Spotted Hawk Development: IIIQ 2020 Update

Spotted Hawk Development LLC is the BDC’s largest single remaining energy investment and the only one still generating current income for the BDC. As a result, the BDC Credit Reporter is undertaking an update as of September 30, 2020. The total cost remains $115mn, essentially unchanged from the prior period. However, the fair market value has dropped to $42.3mn from $47.5mn. The reduction occurred in the Tranche A senior loan (there are three tranches), which remains on non accrual.

Currently only Tranche A of the debt is still “performing”, with a cost of $24.7mn and a slightly higher FMV. The debt is priced at a 12.0% yield, generating $3.0mn of annual investment income, equal to 2.7% of the BDC’s annualized Net Investment Income Per Share.

Management provided no update on the company this quarter and no analyst asked a question. We affirm the company’s CCR 5 rating, which has been in place since 2016 and continue to expect – given the parlous state of the energy sector – that this investment will end in a huge realized loss and – probably – a further decrease in fair market value from the IIIQ 2020 level. What’s impossible to tell – given that AINV controls this business and has – is whether Spotted Hawk will continue to pay its interest. Given the valuation trend, the outlook for payment and for valuation looks bleak.

KLO Holdings: IIIQ 2020 Update

With no guidance from BDC lender Apollo Investment (AINV), the BDC Credit Reporter recently wrote an update on October 17, 2020 about KLO Holdings – holding company for a kayak manufacturer with operations in the US and Canada. We posited that the BDC investment in the business – which failed earlier in the year – would result in a 100% write-off and everyone would move on.

Now that we’ve had a chance to dig into AINV’s IIIQ 2020 financials we’re changing our story. Once again we are getting no help from AINV – which like most BDC managers only episodically shares an anecdote or two about underperforming portfolio companies. We do know, though, from the 10-Q that AINV booked a ($3.7mn) realized loss in the IIIQ 2020 associated with KLO Holdings. However, a new borrower is now listed in the KLO Holdings Group : 1244311 B.C. Ltd. To this entity AINV has advanced $4.0mn in debt and $1.0mn in equity.

The $4.8mn invested in cost at the KLO Holdings subsidiary KLO Acquisition, in the form of a loan, remains valued at zero and on non accrual. The Canadian subsidiary of KLO holdings 9357-5991 Quebec Inc. had a cost of $8.657mn as of June, also in the form of a loan. That’s cost has now been reduced to zero. We’re guessing this is where the ($3.7mn) realized loss came from and the remaining $5.0mn transferred to the new entity: 1244311 B.C. Ltd. Of that $4mn in new debt, three quarters is cash paying, according to the 10-Q, and $1mn is in PIK form. AINV has valued its “new” $5.0mn investment at $4.844mn. The rest of the historic advances to KLO Acquisition and 9357-5991 Quebec Inc. are valued at zero.

That took us half an hour to parse out, so if you’re confused we sympathize. The bottom line, though, is that AINV has taken a small realized loss equal to one quarter of its June 2020 exposure to the KLO Holdings companies, but continues to have exposure to a new company by moving obligations around and changing their form. This means KLO Holdings is both a non performing and a performing loan, depending what subsidiary entity you’re talking about !

We have clearly under-estimated the unwillingness of AINV to give up and walk away. Only time will tell though if these are just realized losses delayed by these clever transactions or whether the BDC might participate in some turnaround and eventual partial or full recovery. Admittedly, the current FMV is low: just $2.157mn, and the amount of interest income being now received is very modest. For readers, this story of the changing nature of AINV’s kayak investment is a useful example of the flexibility BDCs have to re-characterize and restructure their assets. Investors have the challenge of trying to keep up in order to have a sense of what value is lost or created.

Ambrosia Buyer Corp : Lender Dispute

Occasionally BDCs use different corporate names for portfolio companies, which is very confusing for the BDC Credit Reporter and requires much checking and double checking. In this case we are going to discuss Ambrosia Buyer Corp; Trimark USA LLC and TMK Hawk Parent Corp. Three names but one company and set of debt. As CreditRisk Monitor explains: “Ambrosia Buyer, Corp. was formed by Centerbridge Partners, L.P. to facilitate its acquisition of TMK Hawk Parent Corp. d/b/a TriMark USA, LLC (“TriMark”) from Warburg Pincus LLC. TriMark is a leading distributor of foodservice equipment and supplies in North America serving over 80,000 customers”. Several BDC lenders are involved in a first lien Term Loan due August 2024 and a second lien maturing one year later. Total BDC exposure is a material $63.5mn at cost, split between four firms: Apollo Investment (AINV); New Mountain Finance (NMFC); Audax Credit BDC and Cion Investment, which is related to AINV.

