Audacy Corporation: Assets Sold

We learned from a trade publication that Audacy Corporation has been sold to Australian firm Electro Optic Systems for $10mn. That’s important to the only BDC with exposure – Horizon Technology (HRZN) – which has $3.9mn invested in Audacy. That exposure is in the form of two loans (maturing in 2020 and 2022) and in common stock. As of September 30, 2019 – and as discussed in an earlier article – the debt was on non accrual and had been since the IIQ 2019. HRZN has written down its investment to $1.5mn.

We get the feeling the $10mn being received from the buyer will not cover all the debt outstanding but – given that Audacy is a private company – we don’t know for sure. We’re guided by the current market value of the two loans mentioned before, which are trading at a (58%) discount to par. Those numbers suggest that the net amount HRZN can hope to receive from the sale of Audacy is in line with the most recent valuation. If that’s true, expect to see a realized loss of ($2.4mn) booked in the IVQ 2019 or IQ 2020, but no further loss beyond what was already provided for.

We will circle round once the final outcome is known from HRZN, and will be in a better position to undertake a post-mortem on this credit that was first booked only in the IIQ 2018 and started to shows signs of trouble only months after HRZN became involved. For the BDC, this represents a loss of under $0.4mn in annual investment income – some of which will presumably be offset by proceeds from the sale of the business – and a modest realized loss equal to 1.1% of equity capital at par.

The Worth Collection: Liquidating ?

According to a trade publication, The Worth Collection may be in the process of “winding down”. The women’s apparel company’s website is no longer operational according to the report, which checks out. Apparently, there has been a broad campaign to raise additional capital or find a buyer but with no success. The company is owned by PE firm New Water Capital following a purchase in 2016.

Publicly available information is sparse at this point, as much of the pertinent information is behind a paywall. However, we did already know that the company’s debt was placed on non accrual in the IIIQ 2019 by its only BDC lender Monroe Capital (MRCC), which wrote the 2021 Term Loan down (34%). As of now that same debt is trading at a (36%) discount according to Advantage Data’s Syndicated Loans records. The exposure was first initiated in 2016, presumably in conjunction with the New Water acquisition.

This is setting up to be a material reverse for MRCC, which is already missing out on over $1.0mn in annual investment income. The BDC may have to write off anywhere from a third to all of its $10.4mn investment. There may be some value in the brand or other assets, but maybe not. We expect to hear something more official shortly.

California Pizza Kitchen: Downgraded by Rating Groups

We pride ourselves on being timely about alerting readers to material new developments at under-performing BDC-financed companies. In this case, though, we’ve been slow to notice the deterioration underway at iconic restaurant chain California Pizza Kitchen (CPK). In July and August 2019, the company was downgraded by both S&P and Moody’s to speculative grade status. Here’s a sample of what the former said: “We are downgrading CPK to ‘CCC+’ from ‘B-‘ to reflect our view that the company’s capital structure may be unsustainable over the long term.

Moody’s said the following: “CPK’s Caa1 Corporate Family Rating is constrained by its high leverage, modest interest coverage, small scale and geographic concentration relative to comparable casual dining concepts. The company is further constrained by the challenging operating environment which includes soft same store sales growth, with weak traffic trends, and increased labor expense as a percentage of restaurant sales which continue to pressure profitability margins“.

All the above notwithstanding, the 2022 and 2023 Term debt in which seven BDCs have committed $48mn was still valued at a discount of less than (10%) last time results were published in September 2019. As of June 2019 the debt was trading (almost) at par. As of now, though, the publicly traded 2022 Term Loan is trading at a (12.5%-15%) discount, and the more junior 2023 facility at (20%) off. Time to get worried about the $5.0mn of annual investment income that is being generated for the BDCs involved.

There are 6 public BDCs with material exposure, led by Main Street (MAIN) and followed in descending dollar amount by Great Elm (GECC); Monroe Capital (MRCC); Capitala Finance (CPTA); Capital Southwest (CSWC) and Oaktree Specialty (OCSL) – a veritable potpourri of funds with little else in common. There does not seem to be any immediate risk of default, although Moody’s did suggest there was a potential need for a covenant waiver or amendment at year end. That may not have been required or has been granted or could be under discussion. We have a Corporate Credit Rating of 3 on CPK on our 5 point scale, but that could move down quickly in 2020 if performance does not turn around – which seems unlikely – or if PE owner Golden Gate Capital, which bought the famous chain in 2011, does not inject new capital.

We admit the BDC Credit Reporter has been a bit slow to flagging CPK’s credit troubles, but expect to hear much more from us in the months ahead if the company’s debt continues to drop in value. We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends – referred to by Moody’s above – that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited.

MPI Products: Company Sold

On January 15, 2020 private equity group Turnspire Capital Partners announced its acquisition of MPI Holdings, LLC, parent of MPI Products, for an undisclosed amount. MPI is a portfolio company of Goldman Sachs BDC (GSBD), which holds $20.0mn of the principal of the January 2020 second lien secured debt. At September 30, 2019, the debt was on non-accrual, and discounted ($5.5mn) from cost. Just under $0.600mn of investment income was not being received.

The debt had been placed on non-performing status only in the third quarter of 2019 and GSBD had revealed on its conference call that a “sales process” was underway. At that point, the BDC was very non committal about the likely outcome.: “…It’s a fluid situation right now. The company is in a sale process. As I mentioned, when you look at the mark today, I think what we’re looking at is industry valuations there, in particular, coming down quite dramatically. So in terms of the range of outcomes, it could be a full repayment, it could be a partial repayment, it could be a variety of different outcomes“.

