Over at the BDC Reporter we’ve been undertaking systematic reviews of several public BDCs following the end of IVQ 2020 BDC earnings season. Most recently we tackled Capitala Finance (CPTA) which happens to be the sole BDC lender to Currency Capital, LLC. The company bills itself on its website as “an exciting FinTech company specializing in transaction enablement“. As far as we can tell, this involves providing equipment financing.
Till the IIIQ 2020, the $16.3mn invested at cost in the company’s first lien debt was carried at only a (1%) discount, although a small preferred stake was valued at half its cost. In the IVQ 2020, though, CPTA placed the debt on non-accrual, resulting in the interruption of over $2.0mn of annual interest income. The debt was written down to just $3.75mn. The preferred was written to zero. We have downgraded Currency Capital (now known as Currency Finance apparently) from CCR 2 to CCR 5 in one fell swoop.
What’s gone wrong ? CPTA did not say on its most recent earnings conference call and the public record is moot on the company’s troubles, so we won’t speculate. However, this is clearly a major reverse for CPTA, and we’ll continue to monitor both publicly available information and any update that CPTA offers.
We’re playing catch-up in discussing Chief Fire Intermediate Inc. (aka Chief Fire Prevention and Mechanical Corp). The kitchen contractor, which serves the north-east, has been non performing since the IQ 2020. That was only one quarter after Capitala Finance (CPTA) first invested in the business with a mix of first lien debt, preferred and common, supporting an acquisition by Trinity Private Equity.
Unfortunately for the company, CPTA and Trinity this was a case of uber- bad timing. The company principally services the restaurant business in New York City, and you know what’s happening there. Within weeks of booking a $8.1mn first lien loan yielding 8.7%, the debt became non performing. The preferred and equity were written to zero. The debt is currently discounted by (25%) as of September 30, 2020 but began at a more modest (12%).
CPTA has said nothing since issuing a press release when the investment was first booked a year ago. As a result, we’re relying on the public record – which tells us nothing – and the quarterly CPTA valuations. The current value given is $6.1mn, an overall (33%) unrealized loss from a total cost of $9.0mn. For our purposes, we wouldn’t be surprised to see the downward valuation trend continue and result in a potential realized loss of (50%). Or more.
Also unknown is whether some sort of resolution is in the cards in the short run. Until then, CPTA’s capital – and potential income – is frozen. For our part, we’ll provide an update when we hear anything new and notable.
According to multiple reports, California Pizza Kitchen (“CPK”) – in Chapter 11 bankruptcy – has reached an agreement in principle in late September 2020 with its first lien lenders and unsecured creditors. That should shortly allow the restaurant chain – already making operational plans for post-bankruptcy operations – to make an exit shortly from the court’s protection.
With a bit of luck CPK should exit bankruptcy in the IVQ 2020 and we’ll get a clear picture of which of the now 6 BDC lenders involved ended up where. Total outstandings from the BDC lenders is $49.5mn in IIQ 2020, slightly higher than in the IQ 2020. (BTW, Prospect Flexible Income appears to be no longer a lender). We already know, though, that this will prove to have been a misstep for all the BDCs involved.
The BDC Credit Reporter has learned some of the background to the recent failure of BigMouth, Inc., a portfolio company of Capitala Finance (CPTA) and – most likely – other Capitala Group entities. We know from CPTA’s 10-Q that in July 2020 a final $2.4mn payment was received by the BDC on $5.372mn invested at cost in the company. At the end of the IQ 2020, total outstandings at cost were $10.3mn. During the second quarter either CPTA received a repayment of the $5mn difference or wrote the debt off. An equity stake had been previously written off in the IVQ 2019.
From a trade article we learned that BigMouth – on the CPTA books since 2016 and on the underperforming list since IVQ 2018 – missed a debt payment to its lenders – including CPTA as recently as April 1, 2020, due to the impact of the pandemic on its business of selling pool inflatables. Very quickly after that a receiver was appointed and the business liquidated in short order. We learned that “Capitala filed suit against BigMouth April 23, claiming that BigMouth owes it $22.9 million. The amount, Capitala said in the filing, includes $20.7 million in principal on the term loan, $2 million in principal on the revolving credit, plus interest on both“.
