BDC Reporter News and Views on the Business Development Company Industry Tue, 31 May 2016 15:02:12 +0000 en-US hourly 1 ALERT ! “Vertellus Specialties Files for Bankruptcy” BDC EXPOSURE: BKCC, TSLX, GLAD Tue, 31 May 2016 15:00:55 +0000
  • Chemical company Vertellus Specialties Inc. has filed for bankruptcy.
  • Vertellus reports liabilities of $710mn, including $455mn in senior first lien secured debt.
  • Sales were $596mn in 2015, and EBITDA $61mn.
  • Company appears to be negotiating debt for equity swap with senior lenders.
  • Many existing senior lenders are providing Debtor In Possession financing of $110mn.
  • BDC exposure principally to BlackRock Investment (BKCC), with smaller advances by TPG Specialty (TSLX) and Gladstone Capital.
  • At 3-31-2016 BDC write-downs in same 2019 senior debt written down 30-40%.
  • BDC Credit Reporter expects up to $40mn in aggregate Realized Losses in IIQ 2016. Exposure to increase due to DIP.
  • Lender (and BDC) proposed continuing control of Company keeps open possibility of future write-downs or equity gains.
  • Company owned by private equity group Wind Point Partners.
  • Company File here.
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    ALERT ! “Triangle USA Petroleum Payment Deadline “. BDC EXPOSURE: FS Investment II Tue, 31 May 2016 13:14:08 +0000 5-31-2016: Back in late April 2016, Triangle Petroleum-a publicly traded oil and gas company-received notice from its asset-based lender Wells Fargo that its borrowing base was being reduced due to the lower price of oil. The amount of the borrowing base was $125mn lower than outstandings under the Wells Fargo facility. As per the agreement, the Company had until May 31st to begin bringing outstandings in line with the collateral base. At the end of April, the Company had $152mn in cash on hand and announced its intention from May 31st to ” elect to repay the borrowing base deficiency in three equal monthly installments”.  Oil price drop

    ANALYSIS: We would be surprised if the Company paid down the Revolver with the last of its cash without negotiating a pre-packaged bankruptcy or other restructuring. A “white knight” acquisition failed to go anywhere recently, and the Company may be out of options. We don’t usually forecast major events such as bankruptcies, but that appears to be the next step.

    BDC EXPOSURE: The only BDC with any investment in Triangle is FS Investment Corporation II, with $2.350,000 at Cost and FMV already greatly written down to $731,000 at March 31 2016:

    Source: Advantage Data (
    Source: Advantage Data (


    CONCLUSION: In our Company File we project a partial to full write-off of the Subordinated Debt. (Click on the link for all the details).  There may be some equity swapped for the forgiveness. We expect FS Investment II-a non-traded BDC-will recognize a Realized Loss in the second quarter 2016 of $2mn or more.

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    BDC CREDIT REPORTER: Fox Rent A Car Inc. BDC EXPOSURE: HCAP, WHF Mon, 30 May 2016 13:45:29 +0000
  • May 30, 2016:  The BDC Credit Reporter noted in the latest 10-Q for the quarter ended March 31, 2016 from WhiteHorse Finance (WHF) that a Subsequent Event was a payment blockage to the second lien lenders reported on April 29, 2016. No further details were available. We used Alpha-Sense to check out the other BDC lender-Harvest Capital or HCAP-which provided the following disclosure in its filing:

    On April 22, 2016, the Company received notice from the senior secured lender to Fox Rent a Car, Inc. (“Fox”) that, due to Fox’s violation of certain covenants under its senior secured credit facility, it was blocking the junior secured term loan lenders from receiving interest payments until the covenant breaches are cured, waived by the senior secured lenders or the blockage period expires. The loan remains on accrual status at March 31, 2016 as the Company believes its loan is within the enterprise value of the business and that it will collect 100% of the contractual cash flows owed under the credit agreement.
    • Both BDCs-payment blocking notwithstanding-continue to carry the second lien debt at full value.
    • The BDC Credit Reporter has added Fox Rent A Car to the Master List, with an initial rating of WATCH.  Click here for the Company File, partially completed.
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    BDC CREDIT REPORTER ALERT: MSC Software Downgraded Fri, 27 May 2016 14:13:47 +0000
  • Big data software company MSC Software Inc. was downgraded by Moody’s, both corporate rating and second lien public debt.
  • Moody’s cites high leverage and financial performance.
  • BDC exposure of $35,091,000 at Cost and $30,479,000 at FMV at 3-31-2016 is all in Second Lien.
  • BDCs invested are Cion Investment Corporation, TCP Capital (TCPC) and Apollo Investment (AINV), listed in decreasing exposure size.
  • BDC Credit Reporter has Company on WATCH. News of downgrade is BAD, but WATCH rating unchanged.
  • We expect lower FMV at 6-30-2016.
  • Link to Moody’s article.
  • Link To BDC Credit Reporter Company File. Still in progress.
  • ◊ All BDC portfolio info from AdvantageData (

