Limetree Bay Ventures LLC: Update

We hear that Limetree Bay Ventures LLC , the owner of the troubled refinery in St Croix – which is bankruptcy – will be seeking to sell the operation. Jeffries haves been engaged and a target date for a closing has been – optimistically – set for mid-October.

The BDC Credit Reporter noted this quote: “According to Bloomberg, existing creditors have the option of using the debt owed to them to make a bid on the refinery business”. Of course, lenders always have that option and many bankruptcies these days use that process. In this case we can’t imagine who else but the existing lenders might be interested in taking on this highly polluting, highly controversial hot potato.

This is important because the only BDC lender to Limetree – FS Energy & Power – already has $300mn invested in the company. Should the BDC – and other lenders involved – seek to become the owners of the refinery that could result in the likelihood of having to advance substantial more funds just to get the business operational again. Furthermore, there’s the risk of litigation from the U.S. government and others to contend with.

On the other hand, if the existing lenders are a last resort and decline to step up, a complete write-down of FS Energy’s investment is likely. Plus, there’s no certainty that there might not be litigation anyway. This places the BDC in a difficult position, but one management must have been preparing for. We’ll be interested to see in the weeks ahead if the existing lenders do actually fashion a bid to purchase the refinery.

Sequential Brands: July 2021 Update

We’ve written extensively about publicly traded Sequential Brands (ticker: SQBG) , beginning in the spring of 2019. In a nutshell, the company has a huge amount of debt but only modest revenues and EBITDA – both of which are in decline – to service their obligations. The debt has required multiple waivers from lenders, which continue at present. On July 26, 2021 Sequential filed an 8-K discussing the non-filing of its financial statements as required by NASDAQ. Making matters more complicated, the Board of the company has now recognized that the 10-K and its IIIQ 2020 10-Q require restatement and can no longer be relied on. The company has a plan to deal with these inadequacies but admits that nothing is yet resolved with its lenders despite months of negotiations:

The Company cannot assure you that its lenders would be willing to negotiate further changes to its financial covenants when necessary and the Company cannot obtain further waivers of the defaults under the Credit Agreements without the consent of the respective lenders thereunder. If the Company is unable to obtain additional waivers of ongoing defaults, or otherwise is unable to comply with its debt arrangements, the obligations under the indebtedness may be accelerated. If an acceleration were to occur, the Company does not have sufficient liquidity to satisfy the loan, and the Company would potentially need to seek protection under the federal bankruptcy code“.

For a time common stock investors – apparently believing in the fundamental value of the many brands Sequential licenses – were looking beyond these difficulties, pushing the stock price to nearly $40 a share in March. However, the mood is darker now, with the stock price under $10 a share. Likewise, back in 2019 and 2020 we were surprised by the full valuations the BDC lenders to Sequential were continuing to book, despite the very obvious challenges.

However, that has changed of late and may change again once a resolution is reached. As of March 31, 2021 BDC exposure to Sequential remained huge: $290mn. All but $10mn (which is in equity) consists of debt due in 2024, split between FS KKR Capital (FSK) and Apollo Investment (AINV). (95% of the debt and all the equity is held by FSK). Currently, the equity has been written to zero – the stock price notwithstanding. The debt is discounted as much as (18%), but seems to be current. (We have to wonder if Sequential is actually paying its interest bill in cash or the lenders are just adding the amount due to the principal, and what might happen when a settlement occurs. FSK and AINV might have to unwind income previously booked).

Anyway, trying to handicap how this transaction might end up for the BDCs is well nigh impossible. Sequential has been shedding assets but the proceeds are too modest to ameliorate the overall picture by much and will only add to the income decline. Everything seems to point to the lenders taking over in some sort of bankruptcy filing before long. However, whether this will be just a modest setback – especially for FSK – or a major realized loss, remains unclear. We will continue to watch this unfolding story and will be interested to see how FSK and AINV value their investments at June 30, 2021 and whether they speak to the subject on their upcoming conference calls. (AINV reports 8/5/2021 and FSK 4 days later).

Limetree Bay Ventures LLC: Bankruptcy Filing Expected

Limetree Bay Ventures LLC is the holding company for a refinery and terminals owned by EIG Global Equity Partners. The businesses are held in separate subsidiary companies. On July 12, 2021, Limetree Bay Refining LLC filed for bankruptcy protection in the State of Texas, although the business operates out of the U.S. Virgin Islands. As this attached article makes clear, the terminals business has not (yet ?) filed for bankruptcy protection.