This all happened very fast and we can’t tell from the 10-Q if the $2.4mn received in July represented the only proceeds or – as mentioned above – whether some other funds were received previously. Overall, the transaction represents a modest-sized setback for the BDC and for the Capitala Group. Unfortunately, the company seems to have been beyond saving as private equity sponsor CID Capital does not seem to have stepped in with any support, nor did Capitala seek a “debt for equity swap”.
CPTA will permanently lose close to ($1.0mn) per annum in investment income from the first lien debt lent to the company. A final realized loss will be booked in the IIIQ 2020. For our records, we have moved BigMouth from CCR 5 to CCR 6, which is the rating system we used for companies no longer held on any BDC’s books, for whatever reason. That’s why you will not find in the BDC Credit Reporter’s database of underperformers.
The BDC Credit Reporter believes privately-held Alternative Biomedical Solutions LLC, a Centre Lane Partners portfolio company, was restructured in the IIQ 2020. We did not find an official announcement but a review of Capitala Finance’s (CPTA) 10-Q suggested some of the 2022 Term debt due the BDC may have been converted into Preferred stock and warrants were issued. Total exposure by CPTA dropped by a third, suggesting a possible realized loss of ($6mn) in the period but that’s not explicitly confirmed in the 10-Q.
Unfortunately, all our information is from CPTA’s results and cannot address the company’s overall balance sheet or what other lenders – if any – might have done. Furthermore, we don’t know if the sponsor made any capital contribution as part of the restructuring. The company had been underperforming since the IQ 2018 and in 2019 CPTA revealed trailing EBITDA had been headed lower but was stabilizing. As of the IQ 2020, the company’s debt was carried as non performing by the BDC.
As a result of the restructuring, we have upgraded the company from CCR 5 to CCR 3. The remaining debt is valued by CPTA at par, as well as the new preferred. The original $0.800mn in equity remains valued at zero. Total cost is $13.1mn and FMV $12.3mn.
We are keeping the company on the underperformers list despite the restructuring, both because the equity remains valued at zero and due to the recent non accrual and need for restructuring. We hope to learn more in the future.
On July 30, 2020 California Pizza Kitchen (aka CPK) filed for Chapter 11, as part of a broad restructuring plan (RSA) agreed with its first lien lenders. As readers will expect by now, the RSA envisages a “debt for equity swap” and additional financing to get the restaurant company through this difficult period, presumably financed by some or all those same lenders that are in the existing financing. CPK hopes to be in and out of bankruptcy in 3 months.
The BDC Credit Reporter has written about the company on three prior occasions. Our most recent contribution followed learning that several BDC lenders had placed their debt outstanding to the business on non accrual, but not all. In any case, bankruptcy has seemed like a forgone conclusion for some time. As a result, the seven BDCs involved (6 of whom are publicly traded) will have to face the consequences of their $48.1mn invested in the debt of CPK.
Common sense suggests the second lien debt holders : Great Elm Corporation (GECC) and Capitala Finance (CPTA) will have to write off the $4.1mn and $4.9mn respectively held. The rest of the debt is in first lien debt (including a tranche held by GECC) and will mostly become non income producing, when swapped for common shares. We expect the BDCs involved will write off 80% or more of their positions, but we’ll gather more details shortly. As usual in these situations, total exposure may increase as some of the lenders fund their share of the additional capital. For the record, the other BDCs involved are Main Street (MAIN); Capital Southwest (CSWC); Monroe Capital (MRCC) and Oaktree Specialty Lending (OCSL) ; as well as non traded TP Flexible Income with a tiny position.
CPK is – arguably an example of a “Second Wave” credit default. Admittedly, the company was already underperforming before Covid-19 but would likely not have had to file Chapter 11 if the virus had not occurred. As recently as the IIQ 2019 GECC – in a case of ill timing – bought into the second lien at a (5%) discount to par. Going forward, a much de-leveraged CPK should have a decent chance of survival, and may even thrive in the long run. This might allow the BDCs involved to recoup some of their capital but it’s going to be a long slog.
