BDC Reporter http://bdcreporter.com News and Views on the Business Development Company Industry Tue, 21 Jun 2016 19:13:10 +0000 en-US hourly 1 https://wordpress.org/?v=4.5.2 BDC Investment Status Report: Southland Capital Management http://bdcreporter.com/2016/06/bdc-investment-status-report-southland-capital-management/ http://bdcreporter.com/2016/06/bdc-investment-status-report-southland-capital-management/#respond Mon, 13 Jun 2016 20:59:09 +0000 http://bdcreporter.com/?p=766 June 13, 2016:  Southland Capital Management, the Registered Investment Adviser which publishes the BDC Reporter, is invested in the BDC sector, both through our small family and friends Fund (BDC II) and through a number of  Separately Managed Accounts (SMA) with different strategies, risk-reward profiles and objectives for clients and for our own account. We offer up to any reader interested how SCM looks at the BDC investing landscape at the mid-point of 2016.

MAIN FOCUS

Currently, we are mostly invested in BDC Notes in our Fund (every investment in fact, except for one short position we’ll discuss below). Moreover, we’re just adding a new SMA client who will be invested exclusively in the Notes and on an unleveraged basis. (The Funds uses leverage up to a maximum of 3:1, but at 2.25x currently).

SLEEPING WELL AT NIGHT

At the current time, investing in BDC Notes is a decent place to be. After the drama of earlier in the year when most BDC Notes (and similar Closed End Funds Preferred and Notes) dropped to prices below par, there has been a sharp reversal of fortune. Of the 22 different positions we hold, 19 are trading above par. Two-thirds are trading above the price we paid for them. Even the BDC Notes trading below our cost are down no more than -0.9%, while paying out annual yields north of 7.0%. On a Total Return basis ALL of our BDC Note investments (some of which date back to 2012) are in the money.

TOMORROW WE COULD BE TOSSING AND TURNING

Of course, Mr Market (as we discuss below) is in a good mood of late. The experience of the last few months suggests that these relatively thinly traded securities could drop back down in value when we have the next crisis. The good news,though, is that the likely drop in value has typically been only a fifth of what happens to the corresponding common stocks, which limits price volatility. Moreover, we continue to be convinced that the BDC Notes we’ve chosen are capable of weathering the next recession and still getting repaid at par (whatever happens in the interim to their price as investors duck and weave), which cannot be said with the same confidence about the common stock price of these same BDCs.

LET’S TALK RISK

By our reckoning we face two major risks in our Fund The first is what happens to interest rates in the next 5 years. An increase in long term rates might reduce the value of the Notes during our holding period, but would not affect investments held to maturity, assuming no credit problems. We might also have to pay more to borrow under our margin agreement should short term rates increase. We are at 1.0% per annum or less (thank-you Federal Reserve) but that could increase and reduce the net yield to be received over the lifetime of the investment.  Still, those are risks that more likely to result in lower than anticipated gains rather than losses and falls into the category of Risks We Are Willing To Take.

Harder to evaluate is the risk of an unexpectedly large drop in the value of the Notes during a crisis and a margin call under our borrowing agreement. Thankfully, the Fund’s lender provides a generous borrowing base calculation, and the Fund does not leverage itself to the hilt. Given the low volatility nature of the investments in portfolio and the diversification across two dozen issues, the chances of a margin call occurring are minor, and would require Note values to drop by nearly a third. In any case, we have the ability to retain income in the Fund to de-leverage, if necessary, or sell some investments if need be.In our Fund and with our eyes open,  we’d rather target mid double digit returns by taking on this risk than play it safer by avoiding the use of leverage.

Of course, our unleveraged new SMA invested in a portfolio of BDC Notes won’t even face this risk, but should be able to continue clipping coupons through any turmoil we can reasonably envisage.

STRESS TESTED

By the way, we stress test every BDC Note with a 20% expected write-off of assets and a host of other calculations before we deem them resilient enough to invest in. Not every BDC Note passes our Stress Test, but most do which accounts for the favoritism which we’ve extended to this asset class.

POOR PICKINGS IN BDC COMMON STOCKS

Finding any opportunities right now in being Long BDC common stocks is very hard. The whole BDC Sector is in rally mode since falling to a post-Great Recession low on February 11th. Using the imperfect measuring stick of the UBS Exchange Traded Note with the ticker BDCS, the sector is up 17% since the depths of February, using the latest price.  (Still, BDCS is trading plumb even with its price at year-end, as we approach the 6 month mark of 2016-a stark reminder of how volatile this sector has been). Moreover, after a month of rallying, BDC prices have remained at relatively stable levels since mid-March. We are now entering the fifth month of the upturn in prices, one of the longest periods in recent BDC history, even if prices have been treading water in the last 12 weeks.

