Back on February 19, 2020 when we first wrote about VIP Cinema Holdings, the movie theater seat manufacturer was in bankruptcy but planning to exit with a plan that included the conversion of debt to equity and new capital. Since then, though, we’ve had the Covid-19 situation, which has been a disaster for so many businesses, including the company’s prospective movie house clients.

Now, thanks to a legal challenge from a disgruntled unsecured creditor (Regal Cinemas) and a full fledged article in Law360, we hear that there is some doubt that the company will be able to proceed and get bankruptcy court approval to exit Chapter 11. Admittedly, this is one sided information as the company has not responded to claims made as yet.

However, one has to wonder – even without Regal’s complaints – if the company can survive in any form the extreme market conditions that Covid-19 has wrought and which show no signs of abating. For the three BDCs involved, this is making a bad situation worse. At year end 2019 – with the debt owed already on non accrual but before the Chapter 11 bankruptcy – VIP’s 2023 Term Loan had been written down by approx (55%). The expectation was that the BDC lenders would become owners in a fully de-leveraged entity. Now a complete loss on $23.6mn invested is a possibility. The BDCs involved are (in descending order of importance) publicly traded Main Street (MAIN); non-traded sister BDC HMS Income and public Garrison Capital (GARS).

We will check back when the BDC Credit Reporter determines if the company successfully exited Chapter 11 or not. Even then – and even without any debt outstanding – VIP may not yet survive. We are in a whole new environment and what was possible only a month ago in terms of company rescue will be very different going forward.

We have written about Constellis Group on four prior occasions. With the publishing of IVQ 2019 BDC results, our most dire predictions appear to be coming true. That’s unfortunate because on January 4, 2020 the BDC Reporter was saying darkly: “We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way“.

Now we’ve just seen OFS Capital’s (OFS) latest valuation of the 4/1/2025 “First Lien” debt. The loan has been discounted by (96%) from cost versus (71%) at 9/30/2019. Worse, and according to Advantage Data, currently that loan trades at 1 cent on the dollar... Likewise, FS-KKR Capital II has also reported IVQ 2019 results and the value of its 4/15/2022 Term Loan. That was discounted by (14%) in September, but (33%) at year-end 2019. Currently that loan – also on non accrual – is discounted (87%).

Let’s tot up the damage. There’s $9mn of investment income already interrupted since November 2019 (according to OFS) and potential realized losses across several tranches of debt of ($96mn-$100mn) by our rough estimate. That’s ($30mn) in additional unrealized depreciation from the 9/30/2019 levels for which we have values for all BDCs involved. We don’t have the latest word about how the restructuring of the company is going but by the time we hear, the lenders involved appear set to recover very little. Even then, that might be in the form of equity rather than cash.

Frankly, this is an unmitigated disaster for this Apollo Group-led buyout and for the BDC lenders involved. To be specific, the biggest hit is being taken by the non-traded BDCs in the FS-KKR Capital construct (FS Investment II; FS Investment III; FS Investment IV and CCT II, all of which are being rolled into one entity). By our count 86% of the exposure is there, with OFS the second BDC group on the list with $9.8mn at cost. Far behind are Garrison Capital (GARS); followed by two non-traded players with small outstandings.

We’ll be checking back when the final decision about a bankruptcy-restructuring is finalized but – from a lenders standpoint – most of the damage has been done and material recovery of any kind seems unlikely from the information at hand.

The BDC Credit Reporter added fishing and hunting specialty retailer Bass Pro Group LLC to the under performers list only in IVQ 2019. That was on the back of a worrisome note by Moody’s about the company, which we wrote about on October 1, 2019. The company is privately owned.

There’s been no new information from the ratings group that we’re aware of since, or anything material in the public record. However, when we checked Advantage Data’s records for the latest valuation of the company’s debt we noted a discount of (12%) on March 13, 2020, significantly higher than before the market melt-down.

