Troubled J.C. Penney raised its 2019 projected results, according to a news report on November 15, 2019. At the same time, same store sales continue to trend downward, and were even worse than expected. Glass half full or glass half empty ?
Interestingly, BDC exposure has increased in the IIIQ 2019 to $18.4mn, from $6.8mn. As so often happens in these troubled retail situations TPG Specialty (TSLX) has stepped up to lend more money in an asset-based loan to the company. TSLX has advanced $15.0mn and the rest is spread – in different facilities – over 3 FS-KKR non-traded BDCs: FSIC II, FSIC II and FSIC IV. All the BDCs involved mark their debt at or above par.
We’ll see in 2020 – following the critical 2019 Christmas season – whether this optimism is warranted.
On October 15, 2019 Ferrellgas Partners published its full year results. For the last quarter of the fiscal year, the giant propane distributor reported a net loss of ($72mn) and Adjusted EBITDA of $4mn, while interest expense and maintenance capital expenditures and the gains from minor assets sales were $41mn. Or, in other words, the company is performing very badly. The stock price dropped by a third, to close at $0.65.
If that wasn’t enough, the 10-K reveals a dispute between the company and its senior lender TPG Specialty Lending . The latter is claiming that by not delivering certain financial information within a prescribed period, the company is in default under its credit agreement – even though the said information was subsequently forwarded. Moreover TPG believes the auditor’s opinion contains language suggesting doubt about Ferrellgas remaining a “going concern”. The company reads the document differently. In any case the parties have not agreed and the lender is expected – both by Ferrellgas and us – to take further action. That might include attempting to force an involuntary bankruptcy.
The company has been headed south for some time, so we’re not surprised about the poor results – or the likely bankruptcy – but only about the manner in which the company and its secured lender have fallen apart, which will add to the complexity. Total BDC exposure is very high: $101mn. Of that $82mn at cost is held by TPG Specialty (TSLX) in the senior secured debt, nominally to mature in 2023 but which the company is now carrying as a short term liability. See pages 52-53 of the 10-K. FS Energy and Power Fund holds two junior tranches of the debt for the remainder. TSLX is very confident that its senior secured status will ensure no loss under most imaginable circumstances. Still, there’s $8.3mn of investment income in play. We hope that TSLS – which has a very good track record of financing troubled businesses in just the right way – knows what they’re doing where propane assets are concerned.
S&P recently downgraded J.C. Penney – the iconic retailer – and now Fitch has joined suit. In this case, the rating for the company has dropped to “junk” status or CCC+ from B-. The reasons given are just what you’d expect. For our prior three articles on Penney’s, click here.
As we’ve explained previously, BDC exposure is modest and whatever happens will have little impact on the three non-listed FS-KKR BDCs involved, which are in the process of going public as a combined FS-KKR II. Also in there is TPG Specialty (TSLX), but with its asset-based status is not expected to lose any money under most possible scenarios.
Of course, Penney is just one example of the retail sector “apocalypse” that’s been going on for years in a long running burn of companies of all kinds. Currently we’ve identified 20 retail-related companies that are under-performing, with a cost of investments of $1.27bn. That’s probably not everyone caught up in this seismic change in how consumers and businesses shop, but captures all the names you’d expect and a few more. The BDC sector has taken a hit, and will continue to do so, but the damage has been spread out over more than two dozen BDCs (roughly a quarter of the listed and non listed players) and over several years, mitigating the blow. Junk bond investors and other forms of lenders have taken more of a body blow f rom this once-in-a-lifetime shift in American commerce.
Standard & Poor’s has downgraded troubled retailer J.C. Penney to CCC from CCC+. Apparently, all the talk about restructuring the company in advance of any Chapter 11 filing, which we discussed in posts on July 23, 2019, when restructuring advisors were first called in and again on August 14, when Bloomberg reported serious talk of a debt for equity swap was in the air.
Not helping Penney’s with S&P is that the retail background for bricks and mortar stores remains challenging, notwithstanding the operational advances management has made. S&P’s view was summed up as follows:
“The negative outlook on JCP reflects the growing risk of a distressed debt exchange or restructuring in the next 12 months as industry headwinds, weak same-store sales, and a burdensome debt load contribute to its unsustainable capital structure.
