Posts for TP Flexible Income Fund

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.

California Pizza Kitchen: Second Lien Debt On Non Accrual

We’ve written about California Pizza Kitchen (or “CPK” to the world) on two prior occasions. Most recently, on April 23, 2020 we discussed the restaurant chain’s ambition to restructure its debt as both secular declines in its business which began some time ago and Covid-19 have made business conditions very difficult. Frankly, we were expecting a bankruptcy filing at any moment, but that has not happened. (That does not mean a Chapter 11 filing could not yet occur).

Now that IQ 2020 BDC results have been published we can see how the 6 different BDCs with exposure have valued their loans. We found that CPK’s first and second lien debt has been placed on non accrual by two of the BDCs and not by four others. Apparently, based on comments made by Monroe Capital Corp (MRCC) – which has not chosen to list the debt as non performing – there is a difference of views between the players. Also choosing to leave the debt on accrual is Main Street (MAIN); Great Elm (GECC) and TP Flexible Income. By contrast, CPTA Finance (CPTA) and Oaktree Specialty Lending (OCSL) have their debt positions marked as non-performing.

Total BDC exposure – spread over first and second lien term loans due in 2022- amounts to $43.3mn at cost. The debt is mostly discounted just under (50%) at FMV, but GECC does have a second lien position written down (78%), while CPTA has discounted its own debt in the same loan by (46%)…

The CPK example speaks to a wider phenomenon that’s always underway where BDC valuations are concerned: discrepancies both about what should be treated as a non accrual and fair value marks. However, the Covid-19 crisis has frequently accentuated the variations and over a much wider number of companies due to the greater degree of uncertainty. This makes taking any one valuation or accrual vs non accrual status too seriously until the credit markets settle down. That could take several quarters as the ratings groups are projecting credit troubles continuing at a heightened level through to 2021.

For our part, we have downgraded CPK from CCR 4 to CCR 5. (We tend to take the most conservative credit position). The company has been removed from the Weakest Links list of companies expected to default given that – as least in two cases – that has already happened. We still believe the chances of a bankruptcy filing are high given that full service restaurants will be challenged for some time and take-out cannot fully make up for business lost.

Update 6/2/2020: CSWC reported IQ 2020 results and placed CPK on non accrual but indicated on the conference call being impressed by management and multiple sources of income to mitigate Covid-19 impact.

GK Holdings: Downgraded To CCR 4

On March 23, 2020 Moody’s downgraded GK Hldng Inc. to Ca from Caa2. More recently Fitch has added the company to its Loans Of Concern list for April. For our part, we had initially added the global training company to our Underperformers list way back in IVQ 2017, but only at CCR 3. There the rating remained even through an earlier Moody’s downgrade in 2019 and a valuation drop of the second lien to as low as (30%) at year-end 2019 and before the Covid-19 crisis.

Now – and a little late – we are downgrading the global training company to CCR 4 AND adding the name to our own list of potential defaults that might occur in the short term to BDC-financed companies. Like the other groups, we are concerned about current market conditions impact on the training business; matched with already high leverage; debt coming due and liquidity challenges ahead. There’s no denying that companies such as GK Holdings with debt to EBITDA north of 8.0x are especially vulnerable to difficult conditions like the one we face. This is another example of a company that was already in some trouble before Covid-19 facing an accelerated decline brought on by the current crisis.

In Advantage Data’s records, BDC exposure is under two names – GK Hldng Inc. and Global Knowledge Training LLC, and is also referred to by BDCs as GK Holdings Inc. but all speak to the same risk. At cost $25.7mn is at risk, spread over 5 BDCs including Goldman Sachs BDC (GSBD); Harvest Capital (HCAP), as well as non-traded Audax Credit; TP Flexible Income and Sierra Income. GSBD is the largest debt holder, with $11.5mn in first and second lien exposure. (HCAP, by contrast, has lent only $3mn). Total investment income in play is nearing $3.0mn, as this was a riskier credit from the outset.

We’ll be keeping an even closer eye on the company going forward as some sort of resolution seems to be appearing on the horizon. In the past, the company’s private equity owner has put in new capital. Maybe that will happen again. Till we have reason to believe otherwise, we are worried.

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.

NPC International: In Forbearance Agreement With Lenders

This has been brewing for a long time (we’ve been writing about the company since June 2019) but NPC International has failed to make debt interest payments on its first and second lien debt; gone into default and been – temporarily – reprieved in the form of a “forbearance agreement” from its lenders. Furthermore, earlier in 2020, NPC received a new $35 million loan to improve liquidity. “The terms of the super-priority loan, which was provided by existing lenders, prevent the company from making payments on the second-lien term loan, the people said“.

As you’d expect Moody’s and S&P were not happy about what has happened and called a non-payment payment of interest what it is – even if the lenders chose to forebear : a default and sharply downgraded the company.

All the above comes from Bloomberg, which also reports that management and its PE sponsor are considering all options (who doesn’t ?); including a Chapter 11 filing. That would allow the company to push back against lease contracts, which would make sense.

