Posts for Guggenheim Credit Income Fund

Belk’s Inc.: Restructuring Deal Agreed ?

People who shouldn’t be talking have been about what’s happening at Belk’ Inc. , the regional department store. Negotiations have been going on – as we discussed in an earlier post – between Sycamore Partners and the company’s first and second lien lenders. “According to people with knowledge of the plans” – says Bloomberg – here’s a thumbnail of the plan:

The restructuring plan involves handing 49.9% of the company’s equity to its lenders, with parent Sycamore retaining a 50.1% stake in exchange for supplying up to $100 million of a new $225 million loan to the company, according to the people“. Plus, the company will make a quick run through bankruptcy court – one day is the goal – and come out the other side. Late February 2021 is the when this is all supposed to come down. That’s the theory anyway.

$450mn of current debt will vanish from Belk’s balance sheet, but will also add $225mn of new debt , of which $100mn might be supplied by Sycamore. We say “might” because the deal envisages Sycamore generously letting hungry lenders provide up to $65mn of its share of the new debt. There’s more besides, including juicy fees, and existing debt maturities being pushed out tp 2025 from 2023.

Given this is all hearsay – even if from people in the room where it happens – and subject to further amendation by the parties involved or by the court brought in to rubber stamp this deal doing, we won’t linger on the details till we hear something more definitive. Mostly the BDC Credit Reporter wants to emphasize that the Belk’s story is finally reaching some sort of conclusion a year after the second lien debt became non performing. (The first lien debt joined in in the IIIQ 2020). We still expect – equity notwithstanding – that major realized losses will need to be booked – see our earlier article. Furthermore – and this is new but not unexpected – the two key BDC lenders involved – FS KKR Capital (FSK) and FS KKR Capital II – will be putting up some share of the new debt monies as well. This could bring total BDC exposure up from $148mn to near $200mn, or possibly more.

This will be an excellent test of how these two BDCs fare in seeking to act as their own turnaround firm rather than taking the loss and walking away. Clearly there are a lot of the best and the brightest involved in this Chapter Two for a quintessential brick and mortar retailer, both on the lending side and from private equity. However, that’s no guarantee of success and the BDC Credit Reporter remains skeptical and in need of convincing this will all turn out alright. We’ll be back to you shortly.

Belk Inc.: Negotiating With Creditors

Bloomberg’s crack business journalists have their ear to the ground – or to the telephone – and have news about troubled regional department store Belk Inc. in an article on January 15, 2021:

Belk Inc., the department store chain owned by Sycamore Partners, is talking with creditors about easing its almost $2.4 billion debt load and has tapped law firm Kirkland & Ellis and investment bank Lazard Ltd. for advice.

Belk and its advisers are huddling with holders of the retailer’s debt — which includes first-lien and second-lien securities — according to people with knowledge of the matter. Options could include a debt-for-equity exchange and new financing, according to the people, who asked not to be named discussing private negotiations”.

It’s been a long time coming. We wrote back in February 2020 – before the pandemic took hold – that Belk’s was laying off headquarters personnel and re-negotiating its debt. Clearly, matters have gotten worse since then and there’s no relief in sight: viz these hush-hush negotiations.

BDC exposure – almost exclusively held by the FS-KKR organization in FS KKR Capital (FSK) and FS KKR Capital II (FSKR) remains “Major” by size : $158mn at cost. However, since last we wrote the FMV – always a moving target where BDC appraisals are concerned – has dropped substantially, to $46mn as of IIIQ 2020. The equity held has been written to zero, the second lien discounted by as much as (76%) and the first lien debt as much as (60%). All the debt is on non accrual at both BDCs. Clearly, if the Belk situation moves to some sort of resolution in the months ahead – whether by agreement between the parties or through the bankruptcy process – some very large losses may occur. We expect the equity and second lien could be fully written off and the senior debt recover only 50%. That would mean a further ($26mn) or more in fair market losses and an eventual aggregate realized loss of close to ($140mn). When these large BDC positions fail, they fail with a big thud.

We wouldn’t be surprised to see KKR accept a debt for equity deal as they’ve done in other transactions but is a department store business model viable today ? That’s a question being asked of several BDC-financed retailers already and the jury is still out even if restructuring deals are getting done. Whatever happens, this is going to be a major credit disaster for the FS KKR group, although management can reasonably point out that the initial investment was booked all the way back in 2015 and by GSO Blackstone, when that group was in charge of the BDCs lending. However, that second lien exposure – two thirds of total outstandings – looks egregiously risky both by size and by sector.

From a rating standpoint, Belk’s remains rated CCR 5, and is tagged an Important transaction, which means we expect something material to happen – although we don’t know what – in the months ahead that will get reflected in the BDCs net asset value or earnings. We’ll be circling back to Belk’s as soon as something gets resolved in those early stage negotiations Bloomberg warned us of.

