Imagine Print Solutions: Restructuring & Sale Complete

We last wrote about Imagine ! Print Solutions Inc. (recently renamed The Imagine Group) back in early 2020, when some of its debt was on non accrual. We wrote at the time “Clearly the company is highly likely to file for Chapter 11 or restructure shortly“. We were right, except about the time frame, but now the reckoning has occurred. We now know from Moody’s, which is bowing out as a rating group, that :

On 22 January 2020 [we imagine Moody’s meant 2021] , Imagine completed a restructuring whereby first lien and second lien debt holders were either converted to equity or eliminated. Moody’s views these transactions as distressed exchanges and events of default as they reflect a failure to meet the original promise under the debt agreements and results in significant losses to lenders“.

The company will now be owned “by a combination of its former lenders and funds managed by Cerberus Capital Management, L.P. (“Cerberus”), the Goldman Sachs Merchant Banking Division and Arbour Lane Capital Management, LP.“.

Where this leaves the only BDC with remaining exposure to the company – Oxford Square (OXSQ) – is unclear. As of September 30, 2020, OXSQ had $14mn invested at cost in $15mn of second lien 2023 Term debt, with a FMV of under $0.2mn. The debt has been non-performing and depriving OXSQ of $1.35mn in annual investment Income since the IVQ of 2019. Along the way, non-traded Audax Credit BDC and Capital Southwest (CSWC) – through its joint venture – have sold off their positions, which amounted to $1.5mn and $3mn respectively at cost, leaving OXSQ the only BDC standing.

We don’t know if OXSQ is somehow involved with the new ownership or will just be writing off its entire exposure as a result of this transaction. Either way, though, the BDC seems almost certain to record a significant loss from this investment. Technically this was not a Chapter 11 filing but is being treatedas a distressed exchange and thus a default” by Moody’s, and will be added to the BDC Credit Reporter’s list of companies that went bankrupt. Given that OXSQ has essentially already written off the investment, we expect no impact on either book value or income going forwards. Tentatively we have re-rated Imagine from CCR 5 to CCR 6, which indicates sold or no longer held.

Alpha Media, LLC: Lenders In Conflict

Just hours after we wrote about Alpha Media LLC’s Chapter 11 filing, we’ve uncovered further details about what’s happening at this radio chain. According to several trade and financial articles we’ve read, management are working with second-lien lenders to provide Debtor In Possession (“DIP”) capital. In fact, the company already signed a $20 million Senior Secured Priming Superpriority Debtor-In-Possession Note Purchase Agreement.

The fly in the ointment – and what we were not aware of when writing our earlier article – is that there is a dispute about the future of the business – and its $267mn in debt – between first lien and second lien lenders. The group funding the DIP is from the second lien side, led by Intermediate Capital Group, said to hold over $100mn of pre-petition debt. The new buyers are offering to advance $37.5mn in expansion capital, which has the understandable support of the radio chain’s management. Here’s the actual bankruptcy filing with all the details.

The fly in the ointment is that – according to financial news reports – the senior lenders to Alpha Media, led by Fortress Investment Group, oppose the restructuring plan. Apparently Fortress made the company an offer it could refuse earlier and has chosen to go with the second lien lenders and their proposal of less debt and additional capital instead. More we cannot tell you at this stage but this might mean this Chapter 11 could get contentious. That can sometimes extract more capital for the company involved but can also exhaust already stretched financial resources and prolong the period of insecurity which a Chapter 11 filing involves.

Where the only BDC lender with exposure – WhiteHorse Finance (WHF) – sits in all this – with $11.2mn of exposure – we can’t say for certainty. WHF’s filings show the BDC holds a “first lien secured term loan“. That would suggest the BDC would line up with Fortress, but we don’t know. Probably WHF – due to its small position (which dates back to 2018 ) – has only little say in this situation. Just how this all plays out for WHF – and all the parties involved – remains a question mark that will get its answer in the weeks ahead. We’ll circle back as appropriate.

Alpha Media LLC: Files Chapter 11

According to trade publication Radio Online, the media company Alpha Media, LLC has filed for bankruptcy protection. We also learn that “certain lenders” have agreed to advance Debtor In Possession monies and additional capital in the future (and,, presumably, will forgive some legacy debt) to get the business back on its feet in return for 100% control of the company, alongside management. Now the lenders and management are seeking court approval of this plan. We also learned : “Alpha Media said it will continue operating its stations without interruption, providing engaging news, music, sports and entertainment to its communities. The company’s day-to-day operations will continue in the normal course during this process“.