Currently, the BDC Reporter has rated CPK CCR 5 – or non performing – which remains unchanged. We’ll re-rate the company when the RSA – or some other outcome – is finalized. By the way, this is the ninth BDC-financed company to file for bankruptcy – all Chapter 11 – in the month of July, keeping up the blistering pace set in June.
After much back and forth Bluestem Brands Inc. has been acquired out of bankruptcy by its lenders – led by Cerberus Capital Management. The centerpiece of the deal ? Forgiveness of $250mn in debt in return for control of the company in a “debt-for-equity” swap. These details are from a Wall Street Journal article on July 7, 2020. Haggling continued till the very end. At first the buying group offered $300mn, then $200mn and finally $250mn, as discussed in prior articles.
For the four BDCs involved with $34.0mn invested at cost – all in debt – this brings the day of resolution and restructuring closer. The BDCs have already written down their pre-petition positions by (31%)-(40%). We estimate that discount will increase to (55%) when all is said and done. The post-petition debt should get repaid in full or rolled into whatever new capital structure the new owners envisage. Expect to see significant realized losses booked in the third quarter 2020, in the order of ($12mn-$15mn).
Unknown – but not unlikely – is that Main Street (MAIN); HMS Capital; Capitala Finance (CPTA) and Monroe Capital (MRCC) will need to advance more capital going forward to give Bluestem a chance at success. Our readers may expect to be reading about the company – maybe under a new name – for some time to come. The good news ? Maybe some portion of the debt will start paying out its lenders again shortly.
However, the chances of a Chapter Twenty Two, i.e the business falling back into bankruptcy again remain high given the difficult market conditions. Also, much depends on how generously the new Cerberus-led group carves out a new capital structure. We’ve seen multiple examples of new, lender-led groups being shy about making the necessary sacrifices in writing off debt and not injecting new capital. Maybe it’s not in the DNA of lenders more intent on getting their money back than ensuring a business thrives. We need to dig deeper and find out what sort of plan Cerberus and its group has in mind.
The BDC Credit Reporter – and everyone else – saw this coming weeks ago: Sur La Table filed Chapter 11 on July 8 2020. Also not surprising is that the company comes to bankruptcy court with a plan to be bought out by a “stalking horse” bidder- Fortress Investment, which is working with the existing lenders. The lenders are offering debtor-in-possession (“DIP”) financing to bridge this difficult period. (The amount involved is what seems like a paltry $3.0mn, according to court filings). The company itself – which had already reduced corporate staff – will be closing up to 51 of its stores.
From a lender standpoint, this was a borrower already on non accrual since IQ 2020. What is unclear is how the two BDCs with $31.5mn exposure in the company’s first lien debt will fare. Capitala Finance (CPTA) has already discounted its position by (41%) and Blackrock Capital (BKCC) by (34%) – typical of the fluid world of BDC valuations. We’re assuming the two BDCs are involved in the DIP facility and are part of the buying group. More capital – besides writing off debt – may be required in some form. We’re waiting for further filings to get a clearer picture.
What we did learn from the CEO’s first day filings with the bankruptcy court is that he was hired back in August 2019 to turn around the business. Also new to us was that Sur La Table was in default under its debt agreements and raised $15.0mn from its investors on June 12, 2019 to pay down some of the debt and get back in compliance. However, Advantage Data records show that in neither that quarter, nor the quarter before nor the quarter after the default and loan reduction did either CPTA or BKCC discount their positions to reflect the strained situation. The debt, though, did drop from $45mn to $31.5mn.
In an earlier article on June 29, 2020 we mentioned that we were disappointed by the values at which Sur La Table was carried on both BDCs books. This latest revelation in a court filing indicates without a doubt that the company was in deep trouble more than a year ago. Yet, the debt was not discounted on either BDC’s books by a material percentage till IQ 2020. That’s the same quarter as the Term Loan was placed on non accrual. This does not speak well to the valuation methodologies of either BDC involved.
