INTRODUCTION

This has been a slow week for BDC news. Maybe everyone is getting ready for III 2024 earnings season, less than a month away for everyone but Saratoga Investment (SAR) which reports its results for the quarter ended August on October 8, 2024. However, there have been some developments where BDC credit is concerned. Robertshaw US Holding has just exited bankruptcy. However, only BDC had exposure as of June 2024 – Portman Ridge (PTMN) – and the amounts involved were not materiakl – both at cost or FMV.

Of greater interest – and the subject of our article below copied from the BDC Credit Reporter – is a large debt and equity capital injection at STG Logistics, a freight company whose debt is found on the books of 9 BDCs, including six that are in our coverage universe. Moreover, the amount invested by the BDCS is above average – and as you’ll see – on the rise.

This is a “good news for now” credit development but things could change…

Reprinted from the BDC Credit Reporter

STG Logistics: Lenders And Sponsor Inject Capital

October 4, 2024

Sometimes we don’t have to wait around for the BDCs to report their latest results in order to write an update about what is happening to one of their portfolio companies. The BDC Credit Reporter automatically searches for news about several hundred BDC-financed companies daily. Today, we learned that STG Logistics (also known as Reception Purchaser and Reception Mezzanine Holdings) – an intermodal freight operator – has “secured” $300mn in new capital from its lenders and sponsor. As is often the case with this sort of press release, very few details are provided, like the split between sponsor and lenders of those monies, or the terms of the new debt or whether any equity was issued for these additional funds.

However, we can tell you that this funding is arriving just in time. Despite a $40mn injection by the sponsor in April of this year, Fitch Ratings downgraded the company less than a month ago to CCC from B-. The crux of the ratings group’s concern was the “expectation that weaker than expected cash flow in the second half of 2024, mainly due to depressed freight rates, will substantially deplete the company’s cash-on-hand by year-end”. That was a pretty serious issue and must have been a trigger for this new capital injection.

We believe that amongst the lenders generously opening their wallets are 6 public BDCs and 3 non-traded BDCs. The former are Logan Ridge (LRFC); OFS Capital (OFS); PennantPark Floating (PFLT); PennantPark Investment (PNNT), Portman Ridge (PTMN) and Prospect Capital (PSEC). Total BDC exposure is already – as of the IIQ 2024 – $103mn, consisting of loans due at different dates in 2028. The BDCs involved have discounted their positions by as little as (2%) to as much as (23%). We’ve rated STG Logistics a 3 on our 5 point scale since the IVQ 2023. That places the company on our watch list but not amongst the entities that we are most pressingly concerned about.

For the moment, we are retaining the CCR 3 rating, the new monies notwithstanding. There is the possibility that even this new round of financing may not do the trick. That’s because the industry in which STG operates is facing depressed pricing; leverage was already very high before this new debt injection and there’s no certainty that fundamentals will improve in 2025. This is part of what Fitch had to say back in September:

Fitch forecasts EBITDA interest coverage of under 1.0x in 2024, before improving to 1.0x in FY2025, contingent on the realization of higher rates and lower forward SOFR expectations. Fitch projects EBITDA leverage will be above 10x in FY2024 and remain around 10x in 2025, depending on whether operating profits improve. These metrics are weak for the business model and more consistent with the ‘CCC’ category….In 2025 STG will also be subject to the resumption of its net leverage financial covenant, which is set at 7.0x at YE25. Fitch does not expect the company to be able to comply with the covenant without external support or modification.

We always have to be vigilantly worrying about a “good money after bad” situation even if the BDCs involved are likely to improve their valuations following this funding. The intermodal logistics business is – to state the obvious – “highly cyclical“. Moreover – as Fitch concedes – susceptible “to supply and demand imbalances within intermodal and truckload markets”. To add further insult to injury “the industry has limited pricing power given its reliance on third party transporters and the availability of substitute trucking options”. None of these negative intrinsic factors are going away, so our concern remains.

In fact, we’re surprised that so many BDCs – which almost always preach that they avoid “cyclical” businesses have thrown themselves into this sort of borrower. Admittedly, none of the public BDCs involved have taken too large a position. PNNT has the largest amount of debt advanced at $15mn, but that’s presumably going to increase.

We’ll circle back in the future, both to have a look at how the BDCs choose to value their investments and to check on how STG is performing in this tough industry.