After a press release from Moody’s, we updated the Confie Seguros Holdings II Company File. Click here . The company remains rated CCR 3, and is held by 5 BDCs, and we anticipate no material change when IQ 2021 results are published.
Posts for Hancock Park
We are updating the BDC Credit Reporter’s file on Online Tech Stores, a wholesaler of computer printing products, as of June 30, 2020. The company went on non accrual in the IQ 2020. Given that the company was performing as planned before the pandemic – based on valuation levels anyway – we expect the reason for the non-performance was the slowdown in business activity. On the other hand, we heard from a trade report that the CEO was let go in April and a new executive appointed in May by the PE group that controls the company, so the troubles at Online Tech Stores might have been going on for some time.
In any case, the only two BDCs with exposure are publicly-traded OFS Capital (OFS), which has advanced $16.1mn and non-traded Hancock Park Corporate Income with a modest $1.0mn. Both lenders are involved in a 2023 Subordinated Loan that was first launched in 2018, shortly after Blackford Capital acquired the company. As mentioned, the debt became non-performing from the IQ 2020 – resulting in ($1.8mn) of annual investment income being impacted. The discount taken by both BDCs was (54%) and that remains almost the same as of June 2020: (56%).
OFS has not been forthcoming about what the plans are to turn the company around or what the PE group might be doing. We’re not reassured by the nature of the business at this stage, nor about the junior nature of the capital advanced by the BDCs. We downgraded the company from CCR 2 to CCR 5 in one fell swoop in the IQ 2020, and that rating still obtains.
Hopefully, OFS will let us know more about what’s happening when IIIQ 2020 results are announced in late October or early November 2020. The BDC still has plenty to lose: over ($0.50) a share in book value if that Subordinated debt gets fully written off. On the other hand, if a recovery is possible, the BDC has both an increase in fair market value and in income forthcoming. Hancock Park has a much smaller upside and downside.
The BDC Credit Reporter is pro-actively – if randomly – seeking out companies and sectors that are likely to be disproportionately impacted by the Covid-19 crisis. We don’t just want to wait around till BDCs start reporting new under-performing portfolio companies weeks from now, or longer. (The SEC is now allowing delays in valuations, according to a legal update we saw from a law firm that a reader passed on).
In this regard, we’re downgrading The Escape Game, LLC from performing (CCR 2) to CCR 3 (Watch List). Three reasons: First, the very nature of the business. This involves small groups of people choosing to go into a small enclosed space to play the “escape game”. Fun, but not recommended at this time and we believe most locations must be closed or closing. Second, the two Term loans in which lenders are involved (2020 and 2022) are trading – if Advantage Data’s records are correct – at a (20%) discount. Third, the 2020 Term Loan matures at the end of March, just 4 days away. Will that be refinanced, extended or what in this environment ?
There are two BDCs with $20.0 of exposure at cost, and all performing as hoped at 12/31/2019: The first is publicly traded OFS Capital (OFS) with $18.6mn. The remainder – which does not amount to much – is held by non-traded Hancock Capital. With first quarter 2020 valuations about to be fixed, we expect to see the debt valuations drop by at least 20%, or ($4mn) of unrealized depreciation. We’ll check back after OFS and Hancock Park report results, or earlier, if there’s any new information on this closely held company acquired in a leveraged buyout back in late 2017.
We have written about Constellis Group on four prior occasions. With the publishing of IVQ 2019 BDC results, our most dire predictions appear to be coming true. That’s unfortunate because on January 4, 2020 the BDC Reporter was saying darkly: “We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way“.
Now we’ve just seen OFS Capital’s (OFS) latest valuation of the 4/1/2025 “First Lien” debt. The loan has been discounted by (96%) from cost versus (71%) at 9/30/2019. Worse, and according to Advantage Data, currently that loan trades at 1 cent on the dollar... Likewise, FS-KKR Capital II has also reported IVQ 2019 results and the value of its 4/15/2022 Term Loan. That was discounted by (14%) in September, but (33%) at year-end 2019. Currently that loan – also on non accrual – is discounted (87%).
Let’s tot up the damage. There’s $9mn of investment income already interrupted since November 2019 (according to OFS) and potential realized losses across several tranches of debt of ($96mn-$100mn) by our rough estimate. That’s ($30mn) in additional unrealized depreciation from the 9/30/2019 levels for which we have values for all BDCs involved. We don’t have the latest word about how the restructuring of the company is going but by the time we hear, the lenders involved appear set to recover very little. Even then, that might be in the form of equity rather than cash.
Frankly, this is an unmitigated disaster for this Apollo Group-led buyout and for the BDC lenders involved. To be specific, the biggest hit is being taken by the non-traded BDCs in the FS-KKR Capital construct (FS Investment II; FS Investment III; FS Investment IV and CCT II, all of which are being rolled into one entity). By our count 86% of the exposure is there, with OFS the second BDC group on the list with $9.8mn at cost. Far behind are Garrison Capital (GARS); followed by two non-traded players with small outstandings.
