This version updates crude oil prices as of this afternoon, adds marks against principal amounts, and clarifies bids for Larchmont Resources among HMS Income Fund, Main Street Capital, and White Horse Finance.
There’s no doubt that BDCs will write down fourth-quarter valuations for Oil & Gas sector investments. The big question hanging over the market, therefore, is by how much?
Oil & Gas values at BDCs have tracked the same downward trajectory as bids in the S&P/LSTA Index over the past year, albeit at a less severe pace, an LCD analysis shows.
For the Index, Oil & Gas loans slumped 21% in the fourth quarter amid further declines in oil prices. If BDCs continue to shadow the Index, marks should fall somewhere inside that level.
KBW is estimating a decline of roughly 10%, according to equity analyst Greg Mason. BDCs start reporting fourth-quarter results this month, followed by details of investment portfolios shortly thereafter.
Looking at the third quarter, Oil & Gas in the Index slid 17%, to 70.8, from 85.51. Comparatively, BDC fair values dropped 6.9% against principal amount, and 7.2% against cost.
Not quite apples to apples
There are a couple of meaningful differences underlying Index bids versus BDC bids. To start, the BDC average bid is supported by a much larger number of investments: 125 versus 54 in the S&P LSTA Index.
Secondly, a large chunk of the BDC grouping skews to small-cap companies that are private and unknown to institutional investors. That makes them difficult to value, and as a result, they may not be as visibly volatile as the large, liquid names housed within the Index.
Additionally, values for the same asset can vary significantly among BDCs.
For example, marks for AAR Intermediate Holdings are 10 points apart. The 12% term loan due 2019 is marked at 70.4 against principal at Medley Capital, and at 80 at CM Finance. (At cost, the paper shows unrealized losses of 26 points at Medley, and 14 points at CM Finance.)
Meanwhile, values for Larchmont Resources are tight between debt investors. The 8.75% term loan due 2019 for Oklahoma City–based Larchmont Resources is marked at 85 against principal at HMS Income Fund and Main Street Capital (which is a sub-adviser to HMS, a non-listed BDC), and at 84 at White Horse Finance. (At cost, the paper indicates unrealized losses of three points at HMS, 11 points at Main, and 17 points at White Horse.)
Larchmont is backed by EIG Global Energy Partners.
There are a few shining stars in Oil & Gas, portfolios show. An 11.5% term loan due 2019 for U.S. Well Services is marked at par against principal at PennantPark, 99.5 at Capitala Finance, and 98 at CM Finance. (At cost, the paper is even at Capitala and CM Finance, and shows a two-point gain for PennantPark).
U.S. Well Services uses a new technology that greatly reduces the cost of extracting gas, so demand for their services has actually increased amid falling oil prices, according to KBW. In 2014, the company signed a five-year contract with Antero, one of the largest gas producers in the U.S. Last September, U.S. Well Services signed a contract with Anadarko. BlackRock has an equity stake in the business in addition to the debt.
On the whole, Oil & Gas represents about $2 billion, or roughly 3.7% of total BDC debt investments tracked by LCD, yet there are a handful of BDCs with higher concentrations.
Data in the above chart was provided by Wells Fargo Securities. Pricing information is based on Bloomberg, which means private or illiquid assets may see greater pricing volatility when credits become stressed. One large lender to Oil & Gas, specialty lender FSEP, was excluded from the chart due to its large size and 95% exposure to the sector.
At the end of the third quarter, Apollo Investment Corporation reduced its Oil & Gas holdings to 15%, from 16%. Apollo sold a portion of a first-lien loan to Deep Gulf and unsecured investments in Denver Parent. Apollo also is exiting Caza Petroleum, which breached covenants. Funds affiliated with Talara Capital Management acquired shares in Caza through a $45.5 million transaction.
For much of 2015, Oil & Gas drove higher the number of non-accrual loans in BDC portfolios, and the list is likely to grow, with dividends potentially under threat.
