Standard & Poor’s has downgraded troubled retailer J.C. Penney to CCC from CCC+. Apparently, all the talk about restructuring the company in advance of any Chapter 11 filing, which we discussed in posts on July 23, 2019, when restructuring advisors were first called in and again on August 14, when Bloomberg reported serious talk of a debt for equity swap was in the air.
Not helping Penney’s with S&P is that the retail background for bricks and mortar stores remains challenging, notwithstanding the operational advances management has made. S&P’s view was summed up as follows:
“The negative outlook on JCP reflects the growing risk of a distressed debt exchange or restructuring in the next 12 months as industry headwinds, weak same-store sales, and a burdensome debt load contribute to its unsustainable capital structure.
“We could lower our ratings on JCP if the company announces a debt exchange or restructuring or if its operating conditions worsen such that we see a restructuring as increasingly likely in the next six months.
“Before raising our rating on JCP, we would expect the company to demonstrate a significant and sustained improvement in its performance that leads us to view a distressed exchange as less likely.”
We have rated J.C. Penney CCR 4 on our 1-5 scale, aka on our Worry List, where we believe the chances of an ultimate loss are greater than that of full recovery. Thankfully from a BDC perspective although there are 4 BDCs with exposure (including three non-traded FS Investment-KKR Capital BDCs) total exposure is very modest at $6.8mn at cost. All the debt sits towards the top of the capital structure and the biggest discount to cost is only (8%) as of June 2019. We believe the actual loss will be more substantial if and when a debt for equity swap or Chapter 11 occurs, but either way the impact on BDC net asset value and income should be modest. That’s a statement that cannot be made about the many other lenders to J.C. Penney, whose borrowings are substantial.
On June 19, 2019 Moody’s “downgraded Medical Depot Holdings, Inc.’s (d/b/a Drive DeVilbiss – “Drive”) Corporate Family Rating to Caa2 from Caa1. Moody’s also downgraded the company’s Probability of Default Rating to Caa2-PD from Caa1-PD, its first lien credit facilities to Caa2 from Caa1 and its second lien term loan to Ca from Caa3. The outlook is stable“.
The ratings group believes the capital structure of the medical equipment manufacturer is “unsustainable“. Added: “Adjusted debt/EBITDA (based on management’s adjusted EBITDA) exceeded 12 times for the twelve months ended March 31, 2019. At the same time, the company’s liquidity has weakened given sustained negative free cash flow and increased utilization of its revolving credit facility. This is due to the cash costs associated with restructuring activities and weaker operating performance“.
All the above is bad news for the two BDCs with exposure to the company: Bain Capital Specialty Finance (BCSF) and Business Development Corporation of America (BDCA). Both are lenders in the first lien 2023 debt, with exposure of $32.4mn and $2.7mn of income at risk of interruption. At June 20219, both lenders had sharply discounted their loans (23%) and (27%). Yet, since then the market value has dropped even further: to a (30%) discount, as we write this on August 31, 2019.
It’s hard to envisage a scenario where some sort of loss does not occur given the amount of debt involved, but we’ll have to wait and see. We have a Corporate Credit Rating of 4. That’s our Worry List.
An August 26, 2019 article indicates several of the largest institutional investors in AAC Holdings (aka American Addiction Centers) have been dumping their shares in the troubled public company.
“Deerfield Management, the company’s largest shareholder in March and a major investor since 2015, sold all of its holdings in AAC during the second quarter. Similarly, TimesSquare Capital Management — another of the largest shareholders early this year — and Apollo Management also had sold all of their shares by the end of June. And Morgan Stanley’s stake in the company fell from 1.4 million shares in June 2018 to about 1,600 shares in June 2019“.
So what ? The defections suggest some of the most knowledgeable investors are not buying in to management’s oft repeated plans of a turnaround plan. At $0.58 a share, the stock trades only $0.08 off its all-time low and supports the BDC Reporter’s fears that AAC will eventually file for Chapter 11 or undertake a wide ranging restructuring. Debt holders should probably pay attention.
At June 30, 2019, there were 4 BDCs with $66mn of exposure – all first lien – in the company and more than $7mn in annual income at risk. To date, discounts taken on cost have been very modest, which will make the potential impact on BDC net assets all that more telling should AAC stumble.
