PROFILE

"Ares Capital Corporation (ticker: ARCC) , a Maryland corporation is a specialty finance company that is a closed-end, non-diversified management investment company. ARCC was founded on April 16, 2004, and completed its initial public offering on October 8, 2004. As of September 2019, ARCC was the largest BDC in the United States, with portfolio assets at fair market value of $13,892bn. The BDC is externally managed by Ares Capital Management LLC (“Ares Capital Management”), a subsidiary of Ares Management Corporation (NYSE:ARES) , a publicly traded, leading global alternative asset manager. The BDC's investment objective is to generate both current income and capital appreciation through debt and equity investments. ARCC invests primarily in U.S. middle-market companies. However, ARCC also invests in larger or smaller companies"





Posts for Ares Capital Corporation

Instituto De Banca Y Comercio Inc: IVQ 2020 Status

Instituto De Banca Y Comercio is a trade school for bank personnel in Puerto Rico, which we’ve been tracking for years. The only BDC with exposure is Ares Capital (ARCC), dating back to 2007 when the for-profit business was bought out by a PE group: Leeds Equity Partners. At one point, ARCC held a position via its joint venture with GE Capital but bought back its position – following some complex accounting – in 2016 when the company was non performing and the BDC was breaking up with its JV partner. At the end of 2020, this now 13 year relationship consisted of total exposure of $121mn in the form of debt and preferred, with a FMV of $32.3mn. $17.3mn in first lien debt is accruing at 10.5%, and there is $103.7mn in preferred. We’re not sure if ARCC is booking any income on the preferred, which only has a value of $15.0mn.

We don’t know how the business is performing but the valuation trend is unchanged between IVQ and IIIQ 2020. ARCC does not mention the company much anymore since the buyout of the GE position from the JV in 2016. Understandably, given the near ($90mn) written down already, the BDC Reporter has a CCR 4 rating on the company. Should the debt go on non accrual ARCC would forgo ($1.8mn) of annual interest income. A full realized loss of the preferred would reduce net assets by ($15.0mn). These are sizeable numbers but not especially material for a BDC of ARCC’s size.

We have no reason to believe anything is going to happen soon as the debt is not due till 2022, and the public record is bare on any details on how the company is performing, so we don’t have Instituto as Trending, but it is a Major exposure being over $100mn at cost. We’ll check back periodically to see how outstandings and valuations change on this “zombie” investment that just keeps going and going without much in the way of resolution. ARCC has extended the debt at least 4 times since 2007.

ADG, LLC: IVQ 2020 Update

ADG, LLC (dba Great Expressions Dental Centers) is a BDC portfolio company we should have written about ages ago for a number of reasons. First, BDC exposure is Major: $106mn at cost, almost all held by Ares Capital (ARCC), with New Mountain Finance (NMFC) holding a $5.9mn second lien position. Second, the company was underperforming by our standards even before the pandemic and since everyone’s been sheltering in place, has been on non accrual since IQ 2020. Finally, we’re projecting the company is Trending, i.e. likely to materially change in value in early 2021. More on that at the end. Although we’ve not written about ADG, LLC before we’ve been tracking the business in our Company Files and in our daily search for new developments.

Here’s the lie of the land: At year-end 2020, ARCC had a small first lien debt position of $7mn, half the size of the quarter before and performing, valued at a (10%) discount to par. The BDC also holds an $89mn second lien debt position due 3/1/2024 that is on non accrual but discounted only (12%). NMFC also holds a second lien debt position – maturing at the end of March 2024 – and discounted (24%). However NMFC’s debt – which may or may not be in the same facility – is not carried as non performing but its 11.0% yield is all Pay-In-Kind. Then there’s $3.0mn in equity held by ARCC (which has a very long standing relationship with the company that predates its current PE owner) , valued at zero. The total FMV for all positions and both BDCs is $89mn. ARCC is forgoing about ($7.5mn) of annual investment income due to the non accrual.

There’s no up to the minute news in the public record but the BDC valuations have been greatly improving in the last three quarters. That suggests the business is turning around. We do know that the whole dentistry sector is on the upswing after some dark months last year when dental chairs were off limits in many states due to Covid-infection fears. Sadly, neither ARCC or NMFC has mentioned ADG on their conference calls. Nonetheless, we’ll go out on a limb and suggest there’s better news ahead. That’s why we have ADG, LLC “Trending”, with the prospect of higher debt or even equity valuations and the possibility the second lien debt might return to performing status.

