Posts for FS Investment II

AVF Parent: Seeking Bankruptcy Stay

Art Van Furniture, which is held by AVF Parent, is in Chapter 11 bankruptcy, and was proceeding – til the impact of the coronavirus was fully felt – with the process. (We last and first wrote about the company back on March 5, 2020). Now the company and its creditors – in a highly unusual move in these extraordinary times – seem to have agreed to put the bankruptcy process into deep freeze for several weeks. That was the case made by attorneys for AVF Parent to the judge in the case.

The problem is that the states in which the furniture retailer operates are on lockdown, which coincided with the attempted liquidation of much of the furniture. With all prospective customers huddled at home, the “going out of business” banners have been put away and a different approach sought. As the Law360 article we consulted for this report explained: “With this plan in place, .. the debtors hope to preserve [their] options to restart going-out-of-business sales at the bulk of AVF’s] stores and possibly revive a scuttled deal to sell 44 others as a going concern”.

We’re not sure how the judge will rule but that’s one more spanner in the works for creditors – including the two BDCs with exposure in the company’s 2024 Term Loan – getting much in way of a recovery. At year-end 2019, the debt was already on non accrual and discounted by FS-KKR Capital (FSK) and FS Investment II by (67%). At time of writing – March 31 2020 – the debt was trading at a discount of (84%). This suggests the two BDCs should not be expecting to get much more than crumbs in the ultimate resolution and that realized losses – probably recognized in the IIQ 2020 – will be huge: somewhere around ($150mn).

Craftworks Restaurant & Breweries: To Shutter All Locations.

Poor old restaurant chain group Craftworks Restaurant & Breweries. After filing for Chapter 11 on March 3, 2020 – shortly after our first and only article on the company so far on February 21, 2020. Then, we had predicted a bankruptcy or restructuring. Tick.

What we did not expect was the arrival on the scene of Covid-19, which has caused the company to lose its Debtor-In-Possession (“DIP”) financing and the decision to close all its locations. Craftworks hope the closures will be temporary – as does every restaurateur and diner in America – but cannot be sure.

One way or the other, the $13.4mn at cost lent to the company in the form of second lien debt – which only began a couple of quarters ago – seems to be in danger of being fully written off. At 12/31/2019, the 2024 debt was valued at a (25%) discount and was still current at a PIK rate of 12.0%, or $1.6mn a year of investment income. Chances are very high the BDC lenders will have to write down all the $10.2mn of FMV remaining in the next quarter, and lose all the income. FS-KKR (FSK) has invested $7.2mn and non-traded FS Investment II has $6.2mn.

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.

Constellis Group Inc.: Update

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.

Hudson Technologies Company: IVQ 2019 Results

We last wrote about refrigerants distributor Hudson Technologies Company back on February 14, 2020. Then, we wondered aloud how the BDC term lenders to the troubled company – who have just participated in a restructuring and amendment of their debt – would value their exposure at year end 2019. As of the third quarter, FS KKR Capital (FSK) – for one – had applied a (44%) discount to their $38mn position. Now FSK has reported its latest IVQ 2019 valuation and the valuation remains essentially unchanged – discounted (42%), albeit the public BDC has reduced its capital at risk by ($5.3mn). No reason was mentioned by management for the lower debt level on the latest FSK conference call, but we’re guessing it’s part of a general debt paydown of its obligations by the company.

The unchanged discount suggests that the lenders remain unsure that the turnaround measures which the lenders – including Wells Fargo , which provides the company’s Revolver – will succeed.

On February 4, 2020 the company released its IVQ 2019 earnings and held a conference call. We’ve read both documents and are impressed by management’s optimism about market conditions and about the $22mn of availability supporting the company’s liquidity. The CEO said the following to sum up the financial re-engineering that has been accomplished:

“The amendment [ of the Term Loan ] reset the maximum total leverage ratio of financial covenant through December 31, 2021, reset the minimum liquidity requirement; and added a minimum LTM adjusted EBITDA covenant. With the new revolving credit facility and the amendment of the term loan in place, we believe we have the financial flexibility and liquidity that drive improved operating performance as we move through 2020 and beyond”.

