BDCs head to Washington to make case to modernize rules

In 2013, Rep. Mick Mulvaney (R-SC) toured the factory of Ajax Rolled Ring and Machine which manufactures steel rings used in construction equipment and power turbines.

The factory, which is located in York, S.C., now employs about 100 people. It has since been acquired by FOMAS Group.

But at the time of Mulvaney’s tour, Ajax was controlled by Prospect Capital, a business development company, or a BDC. Propsect Capital’s investment from April 2008 included a $22 million loan and $11.5 million of subordinated term debt.

Mulvaney said he had never heard of a BDC before that day at Ajax, nor realized how important BDCs were as an investment source in his district.

That has changed. Bringing laws for BDCs up-to-date has since become a key issue for Mulvaney, who is on the House Committee on Financial Services. He has proposed a draft bill to modernize the laws governing BDCs.

As a former small business owner himself, Mulvaney believes allowing BDCs to grow more easily, a key component of his proposed legislation, will provide much-needed financing to the mid-sized companies to which banks have cut lending since the credit crisis.

“BDCs fill a niche for companies too big to access their local banks, but too small to access public debt and equity markets. I am acutely aware of the importance of having capital for growth when you are running a company,” Mulvaney said.

Last week, the modernization of the laws governing BDCs was the subject of a hearing by the House Subcommittee on Capital Markets and Government Sponsored Enterprises. The hearing brought together titans of the BDC industry.

“The BDC industry is maturing, and growing in a meaningful way. They are beginning to realize they need to come together as a regulated industry and speak with a common voice,” said Brett Palmer, President of the Small Business Investor Alliance (SBIA).

“They are incredibly competitive, which is one of the challenges of getting them all in the same regulatory boat, rowing in the same direction.”

The timing of Prospect Capital’s purchase of Ajax Rolled Ring in April 2008 was not fortuitous. The company was heavily reliant on Caterpillar, which accounted for roughly 50% of revenue, and the global financial crisis took a heavy toll on Ajax in 2009 and 2010.

Still, Prospect Capital increased its investment in Ajax during those tough years. That investment allowed Ajax to build a machine shop, and thus deliver a more finished product to its customers. Last year, when Italy-based FOMAS unveiled an offer for Ajax in a bid to expand in the U.S. market, Ajax was a much stronger business with revenue diversified away from Caterpillar, according to Prospect Capital.

Rep. Mulvaney is hoping a bill could be ready at the end of July, and that it could be on the floor for debate by fall. The new draft of the bill addresses concerns raised over a prior proposal to reform BDC rules.

One size does not fit all
The SBIA estimated the number of active BDCs exceeds 80, and the size of the rapidly growing industry has surpassed $70 billion. “What’s a priority for one BDC is not necessarily a priority for another,” SBIA’s Palmer said.

Even with differences across the industry, possibly the most important potential change for BDCs is the asset coverage requirement. The change would effectively raise the leverage limit to a 2:1 debt-to-equity ratio, from the current 1:1 limit.

BDC managers argue that even with the change, leverage of BDCs would be conservative compared to other lenders, which can reach a level of 15:1, for banks, and even higher, to the low-20x, for hedge funds.

“It should allow BDCs to invest in lower-yielding, lower-risk assets that don’t currently fit their economic model,” Ares Capital Board Co-Chairman Michael Arougheti told the hearing. “In fact, the current asset coverage test actually forces BDCs to invest in riskier, higher-yielding securities in order to meet the dividend requirements of their shareholders.”

BDC managers say that BDCs are far more transparent than banks traditionally have been. After all, BDCs regularly publish their loans, as well as the loans’ interest rates and fair values, in quarterly disclosures with the Securities and Exchange Commission.

“We believe it would be good public policy to increase the lending capacity of BDCs, and promote the more heavily regulated, and more transparent, BDC model,” said Mike Gerber, an executive vice president at Franklin Square Capital Partners.