Moreover, we couldn’t help surmising that a company still heavily reliant on walking around consumers – now stuck at home in some cases – might be impacted going forward. As Moody’s previously noted, the owners have had an “aggressive” financial stance. The loan in which the BDCS involved are funded was expanded in 2018 to allow for the repayment of junior capital, as Moody’s reported at the time. Also, EBITDA is at or above the levels we’d prefer for companies of this size. We are affirming our CCR 3 rating, but will be paying ever closer attention.

At the moment, though, BDC exposure is relatively modest: now just 2 players: publicly traded OFS Capital (OFS) and Garrison Capital (GARS), with $9.0mn invested at cost. (The latter has the bulk of the exposure). Non-traded GSO-Blackstone appears to have dropped out as lender late in 2019. In both remaining cases, the exposure is limited to involvement in the syndicated 2024 Term Loan, mentioned above. OFS actually valued the debt at a premium to par at 12/312/2019 (the GARS report is not available). That might even suggest the debt will shortly be repaid.

In our database, we’ve assumed some potential material credit losses in a worst case, but there’s no immediate reason to be concerned for the BDCs involved. Income at risk is just $0.6mn as the debt is priced at LIBOR + 500 bps.

Well, that’s embarrassing. For the last few weeks we’ve prided ourselves on having identified all BDC-funded companies that are under-performing. However, we’ve now learned that cinema seat manufacturer VIP Cinema Holdings has just filed Chapter 11, and that there are 3 BDCs involved and $24mn invested at cost who are about to take a haircut. VIP Holdings was not on our under performers list. All BDC exposure is in a 2023 Term Loan. We should have placed the company on the under performers list in the IIIQ 2019 (the last one reported) when the debt was discounted up to (25%), versus (8%) the prior quarter. The BDCs involved are Garrison Capital (GARS); Main Street (MAIN) and non-traded HMS Income, which is managed by MAIN.

The company appears to have a plan in place to allow a fast exit from bankruptcy: a debt-for-equity swap with the existing lenders that will see $178mn in debt extinguished out of $210mn and new capital brought in by a PE group – H.I.G. Capital. Reuters reports that the company “hopes to emerge from bankruptcy by mid-April, while preserving 373 jobs”

For the record: VIP was founded in 2008 in New Albany, Mississippi, as a residential furniture maker and reportedly has a 70% share of the U.S. market for luxury movie theater seating.

Questions have to be asked about lenders underwriting a single product company which services an industry (movie houses) whose troubles are well known. Also, when a borrower has a 70% market share the most likely direction is usually down. Still, we don’t know exactly how the BDCs involved will fare and exactly what portion of their debt will be converted to equity and what kind of realized loss – if any – will be booked. That’s likely to become evident in the IQ or IIQ 2020 results.

This new non accrual/bankruptcy is notable – besides from the fact that we missed the name in our research- for the speed at which the company went from performing to non performing. This credit dates back to IQ 2017, according to Advantage Data. As mentioned above VIP’s debt was valued close to par through IIQ 2019. Just a few months later virtually all its debt has to be written off for the business to be viable. This begs questions about the valuation process of the BDCs involved as we can’t imagine the slowdown in VIP’s sales was a very recent phenomenon. We worry that BDC lenders – and the army of valuation experts that review their investments just about every quarter – are only recognizing problems when they are right in front of them and inescapable. That’s good for manager compensation levels and keeps investors from worrying for a while, but may keep matters that should be brought into the open in the dark.

We’ve written eight prior articles about the publicly traded telecom + cable giant Frontier Communications, dating all the way back to March 2019. In fact, the company was added to our Under Performer list following IVQ 2018 results with a CCR 3 (Watch List) rating and downgraded further to a CCR 4 (Worry List) back on June 13, 2019. More recently, we predicted the company might file Chapter 11 in the IVQ 2019, but that did not happen. In our last report before this one, though, we said a Chapter 11 filing was likely in the IQ 2020. With the latest news reports, that seems likely to turn out to be true.

“People with knowledge of the matter” – and there are dozens of lenders, lawyers, insiders and regulators involved at this stage so journalists have plenty of sources – indicate the company is aiming to file a consensual, pre-packaged bankruptcy by March. On the horizon are $356mn of interest payments due in mid-March. As a result, Frontier’s new CEO and his team have been busy – according to these reports – meeting creditors and seeking to craft out a restructuring plan that would be blessed by the court. (The company itself has no comment).

