It’s good to have a plan: a restructuring plan that is. Pace Industries entered Chapter 11 back on April 13, 2020 with a pre-agreed restructuring agreement worked out with its lenders. Just six weeks later, the manufacturer of die casts, is out of bankruptcy and with “a new go-forward growth strategy, focused on building its position in key industries and expanding in growth markets”. This speedy exit has been possible by both the conversion of 100% of secured debt (!) into equity and the provision of Debtor In Possession (“DIP”) financing by those same creditors, now owners.
For the only BDC with exposure – non-traded TCW Direct Lending – this will be a bittersweet resolution. The lender has advanced $96.2mn in senior debt, discounted (19%) at March 31, 2020, just before the filing. We can only guess – but we won’t – at what the ultimate write-down might be. The debt will turn into equity in Pace. We’re not clear if the DIP financing will be converted into longer term debt financing or will be extinguished. If that’s the case, total invested capital by TCW might yet increase.
We will circle back to the BDC when IIQ 2020 results are published to get all the details straight. This is definitely a set-back for the lenders – and for TCW – but hope springs eternal that – over time – the company will prosper and what has been lost will be recouped. As a result, we expect to be covering the company for some time yet. We’re currently upgrading Pace from CCR 5 to CCR 3, still underperforming, till we get all the perinent details.
On June 1, 2020 Templar Energy LLC filed for Chapter 11. We first wrote about the troubled energy company back on April 28, 2019 when the CEO resigned and the outlook was bleak even then. Now the company’s lenders are seeking the sale of Templar’s assets and its eventual dissolution, says Law360.
We won’t spend any time on the bankruptcy details given that the only BDC exposure is in the company’s preferred and equity ($12.8mn) at cost and has already been effectively written down to nothing at the end of the IQ 2020. This will result in a ($12.8mn) much expected realized loss for non-traded BDC FS Investment II.
This is a borrower with a long history for BDC lenders, which once included Main Street Capital (MAIN) and HMS Income, and which filed for bankruptcy back in 2016 when BDC exposure at cost was close to $130mn. Realized losses were taken then but FSIC II received equity which was carried till now, if we understand the back story correctly.
In any case, this is just one more casualty amongst many for the partnership between KKR and FS Investments. In this case, though, as in many others, KKR inherited an investment left over from when FS Investments was teamed up with GSO Blackstone. This bankruptcy will at least clear the BDC’s books of a “zombie” investment that has been kicking around for many quarters, generating no income and with little chance of ever being worth anything.
We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).
Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.
Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…
The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.
For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.
Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.
The BDC Credit Reporter is having a hard time keeping up with the ever increasing number of BDC-financed companies being added to the non accrual category. This latest addition, though, is a big one, so we apologize for the delay. Production Resource Group, LLC “rents equipment, labor and production management services to end users in sports, live TV, music and film“, says bankruptcy publication Petition. As you’d expect, with Covid-19 and those end users in lockdown, business is not good.
There are three BDCs with a remarkable $511.3mn invested at cost in the company’s first lien 2024 term debt. Leading the trio is non-traded FS Investment II with $381mn, followed by Ares Capital (ARCC) and then TCW Direct Lending VII, LLC. From the IQ 2020, that debt was placed on non accrual and discounted between (30%) and (42%). [As always, there are sometimes inexplicable variations in valuations between BDCs holding the same debt tranche]. The company had been on the underperformers list since IIIQ 2019 with a CCR 3 rating, but has now leapfrogged to CCR 5, or non performing. The investment forgone to these three BDCs is huge for a credit with a middle of the road pricing of LIBOR + 700 basis points: about $42mn.
We have very few other details to offer so we’ll just wonder aloud at why the largest BDC lender to the company would take such a huge position. The FS Investment II loan represents 5% of that BDC’s total portfolio at cost and the FMV at March 31, 2020 equal to 6% of it’s net assets.
Also notable is that Production Resources Corp tops the BDC Credit Reporter’s list of so-designated Major underperforming companies – those with $100mn or more in outstandings at cost. There are 40 names on what’s we’ll begin to call our Biggest Hitters list and Production Resource Group has the dubious honor of being listed number one. These larger underperformers are important because this relatively small group amidst the 527 companies on the full underperformers list account for more than 40% of all investments at cost and FMV.
