BDC CREDIT

Week 1

New!

Starting right now, we’re adding a new regular article feature: a weekly review of all significant credit developments that have occurred to BDC-financed companies.

Drawn From

This is an offshoot of the research we’re doing over at our sister publication – the BDC Credit Reporter.

There we “go deep” into every twist and turn we can identify of all underperforming companies in which any public BDC is involved and maintain a unique searchable database of hundreds of troubled entities.

Focused

This weekly article will be more of a summary and will also cover Chapter 11 and other credit developments occurring to non-BDC financed companies.

These can provide useful hints as to the credit stresses lenders are facing and which could affect the BDCs in our own universe before long.

We’ll also look at any sectors which – based on what we’ve read in our wide-ranging research – appear to be credit-challenged and – using the records of Advantage Data and our database – speculate on how exposed the 43 BDCs we track are to any crack-up.

Frankly, we’re still in the process of designing this format, so bear with us as we seek to squeeze a great deal of information into a small space.

KeyTroublespots

There were only 4 business days in the first week of January, but there were plenty of credit developments.

We identified two major BDC-financed company reverses affecting 4 public BDCs and involving $75mn of investment assets at cost, mostly in the form of first-lien debt.

Parties Involved

The two companies – K&N Engineering (aka K&N Parent) and Interior Define Inc. – have recently undergone major financial restructurings involving hundreds of millions of debt being written off or converted to equity.

The BDCs involved are Cion Investment (CION); Midcap Financial (MFIC) and Prospect Capital (PSEC) where K&N Engineering is concerned. The latter two BDCs are the ones likely to absorb realized losses of up to ($49mn) and write-downs in value of ($28mn) because invested in a second lien position. CION, whose debt is first lien, may dodge this bullet.

Over at Interior Define, Inc. – where the credit story is murky and our information is based on trade articles – the BDC at risk is Horizon Technology Finance (HRZN) with a prospective realized loss of ($12mn) and a write-down from September 2022’s value of ($10mn). In addition, ($1.6mn) of investment income might be forgone.

Big Picture Impact

With aggregate BDC investment assets aggregating $125.4bn at 9/30/2022, these potential realized losses amount to 5% of the total.

The incremental losses of ($41mn) amount to (3%) of aggregate BDC investment assets at fair market value.

If we’re correct, that’s not a great start to 2023.

Newbies

By the way, both companies only became underperforming recently: K&N from the IQ 2022 and Interior Define from the IIQ 2022, judging by the valuations of the BDCs involved.

OTHER BDC COMPANY DEVELOPMENTS

No company amongst the 4,000+ financed by public BDCs formally filed for bankruptcy this week.

However, as you may have read elsewhere, Bed Bath & Beyond – the publicly traded retailer – warned that such an outcome might be on the cards.

Judging from what we read, the chances are very high that this will occur and not in the expedited “pre-packaged” form where all the major parties agree to a new arrangement in advance.

This week we downgraded Bed Bath to CCR 3, but are not yet presuming any ultimate loss will occur.

Based on prior experience, we expect TSLX will come out of this smelling of roses even if the company files Chapter 11.

ALREADY IN BANKRUPTCY

The main news item of the week about BDC-financed companies already under court protection was that crypto-miner Core Scientific was able to convince its bankruptcy judge to allow it to reject a loss-making contract with its largest customer. See the BDC Credit Reporter article on the subject.

We’re not in the least sure what ultimately realized losses might be and whether this latest development will make much of a difference. On the one hand, Core Scientific continues to operate normally. On the other hand, news coming out of every corner of the crypto-digital asset space continues to be dismal. The implosion of the crypto industry looks to wipe out billions – if not trillions – of investor value in one of the biggest and fastest reverses any sector has ever known. It’s hard to imagine Core Scientific – and BBDC and TRIN – avoiding anything less than major losses.

NON BDC-FINANCED COMPANY CREDIT ISSUES

Things Remembered, once a retail chain with 800 locations offering personalized gifts is finally closing down forever. Formerly a BDC-financed company (Ares Capital, or ARCC), Things Remembered filed for and exited Chapter 11 in 2019, but was never able to recover. Now, the few remaining locations are closing down. Not terribly surprising as Things Remembered was principally located in malls, but yet another sign many retailers – see below – are under pressure.

Along the same lines, Morphe Cosmetics – a long-troubled company – announced its intention to close all its U.S. retail locations.

Toms King LLC, based in Palatine, Ill., a leading Burger King franchisee that operates 90 restaurants in Illinois, Pennsylvania, Virginia and Ohio, filed for Chapter 11 protection this week, blaming lower foot traffic and rising costs.

The crypto crisis continues to involve an ever-expanding number of players. This week Silvergate Bank saw Moddy’s downgrade its long-term rating as the institution continued to deal with the fall-out from being associated with now infamous FTX and Alama Research:

Silvergate Bank lost $718 million as it liquidated debt to cover $8.1 billion in withdrawals, according to reports on Jan. 5. It also laid off 40% of its workforce, about 200 people. In addition, crypto-related deposits were down 68% in the fourth quarter of 2022.

