Posts for Oaktree Specialty Lending

Edmentum Ultimate Holdings: Company Sold

In December 2020 , the Vistria Group – a private equity firm – acquired Edmentum Inc. and its parent, Edmentum Ultimate Holdings. Terms were not disclosed but the press release announcing the acquisition indicated “New Mountain Finance Corporation and funds managed by BlackRock will retain ownership positions“.

From a BDC perspective this is a very important transaction as Edmentum was – through September 30, 2020 – one of the larger BDC-financed portfolio companies (number 79 on the list maintained by Advantage Data). Also, there are five BDCs involved, many of them with very large dollar exposure. These include New Mountain Finance (NMFC) and BlackRock TCP Capital (TCPC). Also important is that with the Vistria Group acquisition the future exposure of the 5 BDCs involved is changing. See the Advantage Data Table for IIIQ 2020 of all BDC exposure:

Edmentum has been on BDC books since IVQ 2012 – initially only in the form of first and second lien debt -and has had a chequered past. In 2015 the company was restructured and several of the lenders recognized realized losses. (For example, NMFC lost half of its $31mn then invested). In the restructuring, Oaktree Specialty Lending (OCSL); Prospect Capital (PSEC), NMFC and BKCC initiated equity stakes. To keep a long story short, over the years BDC exposure increased to reach $204.4mn even as some of the debt outstanding was carried as non-performing at different times by different lenders. The BDC Credit Reporter has carried Edmentum on its underperforming list since the IVQ 2014.

However, in recent quarters the valuation of the BDC investments has been improving. As of September 2020 virtually all the different debt and equity stakes held by BDCs were valued at par or at a premium, with the exception of a small equity stake held by Gladstone Capital (GLAD). Now as we begin to hear from BDCs about IVQ 2020 results the outcome of their investments is becoming known, with varying results. GLAD reported the following :

In December 2020, our investment in Edmentum Ultimate Holdings, LLC was sold, which resulted in a realized loss of approximately $2.4 million on our equity investment. In connection with the sale, we received net cash proceeds of approximately $4.9 million, including the repayment of our debt investment of $4.6 million at par.

PSEC fared better: On December 11, 2020, we sold our 11.51% Class A voting interest in Edmentum Holdings and recorded a realized gain of $3,724 in our Consolidated Statement of Operations for the quarter ended December 30, 2020. Concurrently, Edmentum Holdings fully repaid the $9,312 Unsecured Senior PIK Note and the $45,277 Unsecured Junior PIK Note, and Edmentum, Inc. fully repaid the $8,758 Second Lien Revolving Credit Facility receivable to us at par.

OCSL also ended up in the black : “We realized a full par recovery on our debt investment and recorded a total gain of $23 million”. 

Not heard from yet are NMFC and BKCC. However, we get the impression from the press release and comments made by TCPC after the IIIQ 2020 results that New Mountain and BlackRock intend to maintain investments in post-sale Edmentum. Here’s what NMFC said on its November 5, 2021 conference call in answer to a question about its intentions for Edmentum: “We’d like to maybe take some chips off the table, recapitalize the balance sheet, maybe bring in a partner. But at the same time, we do think there’s very significant upside from here that you probably wouldn’t quite get until you show the sustainability of the earnings trend, which we absolutely believe in. And so we may elect to hold some exposure for another period of time to get the benefit of that incremental value gain”.

So while 3 BDCs are going out the door, these two others are likely to remain, but we’ll need the IVQ 2020 results to suss out all the details.  The GLAD realized loss and the earlier 2015 losses notwithstanding, this is a positive turnaround for Edmentum, which was rated CCR 5 as recently as September 2019 and which we have maintained at a CCR 3 rating ever since. After we hear from TCPC and NMFC we’re likely to return Edmentum to CCR 2 status, especially if and when we get a better understanding of the new capital structure and prospects for the business.   

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 ?

California Pizza Kitchen: Reaches Agreement With Lenders

According to multiple reports, California Pizza Kitchen (“CPK”) – in Chapter 11 bankruptcy – has reached an agreement in principle in late September 2020 with its first lien lenders and unsecured creditors. That should shortly allow the restaurant chain – already making operational plans for post-bankruptcy operations – to make an exit shortly from the court’s protection.

