Every week, we re-publish in the BDC Reporter one article from the BDC Credit Reporter that we believe will be interesting to our readers. It’s only Monday, but this is a holiday shortened week and the bankruptcy featured below is likely to materially impact the long-term performance of both the public BDCs mentioned above.

Re-published from the BDC Credit Reporter

Hearthside Food Solutions: Files Voluntary Chapter 11

Remains Rated CCR 5 And An Important Underperformer.

November 25, 2024

As expected, one of the most impactful bankruptcies of the year where BDCs are concerned has just occurred. On November 22, 2024, H-Food Holdings and certain of its subsidiaries – including Hearthside Food Solutions – filed for a voluntary Chapter 11 bankruptcy. We’ve written about the company multiple times before and have long warned of the coming restructuring as well as the likely major realized losses of capital and income to come for the 3 BDCs involved.

The company – as expected – has entered into a Restructuring Support Agreement (RSA) with its stakeholders in order to expedite the bankruptcy, which is expected to be completed by the end of the IQ 2025. We now know that the parties have agreed to a whopping write-off of $1.9bn of the company’s debt and the injection of $200mn of new equity capital “at exit”. (Last we heard, total debt was $2.0bn). In addition, “Hearthside has filed a motion seeking approval of $300 million of debtor-in-possession (“DIP”) financing, including $150 million of new money from existing lenders. Following Court approval, the Company anticipates this financing will provide ample liquidity to support its operations during the Chapter 11 process“.

As of the IIIQ 2024 – when the writing was on the wall and much of the above was likely already in draft form – Ares Capital (ARCC); Blue Owl Capital (OBDC) and non-traded Blue Owl Capital II, had advanced $226mn to Hearthside in first and second lien debt and in equity. The value was given as $54mn, indicating a (76%) write-down already. We have been projecting losses will be in the 75%-100% range.

As we’ve explained before, the severity of the likely loss to come is due to the fact that 87% of BDC exposure is in second lien debt and equity. As it seems that Hearthside may be getting virtually all its existing debt forgiven, the existing junior capital is likely headed to the scrapyard. Already, the debt is discounted (87%) and the equity (100%). The first lien debt – most of which is likely to be swapped for equity in the restructured company – is being discounted up to (25%). That seems a little low but that’s the magic of these debt-for-equity swaps – the lenders-now-owners involved get to mitigate some of their losses as part of the process.

However, there seems little doubt that essentially all the interest income that was being received by the BDCs before the company began to default in the IQ 2024 will be forgone and that amounts to about ($30mn) a year. The biggest hit – both in terms of capital loss and income (about 50%)) – will be felt by OBDC, but ARCC is not far behind with well over ($70mn) invested in the junior capital and $27mn in the first lien debt.

To put matters into perspective, the likely income forgone by OBDC amounts to about (2%) of the BDC’s full year 2023 net investment income, and the $109mn invested in Hearthside’s second lien debt represents (1.8%) of the BDC’s equity capital at par. If OBDC is a very large BDC in terms of capital, ARCC is even bigger and faces a more modest loss: (0.5%) of its own equity capital at par. Still, these are stinging losses for both players should they be booked. However – as mentioned – it’s always possible the Hearthside restructuring will allow the BDCs to duck out of taking their full realized loss.