Knowland Technology Holdings: Placed On Non Accrual

We’ve written about Knowland Technology Holdings (aka Knowland Group) once before, back on January 7, 2022. Already, at that point the company had been on the BDC Credit Reporter’s list of underperformers since May 2020, and was rated CCR 4. We were worried then that $1.7mn of annual investment income might get interrupted in the future.

Here we are a few months, and two quarterly periods later, and the only BDC lender – Saratoga Investment (SAR) – to Knowland has placed its $15.9mn in second lien debt on non accrual as we feared. Just what ails the business was not discussed by SAR on its just completed conference call for the quarter ended May 31, 2022 but may relate to the slow recovery in group travel in the wake of Covid.

We are downgrading Knowland from CCR 4 to CCR 5. Given that the outstanding debt is in a junior position, there is a very real possibility of an eventual significant realized loss. As of the latest 10-Q, SAR has discounted its debt by (37%), from (33%) in the prior quarter. That’s nearly ($6mn) of unrealized write-down already, and that might get worse, or better.

Knowland and SAR, according to the latter, might agree to converting the cash interest payments to pay-in-kind, which might allow the BDC to resume recognizing income. This quarter, though, the BDC reversed 5 months of interest while placing the debt on non accrual. The fact that SAR is considering such a move is bullish from a credit standpoint.

Clearly, Knowland – the only non accrual on SAR’s books – will be worth tracking because of the current and future material impact on the BDC’s earnings and net asset value. We’ll revert with any development we pick up from the public record, or when SAR reports its next quarterly results.

Pepper Palace: Added To Underperformers List

On July 6, 2022, we heard from Saratoga Investment (SAR) regarding its calendar IIQ 2022 results ended May 31. One of the key credit developments was the unrealized write-down of the BDC’s investment in Pepper Palace, Inc. – a specialty food manufacturer of spicy sauces and seasonings. Exposure consists of $34.5mn at cost in first lien debt and equity. The equity was sharply discounted from a cost of $1.0mn, down to a value of $0.2mn. The debt has been reduced from $33.5mn to $28.8mn. The amount of annual investment income at risk is $2.7mn.

SAR said the following about the newly underperforming company, which we rated CCR 2 previously:

This markdown reflects the current performance of the company, but they continue to pay interest. We are working closely with the company and the sponsor as they work to improve performance.

Saratoga Investment – Conference Call – July 7, 2022

There is nothing in the public record which explains what’s wrong at the Tennessee-based company, which has “200-500 employees”, according to LinkedIn. We do know that the investment is a relatively new one for SAR – which has been on a portfolio growth spurt of late – booked in the middle of 2021.

All we can do is add the company to our underperformers list with a rating of CCR 3 on our 5 point scale. We will track the public record daily for any development worth bringing to readers attention.

Engine Group: Sells Subsidiary

In March 2022, the Engine Group – “a global, multi-disciplined marketing services platform with leading-edge digital capabilities” – sold its British subsidiary : Engine Group UK, which is owned by Lake Capital. Since 2021, Lake Capital has been actively seeking to sell all or parts of Engine Group – now named just Engine. The proceeds here were Sterling 77.5mn, or roughly $100mn.

There is only one BDC with exposure to the Engine Group: Prospect Capital (PSEC). Advantage Data records shows that exposure began with first lien and second lien loans, first booked in IIIQ 2017, with a total cost of $40mn. Everything went to plan till 2018, when the first unrealized write-downs began. By the IIQ 2020, both loans were on non accrual, and written down to about $11mn from the-then $39mn advanced.

Some sort of restructuring appears to have occurred, with the exposure swapped into a first lien loan due in November 2023, with a cost of $12mn and equity of $27mn. The debt, though, has been amortizing in the intervening quarters and only $3.6mn was left as of March 2022, valued close to par. The equity at cost, though, was unchanged and valued at next to nothing : $294,000.

Normally, we’d expect that PSEC – as both lender and investor – might benefit from the sale of a key subsidiary. However, the transaction occurred in the first quarter of the year and did not seem to affect the equity valuation much, but may have accelerated the debt payoff.

In any case, we rate Engine CCR 4, and will wait to see if the ($27mn) of unrealized losses still booked will get realized, or if the loss will shrink. There was no word on the subject either this quarter, or at any other time, on its conference call.

Viasat Inc: Receivables Placed On Non Accrual

We’ve been reviewing the Great Elm Capital (GECC) IQ 2022 results, principally to understand what’s happening at satellite operator Avanti Communications. However, we also noticed that receivables due from another satellite company – Viasat Inc. – had been placed on non accrual for the first time. There are 3 different receivables involved, acquired in 2021. One tranche was due March 15, 2022 and the remaining two in June and September of this year. The total amount invested at cost is only $1.1mn.

However, as of March 31, 2022 the value of all three receivables has been dropped to $100K each, or $0.3mn in total – a (73%) discount. We have no idea why this has occurred. GECC has invested in and collected Viasat receivables in the past without any problem. Viasat itself is a public company, performing normally. If we learn more, we’ll provide an update. For the moment, we are rating the company CCR 5 on our 5 point scale.

Avanti Communications: Great Elm Capital Write-Downs

On May 9, 2021, the BDC Credit Reporter indicated that satellite operator Avanti Communications has seen its balance sheet restructured again. We also projected that the company’s main lender and substantive investor – Great Elm Capital (GECC) – would place any performing loan on non accrual and write-down – or off – the remaining $8mn value in Avanti carried at December 31, 2021:

We’ve not yet heard from GECC regarding IQ 2022 but everything points to all debt owed either being placed on non accrual or written off. As a result, realized losses are likely to be on the way. As far as we know, GECC and the other BDC lenders may have no debt outstanding in the restructured company. Even if they do, the huge Avanti exposure that has been around for years must have virtually no remaining value. For GECC, the $8mn of value left in Avanti at year-end will likely drop to an immaterial $0-$3mn when all the dust settles.