With a bit of luck CPK should exit bankruptcy in the IVQ 2020 and we’ll get a clear picture of which of the now 6 BDC lenders involved ended up where. Total outstandings from the BDC lenders is $49.5mn in IIQ 2020, slightly higher than in the IQ 2020. (BTW, Prospect Flexible Income appears to be no longer a lender). We already know, though, that this will prove to have been a misstep for all the BDCs involved.

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.

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.

California Pizza Kitchen: Files Chapter 11

On July 30, 2020 California Pizza Kitchen (aka CPK) filed for Chapter 11, as part of a broad restructuring plan (RSA) agreed with its first lien lenders. As readers will expect by now, the RSA envisages a “debt for equity swap” and additional financing to get the restaurant company through this difficult period, presumably financed by some or all those same lenders that are in the existing financing. CPK hopes to be in and out of bankruptcy in 3 months.

The BDC Credit Reporter has written about the company on three prior occasions. Our most recent contribution followed learning that several BDC lenders had placed their debt outstanding to the business on non accrual, but not all. In any case, bankruptcy has seemed like a forgone conclusion for some time. As a result, the seven BDCs involved (6 of whom are publicly traded) will have to face the consequences of their $48.1mn invested in the debt of CPK.

Common sense suggests the second lien debt holders : Great Elm Corporation (GECC) and Capitala Finance (CPTA) will have to write off the $4.1mn and $4.9mn respectively held. The rest of the debt is in first lien debt (including a tranche held by GECC) and will mostly become non income producing, when swapped for common shares. We expect the BDCs involved will write off 80% or more of their positions, but we’ll gather more details shortly. As usual in these situations, total exposure may increase as some of the lenders fund their share of the additional capital. For the record, the other BDCs involved are Main Street (MAIN); Capital Southwest (CSWC); Monroe Capital (MRCC) and Oaktree Specialty Lending (OCSL) ; as well as non traded TP Flexible Income with a tiny position.

CPK is – arguably an example of a “Second Wave” credit default. Admittedly, the company was already underperforming before Covid-19 but would likely not have had to file Chapter 11 if the virus had not occurred. As recently as the IIQ 2019 GECC – in a case of ill timing – bought into the second lien at a (5%) discount to par. Going forward, a much de-leveraged CPK should have a decent chance of survival, and may even thrive in the long run. This might allow the BDCs involved to recoup some of their capital but it’s going to be a long slog.

Currently, the BDC Reporter has rated CPK CCR 5 – or non performing – which remains unchanged. We’ll re-rate the company when the RSA – or some other outcome – is finalized. By the way, this is the ninth BDC-financed company to file for bankruptcy – all Chapter 11 – in the month of July, keeping up the blistering pace set in June.

Covia: Files Chapter 11-Updated

Yet another energy-related company files for bankruptcy protection. This time it’s Covia (full name Covia Holdings Corporation). The company “is a leading provider of diversified mineral solutions“. We’ve written about Covia twice before and this outcome was not a surprise as the company had been rated CCR 4 by the BDC Credit Reporter since April 16, 2020. According to its press release, Covia has entered into a restructuring plan which will reduce $1bn of debt and fixed costs while still maintaining $250mn in cash resources to support operations. Given the liquidity and the pre-agreed “debt for equity swap” (the details of which we don’t fully understand as yet) Covia hopes to be in and out of bankruptcy court in short order. We shall have to see.

Typically, Oaktree Specialty Lending (OCSL) does not invest in the energy sector but made an exception – now regretted – for Covia. The BDC has $7.9mn invested in the company’s 2025 Term Loan, first booked in the IIQ 2018. At March 31, 2020 OCSL already had the debt placed on non accrual and the position discounted by a conservative (53%). This position first slipped onto the underperformers list in the IVQ 2018 and was rated CCR 3 and discounted (22%) before Covid-19 came along and brought the energy sector to its knees. In that regard Covia is yet another First Wave credit – a company already in trouble before the virus. Moody’s had a B3 rating on the company in November 2019.