To garner support for the leverage change, the bill may require BDCs to give as much as a year’s notice for any increase, allowing shareholders to sell holdings before any change comes into effect, if they don’t approve.

However, the idea of “increasing leverage” has suffered a tarnished image with the public since the credit bubble and resulting global financial crisis. BDCs are popular with retail investors because of their high dividends.

Testimony of Professor J. Robert Brown, who was a Democratic witness at the June 16 hearing on BDC laws, could help repair this image problem, supporters of the change say. Brown said reducing the asset coverage for senior securities was an “appropriate” move toward giving BDCs more fundraising capacity.

“Such a change will potentially increase the risks associated with a BDC. Nonetheless, this is one area where adequate disclosure to investors appears to be a reasonable method of addressing the concern,” Brown’s published testimony said.

“In addition, the draft legislative proposal provides investors with an opportunity to exit the company before the new limits become applicable.”

Save paper
Another change under discussion is the definition of  “eligible portfolio company,” which dictates what type of companies BDCs can invest in.

BDCs were designed to furnish small developing and financially troubled businesses with capital. Existing rules dictate that BDCs invest at least 70% of total assets into “eligible portfolio companies,” leaving out many financial companies.

Some argue that the economy has changed since this BDC rule was put in place, moving away from traditional manufacturing companies.

“Changing the definition of eligible portfolio company to permit increased investment in financial firms may result in a reduction in the funds available to operating companies. It may also result in an increase in the cost of funds to operating companies,” Brown said in his published testimony.

Less controversial in a potential BDC modernization bill appears to be the desire to ease regulatory burdens for BDCs.

Main Street Capital CEO Vincent Foster drew attention to the SEC filing requirements born by even the smallest BDCs. He called for reform to the offering and registration rules, such as allowing BDCs to use “incorporation by reference” that would allow them to cite previous filings instead of repeating information in a new SEC filing. He said the change would not diminish investor protections.

By way of example, Foster held up a stack of papers at the hearing on the BDC bill, about four inches thick, that was needed by Main Street to issue $1.5 billion in stock. He then held up a stack of papers, less than one inch thick, needed by CIT, not a BDC, to allow for a $50 billion equity issuance.

“Do four more inches of paper protect better than a half an inch? Hundreds of pages represent wasted money and manpower,” Foster said.

“This discussion draft would fix this absurdity and make a host of clearly-needed reforms.” – Abby Latour

Follow Abby on Twitter @abbynyhk for middle-market deals, leveraged M&A, BDCs, distressed debt, private equity, and more.


Energy sector, Colt Defense focus of LCD’s Restructuring Watchlist

The beleaguered energy sector dominated activity this quarter on LCD’s Restructuring Watchlist, with Sabine Oil & Gas missing an interest payment on a bond and Hercules Offshore striking a deal with bondholders for a prepackaged bankruptcy.

Another high-profile bankruptcy this month was the Chapter 11 filing of gunmaker Colt Defense. Colt’s sponsor, Sciens Capital Management, agreed to act as a stalking-horse bidder in a proposed Section 363 asset sale. The bid comprises Sciens’ assumption of a $72.9 million term loan, a $35 million senior secured loan, and a $20 million DIP, and other liabilities.

The missed bond interest payment for Sabine Oil & Gas was due to holders of $578 million left outstanding of Forest Oil 7.25% notes due 2019, assumed through a merger of the two companies late last year.

The skipped payment comes after a host of other problems. Sabine Oil has already been determined to have committed a “failure to pay” event by the International Swaps and Derivatives Association, and will head to a credit-default-swap auction. The determination by ISDA is related to previously skipped interest on a $700 million second-lien term loan due 2018 (L+750, 1.25% LIBOR floor).

Meantime, Hercules Offshore on June 17 announced it entered a restructuring agreement with a steering group of bondholders over a Chapter 11 reorganization. The agreement was with holders of roughly 67% of its10.25% notes due 2019; the 8.75% notes due 2021; the 7.5% notes due 2021; and the 6.75% notes due 2022, which total $1.2 billion.