All BDC exposure – which totals $301mn – is to Limetree Bay Ventures LLC – and consists of first lien debt, subordinated debt, preferred and equity. At March 31, 2021 – weeks before the refinery was closed by the EPA and before liquidity ran out – all the equity, preferred and subordinated had been written to zero. The senior debt had a fair market value of $151mn. However, given what we’ve read from multiple sources about the financial and ecological disaster engendered by Limetree, we’d be very surprised if this does not end up being a complete write-off.

The only BDC with exposure is FS Energy & Power Fund, which began advancing $75mn in 2018 and has managed to quadruple its exposure in the intervening period. At March 31, 2021, all the debt was already on non accrual. As a result, the likely greatest impact on the BDC might be a further ($151mn) unrealized loss – which will likely be booked in the IIQ 2021. The realized loss that we expect will have to await the resolution of this bankruptcy and others that may occur. (The company is rated CCR 5 – due to the non accrual – and added to our Trending List because we expect the next set of FS Energy’s results to reflect drastic change in value).

This is obviously a major exposure for FS Energy. The $151mn of value remaining is equal to 10% of the non-traded BDC’s net book value, and continues a long list of energy faux pas that has resulted in half its equity capital being written down or off. A quick look down the BDC’s portfolio company list suggests, though, that Limetree is the biggest single exposure at cost remaining on its books.

We’ll circle back as we learn more in the weeks ahead, but at this stage “disaster” is writ large for both Limetree and FS Energy.

U.S. Well Services: Loses Lawsuit

Poor old publicly traded U.S. Well Services (USWS) is spending more time in court these days than in its business of providing drills for the oil and gas business. A Delaware judge has ruled recently against the company in a contract dispute with Smart Sand Inc. (ticker: SND) and required USWS to pay $48mn in damages. That’s a major blow for an oil services company that is going through a major transition – dropping diesel pumps for electric ones and letting go of 171 employees as part of the transition. In a filing, USWS has indicated it’s likely to appeal the judge’s decision so this legal drama will play out a little longer.

All this is bad news for the two remaining BDCs with exposure: Capitala Finance (CPTA) and PennantPark Investment (PNNT). Both own over 1mn shares each in the company. (In the past, BlackRock Investment has as much as $46mn invested at cost in the stock, but that’s been sold, leaving only CPTA and PNNT). At March 31, 2021, when the last valuation was fixed, USWS was valued at $1.040. That price has dropped to $0.9593, an (8%) drop. The total value was $2.6mn in March and should move materially lower by the end of the second quarter. Thankfully, the amounts are not significant for either BDC.

We are retaining a CCR 4 rating for USWS and adding the company to our Trending list, given the likely (modest) change in fair market value to occur in the IIQ 2021.

American Teleconferencing Services: Ratings Downgraded, Withdrawn.

On June 4, 2021 S&P announced that conference audio and video provider Premier Global Services Inc., (dba PGi), whose wholly owned subsidiary is American Teleconferencing Services, was downgraded to CCC-, from CCC+, with a negative outlook, with the rating agency citing “significantly” deteriorating operating performance over the past quarter. Also downgraded was the company’s senior secured debt to CCC-, from CCC+. S&P noted that the company’s declining operating performance “increases the likelihood that [PGi] will default or undertake a distressed exchange” in the next six months unless the company’s private equity sponsor injects equity. Just the day before, Moody’s was more radical and just withdrew its ratings altogether, citing “insufficient information”.

This is obviously not good for the company or for the 10 BDCs with $171mn in first lien and second lien debt exposure to PGi or its subsidiary. At March 31, 2021, a couple of lenders were already carrying their exposure as non performing but most had not yet made the move. Aggregate FMV was already down to $117mn, a (32%) discount.

Our last update on these pages dates back to August 26, 2020 when the business was already struggling, and we applied a CCR 4 rating. Now, PGi/American Teleconferencing might slip into non performing – CCR 5 – status shortly judging by the rating agency hullabaloo. Most at risk are likely to be BDC lenders holding the second lien debt, which can often get written to zero in these situations. There is currently nearly $24mn in second lien debt at FMV. Then there are wide variations in how first lien debt is discounted: from (6%) to (46%). We calculate that after netting out already non performing loans, some $12mn of investment income is still at risk of interruption temporarily, or forever should the company fail.

We expect we’ll be circling back to PGi/American Teleconferencing again shortly as the situation clarifies. At the moment, the chances of further unrealized losses seems the likeliest short term outcome, which could show up in the IIQ 2021 BDC valuations.

