IQ 2021 CREDIT UPDATE

CSWC undertakes an internal investment rating process, which estimates underperforming investments amount to $53mn at FMV. The BDC Credit Reporter's evaluation places CCR 4 and CCR 5 assets at $72.5mn. Total portfolio assets at 3/31/2021 were $704mn at cost and $688mn at FMV, a discount of (2.3%). CSWC had 55 portfolio companies (including its JV), of which 3 were rated as CCR 4 on our 5 point credit performance scale. There were no CCR 5 - non performing - assets. The cost of the underperformers was $100.6mn and the FMV $72.5mn . The discount was (28%). Underperformers at FMV were equal to 10.5% of CSWC's portfolio.

The largest individual underperformer (by the BDC Credit Reporter's standards) - is the I 45 SLF JV which CSWC manages with Main Street Capital (MAIN). The JV is leveraged and invests in large cap syndicated loans. Second in size is SIMR, LLC (aka STATinMED Research). Some $2.6mn of income is at risk in first lien debt. Finally, there's American Teleconferencing Services (aka Premiere Global Services or PGi) For the full list of CSWC underperformers at IQ 2021, see the attached table.

CSWC also has a post-bankruptcy stake in AAC Holdings, and sits on the restructured company's board. The investment is valued at cost but resulted in a realized loss previously and remains in turnaround mode. Likewise, CSWC has both debt and equity in a restructured California Pizza Kitchen.

Posts for Capital Southwest Corporation - CSWC

Dunn Paper: Lenders Seeking Sale Of Company

Dunn Paper has been in financial difficulties in recent months due to “declining profitability and elevated leverage”, as admitted by the company in a press release. In March 2022, an interest payment on senior debt was missed, which required the borrower to enter into a forbearance agreement with some of its lenders. A new credit facility has been received, although the amounts and terms are not known. (For a brief explanation of Dunn Paper, see a company description at the bottom of this post).

The above notwithstanding – on April 26, 2022 – a specialist publication – quoting anonymous sources – indicated second lien lenders are banding together; hiring counsel and seeking to push for a sale of the company. As you’d expect details are sparse. However, we imagine several BDCs might be represented in this group of second lien lenders. Prospect Capital (PSEC), Southwest Capital (CSWC) and a non-traded BDC all have second lien exposure to Dunn. (PSEC is also in the first lien debt).

Dunn has been underperforming only quite recently – since IIIQ 2021 – when all the BDCs involved started to write down the value of the second lien debt. As of the IVQ 2021, the biggest discount was applied by CSWC: (16%). All in all, BDC exposure amounts to a relatively modest $21mn, with PSEC holding $16mn, including $4mn in first lien exposure. Until the latest news, we rated Dunn CCR 3 on our 5 point investment rating scale. Now, Dunn has been moved – due to its failure to make an interest payment – to CCR 5.

The yield on the second lien debt was being charged at just over 10%, suggesting total annual income forgone on the second lien debt is ($1.7mn), and another ($0.3mn) on the first lien.

Dunn’s weak financial performance – according to their own reports – seems to derived from the supply chain and related inflationary increase of input costs. That might mean what ails the business might be salvageable by a restructuring or the sale to the right party. The PE sponsor recently brought back “Founder” Brent Earnshaw as CEO, amidst other senior executive changes. That must give some hope to the second lien lenders that a full recovery – or something very close to one – is a realistic prospect. We get the impression from reading between the lines that this troubled situation will be resolved within a relatively short period.

We will continue to track the public record and ascertain what valuations PSEC and CSWC ascribe to their respective positions when IQ 2022 results are published. Neither BDC, though, has yet set a date for reporting their most recent results. At the moment, we expect neither the interruption of income nor any realistic prospective loss to be material for the BDCs involved, and there’s always a chance this will be resolved without any significant loss.

About Dunn Paper
Dunn Paper is a leading manufacturer and supplier of advanced paper, tissue, and packaging products for use in food, medical, and specialty markets. The company operates 7 paper mills across the United States and Canada and focuses on eco-friendly specialty paper and tissue. Dunn Paper also works with top converters allowing their sustainable paper products to have thousands of potential applications. The company’s first mill opened in 1924, and in 2016 the company was acquired by Arbor Investments, a specialized private equity firm with a focus on premier companies in food, beverage, and related industries.

