Everything old is new again. Back in 2020 Serta Simmons Bedding, LLC was forced to recapitalize, in an effort to reduce its debt load. We wrote 7 articles (!) on the subject, beginning in 2019. Two years later and Serta seems to be in serious trouble again. According to news reports, Moody’s has just downgraded the company and its debt:
DORAVILLE, Ga. – Moody’s Investors Service has downgraded Serta Simmons Bedding’s corporate rating to Ca from Caa3 and said the outlook was negative for the bedding manufacturer based on $1.9 billion of debt it is facing next year and its declining cash reserves.
In addition to the corporate rating, Moody’s downgraded SSB’s probability of default to Ca-PD from Caa3-PD; first lien super-priority first-out term loan to B3 from B2; first lien super-priority term load to Ca from Caa2; and first lien term loan to C from Ca.Sheila Long O’Mara Furniture Today September 7, 2022
Then as now, BDC exposure to Serta is limited. According to Advantage Data, there is only one BDC lender to the privately-held mattress company. That’s Barings BDC (BBDC), which is both a first lien and second lien lender. Judging by the IIQ 2022 BBDC valuations, the strain on the business has been recognized as the $3.4mn invested in the second lien lien was valued at $2.5mn – a (26%) discount. By contrast, the $7.2mn invested in a first lien loan – both of which come due in August 2023 – is carried close to par.
We have downgraded Serta Simmons to CCR 4 from CCR 3, just one quarter after adding the company back to the underperformers watchlist. We’ll continue to watch this developing story, but given the modest exposure by BBDC, no great impact is expected whatever happens. (We expect a Chapter 11 restructuring not dissimilar to th one that came before is the likeliest outcome).
We’ve written about bedding manufacturer Serta Simmons Bedding LLC multiple times before because much has been going on with the company. Even before the pandemic, the company was underperforming. The BDC Credit Reporter downgraded Serta to a CCR 3 rating in the IQ 2019. That was raised to a CCR 4 in the IQ 2020 when the debt of the BDC was discounted by (50%), and talk of bankruptcy was in the air. Our most recent update occurred on June 23, 2020 shortly after the company dodged the bankruptcy bullet by undertaking a controversial restructuring gambit.
As this thoughtful article from Bloomberg explains, management sided with certain of its existing lenders to (essentially) stiff some of the other lenders; while reducing total debt and generating fresh liquidity at the same time. We won’t get into a detailed discussion of how the situation played out but will say that the only BDC with exposure – Barings BDC (BBDC) – joined in with the “winners” in this internecine struggle. The losers – led by Apollo Global – went to court to dispute the deal and lost.
For our purposes, BBDC went from a $4.9mn par position ($3.9mn at cost) in a first lien term loan due in November 2023 priced at LIBOR + 350 (with a 1% floor) to positions of $10.6mn at cost in two “super priority loans” with a August 1 2023 end date, but priced at LIBOR + 750, also with a 1% floor. Although pricing is the same, one tranche is a “first out” and the other a “second out” and are valued differently by BBDC and the market. As of September 30, 2020 BBDC values the first out at a premium to par and the second lien at a (12%) discount, slightly worse than the prior quarter when this debt was first booked.
To get to this point – better pricing and “super priority” status – BBDC had to agree to swap out its earlier debt at a discount and advance new funds to the struggling mattress manufacturer. Not clear from the BDC’s financial statements is whether a realized loss of any sort was booked as part of this bold exchange. (We had first thought BBDC was going for a debt for equity swap, but realize now that this is a debt for debt swap – also a standard restructuring technique).
At this stage, we have upgraded Serta to CCR 3 status. However, we don’t believe the company is out of the woods yet given market conditions and the still substantial debt load. Furthermore, BBDC has essentially “tripled down” in terms of total exposure, raising what was a modest exposure to a more material level. Undoubtedly, we will be revisiting Serta’s long and winding credit road again.
On June 22, 2020 Serta Simmons Bedding announced by press release that a previously disclosed restructuring arrangement with some of its lenders had been finalized.
“The transaction includes $200 million of new capital and the exchange of approximately $1 billion in First Lien Debt and $300 million in Second Lien Debt, and will reduce the Company’s debt held by participating lenders by over $400 million, increasing the Company’s liquidity and financial strength, while supporting the acceleration of SSB’s business transformation plan“.
