Naturally enough, a few days after we remarked that BDC-financed company bankruptcies had slowed to a seeming halt, a major Chapter 11 filing occurs. In this case, Arena Energy L.P. filed for bankruptcy protection on August 21, 2020. According to the Wall Street Journal, the company has already agreed on a sale to PE-group Lime Rock Partners and management. The existing lenders have mostly signed off on the sale. Apparently, the term loan lenders, who are junior to the reserve-based secured lenders, will receiving a mere 2% of their $439mn in debt back.
This is sad, but not unexpected news, for the three BDCs involved- all part of the FS-KKR Capital organization: non-traded FS Energy & Power and twin public entities FS-KKR Capital (FSK) and FS-KKR Capital II (FSKR). In total, the BDCs funded $179.5mn, all in second lien debt, and which used to be priced at LIBOR + 12.00%. The debt has underperforming and on non accrual since the IQ 2020, reflecting a very sharp drop in fortunes in a brief period. This is debt that dates back to 2015, and when GSO Blackstone was managing these BDCs. Unfortunately, new external manager KKR has not been able to rescue this unfortunate investment in the years since taking over.
If the 2% recovery rate is correct, the BDCs will have to take a further unrealized loss in the next quarter because the existing position was written down (86%). Either in the IIIQ or IVQ 2020 we expect the lenders will have to book a final realized loss of approx ($175mn) ! Also lost is the near ($22mn) of annual investment income being booked through the IVQ 2019. This is a significant reverse by any measure, with FS Energy absorbing about two-thirds; then FSKR with $54mn at cost and finally FSK at $9mn. The almost 100% loss is deeply disconcerting and suggests the lenders – whether they recognized it or not – were investing more like a PE group than a lender but with a capped return and an unlimited downside. Finally, this proves the BDC Credit Reporter’s oft-made point that energy lending is an oxymoron and an inappropriate asset for an industry with a predominantly retail investor base.
We had already rated the company a CCR 5, and expect to see the name removed from the books of all the BDCs involved by year-end.