That’s all the more reason for us to keep tabs for what happens next at Production Resource Corp and other giant positions which individually can materially affect BDC returns. We expect to hear more no later than when the BDCs involved report second quarter results in the early summer.
One of the undercovered stories of the current crisis is the impact of the fast decline in loan prices on many BDCs off-balance sheet joint ventures. Typically these JVs consisted of a curated portfolio of relatively liquid and lower risk first lien loans and are highly leveraged in order to create a superior yield and income stream. To avoid having to consolidate these assets on their balance sheets BDCs have taken on joint venture partners who provide a portion of the junior capital and divide up voting duties between them. This allows the BDCs to treat the joint ventures as unconsolidated subsidiaries and – in almost every case – leverage up the vehicle’s balance sheet with secured third party debt at generous advance rates given the perceived liquidity and quality of the collateral.
Barings BDC (BBDC) has had one such JV since 2019 with the State of South Carolina Retirement Systems (“SCRS”). The long term goal is ambitious given that BBDC committed $50mn in equity capital and its partner $500mn. At March 31, 2020, though, BBDC had actually advanced only $10.1mn and SCRS $100mn, both in the form of equity capital. The JV had $358mn in portfolio assets, suggesting third party debt must be around $248mn. The JV’s assets are a motley crew according to BBDC’s 10-Q: ” As of March 31, 2020, Jocassee had $67.4 million in senior secured private middle-market debt investments, $186.4 million in U.S. syndicated senior secured loans, $43.7 million in European syndicated senior secured loans, $21.3 million in structured product investments, $7.3 million in an equity investment and $31.8 million in a short-term investment“.
In the IQ 2020, BBDC wrote down its investment in the JV by (37%) due to a drop in portfolio value that seems to have exceeded (10%). According to the 10-Q, no income was received. As a result we have downgraded Jocassee Partners from performing status (CCR 2) to CCR 4. Although there’s a good chance the book value of the portfolio and of BBDC’s equity investment may rise in the future, we’re projecting there will be losses of some kind, which is why we’ve leapfrogged from CCR 2 to CCR 4.
As far as we can tell the two partners seem to be prepared to continue growing the portfolio. Just in the IQ 2020 BBDC sold $69mn in assets to the JV and on its conference call BBDC’s management indicated new investments were being made: “We completely reevaluate the opportunities in areas such as European credit, structured credit, and continue to make investments in these areas that all have attractive risk-adjusted return profiles in this environment“.
The public record is light on the balance sheet of the JV or who its secured lender might be and – unlike many other BDCs – no portfolio list has been made available. This makes the BDC Credit Reporter’s assessment more difficult than usual for a JV, but we expect to be able to offer quarterly updates for many periods to come. Unlike many of its BDC peers BBDC does not seem to have any plans to bring those JV assets back onto their own balance sheet.
By recent large company bankruptcy standards, Borden Dairy has remained under court protection for longer than most. That’s because there was no consensus between the owners and the lenders when the dairy giant first elected Chapter 11, as we discussed at the time. Then there were disputes about how to apply liquidity and plans by bondholders to merge Borden with that other bankrupt dairy name: Dean Foods. The latest news is that the judge in the case has agreed that the company may sell its assets at an auction in June if no other viable restructuring plan does not take precedence.
We have used the opportunity to update the latest numbers from the IQ 2020 results about BDC exposure. Where there were 4 BDCs involved now there are only two because FS Investment II acquired FS Investment III and FS Investment IV. Now there’s $170.5mn at cost of first lien debt exposure divided up between the afore mentioned non-traded FS Investment II and its public sister BDC FS KKR Capital (FSK), split $103.1mn and $67.4mn. That’s much unchanged since the bankruptcy began. The FMV, though, has dropped from $152.5mn before the bankruptcy to $75.7mn. Even since the IVQ 2019 results, when the company was already in Chapter 11, the debt has dropped sharply in value, from $90.5mn. We can’t determine if a further discount is likely, but current market conditions can’t help.