The debt was performing normally till Covid came along but was downgraded from CCR 2 to CCR 3 in the IQ 2020 and then to CCR 4 in the IIQ 2020. We were influenced by the ever lower BDC valuations and a major downgrade of Trimark by Moody’s in the spring. As of September 2020, the BDCs involved are discounting their exposure by anywhere from (21%) to (33%). The AINV/Cion combo are in the second lien debt and the other BDCs in the 2024 first lien. However, AINV/Cion have applied the more modest discounts, which seems counter-intuitive.

In any case, Ambrosia/Trimark is caught up in a major struggle between lenders that has ended up in court. Here is the dispute in a nutshell as spelled out by Institutional Investor: “

“…a group of lenders to TriMark USA, which provides equipment to the foodservice industry, sued their fellow private credit providers, alleging that they improperly amended the credit agreement.

TriMark has been struggling during the pandemic, as its customers — restaurants — had to close. The lenders changed the credit agreement in a bid to give the company more liquidity.  

Friday’s lawsuit claims that these changes devalued certain lenders’ debt and makes it less likely that they’ll get repaid if TriMark defaults. “This breach-of-contract case arises from a cannibalistic assault by one group of lenders in a syndicate against another,” the lawsuit said.” 

The plaintiffs include Audax, BlueMountain Capital Management, Golub Capital Partners, Intermediate Capital Group, New Mountain Finance Corp., Shenkman Capital Management, York CLO Managed Holdings, and Z Capital Credit Partners. 

..The list of asset managers and owners they are suing is long. Two of the defendants are TriMark’s private equity owners Centerbridge Partners and Blackstone, which holds a minority stake in the company. “Blackstone is a minority investor in the company and these claims are wholly without merit,” a spokesperson for the firm said via email. A spokesperson for Centerbridge declined to comment

The plaintiffs are also suing BlackRock, Ares Management, Oaktree, Sculptor Capital Management, Australia’s Future Fund, and the Canadian construction industry pension plan, among several others“.

We can’t hope to disentangle here which BDC is on which side and who might be doing what to whom. The attached FT article is a useful primer, but may get overtaken by events. Our purpose is simply to highlight that this is a contentious credit and may yet result in significant defaults occurring. Most at risk on paper is NMFC with $33mn invested at cost, but in first lien debt. Next is AINV with $21.1mn, followed by Cion with $13.2mn, both in the 2025 Term loan. Audax has a very modest, noin material exposure.

We are maintaining the CCR 4 rating assigned earlier in the year and will revert back when this dispute plays out in a way that allows us to determine what lasting damage might occur to the BDCs involved – if any. As half of Ambrosia/Trimark’s customers – according to Moody’s – are restaurants and that the group already has a Caa rating on the company, we are not optimistic. We don’t know enough to add the company to the Weakest Links list, so we’re not “calling” an imminent payment default. Would we be surprised if one occurred ? No, given the dire economic conditions and the 10X debt to EBITDA remarked on by Moody’s as far back as April 2020.

A-L Parent: IIIQ 2020 Update

After reviewing the IIIQ 2020 BDC results, there are two developments worth noting at Learfield Communications, owned by A-L Parent, which we last wrote about last quarter. First, our decision to downgrade the company to CCR 4 from CCR 3 on August 7, 2020 was validated by Apollo Investment’s (AINV) latest valuation. The BDC is discounting the second lien Term loan by (34%) from (22%). That’s a ($0.650mn) reduction in FMV to $3.654mn. The income involved – still being received – amounts to just under $0.5mn a year.

Secondly, Bain Capital Specialty Finance (BCSF) – which was also a second lien lender as of June, seems to have decamped, leaving AINV as the only remaining lender.

We affirm the CCR 4 rating and the inclusion of the company on the Weakest Links list, which means chances are high of a default in the next quarter.

Maxus Carbon: Debt For Equity Swap

This is the fourth article we’ve written about Maxus Carbon’s, Apollo Investment’s (AINV) poorly performing project finance for a chemical plant that has been around for 7 years. Click here for the prior articles and to get caught up. After placing remaining debt on non accrual in the IIQ 2020, the BDC in the IIQ 2020 has quietly restructured its position in the company. Again. We say “quietly” because management made no mention of the conversion of the $30.4mn in first lien debt – albeit non performing – into equity on its IIIQ 2020 conference call transcript. This removed Maxus from AINV’s long list of companies on non accrual but – arguably – further weakened the BDC’s position on the company’s balance sheet, which is now all equity for $77.9mn at cost. Of course, no income is being received.

AINV valued some of its earlier equity at $24.9mn at FMV and the just converted debt at zero. Counter-intutively, the latest valuation is slightly higher than last quarter, which was for $22.6mn. At this point AINV has written down 69% of invested capital and has no income coming in. When this investment started out AINV made a $60mn loan and charged 13%. That’s ($7.8mn) of annual income lost along the way.