Sequential Brands: Loan Waiver Extended

Common stock shareholders were excited to hear that lenders to Sequential Brands had extended a waiver of loan defaults from May 10 to June 7, 2021. At the time – according to Seeking Alpha – the stock price jumped 30%. However, for the lenders to the troubled company this means no resolution has yet been found to troubles that date many months back. We’ve written about Sequential Brands seven times before, so we won’t rehash the whole backstory.

However, we’ll note that BDC exposure – in both debt and equity – to the company remains huge: $277.1mn at cost. The debt at March 31, 2021 has been discounted by (16%) and the equity by (100%). The BDC lenders are FS KKR Capital (FSK) and FS KKR Capital II (FSKR), as well as Apollo Investment (AINV). However, given that FSKR is to be merged into the outstandings can rightfully be allocated all to FSK. Over a quarter of a billion dollars is a Major exposure for the KKR-managed BDC. (AINV has invested $12.8mn at cost).

We have no idea how this is going to play out, although some sort of resolution must be the horizon. We retain a Trending rating for Sequential as chances are good valuations or income derived therefrom could change shortly. We’re also affirming our CCR 4 credit rating which suggests we believe some sort of realized loss will eventually occur. However, whether that will be a few tens of millions or hundreds of millions – an important distinction – remains unclear.

Isagenix Intl LLC: S&P Rates D

S&P is not happy that Isagenix Intl LLC has bought back $65mn of its $375mn term loan at a discount, and given the company a D rating. The discount was said to be substantial.

We know less than we’d like to: such as which term loan is involved and which lenders were involved ? Nonetheless, this is a reminder that 5 BDCs have $34.5mn in exposure to the company – all in the 2025 term loan. At year-end 2020, the positions were valued at discounts that ranged from (28%) to (45%).

Isagenix is rated CCR 4, and some $2.3mn of investment income is involved. We last wrote about the company on August 28, 2020 when the principals of the business injected new capital. At the time, we concluded: “Maybe this capital infusion will be what it takes to return Isagenix to the ranks of normal performance“. Based on the latest valuation discount that does not seem to have been the case and material losses – of both capital and income – seem likely.

We’ll learn more in the days and weeks ahead – and whether some BDCs have crystallized some or all of their losses. The BDC Credit Reporter will return to Isagenix once we have more information.

My Alarm Center: Files Chapter 11

You might have expected in this period of easy money and hot markets, that leveraged companies had become immune from failure. That’s not the case, as proven by My Alarm Center, LLC, which has just filed for Chapter 11 bankruptcy protection, as discussed in trade publication SecurityInfoWatch:

“In a statement provided to SecurityInfoWatch.com, My Alarm Center said that its lenders and other key stakeholder have agreed to support its reorganization plan, which provides for the elimination of approximately $235 million in legacy debt obligations, strengthens its financial structure and supports its long-term growth plans“. 

We won’t spend a great deal of time on the company’s restructuring plans because the three BDCs with exposure are all currently in the equity and preferred. Chances are high the $8.0mn invested at cost – and with an aggregate FMV of $0.4mn at year-end 2020 – will all be written off. The BDCs involved are Saratoga Investment (SAR); Crescent Capital (CCAP), which inherited the investment from Alcentra Capital, and OFS Capital (OFS). SAR has the biggest exposure at just under $5mn at cost, but a FMV of just $0.3mn. The BDC already booked a realized loss of ($7.7mn) back in 2017 when the company was previously restructured. At that point SAR – and others – fronted more capital, which is now likely to be lost as well.

We had already rated the company CCR 5 due to SAR carrying one of its preferred positions as non performing. The rating remains unchanged. We expect to see realized losses booked by the BDCs involved in the second or third quarter 2021, probably the former. From a fair market value standpoint, the impact on the BDCs will be minimal.

All in all, a sorry episode for all the BDCs involved and in an industry famous for its allegedly high, stable cash flows where companies are sold for multiples of revenue. However, technological change and competition have resulted in a number of setbacks in the alarm monitoring business. For the BDC sector a rare new bankruptcy in 2021.

Mississippi Resources LLC: Major Realized Loss Booked

Understandably enough BDCs are loath to discuss with their shareholders losses taken on portfolio investments gone wrong. Managers prefer to spend time on their successes; latest deployments and just about anything but setbacks. However, from the BDC Credit Reporter’s perspective investors should want to know about what did not work – and why – to better evaluate a BDC’s chosen strategy and implementation. So we’re going to spotlight the announced the ($32.2mn) realized loss booked in the IVQ 2020 by Sixth Street Specialty Lending (TSLX) on its investment in independent oil and gas producer Mississippi Resources LLC.