As we explained in a prior article, this is a classic debt for equity swap, with the existing lenders also putting up fresh capital to float the business in its next incarnation. From a BDC perspective there are no great amounts involved. The only BDC with exposure – Barings BDC (BBDC) – has only $3.9mn at cost invested and a FMV of $1.9mn. Their aggregate capital invested might go up, but not in a way that will move any needles.
For the BDC Credit Reporter the transaction – which included much friction with another group which we covered in our prior post – remains interesting as a fast moving example of the “debt for equity swap” and the changing roles of the debt providers in failed leveraged buyouts.
We retain our current rating of CCR 4 for the company till bankruptcy is formally exited, at which point a rating of CCR 3 or CCR 4 is likely. Which one will depend on the final structure and business conditions in the already highly competitive mattress market in the near future.
The plot thickens at Serta Simmons Bedding just two days after the BDC Credit Reporter last wrote about the mattress giant. A June 11 article in the Wall Street Journal describes an ongoing legal battle between two different groups of lenders for control of the company, which is teetering on the edge of bankruptcy. On one side there’s Apollo Global Management and on the other Advent International and a group of debt holders (led by mutual funds that invest in debt) that includes the only BDC with exposure: Barings BDC (BBDC).
What’s important to know is that BBDC’s group, working with Advent, is offering a debt for equity swap, summarized thus by the WSJ:
“The traditional loan funds that own most of Serta’s debt made a counteroffer to Advent, pledging to lend Serta $200 million and to exchange about $1.3 billion of loans they owned for $875 million of new ones, reducing the company’s overall debt by $400 million. But the funds, many of which bought their loans years ago for face value, demanded that the new debt they purchased and swapped into have first claim on all of Serta’s assets, essentially leapfrogging Apollo and other lenders. Advent took the offer from Eaton Vance and the other mutual funds, prompting Apollo and its group to ask the court to block the deal“.
Who knows who will win this legal battle ? We don’t and – in any case – the terms could change again. However, this does give us a glimpse of how BBDC is prepared to proceed: advancing more monies; remaining a lender but also becoming an equity investor. That would tie the BDC to Serta’s fortunes for many years to come and increase its total investment outstanding, though likely only modestly.
Not to make too much of one incident in one company by one BDC, but the BDC Credit Reporter believes the strategy being chosen for Serta may be repeated many times over in the months ahead as more companies face or file bankruptcy. Big asset managers like Barings – with plenty of cash, big teams of professionals standing by and an army of lawyers on retainer – will – most of the time – choose fight over flight. The relative portion of any debt owed that will be turned to equity and any new cash to be advanced will vary by transaction but the basic model will be the same.
If played out dozens or hundreds of times as we expect, this will continue to shift the traditional roles of lenders to non-investment grade companies. No longer do mutual funds, BDCs or other lenders just supply inexpensive first and second lien debt but are also seeking to be owners when necessary to protect their interests. This could never have happened when banks dominated leveraged lending in years past, but asset managers, mutual funds and other non-bank groups do not have the same regulatory requirements or the same mindset. The Covid-19 recession (still looking for a good name) could accelerate this shift that’s been underway beneath the radar for years.
Once again we’re hearing what’s going on in the conference rooms of troubled companies through the anonymous whisperings of a “person familiar with the matter” to the Wall Street Journal. In this case, the word is that Serta Simmons Bedding is eschewing bankruptcy and seeking to negotiate an out-of-court restructuring of its huge debt load. The WSJ indicates some debt would be swapped for equity and new capital would be injected in some form that is not clear to the BDC Credit Reporter. Nothing is yet finalized so just consider this a rumor in progress.
We’ve written about Serta Simmons before – one of a series of bigger companies considered lower risk when the debt was first issued at pricing of LIBOR + 350 bps which have gotten into trouble. As we noted on April 22, 2020, we’ve rated Serta CCR 4, which indicates that we expect some sort of loss to eventually happen. This news story, although not definitive, confirms our prediction. So do market prices, with the 2025 Term Loan involved here trading at a (60%) discount at the moment, even higher than the (51%) discount at March 31, 2020 when the only BDC involved – Barings BDC (BBDC) last valued its position.