For the BDC Credit Reporter, this was unexpected news as the only BDC that still has exposure to the company – in the form of a 2022 Term Loan to the tune of $5.0mn – last valued its position at close to par and as performing. That BDC is WhiteHorse Finance (WHF), who briefly mentioned Alpha Media in its last conference call and said its value was “improving”. No word of an imminent bankruptcy. However, with the benefit of hindsight, we notice that the pricing on the loan was hiked up in the IIIQ 2020 from LIBOR + 600bps to Prime + 750 bps. Never a good sign.

We’re in no position to suss out what the final resolution of this investment might be. We don’t even know if WHF is part of the rescue creditor group. What we can say is that this company has been added to our IMPORTANT list, which means we expect a material change to show up in upcoming results. Technically Alpha Media has gone Chapter 11 in IQ 2021 but the debt may have been placed on non accrual earlier. In any case, over half a million dollars of investment income a year is in danger of not being collected for some period. More will be learned when WHF reports IVQ 2020 results.

The amount at risk is relatively modest, but we’ll still be interested to see how the BDC approaches this situation: inject more capital, time, sweat and tears or walk away. This is a calculation many BDC lenders have had to make of late, with most voting for the former. Our money in on WHF – sitting at the top of Alpha’s balance sheet – opting for doubling down.

Avanti Communications: In Financial Difficulty

Space IntelReport – basing itself off a company press release – indicates satellite operator Avanti Communications may be in a “spot of bother” as the British say in their understated way. Here is everything we learned from the trade publication, and which we were not able to duplicate elsewhere:

[Avanti] is back on a cliff edge and facing a British Chapter 11-type restructuring as a bond payment deadline approaches that would trigger a broader default. Avanti said it was in “advanced discussions with a financing source” to cover the debt payment, due Feb. 8, but a recent change in Britain’s bankruptcy code could make a Chapter 11-type filing more appealing than a refinancing on onerous terms“.

BDC exposure to Avanti is “Major”, i.e. over $100mn, or $115mn to be exact as of September 30, 2020. Of that $103mn at cost is held by Great Elm (GECC) and the $12mn remainder by BlackRock TCP Capital (TCPC). At fair market value GECC has $39mn, split between debt and equity and TCPC $5mn. The latter BDC has some of its debt carried as non accrual but GECC does not. All GECC’s debt is paid is kind at rates that range from 9.5% and 12.0%.

We’ve written about Avanti both at the BDC Credit Reporter and at the BDC Reporter for years, ever since Great Elm contributed its position when taking over Full Circle Capital and changing the BDC’s ownership. The company has faced many financial challenges and has been restructured before, leaving the business hugely leveraged. This last challenge could be the proverbial straw but we have no way of really knowing.

If a British bankruptcy should occur, though, a day of reckoning might be here for the bulk of the GECC and TCPC exposure. Just over $100mn of the $115mn invested is in second lien and equity and is very unlikely to have any value. Even the roughly $15mn in “senior debt” might be subject to a haircut. This could prove the biggest BDC portfolio company mishap of 2021 so fat, admittedly only three weeks in.

Far and away most at risk is GECC, despite regularly writing down its position over the years. At cost Avanti represents 38% of GECC’s portfolio assets and a less overpowering 16% at FMV. Also importantly, Avanti seems to represent 17% of investment income, which is the equivalent of 50% of the BDC’s latest Net Investment Income.

the company continues to grow revenue and EBITDA and unleveraged free cash flow. And we are pleased with that progress. We expect them to continue upon that trajectory and are hopeful that the continuation of that trajectory leads to a good result for our investment in the company and ultimately, a successful exit for our investment in the company“.

Belk Inc.: Negotiating With Creditors

Bloomberg’s crack business journalists have their ear to the ground – or to the telephone – and have news about troubled regional department store Belk Inc. in an article on January 15, 2021:

Belk Inc., the department store chain owned by Sycamore Partners, is talking with creditors about easing its almost $2.4 billion debt load and has tapped law firm Kirkland & Ellis and investment bank Lazard Ltd. for advice.

Belk and its advisers are huddling with holders of the retailer’s debt — which includes first-lien and second-lien securities — according to people with knowledge of the matter. Options could include a debt-for-equity exchange and new financing, according to the people, who asked not to be named discussing private negotiations”.

It’s been a long time coming. We wrote back in February 2020 – before the pandemic took hold – that Belk’s was laying off headquarters personnel and re-negotiating its debt. Clearly, matters have gotten worse since then and there’s no relief in sight: viz these hush-hush negotiations.

