Posts for Oaktree Strategic Income

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 ?

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.

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.

UFC: Downgraded By Ratings Group- Updated

UFC (full name UFC Holdings LLC) ,which is a subsidiary of Endeavor Operating Company LLC , has seen S&P downgrade both the company and its parent’s debt. As Forbes reported on March 16, 2020:

According to S&P, Endeavor and UFC “have significant exposure to live events, entertainment and content production, which are at risk of closure in the near term due to the spread of the coronavirus.” S&P placed all ratings on Endeavor and UFC, including the “B” issuer credit rating, on CreditWatch with negative implications. In other words, the junk bond ratings for both Endeavor and UFC could be lowered. S&P cited concerns over EBITDA (earnings before interest, taxes, depreciation and amortization) and liquidity.

To date, UFC management is holding off employee layoffs and even planning for a live event in mid-April. [Update: the live event has now been cancelled, as per April 10, 2020 news reports]

Nonetheless, we note that the 2026 Term Loan held by the only BDC with exposure – Oaktree Strategic Income (OCSI) – is trading at a (12%) discount. At year-end 2019, the $4.9mn in debt was carried at par.

The downgrade and the latest valuation are enough for the BDC Credit Reporter to place UFC on the Under Performers List. We are initiating coverage with a Corporate Credit Rating of 3. That means we’re still hopeful full recovery is more likely than not and keeps up from trying to estimate what any loss might be.

As we see, BDC exposure is modest and income at risk even more so given that UFC’s parent has several billion dollars in debt. That may be just as well given that UFC could be impacted for many more weeks to come by the abandonment of all public events. In the short run, a further downgrade by the BDC Credit Reporter – and others – is more likely than an upgrade. Longer term we are more optimistic.

Frontier Communications: Bankruptcy Plan & Date Set

After many months of delay – and ten prior articles from the BDC Credit Reporter – Frontier Communications (ticker: FTR) is going to file for Chapter 11 and that’s a Good Thing for the three BDCs and the $35.1mn in debt they have outstanding to the telecom company. We’ve reviewed the various restructuring plans that management and creditors are hashing out. All include provisions for the secured debt of Frontier to be repaid with….more secured debt. This debt will have new maturities but seemingly identical pricing. All BDC exposure is in the secured debt in various forms.

Below the current secured lenders there is $10bn of unsecured debt. At a stroke, that debt is going to be swapped into equity and lenders will become owners while the current public shareholders will be wiped out, or pretty much so.

For the BDCs involved – who’ve continued to value their positions at a premium through the seemingly endless restructuring negotiations this should be a positive outcome as the restructured and relaunched Frontier Communications – when the telecom emerges from Chapter 11 – will be much less leveraged: two-thirds off (see page 34 of the slide deck).

Down the road, we may even be able to remove the company from the under performers list, but we’re not getting ahead of ourselves. First, FTR has to actually file Chapter 11 (tentatively set for April 14). Then, Frontier has to emerge therefrom which – even with a pre-agreed plan in place- is not so straightforward in the current environment. Most difficult of all, the company has to successfully re-invent itself. We won’t get into everything Frontier has been and will need to become, but look at the company’s slides 15-17 for an idea of the strategic challenge involved.

All in all, though, for the BDCs involved – our principal concern – this is a likely positive outcome when those are in short supply right now. This is hardly the end of the Frontier Communications story on these pages, but maybe – to quote Winston Churchill – “the end of the beginning” ?

Frontier Communications: To Skip Interest Payments

On March 16, 2020 Bloomberg reported that troubled telecom giant Frontier Communications plans to skip making interest payments on some of its bonds, starting a 60 day countdown to a payment default. We’ve written nine times (!) about Frontier before, given the twists and turns of what promises to be “one of the biggest telecom reorganizations since Worldcom Inc. in 2002″.

None of that is surprising as news reports and the BDC Credit Reporter have been predicting a Chapter 11 filing and a massive re-organization for months, but does indicate the day of reckoning is coming ever closer. The bankruptcy – which we expected in the IVQ 2019 – looks likely to land in the IIQ 2020.