For the moment ADG, LLC remains rated CCR 5 but we’ll be looking out for ARCC’s disclosure about the company on April 28, 2021 when its IQ 2021 results get published.

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 ?

Sundance Energy: Files Chapter 11

Despite a higher oil price, there’s still plenty of credit trouble in the energy sector as reflected in the just-announced voluntary Chapter 11 filing of Sundance Energy Inc. (NASDAQ: SNDE) and its affiliates. As you might expect, the company and its major lenders have a plan already in place to restructure the balance sheet and exit from bankruptcy. The second lien Term Loan lenders seem to be ready to convert all or most of the $250mn owed to them into equity. Moreover, the press release suggests “certain of its Term Loan lenders” will provide $45mn in debtor-in-possession (“DIP”) financing to keep the business running. When this is all said and done:

Upon emergence, the Company’s recapitalized balance sheet will include (i) $137.5 million of funded indebtedness comprising a senior secured reserve-based revolving credit facility, a senior secured second out term loan, and, if necessary, a senior secured third out term loan, in each case provided by the existing RBL Facility lenders and (ii) new common equity interests issued in exchange for DIP financing claims and Term Loan claims, subject to dilution by new common equity interests granted under a new management incentive plan“.

The only BDC with exposure is Ares Capital (ARCC) with $58.6mn invested at cost (par value is slightly higher) in the second lien Term loan. The debt has been non-performing since the IIIQ 2020, and was already discounted (37%) as of IVQ 2020. Before the debt went on non accrual ARCC was earning $6.7mn on an annual basis of investment income. We now expect there will be both a realized loss booked in the IQ or IIQ 2021 associated with the restructuring and – most likely – new capital advanced.

We won’t try to estimate the extent of ARCC’s loss, especially as this restructuring is just a way station in the BDC’s relationship with Sundance Energy, which began in IIQ 2018. Frankly, we don’t understand why ARCC – which often makes a great deal of its modest energy exposure – would have invested second lien capital in a “independent oil and natural gas company focused on the development, production and exploration of large, repeatable resource plays in North America“. To be blunt, given what has happened to a multitude of similar companies in recent years this seems unwise credit underwriting.

We’ll circle back once the restructuring plan is approved and when we discover how stage two of ARCC’s relationship with Sundance Energy looks like. This could be an investment we’ll be writing about for years to come.

Centric Brands Inc.: Exits Bankruptcy

The long line of companies that filed for bankruptcy as the pandemic took hold in the spring of 2020 is now headed in the other direction with cleaned up balance sheets, new owners and high hopes. Included in this group is Centric Brands, which exited Chapter 11 on October 9, 2020 following a “debt for equity swap” with its well known lenders, including Blackstone and Ares Management. Old debt is being forgiven in return for a controlling equity and new debt (including a securitisation facility) being provided by the owner/lenders.

The BDC Credit Reporter has been writing about Centric for some time, and with special interest, given the large amounts of BDC capital advanced to the company even before the restructuring : $129.9mn at cost. We’re guessing that the valuations by the 3 BDCs involved as of June 2020 must be close to the final deal struck, which has been in the works since the filing in May. Almost certainly written off is the $24.6mn invested in the equity of pre-bankruptcy Centric by Ares Capital (ARCC), which the BDC has written down to zero. That was carried at par back in early 2019.

Then there’s $98.5mn in first lien 2023 Term debt, held by ARCC, TCW Direct Lending VII and Garrison Capital (GARS), which has been discounted between (4%) and (16%) by the lenders involved. There are some “last out” arrangements in the debt which may explain the discrepancies.

Interestingly, and despite the bankruptcy, none of the BDCs carried any of their debt as non-performing as of June 2020. That may be because the 2023 debt was Pay-In-Kind anyway. Finally, there’s $6.7mn in 2021 DIP financing provided by the same trio, which is likely to be folded into the post-bankruptcy capital structure. In fact, we wouldn’t be surprised that after all is said and done the BDCs involved end up with more capital in Centric than ever before.

