Posts for Sixth Street Specialty Lending

Mississippi Resources LLC: Major Realized Loss Booked

Understandably enough BDCs are loath to discuss with their shareholders losses taken on portfolio investments gone wrong. Managers prefer to spend time on their successes; latest deployments and just about anything but setbacks. However, from the BDC Credit Reporter’s perspective investors should want to know about what did not work – and why – to better evaluate a BDC’s chosen strategy and implementation. So we’re going to spotlight the announced the ($32.2mn) realized loss booked in the IVQ 2020 by Sixth Street Specialty Lending (TSLX) on its investment in independent oil and gas producer Mississippi Resources LLC.

This investment – which began in 2014 with $44.2mn of debt and equity invested – has been an abject disaster for TSLX – far and away the worst in its history. As is so often the case in these E&P investments ,TSLX does not seem to have been willing to accept the initial reverse on its investment when oil prices crattered in the latter half of 2014. As a result the company has been restructured and essentially taken over by the Sixth Street organization (then TPG Specialty Lending) and more funds advanced.

Over the years – starting in 2017 – the BDC has been forced to book realized losses on the investment. The first write-off was ($21.8mn); the next year ($9.6mn) and ($4.2mn) in 2019. This culminated in 2020 with the ($32.2mn) realized loss. That a total of ($67.8mn). Currently, Mississippi Resources remains on the books with a $1.5mn Term loan due in 2021, which is on non accrual and has been written to zero. (In fact, none of the debt outstanding to the company has been accruing for the past 4 quarters).

The total realized loss is half as much again as the initial amount committed back in 2014 and equal to 6% of all the equity capital TSLX has raised in its history and the equivalent of 42% of its 2020 Net Investment Income. Fortunately for TSLX’s management the 2020 write-off was overshadowed by slightly larger realized losses elsewhere, which kept total net realized losses at ($2.6mn) for the year just passed.

We’d say there are three lessons learned from the Mississippi Resources story. One is a recurring theme of ours: lending/investing in commodity-driven industries like energy is highly risky and better left to speculators or specialists. Second is that TSLX – like every other lender – is at great risk when “doubling down“, continuing to advance monies when initial amounts put into play get into trouble. The flexibility BDCs have to invest in almost anything and without regulators looking over their shoulders might be a boon at times. However, at other times, such as in this instance, bad money follows bad – to coin a phrase. Third, even well regarded BDC management teams – with an excellent credit track record over long periods – like TSLX’s – are not immune from making occasional MAJOR mistakes. It’s the nature of the business. We’re only sorry the management team could not – figuratively speaking – look their shareholders and analysts in the eye and de-construct for everyone’s sake what went wrong and how any lessons learned might help future outcomes.

American Achievement Corp: Exits Chapter 11

We hear from S&P Global Market Intelligence that “the bankruptcy court overseeing the involuntary bankruptcy petition filed against American Achievement Group Holding Corp. on March 16 has dismissed the case, according to a court order, ending the company’s brief encounter with Chapter 11“. The BDC Credit Reporter had written about the involuntary bankruptcy (which occurred January 14, 2021) back on February 20, 2021. We won’t go back into the whys and wherefores that caused the bankruptcy filing. However, we don’t know the full details of how matters have been patched up except that the parties have agreed to an out-of-court restructuring which will “would leave all creditors unimpaired“. Another $35mn Revolver is contemplated to provide the company with liquidity.

We can’t say when all this will come together but the news seems to be good for the only BDC with exposure: Sixth Street Specialty Lending (TSLX). The BDC had placed its $23.8mn in senior debt to the company on non accrual in the IVQ 2020 and discounted its position by ($2.2mn), or (9%). Presumably the debt will shortly return to accrual status and – we assume – accrued interest will be collected.

The company is rated CCR 5 and remains there for the moment. However we are adding American Achievement to our Trending list because we expect in the IQ or IIQ 2021 for a significant change in status (from non performing to performing) and the resumption of interest income, which amounts to $2.2mn a year, not to mention a rating upgrade. We will circle back when we receive confirmation from TSLX that all is well.