Since our last report a couple of the many BDCs that hold the company’s debt have reported IVQ results and their latest valuations on their Frontier positions. Oaktree Strategic Income (OCSI) and non-traded sister BDC Oaktree Strategic Income II hold the 6/15/2024 senior Term debt and – in the case of latter BDC – the 2026 Senior Note. All we can report – without comment because we don’t understand the capitalization of Frontier well enough to differ – is that the debt is still carried at a premium. Obviously, Oaktree – which must be familiar with whatever plans for a restructure are underway – believes that there will be no loss booked if and when the seemingly inevitable bankruptcy happens.

We’ve not yet heard from all the other BDCs that have a position in Frontier, most of whom are part of the FS Investments-KKR group. However, publicly traded FS KKR Capital (FSK) has reported its IVQ 2019 portfolio and we see that Frontier has dropped out since September 2019. No comment was made on the latest conference call, but we imagine management may have decided caution was the better part of valor and sold out its position. For all we know that may be true for its 4 sister non-listed BDCs. If that’s true, BDC exposure to this upcoming massive bankruptcy might be very small.

We’ll continue to track this company and expect to be discussing the Chapter 11 filing and its implications before long.

McDermott International: Files Chapter 11

On January 21, 2020 McDermott International announced its intention to “commence [a] prepackaged Chapter 11 filing in the U.S. Bankruptcy Court for the Southern District of Texas (“the Court”) later today“. In a press release, the oil field services giant indicated that “two-thirds of all funded debt creditors” had agreed to a re-structuring package that would “de-lever” its balance sheet. That’s a massive $4.6bn of debt getting vaporized. The company hopes to re-emerge with just $500mn of funded debt and the ability to provide letters of credit in support of work projects – a critical aspect of its business. That will mean “nearly all funded debt” will be converted to equity.

To move the Chapter 11 along, McDermott has arranged $2.8bn in Debtor-In-Possession (DIP) financing. As has been frequently the case recently in these “pre-packs” the company hopes to be in and out of bankruptcy in a short period: two months is the estimate given till court confirmation of the plan is expected.

We learned from the press release that subsidiaries of McDermott have entered into a share and asset purchase agreement with a joint partnership between The Chatterjee Group and Rhône Group which will serve as the “stalking-horse bidder” in a court-supervised sale process for Lummus Technology. The sale of this subsidiary has been a key element in the MCDermott saga. Here are the key details from the press release:

Under the terms of the Agreement, the Joint Partnership has agreed, and is committed, to acquire Lummus Technology for a base purchase price of $2.725 billion. McDermott will have the option to retain or purchase, as applicable, a 10 percent common equity ownership interest in the entity purchasing Lummus Technology. McDermott expects to hold an auction in approximately 45 days to solicit higher or better bids for the Lummus Technology business. Either the Joint Partnership or the winning bidder at the auction will purchase Lummus Technology as part of the Chapter 11 process, subject to regulatory and court approval. Proceeds from the sale of Lummus Technology are expected to repay the DIP financing in full, as well as fund emergence costs and provide cash to the balance sheet for long-term liquidity.

We’re not bankruptcy experts so we don’t know what the odds are of the McDermott plan – which is ambitious by any standard – being accepted in its current form and timetable. More certain is that the two BDCs involved are likely to lose the $0.700mn of annual investment income being accrued and some sort of realized loss will be booked in 2020. The only BDC with material exposure as of September 30, 2019 was non-listed Business Development Corporation of America, with $9.8mn invested at cost in the May 2025 Term Loan, already written down (35%) as of the IIIQ 2019. Oaktree Strategic Income (OCSI) has a tiny $0.6mn exposure in the same Term Loan.

For our part, we’ve had McDermott on our Under Performers list since July 2019 and with a Corporate Credit Rating of 4 (Worry List) for months. Since October 2019, we’ve added the company to our Bankruptcy Imminent list, where we seek to flag for readers those credits most likely to hit the headlines. For all prior McDermott articles, click here. We expect there’ll be one or two more follow-up articles as the restructuring plays out, but the McDermott credit story seems closer to the end than the beginning.

McDermott International: Forbearance Extended

According to the Wall Street Journal, McDermott International’s lenders agreed “to wait at least six more days before they declare a default, the engineering company said as it continues restructuring negotiations“. The initial forbearance was due to expire on the stroke of midnight (the BDC Credit Reporter is adding dramatic effect) on January 15th, 2020 after a missed interest payment in November of 2019.

