California Pizza Kitchen: Second Lien Debt On Non Accrual

We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).

Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.

Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…

The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.

For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.

Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.