Now we know the sale has occurred but not the price and cannot say if this is Good News, Bad News or Not-So Bad News. What we do know is that some kind of resolution has occurred, which means the IVQ 2019 valuation that will be published shortly should be very accurate and that some sort of realized loss or full repayment (including interest) will occur in IQ 2020. If the latter occurs, that might give a one time boost to GSBD’s earnings as previously unpaid interest income is collected. If the former happens – this is a second lien position after all – GSBD will be losing both some capital and some earnings power.

GSBD – according to Advantage Data records – had a long history with MPI dating back to 2014 in this same 2020 loan, which performed normally till only the IIQ 2019, when the debt was discounted (9%). The next quarter the non-accrual occurred and for reasons that are not yet clear. GSBD were not very forthcoming when discussing the company for the one and only time in six years on the most recent conference call, claiming the decrease in the value of the investment in the quarter was due to lower sector values:

So I think when we look at that business, what’s impacting the mark in this go around is pretty significant valuation changes taking place in that specific industry. So I wouldn’t read anything sort of that would impact other parts of the investment. It’s very much a function of the specific industry that, that company sits within“.

We can’t quite reconcile that level of sudden write-down and the shift to non accrual and this subsequent sale of the company to a “special situations” focused PE group to just a technical change in auto industry valuations. The apparent opaqueness of GSBD’s disclosures – in answer to a direct question from an analyst – is a little disconcerting, but we might be misreading the transcript. In any case, we hope to get a clearer picture from GSBD’s management when the IVQ 2019 or IQ 2020 results are published and discussed and MPI gets placed in either the win or loss column.

McDermott International: Files Chapter 11

On January 21, 2020 McDermott International announced its intention to “commence [a] prepackaged Chapter 11 filing in the U.S. Bankruptcy Court for the Southern District of Texas (“the Court”) later today“. In a press release, the oil field services giant indicated that “two-thirds of all funded debt creditors” had agreed to a re-structuring package that would “de-lever” its balance sheet. That’s a massive $4.6bn of debt getting vaporized. The company hopes to re-emerge with just $500mn of funded debt and the ability to provide letters of credit in support of work projects – a critical aspect of its business. That will mean “nearly all funded debt” will be converted to equity.

To move the Chapter 11 along, McDermott has arranged $2.8bn in Debtor-In-Possession (DIP) financing. As has been frequently the case recently in these “pre-packs” the company hopes to be in and out of bankruptcy in a short period: two months is the estimate given till court confirmation of the plan is expected.

We learned from the press release that subsidiaries of McDermott have entered into a share and asset purchase agreement with a joint partnership between The Chatterjee Group and Rhône Group which will serve as the “stalking-horse bidder” in a court-supervised sale process for Lummus Technology. The sale of this subsidiary has been a key element in the MCDermott saga. Here are the key details from the press release:

Under the terms of the Agreement, the Joint Partnership has agreed, and is committed, to acquire Lummus Technology for a base purchase price of $2.725 billion. McDermott will have the option to retain or purchase, as applicable, a 10 percent common equity ownership interest in the entity purchasing Lummus Technology. McDermott expects to hold an auction in approximately 45 days to solicit higher or better bids for the Lummus Technology business. Either the Joint Partnership or the winning bidder at the auction will purchase Lummus Technology as part of the Chapter 11 process, subject to regulatory and court approval. Proceeds from the sale of Lummus Technology are expected to repay the DIP financing in full, as well as fund emergence costs and provide cash to the balance sheet for long-term liquidity.

We’re not bankruptcy experts so we don’t know what the odds are of the McDermott plan – which is ambitious by any standard – being accepted in its current form and timetable. More certain is that the two BDCs involved are likely to lose the $0.700mn of annual investment income being accrued and some sort of realized loss will be booked in 2020. The only BDC with material exposure as of September 30, 2019 was non-listed Business Development Corporation of America, with $9.8mn invested at cost in the May 2025 Term Loan, already written down (35%) as of the IIIQ 2019. Oaktree Strategic Income (OCSI) has a tiny $0.6mn exposure in the same Term Loan.

For our part, we’ve had McDermott on our Under Performers list since July 2019 and with a Corporate Credit Rating of 4 (Worry List) for months. Since October 2019, we’ve added the company to our Bankruptcy Imminent list, where we seek to flag for readers those credits most likely to hit the headlines. For all prior McDermott articles, click here. We expect there’ll be one or two more follow-up articles as the restructuring plays out, but the McDermott credit story seems closer to the end than the beginning.

Commercial Barge Line: Negotiating Restructuring

Another casualty in the slow-down in the freight industry that has been going on for several quarters is American Commercial Barge Line, one of the largest barge operators in the U.S. We’ve had the company on our Under Performers list with a CCR 3 rating since the IIIQ 2017 BDC valuations came out. That was downgraded to a CCR 4 (Worry List) when the value of the 2020 Term Loan we were tracking continued to drop. Moody’s also downgraded the company’s debt back in April 2019, which magnified our pessimism.