BDC exposure – almost exclusively held by the FS-KKR organization in FS KKR Capital (FSK) and FS KKR Capital II (FSKR) remains “Major” by size : $158mn at cost. However, since last we wrote the FMV – always a moving target where BDC appraisals are concerned – has dropped substantially, to $46mn as of IIIQ 2020. The equity held has been written to zero, the second lien discounted by as much as (76%) and the first lien debt as much as (60%). All the debt is on non accrual at both BDCs. Clearly, if the Belk situation moves to some sort of resolution in the months ahead – whether by agreement between the parties or through the bankruptcy process – some very large losses may occur. We expect the equity and second lien could be fully written off and the senior debt recover only 50%. That would mean a further ($26mn) or more in fair market losses and an eventual aggregate realized loss of close to ($140mn). When these large BDC positions fail, they fail with a big thud.

We wouldn’t be surprised to see KKR accept a debt for equity deal as they’ve done in other transactions but is a department store business model viable today ? That’s a question being asked of several BDC-financed retailers already and the jury is still out even if restructuring deals are getting done. Whatever happens, this is going to be a major credit disaster for the FS KKR group, although management can reasonably point out that the initial investment was booked all the way back in 2015 and by GSO Blackstone, when that group was in charge of the BDCs lending. However, that second lien exposure – two thirds of total outstandings – looks egregiously risky both by size and by sector.

From a rating standpoint, Belk’s remains rated CCR 5, and is tagged an Important transaction, which means we expect something material to happen – although we don’t know what – in the months ahead that will get reflected in the BDCs net asset value or earnings. We’ll be circling back to Belk’s as soon as something gets resolved in those early stage negotiations Bloomberg warned us of.

NPC International Inc: Company Sold

The long and winding road for NPC International Inc. appears to be reaching a final resolution. The franchisee of hundreds of fast food locations, which filed for bankruptcy back on July 1, 2020 has inked a $801mn deal to sell its assets to two different buyers. The company is likely to exit bankruptcy shortly. We won’t get into all the details or the history of the company’s failure, but refer readers to our five earlier articles.

For the only BDC with exposure –Bain Capital Specialty Finance (BCSF) – this will mean a final tallying up. As of June 2020, the BDC had $14.5mn showing in first and second lien debt to the company, which had been on non-accrual since IVQ 2019. As of September 2020, only the first lien debt shows up in BCSF’s investment list, suggesting a realized loss of ($9.2mn) has already been booked. We can’t be 100% certain as the BDC does not name names when these losses occur.

BCSF had $5.3mn at cost and $4.3mn at FMV left outstanding – all in first lien debt – as of September 2020. We believe – in the absence of harder numbers – that’s a pretty good picture of what to expect going forward in terms of proceeds to be received, all of which may show up in the IQ 2021 results. If we’re right, BCSF will have lost two-thirds of the maximum funds advanced to NPC, a relationship that began IQ 2017.

This transaction is close enough to its resolution for the BDC Credit Reporter to mention – again – that the restaurant business is a very difficult one for lenders. We searched our own archives with the word “restaurant” and were reminded of the large number of casualties we’ve seen over the years, even before Covid-19 raised the stakes further. The sector should probably be added to oil & gas exploration; energy services and brick and mortar retail as segments that BDCs – and their shareholders – should treat with extreme caution.

We undertook a search of Advantage Data’s database of all BDC investments and found 59 different restaurant-related companies listed. The BDC Credit Reporter’s own database shows 14 different restaurant companies underperforming. That’s a very rough way to assess such things but a quarter of all restaurant names in some sort of trouble seems high to us. Food for thought. Pun intended.

AMP Solar Group: Carlyle To Invest In Company

Here’s a mystery for you. What are the implications of the announcement that Carlyle Group is making a $374mn investment commitment to AMP Solar Group ? As Carlyle’s press release says, the company :

…”is a global renewable energy infrastructure manager, developer and owner. Since 2009, the Company has successfully developed over 1.8 gigawatts of distributed and utility-scale renewable generation projects, hybrid generation plus storage projects, and stand-alone battery storage projects around the world. Amp Energy’s proprietary digital energy platform, Amp X, also provides a diverse portfolio of disruptive and interoperable solutions, including a state-of-the-art smart transformer, that enable real-time autonomous management and optimized dispatch of all forms of distributed generation and loads across the grid. The Carlyle investment will help catalyze the continued rapid growth of both Amp’s asset base and Amp X within its core markets of North America, Japan, Australia, Iberia and the UK.

Apollo Investment (AINV) has $10mn invested in equity in AMP Solar (owns 6.6%) and $13.2mn in a UK subsidiary, which goes by the name AMP Solar Group UK or Solarplicity. The former investment is valued at a (14%) discount to cost while the latter is valued at only $0.17 on the dollar. The debt and the preferred on the UK company is on non accrual so the entire $23.2mn which AINV has invested at cost is non-income producing.