LOCKSTEP

Drilling down a bit, we note that three-quarters of BDCs are trading above their 200 Day Moving Average, and 60% above the 50 Day Average. Many BDCs are trading close to or above their Net Asset Value, after having been at big discounts to book in the winter. 15% of the public BDCs we track are within 5% of their 52 week highs, and only a couple are even near their 52 week lows. As usual, the entire BDC sector is moving-more or less-in lock step.Tracking No Hat

BARGAIN HUNTING

As we fancy ourselves as “value buyers”, there are very few “bargains” out there, both from a short term or long term perspective.  Regarding the former, after the very sharp mark-up in prices that has already occurred and the flattening out in prices of the March-June period, we are not ready to presume there will be another leg up in BDC prices.  The challenges which caused the 37% drop in BDCS between July 2014 and February 11th 2016  have not gone away. Energy investments in BDC portfolios continue to be challenged and we expect write-downs to continue to outpace any write-ups. There are plenty of credit issues to worry about in non-energy credits. Then there are all the usual suspects of macro risks to worry about, including Brexit and what that might do to the world economy. (Remember that the last time the markets worried about the European Experiment in 2011 BDCS dropped 28% in a few weeks, even as credit quality remained excellent). We could be wrong-Mr Market never fails to surprise, beguile and bewilder-but we’re comfortable just saying No Thank-You. Also galling is that borrowers-after a few weeks away-are back in the driver’s seat in leveraged finance. There is still plenty of capital looking for a home, and borrowers are once again being offered generous pricing and loose covenants by lenders of every stripe, from High Yield down to middle market LBO lending. If there’s anything we’ve learned from investing in the BDC sector over the past decade or more is that-like the weather-change in sentiment is a constant. Today everything is expensive. The day after tomorrow we could be back at an all-time low.

GOOD BUT GOOD ENOUGH ?

Longer Term there are a number of better-quality BDC companies which can reasonably navigate any recession we’re likely to have over the next 5 years (our rule of thumb ) and generate a decent return, based on our models.  However, our projections-which typically assume 10%-20% NAV erosion even for the better companies (heresy to some but supported by the facts if you look at the long term performance) suggest average annual returns will be in the high single digits at best, with much rocking and rolling along the way. We’d rather be in BDC Notes at 2:1 leverage and earn a 14% or so annual net return (and take the ensuing interest rate risk) while remaining higher up on BDCs balance sheet 7 years into the economic expansion.  As far as we know globalization and technological change have not abolished the cyclicality inherent in capitalist economies. As we’ve said, there are very few BDC common stock investments out there which promise to generate a 15% per annum return over the next 5 years in our Base Case at current prices. We only have two holdings which fall into that category, and both are held in our house account.

SHORT SHORT LIST

We’re left looking either at “shorting” certain BDCs whose valuations have risen too far in the latest rally or “special situations”. Regarding the former, we have a number of names on our Watch List which both offer up the opportunity for “shorting” and which we can borrow in volume and at a borrow cost that is acceptable. However, with the Good Times Are Here Again atmosphere obtaining in the BDC Sector and leveraged finance space right now, this is not yet the time-in our minds-to be shorting. We need individual catalysts to separate BDCs from the rallying pack. We had success shorting BlackRock Investment (BKCC) , helped when the Company announced several new non-accrual loans in the IQ 2016. However, we closed down our position in Prospect Capital (PSEC) on recognizing that renewed investor enthusiasm for this controversial stock was not about to abate in the short term. As we’ve said above, we’re only left with a “short” in FS Investment Corporation (FSIC). We did the research and came away convinced that there are potentially many credit losses ahead in that portfolio and the stock has been trading at or above NAV, which seems unsustainable. Nonetheless, we’re still in the red on that insight by 8% three months after the short was initiated. The next earnings report might be the catalyst we’re looking for, but there’s no guarantee what Mr Market will do.

Analysis
Analysis

SPECIAL SITUATIONS

That leaves us with Business Development Company Special Situations. These are typically short term opportunities to take advantage of an unusual set of circumstances that might be keeping a BDC’s stock price down.  This usually involves SCM undertaking some “deep dive” analysis to identify the opportunity and to quantify the potential downside. We recently closed out such a Special Situation investment in American Capital (ACAS). We initiated the investment shortly after the management of the BDC bowed down to pressure from Elliott Management to finally relinquish control over their mismanaged assets.  After much scrubbing of the huge ACAS portfolio, and reviewing filings galore, we came to the conclusion that the chances of a premium to the then stock price was high and the downside was limited, given the discount in place and the presence of some very clear value within the trail mix of a portfolio that American Capital had assembled. Months later we were rewarded with news of the Ares Capital (ARCC) purchase of the bulk of the the ACAS assets (still underway) and we closed out with a gain. (Of course, we could have squeezed out more dollars by hanging in there till the deal closes but we preferred to take the money and run. In this case we just ran right over to Ares Capital for immediate re-investment as a Long Term investment…)

INVESTMENT OF ONE

Today we only have one Special Situation/Best Idea long BDC common stock investment on the books, using our own capital.  Two months ago, we undertook a “deep dive” into Full Circle Capital (FULL). This micro BDC is in the throes of being liquidated one way or another (getting repaid from existing borrowers or selling assets in the market or to another lender). Our review-at a time when the stock price was at $2.52 a share-indicated the ultimate value of FULL-after all bills get paid and taking into account some very poorly underwritten credits-is $3.0-$3.25 a share. That was two months ago. We are up just under 6% so far, but there are still several months to go before we find out if we were wise or foolish. The Company just agreed to reduce its Revolver from $45mn to $5mn with Santander Bank, which suggests the portfolio liquidation is continuing apace. There is a October 2016 deadline on the amended facility, which MIGHT suggest there is a timetable that management and the lenders are following.