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    CREDIT SPOTLIGHT: The Second Act of Aspect Software Inc. BDC EXPOSURE: FSIC, FSIC II, FSIC III, VII Peaks II Wed, 25 May 2016 19:48:28 +0000 May 25, 2016: The BDC Credit Reporter is shining a spotlight on the biggest credit news of the day in the Business Development Company sector: the exit of Aspect Software,Inc. from a brief stint in bankruptcy, and its return to Performing status.  With a lightened debt load, the ” leading cloud provider of fully-integrated consumer engagement, workforce optimization, and back-office solutions” hopes to get back to business as usual.


    This is news in our corner of leveraged finance because there are 4 Business Development Companies with $68,204,000 in debt exposure at par/cost to the Company.


    Info provided by Advantage Data (
    Info provided by Advantage Data (



    We have updated our BDC Credit Reporter Company File on Aspect Software and tweeted an Alert about the news. We’ll be updating our Daily Alert table with summary information about the deal, but the Company File is as comprehensive as we get (although we’ll be updating fields continually). One section in the Company File is entitled OUR VIEW, in which we sum up what is happening to the Company, the exposure of the BDC sector thereto and provide our projection of what might happen to investment income and asset value in the short and long term. We provide both an Optimistic and a Conservative assessment. We are reprinting the Our View analysis for Aspect Software-which we’ve just completed- for our readers:


    The Company is a billion dollar in assets, $400mn in sales, $100mn EBITDA cloud services provider. We’ve not had the time to research the Company’s whole history , but we understand there have been a number of acquisitions over the years.

    However, in 2015, high leverage combined with less than expected financial performance, plus debt maturities coming due, caused the Company to recognize that a drastic change was necessary. In March 2016, after negotiations with its senior lenders, the Company filed for a pre-packaged bankruptcy (that’s a BK where most of the key provisions necessary to re-emerge as a solvent company have been negotiated between the stakeholders in advance).

    On May 25th, even faster than expected, the Company announced that they were ready to resume business as usual. Basically, the lenders-especially the senior lenders-reduced Term debt outstanding by over $300mn in return for the equity in the “new” company, while providing both $30mn of Debtor in Possession financing and growth capital.

    According to news reports, long term debt has been reduced by 40%. Total debt at the time of bankruptcy was said to be $1bn, and $320mn was written off in the restructuring, which suggests total debt reduction was more in the order of one-third.

    There is going to be a new $60mn bond offering for future financing needs, but which reduces further the debt load reduction.

    Apparently the EBITDA of the Company (not including any value for necessary capital expenditures in the change intensive world of computing) is $100mn. That implies Debt to EBITDA, which was at 10: 1, will drop to a still high 7x, but with new maturity schedules.

    See CBS article:


    What this means for BDC exposure to the Company is unclear, but we’re going to make some informed guesses. Virtually all the exposure from 4 BDCs is held by Franklin Square funds and the new capital structure negotiations were spearheaded by GSO Blackstone-its sub-adviser. Guggenheim was also involved.

    Total exposure at cost was over $60mn, and spread out over Senior Secured Debt, Senior Notes and Second Lien debt. From what we can tell, the Notes were written down to nearly zero, but the First Lien Debt was written up by a corresponding amount, based on Investment Ownership info from Advantage Data ( that we use. We’re guessing the Notes were exchanged for Senior Loans as part of the deal. The effective result is that the three Franklin Square funds exposure at 3-31-2016-after the Company went into bankruptcy-was valued at par.