From a BDC perspective, the question is now more about how each lender class will fare in the restructuring, and what impact there will be on interest income – running about $5mn a year. As we’ve noted before, the debt held by the BDC lenders remains valued at a premium to par, both in their own valuations and when we look at the market price of their secured debt on Advantage Data. Will Frontier restructure itself, go in and come out of Chapter 11 in a hurry and have no impact on the value or income of the $67.5mn in debt held by 8 BDCs ? We have our doubts, but that’s the state of play at the moment. We shall soon learn if those valuations are appropriate.

We warned in an earlier article on October 9, 2019 that for Constellis Holdings “a day of reckoning is coming – and fast”. Judging from two major – and related – developments, the time is nigh. On January 3, 2020 the Wall Street Journal reported the troubled security company “is in talks with creditors on a deal to restructure its $1 billion of debt, according to people with knowledge of the discussions”. Darkly, unnamed sources, warned that if an out of court restructuring didn’t happen, a “pre-packaged” Chapter 11 filing was also on the table. (That’s all part of the negotiation process in these kind of deals as interested parties suddenly find their way to the phone to confide to journalists, who are themselves happy to be of service).

We also learned that the company failed to make a scheduled principal payment on December 31 and has received a short term forbearance from its lenders.

At the same time, Moody’s went and downgraded the company’s corporate rating to Ca, and re-rated several debt tranches outstanding. Most worrying of all is that Moody’s reports that the company’s finances suddenly deteriorated in the last quarter of the year, resulting in a “liquidity crunch”.

All of which suggests the Day of Reckoning is here for the 8 BDCs with nearly $107mn in debt exposure at various points in the company’s balance sheet. Just one month ago, one of those BDC lenders – OFS Capital or OFS – waxed relatively optimistic about the outlook for Constellis: ” I want to note that the company is current on its payments. And based on discussions with management, they have stressed that they have adequate liquidity to fund operations. The company has a growing backlog and expects sequential performance improvement. The sponsor has substantial amount of cash invested in this business, and we expect continued focus from the sponsor”.

We now know that at least some of those reassurances are no longer true. This is reflected in the public prices of the outstanding debt as provided by Advantage Data. The 2022 Term Loan is trading at a (57%) discount, versus (14%) at September 30, 2019. The second lien debt is worth only 10 cents on the dollar in the market, down from 25 cents. At 9/30/2019 FMV was still around $84mn, down ($23mn) from cost. Now, we wouldn’t be surprised to see further losses of ($30mn)-($40mn) more at FMV and ultimate Realized Losses – which could crystallize very soon – of nearly ($75mn). Add to that the loss of income and you’ve got the first bona fide major set-back for BDC lenders in 2020 , should there be no last minute rescue.

As we’ve noted before, the bulk of the exposure – and thus any damage – will be concentrated in the four non-listed FS-KKR BDCs – CCT II, FSIC II, FSIC III and FSIC IV. This was a borrower that the group jumped into under the KKR regime, bringing BDC exposure from modest ($12mn) to major, when they initiated exposure in the IVQ 2018. Maybe the far sighted folk at the jointly run asset manager have their eyes on becoming equity owners of Constellis, but we don’t think so as Advantage Data’s records show the debt was purchased at a cost very close to par, and before the current downturn in corporate fortunes.

We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way.

We are initiating our credit coverage of Centric Brands Inc. with a rating of CCR 3, dating back to the IIQ 2019. At that time, Ares Capital (ARCC) discounted the value of its $24.6mn equity stake in the company by (24%), from par in the prior period. Given that the company is publicly traded (ticker: CTRC) that reflects a declining stock price, which was as high as $5.33 a share in mid-March. By the end of June CTRC was at $4.11. As we write this on December 28, 2019, the stock price has halved since the summer to $2.15.