For OCSL, with its income from Covia already interrupted and the valuation close to or lower than the market value of the 2025 Term debt, the impact of this bankruptcy should be minimal. However, we don’t yet know if any investment income will be forthcoming post-bankruptcy and whether the BDC will have to ante up some new funds as part of the restructuring. More will be learned shortly. Nonetheless, this story is mostly notable that yet another BDC-financed company has filed for bankruptcy in June, which is turning out to be a record month in all the wrong ways.

Addendum: A reader brought to our attention after the initial publication of this article that Oaktree Strategic Income (OCSI) also has $6.9mn invested at cost in Covia as of March 31, 2020. The debt is held in the BDC’s JV, and treated in the same way as OCSL: placed on non accrual and with the same discount. The exposure did not show up in our search, so we apologize for the miss. Even databases can miss out sometimes.

California Pizza Kitchen: Second Lien Debt On Non Accrual

We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).

Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.

Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…

The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.

For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.

Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.

Covia : Downgrade To CCR 4 From CCR 3

We hear that Covia Corp. – “a minerals and materials supplier for industrial and energy markets” – has been engaged in drastic cost cutting in the wake of the Covid-19 crisis “designed to reduce overhead expenses by about $25 million from 2019 levels”. The company had been struggling even before Covid-19 – and lower oil prices came along – due to its status as a supplier to the energy sector.

We initiated the company on the Underperformers list back on January 1, 2020, with an initial Corporate Credit Rating of 3. With the latest news and with the 2025 Term Loan trading at a (55%) discount compared to (22%) at year end 2019, we have downgraded the outlook to CCR 4 from CCR 3. We’re not yet placing the company on our Weakest Links list – companies deemed highly likely to become non performers shortly – but it’s early days yet. The stock it at risk of being delisted from the NYSE and trades at just $0.45. A year ago that was $6.25…

The only BDC with exposure to publicly traded Covia remains Oaktree Specialty Lending (OCSL) with a cost of $7.9mn and a current value probably close to $3.5mn. That means an unrealized loss of ($2.6mn) is likely to be booked at the end of the IQ 2020. Income at risk – should Covia default – is about $0.400mn a year. We’ll check back after OCSL reports IQ 2020 results or earlier if anything new transpires.

Houghton Mifflin Harcourt: Debt Valuation, Stock Price Drop.

Publisher Houghton Mifflin Harcourt has gone and drawn on its revolver for a second time in two weeks. The company “drew down $100 million under the facility on March 24 and then another $50 million on March 30 to boost liquidity“.

In addition, the stock price of the publicly traded company (ticker: HMHC) has fallen precipitously and closed on Friday April 3, 2020 at just $1.52. The company has lost more than three-quarters of its market value in a few weeks.

This is bad news for the two BDCs with $9.1mn in debt exposure, which was valued at a premium as of December 31, 2019. The biggest exposure is held by Oaktree Specialty Lending (OCSL) and then there’s non-listed Guggenheim Credit Income Fund 2019. Both seem to be invested in the 2024 Term Loan, which is currently trading at 88 cents on the dollar. The income at risk is three-quarters of a million dollars annually. Sadly, both BDCs only got involved with this credit in the IVQ 2019 and must be in a state of lender’s regret given the very fast deterioration.

We have added the company to the Under Performers List, with an initial Corporate Credit Rating of 3 on our 5 point scale. At this point – based on that still modest drop in value on the debt – we are not yet projecting an ultimate realized loss. After all, the cash from those drawn revolvers will serve as a temporary buffer. We’re in wait-and-see mode here as in so many other places. Much depends on how long the stay-at-home orders last.

Belk Inc.: Lay-Offs Announced

This is the BDC Credit Reporter’s first article about Belk Inc., the revered North Carolina department store company. However, we’ve had Belk on our radar – and on the under performers list – since IVQ 2016. No wonder: the business of Belk is retail and you know what’s happened to that…

Furthermore – and worrying – is the large amount of BDC capital invested in the debt and equity of the company. Mostly the former. At 9/30/2019 there were 6 BDCs involved with a combined $170mn invested at cost in various debt tranches and a sliver of common stock. The FMV was $128mn, and may go lower when IVQ 2019 results get published. According to Advantage Data, which keeps a list of all BDC funded companies by capital committed, Belk was the 103rd largest investment, out of 4,000 or more companies out there.

