Posts for FS KKR Capital Corp II

Sequential Brands: Lender Appoints Board Members

Sequential Brands is the BDC Credit Reporter’s Godot. We’ve written multiple articles over the past two years breathlessly warning that something bad – a bankruptcy or a forced sale – was close to happening. Then: nothing. The company and their lenders always seem to arrive at a temporary modus vivendi, but no permanent resolution. (We’re desperately trying not to use the kicking of cans down the road analogy again). At times – given the high valuations the BDC lenders have maintained – we’ve doubted ourselves and the urgency of the situation.

However, the latest developments suggest – once again – that SOMETHING is going to occur at Sequential in the near future and that there is a possibility the BDCs – with $290.5mn outstanding in debt and equity to the company – may be materially impacted. Here’s what we know: According to a March 31, 2021 regulatory filing the company and one of its lender groups – led by Wilmington Trust – extended “a waiver of existing defaults under the Credit Agreement through April 19, 2021“. Furthermore, the lender “shall have the right to appoint an independent majority of the Board of Directors of the Company“. So gone is Martha Stewart and three other less famous Board members, probably letting out a sign of relief. Also a red flag: the company has not yet filed its IVQ 2020 and full year results.

The short extension period by Wilmington suggests that whatever “strategic alternatives” the company has been exploring since December 2020 is reaching some sort of conclusion. That might involve a sale of the business – in whole or in parts – or some pre-agreed Chapter 11 filing. The public shareholders seem to be bullish about this likely outcome, with Sequential trading at $22.22 as of the close on Thursday April 1, 2021. We are less optimistic – as is our self appointed mandate.

At risk for the BDCs involved is the prospect of ($28mn) of annual investment income from their 2024 Term debt outstanding being interrupted. Then there’s a good chance – based on the most recent quarterly valuations which discounts the equity owned by (99%) – a realized loss of up to ($10mn) will be incurred. However, the most important question mark is how the second lien debt will fare in the half billion dollar of borrowings Sequential owes. FS KKR Capital (FSK) and FS KKR Capital II (FSKR) and Apollo Investment (AINV) have advanced $280.5mn– more than half the total debt outstanding.

Currently, FSK and FSKR discount their debt by only (12%) and AINV by just (4%). If we apply the more conservative discount, that would still result in ($34mn) of realized losses on the debt and ($44mn) in total. The loss could be higher, but even ($44mn) is material given the big bets placed by the FS- KKR organization and which will shortly all be held by FSK, as FSKR is about to merge into its sister BDC. (AINV’s exposure is – clearly – much more modest even adjusting for the respective BDC sizes).

We should say – to be fair and recognizing that the stock market seems to believe that there is considerable market value left in Sequential – that this could all pass as quickly and harmlessly as a summer storm. Some deep pocketed buyer could be finalizing a generous deal as we write this or some hard working lawyers could be arranging a favorable “debt for equity swap” which will leave creditors undiminished. Maybe there’s a SPAC out there who wants to own a group of consumer brands…We don’t know, but we are as confident as we’ve been in two years that a change of status is in the cards for the company in the near future.

We are maintaining our CCR 4 rating on the company – as an eventual loss seems more likely than repayment in full. We are also adding Sequential to our Trending list because of the expectation that whatever is in the company’s future in the weeks ahead will be reflected in the BDC valuations and income – most probably in the IIQ 2021. For FSK especially this could either be a body blow, or not. We’ll be tracking the situation daily and will report back when something material occurs.

Production Resource Group LLC: IVQ 2020 Update

A reader wrote to ask for an update on Production Resource Group, LLC which we wrote about on May 27, 2020, just after the debt went on non accrual. This is a fair question and reminds us to set up a more formal regular credit follow-up system, especially for larger amounts at risk. In this case the advances by the three BDCs involved were huge – $511mn – as of the IQ 2020.

The current amount outstanding at year-end 2020 from two of the BDCs involved – FS KKR Capital II (FSKR) and Ares Capital (ARCC) – is high but has decreased, as we’ll explain – to $267mn. (No word yet from non-traded TCW Direct Lending VII, which had advanced $30.2mn as of IIIQ 2020).