With the stock price of the public company at $0.85 and with the FSK debt still deeply discounted, Hudson Technologies lives on to fight another day. We cannot tell if the procurement issues arising in China from the coronavirus will help or hinder its results going forward. We continue to have a CCR 4 rating on the company, which means we expect the odds of a loss are greater than of full recovery. For 2020, given what we know, we still expect further deterioration in value but don’t predict a move to non performing (CCR 5).

AVF Parent: Liquidating Business

Ouch ! This one is going to hurt. Art Van Furniture (aka AVF Parent in Advantage Data), the largest furniture retailer in the Midwest, has begun to liquidate the inventory at all its company owned stores. “Despite our best efforts to remain open, the company’s brands and operating performance have been hit hard by a challenging retail environment,” the company spokeswoman Diane Charles said in a statement. According to news reports there is still a chance the company will find a buyer, but the odds don’t look great. Not helping the matter is that the CEO has just resigned. A bankruptcy filing is imminent. This could end up Chapter 7 rather than Chapter 11.

Chances are the $169mn invested in the first lien debt of the company by 4 related FS/ KKR Advisor LLC BDCs is going to take a big hit. At December 2019, the only BDC lender to have reported so far – publicly traded FS KKR Capital (FSK) – has already discounted its $55mn at cost to $18mn. Even that ($37mn) write-down may not be As Bad As It Gets. If the company ends up liquidating completely, net proceeds may be even lower. Have you ever tried to sell furniture in a hurry in the midst of a health crisis ? The Term Loan in which the BDCS are invested sits behind an $85mn asset-based Revolver, which may sweep up all proceeds.

Let’s tot up the damage. Total investment income lost already thanks to the company being on non-accrual since the IIIQ 2019 on debt charged at LIBOR + 725 bps: about ($15mn) per annum. The unrealized losses in aggregate will be ($115mn). As we’ve discussed this will translate into an equal or greater realized loss. At worst, we wouldn’t be surprised if ($150mn) was written off. Or even the full ($169)mn…

For the FS KKR organization this has to be a major reverse. Still, the initial investment in a furniture retailer – almost a code word for risk amongst old time lenders like the BDC Credit Reporter – dates back to IQ 2017 when GSO Blackstone was in charge of underwriting. The initial exposure was $130mn., all in the same 2024 Term Loan that’s in trouble today. The first crack in the valuation didn’t occur till IIQ 2018 by which time $174mn was at risk. Still, the valuation discount did not exceed our hurdle of (10%) till the IIQ 2019. Two quarters later, Art Van Furniture was on non accrual and now in liquidation.

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.

J.C. Penney: Sales Down. Debt “Untenable” ?

Just a brief update about highly troubled J.C. Penney’s. (We’ve already written six times previously about the famous retailer). A Seeking Alpha article on February 13, 2020 reports same-store sales over the Christmas/New Year period were down (7.5%). The article’s author – using company numbers for projected 2020 EBITDA – estimates debt to EBITDA could reach 8.8x. Debt is called “untenable”. Notes that the stock price has “broken the buck”. As of today the stock closed at $0.71.

We already have a CCR 4 rating on the company and recently added Penney’s to companies we expect to file to Chapter 11 and go on non accrual in 2020. We reiterate our opinion based on the most recent data. Not helping the situation is that the retailer’s liquidity – as mentioned in the article – is very modest so matters could go south very fast.

BDC exposure remains at what we knew last time we wrote, back on November 19, 2019. When we hear from the 4 BDCs involved about IVQ 2019 results the exposure numbers could change.

Hudson Technologies Company: Update

We last wrote about refrigerants distributor Hudson Technologies back in mid-2019, and we were not optimistic about the outlook for the business. We had rated Hudson CCR 4 and anticipated that a restructuring or bankruptcy filing was possible. Since then, the underlying business of the company has continued to deteriorate; the existing working capital lender (PNC) has been replaced by a new one (Wells Fargo) ; the Term debt covenants have been reset and the common stock of this public entity may shortly be de-listed from NASDAQ. Not to mention that Hudson ended the IIIQ 2019 with a “Going Concern” anvil above its head.