The BDC with the most to lose is FS-KKR Capital (FSK), which has committed $122mn, or 72% of the total – all in junior debt or equity. In the IIIQ 2019, there was an amendment made to the debt, and the second lien was split into two. One tranche is carried at par and the second – larger – amount was discounted in value even more than before. See the discussion on FSK’s Conference Call.

As far back as June of 2019 S&P was on the record with a downgrade to CCC, and the contention “a debt exchange that we would view as distressed could occur over the next 12 months”. For our part – not to be outdone – we long ago added the retailer to our list of companies that we expect to default or be restructured in 2020.

All the above is to explain why we’re writing about what might be – or might not – a minor development (except to the individuals involved) at the company: the lay-off of 80 personnel at headquarters. This seems to be yet another sign that all is not well in North Carolina and there may be other shoes to drop. We’ll be keeping close tabs – including those fourth quarter 2019 BDC valuations and any color coming from conference call.

California Pizza Kitchen: Downgraded by Rating Groups

We pride ourselves on being timely about alerting readers to material new developments at under-performing BDC-financed companies. In this case, though, we’ve been slow to notice the deterioration underway at iconic restaurant chain California Pizza Kitchen (CPK). In July and August 2019, the company was downgraded by both S&P and Moody’s to speculative grade status. Here’s a sample of what the former said: “We are downgrading CPK to ‘CCC+’ from ‘B-‘ to reflect our view that the company’s capital structure may be unsustainable over the long term.

Moody’s said the following: “CPK’s Caa1 Corporate Family Rating is constrained by its high leverage, modest interest coverage, small scale and geographic concentration relative to comparable casual dining concepts. The company is further constrained by the challenging operating environment which includes soft same store sales growth, with weak traffic trends, and increased labor expense as a percentage of restaurant sales which continue to pressure profitability margins“.

All the above notwithstanding, the 2022 and 2023 Term debt in which seven BDCs have committed $48mn was still valued at a discount of less than (10%) last time results were published in September 2019. As of June 2019 the debt was trading (almost) at par. As of now, though, the publicly traded 2022 Term Loan is trading at a (12.5%-15%) discount, and the more junior 2023 facility at (20%) off. Time to get worried about the $5.0mn of annual investment income that is being generated for the BDCs involved.

There are 6 public BDCs with material exposure, led by Main Street (MAIN) and followed in descending dollar amount by Great Elm (GECC); Monroe Capital (MRCC); Capitala Finance (CPTA); Capital Southwest (CSWC) and Oaktree Specialty (OCSL) – a veritable potpourri of funds with little else in common. There does not seem to be any immediate risk of default, although Moody’s did suggest there was a potential need for a covenant waiver or amendment at year end. That may not have been required or has been granted or could be under discussion. We have a Corporate Credit Rating of 3 on CPK on our 5 point scale, but that could move down quickly in 2020 if performance does not turn around – which seems unlikely – or if PE owner Golden Gate Capital, which bought the famous chain in 2011, does not inject new capital.

We admit the BDC Credit Reporter has been a bit slow to flagging CPK’s credit troubles, but expect to hear much more from us in the months ahead if the company’s debt continues to drop in value. We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends – referred to by Moody’s above – that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited.

Covia: Announces Multiple Financing Developments

Covia Holdings – a publicly traded “provider of mineral-based material solutions for the Industrial and Energy markets” – announced a series of financial measures intended to improve its “financial flexibility” on December 31, 2019. The most material development was the arrangement of an $85 million committed credit facility from PNC Bank. The new facility is secured by the Company’s U.S. accounts receivable. At the same time the company voluntarily canceled its $200 million revolving standby credit facility that contained restrictive covenants.

The above measures – and other actions taken as outlined in the company’s press release – are supposed to improve future results and provide liquidity. Nonetheless, substantial worries remain given Covia’s recent poor financial performance and exposure to the energy market. In fact, we added the company to the Under Performers List back in IVQ 2018, with a CCR of 3, based on a reduction in the value of the 2025 Term Loan held by the only BDC lender – Oaktree Specialty Lending or OCSL – to a discount of (28%). Subsequently the value of that debt has fluctuated, closing as of December 31 2019 of (24%).