For months, we’ve had NPC rated CCR 4 and placed on our list of companies that we expect will file bankruptcy or drastically restructure in 2020. Given the depths of the company’s troubles – very high debt; liquidity crunch; declining industry sector – there’s an aura of inevitability about this story.

For the only BDC with material exposure – Bain Capital or BCSF – that means the likely wipe-out of its second lien debt, which is currently trading at 5 cents on the dollar. BCSF also holds the first lien debt, which is trading at 48 cents on the dollar. If those discounts hold, BCSF will be taking a realized loss of ($11.5mn), out of the $14.2mn committed. Unfortunately, as of September 2019, the BDC had only reserved ($8.3mn), so there’s nearly another ($4mn) to go. Also, $1.2mn of investment income will be suspended, and most of that is unlikely to be coming back post-conclusion of any restructuring. For a huge BDC like BCSF not a major blow, but hardly immaterial either.

The collapse of NPC has happened over a relatively short period, according to Advantage Data records. BCSF signed up in the IQ of 2017. Until the IIIQ 2018, all the debt was carried at or above par. Since the IVQ 2018, though, every quarter has brought a further devaluation. We added the company to the under performers list when BCSF devalued some of its debt greater than (10%) in the IQ 2019, and has been CCR 4 – our Worry List – since the IIQ 2019. Our latest update on these pages was in August 2019 and by then the die was almost cast. In a more general sense, this chronology supports our view that we should start paying attention whenever a company’s previously stable valuation starts to erode. That may provide some false negatives, but also provide a little more lead time about credits going awry. By the time the actual default occurs – as in this case – most of the damage is done.

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.

Deluxe Entertainment: Receives Court Approval To Exit Chapter 11

Deluxe Entertainment Group will be shortly exiting from bankruptcy, after receiving court approval of a “comprehensive refinancing”. According to the company’s press release – which is short on details but big on reassurances – debt will be cut “by more than half” and $115mn of new financing will come available. If Bloomberg Law is correct, $800mn of debt will be written off. Bankruptcy should be officially exited within a month.

We’ve written extensively about this bankruptcy, and we will again. After all, the BDC lenders involved seem to be moving from creditors to owners, or maybe both. Most likely, any realized loss to be taken will occur in the IVQ for Harvest Capital (HCAP) and non-listed Cion Investment and TP Flexible Income Fund. Before that, we’re likely to see an unrealized write-down in the IIIQ results, given that HCAP was carrying its debt investment at par as of June 2019, while the other two BDCs discounted their positions no more than (10%).

Even after the company exits Chapter 11, we will continue to carry Deluxe on our under-performing list for an indefinite period. The weakness in the underlying business has not been eliminated by this partial de-leveraging and years may yet pass before the BDCs involved – who began lending back in 2017 – can exit this credit.

Deluxe Entertainment: Additional Info About Credit Troubles

In a broader article by Bloomberg BusinessWeek about the CLO market, was a useful backgrounder on what happened to Deluxe Entertainment Group that caused the company to recently file for bankruptcy:

Deluxe Entertainment Services Group Inc. shows just how quickly liquidity in the leveraged loan market can evaporate. A postproduction media services company for the film industry, Deluxe has struggled with a changing digital media landscape in Hollywood and an increasingly burdensome debt load. But with tens of billions pouring into the leveraged loan market and a CLO machine cranking out deal after deal, Deluxe and its owner, Ronald Perelman’s MacAndrews & Forbes, had little trouble in recent years raising new debt to keep the company afloat.

Deluxe refinanced its debt in 2014, getting enough demand from investors that it was able to upsize its loan by $35 million, to $605 million, and cut its interest rate by a full percentage point. Two years later, the company returned to the market for an additional $75 million, and it tacked on $200 million more in 2017 to refinance some of its other debt.

But as Deluxe’s problems mounted, its cash thinned. After an unsuccessful effort to sell its creative services unit, it turned to its existing lenders, who agreed to back a $73 million loan in July. That’s when it got ugly. The news of the abandoned sale and new debt caused the value of Deluxe’s loan—with $768 million still outstanding—to plunge from 89¢ on the dollar to less than 40¢ in some 24 hours. Within about a week, S&P downgraded its rating by three notches, to CCC-. The downgrade blocked some existing CLO lenders, bound by the 7.5% limit, from fronting additional cash. On Oct. 3, the company filed for Chapter 11. The existing loan now trades at less than 10¢ on the dollar. Deluxe said in a statement that “We appreciate the support we have received from our lenders throughout this process and look forward to completing the refinancing shortly.”

With BDC earnings season coming round, we’ll shortly learn how Harvest Capital (HCAP), Cion Investment and TP Flexible Income Fund, with $20.7mn invested in the bankrupt company as of June have navigated this complex situation. We expect substantial losses to be booked this quarter or next and – possibly – an increase in invested capital.