This investment – which began in 2014 with $44.2mn of debt and equity invested – has been an abject disaster for TSLX – far and away the worst in its history. As is so often the case in these E&P investments ,TSLX does not seem to have been willing to accept the initial reverse on its investment when oil prices crattered in the latter half of 2014. As a result the company has been restructured and essentially taken over by the Sixth Street organization (then TPG Specialty Lending) and more funds advanced.

Over the years – starting in 2017 – the BDC has been forced to book realized losses on the investment. The first write-off was ($21.8mn); the next year ($9.6mn) and ($4.2mn) in 2019. This culminated in 2020 with the ($32.2mn) realized loss. That a total of ($67.8mn). Currently, Mississippi Resources remains on the books with a $1.5mn Term loan due in 2021, which is on non accrual and has been written to zero. (In fact, none of the debt outstanding to the company has been accruing for the past 4 quarters).

The total realized loss is half as much again as the initial amount committed back in 2014 and equal to 6% of all the equity capital TSLX has raised in its history and the equivalent of 42% of its 2020 Net Investment Income. Fortunately for TSLX’s management the 2020 write-off was overshadowed by slightly larger realized losses elsewhere, which kept total net realized losses at ($2.6mn) for the year just passed.

We’d say there are three lessons learned from the Mississippi Resources story. One is a recurring theme of ours: lending/investing in commodity-driven industries like energy is highly risky and better left to speculators or specialists. Second is that TSLX – like every other lender – is at great risk when “doubling down“, continuing to advance monies when initial amounts put into play get into trouble. The flexibility BDCs have to invest in almost anything and without regulators looking over their shoulders might be a boon at times. However, at other times, such as in this instance, bad money follows bad – to coin a phrase. Third, even well regarded BDC management teams – with an excellent credit track record over long periods – like TSLX’s – are not immune from making occasional MAJOR mistakes. It’s the nature of the business. We’re only sorry the management team could not – figuratively speaking – look their shareholders and analysts in the eye and de-construct for everyone’s sake what went wrong and how any lessons learned might help future outcomes.

Sequential Brands: Lender Appoints Board Members

Sequential Brands is the BDC Credit Reporter’s Godot. We’ve written multiple articles over the past two years breathlessly warning that something bad – a bankruptcy or a forced sale – was close to happening. Then: nothing. The company and their lenders always seem to arrive at a temporary modus vivendi, but no permanent resolution. (We’re desperately trying not to use the kicking of cans down the road analogy again). At times – given the high valuations the BDC lenders have maintained – we’ve doubted ourselves and the urgency of the situation.

However, the latest developments suggest – once again – that SOMETHING is going to occur at Sequential in the near future and that there is a possibility the BDCs – with $290.5mn outstanding in debt and equity to the company – may be materially impacted. Here’s what we know: According to a March 31, 2021 regulatory filing the company and one of its lender groups – led by Wilmington Trust – extended “a waiver of existing defaults under the Credit Agreement through April 19, 2021“. Furthermore, the lender “shall have the right to appoint an independent majority of the Board of Directors of the Company“. So gone is Martha Stewart and three other less famous Board members, probably letting out a sign of relief. Also a red flag: the company has not yet filed its IVQ 2020 and full year results.

The short extension period by Wilmington suggests that whatever “strategic alternatives” the company has been exploring since December 2020 is reaching some sort of conclusion. That might involve a sale of the business – in whole or in parts – or some pre-agreed Chapter 11 filing. The public shareholders seem to be bullish about this likely outcome, with Sequential trading at $22.22 as of the close on Thursday April 1, 2021. We are less optimistic – as is our self appointed mandate.

At risk for the BDCs involved is the prospect of ($28mn) of annual investment income from their 2024 Term debt outstanding being interrupted. Then there’s a good chance – based on the most recent quarterly valuations which discounts the equity owned by (99%) – a realized loss of up to ($10mn) will be incurred. However, the most important question mark is how the second lien debt will fare in the half billion dollar of borrowings Sequential owes. FS KKR Capital (FSK) and FS KKR Capital II (FSKR) and Apollo Investment (AINV) have advanced $280.5mn– more than half the total debt outstanding.

Currently, FSK and FSKR discount their debt by only (12%) and AINV by just (4%). If we apply the more conservative discount, that would still result in ($34mn) of realized losses on the debt and ($44mn) in total. The loss could be higher, but even ($44mn) is material given the big bets placed by the FS- KKR organization and which will shortly all be held by FSK, as FSKR is about to merge into its sister BDC. (AINV’s exposure is – clearly – much more modest even adjusting for the respective BDC sizes).

