in a 2022 Term Loan, held by FSIC II. We don’t know what happens to that debt under the restructuring but income is likely to be interrupted till the deed is done. That’s another $0.600mn of income put on hold till the restructuring has been approved.
We will learn more and revert back in a later post. However, at first glance this appears to be another setback for the KKR FS Investments platform. Still, like so many other credit reverses at the huge credit asset manager this was a borrower first signed up – and we’re going by the date of the initial lending – back when FS Investments was in league with GSO Blackstone.
The test for KKR – which is in charge of the credit work in this partnership – will be making lemonade out of many lemons in the portfolio, and with many more to come. This “debt for equity swap” format has been and will remain – if liquidity is available – the recurring method by which KKR can hope to recover losses. The short term impact will – typically – be lower investment income; more capital advanced at both the top and bottom of the capital structure – and an ultimate hope of significant equity gains years out as companies are financially engineered back to health. Of course, there’s much more to the process including having the right managers, incentives and strategy in place, but those are hard to assess by outsiders. The proof – as has been said – will be in the pudding i.e. the long term total return.
We believe that as much as a fifth of all portfolio companies in the middle and upper middle market will become “lender owned” in the next year, turning what has been a trickle into a flood. The BDC Credit Reporter, who tracks these investments from cradle to grave regardless of capital structure, will seek to evaluate how each performs over the full cycle. We’ll be keeping track in our database of all companies like Quorum that are “swapped out” so we can evaluate if this approach provides tangible returns to the lenders involved, most notably the BDCs that are our focus.