Now we hear from the Wall Street Journal, which does a great job covering the multitude of bankruptcy-ready companies, that Barge Line is negotiating a wide-ranging debt restructuring, covering more than $1.0bn of its debt. Still left open, though, is the possibility of a Chapter 11 filing if an agreement cannot be reached. “The company, which is owned by Platinum Equity LLC, has hired investment bank Greenhill & Co. as restructuring adviser, they said, while lenders are working with investment bank Evercore Inc. American Commercial Barge and Platinum declined to comment“, re the WSJ.

From a BDC perspective, where total exposure is $18.0mn, the chances of an upcoming loss are very high. There are two BDCs with exposure: micro-BDC Great Elm Corporation (GECC) and one of the biggest public BDCs out there: FS-KKR Capital (FSK). The latter seems to have inherited this position from when GSO Blackstone managed Corporate Capital Trust, which was recently merged into FSK. GECC started buying the debt in 2017 and has repeatedly grown its position with new purchases to reach $13.9mn from $1.7mn initially. That’s a significant exposure for a BDC of the size of GECC; less so for the $4.1mn invested by FSK, and already discounted (41%).

As of now, though, the 2020 Term debt in which both BDCs are invested is trading at a discount of (55%). That could go lower, depending on how these negotiations turn out. We expect both BDCs will taking a further haircut off their September valuations 2019 valuations when year-end results are published. If a restructuring deal is struck or even if we proceed to a bankruptcy, some sort of Realized Loss should follow in 2020. For the moment, we’re adding the company to our Bankruptcy Imminent list, which seems to be growing by leaps and bounds. We’ll be digging in a little more to what a restructuring might look like for the company and its lenders – who are at risk of losing $2.0mn of investment income for, at least, some period.

Frontier Communications: March Bankruptcy Targeted

We’ve written eight prior articles about the publicly traded telecom + cable giant Frontier Communications, dating all the way back to March 2019. In fact, the company was added to our Under Performer list following IVQ 2018 results with a CCR 3 (Watch List) rating and downgraded further to a CCR 4 (Worry List) back on June 13, 2019. More recently, we predicted the company might file Chapter 11 in the IVQ 2019, but that did not happen. In our last report before this one, though, we said a Chapter 11 filing was likely in the IQ 2020. With the latest news reports, that seems likely to turn out to be true.

People with knowledge of the matter” – and there are dozens of lenders, lawyers, insiders and regulators involved at this stage so journalists have plenty of sources – indicate the company is aiming to file a consensual, pre-packaged bankruptcy by March. On the horizon are $356mn of interest payments due in mid-March. As a result, Frontier’s new CEO and his team have been busy – according to these reports – meeting creditors and seeking to craft out a restructuring plan that would be blessed by the court. (The company itself has no comment).

From a BDC perspective, the question is now more about how each lender class will fare in the restructuring, and what impact there will be on interest income – running about $5mn a year. As we’ve noted before, the debt held by the BDC lenders remains valued at a premium to par, both in their own valuations and when we look at the market price of their secured debt on Advantage Data. Will Frontier restructure itself, go in and come out of Chapter 11 in a hurry and have no impact on the value or income of the $67.5mn in debt held by 8 BDCs ? We have our doubts, but that’s the state of play at the moment. We shall soon learn if those valuations are appropriate.

AAC Holdings: Lenders Terminate Forbearance

In an 8-K on January 16, 2020 treatment center operator AAC Holdings Inc. announced that its banks had terminated a Forbearance Agreement that had been in place since October of 2019, and were exploring all options regarding defaults under their credit agreement. In fact, the break-up occurred on January 9, with the delivery of a notice by the lenders, headed by Credit Suisse.

The BDC Credit Reporter has written about the troubles at AAC – also known as American Addiction Centers – eight times, starting in April 2019 and – most recently- on October 25, 2019 when the forbearance was agreed upon. Throughout, based upon our review of the company’s publicly available financial statements and due to the ever lower stock price, we’ve been pessimistic about the likelihood of AAC Holdings being able to right its own ship without a restructuring or bankruptcy. With this move by the lenders, our thesis seems ever more likely to be realized.

Not helping is that the falling out with the lenders was – if this latest filing is to be believed – triggered by ” the failure of the Company under the Forbearance Agreements to have provided the Forbearing Lenders with a three-year business plan for the Company“. There’s more going on because the company also announced – in a highly unusual or even bizarre move – the “conditional resignation” of its CEO. We’ll quote from the release to leave no doubts as to the situation:

On January 8, 2020, Michael T. Cartwright, Chairman of the Board of Directors (the “Board”) and Chief Executive Officer of AAC
Holdings, Inc., a Nevada corporation (the “Company”), delivered to the Board his conditional resignation as Chief Executive Officer.
Mr. Cartwright’s resignation as Chief Executive Officer will become effective only upon (i) the Company entering into amendments to its two
previously reported forbearance agreements, each dated October 30, 2019, entered into between the Company and the lenders under the
Company’s two primary credit facilities and (ii) the Company receiving $10.0 million of incremental funding under the Company’s previously
disclosed credit facility entered into by the Company in March 2019. Mr. Cartwright currently intends to remain as Chairman of the Board.
Also on January 8, 2020, the Board appointed Andrew W. McWilliams, the Company’s Chief Financial Officer, to serve as Chief Executive
Officer, commencing upon the effectiveness of Mr. Cartwright’s resignation, as described above.