On August 26, 2019 the Wall Street Journal reported that the bankrupt company is seeking court approval to hire a specialist firm to sell items of its intellectual property. That may help paying some of the bills associated with the liquidation of the business but is unlikely to end up in the pockets of its three BDC lenders (THL Credit, Cion Investments and Sierra Income) with $37.4mn invested at cost.
As of June 2019, the FMV of the investments – probably based on the hope of some recovery like this – is at $0.800mn, or 2% of capital invested. Notwithstanding the prospective intellectual property sale, we expect all BDC investments to be effectively wiped out. A resolution should occur before year end.
An August 22, 2019 article about Lannett Company on Seeking Alpha is a useful summary of the bear case about future business prospects. For our part, we were intrigued by the argument made that the company is “dangerously leveraged at 5.8x adj. Net Debt to EBITDA and just 1.76x interest coverage”. This mirrors earlier concerns expressed by Moody’s last year when the company’s corporate and debt ratings were all downgraded following the loss of a major contract.
As of the IIQ 2019, the two BDCs with $9mn of aggregate exposure are Oaktree Strategic Income (OCSI) and Oaktree Specialty Lending (OCSL) in two senior debt loans maturing in 2020 and 2022. The biggest discount is modest – (6%) – but we have placed Lannett on our under-performing list in the Watch category (CCR 3) since the IIIQ of 2018 regardless, due to the concerns reflected above about high leverage and business reverses. As of now, the 2022 debt – which is publicly traded – remains valued at the same discount as of June 2019. However, that could change and $0.700mn of income is at risk. Neither BDC has a substantial exposure (although OCSI has the proportionately much bigger position and in the riskier 2022 loan) , but still deserves mention.
On August 21, 2019 Joerns Healthcare announced the restructuring of the company – undertaken under bankruptcy court protection – is complete. As noted in our two earlier posts on July 3 and August 10, the key element of the company’s plan was a debt for equity swap which will extinguish $320mn out of $400mn of pre-petition debt, and turn lenders into owners.
For the three BDCS involved (Golub Capital, Main Street and HMS Income), with $30mn of exposure – mostly in first lien pre-petition debt – this means Realized Losses will shortly be taken which will show up in the third quarter 2019 results. We expect losses taken to be over $20mn. Similarly, there will be income lost as most of the capital invested in debt form will either be written off or converted to equity.
The biggest impact will be felt by Main Street (MAIN), which has close to $15mn invested and will lose a substantial portion of its invested capital, which dates back to 2013. The Good News ? The whole bankruptcy/restructuring process has occurred over a relatively short time frame, benefiting both the company and its long term prospects and its creditors/owners.
Nonetheless, Joerns will remain on our under-performing list even now the restructuring is complete and notwithstanding the above average debt write-off. This was supposed to be a lower risk, standard loan in an industry beloved by most every lender out there. This set-back is worrisome both for Joerns itself and for the huge healthcare sector as a whole. For what it’s worth, the BDC Credit Reporter has so far identified 23 under-performing companies held by BDCs, or 10% of all under-performing credits in our database.
According to news reports, closely held NPC International – a major Pizza Hut franchisee – is getting ever closer to breaching a key financial covenant after reporting IIQ 2019 results.
“Total debt rose to 6.9 times a measure of earnings, just below the threshold that would trigger a default under the company’s revolver, according to a person with knowledge of the matter. The ratio stood at around 6.3 times in the first quarter”.
The only BDC with exposure – both first lien and second lien – is Bain Capital Specialty Finance (BCSF). Total cost is $14.2mn. There’s $1.2mn of income at risk should NPC file for bankruptcy. We placed the company on the under-performing list from the first quarter of 2019, when the second lien debt was written down by (13%). The second quarter discount is (39%) and the current market price is discounted (57%). Judging by the challenges facing the industry; the trend of the valuation and the latest market price, chances of a further downgrade – currently CCR 4 – to CCR 5 (non accrual) is high.