    We would be surprised if there was not some Realized Loss booked from the conversion of so much Term Debt into equity, even if replaced with an equity interest. We project-and we’re spit balling here-about $20mn of Realized Losses between the FSIC funds and a 80% or greater write-off of the Second Lien loan.


    With the restructuring, the FSIC lenders will have both debt and equity exposure to the Company. The debt will return to accrual status (terms unknown but likely to be lower than before) and in smaller size. As a result, we expect income to drop from the levels achieved before the non accrual/bankruptcy. The income loss might be as much (between a lower rate and less outstanding) as 75%.


    Whatever the lenders and management might say, this successful pre-packaged bankruptcy is not the end of the story. Between the DIP loan and the new $60mn Note to be issued and other financings that might be needed BDC exposure at par is more likely to grow rather than decrease.

    If debt to EBITDA at the new restructured Company is 7X or more as we anticipate, and if we take into account that this is a business with high capital expenditure requirements to remain relevant in the technology field, and we remember competitors like Avaya (another BDC owned company) are also challenged at the moment, there is no guarantee that this will not prove to be just a holding pattern for the business.


    If the Company’s financial performance improves, the Optimistic View is that the shrunken debt load will ultimately get repaid and the equity will be worth….something. Our Conservative View is that Realized Losses are going to happen now and may yet happen later if changing the capital structure is followed by any drop in financial performance. The new equity will be at risk of a complete write-off, and the Senior Debt will have to contend with the natural skepticism of the markets if there’s a double dip of poor performance and might have to be party written down again.


    Credit watching is a long term endeavor. BDCs have been lending to Aspect for years and seen their loans drop in value, face bankruptcy and now return again in a new form. Even then, we are far from over. It’s the BDC Credit Reporter’s task to keep tracking this story to its ultimate resolution, which could be yet years away, and may still result in substantial recovery but could also end with even more red ink. Check back in with us regularly an/or sign up in the box above to stay apprised once we renew our Weekly Newsletter (in hiatus while we refine our BDC Credit Reporter format).

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    BDC CREDIT REPORTER: “Speed Commerce, Inc. Throws In The Towel” BDC EXPOSURE: GARS, Credit Suisse BDC-UPDATED Tue, 24 May 2016 17:12:08 +0000 5-24-2016: Yesterday,  former public company Speed Commerce, Inc. took the final step in its dissolution. In bankruptcy court, the e-commerce services company agreed to allow its lenders to gain control of its assets in return for writing off its debts. Apparently, the lender group intends to operate the business of the bankrupt and de-listed Company.

    Two BDCs have exposure to what appears to be a major credit loss: Garrison Capital (GARS) and Credit Suisse BDC, a non-traded entity.

    Here is what we wrote in the OUR VIEW section of the BDC Credit Reporter’s file on Speed Commerce, Inc., which we’ve just updated with the latest news. Click on the file for more details about the Company, the BDC lenders involved and what has happened.

    Garrison Capital (GARS) and Credit Suisse BDC have exposure to this small public company, which has been a complete faux pas. Both lenders were involved with the Company since 2014 when Garrison Financial Services arranged a $100mn facility (see INVESTMENT INFO)and the exposure was marked at par through June 2015. Then an acquisition went terribly wrong, and everything went to heck in a very short period. A buyer was sought and not found, a new President brought in and many amendments of the debt occurred.

    The Company defaulted and filed for bankruptcy and was de-listed, the lenders (led by Garrison) foreclosed on the collateral and are-as far as we can see-are going to try and run the business themselves. In fact Garrison made a $1mn advance in bankruptcy to keep the Company funded.

    As of May 23, 2016, the Company agreed in court to let the lenders (we don’t know Credit Suisse BDC”s role) have the collateral in exchange for the extinguishment of the debt.

    As of March 31, 2016, the $27mn invested at cost in the Company by the two BDCs with exposure had been written down by 80%. In the IIQ of 2016, both lenders will surely need to recognize Realized Losses, which may equal or exceed the current Unrealized Depreciation.

    Unknown is the future of the business and what plans the lenders have. In our Worst Case we assume a complete write-off of all $27mn and any additional funds advanced. Even in our Optimistic case we don’t expect that this investment will result in anything less than a major write-off of 50% or more, even if the business is saved in some way.

    This is a major reversal for the Garrison organization, both as to the amounts of Realized Losses likely to be involved and the speed of the credit decline, and only a year after arranging the loan.