Nonetheless – and to their credit – Hudson is still with us. Thanks to the new facility and the amendment/waivers from its Term Lenders, the company lives to fight another day. On Seeking Alpha at least one author is projecting that “great days lie ahead” for shareholders.

We’re sorry to throw cold water on all this, but our review of the Term Loan Amendment and the attendant measures agreed between the company and its lenders does not reassure us. It’s true that the lenders – in the short term – have agreed to an incredibly high new leverage level (16.57x this quarter), but that quickly ramps down to “just” 10.67x in the following three months. Moreover – and ominously – lenders have required the appointment – at a cost of $120,000 a month – of a Chief Restructuring Officer (CRO) brought in from Grant Thornton. He took up his post on January 2, 2020. There’s much more besides that causes us to believe this is more a transition to an eventual bankruptcy or major restructuring than a good odds rescue effort within the current capital and ownership structure. This provision in the amendment illustrates what we mean:

The Fourth Amendment also adds a new covenant providing that in the event of a breach of a financial covenant contained in the Term Loan Facility or any failure to make a required principal repayment (a “Trigger Event”), then on or prior to six months after a Trigger Event, the Company shall commence a process to (x) sell its businesses and/or assets, and/or (y) consummate a refinancing transaction with respect to the Term Loan Facility (a “Transaction”), in each case, subject to enumerated time milestones contained in the Fourth Amendment, and which requires that Transaction shall, in any event, be consummated on or prior to the eighteen (18) month anniversary of the Trigger Event.

BDC exposure to Hudson is major – just over $100mn – and the debt involved (the 2023 Term Loan referenced above) was discounted (44%) at September 30, 2019, according to Advantage Data. When we hear from the FS-KKR organization about IVQ 2019 results, we’ll be interested to see if the valuation has been increased in light of the amendment. Even if it has, we will continue to be highly skeptical of the company’s odds of survival in its current form. For the BDC lenders involved – including publicly traded FS-KKR Capital (FSK) with $38.5mn at cost – there is a large amount of investment income at risk: about $12mn a year. Given that the company is public and FSK will shortly be reporting its valuations, expect to hear back from us with yet another update sooner rather than later.

Frontier Communications: March Bankruptcy Targeted

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.

J.C.Penney: Holiday Sales Place Future In Doubt

Embattled retailer J.C. Penney is often in the news now that Sears has left the building. A new CEO with a well regarded strategy for rejuvenating the company has given hope to some that “Penney’s” will survive where so many others have failed. We’ve written about the company multiple times in recent months, starting in July 2019. The company, though, has been on our Under Performers list since IVQ 2018 and is currently rated CCR 4 on our 5 point scale, just above non-performing.

Hopes were high that the holiday shopping season might prove a turning point for the company. However, as an article in Motley Fool suggests, that’s not been the case. Same store sales have been disappointing: “The company saw comparable-store sales drop by 7.5% for the nine-week period ending Jan. 4. If you exclude the fact that the retailer exited the appliance and furniture categories, comp sales dropped by “only” 5.3%. For the full year, the company expects same-store sales to drop by 7%-8%. That number improves compared to a loss of 5%-6% if you exclude the company dropping appliances and furniture”.

Once again the company’s survival is in question as there is no reason to believe the downward trend is reversible. We’ve added J.C. Penney to the list of companies that we expect to drastically restructure or file for some sort of bankruptcy protection in 2020.

As we noted in our most recent post, BDC exposure has actually grown in the IIIQ 2019 (to $18mn at cost) as TPG Specialty (TSLX) joined FS Investment II, III and IV as lenders, but in an asset-based facility. How any of these blenders will fare in a potential bankruptcy is impossible to suss out at this point. In late September all but one of the positions held were marked at par or better. As we’ve seen with other borrowers on a long downward slide those valuations can change, though, when an actual bankruptcy happens. Even TSLX – which has magisterially navigated multiple troubled companies that eventually went into bankruptcy – will have to keep their wits about them. At some point in 2020 we expect to join Warren Buffet to find out who’s been swimming naked.

