Posts for Golub Capital BDC

Paper Source Inc. : Files Chapter 11

On March 2, 2021 stationery retailer Paper Source Inc. filed Chapter 11. According to Bloomberg: “The company intends to hand control of the business to an affiliate of MidCap Financial, a lending arm of Apollo Global Management, in exchange for debt forgiveness, court papers show. Paper Source owes about $103 million to lenders, including more than $55 million under a first-lien term loan“.

This is no great surprise to the BDC Credit Reporter, which has had the company on its underperformer list with a CCR 3 rating since IIQ 2017. A further downgrade occurred in April 2020 tro CCR 4 and will now be moved to a CCR 5 – non performing. The principal BDC lender is Apollo Investment (AINV) , which has invested $14.2mn in the company, principally in the form of first lien debt, which was valued at $11.4mn at year-end 2020, a (20%) discount. Presumably some ($1.2mn) of annual interest income will be forgone as Paper Source is sorted out.

From what is being said in court papers, the Apollo Global owned lender Mid-Cap Financial – with whom AINV participated – envisages some sort of debt for equity swap. This will make the lenders owner/lenders going forward and reduce the company’s debt. Here is an outline of the plan, according to the Chicago-Tribune, quoting from court papers:

Paper Source said MidCap Financial agreed to serve as an initial bidder, or “stalking horse,” to purchase the company’s assets for up to $88.8 million, which includes $16.5 million in financing to help the company continue operating… A sale is expected to close in about 90 days”.

AINV only arrived on the scene as a lender in June 2019 when Paper Source was already underperforming, possibly as part of a “lend-to-own” strategy or just in a case of bad timing. Chances are now high that the BDC will be advancing additional monies; restructuring debt and the like and extending indefinitely its relationship with the retailer.

For AINV, whose credit troubles have been mostly concentrated in “legacy assets” booked some time ago under a different management team, this is a rare setback for loans booked by Mid-Cap Financial, the principal source of the BDC’s current new investment activity. We’re adding Paper Source to our Alert List because both income and investment values should be substantially different in the IQ 2021 results.

Petrochoice Holdings Inc.: Downgraded By S&P

The BDC Credit Reporter really tries to be comprehensive and catch wind of credit troubles brewing at every BDC-financed portfolio company, but we’re not perfect. Here’s a case in point. We missed PetroChoice Holdings Inc. : ” one of the largest distributors of lubricants and lubricant solutions in the United States“. This is a business that was highly leveraged before Covid-19 and is being impacted by lower demand for lubricants because we’re all driving less.

Back in the IQ 2020 – we can now see with the benefit of hindsight – the company began to underperform. The ratings groups were fast to act with Moody’s downgrading the company from B3 to Caa1. The first and second lien debt – more on that in a minute – also got downgraded.

Fast forward to this week and we hear PetroChoice was also downgraded by S&P Global Ratings to CCC+ from B- on concerns about the company’s liquidity in the face of a “challenging” economic environment. Ratings on the company’s borrowings were cut as well, with the first-lien credit facility dropped to B-, from B, and the second-lien loan to CCC-, from CCC. Both ratings groups are worried about debt coming due in 2022 and the currently low odds that the company will be able to refinance the obligations.

This is worrying for 5 BDCs with first and second lien debt exposure. The total amount outstanding at cost is $102mn – a Major borrower by our standards. There’s more than $9mn of investment income at risk of interruption and/or loss if PetroChoice defaults. You might think the company has plenty of time to deal with its challenges but S&P warned forebodingly that by mid-2021 “total liquidity sources to fall below $10 million.” That’s too little to run a business of this size so we expect to hearing more about PetroChoice in the weeks ahead.

The BDC with the biggest exposure is FS KKR Capital (FSK) with $65mn at cost – all in the more vulnerable second lien debt, and priced at LIBOR + 875 bps, plus a 1.0% floor. The income involved is equal to 1.0% of investment income and 2% of Net Investment Income at the giant BDC. FSK has only discounted its position by -11% – which represents about 2% of its net worth. Of course, if things go awry at PetroChoice both income and net assets could be materially impacted.

Also at risk of taking a knock if PetroChoice should stumble is Bain Capital Specialty Finance (BCSF) with just over $16mn invested, but all in the senior debt, leaving both less income and capital at risk of ultimate loss. Golub Capital (GBDC) has a small position and two non-traded BDCs have moderate sized exposure..

We are rating PetroChoice CCR 4 because the odds of a loss at this stage are higher than of full recovery. We are also placing the company on our Alerts list – a new feature of the BDC Credit Reporter coming shortly and which you’ll find in the Data Room section showing which troubled companies credit situation is reaching some sort of resolution in the short term. There are so many underperforming companies out there we need a way to point out which ones might be affecting BDC results – for good or ill – in the coming quarter or two.