Nonetheless, not all is well between junior and senior lenders, with the latter more forgiving and flexible and the former less so, leaving the possibility of an inter-creditor battle if and when Chapter 11 occurs, which we consider an imminent possibility. For the moment, though, as the WSJ indicates : “Lenders could have let the forbearance expiration on the junior bonds trigger a cross-default. They instead made a deal with the company to wait until at least Tuesday before declaring a default on their own claims“.

We expect to be updating the McDermott story, which we’ve written about 6 times since September 2019, shortly.

Frontier Communications: Debt Recovery In Bankruptcy Estimate

We’ve been tracking the credit decline of Frontier Communications through most of 2019, in multiple posts. The communications giant has been moved from a CCR 3 rating to CCR 4. In October, we added Frontier to our Bankruptcy Imminent list. In fact, there was no Chapter 11 or restructuring in the fourth quarter of 2019 and – given decent liquidity – there might not be any move in that direction in the IQ 2020 either. However, we’re confident enough to project that a bankruptcy in the IQ 2020 is highly likely.

BDC exposure to the company remains high with $67.5mn outstanding at cost, spread over 8 different BDCs, and three asset management organizations (FS Investment-KKR; Oaktree and Business Development Corporation of America). To date, though, all outstandings – despite ever worsening financing performance and multiple downgrades by both Moody’s and S&P – have been valued at or above par. That suggests debt investors are not worried about taking any kind of haircut should a Chapter 11 occur.

We analyzed the debt held by the BDCs against Frontier’s latest 10-Q. Broadly speaking, one third of the company’s huge debt load is secured and two-thirds unsecured. All BDC exposure is in first lien and second lien secured debt, which explains debt holder sanguinity. Valuations did not materially change at the top of the capital structure even after Frontier’s CEO left his post in early December, and replaced by a former DISH executive first brought in as a financial adviser and then appointed to the top job.

Nor were senior debt holders fazed – if prices reflect their views – by the never ending drop in the company’s stock price – now being de-listed from the NYSE and trading under $1.0. Since we wrote our first post, Frontier has lost two-thirds of its market capitalization.

We’re not so sure that Frontier’s senior lenders – including those 8 BDCs – should be so complacent about the value of their loans – which mature between 2024 and 2027, according to Advantage Data’s summary records. Our suspicions are confirmed by an article in Seeking Alpha on December 31, 2019 by Gary Chodes, which seeks to evaluate what the recovery rate on Frontier’s secured and unsecured debt might be if worst came to worst. The conclusion of interest to senior lenders: an estimated 24% recovery rate. That would imply over ($50mn) in ultimate Realized Losses for the BDC group, not including interest forgone. Readers can make up their own mind about the validity of Mr Chodes calculations. We don’t have a deep enough understanding of the company’s financial situation and business prospects to offer up a competing view. Instead, we offer up this warning on a take it or leave it basis. In any case, we expect to be returning to the Frontier Communications imbroglio repeatedly in 2020.

McDermott International: Bankruptcy Imminent ?

Bloomberg reported on December 30, 2019 that McDermott International’s stock had been declining for the past two days on rumors that a Chapter 11 filing was in the works and $2.0bn of financing has already been lined up to help the engineering company post filing as access to letters of credit to support projects is critical in its business.

None of the above will come as any surprise to the readers of the BDC Credit Reporter. We’ve been ringing the bell since September about the company and not been much impressed with the financial rescue plans that have been mooted or implemented in the interim to keep McDermott from “going chapter”. On October 21, 2019, we even placed McDermott on our Bankruptcy Imminent list. That fate for the company now seems everything but certain. The common stock shareholders seem to have come to a similar conclusion. Since that October post, the market capitalization of McDermott has dropped by nearly two-thirds.

For the BDC sector, the only good news – as noted in earlier posts – is that BDC exposure is small ( $10.4mn at cost) and limited to non-traded Business Development Corporation of America and Oaktree Strategic Income (OCSI). Both BDCs are invested in the 2025 Term Loan, which they’ve already discounted (35%) at September 30, 2019. According to Advantage Data that same loan now trades at a (43%) discount. Up ahead is likely some interruption/loss of investment income as well, with the non-listed BDC with the most to lose with 95% of the exposure.