We are “upgrading” Maxus from CCR 5 to CCR 4 because technically no longer non performing. Still, at best this is a lateral move.

Based on the ever lower valuation and the debt to equity conversion, the BDC Credit Reporter does not hold up much hope and would not be surprised if AINV – one day – would write off the entire project. The current FMV of the investment would amount to about 2.5% of net assets as of September 2020.

As always we are at the mercy of AINV in terms of updates on the chemical plant’s progress. We’ll provide the latest disclosure next quarter of what remains – even with two thirds of the value written down – a material “Legacy” investment for the BDC and an almost certain dud once the final bill comes due.

Merx Aviation: IIIQ 2020 Update

On November 5, 2020 Apollo investment (AINV) provided a substantive qualitative update on aircraft leasing and servicing investment Merx Financial during its IIIQ 2020 conference call. We’ll quote in full from the lengthy – but still lacking in detail – prepared remarks:

” …the pandemic has had a significant adverse effect — impact on the global economy with direct implications for the aviation sector, although we are starting to see some recovery in global air traffic. Merx continues to closely monitor the current market environment and proactively maintain dialogue with its airline clients globally.

During the quarter, the fair value of AINV’s investment in Merx declined by $5.7 million or 1.8%. The quarter-over-quarter change reflects the decline in the fair value of Merx’s fleet given the challenging environment, partially offset by an increase in the value of Merx’s servicing business.

As discussed in the past, in addition to aircraft leasing, Merx has built a best-in-class servicing platform and acts as a servicer or technical adviser for aviation assets across the broader Apollo platform. Merx is now benefiting from a growing servicing business, which has helped partially offset the decline in fair value of its fleet during the quarter. We believe Merx’ portfolio compares favorably with other major lessors in terms of asset, geography, age, maturity and lessee diversification. Merx’s portfolio is skewed towards the most widely used types of aircraft, which means demand for Merx’s fleet should be somewhat more resilient. Merx’s fleet primarily consists of narrow-body aircraft serving both the U.S. and foreign markets. At the end of September, Merx’s own portfolio consisted of 81 aircraft, 10 aircraft types, 40 lessees in 26 countries with an average aircraft age of 9.6 years. Merx’s fleet includes 78 narrow-body aircraft, 2 wide-body aircraft and 1 freighter.

Similar to other industry participants, many of Merx’s lessees requested rent deferrals and/or rent reductions. Merx has been working with its lessees to provide the necessary flexibility during these unprecedented times. Each request was reviewed on a case-by-case basis. Some of the deferral periods have expired, and we’re now seeing a recovery in lease payments. Despite the current industry challenges, we do not expect Merx to require funding from AINV in the near term.

The aviation team has the experience to skillfully navigate this period of market stress and the requisite capabilities to mitigate potential adverse outcomes. Additionally, the Apollo aviation platform will continue to seek to opportunistically deploy capital in the face of widespread uncertainty and market disruption. To be clear, Merx is focused on the existing portfolio and not seeking new investments. However, growth in the overall Apollo aviation platform will inure to the benefit of Merx as the exclusive servicer of aircraft owned by other Apollo firms“.

In the Q&A, AINV also revealed that many lessees received 6-9 month payment deferrals earlier in the year which have not expired. Should those payments not resume – which must be a strong possibility in many cases – that would materially impact results.

The net write-down of Merx was only ($5.9mn) because AINV also wrote up the company’s servicing business in the quarter by $4.4mn due to a deal done with Delta and because “the pipeline remains very, very robust in terms of other opportunities“.  

The BDC Credit Reporter is unconvinced – given the drastic market conditions – that the overall value of Merx at $324mn – a slight premium to $320mn in cost – is appropriate. In the IIQ 2020, the BDC was forced by the impact of the pandemic to restructure its investment, resulting in a substantial loss of interest income due to a lower loan balance and yield. Yet in all of 2020, AINV has written down its value in Merx by only ($39mn), or only (10%).

Of course we don’t have access to the financial records of this huge operation, except for some summary and not very useful numbers AINV is required to reveal. Common sense – and the knowledge that AINV’s capital sits underneath a mountain of secured debt – suggests, though, that the BDC should be sharpening their pencil more. This leaves open the possibility of a further write-down or restructuring of this very large AINV investment in the future as reality catches up with valuation. In fact what happens in the next few quarters to the valuation of Merx will speak very loudly to the BDC’s credibility when marking “control investments”, of which AINV has many.

AG Kings Holdings: IIIQ 2020 Update

We have just heard from one of the two BDC lenders to AG Kings HoldingsCapital Southwest Corporation (CSWC) about where things stand for the grocery chain in bankruptcy. Apparently, the purchase of the business by Albertson’s is proceeding. CSWC had only this to say ” That’s in process of closing/documentation process“. As of September 2020, CSWC is valuing its non performing senior debt (except for a DIP loan which is valued at par) at a (26%) discount. That’s better than two quarters ago when the debt was discounted by as much as (48%).