BDC Credit Reporter – Avanti Communications : Completes Restructuring May 9, 2022

On May 11, 2022 GECC reported IQ 2022 results and – as expected – placed the two performing loan tranches: Avanti 1.25 Lien Loan and 1.125 Lien Loan on non-accrual as of March 31, 2022, ” with any accrued but uncapitalized interest income reversed as of the accrual date”. All 4 types of debt held by GECC, amounting to $66mn at cost, are now non performing.

GECC – which had already written its $50.7mn of equity investment in Avanti to zero in previous quarters, wrote down the $8mn of remaining value in the Avanti debt to just $0.6mn – as we had anticipated. The debt will be converted to equity but is unlikely to have any value and may become a realized loss before long. In addition, we learned that new funds were advanced recently to Avanti but GECC – unlike in prior times – did not participate.

With these moves, the $117mn invested at cost by GECC in Avanti has been written down by (99.5%). No further income is being generated. The two most recent loans placed on non accrual generated $0.7mn annually in investment income by our estimate.

As we’ve said previously, the Avanti story is not yet over, but for the two public BDCs involved – which includes BlackRock TCP Capital (TCPC) with GECC – $130mn invested in the debt and equity of the satellite operator has a remaining value of just over $1mn and no investment income is being generated.

This is a credit disaster that’s been a very long time coming as Avanti – to any outside observer – has seemed way over-leveraged and unviable for years. For TCPC this is a modest reverse, given its size and relatively modest exposure. For GECC, Avanti has been its biggest investment and a major income producer till recently and frequently required special disclosures in its financial statements. Now Avanti – for better or worse – is a negligible part of the BDC’s portfolio, which is now dominated by a handful of specialty finance investments.

Avanti Communications: Completes Restructuring

Yet again satellite operator Avanti Communications has restructured its balance sheet. The company itself gave some of the details in a press release in April 2022 – but left us with some questions. We heard that total debt has been reduced “from $810 million to $260 million”. Apparently, control of the company has changed as well. The company indicates:

“Funds (or subsidiaries of such funds) and/or accounts managed, advised or controlled by HPS Investment Partners LLC or affiliates/subsidiaries thereof ($80 billion leading global investment firm) and Solus Alternative Asset Management LP (leading US registered investment advisor specialising in corporate recapitalisations) will become the principal shareholders”.

Avanti Communications Press Release – April 13, 2022

Business continues as usual, but there are unresolved financial and legal items as well. Here’s what a trade publication reported:

The financial reconstruction also sees Avanti pass to Glas Trust Corp. Ltd. (as one of the Primary Security Agents which also includes The Bank of New York Mellon) new or extensions to debentures on some assets of Avanti’s Hylas 2 (AH2) satellite and payment obligations to Glas Trust. The agreement is in the form of a formal charge on the company’s assets and signed on March 22 between the parties.

Some of Avanti’s subsidiary/related companies are officially in default as regards their financial filings to the UK’s Companies House. For example, Avanti Communications Group plc should have filed by June 30 2021 (for the accounts up to Dec 31st 2020) and are now overdue.

Advanced Television – April 14, 2022

Exactly how this translates for the BDCs with exposure to Avanti is not clear, but cannot be good. As of the year-end 2021, there were 3 players involved, led by Great Elm Capital (GECC); BlackRock TCP Capital (TCPC) and non-traded AB Private Credit Investors, with an aggregate cost of $136mn. At that point FMV was down to $15mn, a (89%) discount. Judging by TCPC’s just released IQ 2022 valuations and the restructuring news, the value of Avanti has even further to drop.

Most impacted – and much discussed over the years on these pages – is GECC with $118mn invested in equity and debt investments. The BDC in its latest 10-K was required to make some very sharp disclosures about its Avanti relationship, which we’ll quote at length:


Avanti is highly leveraged.  If there is an event of default under the indenture governing the PIK Toggle Notes or any other indebtedness and the obligations under the PIK Toggle Notes are accelerated, Avanti likely will not have sufficient liquidity to pay the obligations under the PIK Toggle Notes.  Under such circumstances, Avanti may consider other restructuring options, such as entering into an insolvency procedure under English law or by filing for Chapter 11 protection under the U.S. Bankruptcy Code, the consequences of which could include a reduction in the value of the assets available to satisfy the PIK Toggle Notes and the imposition of costs and other additional risks on holders of the PIK Toggle Notes, including a material reduction in the value of the PIK Toggle Notes.  In such an event, we may lose all or part of our investment in Avanti…

In addition, as noted above, we own approximately 9% of Avanti’s common stock. Avanti’s common stock was delisted from its primary exchange in September 2019 and no longer trades on an exchange, which limits the liquidity of our investment.  Equity securities also expose us to additional risks should Avanti default on its debt or need additional financing. Equity securities rank lower in the capital structure and would likely not pay current income or PIK income, which we had been receiving on our investment in Avanti prior to the 2017 liability management transactions. 

We are currently receiving PIK interest on our Avanti investment under the PIK Toggle Notes and we have generated significant non-cash income in the form of PIK interest.  As part of the 2017 restructuring, the PIK Toggle Notes became pay-if-you-can notes whereby Avanti is required to make interest payments in cash, subject to satisfying certain minimum cash thresholds.  Otherwise, the interest will be paid as PIK interest. … … The Avanti common stock was delisted from its primary exchange in September 2019 and no longer trades on an exchange.

