Apollo Investment (AINV) reported that its largest investment – Merx Aviation – was restructured in a couple of ways in the second quarter 2020. The aircraft leasing and servicing company, which AINV owns 100% of the stock of, saw $105mn of its $305mn in Revolver debt outstanding from AINV converted to debt. Second, the remaining debt saw its interest rate drop to 10.0% from 12.0%. Management of the BDC were circumspect in discussing the company’s performance, even though Merx’s FMV represents one-third of net book value at June 30, 2020. On the conference call AINV executive spoke in general terms, like this: “The pandemic has caused an unprecedented decline in global air traffic, which has led to a widespread lease deferrals throughout the industry. Although aircraft — air traffic trends have improved slightly more recently, it remains significantly below pre-pandemic levels“.
Despite the huge strains on aircraft lessors and the loss of substantial income because of the above, AINV wrote down its equity stake in Merx – which just increased by 800% at cost – by only ($4.2mn).
BDC portfolio company valuations are always a riddle wrapped in an enigma, initially prepared by internal staff, often reviewed by an outside appraisal firm and the final responsibility of the directors. To our minds – given what we do know about market conditions; the high leverage involved and the restructuring, this write-down is wholly inadequate and inexplicable. At this stage, AINV’s Merx investment taken overall is still valued above cost and would not show up on the BDC’s own underperforming company list.
For our part, we reaffirm the BDC Credit Reporters Corporate Credit Rating of 4, which we instituted last quarter. We do not have Merx on our Weakest Links list only because AINV has such latitude to continue paying interest even if the business is insolvent, which may be the case from what little we know. The fact that one third of debt is no longer accruing income is a negative sign, as is the need to lower the rate. These are the actions of an owner rather than a lender and make the entire valuation questionable.
This is a very serious challenge for AINV. In a short time, the BDC has lost ($16.6mn) in annual investment income. That’s just over 10% of IQ 2020 Net Investment Income. If the entire debt goes on non accrual another ($20.0mn) in annual Investment Income would be lost and AINV would have lost (25%) of its earlier Net Investment Income. We’ve already mentioned the size of the Merx investment on the balance sheet and in relation to net book value.
We will continue to update readers about Merx, but may not have anything to report till AINV does so given the closely held nature of the investment and management’s closed lips. There is a danger of an “October surprise” when AINV reports IIIQ 2020 results, especially as the global aviation business continues to face dire circumstances. Unfortunately, AINV shareholders may not find out till it’s too late that the current valuation was unrealistic. For everybody concerned, we hope otherwise.