Elite Dental Partners LLC: Restructured

We learn from Golub Capital’s (GBDC) December 1, 2020 10-K filing and subsequent conference call that portfolio company Elite Dental Partners, LLC was restructured in the IIIQ 2020. A “debt for equity” swap was involved and GBDC booked a ($6.5mn) realized loss. (As far as we can tell, this was the largest realized loss incurred by GBDC in FY 2020 where total realized losses reached -$18.7mn, and one of two such setbacks in the dental field). After the restructuring was completed, the debt – which was on non accrual – returned to accrual status. Currently total remaining exposure amounts to $15.5mn, with $11.4mn in a unitranche loan and the rest in equity. GBDC values its overall investment at a slight discount to cost. The maturity (2023) and pricing of the debt (L + 525 bps) is unchanged from before the default and restructuring.

We wish we had more color to offer but GBDC is typically very tight lipped about its troubled credits and this is no exception. We believe Elite Dental – default notwithstanding – avoided filing for bankruptcy with this restructuring. We can also deduce that GBDC went from owning less than 5% of the equity to having somewhere between 5%-25%. Finally, we believe that the company’s troubles – which had begun to show up from a valuation perspective in the IVQ 2019 – were exacerbated by the pandemic and the virtual shut-down of dental practices in most places. Understandably the stakeholders – including GBDC – must have concluded that the fundamental business was worth saving and have done so.

The BDC Credit Reporter has upgraded the company from CCR 5 – non performing – to CCR 3. We are leaving the company on the underperformers list because the dental business continues to be challenged by rolling stay-at-home orders. Furthermore, we don’t know how generous the lenders were in cutting debt service obligations and what other creditors might be involved and on what terms. We do note that the unitranche debt is paying only 2% in cash going forward, with the remainder in PIK form. That suggests boosting/preserving liquidity remains important to Elite’s management.

We will continue to monitor the progress – of what remains a relatively large investment for GBDC – going forward. Given that the company is privately-held much of what we might learn – unless conditions deteriorate – will be from GBDC’s quarterly revaluations. Some $0.7mn of annual investment income remains in play.

Rubio’s Restaurants Inc.: Files Chapter 11

On October 26, 2020 Mexican casual chain Rubio’s Restaurants Inc. filed for Chapter 11 bankruptcy protection in Delaware. However, the company has already negotiated a restructuring plan with its private equity sponsor Mill Road Capital and with its lender, funds managed by Golub Capital. A “debtor in possession facility” has already been negotiated and there is hope the chain will be in and out of bankruptcy within weeks. Still, 26 locations out of 150 are being permanently closed, which may explain why the trip through bankruptcy court was chosen.

The only BDC with exposure is Golub Capital BDC (GBDC), which holds close to $18mn in first lien debt and $0.45mn in preferred stock. In total Golub Capital related funds have $80mn plus in exposure to the pre-bankruptcy company and are advancing another $8mn in debt and equity going forward. Mill Road Capital is reportedly also making an equity contribution. This looks a partial debt for equity swap where Golub – through its funds – will increase its equity stake in Rubio’s in return for the additional funds and some debt forgiveness.

The debt outstanding at GBDC has been on non accrual since Covid-19 devastated the restaurant business in the IQ 2020. We downgraded the business from CCR 3 to CCR 5 at that time. Rubio’s is now added to the BDC Credit Reporter’s list of BDC-financed portfolio companies in bankruptcy, the fourth in October for those keeping score. GBDC has written down its debt by just shy of (50%) and the preferred is valued at zero. We expect that this presages what the realized loss might look like, which could be booked in the IVQ 2020: about ($10mn). There will be no impact on investment income as the debt has been non-performing. In fact, from early 2021 GBDC may begin to earn income on some $10mn of remaining debt and new proceeds.

As always in these situations where a BDC goes from lender to owner, how long the investment will last is unknowable. The BDC, though, has been involved with Rubio’s since 2010 when Mill Road fist bought the business. For all we know, the restaurant chain may yet be on the Golub books another decade from now.

This is an undeniable setback for GBDC and the amounts involved are material, although the final gain or loss will not be known for years. The BDC Credit Reporter would question why GBDC – or any other BDC lender -would invest in the restaurant business in the first place. Along with E&P production; energy services; bricks and mortar retail, eateries are a controversial choice from a credit standpoint as reflected on the many troubled companies we’ve mentioned on these places. In our day many lenders had the restaurant sector on their prohibited list.