    The impact on GARS and Credit Suisse BDC’s NAV in the IIQ 2016, though, is unlikely to be very material given the sharp Unrealized Depreciation already booked. The loans were already on non-accrual at year end so income will not be impacted any further.

    All BDC portfolio holdings information supplied by Advantage Data (

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    BDC REPORTER: First cut analysis of Ares Capital’s proposed acquisition of American Capital: Good Enough ? Mon, 23 May 2016 19:51:29 +0000 5-23-2016: Finally ! The long and winding road for American Capital (ACAS), which has been in transition since the Great Recession and undertaking a “strategic review” for many months after a long winded and failed attempt to spin off its loan assets into two (!) BDCs and convert itself into an asset management company failed, has come to an end. The mortgage business management of American Capital is being acquired by American Capital Agency (AGNC),  its publicly traded mortgage REIT. That’s a whole story unto itself but the BDC Reporter is mostly concerned with the leveraged finance business. That is being sold-lock, stock and barrel to industry stalwart  Ares Capital (ARCC).


    What will American Capital shareholders-who’ve been kept in the dark for months about what’s been happening in the  conference rooms of Wall Street-get after holding their breath these many months ? In a nutshell: a mixture of cash and stock. We quote from the press release:

    American Capital shareholders will receive $1.470 billion in cash from Ares Capital, or $6.41 per share, plus 0.483 Ares Capital shares for each American Capital share, resulting in approximately 110.8 million Ares Capital shares, or $1.682 billion in value or $7.34 per share based on Ares Capital’s closing stock price of $15.19 as of Friday, May 20, 2016, issued in exchange for approximately 229.3 million American Capital shares. Following the transaction, Ares Capital shareholders are expected to own approximately 73.9% and American Capital shareholders are expected to own approximately 26.1% of the combined company.


    It’s a patchwork of a deal, and like everything associated with American Capital in recent years leaves one wondering if one’s pocket is being picked or is that as good as it gets, given the potpourri of investment assets American Capital had acquired (not one but two mortgage REITs, European loans and investments, venture capital deals, huge sponsor-financing loans and control positions in middle market companies, real estate holdings and Uncle Tom Cobley and all). We hear from Ares Capital that the portfolio will be “re-positioned” in the months ahead. That’s lender speak for selling a bunch of investments at the best price available, and should result in a portfolio that will look more like the buyer’s than the seller’s.  That’s probably a Good Thing as the very diversity of the American Capital portfolio resulted in the need for multiple-and very expensive specialized management teams-and made the company a “black box” from an investor’s standpoint. First out of the door will be the mortgage REIT managers as we’ve discussed at the top. We expect Ares might sell off the large CLO exposure ACAS has acquired, as well as the European loan and equity business, but we’re just guessing.


    There have been a flurry of ACAS realizations in recent weeks of control investments-never of great interest at Ares Capital, which sees itself as a partner to the large Private Equity groups out there rather than a competitor. We expect there might be more sales on the docket if the opportunity arises and no new additions to that type of business-where ACAS provided both debt and equity to acquire U.S. companies. In fact, the press release directly addresses the subject:

    Prior to closing, American Capital may continue its plans to monetize certain investments (in collaboration with Ares Capital) and the proceeds of any such sales would be used to retire indebtedness or to remain in cash balances as the company has ceased its stock repurchase. Since March 31, 2016, American Capital has announced sales of over $550 million in balance sheet investments.

      The low yield, lower risk highly liquid loan book has already been sold off, only a year or two after ACAS bulked up on those kind of assets.

    Sign roads going two ways


    Instead, Ares Capital intends to re-direct all that freed up capital into “directly-originated investments”. We have not had time to run the numbers but expect that once all the dust settles and American Capital’s assets are “re-positioned” a year or more from now most of the investments that currently appear on the ACAS books will be gone. If ACAS shareholders want to know what their investment will look like from a risk and return standpoint, we suggest they look over at the current balance sheet of Ares Capital because that’s what you’re going to own, but in greater bulk.

    Obviously, this is probably a very good deal in the long term for Ares Capital.  Based on the very competent purchase by Ares of Allied Capital several years ago when that other former behemoth of the BDC-world was up for grabs we imagine the would-be buyers have been through the portfolio with a fine tooth comb and already have a game plan for every loan, investment and knick-knack that the ACAS managers have assembled.  ARCC’s parent Ares Management have been roped in to put up some of the cash for the acquisition (as well they should as this will make them a huge amount of money in years to come).