Exactly how large the realized losses will be is impossible to tell as each BDC might value its new equity stake differently. We’re guessing that total losses booked will be ($35mn-$40mn), or roughly a third of the capital invested at June 30. ARCC will be the biggest loser by far, followed by TCW Direct Lending and with GARS losing ($1mn-$2mn). Losses could have been much higher but the BDCs were positioned above $700mn+ in second lien debt held by Blackstone. That’s the debt being written off and which will reduce leverage by about half. For that Blackstone receives 70% of the equity of the new Centric and the other lenders 30%.

Of course, neither Centric Brands nor BDC exposure is going anywhere and success is not guaranteed. We are upgrading the company from CCR 5 to CCR 3, still on the underperformers list. Centric has had to lay off hundreds of employees and continues to be leveraged, so questions will remain for some time about its viability under its new lender ownership.

We will circle back with an update when IIIQ 2020 or IVQ 2020 BDC results are published and we can ascertain what realized losses were booked and what the revised outstandings look like for all three BDCs involved.

Centric Brands Inc: Reorganization Plan Approved

Since May 2020 Centric Brands, Inc. has been under bankruptcy court protection. Now, though, the company is poised to exit that status by mid-October 2020 following court approval of a reorganization plan and some well placed settlement payments to disgruntled creditors. The deal seems like a debt-for-equity swap, with first lien and second lien lenders receiving equity in the restructured company while continuing as lenders in new, smaller, debt facilities.

After all conditions have been finalized, Centric Brands — whose owned brands include Zac Posen, Hudson and Swims — plans to exit Chapter 11 by the end of October with a “recapitalized” balance sheet, as well as new financing facilities, “significantly reduced” debt and interest payments, plus the full support of all of its lenders.

This is a Major BDC investment by BDC Credit Reporter’s standards: i.e. over $100mn at cost or $129.9mn in this case. There are three BDCs involved, headed by Ares Capital (ARCC), which is invested in both the debt and equity of Centric. Then there’s non-traded TCW Direct Lending VII and publicly traded Garrison Capital (GARS). The debt held by the BDCs matures in 2021 and 2023. The latter with a cost of close to $100mn is valued at roughly a (15%) discount and is likely to be partly written off when the company exits bankruptcy. That will result in about ($15mn) in realized losses along with nearly ($25mn) ARCC holds in the equity of the insolvent entity, or a total loss of about ($40mn). The 2021 debt is Debtor In Possession financing and is likely to be repaid in full. What we don’t know is if the lender-now-owners will have to inject incremental new capital or not. More details to follow.

This will be a significant – but not overwhelming loss, principally for ARCC, and to a much lesser degree for the other two. On the other hand, it looks like all the players will live to fight another day and – potentially – recoup proceeds lost from an eventual sale of the restructured Centric Brands another day.

We will be upgrading the company from CCR 5 to CCR 3 or CCR 4 when the exit from bankruptcy occurs. As we’ve written in earlier articles about Centric, much will depend on how generous the new lender owners have been in structuring the going forward balance sheet. The company continues to operate in an industry – lifestyle brands sold mostly at retail – that continues to be pandemic impacted. Furthermore, some debt for equity swaps in the past have been done with less than generous terms, rapidly returning the business to the bankruptcy court. We hope Centric won’t be a “Chapter 22” story.

Alcami Holdings LLC: Downgraded By Moody’s

Moody’s has downgraded pharmaceutical preparation company Alcami Corporation (“Alcami Holdings” in Advantage Data) to a corporate credit rating of Caa2 from Caa1. The ratings group believe the underlying industry is strong, but worries about high leverage (adjusted debt/EBITDA over 10x) ; worsening liquidity and the chances the company might seek a “distressed” exchange in the near future.

There are two BDCs with “Major” exposure to the company – i.e. any aggregate amount at cost over $100mn, but 99% is held by Ares Capital (ARCC), with $145.6mn. The other BDC involved but with less than a $1mn outstanding is non-traded Audax Credit BDC. We’ll focus most of what follows on ARCC. As of March 31, 2020 ARCC held positions in two first lien term loans due in 2023 and 2025, a second lien loan and equity in Alcami. Only the last two had been materially discounted by ARCC’s valuation group: (15%) and (61%) respectively.