Avanti’s financial condition is uncertain. The 2017 liability management transactions did not materially change Avanti’s long term capital structure and did not address the longer-term sustainability of Avanti’s business model. In addition, Avanti is faced with near term debt maturities, including related to the PIK Toggle Notes, which mature in October 2022. As of result of the uncertainty surrounding Avanti’s financial condition and ongoing liquidity challenges, as of December 31, 2021, we determined that our investment in the PIK Toggle Notes was fair valued at zero and, we put our investment in the PIK Toggle Notes and the 1.5L loan on non-accrual, with any accrued but unpaid or capitalized interest income reversed as of period end. As a result of this write down and non-accrual status, we have determined that that the accrued incentive fees payable associated with the portion of PIK interest generated by the PIK Toggle Notes and 1.5L loan should not at this time be recognized as a liability and as such we have reversed $5.0 million in accrued incentive fees related to those investments in the current period.

Great Elm Capital – 2021 10-K

We’ve not yet heard from GECC regarding IQ 2022 but everything points to all debt owed either being placed on non accrual or written off. As a result, realized losses are likely to be on the way. As far as we know, GECC and the other BDC lenders may have no debt outstanding in the restructured company. Even if they do, the huge Avanti exposure that has been around for years must have virtually no remaining value. For GECC, the $8mn of value left in Avanti at year-end will likely drop to an immaterial $0-$3mn when all the dust settles.

Even now, the Avanti story is not yet over. Expect more updates in the near future. However, the damage appears to be almost fully done and the prospect – always slim – of some eventual recovery from a business turnaround. For the BDC investors involved this has been a slow motion horror show and one that does not reflect well on either GECC or TCPC, both of whom were unwilling to accept what was obvious to almost everyone else: that Avanti was way too over-leveraged to affords the debt piled on through the years.

MacuLogix Inc: Debt In Default

In the IVQ 2021, MacuLogix Inc. – a company that develops tests for macular degeneration – defaulted on its debt maturing September 1, 2023. We know this from Horizon Technology Finance (HRZN) – one of its senior lenders. (The BDC also owns equity in the company).

Now we’ve just heard from HRZN regarding its IQ 2022 results and discovered the debt remains on non accrual and has been reduced further in value. Moreover, the BDC has made additional loans, due in 2022. All these loans are carried as non performing. The total capital invested is $12.1mn, up $0.4mn from the prior quarter, at cost. The latest value is $5.5mn, indicating a (55%) discount has been taken by the BDC overall.

The BDC Credit Reporter rates the company CCR 5.

We can’t tell from the public record what ails MacuLogix, or what the outcome might be for HRZN’s investment. We can say that the BDC is not receiving ($1.2mn) of annual investment income and may yet have to advance more funds to protect its interests. We’ll provide an update when we hear anything useful.

Grupo Hima San Pablo: BDC Writes Investment Off

On May 3, 2022, we heard the following from WhiteHorse Finance (WHF) in a press release which previewed IQ 2022 results:

During the three months ended March 31, 2022, the realization from Grupo HIMA San Pablo, Inc. generated an approximate $6.9 million net loss, or approximately a net loss of 29.8 cents per share.

WhiteHorse Finance Press Release May 3, 2022

No further details were provided, but this does provide a useful heads up regarding the Puertno Rican hospital chain, whose debt has been non performing in one way or another since IVQ 2017 (!). As of the IVQ 2021, 4 BDCs – including WHF – have exposure to Grupo Hima, in the form of first lien and second lien debt, with a cost of $44.4mn. At fair market value the positions already aggregated only $10.9mn.

WHF – according to its latest 10-K – had invested $19.5mn in the hospital chain, but had written exposure to $7.5mn. Assuming we understand what WHF is doing, this suggests the BDC will be recognizing a final loss but recovering $12.6mn of capital advanced and a small fair market value gain from the settlement of this long troubled credit.

The other BDCs involved – none of which have reported results yet are Portman Ridge (PTMN); Main Street Capital (MAIN) and Stellus Capital (SCM). The news out of WHF suggests the “realization” of the Grupo Hima situation means a final resolution has been made. Unfortunately, we don’t know the details and could not find anything from a quick search of the public record. We hope to circle back with more details when one or more of the BDC lenders provides more of an explanation of what has happened.

Rug Doctor/RD Holdco: Second Lien Debt On Non Accrual

We don’t know what’s going wrong exactly at Rug Doctor (aka RD Holdco) – the carpet cleaner rental company, but matters seem to be getting worse. Admittedly, based on the trend of BDC valuations we’ve tracked on Advantage Data, performance has not met expectations since – at least – 2018. Now that Ares Capital (ARCC) has reported its IQ 2022 results ahead of its peers, we can report the company’s second lien debt – due 5/2023 – has been placed on non accrual for the first time.

There are 3 other BDCs with exposure to the debt and equity of the company, and total outstandings at cost (using the year end 2021 data) amounted to $92mn. For ARCC, the loss of income on an anualized basis will amount to about ($2.2mn). That a 10% yield on $22mn at cost. The BDC also has $14mn invested in the equity but that remains valued at zero, unchanged at that level since IQ 2020.

The other BDCs – SLR Investment (SLRC); Main Street Capital (MAIN) and non-traded MSC Income Fund share $56mn in combined exposure and have not yet reported their IQ 2022 valuations. SLRC has the biggest stake – also in second lien and equity – and will probably be writing down both from a cost of $32mn to $9mn if they follow the ARCC lead. SLRC’s total value as of IVQ 2021 was $17mn, so there’s a potential ($8mn) unrealized write-down in play.

MAIN has $10.9mn in a “Senior Note” which was last valued at par and may not be subject to as much of a potential write-down, if any. Ditto for MSC Income Fund with $12mn in that same senior facility.

Looking down the road is not easy, given we know so little about what ails Rug Doctor. However, one can make a case that the – given this latest non accrual and years of underperformance – both the equity invested and the second lien obligations are in danger of a complete realized loss at some point. If that’s how matters pan out, two-thirds of the funds invested at cost by the BDCs could be lost – all of which would affect ARCC and SLRC. Both BDCs are sufficiently large in terms of capital base to absorb such losses, but this would be a reverse nonetheless and one that’s been a long time coming.