On August 13, 2019 Great Elm Corporation (GECC) reported its IIQ 2019 portfolio. Included were new advances to long troubled satellite operator Avanti Communications. Despite GECC and other BDC lender/investor BlackRock TCP Capital (TCPC) writing down the existing debt and equity to the company in the quarter, management waxed enthusiastically about lending out more to Avanti. CEO Peter Reed used the opportunity to re-iterate GECC’s increasing confidence in the company, and its new CEO on the most recent Conference Call:
“When we formed GECC, Avanti was struggling to monetize the capacity of its satellite network.As Avanti encountered financial difficulty, we worked with other key creditors to improve the company through deleveraging its balance sheet, launching its biggest satellite to date and identifying and recruiting new Board members who brings stability and strategic insight into company. These improvements paved the way to hire Kyle Whitehill as the new CEO in April of 2018.
Since Kyle’s start, he has dramatically overhauled sales and marketing, resulting in large contract wins and rapidly growing recurring core bandwidth revenue. With the business heading in an exciting direction, Great Elm and other significant Avanti stakeholders were given the unique opportunity to participate in the new 1.5 lien delayed draw term loan facility.
As you can see from the tables on the bottom of the slide, the debt carries only an attractive interest rate but also a significant [feed] that accretes to GECC’s benefit. On its current trajectory and with minimal required capital expenditure, we expect that Avanti will have visibility into generating positive unlevered free cash flow”.
There is now $105mn of senior, second lien and equity exposure by the two BDCs in Avanti, with a value of about $45mn. There is no doubt that the company has made some progress recently, with a new satellite successfully launched just a few days ago. Even more recently Avanti has chosen to de-list itself from the London stock exchange given its concentration of ownership in 5 major shareholder groups. Unfortunately, that will make even less public information available to those of us on the outside looking in.
The BDC Credit Reporter will continue to remain fair minded but skeptical, given the company’s history; high levels of debt, opaque reporting and the very large amounts of BDC capital involved. Is Avanti a proverbial can being kicked down a very long road or a bona fide turnaround in the making ? We just can’t tell as we mostly have the BDC managers – with their conflicts of interest – as one of our principal sources of information.
On August 20, 2019 Zep Inc., an industrial cleanings product developer, announced the hiring of a new CEO: Dan Smytka.
That’s notable from a BDC standpoint, both because of the substantial exposure to the company ($126.6mn at June 2019) from 6 public and non-traded BDCs and because the business has been under-performing of late. That caused the second lien debt in the latest quarter to be written down by as much as (30%) and first lien debt by (19%), according to Advantage Data‘s records. (As usual there’s much variation in values between BDCs). By comparison, a year ago the debt was valued, in all cases, close to par. We checked the latest prices on Advantage Data for both tranches of debt and found discounts of (25%) and (30%), suggesting the markets have been getting more pessimistic since mid-year.
What’s more, Moody’s downgraded the company to speculative status back in April, including the first lien secured debt. The rating group is concerned about debt to EBITDA that exceeds 10x ! A saving grace is that the earliest debt maturity is 2022.
Clearly Mr Smytka has a big challenge ahead and the BDCs involved – especially three Goldman Sachs funds with the bulk of the exposure – will be watching with great interest if a turnaround can be achieved. With over $12mn of annual investment income at risk, this is one of the largest BDC trouble spots. We have the company on our Worry List or CCR 4.
On August 19, 2019 news reports indicate an ownership change has occurred at upstate New York hotel/casino Del Lago. One 50/50 JV partner is buying out the other. By itself that’s not a reason for a post, but with nearby competitor Resorts World Catskills talking “voluntary Chapter 11” , attention is deserved. Note, too, that Moody’s downgraded Del Lago back in January to Caa3.
As of June 2019, only one BDC – PennantPark Floating Rate (PFLT) – has exposure to Del Lago. According to Advantage Data records, the first lien debt has been on the BDC’s books since 2016 and consistently valued close to par. That includes the period after the Moody’s downgrade. Nonetheless, we are adding Del Lago to the under-performing BDC portfolio company list, with an initial Corporate Credit Rating (Watch) of 3 on our 5 point scale.
On August 19, 2019 a trade publication indicated that Serta Simmons Bedding had recently undertaken a major organizational restructuring. This was revealed by a senior executive of the firm.
Not by itself earth shattering news, but when associated with the recent devaluation of Barings BDC’s (BBDC) debt position in the company, now discounted from cost by (29%), after being only written down (8%) at 2018 year-end underscores that not all is well. Not helping was the departure on April 17, 2019 of Serta’s CEO and the July 2019 placing the debt on Fitch’s “Loans Of Concern” (similar to the BDC Reporter’s Worry List).