The BDC Credit Reporter has rated the company as underperforming with a CCR 3 handle since IVQ 2018 but only because of the discounted equity, written down (20%) at that time. Even the second lien loan was discounted only (9%) through the end of 2019. Now we are downgrading Alcami to CCR 4, as the chances of an ultimate loss seem higher than full recovery. Moreover, we’re adding the company to the Weakest Links list, based on the tight liquidity at the business and Moody’s view about a possible “distressed exchange” – something that is getting to be very common these days.

Given the size of the overall exposure, and with $112mn of exposure in the equity and second lien debt, Alcami represents a significant problem for ARCC. Total investment income at risk is close to ($9.0mn) on an annual basis. That’s roughly equal to 1% of the BDC’s annualized Net Investment Income Per Share. In the short run – unless ARCC ignores Moody’s – we expect to see a lower valuation in the second and/or third quarter valuations. Should the worse happen, a write-off of the second lien and equity is not impossible, which would drop value by ($78.6mn) from the value at the end of March. (Ironically, ARCC made a huge gain of $324mn on the sale of Alcami – inherited from American Capital – back in 2018).

In terms of investment size, this is the biggest Weakest Link added to our list – currently 28 companies long – since May 2020. We’ll be paying close attention to what’s happen next at Alcami, including peeping at how the BDC valued its positions at June 30, 2020 when those results come out shortly.

VPROP Operating LLC: Files Chapter 11

VPROP Operating LLC (also known as Vista Proppants and Logistics) has filed Chapter 11, according to news reports. We had written about the supplier of sand to frackers on February 12, 2020 when we heard about the company’s debt going into default in IVQ 2019. Now we’re waiting on the bankruptcy filings to find out what direction the owners and the company’s seemingly sole lender – Ares Capital (ARCC) – take the business. Consider this a placeholder article till those details get filled in.

For ARCC this is a major reverse with $158.5mn invested at cost and a FMV that dropped to $70.7mn as of March 2020 for the non accruing first loan and a dab of common stock. That gives you an idea of the extent of the likely realized loss: (55%) or more. Some ($17.2mn) of investment income has already been lost since the end of the IVQ when $148.8mn of first lien debt became non performing. (The remainder is in now value-less equity).

From a BDC sector perspective, this is the largest BDC-company bankruptcy in cost terms since Borden filed Chapter 11 ($170.5mn) back on January 7, 2020 according to our records. This is the fourth BDC-financed company to seek court protection in June and we’re just one-third of the way through the month.

From a finger wagging perspective, this is a classic investment in the oil services space, an area that most BDCs – including ARCC – have nominally “underweighted” or avoided, a fact that the BDC’s management was boasting of on its last conference call. VPROP may be the exception to the rule but its a significant one and may result in the BDC’s largest realized losses in some time. What’s more the BDC does have a total of over half a billion dollars at cost invested in energy over 6 companies (including VPROP) so this might not be the only ARCC-financed casualty of the BDC’s only partial avoidance of this most dangerous segment of the lending market.

For our part, we’ll be adding the company to the list of BDC-financed bankruptcies in 2020, bringing the aggregate cost this year to $830mn at cost. We will report back when the likely way forward for the company and ARCC – future owner of a frac sand supplier ? – becomes clearer.

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.

Centric Brands Inc.: Files Chapter 11, Restructures.

On May 18, 2020 Centric Brands Inc. announced a major restructuring. This includes the public company going private and a pre-negotiated trip through Chapter 11 bankruptcy. What’s more the company is getting $435mn in Debtor-In-Possession financing to smooth the way forward. $700mn of second lien debt is being written off. The existing first lien lenders – including three BDCs – will be staying on, but will be receiving equity in the new ownership.

Management blames Covid-19 for its troubles. However, back in December 2019 when first wrote about Centric Brands we were skeptical that the company could survive in its then-capital structure where interest expense matched EBITDA. By the time we posted again in April of 2020, the bankruptcy/restructuring die was seemingly cast with only the details to be worked out. Centric was on the BDC Reporter’s Weakest Links list. Like so many other names we’ve placed there, the company now moves to our non performers list until the bankruptcy judge approves this restructuring.