Given that we seem to be in the final furlong, the BDC Credit Reporter believes the current valuation is likely to be very close to the final outcome. That means CSWC will be booking a permanent ($2mn) realized loss, but will be recouping $6mn or so (including that DIP advance) to reinvest into new deals elsewhere. Chances are good that will show up by year end 2020.

Also affected is WhiteHorse Finance (WHF) – which has not reported yet – but which holds a much bigger position and much of which was recently added. We’ll refrain from guessing what loss – if any – WHF might incur till that BDC files its results.

At a time when so many troubled companies are finding an exit only by a “debt for equity swap” with their lenders, this outcome is more traditional with a sale to a third party. Ironically, AG Kings was lucky enough to be in the right segment of the food and supplies business in the time of Covid-19, which has reduced what looked like a significant loss for the lenders to a modest one. We expect to be able to close the file when CSWC and WHF report IVQ 2020 results, or by IQ 2021 at the latest.

Mesa Air Group Inc.: Downgraded to CCR 3

We’ve just heard from BlackRock TCP Capital (TCPC) about its IIIQ 2020 performance. That included the latest valuation of the $24mn at cost lent to regional air carrier Mesa Air Group Inc (dba Mesa Airlines). Management – as has often been the case this year – specifically discussed the company on its conference call, expressing confidence all is well despite the impact of the pandemic on flying in metal tubes in the sky. As has been the case since the crisis began, TCPC has valued all debt outstanding at close to par and pointed to its aircraft collateral as one reason for its confidence. Here’s the latest commentary made by TCPC on November 2, 2020:

In the case of Mesa, they are a regional operator, they connect jet service to American and United feeding into their hubs. They’ve obviously been impacted that dramatically. They have gotten federal money under the CARES Act that loans continue to perform fully on amortization and interest, of course we all know that the sector has been impacted.We do think our approach to underwriting focusing typically on somewhat older equipment, These are all backed by assets and engines has proved highly effective since we started in this business, financing planes and playing parts since 2003, but clearly there is some disruption there”

The BDC Credit Reporter most of the time will defer to a BDC’s valuation judgement as they have much more information available and are often supported by an independent firm. However, there are times when our credit antennae are up and we differ. This is one of those times. We don’t pretend to have special insights but believe that the market conditions – the worst we’ve ever seen – warrant more caution.

As a result, we have unilaterally decided to downgrade Mesa from CCR 2 to CCR 3 until conditions are clearer. There’s over $1.8mn of annual investment income in play, all of which is still being paid in cash.

As recently as yesterday the company announced borrowing an additional $200mn of secured debt under the CARES Act. Those funds may have repaid the TCPC obligations and may explain the high valuation as of September but no mention was made of that publicly revealed development on the BDC’s conference call. We apologize for being alarmist if TCPC has just been – or shortly will be – repaid. If not, though, this latest borrowing expedition only increases our concern about the company’s financial condition. We will circle back once new information becomes available.

AGY Holding Corp: Company Restructured.

Last time we wrote about AGY Holding Corp in May 2020, we darkly warned that “caution is warranted. Forewarned is forearmed“. This was not a very bold statement as at the time the company had been on partial non accrual since IIIQ 2019. Still, the two BlackRock public BDCs, BlackRock Investment (BKCC) and BlackRock TCP Capital (TCPC) were continuing to carry first lien obligations as current and at full value.

Now we hear from TCPC on its IIIQ 2020 conference call that the company has been restructured. Apparently, all the debt has been sold for a nominal amount and the TCPC and BKCC left with small preferred stock positions with little immediate value. Furthermore, TCPC has booked a realized loss of somewhere between ($16.5mn and ($18.0mn). Just from last quarter, the FMV of the BDC’s exposure has dropped by ($4.0mn).

Management put a brave face on the subject but the truth of the matter is that the company is an almost complete loss for the BlackRock BDCs, with over ($70mn) in capital invested likely to be written off. In an even worse position than TCPC is BKCC, which was showing $57mn invested at cost as of June 2020. The coming realized loss is greater than 12% of all the losses BKCC has booked over its long history. Even the loss of net book value per share between this quarter and June will knock about ($0.20) out of BKCC, or about (4%).

The amount of investment income lost is over ($8.0mn) on an annual basis, some of which was still being taken into income all the way through June and – maybe – beyond. Now the realized losses have been booked, per our system, we are upgrading the remaining preferred investment in a restructured AGY to CCR 3 from CCR 5. However, judging by the $0.5mn left on TCPC’s books as a preferred stock investment from the IIIQ 2020 on, the size of the public BDC exposure may not be material by the BDC Credit Reporter’s standards and may get dropped from coverage.