UPSIDE-DOWNSIDE

Since we initiated our position there has been some news about portfolio asset sales, but nothing definitive or which will decisively move the needle one way or another. We wait, watch and worry. We are targeting a 20% capital gain over a 6 month total time horizon, or 40% per annum if we’re right. If we’re wrong, the downside should be limited by the fact that most of the Company’s debt has been paid off or is covered by cash from asset dispositions.  Given the work we’ve been doing on the BDC Credit Reporter we’re familiar with some of the Company’s more liquid assets and believe that has helped us in evaluating the de minimis value of the portfolio. Moreover, everything points to the final liquidation of the Company by the autumn.

UPDATES

We will update the status of the investment every month or if we sell our position.

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BDC Credit Reporter: Company Alerts-UPDATED http://bdcreporter.com/2016/06/752/ http://bdcreporter.com/2016/06/752/#respond Wed, 08 Jun 2016 14:15:44 +0000 http://bdcreporter.com/?p=752                                                                                                                                                                SEE ALL ALERTS

Tuesday June 21, 2016

Caesar’s Companies Agree Amendment With Senior Lenders

  • Both bankrupt Caesar’s Entertainment Operating C0. (CEOC) and non-bankrupt parent Caesar’s Entertainment (CEC) agree amendment with senior lenders.
  • Key provisions include lenders support for CEOC restructuring plan, in return for repayment (if BK court allows) of $300mn of Revolver debt outstanding in next few weeks.
  • Also CEC to pay $10mn monthly  to lenders from January-June 2017 on CEOC obligations, under certain circumstances.
  • Amendment appears to be net positive for both senior lenders and chances of CEOC bankruptcy plan getting approved by bankruptcy court.
  • However, CEC already envisaging potential bankruptcy for itself should deal with CEOC creditors requiring asset restitution fail.
  • BDC exposure is Major: over $200mn. 5 BDCs involved but principally held by Franklin Square funds. 99% in senior secured. See Advantage Data chart.
  • Write-downs at 3-31-2016 4-14% (depending on BDC) for same loan.
  • Today’s news appears to be net positive for valuation, but far from resolved. BDC Credit Reporter has both companies on WATCH status. No snr. debt loss expected.
  • FSIC, FSIC II, FSIC III, CORPORATE CAPITAL, VII PEAKS

Screen Shot 2016-06-21 at 6.58.18 AM


Monday June 20, 2016

Halcon Resources: Solicits Creditor Approval of Restructuring/De-Leveraging Plan.Oil price drop

  • Energy co. in Chapter 11 Halcon Resources formally requests all creditor approval of restructuring plan in order to emerge from bankruptcy.
  • Proposed restructuring plan apparently unchanged from outline described on June 10, 2016 (see below).
  • BDC exposure is modest and exclusively in Subordinated Notes, which are receiving modest cash and equity and being written off.
  • BDCs involved: Main Street Capital (MAIN) & HMS Income Fund. Written down exposure at 3-31-2016 by 80%.
  • BDC Credit Reporter expects Realized Loss to be booked in IIQ 2016, and none to small further write-down in value, if restructuring closes.
  • MAIN,HMS

Speed Commerce Operating Company LLC: New Company announces acquisition by Garrison Investment Group

  • Garrison Investment Group announced completion on June 15 of acquisition of assets of bankrupt Speed Commerce Inc. and launch of new operating company.
  • New entity called Speed Commerce Operating Company, LLC (NewCo) and will be owned by the creditors of the former entity, principally Garrison funds.
  • NewCo has recruited new senior management (CEO, CFO and COO) and intends to continue and expand Speed Commerce’s prior business.
  • Details are spare but Garrison has $150mn invested in prior investments in bankrupt company and new capital.Navistar truck
  • New CEO-in interview with trade publication-announces ambitious plan for bigger footprint and staffing increase.
  • Major example of lenders becoming control owners in a failed business.
  • BDC Exposure: Moderate:$27mn at cost to Garrison Capital (GARS) and non-traded Credit Suisse Park View BDC.
  • All exposure apparently in uni-tranche loan to Speed Commerce Inc. NewCo exposure in amount and form unknown.
  • Uncertainty about how BDCs will value new investment after 75%-85% write-downs through March 31, 2016 prior to NewCo launch. Realized Losses expected.
  • GARS, CREDIT SUISSE

 

Tuesday June 14, 2016

Gymboree StoreGymboree Corporation: Reports Earnings As Projected. Debt Level Remains High.

  • Children’s clothes retailer Gymboree Corporation reported quarterly results.
  • Sales, Adjusted EBITDA above same period last year. 2016 guidance re-affirmed at Adj EBITDA of $120mn-$135mn.
  • Company claims liquidity “sufficient” to service debt and “invest in the business”.
  • However, rest of 2016 Plan includes closing 20-30 stores, opening 6. Capex cost: up to $35mn in FY 2016.
  • BDC Credit Reporter points out: Despite buying back debt at discount, leverage remains very high: nearly 8x Adjusted EBITDA.
  • See earlier article dated April 27, 2016.
  • Free cash flow calculated as median Adj EBITDA less interest and median capex only approx. $15mn projected vs debt over $1.0bn.
  • BDC exposure: Modest. 3 BDCs with Senior or Subordinated debt. Biggest: Corporate Capital with $11mn At Cost. FMV: 31% lower.
  • Corporate Capital Trust, KCAP, VII Peaks II.