The BDC that will be most impacted in the short term will be Ares Capital (ARCC). At March 31, 2020 ARCC held $24.6mn at cost in Centric Brands public stock, which is now worthless. That will likely result in a ($3.2mn) write-down from the latest valuation and a ($24.6mn) realized loss. Less clear is whether ARCC’s first lien debt ($57.1mn at cost) as well as that of TCW Direct Lending VII and Garrison Capital (GARS) will be getting a haircut. If so, it’s unlikely to be much larger than the (10%) unrealized loss booked at quarter end by ARCC. Income, though, will likely be impacted during the bankruptcy period. We have no idea if accrued interest gets repaid in the new arrangement.

What is likely is that the existing first lien lenders are involved in that very large DIP financing, so BDC exposure – between debt and equity – is likely to increase rather than decrease when all the beans are counted once the restructuring is completed. Moreover, the BDCs relationship with Centric Brands may last a good deal longer now that lenders are becoming part owners. No word yet if any new capital is being injected and by whom.

We are downgrading the company’s credit rating from CCR 4 to CCR 5. After the restructuring occurs – assuming no blips – we will be maintaining the company on our underperformers list. The restructuring does not magically wave away the difficult retail environment Centric is likely to face. Moreover, no news of any new equity capital infusion worries us that the new owners, led by Blackstone, may be undertaking this turnaround too cheaply. Centric Brands would not be the first retail-oriented company that went through Chapter 11 twice… The BDC Credit Reporter will await more details about the transaction and the respective BDCs valuations of their post-recapitalization positions.

We will also be watching how this situation plays out in the context of evaluating how well BDCs like ARCC fare when they transition from lenders to owner-lenders. In this case the BDCs involved appear to have only a minor role to play in the new Centric Brands. Nonetheless, we shall evaluate the age old question of whether this is good money after bad or a masterful way to recoup some, all or more of capital advanced.

Garden Fresh Restaurant Corp: Files Chapter 7

On May 15, 2020 Garden Fresh Restaurant Corp – which owns Souplantation filed for Chapter 7. We had written about the restaurant operator’s troubles on May 9th, and it was clear at the time that the owners had little hope of being to able to keep the doors open in the Covid-19 era. Thus, the Chapter 7 liquidation decision.

This leaves the only BDC with $20mn of term debt exposureAres Capital (ARCC) – facing a certain realized loss once the company’s $50mn-$100mn in assets are sold and its 10,000 (!) creditors dealt with. As of March 2020, ARCC had the loan on non accrual and marked down (45%). The BDC is losing out on about $1.9mn of annual investment income on a loan that was faring fine till the virus changed everything. We’ll stick our neck out and guess that even a (45%) discount might not be enough here to reflect the final loss. We’re guessing (75%)-(100%)… We should have a clearer picture when ARCC reports IIQ 2020 results in the early summer.

This credit is notable for three reasons. First, this is one of the earliest bankruptcies of a company that was performing well before Covid-19 came along. Most of the other filings or restructurings we’ve memorialized in recent weeks are of companies that were already in deep trouble before Covid-19 sealed the deal. Second, the fact that liquidation has been chosen because of the ongoing change to the world as we knew it underscores the BDC Credit Reporter’s contention that this recession might see lower recoveries than might otherwise have been expected. That’s ominous news for lenders everywhere.

Finally – and as mentioned in our prior article – this represents a black mark from a credit underwriting standpoint for well regarded ARCC. Lending into the restaurant business and into an entity which had failed before (Garden Fresh filed Chapter 11 in 2018) was a credit bridge too far.

We will retain the company’s CCR 5 rating till liquidation is complete, which should be complete by the end of the year or earlier.

Garden Fresh Restaurant Corp: May File Bankruptcy

Garden Fresh Restaurant Corp owns chains like Souplantation and Fresh Tomatoes and commisary kitchens. Most of the food offerings are in a buffet format and that’s a problem with Covid-19. As a result, the private equity owner of the company is preparing to file for bankruptcy, after losing $1mn a week trying – unsuccessfully – to make its model work. The company had $250mn in sales before the current crisis.

This is bad news for the only BDC with exposure: Ares Capital (ARCC). The BDC giant has $20.0mn invested in the first lien Term Loan of the company. That debt was on non accrual for the first time in the IQ 2020 results, and written down (45%). The quarter before the debt was valued at par and ARCC was collecting close to $2.0mn in annual investment income.