To conclude by stating the obvious, the amount of the AGY loss – and the very high discount to cost involved – represents a serious setback for both BDC lenders. The problem appears to have been an increase in the cost of one critical ingredient in AGY’s business which management and its lenders never found a way around over a multi-quarter period of distress. As is often the case in this situation, the BDCs have been slow to write down the value of their failing investment. Even when the first non accrual occurred, the combined FMV was still $57mn versus a cost of $64mn. Roll forward one year and another $50mn plus has received the ax.

Protect America Inc: Updated Company File

With Stellus Capital’s (SCM) IIIQ 2020 results just published , we have updated security company Protect America Inc.’s Company File, and added to the BDC Credit Reporter’s credit commentary. Spoiler alert: No progress here and odds look good that the BDC will eventually have to write off all its second lien debt position. The rating is CCR 5 and has been for multiple quarters.

Furniture Factory Outlet LLC: IIIQ 2020 Update

We last wrote about Furniture Factory Outlet LLC on August 1, 2020 when the situation at the retailer was dire. Now the only BDC lender – Stellus Capital (SCM) – has reported IIIQ 2020 results and written down its first lien debt to the company by (84%) from (67%) the quarter before. (The subordinated debt and equity remains valued at zero). The BDC did not offer up any more color on what’s happening but the valuation speaks for itself.

The BDC Credit Reporter maintains its CCR 5 rating that dates back to IQ 2020 and expects that a complete write-off (give or take a few hundred thousand dollars) might be the most likely final outcome. In dollars and cents that might mean a further ($2mn) write-down and a ($13mn) realized loss unless there’s a drastic turn of events. We’ve checked the public record and the company seems to be still in operation and has not filed for bankruptcy. Otherwise, though, the outlook seems grim for this SCM investment that dates back to 2016, but which began to weaken in the IQ 2020. Covid-19, though, has accelerated and amplified the downturn.

This particular investment is notable principally for illustrating that being in “first lien” position is no guarantee that the ultimate loss might be not be very high or even a complete write-off. Just scanning down a BDC’s filing for its percentage of portfolio assets in first lien, second lien and equity does not tell us much about default and recovery prospects. As always, one has to look under the hood of each borrower in turn, which is no easy task.

See the Company File here.

Accent Food Services LLC : IIIQ 2020 Update

Fidus Investment (FDUS), the only BDC with exposure to Accent Food Services LLC, has just reported IIIQ 2020 results. (See the IIQ 2020 update here). Accent is the only non performing company in the BDC’s portfolio and was the subject of very direct questions from analysts about what’s happening at the business. The BDC’s CEO artfully avoided providing any hard details. Nonetheless, we know that FDUS reduced its valuation sharply to $5.3mn from $16.1mn. That’s a worrisome sign and that the junior capital provided by the BDC might be at risk to an almost complete loss.

We are maintaining the BDC Credit Reporter’s CCR 5 rating and the loss outlook is for a Severe or Full Write-Off.

BarFly Ventures LLC: Assets Acquired Out Of Bankruptcy

After filing for Chapter 11 bankruptcy in June as a result of COVID-19 pandemic-related challenges, Grand Rapids, Mich.-based BarFly Ventures LLC sold its assets — including craft beer bar/restaurant HopCat, Stella’s Lounge, and Grand Rapids Brewing Co. — to Congruent Investment Partners and Main Street Capital for $17.5 million, the company announced on Tuesday. Longtime investors Congruent Investment and Main Street Capital formed a new operating company, Project BarFly LLC upon acquisition of the brands“. Nation’s Restaurant News

Apparently, the new owners want to revive the existing Michigan operations of the restaurant chain, and expand beyond the state.

Main Street Capital (MAIN) – as well its sister non traded HMS Income -have a long standing relationship with the predecessor company that dates back to 2015. From the IQ 2020, though, the two BDCs debt to the company was placed on non accrual and a Chapter 11 bankruptcy followed in June. As of the most recent results at mid year, the two BDCs had invested $15.0mn in debt and equity, but had written down the positions to just $1.7mn.

Back in June, the BDC Credit Reporter asked itself the following:

Will MAIN/HMS seek to take an ownership situation and – maybe – double down with some additional financing ? Or will the BDCs kick themselves for having invested in the restaurant business in the first place and with a growth strategy – as the CEO himself tells it – based on growth by debt-funded acquisitions. The model was already in trouble before Covid-19 came along but the impact of the virus was the equivalent of a body slam. You can’t win them all, but this investment seems to have been dubious from the start“.

Now we have our answer but just how this will flow from a realized loss point of view and how much new capital will be advanced by the BDCs remains unclear. Furthermore, years are likely to pass before we’ll be able to tell if this latest transaction was a genius move that might return all the monies invested and more, or will end up itself in bankruptcy court and a further loss. If nothing else, though, this transaction does underscore how some BDCs are serving as their own “distressed assets” investors and are willing to become owners in certain situations rather than just take a loss and walk away. For shareholders in these BDCs this requires a different set of lenses when evaluating a portfolio and its outlook.