For the moment, we are downgrading Rug Doctor from CCR 4 to CCR 5. We’ll provide an update as we learn more from the BDCs involved and/or publicly available information.

Dunn Paper: Lenders Seeking Sale Of Company

Dunn Paper has been in financial difficulties in recent months due to “declining profitability and elevated leverage”, as admitted by the company in a press release. In March 2022, an interest payment on senior debt was missed, which required the borrower to enter into a forbearance agreement with some of its lenders. A new credit facility has been received, although the amounts and terms are not known. (For a brief explanation of Dunn Paper, see a company description at the bottom of this post).

The above notwithstanding – on April 26, 2022 – a specialist publication – quoting anonymous sources – indicated second lien lenders are banding together; hiring counsel and seeking to push for a sale of the company. As you’d expect details are sparse. However, we imagine several BDCs might be represented in this group of second lien lenders. Prospect Capital (PSEC), Southwest Capital (CSWC) and a non-traded BDC all have second lien exposure to Dunn. (PSEC is also in the first lien debt).

Dunn has been underperforming only quite recently – since IIIQ 2021 – when all the BDCs involved started to write down the value of the second lien debt. As of the IVQ 2021, the biggest discount was applied by CSWC: (16%). All in all, BDC exposure amounts to a relatively modest $21mn, with PSEC holding $16mn, including $4mn in first lien exposure. Until the latest news, we rated Dunn CCR 3 on our 5 point investment rating scale. Now, Dunn has been moved – due to its failure to make an interest payment – to CCR 5.

The yield on the second lien debt was being charged at just over 10%, suggesting total annual income forgone on the second lien debt is ($1.7mn), and another ($0.3mn) on the first lien.

Dunn’s weak financial performance – according to their own reports – seems to derived from the supply chain and related inflationary increase of input costs. That might mean what ails the business might be salvageable by a restructuring or the sale to the right party. The PE sponsor recently brought back “Founder” Brent Earnshaw as CEO, amidst other senior executive changes. That must give some hope to the second lien lenders that a full recovery – or something very close to one – is a realistic prospect. We get the impression from reading between the lines that this troubled situation will be resolved within a relatively short period.

We will continue to track the public record and ascertain what valuations PSEC and CSWC ascribe to their respective positions when IQ 2022 results are published. Neither BDC, though, has yet set a date for reporting their most recent results. At the moment, we expect neither the interruption of income nor any realistic prospective loss to be material for the BDCs involved, and there’s always a chance this will be resolved without any significant loss.

About Dunn Paper
Dunn Paper is a leading manufacturer and supplier of advanced paper, tissue, and packaging products for use in food, medical, and specialty markets. The company operates 7 paper mills across the United States and Canada and focuses on eco-friendly specialty paper and tissue. Dunn Paper also works with top converters allowing their sustainable paper products to have thousands of potential applications. The company’s first mill opened in 1924, and in 2016 the company was acquired by Arbor Investments, a specialized private equity firm with a focus on premier companies in food, beverage, and related industries.

Dunn Paper Press Release April 22, 2022

PhyMed Management LLC: Debt Placed On Non Accrual

On April 26, 2022 Ares Capital (ARCC) – one of two BDC lenders to PhyMed Management, LLC – an anesthesiology company – reported its IQ 2022 results, which included a sharp write-down of the value of its second lien loan and marking the obligation as non-performing. At cost ARCC invested $56mn in the debt – due in September 2022 – but has now written the fair market value to just $14mn. Last quarter, according to Advantage Data, ARCC valued this loan at $52mn. That was only a (5%) discount to par and would have rated the company as performing normally – a rating of 2 on our standard 5 point scale.

A second BDC lender in the same loan – SLR Investment (SLRC) has advanced $38mn and was valuing its exposure at $37mn, and performing normally at year end. SLRC has not yet reported IQ 2022 performance, but expect to see a drastic drop in the value of this investment.

Obviously, something has gone wrong in the last few months to take PhyMed from performing to non-performing (aka CCR 5) so quickly. We have searched the public record for an explanation but none is readily forthcoming as yet.

For the two BDCs involved, with $94mn advanced, the impact on income will be material from the non accrual. In a sign – with the benefit of hindsight – that not all was right at PhyMed – the loan at ARCC was being charged an interest rate of 15% at year-end 2021, mostly in PIK form. For SLRC, this facility is the 5th largest in its portfolio at year end 2021, representing 1.8% of assets and is showing on its 2021 10-K with a 16% yield. Between ARCC and SLRC, nearly ($15mn) in annual interest income will be forgone until this issue is resolved.

Moreover – in the absence of any other information – the sharp drop in the valuation ascribed by ARCC on what is a second lien obligation leaves open the possibility that ultimately a significant – if not complete – realized loss might be the eventual outcome. Should ARCC write-off the full exposure, the loss on a net asset value per share basis would be ($0.11). The BDC – the largest in the sector – just reported a $58mn net realized gain for the IQ 2022. PhyMed may end up cancelling those gains when this matter is settled out. (We’ll wait to calculate the corresponding number for SLRC which has just merged with a sister BDC, and whose share count we don’t have at hand to make the calculation).

Hope springs eternal, and it’s possible PhyMed will be rescued in some way. We’ll add the name to our daily searches of the public record and wait to see what ARCC and SLRC have to say – if anything – on their upcoming earnings conference calls. At the moment, though, this looks like a very sharp and material reversal for both BDCs.

Teligent, Inc.: To Liquidate, Part Repay Lenders

Good news (of a sort): Teligent, Inc. is being liquidated. We wrote about the troubled pharmaceutical manufacturer twice previously. Bankruptcy was filed back in 2021 and has now become a liquidation after assets were sold to a third party. From the very sparse public record, we learn on April 11, 2022 from Bloomberg Law that the company will be paying its lender $33mn out of the $90mn owed. (Unsecured creditors – who’ve been battling in court with the lender – will receive 11 cents on the dollar).

