Energy Alloys, LLC: Files Chapter 11

According to multiple news reports, Energy Alloys, LLC filed for Chapter 11 on September 9, 2020. The company bills itself as “the only 100% oil and gas focused supplier of specialty metals to the global oilfield industry“, so you can imagine how the business ended up in Chapter 11. Energy Alloys has operations both in North America and around the world, but in its bankruptcy filing claimed just $10mn- $50mn in assets and $100mn-$500mn in liabilities. Curiously GSO Blackstone – the credit arm of Blackstone- has been the owner since 2011.

What this all means for the only BDC lender to the company – Sixth Street Specialty Lending (TSLX) – is not clear. As of June 30, 2020, the BDC had $18.3mn lent at cost in an asset-based Term Loan to the company, which was valued at par. TSLX had made the following disclosure in an earnings press release dated July 23, 2020: “As a result of the challenging commodity price environment, Energy Alloys, our second largest energy exposure at quarter end, is pursuing an out-of-court wind-down of the business through a liquidation of its assets. Post quarter end, we received a paydown on half of our principal position on Energy Alloys and expect to be fully repaid by Q4“.

No mention there of a bankruptcy filing which leads is to believe conditions may have worsened since July. Or – possibly – this was all part of the unwinding plan for the troubled business. Up in the air is whether TSLX will receive that last $9mn or so in outstandings in the IVQ 2020 or not. This might impact both income – which was still being accrued through the IIQ 2020 – and the expected repayment in full. We should learn more when TSLX reports IIIQ 2020 results in October, but a final settling of accounts may take till the end of the year or longer if the company lingers in bankruptcy.

As is often the case TSLX zigged when most other lenders would have zagged, booking the debt to Energy Alloys as recently as III 2019, but before the oil price meltdown and everything that has followed. The BDC points to its highly collateralized status as the reason for its comfort, carrying its position at par through its short history. The ultimate outcome of this transaction will tell us whether the uber confidence TSLX demonstrates in these difficult credit situations are justified. However, even if a loss does get booked at the final hurdle, the amount is modest by comparison with the BDC’s billion dollar net worth and should not materially impact future results.

We are downgrading the company from CCR 4 to CCR 5. Energy Alloys was on our Weakest Links list previously.

J.C. Penney: Non Binding Purchase Agreement Finalized

Despite what you may have heard in the headlines, J.C. Penney has not yet been purchased by mall owners Simon Property Group and Brookfield Property Partners. The reality is more complicated and more interesting. The parties have only agreed on a non-binding letter of intention to acquire certain assets of the bankrupt retailer and are far from being in charge as yet. Furthermore, the existing first lien lenders will become owners of two new REITs that will own stores and distribution centers respectively. The lenders would also receive $500mn in “take back” debt and new financing is being arranged as well. With a bit of luck, a very restructured J.C. Penney – in name – would be back and running out of bankruptcy by year’s end. (All the above learned from an excellent synopsis by WYCO Researcher on Seeking Alpha).

This is important news for the only BDC with exposure to Penney’s: Sixth Street Specialty Lending (TSLX). The picture here is complex as well. The current Debtor In Possession (DIP) financing, with a cost of $5.781mn and yielding 13.0% is most likely to get repaid in full. This is what TSLX anticipates, given the premium valuation at June 2020. More difficult to suss out is what the value will be of the two first lien debt positions owned – due in 2023 – and both already on non accrual. We expect TSLX will gain a small non income producing equity stake in the two REITs and some performing debt paper. From an income standpoint that can’t be any worse than the $20.0mn at cost in non-DIP debt held which is being carried as non performing. From a valuation standpoint it’s impossible to tell – even for TSLX at this stage – whether the new arrangement is more valuable than the $8.7mn in FMV as of June 2020.

Most of all, TSLX will probably be glad to have the Penney situation resolved – even if only for a while. This looks like one of the rare instances where the crafty BDC – whose non-DIP debt was bought at a discount in mid-2019 – will not come out of a bankruptcy situation smelling like roses. TSLX has admitted as much in its last 10-Q: “Given expectations for less-than-par recoveries, the Company has applied the regularly scheduled cash interest payments it received to the amortized cost of these positions, all of which were acquired at prices less than par“. Based on the latest values, TSLX could be booking a realized loss of anywhere from ($6mn-$9mn) in the IVQ 2020. Painful but manageable for a BDC with a net book value in excess of a billion dollars.

