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.

Frontier Communications: Debt Recovery In Bankruptcy Estimate

We’ve been tracking the credit decline of Frontier Communications through most of 2019, in multiple posts. The communications giant has been moved from a CCR 3 rating to CCR 4. In October, we added Frontier to our Bankruptcy Imminent list. In fact, there was no Chapter 11 or restructuring in the fourth quarter of 2019 and – given decent liquidity – there might not be any move in that direction in the IQ 2020 either. However, we’re confident enough to project that a bankruptcy in the IQ 2020 is highly likely.

BDC exposure to the company remains high with $67.5mn outstanding at cost, spread over 8 different BDCs, and three asset management organizations (FS Investment-KKR; Oaktree and Business Development Corporation of America). To date, though, all outstandings – despite ever worsening financing performance and multiple downgrades by both Moody’s and S&P – have been valued at or above par. That suggests debt investors are not worried about taking any kind of haircut should a Chapter 11 occur.

We analyzed the debt held by the BDCs against Frontier’s latest 10-Q. Broadly speaking, one third of the company’s huge debt load is secured and two-thirds unsecured. All BDC exposure is in first lien and second lien secured debt, which explains debt holder sanguinity. Valuations did not materially change at the top of the capital structure even after Frontier’s CEO left his post in early December, and replaced by a former DISH executive first brought in as a financial adviser and then appointed to the top job.

Nor were senior debt holders fazed – if prices reflect their views – by the never ending drop in the company’s stock price – now being de-listed from the NYSE and trading under $1.0. Since we wrote our first post, Frontier has lost two-thirds of its market capitalization.

We’re not so sure that Frontier’s senior lenders – including those 8 BDCs – should be so complacent about the value of their loans – which mature between 2024 and 2027, according to Advantage Data’s summary records. Our suspicions are confirmed by an article in Seeking Alpha on December 31, 2019 by Gary Chodes, which seeks to evaluate what the recovery rate on Frontier’s secured and unsecured debt might be if worst came to worst. The conclusion of interest to senior lenders: an estimated 24% recovery rate. That would imply over ($50mn) in ultimate Realized Losses for the BDC group, not including interest forgone. Readers can make up their own mind about the validity of Mr Chodes calculations. We don’t have a deep enough understanding of the company’s financial situation and business prospects to offer up a competing view. Instead, we offer up this warning on a take it or leave it basis. In any case, we expect to be returning to the Frontier Communications imbroglio repeatedly in 2020.

McDermott International: Bankruptcy Imminent ?

Bloomberg reported on December 30, 2019 that McDermott International’s stock had been declining for the past two days on rumors that a Chapter 11 filing was in the works and $2.0bn of financing has already been lined up to help the engineering company post filing as access to letters of credit to support projects is critical in its business.

None of the above will come as any surprise to the readers of the BDC Credit Reporter. We’ve been ringing the bell since September about the company and not been much impressed with the financial rescue plans that have been mooted or implemented in the interim to keep McDermott from “going chapter”. On October 21, 2019, we even placed McDermott on our Bankruptcy Imminent list. That fate for the company now seems everything but certain. The common stock shareholders seem to have come to a similar conclusion. Since that October post, the market capitalization of McDermott has dropped by nearly two-thirds.

For the BDC sector, the only good news – as noted in earlier posts – is that BDC exposure is small ( $10.4mn at cost) and limited to non-traded Business Development Corporation of America and Oaktree Strategic Income (OCSI). Both BDCs are invested in the 2025 Term Loan, which they’ve already discounted (35%) at September 30, 2019. According to Advantage Data that same loan now trades at a (43%) discount. Up ahead is likely some interruption/loss of investment income as well, with the non-listed BDC with the most to lose with 95% of the exposure.

Centric Brands Inc: Credit Coverage Initiated

We are initiating our credit coverage of Centric Brands Inc. with a rating of CCR 3, dating back to the IIQ 2019. At that time, Ares Capital (ARCC) discounted the value of its $24.6mn equity stake in the company by (24%), from par in the prior period. Given that the company is publicly traded (ticker: CTRC) that reflects a declining stock price, which was as high as $5.33 a share in mid-March. By the end of June CTRC was at $4.11. As we write this on December 28, 2019, the stock price has halved since the summer to $2.15.

Admittedly, most of the substantial BDC exposure of $123.8mn at cost is in the form of Term debt due in 2023, held by the afore mentioned ARCC, TCW Direct Lending and Garrison Capital (GARS). That debt has been valued very close to par since first being booked and remains so in late December, according to Advantage Data’s records.