Houghton Mifflin Harcourt: Downgraded By Moody’s

Moody’s has downgraded education publishers Houghton Mifflin Harcourt Publishers (“Houghton” or “HMH”) to Caa1 from B3. Here’s an extract from the press release on the subject:

“The downgrades reflects Moody’s expectation of a sharp decline in revenue in 2020 caused by budgetary constraints and likely deferrals of purchasing decisions by school districts amid the coronavirus pandemic, which will lead to HMH’s earnings decline and a spike in leverage in the next 12-18 months,” according to Dilara Sukhov, Moody’s lead analyst on Houghton Mifflin. “Meaningful rebound in the company’s performance in 2021 is unlikely given the potential educational funding pressures at state and local level, making it difficult for HMH to achieve earnings growth that is necessary to reduce its very high leverage and generate positive free cash flow”

BDC exposure is modest ($8.9mn) – all in first lien debt) and limited to Oaktree Specialty Lending (OCSL) and non-traded Guggenheim Credit. We are downgrading the company – given that the current rating is in the speculative spectrum and industry conditions are clearly difficult – to CCR 4 from CCR 2. Nonetheless, Moody’s suggests the company is in no immediate danger of liquidity crisis or default so we’ll leave Harcourt off the Weakest Links list.

Houghton Mifflin Harcourt: Debt Valuation, Stock Price Drop.

Publisher Houghton Mifflin Harcourt has gone and drawn on its revolver for a second time in two weeks. The company “drew down $100 million under the facility on March 24 and then another $50 million on March 30 to boost liquidity“.

In addition, the stock price of the publicly traded company (ticker: HMHC) has fallen precipitously and closed on Friday April 3, 2020 at just $1.52. The company has lost more than three-quarters of its market value in a few weeks.

This is bad news for the two BDCs with $9.1mn in debt exposure, which was valued at a premium as of December 31, 2019. The biggest exposure is held by Oaktree Specialty Lending (OCSL) and then there’s non-listed Guggenheim Credit Income Fund 2019. Both seem to be invested in the 2024 Term Loan, which is currently trading at 88 cents on the dollar. The income at risk is three-quarters of a million dollars annually. Sadly, both BDCs only got involved with this credit in the IVQ 2019 and must be in a state of lender’s regret given the very fast deterioration.

We have added the company to the Under Performers List, with an initial Corporate Credit Rating of 3 on our 5 point scale. At this point – based on that still modest drop in value on the debt – we are not yet projecting an ultimate realized loss. After all, the cash from those drawn revolvers will serve as a temporary buffer. We’re in wait-and-see mode here as in so many other places. Much depends on how long the stay-at-home orders last.

Belk Inc.: Lay-Offs Announced

This is the BDC Credit Reporter’s first article about Belk Inc., the revered North Carolina department store company. However, we’ve had Belk on our radar – and on the under performers list – since IVQ 2016. No wonder: the business of Belk is retail and you know what’s happened to that…

Furthermore – and worrying – is the large amount of BDC capital invested in the debt and equity of the company. Mostly the former. At 9/30/2019 there were 6 BDCs involved with a combined $170mn invested at cost in various debt tranches and a sliver of common stock. The FMV was $128mn, and may go lower when IVQ 2019 results get published. According to Advantage Data, which keeps a list of all BDC funded companies by capital committed, Belk was the 103rd largest investment, out of 4,000 or more companies out there.

The BDC with the most to lose is FS-KKR Capital (FSK), which has committed $122mn, or 72% of the total – all in junior debt or equity. In the IIIQ 2019, there was an amendment made to the debt, and the second lien was split into two. One tranche is carried at par and the second – larger – amount was discounted in value even more than before. See the discussion on FSK’s Conference Call.

As far back as June of 2019 S&P was on the record with a downgrade to CCC, and the contention “a debt exchange that we would view as distressed could occur over the next 12 months”. For our part – not to be outdone – we long ago added the retailer to our list of companies that we expect to default or be restructured in 2020.

All the above is to explain why we’re writing about what might be – or might not – a minor development (except to the individuals involved) at the company: the lay-off of 80 personnel at headquarters. This seems to be yet another sign that all is not well in North Carolina and there may be other shoes to drop. We’ll be keeping close tabs – including those fourth quarter 2019 BDC valuations and any color coming from conference call.

Basic Energy Services: To Sell Assets

Is this good news or bad news for lender to Basic Energy Services, an oil services company ? On December 12, 2019 the publicly traded company with the ticker BAS but just delisted from the NYSE, announced its intention to sell “its pumping services assets (not inclusive of coiled tubing) in multiple transactions with expected proceeds of approximately $30 million to $45 million“. The proceeds – says the press release – “will fund the projected 2020 and 2021 capital budget of Agua Libre Midstream, the Company’s rapidly growing, high return-on-assets business“. No word about proceeds being used to pay down any debt.