This latest news item does not move any credit rating needles but suggests the company and its lenders are – at least – getting close to an understanding. The news story also suggests the company – not unsurprisingly – seems to be in need of fresh liquidity, which always focuses deal doing. Not to get ahead of ourselves, though, the amount of debt that might be converted from debt to equity seems relatively modest and may leave Serta still on our underperforming list even if some consensus is reached.
For BBDC – as in many other positions – the exposure is modest in and of itself and should not result in any significant loss of capital or income whatever happens. This investment, though, falls squarely in what we’re calling the “First Wave” of defaults/restructurings because Simmons was facing business headwinds even before Covid-19 kept their customers out of the showrooms. We’ll circle back if and when we get beyond Deep Throat-like coat and dagger revelations and official terms are agreed. Or not.
Serta Simmons Bedding which is a major manufacturer of…beds, has been downgraded by S&P to CCC-. The outlook is Negative. The 2023 Term Loan that trades in the debt markets is discounted nearly 60%. The ratings group is worried about liquidity and weak operating results.
For our part, we have the well known company rated at a Corporate Credit Rating of 4, as discussed in our earlier articles dating all the way back to August 19, 2019. Obviously, we’d not anticipated the current situation at the time, but the likelihood of the company climbing back up the 5 point rating system to performing status seems ever less likely.
The only BDC with exposure remains Barings BDC (BBDC), which took on this apparently “safe” borrower back in the IIIQ 2018 as part of its “safety first” strategy on becoming a public BDC following the acquisition of Triangle Capital. That’s not working out as planned here, with the $3.9mn in debt exposure at cost in the 2023 loan was already written down by (19%) at year end 2019. If the value remains unchanged, the three quarter of a million dollar unrealized loss could triple, or worse. Not a huge position because – thankfully – BBDC also chose to build a very “granular” defensive portfolio which may yet serve them well. Serta Simmons, though, looks like an almost certain loss maker.
In an unusual move, Serta Simmons Bedding publicly scolded S&P Global Ratings for recently downgrading the company to a CCC rating from CCC+. As this trade article explains, management’s contention is that the rating agency was making the move “based mostly on where our debt is trading in the markets”. The company went on to point to “continued trends of improved performance in our cash and EBITDA” as the reasons why S&P is wrong. Furthermore, the company contrasted the S&P approach with its arch rival Moody’s who were seen by Serta’s management as taking a more constructive approach. We don’t quite understand that last point as Moody’s downgraded Serta to Caa1 from B as far back as April.
For our part, we initiated coverage with a Corporate Credit Rating of 4 (Worry List) back on August 14, 2019. That’s only one level above non performing on our 5 point scale and indicates that we believed the chances of an eventual loss were greater than of full recovery. Initially, we added the company to the under-performing company list following the valuation of its debt by the only BDC with exposure – Barings BDC or BBDC – in the IQ 2019 results. At that point, the 2023 Term Loan in which BBDC was invested – which is institutionally traded – was discounted (19%). As of September 2019, that discount had increased to (33%). For what’s worth, as we write this, the discount has increased to (40%) in the loan market.
All the above only solidifies our concerns and CCR 4 rating where Serta is concerned, especially as the whole sector is going through a difficult period with competitors filing for bankruptcy, as we’ve covered on these pages.
On August 19, 2019 a trade publication indicated that Serta Simmons Bedding had recently undertaken a major organizational restructuring. This was revealed by a senior executive of the firm.
Not by itself earth shattering news, but when associated with the recent devaluation of Barings BDC’s (BBDC) debt position in the company, now discounted from cost by (29%), after being only written down (8%) at 2018 year-end underscores that not all is well. Not helping was the departure on April 17, 2019 of Serta’s CEO and the July 2019 placing the debt on Fitch’s “Loans Of Concern” (similar to the BDC Reporter’s Worry List).
We are currently giving the company a Corporate Credit Rating of 4, in our 1-5 scale. The only BDC with exposure is BBDC with $2.7mn at cost, $3.0 at par and $1.9mn at FMV as of June 2019. The amount of investment income at risk – under $0.200mn – is modest, due to the low interest rate charged.