A new bankruptcy, three restructurings and more.

BDC CREDIT UPDATE

Week 43

BDC-Financed Company Bankruptcies: As anticipated in these pages last week, Air Methods Inc. filed for Chapter 11 bankruptcy. This article provides a useful summary of the reasons for the failure and the debt involved. As a reminder, the only BDC with exposure is SLR Investment (SLRC), and its exposure – in first lien debt – is only $3.4mn. If a loss is forthcoming, the BDC will be barely impacted.

This week we also heard from Ares Capital (ARCC) – which reported its IIIQ 2023 results. The leading BDC revealed three major realized losses in the period. One was in Benefytt Technologies – which filed for bankruptcy in May of this year and has taken on a new life following a debt-for-equity swap. Here’s an extract from the BDC Credit Reporter’s article on the subject:

ARCC used to have $29.1mn advanced at cost to Benefytt, but booked a ($17mn) realized loss in the IIIQ 2023 as part of the restructuring. Now, the BDC’s total investment is $12mn, in two first-lien loans due in 2028 and 2033. The BDC also owns no cost equity – 32,391,330 class B units …The BDC values its positions at par.

BDC Credit Reporter

In July 2023, ARCC was involved in a restructuring of Visual Edge Technology. We count this as equivalent to bankruptcy. Here is the bottom line:

In the IIIQ 2023 ARCC booked a ($47mn) realized loss – its biggest loss of the quarter. Gone is the subordinated loan. Some of the amount due was written off (hence the realized loss) and the remainder converted into preferred. A $33mn first lien loan has been extended till 2025 that was previously due in 2022. A small $3.9mn equity stake remains – still valued at zero. The amount of income lost is substantial by our estimation as ARCC – before the subordinated loan was placed on non-accrual – was earning annualized interest income – in PIK form – of $16mn. However, that hasn’t occurred since the IQ 2022 when the sub debt was last performing.

BDC Credit Reporter

Then there was another restructuring of some sort at JDC Healthcare – a dental services company. We don’t know all the details but ARCC wrote off most of its $31.5mn in first lien loans to the company, which were replaced with a new subordinated loan of only $0.700mn. The BDC booked a realized loss of ($20mn).

In total, these bankruptcies/restructuring involved $188mn of advances by ARCC and resulted in ($84mn) in realized losses and a “recovery rate” of 55%. However, given that all the companies continue in some form, further losses are possible, albeit the downside at JDC Healthcare is now immaterial.

With this latest bankruptcy and two restructurings (we’re not counting Benefytt which was already added back in May), the total for the year comes to 37 in Week 43 – still below one a week.

New Downgrades: Despite reviewing the latest valuations for 475 ARCC companies, we did not identify any significant changes which would require any downgrades in the BDC’s portfolio in the IIIQ 2023. There were no companies rated 1 or 2 – performing to plan or above – slipping into underperforming status (rating 3-5). Even amongst the existing underperformers, no downgrades were applied to a lower rating. In all 2023, only 3 ARCC portfolio companies have been added to their underperformers list, which now numbers 45 names. (Subscribers to the BDC Credit Reporter can access a database with the names of all the ARCC underperformers, and a Company File on each).

Other Developments: Across the public BDC universe we updated the files of 49 companies this week, some of which we’ve covered above. Most of the companies involved were ARCC-related. The restructurings and write-offs taken by the BDC have had the effect of reducing the number of its Important Underperformers – those companies rated 4 or 5 on our 5-point scale and with a fair market value in aggregate in excess of $5mn. In the IIQ 2023, there were 14 Important Underperformers. Now there are 10. The total cost of investments in this group is $633mn and the FMV is $434mn. At a time when some observers might have expected the number and value of deeply troubled companies to be increasing, the opposite is occurring.

BDC Credit Table: With BDC IIIQ 2023 just getting underway, we’d like to start a series of updates of where we stand from a credit standpoint as the data comes in. We’ve heard from two BDCs: ARCC and Saratoga Investment (SAR) – one upper middle market, very large BDC and another one that principally targets the lower-middle market There is very little overlap between the borrowers in the two BDCs given that the EBITDA of ARCC’s companies averages in the hundreds of millions and at SAR more in the $5mn-$20mn range. Still, these are two early windows into the UMM and LMM markets.

Total portfolio assets of these two BDCs amounts to $23.0bn, which represents about 18% of the universe we track going by the IIQ data. Portfolio assets at FMV have increased by 2%, with both players increasing in size. Also, the number of portfolio companies/entities comes to 547, up from 533 in the IIQ 2023 and 516 at year-end 2022. Despite a more treacherous macro environment and lower M&A activity, more “platform” companies are being added.

Both BDCs offer shareholders quarterly investment ratings for their portfolios. According to ARCC and SAR, underperforming assets have a value of $1.443bn, 6.5% of its portfolio for ARCC and 1.6% for SAR. Both metrics are within a normal range – which we’ve set at 0%-15%. In the IIIQ 2023, underperforming assets have dropped by 8% – from $1.569bn in the prior quarter. However, the change in the percentage of underperforming assets for both BDCs remains unchanged.

As far as we can tell – because ARCC’s data is opaque – the total number of companies non-performing is unchanged at 13. As we’ve discussed previously, SAR added a significant new non-accrual in the form of food manufacturer/retailer Pepper Palace, bringing their total non-accruals to 2. ARCC’s restructuring of Benefytt and Visual Edge removed them from the non-accrual list, although JDC Healthcare remains there but with far fewer dollars involved. However, Lifescan Global had a second lien loan become non-performing – bringing ARCC’s total down to 11 from 12.The dollars involved at FMV in non-accrual loans amounts to $150mn, or 0.7% of the two BDCs portfolio assets.

For the quarter total realized losses incurred – all by ARCC – amount to ($76mn). For the calendar year those losses amount to ($208mn). These have all been incurred – with the exception of ($1mn) by ARCC. This quarter, the major individual losses were the three previously mentioned restructurings. In the IIQ, there was the restructuring of ADG, LLC and in the IQ 2023 the “National College of Business” – all of which we discussed before.

The two BDCs, though, have been able to offset realized losses with $122mn in unrealized gains in the IIIQ 2023. A good deal of those gains are write-backs of written-off investments and an increase in the value of various investments. In total ARCC showed a significant gain and SAR an insignificant loss. This, and the retaining of earnings, has contributed to both BDCs NAVPS being up modestly for the year.

Moreover, net investment income for SAR and ARCC in the latest period has amounted to $303mn, “covering” realized losses 4x over.

CONCLUSION

Not So Bad

Notwithstanding the three realized losses by ARCC – all very close to their IIQ 2023 valuation – and the addition of 2 new names on the 2023 bankruptcy/restructuring list, BDC credit conditions remain reassuring. In fact, more troubled companies are being “fixed” or settled out than are being added.

However, we are just at the beginning of earnings season so we’ll avoid drawing any broad conclusions. Check back with us every week – and the BDC Credit Table at any time – for the latest data.