What’s Been Happening

Apparently, BDC stock prices – after bouncing up and down for several days – have reached stasis. On Wednesday June 23, 2021 BDCZ – the UBS Exchange Traded Note which we use to measure sector price changes – was unchanged at $19.84. This followed a mere 0.06% upward move the day before. After all, we’re in the middle of the summer months with the July 4th holiday right round the corner and investors appear to have run out of enthusiasm to both buy and sell. In terms of individual BDC price performance – just like the day before – 21 stocks were up or unchanged and 20 were down. Furthermore – unusually – no stock moved up or down by 3.0% or more on the day. We also checked the broader indices and found much the same price languor, with the S&P 500 – for example – off just (0.1%) on Wednesday.

In terms of hard news, we’ve heard about a loan extension from a smaller sized venture-debt BDC and used the opportunity to review its liquidity and capital structure and engage in some guesswork as to what might happen next. Also, an existing Baby Bond gets officially called in, as we’d been expecting. Finally, we’ve got credit developments to report at a public company to which two BDCs have hundreds of millions of exposure and we’ve undertaken a credit analysis through the IQ 2021 of a mid-sized BDC and concluded that matters are greatly improved over a year ago, or even a few weeks ago.

• Horizon Technology (HRZN) Amends And Extends Key Facility:  The BDC has multiple sources of secured and unsecured financing. This includes a long standing (started in 2013) secured revolver with Key Bank: the “Key Facility”. On paper, the line has a commitment of $125mn, but that could be extended to $150mn. This is a major component of the BDC’s financing structure, representing one-third of the total debt capital committed to HRZN. At 3/31/2021, there was no balance outstanding under the Key facility – which is not uncommon – but the revolver was drawn down intra-quarter in the IIQ 2021 to fund the redemption of HRZN’s Baby Bond maturing in 2022 with the ticker HTFA, which was paid off for $37.7mn in principal and interest. Given that the Key Facility had available borrowing capacity of $67mn at 3/31/2021, roughly half the revolver has been tapped, notwithstanding the nominal $125mn limit. More on that later.

HRZN has now announced that the draw period for the revolver has been extended to June 22 2024 from September 30,2021. The final maturity of the facility has been extended to June 22, 2026, versus April 6, 2023 previously.

Furthermore, as far as we can tell, pricing has been switched to only use a Prime Rate base rate:

“…to the greater of (a) 4.00% and (b) the rate of interest published in The Wall Street Journal as the prime rate in the United States, plus the “Applicable Margin”. The Applicable Margin is (x) 0.25% during the draw period, (y) 0.75% during the first 12 months following the draw period and (z) 1.25% thereafter”.

Previously, the facility was based on LIBOR – including a “floor” of 1.0% – and a spread. As of the IQ 2021, the average interest rate on the Key facility was 4.25%, according to the 10-Q. If we read the amendment correctly, the current yield will be 4.0%. The current Prime Rate is 3.25%, and when the Applicable Margin is added reaches 3.5%. As the language above indicates, that should mean the 4.0% referred to in (a) is the rate charged. This might mean a slightly lower interest expense bill and no LIBOR option going forward.

(HRZN continues to pay 0.5% on the unused amount of the Revolver. That can reach ($0.625mn) per annum on a pro-forma basis).

The BDC Reporter believes HRZN’s financing is in transition. Already this year the BDC has issued $57.500mn of new unsecured notes (ticker: HTFB) and repaid the afore mentioned 2022 Baby Bond of $37.4mn. In addition, HRZN has $100mn in “asset-backed notes” outstanding in another secured facility, which is costing 4.21%. Starting on July 15, 2021, the re-investment period ends and any of the underlying investments which collateralize the obligation will be used to repay the corresponding debt outstanding. The final maturity of the asset-backed notes is September 15, 2027.

Furthermore, as we’ve also seen, HRZN has used up half its Key Facility capacity to repay the 2022 Baby Bond. That means only 23% of the BDC’s outstanding debt is in unsecured form versus 39% as of March 31, 2021. To both boost its liquidity and to rely less on secured financings – all of which come with myriad covenants and other requirements – we wouldn’t be surprised if HRZN issued another Baby Bond shortly – probably in the public debt market.

The most recent such offering of HTFB was at an interest rate of 4.875%. A repeat performance should attract similar – or better – terms than the March 2021 HTFB offering. Should that occur, the increase in interest expense – if the funds were initially used to repay the Key Facility and to make up for any reduction in the asset-backed notes – should be relatively modest. As we’ve seen here and elsewhere in the BDC landscape, the differential in yield between secured and unsecured debt has narrowed so much that managers can greatly increase the proportion of the latter type of debt without endangering running rate EPS levels.

This is especially the case in very high yielding BDCs like HRZN – and all the venture debt lenders. As of the IQ 2021, HRZN was rightly boasting of its “industry leading 15.2% yield on our debt investments“. A greater than 10% spread between what HRZN receives from its portfolio companies and pay out in debt financing leaves a lot of room for maneuver.