Boardriders Inc.: Restructured

We hear from S&P that Boardriders Inc. has recently been significantly restructured by its sponsor Oaktree and with the support of some of its lenders and other parties:

“S&P noted that Boardrider recently issued $155 million of new money debt, including:

  • $65 million contributed by Boardriders’ financial sponsor owner, Oaktree, consisting of a $45 million initial term loan and a $20 million delayed draw term loan (currently undrawn);
  • $45 million contributed by other existing lenders; and
  • $45 million via a facility backed by a European government.

The transaction provides needed liquidity and fund an operational turnaround

S&P considers the new debt “distressed” and has lowered its rating to SD or Selective Default, but may raise it back to CCC shortly. (This is part of the complex mechanics of rating groups). S&P is not optimistic about the medium term outlook given “[Boardriders] still-unsustainable debt leverage, high debt service commitments, and our view that the company will likely have difficulty generating consistently positive free cash flow before its next significant debt maturity in 2023].

Great Elm Corporation (GECC) remains the only BDC with exposure. What we don’t know is whether the BDC participated in the restructuring and advanced new monies or did not and became structurally subordinated to the new debt in what sounds like a controversial move by the principals. We are retaining the CCR 4 rating on the company that dates back to May and are not choosing to add Boardriders to the Weakest Links list as all the new cash will temporarily help liquidity and ensure debt service. Nonetheless, the outlook for GECC – one way or another – remains highly uncertain. The BDC has discounted its 2024 Term Loan position by (28%) at the end of June, but current market indicators shown by Advantage Data suggest – not surprisingly – that the discount might be (40%).

We’ll be checking the IIIQ 2020 GECC results to learn more about how the BDC acted when asked for more funds and what that has done to total exposure and valuation. In any case, this is a credit whose tribulations are likely to continue for some time to come so – unless GECC sells out its position – expect to hear more. Attached, though, are our prior two articles.

Accent Food Services: IIQ 2020 Update

We’ve learned a little more – sufficient to put pen to paper for an update – regarding Accent Food Services. This vending machine company has been on non accrual since IVQ 2019, and performance appears to be deteriorating. Everything we know comes from Fidus Investment (FDUS), the only BDC lender to the Texas-based company and which recently published its IIQ 2020 valuation and commented briefly on an ensuing conference call. The BDC has written down its second lien and equity stake – with a cost of $35.3mn to $16.1mn. Two quarters ago when the debt first became non performing, the FMV was twice as high. In the most recent quarter the FMV dropped ($9.6)mn.

As to what is happening or not happening at the company, details are scarce. We know that management is implementing operational improvements, a process that began before the pandemic. We imagine business conditions – with so many companies closed or working at part capacity – has only compounded Accent’s problems. This is what FDUS said: “And quite frankly, the company has been impacted by the shelter-in-place orders and also its geographic locations, in particular, its biggest locations in Texas“.

We know too little – even the identity of the first lien lender and its payment status – so we can’t estimate whether Accent will pull out of this valuation dive or not. Given the second lien status, though, a complete write-off is possible. That’s why lenders like FDUS get paid a 10.0% yield: to take those junior capital risks. This is a material position for the BDC, representing over 5% of the entire portfolio at cost and about 4% of its pre-default investment income. It’s too early to tell, though, if this is going to be a significant credit setback or just a bump along the way. FDUS speaks highly of the business and the management but that’s no guarantee that all will end well.

Accent, which FDUS added to its books in 2016, has been underperforming since IIQ 2017 and was rated CCR 3 until – as mentioned – it went on non accrual at the end of 2019. We are retaining our rating of CCR 5 and an outlook of Significant Loss until we hear otherwise.

Denbury Resources: Court Approves Restructuring Plan

Once a company agrees a restructuring plan and files for bankruptcy, a quick exit is often in the cards. That seems to be the case for energy player Denbury Resources, who has just had its pre-packaged Restructuring Plan blessed by its bankruptcy judge. According to a company press release: “The Plan received the overwhelming support of the Company’s stakeholders, receiving high consensus across all voting classes and unanimous acceptance from second lien and convertible noteholders.  The Company expects to successfully complete its financial restructuring and emerge from Chapter 11 in mid-September“.