Apparently – according to FSKR – a “debt for equity ” swap occurred in the fall of 2020:

We have reached a definitive agreement to recapitalize the Production Resource Group balance sheet and bolster liquidity. In exchange for our term loan position we will receive a package of take-back securities that are comprised of a reinstated term loan, preferred equity and common equity. The consensual restructuring transaction provides for a substantially reduced debt and interest burden while maintaining a path for a substantial recovery of our original par balance along with significant upside beyond that.

FSKR CC – 8/11/2020

In the IVQ 2020 this was reflected on the BDCs balance sheets and P&L. ARCC booked a realized loss of ($60mn) and its total exposure at cost dropped from $104mn at cost/$38.4mn at FMV in IIIQ 2020 to $45.6mn/$45.8mn. Exposure consisted of two Term Loans maturing in 2024, but with much lower pricing than before. Our rough estimate is that ARCC’s investment income will have dropped from $9.0mn annually to $3.9mn – a ($5.1mn) loss of income. The BDC also has Class A common stock units with a cost of $4.9mn and an FMV of $5.2mn.

FSKR’s exposure at cost just before the non-accrual was $381mn – a large amount even for a BDC its size. As of year end 2020 FSKR has $221mn invested between 4 term loans and two preferred stock holdings. We suppose – but cannot confirm – that the ($160mn) difference was booked as a realized loss. Unlike ARCC, FSKR does not call out Production Resources Group in its 10-K, with its ($872mn) of net realized portfolio losses in 2020. FSKR currently values its multiple holdings at a combined $199.7mn.

We have upgraded the restructured company from CCR 5 to CCR 3 – after three quarters of non performance – from IVQ 2020. Given the very little information we have about the new financial structure and the still challenged business of sports broadcasting, the company remains on the BDC Credit Reporter’s underperforming companies list. We’ll update our Company file when we hear from TCW Direct Lending VII and write a new update when all the IQ 2021 results are out.

For both ARCC and FSKR, this has been a material set-back, permanently reducing both income and capital and illustrates the danger of taking very large positions (especially in the case of FSKR, which is half the size of ARCC but took on more than twice the exposure). For ARCC, this was the second largest realized loss of 2020, out of total net realized losses of ($148mn). Nor was being at the senior level in the capital structure much protection against loss. Judging from ARCC’s write-offs, some 60% of capital advanced when things turned sour has been lost. All the BDCs involved will have to hope their equity stakes in the reorganized company provide some eventual offset. Maybe Production Resource Group will be bought by a SPAC ?

Aptim Corp: S&P Global Ratings Update

According to a news report, S&P Global Ratings is feeling a little better about Aptim Corporation, an environmental consulting and remediation company. APTIM Corp. was “affirmed” on Feb. 11 2021 at CCC+ and its outlook revised to “stable” from “negative”. Apparently some receivables that had been of questionable collectibility have come in, improving liquidity.

The CCC+ rating on the company’s $515 million of 7.75% senior secured notes due 2025 was affirmed as well.S&P Global Ratings believes Aptim’s balance sheet cash will be sufficient to handle fixed charges over the next 12 months“. However, as you can see by the speculative rating, Aptim is hardly free and clear of trouble as leverage is high, operating profitability poor and the company’s capital structure as “unsustainable”.

Nonetheless, these developments – and the modestly positive signal from S&P – might result in shrinking the discount on the value of the 2025 debt – with a cost of $30.5mn and a IIIQ 2020 discount that ranges between -37% and -48%. We note that Main Street (MAIN); Great Elm (GECC); FS KKR Capital II (FSKR) and non-traded HMS Income all hold the same debt but their valuations differ. In fact, FSKR even carries the debt as non-performing.

The -$13mn in unrealized losses might shrink either in the IVQ 2020 valuation or in the IQ 2021 based on the improving situation at Aptim. We have rated the company as underperforming since the IVQ 2018; and further downgraded the business to a CCR 5 when we first saw the FSKR non-accrual in the IIQ 2020.

The BDC Credit Reporter will circle back as the IVQ 2020 results come in from the BDCs involved and see what we’ll learn. We have no view as to the likelihood of an eventual loss but that “unsustainable” capital structure remains cause for concern, especially as the BDC debt outstanding is in junior debt capital. Still, in the short term values might be going up rather than going down or getting written off.