What does seem probable is that some sort of resolution is coming. That means a realized loss is likely to be booked in the IIIQ 2020 which could be as high as ($100-$120mn). (BTW, this is far and away the biggest BDC exposure to a sector that has been in secular decline for years, but we have found two other underperformers in our database with dairy credentials. More on those in future posts).
We wonder if the FS-KKR organization is really interested in becoming an owner of this business in this sector by involving itself in a standard “debt for equity swap“. That will almost certainly require deploying new capital at a time when BDC liquidity is constrained and remaining involved in the milk business with its Byzantine complications for many more years to come. More likely – in our purely speculative view – is that the BDC lenders will let some third party acquire Borden’s assets and take their credit loss medicine and walk away with whatever proceeds are available. We will find out shortly.
Borden remains rated CCR 5 or non performing. Given that BDC exposure is over $100mn this is a “Major” company by the BDC Credit Reporter’s standards, which just means that we keep special tabs on what’s going o because the financial impact is so high. FYI: At the moment Borden ranks tenth highest – on a cost basis – of the 45 “Major” underperforming BDC-financed companies in our database.
On May 22, 2020 Hertz Corp filed for Chapter 11. The BDC Credit Reporter had anticipated as much in our earlier – and first – article about the car rental giant on April 24, 2020. Apparently, despite much back and forth with lenders, the company will be entering bankruptcy without a pre-agreed restructuring deal so the future remains uncertain. Furthermore, some payment relief is being negotiated with asset-based lenders, but that’s not yet resolved. Any number of outcomes remain possible with the travel industry still in a state of high uncertainty. (We avoided saying “unprecedented”).
There is only one BDC with exposure, as discussed in our earliest post: Barings BDC (BBDC). We cannot assess if the (30%) fair market discount taken at 3/31/2020 will be sufficient or whether a further loss – and then a realized loss – will be coming. Certainly, chances are the $0.2mn of annual investment income will be suspended until a final resolution emerges. Given the size of BBDC the impact both in NAV and income terms will not be material.
However, the Hertz story is notable for other reasons. First, this is one of the most high profile BDC-financed companies to file for bankruptcy protection since Covid-19 came along and is undoubtedly a victim of the virus impact. At year end 2019 BBDC and all other lenders valued the debt of Hertz at par or better. The length of time from the initial impact of the virus on business activity has been short – less than 3 months.
Also – as the Hertz press release ruefully mentions – the multitude of programs offered by the Treasury and Federal Reserve to help Covid-19 affected companies failed to do so in this instance. As far as safety nets go there appear to be big holes through which many companies may yet fall.
Finally, to those who claim the government should do nothing to help in these troubled times because bankruptcy is an almost painless transition from one set of owners to another with little other consequence, we note that Hertz will be “reducing planned fleet levels through vehicle sales and by canceling fleet orders“, which will reverberate for years to come across the automotive industry. Also, Hertz will be “deferring capital expenditures and cutting marketing spend” which will hurt a myriad associated businesses.
Most important of all, for a government with the stated goal of minimizing the impact of Covid-19 on employment, Hertz will be “implementing furloughs and layoffs of 20,000 employees, or approximately 50% of its global workforce“. The moral hazard here is not government propping up troubled companies but the fact that the governmental lifeboat is – seemingly randomly – picking up some of those in the water and some not. But we digress.
Glacier Oil & Gas is an Alaskan oil & gas exploration company. We learn from Apollo Investment’s (AINV) IQ 2020 conference call that – not surprisingly – the company is performing poorly. As a result, the BDC’s $37.2mn of second lien debt has been placed on non accrual. That will result in $3.7mn of investment income not being received. (We believe the income was being paid in PIK form before so the cash impact on AINV will be nil).
We are downgrading Glacier from CCR 4 to CCR 5, or non performing. We did not have the company on our Weakest Links list given that AINV – with a 98% ownership position – has great flexibility about when to choose to be paid interest or not. That makes prognostication difficult. With the benefit of hindsight considering the current market conditions moving to non accrual makes sense.