The key element in the Restructuring Plan is that the company’s $1.2bn in pre-filing term debt will be converted into equity, in a standard “debt for equity swap”, where lenders become the new owners. As a result, we expect FS Energy & Power – the only BDC with exposure – will become an equity owner of the company when it emerges from Chapter 11 status later in the month and that will be reflected in the IIIQ 2020 results of the BDC.

As of the IIQ 2020, the BDC valued its debt at $17.1mn versus a cost of $42.1mn, suggesting a realized loss of at least ($25.0mn) will be booked. It’s possible the BDC will also be involved in any new financing added to the restructured balance sheet. Otherwise, though, the chances are this becomes a small equity, non income producing, stake that may or may not have value in the future.

We will circle back when the company formally emerges from Chapter 11 and when FS Energy & Power reports IIIQ 2020 results. In the interim, we’re upgrading the company from CCR 5 to CCR 3 prospectively, given the favorable capital structure envisaged. At this stage, more BDC-financed companies seem to be getting off the mat – typically by way of restructuring agreements like these but also from liquidations – than are newly filing for bankruptcy. Still, the damage to the investment income of the BDCs involved has been done.

BigMouth, Inc. : Liquidated

The BDC Credit Reporter has learned some of the background to the recent failure of BigMouth, Inc., a portfolio company of Capitala Finance (CPTA) and – most likely – other Capitala Group entities. We know from CPTA’s 10-Q that in July 2020 a final $2.4mn payment was received by the BDC on $5.372mn invested at cost in the company. At the end of the IQ 2020, total outstandings at cost were $10.3mn. During the second quarter either CPTA received a repayment of the $5mn difference or wrote the debt off. An equity stake had been previously written off in the IVQ 2019.

From a trade article we learned that BigMouth – on the CPTA books since 2016 and on the underperforming list since IVQ 2018 – missed a debt payment to its lenders – including CPTA as recently as April 1, 2020, due to the impact of the pandemic on its business of selling pool inflatables. Very quickly after that a receiver was appointed and the business liquidated in short order. We learned that “Capitala filed suit against BigMouth April 23, claiming that BigMouth owes it $22.9 million. The amount, Capitala said in the filing, includes $20.7 million in principal on the term loan, $2 million in principal on the revolving credit, plus interest on both“.

This all happened very fast and we can’t tell from the 10-Q if the $2.4mn received in July represented the only proceeds or – as mentioned above – whether some other funds were received previously. Overall, the transaction represents a modest-sized setback for the BDC and for the Capitala Group. Unfortunately, the company seems to have been beyond saving as private equity sponsor CID Capital does not seem to have stepped in with any support, nor did Capitala seek a “debt for equity swap”.

CPTA will permanently lose close to ($1.0mn) per annum in investment income from the first lien debt lent to the company. A final realized loss will be booked in the IIIQ 2020. For our records, we have moved BigMouth from CCR 5 to CCR 6, which is the rating system we used for companies no longer held on any BDC’s books, for whatever reason. That’s why you will not find in the BDC Credit Reporter’s database of underperformers.

Great Western Petroleum: Debt Exchange Fails

We’re writing this story based on one tweet from Debtwire claiming that Great Western Petroleum’s planned debt exchange has fallen through and the beleaguered company is being helped by a major bank to find a private credit alternative. If correct – and we have no reason to doubt the author or the publication, that will be yet another setback for the company’s attempts to reshape its balance sheet and increases the risk of a Chapter 11 filing.

We first wrote about Great Western on April 26 2020 when first downgrading the company from CCR 3 to CCR 4 on news of the now-failed restructuring. At that point, the only BDC lender – FS Energy & Power – had only discounted its junior capital positions by a modest (7%) to (10%). Now with two more quarters of reported results our skepticism about those values has been – partly – vindicated. As of the IIQ 2020, preferred held is discounted (35%) and one of its two subordinated debt holdings maturing in 2021 is discounted by (38%). On the other hand, another subordinated debt position maturing in 2025 is valued at only (1%) below cost. These values may be based on an expectation of the restructuring occurring as planned.