We should say – to be fair and recognizing that the stock market seems to believe that there is considerable market value left in Sequential – that this could all pass as quickly and harmlessly as a summer storm. Some deep pocketed buyer could be finalizing a generous deal as we write this or some hard working lawyers could be arranging a favorable “debt for equity swap” which will leave creditors undiminished. Maybe there’s a SPAC out there who wants to own a group of consumer brands…We don’t know, but we are as confident as we’ve been in two years that a change of status is in the cards for the company in the near future.

We are maintaining our CCR 4 rating on the company – as an eventual loss seems more likely than repayment in full. We are also adding Sequential to our Trending list because of the expectation that whatever is in the company’s future in the weeks ahead will be reflected in the BDC valuations and income – most probably in the IIQ 2021. For FSK especially this could either be a body blow, or not. We’ll be tracking the situation daily and will report back when something material occurs.

Currency Capital LLC: Placed On Non-Accrual

Over at the BDC Reporter we’ve been undertaking systematic reviews of several public BDCs following the end of IVQ 2020 BDC earnings season. Most recently we tackled Capitala Finance (CPTA) which happens to be the sole BDC lender to Currency Capital, LLC. The company bills itself on its website as “an exciting FinTech company specializing in transaction enablement“. As far as we can tell, this involves providing equipment financing.

Till the IIIQ 2020, the $16.3mn invested at cost in the company’s first lien debt was carried at only a (1%) discount, although a small preferred stake was valued at half its cost. In the IVQ 2020, though, CPTA placed the debt on non-accrual, resulting in the interruption of over $2.0mn of annual interest income. The debt was written down to just $3.75mn. The preferred was written to zero. We have downgraded Currency Capital (now known as Currency Finance apparently) from CCR 2 to CCR 5 in one fell swoop.

What’s gone wrong ? CPTA did not say on its most recent earnings conference call and the public record is moot on the company’s troubles, so we won’t speculate. However, this is clearly a major reverse for CPTA, and we’ll continue to monitor both publicly available information and any update that CPTA offers.

Integro Parent Inc: Downgraded By Moody’s

Integro Parent Inc. (aka Tyser’s) is a London-based specialty insurance broker and has just seen its corporate credit rating and debt tranches downgraded by Moody’s. The outlook is “Negative”. Apparently, the pandemic has impacted business conditions in many markets, leaving the company in a classic highly leveraged state, with weak liquidity and cash flow. The company rating has been lowered to a speculative Caa1.

That was enough for the BDC Credit Reporter to add the company to our underperformers list – the first addition in some time – with an initial rating of CCR 3. There are two BDCs with material exposure up and down the company’s capital structure : New Mountain Finance (NMFC) and Crescent Capital (CCAP). Total exposure at cost was $48.5mn at year-end 2020, most of which is held by NMFC, as this table from Advantage Data shows:

Both BDCs are valuing both first and second lien debt at or above par. The first lien is priced at 6.75% and the second lien at 10.25%. (CCAP holds a non-material equity position as well). We have also added Integro to our Trending list because it’s possible that with the Moody’s downgrade, the BDCs involved might reduce the value of their positions in the upcoming IQ 2021 results. Just a 20% overall discount could reduce the FMV by ($10mn) or so. We’ll check back when we hear from CCAP and NMFC in the next few weeks.

Bioplan USA Inc. : Moody’s Downgrades

On March 24, 2021 Moody’s downgraded BioPlan USA Inc. (also known as Arcade Beauty) to “D-PD from Caa2-PD, following the recent restructuring of the company’s first-lien and second-lien credit facilities“. By its standards, Moody’s considers the just completed restructuring at the company as a “distressed exchange and thus a default“. Here’s a link to a Moody’s press release with much more information.

The basic issue is that the lenders to the company appear to have “kicked the can down the road“, extending the maturity of all outstanding debt, and adding a payment-in-kind (“PIK”) requirement which will effectively increase the balance owed. Although the sponsor – Oaktree Capital Management – kicked in another $20mn of equity capital, Moody’s still believe the company’s capital structure is “unsustainable“. As the press release makes clear BioPlan has plenty of challenges including negative free cash flow; a slow return to “normal conditions“; very high leverage and much more.Still, the lenders and the sponsor seem to believe there’s a way out given enough time

There are two BDCs with exposure to the beauty products company: publicly traded Investcorp Credit Management (ICMB) and non-traded Guggenheim Credit, with total exposure at cost – all in the just restructured first lien 2021 Term Loan – of $18.2mn. The former BDC is on the record on its conference calls as being optimistic about the company’s prospects and has discounted its debt by (22%). Guggenheim is more conservative and has a (37%) discount.