We don’t know if Carlyle’s involvement validates the multi-year investment in AMP Solar and we will see either a sale of the BDC’s position to them or an increase in the business valuation. Maybe the debt to the UK operation – never very profitable as the yield was fixed at 4% – will return ? We just don’t know but hope to learn more from AINV when IVQ 2020 results are published and discussed in February 2021.

Furniture Factory Outlet: Files Chapter 11

We’re a few weeks late to this news but troubled retailer Furniture Factory Outlet, LLC filed Chapter 11 on November 5, 2020. This was no great surprise as the company – as discussed in two prior articles – has been underperforming even before the pandemic began. With Covid-19 in the mix, the company entered a spiral, went on non accrual and is now under court protection and has a $7mn “stalking horse” bid from American Freight. Apparently Furniture Factory has $50mn in funded debt to contend with and liquidity challenges.

This looks like the final nail in the coffin for the company’s only BDC lender/investor: Stellus Capital (SCM). The $18mn invested – mostly in first lien debt – was written down to $2.1mn as of September 2020. That value was probably set with the knowledge of the pending bankruptcy. The chances are SCM will have to write off 90% – or even more – of its capital invested, but no material further change in value is likely, if only because the remaining value is so low. The first lien and small subordinated loan SCM holds were generating $0.9mn a year of investment income through IQ 2020.

We checked and confirmed that the company remains in bankruptcy here in mid-January 2021. This might push a final resolution – and a realized loss – to beyond the IQ 2021. At this point, though, there’s no reason to believe that the company is anything but a large loss – albeit one that has been in the cards for months – for SCM.

The furniture business – as old credit hands like the BDC Credit Reporter will tell you – is a notoriously difficult industry to lend into, even if the bulk of your exposure – as with SCM – is nominally in first lien debt. This investment by SCM dates back to 2016, before the general “retail apocalypse” became crystal clear to all. However, as recently as IQ 2018, the BDC doubled its exposure, just when mall vacancies in the U.S. reached a six year high. In retrospect, SCM may have wished they had headed in the opposite direction.

Black Angus Steakhouses: To Scale Down Operations

Restaurant chain Black Angus Steakhouses LLC has closed half of its eateries in response to the pandemic. This follows the earlier permanent closure of several locations in two states. According to the San Fernando Valley Business Journal the Sherman Oaks-based chain “now has 15 restaurants operating in California, Arizona, Washington and Hawaii. The company owns a total of 34 locations in five states“.

This is bad news for the two BDC lenders to the company: PhenixFIN (PFX) and non-traded Sierra Income. (Until recently PFX was managed by Medley Management which controls Sierra and was called Medley Capital or MCC). The two BDCs have advanced just short of $31mn in first lien debt to the company that was due 12/31/2020. However, the obligations have been on non accrual since the IQ 2020 and it’s unlikely the debt has been repaid since last we heard from PFX at the end of the IIIQ 2020. At that point, both BDCs were discounting their non income producing loans by (35%) – (38%).

Common sense suggests that things may go from worse to worser at Black Angus and a further reduction in the value of the debt investment will be forthcoming. We’re changing our outlook for ultimate resolution to a loss of (50%-75%) of cost. At the upper end of the range that might result in several million dollars of further write-downs in the BDC positions before this credit gets resolved in one way or another.

We’ll revert when we hear more from Black Angus or when Sierra and PFX report IVQ 2020 results.

Community Intervention Services: Files Chapter 11

On January 5, 2021 substance abuse chain Community Intervention Services Inc. filed Chapter 11. At the same time – as reported by the WSJ – the company’s assets are to be sold to the Mentor Network, which is based in Boston, for $39.5mn.

The only BDC with exposure – as featured in an earlier article on March 14, 2020 is OFS Capital (OFS), which has invested $7.639mn at cost in the subordinated debt. The loan has been on non accrual since June 2016, and valued at zero since IVQ 2017. Chances do not look good that OFS, or any junior creditors, will receive anything from any eventual assert sale.

We expect a realized loss will be booked at some point in 2021 by OFS when the transaction is fully settled. There should be no further impact. OFS long ago ceased to discuss the company in its quarterly conference calls: the last time Community Intervention was mentioned was in 2018.

More notable is that – as far as we can tell – this is the first bankruptcy of a BDC-financed portfolio company in 2021. The substance abuse sector has not been kind to BDC lenders of late, with a public company recently filing for Chapter 11. This was an HIG portfolio company , acquired in 2013 and seems to be a complete write-off for the sponsor and the junior creditors as well.