For the moment, the BDC Credit Reporter’s rating remains CCR 5. We’ll provide an update on likely recovery once further details come in.
A Seattle Times reporter appears to have found a “Deep Throat” equivalent at troubled “Sur La Table, a company already non performing and which we’ve written about twice before. As a result, we’ve learned – and the company has confirmed – that 27 employees – a fifth of its corporate employees- will be laid off. Less clear cut is the possibility that 5 stores will be closed. The most interesting development, learned from an anonymous just laid-off employee, is that the company’s troubles may have predated Covid-19 and the forced temporary closure of its 130 stores in March.
“As recently as 2018, when Sur La Table still shared sales data with employees, monthly revenues from physical locations were routinely in the ‘minus 6 and 7 percent’ range, the employee said”.
That made the BDC Credit Reporter wince because all the way through 2018 and 2019, right up to when the company’s debt was placed on non accrual in IQ 2020, its BDC lenders Capitala Finance (CPTA) and BlackRock Capital (BKCC) carried the value of the then-performing debt at par. Nor were the amounts negligible: $45mn through the IQ 2019 and $31.5mn thereafter following a partial repayment. We’d expect that if employees were being shown same store sales results so were its lenders, but cannot confirm that.
Is Sur La Table a Second Wave credit casualty, an innocent bystander but otherwise strong business brought low by the impact of the crisis or a member of the First Wave whose business was already weak before the closures made everything worse ? It’s important because the BDC Credit Reporter, and the investors who rely on quarterly BDC valuations, want to believe that the managers, and the external valuation firms engaged at great cost to shareholders, are providing loan estimates that reflect reality. There is already a high degree of skepticism amongst many users of these valuations about their accuracy and this anecdote from an insider only heightens the concern that some of these asset values cannot be relied on.
We’re not casting aspersions at the two BDCS involved or anyone else, but analysts and investors might want to ask harder questions as to what has to happen before an investment is de-valued and whether that process fully reflects the risks the businesses involved are facing.
As we last wrote on March 11, 2024, Bluestem Brands is in Chapter 11. Now we hear from the Wall Street Journal that the “stalking horse” offer by Cerberus and a group of lenders to the company has been reduced from $300mn to $200mn. Further details are as yet unavailable.
The implications for the 4 BDCs with exposure – which has now increased to $34mn as the lenders provide DIP financing which is performing – are not clear. We expect the BDCs are part of the Cerberus headed attempt to undertake a debt for equity swap. Clearly market conditions have deteriorated since the bankruptcy. This might result in each lender getting a bigger equity slice of a smaller pie or cause another buyer to swoop in or delay the exit from Chapter 11, which has the effect of depleting cash resources. (Bankruptcy is a very expensive process, and this one will shortly be entering its fourth month).
The BDCs involved in the original debt have already discounted their loans by (40%) as of March 31, 2020. Given the reduced perceived value of Bluestem, this might result in a yet bigger discount as of the June 30 valuation and a bigger realized loss when this phase is completed. The $6.3mn in DIP financing, though, should continue to be unaffected for the moment. We maintain the company’s CCR 5 rating.
This drop in the value of Bluestem is emblematic of what is likely to happen to recovery values going forward. Before Covid-19 struck, bankrupt companies were – by and large – retaining much of their value given plentiful capital in the market. Now buyers, investors and lenders are all pulling out their forensic microscopes and values are dropping. We’ll be interested to compare the final discount the lenders have to absorb against the March 31 value when this transaction plays out. It will be instructive both about Bluestem Brands and about recovery expectations more generally. The BDC Credit Reporter guesses we could see a substantial further drop. This is what happens in recessions. The days of a V recovery seem far off.
We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).
Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.
Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…
The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.
For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.
Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.
Back on May 3, 2020, the BDC Reporter downgraded Sur La Table to CCR 4 on reports of an imminent Chapter 11. As we write this on May 9, 2020 that has not yet come to pass. In the interim, though, both BDC lenders to the company – and both in the 2022 Term Loan – have reported IQ 2020 results. Both are carrying Sur La Table as non-accruing. BlackRock Capital (BKCC) has discounted the debt by (34%) and Capitala Finance (CPTA) by (41%). As a result, we have downgraded the company’s rating to non-performing, or CCR 5. We had placed the company on our “Weakest Links” list, projecting that a non-accrual was likely, an issue which is now moot.
