With the publication of the IIQ 2019 valuations by 8 BDCs with $107mn in various forms of debt exposure (2022-2024 and both senior and second lien), we’ve added Constellis Holdings to our under-performers list with an initial rating of CCR 3 (Watch List). The debt has been discounted between (6%-30%) from 0% to (5%) in the prior quarter.
This is not surprising as there has been a massive number of changes in senior management in recent months and downgrades from both S&P and Moody’s in the spring, worried about high leverage; cash flow losses and operational challenges. For the BDC sector, this is very big exposure in aggregate, with annual income of approx. $9mn at risk should the company default down the road. With that said $90mn of the debt is held by the three FS-KKR non traded BDCs (FS II-III and IV), which are intending to go public under one banner before long. How Constellis plays out will be of above average interest at FS Investment-KKR in the quarters ahead.
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.
Another famous retailer – J.C. Penney – has been back in the news since Reuters announced on July 18, 2019 the hiring of restructuring advisors. We added the retailer to our Worry List on the news. Now Motley Fool has provided a useful summary of the company’s financial condition. Here are highlights: ”
“As of the end of last quarter, J.C. Penney had $3.9 billion of debt, plus another $1.2 billion of lease liabilities. Meanwhile, the company’s adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) has plunged in recent years due to strategic missteps and tough business conditions. This has driven J.C. Penney’s leverage to unsustainable levels. Adjusted EBITDA totaled $568 million in fiscal 2018 — down from $1 billion in fiscal 2016 — putting J.C. Penney’s leverage ratio at more than seven times EBITDA. For comparison, most investment-grade companies have debt that is no more than three times EBITDA”.
The real problem is looming farther out. J.C. Penney has about $2.5 billion of secured debt that will mature between 2023 and 2025. It also has $1.2 billion of unsecured debt maturing between 2036 and 2097. J.C. Penney needs to whittle down the principal balance of this debt while ensuring that it can extend the maturities of what remains.
J.C. Penney’s unsecured debt maturing in 2036 and beyond currently trades for between $0.23 and $0.26 on the dollar. Even some of its lower-priority secured debt trades for less than $0.50 on the dollar. Thus, the market is already factoring in a substantial likelihood that creditors won’t be repaid in full. This should motivate them to cooperate with the company’s efforts to restructure its debt. It might even make sense to write off some of the principal if J.C. Penney can offer more collateral in exchange (and perhaps some equity warrants to reward creditors if the company manages to turn itself around).
From a BDC perspective, the exposure is modest at $3.3mn, and spread over three FS KKR non-traded BDCs: FSIC II, FSIC III and FSIC IV in two different loans/notes, one maturing in 2020 and another in 2023. We expect lower valuations will be applied in future quarters than as of 3/31/2019 when FMV was close to par, but the impact on individual BDC balance sheets and income statements, even if Chapter 11 does eventually occur, should be modest.
As of June 19, 2019 the stock price of publicly traded refrigerants distributor Hudson Technologies (ticker: HDSN) has dropped below $1.00 and become a “penny stock”. The company – based on BDC valuations – has been under-performing since June 2018. As a public entity, we’ve been able to review quarterly filings and read the ever bullish Conference Call transcripts. We added Hudson first to our Watch List (CCR 3) and then – more recently – to our Worry List (CCR 4) and are concerned that the company may soon join our Bankruptcy List (CCR 5). Admittedly as of IQ 2019, the company was in compliance with much adjusted covenants on both its secured Revolver and its Term Loan. The business is admittedly seasonal but Operating Income was under a quarter million dollars and interest expense $2.4mn. Total debt, which includes the 2023 Term debt where all BDC exposure sits, is $131mn. All of which to say that the signs do not look good for the business and for its lenders. BDC exposure is $102mn, and generates $13mn of annual investment income. All the BDCs are part of the FS Investments-KKR complex and include publicly traded FSK ($39mn) and non-traded FSIC II, FSIC III and FSIC IV. At March 31, 2019 the Term debt had already been discounted (29%). The debt is publicly traded and that discount holds as of June 19, 2019 based on Advantage Data’s middle market loan real-time data. Unfortunately, the fundamentals of the industry in which the company operates are currently negative and we worry that if a Chapter 11 filing or out of court restructuring occurs there will be both income interruption and further losses both realized and unrealized. At worst, the BDC lenders might have to write off (or convert to equity) 50% of debt outstanding, or around $50mn, compared to ($30mn) already discounted. Given the size of the BDC exposure; the substantial investment income accruing; the very sharp drop in the stock price and the negative tilt in recent results, this is a credit worth paying close attention to.