Paper Source Inc. : Files Chapter 11

On March 2, 2021 stationery retailer Paper Source Inc. filed Chapter 11. According to Bloomberg: “The company intends to hand control of the business to an affiliate of MidCap Financial, a lending arm of Apollo Global Management, in exchange for debt forgiveness, court papers show. Paper Source owes about $103 million to lenders, including more than $55 million under a first-lien term loan“.

This is no great surprise to the BDC Credit Reporter, which has had the company on its underperformer list with a CCR 3 rating since IIQ 2017. A further downgrade occurred in April 2020 tro CCR 4 and will now be moved to a CCR 5 – non performing. The principal BDC lender is Apollo Investment (AINV) , which has invested $14.2mn in the company, principally in the form of first lien debt, which was valued at $11.4mn at year-end 2020, a (20%) discount. Presumably some ($1.2mn) of annual interest income will be forgone as Paper Source is sorted out.

From what is being said in court papers, the Apollo Global owned lender Mid-Cap Financial – with whom AINV participated – envisages some sort of debt for equity swap. This will make the lenders owner/lenders going forward and reduce the company’s debt. Here is an outline of the plan, according to the Chicago-Tribune, quoting from court papers:

Paper Source said MidCap Financial agreed to serve as an initial bidder, or “stalking horse,” to purchase the company’s assets for up to $88.8 million, which includes $16.5 million in financing to help the company continue operating… A sale is expected to close in about 90 days”.

AINV only arrived on the scene as a lender in June 2019 when Paper Source was already underperforming, possibly as part of a “lend-to-own” strategy or just in a case of bad timing. Chances are now high that the BDC will be advancing additional monies; restructuring debt and the like and extending indefinitely its relationship with the retailer.

For AINV, whose credit troubles have been mostly concentrated in “legacy assets” booked some time ago under a different management team, this is a rare setback for loans booked by Mid-Cap Financial, the principal source of the BDC’s current new investment activity. We’re adding Paper Source to our Alert List because both income and investment values should be substantially different in the IQ 2021 results.