Rubio’s Restaurants Inc.: Files Chapter 11

On October 26, 2020 Mexican casual chain Rubio’s Restaurants Inc. filed for Chapter 11 bankruptcy protection in Delaware. However, the company has already negotiated a restructuring plan with its private equity sponsor Mill Road Capital and with its lender, funds managed by Golub Capital. A “debtor in possession facility” has already been negotiated and there is hope the chain will be in and out of bankruptcy within weeks. Still, 26 locations out of 150 are being permanently closed, which may explain why the trip through bankruptcy court was chosen.

The only BDC with exposure is Golub Capital BDC (GBDC), which holds close to $18mn in first lien debt and $0.45mn in preferred stock. In total Golub Capital related funds have $80mn plus in exposure to the pre-bankruptcy company and are advancing another $8mn in debt and equity going forward. Mill Road Capital is reportedly also making an equity contribution. This looks a partial debt for equity swap where Golub – through its funds – will increase its equity stake in Rubio’s in return for the additional funds and some debt forgiveness.

The debt outstanding at GBDC has been on non accrual since Covid-19 devastated the restaurant business in the IQ 2020. We downgraded the business from CCR 3 to CCR 5 at that time. Rubio’s is now added to the BDC Credit Reporter’s list of BDC-financed portfolio companies in bankruptcy, the fourth in October for those keeping score. GBDC has written down its debt by just shy of (50%) and the preferred is valued at zero. We expect that this presages what the realized loss might look like, which could be booked in the IVQ 2020: about ($10mn). There will be no impact on investment income as the debt has been non-performing. In fact, from early 2021 GBDC may begin to earn income on some $10mn of remaining debt and new proceeds.

As always in these situations where a BDC goes from lender to owner, how long the investment will last is unknowable. The BDC, though, has been involved with Rubio’s since 2010 when Mill Road fist bought the business. For all we know, the restaurant chain may yet be on the Golub books another decade from now.

This is an undeniable setback for GBDC and the amounts involved are material, although the final gain or loss will not be known for years. The BDC Credit Reporter would question why GBDC – or any other BDC lender -would invest in the restaurant business in the first place. Along with E&P production; energy services; bricks and mortar retail, eateries are a controversial choice from a credit standpoint as reflected on the many troubled companies we’ve mentioned on these places. In our day many lenders had the restaurant sector on their prohibited list.

Nonetheless, the ability and willingness of GBDC – along with the Golub organization – to step up to become an owner-lender might mitigate ultimate losses. Or make them worse once all the beans are counted. Time will tell us. In the interim, we expect to be writing about Rubio’s multiple more times in the years ahead as the proposed turnaround gets into gear.

KLO Holdings, LLC: Update

Did you ever wonder what happened to KLO Holdings LLC (aka Hemisphere Design Works), a kayak manufacturer which was a fruit of the combination of a combination of Michigan-based KL Outdoor and Montreal, Canada-based GSC Technologies ? We did. We last wrote about the business on January 31, 2020 when the business was already in deep trouble and on non accrual since mid-2019. Overall, we’d written three articles about the company, based on BDC valuations and what we were able to learn from the public record.

Now, thanks to a regional publication in Muskegon, Michigan we’ve been (almost) fully updated about what has happened to the company in recent months:

After an abrupt closure last year, kayak-maker KL Outdoors is back under new ownership, and business is “booming,” according to a company representative...KL Outdoors has since been resurrected by the founder of the Canadian company, GSC Technologies, state records show. The company has produced 64,000 kayaks since purchasing the liquidated assets of KLO Industries in June, David Baun of the new KL Outdoors told the Muskegon City Commission earlier this week.“We have 84 employees and we’re looking at continuing to grow,” Baun said.

As of June 2020 there were two BDCs with $11.8mn invested in the 2022 Term Loan of KLO Acquisition and KLO Intermediate – the predecessor company and its subsidiary, as well as in its Canadian company the inelegantly named 9357-5991 Quebec Inc. These were Apollo Investment (AINV) and Cion Investment. The former- public – BDC had written down its $4.8mn stake in KLO Acquisition to zero. (For some reason, Cion, although invested in the same facility still valued its position at $1.6mn).

AINV values its position in the Canadian entity at $2.2mn. Given what we know, we expect that both BDCs will take a 100% realized loss on the liquidation of the company in the IIIQ 2020 results. For AINV, this means a modest loss given the amount involved and the BDC’s size and a more material hit for Cion. We estimate the loss of annual investment income will be ($1.6mn), but that’s already impacted both lenders for over a year.