Cointelegraph – January 6, 2022

Crypto lender Genesis Trading cut its workforce by 30% during the week and joined a long list of entities announcing the prospect of filing for Chapter 11 protection.

SECTOR CREDIT ISSUES

This week, we heard about broad sectoral credit concerns about three industries: Furniture Manufacturing; Retail, and Hotels.

An excellent article by the trade publication Furniture Today about the industry was triggered by trouble at a major manufacturer: United Furniture, which has just filed Chapter 11.

In an exclusive Furniture Today survey, nearly 69% of all respondents said they were very or somewhat concerned about additional closures of furniture manufacturers in the wake of what occurred with Lane’s parent company in late November. That’s in stark contrast to just 16% that were mildly or not at all concerned…….“I think it is the beginning of several companies like Lane, which was not able to or did not handle the pandemic well and make their company better when the resurge was able to happen,” one person shared. “I think several companies are going to fold: big ones, name brands. The healthy will buy what is left that is worth anything and make themselves better.”

Furniture Today- FT Exclusive | In the Lane aftermath, a wary industry worries: ‘What company could be next?@ – January 3, 2022

This was a little chilling combined with the Interior Define story above; the troubles at BDC-financed Walker Edison (total BDC exposure $236mn and just gone on non-accrual); the disaster of Hilding Anders (FS KKR Capital invested $141mn and values its investment at 0); the likely bankruptcy of famous mattress manufacturer Serta Simmons (BDC exposure: $12.4mn) and more besides that we do not have the space to discuss.

Most BDCs are well aware that furniture manufacturing and retailing are cyclical businesses, often subject to catastrophic failure as evidenced by several bankruptcies and liquidations during the 2020 pandemic, and most stay away. However, there are enough exceptions to the rule scattered across the BDC sector to be worth keeping alert.

Big Tent

Of course, Retail is a very big and unwieldy category. An article this week from a law firm listed 10 retailers that might file for bankruptcy in 2023. With great trepidation, we checked the list against Advantage Data’s records to see what BDC exposure might be. The good news – is that for these ten names at least – there was virtually no BDC capital at risk. That’s good news, but retail in the broadest sense is likely to be impacted in 2023 by lower consumer spending – a process already underway in most corners of this vast category.

Hot Spot

As you might imagine, BDC exposure to retailers of one sort or another is wide (Advantage Data lists 34 names, and our database over 50). There is exposure to department stores (the dinosaur of the industry); retail clothing shops; pet stores; shoes and e-commerce, etc. Anyone watching BDC credit developments should keep a wary one on Retail as well.

Getting Away

Finally, that excellent publication – Bloomberg Law – offered up an article with this depressing headline: “Hotels’ Distress Lays Groundwork For More Bankruptcies in 2023”.

Hotels across the US are in line for a potential uptick in bankruptcies and out-of-court restructurings in 2023 as distress mounts from rising interest rates, staffing costs, and expectations of a mild recession.

Parts of the hospitality industry may finally be reaching a tipping point—even after managing to stay afloat over the last two years by weathering an unprecedented drop in business caused by the pandemic. Hotel owners and lenders across the country are now increasingly reaching out for help as new economic challenges, including rising interest rates and staffing costs, emerge.

As of December, close to $4.1 billion out of roughly $93 billion in outstanding lodging loans are delinquent, according to data from CMBS analytics firm Trepp Inc. It currently projects about $35 billion worth of those loans to mature this year.

Bloomberg Law – January 6, 2022

From a BDC perspective, though, there’s little to worry about. A search of our admittedly incomplete database and Advantage Data’s comprehensive records do not turn up virtually any direct BDC exposure to hotels and not much to related segments (like management companies). Thankfully, this is one sector that BDCs have not yet added to their ever-expanding financing coverage.

CONCLUSION

Not a great start to 2023 with the two BDC-financed companies causing likely significant losses to at least 3 public BDCs. Just offstage several companies – some of which we’ve discussed and others we didn’t have the room for – are getting ready to file for bankruptcy or undertake drastic restructurings. Moreover, the crypto industry continues to be in deep trouble and the outlook for recovery at the several companies financed by BDCs (mostly TRIN and BBDC) remains problematic.

It’s still very early in the year, but we’ve noted at least 3 warnings about sector credit challenges, two of which might impact BDC borrowers down the road. The stress likely to hit hotels is the only exception.

Excuse us if this sounds unduly dramatic – we pride ourselves on staying calm and carrying on – but 2023 is setting up to be a difficult year for BDC credit results, following an unexpectedly stable 2022.

The chickens are coming home to roost. The question, though, still remains if we’re going to get a “manageable” tremblor or a major, earth-splitting earthquake of a year.