Nonetheless, even a quick glance at the company’s 10-Q is enough to elicit credit concern. The company is fast growing, thanks to acquisitions in 2018 and 2019, but debt levels are very high and getting higher. We note that Adjusted EBITDA, as reported in the latest 10-Q for the first 9 months of 2019, was given as $122mn. Interest expense – which admittedly includes Pay-In-Kind income – was $142mn…The ‘comprehensive loss” over the same 9 month period was ($171mn). Yes, we know investors are too clever to take GAAP accounting as the be-all in this brave new world of adjusted numbers but that’s still a lot to swallow.

Notwithstanding the apparent complacency of the debt markets, the BDC Credit Reporter is worried about the leverage levels. Our concern is heightened because the amount of total BDC exposure is so high, especially for ARCC and TCW Direct Lending. Any sort of stumble by the company could materially impact book value and investment income earned. Nor should debt holders take too much comfort from the “first lien senior secured” appellation of the $99mn in term debt held by the BDCs. Sitting above them in order of priority is a secured Revolver – led by ARCC as administrative agent – and many of the company’s trade receivables are being sold off in a different financing facility.

We expect that we’ll be updating readers multiple times in the year ahead given that Centric is a public company and every quarter brings a new snapshot of performance. We’ll also keep an eye on stock and debt price performance, even if we don’t fully trust the credit antennas of the latter in the current frothy and generous market conditions.

TOMS Shoes LLC: Bankruptcy Imminent

Reuters has a scoop: TOMS Shoes LLC will be filing for a pre-packaged bankruptcy at any moment which involves a debt-for-equity swap; the injection of new capital and a change of ownership. Apparently, the lenders to the company will be providing “debt relief” – how much is not known – and are throwing in $35mn to help the business function. Bain Capital and founder Blake Mycoskie will be losing their respective 50% equity interests in TOMS.

None of this is a great surprise for the BDC Credit Reporter. We’ve been warning about TOMS since May 2019 and have carried the company as under-performing for the last 4 years ! In our most recent post in June – shortly after S&P downgraded the company’s credit rating , we said the following: “Our current Credit Corporate Credit Rating is 4, just one notch above non performing. Bankruptcy or a debt for equity swap seems almost inevitable despite the best efforts of PE owner Bain Capital to effect a turnaround

 However, as we’ve noted before, BDC exposure to the once highly popular shoe brand is relatively modest. As of September 2019, total exposure at cost – all in the upcoming 2020 Term Loan that TOMS did not have the resources to refinance – was $9.3mn and had been written down by (34%). For what it’s worth, that same debt is trading currently at a (30%) discount. Maybe holders expect some of the debt to get repaid or are estimating the value of what equity will be received. In any case the BDCs involved – Main Street Capital (MAIN) and non-listed HMS Income are likely to lose some or all the investment income on the loan (priced at LIBOR + 550 bps) and have to book some sort of Realized Loss this quarter or next. Rough guess: ($3mn-$5mn). We don’t expect that TOMS will be staying in bankruptcy for long, and the current lenders may soon be equity owners with an indeterminable timetable for repayment.

Not to be short of Christmas cheer, even after the pre-packaged bankruptcy, TOMS will continue to face challenges in a negative retail environment and after a considerable period of declining sales. Capital can only take a business so far, and the new owners will have to show that the TOMS business model makes sense. If the BDC lenders end up still holding debt and/or equity in the new TOMS, we’re likely to keep the company on the Under Performers list. For the moment, tipped off by Reuters, we’re moving our Corporate Credit Rating from 4 (Worry List) to 5 (Non Performing). When we learn more about the final disposition of the restructuring, we’ll have more to add.

Melinta Therapeutics: Files Chapter 11

It’s never too late in the year to file for bankruptcy. On December 27, 2019 Melinta Therapeutics, which manufacturers antibiotics, sought court protection in a Chapter 11 filing. Apparently, the company has arranged a debt for equity swap which see $140mn be wiped out in return for taking on Deerfield Management as its new owner.

The only BDC with exposure is Hercules Capital (HTGC), which had $2.6mn in equity at cost invested in the company. We surmise that the investment – already non income producing and written down to almost nothing – will get written off. Expect a modest but predictable Realized Loss this quarter or next.

The BDC will consider itself lucky to have gotten away with so little damage. Not so long ago HTGC had as much as $30mn advanced in the form of debt to the company but that got repaid in a transaction back in 2017 when Melinta merged with a subsidiary of Cempra, according to a footnote in the 10-Q. You win some and you lose some in venture debt investing, but HTGC will probably be glad this loss was a modest one that will have no impact on NAV or even on its total realized loss column.