Sequential Brands: Charged With Accounting Fraud

The BDC Credit Reporter has written multiple articles about publicly traded Sequential Brands (SQBG) over the last two years. There are five different updates in the archives. In the past, we were mostly concerned about the consumer brands conglomerate’s liquidity. Now the company, it’s shareholders and creditors face a new challenge: charges by the SEC that the company did not properly account for goodwill.

The complaint, filed in federal district court in Manhattan, charges Sequential with violating antifraud, reporting, books and records, and internal controls provisions of the federal securities laws and seeks injunctive relief and civil monetary penalties”.

As reported previously, there are three BDCs with exposure to the company, of which two have outsized amounts outstanding – mostly in first lien debt due in 2024: FS KKR Capital II (FSKR) and FS KKR Capital (FSK), with $218mn and $61mn respectively invested at cost. Far behind in terms of dollars – but invested in second lien debt is Apollo Investment (AINV) with $13mn.

For our part, we had recently upgraded Sequential from CCR 4 to CCR 3 in mid-year 2020 as our concerns about weak liquidity and a potential restructuring or bankruptcy seemed overblown at a time when the BDCs themselves (through IQ 2020) were valuing their debt almost at par. We had removed the company from our Weakest Links list as well.

Still, back on September 2, 2020 we wrote in our internal notes: “We wonder – after reviewing the IIQ 2020 results again – whether we were wise to upgrade from CCR 4 to CCR 3 following the IQ 2020 valuations. We may have allowed ourselves to be taken in by the almost knee jerk optimistic valuation of BDC lenders/investors when facing a major exposure. For example, AINV’s second lien debt is discounted but -5%. Regrets. We may have a few“.

Now we’re back to downgrading Sequential to CCR 4 again. It’s not just the SEC charges – which do not seem to have fazed shareholders. We also note that the Board has announced its intention to explore “strategic alternatives“. Furthermore, we’ve noticed that the FS KKR BDCs have been increasing their discount of the first lien debt in the last two quarters. At September 30, 2020 the discount was (15%). (AINV discounts its more junior debt only -4%).

Taken together, this is worrying and given the aggregate size of BDC exposure – $292mn at cost and $25mn of annual interest income – worth paying attention to. FSKR and FSK shareholders should have a special interest in any outcome – especially a poor one. Given the “strategic alternatives” exploration, we may hear sooner rather than later about the direction of Sequential Brands.

Chief Fire Intermediate: IIIQ 2020 Update

We’re playing catch-up in discussing Chief Fire Intermediate Inc. (aka Chief Fire Prevention and Mechanical Corp). The kitchen contractor, which serves the north-east, has been non performing since the IQ 2020. That was only one quarter after Capitala Finance (CPTA) first invested in the business with a mix of first lien debt, preferred and common, supporting an acquisition by Trinity Private Equity.

Unfortunately for the company, CPTA and Trinity this was a case of uber- bad timing. The company principally services the restaurant business in New York City, and you know what’s happening there. Within weeks of booking a $8.1mn first lien loan yielding 8.7%, the debt became non performing. The preferred and equity were written to zero. The debt is currently discounted by (25%) as of September 30, 2020 but began at a more modest (12%).

CPTA has said nothing since issuing a press release when the investment was first booked a year ago. As a result, we’re relying on the public record – which tells us nothing – and the quarterly CPTA valuations. The current value given is $6.1mn, an overall (33%) unrealized loss from a total cost of $9.0mn. For our purposes, we wouldn’t be surprised to see the downward valuation trend continue and result in a potential realized loss of (50%). Or more.

Also unknown is whether some sort of resolution is in the cards in the short run. Until then, CPTA’s capital – and potential income – is frozen. For our part, we’ll provide an update when we hear anything new and notable.

Infinite Care LLC: Returns To Performing Status

BDC managers do not like to name names – even when they have good news to report. On December 24, 2020 Harvest Capital (HCAP) – as part of a conference call devoted to its proposed merger with Portman Ridge (PTMN) – reviewed recent developments at two of its four non performing portfolio companies. In this regard we learned the following about an anonymous company: “..Another one of our longer-lived nonperformers is we recently took active management of the company, and its performance has improved dramatically in the last 6 months and is back on accrual status this quarter. And we’re hoping to be out of that investment potentially in the next 6 months“.

By a process of deduction, we’re 99% certain HCAP is talking about Infinite Care LLC – a home health care operator. The company has been on HCAP’s books since 2016 and in 2017 was completely restructured and the BDC took legal and operational control. The debt has remained non performing for years. Of late, though, despite having first lien debt remaining on non accrual, HCAP has been valuing one of the loans above cost, a suggestion something has been changing for the better.