The income lost on the $35mn invested at cost by the BDCs involved is ($3.5mn). BTW, BKCC has $21mn and CPTA the rest. We expect the final realized loss – barring a miracle – could be coming in the second or third quarter 2020 and might be as high as 50% of cost or ($17.5mn). That would mean slightly greater write-downs by both BDCs to book value. However, our loss projection is just a guesstimate.
With the benefit of hindsight, one has to question the wisdom of lending to a bricks & mortar retailer. In defense of both BKCC and CPTA, the initial loan was entered into years ago: 2011 and late 2016 respectively. One might argue that the retail apocalypse had not yet begun. Moreover, outstandings reduced from $45mn to the current level thanks to a repayment in mid-2019, so things could be worse. At year end 2019 the debt had been written down (4%), but was still carried as performing, even though we had some concerns given the sector and managerial changes.
The fact that we’ve gone from CCR2 to CCR5 in one quarter can be laid at the door of Covid-19. So far, though, neither the company’s PE sponsor nor any government program has been capable of supporting the firm, underscoring the limitations of both in these extreme conditions. We wouldn’t be surprised to see CPTA and BKCC end up as as owners in an eventual debt for equity swap, but that may require new capital to restart operations. Historically, BDCs taking over retailers has not worked out very well so we’ll reserve judgement – and any more commentary – till we learn more about the future plans of Sur La Table.
On May 1, 2020 we heard from Bloomberg that cookware retailer Sur La Table may file for Chapter 11 bankruptcy. As usual, this came from “people familiar with the matter”. A sale of the 125 store chain is also underway, but no details were mentioned. We don’t know how poorly Sur La Table is performing but with its retail locations mostly closed, online commerce can only take the company so far. Not to mention that even without Covid-19, Sur La Table was already competing in a retail sector in a long term apocalypse of changing customer mores.
There are two BDCs with $31.6mn in first lien debt exposure to the company: BlackRock Capital (BKCC) and Capitala Finance (CPTA). Both are in a 2022 Term Loan and both are long term lenders, with the former a lender since 2011. A small relief for both BDCs will be that their exposure dropped from $45mn to the current level when an earlier 2020 Term Loan was refinanced in the IIQ 2019.
Still, there’s nearly $3.5mn of investment income at risk of being interrupted shortly. It’s hard to estimate what realized loss might be involved, especially in the current conditions, so we won’t try. We do know, though, that the two lenders discounted the debt only (5%) at year end 2019, so a bigger final loss should be expected before long, probably in the second or third quarter. The gradual re-opening of America might mitigate the damage but appears to be happening too late to save the company or private equity owner Investcorp, who bought the chain nearly ten years ago.
We have downgraded the company from performing or CCR 2 to CCR 4. Furthermore, we’ve added Sur La Table to the Weakest Links list, i.e. those companies we expect to become non performing shortly. The list can be found in the BDC Credit Reporter’s Data Room. There are now 31 companies on the list with a FMV of $1.3bn.
When we last wrote about California Pizza Kitchen (“CPK”) in December of last year, we said the following about the company and the sector in which it operates: “We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends …that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited“. We rated CPK a Corporate Credit Rating of 3.
Of course, in the interim we have moved into an “apocalypse” phase for eateries. Not surprisingly, an already weakened and highly leveraged CPK is not faring well. According to the Wall Street Journal on April 23, 2020 , the company has hired restructuring firm Alvarez & Marsal Holdings LLC, along with Guggenheim Partners, to facilitate deal talks with its lender. On the other side the lenders have hired FTI Consulting Inc. and Gibson, Dunn & Crutcher LLP to represent them legally. Now we know – at least – that big fees are going to get paid out by the company…
The situation is very serious, with the two Term loans in which $48.2mn of BDC exposure is invested – one maturing in 2022 and the other in 2023 – are trading in the syndicated markets at discounts of (65%) and (85%) respectively. Not to beat about the bush, we project that a drastic restructuring or a Chapter 11 filing is imminent. We are downgrading CPK to a CCR 4 rating and adding them to our Weakest Link list of companies we expect to shortly move to non accrual.