Nonetheless, the ability and willingness of GBDC – along with the Golub organization – to step up to become an owner-lender might mitigate ultimate losses. Or make them worse once all the beans are counted. Time will tell us. In the interim, we expect to be writing about Rubio’s multiple more times in the years ahead as the proposed turnaround gets into gear.

Oliver Street Dermatology: Defaults On Debt

Right up front we have to warn that the BDC Credit Reporter is playing the “name game” here. Here’s the background: Bloomberg reported on February 5, 2020 that “U.S. Dermatology Partners has defaulted on a $377 million financing provided by a group of investment firms, according to people with knowledge of the matter“. The article went on to say the debt was funded – at least in part – by BDC offshoots of Golub Capital (GBDC); Carlyle Group (CGBD) and Ares Management (ARCC). The rub ? No such company name exists in the Advantage Data records, nor even the prior name of the business: Dermatology Associates.

After much rifling through virtual files, we’ve worked out that GBDC carries its portion of the unitranche debt – which is nominally publicly traded – as Oliver Street Dermatology and has a $27.5mn investment at cost, all but $0.2mn of which is in the May 2022 unitranche loan. At September 30, 2019 that debt was discounted between (12%) and (18%). CGBD’s exposure is even bigger ($73mn) and goes under the name Derm Growth Partners III. Like ARCC, CGBD has a sliver of equity in the company ($1mn), valued at zero. The debt – in that same 2022 unitranche loan – was discounted (30%). We’ve not been able to clarify if ARCC has any exposure to the troubled company under yet another name.

What we do know is that we placed the company on the Under Performers List with a CCR 3 rating in the IQ 2019, when the equity stake was written down by CGBD by (86%), after being carried at a 45% premium the quarter before. That kind of valuation change is what draws our attention to previously performing companies.

The rating was dropped to CCR 4 when the debt – as mentioned above – was discounted (30%), compared to (13%) in the IIQ 2019. Now, with the default, we’ll be downgrading the company by whatever name to CCR 5.

We know a little about what’s ailing the privately-held company from CGBD’s last Conference Call: “We’re working through some operational and financial performance challenges with the sponsor and the company“. CGBD, though, waxed optimistic about any ultimate outcome because “this is a first lien tranche“. Still, if we read the filings right, the interest rate on the debt has been upped by 1.0% recently and was entirely on PIK through September 2019 – typical signs of credit weakness.

Now we seem to be looking at yet another “debt for equity swap” – a favored resolution in these situations amongst leveraged lenders, who move from lender to owner, or some hybrid thereof. We’ll wait for further details before drawing any grandiose conclusions but, given the $100mn of public BDC exposure to the business – owned by ABRY Partners since 2016 – this is a story worth following.

Joerns Healthcare: Restructuring Complete

On August 21, 2019 Joerns Healthcare announced the restructuring of the company – undertaken under bankruptcy court protection – is complete. As noted in our two earlier posts on July 3 and August 10, the key element of the company’s plan was a debt for equity swap which will extinguish $320mn out of $400mn of pre-petition debt, and turn lenders into owners.

For the three BDCS involved (Golub Capital, Main Street and HMS Income), with $30mn of exposure – mostly in first lien pre-petition debt – this means Realized Losses will shortly be taken which will show up in the third quarter 2019 results. We expect losses taken to be over $20mn. Similarly, there will be income lost as most of the capital invested in debt form will either be written off or converted to equity.

The biggest impact will be felt by Main Street (MAIN), which has close to $15mn invested and will lose a substantial portion of its invested capital, which dates back to 2013. The Good News ? The whole bankruptcy/restructuring process has occurred over a relatively short time frame, benefiting both the company and its long term prospects and its creditors/owners.

Nonetheless, Joerns will remain on our under-performing list even now the restructuring is complete and notwithstanding the above average debt write-off. This was supposed to be a lower risk, standard loan in an industry beloved by most every lender out there. This set-back is worrisome both for Joerns itself and for the huge healthcare sector as a whole. For what it’s worth, the BDC Credit Reporter has so far identified 23 under-performing companies held by BDCs, or 10% of all under-performing credits in our database.

Joerns Healthcare: Restructuring Plan Approved By Bankruptcy Court

On August 9, 2019, news reports indicated Joerns Healthcare Inc. has had its restructuring plan approved by the bankruptcy court. As we wrote earlier, the company had filed for Chapter 11 back in July. One of the BDCs involved – Main Street Capital (MAIN) – had indicated as much on its Conference Call :

” Joerns is, basically, liquidity squeeze based on transition of the business from a sale model more than rental business. And from a capital structure perspective, we need to equitize the debt. That company entered bankruptcy in the second quarter, and we expect to exit here in the next 15 to 30 days with a restructured balance sheet”.