Serta Simmons Bedding: Disagrees with S&P Rating

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.

Akorn, Inc.: May File Chapter 11

This came out of left field for Akorn,Inc.’s debt and common stock holders. Sort of. The company – which has been the subject of numerous lawsuits – has been in a standstill period with its lenders since May 6, 2019. The idea was that the company and lenders would arrive at a “comprehensive amendment to the Term Loan Agreement” by December 15, 2019. By the deadline no agreement had been reached and the standstill was extended a few days ago to February 7, 2019. However, in the 8-K filing where this extension was memorialized, the company admitted one of its possible alternative solutions was a Chapter 11 filing. All hell broke loose and the common stock price dropped (28%) on the day. The volume of shares traded was 12x the normal volume.

To this point, we had rated the company as performing as expected, or CCR 2. After all, it’s only BDC lender – Garrison Capital (GARS) carried its 2021 Term Loan at only a modest (7%) discount to par as of September 30, 2019. Absent any other adverse information, the BDC Credit Reporter typically does not add any company to the under-performers list without a downward move on debt held by (10%) or more. Clearly, we had missed the standstill agreement, which normally would have been a red flag and caused a downgrade to under-performing.

Now, we’ve skipped down two levels to CCR 4 (Worry List), based both on what Akorn said in the 8-K and the tight deadline the lenders are giving the company, which suggests the parties are not close to a satisfactory resolution. Some $854mn in debt could immediately come due and payable at any time…

We can’t imagine that if the company does file Chapter 11, the GARS debt – besides becoming non-performing – will not drop further in value. The loan is being charged at LIBOR + 625 bps, increased from two quarters before as compensation for the standstill. If Akorn files for Chapter 11, $0.160mn in annual investment income will be interrupted. This is likely to accelerate very quickly – either to a resolution or a filing – so stay tuned.

Harland Clarke Holdings: Dispute Between Creditors

Back on November 29, 2019 when we first wrote about Harland Clarke Holdings Corp. we warned that we might be writing again about the troubled check printer before long. That’s because the day of reckoning about how to handle debt maturing was fast approaching. Just three weeks later and we hear from the Wall Street Journal that the struggle to reorganize the company’s balance sheet is underway.

Apparently, the company has reached out to junior creditors to swap their claims for cash or more senior ranked debt. As you might expect, the existing senior lenders are not happy about such a move. That’s all we know for now, but we see that the value of the 2023 Term Loan held by Cion Investment – the only BDC lender to the company – has dropped from a (21%) discount at September 30, 2019 to (28%). We’re quoting from Advantage Data’s Syndicated Loans real-time pricing module.

The BDC Credit Reporter is still new to this particular under-performing company, but it’s fair to say that all the ingredients exist for a default or restructuring that could happen sooner rather than later and would affect Cion and many other creditors. Nearly $0.900mn of investment income is at risk of interruption for the sole BDC with exposure, and a further unrealized depreciation is likely when IVQ 2019 results are published. We expect to posting about the company once again before too much time passes.

Acosta Holdco: To Exit Bankruptcy

Well, that was quick. According to the Wall Street Journal, Acosta Inc. – which is held by Acosta Holdco – is close to exiting bankruptcy just two weeks after filing. That was what expected back on September 30, 2019 months before the actual filing, when we first wrote about the credit problems of the marketing company.

Here’s what we wrote at the time, most every bit of which has turned out to be correct:

We expect the debt [of Acosta] to be shown as on non accrual in the upcoming IIIQ FS-KKR portfolios when earnings are released and to be written down to the market level, which should cut the fair market value by at least $6mn. We’re likely to see a restructuring done relatively quickly – if past experience is any guide – and a realized loss is likely to follow but we don’t have sufficient information to estimate the extent. This is almost certainly going to be another reverse for the FS-KKR organization. Curiously FSKFSIC III and FSIC IV appear to have jumped in relatively recently – perhaps ill advisedly seeking a bargain. Total BDC exposure jumped from $13.4mn at the end of 2017 to the $40.1mn current level. That’s a tripling of Acosta debt held.

In the IIIQ 2019 results, all 5 BDCs involved – with aggregate exposure of $39.7mn – placed the debt on non accrual and wrote it down between (58%) and (65%), according to Advantage Data records. (Interestingly, every BDC involved – all of whom are in the FS-KKR family and all of whom are in the same 2021 Term Loan – used a different discount percentage). What we don’t know yet is how the lenders will treat this negotiated debt-for-equity swap, but we expect to see realized losses booked if bankruptcy is exited by year end.

