Delphi Behavioral Health: Restructured

We learned from Capital Southwest (CSWC) – the only BDC lender to what was called Delphi Intermediate Healthco – that the troubled mental health company was restructured out of court. As a result the debt – which was on non accrual -has been returned to performing status from the IIQ 2020 but with a new capital structure, and after CSWC absorbed a significant realized loss. (See below). Furthermore, the company’s name was changed on CSWC’s books to Delphi Behavioral Health Group LLC. The BDC owns a significant – but undetermined stake in the restructured business and sits on the Board.

The realized loss booked by CSWC in the second quarter on Delphi was ($5.5mn) or nearly half the $11.7mn invested in debt just prior to the restructuring. According to Advantage Data, this was a portfolio company on the BDC’s books since IVQ 2017 and in an industry which CSWC feels it understands given its exposure to similar entities in its portfolio. Delphi performed normally – judging by CSWC’s portfolio valuations and absence of conference call commentary – right up to the IVQ 2019 when the debt was placed on non accrual. The initial discount on the defaulted first lien loan was (40%), but ended up to be higher by the time the realized loss was booked.

Given the timing, the problems at Delphi clearly pre-dated the Covid-19 crisis but the pandemic must have made the situation worse. We call these failures First Wave credit problems.

The new debt on a restructured/renamed Delphi is more expensive than before, but currently paid in PIK form and the debt matures in 2023 versus 2022 previously. We know little about which other lenders are involved or the overall capital structure. We do know that CSWC has increased its internal rating from a 4 to 2 on their internal rating scale. The BDC Credit Reporter has also upgraded the company from a CCR 5 to CCR 3. That’s still in our underperforming category and on our Watch List. Like CSWC, though, we are hopeful that the business will recover and the BDC – and its shareholders – might regain some or all their capital loss from an eventual sale. Still, it’s early days and a business needs more than a restructured and de-leveraged balance sheet to be successful.

Delphi will also be a test of CSWC’s skill at “turning around” unprofitable companies; taking equity positions and sticking around for the long haul. These debt-for-equity swaps take up management time; often result in more capital being advanced and typically result in lower current income. If all those sacrifices result in an eventual repayment of all debt and interest and an equity gain, kudos to the BDC manager. If not – and over a number of transactions – one has to question the approach. For the record, CSWC has 9 companies – including Delphi – which are marked as “affiliated” and in which the BDC has some sort of equity interest. Of those 3 are “underperforming” to various degrees. [We’re not counting CSWC’s investment in its I-45 JV with Main Street, also underperforming].