We retain hope that the company can pull itself out of its doldrums, but note that debt to Adjusted EBITDA is very high (in excess of 10x by our estimate) and that the debt contains no covenants. The fact that Covia is raising new debt by essentially carving out valuable balance sheet assets to maintain liquidity is more worrying than reassuring for existing lenders who are essentially being pushed down the priority repayment scale.

At September 30, 2019 OCSL’s exposure – all in the 2025 Term Loan – amounted to $7.9mn, and $0.5mn of investment income is at risk. That’s a modest exposure for the public BDC (0.5% of its portfolio) and – apparently – not in any imminent danger. This article initiates our coverage in the BDC Credit Reporter. We’ll be checking back in periodically as new results are published.

Citgo Holdings: Possible Foreclosure of Shares

Here’s a “down the rabbit hole” credit story that’s just come to our attention, but which might have a happy ending for the BDCs involved. Citgo Holdings has pledged 50.1% of its stock to support its parent – Petroleos de Venezuela’s (PDVSA)- 2020 bonds. A billion dollar debt payment is due, and the funds are not available. Big debt holder of the PDVSA bonds Ashmore Group wants to be repaid and proposes to foreclose if not paid. However – and this where business and politics torn from the headlines intersects – the Trump Administration might intervene to prevent the seizure. That’s because PDVSA and Citgo are effectively controlled by Venezuela’s opposition leader and “self proclaimed President” Juan Guaido.

Guaido is a U.S. ally and an opponent of actual President Nicolas Maduro. That’s making the Trump administration consider an unusual intervention in the debt markets. This is ably described in a Bloomberg article by Ben Bartenstein published on October 22 about the subject:

While some U.S. officials are leery of interfering in the bond market or property rights, the White House also worries that it would be a political disaster for Guaido to lose Citgo, the Houston-based refining unit of Venezuela’s state-owned oil company, the people said. President Nicolas Maduro’s regime could blame that on Guaido, Trump and Wall Street, they said.

As a result, officials in Washington are acknowledging the increasing likelihood that the Treasury Department’s Office of Foreign Assets Control revokes General License 5, effectively putting transactions related to the PDVSA 2020 bonds on the same footing as other Venezuelan financial deals that are prohibited. There’s still some opposition to such a move, the people said, and talks continue. The U.S. has refrained from formally promising this to Guaido’s representatives because that may dissuade them from negotiating with creditors, the people said.

“If OFAC revokes GL5 and makes changes to the related FAQ guidance, the enforcement on the collateral securing the 2020 bonds will be unauthorized,” said Cecely Hugh, investment counsel in emerging-market debt at Aberdeen Standard Investments in London. “This means that the collateral would be effectively worthless while the sanctions are in place.”

At June 30, 2019 one BDC – Oaktree Specialty Lending (OCSL) had invested $21.8mn in Citgo Holdings debt due 2020. The debt was valued at par. Now the good news: on August 15, 2019 the 2020 debt seems to have been refinanced, according to a company press release. What we don’t know is if OCSL doubled down and invested in either of the two new facilities that “took out” the 2020 debt. Also both OCSL and sister BDC Oaktree Strategic Income (OCSI) have close to $30mn invested in the debt of Citgo Petroleum Corp, a subsidiary of Holdings. We don’t know if that debt will be affected now – or by the final maturity in 2024 – by what’s happening in the world of realpolitik. The good news is that all publicly traded Citgo Petroleum debt – as opposed to the PDVSA debt – is trading at or above par.

This is more complicated than our usual credits, but we’re adding Citgo – parent and subsidiary – to the under-performers list with a CCR rating of 3 (Watch List) till the smoke clears.

Lannett Company: Negative Seeking Alpha Article

An August 22, 2019 article about Lannett Company on Seeking Alpha is a useful summary of the bear case about future business prospects. For our part, we were intrigued by the argument made that the company is “dangerously leveraged at 5.8x adj. Net Debt to EBITDA and just 1.76x interest coverage”. This mirrors earlier concerns expressed by Moody’s last year when the company’s corporate and debt ratings were all downgraded following the loss of a major contract.