The lender in this case is Ares Capital (ARCC) or “its affiliates”. Previously, given the serious troubles at Teligent that we won’t regurgitate here, we were concerned that ARCC might have to write off 100% of its $77mn of exposure reported as of December 31, 2021. We’re not sure what the difference is between the IVQ 2021 stated exposure and the $90mn mentioned by Bloomberg Law. Most likely, the difference consists of post-bankruptcy monies advanced by ARCC not on the books at year-end and which kept Teligent afloat long enough to achieve the asset sale.

The numbers being thrown around imply that ARCC will end up booking a realized loss of ($57mn) on Teligent when all is said and done. To put that into context ARCC has booked $17mn in annual realized gains over the last 3 years (ARCC had a very good 2021, but losses in 2019-2020). Net assets at 2021 year end were in excess of $20bn, so this loss – while notable – may not move the needle much and any income once earned on this investment has not been received since IQ 2020.

As of the IVQ 2021, ARCC had already written down its exposure by ($38mn). If we’re right about the final bill, the BDC will be ultimately booking another ($19mn) in losses. This probably means a further unrealized drop in the upcoming IQ 2022 results and a final realized loss in the IIQ 2022 numbers.

Although we were overly-conservative about ARCC’s prospective loss, the BDC itself seems to have been somewhat over optimistic about its recovery, based on the numbers at year end. As always, these are very hard outcomes to handicap once the courts – and other parties get involved.

Sungard Availability Services: Files For Bankruptcy Again

Just three years after filing for Chapter 11 bankruptcy Sungard Availability Services – an IT company – has done so again. A pre-packaged bankruptcy plan agreed with its lenders has taken the company in and out of Chapter 11 status, with similar filings in the UK and Canada. Management is putting the best possible spin on this “Chapter 22”:

“Like many companies, our business has been affected by challenges in our capital structure, driven by the global COVID-19 pandemic and other macroeconomic trends including delayed customer spending decisions, insourcing and reductions in IT spending, energy inflation, and reduction in demand for certain services,” said Michael K. Robinson, Chief Executive Officer and President, Sungard Availability Services. “Over the past three years, we’ve made significant network, product and infrastructure investments which are being well-received by customers and gaining significant traction.  We believe the chapter 11 process is a right and critical step forward for the future of our business and our stakeholders.”  

Sungard Availability Services Press Release- April 11, 2022

The company has arranged $95mn of Debtor In Possession (“DIP”) financing and with monies in hand will tackle over the next several months “uneconomical leases and underutilized space”. Thanks to the DIP monies “Sungard AS intends to meet its financial obligations, including paying suppliers in the normal course of business for goods and services delivered from today forward. The Company also has filed the customary motions to honor its ongoing commitments to employees and customers”.

There is only one BDC with exposure: FS KKR Capital (FSK). The bankruptcy move will not be a surprise to FSK which has been involved with the business since 2014, when an earlier manager of the BDC first booked exposure. FSK – and its sister BDCs that have since been combined into FSK – were involved in the 2019 restructuring and took an undetermined amount of realized losses. As of year end 2021, FSK’s exposure at cost amounted to $26.3mn in first lien, second lien and equity. (The last of those seems to have been added after the 2019 restructuring). The FMV was $14.3mn, with the equity written to zilch, the second lien discounted (39%) – and placed on non accrual. The first lien debt was valued at a slight premium.

We have very few details – if any exist – about what post-Chapter 22 Sungard will look like. We can reasonably imagine, though, that the equity and second lien debt will be written off (cost $20.6mn and an additional $8.3mn loss at FMV). The impact on FSK’s income should be modest as the second lien loan is already non accruing. Even if the first lien debt becomes non performing, there is only $5.8mn outstanding and at a sub-market, non income producing rate of 3.8% PIK.

Or, in other words, most of the damage – except for the potential further write-down of the second lien (equal to 0.1% of FSK’s net assets) – is already done, earlier in 2021 and back in 2019. The most interesting aspect of all this might be whether FSK receives more equity going forward in Sungard and whether that amounts to anything more than a wing and prayer.

As we’ve been writing about of late, BDCs do have the ability to take the long view and benefit therefrom should a turnaround occur. (An article we’ve read – which may be out of date – indicates a FSK representative sits on the Board of this company that used to have over $1bn in annual sales). The amounts invested here, and FSK’s share of the DIP financing, may prove to be too small to provide much of a potential upside, but still deserves watching.

California Pizza Kitchen: International Expansion Underway

Mea Culpa. We’ve not written about California Pizza Kitchen (CPK) – one of the more prominent casualties of the pandemic – in some time. The restaurant chain filed for bankruptcy back in 2020 with hundreds of millions of dollars of debt on the books, including $60mn from 8 BDCs. Then a great deal of the debt was converted to equity (which resulted in realized losses) and equity was granted to the lenders in compensation. More recently the company rid itself of its $177mn in post-bankruptcy debt.

This left, since IIIQ 2021, three BDCs with exposure to the rejigged CPK – all in the form of equity stakes. The BDCs involved are Great Elm (GECC); Capital Southwest (CSWC) and Monroe Capital (MRCC), with total exposure at cost of $15.6mn. The equity was received in the IVQ 2020 and has fluctuated in value every quarter since, along with the chain’s business prospects.

These equity valuations peaked in IIIQ 2021 when the three positions were valued at $13.3mn, a (15%) discount to the average cost. In the most recent IVQ 2021, the valuation dropped slightly, probably due to concerns about omicron or perhaps reflecting recent metrics. Nonetheless, the well regarded management of CPK have an aggressive expansion plan in place and just announced two international franchise agreements, and plans to open 7 restaurants overseas by year end 2022.