As in our earlier post, given the strains on the industry and the junior status of all the BDC lender’s capital, we continue to believe a complete realized loss is possible and made all the more likely by the latest, hot off the bad news presses. With $93.3mn invested at cost, this a material exposure for much battered FS Energy & Power. We continue to believe a default is likely, retaining the company on our Weakest Links list.

Alternative Biomedical Solutions: Restructured

The BDC Credit Reporter believes privately-held Alternative Biomedical Solutions LLC, a Centre Lane Partners portfolio company, was restructured in the IIQ 2020. We did not find an official announcement but a review of Capitala Finance’s (CPTA) 10-Q suggested some of the 2022 Term debt due the BDC may have been converted into Preferred stock and warrants were issued. Total exposure by CPTA dropped by a third, suggesting a possible realized loss of ($6mn) in the period but that’s not explicitly confirmed in the 10-Q.

Unfortunately, all our information is from CPTA’s results and cannot address the company’s overall balance sheet or what other lenders – if any – might have done. Furthermore, we don’t know if the sponsor made any capital contribution as part of the restructuring. The company had been underperforming since the IQ 2018 and in 2019 CPTA revealed trailing EBITDA had been headed lower but was stabilizing. As of the IQ 2020, the company’s debt was carried as non performing by the BDC.

As a result of the restructuring, we have upgraded the company from CCR 5 to CCR 3. The remaining debt is valued by CPTA at par, as well as the new preferred. The original $0.800mn in equity remains valued at zero. Total cost is $13.1mn and FMV $12.3mn.

We are keeping the company on the underperformers list despite the restructuring, both because the equity remains valued at zero and due to the recent non accrual and need for restructuring. We hope to learn more in the future.

Isagenix International, LLC: Capital Infusion By Owners

Did the cavalry arrive in the nick of time at Isagenix International LLC ? On almost the same day as Fitch Ratings suggested the company might default before year-end, a press release indicates the principals of the company have injected $35mn in new equity capital. Moreover – but with less specificity- we learn that the existing lenders to the troubled company “have reconfirmed their support for the business with an amendment to their credit agreement, which will give the company greater flexibility for growth“.

That’s just as well for the 6 BDCs with an aggregate of $35.6mn in first lien loans to the company. As of June 2020, the debt was being discounted by (60%) or more. The debt – priced at a moderate LIBOR + 575 bps – was poised to be added to the BDC Credit Reporter’s Weakest Links list. We’ll hold off for the moment. By the way, the principal debt holder amongst the BDCs involved is non-traded Cion Investment with $13.4mn at cost; followed by Crescent Capital (CCAP) with $6.3mn and then by sister funds Main Street Capital and HMS Income Fund, both with $5.7mn.

We will retain the current Corporate Credit Rating of 4 till further details are made available and we hear more about the financial performance of the closely-held weight loss company. Nonetheless, the news of the capital support must be a positive for everyone involved. Although we’re writing about Isagenix for the first time here, the company has been underperforming since the IIQ 2019, first with a CCR 3 rating and CCR 4 since IQ 2020. Maybe this capital infusion will be what it takes to return Isagenix to the ranks of normal performance.

Houghton Mifflin Harcourt: Downgraded By Moody’s

Moody’s has downgraded education publishers Houghton Mifflin Harcourt Publishers (“Houghton” or “HMH”) to Caa1 from B3. Here’s an extract from the press release on the subject:

“The downgrades reflects Moody’s expectation of a sharp decline in revenue in 2020 caused by budgetary constraints and likely deferrals of purchasing decisions by school districts amid the coronavirus pandemic, which will lead to HMH’s earnings decline and a spike in leverage in the next 12-18 months,” according to Dilara Sukhov, Moody’s lead analyst on Houghton Mifflin. “Meaningful rebound in the company’s performance in 2021 is unlikely given the potential educational funding pressures at state and local level, making it difficult for HMH to achieve earnings growth that is necessary to reduce its very high leverage and generate positive free cash flow”

BDC exposure is modest ($8.9mn) – all in first lien debt) and limited to Oaktree Specialty Lending (OCSL) and non-traded Guggenheim Credit. We are downgrading the company – given that the current rating is in the speculative spectrum and industry conditions are clearly difficult – to CCR 4 from CCR 2. Nonetheless, Moody’s suggests the company is in no immediate danger of liquidity crisis or default so we’ll leave Harcourt off the Weakest Links list.

