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.
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.
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.
TridentUSA is already in bankruptcy, and has been since February of this year. On September 26, 2019 the company settled two outstanding whistleblower lawsuits brought by the government, agreeing to pay out $8.5mn, as reported by the Baltimore Business Journal. “Trident provides mobile diagnostic services to residents of nursing homes. The company earns federal money to provide mobile x-rays to Medicare and Medicaid participants in the nursing homes. The whistleblowers had alleged that Trident had violated federal law by engaging in a kickback scheme, which led to a government investigation of Trident’s pricing arrangements and its costs to provide mobile x-rays at these facilities“.
In a round-about way, this settlement might be a Good Thing for the embattled company and facilitate its exit from Chapter 11. This report tells us nothing of the bigger picture.
For the BDCs involved, there is nowhere to go but up from here. Four well known public BDCs have $108mn in first and second lien loans to the company or its equally compromised sister entities. The exposure has been almost completely written off as of June 2019 and well over $10mn of investment income lost. The BDCs involved are all publicly listed: Solar Senior Capital (SUNS), Oaktree Strategic Income (OCSI), Gladstone Capital (GLAD) and the biggest player of all Ares Capital (ARCC).
Trident is one of a series of significant healthcare failures due to some kind of fraud that we’ve come across of late. Most recently, we discussed Oaktree Medical Centre in a similar vein on these pages. In recent memory, but before the advent of the BDC Credit Reporter, there have been at least two other similar cases of healthcare fraud or other catastrophic difficulty involving BDC lenders. One notable example would be RockDale BlackHawk. Maybe we should ask harder questions about the due diligence capabilities of the BDC underwriters or are stories like these just the exceptions to the rule ?
With the release of TCG BDC’s (CGBD) 10-Q on August 8, 2019, we see that the first lien debt held by the Carlyle BDC has been placed on non-accrual and written down on an unrealized basis by (57%). Ares Capital (ARCC), which has both first and second lien debt outstanding – also on non accrual in both case – has discounted the former by (42%) and (94%). All this augurs badly for the two BDCs. If all continues to go poorly for Indra – which owns clothes manufacturer Totes Isotoner – the second lien loan ($65mn at cost) and most of the senior debt ($25mn) could become a Realized Loss, and relatively soon. At least, this troubled debt will no longer have any income impact on either BDC going forward. Nonetheless, if things don’t turn around for Indra, these loans – on the books since 2014 – promise to be major reverses for ARCC and CGBD and for their credit underwriting track records.