Navistar International: Analyst Downgrades. Expresses Credit Concerns In Long Term.Navistar truck

  • Truck manufacturer Navistar International (ticker:NAV) downgraded by analyst at Stifel.
  • Action follows release of quarterly earnings and big jump in stock price last week.
  • Stifel concerned with heavy truck market conditions, Navistar market share and heavy debt load.
  • BDC Credit Reporter spotlighted similar concerns in article on June 7th, after reviewing results and outlook.
  • We downgraded Company from WATCH to WORRY.
  • FSIC, FSIC II, FSIC III

Monday June 13, 2016Landfill Compactor

City Carting: Company assets sold to strategic buyer

  • Waste management company City Carting sold certain operations to Tunnel Hills Partners on June 3rd in a cash and stock transaction.
  • Assets sold generated $110mn of sales in 2015. Terms of transaction not known.
  • City Carting has been on block for over a year.
  • BDC exposure is Modest: all in two Preferred issues totaling $15mn at cost from Alcentra Capital (ABDC)
  • At 3-31-2016, junior Preferred tranche was written down by $1.5mn.
  • Possible Realized Loss to be booked in IIQ 2016.
  • See Alerts database and Company File.
  • ABDC

Friday June 10, 2016

Halcon Resources, LLC: Restructuring Agreement in Chapter 11 Announced

  • Bankrupt public oil and gas producer Halcon Resources (HK) announced a complex restructuring deal with its creditors while in Chapter 11.
  • The plan-which was as expected-involves the swapping of nearly $2bn (or two-thirds) of debt outstanding for equity in the Company.
  • Proposed arrangement would de-leverage balance sheet, reduce interest expense by $200mn annually, and allow exit from BK.
  • The arrangement still requires more creditors approval and court approval.
  • BDC Credit Reporter View: No Change from news.
  • BDC exposure is modest and exclusively in Subordinated Notes, which are receiving modest cash and equity and being written off.
  • BDCs involved: Main Street Capital (MAIN) & HMS Income Fund. Written down exposure at 3-31-2016 by 80%.
  • BDC Credit Reporter expects Realized Loss to be booked in IIQ 2016, and none to small further write-down in value, if restructuring closes.
  • MAIN,HMS

Charming Charlie, LLC: Requests bank loan amendment

  • S&P reports senior secured loan group to women’s accessory retailer consented to amendments to Loan Agreement on June 1, 2016
  • Terms of amendment unknown, but may relate to step-down requirements on leverage and debt service in 2016. Worrisome development.
  • Company has been under-performing for several quarters due to lower same store sales causing material drop in EBITDA (35% in 2015)
  • To the best of our knowledge, S&P credit rating remains at B, after reduction in December 2016.
  • 4 BDCs with exposure to Company-all in senior debt- with aggregate cost $45mn. Write-downs began second half 2015. Still modest. May increase IIQ 2016.
  • Biggest exposure is by THL Credit (TCRD) with cost of $24.6mn, according to Advantage Data.
  • BDC Credit Reporter downgraded Company from WATCH to WORRY on out-sized EBITDA drop, bank amendment, weak mall retail environment.
  • See Alerts database for further details.
  • TCRD, SIERRA, CION, PFLT

Thursday June 9, 2016

Cenveo Corporation: Completes Debt Restructuring

  • Print product public company Cenveo Corporation announced the completion of a major debt restructuring.
  • Complex restructuring includes debt forgiveness for equity issuance and  extension of debt maturities. Avoids bankruptcy.
  • Total debt to drop as well as interest expense according to 8-K filing.
  • BDC Credit Reporter expects rating agencies to increase credit rating
  • BDC exposure: $12.8mn at Cost in 2019 Senior Secured debt: Main Street and HMS Income Fund.
  • Current 12% write-down expected to be written up IIQ 2016.
  • BDC Credit Reporter maintains Company on WATCH status.
  • See full Company File from Master List of all BDC under-performing companies.
  • MAIN, HMS

Wednesday June 8, 2016

Glori Energy: Change In Senior Management

  • The Company announced the departure of its Chief Executive, replaced by the Executive Chairman as Interim CEO.
  • New CEO has 30 years experience in oil and gas production
  • Source: Press Release
  • SCM, HTGC

Navistar International: Citi Credit Analyst Downgrades Debt

  • Citi credit analyst downgraded 2021 Notes from Buy to Neutral after reviewing quarterly earnings
  • Reasons: “Debate around long-term fundamentals & the cycle, management expectations for a much weaker 2H [2016]”.
  • Source: Barron’s
  • See BDC Credit Reporter Spotlight article prior day with similar conclusions.
  • FSIC III, FSIC II, FSIC

 

 

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BDC Credit Reporter Spotlight: Navistar International Announces Quarterly Results http://bdcreporter.com/2016/06/bdc-credit-reporter-spotlight-navistar-international-announces-quarterly-results/ http://bdcreporter.com/2016/06/bdc-credit-reporter-spotlight-navistar-international-announces-quarterly-results/#respond Tue, 07 Jun 2016 17:02:38 +0000 http://bdcreporter.com/?p=748 On June 2, 2016  the BDC Credit Reporter published an Alert relating to a Zacks report suggesting troubled truck manufacturer would announce better than expected EBITDA performance for the fiscal quarter ended April 30, 2016 when results were published on June 7th. We suggested that the report-if true-might result in some upgrade to the outlook for the Company’s subordinated debt (where all BDC exposure resides) and which were written down by a fifth from cost at 3-31-2016.