I-45 SLF LLC : IIQ 2020 Update

The “I-45 SLF LLC” is a joint venture set up between two public BDCs that have a history of working together: Main Street Capital (MAIN) and Capital Southwest (CSWC). The JV dates back to 2015 and was rated as performing through the end of 2019. However, the BDC Credit Reporter first downgraded the entity to CCR 3 in the IVQ 2019 as multiple portfolio companies experienced credit problems. The situation was only exacerbated by the pandemic and the rating was dropped to CCR 4 in IQ 2020, as the discount on the BDC’s junior capital in the entity reached (43%). In the second quarter 2020 the valuation increased modestly – along with market loan values. Nonetheless, we are retaining the CCR 4 rating.

In the most recent quarter income from the JV paid out to its sponsors was reduced due to the precipitous drop in LIBOR only marginally offset by the 80 basis point average “LIBOR floors”. Furthermore, MAIN and CSWC injected additional equity capital in the quarter while the JV’s lender reduced its debt commitment, as mentioned in CSWC’s 10-Q: “On April 30, 2020, the I-45 credit facility was amended to permanently reduce the I-45 credit facility amount through a prepayment of $15.0 million and to change the minimum utilization requirements”. 

A quick look down the portfolio list of I-45 SLF shows that several troubled companies already on CSWC and MAIN’s own books are here as well. We’ve reviewed the entire portfolio and identified several underperformers and noted that cost to FMV is only 85%, even after loan values generally increased in the June 2020 quarter. We’re pretty sure the BDC partners will not be getting back in full the capital deployed whenever the JV is eventually closed down. At this stage we expect the eventual realized loss will be ($15mn-$20mn), split 80/20 between CSWC and MAIN. In the interim, though, the JV should continue to pay out a dividend, so we’re not adding the name to the Weakest Links list.

American Teleconferencing Services: IIQ 2020 Update

Now that IIQ 2020 BDC results have been released, we can confirm that American Teleconferencing Services – a wholly owned subsidiary of communications company Premiere Global Services – remains rated CCR 4. We’re guided mostly by the latest valuations from multiple BDCs with first lien and second lien exposure. The former is discounted by wildly varying percentages : (6%) to (35%). The latter has been nearly cut by half in value. Moody’s has given the company a Caa2 rating as recently as August . The ratings group had this to say:

“The debt restructuring in October 2019, surge in audioconferencing volumes and virtual events during the pandemic and sponsor’s equity contributions have improved the liquidity position but it is uncertain how the business will perform when the crisis abates. The rating additionally considers execution risks in plans to cross-sell services and operate under shared services agreements with TPx Communications, which was acquired in February 2020 by affiliates of Siris Capital, which also owns the parent company of American Teleconferencing Services.”

There does not seem any reason to add the company to the Weakest Links list yet but the business has some considerable way to go before lenders are out of the woods in what is a Major position in aggregate: $109.4mn at cost and $88.8mn at FMV. Most at risk – but with modest exposure – is Capital Southwest (CSWC) with $2.1mn in the second lien, which is valued at $1.1mn. The outlook is favorable in the short run, as Moody’s suggests but the company will need monitoring.

AG Kings Holdings: Files Chapter 11

On August 24, 2020 AG Kings Holdings, a grocery chain that includes regional names like Balducci’s and King’s Food Market, filed Chapter 11. According to a trade publication, the company – which has been troubled for some time -has a “stalking horse” buyer willing to pay $75mn for most of the stores in the chains. Furthermore, other buyers will be solicited under court protection. We learned that the company has “nearly $115mn in debts”. Of late the company has performed better than in the past thanks to Covid-19. Ironically, though, this recent success only encouraged management to strike while market conditions were as favorable as possible. The goal – despite unresolved issues with the company’s unions – is to be in and out of bankruptcy before the end of 2020.