As of the IIQ 2019, the two BDCs with $9mn of aggregate exposure are Oaktree Strategic Income (OCSI) and Oaktree Specialty Lending (OCSL) in two senior debt loans maturing in 2020 and 2022. The biggest discount is modest – (6%) – but we have placed Lannett on our under-performing list in the Watch category (CCR 3) since the IIIQ of 2018 regardless, due to the concerns reflected above about high leverage and business reverses. As of now, the 2022 debt – which is publicly traded – remains valued at the same discount as of June 2019. However, that could change and $0.700mn of income is at risk. Neither BDC has a substantial exposure (although OCSI has the proportionately much bigger position and in the riskier 2022 loan) , but still deserves mention.

Zep, Inc: New CEO Hired

On August 20, 2019 Zep Inc., an industrial cleanings product developer, announced the hiring of a new CEO: Dan Smytka.

That’s notable from a BDC standpoint, both because of the substantial exposure to the company ($126.6mn at June 2019) from 6 public and non-traded BDCs and because the business has been under-performing of late. That caused the second lien debt in the latest quarter to be written down by as much as (30%) and first lien debt by (19%), according to Advantage Data‘s records. (As usual there’s much variation in values between BDCs). By comparison, a year ago the debt was valued, in all cases, close to par. We checked the latest prices on Advantage Data for both tranches of debt and found discounts of (25%) and (30%), suggesting the markets have been getting more pessimistic since mid-year.

What’s more, Moody’s downgraded the company to speculative status back in April, including the first lien secured debt. The rating group is concerned about debt to EBITDA that exceeds 10x ! A saving grace is that the earliest debt maturity is 2022.

Clearly Mr Smytka has a big challenge ahead and the BDCs involved – especially three Goldman Sachs funds with the bulk of the exposure – will be watching with great interest if a turnaround can be achieved. With over $12mn of annual investment income at risk, this is one of the largest BDC trouble spots. We have the company on our Worry List or CCR 4.

Weatherford International: Final Approval Of DIP Financing

The bankruptcy court allowed the bankrupt oil field services company access to the full $250mn of debtor-in-possession financing requested. From a BDC perspective – with the only material exposure that of OakTree Specialty Lending (OCSL) in the 2024 senior debt – we wonder if there’s been any involvement in this new post-Chapter 11 facility. OCSL has $12mn at par in the existing debt now in default, costing nearly $1.2mn of annualized investment income since the filing on July 7, 2019, which should be reflected in its third quarter results. We also know OCSL had written the debt down (25%) at March 31, 2019 but was trading much lower in the markets as of today: a (55%) discount. Suggests the ultimate realized loss for OCSL might be in excess of $6mn, but these numbers will shift with the final resolution of the bankruptcy.

99 Cents Only Stores: Completes Recapitalization

On July 18, 2019, 99 Cents Only Stores announced by press release the completion of a restructuring plan that the BDC Credit Reporter discussed more than a month ago. Basically, the second lien and third lien debt holders are undertaking a debt for a minority equity stake position in the troubled value retailer. In addition, the sponsors – Ares Management and a Canadian pension fund – and other players will be injecting new equity capital as well. Moody’s has already – back on June 12, 2019 – called the restructuring ” a distressed exchange” , and downgraded the company’s rating. We had previously believed that a $20mn portion of the $55mn at cost in BDC exposure owned by sister funds Oaktree Specialty Lending (OCSL) and Oaktree Specialty Income (OCSI) was going to convert to equity, as part of the restructuring. (We assumed the asset-based loan in which TPG Specialty – TSLX –  has $32mn invested would either continue unchanged or be refinanced). On further review, and without any guidance on the subject from the BDCs involved or the company’s press release, we’ve changed our mind and assume the first lien debt will continue as before and not be involved in the conversion to equity. Both the OCSI/OCSL debt and the facility in which TSLX is involved in were trading at the close on July 19, 2019 at a (9%) discount to par, and were paying interest normally. (These are publicly traded debt issues, and we used Advantage Data’s real-time loan and bond pricing module). Given the new capital structure; the infusion of capital and reports that the operational turnaround underway at 99 Cents Only Stores that has been underway for months is bearing fruit, the short term credit outlook is up. We are upgrading the company from a CCR 4 Rating (what we call or Worry List) to a CCR 3 rating (aka Watch List). Much remains to be done following this second restructuring in so many years, and we do not forget that 99 Cents Only operates in the Bermuda Triangle industry of retail where other players have restructured or gone through Chapter 11 only to go bankrupt again. For the moment, though, we are cautiously optimistic and expect Moody’s may shortly upgrade the company and the remaining debt.