We’ll be checking back when the final decision about a bankruptcy-restructuring is finalized but – from a lenders standpoint – most of the damage has been done and material recovery of any kind seems unlikely from the information at hand.
On March 14, 2020 we added opioid treatment company Baymark Health Services to the BDC Credit Reporter’s under-performers list, with an initial rating of CCR 3 on our five point scale.
We were motivated by five factors. First, the publicly traded 2025 Term Loan debt of the company dropped (8%) in value during the most recent market melt-down. Second, we noted that – after a 12 month period – the private equity owner of the fast growing chain of treatment centers “pulled” the company from being sold. Third, the BDC Credit Reporter is aware – and has written about – multiple other similar dependency treatment centers of late facing financial and operational difficulties. Fourth, the company has been growing very quickly of late – by merger and acquisition. Recently, a number of “roll-ups” in various sectors have gone wrong, raising a red flag to the BDC Credit Reporter where Baymark is concerned. Fifth, the industry is highly dependent on reimbursement by governmental authorities and insurance groups, whose track record for reliability has been unconvincing of late.
However, to be fair, the latest BDC valuation of that same 2025 Term Loan was at a slight premium to cost. That was by OFS Capital (OFS) – one of 3 BDCs with $12.9mn invested in aggregate, all in that same 2025 Term Loan. The other BDCs involved are non-traded Hancock Park and recent public BDC Crescent Capital (CCAP), which inherited the investment from Alcentra Capital, whose portfolio has been acquired. All the BDCs exposure dates back to early 2018. Investment income involved is $1.3mn.
To date, the term debt has been trouble-free, judging by the quarterly valuations. We are adding the company to our watch list (CCR 3) out an abundance of caution and remembering – if Alcentra’s disclosure back in the day when the loan was first booked – this is a second lien position. That seems to be confirmed by the pricing: LIBOR + 825 bps.
We admit that not everyone might agree that BayMark – owned by eminent PE group Webster Equity Partners – should even be on the under performers list. We leave to readers – having made our case herein – to make their own minds up.
We’ve written eight prior articles about the publicly traded telecom + cable giant Frontier Communications, dating all the way back to March 2019. In fact, the company was added to our Under Performer list following IVQ 2018 results with a CCR 3 (Watch List) rating and downgraded further to a CCR 4 (Worry List) back on June 13, 2019. More recently, we predicted the company might file Chapter 11 in the IVQ 2019, but that did not happen. In our last report before this one, though, we said a Chapter 11 filing was likely in the IQ 2020. With the latest news reports, that seems likely to turn out to be true.
“People with knowledge of the matter” – and there are dozens of lenders, lawyers, insiders and regulators involved at this stage so journalists have plenty of sources – indicate the company is aiming to file a consensual, pre-packaged bankruptcy by March. On the horizon are $356mn of interest payments due in mid-March. As a result, Frontier’s new CEO and his team have been busy – according to these reports – meeting creditors and seeking to craft out a restructuring plan that would be blessed by the court. (The company itself has no comment).
From a BDC perspective, the question is now more about how each lender class will fare in the restructuring, and what impact there will be on interest income – running about $5mn a year. As we’ve noted before, the debt held by the BDC lenders remains valued at a premium to par, both in their own valuations and when we look at the market price of their secured debt on Advantage Data. Will Frontier restructure itself, go in and come out of Chapter 11 in a hurry and have no impact on the value or income of the $67.5mn in debt held by 8 BDCs ? We have our doubts, but that’s the state of play at the moment. We shall soon learn if those valuations are appropriate.
We warned in an earlier article on October 9, 2019 that for Constellis Holdings “a day of reckoning is coming – and fast”. Judging from two major – and related – developments, the time is nigh. On January 3, 2020 the Wall Street Journal reported the troubled security company “is in talks with creditors on a deal to restructure its $1 billion of debt, according to people with knowledge of the discussions”. Darkly, unnamed sources, warned that if an out of court restructuring didn’t happen, a “pre-packaged” Chapter 11 filing was also on the table. (That’s all part of the negotiation process in these kind of deals as interested parties suddenly find their way to the phone to confide to journalists, who are themselves happy to be of service).
We also learned that the company failed to make a scheduled principal payment on December 31 and has received a short term forbearance from its lenders.
At the same time, Moody’s went and downgraded the company’s corporate rating to Ca, and re-rated several debt tranches outstanding. Most worrying of all is that Moody’s reports that the company’s finances suddenly deteriorated in the last quarter of the year, resulting in a “liquidity crunch”.
All of which suggests the Day of Reckoning is here for the 8 BDCs with nearly $107mn in debt exposure at various points in the company’s balance sheet. Just one month ago, one of those BDC lenders – OFS Capital or OFS – waxed relatively optimistic about the outlook for Constellis: ” I want to note that the company is current on its payments. And based on discussions with management, they have stressed that they have adequate liquidity to fund operations. The company has a growing backlog and expects sequential performance improvement. The sponsor has substantial amount of cash invested in this business, and we expect continued focus from the sponsor”.