We know from another Wall Street Journal article – and other sources – the outline of the new structure. Remarkably, the company is having its entire debt written off and is receiving $250mn in new equity capital. That might just get Acosta off our under-performing company list, from a rating of CCR 5 (Non Performing) currently. Still, the BDCs involved will be losing roughly $2.0mn in annual investment income. They will be hoping Acosta is able to use this second chapter to become successful and earn back – one day – any realized losses incurred from this drastic restructuring. For the medium term, though, the BDC capital lent/invested in Acosta will be “dead money”.

Holland Intermediate Acquisition: IIIQ 2019 Update

Holland Intermediate Acquisition Corp. is a closely-held energy company which has been funded by THL Credit (TCRD) since IIQ 2013. TCRD is one of only two BDCs with exposure and essentially the only source of news about how the business is performing given that non-traded Sierra Income rarely discusses portfolio issues. Total exposure at cost is $25.6mn, 80% of which is held by TCRD. As you’d expect for a company in the energy sector, Holland Intermediate has been on the under-performing list for some time: since IIIQ 2015; based on the first lien debt being written down by more than (10%) by one of the BDC lenders.

At June 2019, TCRD was discounting its first lien debt to the company – which is the same facility as Sierra owns – by (15%). The non-traded BDC was using a materially more conservative discount of (31%). We had already assigned the company a Corporate Credit Rating of 4 (Worry List); alarmed by both Sierra’s valuation and the negative trends in the sector. At the time TCRD offered this pint-sized assessment of the company’s status: “The business continues to make progress, albeit at a slower-than-expected pace, and we’ve adjusted the value of our holdings this quarter to reflect this

In the third quarter 2019 results, both BDCs doubled the discount on their positions, with Sierra Income writing down the debt by (68%), the highest ever in any quarter judging from the Advantage Data records. TCRD increased its discount to (35%). From TCRD’s Conference Call on November 5, 2019 we learned that the BDC is “closely monitoring” the company. The color offered on the call was as follows: “The business continued to face market headwinds this quarter due to overall reduced M&A activity in the energy space, and was marked down accordingly“.

Obviously, these are clear signals to be concerned about, even if the underlying business reason is not clear. We also worry about whether the debt – which is coming up to its maturity in May 2020 will get repaid. The loan is priced at an expensive – but not inordinate – LIBOR + 900 bps. AD’s records show, though, that this loan just refinanced the lenders original loan booked in 2013, which had a 5 year maturity, in 2018. When lenders refinance a medium term loan with a much shorter time period that’s usually sign of stress. We may see another short term loan with the same lenders occur in the first half of 2020. However, if things go awry and a default occurs, there is a material $2.8mn of investment income at risk. We’ll be updating the Holland Intermediate story every quarter when we hear from TCRD, or if we learn something from the public record which – to date – has offered no clues.

Hollander Sleep Products: Credit Post-Mortem

For some time, the BDC Credit Reporter has been promising to undertake credit post-mortems of under-performing BDC investments that reach the end of the line, and are removed from active status. That removal can be because of a successful resolution where all invested capital is returned or any number of scenarios where some sort of realized loss is incurred. Expect more of the latter than the former. The goal of looking back is to ascertain how an investment played out and what we can learn in hindsight about the risks taken and what the outcome tells us about the underwriting of the BDCs involved. As always, information is patchy and we will have to make some assumptions to get to any conclusions. Nonetheless, we believe this is a valid undertaking which should be instructive, both about whatever individual investment is involved and as a window into the broader leveraged debt investment process.

Our inaugural post is about Hollander Sleeping Products, a bedding manufacturer, which first appeared on the books of PennantPark Floating Rate (PFLT) and sister firm PennantPark Investment (PNNT) in late 2014 and was originally consisted of $35.5mn in first lien term debt due in 2020. The debt was priced at LIBOR + 8.0% and was a syndication. The debt was part of the leveraged buy-out of the company by Sentinel Partners. The type of borrower, the pricing, the terms and the purpose were in line with both BDCs stated target market. The external manager does not seem to have originated or “controlled” the loan.

That initial loan performed very well and was valued at or close to par throughout its entire tenure, which ended with its pre-payment in the middle of 2017. At that time, the company acquired Pacific Coast Feather and raised a new Term Loan – also first lien – with a 2023 maturity which, presumably, also financed the acquisition. The pricing remained the same: LIBOR + 8.0%.

The merger makes Hollander the single-largest supplier in the U.S. in the home textiles industry,” said Jennifer Marks, editor-in-chief of industry publication, Home & Textiles Today. She said Hollander already was the single-largest supplier in the nation of filled utility bedding”.