Borden Dairy: Files Chapter 11

2020 has started with a bang where BDC credit challenges are concerned with one of the biggest BDC-funded bankruptcies in recent memory. On January 7, 2020 Borden Dairy filed for Chapter 11. Management set out its goal as follows: “The Company intends to use the court process to pursue a financial restructuring designed to reduce its current debt load, maximize value and position the Company for long-term success. Borden plans to continue operating in the ordinary course of business, under the court’s supervision“.

Lenders were not sympathetic or supportive. As the Wall Street Journal reported, the principal lenders to the company complained that a Chapter 11 filing was not necessary, and seemed more like a gambit to avoid whatever concessions might have been necessary with its creditors. Apparently, negotiations had been ongoing for some time. One lender complained that Borden made the bankruptcy move without notice to its lenders (which is very common but still shocking to some) and without bringing on specialized turnaround personnel.

The principal complaint the lenders seem to have is that Borden is not really that financially damaged. The company itself admitted being EBITDA positive and one of the two private owner groups was sanguine about retaining “primary ownership of the business after the bankruptcy”, which does not signal extreme distress. Anyway, that’s for the court to decide about but does imply that the chances of recovery for senior creditors is higher than average.

That’s good news for the 4 BDCs involved – all part of the FS-KKR Capital complex: publicly traded FSK and its three non-listed sister entities: FSIC II, FSIC III, and FSIC IV. The face amount of debt at risk – all in the 2023 Term Loan – is huge by BDC standards: $175.0mn. (Here’s another example of how the BDC sector has expanded way beyond its origins financing supposedly capital starved lower middle market private companies. Borden – by contrast – boasts $1.18bn in 2018 sales and 3,300 employees). The bankruptcy will interrupt annual investment income of nearly $16.00mn. However, if Borden management gets its way, that might only be a matter of a few weeks.

More important will be what happens to the 2023 Term Loan and the rest of the company’s liabilities. Clearly, there is no consensus between the owners and creditors so pretty much anything could happen and we are not privvy to any of the plans. As always in these situations where the debt is publicly traded – more often than not these days – we look to Advantage Data’s real time loan pricing module which shows the 2023 debt trading at a (13%) discount to par. That’s in line with what the debt was valued on the BDCs books at September 30, 2019 and gives a hint of what haircut these lenders might have to take. That would be a Realized Loss of ($23mn).

Yet, it’s too early to start counting beans. This could come and go out of bankruptcy very fast and with little impact on the lenders or something else altogether could happen. Once a company throws itself on the mercy of the bankruptcy court anything can happen. We’ll provide updates as any material news appears.

Unfortunately, though, this is prospectively another credit black eye for KKR, which only took on the credit in the IIIQ 2017 and which has committed a great deal of capital to this borrower. KKR is sparring with Acon Investments – the private equity group on the other side of the table; as opposed to finding the mutually agreeable middle way that some other transactions have gone down. This will be a useful test of how well originating and leading a debt tranche will serve KKR – and its BDC shareholders. Who will prevail – if anyone – in the test of wills and documentation that is shaping up between owners and lenders ?

For our part, we didn’t even have Borden on our Under Performers list until after the IIIQ 2019 BDC debt valuations were published when the FS-KKR entities marked the Term Loan at a (12%) discount, which caused us to give Borden a Corporate Credit Rating of 3. Of course, that’s now been dropped to a CCR 5 (Non Performing) just a few weeks later. It’s worrying to us, and should be to anyone invested in credit, how quickly companies can go from apparently performing modestly below expectations to standing in front of a bankruptcy judge. We are going to respond by being more vigilant and ready to add new names to the Under Performer List at the very earliest signs of trouble. Forewarned is forearmed.

Constellis Holdings: Restructuring Underway

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.

Fairway Group: Second Bankruptcy Rumored

Oops, they’re going to do it again: filing Chapter 11 – or even Chapter 7 liquidation – if news reports about NY grocery chain Fairway Market are accurate. The New York Post reported on January 2, 2020 that a new filing is in the works, based on “multiple sources”. We’ve been down this road before back in 2016, but the grocer emerged quickly after a major debt for equity swap, as lenders became owners. Currently – according to the Post – the beleaguered 14 store chain is owned by  “lead shareholders Brigade Capital Management and Goldman Sachs Group“.

