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Great Elm Corporation: Portfolio Company Downgraded

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Preamble

We are re-publishing an article from the BDC Credit Reporter about Boardriders Inc

In case you’re not aware, the apparel company, which owns multiple brands, caters to “boardriders around the world. Our apparel and footwear brands represent a casual lifestyle for young-minded people who are inspired by a passion for outdoor action sports”. 

With young-minded people trapped at home, sales have suffered and –  as discussed below – two major rating groups have downgraded the company’s debt.

We are taking this opportunity both to update Great Elm Corporation (GECC) investors – the only BDC with exposure – on the latest developments and to make a broader point.

Surfers Will Understand

Regarding the latter, Boardriders is the almost perfect example of what we’re calling candidates for a “Second Wave” of credit defaults.

The first wave consists of companies that were already struggling before Covid-19, and were typically already rated CCR 4 in our 5 point credit rating scale and whose value had typically been written down by its BDC lenders.

Think Art Van Furniture, Neiman Marcus, J.C. Penney, BarFly Ventures and many more you can find in the BDC Credit Reporter and which have defaulted and/or filed for bankruptcy in 2020, pushed over the edge by Covid-19.

There are many companies in this category, both which have already defaulted and a great many others hanging on by a thread.

Yesterday’s News ?

However, the existence of these companies has been well known to the BDC lenders involved – and to the markets – for some time and some degree of likely default is already “baked into” investor expectations.

Harder to quantify – although potentially much larger in size – are the companies caught up in the “Second Wave”.

These are entities that – at least from a distance – seemed to be performing normally before Covid-19 came along.

That’s usually reflected in BDC valuations of their debt, and even equity, being carried at or above cost at the end of 2019 and/or above the lowest rungs on the ratings groups scale or the BDC Credit Reporter’s own.

Covid-19, though, has impacted the business and creditworthiness of these “Second Wave” companies – like Boardriders.

The Process

The initial result were unrealized losses booked in IQ 2020, most of them modest that were supposed to reflect the deteriorating market conditions.

In the case of this company – whose debt is traded – the discount was just (10%) March 31, 2020. 

Currently, though, Advantage Data’s middle market pricing module indicates the debt is trading at 67 cents on the dollar, a (33%) discount.

That makes sense given the deteriorating fundamentals at the company that S&P and Moody’s downgrades reflect.

Where this ends for Boardriders – and the very large number of businesses in the same boat – is unknowable and is likely to vary widely.

No Going Back Just Yet

In the short term (i.e. IIQ 2020) most of the Second Wave credits that suddenly joined the underperformers category after the IQ 2020 are unlikely to be returning to performing status.

Now instead of one month of Covid-19 impact the companies have a full quarter of shut-downs; supply chain interruptions; debt service; etc. to contend with. 

We’d love to be able to quantify for our readers how many companies are in this potential “Second Wave” of defaults, but we can’t. Yet.

The number of new underperformers in the IQ 2020 BDC portfolios has been so huge that we’re only halfway done updating the BDC Credit Reporter’s database of all underperforming BDC-financed companies.

So Close, But Yet…

After the IVQ 2019 results came out, the BDC Credit Reporter had actually managed to identify – more or less – every underperformer at every public BDC and most at the non-traded funds.

However, Covid-19 came along and we’ve had to spend an inordinate amount of time tracking down all the new underperformers popping up, like Boardriders

To date, the database indicates we’ve added 116 new underperformers rated CCR 3 or CCR 4 in the IQ 2020, with a cost of $3.4bn and an FMV of $3.1bn.

By the time we’re done – just in time for IIQ 2020 results – we wouldn’t be surprised if those numbers didn’t double

Candidates

It’s from the ranks of these newly added underperformers that we expect the “Second Wave” of defaults.

There have been a few already who went from operating normally to a standstill in a matter of weeks: Alaskan airline Ravn Air Group, which filed Chapter 11; Garden Fresh Group, which filed chapter 7 and laid low by its restaurant business model built around buffets and – most famously – Hertz Corp. 

How many of the Second Wave companies – currently rated CCR 3 or CCR 4 – will join the ranks of bankrupt and defaulting companies is impossible to know.

What our data shows, though, is that there are plenty of candidates so keeping an eye on the likes of Boardriders – although a relatively small position by itself – is worthwhile canary-watching.

One More ?

In future articles we’ll get to the POTENTIAL “Third Wave” of credit defaults: companies that passed the initial Covid-19 test for one reason or another but who get dragged down by the piling on of weaker business conditions and the high leverage that virtually every BDC-financed company – big or small – carries after 11 years of an expanding economy and easy money.

We won’t even begin to estimate how big that POTENTIAL wave might be, but we should start to get an inkling as early as when the IIQ 2020 results come out.

After all, by the end of June companies will have been affected by these extraordinary economic conditions for 4 months; any Payroll Protection Program monies will have been spent and government and creditor largesse will be diminished.

We’ll be looking for lower investment values but also whether companies are laying off staff; suddenly selling off subsidiaries; cutting back expansion plans and all those signs of “hunkering down.”

The IIIQ 2020, though, will be even more useful in quantifying the Third Wave challenge, if any.

Much can change between now and then so we’ll be focusing principally on the first two.


Boardriders Inc: Downgraded By S&P

Bad news for Boardriders Inc., the apparel company. A few weeks after an earlier article by the BDC Credit Reporter triggered by a downgrade by Moody’s, here comes another ratings blow – from S&P. The company’s rating has been lowered to CCC+ from B. The outlook is Negative. What caught our attention was this remark: that Boardriders would “likely need additional liquidity to meet its obligations over the next 12 months; otherwise a default might become highly likely,

We had already downgraded the company in our database on May 11, 2020 to CCR 4 from CCR 3. Now we are also adding the company to our Weakest Links list, based on S&P’s comments and the still difficult market conditions. As before, the only BDC with exposure is Great Elm Corporation (GECC), whose $8.8mn invested at cost in the debt of the company was valued at $8.0mn as of March 31 2020.

@BDC Credit Reporter 2020
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