Dunn Paper Press Release April 22, 2022

California Pizza Kitchen: International Expansion Underway

Mea Culpa. We’ve not written about California Pizza Kitchen (CPK) – one of the more prominent casualties of the pandemic – in some time. The restaurant chain filed for bankruptcy back in 2020 with hundreds of millions of dollars of debt on the books, including $60mn from 8 BDCs. Then a great deal of the debt was converted to equity (which resulted in realized losses) and equity was granted to the lenders in compensation. More recently the company rid itself of its $177mn in post-bankruptcy debt.

This left, since IIIQ 2021, three BDCs with exposure to the rejigged CPK – all in the form of equity stakes. The BDCs involved are Great Elm (GECC); Capital Southwest (CSWC) and Monroe Capital (MRCC), with total exposure at cost of $15.6mn. The equity was received in the IVQ 2020 and has fluctuated in value every quarter since, along with the chain’s business prospects.

These equity valuations peaked in IIIQ 2021 when the three positions were valued at $13.3mn, a (15%) discount to the average cost. In the most recent IVQ 2021, the valuation dropped slightly, probably due to concerns about omicron or perhaps reflecting recent metrics. Nonetheless, the well regarded management of CPK have an aggressive expansion plan in place and just announced two international franchise agreements, and plans to open 7 restaurants overseas by year end 2022.

We can’t be sure, but there’s a good chance CPK’s equity could increase in value as a result of these and other actions, and the improving Covid situation. If so, the BDCs left with an equity stake might be able to recoup their initial pre-bankruptcy investment in full, or even better. GECC has the most to (re)gain, with a current value of $4.7mn; followed by MRCC with $3.7mn and CSWC at $2.3mn. We’ll be looking out for the latest values when BDC earnings season returns in late March/early April 2022.

Dunn Paper Holdings: Debt Refinancing Concerns

The bad news continues to pile up at specialty paper manufacturer Dunn Paper Holdings (“Dunn Paper”). In late November 2021, the company was downgraded by Moody’s. Importantly, the borrower’s 2022 first lien debt was also downgraded to Caa1 and the second lien debt coming due in 2023 to Caa3. The major culprit: higher pulp prices, but also very high debt/EBITDA (over 9x), “negative free cash flow” and refinancing concerns with the debt needing refinancing in August 2022. S&P followed suit with its own downgrade in January 2022.

Now we hear that loan defaults have occurred and the lenders have brought in an advisor to assist with negotiations and that an investment banker is pounding the pavement determining market appetite for a refinancing.

There are 3 BDCs with $21.3mn invested in Dunn Paper in both the first lien and second lien. Two of those BDCs are public : Capital Southwest (CSWC) and Prospect Capital (PSEC) and then there’s non-traded $1.0bn AUM Barings Private Credit. PSEC is invested in both the first and second lien but the other two players are only in the second lien.

Worryingly for BDC valuation credibility, the discount applied by the 3 BDCs with second lien exposure varied widely in the most recent quarter ended September 30, 2021. PSEC and Barings discounted their positions by only (1%) and (6%) respectively from cost , while CSWC was more conservative with a (15%) discount. (The first lien debt remains valued at par).

With some sort of default having already occurred – if those reports mentioned are true – a bankruptcy or out-of-court restructuring seems increasingly likely, as does the need for the BDC second lien lenders ($16.8mn in total) to further write-down their debt, which should show up in the IV Q 2021 results and – possibly – in the IQ 2022. We add Dunn Paper to our Trending list, meaning that we expect a material change in value is coming, and rate the company CCR 4. Given that considerable exposure is in a junior position and borrower and lenders have already unsuccessfully sought to refinance the business (so it seems), the odds of an eventual realized loss seem higher than repayment in full.

We’re also noting – a new feature in 2022 – the underlying reason for the company’s financial difficulties: an increase in pulp prices that Dunn has not been able to fully pass along to its own customers. This makes the company a victim of the much discussed inter-twined challenges of supply chain disruption and rapid inflation. The BDC Credit Reporter will be highlighting these causes when possible, using the tag INFLATION.

With BDC earnings season round the corner, there’ll be more news shortly, or at least up to date valuations, although that value may be in the eye of the beholder. We may also hear more whispers from unidentified sources or even the principals themselves as the restructuring discussions play out.

Still, to keep matters in perspective, the aggregate amounts at risk for the BDCs are modest, with PSEC having the most exposure by far: $15.8mn or three quarters of the total.

For anyone interested in getting all the details of each BDC’s exposure since inception where Dunn Paper – or any of the companies we track in the BDC Credit Reporter – is concerned, we recommend talking to Advantage Data about a subscription to their BDC Holdings module – which contains a treasure trove of data that we regularly utilize for these articles. In this case, BDC exposure dates back to 2016.

