Posts for OFS Capital

The Escape Game, LLC: Debt Valuation Drops

The BDC Credit Reporter is pro-actively – if randomly – seeking out companies and sectors that are likely to be disproportionately impacted by the Covid-19 crisis. We don’t just want to wait around till BDCs start reporting new under-performing portfolio companies weeks from now, or longer. (The SEC is now allowing delays in valuations, according to a legal update we saw from a law firm that a reader passed on).

In this regard, we’re downgrading The Escape Game, LLC from performing (CCR 2) to CCR 3 (Watch List). Three reasons: First, the very nature of the business. This involves small groups of people choosing to go into a small enclosed space to play the “escape game”. Fun, but not recommended at this time and we believe most locations must be closed or closing. Second, the two Term loans in which lenders are involved (2020 and 2022) are trading – if Advantage Data’s records are correct – at a (20%) discount. Third, the 2020 Term Loan matures at the end of March, just 4 days away. Will that be refinanced, extended or what in this environment ?

There are two BDCs with $20.0 of exposure at cost, and all performing as hoped at 12/31/2019: The first is publicly traded OFS Capital (OFS) with $18.6mn. The remainder – which does not amount to much – is held by non-traded Hancock Capital. With first quarter 2020 valuations about to be fixed, we expect to see the debt valuations drop by at least 20%, or ($4mn) of unrealized depreciation. We’ll check back after OFS and Hancock Park report results, or earlier, if there’s any new information on this closely held company acquired in a leveraged buyout back in late 2017.

Constellis Group Inc.: Update

We have written about Constellis Group on four prior occasions. With the publishing of IVQ 2019 BDC results, our most dire predictions appear to be coming true. That’s unfortunate because on January 4, 2020 the BDC Reporter was saying darkly: “We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way“.

Now we’ve just seen OFS Capital’s (OFS) latest valuation of the 4/1/2025 “First Lien” debt. The loan has been discounted by (96%) from cost versus (71%) at 9/30/2019. Worse, and according to Advantage Data, currently that loan trades at 1 cent on the dollar... Likewise, FS-KKR Capital II has also reported IVQ 2019 results and the value of its 4/15/2022 Term Loan. That was discounted by (14%) in September, but (33%) at year-end 2019. Currently that loan – also on non accrual – is discounted (87%).

Let’s tot up the damage. There’s $9mn of investment income already interrupted since November 2019 (according to OFS) and potential realized losses across several tranches of debt of ($96mn-$100mn) by our rough estimate. That’s ($30mn) in additional unrealized depreciation from the 9/30/2019 levels for which we have values for all BDCs involved. We don’t have the latest word about how the restructuring of the company is going but by the time we hear, the lenders involved appear set to recover very little. Even then, that might be in the form of equity rather than cash.

Frankly, this is an unmitigated disaster for this Apollo Group-led buyout and for the BDC lenders involved. To be specific, the biggest hit is being taken by the non-traded BDCs in the FS-KKR Capital construct (FS Investment II; FS Investment III; FS Investment IV and CCT II, all of which are being rolled into one entity). By our count 86% of the exposure is there, with OFS the second BDC group on the list with $9.8mn at cost. Far behind are Garrison Capital (GARS); followed by two non-traded players with small outstandings.

We’ll be checking back when the final decision about a bankruptcy-restructuring is finalized but – from a lenders standpoint – most of the damage has been done and material recovery of any kind seems unlikely from the information at hand.

Community Intervention Services: IVQ 2019 Update

Community Intervention Services is a PE-owned dependency treatment center chain that has attracted BDC financing as far back as 2015. The two BDCs involved were Triangle Capital, whose loan was acquired by Business Development Corporation of America (BDCA) some time ago when all its assets were sold to the non-traded BDC; and OFS Capital (OFS).

The initial subordinated loan facility was led by Triangle Capital and OFS was a participant, according to the latter. At the height, the two BDCs had $25.7mn invested in the company, but that’s down to $7.6mn at December 31, 2019. That’s because BDCA wrote off its entire investment back in 2019. OFS continues to have the $7.6mn at cost outstanding on its books.

