BDC CREDIT

WEEK 13

INTRODUCTION

We’re just under four weeks away from the next round of BDC earnings releases. As we’ve mentioned in earlier articles – and based on our daily research into BDC credit developments – we expect credit metrics to worsen from the IVQ 2022 but to remain within a “normal” range for the bulk of BDCs. We’ll even suggest credit troubles in the venture-debt segment should remain modest, despite what happened to Silicon Valley Bank (SVB). Check out the BDC Credit Table from May on as we update a whole range of important metrics as fast as we can after every BDC reports.

This week, we’ll discuss some of the BDC credit stories picked up on the radar at our sister publication the BDC Credit Reporter.

IN THE NEWS

Let’s begin with Cano Health, where 3 Board members resigned in protest at the alleged poor management of the company and promised to wrest back control. That makes for an enjoyable Monday evening watch when Succession is involved, but must be worrying for three BDCs with $10mn of exposure – all held in their off-balance sheet joint ventures. The BDCs are NMFC, MRCC, and CCAP.

Cano has much more to worry about than an internecine struggle and the BDC Credit Reporter downgraded the company to CCR 4 on its 5-point scale, which indicates a realized loss is more likely than not. The only good news is that the amounts advanced by each BDC are modest, and should not move the net asset value needle of their JVs too much.

Homer City Generation is a CION-financed coal-powered plant in Pennsylvania. This week, the owners decided to close down the operation after a half-century. The likely result is a realized loss for CION as the plant will probably be decommissioned or sold for a “greener” use. At the end of 2022, CION had advanced $13.1mn but had written off only ($2.8mn) on an unrealized basis. A bigger loss as well as the company being added to their non-accrual list seems likely. An above-average amount of interest income will be forgone as two Term Loans were being charged at 15.0% and 17.0%. This setback was not entirely unexpected as the BDC Credit Reporter had downgraded Homer City to CCR 4 since October of last year. Now the rating is CCR 5 – as low as you can go.

The biggest credit story of the week in the BDC Credit Reporter is that footwear manufacturer Shoes For Crews has a refinancing challenge up ahead. As we wrote about in the BDC Common Stocks Market Recap this week, the key theme in credit right now is the challenge many companies are facing replacing existing debt coming to maturity in 2023 or 2024. Lenders have pulled in their horns and how much they will lend, triggering the prospect of a restructuring or a bankruptcy filing for many leveraged companies. At the moment, given that the problem is more of a balance sheet one than of a flawed business model, restructuring is usually the preferred solution. In this case, both the company and some of its lenders with $350mn of debt coming due in 2024 have hired advisers and are preparing for negotiations.

We call this a “Major” credit because total BDC exposure is over $100mn. As of the IVQ 2022, $138mn was involved, spread over 4 BDCs. Most at risk, though, is ARCC. Not only does the market-leading BDC have the largest single exposure but its loan is in the second lien position. At year-end 2022, the second lien debt was already non-performing (never a good sign) and a (31%) discount was taken. This could yet turn into a larger – realized – loss for ARCC and – to a lesser degree for the other BDCs invested in a first lien position. Those other BDCs are OCSL, SLRC, and GBDC.

Also in the news was the bankrupt Independent Pet Partners. The three BDCs involved – MAIN, CION, and non-traded MSC Investments – had $64mn advanced at year end-2022. That amount has likely much increased as the BDCs have banded together to provide Debtor-In-Possession (DIP) financing and purchase most of the business in a classic debt-for-equity swap. Their “stalking horse” bid was approved by the bankruptcy court this week, so it seems these three BDCs will be the owners of a chain of pet stores before long. We’ll be very curious to see how the BDCs value their investment and what realized loss – if any – might be booked from this strategic kicking of the can down the road. This was not good news per se but the parties involved must be delighted to have spent very little time in bankruptcy and must be hoping that – one day – they might yet get out of this investment whole.

CONCLUSION

As you can see from the above, there’s always something going on where BDC credit is concerned. Every underperforming company has a different story and a different outcome. At the moment – as the BDC Credit Table shows – just in the public BDC arena there are over 5,000 portfolio companies. (Admittedly, there are duplicates involved where several BDCs – like at Shoes For Crews – are involved).

As we’ve said at the top, we expect the BDC sector as a whole to weather the storm brewed by higher rates; tighter markets, and a slowing economy. However – as is always the case in these downturns – there will be huge variability in credit performance on a BDC-by-BDC basis. In the next year or two, we’ll find out which BDCs – to borrow from Warren Buffet – have been “swimming naked”.