    Already law firms are circling, and arguing that the proposed deal is not favorable to ACAS shareholders. Presumably, there’s still a chance someone will step up and make a better offer. (Will Prospect Capital-PSEC-make a last minute charge like they didApples and Oranges On Scale during the Allied transaction ? We don’t think so, but the ensuing drama would make for great copy). Without the benefit of all the access Ares and other potential buyers (and this has been hawked all over the financial world we presume) it’s very hard to say, but seems unlikely. Unlike some other “sweetheart” deals in the BDC space where busted BDCs have been sold off without the benefit of an auction, there appears to have been a true auction conducted here. We doubt there are too many groups out there, given the hundreds of investments at ACAS involved, as well as all the complexities of an internally managed BDC where the managers have negotiated very favorable compensation and termination terms over the years that have to be contended with, who might want to go through the headache of a last minute challenge.


    The BDC Reporter is going to be practical. This has gone on long enough, and is not to the benefit of ACAS shareholders to continue in the limbo that has existed for many quarters as ACAS lost any strategic direction (one day we were going to have multiple BDC spin-offs, then we were back to one BDC, etc.). Many key assets have already been sold and many managers are already out the door or actively on LinkedIn looking for work.


    Most importantly “BDC activist” and king-maker Elliott Management has agreed to support the deal when shareholders get to vote. Here is their just amended Support Agreement. In the press release announcing the transaction Elliott Management’s support was highlighted, both to underscore to shareholders that a sophisticated investor has blessed this Chinese puzzle of a transaction and to remind anybody would might be contemplating a No vote that Ares has the votes-or at least 14.4% of them. Here is the language:

    Elliott Management, holder of a 14.4% interest in American Capital, strongly supports the transactions and will vote its shares in favor at the upcoming Special Meeting. Portfolio Managers Jesse Cohn and Pat Frayne said in a statement, “We are pleased with the result of the Strategic Review and thank the Independent Board Committee of ACAS for its hard work and success in delivering an excellent outcome for shareholders. We believe this transaction represents the best path forward for ACAS shareholders and creates a tremendous opportunity for value creation as shareholders of Ares Capital after the deal is completed. ACAS’s streamlined portfolio will benefit from management by an Ares team that has a stellar track record of delivering shareholder value.”


    Given that ACAS shareholders are being offered both cash and shares in Ares Capital the key question is less about what American Capital is worth, but whether Ares Capital is a good place to be invested. Obviously Ares has proven itself over the years a far better steward of shareholders capital than American Capital. Of all the bigger BDCs, they have been one of the more generous (less rapacious ?) on management and incentive fees, and have been careful not to abuse shareholder trust by raising capital below NAV. Credit quality and Net Asset Value have been very stable in a way that competitors like Fifth Street Finance, Medley Capital and-most recently-BlackRock Investment can only dream of. Of all the potential buyers that could have acquired ACAS, Ares Capital has to be towards the top of most shareholders wish list, barring just getting full value in cash and being able to decide to re-invest in whatever one chooses.


    Nonetheless, our job is to worry about risk (in this case-if things work out return will look after itself with Ares already claiming the deal will be “immediately accretive to core earnings per share”). In this case, ACAS and ARCC shareholders will have to worry about what happens to market conditions in the many months ahead, if conditions remain as they are, many more assets will be sold off at par or above. If conditions deteriorate, we may have one of those Warren Buffet situations where we find out who was swimming naked when the tide goes out. There are going to be many moving parts-most of which will be shifted around quietly and intra-quarter behind the scenes-which will make evaluating what the pro-forma picture for Ares Capital will look like. Faith and fingers crossed will be necessary, and the sense that the buyer has not hobbled itself by over-paying, but there’s no guarantee that the ACAS assets might not yet drag down Ares.