We are currently giving the company a Corporate Credit Rating of 4, in our 1-5 scale. The only BDC with exposure is BBDC with $2.7mn at cost, $3.0 at par and $1.9mn at FMV as of June 2019. The amount of investment income at risk – under $0.200mn – is modest, due to the low interest rate charged.
With the publication of the IIQ 2019 valuations by 8 BDCs with $107mn in various forms of debt exposure (2022-2024 and both senior and second lien), we’ve added Constellis Holdings to our under-performers list with an initial rating of CCR 3 (Watch List). The debt has been discounted between (6%-30%) from 0% to (5%) in the prior quarter.
This is not surprising as there has been a massive number of changes in senior management in recent months and downgrades from both S&P and Moody’s in the spring, worried about high leverage; cash flow losses and operational challenges. For the BDC sector, this is very big exposure in aggregate, with annual income of approx. $9mn at risk should the company default down the road. With that said $90mn of the debt is held by the three FS-KKR non traded BDCs (FS II-III and IV), which are intending to go public under one banner before long. How Constellis plays out will be of above average interest at FS Investment-KKR in the quarters ahead.
On August 12, 2019 OHA Investment (OHAI) reported its IIQ 2019 results, which included a slight increase in the valuation of OCI Holdings, a health care provider. The Texas-based company remains on non-accrual, which began in October 2018. The subordinated debt is discounted (89%) to $2.5mn, and an equity stake written to zero. Why OCI, grappling with reimbursement challenges from the Texas government, merited this slight uptick in value was not explained by OHAI on its Conference Call.
With the upcoming transition of the OHAI portfolio to Portman Ridge Financial (PTMN), we’ll be keeping a close eye on what happens to this fallen angel in which the BDC has invested $26mn at cost and was once its largest investment at fair value. A rebound in the value is possible but so is a complete write-off. It’s PTMN shareholders who will reap the benefit or consequences.
On December 18, 2019, Portman Ridge Financial (PTMN) acquired OHAI’s assets.
According to news reports, energy company bankruptcies are on the rise again:
“The number of oil and gas bankruptcy filings through mid-August has nearly equaled the total tally from 2018, and the aggregate debt from 2019 bankruptcy filings of almost $20 billion has already surpassed the roughly $17 billion from a year ago, according to the energy bankruptcy monitor maintained by the Houston law firm Haynes and Boone“.
The article goes on to name names: “The biggest filings this year includes the oilfield services giant Weatherford International and a slew of oil and gas producers such as Houston’s Sanchez Energy, Halcón Resources, Vanguard Natural Resources and Midland-based Legacy Reserves”. Of those only Weatherford has BDC exposure, and has been the subject of an earlier post.
However, we queried our own database of BDC-financed energy companies and found 38 names, with a total cost of $2.378bn. Of those, 25 are under-performing to some extent, or two-thirds. The investment at risk is $1.171bn at cost and is spread over 30 different public and non-traded BDCs. We’ll be working with Advantage Data to develop an even more comprehensive list of BDC-funded energy names, but readers should expect to hear more about trouble in the oil patch in the months ahead.
Bedding manufacturer Hollander Sleep Products is under bankruptcy court protection since May, but seeking to get its plan approved and to return to a normal, but less leveraged status. On July 22, 2019 the company “sought a court order … approving a settlement with unsecured creditors that revises its restructuring support agreement and marks an important step toward the maker of bedding products emerging from Chapter 11 bankruptcy”.
There are two sister BDCs with $34mn of exposure to Hollander: PennantPark Floating Rate (PFLT) and PennantPark Investment (PNNT). Most of that exposure is in pre-petition debt and on non accrual. (There is also $3.7mn of DIP financing paying interest currently). At June 2019, the Pennants had discounted the old debt by (53%), up from (13%) after the debt first became non performing. That suggests realized losses – when Chapter 11 exit does likely occur in the IVQ – will exceed ($20mn) and leave the two BDCs with over $2.0mn a year in lower investment income. What the new capital structure of Hollander will look like; whether there will be a debt for equity swap and what the role of the two BDCs will be we’ll leave for a future post as the dust settles.
Arthur Penn – CEO of both BDCs- did address the subject of Hollander on the latest PNNT Conference Call on August 8, 2019. He made clear PNNT/PFLT were not leading the debt discussions, He said there were “stalking horse” bids, but did not seem confident what the ultimate value of the company might be in the marketplace. That leaves open the possibility that the value at June 30, 2019 may yet materially drop further, making a bad situation worse for both PFLT and PPNT.