American Achievement Corp: Debt On Non Accrual

We learn from Sixth Street Specialty Lending (TSLX), following IVQ 2020 results, that a new portfolio company has been placed on non-accrual: American Achievement Corp. The company “manufactures and supplies yearbooks, class rings and graduation products, and as a result of COVID, underperformed for the 2020 sales season“. TSLX added: “We are currently working with the company on a potential restructuring to keep our term loan outstanding and to receive a majority of the equity in the business as a lender group. We expect to reach resolution on this in the near term“.

What TSLX failed to say is that the company “filed for involuntary Chapter 11 bankruptcy protection January 14, 2021, in the Northern District of Texas“, according to public records. In addition, TSLX did not mention that the near half a billion dollar in debt owed by the company is the subject of heated disputes, which adds an element of uncertainty to the outcome. This article by S&P describes some of the maneuverings underway.

TSLX seems to be (unduly ?) optimistic, writing down its $23.8mn first lien loan by only (9%). Furthermore, if a debt for equity swap – as mentioned above – seems the likeliest resolution, it seems unlikely that the debt will not be subject to a major haircut, which will impact long term income. At the moment, with the non-accrual TSLX has temporarily lost ($2.2mn) of annual investment income.

We have downgraded the company from CCR 2 to CCR 5 in one fell swoop. (As of the IIIQ 2020 TSLX valued its investment at a modest discount of (7%) and no mention was made by TSLX – the only BDC lender – of any challenges at the company). We are also adding AAC – as its known – to our Alerts list because it’s likely that the income, value and outstandings involved will be subject to substantial change in the next couple of quarters.

Frankly, we’re a little disappointed by the transparency of TSLX at this stage. Maybe with so much ill feeling between the parties involved with the company, the BDC did not want to stir up the pot on its February 18, 2021 conference call, but investors are left with an incomplete picture. This a company that bears watching and which we’ve added to our daily review for any new developments.

MD America Energy: Emerges From Bankruptcy

Now that Sixth Street Specialty Lending (TSLX) has reported IVQ 2020 results, we’ve learned about what has happened to its troubled energy company, MD America Energy. We last wrote about the company in December 2020 when bankruptcy was filed. At the time, we projected – from what we knew at the time : “We are expecting the BDC will book a realized loss of ($5mn-$8mn), probably in the IVQ 2020“.

This is what TSLX’s management said on its February 17, 2021 conference call:

In December, we also removed our first lien loan in an E&P company, MD America, from nonaccrual status following the company’s emergence from Chapter 11. During Q4, our $13.6 million fair value loan was restructured into a $9 million first lien loan and a $3.9 million equity position. We believe the company’s new capital structure is more appropriately suited for today’s commodity price environment“. 

The 10-K shows TSLX has booked a realized loss of ($4.0mn). Still, the BDC – as of September 2020 – had invested $17.9mn, but now has a new Term Loan – with a maturity of 2024 – with a par value of $9.0mn, yielding 9.25%. The prior debt – due in 2023 – had a par value of $18.1mn and its yield was 10.0% before going on non accrual. This means TSLX is permanently losing ($1mn) of annual investment income. The BDC will have to hope the $3.9mn in the equity of SMPA Holdings – the new entity – will be worth something one day. If not – and assuming this new debt gets repaid – TSLX will have lost half its investment in the energy company.

We are upgrading MD Energy/SMPA Holdings from CCR 5 to CCR 3. You will not be surprised that we are keeping the company on the underperformers list given the sector in which it operates and its recent failure. We can’t help worrying that the $3.9mn equity stake has an element of being a can kicked down the road. Even the new senior debt cannot be considered safe with three years till repayment. We’ll check back in next quarter with TSLX to see what progress the restructured company is doing.

MD America Energy LLC: Files Chapter 11

Credit troubles continue to haunt the oil patch and – occasionally – still involve BDC lenders. On October 12, 2020 MD America Energy LLC – a Texas E&P company – filed Chapter 11. As per the usual, the company and its lenders have a plan. This would involve cutting the $117mn or so of debt on the balance sheet in half and giving the existing lenders control of the company’s equity in a now-standard debt for equity swap. New debt of $60mn would be issued as part of this transaction and management expects to be back operating normally before very long.