US TelePacific Corp: Debt Refinancing Concerns

Privately-held communications company U.S. TelePacific (aka as TPx Communications) is in protracted negotiations with its existing lenders. Apparently, since November 2021 the company has brought on an adviser to assist in negotiations regarding its revolver and term loan, which mature in May 2022 and May 2023 respectively. The debt markets are already valuing the Term Loan at 75.6% of par. Furthermore, back in September 2021 S&P – and later Fitch – downgraded the company. The former has downgraded the business to a CCC+ rating. Commentators are projecting that private equity group Siris Capital Group – which acquired the company back in February 2020 – and has already lobbed some extra capital in to support the business might have to write another cheque. If not, liquidity might become a serious problem within months….

This is a material problem for 4 BDCs with exposure to the company – all in that $655mn Term Loan. Three of the BDCs are publicly traded: Main Street Capital (MAIN) with $17.0mn at cost; TCG BDC (CGBD) with $6.6mn and Capital Southwest (CSWC) with $5.2mn. Non-traded MSC Investment has $12.4mn at risk.

Till the IIQ 2021 – based on the BDC valuations – the company was rated as “performing to plan”, as the maximum discount taken on the debt (the S&P downgrade notwithstanding) was (7%). [The BDC Credit Reporter does not typically move any company to “underperforming” until a (10%) discount or greater has been reached]. However, in the IIIQ 2021 – probably reflecting the challenges mentioned above – the discount reached (18%). Given what we’ve heard of the current valuation a further unrealized loss is likely in the IVQ 2021. As a result, we rate the company as Trending (i.e. likely to show a material change in valuation on the next quarterly valuation).

We are rating U.S. TelePacific CCR 4 (An eventual realized loss is more likely than full repayment) because the market discount is substantial for a “secured” term loan. Moreover, we hear that many of the outstandings are held by CLOs, which might make finding a resolution – such as a debt for equity swap – more difficult. Finally, we’re concerned that 10 weeks or more have passed without a resolution between borrower and lenders.

Both the CSWC and CGBD positions are held in their joint ventures, but MAIN and – we believe – MDC Investment’s are carried on their balance sheet. We’ll learn more when IVQ 2021 results are published but a final resolution – positive or negative – is likely not to occur till later in 2022, or even later is no meeting of the minds can be reached.

American Teleconferencing Services: Debt Defaults

Now that we’ve heard IIQ 2021 results, multiple BDCs have reported that American Teleconferencing Services (AFS) and parent Premiere Global Services Inc. (dba PGi) have defaulted on a tranche of their debt: one that matures 6/8/2023. We’ve written about AFS before, warning that a default was likely back on June 4, 2021. A second lien loan to PGi that matures in 2024 has been non performing for several quarters.

As many as 8 BDCs – both public and non traded are involved with the two related borrowers with a total cost of $135mn. At this point, the $13mn in the second lien debt – all held by Oxford Square (OXSQ) has been written down by as much as (98%). Odds of recovery seem low. The remainder of the debt is first lien – mostly in the 6/8/2023 debt. The discounts applied by different BDCs in the same tranche vary widely: from (14%) to (56%). However, all the lenders involved increased their discount over the prior period, as per this data from Advantage Data.

Although PGi and AFS are clearly deteriorating, we’ve had no luck finding any direct discussion of the subject by the BDCs involved or in the public record. In the interim, though, we’ve downgraded AFS to CCR 5 from CCR 4 (PGi was already CCR 5).

We’ll be posting again when we find a credible update about what is happening at AFS/PGi.

I 45 SLF LLC: IQ 2021 Update

We’ve written once before about this joint venture, which invests in large cap borrower syndicated loans, between Main Street Capital (MAIN) and Capital Southwest (CSWC). That was back in the beginning of the pandemic as the nature of the investments, the leverage being used and lower LIBOR were all conspiring to drive down I-45’s value. This caused the two BDC partners to ante up additional capital. At its worst – in the IQ 2021 – the discount applied was (42%).