The overall investment in Glacier, which has a cost of $67.0mn is now valued at just $14.7mn. For our purposes, we are assuming AINV will eventually have to write the entire investment off, ending a journey that began in 2012 when Glacier was called Miller Energy with $40mn committed. Since then, the BDC restructured and renamed the business (in 2016) which now faces an existential challenge. We expect a further write-down will occur in AINV’s IIQ 2020 results.
The Wall Street Journal – which has been meticulously covering the troubles at bankrupt coal miner Murray Energy – provided another update on May 21, 2020. The company apparently has managed to default on its financial package assembled following its Chapter 11 filing to assist in preparing for an eventual exit. There’s $440mn of post filing financing involved that’s in default. Now the embattled company wants its lenders, who are seeking to become its owners, to roll over the new monies into whatever the exit financing package will look like. For our part, we believe that a liquidation is more likely than an orderly return to business as usual at this stage but much will depend in the days ahead on what the bankruptcy judge and the lenders decide.
This is yet another concern for the two BDCs with $16.1mn of exposure: Business Development Corporation of America and Cion Investment. The two non-traded BDCs are lenders in the pre-bankruptcy Murray Energy first lien debt and in the new financing to the tune of $2.8mn between them. This most recent debt was supposed to be bulletproof but as of March 31, 2020 the BDCs had discounted their loans by as much as (9%). Both the earlier debt (discounted 88%) and the newer facility are in danger of losing more value by the next time the BDCs report and resulting in a realized loss if a liquidation does occurs.
For neither BDC is the total exposure very high and the income being received on the new debt is very modest. This story is more important as a warning that, in the current economic conditions, even debtor-in-possession financings are not necessarily safe from loss. That could cause some lenders in some bankruptcy situations to throw up their hands and not provide essential financing. This would increase the number of liquidations and the value of realized losses. Maybe Murray Energy is just an outlier, but we’ll be watching.
Oil & gas production company Spotted Hawk Development – which has faced difficult conditions for years and has already endured one major restructuring – is faring even worse under the current oil price drop. According to its lender-owner Apollo Investment (AINV) “the company has reduced expenses and capital expenditures to necessary maintenance items and temporarily curtailed production“.
AINV also disclosed on its IQ 2020 conference call that of the three debt facilities outstanding to Spotted Hawk, two are now on non-accrual, up from one previously. This time a $45.5mn Term Loan with an interest rate of 4.0% has been moved to non-performing. That’s $1.8mn of annual investment income that AINV will not be receiving. That leaves just one 2021 loan trache with a face value of $24mn and an interest rate of 12.00% still generating income for AINV. Understandably enough one has to wonder if that last tranche can remain income generating ($2.9mn annually) for much longer. The company has been benefiting from price hedges on its production but those expire – according to AINV – shortly…
Overall, AINV has invested $114.8mn in Spotted Hawk in an attempt to rescue an investment that began in 2012 with just $24mn. If the business fails, AINV stands to lose up to ($47.2mn) and that remaining loan income. With the BDC manager clearly not interested in adding new rescue capital under virtually any scenario, the chances of failure seem high.
The investment – one of those “legacies” left over from an earlier strategy by a different management team – illustrates both the risks involved in lending/investing in oil & gas and of serving as both owner and lender to a cash strapped company. That has turned AINV into the investor of last resort on multiple occasions and caused a small credit mistake to grow into a very big one and the second largest in the BDC’s portfolio. Many BDCs have learned to avoid energy investments but the more complex matter of serving as lender-owner remains unsettled. Yet, in the quarters ahead we will see many more of the latter than of the former and will have an opportunity to revisit whether the BDCs involved have demonstrated whether they know “when to hold them and when the fold them“.
Apollo Investment (AINV), the only lender that we know of to Maxus Carbon, a chemical plant with innovative technology, has just reported IQ 2020 results. The BDC has reduced the fair market value of its investment $76.5mn investment in Maxus by ($22.6mn), bringing the FMV of the debt and equity involved to $32.6mn. Income from the long standing investment remains very modest, just $0.318mn for the past 12 months. We last wrote about the company following a restructuring in February 2020.