For the 6 BDCs involved that will mean – if not already happening – an interruption of over $4mn of annual investment income and potential realized losses of ($30mn-$40mn). Unfortunately, the challenges facing eat-in restaurants are not going away any time soon and the delivery business cannot make up for the switch up in how customers feed themselves.
The biggest BDC exposure in dollar terms is that of Main Street Capital (MAIN), with $14mn in the first lien 2022 Term Loan. Capital Southwest (CSWC) and Monroe Capital (MRCC) are also holders of the 2022 loan. However, likely to take it most on the chin from a write-off standpoint are Capitala Finance (CPTA) with $4.9mn invested at cost and Great Elm Corporation (GECC) ($4.0mn) , which are both in the 2023 second lien debt. If past is prolog, the chances are high a complete write-off is in the cards for the 2023 Term Loan holders. (GECC also holds a position in the first lien). We expect some sort of debt for equity swap will be the ultimate resolution as CPK continues to have a viable – albeit shrunken business model. We’re getting ahead of ourselves, though, and will wait to hear how the dueling advisers hash out a plan for the restaurant chain.
US WELL SERVICES: Hit by both lower oil prices and the Coronavirus, the publicly traded oil services company cuts back on staff and salaries. http://bit.ly/USWS03202020 Last Article: http://bit.ly/USWS03042020
After many quarters of balancing on the brink, Bluestem Brands Inc. has filed for Chapter 11. In a press release, the retailer indicated its commitment to remaining in business through the bankruptcy process, and the arrangement of a $125mn DIP financing by a “syndicate of lenders”. The “syndicate” is also serving as a “stalking horse bidder” for the company’s assets, and seeks to de-leverage and restructure the company’s balance sheet.
Who are the members of the syndicate ? Not disclosed. What might the assets be valued at ? Not mentioned ? How much debt might be wiped from the balance sheet ? Still to be determined. Nonetheless, this seems to be a classic debt-for-equity swap where the lenders become part, majority or the exclusive owners of the new Bluestem Brands. Sometimes that works, and sometimes not.
We’ve been writing about Bluestem Brands for a very long time, both in the BDC Credit Reporter and in our database of all under performing BDC companies that we maintain. Barely a week ago we wrote to ourselves the following summation of our views:”3/4/2020: We worry that Bluestem might be about to meet its moment of reckoning in 2020 with the need to repay its publicly traded Term Loan in November 2020 and its modest liquidity above the mandated level at the end of the IIQ 2019. Sales and EBITDA trends are either anemic or negative. The debt is already discounted by nearly a quarter. As a result, we’ve added the company to the 2020 At Risk Of Non Accrual list.”
Now that’s happened we’ll be interested to see what the 4 BDCs with $28.2mn of exposure at cost – Main Street (MAIN); Capitala Finance (CPTA); Monroe Capital (MRCC) and non-listed HMS Income – will be doing. We imagine they are committed to a portion of the DIP financing and are likely to end up as owners, and may also be committing more junior capital. As mentioned above, we don’t know how much historical debt will be forgiven. So any sort of valuation is hard , but Advantage Data shows the 2020 Term debt in which all the BDCs are invested trading at a (29%) discount; just slightly worse than the recently announced IVQ 2019 (25%) discount announced by the three public BDCs. That suggests, but does not guarantee, the eventual realized loss to be taken might be over ($8mn). In an earlier article, though, we’d been estimating ($15mn). More immediately, income forgone will be about ($1.4mn) annually, mostly absorbed (4/5ths) by sister BDCs: MAIN and HMS Income.
We will report back as we learn more about how this bankruptcy will play out, and what individual BDC exposures to old and new capital (if any) will look like.