We’ve downgraded the company in one fell swoop from CCR 2 to CCR 5. We have little expectation that the company will be making a comeback or that ARCC – whose position is relatively small by its standards – would be interested in a debt-for-equity swap in this situation. The principal remaining question is what the company is worth – if anything. We won’t guess, but will circle back when a more tangible resolution has arrived.

We’re surprised that ARCC would have involved itself with either the sector (even before Covid-19) or the company, which has a history including filing for bankruptcy previously, resulting in major losses for other lenders. The restaurant business is famously difficult to lend to due to its narrow margins; changing consumer tastes; high fixed costs and – now – virus concerns. Nor is the first lien status of ARCC in the capital structure any protection against loss. A reminder that even the biggest – and in the mind of some one of the best credit underwriters out there – BDCs can make mistakes.

Capstone Logistics Acquisition: Downgraded To CCR 3

On April 27, 2020 the BDC Credit Reporter pro-actively downgraded Capstone Logistics Acquisition to a Corporate Credit Rating of 3 from a CCR of 2. Capstone is “an outsourced supply-chain-solutions provider offering freight handling services, supply-chain consulting, and management of distribution centers“. We downgraded the company, and the $128mn in BDC debt due to our concerns what the national shut-down of business activity may have had on business activity given the leveraged nature of Capstone.

Centric Brands Inc.: May File Bankruptcy

According to news reports, Centric Brands Inc. has hired restructuring advisers and is considering a Chapter 11 filing. As always, we know this “from people familiar with the matter”. That’s most likely the borrower, or the borrower’s many professional advisers, whispering down the phone line. Centric designs and manufactures apparel under licensing agreements from brands. A debt load of $1.4bn needs to be restructured. Public shareholders appear to have given up already. The stock trades at $0.77.

The BDC Credit Reporter initiated coverage with a CCR 3 rating back in late December 2019. As you’ll see from a quick reading, we’d reviewed the company’s filings and were already deeply worried before Covid-19 struck. Now a move down to CCR 5 – non performing – status seems all but inevitable. For the moment, we are downgrading Centric to CCR 4, but don’t expect that to be for long.

BDC exposure since we last wrote continues to be “Major”: i.e. over $100mn. At 12/31/2019 there was $123mn invested at cost by three BDCs and an FMV of $113.1mn. Most at risk of loss remains Ares Capital (ARCC) whose $24.6mn invested at cost in the company’s equity is looking fragile. The leading BDC also holds a $57.8mn position in the First Lien 2023 Term Loan, along with TCW Direct and Garrison Capital (GARS). In a bankruptcy we assume there’ll be some kind of debt for equity swap and a haircut will be taken. Judging by year end 2019 valuations from all three BDCs, any loss will be minor as the debt was still valued at par. We remain much more skeptical just by looking at the enterprise value of the business before Covid-19 came along, let alone now.

We will learn more shortly most likely and will come back with a better assessment of what ultimate BDC losses are likely to be.

DTI Holdco Inc: Downgraded To CCR 4

We’ve downgraded DTI Holdco Inc. (dba Epiq Global) to a Credit Corporate Rating of 4. The huge legal services company was first added to the Underperformers list in the IVQ 2019 with a CCR of 3. Since then, Moody’s downgraded the company in mid-March to Caa2 from B3. The ratings group was concerned about liquidity and worsening business conditions from a ransomware attack that later caused large layoffs. The traded debt of the company is now marked at a (25%) discount).

The company has over a billion dollars in debt outstanding. However, BDC exposure is modest. Ares Capital (ARCC) has invested $9.3mn, mostly in equity but also in debt. Carlyle’s TCG BDC (CGBD) and non-traded CGBD II are in the 2023 First Lien Term Loan that is being discounted by 25%. We don’t foresee any payment default any time soon, but will need watching. Should conditions in the economy – and in legal services normalize – the company is likely to recover.

Portillo Holdings: Downgraded

Restaurant operator Portillo Holdings has been struggling with huge sales declines associated with you know what. Now, the company has to contend with (justified) downgrades from the rating agencies. S&P has given Portillo a CCC rating with a “negative outlook”. That’s down from B-. Moody’s has arrived at a similar conclusion in late March. Liquidity is a problem along with high leverage and the outlook for sales, even after re-opening, is weak. A restructuring is likely and an “ad hoc” group of lenders is already in negotiations with the company.

