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.