UPDATE: We have added Aptim to our Alerts list of companies whose value is expected to materially change in the next 1-2 quarters.

Belk’s Inc.: Restructuring Deal Agreed ?

People who shouldn’t be talking have been about what’s happening at Belk’ Inc. , the regional department store. Negotiations have been going on – as we discussed in an earlier post – between Sycamore Partners and the company’s first and second lien lenders. “According to people with knowledge of the plans” – says Bloomberg – here’s a thumbnail of the plan:

The restructuring plan involves handing 49.9% of the company’s equity to its lenders, with parent Sycamore retaining a 50.1% stake in exchange for supplying up to $100 million of a new $225 million loan to the company, according to the people“. Plus, the company will make a quick run through bankruptcy court – one day is the goal – and come out the other side. Late February 2021 is the when this is all supposed to come down. That’s the theory anyway.

$450mn of current debt will vanish from Belk’s balance sheet, but will also add $225mn of new debt , of which $100mn might be supplied by Sycamore. We say “might” because the deal envisages Sycamore generously letting hungry lenders provide up to $65mn of its share of the new debt. There’s more besides, including juicy fees, and existing debt maturities being pushed out tp 2025 from 2023.

Given this is all hearsay – even if from people in the room where it happens – and subject to further amendation by the parties involved or by the court brought in to rubber stamp this deal doing, we won’t linger on the details till we hear something more definitive. Mostly the BDC Credit Reporter wants to emphasize that the Belk’s story is finally reaching some sort of conclusion a year after the second lien debt became non performing. (The first lien debt joined in in the IIIQ 2020). We still expect – equity notwithstanding – that major realized losses will need to be booked – see our earlier article. Furthermore – and this is new but not unexpected – the two key BDC lenders involved – FS KKR Capital (FSK) and FS KKR Capital II – will be putting up some share of the new debt monies as well. This could bring total BDC exposure up from $148mn to near $200mn, or possibly more.

This will be an excellent test of how these two BDCs fare in seeking to act as their own turnaround firm rather than taking the loss and walking away. Clearly there are a lot of the best and the brightest involved in this Chapter Two for a quintessential brick and mortar retailer, both on the lending side and from private equity. However, that’s no guarantee of success and the BDC Credit Reporter remains skeptical and in need of convincing this will all turn out alright. We’ll be back to you shortly.

Belk Inc.: Negotiating With Creditors

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

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

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

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

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

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

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

Sequential Brands: Charged With Accounting Fraud

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

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

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

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

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

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

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

Mood Media: Company Sold

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

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

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

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

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

Arena Energy: Files Chapter 11

Naturally enough, a few days after we remarked that BDC-financed company bankruptcies had slowed to a seeming halt, a major Chapter 11 filing occurs. In this case, Arena Energy L.P. filed for bankruptcy protection on August 21, 2020. According to the Wall Street Journal, the company has already agreed on a sale to PE-group Lime Rock Partners and management. The existing lenders have mostly signed off on the sale. Apparently, the term loan lenders, who are junior to the reserve-based secured lenders, will receiving a mere 2% of their $439mn in debt back.

This is sad, but not unexpected news, for the three BDCs involved- all part of the FS-KKR Capital organization: non-traded FS Energy & Power and twin public entities FS-KKR Capital (FSK) and FS-KKR Capital II (FSKR). In total, the BDCs funded $179.5mn, all in second lien debt, and which used to be priced at LIBOR + 12.00%. The debt has underperforming and on non accrual since the IQ 2020, reflecting a very sharp drop in fortunes in a brief period. This is debt that dates back to 2015, and when GSO Blackstone was managing these BDCs. Unfortunately, new external manager KKR has not been able to rescue this unfortunate investment in the years since taking over.

