Posts for Capital Southwest Corporation

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.

California Pizza Kitchen: Seeks To Restructure Debt

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.

ASC Ortho Management Company: Added To Underperformers

ASC Ortho Management Company, which also does business as Washington Spine Institute and OrthoBethesda is a health-care provider of musculoskeletal care to patients in the greater Washington, DC market. Based on a website search, we’ve noted that the company’s clinics – due to Covid-19 – have been discouraging office visits since mid-March and – in all likelihood – postponing all but the most essential surgeries. The company is owned by PE group Atlantic Partners and financed by three different BDCs who have provided a total of $25.7mn of a mix of first lien debt , second lien debt (all in PIK) and equity. At year end 2019 an unused Revolver was also available. The BDCs involved are Capital Southwest (CSWC), as well as Main Street (MAIN) and non-traded HMS Income.

Without much more information than we’ve shared above, we’re adding the company to the Underperformers list on the common sense assumption that revenues will be greatly impacted by the indirect impact of Covid-19. Given that the company is highly leveraged and the BDCs involved have significant amount of junior capital at risk, this might result in a lower valuation at March 31, 2020. We are initiating coverage at a CCR of 3, down from CCR 2. As of IVQ 2019, all the debt was valued at par, but the equity stake was discounted by (24%) for a second quarter in a row.

We will be focused especially on CSWC, which has half the overall exposure, including the riskier second lien ($3.6mn and all paid with PIK) and a sliver of common equity. Reassuring is that the company does have access to the Revolver and the support of a well known equity partner and that there is nothing fundamentally wrong with the business or its long term prospects because of Covid-19. This might well return to performing status in the second or third quarter. We shall see.

Alliance Sports Group: Added To Underperformers

Frankly, the BDC Credit Reporter does not want to wait around passively till the next round of BDC results comes out or a development occurs in the public record that causes us to add a BDC portfolio company to our database of underperforming companies. Instead – where we can – we’re pro-actively reviewing companies that were previously performing and sought to determine – even in the absence of tangible information – whether their credit status is likely to have changed with the new Covid-19 situation.

Alliance Sports Groupdesigns and markets a broad range of branded consumer products known for their innovative designs, unique features, and high quality across multiple product categories in the outdoor enthusiast and active lifestyle market. The Company distributes these products through six different brands: NEBO (flashlights and lighting tools), iProtec (lighting and firearm accessories), True Utility (utility and everyday carry tools), Bollinger (fitness accessories) and WeatherRite and Quarrow (outdoor lighting and fishing accessories)“.

We’re surmising business activity must be greatly curtailed at the current time. Capital Southwest (CSWC) is the only BDC with $12.5mn of exposure to the company, which consists of Subordinated debt and a 3.88% equity interest, both of which were valued very close to par at 12/31/2019. Thankfully, there is a private equity group involved: LKCM Headwater Investments, which bought the company in 2017, which was when CSWC got involved.

Out of an abundance of caution, because of the economic situation; the industries in which the company operates and its reliance on retail customers; as well as the junior nature of the CSWC capital at risk, we’re downgrading Alliance to a Corporate Credit Rating of 3, from a CCR of 2 – Performing. We’ll re-assess when CSWC reports IQ 2020 results and we’ll begin to see if we were unduly conservative or (slightly) ahead of the curve.

AAC Holdings: Forbearance Extended

Back on January 30, 2020 we wrote that troubled publicly traded AAC Holdings (aka American Addiction Centers) had negotiated an extension to its forbearance agreement with its lenders after a prior falling out. That provided some hope that borrower and lenders – who’ve been going back and forth for many months – would eventually come to some sort of modus vivendi, as opposed to ending up in court arguing.