However, the existing owner of the company – Meidu Energy Corp – who lost out in court to the MD America lenders – is not happy about the outcome, and is suing. So consider all the above provisional until the litigation is resolved.

The only BDC lender with exposure – surprisingly enough – is Sixth Street Specialty Lending (TSLX), which has $18.6mn invested in a 2023 Term Loan about to be converted into equity and a likely part recipient of the new, smaller Term loan proposed. TSLX had written down its position by only (14%) as of June 2020. With the bankruptcy, some ($1.9mn) of annual interest income will be interrupted for an undetermined period. If the restructuring plan is accepted, when income does resume half will not be coming back, and TSLX will have to look to some auspicious future and to its new common shares in the company for future value. We are expecting the BDC will book a realized loss of ($5mn-$8mn), probably in the IVQ 2020, but also possibly next year given the litigation.

We are downgrading the company from CCR 3 – which only occurred in the IIQ 2020 – to CCR 5 and adding the name to our Bankruptcy list. In our self appointed role as Monday Morning Credit Quarterback, we don’t see why TSLX had to involve itself in this sector (already bitten by another problematic energy borrower: Mississippi Resources). Moreover, the data at the moment suggests the ultimate loss here might be more severe than reserved for in June – when the oil sector was already in deepest trouble. TSLX may yet prove us wrong, so we’ll wait, see and report back.

Neiman Marcus: Exits Bankruptcy

After many disputes, Neiman Marcus has emerged from Chapter 11 protection on September 25, 2020. According to news reports, the iconic retailer has shed $4.0bn of its $5.5bn in debt. That’s $200mn a year of debt service saved. The new ownership “which include PIMCO, Davidson Kempner Capital Management, and Sixth Street” have  arranged $750mn in new exit financing that will repay the Debtor-In-Possession borrowings outstanding. There’s also a $125mn FILO secured facility and

.. “liquidity provided by $900 million in asset-based lending (ABL) led by Bank of America and a consortium of commercial banks. With the support of its new shareholders and funds available from the exit financing, FILO facility, and ABL facility, the company expects to be able to execute on strategic initiatives to help ensure long-term operations for Neiman Marcus“.

As you can see there a lot of comings and goings where the debt is concerned. This is important because all BDC exposure is held by Sixth Street Specialty Lending (TSLX) in three debt facilities. The fate of one of those debt facilities is straightforward – the $11.2mn 2020 DIP loan – which is about to be repaid, fees and all. That’s why TSLX carries the debt at a premium. Less clear is what happens to 2021 Term Loan, with a cost of $71.4mn. However, we expect that gets paid off as well and TSLX has valued the position very close to par. There’s a tiny 2023 Term Loan with a cost of only $0.8mn, which is likely to be written off.

We don’t know if TSLX will be signing up for a new tour of duty or whether the presence of the Sixth Street organization amongst the buyers makes that problematic. Chances are TSLX will receive its proceeds and as early as the end of the IIIQ 2020 (and may have already) and will exit Neiman with very little in the way of collateral damage. If so, that will be another feather in the cap of TSLX. By getting out whole from a credit where others have lost billions, the BDC validates its unique strategy of running towards – rather than away – from some of the worst bankruptcy prone companies in recent American history.

We will be upgrading Neiman from CCR 5 to CCR 3 if any BDC exposure remains, which we’ll learn more about when IIIQ 2020 results are published.

Energy Alloys, LLC: Files Chapter 11

According to multiple news reports, Energy Alloys, LLC filed for Chapter 11 on September 9, 2020. The company bills itself as “the only 100% oil and gas focused supplier of specialty metals to the global oilfield industry“, so you can imagine how the business ended up in Chapter 11. Energy Alloys has operations both in North America and around the world, but in its bankruptcy filing claimed just $10mn- $50mn in assets and $100mn-$500mn in liabilities. Curiously GSO Blackstone – the credit arm of Blackstone- has been the owner since 2011.