“We could lower our ratings on JCP if the company announces a debt exchange or restructuring or if its operating conditions worsen such that we see a restructuring as increasingly likely in the next six months.
“Before raising our rating on JCP, we would expect the company to demonstrate a significant and sustained improvement in its performance that leads us to view a distressed exchange as less likely.”
We have rated J.C. Penney CCR 4 on our 1-5 scale, aka on our Worry List, where we believe the chances of an ultimate loss are greater than that of full recovery. Thankfully from a BDC perspective although there are 4 BDCs with exposure (including three non-traded FS Investment-KKR Capital BDCs) total exposure is very modest at $6.8mn at cost. All the debt sits towards the top of the capital structure and the biggest discount to cost is only (8%) as of June 2019. We believe the actual loss will be more substantial if and when a debt for equity swap or Chapter 11 occurs, but either way the impact on BDC net asset value and income should be modest. That’s a statement that cannot be made about the many other lenders to J.C. Penney, whose borrowings are substantial.
Bloomberg reported on August 7, 2019 that J.C. Penney creditors are seriously considering a debt swap to give the troubled department store chain more time to turn its business round.
That may not affect the several BDCs with $6.8mn of first lien exposure (most recently TPG Specialty – TSLX – has gotten involved), but will draw in second lien debt.
In any case, although the company has liquidity and no immediate debt maturities, chances are increasing that something will happen in the weeks ahead. That might result in lower values for the 3 FS-KKR non-traded funds involved, all of whom have valued their modest exposure at or close to par last time results were published – in IQ 2019.
The retail apocalypse marches on.
On July 18, 2019, 99 Cents Only Stores announced by press release the completion of a restructuring plan that the BDC Credit Reporter discussed more than a month ago. Basically, the second lien and third lien debt holders are undertaking a debt for a minority equity stake position in the troubled value retailer. In addition, the sponsors – Ares Management and a Canadian pension fund – and other players will be injecting new equity capital as well. Moody’s has already – back on June 12, 2019 – called the restructuring ” a distressed exchange” , and downgraded the company’s rating. We had previously believed that a $20mn portion of the $55mn at cost in BDC exposure owned by sister funds Oaktree Specialty Lending (OCSL) and Oaktree Specialty Income (OCSI) was going to convert to equity, as part of the restructuring. (We assumed the asset-based loan in which TPG Specialty – TSLX – has $32mn invested would either continue unchanged or be refinanced). On further review, and without any guidance on the subject from the BDCs involved or the company’s press release, we’ve changed our mind and assume the first lien debt will continue as before and not be involved in the conversion to equity. Both the OCSI/OCSL debt and the facility in which TSLX is involved in were trading at the close on July 19, 2019 at a (9%) discount to par, and were paying interest normally. (These are publicly traded debt issues, and we used Advantage Data’s real-time loan and bond pricing module). Given the new capital structure; the infusion of capital and reports that the operational turnaround underway at 99 Cents Only Stores that has been underway for months is bearing fruit, the short term credit outlook is up. We are upgrading the company from a CCR 4 Rating (what we call or Worry List) to a CCR 3 rating (aka Watch List). Much remains to be done following this second restructuring in so many years, and we do not forget that 99 Cents Only operates in the Bermuda Triangle industry of retail where other players have restructured or gone through Chapter 11 only to go bankrupt again. For the moment, though, we are cautiously optimistic and expect Moody’s may shortly upgrade the company and the remaining debt.
Monitronics International – an alarm monitoring company that we’ve discussed on two prior occasions on March 23, 2019 and again on May 23, has filed for a pre-packaged Chapter 11. It’s fair to say that the restructuring plan – approved by most creditors but still requiring shareholder approval of the parent of the company – Ascent Capital – is highly complex. From what we understand Monitronics will be shedding about half of its existing debt load; raising a quarter billion dollars of debtor-in-possession debt financing to be followed by even more “exit financing”; as well as raising equity capital through a Rights Offering and receiving $23mn from Ascent as part of a scheme to have the parent absorbed by the subsidiary. At the end of all this Monitronics – despite having nearly $1bn in debt still on its books – will have “the strongest balance sheet in our industry”, according to the CEO. We’re still trying to determine what the impact of this restructuring plan will have on the 5 BDCs with $20.7mn of term debt exposure. At March 31, 2019 the debt was already discounted to varying degrees. A final accounting will have to wait till this bankruptcy process plays out. Management is predicting an exit within 75 days, or mid-September. Given the numerous moving parts, we are skeptical about the timetable, even though we’ve seen this pre-packaged Chapter 11 situations move through the courts in as little as one day ! For the moment at least, the most tangible impact is that investment income on the debt will be interrupted for some or all the third quarter of 2019. The biggest impact will be felt by Business Development Corporation of America (BDCA), which has half the total BDC exposure.
