The BDC Credit Reporter has written three times before about Bakken oil and gas operator Spotted Hawk Development. Since our last article in June, the company has been restructured yet again. This has required the only BDC with debt exposure (and a 38% equity interest) – Apollo Investment (AINV) – to convert one of its debt tranches to equity and another tranche was written off. This resulted in a ($44.4mn) realized loss, or roughly one third of the amount the BDC had invested in the company.
Currently, AINV has one debt tranche of $24.7mn valued slightly above par and current on its 12% interest. The debt matures at the end of June 2022. Two tranches of equity with a cost of $45.5mn is valued at $6.7mn. The total FMV of AINV’s position is $32.2mn. (At its peak in 2020 AINV had $116mn invested at cost in the business).
We get the impression from AINV’s latest conference call that some sort of liquidity event for Spotted Hawk is planned in the next 12 months. Here’s a quote from AINV’s IIQ 2021 conference call that is relatively explicit on the BDC’s motivations.
This latest restructuring may have been arranged to facilitate that purpose. How this plays out will be important for the BDC’s net asset value and income.
If AINV receives $32mn – as per the latest valuation – the income generated from re-investing the proceeds will not make any difference as AINV’s new investments yield about 9% (or lower), which would generate the same income as currently from the 12% Spotted Hawk Term Loan. NAV would not change either. However, if this turns out to be a write-off, AINV will lose ($2.9mn) of annual investment income and take a further ($0.5) per share hit to net asset value per share. Given that something is LIKELY to happen in the next few quarters, we have the company as Trending. However, whether the trend will be positive or negative is hard to handicap. Oil prices are high, but that did not help in prior periods, so the outcome is unclear.
For the moment, Spotted Hawk remains rated CCR 5. We’ll report back if we hear any news or when the IVQ 2021 AINV results are published.
We’ve written about Apollo Investment’s (AINV) long standing and ill fated investment in Spotted Hawk Development (aka SHD Oil & Gas) twice before. The last time – back on November 27, 2020 – we noted that two of the three debt tranches AINV has advanced were on non accrual and the FMV of the $115mn invested was only $42.3mn, based on IIIQ 2020 results.
Six months later – and going off the IQ 2021 AINV results – not much has changed. Total exposure at cost remains the same and two of the debt facilities remain on non accrual. The FMV is $35.4mn. (However, that valuation is slightly better than in the IVQ 2020 when the FMV was $32.4mn, the lowest ever. Maybe the increase in the price of oil has begun to revive Spotted Hawk’s value, if only on paper.
Back on May 20, 2021 AINV’s management had the following, vaguely encouraging, update to offer on the company:
“Sort of now that oil prices have picked up, and there’s some sense of — there’s some — visibility is too strong a word. There’s some possibility of sort of constructive transactions. We’re going to be as aggressive as we can there to sort of exit that, but we don’t have anything”.
We continue to rate the oil and gas explorer as CCR 5 – given the two non accruals. However, we have the investment on our Trending List because there’s a strong possibility – with $70+ oil and much enthusiasm about everything in the markets these days – that the value of the business might be improving and its cash flows – potentially – increasing. Furthermore, we’re sure that if anyone shows any interest in AINV’s 38% interest in the company, they’ll find a receptive seller. This may yet be an almost complete write-off when AINV finally creates some resolution, but there’s a chance the BDC might do better than one might have expected just a few months ago. Of course, these things change very quickly in any commodity industry.
Spotted Hawk Development LLC is the BDC’s largest single remaining energy investment and the only one still generating current income for the BDC. As a result, the BDC Credit Reporter is undertaking an update as of September 30, 2020. The total cost remains $115mn, essentially unchanged from the prior period. However, the fair market value has dropped to $42.3mn from $47.5mn. The reduction occurred in the Tranche A senior loan (there are three tranches), which remains on non accrual.
Currently only Tranche A of the debt is still “performing”, with a cost of $24.7mn and a slightly higher FMV. The debt is priced at a 12.0% yield, generating $3.0mn of annual investment income, equal to 2.7% of the BDC’s annualized Net Investment Income Per Share.
Management provided no update on the company this quarter and no analyst asked a question. We affirm the company’s CCR 5 rating, which has been in place since 2016 and continue to expect – given the parlous state of the energy sector – that this investment will end in a huge realized loss and – probably – a further decrease in fair market value from the IIIQ 2020 level. What’s impossible to tell – given that AINV controls this business and has – is whether Spotted Hawk will continue to pay its interest. Given the valuation trend, the outlook for payment and for valuation looks bleak.
Oil & gas production company Spotted Hawk Development – which has faced difficult conditions for years and has already endured one major restructuring – is faring even worse under the current oil price drop. According to its lender-owner Apollo Investment (AINV) “the company has reduced expenses and capital expenditures to necessary maintenance items and temporarily curtailed production“.
AINV also disclosed on its IQ 2020 conference call that of the three debt facilities outstanding to Spotted Hawk, two are now on non-accrual, up from one previously. This time a $45.5mn Term Loan with an interest rate of 4.0% has been moved to non-performing. That’s $1.8mn of annual investment income that AINV will not be receiving. That leaves just one 2021 loan trache with a face value of $24mn and an interest rate of 12.00% still generating income for AINV. Understandably enough one has to wonder if that last tranche can remain income generating ($2.9mn annually) for much longer. The company has been benefiting from price hedges on its production but those expire – according to AINV – shortly…
Overall, AINV has invested $114.8mn in Spotted Hawk in an attempt to rescue an investment that began in 2012 with just $24mn. If the business fails, AINV stands to lose up to ($47.2mn) and that remaining loan income. With the BDC manager clearly not interested in adding new rescue capital under virtually any scenario, the chances of failure seem high.
The investment – one of those “legacies” left over from an earlier strategy by a different management team – illustrates both the risks involved in lending/investing in oil & gas and of serving as both owner and lender to a cash strapped company. That has turned AINV into the investor of last resort on multiple occasions and caused a small credit mistake to grow into a very big one and the second largest in the BDC’s portfolio. Many BDCs have learned to avoid energy investments but the more complex matter of serving as lender-owner remains unsettled. Yet, in the quarters ahead we will see many more of the latter than of the former and will have an opportunity to revisit whether the BDCs involved have demonstrated whether they know “when to hold them and when the fold them“.