We can’t be sure, but there’s a good chance CPK’s equity could increase in value as a result of these and other actions, and the improving Covid situation. If so, the BDCs left with an equity stake might be able to recoup their initial pre-bankruptcy investment in full, or even better. GECC has the most to (re)gain, with a current value of $4.7mn; followed by MRCC with $3.7mn and CSWC at $2.3mn. We’ll be looking out for the latest values when BDC earnings season returns in late March/early April 2022.

Battery Solutions: Company Sold

Back in the day, Battery Solutions was an underperforming portfolio company of Alcentra, a BDC since acquired by Crescent Capital (CCAP). At its worst point, Alcentra/CCAP had nearly $5mn invested at cost in subordinated debt and preferred, the latter discounted by (78%). Even as recently as the IIIQ 2021, the preferred and debt were both discounted and rated CCR 3.

However, in the IVQ 2021 CCAP valued the preferred at a premium of 43% all of a sudden and the debt outstanding almost at par. We now know why: Battery Solutions has been sold to Retriev Technologies, according to the Lancaster Gazette. Terms were not disclosed, but we get the impression CCAP has booked itself a realized gain in the IQ 2021 of about $1.5mn above the $5.5mn invested at cost as of the IVQ 2021.

That’s a positive outcome for the Crescent organization, and for an investment that was first booked by the late Alcentra way back in 2014 and has suffered through plenty of ups and downs. We’ll be interested to see if CCAP is in any way involved in Retriev’s financing package or whether the investment is truly off the books. IQ 2022 results should tell the story.

Logan Ridge Finance: Quarterly Credit Review

Portfolio Data

Logan Ridge Finance (LRFC) at the end of IVQ 2021 had 40 portfolio companies, and a portfolio with a cost of $190.5mn and a FMV of $198.2mn, a premium of 4%. Inception to date losses on $189mn of equity capital at par were ($82mn), or 43%.

First lien debt as a percentage of the portfolio at fair value was 49.6%, second lien debt 15.2%, subordinated debt 2.5%, collateralized loan obligations 3.9% and equity portfolio 28.8%.

Performing vs Underperforming

Of the 40 companies in portfolio, 36 are performing or are non-income producing. Performing investments are $176mn and underperforming investments are $22mn, of which $8mn are non-performing. (LRFC’s manager does not offer an investment ratings table. All the data here is compiled by the BDC Credit Reporter).

Underperforming investments account for 10.9% of the portfolio as whole. The percentage of underperformers has dropped from $26mn and 13.2% of the portfolio in IIIQ 2021. Note, though, that LRFC booked ($8.3mn) in realized losses in IVQ 2021 and ($8.0mn) for the year as whole. Furthermore – despite paying no distribution – net asset value per share fell for a third quarter in a row, to $39.48.

See the BDC Credit Table for further data.

Underperformers

There are two companies rated CCR 3 in our 5 point investment rating scale: Alternative Biomedical Solutions and Vology Inc, with a fair market value of $14.1mn. Both companies value trended downward in the IVQ 2021.

There are two companies rated CCR 5 – non accrual: BigMouth Inc and Sequoia Healthcare Management. The former is a liquidated business and the investment at risk is non material at $0.6mn. The latter is a hospital group accused of fraud, with a FMV of $6.4mn, down from $8.3mn in the prior quarter and with a cost of $11.9mn. All the exposure is in a term loan maturing 1/14/2022. (Cion Investment also has first lien debt to the company, which is also on non accrual but with a different maturity).

Potential Upside

As noted above, LRFC has an unusually high proportion of investments in the form of junior capital (common stock, warrants and preferred). The total cost is $51.7mn and the FMV $64.7mn. Seven performing company equity investments (not including two CLOs and Vology, which is underperforming) are valued over $2mn. The largest value by far is the $16.3mn of equity in Eastport Holdings, a full service marketing firm, which represents a quarter of the total. The value of Eastport has been trending downward for several quarters, but remains 500% of its cost.

Conclusion

By BDC standards, LRFC’s portfolio is small – the second smallest in the public universe after PhenixFin – and with an unusually high proportion of non-income producing investments and a low percentage of first lien debt. However, the number and value of underperforming companies and investments is normal by BDC standards, and the names involved are unchanged, albeit mostly being written down further. This follows a quarter where several poor performers were written off the books.

Projection

Looking forward, the underperformers are more likely than not – as a group – to drop further in value, but that may be offset by increases in the value of equity investments. The manager’s plans to decrease its proportion of equity investments should increase the proportion of income producing investments over time, but the timing and the percentage involved is unknowable.

We project that given more difficult market conditions; downward pressure on the valuations of underperformers and the decreasing value of Eastport Holdings of late that NAV Per Share is more likely than not to decrease by the end of 2022 versus the level as of December 31, 2021. Since the end of 2017, LRFC’s NAV Per Share has dropped (53%), including (2%) in 2021. That metric could reach (55%) or greater in 2022. See the BDC Nav Change Table.

Bain Capital Specialty: IIIQ 2021 Credit Status

With the IVQ 2021 BDC earnings season right round the corner, the BDC Credit Reporter is updating the credit status of as many public BDCs as possible, using IIIQ 2021 data and any subsequent developments we are aware of.

Portfolio Metrics

In the case of Bain Capital Specialty Finance (BCSF), total investment assets at cost amount to $2.380bn, and the fair market value to $2.357bn, a slight discount of (1%). The BDC portfolio at fair value has shrunk (5%) in the first 9 months of 2021.

Investment Rating

There are 105 portfolio companies. The BDC rates the credit status of its portfolio quarterly. As of September 30, 2021 the value of under-performing assets was $244mn, or 10.3% of the entire portfolio. Both the amount and the percentage are largely unchanged from the quarter before.