Here’s what management explained on the latest conference call about Maxus Carbon:
“So this is a petrochemical plant in Texas, referred to as carbon-free with a technology, think of it as a greener alternative to carbon capture and has experienced historical issues. In terms of ramp of — the facility has attracted significant equity capital over its life — it creates — it produces three separate outputs, one of which is hydrochloric acid, which itself is used heavily in fracking of wells and the prices for that have also — have obviously gone down significantly in the current market environment, offset to a certain extent by the other output or the other two outputs, and in particular, bleach and caustic soda, bleach being something that has seen demand relatively resilient and pricing relatively resilient. And so the — and then this is also an investment in which we undertook a restructuring whereby we would have a greater deal of our value with the value of the IP, which we do believe to be valuable and the company’s go-forward strategy is to find a partner for use of that that IP. And if you kind of think about in the context of the broader concerns and motivations and mandates to make more green such processes. We’re hopeful that, that will drive some value. So that’s that investment“.
The outlook remains poor for this 4th largest of AINV’s investments, which has been written down by ($32.4mn) in the past 12 months and incurred a realized loss. We are affirming our Corporate Credit Rating of 4. Should the company fail – although we’re in no position to tell if and when that might happen – we imagine most of the remaining value (which amounts to about $0.50 per share) will be lost. This is a “Legacy Investment” at AINV, and demonstrates that project finance is not an area that BDCs should be involved in.
On May 21, 2020 Akorn Inc. filed for Chapter 11. Last time we wrote about the pharmaceutical company on April 6, 2020 was to warn that a bankruptcy was coming up. The company appears to have agreed a plan with its lenders, which will involve both a debt-for-equity swap and the arrangement of debtor-in-possession financing. This ends a sorry period that included a failed sale; accusations of fraud and many other disturbing revelations. From a lender’s perspective, news that the company had “not made an annual profit in two years and generated $310 million in negative EBITDA in 2018” is the most disturbing of all. As always, we remind readers that filing Chapter 11 – especially when lenders become owners and sometimes have to ante up further funds to keep business ticking over – is just one more twist in the tale. We’ll be writing again about Akorn before long.
Thankfully, BDC exposure is limited to Garrison Capital (GARS) with only $2.0mn invested in the first lien debt as of March 31, 2020 and valued at $1.6mn. Still, the interest rate being charged was very high: over 15%, so GARS will be losing out on $0.3mn of annual investment income. A realized loss is likely to be booked in the next quarter or two once the company exits bankruptcy. We won’t even try to assess what the final results might be given the immaterial size of this position.
Otherwise, this bankruptcy falls into the category of the already walking wounded companies that existed before the Covid-19 crisis. The current conditions have not helped, but the possible wave of directly-related virus defaults has not yet hit. We are downgrading Akorn from CCR 4 to CCR 5; removing the name from the Weakest Links list now that non accrual has happened but added it to the ever longer list of bankrupt BDC-financed companies.
Ultra Petroleum, which is owned by Ultra Resources Inc., filed for Chapter 11 on May 14, 2020. The BDC Credit Reporter had anticipated as much a month ago, on April 16. As is de rigueur in this industry, the only parties willing to support the gas driller were its existing lenders who will be swapping a huge amount of debt for equity and the hope that the business can yet be revived. According to the Wall Street Journal, informed by court filings “Ultra’s existing lenders are providing a $60 million loan to the company when it exits bankruptcy. The company also plans to raise $85 million from senior lenders through a rights offering, which will fund recoveries for the company’s other creditors“. About 80% of the company’s debt is to be written off/swapped.
The only BDC lender remains non-traded FS Energy & Power. Since we last wrote, though, the total amount invested by the BDC has risen slightly now that IQ 2020 results are out: to $57.3mn at cost and $32.9mn at FMV. We’re not quite sure what happens to the debt the BDC holds going forward but some sort of realized loss is coming – probably ($25mn-$30mn). Income, too, will be interrupted to the tune of $2.7mn. The parties hope to be out of bankruptcy within 3 months with their packaged plan.
