BDC Portfolio Company News

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.

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.

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.

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.

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.