Introduction

The BDC Credit Reporter is gradually – very gradually – revisiting every underperforming BDC portfolio company and writing an update on its current status in light of the Covid-19 crisis.

Here we discuss the leading wood pellet manufacturer in the United States, which Gladstone Capital (GLAD) has invested close to $30mn in and which was recently added to the underperformers list with a rating of 3 on our 5 point scale.

As the article shows, the company’s value and business took a dip a few weeks ago but both are currently recovering.

This is a typical example of how the current crisis has brought a very large number of previously performing companies into the CCR 3 category, which we describe as being for borrowers who are more likely to meet their obligations than to fail to do so.

What will be critical to determine is whether – in the weeks and months ahead – those new underperformers slip in to a CCR 4 rating – where the odds of loss are greater than that of recovery or to CCR 5 – non performing.

We are optimistic about the prospects for this Gladstone company – which is just as well for the BDC as all exposure is in junior capital – but each company has to be taken in turn.

In this case, the company was deemed an “essential business” which spared the manager and employees from having to mothball operations and continue some level of business activity.

“Back in late March 2020 when the debt of Lignetics Inc. – a major wood pellet manufacturer – was trading at a (20%) discount to par, we downgraded the company to underperforming from performing: i.e. from CCR 2 to CCR 3. Since then the debt discount has narrowed, but we are maintaining the 3 rating.

The company has recently raised $70mn in new senior debt financing from Fifth Third Business Capital and from its only BDC lender – Gladstone Capital (GLAD) – to fund a major acquisition that was on the cards before the Covid-19 crisis developed. Shortly after that, the enlarged company had to make entreaties to state authorities in Pennsylvania to be deemed an “essential business”. That eventually occurred and allows the business to operate “normally”, according to recent news reports.

“Now back manufacturing pellet heating fuel for homes and businesses, Energex Inc.—recently acquired by Lignetics, the largest residential wood pellet manufacturer in the U.S.—and all other facilities owned by Lignetics are taking extensive COVID-19 precautions”

This will be reassuring for GLAD which is both a second lien lender and equity investor in the company, with $24mn invested at cost as of December 31, 2019. In January 2020 GLAD advanced $5.5mn more in a mixture of debt and equity. Total annual investment income – given a 12.0% interest rate on the second lien debt – is substantial at approx. $3.0mn. With many mills closing in recent days, Lignetics may not be safe yet. We shall learn more when GLAD reports IQ 2020 results in early May”.