If the 2% recovery rate is correct, the BDCs will have to take a further unrealized loss in the next quarter because the existing position was written down (86%). Either in the IIIQ or IVQ 2020 we expect the lenders will have to book a final realized loss of approx ($175mn) ! Also lost is the near ($22mn) of annual investment income being booked through the IVQ 2019. This is a significant reverse by any measure, with FS Energy absorbing about two-thirds; then FSKR with $54mn at cost and finally FSK at $9mn. The almost 100% loss is deeply disconcerting and suggests the lenders – whether they recognized it or not – were investing more like a PE group than a lender but with a capped return and an unlimited downside. Finally, this proves the BDC Credit Reporter’s oft-made point that energy lending is an oxymoron and an inappropriate asset for an industry with a predominantly retail investor base.

We had already rated the company a CCR 5, and expect to see the name removed from the books of all the BDCs involved by year-end.

Borden Dairy: Exits Bankruptcy

These days the BDC Credit Reporter is busy writing about BDC-financed companies filing for bankruptcy, or on the verge of doing so. This article, though, is about a company exiting the bankruptcy process and still BDC-financed : Borden Dairy. Capitol Peak Partners and FS Investments- KKR Capital funds purchased the business for $340mn and have “appropriately capitalized” the new business which – operationally – will continue much as before the filing.

This has been a 6 month process which we’ve written about extensively. As was clear early on, the lenders – headed by the FS Investment- KKR organization – were intent on being part of a “debt for equity swap” and that has come to pass, wiping out the equity interest of the prior owners. However, just the financial details of the new company and how much old and new capital FS-KKR has in play – and in what form – is unclear. We expect to learn more and will report back.

In the interim, we remind readers that two BDCs – FS KKR Capital (FSK) and KS KKR Capital II (FSKR) have advanced $171mn in first lien debt to the old Borden and have already written down ($95.1mn). Presumably – but not necessarily – this amount or thereabouts will become a realized loss now the transaction has been closed and will show up in the IIIQ 2020 financials. Total exposure may actually grow if the lenders have advanced more monies.

Not to be Grinchy, the future of Borden is far from assured. Milk demand in the U.S. has been on the decline for years, and the Covid-19 situation is not helping. Moreover, competition remains fierce with Dean Foods and others and regulation can be difficult as well. Furthermore, we don’t know yet how much elbow room the new owners have left themselves and what amount of debt the new Borden will have to contend with.

For the moment, we are upgrading the company from non performing, or CCR 5, to CCR 3, until we learn more about what Borden will look like in the future and how much debt will be carried. We hope to learn more when FSK and FSKR report IIQ 2020 results, which could cause a revaluation up or down. The bottom line: both BDCs – and their shareholders – will be involved in the business of milk for a very long time, having started out in IIIQ 2017 as lenders.

Chisholm Oil & Gas: Files Chapter 11-Corrected

On June 18, 2020, Chisholm Oil & Gas Operating LLC filed for Chapter 11. The oil & gas explorer, though, has a restructuring support agreement in place with its two lending groups and plans for an exit sooner rather than later. The lenders include the reserve-based lending facility and the holders of the 2024 Term Loan. The restructuring plan involves converting all the $517mn in debt to equity; issuing two new – smaller – debt facilities; use of cash collateral and various minor concessions to other creditors. We’ve skimmed the 107 page filing – which includes the reasons for why the company got into trouble in the first place – and are not fully convinced this will provide a lasting solution, but nobody is asking the BDC Credit Reporter.

We should say from the outset that this a Major non-performing asset with $295mn invested in Chisholm’s debt and equity, spread over 3 BDCs. Sweating most heavily right now will be non-traded FS Energy & Power with $226mn. Next is FS KKR Capital II (FSK) , which is newly public with $39mn. Sister BDC FS KKR Capital (FSK) has $16mn of debt. Admittedly, the bankruptcy was expected as the debt was placed on non-accrual as of the IQ 2020 and the total fair market value marked down to $124.0mn.

We fear, though, that – notwithstanding the restructuring plan which envisages a debt for equity swap – losses could increase further now that the bankruptcy has hit the proverbial fan. If we’re reading the plan right, the Term Loan holders will only be getting 3% of the restructured company’s equity because the secured debt is deeply underwater from an availability standpoint. $263mn is owed but the current availability is only $120mn…We expect most of the capital invested by the BDCs to be worthless. Unclear is whether the same BDC lenders will provide some portion of the new restructuring facilities. At the end of the day the BDCs could write off $250mn or more of the $302mn invested and lose out on all the $21mn or so in investment income that was being booked on an annual basis before the non accrual in the IQ 2020.