The owners sought a buyer in September but no one came forward. There is a small mountain of debt coming due in 2023 and 2024, but the company does not seem to have the resources to even hang in till then. Given that the company is reportedly looking to sell its flagship store and has closed several other locations, we’re guessing a liquidation – and some major credit losses – are in the works.

This is a privately held business so we don’t know all the details. However, thanks to Advantage Data’s records we know there are two non-listed BDCs with $30.9mn in first lien , second lien and equity in the company. Some of the debt is already on non accrual and the entire exposure has already been written down substantially to a FMV of $16.6mn at September 30 2019. The two BDCs are FS Investment II and FS Investment III, which will shortly be merged with the former as the surviving entity.

Some investment income will be lost if all debt facilities go on non accrual but cash won’t be affected as the interest income of late has been pay-in-kind. We don’t pretend to have an intimate understanding of the debt structure at the grocer, but chances are high the two BDCs – which already took a Realized Loss in 2016 – will be booking significant losses above and beyond the September 2019 valuation, and sooner rather than later. Presumably, this was one more troubled investment that FS-KKR inherited from the prior co-manager of the funds: GSO Blackstone. What’s not clear is who green lit the nearly 30% increase in exposure in IIIQ 2018. Was it the new combo of FS Investments and KKR or GSO ? In any case we’ve added Fairway to our Bankruptcy Imminent List for the IQ 2020.

Acosta Holdco: Exits Bankruptcy

As anticipated in our article of December 17, 2019 Acosta Inc. (owned by Acosta Holdco) has exited bankruptcy after a very brief stay. As a trade article indicates, the company went into court protection on December 1 2019 and now – just 30 days later – is back to business as usual. This follows, as detailed in the company’s press release, a monumental shedding of debt and the input of new capital by the new owner group, which composed of the company’s former lenders: “Through the process, Acosta eliminated all of its approximately $3 billion of long-term debt, and its new investors have funded $325 million in new equity capital“.

What we don’t know is which of the 5 FS Investments – KKR non-listed and public BDCs still have exposure to Acosta. At September 30, 2019 the BDCs had exposure of $39.7mn at cost, written down on an unrealized basis by (58%) to (64%), and all in the same 2021 Term Loan. The debt was on non accrual. Acosta had been on the Under Performers list since 2017, but only moved to non accrual in the weeks before the bankruptcy.

We did hear from FS Investment -KKR Capital (FSK) that its $17.3mn invested in $19.0mn of the par debt, which was valued at just $6.0mn, was sold after the third quarter end and at a premium to the published September price. This is what was said on the most recent Conference Call by FSK: “We placed Acosta on nonaccrual due to ongoing restructuring negotiations during the quarter and chose to exit this position after the quarter end at a gain to our third quarter mark“. That implies the public BDC will be taking a ($10mn-$11mn) realized loss in the IVQ 2019. That’s roughly $1.0mn of investment income permanently lost, a material but not market moving set-back.

That leaves $22.6mn held by the other 4 sister BDCs which may have been sold off as well or are now converted into equity. If the BDCs stayed put, their exposure may actually have increased if participating in the new capital infusion. We’ll circle back after the IVQ 2019 results are published to get the lay of the land. It’s too early to undertake a post mortem on this BDC investment as exposure may go on for years. For FSK, though, which jumped in during the IVQ 2018 – according to Advantage Data records – and then jumped out at a loss a year later, this was not anything to write home about.

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.

Acosta Holdco: To Exit Bankruptcy

Well, that was quick. According to the Wall Street Journal, Acosta Inc. – which is held by Acosta Holdco – is close to exiting bankruptcy just two weeks after filing. That was what expected back on September 30, 2019 months before the actual filing, when we first wrote about the credit problems of the marketing company.

Here’s what we wrote at the time, most every bit of which has turned out to be correct:

We expect the debt [of Acosta] to be shown as on non accrual in the upcoming IIIQ FS-KKR portfolios when earnings are released and to be written down to the market level, which should cut the fair market value by at least $6mn. We’re likely to see a restructuring done relatively quickly – if past experience is any guide – and a realized loss is likely to follow but we don’t have sufficient information to estimate the extent. This is almost certainly going to be another reverse for the FS-KKR organization. Curiously FSKFSIC III and FSIC IV appear to have jumped in relatively recently – perhaps ill advisedly seeking a bargain. Total BDC exposure jumped from $13.4mn at the end of 2017 to the $40.1mn current level. That’s a tripling of Acosta debt held.