On April 16, 2019, SolAero Technologies, ” a leading provider of satellite solar power and structural solutions” , announced by press release a new financing arrangement which will cede control of the business to a new group of investors/lenders. The new group includes the Carlyle Group, GSO Capital Partners LP, First Eagle Private Credit LLC and Ares Management Corporation.
This allowed the company to restructure its debt – most of which was on non accrual. Based on a review of the IIQ 2019 10-Q, the only BDC with exposure – TCG BDC (CGBD) – seems to have booked an interim Realized Loss of ($9.1mn) and been left with $22mn of debt and equity in the restructured entity. The debt is carried at par, but we’re still keeping the company on the under-performing list with a Corporate Credit Rating of 3, till we see real improvements in the business. Solar has been a graveyard for capital and this story is only half told.
As is often the case where CGBD is concerned, none of the above was discussed on the latest (IIQ 2019) Conference Call or in any earlier communication with shareholders. Unfortunately, asset managers that have sprung out of private equity origins can be close mouthed about sharing investment details with public shareholders. It just goes against all their training. All the better for justifying the BDC Credit Reporter to our readers , so we’re not complaining.
On August 6, 2019, TCG BDC (CGBD) reported IIQ 2019 results, including placing its first lien debt to dental services chain Dimensional Dental Management on non accrual. This debt has been on the books since IQ 2016, and on the under-performing list from IIIQ 2018. We have no information from CGBD as to what’s going wrong in the PE-owned company, but a (37%) discount, up from (15%) just a quarter before, suggests a loss is more likely than not when the smoke clears. CGBD has already been deprived of $3.0mn of annualized investment income, and could yet lose some substantial portion of the $33.3mn at cost, currently valued at $20.9mn.
With the release of TCG BDC’s (CGBD) 10-Q on August 8, 2019, we see that the first lien debt held by the Carlyle BDC has been placed on non-accrual and written down on an unrealized basis by (57%). Ares Capital (ARCC), which has both first and second lien debt outstanding – also on non accrual in both case – has discounted the former by (42%) and (94%). All this augurs badly for the two BDCs. If all continues to go poorly for Indra – which owns clothes manufacturer Totes Isotoner – the second lien loan ($65mn at cost) and most of the senior debt ($25mn) could become a Realized Loss, and relatively soon. At least, this troubled debt will no longer have any income impact on either BDC going forward. Nonetheless, if things don’t turn around for Indra, these loans – on the books since 2014 – promise to be major reverses for ARCC and CGBD and for their credit underwriting track records.
Bloomberg reported on August 7, 2019 that J.C. Penney creditors are seriously considering a debt swap to give the troubled department store chain more time to turn its business round.
That may not affect the several BDCs with $6.8mn of first lien exposure (most recently TPG Specialty – TSLX – has gotten involved), but will draw in second lien debt.
In any case, although the company has liquidity and no immediate debt maturities, chances are increasing that something will happen in the weeks ahead. That might result in lower values for the 3 FS-KKR non-traded funds involved, all of whom have valued their modest exposure at or close to par last time results were published – in IQ 2019.
The retail apocalypse marches on.
Law360 reports that a bankruptcy judge approved the sale of 15 hospitals for $34mn by LifeCare Holdings. That brings ever closer the resolution – and likely liquidation – of the long term care chain, which filed for Chapter 11 in May, 2019. The company has been on the BDC Credit Reporter’s Bankruptcy List, but may get removed shortly.
The only BDC with exposure is PennantPark Floating Rate (PFLT), with $4.6mn at cost, written down to just $0.758mn at June 2019 and on non accrual since the IQ 2019. Presumably, the latest valuation was based on the likely proceeds from the proposed sale, so no great increase in what PFLT might receive at the end of the day is expected. The worrisome element here from a PFLT perspective is not the size of the investment – which was small, nor the minimal of income lost, but the likely severe discount of proceeds from the cost basis, despite a “first lien secured debt” status: (84%). Investors expect recovery rates on failed loans will be substantially higher for senior debt, and makes us worry about the prospects for other loans of PFLT- and similar BDC lenders – when defaults occur.