For our part, the BDC Credit Reporter will be downgrading the company to a CCR 5 – non performing – status – from CCR 4. We’ll also remove Ultra from the Weakest Links list now that the default that we anticipated has occurred. Management will blame the market conditions brought on by Covid-19 but Ultra was first written about on these pages in mid-2019. All the debt on the books made the company a bankruptcy waiting to happen. The current crisis has only accelerated the inevitable and made more difficult the recovery. Although we don’t know the exact amount of the likely realized loss to come, the investment also demonstrates that a so-called “First Lien secured loan” is no protection against a major loss in the oil space. For FS Energy this has been a lesson learned and relearned in recent months.
On May 18, 2020 Centric Brands Inc. announced a major restructuring. This includes the public company going private and a pre-negotiated trip through Chapter 11 bankruptcy. What’s more the company is getting $435mn in Debtor-In-Possession financing to smooth the way forward. $700mn of second lien debt is being written off. The existing first lien lenders – including three BDCs – will be staying on, but will be receiving equity in the new ownership.
Management blames Covid-19 for its troubles. However, back in December 2019 when first wrote about Centric Brands we were skeptical that the company could survive in its then-capital structure where interest expense matched EBITDA. By the time we posted again in April of 2020, the bankruptcy/restructuring die was seemingly cast with only the details to be worked out. Centric was on the BDC Reporter’s Weakest Links list. Like so many other names we’ve placed there, the company now moves to our non performers list until the bankruptcy judge approves this restructuring.
The BDC that will be most impacted in the short term will be Ares Capital (ARCC). At March 31, 2020 ARCC held $24.6mn at cost in Centric Brands public stock, which is now worthless. That will likely result in a ($3.2mn) write-down from the latest valuation and a ($24.6mn) realized loss. Less clear is whether ARCC’s first lien debt ($57.1mn at cost) as well as that of TCW Direct Lending VII and Garrison Capital (GARS) will be getting a haircut. If so, it’s unlikely to be much larger than the (10%) unrealized loss booked at quarter end by ARCC. Income, though, will likely be impacted during the bankruptcy period. We have no idea if accrued interest gets repaid in the new arrangement.
What is likely is that the existing first lien lenders are involved in that very large DIP financing, so BDC exposure – between debt and equity – is likely to increase rather than decrease when all the beans are counted once the restructuring is completed. Moreover, the BDCs relationship with Centric Brands may last a good deal longer now that lenders are becoming part owners. No word yet if any new capital is being injected and by whom.
We are downgrading the company’s credit rating from CCR 4 to CCR 5. After the restructuring occurs – assuming no blips – we will be maintaining the company on our underperformers list. The restructuring does not magically wave away the difficult retail environment Centric is likely to face. Moreover, no news of any new equity capital infusion worries us that the new owners, led by Blackstone, may be undertaking this turnaround too cheaply. Centric Brands would not be the first retail-oriented company that went through Chapter 11 twice… The BDC Credit Reporter will await more details about the transaction and the respective BDCs valuations of their post-recapitalization positions.
We will also be watching how this situation plays out in the context of evaluating how well BDCs like ARCC fare when they transition from lenders to owner-lenders. In this case the BDCs involved appear to have only a minor role to play in the new Centric Brands. Nonetheless, we shall evaluate the age old question of whether this is good money after bad or a masterful way to recoup some, all or more of capital advanced.
On May 15, 2020 Garden Fresh Restaurant Corp – which owns Souplantation – filed for Chapter 7. We had written about the restaurant operator’s troubles on May 9th, and it was clear at the time that the owners had little hope of being to able to keep the doors open in the Covid-19 era. Thus, the Chapter 7 liquidation decision.
This leaves the only BDC with $20mn of term debt exposure – Ares Capital (ARCC) – facing a certain realized loss once the company’s $50mn-$100mn in assets are sold and its 10,000 (!) creditors dealt with. As of March 2020, ARCC had the loan on non accrual and marked down (45%). The BDC is losing out on about $1.9mn of annual investment income on a loan that was faring fine till the virus changed everything. We’ll stick our neck out and guess that even a (45%) discount might not be enough here to reflect the final loss. We’re guessing (75%)-(100%)… We should have a clearer picture when ARCC reports IIQ 2020 results in the early summer.