We have had a CCR 4 rating for the company since the IQ 2020 when the onset pandemic sharply cut foot traffic at malls and the demand for fragrance sprays. We are adding Bioplan to our Trending list because we expect that with the restructuring there might be a change – probably upward – in the debt’s valuation. This should show up in the IQ or IIQ 2021 results of the two BDCs involved and – for the moment – reduces the risk of the debt going on non accrual. We cannot say whether in the long run this will result in a loss for the BDCs involved. Most at risk – but only modestly so – is ICMB, which could see nearly $0.7mn of annual investment income interrupted should the debt go on non accrual. Ironically, in the short term, the BDC’s income (and Guggenheim’s ) could increase thanks to the new PIK pricing…

We’ll circle back when ICMB and Guggenheim report 2021 results.

Avanti Communications: IVQ 2020 Update

We’ve just heard from Great Elm (GECC) regarding its IVQ and full year 2020 results. This includes an update on the BDC’s valuation of its largest investment : Avanti Communications. According to the BDC, the values attached were depressed by the then-uncertainties regarding the refinancing of the satellite company’s debt, which has been subsequently extended for a year. The total investment in debt and equity by GECC is now $105.6mn and the FMV $29.3mn. This compares to $103.0 at cost in the prior quarter and FMV of $39.3mn. That’s a (25%) decrease in the FMV of the BDC’s investment in the IVQ 2020.

The BDC Credit Reporter continues to believe that a complete loss is possible where Avanti is concerned, and that’s increasingly reflected in the valuation. All the debt instruments the BDC holds are accruing interest on a non-cash basis while the other BDC with exposure – BlackRock TCP Capital (TCPC) – has its loans showing as non performing. Effectively, despite $118mn invested at cost between the two BDCs – of which $62.4mn is in the form of debt – no cash income is being received already.

We maintain our CCR 5 rating and have Avanti on our Trending List. Next quarter we expect to see the total amount invested increase due to the previously mentioned refinancing. GECC will be adding $3.7mn to one of the debt facilities – as disclosed in its 10-K. TCPC may also invest further funds, but on a smaller scale. The valuation may increase as a result of the refinancing achieved but that will not necessarily continue in future quarters. We will revert back when the IQ 2021 results come out for GECC and TCPC or if something new transpires at Avanti.

Sundance Energy: Files Chapter 11

Despite a higher oil price, there’s still plenty of credit trouble in the energy sector as reflected in the just-announced voluntary Chapter 11 filing of Sundance Energy Inc. (NASDAQ: SNDE) and its affiliates. As you might expect, the company and its major lenders have a plan already in place to restructure the balance sheet and exit from bankruptcy. The second lien Term Loan lenders seem to be ready to convert all or most of the $250mn owed to them into equity. Moreover, the press release suggests “certain of its Term Loan lenders” will provide $45mn in debtor-in-possession (“DIP”) financing to keep the business running. When this is all said and done:

Upon emergence, the Company’s recapitalized balance sheet will include (i) $137.5 million of funded indebtedness comprising a senior secured reserve-based revolving credit facility, a senior secured second out term loan, and, if necessary, a senior secured third out term loan, in each case provided by the existing RBL Facility lenders and (ii) new common equity interests issued in exchange for DIP financing claims and Term Loan claims, subject to dilution by new common equity interests granted under a new management incentive plan“.

The only BDC with exposure is Ares Capital (ARCC) with $58.6mn invested at cost (par value is slightly higher) in the second lien Term loan. The debt has been non-performing since the IIIQ 2020, and was already discounted (37%) as of IVQ 2020. Before the debt went on non accrual ARCC was earning $6.7mn on an annual basis of investment income. We now expect there will be both a realized loss booked in the IQ or IIQ 2021 associated with the restructuring and – most likely – new capital advanced.

We won’t try to estimate the extent of ARCC’s loss, especially as this restructuring is just a way station in the BDC’s relationship with Sundance Energy, which began in IIQ 2018. Frankly, we don’t understand why ARCC – which often makes a great deal of its modest energy exposure – would have invested second lien capital in a “independent oil and natural gas company focused on the development, production and exploration of large, repeatable resource plays in North America“. To be blunt, given what has happened to a multitude of similar companies in recent years this seems unwise credit underwriting.

We’ll circle back once the restructuring plan is approved and when we discover how stage two of ARCC’s relationship with Sundance Energy looks like. This could be an investment we’ll be writing about for years to come.