We now know that at least some of those reassurances are no longer true. This is reflected in the public prices of the outstanding debt as provided by Advantage Data. The 2022 Term Loan is trading at a (57%) discount, versus (14%) at September 30, 2019. The second lien debt is worth only 10 cents on the dollar in the market, down from 25 cents. At 9/30/2019 FMV was still around $84mn, down ($23mn) from cost. Now, we wouldn’t be surprised to see further losses of ($30mn)-($40mn) more at FMV and ultimate Realized Losses – which could crystallize very soon – of nearly ($75mn). Add to that the loss of income and you’ve got the first bona fide major set-back for BDC lenders in 2020 , should there be no last minute rescue.
As we’ve noted before, the bulk of the exposure – and thus any damage – will be concentrated in the four non-listed FS-KKR BDCs – CCT II, FSIC II, FSIC III and FSIC IV. This was a borrower that the group jumped into under the KKR regime, bringing BDC exposure from modest ($12mn) to major, when they initiated exposure in the IVQ 2018. Maybe the far sighted folk at the jointly run asset manager have their eyes on becoming equity owners of Constellis, but we don’t think so as Advantage Data’s records show the debt was purchased at a cost very close to par, and before the current downturn in corporate fortunes.
We’ll probably be learning a lot about the company’s plans and the impact on its various lenders very soon and will be able to make a better assessment. At this point, though, with a potential loss range of $75mn-$100mn in a down case, this looks like a major credit reverse is on its way.
The Wall Street Journal reports on October 9 that defense contractor Constellis Holdings “has engaged PJT Partners Inc. to engineer a plan for restructuring the company’s debt-laden balance sheet, according to people familiar with the matter“. PJT Parners is an investment bank, often used in turnaround work.
Otherwise, the WSJ article has no new information, except a recap of some of the highlights from the most recent financial filings. Some of that data is admittedly dire. We noticed that even after a recent asset sale – the subject of our last post about Constellis – “the company’s liquidity remained tight, amounting to just $33 million of cash and $18 million of availability on a revolving credit facility as of June 30“. That alone should send chills down the spines of anyone concerned about the company.
Anyway, the advent of a restructuring firm and those slim liquidity numbers suggests a day of reckoning is coming – and fast.
We discussed BDC exposure before when we first added Constellis to the under-performing list back in August. Judging by the current market valuations (source: Advantage Data) of the three different loans outstanding in which BDC lenders are involved, the debt is discounted from (8%) to (70%), higher than in June. Thankfully, 90% of of BDC exposure is in the 2022 Term Loan, which is valued the highest even after the news of a prospective restructure. Nonetheless, at current levels – and things could get much worse – potential ultimate realized losses could reach $20mn on the $109mn invested at cost, most of which has not been recognized even on an unrealized basis as of June 2019. Not to mention the loss of investment income, which we’ve previously pegged at $9mn annually.
Unfortunately Constellis has the possibility of being one of the biggest credit hotspots of the fourth quarter (if that’s when the rubber meets the road) for the BDC sector. The prospective damage will be widespread. There are 4 FS-KKR related non-listed funds with $90mn at cost lent to Constellis. OFS Capital (OFS) and Garrison Capital (GARS) and – to a lesser degree – two non-listed BDCs are also exposed.
According to the Wall Street Journal’s crack Pro publication, Constellis Holdings – a troubled leading defense contractor with multiple operations – has sold a training facility for $40mn. More than the amount involved – which is modest by comparison with the debt on the company’s balance sheet – we noted that the WSJ article indicated the sale was undertaken to “avert a liquidity crunch”.
We added Constellis to the under-performing list (CCR 3) only in the IIQ 2019, as reported in a post on August 17, 2019 and based in downward valuation changes, rating downgrades and changes in the C-suite. As we become more familiar with the Apollo Global-owned private company, we recognize that Constellis should have been a candidate for our concern some time before. The drawdown of US forces in Afghanistan and Iraq, which has been going on for some time, is one negative factor; along with a major restructuring of its business underway, discussed by its CEO in a recent article in a defense trade publication.
The sale of the training facility by itself will not be sufficient to right the ship, and we’ll be keeping a close eye on developments at the company in the months ahead. Given the over $100mn invested by 9 BDCs – especially 4 FS-KKR entities – this deserves watching.
With the publication of the IIQ 2019 valuations by 8 BDCs with $107mn in various forms of debt exposure (2022-2024 and both senior and second lien), we’ve added Constellis Holdings to our under-performers list with an initial rating of CCR 3 (Watch List). The debt has been discounted between (6%-30%) from 0% to (5%) in the prior quarter.
This is not surprising as there has been a massive number of changes in senior management in recent months and downgrades from both S&P and Moody’s in the spring, worried about high leverage; cash flow losses and operational challenges. For the BDC sector, this is very big exposure in aggregate, with annual income of approx. $9mn at risk should the company default down the road. With that said $90mn of the debt is held by the three FS-KKR non traded BDCs (FS II-III and IV), which are intending to go public under one banner before long. How Constellis plays out will be of above average interest at FS Investment-KKR in the quarters ahead.