As the AAC Holdings credit story becomes more confused, we remind readers that BDC exposure is material: $66mn at cost spread over 4 BDCs, three public and one non-listed. The public BDCs are Capital Southwest (CSWC); Main Street Capital (MAIN) and New Mountain Finance (NMFC). The private BDC is HMS Income, which is managed by MAIN. The debt is in the company’s 2020 and 2023 Term Loans and three BDCs marked their positions as being on non accrual from the IIIQ 2019. The FMV totals $56mn, leaving plenty of room for further valuation losses.

This is publicly traded debt and we’ve checked Advantage Data’s Middle Market Loan marketplace and found the 2020 Term Loan still valued at par by the market and the 2023 discounted (25%), only slightly lower than at 9/30/2019. Nonetheless – re-iterating the position we’ve held for some time – we have little hope that the company can avoid bankruptcy/restructure for much longer, and we expect ultimate recoveries to be lower than current valuations. Most immediately at risk for the BDC lenders is receiving any investment income. In total, there’s nearly $10mn of annual interest in play over all facilities. According to Advantage Data records, the BDC with the greatest dollar exposure is NMFC with nearly $25mn at cost, but all in the 2020 debt. Tied for most at risk in the 2023 Term Loan is MAIN and HMS Income, with CSWC in third place.

We expect to be reporting back shortly on what is becoming a strange credit story and a potentially material set-back for several well regarded BDC lenders. On the other hand, we’d be the first to admit that it’s not over till it’s over.

McDermott International: Forbearance Extended

According to the Wall Street Journal, McDermott International’s lenders agreed “to wait at least six more days before they declare a default, the engineering company said as it continues restructuring negotiations“. The initial forbearance was due to expire on the stroke of midnight (the BDC Credit Reporter is adding dramatic effect) on January 15th, 2020 after a missed interest payment in November of 2019.

Nonetheless, not all is well between junior and senior lenders, with the latter more forgiving and flexible and the former less so, leaving the possibility of an inter-creditor battle if and when Chapter 11 occurs, which we consider an imminent possibility. For the moment, though, as the WSJ indicates : “Lenders could have let the forbearance expiration on the junior bonds trigger a cross-default. They instead made a deal with the company to wait until at least Tuesday before declaring a default on their own claims“.

We expect to be updating the McDermott story, which we’ve written about 6 times since September 2019, shortly.

Fusion Connect: To Exit Chapter 11

The BDC Credit Reporter has written on four prior occasions about Fusion Connect Inc. ever since the “leading provider of integrated technology solutions” failed to make an interest payment on its debt back in April 2019. Subsequently the company agreed to a debt for equity swap with its senior lenders and filed for Chapter 11 back on June 4, 2019. Those senior lenders were owed $574mn. From today’s announcement, we know $400mn of debt has been written off. Furthermore, some existing lenders have agreed to provide $115mn in an “exit financing loan”. We’re not sure if that rolls up the D.I.P. financing in place or is a new facility.

Back in July we’d anticipated the Chapter 11 exit momentarily, so there’s been some delay. In the interim, the company has appointed a new CEO from within.

With the exit, we are upgrading our credit rating to CCR 3 (Watch List) from CCR 5 (Non Performing). We’ll be keeping Fusion in our BDC portfolio company Under Performers database until we learn a good deal more about the company’s long term prospects with its new manager and balance sheet. For the two BDCs involved Garrison Capital (GARS) and Investcorp Credit Management (ICMB), with at least $20.3mn in exposure, a day of reckoning is now nigh. The BDCs should be writing off a portion of the 2023 Term Loan they hold in the IQ 2020 results. Based on the current market value of that debt, we expect a third of the position may be written off. The small DIP positions the two BDCs have is likely to be repaid or continue in the unspecified “exit” facility.

Even at this interim stage, this is a material blow to both BDCs, with ICMB with the greatest exposure on the 2023 Term Loan-turned equity, with $11.4mn at cost and a likely Realized Loss of over ($3mn). GARS has $7.4mn invested at cost in the 2023 debt, but had not taken as big a discount as ICMB last quarter in valuation terms (27% versus 34%). As a result, GARS might have to take an incremental unrealized loss before booking its realized loss of over ($2mn). All the above is just speculation because BDCs have wide latitude on how to value these investments gone wrong and converted into different security types. Undeniably, though, both BDCs will permanently lose much of the $1.8mn of investment income being generated before everything went wrong.

A final word. As Advantage Data’s records show both BDCs got involved in lending to the fast growing (i.e. risky) technology company only in the second half of 2018. ICMB joined the lending group in the IIIQ 2018 and GARS started a quarter earlier. By the IQ 2019, the company was in trouble due to its inability to successfully integrate two major acquisitions and the debt went on non accrual. That’s a very brief period to go from performing credit to non performing. Hopefully for both BDCs the company’s future performance – and the stock that they now own – will offset these early reverses.

J.C.Penney: Holiday Sales Place Future In Doubt

Embattled retailer J.C. Penney is often in the news now that Sears has left the building. A new CEO with a well regarded strategy for rejuvenating the company has given hope to some that “Penney’s” will survive where so many others have failed. We’ve written about the company multiple times in recent months, starting in July 2019. The company, though, has been on our Under Performers list since IVQ 2018 and is currently rated CCR 4 on our 5 point scale, just above non-performing.

Hopes were high that the holiday shopping season might prove a turning point for the company. However, as an article in Motley Fool suggests, that’s not been the case. Same store sales have been disappointing: “The company saw comparable-store sales drop by 7.5% for the nine-week period ending Jan. 4. If you exclude the fact that the retailer exited the appliance and furniture categories, comp sales dropped by “only” 5.3%. For the full year, the company expects same-store sales to drop by 7%-8%. That number improves compared to a loss of 5%-6% if you exclude the company dropping appliances and furniture”.