Joerns is wiping out $320mn in debt out of $400mn, according to news reports. In addition, the company is gaining $40mn in fresh advances. Looking at the (45%) discounts being taken by the unitranche lenders in the IIQ 2019 valuations, BDC losses on the $28mn of exposure will be significant. With those lenders becoming equity holders – a Golub representative will be sitting on the Board , amongst others – investment income from the original capital will be greatly reduced. There was $2.8mn of investment income spread amongst MAIN, Golub Capital (GBDC) and HMS Income. That’s all been suspended since July and is likely to resume by the end of September. When interest income does resume, the amount may be 50%, or more, lower.

Nor is the company out of the woods. The CEO has left and the new lender-owners are out seeking a replacement. This will be another test of whether lenders – including several well known BDCs – are well suited to “turn around” their own failing companies.

Also noteworthy is that the BDCs involved were marking this credit at only modest discounts to book until IVQ 2018, when all 3 discounted the unitranche loan by a tenth. Two quarters later the debt is on non accrual and written down 4.5x more…However, we read in a trade article that the company was in default under its debt from 2018, and much was happening behind the scenes to attempt a rescue. All of which ultimately failed to get traction and resulted in the pre-packaged deal with the unitranche lenders. This big a haircut, though, indicates the lenders underwriting was far too generous, and the timing of the write-downs suggests the BDC’s shareholders were being kept out of a loop that they deserved to be included in.

On the plus side, these are losses the BDCs involved can absorb on an individual basis without too much difficulty. For example, the amount MAIN invested at cost is equal to 0.5% of its total assets. Still, this a serious credit reverse for what was envisaged as a low to mid risk loan, priced at LIBOR + 6.00%.

Uinta Brewing: More Details On Investor Exit

We knew that Riverside Company had exited Uinta Brewing Company in March 2019, based on a trade article on July 10, 2019. This was relevant as the unitranche lender to the craft brewer is Golub Capital (GBDC), which at year end 2018 had $5.9mn invested in debt and equity. In the IQ 2019, the exposure was reduced to $1.6mn.  All debt was on non accrual since IIQ 2018.  Golub now owns Uinta, and a new capital structure will emerge, which we may learn more about on the next Conference Call. That may involve the asset manager providing additional capital to boost the business. In the interim, we’ve learned more – thanks to a trade publication – what ails the brewer. The company, thanks to Riverside’s investment capital,  grew very fast to become a national presence. Here’s an extract explaining what went wrong:

That expansion led to a wide but shallow market. Increased competition from an ever-growing number of breweries resulted in market penetration weaker than expected.

“Over the course of (the Riverside investment), the challenge of competing on a national scale without large marketing budgets and personnel became extraordinarily difficult for us to sustain,” Uinta president Jeremy Ragonese told Brewbound.

As a result, Uinta has been pulling back from a variety of markets in a reconfiguration of the footprint expected to last through the summer.

The question going forward is whether Golub can do any better.

Pet Supplies Plus: Recall

On July 3, 2019 Pet Supplies Plus published a press release to the FDA website announcing a recall of its bulk ear products sold to dog owners as treats. The company was concerned that the treats might be infected with salmonella. As a trade publication explained “Salmonella can not only affect animals that eat the product, but also pose a risk to humans who handle, especially if they have not washed their hands”. To date no one has fallen ill from contact with the company’s products but 45 people in 13 states have been diagnosed with Salmonella-related illness from bulk ear products. Three different public and non-traded BDCS have $17mn in exposure to Pet Supplies Plus, in the form of both debt and equity, which began only in IVQ 2018, and is valued at cost. We cannot determine as yet what impact – if any – this recall might have on the company’s business and prospects.

Joerns HealthCare: Files Chapter 11

Joerns Healthcare has filed for Chapter 11. “The company is seeking court approval of a restructuring plan that is supported by the majority of its lenders and noteholders. The plan will eliminate a substantial amount of debt and provide operating capital during the restructuring process and beyond. The company has requested that the plan be approved and the process complete within the next 30-45 days”. This is bad news for the three BDCs with $27.9mn in exposure in 2020 senior/unitranche debt – all publicly traded. Main Street Capital (MAIN) has the biggest share with $13.3mn, and sister non traded fund HMS Income ($11.0mn). Golub Capital (GBDC) comes in third with only $3.5mn, but we imagine the asset manager has exposure in other affiliated funds. Until a restructuring falls into place $0.200mn a month of interest income will be lost. The company was still carried as performing through IIIQ 2018, but the discount increased from the IVQ 2018 and closed the IQ 2019 at (15%).  Chances look high that a Realized Loss will have to be booked, but we’ll postpone making any predictions till we review the restructuring plan that the company is so confident will be approved and implemented in short order.