From a valuation standpoint, the new loan performed well all the way up to IVQ 2018 when a (3%) discount was applied by the BDCs, more or less in line with the trading value of the debt at the time. However, by the IQ 2019 the debt was on non-accrual and by May 19, 2019 Hollander filed for Chapter 11.

As of March 2019 the debt was valued at a discount of only (13%) and as of June – which the last quarter on the books – the discount was (53%). At the time, an analyst inquired as to why the valuation could remain so high on a non accruing debt and the BDC manager pointed to the valuation firm who came up with the number, probably linked to the “trading” price of the debt.

The company blamed higher raw material costs and the expense of integrating Pacific Coast for its failure. The initial plan involved new DIP financing from ABL lender Wells Fargo and its existing term lenders. PNNT and PFLT ponied up $3.3mn of extra debt for a total of $34mn. The initial idea was to undertake a partial debt for equity swap.

However, by September management switched course and returned to court to request that the plan be changed to a $102mn asset sale to the only remaining would-be strategic buyer:

A revised plan with a “toggle” feature to allow switching to an asset sale was put to a vote by the impaired creditors and received approval from the holders of all of the company’s $173.9 million in term loan debt and the holders of more than 95% of its $38.5 million in unsecured debt, it said.

Hollander noted that additional changes to the plan include that the providers of the company’s $90 million in debtor-in-possession funding have agreed to accept less than full repayment and to cede repayment priority to Hollander’s prepetition term loan creditors, as well as the establishment of a $1 million wind-down reserve fund.”

As a result of the sale – according to PennantPark – its Hollander investment “was written down completely “. Exactly what that means is not clear as neither BDC calls out by company realized losses. We know that Hollander is no longer carried as an investment as of the September 2019 results and that the PNNT Realized Loss for the quarter was exactly equal to the investment at cost in the 2023 Term Loan. Maybe the DIP financing was repaid in full ?

PennantPark claims it favored proceeding with the debt for equity swap but was out voted by other lenders not willing to move forward in that direction. However, as the quote above shows in the final plan “all” the company’s term debt creditors voted for the asset sale.

From PennantPark’s standpoint the lesson learned from its substantial ($30mn) or so loss is the risk involved in sponsor-led company “roll-ups” and insufficient oversight by the PE group. Here is what was said on the PFLT CC: “And with Hollander, they were just doing too many acquisitions too quickly. They didn’t have enough kind of oversight of the company. And the last acquisition didn’t work. So moving too quickly“.

From the BDC Credit Reporter’s standpoint there are 3 lessons here:

  1. Investments can go from hero to zero in a very short period (i.e. from performing to under-performing or non-performing in this case). We doubt that Hollander’s business performance deteriorated so quickly, suggesting that there can be a lag between when bad things begin to happen (higher costs in this case) and its reflection in the valuations despite all those experts re-valuing positions every 3 months. Maybe there was undue reliance on the “market price” of the debt rather than an evaluation of the enterprise value of the firm.
  2. As is often the case, a “First Lien” or “Senior sScured” nomenclature tells investors very little about the prospects of capital recovery – in this situation nil – when a default/bankruptcy occur.
  3. BDC lenders – if PennantPark is a fair example – are loath to offer much in the way of financial details or color about “failed” investments. Just identifying how much realized losses come to is difficult. In terms of discussion, the manager offered on PFLT’s Conference Call only 3 sentences in their IIIQ 2019 conference call on the subject. Yet, the realized loss incurred for the quarter was roughly equal to the BDC’s entire Net Investment Income, on which much more time was spent parsing the numbers. Most of what we did learn about Hollander – slightly more substantively – came in response to analyst questions. It’s understandable that managers don’t want to linger over credits gone wrong but – in our opinion – it’s a critical element for investors to evaluate how much of performance is “idiosyncratic” and how much not.

Men’s Wearhouse : IIIQ 2019 Results Weaker

On December 11, 2019 Tailored Brands (TLRD), which owns Men’s Wearhouse Inc., reported third quarter 2019 results. To listen to the company’s CEO on the ensuing Conference Call – as we did – is to believe that the famous retailer with several well known brands is making progress. On the other hand, the Motley Fool’s take on reviewing the latest results was the opposite: Tailored Brand’s continues to face multiple challenges in the retail space and is “running out of time”.

The BDC Credit Reporter added Men’s Wearhouse – a subsidiary of TLRD – to the under-performing list in the IIQ 2019 and wrote our first post on September 13, 2019, rating the company CCR 3 (Watch List), shortly after the dividend was suspended. We had a look at all the results – including the 10-Q – for the latest quarter and came away confirmed in our initial skepticism and that of Motley Fool. The highlights of our concerns; sales dropping at all brands; the departure of a senior manager; huge losses to the bottom line; a declining stock price and still very high debt (given as 4.4x debt to EBITDA by management but much higher when mandatory capex is included).