Non Accruals

BCSF has no loans on non accrual, although two portfolio companies have some debt which is non -performing, as we’ll discuss shortly.

Underperformers

We have identified 7 underperforming portfolio companies, with an aggregate value of $181mn. However, 2 are not material and non income producing. These are NPC International (fast food), which we wrapped up in an article on January 14, 2021 and East BCC Coinvest II (capital equipment).

That leaves 5 companies, of which 2 are rated CCR 3. First there is GSP Holdings, LLC. The company has been underperforming since IIQ 2020 and its first lien debt held by BCSF is discounted up to (21%), but was at a (46%) at worst, suggesting some improvement recently. We have found very little public info on the company. The latest value is $34.1mn.

We also don’t know much about TLC Purchaser and TLC Holdco, with a value – mostly in debt – of $42mn. Of late, the valuation has been modestly trending down with the equity held discounted (57%) and the debt up to (15%). TLC has been underperforming since 2020.

Credit Focus

Of greater concern are Ansira Holdings, Direct Travel and Chase Industries, all of which we rate CCR 4, where the likelihood of an ultimate realized loss is greater than full recovery. We discussed Ansira, which has multiple BDC lenders, back in November 2021. One BDC has its unitranche loan exposure marked as non accruing but BCSF has its loan positions as performing. Total exposure by BCSF is $43.6mn, with much of the income already booked as pay-in-kind. Should the marketing services company default, BCSF has $3.7mn of annual investment income at risk of interruption.

Direct Travel is in a difficult business right now and has already been restructured earlier in the pandemic. Another BDC lender – TCG BDC – carries its exposure to the company’s 10/1/2023 loan as non-performing but BCSF’s 10/2/2023 term loan is still counted as performing, but discounted in value by up to (20%). Furthermore, all the income being booked is in PIK form…Some $6.5mn of annual interest income is in play here – 3.3% of the BDC’s total investment income, so what happens at Direct Travel will materially affect the BDC.

Finally, there’s Chase Industries. Again this specialty door manufacturer has multiple BDC lenders. Also again, BCSF’s income is at least partly being booked in PIK form. BCSF’s exposure is in the first lien debt, which is discounted only (17%). However, Goldman Sachs BDC is in second lien debt, which is non performing (63%). This is cause for concern for BCSF, and the main reason why we’ve applied a CCR 4 rating. The BDC’s debt has a value of $11.4mn and $0.900mn of annual interest income at risk.

Follow Up

We’ll be focused principally on Ansira, Direct Travel snd Chase Industries when BCSF publishes its IVQ 2021 results on February 23, 2022. Clearly, bad news is possible that may cause both further unrealized losses and material loss of interest income. On the other hand, with travel recovering; housing on an uptick and business conditions favorable all three companies financial performance could improve, boosting asset values and leaving income untouched. We’re also reassured that the $114mn of exposure at FMV is almost all in a first lien position. As they say, this could go either way in the short run where valuation and income is concerned but the ultimate outcome promises to be favorable for BCSF.

Barings BDC : IIIQ 2021 Credit Status

With the IVQ 2021 BDC earnings season right round the corner, the BDC Credit Reporter is updating the credit status of as many public BDCs as possible, using IIIQ 2021 data and any subsequent developments we are aware of.

Portfolio Metrics

In the case of Barings BDC (BBDC), total investment assets at cost amount to $1.632bn, and the fair market value to $1.654bn, a slight premium to par. The BDC portfolio at fair value has grown 10% in the first 9 months of 2021.

Unrated

There are 146 portfolio companies. Unfortunately, the BDC does not rate the credit status of its portfolio, only reporting on the number of non accruals. In its absence, the BDC Reporter has undertaken its own calculations of the value of underperforming companies.

Non Accrual (s)

As of September 30, 2021 there was 1 company non performing: Legal Solutions Holdings. See our November 22, 2021 article. This is what was said in the BBDC 10-Q on the subject:

In connection with the MVC Acquisition, we purchased our debt investment in Legal Solutions Holdings, or Legal Solutions. During the quarter ended September 30, 2021, we placed our debt investment in Legal Solutions on non-accrual status. As a result, under U.S. GAAP, we will not recognize interest income on our debt investment in Legal Solutions for financial reporting purposes. As of September 30, 2021, the cost of our debt investment in Legal Solutions was $10.1 million and the fair value of such investment was $11.0 million.

Barings BDC 10-Q IIIQ 2021 11/9/2021

Subsequent to quarter’s end, Carlson Travel was restructured, filed for bankruptcy and after one day exited court protection. The FMV of BBDC’s exposure was valued at $8.9mn. See our November 15, 2021 article.

Rest Of The Worst

The BDC Credit Reporter has identified 3 additional underperformers – all of which are performing (i.e. paying interest) and are rated CCR 3 on our 5 point rating scale. The companies are Accurus Aerospace ($20.9mn) ; Custom Alloy ($36mn) which is discussed further below and the MVC Private Equity Fund ($8.2mn).

The total FMV of the underperformers is $86mn, or 5.2% of the portfolio as a whole. Of the 5 companies, 3 are rated as Trending, which means they are expected to show meaningful changes in values or amounts outstanding at the next earnings release. These are Carlson Travel, Custom Alloy and Legal Solutions.

Credit Focus

Our greatest concern from a credit standpoint – in terms of value or income loss – is at Custom Alloy, whose value dropped sharply in the IIIQ 2021. This is what we wrote most recently on the subject:

This is a credit worth tracking as Custom Alloy accounts for 7% of BBDC’s total investment, and even more of its NII because of the high rates being charged. We have added the company to the Trending List and will be monitoring BBDC’s IVQ 2021 results with great interest for signs of any further weakening. We were encouraged, though, by a recent October 2021 news item that indicated the company is investing $8.1mn in a new facility to service a Navy contract. Maybe Custom Alloy’s troubles – whatever they are – are just a passing phase and – once again – the company will be removed from the underperformers list.