Now we hear from a company press release that the parties “have reached an agreement to extend the deadline to enter into a restructuring support agreement with its senior secured lenders from February 21, 2020 to March 20, 2020“. Such an extension had been contemplated back in January, as we discussed at the time after reading the legal agreement:

“Even that date is not fixed, as the parties have agreed the forbearance is “subject to extension in the discretion of the Forbearing Lenders if the Company shall not have entered into agreements embodying the material terms of a consensual financial restructuring among the Company and the parties to the Credit Facilities“.

This new extension of the extension allows the company to draw another $2mn from funds committed by the lenders.

We’re not sure if the fact that this negotiation keeps going on and on is a good sign or not. Rather than draw any conclusions from what little information we have, we’ll just wait for the next chapter in this long saga. We’ve now written over 10 articles about AAC Holdings ! We can say,though, that the total amount advanced – based on Capital Southwest’s (CSWC) IVQ 2019 financials – has increased from the $66.2mn balance as of September 30, 2019. The lenders are anteing up funds to keep the business solvent. By the time all 4 BDCs involved report their exposure, the cost could be over $70mn and potentially subject to further increases. Sometimes you’ve got to spend money to save money seems to be the philosophy here.

AAC Holdings: Reaches Agreement With Lenders

AAC Holdings (aka American Addiction Centers) has been in contentious negotiations with its lenders. Back in October 2019 – after the company defaulted on its loan – lenders agreed to forebear for a period while negotiations continued. Then- just a few days ago – the lenders terminated that forbearance. At the same time, the CEO quit if the bankers would not advance additional monies. See our nine prior articles dating back to April 25 2019, but especially the last two posts.

Now, borrower and lenders have agreed that the latter will advance $12mn in new monies after all. $10mn was funded at the close on January 24, 2019 and $2mn will be drawn later, if needed The forbearance period has now been extended to February 21. Even that date is not fixed, as the parties have agreed the forbearance is “subject to extension in the discretion of the Forbearing Lenders if the Company shall not have entered into agreements embodying the material terms of a consensual financial restructuring among the Company and the parties to the Credit Facilities“. That’s when the last $2mn can be accessed. No word as to the employment status of the CEO.

This a good sign that lenders and management in the public company still have some hope of agreeing on a restructuring agreement for the highly troubled business. Whether an agreement is reached or not, a bankruptcy filing is still the most likely outcome. However, there’s a big difference between a pre-packaged Chapter 11 and an involuntary or the company seeking protection from its creditors. AAC Holdings remains on our Bankruptcy Imminent list, but the parties may have – very literally – bought themselves more time.

As unclear as before is what will happen to the different BDC debt tranches involved. About half of BDC exposure, held by Capital Southwest (CSWC), Main Street (MAIN) and non-traded HMS Income is in the more junior 2023 Term Loan, which is currently valued at a (25%) discount in the market and is on non-accrual. Sitting higher on the balance sheet is 2020 Term debt, still fully valued by sanguine holders. With so many twists and turns in the narrative, the BDC Reporter can’t be anything but a little worried that losses could be higher than already anticipated.

California Pizza Kitchen: Downgraded by Rating Groups

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.

AAC Holdings: Lenders Terminate Forbearance

In an 8-K on January 16, 2020 treatment center operator AAC Holdings Inc. announced that its banks had terminated a Forbearance Agreement that had been in place since October of 2019, and were exploring all options regarding defaults under their credit agreement. In fact, the break-up occurred on January 9, with the delivery of a notice by the lenders, headed by Credit Suisse.

The BDC Credit Reporter has written about the troubles at AAC – also known as American Addiction Centers – eight times, starting in April 2019 and – most recently- on October 25, 2019 when the forbearance was agreed upon. Throughout, based upon our review of the company’s publicly available financial statements and due to the ever lower stock price, we’ve been pessimistic about the likelihood of AAC Holdings being able to right its own ship without a restructuring or bankruptcy. With this move by the lenders, our thesis seems ever more likely to be realized.

