We are re-publishing a just posted article from the BDC Credit Reporter about the Chapter 11 filing of Borden Dairy. (If you’re thinking of Elsie the spokes-cow, that’s the company).  This is a notable development in a first full week of 2020, with little in the way of other BDC news, because of the exposure of FS-KKR Capital (FSK) to Borden – along with three of its non-listed peers – in the 2023 Term debt. Of the $175mn held by the FS-KKR BDC complex, FSK has $70.0mn, or 40% of the total. That means the public BDC is on the hook to see $3.6mn of annual investment income suspended for some period. If and when a modus vivendi is concerned, and if current discounts to par continue, FSK could have to book a Realized Loss of ($5.2mn). Of course, the final outcome – which might take a few months to play out as owners and creditors are not on the same page – could be better or worse for FSK and all the lenders involved.

This is a material exposure and the BDC Reporter is keen to bring “market moving” news to our readers attention rather than just the latest dividend announcement (even though we do that anyway on our Twitter News Feed and in our Dividend Table). Moreover, and as we say in the article below, this challenging credit will be an excellent test case of KKR’s underwriting credibility. Loans are going to go wrong. What separates the better BDCs from the also-rans is how well the credit arrangements have been structured and what sort of recovery is achieved. Both owners and creditors – otherwise in febrile disagreement at the moment – seem to concur that Borden’s basic business remains viable. That should allow FSK to escape this massive bankruptcy – by BDC standards – with little or no loss. We will find out in the weeks or months ahead. 

From the BDC Credit Reporter: 1/8/2020

“2020 has started with a bang where BDC credit challenges are concerned with one of the biggest BDC-funded bankruptcies in recent memory. On January 7, 2020 Borden Dairy filed for Chapter 11. Management set out its goal as follows: “The Company intends to use the court process to pursue a financial restructuring designed to reduce its current debt load, maximize value and position the Company for long-term success. Borden plans to continue operating in the ordinary course of business, under the court’s supervision“.

Lenders were not sympathetic or supportive. As the Wall Street Journal reported, the principal lenders to the company complained that a Chapter 11 filing was not necessary, and seemed more like a gambit to avoid whatever concessions might have been necessary with its creditors. Apparently, negotiations had been ongoing for some time. One lender complained that Borden made the bankruptcy move without notice to its lenders (which is very common but still shocking to some) and without bringing on specialized turnaround personnel.

The principal complaint the lenders seem to have is that Borden is not really that financially damaged. The company itself admitted being EBITDA positive and one of the two private owner groups was sanguine about retaining “primary ownership of the business after the bankruptcy”, which does not signal extreme distress. Anyway, that’s for the court to decide about but does imply that the chances of recovery for senior creditors is higher than average.

That’s good news for the 4 BDCs involved – all part of the FS-KKR Capital complex: publicly traded FSK and its three non-listed sister entities: FSIC II, FSIC III, and FSIC IV. The face amount of debt at risk – all in the 2023 Term Loan – is huge by BDC standards: $175.0mn. (Here’s another example of how the BDC sector has expanded way beyond its origins financing supposedly capital starved lower middle market private companies. Borden – by contrast – boasts $1.18bn in 2018 sales and 3,300 employees). The bankruptcy will interrupt annual investment income of nearly $16.00mn. However, if Borden management gets its way, that might only be a matter of a few weeks.

More important will be what happens to the 2023 Term Loan and the rest of the company’s liabilities. Clearly, there is no consensus between the owners and creditors so pretty much anything could happen and we are not privvy to any of the plans. As always in these situations where the debt is publicly traded – more often than not these days – we look to Advantage Data’s real time loan pricing module which shows the 2023 debt trading at a (13%) discount to par. That’s in line with what the debt was valued on the BDCs books at September 30, 2019 and gives a hint of what haircut these lenders might have to take. That would be a Realized Loss of ($23mn).

Yet, it’s too early to start counting beans. This could come and go out of bankruptcy very fast and with little impact on the lenders or something else altogether could happen. Once a company throws itself on the mercy of the bankruptcy court anything can happen. We’ll provide updates as any material news appears.

Unfortunately, though, this is prospectively another credit black eye for KKR, which only took on the credit in the IIIQ 2017 and which has committed a great deal of capital to this borrower. KKR is sparring with Acon Investments – the private equity group on the other side of the table; as opposed to finding the mutually agreeable middle way that some other transactions have gone down. This will be a useful test of how well originating and leading a debt tranche will serve KKR – and its BDC shareholders. Who will prevail – if anyone – in the test of wills and documentation that is shaping up between owners and lenders ?

For our part, we didn’t even have Borden on our Under Performers list until after the IIIQ 2019 BDC debt valuations were published when the FS-KKR entities marked the Term Loan at a (12%) discount, which caused us to give Borden a Corporate Credit Rating of 3. Of course, that’s now been dropped to a CCR 5 (Non Performing) just a few weeks later. It’s worrying to us, and should be to anyone invested in credit, how quickly companies can go from apparently performing modestly below expectations to standing in front of a bankruptcy judge. We are going to respond by being more vigilant and ready to add new names to the Under Performer List at the very earliest signs of trouble. Forewarned is forearmed”.

© BDC Investment Advisors, LLC 2016 – 2019