The good news is that the company has plenty of liquidity thanks to undrawn secured revolver debt and some cash and no debt maturities in the short term. We are maintaining our CCR 3 rating in that there is still a decent chance the business can be turned around without a restructuring or bankruptcy. We do note, though, that since the last time we wrote the only BDC with exposure – Barings BDC (BBDC) – discounted its $10mn investment in the 2025 Term Loan by (17%), lower than in June 2019.

Clover Technologies/4L Holdings: To File For Bankruptcy

Clover Technologies Group LLC, which does business as 4L Holdings (the “world’s largest collector of used printer cartridges”) is filing for a pre-packaged Chapter 11 bankruptcy, but not before selling one of its subsidiaries – Clover Imaging – to its management and Norwest Group, according to a trade publication.

According to a December 11, 2019 press release from the company, the envisaged restructuring is radical. Essentially all outstanding long term debt will be converted into equity in a classic “debt for equity” swap; eliminating a reported $644mn of borrowings. There’s more to the deal including that Clover Imaging sale and the concurrent acquisition on December 4 by a Clover Technologies subsidiary of a company called Teleplan.

Given that the bankruptcy is pre-packaged and apparently non-controversial, the company expects only a brief stay under court protection and to continue operating normally. Some international subsidiaries of this large business with 18,000 employees won’t even be included in the bankruptcy. Chances are Clover Technologies will be back operating normally – but with a very different balance sheet – in a few weeks. We’ve seen some very fast bankruptcy resolutions, so that’s just an estimate taking into account the holiday season.

Kirkland & Ellis LLP is serving as 4L’s legal counsel, Jefferies LLC is serving as its financial advisor and Alvarez & Marsal is serving as restructuring advisor.  Gibson, Dunn & Crutcher LLP is acting as legal counsel for the ad hoc group of term loan lenders and Greenhill & Co. is acting as its financial advisor”.

There are two BDCs with $22.3mn of debt exposure to the company: non-listed Business Development Corporation of America and Investcorp Credit Management (ICMB) in a roughly 55/45 split. Advantage Data records show exposure dating back to 2012-2013. At the moment both BDCs own the company’s 2020 Term Loan, which is publicly traded. From a valuation standpoint, the company did not appear on our under-performing list till the IIQ 2019. As of the IIIQ 2019 ICMB was discounting its position by (38%), BDCA by (46%). Currently, the debt trades at (46%) off, suggesting ICMB will have to write down its position slightly. Going forward, the most impactful element will be the permanent loss of investment income that amounts to about $1.4mn annually. There will be a realized loss involved as well which should show up in the IVQ 2019 or the first quarter of 2020.

The good news is that – given the absence of leverage – Clover Technologies may drop off the under-performing list in 2020 if the radical balance sheet changes causes the equity to trade at par or higher.

Team Health Services: Bond Values Lower

The BDC Credit Reporter is a work-in-progress in that we are still loading all the several hundred under-performing BDC financed companies into our database and this website. We mention this to explain why we’re only getting round to waving warning flags about Team Health Inc. (aka Team Health Holdings), a company that has been under-performing since the IQ 2019; held by 6 different BDCs and which seems to be getting worse rather than better.

Back on August 12, 2019, as this trade article summarizes nicely, Moody’s downgraded the outlook for the company:

Team Health Holdings Inc.’s ongoing contract fight with UnitedHealth Group Inc. is hurting the bond status on the Knoxville-based hospital staffing and management company.

Moody’s Investors Service on Friday downgraded the outlook for Team Health from stable to negative, after affirming the company’s B3 Corporate Family Rating and B3-PD Probability of Default Rating.

The change of outlook reflects rising uncertainty around Team Health’s ability to reduce leverage given its recently disclosed dispute with UnitedHealth Group Inc., one of its largest commercial payors,” Moody’s said.

Moody’s also affirmed the B2 rating on Team Health’s senior secured credit facilities and Caa2 rating on its unsecured notes“.

We’re read Moody’s Ratings Action, and it’s clear that Team Health has a myriad business and financial challenges, including debt to EBITDA (admittedly a multiple that has become almost meaningless without knowing how the denominator is derived) of over 8x.