This the eighth BDC-financed company to file for bankruptcy protection in June and the 24th in 2020 and – by far – the largest in both those categories. We are maintaining our CCR 5 rating till bankruptcy is exited and realized losses are booked in the second or third quarter 2020, including potentially incremental losses of ($80mn) over the IQ 2020 level.

For all the BDCs involved this seems to a classic example of why not to get involved in energy lending. This transaction is notable because even the reserve-based lender – who often dodges any losses due to their low advance rate and secured status – has managed to get into trouble. What hope did the second lien lenders and equity investors (where the BDCs were concentrated) have ? The investment was not even particularly richly priced for the potential catastrophic losses: LIBOR + 550bps.

We’ll update readers when we receive further information.

Correction: This article was updated on June 22, 2020 to remove our mention of Main Street (MAIN) and HMS income as lenders to the company. In fact, their investment is in Chisholm Energy Holdings, LLC, a separate entity with HQ in a different state. We apologize for the error.

APTIM Corp.: Wins Federal Contract

A subsidiary of APTIM Corp – the engineering management company – has been awarded a $129mn Federal contract for Navy barge dismantlement, according to a June 10, 2020 report. This follows the recent addition of a new CEO at the troubled company whose debt trades at a severe discount. He joined April 20, 2020. Nonetheless, we note that the 2025 bond is trading 5% points up currently versus the end of the IQ 2020. At that point, the 4 BDCs with $30.9mn exposure to that debt had applied a FMV discount to cost of as much as (65%).

These are green shoots for APTIM, and make our last May 11, 2020 assessment of the company – which is on our Weakest Links list with a CCR 4 rating – possibly too harsh. For the moment we are not changing our corporate credit rating, but we are removing APTIM from the Weakest Links list.

Borden Dairy: Bankruptcy Auction Completed

After much back and forth and a hard fought auction, bankrupt Borden Dairy was purchased by a joint venture consisting of Capitol Peak and “KKR & Co” according to the Wall Street Journal. (For the record, the WSJ in its article constantly refers to “KKR” as a lender to Borden, but – in fact – the debt is held by two BDCs which the famous investment manager co-manages with FS Investments: non-traded FS-KKR Capital II (soon to have the ticker FSKR) and publicly traded FS KKR Capital (FSK). As we’ve been discussing for months, these two BDCs, the management of which KKR took over from GSO Blackstone a few years ago, have $171mn in first lien debt outstanding at cost to Borden. We’ve read other publications, such as Bloomberg, all of which have not quite cottoned on that KKR’s involvement is through these BDCs which KKR & Co only co-manages and cannot even be called – as one journalist did – “KKR’s credit arm”.

Anyway, as far as we can tell, the two FS-KKR lenders are teaming up with Capitol Peak and will – in all likelihood – undertake some sort of “debt for equity” swap. More details to follow, so we won’t speculate about what the ultimate impact on FSK and FSKR might be. What seems sure is that the BDCs caught up in this bankruptcy will remain involved in the milk business for a long time yet and may yet be putting more capital to work.

Debt for equity swaps have been a way of life in the energy business for years, with unremarkable results for the former lenders as the industry has continued to struggle and is a mighty devourer of capital. Of course there have been debt for equity swaps in other industries as well and we expect the strategy to be the most popular one across the bankruptcy spectrum in 2020. That will leave many would-be buyers of distressed assets – currently raising funds as fast as they can – grinding their teeth. Lenders like KKR/FS Investments understandably believe “anything you can do, we can do as well” and are loath to walk away from troubled situations. So we expect a lot of debt turning into equity; more capital advanced in debt or equity and bold attempts to turn around businesses that have fallen on hard times. Like Borden. Whether that will prove a successful approach overall remains to be seen, but the BDC Credit Reporter will keep score best we can.

For the moment – short on gritty details and with the bankruptcy judge still needing to approve the winning bid – we are not changing any of our ratings. The debt remains rated CCR 5 – non-performing. Expect to be hearing more from us before long.