As of September 2020 total HCAP exposure at cost to Infinite Care was $13.7mn, of which $7.8mn was in debt priced at a below market 3.0% and due 1/1/2021. The $5.9mn of equity involved is still valued at zero, but that may change based on the opaque disclosure on that conference call. Overall, HCAP’s outstandings were valued at $8.5mn.

It’s too early to assume HCAP will be making a full recovery – or better, but the trend is positive. At this point we’re guessing that a buyer is being negotiated with and that the New Year 2021 loan maturity will be extended. Maybe HCAP will get away with a small realized loss when all is said and done, and a greater value than what was showing at September 30, 2020. As importantly the capital tied up in this business for many years will get freed up to benefit whoever the future shareholders of the BDC will be.

Mood Media: Company Sold

According to news reports Mood Media Corp. has been sold to Vector Capital for an unknown amount. Current lenders are to continue to provide debt financing under the new ownership. The BDC Reporter has written about the company on three prior occasions. Most recently, we wrote about Mood Media when the business re-structured and emerged from bankruptcy for a second time in recent years.

For the three BDCs with exposure – publicly traded FS KKR Capital (FSK) and FS KKR Capital II (FSKR) and non-traded Business Development Corporation Of America (“BDCA”) – this company has been a major disaster from a credit standpoint. As of June 2020, total exposure at cost – both in the form of senior debt and equity – totaled $122mn. Then came the most recent restructuring in August 2020 and huge realized losses had to be recognized. As far as we can tell (the BDCs themselves are coy in the filings about the specifics and on their conference calls) $110mn or more was permanently written off.

As of September – FSK and FSKR held an equity stake in restructured Mood Media but that had no cost or FMV attached. We assume the two sister BDCs permanently wrote off ($108mn) in August and do not seem to have participated in any post-restructuring debt facilities. By contrast, BDCA still has $12.4mn of debt and equity at cost and $14.4mn at FMV. (We have no explanation for these discrepancies as this is a privately-held company which does not disclose much in the way of information).

Now that Mood Media has been sold, we expect FSK and FSKR will just move on, but BDCA might continue as lender. We’ll be curious to see if the $4.4mn value of restructured equity will be reflected in the IVQ 2020 BDCA results.

For FSK and FSKR it’s been a long and winding road that begin in 2011 and 2012 respectively and quadrupled in size over time. Given that the two BDCs at the end of the day had to write off essentially every dollar advanced is a black mark. Even for BDCs of this size realized losses of ($50mn) plus are material.

AAC Holdings: Completes Restructuring

The BDC Credit Reporter write about AAC Holdings, Inc (aka “American Addiction Centers”) a lot. This is our eleventh update and will not be the last. Last time we wrote – back on June 21, 2020 – we concluded in this way: “We get the feeling a debt for equity swap is in the cards and the BDCs on the books will be involved for many more years to come and the amounts of capital deployed will yet increase, possibly to over $80mn“.

That’s just what seems to have happened, based on a press release from the company on December 14, 2020. This announced the completion of “ a financial restructuring process” which involves a much lower debt load ($500mn !); a new CEO (picked from within the ranks of the company’s senior management) and a new Board. The Chairman of that new 7 person Board is Bowen Diehl, the CEO of Capital Southwest (CSWC). The BDC is one of four BDCs – both public and private – with what is now $82mn in exposure to the company.

Otherwise, the press release is un-generous in providing the details of what is clearly a debt for equity swap that will take the previously public business private. Perhaps we’ll have to wait till the IVQ 2020 BDC results are published in February 2021 to learn what realized loss might be booked and which lender owns what of AAC and what debt is left ? As of September 2020, the lenders-future owners had already taken ($24mn) in unrealized losses, or nearly 30% of funds advanced. Some of the lenders in the 2023 Term debt had booked discounts of (54%).

Clearly, from a credit standpoint and with some of the debt on non accrual for over a year (from IIIQ 2019) this has been a material setback for CSWC; Main Street Capital (MAIN); New Mountain Finance (NMFC) and non-traded HMS Income, which MAIN manages. We assume that the lenders have high hopes that the company – still facing plenty of pandemic-related operational challenges – can recoup some or all what has been lost in the years ahead with the lenders at the tiller. Before that begins, though, we need to know what the bill has been for the BDCs shareholders so far.

This is going to be an excellent test case of whether the BDCs involved can successfully rescue a portfolio company or whether good money (and managers time) is going after bad. CSWC is very familiar with this sector and Mr Diehl is a logical Chairman of a re-structured AAC. Still, that’s no guarantee that the business can be saved.

Covia: Investment Exit and Realized Loss

In the IIQ 2020, both Oaktree Strategic Lending (OCSL) and Oaktree Strategic Income (OCSI), disposed of their first lien loans to Covia, “a minerals and materials supplier for industrial and energy markets“. As we discussed in an earlier post on June 30, 2020, the two sister BDCs had $14.7mn in exposure, which had been placed on non accrual in IQ 2020 and which had been discounted by (52%).