TridentUSA Health Services: Written Off

Ares Capital (ARCC) – the largest BDC lender to TridentUSA Health Services (also known as New Trident Holdcorp and Trident Health Services) – has taken a 100% realized loss on its non-performing debt outstanding to the company, which filed for bankruptcy back in February, and which we discussed in a post on September 30, 2019. The loss was realized in the IIIQ 2019. This has a resulted in a major loss for the BDC: $96mn. Moreover, that means 3 other BDCs with another $12mn of exposure are likely to be taking similar write-offs when their results are published: Gladstone Capital (GLAD), Solar Senior Capital (SUNS) and Oaktree Strategic Income (OCSI).

What’s more, back in IVQ 2017 when the company first went on non-accrual other BDCs, such as PennantPark Floating (PFLT) and Investcorp Credit Management BDC (ICMB) had positions as well. In fact, total BDC exposure was $157mn at its peak but only $108mn as of June 2019 when the debt had all been effectively written down on an unrealized basis to zero. We expect those departed BDCs took some sort of realized loss to depart the scene early. If the other BDCs lenders still involved follow ARCC’s path, SUNS will be losing ($7.7mn), GLAD ($4.4mn) and OCSI well under ($1mn). About $12mn of investment income that was being charged will be lost.

This is a credit that dates back to 2013 for ARCC (and other involved) when the BDC giant made a $80mn second lien investment. The debt was added to the under-performing list in the IIQ 2016. The valuation went up and down from there, including rising at one point on the hope of a sale. However, by IVQ 2017, the second lien debt was placed on non accrual. ARCC advanced $16mn in additional debt, on a first lien basis. In the spring of 2018 new debt was advanced and existing debt renegotiated, which Moody’s deemed to be “a distressed exchange” and downgraded the company. Finally, in February 2019 the New Trident filed for Chapter 11. By then most BDCs had written down their exposure 100% or close to.

What went wrong ? You’d be hard pressed to find out from ARCC – which prides itself on its transparency – from the latest Conference Call transcript. Management only discussed the company in response to a question, describing the investment as “unsuccessful” and the amount lost as “pretty substantial”. We’d agree with that last assessment: $96mn is equal to 1.3% of ARCC’s equity capital at par and is equivalent to 45% of this quarter’s Net Investment Income.

We know that the company and its subsidiaries is owned by private equity sponsors Formation Capital, Audax Group, and Revelstoke Capital Partners and that annual revenues are approximately $500 million, according to Moody’s. A couple of BDCs have been quick to say the health care company’s problems were “idiosyncratic” but the bankruptcy has occurred at a time when both the BDC Credit Reporter and rating groups have noticed a deterioration in the sector more generally – a grave concern considering the ubiquity of health care related credits in leveraged lending.

Frontier Communications: Hedge Fund Recommends Bankruptcy

The Frontier Communications saga continues with hedge fund and investor Robert Citrone recommending the company file for Chapter 11 bankruptcy sooner rather later. As the attached article reminds us, there’s an ongoing debate amongst “stakeholders” as to what the communications company should do to deal with its heavy debt load and uncertain future.

“Normally haste makes waste, but in this instance we believe haste limits waste,” Ormond said in the letter. “The further the delays in addressing the balance sheet and state of the business in a court-supervised process, the greater the risk to the corporation, operating assets, employees and surrounding Norwalk.”

Increasing subscriber losses and turnover, combined with limited financial guidance, will only lead to further deterioration in the business, according to the letter.

We have no view on whether to file or not is better, but the pressure does increase the chances of the former. We are adding Frontier to our Bankruptcy Imminent list. The company is already rated CCR 4 (Worry List). As a reminder BDC exposure is substantial at $61.7mn and valued close to par. A bankruptcy could have detrimental effects – but to varying degrees – on the 9 BDCs involved.

McDermott International: SA Article

On October 23, 2019 Seeking Alpha author Henrik Alex wrote an article about McDermott International entitled: “The ‘One McDermott Way’ Might Still End In Bankruptcy Court“. The article lays out in useful detail the various options available to the company and the obstacles faced in taking advantage of the supposed “financial lifeline” offered by certain secured lenders. Any one interested in the subject will find the article helpful. For our own earliest posts about McDermott, click here.

Mr Alex’s conclusion is as follows:

Even after Monday’s bridge loan announcement, the much-touted “One McDermott Way” might still end in bankruptcy court if the company fails to arrange a quick sale of the Lummus Technology business given the dealbraker requirement to exchange at least 95% of the company’s senior unsecured notes into new PIK notes. While secured lenders would likely waive a minor consent shortfall (e.g. 90%), I do not expect them to approve a material amount of holdouts. But even if the condition will be waived, McDermott will face a reduction in borrowing capacity and letters of credit.