CSM Bakery: In Forbearance With Lenders

Business and financial conditions have deteriorated fast at CSM Bakery which – according to Moody’s – “produces and distributes bakery ingredients and products for artisan and industrial bakeries, and for in-store and out-of-home markets, mainly in Europe and North America“. Both Moody’s and S&P have downgraded the company’s debt to SD, or “selective default“. Right now, the asset-based lenders to the company have entered into a forbearance agreement, but only till June 11. Moreover, the 2020 and 2021 term loans have been downgraded to CC and C respectively. This does not look good and a default or restructuring seems likely.

This is bad news for the 4 BDCs involved with $17.3mn invested at cost in those term loans, one which is senior secured and the second subordinated/second lien, according to Advantage Data’s records. The BDCs involved (in descending order of debt held) are non-traded FS Investment II; Monroe Capital (MRCC); Portman Ridge (PTMN) and FS-KKR Capital (FSK). PTMN is in both the loans and MRCC in just the subordinated.

At the end of 2019, this debt was performing and valued close to par. As of March 2020, the BDCs valuations had been discounted by as much as (18%) and the subordinated by (22%). (As always, BDC valuations vary). The current market value of these syndicated loans – using AD’s module – are not much worse right now despite the downgrades. Whether that will continue, especially for the more junior debt, if a default/restructuring occures remains to be seen. As is often the case, we are more pessimistic.

The BDC Credit Reporter had downgraded the company to CCR 3 from CCR 2 after the IQ 2020 results but now reduces the rating to CCR 4, as a loss seems very likely. Furthermore, we are adding the company to our Weakest Links list given the proximity of a non accrual and/or bankruptcy, even though interest has been paid currently till now. There’s ($1.2mn) of investment income at risk of interruption very soon and eventual losses that could exceed ($6.5mn) in our ungenerous estimation, or 38% of cost.

CSM is another example of that second wave of BDC portfolio companies affected by the impact of Covid-19. (The first wave were the companies already badly unperforming but still accruing income before the virus struck. many of those companies have since defaulted/filed Chapter 11 or undertaken major out of court restructurings or are close to doing so). Judging by its valuation the company was performing adequately before the crisis but has deteriorated fast. (Moody’s valued the first lien debt Caa1 in mid-2019). In less than 6 months CSM has gone from adequate performance to the edge of bankruptcy.

(Word to the wise, there will most likely also be a third wave of underperforming companies if the economy does not recover – even if not directly in the worst affected industries – as the weight of servicing debt and the difficulty of raising new capital increases. However, that’s an issue for another time).

We expect to be reporting back on CSM very shortly, given the short leash the lenders are giving the company.

Pure Fishing: Downgraded by S&P

The last time we wrote about outside sports retailer Pure Fishing was in response to a downgrade by Moody’s to speculative grade. Now S&P has joined in, dropping the company’s credit rating to CCC+, from B-, according to an article. There’s only a six week gap between these ratings so there’s not much new bad news. However, we did focus principally on liquidity matters, which included this comment by S&P: “…we expect working capital to be a use of liquidity in 2020, as slowed inventory turns coupled with delayed collections result in a net use of the company’s cash and reliance in 2020 on its $125 million ABL revolver, which had a $100.6 million balance at the end of March 2020. We expect the company to continue to generate negative operating cash flow through the end of 2020“.

We already had Pure Fishing in “speculative” territory, i.e. rated CCR 4 on our 5 point system. No change there. We also continue to have Pure Fishing on our Weakest Links list, expecting a default or restructuring to occur in the short term. That’s been a bridge too far till now, as the S&P review seems to suggest the company may yet avoid that fate. We tend to be more conservative, especially as BDC exposure here is in the more vulnerable second lien level.

Since we last wrote IQ 2020 results have been published. The two BDC lenders exposure at cost ($125.8mn) remain Major, but unchanged. Not surprisingly, the fair market value marks are catching up with the company’s problems. The discount is now (19%) from (13%) at the end of 2019. We continue to believe that’s still not a big enough discount. Given this latest downgrade; lower sales; Covid-19 etc we expect FS Investment (FSK) and FS Investment II will be taking a further unrealized write-down at the end of the IIQ 2020.