Furniture Factory Outlet: Post Mortem

Now that Stellus Capital (SM) has reported IVQ 2020 results, we know the final outcome of bankrupt retailer Furniture Factory Outlet (FFO) that we’ve written about 3 times before. Unfortunately, despite booking a major final realized loss on the investment, SCM’s external manager was tight lipped about many of the details and was even shy of mentioning the company by name. However, from what we can tell the $13.1mn invested at cost as of September 2020 and valued at $2.1mn was written off in this most recent quarter, resulting in a ($10.1mn) realized loss. Virtually all that exposure – and loss – was in the form of first lien debt.

For SCM this means the permanent loss of about ($0.750mn) – taking into account the $2.1mn recovery – of annual investment income. However, the debt has been on non accrual since IIQ 2020 so the impact has already been reflected in the BDC’s most recent results. The company has now been fully removed from SCM’s books.

This has been a material credit set-back for SCM, equal to 3.7% of the BDC’s equity capital at par and more than three quarters of the funds advanced to FFO. From a post-mortem, Monday Morning Quarterback credit perspective this was probably an avoidable loss. As we explained in our prior article – which we’ll quote below – the choice of industry from the outset was problematic and the first lien position in the balance sheet afforded little protection:

The furniture business – as old credit hands like the BDC Credit Reporter will tell you – is a notoriously difficult industry to lend into, even if the bulk of your exposure – as with SCM – is nominally in first lien debt. This investment by SCM dates back to 2016, before the general “retail apocalypse” became crystal clear to all. However, as recently as IQ 2018, the BDC doubled its exposure, just when mall vacancies in the U.S. reached a six year high. In retrospect, SCM may have wished they had headed in the opposite direction“.

Paper Source Inc. : Files Chapter 11

On March 2, 2021 stationery retailer Paper Source Inc. filed Chapter 11. According to Bloomberg: “The company intends to hand control of the business to an affiliate of MidCap Financial, a lending arm of Apollo Global Management, in exchange for debt forgiveness, court papers show. Paper Source owes about $103 million to lenders, including more than $55 million under a first-lien term loan“.

This is no great surprise to the BDC Credit Reporter, which has had the company on its underperformer list with a CCR 3 rating since IIQ 2017. A further downgrade occurred in April 2020 to CCR 4 and will now be moved to a CCR 5 – non performing. The principal BDC lender is Apollo Investment (AINV) , which has invested $14.2mn in the company, principally in the form of first lien debt, which was valued at $11.4mn at year-end 2020, a (20%) discount. Presumably some ($1.2mn) of annual interest income will be forgone as Paper Source is sorted out.

From what is being said in court papers, the Apollo Global owned lender Mid-Cap Financial – with whom AINV participated – envisages some sort of debt for equity swap. This will make the lenders owner/lenders going forward and reduce the company’s debt. Here is an outline of the plan, according to the Chicago-Tribune, quoting from court papers:

Paper Source said MidCap Financial agreed to serve as an initial bidder, or “stalking horse,” to purchase the company’s assets for up to $88.8 million, which includes $16.5 million in financing to help the company continue operating… A sale is expected to close in about 90 days”.

AINV only arrived on the scene as a lender in June 2019 when Paper Source was already underperforming, possibly as part of a “lend-to-own” strategy or just in a case of bad timing. Chances are now high that the BDC will be advancing additional monies; restructuring debt and the like and extending indefinitely its relationship with the retailer.

For AINV, whose credit troubles have been mostly concentrated in “legacy assets” booked some time ago under a different management team, this is a rare setback for loans booked by Mid-Cap Financial, the principal source of the BDC’s current new investment activity. We’re adding Paper Source to our Trending List because both income and investment values should be substantially different in the IQ 2021 results.

NGL Energy Partners LP: Suspends Dividends

We learn from a recent Seeking Alpha article (Trapping Value on February 21, 2021) that NGL Energy Partners LP (ticker: NGL) has recently refinanced its debt. As part of the agreement with the public company’s new lenders, all common and preferred dividends have been suspended. Admittedly, the suspension is supposedly only temporary and the payouts will resume once a target leverage is met. Still, given the pressures in the oil patch, we don’t suggest shareholders should hold their breath.

For the only BDC with exposure – FS Energy & Power – this looks like a body blow from what we can tell. That’s because the BDC has $173mn invested at cost in equity and preferred, of which $166mn is in the latter and yielded 14.3% from distributions. Our calculator indicates that’s ($23.7mn) of annual dividend income lost. A glance at the non-traded’s BDC IIIQ 2020 financial statements indicates that’s equal to 13% of total investment income and over 50% of Net Investment Income.