Judging by this week’s trading pattern so far, both unsecured bond- and equityholders seem to have very little conviction in the company avoiding a bankruptcy filing and so do I.

That said, the company still has until January 31, 2020 to enter into a firm purchase agreement for Lummus Technology “in form and substance satisfactory to the Supermajority Lenders and the Administrative Agents” as required by the terms of the credit agreement.

Should McDermott indeed have to seek bankruptcy protection, common equityholders will almost certainly end up with nothing. Even unsecured noteholders might see very little or even no recovery as already implied by the very low trading price.

That conclusion largely coincides with our own thoughts, except that we are more skeptical about the chances of selling Lummus Technology, which has been for sale for some time. This validates our decision to add McDermott to our Bankruptcy Imminent list. Thankfully, BDC exposure is small: limited to two BDCs. Business Development Corporation of America has the biggest chunk: $9.8mn and Oaktree Strategic Income (OCSI) just $1.3mn.

McDermott International: Stock Price Drops

Despite the financial lifeline offered by certain lenders to McDermott International, which we discussed two days ago, the company’s stock price continues to drop and has reached $1.6550 at time of writing, falling nearly (7%) intra-day. We have McDermott on our recently launched Bankruptcy Imminent list – our attempt to give readers a heads up on what credit calamity might be round the next corner. We’ve also checked on the current value of the company’s publicly traded loans and bonds, and both seem to be trending down in value in most cases. This is all adding to our concern that McDermott – and the $11.1mn of first lien BDC exposure to two BDCs – could default or be restructured in the fourth quarter 29019.

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.

McDermott International: Arranges Additional Financing

Nominally on October 21, troubled oil services company McDermott International arranged $1.7bn of additional financing to meet an upcoming severe cash shortfall.  That sounded like very good news to the stock and bond markets worried about the solvency of the company for several weeks now. The stock price jumped. However, investors soon began to have second thoughts and the stock and bonds both dropped ! The Wall Street Journal reportedMcDermott’s bond rose as high as 33 cents on the dollar after the refinancing was announced, from about 29 cents on Friday, before falling to about 24 cents when the revised estimates were disclosed in a U.S. Securities and Exchange Commission filing. The company’s shares plotted a similar course, opening 21% higher at $2.84 before dropping to $2.04“.

The reasons include the fact that the “lifeline” debt cannot be accessed in one lump sum , or at will, but only in 4 tranches that relate to performance and require “sign-off” by other creditors, which is another word from concessions. Those were well spelled out in another article, this time from Bloomberg. Furthermore, the company paid out millions in retention bonuses to senior executives. Often when you’re paying your senior people a small fortune to do the work they’ve been doing for a healthy paycheck already, the chances of things going off the rails is high. Just as importantly, the company revised its earlier financial projections for 2019:

The company changed its estimate of earnings before interest, tax, depreciation and amortization, or Ebitda, to $474 million in 2019 from $725 million because of incremental charges on existing projects, according to the SEC filing. It also revised its free-cash-flow estimate for the year to negative $1.2 billion from negative $640 million.

This is far from resolving McDermott’s financial troubles and may – ironically enough – accelerate the need for a Chapter 11 filing or a full scale reorganization. We’ve been writing about the credit since September 19, 2019 when a restructuring firm was first hired, but the company has been rated CCR 4 – our Worry List – since July 30. We followed up with an update regarding this impending lifeline on September 25, 2019.  Now – as then – we remain skeptical that McDermott can dodge the bankruptcy/restructuring bullet.  Furthermore, we’re placing the company on our still-under-development Bankruptcy Imminent list, which means we believe there is a strong chance of a filing or re-organization occurring within the next 3 months. Judging by the market reactions by closing time, we may not be alone. This would cause – judging by the current valuation of the 2025 debt in the markets – a (35%) or greater loss for the two BDCs involved, or close to ($4mn) between the two, and the loss for some time of nearly $0.800mn of investment income. Not disastrous for either BDC but another reminder that the “oil patch” is a difficult place to play in.