    Then there’s the risk inherent in the ambition of Ares Capital, and its publicly traded parent Ares Management. In recent years we’ve noted the ever increasing risk profile of the BDC’s portfolio, both on balance sheet and off balance sheet. We’ve written before that we’re concerned-as were some of the rating agencies at times-at the use of its joint venture with GE Capital (and now with Varagon) to take on much higher effective leverage than the BDC rules allow on balance sheet. Moreover, to boost earnings and protect the dividend, Ares Capital has continued to invest heavily in second lien and riskier investments in recent quarters even as many signs of the possible Credit Apocalypse have been gathering. To date, all those concerns have not translated into any great deficit in credit losses (although IVQ 2015 results were not stellar) or any material drop-off in profitability. Management continues to argue that they are as cautious and conservative as they’ve ever been, but could they say anything else ?  With the bulking up in the total size of Ares Capital (and the ultimately huge boost in recurring management and incentive fees that will follow for the parent) we worry that high leverage (even if disguised by holding assets off in its joint ventures) and credit risk taking will continue, but on a bigger scale.


    To be specific, we’re not huge fans of the staple of Ares Capital’s lending activity-financing very large sponsor financed buy-outs. Yes, the lender has a moneyed and experienced partner in the Private Equity groups involved (Ares Capital works with the Best, the Brightest and The Biggest), but this is a highly competitive business where spreads are thin. Yes, credit losses have been very low in recent years, but this has been a long expansionary period. Yes, Ares has operated successfully in this arena thanks to the firepower available from its relationship with GE Capital (and now with the extra capital from ACAS shareholders) and by taking on most of the credit risk involved in return for a mid-teens (!) all-in return. However, the time may come when the piper has to be paid and the exposure to these very large buy-outs may result in out-sized losses that will surprise current shareholders, and the newly arrived former ACAS owners who might have thought they were done with such drama.


    Ares Capital is buying out American Capital at what appears to be a reasonable price point. We expect the deal will go though when voted on in July. ACAS shareholders should take comfort that their assets will no longer be managed by a self-serving and inefficient American Capital management organization and will be entrusted to one of the most successful BDCs of all time.  Yet, this story is not over because much can happen in the short term to the market and in the long term as Ares Capital presses on with its strategy of big ticket lending, and taking every advantage of the capital markets to maximize asset deployment.


    We were Long both American Capital (in our Fund and in our BDC Value portfolio) and in Ares Capital (in just our BDC Value portfolio) at the open. In our Fund, the ACAS position was a Best Idea (we only have two or three at a time, and this leaves us with only two left). We hoped to make a capital gain and get out when the acquisition came to fruition, which we did today. We bought ACAS at $14.0456, and sold at $15.73. That’s a 12% gain over about 120 days (we bought in January) or about 36% annualized (which always sounds better). We would not be surprised if the price moved up after the deal is approved and some of the uncertainties removed. However, we’re in a “take-the-money-and run” mood after a long holding period for this particular Best Idea. ACAS management have taken a very long time to accept the inevitable and sell. We typically hope our Best Ideas will prove themselves out in a matter of weeks.

    By the way if anybody is interested in knowing what our other two Best Ideas are (we have not had time-with all the energy spent on the BDC Credit Reporter-to write them up here), please drop us a line at, and we’ll be happy to let you know. Both are still playing out and trending in the right direction.

    We are keeping our position in Ares Capital in our BDC Value portfolio, where we take a longer term view (5 years or more). The stock price drop today of ARCC (down 2.4%) does not bother us. We have enough confidence in the buying capability of Ares Capital (even if their judgement may be partly clouded by the prospect of all those extra management fees). We hope for a greater pull-back to add to our position.




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    NEW BDC CREDIT REPORTER FILE: Healthcare Associates of Texas BDC EXPOSURE: ABDC Mon, 23 May 2016 15:45:04 +0000 5-23-2016: We’ve added a new company to our Master File of all companies to which Business Development Companies have exposure. Alcentra Capital (ABDC) announced in a press release and in its recent earnings report a new loan to Healthcare Associates of Texas. Click here for the full file, and details on the acquisition that generated the new financing, the key terms of the loan and what we know so far about the Company. As new information is gathered in the months ahead,  the file will be updated.

