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Portfolio Company of 4 Business Development Companies Files Chapter 11

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On October 3, 2017  GST Autoleather, Inc. announced filing for Chapter 11.  Given that the automotive upholstery company has borrowed $67mn from 4  BDCs, the BDC Reporter has delved into the details of the bankruptcy; reviewed – using Advantage Data‘s records – BDC exposure to the Company and sought to analyze the likely impact on each lender. The press release is attached.


NEWS

Company

The Company sought voluntary bankruptcy Chapter 11 relief in Delaware, and is seeking to remain a going concern.

Total liabilities were listed as $196mn.

The unnamed “senior secured lenders”  have agreed in advance to provide a $40mn Debtor-In-Possession (“DIP”) financing to help the Company post bankruptcy.

The Company has agreed with the Bankruptcy Court to undertake “a court-supervised going concern sale, commonly referred to as a ‘363 Sale’ “.

The senior secured lenders – as a group – are seeking to negotiate the purchase of the Company out of bankruptcy, as a backstop.

GST Autoleather was acquired in 2008 by Japanese investment group Advantage Partners for $300mn. However, the Company had severe financial troubles in 2011, which required additional capital and extraordinary financial measures by the owners to rescue the operation.

In opening court filings  the Company said that it had been exploring all-asset sale options since 2015. That effort accelerated recently amid liquidity concerns created by declining prices for leathers, a decline in the amount of leather used in new vehicles and quality problems…

BDC Exposure


ANALYSIS

Capital Structure

According to “sources”, the Company’s financial performance has suffered as several contracts with “major auto-suppliers are in jeopardy”, according to a July 2017 article.

Based on the above article, the Company appears to be financed by a $30mn Revolver, provided by the said “senior secured lenders”, a senior secured Term Loan (which may contain A and B tranches) and a $30mn “mezzanine tranche with two funds”.

Upstairs/Downstairs

BDC exposure is neatly divided between secured and unsecured. Main Street (MAIN) and HMS Income Fund – it’s non-traded sister BDC- are in the Term Loan, and presumably part of the DIP financing and potential buying group.

At June 30, 2017, the two BDCs had $35mn in exposure at cost (which may represent a third or more of the Term Loan) and the debt was carried at a slight premium to par.

The Term Loan is priced at LIBOR + 5.5%, with a 1.0% Floor. However, with LIBOR at 1.3% in the IIQ of 2017, the yield was 6.8%.

Given the bankruptcy, MAIN will cease to earn $1.3mn of annual interest, but that may be partly offset by its participation in the proposed DIP facility.

The Term Loan trades in the market and is marked at 98% of par today, suggesting the senior lenders expect full repayment of their loans.

Damage

However, Triangle Capital (TCAP) and Alcentra Capital (ABDC) provided the $30mn “mezzanine” loan and are as listed as “unsecured creditors”.

The interest rate was set at 11.0% and the two BDCs will forgo $3.3mn in annual investment income between them, with TCAP representing nearly three-quarters of the outstandings.

At June 30, 2017, the “mezzanine loans” had been marked down (15%-16%) by the two BDCs, after being carried at par through March 2017.


VIEWS

No Problem ?

We only have partial information, but the BDC Reporter’s common sense conclusion is that – initially – the senior lenders will be able to avoid any material write-down of their exposure to the Company, bankruptcy notwithstanding.

However, we would be very surprised if TCAP and ABDC did not have to take a substantial further reduction in their debt value, potentially all the way down to zero.

At the very least, the junior lenders are unlikely to receive any interest payments even after a restructuring/sale is completed.

Unsettled

As usual the BDCs involved will seek to point to the resolution of the bankruptcy as indicating the loans have been removed from non-accrual.

However, given that both the senior lenders and the mezzanine holders might end up owning the troubled company (which has been through at least three financial crises since 2008)  this will be an ongoing story, potentially for years to come.

With the auto industry in pull-back mode, the Company’s long term prospects must be in question.

In the short run, BDC exposure might increase by $10mn or more, via the DIP and other financing which might be needed.

All the BDCs involved  will face interruption of investment income for an unknown period while the bankruptcy process continues: around $5.7mn annualized.

Aside

The circumstantial facts again causes the BDC Reporter – with our BDC Credit Reporter hat on – to worry about how forthright BDCs (or at least this group) are being about the value of their investments.

As we saw above, GST Autoleather admits to have been exploring strategic alternatives – due to its declining financial condition – for the past two years.

Yet, till the latest quarter, no BDC ever wrote down its debt by more than (2.74%), and that was the senior secured debt !

Presumably, even in the quarter ended June 2017, discussions were probably underway amongst the lenders about a bankruptcy, yet valuations remained very high.

If either the senior or unsecured lenders ultimately write down or write off a substantial exposure of their exposure nonetheless, it will suggest to the BDC Reporter that valuations are being made using rose colored glasses.

Not Going Away

We will continue to evaluate the investments – even if debt gets turned to equity – as a test case of whether BDCs are using the restructuring process as a way of maintaining values (and thus fees) unfairly high.

With no regulators looking over their shoulders, toothless Boards and “independent valuation firms” chosen by the Investment Advisors whose assets are being valued  (but paid by the BDCs) there is a risk that the system is deeply flawed.

The BDC Reporter would like to have a penny for every time we’ve been told confidentially by a third party who has compared some BDCs loan values against their own assessment and found the former bloated.

We don’t want to come into the Next Recession and be hit with a tsunami of revised valuations from BDCs that have been systematically over-valuing their assets, helped by the lax rules applying to the industry and the absence of publicly available information in these privately-held companies, and which become even more opaque when “acquired” by their former lenders.

Readers should expect a follow-up both about the fate of GST Autoleather, but also about the valuation process involved.

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