Of course, this is just the BDC Reporter’s supposition. For any number of reasons – valid or otherwise – HRZN may choose to continue to finance itself principally with secured debt. In our view – whatever the cost savings – that would create a question mark about the ability of the fast growing BDC’s ability to withstand a future balance sheet shock. During the pandemic, the value of most venture investments – both the debt and equity – held up very well. As a result , HRZN and its peers were not much challenged by falling asset values as was the case elsewhere in the BDC eco-sphere. That’s not to say, though, that in the future the VC world may not face difficult times and losses in value and in credit might not ensue. At that point, too great a reliance on secured debt facilities, and their fast changing borrowing bases and net worth covenants, could be highly detrimental. We remind readers with elephantine memories what happened to Hercules Capital (HTGC) during the Great Recession when its principal secured lender de-camped at a critical time. Other old hands will remember what happened to a BDC called TICC Capital, which also specialized in technology lending, and had to de-leverage itself during that difficult period and re-position itself as Oxford Square Capital (OXSQ).  Today the sun is shining for venture-debt investing – and BDCs generally. This will not always be the case.

Great Elm Capital (GECC) Sets Date For Baby Bond Redemption: We’ve been writing often about GECC’s latest unsecured public debt offering with the ticker GECCO, and the BDC’s intention to use the proceeds therefrom to redeem its existing Baby Bond with the ticker GECCL. We have now found out the official date the 2022 Baby Bond will be repaid: July 23, 2021. 

We’ve updated the BDC Fixed Income Table accordingly and are still waiting for GECCO to trade in the open market before adding the new issue to our (shrinking) list of public debt issues.

CREDIT

Troubled Sequential Brands received yet another waiver from its lenders, as negotiations between company and creditors grind on. The BDC Credit Reporter has written extensively about the credit troubles at Sequential, most recently on May 19, at the time of an earlier lender waiver. Nothing much has changed in terms of BDC exposure or risk, so we’ll copy what the BDC Credit Reporter wrote last time:

“…we’ll note that BDC exposure – in both debt and equity – to the company remains huge: $277.1mn at cost. The debt at March 31, 2021 has been discounted by (16%) and the equity by (100%). The BDC lenders are FS KKR Capital (FSK) and FS KKR Capital II (FSKR), as well as Apollo Investment (AINV). However, given that FSKR is to be merged into the outstandings can rightfully be allocated all to FSK. Over a quarter of a billion dollars is a Major exposure for the KKR-managed BDC. (AINV has invested $12.8mn at cost).

We have no idea how this is going to play out, although some sort of resolution must be the horizon. We retain a Trending rating for Sequential as chances are good valuations or income derived therefrom could change shortly. We’re also affirming our CCR 4 credit rating which suggests we believe some sort of realized loss will eventually occur. However, whether that will be a few tens of millions or hundreds of millions – an important distinction – remains unclear”.

We got round to a credit analysis of WhiteHorse Finance (WHF) and updated the BDC Credit Table accordingly. There was a lot of “good news, bad news” at the BDC with $617mn in portfolio assets, and 62 companies.  Starting with the good news – and as expected – the number of companies on non accrual dropped from 3 to 2 as AG Kings was sold, and WHF actually made a profit because of its decision to buy debt at a discount before matters were resolved. However, Puerto Rican hospital –  Grupo Hima San Pablo – saw its first lien debt join its second lien debt in the non performing column. Here’s what management shared on the latest conference call in May:

“We are disappointed to share that Grupo HIMA failed to make its interest payment during Q1. This Puerto Rican hospital company, like other hospital companies, is being impacted by COVID. As a result, we wrote off 2 months of current accrued interest previously recorded in Q4 and placed a first lien loan on non-accrual. This reversal had a negative impact of $0.014 to net interest income. We are actively engaged in restructuring negotiations with Grupo HIMA, and we’ll provide updates as they become available”.

The damage from Grupo Hima was not limited to WHF, as three other BDCs have exposure to the long suffering hospital chain, underperforming since mid-2016 ! Here is the latest list of BDC holders and amounts at cost and FMV, as reflected in Advantage Data:

On the other hand, WHF had positive developments to report on its other non performing company: Sure Fit Home Products. The company has been non accruing for 4 quarters in a row. However, WHF’s management indicated:

“…we’re pleased to report that subsequent to [IQ 2021] quarter end, Sure Fit merged with Hollander Sleep Products…both Sure Fit and Hollander are owned by the same sponsor. As a result of this merger, our loan investment in Sure Fit will be back on accrual in Q2 and all past due interest and fees have been paid. At the end of the first quarter, Sure Fit .. accounted for 0.8% of our nonaccruals at fair value. After giving effect for Sure Fit going back on accrual, on a pro forma basis, our Q1 non-accruals would have been only 1.7% of the debt portfolio at fair value. We are pleased that even with the markdown on HIMA, NAV was still up during Q1 as the rest of our COVID impacted accounts improved”. 

As far as we can tell WHF will only have Grupo Hima on its non performing company list in the IIQ 2021, with a FMV of $13.17mn. No income is being received, but that FMV (down from a cost of $21.8mn) could drop further. However, with no other borrower in trouble, WHF’s credit troubles are limited.

Still, the BDC’s own valuation of underperforming assets was $97mn at 3/31/2021, or 15.7% of the portfolio as a whole and not much better than the prior quarter. On the other hand, $87mn of those underperforming assets were in the top underperforming category on the BDC’s 5 point scale – 3. We might see further write-down at Grupo Hima offset by unrealized write-ups elsewhere in the underperforming portion of the portfolio and – possibly – new gains on a few small equity stakes the BDC holds.

At this point, the worst of the credit impact of the pandemic seems to be behind WHF. A year ago, the BDC had 5 companies on non accrual and 34% of its portfolio was underperforming…