Readers will know we have written about the company multiple times before, most recently on August 21, 2020. There are two BDCs with exposure of $26.9mn at June 30, 2020: Capital Southwest (CSWC) and WhiteHorse Finance (WHF). The latter recently added to its position in the first lien debt by buying an expanded position at a substantial discount. As a result, the aggregate FMV of the positions held is greater than the cost. WHF has two-thirds of the debt – including the most recent addition – and CSWC the rest.

The debt has been on non accrual since the IVQ 2018, so some sort of resolution was expected. From what we’ve learned from the Chapter 11 filing, and with the possibility of other buyers joining in, the BDCs have a good chance to get repaid in full or in part and in short order. From what we can tell, CSWC and WHF are not part of the buying group. We do know that the company’s “existing secured lender” is providing a $20.0mn Debtor In Possession facility, but we don’t know if that includes the BDCs who are principally in the Term Loan that nominally matures August 8, 2021. (CSWC does show an undrawn Revolver in its portfolio list).

We are retaining the CCR 5 rating for the moment and project the ultimate realized loss will be no greater than what CSWC – which invested close to par value – has booked : (30%) of its cost. If we’re right, CSWC will absorb a realized loss of just over ($3.0mn) and WHF – thanks to boldly buying more debt at a discount – may get away without a net loss. That could occur by the IVQ 2020 results. We expect both lenders will be happy with such an outcome and even more delighted if the company attracts more generous buyers. Much can happen in bankruptcy, but this may be the best outcome available after a year and a half of waiting around and no income coming in.

The BDC Credit Reporter will revisit this story as we learn what the final outcome looks like and we can estimate with greater accuracy what the ultimate economics might look like.

Arena Energy: Files Chapter 11

Naturally enough, a few days after we remarked that BDC-financed company bankruptcies had slowed to a seeming halt, a major Chapter 11 filing occurs. In this case, Arena Energy L.P. filed for bankruptcy protection on August 21, 2020. According to the Wall Street Journal, the company has already agreed on a sale to PE-group Lime Rock Partners and management. The existing lenders have mostly signed off on the sale. Apparently, the term loan lenders, who are junior to the reserve-based secured lenders, will receiving a mere 2% of their $439mn in debt back.

This is sad, but not unexpected news, for the three BDCs involved- all part of the FS-KKR Capital organization: non-traded FS Energy & Power and twin public entities FS-KKR Capital (FSK) and FS-KKR Capital II (FSKR). In total, the BDCs funded $179.5mn, all in second lien debt, and which used to be priced at LIBOR + 12.00%. The debt has underperforming and on non accrual since the IQ 2020, reflecting a very sharp drop in fortunes in a brief period. This is debt that dates back to 2015, and when GSO Blackstone was managing these BDCs. Unfortunately, new external manager KKR has not been able to rescue this unfortunate investment in the years since taking over.

If the 2% recovery rate is correct, the BDCs will have to take a further unrealized loss in the next quarter because the existing position was written down (86%). Either in the IIIQ or IVQ 2020 we expect the lenders will have to book a final realized loss of approx ($175mn) ! Also lost is the near ($22mn) of annual investment income being booked through the IVQ 2019. This is a significant reverse by any measure, with FS Energy absorbing about two-thirds; then FSKR with $54mn at cost and finally FSK at $9mn. The almost 100% loss is deeply disconcerting and suggests the lenders – whether they recognized it or not – were investing more like a PE group than a lender but with a capped return and an unlimited downside. Finally, this proves the BDC Credit Reporter’s oft-made point that energy lending is an oxymoron and an inappropriate asset for an industry with a predominantly retail investor base.

We had already rated the company a CCR 5, and expect to see the name removed from the books of all the BDCs involved by year-end.

AG Kings Holdings: Valuation Differences

We’ve now heard from the two BDCs with first lien debt exposure to “troubled” retailer AG Kings Holdings. The debt has been on non-accrual since 2019 and remains so after IIQ 2020. However, Capital Southwest (CSWC) discounts it’s $9.5mn invested at cost by (35%). WhiteHorse Finance (WHF), by contrast, values the same debt ($17.3mn at cost) at a 20% premium…That discrepancy seems to be due to the fact that WHF doubled down in the period and bought more of the company’s debt in the secondary market at a discount that management was not willing to share on its conference call, but which an analyst placed at (63%).