BDC Credit Reporter- Custom Alloy Corporation: IIIQ 2021 Update November 23, 2021

Solid

Both troubled Carlson Travel and Legal Solutions do not appear to be in danger of more than immaterial losses. The former consists principally of first lien debt which should remain fully valued in the recent restructuring and the latter is supported by a credit indemnification from the BDC’s manager, part of the MVC acquisition terms.

Follow Up

We will update BBDC’s credit status following its IVQ 2021 results for which a publication date has not yet been set.

Dunn Paper Holdings: Debt Refinancing Concerns

The bad news continues to pile up at specialty paper manufacturer Dunn Paper Holdings (“Dunn Paper”). In late November 2021, the company was downgraded by Moody’s. Importantly, the borrower’s 2022 first lien debt was also downgraded to Caa1 and the second lien debt coming due in 2023 to Caa3. The major culprit: higher pulp prices, but also very high debt/EBITDA (over 9x), “negative free cash flow” and refinancing concerns with the debt needing refinancing in August 2022. S&P followed suit with its own downgrade in January 2022.

Now we hear that loan defaults have occurred and the lenders have brought in an advisor to assist with negotiations and that an investment banker is pounding the pavement determining market appetite for a refinancing.

There are 3 BDCs with $21.3mn invested in Dunn Paper in both the first lien and second lien. Two of those BDCs are public : Capital Southwest (CSWC) and Prospect Capital (PSEC) and then there’s non-traded $1.0bn AUM Barings Private Credit. PSEC is invested in both the first and second lien but the other two players are only in the second lien.

Worryingly for BDC valuation credibility, the discount applied by the 3 BDCs with second lien exposure varied widely in the most recent quarter ended September 30, 2021. PSEC and Barings discounted their positions by only (1%) and (6%) respectively from cost , while CSWC was more conservative with a (15%) discount. (The first lien debt remains valued at par).

With some sort of default having already occurred – if those reports mentioned are true – a bankruptcy or out-of-court restructuring seems increasingly likely, as does the need for the BDC second lien lenders ($16.8mn in total) to further write-down their debt, which should show up in the IV Q 2021 results and – possibly – in the IQ 2022. We add Dunn Paper to our Trending list, meaning that we expect a material change in value is coming, and rate the company CCR 4. Given that considerable exposure is in a junior position and borrower and lenders have already unsuccessfully sought to refinance the business (so it seems), the odds of an eventual realized loss seem higher than repayment in full.

We’re also noting – a new feature in 2022 – the underlying reason for the company’s financial difficulties: an increase in pulp prices that Dunn has not been able to fully pass along to its own customers. This makes the company a victim of the much discussed inter-twined challenges of supply chain disruption and rapid inflation. The BDC Credit Reporter will be highlighting these causes when possible, using the tag INFLATION.

With BDC earnings season round the corner, there’ll be more news shortly, or at least up to date valuations, although that value may be in the eye of the beholder. We may also hear more whispers from unidentified sources or even the principals themselves as the restructuring discussions play out.

Still, to keep matters in perspective, the aggregate amounts at risk for the BDCs are modest, with PSEC having the most exposure by far: $15.8mn or three quarters of the total.

For anyone interested in getting all the details of each BDC’s exposure since inception where Dunn Paper – or any of the companies we track in the BDC Credit Reporter – is concerned, we recommend talking to Advantage Data about a subscription to their BDC Holdings module – which contains a treasure trove of data that we regularly utilize for these articles. In this case, BDC exposure dates back to 2016.

US TelePacific Corp: Debt Refinancing Concerns

Privately-held communications company U.S. TelePacific (aka as TPx Communications) is in protracted negotiations with its existing lenders. Apparently, since November 2021 the company has brought on an adviser to assist in negotiations regarding its revolver and term loan, which mature in May 2022 and May 2023 respectively. The debt markets are already valuing the Term Loan at 75.6% of par. Furthermore, back in September 2021 S&P – and later Fitch – downgraded the company. The former has downgraded the business to a CCC+ rating. Commentators are projecting that private equity group Siris Capital Group – which acquired the company back in February 2020 – and has already lobbed some extra capital in to support the business might have to write another cheque. If not, liquidity might become a serious problem within months….

This is a material problem for 4 BDCs with exposure to the company – all in that $655mn Term Loan. Three of the BDCs are publicly traded: Main Street Capital (MAIN) with $17.0mn at cost; TCG BDC (CGBD) with $6.6mn and Capital Southwest (CSWC) with $5.2mn. Non-traded MSC Investment has $12.4mn at risk.

Till the IIQ 2021 – based on the BDC valuations – the company was rated as “performing to plan”, as the maximum discount taken on the debt (the S&P downgrade notwithstanding) was (7%). [The BDC Credit Reporter does not typically move any company to “underperforming” until a (10%) discount or greater has been reached]. However, in the IIIQ 2021 – probably reflecting the challenges mentioned above – the discount reached (18%). Given what we’ve heard of the current valuation a further unrealized loss is likely in the IVQ 2021. As a result, we rate the company as Trending (i.e. likely to show a material change in valuation on the next quarterly valuation).

We are rating U.S. TelePacific CCR 4 (An eventual realized loss is more likely than full repayment) because the market discount is substantial for a “secured” term loan. Moreover, we hear that many of the outstandings are held by CLOs, which might make finding a resolution – such as a debt for equity swap – more difficult. Finally, we’re concerned that 10 weeks or more have passed without a resolution between borrower and lenders.

Both the CSWC and CGBD positions are held in their joint ventures, but MAIN and – we believe – MDC Investment’s are carried on their balance sheet. We’ll learn more when IVQ 2021 results are published but a final resolution – positive or negative – is likely not to occur till later in 2022, or even later is no meeting of the minds can be reached.