Frankly, we don’t what exactly happened at Portrait Studios, LLC, a portfolio investment of Capitala Finance (CPTA). At this point, it hardly matters because the BDC’s IVQ 2019 10-K says the investment in the company was sold and a ($6.2mn) realized loss taken. At time of writing, CPTA maintains $0.5mn on its books as “First Lien Debt” but a footnote says “the residual value reflects estimated earnout,escrow or other proceeds expected post-closing“. Given that as of September 2019 CPTA had $9.1mn invested at cost in two first lien term loans, preferred and equity, we’ll assume $2.4mn was repaid to CPTA and the rest consists of the loss and the remaining value.
For the II and IIIQ 2019, $4.2mn of debt had been on non accrual, so the sale of the investment will be a wash from an income standpoint. One of the loans – with a cost of $2.3mn was still on accrual, and that – presumably – was what was repaid and will continue generate income for CPTA. However, the BDC has lost $6.2mn of capital through the write-off and may lose that last half a million dollars. At a 9% yield on $6.2mn, CPTA has permanently lost ($0.6mn) of yield producing capacity.
From the BDC’s standpoint, though, a troubling non accrual has been removed, one of 4 in the last quarter of 2019. For our part, we’ve effectively removed the company from our under performers list as there is no other BDC exposure and the remaining amount to be collected is not material.
On March 3, 2020 troubled publicly traded US Well Services (ticker:USWS) published its IVQ 2019 results and held a conference call. The bottom line: in the last quarter of the year the bottom fell out of the market for electric fracturing of oil wells. Here are extracts from the conference call transcript:
“Throughout the course of the year, market conditions deteriorated, culminating in a sharp deceleration activity during the fourth quarter. U.S. Well Services was adversely impacted by customer-driven decisions to delay jobs and longer than anticipated holiday shutdowns. As a result, U.S. Well Services active fleets experienced lower utilization than in prior quarters…Revenue for the fourth quarter was $92.7 million, which represents a 29% sequential decline relative to the third quarter of 2019. USWS generated an adjusted EBITDA of approximately $12.1 million for the fourth quarter as compared to $35.3 million for the third quarter of 2019.”
That’s a two-thirds drop in EBITDA in a short period. No wonder that the stock price of USWS is down to $1.07. That’s much lower than the last time we wrote about the struggling oil services business back on October 3, 2019. Then the stock – at a then all time low – was at $1.82. Only some $50mn in cash and the fact that several drills are operating for customers seems to keeping USWS from imploding. Management does not seem worried but the BDC Credit Reporter notes the $274mn of debt on the balance sheet and the much deteriorating market conditions. We don’t want to be unfair but these seem like ingredients for a bankruptcy (again) or equivalent.
From a BDC perspective, all the lenders who got repaid when the company went public recently must be sighing in relief. At one point not so long ago, there was over $100mn of BDC capital invested, mostly in debt in the company before its transformation into a public company. Now, there are still BDCs with equity exposure, but the amount at September 30, 2019 (we don’t have all the relevant BDCs results yet) was $9.4mn at cost. The BDCs involved were PennantPark (PNNT); Capitala Finance (CPTA) and BlackRock Capital (BKCC). The first two have reported and – curiously – PNNT seems to have increased its exposure from a immaterial $0.7mn to a more material $3mn. Their discount is only (21%), presumably because stock was purchased more recently and cheaply. CPTA’s equity is discounted by as much as four-fifths.
We’ll continue to watch the company’s progress, but the likelihood is high that this will end badly for US Well Services – managerial optimism notwithstanding. For the BDCs involved that would almost certainly result in a complete realized loss on all invested capital, given the debt sitting higher on the balance sheet.
Just in case you didn’t know, it’s the companies themselves who pay for their credit ratings from groups like Moody’s and S&P. (That’s different than at the BDC Credit Reporter, whom nobody pays). We were reminded of this economic fact of life on hearing that Moody’s has “withdrawn’ the ratings of retailer Bluestem Brands. The rating firm – usually prone to long discussions in its regular credit reports – was succinct on this occasion: “Moody’s has decided to withdraw the ratings because of inadequate information to monitor the ratings due to the issuer’s decision to cease participation in the rating process“. No other explanation was given.