Templar Energy: Files Chapter 11

On June 1, 2020 Templar Energy LLC filed for Chapter 11. We first wrote about the troubled energy company back on April 28, 2019 when the CEO resigned and the outlook was bleak even then. Now the company’s lenders are seeking the sale of Templar’s assets and its eventual dissolution, says Law360.

We won’t spend any time on the bankruptcy details given that the only BDC exposure is in the company’s preferred and equity ($12.8mn) at cost and has already been effectively written down to nothing at the end of the IQ 2020. This will result in a ($12.8mn) much expected realized loss for non-traded BDC FS Investment II.

This is a borrower with a long history for BDC lenders, which once included Main Street Capital (MAIN) and HMS Income, and which filed for bankruptcy back in 2016 when BDC exposure at cost was close to $130mn. Realized losses were taken then but FSIC II received equity which was carried till now, if we understand the back story correctly.

In any case, this is just one more casualty amongst many for the partnership between KKR and FS Investments. In this case, though, as in many others, KKR inherited an investment left over from when FS Investments was teamed up with GSO Blackstone. This bankruptcy will at least clear the BDC’s books of a “zombie” investment that has been kicking around for many quarters, generating no income and with little chance of ever being worth anything.

Production Resource Group LLC: Placed On Non-Accrual

The BDC Credit Reporter is having a hard time keeping up with the ever increasing number of BDC-financed companies being added to the non accrual category. This latest addition, though, is a big one, so we apologize for the delay. Production Resource Group, LLCrents equipment, labor and production management services to end users in sports, live TV, music and film“, says bankruptcy publication Petition. As you’d expect, with Covid-19 and those end users in lockdown, business is not good.

There are three BDCs with a remarkable $511.3mn invested at cost in the company’s first lien 2024 term debt. Leading the trio is non-traded FS Investment II with $381mn, followed by Ares Capital (ARCC) and then TCW Direct Lending VII, LLC. From the IQ 2020, that debt was placed on non accrual and discounted between (30%) and (42%). [As always, there are sometimes inexplicable variations in valuations between BDCs holding the same debt tranche]. The company had been on the underperformers list since IIIQ 2019 with a CCR 3 rating, but has now leapfrogged to CCR 5, or non performing. The investment forgone to these three BDCs is huge for a credit with a middle of the road pricing of LIBOR + 700 basis points: about $42mn.

We have very few other details to offer so we’ll just wonder aloud at why the largest BDC lender to the company would take such a huge position. The FS Investment II loan represents 5% of that BDC’s total portfolio at cost and the FMV at March 31, 2020 equal to 6% of it’s net assets.

Also notable is that Production Resources Corp tops the BDC Credit Reporter’s list of so-designated Major underperforming companies – those with $100mn or more in outstandings at cost. There are 40 names on what’s we’ll begin to call our Biggest Hitters list and Production Resource Group has the dubious honor of being listed number one. These larger underperformers are important because this relatively small group amidst the 527 companies on the full underperformers list account for more than 40% of all investments at cost and FMV.

That’s all the more reason for us to keep tabs for what happens next at Production Resource Corp and other giant positions which individually can materially affect BDC returns. We expect to hear more no later than when the BDCs involved report second quarter results in the early summer.

Borden Dairy: Asset Auction Set For June 2020

By recent large company bankruptcy standards, Borden Dairy has remained under court protection for longer than most. That’s because there was no consensus between the owners and the lenders when the dairy giant first elected Chapter 11, as we discussed at the time. Then there were disputes about how to apply liquidity and plans by bondholders to merge Borden with that other bankrupt dairy name: Dean Foods. The latest news is that the judge in the case has agreed that the company may sell its assets at an auction in June if no other viable restructuring plan does not take precedence.

We have used the opportunity to update the latest numbers from the IQ 2020 results about BDC exposure. Where there were 4 BDCs involved now there are only two because FS Investment II acquired FS Investment III and FS Investment IV. Now there’s $170.5mn at cost of first lien debt exposure divided up between the afore mentioned non-traded FS Investment II and its public sister BDC FS KKR Capital (FSK), split $103.1mn and $67.4mn. That’s much unchanged since the bankruptcy began. The FMV, though, has dropped from $152.5mn before the bankruptcy to $75.7mn. Even since the IVQ 2019 results, when the company was already in Chapter 11, the debt has dropped sharply in value, from $90.5mn. We can’t determine if a further discount is likely, but current market conditions can’t help.