What this all means for the only BDC lender to the company – Sixth Street Specialty Lending (TSLX) – is not clear. As of June 30, 2020, the BDC had $18.3mn lent at cost in an asset-based Term Loan to the company, which was valued at par. TSLX had made the following disclosure in an earnings press release dated July 23, 2020: “As a result of the challenging commodity price environment, Energy Alloys, our second largest energy exposure at quarter end, is pursuing an out-of-court wind-down of the business through a liquidation of its assets. Post quarter end, we received a paydown on half of our principal position on Energy Alloys and expect to be fully repaid by Q4“.

No mention there of a bankruptcy filing which leads is to believe conditions may have worsened since July. Or – possibly – this was all part of the unwinding plan for the troubled business. Up in the air is whether TSLX will receive that last $9mn or so in outstandings in the IVQ 2020 or not. This might impact both income – which was still being accrued through the IIQ 2020 – and the expected repayment in full. We should learn more when TSLX reports IIIQ 2020 results in October, but a final settling of accounts may take till the end of the year or longer if the company lingers in bankruptcy.

As is often the case TSLX zigged when most other lenders would have zagged, booking the debt to Energy Alloys as recently as III 2019, but before the oil price meltdown and everything that has followed. The BDC points to its highly collateralized status as the reason for its comfort, carrying its position at par through its short history. The ultimate outcome of this transaction will tell us whether the uber confidence TSLX demonstrates in these difficult credit situations are justified. However, even if a loss does get booked at the final hurdle, the amount is modest by comparison with the BDC’s billion dollar net worth and should not materially impact future results.

We are downgrading the company from CCR 4 to CCR 5. Energy Alloys was on our Weakest Links list previously.

J.C. Penney: Non Binding Purchase Agreement Finalized

Despite what you may have heard in the headlines, J.C. Penney has not yet been purchased by mall owners Simon Property Group and Brookfield Property Partners. The reality is more complicated and more interesting. The parties have only agreed on a non-binding letter of intention to acquire certain assets of the bankrupt retailer and are far from being in charge as yet. Furthermore, the existing first lien lenders will become owners of two new REITs that will own stores and distribution centers respectively. The lenders would also receive $500mn in “take back” debt and new financing is being arranged as well. With a bit of luck, a very restructured J.C. Penney – in name – would be back and running out of bankruptcy by year’s end. (All the above learned from an excellent synopsis by WYCO Researcher on Seeking Alpha).

This is important news for the only BDC with exposure to Penney’s: Sixth Street Specialty Lending (TSLX). The picture here is complex as well. The current Debtor In Possession (DIP) financing, with a cost of $5.781mn and yielding 13.0% is most likely to get repaid in full. This is what TSLX anticipates, given the premium valuation at June 2020. More difficult to suss out is what the value will be of the two first lien debt positions owned – due in 2023 – and both already on non accrual. We expect TSLX will gain a small non income producing equity stake in the two REITs and some performing debt paper. From an income standpoint that can’t be any worse than the $20.0mn at cost in non-DIP debt held which is being carried as non performing. From a valuation standpoint it’s impossible to tell – even for TSLX at this stage – whether the new arrangement is more valuable than the $8.7mn in FMV as of June 2020.

Most of all, TSLX will probably be glad to have the Penney situation resolved – even if only for a while. This looks like one of the rare instances where the crafty BDC – whose non-DIP debt was bought at a discount in mid-2019 – will not come out of a bankruptcy situation smelling like roses. TSLX has admitted as much in its last 10-Q: “Given expectations for less-than-par recoveries, the Company has applied the regularly scheduled cash interest payments it received to the amortized cost of these positions, all of which were acquired at prices less than par“. Based on the latest values, TSLX could be booking a realized loss of anywhere from ($6mn-$9mn) in the IVQ 2020. Painful but manageable for a BDC with a net book value in excess of a billion dollars.