Since then the situation has greatly improved. Some of the extra capital advanced has been returned; troubled credits have improved in value and the discount on the JV – whose total cost is now $91mn – has been reduced to (21%). This is what CSWC’s management said about the status of the JV on May 26, 2021:

 “The I-45 portfolio also continued to show improvement during the quarter as our investment in the I-45 joint venture appreciated by $1.5 million. Leverage at the I-45 fund level is now 1.27 debt-to-equity at fair value. The increase in leverage at I-45 was mainly driven by an equity distribution to the JV partners during the quarter, which represented most of the capital contributed to the JV during the hike of the COVID-related market disruptions. … As of the end of the quarter, 95% of the I-45 portfolio is invested in first lien senior secured debt with diversity among industries and an average hold size of 2.8% of the portfolioIn March 2021, we amended our I-45 credit facility, lowering our cost of capital to LIBOR plus 215 basis points and extending the maturity of the facility to 2026“.

We are retaining the CCR 4 rating on the company, the above notwithstanding, as we still expect a material realized loss will be recognized when I-45 is ultimately wound up. Last time round we projected that hypothetical loss – still years away – could amount to ($15mn-$20mn). We stand by that estimate, but at the moment the unrealized loss is ($19.4mn), 4/5ths of which will inure to CSWC.

We have the JV on our Trending list because we expect a material – albeit not very large – value increase in the IIQ 2021. That’s because large cap borrower loans are in great demand – the JV has 36 companies in its portfolio – and their value has probably increased since March 31, 2021. Overall, though, this is not an investment that causes us much concern under existing market conditions.

American Teleconferencing Services: Ratings Downgraded, Withdrawn.

On June 4, 2021 S&P announced that conference audio and video provider Premier Global Services Inc., (dba PGi), whose wholly owned subsidiary is American Teleconferencing Services, was downgraded to CCC-, from CCC+, with a negative outlook, with the rating agency citing “significantly” deteriorating operating performance over the past quarter. Also downgraded was the company’s senior secured debt to CCC-, from CCC+. S&P noted that the company’s declining operating performance “increases the likelihood that [PGi] will default or undertake a distressed exchange” in the next six months unless the company’s private equity sponsor injects equity. Just the day before, Moody’s was more radical and just withdrew its ratings altogether, citing “insufficient information”.

This is obviously not good for the company or for the 10 BDCs with $171mn in first lien and second lien debt exposure to PGi or its subsidiary. At March 31, 2021, a couple of lenders were already carrying their exposure as non performing but most had not yet made the move. Aggregate FMV was already down to $117mn, a (32%) discount.

Our last update on these pages dates back to August 26, 2020 when the business was already struggling, and we applied a CCR 4 rating. Now, PGi/American Teleconferencing might slip into non performing – CCR 5 – status shortly judging by the rating agency hullabaloo. Most at risk are likely to be BDC lenders holding the second lien debt, which can often get written to zero in these situations. There is currently nearly $24mn in second lien debt at FMV. Then there are wide variations in how first lien debt is discounted: from (6%) to (46%). We calculate that after netting out already non performing loans, some $12mn of investment income is still at risk of interruption temporarily, or forever should the company fail.

We expect we’ll be circling back to PGi/American Teleconferencing again shortly as the situation clarifies. At the moment, the chances of further unrealized losses seems the likeliest short term outcome, which could show up in the IIQ 2021 BDC valuations.

SIMR, LLC: IQ 2021 Update

We’ve not written about SIMR, LLC (aka STATinMED Research) before but the life sciences data company has been underperforming since IIIQ 2019, when we first noted a drop in the equity valuation of the BDCs that held those positions. The situation got worse in 2020 with first lien debt discounted by increasing percentages and the equity written to zero. At IQ 2021, the debt was discounted (10%)-(15%) by the two BDCs with a position: Capital Southwest (CSWC) and non-traded Cion Investment. Overall, BDC exposure at cost was $45.4mn and FMV $27.1mn.

That FMV versus cost alone is cause for concern. However, we also note that back in 2019 the lenders ramped up pricing from LIBOR + 9.00% to LIBOR + 17.00% plus a 2.00% floor ! That’s an all-in rate of nearly 20% and a sure sign that all is not well. For CSWC, that’s a worrying $2.6mn of annual investment income at risk if SIMR should default and even more at Cion: $3.4mn.

We do not know what’s gone wrong at SIMR – which was acquired in 2018 by Ancor Capital Partners. CSWC has been mum about the situation and Cion does not hold conference calls. The public record has provided no clues. We have rated the company CCR 4, but have not added the name to our Trending List as the valuation has been stable of late, and there is no obvious catalyst for a change in value or income in the IIQ 2021 results. However, given the high amount of income at risk (equal – for CSWC – to 8.2% of its FY 2021 Net Investment Income), this is a company whose fortunes are worth tracking regularly.