Admittedly, most of the substantial BDC exposure of $123.8mn at cost is in the form of Term debt due in 2023, held by the afore mentioned ARCC, TCW Direct Lending and Garrison Capital (GARS). That debt has been valued very close to par since first being booked and remains so in late December, according to Advantage Data’s records.

Nonetheless, even a quick glance at the company’s 10-Q is enough to elicit credit concern. The company is fast growing, thanks to acquisitions in 2018 and 2019, but debt levels are very high and getting higher. We note that Adjusted EBITDA, as reported in the latest 10-Q for the first 9 months of 2019, was given as $122mn. Interest expense – which admittedly includes Pay-In-Kind income – was $142mn…The ‘comprehensive loss” over the same 9 month period was ($171mn). Yes, we know investors are too clever to take GAAP accounting as the be-all in this brave new world of adjusted numbers but that’s still a lot to swallow.

Notwithstanding the apparent complacency of the debt markets, the BDC Credit Reporter is worried about the leverage levels. Our concern is heightened because the amount of total BDC exposure is so high, especially for ARCC and TCW Direct Lending. Any sort of stumble by the company could materially impact book value and investment income earned. Nor should debt holders take too much comfort from the “first lien senior secured” appellation of the $99mn in term debt held by the BDCs. Sitting above them in order of priority is a secured Revolver – led by ARCC as administrative agent – and many of the company’s trade receivables are being sold off in a different financing facility.

We expect that we’ll be updating readers multiple times in the year ahead given that Centric is a public company and every quarter brings a new snapshot of performance. We’ll also keep an eye on stock and debt price performance, even if we don’t fully trust the credit antennas of the latter in the current frothy and generous market conditions.

The Wall Street Journal reports on October 9 that defense contractor Constellis Holdings “has engaged PJT Partners Inc. to engineer a plan for restructuring the company’s debt-laden balance sheet, according to people familiar with the matter“. PJT Parners is an investment bank, often used in turnaround work.

Otherwise, the WSJ article has no new information, except a recap of some of the highlights from the most recent financial filings. Some of that data is admittedly dire. We noticed that even after a recent asset sale – the subject of our last post about Constellis – “the company’s liquidity remained tight, amounting to just $33 million of cash and $18 million of availability on a revolving credit facility as of June 30“. That alone should send chills down the spines of anyone concerned about the company.

Anyway, the advent of a restructuring firm and those slim liquidity numbers suggests a day of reckoning is coming – and fast.

We discussed BDC exposure before when we first added Constellis to the under-performing list back in August. Judging by the current market valuations (source: Advantage Data) of the three different loans outstanding in which BDC lenders are involved, the debt is discounted from (8%) to (70%), higher than in June. Thankfully, 90% of of BDC exposure is in the 2022 Term Loan, which is valued the highest even after the news of a prospective restructure. Nonetheless, at current levels – and things could get much worse – potential ultimate realized losses could reach $20mn on the $109mn invested at cost, most of which has not been recognized even on an unrealized basis as of June 2019. Not to mention the loss of investment income, which we’ve previously pegged at $9mn annually.

Unfortunately Constellis has the possibility of being one of the biggest credit hotspots of the fourth quarter (if that’s when the rubber meets the road) for the BDC sector. The prospective damage will be widespread. There are 4 FS-KKR related non-listed funds with $90mn at cost lent to Constellis. OFS Capital (OFS) and Garrison Capital (GARS) and – to a lesser degree – two non-listed BDCs are also exposed.

According to a news report, Moody’s Investors Service “revised Bass Pro Group, L.L.C’s outlook to stable from positive and affirmed the company’s Ba3 Corporate Family Rating, Ba3-PD Probability of Default rating and B1 senior secured rating“. The change was caused by “revenue and earnings weakness“. Please read the article for the key details.

We’re far from panicking based on what we’ve learned to date but have just added the Bass Pro Group to our under-performing list, with an initial CCR 3 rating (Watch List). BDC exposure is a modest $14.4mn, shared by three BDCs. Income at risk is just over $1.0mn annually.

We’ll be keeping close tabs on this credit – leveraged over 5x – going forward.