The good news for 99 Cents Only Stores, LLC – which is owned by Ares Management and the Canada Pension Plan Investment Board ? Chapter 11 bankruptcy has been averted. Back on June 7, we warned on our Twitter feed that bankruptcy was a risk. Now the bad news: Ducking a trip to the bankruptcy court has been accomplished by a debt for equity swap and a fresh capital raise. According to Retail Dive: “under the agreement, 99 Cents Only is to issue common and preferred stock in return for its outstanding $146 million second-lien term loan facility and $143 million secured notes”. From what we can tell, there are two BDCs in the secured notes : sister BDCs OCSL and OCSI, with aggregate exposure at cost of over $20mn, and generating over $1.5mn in annual investment income. (The bulk of the exposure is at OCSL). At March 31, 2019 the debt was still performing and written down only modestly (11-14%), although restructuring negotiations were already underway. This is not a transaction the “new” management at OCSL/OCSI can blame on Fifth Street. According to Advantage Data, the debt was added in late 2017 after Oaktree’s investiture as external manager.
Frankly, we’re a little surprised at how generously the BDCs have valued their exposure throughout. As late as IIIQ 2018, the debt was carried at par even though 99 Cents Only has been in trouble almost from day one, thanks to heavy leverage placed on the 2011 buyout. For a sense of proportion – and quoting Moody’s – debt to EBITDA was around 8x. In 2017, the company almost filed for Chapter 11 and was only saved by an earlier debt restructuring. It’s unclear if this second restructuring will do the trick, but OCSL and OCSI are now in for the long term in a non income producing position at the bottom of a still leveraged balance sheet. We’ll have to wait till the publication of the IIQ 2019 results to see how the BDCs value their new positions and whether any realized losses are booked. BDCs have great latitude in this area, so investors should pay attention to what is done as well as said.
Also with exposure is asset-based specialist TSLX, with $32.2mn in 2021 debt. The BDC has continued to mark the position at par, suggesting TSLX will be repaid in full on its FILO ABL facility when the time comes. We have no further details from the public record. We do know – from Advantage Data – that TSLX will be paid more than OCSL and OCSI and – as far as we can tell – have a better credit outcome thanks to their ABL approach. No wonder multiple other BDCs are eyeing getting into this specialized form of lending. By the way – outside of the public filings – none of the three BDCs involved appear to have discussed the challenges at the company since the debt was booked, either on a Conference Call or Investor Presentation. (We use Sentieo which searches all available filings for any input keywords).
By the way, we don’t have a Company File for the company, but will be adding one given that – this restructuring notwithstanding – BDC exposure continues and the final resolution of the greater than $50mn invested is some way off. After all, S&P has a rating of CC for the company…
On May 20, 2019, the wholly-owned subsidiary of publicly traded Ascent Capital Group (ASCMA) – Monitronics International Inc. – entered into a Restructuring Support Agreement (“RSA”) with its latest creditor. This is part of a major restructuring effort that will reduce Monitronics debt and see the parent company merge into the parent as part of a pre-packaged bankruptcy. BDC exposure aggregates $21mn, spread over 5 public and non- public funds.
On April 29, 2019 USA Today published an in-depth article regarding disputes occurring between the majority shareholder of twice bankrupt Payless, Inc. (aka Payless Shoesource) and certain creditors and lenders. With the future of Payless very much in doubt, the full repayment of $21mn of secured debt held by two BDCs is also questionable. Just a year ago when Payless went bankrupt for the first time, secured lenders got out whole. This time some of those same BDC lenders who funded the Company post bankruptcy may have a harder time collecting 100 cents on the dollar. See the Company File for all the details and our view.