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Charming Charlie Close to Bankruptcy: Impact on BDC Lenders

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Turning Around

On December 1, 2017 , women’s apparel retailer Charming Charlie announced a “Back To Basics” strategy. A press release announced the 375 store chain – many based in malls – would be cut back by an undisclosed number of outlets; its Los Angeles office closed, its recently launched international operations terminated and staff levels reduced at its Houston headquarters. On the very same day Reuters, quoting “people familiar with the matter”, said the company was planning to file for bankruptcy. These same sources indicated 100 stores were in the process of being closed, and even more were under consideration. Yet, these same sources, also indicated negotiations were still underway with its creditors .

We have also learned that Charming Charlie is headed by a new Interim CEO: Lana Krauter. From what we can ascertain Ms Krauter is a retail industry veteran, most notably former President of Sears apparel. No word has been given about the status of the company’s founder,majority owner and former CEO Charlie Chanaratsopon.

Getting Help

Another sign that Charming Charlie is in trouble is the hiring of turnaround experts AlixPartners. For months, the company and its advisers have been seeking to raise additional equity or find alternative solutions to its increasing credit problems. As far back as this time last year, Charming Charlie was choosing investment banking advisors to assist with its turnaround plans.

Safe Bet ?

Given all the above, the likelihood appears very high that Charming Charlie will either file for Chapter 11 or arrive at a last minute out-of-court arrangement which will involve almost equal concessions to its creditors.

Long Time Coming

This has been a slow moving deterioration, dating back to the fourth quarter of 2015. The BDC Reporter first highlighted the company’s problems in an article about the worsening retail crisis a year and a half ago on April 10, 2016.  We placed Charming Charlie on the BDC Credit Reporter‘s internal credit rating of 4 back in November 2016.  A 4 rating means we expect an ultimate  loss is more likely than a full recovery over time. Still, two of the BDC lenders during that period were only marking down their exposure by 6%.

At Risk

As of September 30, 2017, the principal debt outstanding at the company appears to be a “secured” $150mn Term Loan, due in 2019 and a $60mn Revolver, which is collateralized by the accounts receivable and inventory of the business, as discussed in a Moody’s report from the period, when its debt was downgraded. All BDC exposure – which totals $38.7mn at cost according to Advantage Data and measured at September 30, 2017 – appears to be in the Term Loan. A year ago, according to Moody’s, Charming Charlie’s sales were $492mn and the rating agency had some expectation that profits and free cash flow would increase modestly to provide additional liquidity – already under pressure- and to meet debt covenants in 2017. Apparently performance has been below expectations and the Term Loan may go from a Caa1 rating in December 2016 to a default rating shortly.

Who’s Who

At September 30, 2017, there were 4 BDCs with exposure to Charming Charlie. Far and away the BDC with the greatest amount outstanding is THL Credit (TCRD) with a loan of $22.5mn, followed by Sierra Income with $7.9mn, Cion Investment with $4.4mn and PennantPark Floating Rate (PFLT) with $4mn. All the exposure is in the Term Loan and we are not aware of any Last Out arrangements. The loan is priced at LIBOR + 11%, but was at LIBOR + 8.0% a year ago. That would suggest nearly $2.5mn in annual Investment Income – and an almost equal amount of TCRD’s Net Investment Income – is at risk of at least temporary interruption.

Analysis

For TCRD, with IIIQ Net Investment Income annualizing at just under $45mn, the loss of the Charming Charlie income would amount to over 5%, or about $0.08 a share. It may have been this anticipated setback that caused TCRD to offer to waive some of its compensation in an effort to maintain the BDC’s $0.27 a quarter distribution, itself reduced in the last year.

TCRD valued its investment at a (13%) discount to cost at September 30, 2017. However – at the moment – the debt is reportedly trading at “35 to 40 cents on the dollar”, according to Reuters. That number could go even lower in a bankruptcy. At 25 cents on the dollar, TCRD would have to write down its debt by another ($14mn) or ($0.43) a share. That’s a greater amount than a full quarter’s Net Investment Income.

Number Two

The impact on the other public BDC with exposure- PFLT – will be more muted, but not immaterial. The BDC wrote its exposure down by (14%) at September 30. to $3.4mn. Its potential Net Investment Income loss could be over ($0.37mn), or 1 cent a year. Crediting back any potential “benefit” from a lower Incentive Fee, the impact on PFLT might even be marginally lower, and a tangible benefit of having a very diversified portfolio, which TCRD does not.

Questioning Valuations

Another potential casualty of the potential Charming Charlie blow-up: investor faith in BDC internal valuations. If the Term Loan debt gets written down 75% as we’re supposing in our conservative way, or 60-65% as the current market prices suggest, those numbers will both be at a wide variance to the BDCs own unrealized depreciation as of September 2017 – when Charming Charlie was entering its second year of troubles- ranged between (13%) and (19%).

CONCLUSION

Everything seems to point to a Chapter 11 for Charming Charlie and a day of reckoning for the First Lien Debt exposure at 4 BDCs. The BDC most in the crosshairs is TCRD, with PFLT a distant second. Whether this happens or not may be known in the next few days. What happens after that is unknown. Check back for an update. 

 

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