AG Kings Holdings: Sale Of Company Closed

The AG Kings Holdings story is coming to a conclusion. We’ve been covering the company since June 2019 with a series of updates. The retail chain has been sold to Albertson’s Acme Markets in January 2021, according to BDC lender Capital Southwest (CSWC). The sale was known about previously, but not its final closing, which seems to have occurred.

This means that the debtor-in-possession financing provided by CSWC – and by WhiteHorse Finance (WHF) – has been repaid in full. However, some legacy debt will be written off.

CSWC revealed that its 2021 term debt with a cost of $3.5mn was valued at $0.7mn at year end 2020 but was repaid at a higher value in January, but the exact amount was not given. Here’s what CSWC’s management said on its most recent conference call: “So our exit was higher than where it was valued last quarter. So that’s the first thing I would say. And then the $739,000 that’s left is basically the last interest. I mean, there’s a litigation trust and the final bankruptcy cleanup and there’s a final working capital adjustment and some final economics, which, candidly, we believe, is going to be meaningfully higher than the $740,000, we have it valued right now. So we think there’s upside in NAV from that perspective. And then our all-in recovery at the end of the day, will be about $0.80 on the dollar“.

We expect CSWC will end up taking a realized loss of ($2.5mn-$3.0mn). WHF will, in all likelihood, book a loss as well. Nonetheless, the absolute amounts are relatively small. The BDCs were fortunate that the pandemic boosted AG Kings business and its prospects at this critical juncture and resulted in better than might have been expected proceeds from the company’s sale. Once the final payouts are made we’ll re-rate AG Kings from CCR 5 to CCR 6, reflecting the end of all BDC exposure.

American Teleconferencing Services: IVQ 2020 Update

We’ve written about American Teleconferencing Services before: back on August 21, 2020 when we provided a IIQ 2020 update. The company has been troubled since IVQ 2018 and is rated “speculative” by Moody’s. From a BDC perspective this is a “Major” underperformer because aggregate exposure at cost is over $100mn and involves no less than 7 BDCs. We have rated the company CCR 4.

Now Capital Southwest (CSWC) – one of the seven – has published IVQ 2020 results. No word on its conference call about American Teleconferencing. However, the BDC Credit Reporter notes that CSWC has increased its discount on the first lien and second lien held to record levels. The former debt – which matures in 2023 – is discounted -45% and the latter -60%. In the prior quarter, CSWC’s discounts were -33% and -48%.

This does not bode well for the company, or CSWC or the other BDC lenders who have yet to report. We did undertake a public search to get some color but found nothing recently. The downward trend is undeniable, though, and keeps the company rated CCR 4 on our five level scale. We don’t where CSWC rates the investment. Some $8.2mn of annual investment income is involved.

AAC Holdings: Completes Restructuring

The BDC Credit Reporter write about AAC Holdings, Inc (aka “American Addiction Centers”) a lot. This is our eleventh update and will not be the last. Last time we wrote – back on June 21, 2020 – we concluded in this way: “We get the feeling a debt for equity swap is in the cards and the BDCs on the books will be involved for many more years to come and the amounts of capital deployed will yet increase, possibly to over $80mn“.

That’s just what seems to have happened, based on a press release from the company on December 14, 2020. This announced the completion of “ a financial restructuring process” which involves a much lower debt load ($500mn !); a new CEO (picked from within the ranks of the company’s senior management) and a new Board. The Chairman of that new 7 person Board is Bowen Diehl, the CEO of Capital Southwest (CSWC). The BDC is one of four BDCs – both public and private – with what is now $82mn in exposure to the company.

Otherwise, the press release is un-generous in providing the details of what is clearly a debt for equity swap that will take the previously public business private. Perhaps we’ll have to wait till the IVQ 2020 BDC results are published in February 2021 to learn what realized loss might be booked and which lender owns what of AAC and what debt is left ? As of September 2020, the lenders-future owners had already taken ($24mn) in unrealized losses, or nearly 30% of funds advanced. Some of the lenders in the 2023 Term debt had booked discounts of (54%).

Clearly, from a credit standpoint and with some of the debt on non accrual for over a year (from IIIQ 2019) this has been a material setback for CSWC; Main Street Capital (MAIN); New Mountain Finance (NMFC) and non-traded HMS Income, which MAIN manages. We assume that the lenders have high hopes that the company – still facing plenty of pandemic-related operational challenges – can recoup some or all what has been lost in the years ahead with the lenders at the tiller. Before that begins, though, we need to know what the bill has been for the BDCs shareholders so far.