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    BDC CREDIT REPORTER FILE: AAR Intermediate Holdings MCC, CMFN, Sierra Income Sat, 21 May 2016 14:04:32 +0000 5-21-2016:  We’ve just updated our file on AAR Intermediate Holdings, a privately-held oil services company owned by multiple Business Development Companies (including Medley Capital and CM Finance) and which is on non-accrual. Not much has happened this quarter from a valuation perspective. Nonetheless, we expect the $4mn in equity exposure by the BDCs to be written off, and 50%-100% of the $55mn in Senior Debt. At the low end of the range (our Optimistic View) that would result in a slightly greater further write-down in asset value. In a Conservative case, another $33mn might be lost from gross exposure at cost that was close to $60mn.  Click on the file for all the details we’ve been able to assemble and make up your own mind.

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    BDC CREDIT REPORTER REPORT PART I OF II: Apollo Investment (AINV) Energy Portfolio Thu, 19 May 2016 20:20:11 +0000 5-19-2016:  Apollo Investment (AINV)  reported full year and last 3 months results overnight and held a Conference Call a couple of hours ago. The BDC Credit Reporter jumped on the latest portfolio list to determine credit trends, after a quarter in which many investments were written off: $75mn to be specific.  For the full fiscal year Apollo wrote off $195mn, and since inception the BDC-run by an affiliate of supposed credit titans Apollo Group (APO)-has total Realized Losses of $1.3bn. That’s 43% of equity capital raised over the years.


    We  had undertaken a portfolio review last quarter, for the period ending 12-31-2015, and counted two dozen under-performing companies amidst the 100 or so companies in which Apollo lends and invests. After another quarter of focus on restructuring and weeding out troubled credits in this perennially under-performing BDC, we were hopeful that some progress had been made.


    However, our first pass through the portfolio at March 31, 2016 suggests credit quality remains in question, and that there might be further Realized and Unrealized write-downs ahead. In this first of two articles we are going to focus exclusively on what has happened and might happen to  the still very large energy portfolio. Much of the decline in NAV for the period was concentrated in this portion.

    Oil and gas, legacy and commodities accounted for $0.22 of our $0.28 decline [in Net Asset Value].

    Some progress was made in the period, as management discussed on the Conference Call:

    Oil and gas represented 11.9% of our portfolio or $347 million at the end of March, down from 12.9% or $395 million at the end of December on a fair value basis. The decline was due to the partial sale of our investment in Deep Gulf to a third party, as well as fair value adjustments. At the end of March, our portfolio had seven core borrowers.

    FAR, FAR FROM OVER                        Falling from tall building

    With that said, though, there is much unresolved in the portfolio, and several names are still deteriorating:

    Pelican Energy was written down further in the period and added to the already long non-accrual list:

    On Pelican Energy, an entity financing participation in certain wells at Chesapeake Energy, this company’s assets are more tied to gas, which represent 75% of production. We have a $28 million first lien investment marked at 65% of cost. The decline in value during the quarter is the result of lower oil and gas prices, combined with production rolling off. Pelican may PIK  (Pay In Kind] interest going forward to preserve liquidity, and given the tighter liquidity and lower net asset value, the risk rating on this investment was lowered to 5 and placed on non-accrual.

    The $28mn debt and equity invested by Apollo was marked at just about par 9 months ago but has now been marked down three quarters in a row. At March 31 2016, the FMV was still $17.5mn and could presumably drop further. Certainly, with the loan on non-accrual nearly $3mn of annual investment income is going to be lost to the BDC. We expect a Realized Loss will be forthcoming shortly, and a return to some sort of current pay, but Apollo could easily lose half of what was invested in Pelican by the time this plays out. As we’ll explain a little later that does not even necessarily mean the credit is out of the woods…

    Osage Exploration has recently undertaken a restructuring which will mean Apollo will shortly have to recognize a permanent loss of $20mn, leaving $5mn of the original investment to (perhaps) return to accrual status in the current quarter. Income lost here is over 80% of what was previously being earned when all was well.

    Another huge exposure is to Spotted Hawk Development, and that energy deal is still headed downward as management admits:

    Moving to Spotted Hawk, an E&P company with core Bakken assets, we have $84 million first lien investment marked at 76% of cost. The … investment was placed on non-accrual in the quarter. Despite being the core of a good basin, having good drilling results and taking steps to preserve cash, the company’s liquidity remains constrained. We believe the company may go through a restructuring in the near term.

    Based on what has happened in other “restructurings” Apollo may have to recognize another $20mn or more in Realized and Unrealized losses at Spotted Hawk.