There is just one BDC lender to the company: Ares Capital (ARCC). Worryingly, the $32.9mn at cost in the 2024 loan is second lien. At year end 2019, the BDC was carrying the loan at a premium to par, shortly after initiating a relationship in the IVQ 2019. That’s likely to change next time we see a valuation from the BDC. We expect a (10%)-(20%) discount, but these are early days. A second lien loan in a company on the front lines of the current crisis – and which is talking restructuring already – implies we could see an ultimate much bigger loss, and possibly a debt-for-equity swap. There is about $3.5mn of investment income in play, as well.

Expect to see an update sooner rather than later given the fast moving situation and the company’s pressured liquidity. We have added the company to our underperformers list and leapfrogged the credit rating from CCR 2 to CCR 4. We expect to see many more leapfrog credits in the weeks ahead. We’re not yet ready to add Portillo to our Weakest Links list of companies likely to go on non accrual soon, but that could change.

Alteon Health: Cutting Costs

We have to had yet another medical company to the Under Performers list due to the reverberations of the complete focus of the health sector on Covid-19. That’s healthcare recruitment and placement firm Alteon Health, LLC. According to a regional publication, the PE owned form is sharply cutting costs in response to a drastic drop-off in the demand for its services. Based on that news, and the valuation of the company’s traded debt as of April 3 at a 16% discount, we’re initiating at a Corporate Credit Rating of 3.

The three BDCs with $25.4mn of debt at cost to the company were valuing the exposure at close to book value at year-end 2019. All exposure is in the 2022 Term Loan. The BDCs are (in descending order of size): Solar Capital (SLRC); Solar Senior Capital (SUNS) and Ares Capital (ARCC). There’s $2.0mn of investment income in play. There does not seem to be any immediate risk of default but things are moving quickly these days and with the medical crisis in the country likely to last quite some time more, Alteon might be back on our radar very shortly.

VPROP Operating LLC: In Default

Ares Capital (ARCC) reported its IVQ 2019 results on February 12, 2020 and held a Conference Call. Included in the latter was substantial disclosure about a new non-accruing loan: VPROP Operating LLC (also known as Vista Proppants and Logistics). At some point in the last three months of 2019, the company’s debt became non-performing. According to Advantage Data records and ARCC’s 10-K , total BDC exposure – all ARCC’s – was $158.400mn at cost. At the end of 2019, an equity investment of $9.7mn had been written to zero and the 2021 Term Loan,in which the rest of the exposure lies, was discounted (25%). Fair market value dropped to $111.1mn, from $150.8mn the quarter before. ARCC has lost for the time being ($17.3)mn of annual investment income.

VPROP has been an Ares investment since the IVQ 2017 in an almost unchanged amount. Till the IIQ 2019 there were no signs of strain in the quarterly valuations. Then, the equity investment – which had been trading at a premium – moved to a (22%) discount. In the IIIQ 2019, the equity discount doubled and the 2021 Term Loan was ever so slightly written down. Now the equity is fully written down and the debt is deeply discounted and no income is being received.

ARCC’s manager let listeners know that the company was hurt in 2019 by oversupply in the business of selling sand to Texas fracking companies, which led to the default. The company is working with its creditors – including ARCC – on an unspecified “restructuring”. We’d guess that means some sort of “debt for equity swap” where lenders such as ARCC receive all or some of the stock in the privately held company. Unfortunately, the general state of the oil services industry – in which VPROP neatly fits – is poor. So patching together a structure that gives the company a chance to succeed with a new capital structure is tough. However, there’s very little information about the company in the public record so we may have to rely on ARCC for further updates on the progress of the reshaping of VPROP.

For our part, we have downgraded the company from a Corporate Credit Rating of 3 on our scale to a 5, which means non performing. There’s plenty of room for the valuation to drop further yet, but we have no way of evaluating which way performance might go. It should be noted, though, that the amounts “lost” so far, both in book value and income, are some of the highest we’ve seen inflicted on a single BDC, even one with over $14bn in portfolio investments. We will revisit the company whenever we gain additional information.

Centric Brands Inc: Credit Coverage Initiated

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

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

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

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

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

TridentUSA Health Services: Written Off

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

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

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

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

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