Once again the company’s survival is in question as there is no reason to believe the downward trend is reversible. We’ve added J.C. Penney to the list of companies that we expect to drastically restructure or file for some sort of bankruptcy protection in 2020.

As we noted in our most recent post, BDC exposure has actually grown in the IIIQ 2019 (to $18mn at cost) as TPG Specialty (TSLX) joined FS Investment II, III and IV as lenders, but in an asset-based facility. How any of these blenders will fare in a potential bankruptcy is impossible to suss out at this point. In late September all but one of the positions held were marked at par or better. As we’ve seen with other borrowers on a long downward slide those valuations can change, though, when an actual bankruptcy happens. Even TSLX – which has magisterially navigated multiple troubled companies that eventually went into bankruptcy – will have to keep their wits about them. At some point in 2020 we expect to join Warren Buffet to find out who’s been swimming naked.

Harvest Power Inc: Term Loan Written Off

Publicly-traded BDC TriplePoint Venture Growth (TPVG) is issuing new equity so must undertake some updated disclosures, which occurred on January 9, 2020 in a Prospectus. Included was the latest status on one of its under-performing portfolio companies: Harvest Power. The company is an organic waste management company, and went from performing normally to being sharply written down in a hurry. Until the IIQ 2019, the $14.8mn TPVG had invested in the company’s 2021 secured Term Loan was valued at only a (3%) discount. However, in the IIIQ 2019, TPVG wrote the debt down by (49%) to a value of $7.5mn, reflecting the market price of this traded loan.

According to the BDC on its Conference Call on November 11, 2019 , Harvest was exploring “strategic alternatives” – typical code language for being in deep trouble. TPVG expected the subject to be resolved in the IVQ 2019. Based on the most recent TPVG disclosure that turns out to have been correct. The BDC has now written down the value of its investment in Harvest to $4.2mn. Moreover, $2.4mn of that value has actually been collected. (No word on when the rest might be forthcoming or how). Searching in the public record, we’re assuming the fast resolution is related to the sale of two Harvest Power facilities to USA Waste of California, but we could be wrong.

For TPVG that’s a fast but unsatisfactory end to a lending relationship that began in IQ 2014 – according to Advantage Data‘s historic records – and has involved different facilities at different price points. The latest 2021 Term Loan was priced at 12.00%, which suggests a good deal of risk was anticipated when added to the books. Prior loans were priced as low as 7.0%. Now TPVG will end up booking ($10.6mn) in Realized Losses, including a further decrease of ($3.3mn) in value over the FMV at IIIQ 2019 in the year-end portfolio value. Investment income lost from the debt will be $1.8mn, but only $1.6mn once the $4.2mn in proceeds are re-deployed at a similar rate.

We hope to learn a little more – both from the public record and TPVG – when the transaction is fully removed from the books, which will allow us to undertake a credit post-mortem. Mostly, we’d like to understand why Harvest Power went so quickly from hero to zero.

Borden Dairy: Files Chapter 11

2020 has started with a bang where BDC credit challenges are concerned with one of the biggest BDC-funded bankruptcies in recent memory. On January 7, 2020 Borden Dairy filed for Chapter 11. Management set out its goal as follows: “The Company intends to use the court process to pursue a financial restructuring designed to reduce its current debt load, maximize value and position the Company for long-term success. Borden plans to continue operating in the ordinary course of business, under the court’s supervision“.

Lenders were not sympathetic or supportive. As the Wall Street Journal reported, the principal lenders to the company complained that a Chapter 11 filing was not necessary, and seemed more like a gambit to avoid whatever concessions might have been necessary with its creditors. Apparently, negotiations had been ongoing for some time. One lender complained that Borden made the bankruptcy move without notice to its lenders (which is very common but still shocking to some) and without bringing on specialized turnaround personnel.

The principal complaint the lenders seem to have is that Borden is not really that financially damaged. The company itself admitted being EBITDA positive and one of the two private owner groups was sanguine about retaining “primary ownership of the business after the bankruptcy”, which does not signal extreme distress. Anyway, that’s for the court to decide about but does imply that the chances of recovery for senior creditors is higher than average.

That’s good news for the 4 BDCs involved – all part of the FS-KKR Capital complex: publicly traded FSK and its three non-listed sister entities: FSIC II, FSIC III, and FSIC IV. The face amount of debt at risk – all in the 2023 Term Loan – is huge by BDC standards: $175.0mn. (Here’s another example of how the BDC sector has expanded way beyond its origins financing supposedly capital starved lower middle market private companies. Borden – by contrast – boasts $1.18bn in 2018 sales and 3,300 employees). The bankruptcy will interrupt annual investment income of nearly $16.00mn. However, if Borden management gets its way, that might only be a matter of a few weeks.

More important will be what happens to the 2023 Term Loan and the rest of the company’s liabilities. Clearly, there is no consensus between the owners and creditors so pretty much anything could happen and we are not privvy to any of the plans. As always in these situations where the debt is publicly traded – more often than not these days – we look to Advantage Data’s real time loan pricing module which shows the 2023 debt trading at a (13%) discount to par. That’s in line with what the debt was valued on the BDCs books at September 30, 2019 and gives a hint of what haircut these lenders might have to take. That would be a Realized Loss of ($23mn).