99 Cents Only Stores: Completes Debt For Equity Swap

The good news for 99 Cents Only Stores, LLC – which is owned by Ares Management and the Canada Pension Plan Investment Board ? Chapter 11 bankruptcy has been averted. Back on June 7, we warned on our Twitter feed that bankruptcy was a risk. Now the bad news: Ducking a trip to the bankruptcy court has been accomplished by a debt for equity swap and a fresh capital raise. According to Retail Dive:  “under the agreement, 99 Cents Only is to issue common and preferred stock in return for its outstanding $146 million second-lien term loan facility and $143 million secured notes”. From what we can tell, there are two BDCs in the secured notes : sister BDCs OCSL and OCSI, with aggregate exposure at cost of over $20mn, and generating over $1.5mn in annual investment income. (The bulk of the exposure is at OCSL). At March 31, 2019 the debt was still performing and written down only modestly (11-14%), although restructuring negotiations were already underway. This is not a transaction the “new” management at OCSL/OCSI can blame on Fifth Street. According to Advantage Data, the debt was added in late 2017 after Oaktree’s investiture as external manager.

Frankly, we’re a little surprised at how generously the BDCs have valued their exposure throughout. As late as IIIQ 2018, the debt was carried at par even though 99 Cents Only has been in trouble almost from day one, thanks to heavy leverage placed on the 2011 buyout. For a sense of proportion – and quoting Moody’s – debt to EBITDA was around 8x. In 2017, the company almost filed for Chapter 11 and was only saved by an earlier debt restructuring. It’s unclear if this second restructuring will do the trick, but OCSL and OCSI are now in for the long term in a non income producing position at the bottom of a still leveraged balance sheet. We’ll have to wait till the publication of the IIQ 2019 results to see how the BDCs value their new positions and whether any realized losses are booked. BDCs have great latitude in this area, so investors should pay attention to what is done as well as said.

Also with exposure is asset-based specialist TSLX, with $32.2mn in 2021 debt. The BDC has continued to mark the position at par, suggesting TSLX will be repaid in full on its FILO ABL facility when the time comes. We have no further details from the public record. We do know – from Advantage Data – that TSLX will be paid more than OCSL and OCSI and – as far as we can tell – have a better credit outcome thanks to their ABL approach. No wonder multiple other BDCs are eyeing getting into this specialized form of lending. By the way – outside of the public filings – none of the three BDCs involved appear to have discussed the challenges at the company since the debt was booked, either on a Conference Call or Investor Presentation. (We use Sentieo which searches all available filings for any input keywords).

By the way, we don’t have a Company File for the company, but will be adding one given that – this restructuring notwithstanding – BDC exposure continues and the final resolution of the greater than $50mn invested is some way off. After all, S&P has a rating of CC for the company…

Lannett Company: Article Questions Ability To Remain Solvent

According to an article published on Seeking Alpha and in charges brought by the State Of Connecticut, Lannett Company (LCI)  and ” many other generic pharmaceutical firms have been conspiring for years to drive prices of generics up”. The author of the SA article continues :

…there is no clear path for LCI to remain solvent if they receive a fine roughly equivalent to their market cap (high end of the proposed range). In a previous report I highlighted how little free cash flow was projected given the current guidance. With a run rate of ~$107m in EBITDA, $68m in interest expense and $32.5m in CapEx (mid-range of the guidance) the company will be producing ~$7m in FCF.

$7m in FCF isn’t going to be very helpful in paying off the $650m in net debt, but in a situation where the government tacks on a few hundred million of additional liabilities – that probably spells bankruptcy protection”.

Admittedly, the author is short the stock. Nonetheless, there is cause for concern. There are 3 BDCs with $16.4mn in senior secured exposure to the highly leveraged company: OCSI, Cion Investment and OCSL with a smaller position. In the IIIQ 2018, the debt was written down sufficiently to cause us to place the Company on our Watch List. In the IVQ 2018 the discounts increased t0 a range of (6%) to (18%). More write-downs might be ahead or even non-accrual. About $1.25mn of investment income is at risk.