Neither BDC has revealed much about the fate of KLO since an update was made by AINV on a November 5, 2019 conference call, which amounted to the following:

Regarding KLO, our investment was placed on nonaccrual status last quarter due to the underperformance from lower customer demand, consolidation challenges and higher costs. The company’s liquidity position has continued to weaken. The company expects to complete a comprehensive restructuring in the coming months“.

BDC credit stories like these with their only episodic updates and large omissions are part of the impetus for publishing the BDC Credit Reporter. Otherwise, investors are left with more answers than questions by the BDCs involved and have to read the tea leaves of those gradually reducing quarterly valuations. Back in June 2019 when the company’s debt was first placed on non accrual (by one of the BDCs involved but not the other), the discount taken was just (14%), but then increased to (70%) by year end 2019 and now to (100%) and a likely complete write-off. We wonder if AINV will even mention KLO when reporting third quarter 2020 results ?

GK Holdings: To Be Acquired/Upgraded

A very complex transaction involving a SPAC (“special purpose acquisition company”) is happening that will involve its merger with Skillsoft and the concurrent acquisition of Global Knowledge Training LLC (aka GK Holdings Inc. in our records). Both Skillsoft and Global Knowledge/GK Holdings are BDC-financed companies and both are currently on non accrual. Given that the value of the transactions is said to be $1.5bn, chances are the two companies involved – and their lenders – are about to experience a change of fortune.

As of June 2020, Global Knowledge/GK Holdings was financed to the tune of $15mn by three BDCs led by publicly traded Goldman Sachs BDC (GSBD). The BDC has both a first lien and second lien debt position. The latter has been on non accrual since IQ 2020, as the pandemic impacted the education business. Also with outstandings – both in the second lien – are public BDC Harvest Capital (HCAP) with $3.0mn at cost and non traded Audax Credit BDC with $1.0mn. Then there’s non traded Business Development Corporation of America (BDCA for short) which has invested $14.5mn in Skillsoft’s debt, most of which is also on non accrual since the IIQ 2020.

Most likely – as far as we can tell – all this troubled debt will be repaid as part of the envisaged two part transaction and some ($11mn) of unrealized losses reversed by the lenders to the two companies involved. The BDC with the most to gain is BDCA, with GSBD close behind. HCAP’s exposure is small but so is the BDC, which means any improvement in the value of their second lien debt, written down by (40%), will be gratefully accepted.

We’ll be digging deeper and learning more but, at first blush, this all seems to be good news in a situation that was previously headed ever southwards, as detailed in our prior article on April 27, 2020, written before either company’s debt was known to be on non accrual. Based on what we currently understand, the BDC Credit Reporter will be upgrading Skillsoft and Global Knowledge/GK Holdings from CCR 5 all the way back to CCR 2 if and when the deal closes in January 2021. Of course, at that time BDC exposure might be nil if the debt is repaid, making the rating CCR 6 (no further exposure). We will update readers when matters become clearer.

California Resources Corp: Restructuring Plan Approved

A bankruptcy judge has approved the restructuring plan agreed between California Resources Corp and its creditors. Now the troubled and highly leveraged energy company is set to exit from bankruptcy protection shortly, only months after filing in July. As previously announced, the restructuring involves a $5bn debt forgiveness in return for equity control of the business by the lenders. Existing public shareholders are wiped out.

For the only BDC involved – non traded Business Development Corporation of America (BDCA) – this means their relationship with the company – which dates back to 2017 – is likely to go on for years to come but in a new form. As of June 2020, the BDC had written down its $10.3mn term loan position by (64%). We expect that whatever realized loss BDCA might book – probably in the IVQ 2020 – will be in the ($6mn-$7mn) range. Any DIP monies advanced in July might be converted to long term financing or repaid.

This is not over for California Resources or BDCA, but the future remains cloudy. We expect that – the restructuring and exit notwithstanding – the investment will remain on the underperforming list for some time yet.

MD America Energy LLC: Files Chapter 11

Credit troubles continue to haunt the oil patch and – occasionally – still involve BDC lenders. On October 12, 2020 MD America Energy LLC – a Texas E&P company – filed Chapter 11. As per the usual, the company and its lenders have a plan. This would involve cutting the $117mn or so of debt on the balance sheet in half and giving the existing lenders control of the company’s equity in a now-standard debt for equity swap. New debt of $60mn would be issued as part of this transaction and management expects to be back operating normally before very long.

However, the existing owner of the company – Meidu Energy Corp – who lost out in court to the MD America lenders – is not happy about the outcome, and is suing. So consider all the above provisional until the litigation is resolved.

The only BDC lender with exposure – surprisingly enough – is Sixth Street Specialty Lending (TSLX), which has $18.6mn invested in a 2023 Term Loan about to be converted into equity and a likely part recipient of the new, smaller Term loan proposed. TSLX had written down its position by only (14%) as of June 2020. With the bankruptcy, some ($1.9mn) of annual interest income will be interrupted for an undetermined period. If the restructuring plan is accepted, when income does resume half will not be coming back, and TSLX will have to look to some auspicious future and to its new common shares in the company for future value. We are expecting the BDC will book a realized loss of ($5mn-$8mn), probably in the IVQ 2020, but also possibly next year given the litigation.