For the record, we now know that OCSL “exited” the investment in the IIQ 2020, and booked a realized loss of ($3.3mn). As of March, OCSL had invested $7.860mn and booked an unrealized loss of ($4.140mn), leaving a FMV of $3.720mn. The actual realized loss booked was lower than the IQ 2020 valuation might have less us to expect.

We believe OCSI – which held Covia through its Glick JV – also exited its position in IIQ 2020 and booked a similar realized loss. (OCSI’s cost was $1mn lower). However, due to the loose reporting requirements for off balance sheet JVs that does not get explicitly shown in the filings. We do know, though, that Covia was no longer on the JV’s books from the IIQ 2020.

The losses are modest for both BDCs. However, for OCSL the Covia realized loss was the only material write-off in a quarter that included several realized gains. Total investment income lost for both BDCs is around a quarter of a million dollars per annum. The moral in this minor setback ? Maybe it’s to avoid any borrower involved in the highly volatile energy markets. Whether OCSL and OCSI agree with that remains to be seen. The BDCs still own several energy-related credits, but will new ones be added ?

Serta Simmons Bedding: IIIQ 2020 Update

We’ve written about bedding manufacturer Serta Simmons Bedding LLC multiple times before because much has been going on with the company. Even before the pandemic, the company was underperforming. The BDC Credit Reporter downgraded Serta to a CCR 3 rating in the IQ 2019. That was raised to a CCR 4 in the IQ 2020 when the debt of the BDC was discounted by (50%), and talk of bankruptcy was in the air. Our most recent update occurred on June 23, 2020 shortly after the company dodged the bankruptcy bullet by undertaking a controversial restructuring gambit.

As this thoughtful article from Bloomberg explains, management sided with certain of its existing lenders to (essentially) stiff some of the other lenders; while reducing total debt and generating fresh liquidity at the same time. We won’t get into a detailed discussion of how the situation played out but will say that the only BDC with exposure – Barings BDC (BBDC) – joined in with the “winners” in this internecine struggle. The losers – led by Apollo Global – went to court to dispute the deal and lost.

For our purposes, BBDC went from a $4.9mn par position ($3.9mn at cost) in a first lien term loan due in November 2023 priced at LIBOR + 350 (with a 1% floor) to positions of $10.6mn at cost in two “super priority loans” with a August 1 2023 end date, but priced at LIBOR + 750, also with a 1% floor. Although pricing is the same, one tranche is a “first out” and the other a “second out” and are valued differently by BBDC and the market. As of September 30, 2020 BBDC values the first out at a premium to par and the second lien at a (12%) discount, slightly worse than the prior quarter when this debt was first booked.

To get to this point – better pricing and “super priority” status – BBDC had to agree to swap out its earlier debt at a discount and advance new funds to the struggling mattress manufacturer. Not clear from the BDC’s financial statements is whether a realized loss of any sort was booked as part of this bold exchange. (We had first thought BBDC was going for a debt for equity swap, but realize now that this is a debt for debt swap – also a standard restructuring technique).

At this stage, we have upgraded Serta to CCR 3 status. However, we don’t believe the company is out of the woods yet given market conditions and the still substantial debt load. Furthermore, BBDC has essentially “tripled down” in terms of total exposure, raising what was a modest exposure to a more material level. Undoubtedly, we will be revisiting Serta’s long and winding credit road again.

Fieldwood Energy: IIIQ 2020 Update

Dedicated readers with an interest in the “energy-calypse” (trademark pending) will remember that we last wrote about Fieldwood Energy LLC on August 4, 2020. That was when the E&P producer achieved a Chapter Twenty Two – filing for Chapter 11 protection twice. The first time was in 2018. At that point there were three BDCs with $13.3mn in exposure to the company’s debt. Leading the pack was Barings BDC (BBDC) with $10mn, followed by non-traded Monroe Capital Income Plus Corp and NexPoint Capital with just over $3mn invested between them.

We promised at the time to circle back to Fieldwood once we hear about whether the court is in agreement with the proposed plan and when we can evaluate what the company’s balance sheet – and business prospects – might look like going forward“. However, the most interesting news since our last article is that BBDC has thrown in the towel – not unreasonably given the circumstances – and booked a realized loss in the IIIQ 2020 from the disposition of its investment. The BDC did not explicitly spell out what the realized loss was but we know that the $10.063mn at cost had an FMV of $1.817mn at June. This suggests the loss was somewhere between ($8mn) and ($10mn). Given that there was no interest forthcoming as the debt was on non accrual from the IIQ, income is unaffected. BBDC booked ($21mn) in net realized losses in the quarter, so this was a material setback, even if expected.