Not helping is that the falling out with the lenders was – if this latest filing is to be believed – triggered by ” the failure of the Company under the Forbearance Agreements to have provided the Forbearing Lenders with a three-year business plan for the Company“. There’s more going on because the company also announced – in a highly unusual or even bizarre move – the “conditional resignation” of its CEO. We’ll quote from the release to leave no doubts as to the situation:

On January 8, 2020, Michael T. Cartwright, Chairman of the Board of Directors (the “Board”) and Chief Executive Officer of AAC
Holdings, Inc., a Nevada corporation (the “Company”), delivered to the Board his conditional resignation as Chief Executive Officer.
Mr. Cartwright’s resignation as Chief Executive Officer will become effective only upon (i) the Company entering into amendments to its two
previously reported forbearance agreements, each dated October 30, 2019, entered into between the Company and the lenders under the
Company’s two primary credit facilities and (ii) the Company receiving $10.0 million of incremental funding under the Company’s previously
disclosed credit facility entered into by the Company in March 2019. Mr. Cartwright currently intends to remain as Chairman of the Board.
Also on January 8, 2020, the Board appointed Andrew W. McWilliams, the Company’s Chief Financial Officer, to serve as Chief Executive
Officer, commencing upon the effectiveness of Mr. Cartwright’s resignation, as described above.

As the AAC Holdings credit story becomes more confused, we remind readers that BDC exposure is material: $66mn at cost spread over 4 BDCs, three public and one non-listed. The public BDCs are Capital Southwest (CSWC); Main Street Capital (MAIN) and New Mountain Finance (NMFC). The private BDC is HMS Income, which is managed by MAIN. The debt is in the company’s 2020 and 2023 Term Loans and three BDCs marked their positions as being on non accrual from the IIIQ 2019. The FMV totals $56mn, leaving plenty of room for further valuation losses.

This is publicly traded debt and we’ve checked Advantage Data’s Middle Market Loan marketplace and found the 2020 Term Loan still valued at par by the market and the 2023 discounted (25%), only slightly lower than at 9/30/2019. Nonetheless – re-iterating the position we’ve held for some time – we have little hope that the company can avoid bankruptcy/restructure for much longer, and we expect ultimate recoveries to be lower than current valuations. Most immediately at risk for the BDC lenders is receiving any investment income. In total, there’s nearly $10mn of annual interest in play over all facilities. According to Advantage Data records, the BDC with the greatest dollar exposure is NMFC with nearly $25mn at cost, but all in the 2020 debt. Tied for most at risk in the 2023 Term Loan is MAIN and HMS Income, with CSWC in third place.

We expect to be reporting back shortly on what is becoming a strange credit story and a potentially material set-back for several well regarded BDC lenders. On the other hand, we’d be the first to admit that it’s not over till it’s over.

AAC Holdings: To Receive Forbearance From Lenders

On October 22, 2019 AAC Holdings issued a press release indicating that the company was just about to arrive at a mutually satisfactory arrangement with its lenders, following events of default under the debt. This was carefully worded – because nothing has been signed – as follows: “The Company expects to enter into an agreement securing additional liquidity and receiving a forbearance from its senior secured lenders regarding certain previous events of default. The Company expects to finalize the agreement with its senior secured lenders next week, although no assurance can be made that an agreement will result from these discussions within that time frame or that an agreement consistent with these discussions will be reached at all“.

The company also expects to finalize the appointment of three new directors, after losing that many in a mass resignation, which was the subject of our last post. That will allow AAC to remain a public entity.

If all the above happens, AAC Holdings will cheat the hangman a little while longer. That gives the company time to improve fundamentals at its addiction centers and sell off real estate to reduce debt, as has been the plan for some time. Nonetheless, even if the forbearance is formally approved, we continue to keep AAC Holdings rated CCR 4 (Worry List) and on our Bankruptcy Imminent list. BDC exposure is high at $66mn. Click here for all our prior articles. Like Game Of Thrones, the story makes more sense if you begin at the beginning.