Despite what you may have heard in the headlines, J.C. Penney has not yet been purchased by mall owners Simon Property Group and Brookfield Property Partners. The reality is more complicated and more interesting. The parties have only agreed on a non-binding letter of intention to acquire certain assets of the bankrupt retailer and are far from being in charge as yet. Furthermore, the existing first lien lenders will become owners of two new REITs that will own stores and distribution centers respectively. The lenders would also receive $500mn in “take back” debt and new financing is being arranged as well. With a bit of luck, a very restructured J.C. Penney – in name – would be back and running out of bankruptcy by year’s end. (All the above learned from an excellent synopsis by WYCO Researcher on Seeking Alpha).
This is important news for the only BDC with exposure to Penney’s: Sixth Street Specialty Lending (TSLX). The picture here is complex as well. The current Debtor In Possession (DIP) financing, with a cost of $5.781mn and yielding 13.0% is most likely to get repaid in full. This is what TSLX anticipates, given the premium valuation at June 2020. More difficult to suss out is what the value will be of the two first lien debt positions owned – due in 2023 – and both already on non accrual. We expect TSLX will gain a small non income producing equity stake in the two REITs and some performing debt paper. From an income standpoint that can’t be any worse than the $20.0mn at cost in non-DIP debt held which is being carried as non performing. From a valuation standpoint it’s impossible to tell – even for TSLX at this stage – whether the new arrangement is more valuable than the $8.7mn in FMV as of June 2020.
Most of all, TSLX will probably be glad to have the Penney situation resolved – even if only for a while. This looks like one of the rare instances where the crafty BDC – whose non-DIP debt was bought at a discount in mid-2019 – will not come out of a bankruptcy situation smelling like roses. TSLX has admitted as much in its last 10-Q: “Given expectations for less-than-par recoveries, the Company has applied the regularly scheduled cash interest payments it received to the amortized cost of these positions, all of which were acquired at prices less than par“. Based on the latest values, TSLX could be booking a realized loss of anywhere from ($6mn-$9mn) in the IVQ 2020. Painful but manageable for a BDC with a net book value in excess of a billion dollars.