Both BDCs have admitted that the retailer has been performing better thanks to the changed market conditions brought on by Covid-19. Nationally supermarkets have benefited from more people eating at home and AG Kings is no exception.

Given the company is still restructuring and still on non accrual , the BDC Credit Reporter is maintaining the CCR 5 (Non Performing) rating. that dates back to IVQ 2018. However, the outlook for recovery of some sort – perhaps even in full – is looking good. That’s positive news for CSWC and even more for WHF, which has made a bold move in buying non-performing debt. This might be to take advantage of the discounted price and/or as part of its restructuring strategy, but we’re just guessing.

We’ll be keeping as close tabs as we can on this private company and the BDC valuations involved. In an exception to the rule, we may see an upgrade before a liquidation or further write-down.

Delphi Behavioral Health: Restructured

We learned from Capital Southwest (CSWC) – the only BDC lender to what was called Delphi Intermediate Healthco – that the troubled mental health company was restructured out of court. As a result the debt – which was on non accrual -has been returned to performing status from the IIQ 2020 but with a new capital structure, and after CSWC absorbed a significant realized loss. (See below). Furthermore, the company’s name was changed on CSWC’s books to Delphi Behavioral Health Group LLC. The BDC owns a significant – but undetermined stake in the restructured business and sits on the Board.

The realized loss booked by CSWC in the second quarter on Delphi was ($5.5mn) or nearly half the $11.7mn invested in debt just prior to the restructuring. According to Advantage Data, this was a portfolio company on the BDC’s books since IVQ 2017 and in an industry which CSWC feels it understands given its exposure to similar entities in its portfolio. Delphi performed normally – judging by CSWC’s portfolio valuations and absence of conference call commentary – right up to the IVQ 2019 when the debt was placed on non accrual. The initial discount on the defaulted first lien loan was (40%), but ended up to be higher by the time the realized loss was booked.

Given the timing, the problems at Delphi clearly pre-dated the Covid-19 crisis but the pandemic must have made the situation worse. We call these failures First Wave credit problems.

The new debt on a restructured/renamed Delphi is more expensive than before, but currently paid in PIK form and the debt matures in 2023 versus 2022 previously. We know little about which other lenders are involved or the overall capital structure. We do know that CSWC has increased its internal rating from a 4 to 2 on their internal rating scale. The BDC Credit Reporter has also upgraded the company from a CCR 5 to CCR 3. That’s still in our underperforming category and on our Watch List. Like CSWC, though, we are hopeful that the business will recover and the BDC – and its shareholders – might regain some or all their capital loss from an eventual sale. Still, it’s early days and a business needs more than a restructured and de-leveraged balance sheet to be successful.

Delphi will also be a test of CSWC’s skill at “turning around” unprofitable companies; taking equity positions and sticking around for the long haul. These debt-for-equity swaps take up management time; often result in more capital being advanced and typically result in lower current income. If all those sacrifices result in an eventual repayment of all debt and interest and an equity gain, kudos to the BDC manager. If not – and over a number of transactions – one has to question the approach. For the record, CSWC has 9 companies – including Delphi – which are marked as “affiliated” and in which the BDC has some sort of equity interest. Of those 3 are “underperforming” to various degrees. [We’re not counting CSWC’s investment in its I-45 JV with Main Street, also underperforming].

Zep Inc.: Upgraded By Moody’s

On August 17, 2020 Moody’s upgraded the corporate and debt ratings of Zep Inc., a producer of “chemical based products including cleaners, degreasers, deodorizers, disinfectants, floor finishes and sanitizers, primarily for business and industrial use“. The “Corporate Family Rating” was increased to Caa1 from Caa2 . Moody’s also upgraded Zep’s first lien senior secured credit facilities to B3 from Caa1 and its second lien term loan to Caa3 from Ca. The outlook is stable.

Apparently, the company has benefited from “the significant increase in demand for its products as customers across its food & beverage and industrial end markets enhanced standard operating procedures and protocols around cleaning, sanitation and maintenance in their facilities in response to the coronavirus pandemic“. Liquidity, too, is getting better and Moody’s expects these trends to continue.