Yet, it’s too early to start counting beans. This could come and go out of bankruptcy very fast and with little impact on the lenders or something else altogether could happen. Once a company throws itself on the mercy of the bankruptcy court anything can happen. We’ll provide updates as any material news appears.

Unfortunately, though, this is prospectively another credit black eye for KKR, which only took on the credit in the IIIQ 2017 and which has committed a great deal of capital to this borrower. KKR is sparring with Acon Investments – the private equity group on the other side of the table; as opposed to finding the mutually agreeable middle way that some other transactions have gone down. This will be a useful test of how well originating and leading a debt tranche will serve KKR – and its BDC shareholders. Who will prevail – if anyone – in the test of wills and documentation that is shaping up between owners and lenders ?

For our part, we didn’t even have Borden on our Under Performers list until after the IIIQ 2019 BDC debt valuations were published when the FS-KKR entities marked the Term Loan at a (12%) discount, which caused us to give Borden a Corporate Credit Rating of 3. Of course, that’s now been dropped to a CCR 5 (Non Performing) just a few weeks later. It’s worrying to us, and should be to anyone invested in credit, how quickly companies can go from apparently performing modestly below expectations to standing in front of a bankruptcy judge. We are going to respond by being more vigilant and ready to add new names to the Under Performer List at the very earliest signs of trouble. Forewarned is forearmed.

Education Corporation Of America: Involuntary Bankruptcy Filed

For five consecutive quarters Monroe Capital (MRCC) has carried its loan to Education Corporation Of America (ECA) as non-performing. Finally, the BDC – and other creditors – has asked the court to force the for-profit education company into involuntary bankruptcy in Delaware. This is one more step in the slow unwinding of the company. In December of 2018, ECA lost its accreditation and closed campuses all around the country. Subsequently, MRCC bought one of its schools – the New England College of Business – back in May 2019. On MRCC’s books this is now carried as a separate portfolio company. The BDC has $2.2mn in first lien debt and equity invested in the newly acquired education firm which we’ve rated CCR 4. In the IIIQ 2019, the equity value of the MRCC position dropped to $1.1mn from $2.6mn in the prior – inaugural – quarter. That’s not a good sign and given the BDC’s mixed history in this space and the challenges the for profit segment faces, we added New England College to the under performers list.

Back to ECA. That company has been managed by a court appointed receiver for months. Now, for reasons that are not yet clear to us, MRCC and other creditors want a final resolution of this situation. The BDC has $8.2mn at cost invested in ECA, in the form of debt and preferred. Mostly the latter. Interestingly, the BDC still valued its investment at just under $6mn as of September 2019. The creditors may believe there is still some value tied up in the business that might be unlocked by a bankruptcy process.

If the court does accede to the request, the fate of MRCC’s investment in ECA should be known soon. How the New England College Of Business spin-off plays out may take longer to clarify. In any case, this has been a tiresome episode for the BDC, which became involved with ECA and the for profit education sector back in 2015., and which went sideways in a hurry. As recently as March 2018 the investment was valued at par, as Advantage Data’s records show. We added ECA to the under performers list only in the IIQ 2018 and because the preferred was written down a modest (12%). The next quarter ECA was on non accrual. MRCC will likely have to book an eventual Realized Loss of anywhere from ($3mn) to ($8mn). We will undertake a fuller post mortem of the ECA investment in the future once the matter is closed out.

Moran Foods: Recapitalizes

Moran Foods LLC – which is owned by PE group Onex Partners – has agreed a recapitalization with its lenders. In what has become a well trod path, the company will be undertaking a debt for equity swap. That’s $400mn of debt moving down the balance sheet. Also commonly done, Moran – which does business as Save-A-Lot Food Stores – will be getting an infusion of capital from their new owners: $138mn.

The extra capital is critical as the discount grocer – which is very highly leveraged according to an earlier Moody’s report we’ve read – is also seeking to change its business model, which will require capital investment. In a nutshell – and for our purposes – Moran seeks to move to a distribution rather than full direct retail model.

The company is yet another casualty of the well known shifts underway in the retail category. In this case, there’s an element of “if you can’t beat ’em, join ’em”, as a trade article illustrates: ”

As part of the effort, the grocer announced in November the rollout of new services that will enable shoppers to pay for (using Amazon PayCode) and pick up Amazon.com packages in select stores in the St. Louis area. 

It will also shoppers offer Amazon Hub Locker as a convenient delivery option to pick up or return Amazon packages at no additional cost. Both Amazon PayCode and Amazon Hub Locker are expected to expand to more than 400 Save A Lot stores by the end of 2020“.

We already had a Corporate Credit Rating of 4 on the company and we’ve added a CCR of 5, as it seems some debt will be turned into equity while other debt may continue as before. Thankfully for the BDC sector the only exposure to Moran is from TPG Specialty (TSLX), which has $39mn invested in an asset-based loan, due in 2021 and valued at par as of September 30, 2019. Chances are very good the BDC will not be negatively impacted by the new state of affairs and may just continue as before. We’ll learn more – presumably – when the next earnings conference call rolls around.