In the third quarter, 40% of Oil & Gas loans were bid below 80 (against principal), up from 10% in the year ago period. By cost, Oil & Gas showed a loss of 34 points, versus eight points.
There are numerous Oil & Gas investments in BDC portfolios on watch by investors. In the third quarter, Prospect Capital moved one investment to its non-accruals list, CP Energy Services. Prospect Capital owns 82.3% of CP Energy equity.
Prospect Capital said it had “modest” exposure to the energy sector, at 3.5%, including first-lien loans where third parties bear first-loss capital risk. However, in the recent quarter, non-accruals increased to 1.4%, with 1.3% due to energy holdings.
Prospect’s loan investments on non-accrual status include CP Energy Services, Gulf Coast Machine & Supply Company,Wind River Resources Corporation, and Wolf Energy.
Wells Fargo equity analyst Jonathan Bock said it’s worth noting that Prospect Capital’s further exposure to the energy sector through CLO holdings, and the potential for reductions in those valuations going forward. He downgraded shares in Prospect Capital to “underperform” from “market perform” last week.
Meanwhile, Petroflow lifted Ares Capital Corp.’s non-accrual loans to 2.3% of the portfolio at cost in the fiscal third quarter, from 2.2% a year earlier. Petroflow is one of three companies that Ares considers true Oil & Gas–related investments, which only account for roughly 3% of the portfolio. ARCC’s Petroflow investment is a first-lien position originated in July 2014 prior to the dramatic decline in oil prices. Crude today hit $26 a barrel, down from $94 on Nov. 26, 2014, the day prior to last year’s so-called OPEC bombshell meeting.
Ares is working with Petroflow and the lender group to restructure Petroflow’s balance sheet, Ares told investors in an earnings call in November. The principal investment totals $52.3 million. Ares booked the first-lien loan at a cost of $49.7 million, and the deal was marked at a fair value of $37.9 million as of Sept. 30.
There are plenty of markdowns at other BDCs. PennantPark Investment has marked a $45 million second-lien loan due 2019 to New Gulf Resources at $31.5 million as of Sept. 30, alongside a $15.2 million holding in subordinated notes, marked at $1.5 million. Subsequently, New Gulf Resources filed for Chapter 11 in December with a prearranged restructuring plan.
FS Investment Corp.’s second-lien investment in Ascent Resources–Utica, booked at $182 million at cost, is set to be marked down, as is a secured bond investment in SandRidge Energy.
“FSIC accurately marks its book in line with public marks, which we applaud, and we expect the 12/31 book to reflect the recent energy market volatility,” Bock said in a December research report.
The value of Apollo’s holding in Venoco also will be in focus for fourth-quarter investments. Venoco was restructured last year, and the unsecured debt was rolled into secured debt. The Venoco investment as of Sept. 30 consisted of a $40.5 million 12% first-lien loan due 2019 with a fair value of $39.3 million, and a $35.8 million holding of 8.875% notes due 2019, marked at $28 million at fair value, and $46 million on cost basis.
Apollo’s Venoco investment accounted for $12 million of the $30.2 million in realized losses for the quarter ended Sept. 30. In April, Standard & Poor’s raised the corporate rating on Venoco to CCC+, from SD (selective default), after the company completed a debt exchange of unsecured notes for new second-lien notes for 77.5% of par value.
Regardless of how much exposure they have to Oil & Gas, concerns about energy have pressured all BDCs. Assuming the worst case scenario—all investments fall to zero—book values would tank 9%, on average. BDCs with greater exposure to the sector would be looking at hits of 15–25%, KBW estimates.
The worst case is just that, however. “We do not believe this is a realistic assumption,” KBW equity analyst Troy Ward stated in a Jan. 7 research note. The worst case merely “…quantifies the downside risk related to energy,” he added. — Kelly Thompson/Abby Latour
This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.