Among other developments for energy companies, Saratoga Resources filed for Chapter 11 for a second time, blaming challenges in field operations, the decline in oil and gas prices, and an unexpected arbitration award against the company. Thus, Saratoga Resources has been removed from the list. Another company previously on the Watchlist, American Eagle Energy, has been removed following a Chapter 11 filing in May.

Another energy company, American Energy-Woodford, could work itself off the Watchlist through a refinancing. On June 8, the company said 96% of holders of a $350 million issue of 9% notes due 2022, the company’s sole bond issue, have accepted an offer to swap into new PIK notes.

Also, eyes are on Walter Energy. The company opted to use a 30-day grace period under 9.875% notes due 2020 for an interest payment due on June 15.

Another energy company removed from the Watchlist was Connacher Oil and Gas. The Canadian oil sands company completed a restructuring in May under which bondholders received equity. The restructuring included an exchange of C$1 billion of debt for common shares, including interest. A first-lien term loan agreement from May 2014 was amended to allow for loans of $24.8 million to replace an existing revolver. A first-lien L+600 (1% floor) term loan, dating from May 2014, was left in place. Credit Suisse is administrative agent.

Away from the energy sector, troubles deepened for rare-earths miner Molycorp. The company skipped a $32.5 million interest payment owed to bondholders on a $650 million issue of first-lien notes. Restructuring negotiations are ongoing as the company uses a 30-day grace period to potentially make the payment.

In other news, Standard & Poor’s downgraded the Tunica-Biloxi Gaming Authority to D, from CCC, following a skipped interest payment on $150 million of 9% notes due 2015. Roughly $7 million was due to bondholders on May 15, and the notes were also cut to D, from CCC with a negative outlook. The company operates the Paragon Casino in Louisiana.

Constituents occasionally escape the Watchlist due to improving operational trends. Bonds backing J. C. Penney advanced in May after the retailer reported better-than-expected quarterly earnings and improved sales.

In another positive development, debt backing play and music franchise Gymboree advanced after the retailer reported steady first-quarter sales and earnings that beat forecasts. Similarly, debt backing Rue 21 gained in May after the teen-fashion retailer privately reported financial results, according to sources. – Abby Latour

Follow Abby on Twitter @abbynyhk for middle-market deals, leveraged M&A, distressed debt, private equity, and more

Here is the full Watchlist, which is updated weekly by LCD (Watchlist is compiled by Matthew Fuller):

Watchlist 2Q June 2015



GE selling Antares to Canada pension fund CPPIB as part of $12B deal

GE will sell Antares Capital to Canada Pension Plan Investment Board (CPPIB) as part of a $12 billion transaction.

The sale includes a $3 billion bank loan portfolio. Antares Capital will operate as an independent business, and retain the name. The sale is expected to close in the third quarter.

Managing partners David Brackett and John Martin, who have led Antares since its formation, will continue to lead the stand-alone business. CPPIB will retain the Antares team, a statement today said.

Stuart Aronson, the CEO of GE Capital Sponsor Finance, will stay at GE Capital.

The sale accounts for $11 billion of ending net investment. GE Capital has announced sales of roughly $55 billion, and plans to complete $100 billion of sales this year.

The Senior Secured Loan Program (SSLP) will continue to operate for a time prior to the closing of the deal, giving “Ares and CPPIB the opportunity to work together on a go-forward basis.” The SSLP is a joint venture between GE Capital and Ares Capital.

“If a mutual agreement is not reached, it is GE Capital’s intention to retain the SSLP in the future so that it can execute an orderly wind down of this program ($7.6 billion GE Capital investment, $6.1 billion of which is attributable to Sponsor Finance).”

A similar strategy holds for the Middle Market Growth Program (MMGP), which is a joint venture between affiliates of GE Capital and affiliates of Lone Star Funds, GE said. That program accounts for $600 million of GE Capital investment.

GE announced in April it would divest GE Capital, including its $16 billion sponsor finance business. GE Antares specializes in middle market lending to private-equity backed transactions.