UNDERWHELMED

Now that the quarterly numbers for Navistar have rolled in, the BDC Credit Reporter is less sanguine. Yes, EBITDA and (that bugbear of the SEC) Adjusted EBITDA were significantly higher than in prior periods. Moreover, the Company-which is in a highly cyclical business and is heavily leveraged and subject to above average regulatory and litigation challenges-managed to eke out a small profit. That’s notable because Navistar has not been profitable for several years.

QUICK DIVE

That was the good news, but much of the rest of the earnings release, investor presentation  and 10-Q filing, which the BDC Credit Reporter quickly reviewed, suggests the outlook in the short and medium term remains very cloudy. Notably, total sales are well down from the same time last year: 18%. Moreover, in certain segments such as Global Operations, the drop is even sharper: 47% ! Moreover, much of the EBITDA improvement came from a non-recurring item : warranty adjustments.

Crystal Ball

LOOKING INTO A GLASS DARKLY

More importantly, the Company pulled way back on prior guidance for the year ahead on almost every front: sales, EBITDA and cash.

The Lisle, Ill., truck producer now expects 2016 revenue in a range of $8.2 billion to $8.6 billion, down from its already downbeat prior forecast of $9 billion to $9.25 billion. Analysts, according to Thomson Reuters, had anticipated $8.79 billion. The guidance cut comes as Navistar says it now expects retail deliveries of Class 6-8 trucks and buses in the U.S. and Canada to be between 330,000 and 360,000 units, compared with a prior range of 350,000 units to 380,000 units.

The company also lowered its adjusted Ebitda forecast to $550 million to $600 million from its earlier outlook range of $600 million to $650 million.

Manufacturing cash is projected to reach $800mn. Previously, the Company forecast having up to $1bn in cash in FY 2017.

FREE CASH FLOW: GOING BACKWARDS

We are under-whelmed by what’s happening to so-called Manufacturing Free Cash Flow. The number for the quarter was positive by $28mn, but only thanks to receiving cash from the Company’s finance operations (which makes the term “Manufacturing Free Cash Flow” a bit of a misnomer, but we’re quibbling). According to the notes to the Investor Presentation, $64mn of free cash cash was raised from the finance business. That helped the Company pay down a little debt, but as we’ll discuss in a minute, there’s plenty of debt left on the books. Free cash flow over the last 6 months is negative $276mn, which is depleting the manufacturing operation’s cash reserves. In the last three years, a third of Navistar’s manufacturing cash has been used up.

FROM A LENDER’S PERSPECTIVE

This is not reassuring for the Company’s debt holders. At April 28, 2016, Navistar had $3.1bn in debt outstanding, essentially unchanged from the end of the last fiscal year 6 months ago. With capex projected at $125mn a year, interest expense at $240mn, continuing pension liabilities requiring outlays of $100mn-$200mn annually, and a weakening business environment, the Company’s room for maneuver is narrowing. Using our own Adjusted EBITDA (which deducts out capital expenditures), leverage is at 7.3x, which as a rough measure of such things, is very high, and potentially unsustainable.

FROM A BDC PERSPECTIVE

Unfortunately, all the nearly $50mn in BDC exposure to the Company is in the form of Subordinated Debt, due in 2021. Currently all debt obligations are current.

Looking down the road, though, we are concerned that the Company may have problems servicing its multiple obligations should there be any further deterioration in business conditions. No wonder the Subordinated Notes were being carried at a discount ranging from 19% to 24% of par by three different BDCs (all of them Franklin Square related and all sub-advised by GSO Blackstone).  We are guessing that in the IIQ of 2016 the valuation of the credit exposure may drop further.

Here is the Investment Ownership for both Navistar International and Navistar Financial Corp:

Screen Shot 2016-06-07 at 9.52.23 AM

All investment ownership data provided by an arrangement with Advantage Data (www.advantagedata.com)

MR MARKET ON A HIGH

Nonetheless, Navistar International is in no imminent danger. Shareholders are in a good mood after the latest results, with the stock up sharply.

LONG WAY TO THE FINISH LINE

However, the debt holders have another 5 years to go before getting repaid and there are many challenges ahead including possible higher interest rates, a weakening market abroad and at home for new truck purchases, diminishing returns from cost cutting measures, litigation with shareholders and ongoing government investigations.

Exposure at the junior level to a highly cyclical and highly leveraged company suggests Navistar International, and its separately financed subsidiary Navistar Financial (whose senior debt held by FS Investment III is currently valued above par) will be on the BDC Credit Reporter’s Master List for some time to come. Currently, we do not see any catalyst for any meaningful debt reduction in the medium term.

OUR VIEW

The BDC Credit Reporter has three internal rating appellations for under-performing companies: Watch, Worry and Write-Off. It’s too early to predict any Realized Loss (i.e. Write-Off) will occur given current performance, but with debt so high and sales, EBITDA and cash all projected to trend downwards by management themselves, we are placing Navistar International on our WORRY list, which is a downgrade from the WATCH status previously. Should Navistar stumble in the years ahead, we expect a partial or complete loss of the investment  may yet occur on the Subordinated Debt, and will-in all likelihood-require a larger provision than the discount currently applied.

DISCLOSURES

We happen to be short FSIC, and have been for several weeks.