Neiman Marcus: May File Bankruptcy

“People familiar with the matter” are predicting this is the week retailer Neiman Marcus finally files for Chapter 11. Admittedly, this has been predicted before, as in our earlier article about the company on March 27. The difference this time is that the already beaten up luxury retailer has had to furlough essentially all its employees since March 30, and with no end in sight.

For BDC watchers the question then and now remains how the only player with exposure – TPG Specialty (TSLX) – is going to fare in an economic environment that must be worse than any worst case scenario considered when the BDC first invested in an asset-based financing to Neiman in the IIIQ 2019. Miraculously, TSLX has managed to extricate itself from some of the worst performing companies without a financial scratch in recent years. However, we’re increasingly worried that may not be the case this time given the almost shut-down of retail and the general consensus that only a further catastophe will follow the long playing retail apocalypse.

We have added Neiman and the $71.9mn invested by TSLX to the Underperformers list. It’s a testament to TSLX’s track record that we do so with trepidation even as Neiman teeters on the brink. We’ll have to wait now till the filing occurs and some dust settles before ascertaining how this turns out for the BDC which was still carrying its position at par at 12/31/2019. The TSLX conference call in May could be a time for revelations. Or not, if matters are not then settled.

Neiman Marcus: Considering Chapter 11 Filing

Whenever we hear from multiple news outlets that unnamed sources have indicated a company is “considering” filing for bankruptcy we assume some sort of negotiation is going on, and that same someone is leveraging the press for its own advantage. We should also say that 9 times out of 10 of late the rumor has been followed with an actual filing, so it’s worth paying attention to these anonymous whisperings.

Now, iconic retailer Neiman Marcus is said to be close to asking for bankruptcy court protection, which does not seem very surprising given the environment. We shall see and report back.

The only BDC with exposure is the acknowledged master of troubled company lending TPG Specialty (TSLX). The public BDC advanced funds in the form of an asset-based loan in the IIQ 2019 “to support the company’s strategic initiatives”. Obviously that was before the Covid-19 came along to test retail like never before. At year-end the debt was valued at par.

Most recently, though, and despite the ABL nature of the lending, the Term Loan is trading at a (20%) discount according to Advantage Data’s records. That price may not be meaningful in this hot-house environment. However, should Neiman file for bankruptcy, find no buyers and move to liquidation – as has happened to other retailers – the value of the 2021 Term Loan might soon be tested. To date TSLX has dodged every retail bullet. The next few months will be its greatest test of which Neiman Marcus may not even be the most trying one.

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

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

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

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

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

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

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

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

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

Moran Foods: Recapitalizes

Moran Foods LLC – which is owned by PE group Onex Partners – has agreed a recapitalization with its lenders. In what has become a well trod path, the company will be undertaking a debt for equity swap. That’s $400mn of debt moving down the balance sheet. Also commonly done, Moran – which does business as Save-A-Lot Food Stores – will be getting an infusion of capital from their new owners: $138mn.

The extra capital is critical as the discount grocer – which is very highly leveraged according to an earlier Moody’s report we’ve read – is also seeking to change its business model, which will require capital investment. In a nutshell – and for our purposes – Moran seeks to move to a distribution rather than full direct retail model.

The company is yet another casualty of the well known shifts underway in the retail category. In this case, there’s an element of “if you can’t beat ’em, join ’em”, as a trade article illustrates: ”

As part of the effort, the grocer announced in November the rollout of new services that will enable shoppers to pay for (using Amazon PayCode) and pick up Amazon.com packages in select stores in the St. Louis area. 

It will also shoppers offer Amazon Hub Locker as a convenient delivery option to pick up or return Amazon packages at no additional cost. Both Amazon PayCode and Amazon Hub Locker are expected to expand to more than 400 Save A Lot stores by the end of 2020“.

We already had a Corporate Credit Rating of 4 on the company and we’ve added a CCR of 5, as it seems some debt will be turned into equity while other debt may continue as before. Thankfully for the BDC sector the only exposure to Moran is from TPG Specialty (TSLX), which has $39mn invested in an asset-based loan, due in 2021 and valued at par as of September 30, 2019. Chances are very good the BDC will not be negatively impacted by the new state of affairs and may just continue as before. We’ll learn more – presumably – when the next earnings conference call rolls around.