The other two non-traded BDCs continue to have exposure to Fieldwood. The company has arranged a $100mn DIP facility and is seeking to sell its assets. As far as we can tell, the business remains under court protection. From the BDC Credit Reporter’s standpoint, this has become a “non material” company given that the remaining FMV is only $0.75mn.

Whatever the final outcome – and prospects do not look encouraging – this is yet another example – if any were needed – that lending to E&P companies is fraught with risk and not appropriate in almost any situation and at any position in the capital structure.

Elite Dental Partners LLC: Restructured

We learn from Golub Capital’s (GBDC) December 1, 2020 10-K filing and subsequent conference call that portfolio company Elite Dental Partners, LLC was restructured in the IIIQ 2020. A “debt for equity” swap was involved and GBDC booked a ($6.5mn) realized loss. (As far as we can tell, this was the largest realized loss incurred by GBDC in FY 2020 where total realized losses reached -$18.7mn, and one of two such setbacks in the dental field). After the restructuring was completed, the debt – which was on non accrual – returned to accrual status. Currently total remaining exposure amounts to $15.5mn, with $11.4mn in a unitranche loan and the rest in equity. GBDC values its overall investment at a slight discount to cost. The maturity (2023) and pricing of the debt (L + 525 bps) is unchanged from before the default and restructuring.

We wish we had more color to offer but GBDC is typically very tight lipped about its troubled credits and this is no exception. We believe Elite Dental – default notwithstanding – avoided filing for bankruptcy with this restructuring. We can also deduce that GBDC went from owning less than 5% of the equity to having somewhere between 5%-25%. Finally, we believe that the company’s troubles – which had begun to show up from a valuation perspective in the IVQ 2019 – were exacerbated by the pandemic and the virtual shut-down of dental practices in most places. Understandably the stakeholders – including GBDC – must have concluded that the fundamental business was worth saving and have done so.

The BDC Credit Reporter has upgraded the company from CCR 5 – non performing – to CCR 3. We are leaving the company on the underperformers list because the dental business continues to be challenged by rolling stay-at-home orders. Furthermore, we don’t know how generous the lenders were in cutting debt service obligations and what other creditors might be involved and on what terms. We do note that the unitranche debt is paying only 2% in cash going forward, with the remainder in PIK form. That suggests boosting/preserving liquidity remains important to Elite’s management.

We will continue to monitor the progress – of what remains a relatively large investment for GBDC – going forward. Given that the company is privately-held much of what we might learn – unless conditions deteriorate – will be from GBDC’s quarterly revaluations. Some $0.7mn of annual investment income remains in play.

Dynamic Product Tankers: Changes In Debt

For what it’s worth: there’s something happening here, but what it is ain’t exactly clear. We’re cribbing from Buffalo Springfield to reference Dynamic Product Tankers. The shipping business is 85% owned by Apollo Investment (AINV) and has been since 2015. (The rest is held by management). Since 2018, the BDC owner has also been a first lien lender with a $42mn first lien loan due in 2023 and priced at LIBOR + 700 basis points. [There’s another $50mn invested in the equity, which is valued at just $27.1mn but that’s another part of the story].

In the IIIQ 2020 AINV’s 10-Q no longer shows that 2023 first lien loan but a now $22mn subordinated loan due in 2024. Furthermore, the pricing on this ostensibly more junior capital is only LIBOR + 500 basis points. Management has not explained the change on its latest conference call but the 10-Q does show that the value of AINV’s investment has been written down ($9.5mn) in the past 6 months. That represents a third of AINV’s unrealized losses on its control companies in this period: i.e. material.

This could be a glass half full or half empty story. If the former, AINV has received some repayment of its debt, either from Dynamic or from a third party lender refinancing a portion of that first lien debt. If the latter, AINV is being pushed down the capital structure of the company to generate some cash by pledging a first security interest to a new lender. The low pricing for the debt and the continuing drop in the enterprise value makes us plump for the darker theory.

This has already impacted the income generated from this investment, which has dropped from a $3.5mn level to $1.2mn annual pace. Of course, if things are getting worse at Dynamic Product Tankers even that remaining income may be at risk and all the $49.1mn in debt and equity value remaining.

The BDC Credit Reporter affirms our existing CCR 4 rating on the company. We are not adding this to the Weakest Links list because AINV’s dual role of owner and lender makes very difficult handicapping when a default on the debt might be triggered. This may prove to be an important credit story for AINV, or much ado about nothing. We will learn something more when AINV next reports its results.