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BDC CREDIT REPORTER ALERTS: Monday June 6, 2016 http://bdcreporter.com/2016/06/bdc-credit-reporter-alerts-monday-june-6-2016/ http://bdcreporter.com/2016/06/bdc-credit-reporter-alerts-monday-june-6-2016/#respond Mon, 06 Jun 2016 19:04:20 +0000 http://bdcreporter.com/?p=744 UCI International LLC         BDC: VII Peaks BDC II

  • Creditors of recently bankrupt auto parts manufacturer UCI Holdings clashing re: restructuring direction.
  • Company has no Debtor In Possession financing in place. Using cash collateral of senior bank lenders.
  • Bond holders-including $400mn of Notes-expect to become owners in debt for equity swap deal.
  • Company was acquired in leveraged buy-out in 2011 for $980mn. Creditors expect to agree to major debt write-offs/exchanges.
  • Only BDC exposure in Subordinated Notes from non-traded VII Peaks Co-Optivist Income BDC II, Inc.: Cost: $1.4mn. FMV at 3-31-2016: $0.2mn
  • See BDC Credit Reporter Alert file.

Caesar’s Entertainment Operating Company Co.  BDC: FSIC, FSIC II, FSIC III, Corporate Capital Trust, VII Peaks

  • Caesar’s Entertainment Operating Company is a subsidiary of Caesar’s Entertainment (ticker: CZR). The subsidiary is in Chapter 11, the parent is not.
  • The mediator in the bankruptcy announced that the junior creditors in the bankruptcy could not agree on settlement terms with the parent to resolve litigation.
  • The main issue under debate is compensation to the subsidiary for allegedly  unlawfully transferred assets to the parent or other entities priot to the Chapter 11.
  • With no resolution in sight, junior creditors claims may go to court, unless blocked by bankruptcy judge.
  • Without resolution, already very high legal costs for both subsidiary and parent expected to increase.
  • Risk of a bankruptcy of parent increases with no resolution and possible claims in excess of $10bn charged to parent.
  • BDC exposure to subsidiary is Major: $209mn. Divided amongst three Franklin Square funds (two non-public) and 2 other smaller non-traded BDCs.
  • However, all BDC debt exposure first lien senior secured, due 2017. Valued at 3-31-2016 at discounts from 1% to 15%.
  • Risk of bankruptcy of Caesar’s parent and two other subsidiaries increasing due to unresolved claims and costly litigation.

 

 

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BDC ACTIVIST: A Funny Coincidence… http://bdcreporter.com/2016/06/bdc-activist-a-funny-coincidence/ http://bdcreporter.com/2016/06/bdc-activist-a-funny-coincidence/#respond Fri, 03 Jun 2016 21:23:48 +0000 http://bdcreporter.com/?p=738 We could not help noticing that Ares Financial’s (ARCC) financing of the leveraged buy-out of Qlik Technologies will be a big win for “activist” investor Elliott Management. Elliott bought into the public company a few weeks ago at $23.50 a share, taking a big stake. Now, thanks to the buy-out, Elliott will be getting $30.50 a share and a handsome pay-off.

FANCY MEETING YOU HERE

The funny coincidence is that Elliott Management was the activist who encouraged the Board and managers of American Capital (ACAS) to put themselves up for sale. Although we’ve not seen the details, we expect many potential buyers kicked the tires, but Ares Capital got the nod to be the acquirer of the bulk of the ACAS assets and Elliott Management will make another payday.

INQUIRING MINDS

We can’t help wondering if there was any conflict of interest underway here. Did Ares Capital stretch to provide financing for the Qlik Technologies in return for Elliott’s blessing of its acquisition of American Capital ? We are only asking the question because with the thousands of different BDCs, activist investors and large financial institutions milling around on Wall Street, we find it coincidental that Ares Capital and Elliott Management should find themselves in two such high profile transactions within the span of a few days.

WHY INVESTORS SHOULD CARE

Again, we are not insinuating that anyone has done anything wrong. Nonetheless, the shareholders of Ares Capital could potentially be damaged if Ares Capital offered the buyer of Qlick Technologies a “sweetheart” deal to ingratiate themselves or as an offset for getting the nod on the American Capital transaction. Likewise, the shareholders of American Capital could potentially have received less from the sale of their company if Ares Capital received special treatment from Elliott in return for the hurried and generous financing of Glick, which went for over 10X EBITDA.

WE HAVE QUESTIONS

We may be worrying about shadows here. Still, we’re looking forward to hearing more about the sales process for American Capital, which should be forthcoming. Were there any other buyers for the huge BDC ? Why did the buying group for Glick Technologies not raise money from a bank group as usual for these large deals ? Did the availability of generous uni-tranche financing from the BDC group led by Ares Capital allow the buyer’s bid to succeed ?

CONCLUSION

The BDC Activist may be paranoid or completely wide of the mark, but we cannot help wondering if there was any explicit or implicit linkage between the sale of American Capital to Ares Capital and the generous financing of the buy-out of Qlick Technologies in which Elliott Management played the role of biggest shareholder and beneficiary. Just wondering…

 

