The bad news continues to pile up at specialty paper manufacturer Dunn Paper Holdings (“Dunn Paper”). In late November 2021, the company was downgraded by Moody’s. Importantly, the borrower’s 2022 first lien debt was also downgraded to Caa1 and the second lien debt coming due in 2023 to Caa3. The major culprit: higher pulp prices, but also very high debt/EBITDA (over 9x), “negative free cash flow” and refinancing concerns with the debt needing refinancing in August 2022. S&P followed suit with its own downgrade in January 2022.
Now we hear that loan defaults have occurred and the lenders have brought in an advisor to assist with negotiations and that an investment banker is pounding the pavement determining market appetite for a refinancing.
There are 3 BDCs with $21.3mn invested in Dunn Paper in both the first lien and second lien. Two of those BDCs are public : Capital Southwest (CSWC) and Prospect Capital (PSEC) and then there’s non-traded $1.0bn AUM Barings Private Credit. PSEC is invested in both the first and second lien but the other two players are only in the second lien.
Worryingly for BDC valuation credibility, the discount applied by the 3 BDCs with second lien exposure varied widely in the most recent quarter ended September 30, 2021. PSEC and Barings discounted their positions by only (1%) and (6%) respectively from cost , while CSWC was more conservative with a (15%) discount. (The first lien debt remains valued at par).
With some sort of default having already occurred – if those reports mentioned are true – a bankruptcy or out-of-court restructuring seems increasingly likely, as does the need for the BDC second lien lenders ($16.8mn in total) to further write-down their debt, which should show up in the IV Q 2021 results and – possibly – in the IQ 2022. We add Dunn Paper to our Trending list, meaning that we expect a material change in value is coming, and rate the company CCR 4. Given that considerable exposure is in a junior position and borrower and lenders have already unsuccessfully sought to refinance the business (so it seems), the odds of an eventual realized loss seem higher than repayment in full.
We’re also noting – a new feature in 2022 – the underlying reason for the company’s financial difficulties: an increase in pulp prices that Dunn has not been able to fully pass along to its own customers. This makes the company a victim of the much discussed inter-twined challenges of supply chain disruption and rapid inflation. The BDC Credit Reporter will be highlighting these causes when possible, using the tag INFLATION.
With BDC earnings season round the corner, there’ll be more news shortly, or at least up to date valuations, although that value may be in the eye of the beholder. We may also hear more whispers from unidentified sources or even the principals themselves as the restructuring discussions play out.
Still, to keep matters in perspective, the aggregate amounts at risk for the BDCs are modest, with PSEC having the most exposure by far: $15.8mn or three quarters of the total.
For anyone interested in getting all the details of each BDC’s exposure since inception where Dunn Paper – or any of the companies we track in the BDC Credit Reporter – is concerned, we recommend talking to Advantage Data about a subscription to their BDC Holdings module – which contains a treasure trove of data that we regularly utilize for these articles. In this case, BDC exposure dates back to 2016.