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Stellus Capital: Portfolio Company Files Chapter 11

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The BDC Reporter has been writing about Stellus Capital (SCM) of late due to its recent unsecured debt issuance.

There are two articles. Click here and here if interested. 

Over at the BDC Credit Reporter we were inspired to have a latest look at the BDC’s credit performance.

In terms of underperforming assets, the BDC’s own 10-Q indicates there are $63mn in this category in a $622mn portfolio, or about a tenth of the total.

That’s one of the lowest percentages of any BDC that we track. See the BDC Credit Table.

SCM even counts the number of underperforming companies involved, which most BDCs do not bother to do.

(One small step towards better BDC transparency).

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However, neither SCM nor any other BDC identifies which company or investment is in which investment rating category.

That’s where the BDC Credit Reporter steps in and undertakes an independent analysis of each portfolio company to determine how many are underperforming and what fair market value is involved.

Variance Analysis

Sometimes the BDC Credit Reporter’s dovetail with the BDC’s, sometimes not.

One main difference is that the BDC’s numbers are as of the last quarter while the BDC Credit Reporter adjusts upwards and downwards in real time.

Sometimes there are inherent differences in deciding what is underperforming and what not.

Moreover, the BDC has much more financial and business information at hand than the BDC Credit Reporter, which depends on the public record.

Bottom Lined

In this case, our own up-to-date assessment of credit quality counts 8 underperforming companies with a FMV of $38mn, or just 4.5% of the portfolio.

Of the 8, we rate 3 as being IMPORTANT, i.e. likely to have a material impact on the BDC’s NAV and earnings in the next couple of quarters.

One of the three is Furniture Factory Outlet, one of several SCM loans on non accrual.

As the article below from the BDC Credit Reporter indicates, the company has recently filed Chapter 11.

All the details and the implications for SCM are discussed.

We’ll review the other two underperforming companies in the news in a future overall Credit Review of SCM.

Furniture Factory Outlet: Files Chapter 11

We’re a few weeks late to this news but troubled retailer Furniture Factory Outlet, LLC filed Chapter 11 on November 5, 2020. This was no great surprise as the company – as discussed in two prior articles – has been underperforming even before the pandemic began. With Covid-19 in the mix, the company entered a spiral, went on non accrual and is now under court protection and has a $7mn “stalking horse” bid from American Freight. Apparently Furniture Factory has $50mn in funded debt to contend with and liquidity challenges.

This looks like the final nail in the coffin for the company’s only BDC lender/investor: Stellus Capital (SCM). The $18mn invested – mostly in first lien debt – was written down to $2.1mn as of September 2020. That value was probably set with the knowledge of the pending bankruptcy. The chances are SCM will have to write off 90% – or even more – of its capital invested, but no material further change in value is likely, if only because the remaining value is so low. The first lien and small subordinated loan SCM holds were generating $0.9mn a year of investment income through IQ 2020.

We checked and confirmed that the company remains in bankruptcy here in mid-January 2021. This might push a final resolution – and a realized loss – to beyond the IQ 2021. At this point, though, there’s no reason to believe that the company is anything but a large loss – albeit one that has been in the cards for months – for SCM.

The furniture business – as old credit hands like the BDC Credit Reporter will tell you – is a notoriously difficult industry to lend into, even if the bulk of your exposure – as with SCM – is nominally in first lien debt. This investment by SCM dates back to 2016, before the general “retail apocalypse” became crystal clear to all. However, as recently as IQ 2018, the BDC doubled its exposure, just when mall vacancies in the U.S. reached a six year high. In retrospect, SCM may have wished they had headed in the opposite direction.

@BDC Credit Reporter 2021

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