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ALERT: Warren Resources Files For Chapter 11 Bankruptcy. http://bdcreporter.com/2016/06/alert-warren-resources-files-for-chapter-11-bankruptcy/ http://bdcreporter.com/2016/06/alert-warren-resources-files-for-chapter-11-bankruptcy/#respond Fri, 03 Jun 2016 16:35:15 +0000 http://bdcreporter.com/?p=735
  • Oil and gas public company Warren Resources filed for pre-packaged bankruptcy.
  • As of January 2016 , assets were $230mn and debts $545mn.
  • Terms of pre-pack have been negotiated but require court approval. Hope to emerge within 4 months.
  • From reading of filing,  estimate $415mn of debt to be written off for equity swap, including almost 50% senior debt.
  • First Lien lenders to provide $20mn Debtor In Possession financing, which will rolled into post-BK financing.
  • Pricing on new First Lien debt L + 900 bps (plus 1% floor) + 1% PIK. Equal to about 11.5%. Higher than current pricing.
  • Senior and second lien lenders and management to own new equity.
  • Enterprise Value of reorganized Company to be between $160mn-$180mn.
  • First Lien lenders to receive 82.5% of new equity, subject to dilution by management. Notes and second lien: 17.5%.
  • BDC exposure: Major. According to Advantage Data: $235mn at Cost, $189mn at FMV at 3-31-2016.
  • All BDC exposure held by Franklin Square funds. See Company File for details. All BDC exposure in First Lien Loan debt.
  • BDC Credit Reporter expects Realized Losses in First Lien Loan Debt to be about 50% of par.
  • Expect up to $71mn in additional losses from FMV at 3-31-2016 for Franklin Square funds.
  • Income Loss projected at about 40% of pre-default, pre-bankruptcy interest income on First Lien Loans.
  • Expect Franklin Square funds to provide bulk of $20mn DIP financing.
  • Only public Franklin Square BDC-FS Investment Corporation (FSIC) has modest exposure: $3.4mn at Cost.
  • Failure of Warren Resources represemnts major underwriting set-back for Franklin-GSO Blackstone.
  • See BDC Credit Reporter Company File for all details. Will be repeatedly updated.
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    The BDC Credit Reporter reviews leveraged loan defaults in May and impact on BDC lenders. http://bdcreporter.com/2016/06/the-bdc-credit-reporter-reviews-leveraged-loan-defaults-in-may-and-impact-on-bdc-lenders/ http://bdcreporter.com/2016/06/the-bdc-credit-reporter-reviews-leveraged-loan-defaults-in-may-and-impact-on-bdc-lenders/#respond Thu, 02 Jun 2016 16:05:13 +0000 http://bdcreporter.com/?p=730 INTRODUCTION: Leveraged Loan.com just published an article reporting that 4 issuers defaulted in May in the S&P/LSTA Leveraged Loan Index, bringing the default rate up to a 14 month high at 2.0%, and above April’s 1.6% rate. According to the article, the default level-as adjusted for the famous TXU bankruptcy which really belongs to an earlier period-is now at the highest level since December 2013. Of course, these are defaults amongst the very largest non-investment grade borrowers.

    GLASS HALF FULL ?

    However, as LCD’s own long term chart shows, defaults are still within “normal” ranges for expansionary periods. Heck, if you ignored all those bad energy loans (a once in a generation melt-down seemingly unrelated to the performance of the U.S. economy) the default rate might be scraping the bottom of the chart-close to the record lows reached for a period in 2006-2007 and 2011-2012.

    JOB 1:  WORRYING

    Nonetheless, the price of investing in leveraged loans is eternal vigilance-to coin a phrase. As the article suggests, credit watchers worry about the upward trend line in defaults, as much as the absolute level. After all 6 months into the Great Recession in June 2008,  the default rate was still lower than today’s rate !  Defaults are very much a lagging indicator of credit stress, especially in an environment where capital remains widely available, even for under-performing companies.

    Man looking at data

    ADVANTAGE DATA INSIGHTS

    Nonetheless, the BDC Credit Reporter delved a little deeper for matters of interest to our specialized audience. Using the comprehensive database we have access to from Advantage Data (www.advantagedata.com) we checked out how many of the defaulting issuers in May included Business Development Companies amongst their lenders. We can report-on the strength of that data-that only one had BDC exposure: Fairway Group Acquisition Co-the holding company for the New York-based grocery chain. Two Franklin Square non-traded funds (FS Investment Corp II and III) are amongst the lenders in a senior secured first lien facility with over $13mn at cost, and already written down by 25% at the end of the first quarter 2016. Substantial recovery is likely, but there will be Realized Losses being booked.

    Otherwise we found no current exposure in Dex Media, Seventy Seven Operating and Atlas Iron-all of which also filed for bankruptcy in May.

    OTHER THINGS TO WORRY ABOUT

    If BDC exposure to the May defaulters was minimal, and included no publicly traded BDC, readers should remember that there is another way these bankruptcies impact them and, in this regard, we have no clarifying data to offer up. Some or all these defaulting credits may be owned by one or more Collateralized Loan Obligation vehicles in which many BDCs invest. Deteriorating credit quality can eventually lead to junior tranches of the CLOs being not paid and interest and repayment proceeds being directed to the poorly paid but very secure senior tranches. In CLOs credit losses during economic expansions like the one we are in slowly erode the over-collateralization which support the senior tranches. We can’t say what the impact will be because of May’s widely anticipated bankruptcies, but we’d prefer to see even less defaults.  Unfortunately, judging from the BDC Credit Reporter’s own Master Database and other data gathering we conduct, the trend-both in the big ticket leveraged loan space and in smaller middle market transactions-appears to be for higher distress in the months ahead.

    We return to the watchtower.