Just as distressing is the market price of the 2024 publicly traded 2024 Term loan which at December 12, 2019 was trading at a (28%) discount. Many BDCs hold that first lien debt which was trading at an (18%) discount in the market on September 30. (We note that the BDCs own valuations ranged from a (1%) to a (14%) discount in their IIIQ 2019 portfolio values). By the way the BDCs with exposure to Team Health include Barings BDC (BBDC) but only in the first lien; FS-KKR Capital (FSK) and four of its non-traded sister BDCs: FSIC II, FSIC III FSIC IV and CCT II. The biggest exposure is that of FSK, just under $15mn.

If the first lien debt is already trading down so much, where can be the second lien debt be that accounts for half of BDC exposure ? This debt does not trade so that’s a question without an answer, but at September 2019 quarter’s end the BDCs – all related – were writing down the debt by (22%). We’d guess the discount on the second lien – due in 202- might be as high as (50%).

We’ll have much more to say as we dig deeper and more developments occur. Our concern is not only about Team Health but similar health organizations facing pressure relating to payment practices. As the BDC Credit Reporter becomes more comprehensive quickly identifying BDC funded companies with a similar business model – and risk – will become easier. As the song says: “we’ve only just begun”.

Basic Energy Services: To Sell Assets

Is this good news or bad news for lender to Basic Energy Services, an oil services company ? On December 12, 2019 the publicly traded company with the ticker BAS but just delisted from the NYSE, announced its intention to sell “its pumping services assets (not inclusive of coiled tubing) in multiple transactions with expected proceeds of approximately $30 million to $45 million“. The proceeds – says the press release – “will fund the projected 2020 and 2021 capital budget of Agua Libre Midstream, the Company’s rapidly growing, high return-on-assets business“. No word about proceeds being used to pay down any debt.

We’ve had a look at the 10-Q for the company which shows that lenders are collateralized by the assets of the business in both an ABL and 2023 Term Loan that was originated in 2018. The only BDC exposure is in the latter, and resides in non-listed BDC Guggenheim Credit for $2.0mn. At September 30, 2019 the debt was written down on an unrealized basis by (26%). Currently, the institutionally traded loan is trading at a (33%) discount. Maybe the lenders are waiving the use of proceeds from the asset sale for debt repayment or we just don’t have the full picture. For our purposes, and till, we hear otherwise, we’re assuming none of the monies from the asset sales will repay debt.

Basic Energy has been on the BDC Credit Reporter’s under-performing list since the IVQ 2018, almost immediately after Guggenheim booked the investment and has been trending down in value ever since. We have a Corporate Credit Rating of 4 (Worry List). Unfortunately, even before the latest announcement, the company was burdened by very high debt to Adjusted EBITDA, once you adjust for maintenance capex: over 12x by our estimate. The asset sales – if they happen and at the amounts estimated – may not be sufficient to save the company given the amount of debt on the balance sheet and the negative trends in the oil services sector. We believe a default or reorganization is more likely than full recovery on the debt. We’ll continue to update the Basic Energy story, which should come to some sort of fork in the road long before the 2023 maturity of the Term Loan.

HFZ Capital: Director Of Development Fired For Alleged Mob Ties

This is where the BDC Credit Reporter meets the Sopranos: On December 9, 2019 we hear from multiple news outlets – who love this sort of material – that the Director of Development at real estate company HFZ Capital has been fired. Apparently, the individual in question has been charged by prosectors with working with organized crime to siphon off hundreds of thousands of dollars from New York real estate projects in which HFZ was involved. We should note that the Director Of Development has pleaded not guilty.

This is what the company had to say about the episode: “In a statement, HFZ said it, along with other developers in NYC, learned of the investigation into CWC months ago and removed CWC from its projects. “HFZ immediately terminated Mr. Simonlacaj’s employment upon learning of the allegations against him, which run contrary to the values of the firm and how its business is conducted,” HFZ said.”

More disturbing from a credit standpoint is that this individual had been convicted of an earlier offense and spent 3 months in prison and been vouched for by one of the owners of HFZ as recently as 2016…

The only BDC with exposure to closely held HFZ is Monroe Capital (MRCC) which had two term loans outstanding – due in 2019 and 2021 respectively – with a cost of $23.2mn at September 30, 2019. At the time, the loans were carried at par. However, both loans appear to be publicly traded according to Advantage Data records. The 2019 loan has already reached its maturity and has – presumably – been repaid. However, the 2021 loan was last priced at a (44%) discount to par. MRCC has $5.1mn invested at cost in debt with a face value of $9.0mn.

This is the first time we’ve familiarized ourselves with HFZ Capital – a well known developer in New York who’s seeking to build a huge project in the High Line funded by a hedge fund – and there’s much more to learn. Right away, though, we are giving the company a Credit Rating of 4 – our Worry List – due to the very serious charges brought against one of its top executives and the valuation of the 2021 debt.