Constellis Holdings: Restructuring Underway

We warned in an earlier article on October 9, 2019 that for Constellis Holdings “a day of reckoning is coming – and fast”. Judging from two major – and related – developments, the time is nigh. On January 3, 2020 the Wall Street Journal reported the troubled security company “is in talks with creditors on a deal to restructure its $1 billion of debt, according to people with knowledge of the discussions”. Darkly, unnamed sources, warned that if an out of court restructuring didn’t happen, a “pre-packaged” Chapter 11 filing was also on the table. (That’s all part of the negotiation process in these kind of deals as interested parties suddenly find their way to the phone to confide to journalists, who are themselves happy to be of service).

We also learned that the company failed to make a scheduled principal payment on December 31 and has received a short term forbearance from its lenders.

At the same time, Moody’s went and downgraded the company’s corporate rating to Ca, and re-rated several debt tranches outstanding. Most worrying of all is that Moody’s reports that the company’s finances suddenly deteriorated in the last quarter of the year, resulting in a “liquidity crunch”.

All of which suggests the Day of Reckoning is here for the 8 BDCs with nearly $107mn in debt exposure at various points in the company’s balance sheet. Just one month ago, one of those BDC lenders – OFS Capital or OFS – waxed relatively optimistic about the outlook for Constellis: ” I want to note that the company is current on its payments. And based on discussions with management, they have stressed that they have adequate liquidity to fund operations. The company has a growing backlog and expects sequential performance improvement. The sponsor has substantial amount of cash invested in this business, and we expect continued focus from the sponsor”.

We now know that at least some of those reassurances are no longer true. This is reflected in the public prices of the outstanding debt as provided by Advantage Data. The 2022 Term Loan is trading at a (57%) discount, versus (14%) at September 30, 2019. The second lien debt is worth only 10 cents on the dollar in the market, down from 25 cents. At 9/30/2019 FMV was still around $84mn, down ($23mn) from cost. Now, we wouldn’t be surprised to see further losses of ($30mn)-($40mn) more at FMV and ultimate Realized Losses – which could crystallize very soon – of nearly ($75mn). Add to that the loss of income and you’ve got the first bona fide major set-back for BDC lenders in 2020 , should there be no last minute rescue.

As we’ve noted before, the bulk of the exposure – and thus any damage – will be concentrated in the four non-listed FS-KKR BDCs – CCT II, FSIC II, FSIC III and FSIC IV. This was a borrower that the group jumped into under the KKR regime, bringing BDC exposure from modest ($12mn) to major, when they initiated exposure in the IVQ 2018. Maybe the far sighted folk at the jointly run asset manager have their eyes on becoming equity owners of Constellis, but we don’t think so as Advantage Data’s records show the debt was purchased at a cost very close to par, and before the current downturn in corporate fortunes.

We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way.

Fairway Group: Second Bankruptcy Rumored

Oops, they’re going to do it again: filing Chapter 11 – or even Chapter 7 liquidation – if news reports about NY grocery chain Fairway Market are accurate. The New York Post reported on January 2, 2020 that a new filing is in the works, based on “multiple sources”. We’ve been down this road before back in 2016, but the grocer emerged quickly after a major debt for equity swap, as lenders became owners. Currently – according to the Post – the beleaguered 14 store chain is owned by  “lead shareholders Brigade Capital Management and Goldman Sachs Group“.

The owners sought a buyer in September but no one came forward. There is a small mountain of debt coming due in 2023 and 2024, but the company does not seem to have the resources to even hang in till then. Given that the company is reportedly looking to sell its flagship store and has closed several other locations, we’re guessing a liquidation – and some major credit losses – are in the works.

This is a privately held business so we don’t know all the details. However, thanks to Advantage Data’s records we know there are two non-listed BDCs with $30.9mn in first lien , second lien and equity in the company. Some of the debt is already on non accrual and the entire exposure has already been written down substantially to a FMV of $16.6mn at September 30 2019. The two BDCs are FS Investment II and FS Investment III, which will shortly be merged with the former as the surviving entity.

Some investment income will be lost if all debt facilities go on non accrual but cash won’t be affected as the interest income of late has been pay-in-kind. We don’t pretend to have an intimate understanding of the debt structure at the grocer, but chances are high the two BDCs – which already took a Realized Loss in 2016 – will be booking significant losses above and beyond the September 2019 valuation, and sooner rather than later. Presumably, this was one more troubled investment that FS-KKR inherited from the prior co-manager of the funds: GSO Blackstone. What’s not clear is who green lit the nearly 30% increase in exposure in IIIQ 2018. Was it the new combo of FS Investments and KKR or GSO ? In any case we’ve added Fairway to our Bankruptcy Imminent List for the IQ 2020.

GEE Group: IIIQ 2019 Results Published

On occasion, there are credit evaluations where the BDC Credit Reporter differs in its assessment materially from the BDC’s internal evaluation and even from that of the market. This is the case of public recruitment company GEE Group (ticker: JOB). The only BDC with exposure is Investcorp Credit Management (ICMB), which has $11.3mn invested in the company’s 2021 Term Loan. ICMB at September 30, 2019 valued the debt at par. The loan is itself publicly traded and is priced currently at or above par.

The BDC Credit Reporter, though, does not share the complacency about the value of the debt and its repayment in fifteen months. Given that GEE is a public company, we’ve been reading the quarterly filings regularly, which indicate a slow, but definite, downward business performance. We’ve just reviewed the latest 10-K for the year ended September 30, 2019, which only confirmed our earlier concerns. Sales were down, Adjusted EBITDA was down and the latter was insufficient in the last quarter of the fiscal year to even cover interest expense. Net Losses on a GAAP basis were ($17.8mn), higher than ($7.7mn) the year before.