    Then there’s Venoco, which is also right in the middle of its own bankruptcy process. As Jonathan Bock of Wells Fargo highlighted, there might be yet significant downside to the value that energy company is marked at:

    Question – Jonathan Bock: Okay. And then the last question just relates to Venoco. So clearly, see the first lien at 80% and the second lien at 58%, Ted. As we look at just the general reports across the space, can you tell us your confidence level in receiving a 58% recovery on that asset, in light of the fact there may be other points to say that recovery on that loan may be something less? Is there something that perhaps we’re missing or the market is missing that allows a second lien mark at that level to date?

    Answer – Ted Goldthorpe: Yes. So what I would say is, we’re just confirming the second lien mark. I think second lien was actually marked a little lower than what you just pointed out. So I would say on Venoco, I would say they have a very large asset that is a big contributor to value that may or may not happen.

    So the valuation of Venoco specifically, vis-a-vis everything else we do, is probably more variable, I would say. Because the future prospects for the Company have more upside and more downside depending on one large asset that’s subject to regulatory approval. And so that’s why when you see a first lien, I’m assuming the question is, if the first lien is marked at 80%, why is the second lien marked so high?

    And the answer is, if you look at the future outcomes for the business, there’s a whole bunch of scenarios where there’s value through to second liens and there’s also scenarios where the second lien is impaired. It’s a little bit of a one-off vis-a-vis everything else, because there’s just so much future value that’s dependent on approvals of future lease rights. So that’s why the numbers might look a little strange to you.

    There’s $53mn in play where Venoco is concerned. Writing that down by-say-50% would still result in $27mn in further loss to NAV.

    There are 3 other energy investments which appear to be performing as expected on Apollo’s books. However, in this environment “nobody is safe “(as they say in the movies). The BDC has about $150mn in these assets which will remain questionable until secular market conditions change, which might take years.


    Of course, we hope things will turn around for Apollo’s energy investments, and that is still a prospect. However, a Conservative analysis suggests there may be $50mn more of yet unrecognized losses of the values of the 4 under-performing energy companies at March 31 2016, and even more in permanent write-offs to come. If one or more of the performing investments slip up there is 3x as many dollars at risk. That’s anywhere from $0.20 to $0.80 a share in lower NAV possible. We are projecting out only the former.


    However, there is no certainty that the almost cookie cutter process underway in the oil and gas space where over-leveraged companies restructure themselves by converting 75%-90% of their debt to equity-and turning their lenders (including Apollo which is comfortable with such a role) into owners, is going to succeed. Oil and gas companies require huge amounts of capital just to stand still-in the form of additional drilling to replace existing fields. Moreover, the very absence of much oil production being permanently abandoned as well as other factors might yet result in lower oil prices, or no rebound from current levels for many years. Absent more disclosure about the economics of these restructured companies, nobody should be counting their oil money gains. We may yet get a second wave of bankruptcies in the years ahead. The BDC Credit Reporter has had a look at the financial statements pre-bankruptcy of some of the publicly traded players and come to the conclusion that wiping out debt alone may not be sufficient to make many players successful, unless we get a big jump in oil prices.


    THE GODFATHER PART III, Al Pacino, 1990, © Paramount/courtesy Everett Collection, GD3 095, Photo by: Everett Collection (3721)
    THE GODFATHER PART III, Al Pacino, 1990, © Paramount/courtesy Everett Collection, GD3 095, Photo by: Everett Collection (3721)

    Ironically, we may have a situation in the short term where lenders-cum-owners like Apollo will have to advance MORE funds to these troubled and restructured companies to ensure they can continue to operate. Over time there might be a vigorous debate about whether good money is being thrown after bad, especially if oil prices drop below $30 a barrel and stay there.


    Investors and managers alike (one could hear the exhaustion in the voices of Apollo’s senior managers on the latest Conference Call) would like this episode to be over. However, we may yet be in the middle innings of a drastic and wholesale re-jigging of the ownership, funding and prospects of the smaller oil and gas sector in this country.  Much has been lost already by Apollo (although managers and investors are probably hoping their equity interests will pay them back one day-in all or in part). However, much more could yet be lost as there is no easy way for Apollo to sell off existing assets at a decent price and no end in sight to the process that began two years ago with the drop in the $100 drop in the oil price.

    NEXT: We review Apollo’s non-energy exposure. Spoiler Alert: Much to worry about there too…



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