J.C. Penney: Mixed Results in IIIQ 2019 Results

Troubled J.C. Penney raised its 2019 projected results, according to a news report on November 15, 2019. At the same time, same store sales continue to trend downward, and were even worse than expected. Glass half full or glass half empty ?

Interestingly, BDC exposure has increased in the IIIQ 2019 to $18.4mn, from $6.8mn. As so often happens in these troubled retail situations TPG Specialty (TSLX) has stepped up to lend more money in an asset-based loan to the company. TSLX has advanced $15.0mn and the rest is spread – in different facilities – over 3 FS-KKR non-traded BDCs: FSIC II, FSIC II and FSIC IV. All the BDCs involved mark their debt at or above par.

We’ll see in 2020 – following the critical 2019 Christmas season – whether this optimism is warranted.

Ferrellgas Partners: In Default ?

On October 15, 2019 Ferrellgas Partners published its full year results. For the last quarter of the fiscal year, the giant propane distributor reported a net loss of ($72mn) and Adjusted EBITDA of $4mn, while interest expense and maintenance capital expenditures and the gains from minor assets sales were $41mn. Or, in other words, the company is performing very badly. The stock price dropped by a third, to close at $0.65.

If that wasn’t enough, the 10-K reveals a dispute between the company and its senior lender TPG Specialty Lending . The latter is claiming that by not delivering certain financial information within a prescribed period, the company is in default under its credit agreement – even though the said information was subsequently forwarded. Moreover TPG believes the auditor’s opinion contains language suggesting doubt about Ferrellgas remaining a “going concern”. The company reads the document differently. In any case the parties have not agreed and the lender is expected – both by Ferrellgas and us – to take further action. That might include attempting to force an involuntary bankruptcy.

The company has been headed south for some time, so we’re not surprised about the poor results – or the likely bankruptcy – but only about the manner in which the company and its secured lender have fallen apart, which will add to the complexity. Total BDC exposure is very high: $101mn. Of that $82mn at cost is held by TPG Specialty (TSLX) in the senior secured debt, nominally to mature in 2023 but which the company is now carrying as a short term liability. See pages 52-53 of the 10-K. FS Energy and Power Fund holds two junior tranches of the debt for the remainder. TSLX is very confident that its senior secured status will ensure no loss under most imaginable circumstances. Still, there’s $8.3mn of investment income in play. We hope that TSLS – which has a very good track record of financing troubled businesses in just the right way – knows what they’re doing where propane assets are concerned.

J.C. Penney: Downgraded by Fitch Ratings

S&P recently downgraded J.C. Penney – the iconic retailer – and now Fitch has joined suit. In this case, the rating for the company has dropped to “junk” status or CCC+ from B-. The reasons given are just what you’d expect. For our prior three articles on Penney’s, click here.

As we’ve explained previously, BDC exposure is modest and whatever happens will have little impact on the three non-listed FS-KKR BDCs involved, which are in the process of going public as a combined FS-KKR II. Also in there is TPG Specialty (TSLX), but with its asset-based status is not expected to lose any money under most possible scenarios.

Of course, Penney is just one example of the retail sector “apocalypse” that’s been going on for years in a long running burn of companies of all kinds. Currently we’ve identified 20 retail-related companies that are under-performing, with a cost of investments of $1.27bn. That’s probably not everyone caught up in this seismic change in how consumers and businesses shop, but captures all the names you’d expect and a few more. The BDC sector has taken a hit, and will continue to do so, but the damage has been spread out over more than two dozen BDCs (roughly a quarter of the listed and non listed players) and over several years, mitigating the blow. Junk bond investors and other forms of lenders have taken more of a body blow f rom this once-in-a-lifetime shift in American commerce.

J.C. Penney: Downgraded by S&P

Standard & Poor’s has downgraded troubled retailer J.C. Penney to CCC from CCC+. Apparently, all the talk about restructuring the company in advance of any Chapter 11 filing, which we discussed in posts on July 23, 2019, when restructuring advisors were first called in and again on August 14, when Bloomberg reported serious talk of a debt for equity swap was in the air.