However, the company has been on non-accrual since 2016 and the investment written to zero since 2017. That’s due to one of the company’s subsidiaries being caught up in a medical fraud case – a very familiar story in the healthcare sector. For some reason OFS has not followed the lead of its BDC peer and booked a realized loss as yet. We do know quite a lot more from periodic updates by OFS on conference calls over the years, but given that the investment is unlikely to ever be worth anything, we won’t revisit what has become ancient history in credit terms.

However, the BDC Credit Reporter has to assume OFS will eventually write off its position and the company will be removed from the list of BDC funded companies. At the moment, though, Community Intervention Services is an example of a “zombie” investment, of which there are many in BDC portfolios as lenders wait for final resolutions on investments gone bad.

The good news from the OFS perspective – at least – is that the company can have no further impact on its income or book value, except to increase its realized loss column when the time is right. The bad news is the reminder to BDC debt investors that debt investments can result in 100% losses when things go awry, as happened here.

Baymark Health Services Inc : Added To Under Performers

On March 14, 2020 we added opioid treatment company Baymark Health Services to the BDC Credit Reporter’s under-performers list, with an initial rating of CCR 3 on our five point scale.

We were motivated by five factors. First, the publicly traded 2025 Term Loan debt of the company dropped (8%) in value during the most recent market melt-down. Second, we noted that – after a 12 month period – the private equity owner of the fast growing chain of treatment centers “pulled” the company from being sold. Third, the BDC Credit Reporter is aware – and has written about – multiple other similar dependency treatment centers of late facing financial and operational difficulties. Fourth, the company has been growing very quickly of late – by merger and acquisition. Recently, a number of “roll-ups” in various sectors have gone wrong, raising a red flag to the BDC Credit Reporter where Baymark is concerned. Fifth, the industry is highly dependent on reimbursement by governmental authorities and insurance groups, whose track record for reliability has been unconvincing of late.

However, to be fair, the latest BDC valuation of that same 2025 Term Loan was at a slight premium to cost. That was by OFS Capital (OFS) – one of 3 BDCs with $12.9mn invested in aggregate, all in that same 2025 Term Loan. The other BDCs involved are non-traded Hancock Park and recent public BDC Crescent Capital (CCAP), which inherited the investment from Alcentra Capital, whose portfolio has been acquired. All the BDCs exposure dates back to early 2018. Investment income involved is $1.3mn.

To date, the term debt has been trouble-free, judging by the quarterly valuations. We are adding the company to our watch list (CCR 3) out an abundance of caution and remembering – if Alcentra’s disclosure back in the day when the loan was first booked – this is a second lien position. That seems to be confirmed by the pricing: LIBOR + 825 bps.

We admit that not everyone might agree that BayMark – owned by eminent PE group Webster Equity Partners – should even be on the under performers list. We leave to readers – having made our case herein – to make their own minds up.

Bass Pro Group, LLC: Loan Value Dropped

The BDC Credit Reporter added fishing and hunting specialty retailer Bass Pro Group LLC to the under performers list only in IVQ 2019. That was on the back of a worrisome note by Moody’s about the company, which we wrote about on October 1, 2019. The company is privately owned.

There’s been no new information from the ratings group that we’re aware of since, or anything material in the public record. However, when we checked Advantage Data’s records for the latest valuation of the company’s debt we noted a discount of (12%) on March 13, 2020, significantly higher than before the market melt-down.

Moreover, we couldn’t help surmising that a company still heavily reliant on walking around consumers – now stuck at home in some cases – might be impacted going forward. As Moody’s previously noted, the owners have had an “aggressive” financial stance. The loan in which the BDCS involved are funded was expanded in 2018 to allow for the repayment of junior capital, as Moody’s reported at the time. Also, EBITDA is at or above the levels we’d prefer for companies of this size. We are affirming our CCR 3 rating, but will be paying ever closer attention.

At the moment, though, BDC exposure is relatively modest: now just 2 players: publicly traded OFS Capital (OFS) and Garrison Capital (GARS), with $9.0mn invested at cost. (The latter has the bulk of the exposure). Non-traded GSO-Blackstone appears to have dropped out as lender late in 2019. In both remaining cases, the exposure is limited to involvement in the syndicated 2024 Term Loan, mentioned above. OFS actually valued the debt at a premium to par at 12/312/2019 (the GARS report is not available). That might even suggest the debt will shortly be repaid.

In our database, we’ve assumed some potential material credit losses in a worst case, but there’s no immediate reason to be concerned for the BDCs involved. Income at risk is just $0.6mn as the debt is priced at LIBOR + 500 bps.

3rd Rock Gaming Holdings, LLC: Credit Update

Following the Covid-19 engendered market meltdown, the BDC Credit Reporter is laboriously re-assessing every BDC portfolio, and every company therein, to identify any new under-performers or any change to existing denizens. At March 14, 2020, we’re making our way through the OFS Capital (OFS) portfolio with the goal of writing about every under-performing company:

We added 3rd Rock Gaming Holdings to the under-performers list with an initial rating of CCR 3, from CCR 2, on our five point scale back in IVQ 2018 in our database. This is the first article we’ve written about the company for the Credit Reporter but did mention 3rd Rock in the BDC Reporter back in May 2019 as part of an overall OFS credit review. The only BDC lender to the pre-packaged software firm is OFS, which has invested $23.6mn, mostly in a publicly traded 2023 Term Loan and an equity stake. The investment dates back to IQ 2018.

Frankly, we have found very little public information about the company and the BDC’s managers have never discussed 3rd Rock (no relation to the TV show but still appearing in any search results). That’s why readers will not have seen any article before this one. Our downgrade was driven only by the discount in the IVQ 2018 of the equity and the debt, and which has continued through 2019. Most recently, the 2023 Term Loan was discounted (15%) on March 13, 2020 and the equity discounted by (61%) at year end 2019, its highest percentage level ever.

Given the above, we will continue to track the company and the $2.0mn of investment income at risk, but have no immediate concerns. The company is not in a vulnerable sector and the discounts too date are modest in valuation terms.

Frontier Communications: March Bankruptcy Targeted

We’ve written eight prior articles about the publicly traded telecom + cable giant Frontier Communications, dating all the way back to March 2019. In fact, the company was added to our Under Performer list following IVQ 2018 results with a CCR 3 (Watch List) rating and downgraded further to a CCR 4 (Worry List) back on June 13, 2019. More recently, we predicted the company might file Chapter 11 in the IVQ 2019, but that did not happen. In our last report before this one, though, we said a Chapter 11 filing was likely in the IQ 2020. With the latest news reports, that seems likely to turn out to be true.

People with knowledge of the matter” – and there are dozens of lenders, lawyers, insiders and regulators involved at this stage so journalists have plenty of sources – indicate the company is aiming to file a consensual, pre-packaged bankruptcy by March. On the horizon are $356mn of interest payments due in mid-March. As a result, Frontier’s new CEO and his team have been busy – according to these reports – meeting creditors and seeking to craft out a restructuring plan that would be blessed by the court. (The company itself has no comment).

From a BDC perspective, the question is now more about how each lender class will fare in the restructuring, and what impact there will be on interest income – running about $5mn a year. As we’ve noted before, the debt held by the BDC lenders remains valued at a premium to par, both in their own valuations and when we look at the market price of their secured debt on Advantage Data. Will Frontier restructure itself, go in and come out of Chapter 11 in a hurry and have no impact on the value or income of the $67.5mn in debt held by 8 BDCs ? We have our doubts, but that’s the state of play at the moment. We shall soon learn if those valuations are appropriate.

Constellis Holdings: Restructuring Underway

We warned in an earlier article on October 9, 2019 that for Constellis Holdings “a day of reckoning is coming – and fast”. Judging from two major – and related – developments, the time is nigh. On January 3, 2020 the Wall Street Journal reported the troubled security company “is in talks with creditors on a deal to restructure its $1 billion of debt, according to people with knowledge of the discussions”. Darkly, unnamed sources, warned that if an out of court restructuring didn’t happen, a “pre-packaged” Chapter 11 filing was also on the table. (That’s all part of the negotiation process in these kind of deals as interested parties suddenly find their way to the phone to confide to journalists, who are themselves happy to be of service).

We also learned that the company failed to make a scheduled principal payment on December 31 and has received a short term forbearance from its lenders.

At the same time, Moody’s went and downgraded the company’s corporate rating to Ca, and re-rated several debt tranches outstanding. Most worrying of all is that Moody’s reports that the company’s finances suddenly deteriorated in the last quarter of the year, resulting in a “liquidity crunch”.

All of which suggests the Day of Reckoning is here for the 8 BDCs with nearly $107mn in debt exposure at various points in the company’s balance sheet. Just one month ago, one of those BDC lenders – OFS Capital or OFS – waxed relatively optimistic about the outlook for Constellis: ” I want to note that the company is current on its payments. And based on discussions with management, they have stressed that they have adequate liquidity to fund operations. The company has a growing backlog and expects sequential performance improvement. The sponsor has substantial amount of cash invested in this business, and we expect continued focus from the sponsor”.

We now know that at least some of those reassurances are no longer true. This is reflected in the public prices of the outstanding debt as provided by Advantage Data. The 2022 Term Loan is trading at a (57%) discount, versus (14%) at September 30, 2019. The second lien debt is worth only 10 cents on the dollar in the market, down from 25 cents. At 9/30/2019 FMV was still around $84mn, down ($23mn) from cost. Now, we wouldn’t be surprised to see further losses of ($30mn)-($40mn) more at FMV and ultimate Realized Losses – which could crystallize very soon – of nearly ($75mn). Add to that the loss of income and you’ve got the first bona fide major set-back for BDC lenders in 2020 , should there be no last minute rescue.

As we’ve noted before, the bulk of the exposure – and thus any damage – will be concentrated in the four non-listed FS-KKR BDCs – CCT II, FSIC II, FSIC III and FSIC IV. This was a borrower that the group jumped into under the KKR regime, bringing BDC exposure from modest ($12mn) to major, when they initiated exposure in the IVQ 2018. Maybe the far sighted folk at the jointly run asset manager have their eyes on becoming equity owners of Constellis, but we don’t think so as Advantage Data’s records show the debt was purchased at a cost very close to par, and before the current downturn in corporate fortunes.

We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way.

Constellis Holdings: Hires Restructuring Firm

The Wall Street Journal reports on October 9 that defense contractor Constellis Holdingshas engaged PJT Partners Inc. to engineer a plan for restructuring the company’s debt-laden balance sheet, according to people familiar with the matter“. PJT Parners is an investment bank, often used in turnaround work.

Otherwise, the WSJ article has no new information, except a recap of some of the highlights from the most recent financial filings. Some of that data is admittedly dire. We noticed that even after a recent asset sale – the subject of our last post about Constellis – “the company’s liquidity remained tight, amounting to just $33 million of cash and $18 million of availability on a revolving credit facility as of June 30“. That alone should send chills down the spines of anyone concerned about the company.

Anyway, the advent of a restructuring firm and those slim liquidity numbers suggests a day of reckoning is coming – and fast.

We discussed BDC exposure before when we first added Constellis to the under-performing list back in August. Judging by the current market valuations (source: Advantage Data) of the three different loans outstanding in which BDC lenders are involved, the debt is discounted from (8%) to (70%), higher than in June. Thankfully, 90% of of BDC exposure is in the 2022 Term Loan, which is valued the highest even after the news of a prospective restructure. Nonetheless, at current levels – and things could get much worse – potential ultimate realized losses could reach $20mn on the $109mn invested at cost, most of which has not been recognized even on an unrealized basis as of June 2019. Not to mention the loss of investment income, which we’ve previously pegged at $9mn annually.

Unfortunately Constellis has the possibility of being one of the biggest credit hotspots of the fourth quarter (if that’s when the rubber meets the road) for the BDC sector. The prospective damage will be widespread. There are 4 FS-KKR related non-listed funds with $90mn at cost lent to Constellis. OFS Capital (OFS) and Garrison Capital (GARS) and – to a lesser degree – two non-listed BDCs are also exposed.

Elgin Fasteners: Loan Repaid

Once in a while, there’s an under-performing loan story with a happy ending. That’s (mostly) the case with Elgin Fasteners. OFS Capital (OFS) had a $3.5mn Senior Secured Loan to the company that was due in August 2018. That maturity debt came and went, without much feed-back from the BDC as to why. All we knew at the time was that a forbearance agreement was entered into between lenders (this was a syndicated loan) and borrower. We added the company to the under-performing list in the IIIQ 2018 because of the non resolution, and even though OFS valued its position at only a small discount to par.

Scroll forward to the BDC’s IIIQ 2019 10-Q, and we find a “Subsequent Development”: The debt was repaid on October 9, 2019 for proceeds of $3.361mn, resulting in a realized loss, but only a modest one: ($0.122mn). That was in line with the discount taken versus cost by the BDC.

We’ve removed Elgin Fasteners from the under-performers list and OFS shareholders should expect to see the nominal realized loss show up in the IVQ 2019 results. We have no idea what the whole back story that caused a fourteen month delay in getting OFS repaid, but the amount involved does not warrant a full fledged credit post mortem.

Bass Pro Group: Moody’s Revises Outlook

According to a news report, Moody’s Investors Servicerevised Bass Pro Group, L.L.C’s outlook to stable from positive and affirmed the company’s Ba3 Corporate Family Rating, Ba3-PD Probability of Default rating and B1 senior secured rating“. The change was caused by “revenue and earnings weakness“. Please read the article for the key details.

We’re far from panicking based on what we’ve learned to date but have just added the Bass Pro Group to our under-performing list, with an initial CCR 3 rating (Watch List). BDC exposure is a modest $14.4mn, shared by three BDCs. Income at risk is just over $1.0mn annually.

We’ll be keeping close tabs on this credit – leveraged over 5x – going forward.

Constellis Holdings: Sells Assets To Improve Liquidity

According to the Wall Street Journal’s crack Pro publication, Constellis Holdings – a troubled leading defense contractor with multiple operations – has sold a training facility for $40mn. More than the amount involved – which is modest by comparison with the debt on the company’s balance sheet – we noted that the WSJ article indicated the sale was undertaken to “avert a liquidity crunch”.

We added Constellis to the under-performing list (CCR 3) only in the IIQ 2019, as reported in a post on August 17, 2019 and based in downward valuation changes, rating downgrades and changes in the C-suite. As we become more familiar with the Apollo Global-owned private company, we recognize that Constellis should have been a candidate for our concern some time before. The drawdown of US forces in Afghanistan and Iraq, which has been going on for some time, is one negative factor; along with a major restructuring of its business underway, discussed by its CEO in a recent article in a defense trade publication.

The sale of the training facility by itself will not be sufficient to right the ship, and we’ll be keeping a close eye on developments at the company in the months ahead. Given the over $100mn invested by 9 BDCs – especially 4 FS-KKR entities – this deserves watching.

Constellis Holdings: Added To Under-Performing List

With the publication of the IIQ 2019 valuations by 8 BDCs with $107mn in various forms of debt exposure (2022-2024 and both senior and second lien), we’ve added Constellis Holdings to our under-performers list with an initial rating of CCR 3 (Watch List). The debt has been discounted between (6%-30%) from 0% to (5%) in the prior quarter.

This is not surprising as there has been a massive number of changes in senior management in recent months and downgrades from both S&P and Moody’s in the spring, worried about high leverage; cash flow losses and operational challenges. For the BDC sector, this is very big exposure in aggregate, with annual income of approx. $9mn at risk should the company default down the road. With that said $90mn of the debt is held by the three FS-KKR non traded BDCs (FS II-III and IV), which are intending to go public under one banner before long. How Constellis plays out will be of above average interest at FS Investment-KKR in the quarters ahead.

Envocore Holding, LLC: Equity Written Down

Closely-held Envocore Holding, LLC – about which very little is known from the public record – saw its preferred stock written down by both of its BDC lenders: Alcentra Capital (ABDC) and OFS Capital (OFS). Moreover, on its March 12, 2019 Conference Call, ABDC explained that the unrealized loss was due to the company “missing earnings for a variety of reasons”. The lenders are said to be working closely with the sponsor and management. ABDC added Envocore to its recently established Watch List.

We have also added the company to the BDC company under-performer list as of the IVQ 2018, based on the equity write-down and that sliver of an update from ABDC and the sector in which the company operates (see below). Our rating is CCR 3, or Watch List. Total exposure at cost as of the end of 2018 is $37.1mn and consists of first lien debt, preferred and common, about equally divided. The potential income at risk is $4.2mn.

By the way: “Founded in 1991, Envocore Energy Solutions is the leading provider of custom energy (lighting & water) efficiency services to Energy Service Companies and utility clients. The Company acts as a sub-contractor to the Energy Service Companies and utility companies and will perform design, engineering and installation. The Company is based in Gambrills, MD“.