What does seem probable is that some sort of resolution is coming. That means a realized loss is likely to be booked in the IIIQ 2020 which could be as high as ($100-$120mn). (BTW, this is far and away the biggest BDC exposure to a sector that has been in secular decline for years, but we have found two other underperformers in our database with dairy credentials. More on those in future posts).

We wonder if the FS-KKR organization is really interested in becoming an owner of this business in this sector by involving itself in a standard “debt for equity swap“. That will almost certainly require deploying new capital at a time when BDC liquidity is constrained and remaining involved in the milk business with its Byzantine complications for many more years to come. More likely – in our purely speculative view – is that the BDC lenders will let some third party acquire Borden’s assets and take their credit loss medicine and walk away with whatever proceeds are available. We will find out shortly.

Borden remains rated CCR 5 or non performing. Given that BDC exposure is over $100mn this is a “Major” company by the BDC Credit Reporter’s standards, which just means that we keep special tabs on what’s going o because the financial impact is so high. FYI: At the moment Borden ranks tenth highest – on a cost basis – of the 45 “Major” underperforming BDC-financed companies in our database.

Sequential Brands: Doubt About Going Concern-Updated

On May 15, 2020 Sequential Brands reported IQ 2020 results. More importantly, the company reported very tight liquidity even after drawing on its Revolver: just $14mn. Furthermore, in a press release, the company admitted to being in negotiations with its lenders to avoid any prospective loan defaults and raised doubt about its status as a “going concern”. The stock price – not very material to start with – dropped (11%) to $0.19.

The BDC Reporter has rated the company CCR 4 for some time. The chances, though, of a bankruptcy or recapitalization have greatly increased thanks to Covid-19, as reflected in these latest developments. This is what we call a Major BDC borrower (over $100mn), with $292mn invested at cost as of December 31, 2019. (Not all the IQ 2020 outstandings have been reported). The 3 BDCs involved are publicly traded Apollo Investment (AINV); FS-KKR Capital (FSK) and sister non-traded fund FSIC II. Most recently FSK valued its position in the 2024 Term Loan at just a (2%) discount. However, the $10mn in equity owned by two FS-KKR BDCs is valued at next to nothing, as the stock price mentioned above suggests.

If Sequential does default – as we’ve mentioned in earlier articles – the biggest immediate impact will be the receipt of the $30mn of investment income the three BDCs have been used to collecting. Whether there will be any realized loss from the debt held continues to be questionable, but the equity will certainly be written off. Most impacted of all will be FS Investment II, which holds 75% of the BDC exposure.

Of the 6 Major BDC borrowers on the BDC Reporter’s Weakest Links list, Sequential is by far the largest. Should a bankruptcy/restructuring occurs it will be the biggest one since the Covid-19 crisis began from a BDC lender perspective. Like so many other names on that Watch List, Sequential was already deeply troubled before the crisis. Current conditions make an unhappy outcome – and possibly a much bigger loss than the BDCs have been planning for in their valuations – almost certain. We expect to be reporting again shortly.

May 20, 2020 Update: From another news report we have learned that “The company closed the first quarter with $13.3 million of cash and $460.7 million of debt net of cash. As of March 31, availability under its revolver was $7 million, which the company fully borrowed subsequent to the end of the quarter“. The above underscores that Sequential Brands is effectively out of cash and some sort of action will be necessary.

Aptim Corp: Valuation Drops

Great Elm Corporation (GECC) announced IQ 2020 results on May 11, 2020. This included an update on the valuation of Aptim Corp, which we’ve discussed before. GECC wrote down its position in the 2025 Term Loan by (58%). That’s in line with Main Street Capital’s (MAIN) own valuation of the same security. Currently, the discount is even greater at (65%).

Previously we’d rated the company as CCR 4, and added the debt to the Weakest Links list. We affirm both our earlier views following these latest disclosures, and suggest the final value of the 2025 debt – held by 4 BDCs overall at an aggregate cost of $30.9mn – might end up being nil. The other BDCs involved are non-listed FS Investment II and HMS Income, which is managed by MAIN.