This is going to be an excellent test case of whether the BDCs involved can successfully rescue a portfolio company or whether good money (and managers time) is going after bad. CSWC is very familiar with this sector and Mr Diehl is a logical Chairman of a re-structured AAC. Still, that’s no guarantee that the business can be saved.

AG Kings Holdings: IIIQ 2020 Update

We have just heard from one of the two BDC lenders to AG Kings HoldingsCapital Southwest Corporation (CSWC) about where things stand for the grocery chain in bankruptcy. Apparently, the purchase of the business by Albertson’s is proceeding. CSWC had only this to say ” That’s in process of closing/documentation process“. As of September 2020, CSWC is valuing its non performing senior debt (except for a DIP loan which is valued at par) at a (26%) discount. That’s better than two quarters ago when the debt was discounted by as much as (48%).

Given that we seem to be in the final furlong, the BDC Credit Reporter believes the current valuation is likely to be very close to the final outcome. That means CSWC will be booking a permanent ($2mn) realized loss, but will be recouping $6mn or so (including that DIP advance) to reinvest into new deals elsewhere. Chances are good that will show up by year end 2020.

Also affected is WhiteHorse Finance (WHF) – which has not reported yet – but which holds a much bigger position and much of which was recently added. We’ll refrain from guessing what loss – if any – WHF might incur till that BDC files its results.

At a time when so many troubled companies are finding an exit only by a “debt for equity swap” with their lenders, this outcome is more traditional with a sale to a third party. Ironically, AG Kings was lucky enough to be in the right segment of the food and supplies business in the time of Covid-19, which has reduced what looked like a significant loss for the lenders to a modest one. We expect to be able to close the file when CSWC and WHF report IVQ 2020 results, or by IQ 2021 at the latest.

California Pizza Kitchen: Reaches Agreement With Lenders

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.

I-45 SLF LLC : IIQ 2020 Update

The “I-45 SLF LLC” is a joint venture set up between two public BDCs that have a history of working together: Main Street Capital (MAIN) and Capital Southwest (CSWC). The JV dates back to 2015 and was rated as performing through the end of 2019. However, the BDC Credit Reporter first downgraded the entity to CCR 3 in the IVQ 2019 as multiple portfolio companies experienced credit problems. The situation was only exacerbated by the pandemic and the rating was dropped to CCR 4 in IQ 2020, as the discount on the BDC’s junior capital in the entity reached (43%). In the second quarter 2020 the valuation increased modestly – along with market loan values. Nonetheless, we are retaining the CCR 4 rating.

In the most recent quarter income from the JV paid out to its sponsors was reduced due to the precipitous drop in LIBOR only marginally offset by the 80 basis point average “LIBOR floors”. Furthermore, MAIN and CSWC injected additional equity capital in the quarter while the JV’s lender reduced its debt commitment, as mentioned in CSWC’s 10-Q: “On April 30, 2020, the I-45 credit facility was amended to permanently reduce the I-45 credit facility amount through a prepayment of $15.0 million and to change the minimum utilization requirements”. 

A quick look down the portfolio list of I-45 SLF shows that several troubled companies already on CSWC and MAIN’s own books are here as well. We’ve reviewed the entire portfolio and identified several underperformers and noted that cost to FMV is only 85%, even after loan values generally increased in the June 2020 quarter. We’re pretty sure the BDC partners will not be getting back in full the capital deployed whenever the JV is eventually closed down. At this stage we expect the eventual realized loss will be ($15mn-$20mn), split 80/20 between CSWC and MAIN. In the interim, though, the JV should continue to pay out a dividend, so we’re not adding the name to the Weakest Links list.

American Teleconferencing Services: IIQ 2020 Update

Now that IIQ 2020 BDC results have been released, we can confirm that American Teleconferencing Services – a wholly owned subsidiary of communications company Premiere Global Services – remains rated CCR 4. We’re guided mostly by the latest valuations from multiple BDCs with first lien and second lien exposure. The former is discounted by wildly varying percentages : (6%) to (35%). The latter has been nearly cut by half in value. Moody’s has given the company a Caa2 rating as recently as August . The ratings group had this to say:

“The debt restructuring in October 2019, surge in audioconferencing volumes and virtual events during the pandemic and sponsor’s equity contributions have improved the liquidity position but it is uncertain how the business will perform when the crisis abates. The rating additionally considers execution risks in plans to cross-sell services and operate under shared services agreements with TPx Communications, which was acquired in February 2020 by affiliates of Siris Capital, which also owns the parent company of American Teleconferencing Services.”