Apparently S&P Global has not been any kind of succor. That rating group downgraded the company on January 28, 2020 to CCC- from CCC..Here’s the crux of the matter as S&P sees it: “
“Bluestem’s revolver and term loan are due this year and we believe the likelihood that the company will undertake a restructuring in the near term has increased. The company’s $200 million asset-based lending (ABL) facility matures in July and its term loan (roughly $400 million outstanding) comes due on Nov. 7, 2020. In our view, Bluestem does not have a clear refinancing plan and we believe it is increasingly likely that the company will pursue a holistic debt restructuring to address its maturities given its weak operating performance. If the company pursues a restructuring or exchange that provides its lenders with less than they were originally promised under the security, we would view it as distressed and tantamount to a default”.
We’ve written on three earlier occasions about Bluestem, starting back in the spring of 2019. As far back as June 2019, we had a Corporate Credit Rating of 4 on the company – on our five point scale. More recently, when we began projecting out which BDC-financed under-performing companies were most likely to default in 2020, Bluestem was one of our first additions. Now there seems to be a consensus building that the company will not be able to avoid either a “distressed debt exchange” or a Chapter 11 filing in the months ahead.
For the 4 BDCs involved – all in the 2020 Term Loan, which is structurally subordinated to the Revolver (as far as we can tell) – that’s bad news. Not helping is that S&P is only projecting a 45% recovery rate in event of default. That implies ultimate losses of over ($15mn) over cost, or about ($6mn) more than already provided for at September 30, 2019. Then there’s the $2.7mn of annual investment income at risk of interruption…
We expect to be revisiting Bluestem – and its intractable balance sheet inside a retail sector in seemingly permanent crisis – before long.
We pride ourselves on being timely about alerting readers to material new developments at under-performing BDC-financed companies. In this case, though, we’ve been slow to notice the deterioration underway at iconic restaurant chain California Pizza Kitchen (CPK). In July and August 2019, the company was downgraded by both S&P and Moody’s to speculative grade status. Here’s a sample of what the former said: “We are downgrading CPK to ‘CCC+’ from ‘B-‘ to reflect our view that the company’s capital structure may be unsustainable over the long term.
Moody’s said the following: “CPK’s Caa1 Corporate Family Rating is constrained by its high leverage, modest interest coverage, small scale and geographic concentration relative to comparable casual dining concepts. The company is further constrained by the challenging operating environment which includes soft same store sales growth, with weak traffic trends, and increased labor expense as a percentage of restaurant sales which continue to pressure profitability margins“.
All the above notwithstanding, the 2022 and 2023 Term debt in which seven BDCs have committed $48mn was still valued at a discount of less than (10%) last time results were published in September 2019. As of June 2019 the debt was trading (almost) at par. As of now, though, the publicly traded 2022 Term Loan is trading at a (12.5%-15%) discount, and the more junior 2023 facility at (20%) off. Time to get worried about the $5.0mn of annual investment income that is being generated for the BDCs involved.
There are 6 public BDCs with material exposure, led by Main Street (MAIN) and followed in descending dollar amount by Great Elm (GECC); Monroe Capital (MRCC); Capitala Finance (CPTA); Capital Southwest (CSWC) and Oaktree Specialty (OCSL) – a veritable potpourri of funds with little else in common. There does not seem to be any immediate risk of default, although Moody’s did suggest there was a potential need for a covenant waiver or amendment at year end. That may not have been required or has been granted or could be under discussion. We have a Corporate Credit Rating of 3 on CPK on our 5 point scale, but that could move down quickly in 2020 if performance does not turn around – which seems unlikely – or if PE owner Golden Gate Capital, which bought the famous chain in 2011, does not inject new capital.
We admit the BDC Credit Reporter has been a bit slow to flagging CPK’s credit troubles, but expect to hear much more from us in the months ahead if the company’s debt continues to drop in value. We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends – referred to by Moody’s above – that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited.