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Capitala Finance: Under Performing Investment Sold

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The IVQ 2019 was a very important one for Capitala Finance (CPTA). Coincidentally or otherwise, the poor performing BDC has recently added a famous Japanese minority investor, Mitsui USA. In the final quarter CPTA partly sold out its of out-performing portfolio company Nth Degree for a huge payday, realizing a $26mn realized gain. Again – coincidentally or not – the BDC also wrote off – with less fanfare – 4 non performing companies in the same period. We’ll be highlighting each in turn as time allows. One of these is Portrait Studios LLC. CPTA’s exposure – initially in debt and equity – dates back to the IVQ 2017 and initially involved $8.9mn in capital advanced. The Term Loan involved was priced at “only” LIBOR + 7.0%, suggesting the implied risk was low to moderate by CPTA standards whose average portfolio spread is 10% or more over LIBOR.  There was also a Revolver, whose outstandings varied over time. In the IVQ 2018, according to a filing, CPTA seems to have been repaid $4.3mn. That brought down exposure at cost to $7.0mn. However, by the IIQ 2019 the Term Loan was placed on non accrual but the Revolver remained current, and its balance began to grow. (We’re guessing that CPTA continued to receive some payments on the Term Loan from the borrower as the cost of the Term Loan was reduced slightly while on non accrual – a frequently used accounting method in these situations). The Preferred was written to zero in the quarter. Finally, in the IVQ 2019 – as the article below from the BDC Credit Reporter discusses – the whole investment was exited and CPTA booked a ($6.2mn) realized loss. Except for naming the amounts involved, no commentary was provided by management except that this company (and CableOrganizer) was held in the BDC’s SBIC subsidiary. That suggests the privately held entity, that we’ve been unsuccessful at getting much public information about, was relatively small in size. 

If we prepare the final scorecard in this smaller sized – but still material – investment for CPTA, we see that the BDC has lost ($6.2mn) from a maximum exposure of $9.5mn in IIIQ 2018. As we calculate below, the income permanently lost is about ($0.600mn). The loss of ($6.2mn) is equal to 1.7% of iCPTA’s total investment assets at cost in IIIQ 2019 – just before the write off and 2.6% of the BDC’s current equity capital at par. To date CPTA has ($90mn) of distributable losses in its history, and this represents a meaningful 6.9% share. Final conclusion: This could have been worse, but thanks to the IVQ 2018 repayment, the BDC recovered 31% of capital that was at risk in September 2019, just before the exit from the investment. 

What may be disappointing to CPTA investors is how the debt went from being valued at par to non accrual in one quarter,  and initially discounted by a substantial (51%). Two quarters later, almost the entire Term Loan balance was written off, along with the preferred. (A $0.5mn escrow or earn-out continues to be carried on the books). This type of quick valuation descent makes one worry that management and its third party valuation firms are being slow in recognizing in their quarterly values the real problems occurring at companies, and leaving investors wondering what other shoes are left to drop in the portfolio. Moreover, the radio silence about the company’s troubles from CPTA in the few quarters before the realized loss and the lack of any remarks after the disposition are disappointing as well. We understand management, and some analysts, just want to look forward but much can be learned from a frank discussion of credits gone wrong.  Investors are just left with the BDC Credit Reporter’s reports, written from the outside looking in. 


 

Portrait Studio, LLC: BDC Lender Exits

Frankly, we don’t what exactly happened at Portrait Studios, LLC, a portfolio investment of Capitala Finance (CPTA). At this point, it hardly matters because the BDC’s IVQ 2019 10-K says the investment in the company was sold and a ($6.2mn) realized loss taken. At time of writing, CPTA maintains $0.5mn on its books as “First Lien Debt” but a footnote says “the residual value reflects estimated earnout,escrow or other proceeds expected post-closing“. Given that as of September 2019 CPTA had $9.1mn invested at cost in two first lien term loanspreferred and equity, we’ll assume $2.4mn was repaid to CPTA and the rest consists of the loss and the remaining value.

For the II and IIIQ 2019, $4.2mn of debt had been on non accrual, so the sale of the investment will be a wash from an income standpoint. One of the loans – with a cost of $2.3mn was still on accrual, and that – presumably – was what was repaid and will continue generate income for CPTA. However, the BDC has lost $6.2mn of capital through the write-off and may lose that last half a million dollars. At a 9% yield on $6.2mn, CPTA has permanently lost ($0.6mn) of yield producing capacity.

From the BDC’s standpoint, though, a troubling non accrual has been removed, one of 4 in the last quarter of 2019. For our part, we’ve effectively removed the company from our under performers list as there is no other BDC exposure and the remaining amount to be collected is not material.

@BDC Credit Reporter 2020
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