There does not seem any reason to add the company to the Weakest Links list yet but the business has some considerable way to go before lenders are out of the woods in what is a Major position in aggregate: $109.4mn at cost and $88.8mn at FMV. Most at risk – but with modest exposure – is Capital Southwest (CSWC) with $2.1mn in the second lien, which is valued at $1.1mn. The outlook is favorable in the short run, as Moody’s suggests but the company will need monitoring.

AG Kings Holdings: Files Chapter 11

On August 24, 2020 AG Kings Holdings, a grocery chain that includes regional names like Balducci’s and King’s Food Market, filed Chapter 11. According to a trade publication, the company – which has been troubled for some time -has a “stalking horse” buyer willing to pay $75mn for most of the stores in the chains. Furthermore, other buyers will be solicited under court protection. We learned that the company has “nearly $115mn in debts”. Of late the company has performed better than in the past thanks to Covid-19. Ironically, though, this recent success only encouraged management to strike while market conditions were as favorable as possible. The goal – despite unresolved issues with the company’s unions – is to be in and out of bankruptcy before the end of 2020.

Readers will know we have written about the company multiple times before, most recently on August 21, 2020. There are two BDCs with exposure of $26.9mn at June 30, 2020: Capital Southwest (CSWC) and WhiteHorse Finance (WHF). The latter recently added to its position in the first lien debt by buying an expanded position at a substantial discount. As a result, the aggregate FMV of the positions held is greater than the cost. WHF has two-thirds of the debt – including the most recent addition – and CSWC the rest.

The debt has been on non accrual since the IVQ 2018, so some sort of resolution was expected. From what we’ve learned from the Chapter 11 filing, and with the possibility of other buyers joining in, the BDCs have a good chance to get repaid in full or in part and in short order. From what we can tell, CSWC and WHF are not part of the buying group. We do know that the company’s “existing secured lender” is providing a $20.0mn Debtor In Possession facility, but we don’t know if that includes the BDCs who are principally in the Term Loan that nominally matures August 8, 2021. (CSWC does show an undrawn Revolver in its portfolio list).

We are retaining the CCR 5 rating for the moment and project the ultimate realized loss will be no greater than what CSWC – which invested close to par value – has booked : (30%) of its cost. If we’re right, CSWC will absorb a realized loss of just over ($3.0mn) and WHF – thanks to boldly buying more debt at a discount – may get away without a net loss. That could occur by the IVQ 2020 results. We expect both lenders will be happy with such an outcome and even more delighted if the company attracts more generous buyers. Much can happen in bankruptcy, but this may be the best outcome available after a year and a half of waiting around and no income coming in.

The BDC Credit Reporter will revisit this story as we learn what the final outcome looks like and we can estimate with greater accuracy what the ultimate economics might look like.

AG Kings Holdings: Valuation Differences

We’ve now heard from the two BDCs with first lien debt exposure to “troubled” retailer AG Kings Holdings. The debt has been on non-accrual since 2019 and remains so after IIQ 2020. However, Capital Southwest (CSWC) discounts it’s $9.5mn invested at cost by (35%). WhiteHorse Finance (WHF), by contrast, values the same debt ($17.3mn at cost) at a 20% premium…That discrepancy seems to be due to the fact that WHF doubled down in the period and bought more of the company’s debt in the secondary market at a discount that management was not willing to share on its conference call, but which an analyst placed at (63%).

Both BDCs have admitted that the retailer has been performing better thanks to the changed market conditions brought on by Covid-19. Nationally supermarkets have benefited from more people eating at home and AG Kings is no exception.

Given the company is still restructuring and still on non accrual , the BDC Credit Reporter is maintaining the CCR 5 (Non Performing) rating. that dates back to IVQ 2018. However, the outlook for recovery of some sort – perhaps even in full – is looking good. That’s positive news for CSWC and even more for WHF, which has made a bold move in buying non-performing debt. This might be to take advantage of the discounted price and/or as part of its restructuring strategy, but we’re just guessing.

We’ll be keeping as close tabs as we can on this private company and the BDC valuations involved. In an exception to the rule, we may see an upgrade before a liquidation or further write-down.

Delphi Behavioral Health: Restructured

We learned from Capital Southwest (CSWC) – the only BDC lender to what was called Delphi Intermediate Healthco – that the troubled mental health company was restructured out of court. As a result the debt – which was on non accrual -has been returned to performing status from the IIQ 2020 but with a new capital structure, and after CSWC absorbed a significant realized loss. (See below). Furthermore, the company’s name was changed on CSWC’s books to Delphi Behavioral Health Group LLC. The BDC owns a significant – but undetermined stake in the restructured business and sits on the Board.