In the IIIQ 2019 results, all 5 BDCs involved – with aggregate exposure of $39.7mn – placed the debt on non accrual and wrote it down between (58%) and (65%), according to Advantage Data records. (Interestingly, every BDC involved – all of whom are in the FS-KKR family and all of whom are in the same 2021 Term Loan – used a different discount percentage). What we don’t know yet is how the lenders will treat this negotiated debt-for-equity swap, but we expect to see realized losses booked if bankruptcy is exited by year end.

We know from another Wall Street Journal article – and other sources – the outline of the new structure. Remarkably, the company is having its entire debt written off and is receiving $250mn in new equity capital. That might just get Acosta off our under-performing company list, from a rating of CCR 5 (Non Performing) currently. Still, the BDCs involved will be losing roughly $2.0mn in annual investment income. They will be hoping Acosta is able to use this second chapter to become successful and earn back – one day – any realized losses incurred from this drastic restructuring. For the medium term, though, the BDC capital lent/invested in Acosta will be “dead money”.

Team Health Services: Bond Values Lower

The BDC Credit Reporter is a work-in-progress in that we are still loading all the several hundred under-performing BDC financed companies into our database and this website. We mention this to explain why we’re only getting round to waving warning flags about Team Health Inc. (aka Team Health Holdings), a company that has been under-performing since the IQ 2019; held by 6 different BDCs and which seems to be getting worse rather than better.

Back on August 12, 2019, as this trade article summarizes nicely, Moody’s downgraded the outlook for the company:

Team Health Holdings Inc.’s ongoing contract fight with UnitedHealth Group Inc. is hurting the bond status on the Knoxville-based hospital staffing and management company.

Moody’s Investors Service on Friday downgraded the outlook for Team Health from stable to negative, after affirming the company’s B3 Corporate Family Rating and B3-PD Probability of Default Rating.

The change of outlook reflects rising uncertainty around Team Health’s ability to reduce leverage given its recently disclosed dispute with UnitedHealth Group Inc., one of its largest commercial payors,” Moody’s said.

Moody’s also affirmed the B2 rating on Team Health’s senior secured credit facilities and Caa2 rating on its unsecured notes“.

We’re read Moody’s Ratings Action, and it’s clear that Team Health has a myriad business and financial challenges, including debt to EBITDA (admittedly a multiple that has become almost meaningless without knowing how the denominator is derived) of over 8x.

Just as distressing is the market price of the 2024 publicly traded 2024 Term loan which at December 12, 2019 was trading at a (28%) discount. Many BDCs hold that first lien debt which was trading at an (18%) discount in the market on September 30. (We note that the BDCs own valuations ranged from a (1%) to a (14%) discount in their IIIQ 2019 portfolio values). By the way the BDCs with exposure to Team Health include Barings BDC (BBDC) but only in the first lien; FS-KKR Capital (FSK) and four of its non-traded sister BDCs: FSIC II, FSIC III FSIC IV and CCT II. The biggest exposure is that of FSK, just under $15mn.

If the first lien debt is already trading down so much, where can be the second lien debt be that accounts for half of BDC exposure ? This debt does not trade so that’s a question without an answer, but at September 2019 quarter’s end the BDCs – all related – were writing down the debt by (22%). We’d guess the discount on the second lien – due in 202- might be as high as (50%).

We’ll have much more to say as we dig deeper and more developments occur. Our concern is not only about Team Health but similar health organizations facing pressure relating to payment practices. As the BDC Credit Reporter becomes more comprehensive quickly identifying BDC funded companies with a similar business model – and risk – will become easier. As the song says: “we’ve only just begun”.