To add fuel to our concern, the company has many layers of debt and in the 10-K admitted to having needed to amend its debt facilities 6 times to avoid defaults. Here is the disclosure from the 10-K about the latest concession by lenders: “On May 15, 2019, the Company and its subsidiaries, as Borrowers, entered into a fifth amendment and waiver (the “Fifth Amendment”) to the Revolving Credit, Term Loan and Security Agreement, dated as of March 31, 2017 (the “Credit Agreement”). Under the Fifth Amendment, the Company and its Lenders have negotiated and agreed to a waiver for non-compliance with the financial covenants under the Credit Agreement as of March 31, 2019, and amendments to the financial covenants and to the remaining scheduled principal payments“.

The company has just $4.1mn of cash and $0.5mn available under the Revolver but needs to pay $6.5mn in the 2020 fiscal year in principal payments. An even bigger hill to climb will be refinancing the Revolver and Term Loan in March 2021. Remarkably, GEE Group is paying yields of 17%-19% on the Revolver and close to 20.0% on the Term Loan. We won’t even discuss the more junior debt. As to the value of the company’s stock : it’s dropped to $0.40 a share, down (52%) in the last year.

For ICMB, a stumble here would be expensive as the loan pays out interest equal to 15% of the BDC’s annual net investment income and the amount outstanding is equal to 8% of book value. That’s why a proper evaluation of the credit risk here – which we’ve rated CCR 3 but probably should be moved to CCR 4 – is so important. We hope we’re wrong but everything points to a liquidity crunch in calendar 2020 and – possibly – a move to non accrual. We hope we are wrong and ICMB and the market is right, but there are just so many red flags…

Acosta Holdco: Exits Bankruptcy

As anticipated in our article of December 17, 2019 Acosta Inc. (owned by Acosta Holdco) has exited bankruptcy after a very brief stay. As a trade article indicates, the company went into court protection on December 1 2019 and now – just 30 days later – is back to business as usual. This follows, as detailed in the company’s press release, a monumental shedding of debt and the input of new capital by the new owner group, which composed of the company’s former lenders: “Through the process, Acosta eliminated all of its approximately $3 billion of long-term debt, and its new investors have funded $325 million in new equity capital“.

What we don’t know is which of the 5 FS Investments – KKR non-listed and public BDCs still have exposure to Acosta. At September 30, 2019 the BDCs had exposure of $39.7mn at cost, written down on an unrealized basis by (58%) to (64%), and all in the same 2021 Term Loan. The debt was on non accrual. Acosta had been on the Under Performers list since 2017, but only moved to non accrual in the weeks before the bankruptcy.

We did hear from FS Investment -KKR Capital (FSK) that its $17.3mn invested in $19.0mn of the par debt, which was valued at just $6.0mn, was sold after the third quarter end and at a premium to the published September price. This is what was said on the most recent Conference Call by FSK: “We placed Acosta on nonaccrual due to ongoing restructuring negotiations during the quarter and chose to exit this position after the quarter end at a gain to our third quarter mark“. That implies the public BDC will be taking a ($10mn-$11mn) realized loss in the IVQ 2019. That’s roughly $1.0mn of investment income permanently lost, a material but not market moving set-back.

That leaves $22.6mn held by the other 4 sister BDCs which may have been sold off as well or are now converted into equity. If the BDCs stayed put, their exposure may actually have increased if participating in the new capital infusion. We’ll circle back after the IVQ 2019 results are published to get the lay of the land. It’s too early to undertake a post mortem on this BDC investment as exposure may go on for years. For FSK, though, which jumped in during the IVQ 2018 – according to Advantage Data records – and then jumped out at a loss a year later, this was not anything to write home about.

Covia: Announces Multiple Financing Developments

Covia Holdings – a publicly traded “provider of mineral-based material solutions for the Industrial and Energy markets” – announced a series of financial measures intended to improve its “financial flexibility” on December 31, 2019. The most material development was the arrangement of an $85 million committed credit facility from PNC Bank. The new facility is secured by the Company’s U.S. accounts receivable. At the same time the company voluntarily canceled its $200 million revolving standby credit facility that contained restrictive covenants.

The above measures – and other actions taken as outlined in the company’s press release – are supposed to improve future results and provide liquidity. Nonetheless, substantial worries remain given Covia’s recent poor financial performance and exposure to the energy market. In fact, we added the company to the Under Performers List back in IVQ 2018, with a CCR of 3, based on a reduction in the value of the 2025 Term Loan held by the only BDC lender – Oaktree Specialty Lending or OCSL – to a discount of (28%). Subsequently the value of that debt has fluctuated, closing as of December 31 2019 of (24%).

We retain hope that the company can pull itself out of its doldrums, but note that debt to Adjusted EBITDA is very high (in excess of 10x by our estimate) and that the debt contains no covenants. The fact that Covia is raising new debt by essentially carving out valuable balance sheet assets to maintain liquidity is more worrying than reassuring for existing lenders who are essentially being pushed down the priority repayment scale.

At September 30, 2019 OCSL’s exposure – all in the 2025 Term Loan – amounted to $7.9mn, and $0.5mn of investment income is at risk. That’s a modest exposure for the public BDC (0.5% of its portfolio) and – apparently – not in any imminent danger. This article initiates our coverage in the BDC Credit Reporter. We’ll be checking back in periodically as new results are published.