The realized loss booked by CSWC in the second quarter on Delphi was ($5.5mn) or nearly half the $11.7mn invested in debt just prior to the restructuring. According to Advantage Data, this was a portfolio company on the BDC’s books since IVQ 2017 and in an industry which CSWC feels it understands given its exposure to similar entities in its portfolio. Delphi performed normally – judging by CSWC’s portfolio valuations and absence of conference call commentary – right up to the IVQ 2019 when the debt was placed on non accrual. The initial discount on the defaulted first lien loan was (40%), but ended up to be higher by the time the realized loss was booked.

Given the timing, the problems at Delphi clearly pre-dated the Covid-19 crisis but the pandemic must have made the situation worse. We call these failures First Wave credit problems.

The new debt on a restructured/renamed Delphi is more expensive than before, but currently paid in PIK form and the debt matures in 2023 versus 2022 previously. We know little about which other lenders are involved or the overall capital structure. We do know that CSWC has increased its internal rating from a 4 to 2 on their internal rating scale. The BDC Credit Reporter has also upgraded the company from a CCR 5 to CCR 3. That’s still in our underperforming category and on our Watch List. Like CSWC, though, we are hopeful that the business will recover and the BDC – and its shareholders – might regain some or all their capital loss from an eventual sale. Still, it’s early days and a business needs more than a restructured and de-leveraged balance sheet to be successful.

Delphi will also be a test of CSWC’s skill at “turning around” unprofitable companies; taking equity positions and sticking around for the long haul. These debt-for-equity swaps take up management time; often result in more capital being advanced and typically result in lower current income. If all those sacrifices result in an eventual repayment of all debt and interest and an equity gain, kudos to the BDC manager. If not – and over a number of transactions – one has to question the approach. For the record, CSWC has 9 companies – including Delphi – which are marked as “affiliated” and in which the BDC has some sort of equity interest. Of those 3 are “underperforming” to various degrees. [We’re not counting CSWC’s investment in its I-45 JV with Main Street, also underperforming].

California Pizza Kitchen: Files Chapter 11

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.

AAC Holdings: Files Chapter 11

On Saturday June 20, 2020 AAC Holdings (dba American Addiction Centers) filed for Chapter 11 bankruptcy protection, ending a year and a half long “will they ? won’t they ?”. AAC Holdings, according to news reports, listed $517.4mm of total debts against $449.4mm of total assets. The company is planning ahead for the next phase, having arranged $62.5mn of debtor-in-possession financing from its lenders. Other details are still sparse including any agreed amount of debt forgiveness. We’ll circle back later with those details later.

The BDC Credit Reporter has been skeptical of the company’s ability to remain a “going concern” for some time. We’ve written nearly a dozen articles about AAC dating back to early 2019. At the time of the filing, we already rated the company as non performing – CCR 5 – as several BDCs had already ceased booking any investment income from the first lien senior debt. Total exposure is currently $69.9mn (using IQ 2020 numbers), all in debt of one kind or another. Some debt tranches are recent – and were advanced to support the business and are carried as income generating. The original debt, though, has been non performing since the IIIQ 2019.

The BDCs involved include Main Street Capital (MAIN), its sister non-traded BDC HMS Income and Capital Southwest (CSWC), which has a strong relationship with the other two BDCs. The biggest individual position, though, is held by New Mountain Finance (NMFC). For some reason, NMFC’s $25mn 2022 Term Loan position was still accruing income through March 21, 2020, involving close to $2.5mn of investment income that must now be interrupted.

How much the BDCs might lose in this Chapter 11/restructuring and whether lenders will become owners and advance even more monies is not yet known. We can report that at 3/31/2020 the total unrealized write-down was (37%), or ($25.7mn). If the over-optimistic BDC valuations in the past are anything to go by, final losses could be even higher than what’s already booked and the impact on income (especially for NMFC) will be material.

For our part, AAC Holdings retains its CCR 5 rating, but the company is removed from our Weakest Links list after many months of our crying wolf, and is added to the BDC-financed company Bankruptcy list. This is the 9th BDC bankruptcy in June, and the 26th in 2020. By both cost and fair market value this is the 8th largest BDC bankruptcy in the year.

By no means do we believe this will be one of the last posts we’ll be writing about AAC. We get the feeling a debt for equity swap is in the cards and the BDCs on the books will be involved for many more years to come and the amounts of capital deployed will yet increase, possibly to over $80mn.