For the 6 BDCs with $126mn in “Major” exposure to Zep, this is good news. In the IQ 2020, the second lien debt held was discounted (59%) and the first lien (30%), but was already being valued higher in the second quarter, reflecting the same trends as caused the Moody’s upgrade. Most impacted will be the Goldman Sachs organization whose 3 public and private BDC funds each have a major position in Zep to the tune of $88.4mn or two-thirds of the total. Oaktree Specialty Lending (OCSL) is also a significant lender with $31.6mn, mostly in second lien. Also involved are Oaktree Strategic Income (OCSI) as well as non-traded Audax Credit, but for only small amounts.

The BDC Reporter is upgrading Zep to a Corporate Credit Rating of 3 from CCR 4 given that the odds of full recovery are greater than that of eventual loss. Nonetheless, before setting off the fireworks and having a parade at this good news, we should remember most BDC exposure is in the second lien debt which still has a speculative rating (Caa3). Furthermore, the debt does not mature till 2025. Much can happen in the five years ahead, which is why we are retaining Zep on the underperformers list.

Still, in the short term – and the IIQ upward valuation notwithstanding – we may see a lower discount (i.e. unrealized appreciation) in the BDC IIIQ 2020 results.

Merx Aviation: Restructured

Apollo Investment (AINV) reported that its largest investment – Merx Aviation – was restructured in a couple of ways in the second quarter 2020. The aircraft leasing and servicing company, which AINV owns 100% of the stock of, saw $105mn of its $305mn in Revolver debt outstanding from AINV converted to debt. Second, the remaining debt saw its interest rate drop to 10.0% from 12.0%. Management of the BDC were circumspect in discussing the company’s performance, even though Merx’s FMV represents one-third of net book value at June 30, 2020. On the conference call AINV executive spoke in general terms, like this: “The pandemic has caused an unprecedented decline in global air traffic, which has led to a widespread lease deferrals throughout the industry. Although aircraft — air traffic trends have improved slightly more recently, it remains significantly below pre-pandemic levels“.

Despite the huge strains on aircraft lessors and the loss of substantial income because of the above, AINV wrote down its equity stake in Merx – which just increased by 800% at cost – by only ($4.2mn).

BDC portfolio company valuations are always a riddle wrapped in an enigma, initially prepared by internal staff, often reviewed by an outside appraisal firm and the final responsibility of the directors. To our minds – given what we do know about market conditions; the high leverage involved and the restructuring, this write-down is wholly inadequate and inexplicable. At this stage, AINV’s Merx investment taken overall is still valued above cost and would not show up on the BDC’s own underperforming company list.

For our part, we reaffirm the BDC Credit Reporters Corporate Credit Rating of 4, which we instituted last quarter. We do not have Merx on our Weakest Links list only because AINV has such latitude to continue paying interest even if the business is insolvent, which may be the case from what little we know. The fact that one third of debt is no longer accruing income is a negative sign, as is the need to lower the rate. These are the actions of an owner rather than a lender and make the entire valuation questionable.

This is a very serious challenge for AINV. In a short time, the BDC has lost ($16.6mn) in annual investment income. That’s just over 10% of IQ 2020 Net Investment Income. If the entire debt goes on non accrual another ($20.0mn) in annual Investment Income would be lost and AINV would have lost (25%) of its earlier Net Investment Income. We’ve already mentioned the size of the Merx investment on the balance sheet and in relation to net book value.

We will continue to update readers about Merx, but may not have anything to report till AINV does so given the closely held nature of the investment and management’s closed lips. There is a danger of an “October surprise” when AINV reports IIIQ 2020 results, especially as the global aviation business continues to face dire circumstances. Unfortunately, AINV shareholders may not find out till it’s too late that the current valuation was unrealistic. For everybody concerned, we hope otherwise.

Glacier Oil & Gas: Debt Placed On Non-Accrual – Updated

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. [Written My 23, 2020]

IIQ 2020 Update: AINV continued to write down its position in Glacier Oil & Gas by ($3.2mn). The hit was taken on the already non performing second lien loan. That leaves a FMV – all in the debt as the equity has been written down to zero already – of $11.5mn. We continue to believe that the entire investment will be written off but have little confidence of getting a full and frank update from management which said nothing about the company this last quarter. We do know that “production is hedged through 2020”. 2021 may be the year of reckoning if there’s no huge uptick in oil prices. We maintain a CCR 5 rating.