Preamble

We’re re-publishing a BDC Credit Reporter article about a possible Chapter 11 filing for Men’s Wearhouse, a portfolio company of Barings BDC (BBDC).

This company falls into the first of the three waves of bankruptcies and defaults we expect to sweep over the non-investment grade market.

Sputtering

First wave companies – like Men’s Wearhouse – were already underperforming in the months before Covid-19.

In fact, we added the name to the BDC Credit Reporters underperformers list back in IIQ 2019, just about a year ago.

At the time, BBDC marked the debt down by (13%), enough to trigger the switch from performing to underperforming.

Every quarter since the investment has been de-valued further.

Apex

This culminated in the IQ 2020 – with the early impact of the recession being felt – with a discount of (66%), up from (21%) at 2019 year-end.

Now – loaded with debt – and with business coming back (too) slowly – a default and a re-organization in or out of bankruptcy court looks all but inevitable.

Not A Problem 

For BBDC, this individual investment – with a cost of under $10mn and a modest possible income loss of ($0.350mn) annually – should not be a material hit.

That’s the benefit of a “granular portfolio” and a low yielding investment (LIBOR + 325 bps).

Bigger Picture

More importantly is determining how large that “first wave” of already under-performing companies that Men’s Wearhouse belongs to might be.

Given the BDC Credit Reporter’s database of all underperforming companies has become pretty comprehensive we thought we’d try to quantify the risk.

Filtered

We searched all companies currently rated CCR 3 and CCR 4  that were added prior to 2020, and eliminated the non material companies (under $2mn in FMV) and any equity only companies.

What remained are all candidates to be included in the first credit wave of non accruals.

Currently we have identified 206 different entities, with an aggregate cost of $9.0bn and an FMV of $7.3bn.

(For a sense of context, total portfolio assets of all BDCs was $122bn as of the IQ 2020 and about $120bn if you don’t count thodse players not involved in leveraged lending.

Total BDC net assets are around $60bn).

Work In Progress

We won’t draw any grandiloquent conclusions as we’re still updating the database with the latest company values, and still trying to size up the “second wave“.

That’s companies who were performing adequately before Covid-19 but have been suddenly added to the underperformers list in 2020. 

Keep On Coming

Even harder will be the “third wave” – which may not even come to pass – of companies that performed well before and after the advent of Covid-19 but which might stumble in a weaker than anticipated economy.

Many of those companies may not start showing up on our credit radar till the second half of 2020.

In the interim, every new story; default; bankruptcy etc. – as with Men’s Wearhouse – begins to fill in a very complex and fast changing BDC credit picture.

Jigsaw Puzzle

Today we heard that consumer bankruptcies just reached their highest level since 2009. 

Corporate bankruptcies are not far behind and the BDC sector will not be spared, and may actually be disproportionately impacted.

In fact, we expect the next 12-18 months may represent the most challenging credit environment the BDC sector has EVER faced.

Not Inevitable

These “waves” could yet be reduced or diverted by a stronger than expected economic recovery or by government action.

Let’s discuss the latter as handicapping the former is well nigh impossible for even the best economists and we’re not qualified to say anything of note. 

One And Done

Unfortunately, the Payroll Protection Program (PPP) has largely shot its bolt and Congress seems in no hurry to inject additional dollars.

Godot Would Be Proud

You’ll have seen in recent days a revival of press coverage of the Main Street Lending Program whose terms are constantly being tinkered with (which could be a Good or Bad Thing).

Unfortunately – in the BDC Reporter’s view – the Fed is spending its time and energy fiddling with the radio while the motor is falling out.

Or – to be clearer- we believe the flaw with Main Street Lending Program lies less in the size of loans or who might be eligible but through whom the initiative will be delivered.

Wrong

We’re on the record as being deeply skeptical that the banking community – the lever most readily at hand for the Fed – will embrace the spirit of the program or have the ability to reach out to the companies in need.

As we said in April – and when we contributed our two cents along with thousands of others offering up suggestions to the Fed – the non-bank sector (especially BDCs) would have been the better conduit for the program.

Credit Delayed Is Credit Denied

Furthermore, the Fed has taken so long to arrange these “emergency” facilities – none of which have yet hit the street to our knowledge- that many companies -like Men’s Wearhouse – are too far gone to benefit.

Finally, given that real life earnings, EBITDA and cash flows have dropped and continue to do so, adding medium term debt is applying the wrong financing solution to the problem.

We humbly suggest that a “lending” program is probably “a day late and a dollar short”.

Thinking About The Unthinkable

What is needed by thousands of troubled companies of all sizes is longer term equity capital in the form of common, preferred or some special government-arranged flavor thereof.

Would it really be so unthinkable for the U.S. government to inject equity capital into troubled companies in need and remove/sell that capital during the next expansion ?

The Fed has been vigorous in its multi-pronged attempts to shore up the U.S. financial markets and economy and successful – so far – in many areas.

However, in the very heart of the U.S. economy – the middle market – the Fed has not been thinking outside the box; hamstrung by its legal limitations and the gamebook from the last recession.

Unfortunately, we continue to fear that no useful help will be coming from the government.

This will be easy enough to determine in hindsight: if we do get the highest bankruptcies in U.S. history as we fear, some of the blame will have to be left at the door of the Fed, the Treasury and the Congress.

In the interim, we’ll continue to keep score and hope that our worst fears do not come to pass, like the markets seem to believe at the moment.