1888 Industrial Services, LLC: Update

Frankly, we learn more from the public record about what’s going on inside the North Korean politburo than what’s happening in many private companies that are financed by BDCs. Oil patch services company 1888 Industrial Services, LLC was no exception to that rule till the latest conference call by Investcorp Credit Management (ICMB), which provided a substantial update. Here are the highlights:

As we know from Advantage Data‘s records, and other sources, the company was previously known as AAR Intermediate Holdings, and ICMB, Medley Capital (MCC) and Sierra Income were lenders since the IIIQ 2014. As you can imagine that was just about the worst time to be in anything energy-related and the debt and equity investments made, which began at $88mn, quickly deteriorated in value and eventually – in 2015 – went on non accrual. Long story short (because that’s all we know) the company was restructured and renamed 1888 Industrial Services on October 1, 2017. We know that ICMB – and probably the other lenders – booked substantial Realized Losses around the time of the restructuring in 2027.

Under its new identity the value of some of the company’s debt began to deteriorate – according to Sierra Income and MCC’s valuations. In the IQ 2019, some of the debt was placed on non-accrual. ICMB, though, values its debt at cost or at a premium. The BDC’s manager made this explanation on its latest CC, which might explain the discrepancy: ” 1888 made an acquisition to enable the company to grow outside its historic exclusive focus on the DJ Basin, diversifying into the Permian and Wyoming. Our newest debt to term loan D is structured senior to the term loan B, which was created during the restructuring, which is why you’ll see a significant difference in the marks on the 2 tranches

ICMB also indicated that it had been actively involved in the operations of the contractor, hiring both a new CEO and CFO. Moreover, ICMB has provided new working capital debt to fund operations and has agreed to accept “payment-in-kind” on some of its debt facilities outstanding. This was explained as follows:

We have temporarily gone to PIK. We will evaluate that over the next 3 to 6 months. And it is really driven by a lot of the working capital needs. And there’s a huge ramp-up right now around Permian, and so we’ve got to make sure that we don’t starve the capital of cash for our benefit and not facilitate that growth because we all want more cash flow“.

ICMB hopes all these measures will help the company and lead to an exit in as little as 2 years. The BDC Credit Reporter – as is our mandate – is not as optimistic. It’s no secret that the oil field services sector is not performing well. Moreover, the advancing of new monies and going from cash to PIK are usually (albeit not always, we’ll concede) signs of financial weakness. Then there’s the discounts being applied by other BDCs to some of the Term debt. For example a year ago Sierra Income was valuing one debt tranche at a premium to cost. As of September 2019, the debt was on non-accrual and being written down by (72%).

We have placed 1888 Industrial Services on both our Worry List – CCR 4– and Non Performing List – CCR 5. Total BDC exposure appears to be (we’re waiting on MCC’s results) just under $60mn, all of the cost in one form of debt or another. This is ICMB’s largest single exposure, and material for both MCC and Sierra so piercing the veil and keeping up with developments at the company – as best we can – is worth doing. Is this a laudable turnaround in waiting or a can kicked down the road that might eventually end up a credit disaster ?

Murray Energy: Lenders Seek To Acquire Company

As we’ve written about earlier, controversial coal company Murray Energy is in Chapter 11. According to Law360, though, progress is being made towards a plan that will get Murray out of Chapter 11. Apparently, senior lenders with $1.7bn of debt outstanding have clubbed together to offer themselves as a buyer for essentially all the company’s assets. Given that so much of business news is hidden behind a paywall – an ironic complaint from the publisher of the BDC Reporter with its own premium version – we don’t know many of the details.

Speculating, though, remains free. Should the senior lenders successfully become the buyers of the highly troubled company in a declining industry – the likely format is the exchange of much – if not all – existing debt for equity. Most likely, new monies would have to be advanced by those same lenders in some form as well. For the 6 BDCs involved with $52.5mn of debt exposure at September 30, 2019, that’s likely to mean no or little income forthcoming from capital already invested and the prospect of dipping into their pockets for more advances. The $5.7mn of investment income that was being collected before the filing is unlikely to be returning any time soon.

Most affected by the Murray Energy debacle is the FS-KKR complex with roughly $40mn of the BDC debt outstanding, led by FS-KKR Capital (FSK) with $18.9mn already at risk, according to Advantage Data.

How this all plays out remains up in the air, and is subject to further updates before Murray exits bankruptcy court protection. Even after that, given the industry in which the company operates, we imagine we’ll be discussing the company – possibly under a new name – for some time to come as its lenders seem to be digging in.