We had already rated NGL CCR 4 but now downgrade the company to CCR 5, given this was a yield producing investment. If this settled out today we’d expect the BDC to lose (25%-50%) of its investment, but that’s not happening, giving NGL – buoyed by its debt refinancing – the chance to fight on. However, this is a Major investment by our standards (over $100mn) and will be of concern to the manager of the BDC and its shareholders.

American Achievement Corp: Debt On Non Accrual

We learn from Sixth Street Specialty Lending (TSLX), following IVQ 2020 results, that a new portfolio company has been placed on non-accrual: American Achievement Corp. The company “manufactures and supplies yearbooks, class rings and graduation products, and as a result of COVID, underperformed for the 2020 sales season“. TSLX added: “We are currently working with the company on a potential restructuring to keep our term loan outstanding and to receive a majority of the equity in the business as a lender group. We expect to reach resolution on this in the near term“.

What TSLX failed to say is that the company “filed for involuntary Chapter 11 bankruptcy protection January 14, 2021, in the Northern District of Texas“, according to public records. In addition, TSLX did not mention that the near half a billion dollar in debt owed by the company is the subject of heated disputes, which adds an element of uncertainty to the outcome. This article by S&P describes some of the maneuverings underway.

TSLX seems to be (unduly ?) optimistic, writing down its $23.8mn first lien loan by only (9%). Furthermore, if a debt for equity swap – as mentioned above – seems the likeliest resolution, it seems unlikely that the debt will not be subject to a major haircut, which will impact long term income. At the moment, with the non-accrual TSLX has temporarily lost ($2.2mn) of annual investment income.

We have downgraded the company from CCR 2 to CCR 5 in one fell swoop. (As of the IIIQ 2020 TSLX valued its investment at a modest discount of (7%) and no mention was made by TSLX – the only BDC lender – of any challenges at the company). We are also adding AAC – as its known – to our Alerts list because it’s likely that the income, value and outstandings involved will be subject to substantial change in the next couple of quarters.

Frankly, we’re a little disappointed by the transparency of TSLX at this stage. Maybe with so much ill feeling between the parties involved with the company, the BDC did not want to stir up the pot on its February 18, 2021 conference call, but investors are left with an incomplete picture. This a company that bears watching and which we’ve added to our daily review for any new developments.

Country Fresh Holdings LLC: Files Chapter 11

On February 16, 2021 fresh food distributor Country Fresh Holdings LLC filed for Chapter 11 in Texas.

Pandemic-related supply chain and business disruptions have affected Country Fresh and our customers dramatically over the past year,” said Bill Andersen, Country Fresh President and CEO. “Despite efforts to improve company results before and during COVID, we believe that this sale transaction will result in a better capitalized company and positions our customers, suppliers, employees, and all other stakeholders for maximum success going forward.”

The company already has a “stalking horse” bidder in place in the form of PE group Stellex Group and has arranged debtor-in-possession financing with certain of its existing lenders, who were not named. Country Fresh hopes to go through the bankruptcy process in 60 days.

BDC exposure to Country Fresh is significant and includes 4 public and non-traded funds. Leading the group – and the earliest lender – is PennantPark Floating Rate Capital (PFLT) which has $23mn invested in the form of “super senior” term debt; a second lien loan and equity. Only PFLT has reported IVQ 2020 results so far and placed its $5.9mn second lien loan on non accrual for the first time. The other loans were still performing at the end of 2020, but are likely now on non accrual as well. PFLT also has $10.5mn of equity in the company which has been written to zero for the past 3 quarters and is likely to stay there.

Also with substantial exposure is non-traded Cion Investment while Goldman Sachs BDC (GSBD) and Goldman Sachs Private Middle Market Fund have tiny equity stakes left over from a 2019 restructuring and written off already on an unrealized basis.

At first approach, we’d guess PFLT and Cion might be involved in the DIP financing and are likely to receive back their “super senior term loan advances”. Still, realized losses are likely to be substantial: over ($25mn) , or 77% of all capital advanced because mostly concentrated in the second lien and equity. If the “super senior” don’t pay interest investment income will be forgone from the IQ 2021 forward, but may get recouped when the business is sold.

This is second time not the charm for PFLT and Cion, both who were involved in Country Fresh’s earlier restructuring in 2019, which resulted in ($7.1mn) in realized losses at the time for PFLT.

Also notable is that Country Fresh – by our count – is just the fourth BDC-financed company to file for Chapter 11 in 2021. Whether the BDCs involved will convert debt to equity and/or advance new monies in the form of loans or equity is not yet clear. We’ll circle back when we learn more.