Murray Energy: Lenders Seek To Acquire Company

As we’ve written about earlier, controversial coal company Murray Energy is in Chapter 11. According to Law360, though, progress is being made towards a plan that will get Murray out of Chapter 11. Apparently, senior lenders with $1.7bn of debt outstanding have clubbed together to offer themselves as a buyer for essentially all the company’s assets. Given that so much of business news is hidden behind a paywall – an ironic complaint from the publisher of the BDC Reporter with its own premium version – we don’t know many of the details.

Speculating, though, remains free. Should the senior lenders successfully become the buyers of the highly troubled company in a declining industry – the likely format is the exchange of much – if not all – existing debt for equity. Most likely, new monies would have to be advanced by those same lenders in some form as well. For the 6 BDCs involved with $52.5mn of debt exposure at September 30, 2019, that’s likely to mean no or little income forthcoming from capital already invested and the prospect of dipping into their pockets for more advances. The $5.7mn of investment income that was being collected before the filing is unlikely to be returning any time soon.

Most affected by the Murray Energy debacle is the FS-KKR complex with roughly $40mn of the BDC debt outstanding, led by FS-KKR Capital (FSK) with $18.9mn already at risk, according to Advantage Data.

How this all plays out remains up in the air, and is subject to further updates before Murray exits bankruptcy court protection. Even after that, given the industry in which the company operates, we imagine we’ll be discussing the company – possibly under a new name – for some time to come as its lenders seem to be digging in.

Monitronics International: Reports IIIQ 2019 Results

Last time we discussed Monitronics International (dba Brinks Home Security), the company was filing for Chapter 11. Even then, management was aiming to be back operating normally once a major restructuring was effected. We were skeptical – wrongfully so – that this could be accomplished by September 2019 given the many moving parts. Our apologies to the many professionals involved because Monitronics was up and running again out of bankruptcy as a public company (ticker: SCTY) by the end of August.

The company did manage to shed a great deal of debt, as reinforced on the latest Conference Call: “Restructuring resulted in the elimination of over $800 million of debt, including $585 million of bond, and $250 million of the company’s term loans“.

Funnily enough, though, BDC exposure to Monitronics has substantially increased following the voluntary Chapter 11 and restructuring. From $51mn at cost in June 2019, BDC advances have nearly tripled to $148mn. The BDCs involved today are those who were present before, but generally speaking their exposure has greatly increased. That’s because of the nature of the restructuring which saw prior debt partly paid off in cash, equity in SCTY and new Term debt due in 2024. To that was added $295mn in new Term debt and a Revolver. Regarding the latter, $124mn has yet to be drawn.

This is all a wonder of financial engineering, but from what we can tell term debt has only been decreased by just under $100mn, and the revolving debt – if fully drawn – will be greater than the prior balance outstanding. The big change is the write-off of $585mn in 2020 Senior Notes, which received a little cash and 18% of the equity. For all the turgid details see pages 16-18 of the 10-Q.

This leaves Monitronics less leveraged, but not necessarily out of the woods. The company reported its latest results on November 13, which are a mix of before and after bankruptcy and not very instructive from an earnings standpoint. Management did not brave any questions and is still working on its 2020 Plan. As a result neither the BDC Credit Reporter, nor anyone else, has any meaningful metrics to work with. We do note, though, that debt to Adjusted EBITDA (annualizing the IIIQ) remains close to 5:1, and that’s before we get into any mandatory capex.

In any case, Monitronics/Brinks is facing a changing industry, and real challenges with customer attrition that lower debt will not change. Management is promising to make major improvements in how the business is run, promising a “best-in-class” customer experience, including transforming the “sales process from hiring to training, to performance management” and much more in that vein. We wish Monitronics well, but there’s a lot to do in what remains a highly leveraged business with myriad competitors.

This is a classic example of stakeholders – including BDC lenders – “doubling down” on a failing business through a restructuring process. Historically security companies like this one have been cash cows and Brinks has a well known and respected name. So we understand the impetus to try again with a new capital structure and strategic approach. There are no regulators to wag their fingers at the lenders involved and if this does not work out failure is likely to be some time off given the Revolver availability. Regardless, we are rating the “new” Monitronics CCR 4 (WorryList) till we get more tangible news about post-bankruptcy performance, but expect we’ll be reporting back periodically for some time.