This credit is notable for three reasons. First, this is one of the earliest bankruptcies of a company that was performing well before Covid-19 came along. Most of the other filings or restructurings we’ve memorialized in recent weeks are of companies that were already in deep trouble before Covid-19 sealed the deal. Second, the fact that liquidation has been chosen because of the ongoing change to the world as we knew it underscores the BDC Credit Reporter’s contention that this recession might see lower recoveries than might otherwise have been expected. That’s ominous news for lenders everywhere.
Finally – and as mentioned in our prior article – this represents a black mark from a credit underwriting standpoint for well regarded ARCC. Lending into the restaurant business and into an entity which had failed before (Garden Fresh filed Chapter 11 in 2018) was a credit bridge too far.
We will retain the company’s CCR 5 rating till liquidation is complete, which should be complete by the end of the year or earlier.
On May 15, 2020 GNC Holdings – parent of General Nutrition Inc. – announced an agreement was reached with certain of its lenders regarding provisions in its loan agreements. Here are the key changes:
“GNC’s Tranche B-2 term loan, FILO term loan and revolving credit facility feature springing maturities that, prior to today’s amendments, were to become due on May 16, 2020 if certain conditions were not satisfied. Due to COVID-19 related impacts on its business, the Company expected it would not be able to reduce the amount outstanding under the convertible notes to less than $50 million by May 16, a requirement to avoid the springing maturity.
As a result of discussions with its lenders, GNC entered into amendments to its loan agreements to extend the springing maturity dates for the term loan facility, FILO credit facility and revolving credit facility until August 10, 2020, subject to certain conditions that, if not met, would cause the extended springing maturity date to move forward to June 15, 2020“.
There is only one BDC with exposure to the company – Harvest Capital (HCAP) – which appears to have $4.1mn invested at cost in the 2021 Term Loan that “sprang forward” to May 2020. As of IQ 2020 HCAP had discounted that position by (22%). This has caused the credit to be added to our underperformers list with an initial rating of CCR3. Notwithstanding the temporary truce between the company and its lenders featured here, we’re further downgrading General Nutrition to CCR 4. With economic pressures still underway; the fact that the borrower is largely a brick and mortar retailer and the short period given to solve its financial problems we cannot be optimistic. A loss seems more likely than full recovery, which is our standard for this rating level. There’s just over $0.4mn of investment income at risk.
We’ll revisit this credit in the summer to see where the situation stands. We fear that we might have to add the company at that time to our Weakest Links list of businesses where a payment default looks highly likely. For HCAP this is a smaller sized position and one which was only added – purchased at par – in the IQ 2019. Like everyone else the BDC could not have guessed that one year on Covid-19 would strike. However, putting new money into a retailer with 4,000 stores worldwide at a time when that sector’s apocalypse was well underway may be questionable for the Monday Morning Quarterbacks amongst us.
On May 15, 2020 Sequential Brands reported IQ 2020 results. More importantly, the company reported very tight liquidity even after drawing on its Revolver: just $14mn. Furthermore, in a press release, the company admitted to being in negotiations with its lenders to avoid any prospective loan defaults and raised doubt about its status as a “going concern”. The stock price – not very material to start with – dropped (11%) to $0.19.
The BDC Reporter has rated the company CCR 4 for some time. The chances, though, of a bankruptcy or recapitalization have greatly increased thanks to Covid-19, as reflected in these latest developments. This is what we call a Major BDC borrower (over $100mn), with $292mn invested at cost as of December 31, 2019. (Not all the IQ 2020 outstandings have been reported). The 3 BDCs involved are publicly traded Apollo Investment (AINV); FS-KKR Capital (FSK) and sister non-traded fund FSIC II. Most recently FSK valued its position in the 2024 Term Loan at just a (2%) discount. However, the $10mn in equity owned by two FS-KKR BDCs is valued at next to nothing, as the stock price mentioned above suggests.
If Sequential does default – as we’ve mentioned in earlier articles – the biggest immediate impact will be the receipt of the $30mn of investment income the three BDCs have been used to collecting. Whether there will be any realized loss from the debt held continues to be questionable, but the equity will certainly be written off. Most impacted of all will be FS Investment II, which holds 75% of the BDC exposure.