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    ALERT ! : “Navistar International EBITDA outlook improving” BDC EXPOSURE: FSIC, FSIC II, FSIC III http://bdcreporter.com/2016/06/alert-navistar-international-ebitda-outlook-improving-bdc-exposure-fsic-fsic-ii-fsic-iii/ http://bdcreporter.com/2016/06/alert-navistar-international-ebitda-outlook-improving-bdc-exposure-fsic-fsic-ii-fsic-iii/#respond Thu, 02 Jun 2016 14:28:38 +0000 http://bdcreporter.com/?p=728
  • Zacks reports higher anticipated EBITDA at Navistar International (ticker: NAV) when earnings report.
  • According to Zacks adj EBITDA may be up as much as 32% over prior year.
  • Better financial performance may result in credit upgrade by rating agencies, BDC Credit Reporter.
  • BDC exposure to Navistar: over $50mn at cost and principally in Speculative grade rated Subordinated Notes, due 2021.
  • All BDC exposure at Franklin Square funds. Sub Notes median write-down 21% at 3-31-2016.
  • Navistar to report June 7.
  • See Navistar Company File.
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    UNDER THE HOOD: Prospect Capital Sells Harbortouch. http://bdcreporter.com/2016/06/under-the-hood-prospect-capital-sells-harbortouch/ http://bdcreporter.com/2016/06/under-the-hood-prospect-capital-sells-harbortouch/#respond Wed, 01 Jun 2016 23:38:00 +0000 http://bdcreporter.com/?p=723 INTRODUCTION: Prospect Capital (PSEC) just sold one of its largest Control investments, as announced in a press release. The BDC Reporter, as part of one of its Under The Hood series, has a look at what the disposition means for the Company and its shareholders.

    PROCEED TO CHECK-OUT

    First, the key facts as revealed in the press release. The company sold was Harbortouch Payments LLC, which was sold to Searchlight Capital Partners in a transaction that involved current-CEO and minority owner Jared Isaacman remaining in both roles.

    Now for the numbers, which are not broken out and include fees to be received. Prospect “expects to receive” $328mn. That includes fees. Let’s assume $8mn in fees, or just about 2% of the transaction size. That leaves investment proceeds of $320mn.

    DEBT AND EQUITY OUTSTANDING

    At March 31, 2016-according to the 10-Q– PSEC had $297mn in 3 loans outstanding to Harbortouch at cost. There was an equity investment in the form of Class C common stock shares  of $8.7mn at cost. This suggests that the equity value of said equity came in at around $23mn ($320mn in net non-fee proceeds less debt outstanding at par of $297mn). At March 31, 2016, the stated fair market value in the filing was $43mn.

    DEVALUED ?

    A year ago the Class C shares (by which Prospect controlled the Company) were valued at $80mn. Given the drop since June 2015, and the apparent drop since the March 2016 valuation, we’d guess Harbortouch was either exhibiting weaker financial performance or was previously over-valued, given that the FMV of the equity on sale is only 29% of what it was valued as of June 2015.

    Moreover, Prospect will not be getting all the proceeds right away. First, a portion of the sale will be escrowed (details unknown) and $28mn will be re-lent to the Searchlight-owned Harbortouch.  We’re estimating net proceeds in cash terms will be well under $300mn, and may be slightly under the cost of the 3 loans currently outstanding.

    IMPACT ON INCOME

    Prospect has been booking about 10% a year in annual income on its $305mn invested at cost in the Company or about $30,000 a year. Some of the income was in the form of Pay In Kind, which accumulated annually. We don’t know if that was paid pro-rata or not, but did account for $8mn of the $30mn in annual income. The rest was in cash.

    The repayment will theoretically allow the re-deployment into higher yielding investments-whether by lending or by buying back stock.

    The size of the transaction is substantial accounting for nearly 4% of income. However, given the size of the PSEC franchise, and its capital constrained nature, redeployment should not take long, or materially affect recurring earnings per share.

    CREDIT PERSPECTIVE

    From the BDC Credit Reporter‘s standpoint, the repayment (except for the new-presumably riskier but smaller second lien loan for $28mn) is credit positive. That’s especially the case if the performance of Harbortouch was deteriorating prior to the sale.

    CONCLUSION

    This closely held has been on Prospect’s books for 3 years with very modest information forthcoming, despite its importance by size. Although the BDC press release brags about an expected  14% IRR return over the period (a metric we believe is more misleading than revealing) this has not been a home run for Prospect. More like a solid double.  However,  it is hard to determine if the sudden repayment of nearly $300mn will be positive or negative for this complex BDC. $30mn in annual income will have to replaced, but with a huge origination machine and multiple uses for the proceeds new investments, stock buybacks, debt pay-down) we don’t expect much long term impact on earnings and NAV from this transaction.

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    Alert ! “Linc USA Files For Bankruptcy” BDC EXPOSURE: Business Development Corporation CORRECTED VERSION http://bdcreporter.com/2016/06/alert-linc-usa-files-for-bankruptcy-bdc-exposure-acsf/ http://bdcreporter.com/2016/06/alert-linc-usa-files-for-bankruptcy-bdc-exposure-acsf/#respond Wed, 01 Jun 2016 15:55:58 +0000 http://bdcreporter.com/?p=720
  • Oil and gas producer Linc USA GP, and other affiliates, has filed for Chapter 11 bankruptcy.
  • Senior secured lenders providing $10mn in Debtor In Possession financing.
  • Company is seeking to sell many of its assets to repay lenders.
  • BDC exposure: Business Development Corporation of America with $8.9mn in Second Lien debt. Already written down 99% at 3-31-2016.
  • Pennant Park (PNNT) had major exposure to first and second lien but sold for Realized Loss in IQ 2016.
  • BDC Credit Reporter expects Realized Loss in IIQ 2016.
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