We’ve had a look at the 10-Q for the company which shows that lenders are collateralized by the assets of the business in both an ABL and 2023 Term Loan that was originated in 2018. The only BDC exposure is in the latter, and resides in non-listed BDC Guggenheim Credit for $2.0mn. At September 30, 2019 the debt was written down on an unrealized basis by (26%). Currently, the institutionally traded loan is trading at a (33%) discount. Maybe the lenders are waiving the use of proceeds from the asset sale for debt repayment or we just don’t have the full picture. For our purposes, and till, we hear otherwise, we’re assuming none of the monies from the asset sales will repay debt.

Basic Energy has been on the BDC Credit Reporter’s under-performing list since the IVQ 2018, almost immediately after Guggenheim booked the investment and has been trending down in value ever since. We have a Corporate Credit Rating of 4 (Worry List). Unfortunately, even before the latest announcement, the company was burdened by very high debt to Adjusted EBITDA, once you adjust for maintenance capex: over 12x by our estimate. The asset sales – if they happen and at the amounts estimated – may not be sufficient to save the company given the amount of debt on the balance sheet and the negative trends in the oil services sector. We believe a default or reorganization is more likely than full recovery on the debt. We’ll continue to update the Basic Energy story, which should come to some sort of fork in the road long before the 2023 maturity of the Term Loan.

Basic Energy: IIIQ 2019 Results

On October 30, 2019 oil services company Basic Energy Services reported third quarter 2019 results. The company is public, so we were able to review a press release, 10-Q, Investor Presentation and Conference Call transcript. We also had a look at Basic Energy’s stock price – ticker BAS – which is not encouraging. Finally, we used Advantage Data’s real-time records to see how the company’s 2023 debt – the only instrument held by a BDC and its largest debt piece – is performing. Also, not encouraging. Last time we checked back in September, the 2023 debt was trading at a (27%) discount. Now the discount has risen to (30%).

We are writing this post because the recent financial performance, where Adjusted EBITDA does not even cover interest and mandatory capex, and the weak outlook for the sector as a whole, lead us to the conclusion that the chances of a default and loss and greater than that of full recovery. As a result, we are downgrading our internal credit rating to a CCR 4 (Worry List) from CCR 3 (Watch List). Luckily for Guggenheim Credit Income Fund – a non listed BDC – the amount at risk is modest at $2.0mn in a portfolio of $376mn.

Basic Energy: Downgraded By Moody’s

On August 12, 2019 – but only noted by us on September 17 – Basic Energy Services, Inc. was downgraded by Moody’s to Caa1 at the corporate level. The company provides a variety of oil services, a segment that’s been in the doldrums of late. The summary view from the ratings giant was as follows: “The downgrade of Basic’s ratings to Caa1 reflects slow recovery in the business amid a decelerating market outlook, that we expect will keep financial leverage high”, commented Elena Nadtotchi, Moody’s Senior Credit Officer. ‘The company’s cash balances support its liquidity position, while Basic is cutting costs and reduces investment in 2019’.

BDC exposure, though, is limited to one non-traded fund: Guggenheim Credit Income Fund. The BDC has $2mn invested in the 2023 first lien debt, and had valued its position at a (21%) discount as of June 2019, down from the quarter before. The debt was only booked in the third of 2018 but has been sliding in value ever since. Moody’s value this debt even lower than the corporate at Caa2.

We checked Advantage Data’s real-time bond pricing and found that the current discount is (27%), suggesting a potential unrealized write-down is coming in the third quarter 2019 results. If a default does occur, Guggenheim is at risk of annual investment income interruption of $2.2mn. A default does not seem likely in the short run, but nor does a full recovery barring a sea change in industry conditions. We have a CCR 3 (Watch) rating , with a downward trend.

CTI Food Holdings: Exits Bankruptcy

On May 7, 2019 huge food distributor CTI Foods Holdings emerged from Chapter 11, after a short stay that began less than 2 months before. In addition, the company announced the arrangement of a new $110mn Revolver to fund post-bankruptcy operations. For the 3 BDCs with $37mn in debt exposure to CTI Foods, this will result in likely booking of Realized Losses in the IIQ 2019 results. There is $28mn of second lien debt from FSK, CCT II and Guggenheim Credit Income Fund which will be written off as part of the restructuring. Apparently, CTI Foods is shedding $400mn in debt to become viable after many months of deteriorating performance in 2018. Less clear is what happens going forward to first lien and secured DIP financing (advanced in the IQ 2019 to help the transition) outstanding. For the BDC Reporter’s Views on this credit, and for further details, see the Company File.