Of the 6 Major BDC borrowers on the BDC Reporter’s Weakest Links list, Sequential is by far the largest. Should a bankruptcy/restructuring occurs it will be the biggest one since the Covid-19 crisis began from a BDC lender perspective. Like so many other names on that Watch List, Sequential was already deeply troubled before the crisis. Current conditions make an unhappy outcome – and possibly a much bigger loss than the BDCs have been planning for in their valuations – almost certain. We expect to be reporting again shortly.
May 20, 2020 Update: From another news report we have learned that “The company closed the first quarter with $13.3 million of cash and $460.7 million of debt net of cash. As of March 31, availability under its revolver was $7 million, which the company fully borrowed subsequent to the end of the quarter“. The above underscores that Sequential Brands is effectively out of cash and some sort of action will be necessary.
Telecom company –Fusion Connect — which just exited Chapter 11- is arguing in bankruptcy court that a $2.1mn fine imposed by the Federal Government on the company prior to its filing should not need to be paid. That’s all we know but created a reason to have a new look at the company in its new status.
We know that Fusion, according to Investcorp Credit Management (ICMB), that the company – which previously had been on non-accrual – exited Chapter 11 in January 2020. (ICMB got repaid on a DIP Loan at the time). All this from the BDC’s May 12, 2020 conference call. There are 2 BDCs with $18.6mn of exposure in the restructured company: besides ICMB there’s also Garrison Capital (GARS). The first lien debt was already discounted by (20%) and the second lien by (44%) at 3/31/2020. The equity owned is also greatly discounted by ICMB but not by GARS. We don’t understand why.
UPDATE: Full House Resorts to re-open all its casinos by mid-June. See earlier article.
We’ve discussed oil services company 1888 Industrial Services before and the opaque nature of the business reporting and valuation we get from the BDCs involved. Now IQ 2020 results have partially been filed, we can now compare how Medley Capital (MCC) and Investcorp Credit Management (ICMB) are treating their debt exposure to the highly troubled company, caught up in the drastic drop in energy related activity. MCC has written to zero two tranches of 9/30/2021 Term debt, and both are on non accrual. To confuse matters another tranche is still accruing income and is fully valued. By contrast, ICMB has 4 tranches of the same debt (or seems to on paper) and none are carried on non accrual and all but one are fully valued. One tranche, though, has been written down to $4.1mn from $8.0mn in this most recent quarter.
ICMB’s manager did discuss the latest performance at the company in general terms, maintaining an optimistic tone:
“1888 is operating in the same challenging environment as Liberty and ProFrac [two other oil services portfolio companies], driven primarily by decrease in the rig count. With activity in the Permian Basin essentially coming to a halt, they have been focused on cutting costs and maintaining the most important relationships. They are also the beneficiary of funds under the PPP loan program, which will help offset some of the operating costs.1888’s forecast currently shows this company will have adequate liquidity through 2020 at the current oil price levels. We believe the company is doing all the right things to ward this storm“.
The BDC still values its mix of different debt tranche and equity exposure at $12.5mn on $16.3mn invested at cost That’s a discount of less than a quarter overall. By contrast MCC’s discount of its exposure is three times as high. Furthermore, we note that all the income ICMB is booking is in Pay-In-Kind form, given the company’s underlying cash needs, but not a reassuring factor.
The BDC Credit Reporter has already downgraded the company in our rating system as much as we can. However, we’re now reducing our estimate of likely proceeds that will occur at the end of this long and winding road. At the moment we expect only 50% of the $62mn invested at cost by 3 BDCs (non-traded Sierra Income is also invested) to be recovered. This suggests that ICMB still has further write-downs coming whether realized or unrealized. Even receiving PPP monies can only be a temporary relief. In fact, most of the benefit from that move will have faded by the end of the IIQ. There’s nothing in the most recent industry trends that provides any encouragement either. Even at a 50% final loss we may prove to be too sanguine…
We hope we are wrong, but the company – and the capital invested at all levels of the capital structure – seem headed to a seemingly inevitable bankruptcy, which could be Chapter 11 or 7. Most at risk at this point is ICMB for whom 1888 Industrial Services is one of their single largest company exposures. Understandably, that may explain an optimism that seems unfounded to those of us on the outside looking in.