Not helping Penney’s with S&P is that the retail background for bricks and mortar stores remains challenging, notwithstanding the operational advances management has made. S&P’s view was summed up as follows:

“The negative outlook on JCP reflects the growing risk of a distressed debt exchange or restructuring in the next 12 months as industry headwinds, weak same-store sales, and a burdensome debt load contribute to its unsustainable capital structure.

“We could lower our ratings on JCP if the company announces a debt exchange or restructuring or if its operating conditions worsen such that we see a restructuring as increasingly likely in the next six months.

“Before raising our rating on JCP, we would expect the company to demonstrate a significant and sustained improvement in its performance that leads us to view a distressed exchange as less likely.”

We have rated J.C. Penney CCR 4 on our 1-5 scale, aka on our Worry List, where we believe the chances of an ultimate loss are greater than that of full recovery. Thankfully from a BDC perspective although there are 4 BDCs with exposure (including three non-traded FS Investment-KKR Capital BDCs) total exposure is very modest at $6.8mn at cost. All the debt sits towards the top of the capital structure and the biggest discount to cost is only (8%) as of June 2019. We believe the actual loss will be more substantial if and when a debt for equity swap or Chapter 11 occurs, but either way the impact on BDC net asset value and income should be modest. That’s a statement that cannot be made about the many other lenders to J.C. Penney, whose borrowings are substantial.

J.C. Penney: Discussion Of Debt Swap

Bloomberg reported on August 7, 2019 that J.C. Penney creditors are seriously considering a debt swap to give the troubled department store chain more time to turn its business round.

That may not affect the several BDCs with $6.8mn of first lien exposure (most recently TPG Specialty – TSLX – has gotten involved), but will draw in second lien debt.

In any case, although the company has liquidity and no immediate debt maturities, chances are increasing that something will happen in the weeks ahead. That might result in lower values for the 3 FS-KKR non-traded funds involved, all of whom have valued their modest exposure at or close to par last time results were published – in IQ 2019.

The retail apocalypse marches on.

99 Cents Only Stores: Completes Recapitalization

On July 18, 2019, 99 Cents Only Stores announced by press release the completion of a restructuring plan that the BDC Credit Reporter discussed more than a month ago. Basically, the second lien and third lien debt holders are undertaking a debt for a minority equity stake position in the troubled value retailer. In addition, the sponsors – Ares Management and a Canadian pension fund – and other players will be injecting new equity capital as well. Moody’s has already – back on June 12, 2019 – called the restructuring ” a distressed exchange” , and downgraded the company’s rating. We had previously believed that a $20mn portion of the $55mn at cost in BDC exposure owned by sister funds Oaktree Specialty Lending (OCSL) and Oaktree Specialty Income (OCSI) was going to convert to equity, as part of the restructuring. (We assumed the asset-based loan in which TPG Specialty – TSLX –  has $32mn invested would either continue unchanged or be refinanced). On further review, and without any guidance on the subject from the BDCs involved or the company’s press release, we’ve changed our mind and assume the first lien debt will continue as before and not be involved in the conversion to equity. Both the OCSI/OCSL debt and the facility in which TSLX is involved in were trading at the close on July 19, 2019 at a (9%) discount to par, and were paying interest normally. (These are publicly traded debt issues, and we used Advantage Data’s real-time loan and bond pricing module). Given the new capital structure; the infusion of capital and reports that the operational turnaround underway at 99 Cents Only Stores that has been underway for months is bearing fruit, the short term credit outlook is up. We are upgrading the company from a CCR 4 Rating (what we call or Worry List) to a CCR 3 rating (aka Watch List). Much remains to be done following this second restructuring in so many years, and we do not forget that 99 Cents Only operates in the Bermuda Triangle industry of retail where other players have restructured or gone through Chapter 11 only to go bankrupt again. For the moment, though, we are cautiously optimistic and expect Moody’s may shortly upgrade the company and the remaining debt.