TridentUSA Health Services: Settles Whistleblower Suits

TridentUSA is already in bankruptcy, and has been since February of this year. On September 26, 2019 the company settled two outstanding whistleblower lawsuits brought by the government, agreeing to pay out $8.5mn, as reported by the Baltimore Business Journal.Trident provides mobile diagnostic services to residents of nursing homes. The company earns federal money to provide mobile x-rays to Medicare and Medicaid participants in the nursing homes. The whistleblowers had alleged that Trident had violated federal law by engaging in a kickback scheme, which led to a government investigation of Trident’s pricing arrangements and its costs to provide mobile x-rays at these facilities“.

In a round-about way, this settlement might be a Good Thing for the embattled company and facilitate its exit from Chapter 11. This report tells us nothing of the bigger picture.

For the BDCs involved, there is nowhere to go but up from here. Four well known public BDCs have $108mn in first and second lien loans to the company or its equally compromised sister entities. The exposure has been almost completely written off as of June 2019 and well over $10mn of investment income lost. The BDCs involved are all publicly listed: Solar Senior Capital (SUNS), Oaktree Strategic Income (OCSI), Gladstone Capital (GLAD) and the biggest player of all Ares Capital (ARCC).

Trident is one of a series of significant healthcare failures due to some kind of fraud that we’ve come across of late. Most recently, we discussed Oaktree Medical Centre in a similar vein on these pages. In recent memory, but before the advent of the BDC Credit Reporter, there have been at least two other similar cases of healthcare fraud or other catastrophic difficulty involving BDC lenders. One notable example would be RockDale BlackHawk. Maybe we should ask harder questions about the due diligence capabilities of the BDC underwriters or are stories like these just the exceptions to the rule ?

McDermott International: Seeks Bridge Loan

We first wrote about trouble at oil field services giant McDermott International back on September 19, 2019 when a restructuring firm was hired. Now there are reports that the company is seeking a huge bridge loan to fund a $1.7bn working capital deficit until assets can be sold to repay existing debt. Here’s what Bloomberg said about what asset sales might accomplish:

The company confirmed it was working with Evercore to explore unsolicited interest in its Lummus Technology business, with a valuation exceeding $2.5 billion. That amount combined with its $1.5 billion in boats, equipment and buildings, as well as $500 million in storage assets, could be enough to cover its debt and preferred stock, Citi research analysts wrote in a Sept. 18 note.

McDermott said it had about $3.8 billion of gross debt at the end of the second quarter and $1 billion of cash available.

If it were to sell the technology business for more than $500 million, McDermott’s bond rules stipulate that it must use the net proceeds to repay debt, according to a Covenant Review report“.

We’re not expert enough in the intricacies of McDermott’s arrangements to determine if asset sales – were they to happen – would be positive or negative for the 2025 Term Loan held by the two BDCs with $11mn in exposure at cost. What does seems clear: the McDermott story – thanks to its massive cash needs and already high debt – will be on the front burner where credit developments are concerned through the rest of 2019. We maintain a CCR 4 (Worry) rating.

McDermott International: Hires Restructuring Firm

We placed giant oil field services company McDermott International, Inc. on our under-performing list back on July 30, 2019 with a Corporate Credit Rating of 4 (Worry List) after results came in much worse than expected and the stock sank. Now matters are getting worse, as the company has just hired turn around firm AlixPartners. What followed was the equivalent of an earthquake in terms of market reaction, even more so than back in the summer. Here’s what Bloomberg reported: ” The Houston-based company’s stock plunged as much as 76% Wednesday — trading was halted for volatility at least five times — while its bonds dropped more than 30 cents to 37 cents on the dollar, making them Tuesday’s most actively traded debt in the U.S. high-yield market..

BDC exposure is relatively modest ($11mn at cost), divided between two BDCs: non-listed Business Development Corporation of America (BDCA) and listed Oaktree Strategic Income (OCSI). Both appear to be in the same April 2025 senior Term Loan and both valued their exposure at June 30, 2019 at par, or very close. We expect next time round that valuation will drop and even more so if McDermott files for Chapter 11 or restructures. There’s about $750,000 of annual investment income at risk, with BDCA having the bulk of the exposure.

The troubles of McDermott are part and parcel of the distress in the energy industry – especially but not exclusively in oil field services of one type or another, as we’ve previously mentioned. We expect to hear considerably more about the company and its less well known peers in the months ahead. In this segment at least recession-like conditions are already in play.