We are downgrading the company from CCR 3 – which only occurred in the IIQ 2020 – to CCR 5 and adding the name to our Bankruptcy list. In our self appointed role as Monday Morning Credit Quarterback, we don’t see why TSLX had to involve itself in this sector (already bitten by another problematic energy borrower: Mississippi Resources). Moreover, the data at the moment suggests the ultimate loss here might be more severe than reserved for in June – when the oil sector was already in deepest trouble. TSLX may yet prove us wrong, so we’ll wait, see and report back.

General Nutrition Inc: Company Sold

On October 7, 2020 General Nutrition Inc (parent General Nutrition Holdings) was sold to Chinese-firm Harbin Pharmaceuticals as previously agreed to by the bankruptcy court. Just as well given that the $780mn purchase offer for the troubled supplements retailer was the only one on the table. Thankful creditors – both secured and unsecured – overwhelmingly voted for the Harbin plan even though virtually every constituency will lose money. General Nutrition admitted to owing $895mn when first filing bankruptcy. As to the future of the company ? “New GNC will be a wholly owned subsidiary of Harbin and registered in Delaware as a limited liability company“.

For the only BDC involved – publicly traded Harvest Capital (HCAP) – this will be a relief and may even involve in some improvement in net proceeds than the (63%) discount booked as of June 2020 on its $4.0mn in first lien term debt to GNC. Furthermore, as revealed in a footnote in the 10-Q, HCAP advanced additional monies as well:

Subsequent to GNC’s bankruptcy filing and quarter-end, the Company [HCAP] invested $1.0 million in a debtor-in-possession term loan to GNC, which carries an interest rate of LIBOR + 13.0% with a 1.00% LIBOR floor. In addition, the Company converted approximately $1.0 million of its existing senior secured term loan into a new first lien first-out term loan that carries an interest rate of L + 10.0%“. 

We can’t tell you exactly how much of the $5.0mn at cost that HCAP has advanced will end up back in the BDC’s pocket but – we’ll guess – more than $3.0mn. That suggests any realized loss will be minimal, even though HCAP will be losing a nice little 14% earning asset in that DIP loan mentioned above. More importantly, the BDC will have $3mn or more to recycle into new investments or to pay its April dividend, which has been declared but no payment date set. The GNC final tally will show up in the IVQ 2020 books.

We are re-rating General Nutrition to CCR 6 (no longer a BDC portfolio company) from CCR 5. If we’re right, this could be an almost happy ending for a credit that HCAP booked in IQ 2019 and which performed normally till 2020 when Covid-19 was its undoing. This also removes one more BDC-financed portfolio company from the ranks of the bankruptcy list. There are now more exits than entries as troubled companies like GNC get sorted out in a variety of ways.

Mallinckrodt Intl Finance SA: Files Chapter 11

The long projected bankruptcy filing of Mallinckrodt PLC and many of its subsidiaries (including Mallinckrodt Intl Finance SA) has finally occurred on October 12, 2020. Our last article on September 28 had called out a likely filing, but the BDC Credit Reporter has been mentioning the high likelihood of this move since September 2019. Bankruptcy is accompanied by a huge and highly complex restructuring agreement affecting creditors, plaintiffs and other interested parties. However, from our perspective the most important news is the following statement in the company’s press release about the restructuring:

All allowed First Lien Credit Agreement Claims, First Lien Note Claims and Second Lien Note Claims are expected to be reinstated at existing rates and maturities

From what we can tell, the only BDC with exposure is publicly-traded Barings BDC (BBDC), which has invested $3.2mn in first lien debt due in 2024. Based on the above, we expect that no loss is forthcoming. As of June 2020, BBDC carried the debt at a (25%) discount. That is likely to get reversed if and when the restructuring plan is implemented as envisaged. The valuation is likely to be increased in the IIIQ 2020 results when published but a final resolution will have to await what might be a relatively short trip through the bankruptcy process. It’s also possible that BBDC has already sold this position and all the above is moot. In its most recent conference call BBDC did admit to trading out of these large cap, liquid positions where other troubled names were concerned. Maybe Mallinckrodt was on the list…

We are downgrading the company from CCR 4 to CCR 5 for the moment, but may upgrade to CCR 3 – or even CCR 2 – when the bankruptcy process is complete. The company is removed from the Weakest Links list of companies expected to default. As we’ve said in earlier updates, this bankruptcy will be big news in the broader financial markets but is of little importance in the BDC sector given the very modest, single BDC, exposure and at the top of the capital structure.