GE Capital has long reigned as the dominant player in the middle market lending, defined by LCD as lending to companies that generate EBITDA of $50 million or less, or $350 million or less by deal size, although definitions vary among lenders.

In May, Ares Capital CEO Kipp deVeer said Ares plans to continue supporting sponsors and businesses, either directly or through a new program with a new partner. This new partner may be looking to expand their lending to the middle market, or be entering the business for the first time.

He cautioned that there was no guarantee that Ares would reach a deal. In recent weeks, Ares has been working with potential parties, including non-U.S. regulated banks and non-banks such as asset managers, insurance companies, and combinations thereof.

GE Capital is not allowed to unilaterally sell the loans in the SSLP. If no partner is found, the SSLP could be gradually wound down through repayment of the loans. The weighted average life of the SSLP loans was 4.3 years at the end of the first quarter. – Abby Latour

Follow Abby on Twitter @abbynyhk for middle-market deals, leveraged M&A, distressed debt, private equity, and more



Speculative-grade bond defaults in May climb to highest since 2009, S&P report says

The eight speculative-grade corporate bond defaults in May marks the highest one-month count since nine defaults in October 2009, as companies remain challenged by volatility in the commodities markets, according to S&P Global Fixed Income Research (S&P GFIR).

Standard & Poor’s defines speculative-grade debt as having ratings of BB+ and lower.

The oil-and-gas sector leads with downgrades and defaults, but the number of downgrades across all sectors remains elevated. Indeed, downgrades during the month outnumbered upgrades by 35 to 12, according to S&P GFIR.

However, Diane Vazza, head of S&P GFIR tempered the data with the following statement: “Despite the increasingly negative rating actions for speculative-grade U.S. companies, we continue to see positive investor demand in the market; year-to-date issuance is up from last year, credit spreads narrowed slightly during the month, and total returns were modestly positive for the month.”

As for the eight defaults during the month, all were public. Magnetation and Patriot Coal filed for bankruptcy; Colt Defense and Tunica-Biloxi Gaming Authority/Paragon Casino skipped bond coupons; Warren Resources and Midstates Petroleum inked sub-par bond exchanges; and SandRidge Energy and Halcon Resources completed bond-for-equity exchanges, also below par.

With that, the U.S. trailing-12-month speculative-grade corporate default rate is estimated to have increased to 2.0% in May, from 1.8% in April, according to S&P GFIR. The current observation represents the highest level in 17 months, or since the rate was at 2.2% in December 2013.

The S&P GFIR forecast for the U.S. speculative-grade default rate is for a modest increase, to 2.5% by December 2015 and 2.8% by March 2016.

Today’s report, titled “Defaults Rise As Downgrades Remained Elevated In May,” is available to subscribers of premium S&P GFIR content at the S&P Global Credit Portal.

For more information or data inquiries, please call S&P Client Services at (877) 772-5436. – Staff reports


CLO roundup: U.S. supply beats forecasts, Europe nears upper limit

CLO activity in the U.S. was curtailed by the Thanksgiving holiday, with just three U.S. CLOs pricing last week.

Europe managed two transactions, but the primary pipeline is hampered by waning investor appetite and widening liability spreads.

As a result, global issuance has risen to $132.87 billion, according to LCD.

Ahead of the Thanksgiving break, arrangers were focused on getting those deals priced that they could, and lining up further transactions for this week once the market returns. New-issue activity will be on hold again early next week as players head to Dana Point, Calif. for Opal’s CLO Summit this weekend.

LCD subscribers can click here for full story, analysis, and the following charts:

  • Deal pipeline
  • US arbitrage CLO issuance and institutional loan volume
  • European arbitrage CLO issuance and institutional loan volume

– Sarah Husband

Follow Sarah on Twitter for the latest CLO market news and insight.


Fed: Problems with leveraged loans remain, despite recent guidelines

A joint report by the Federal Reserve, FDIC, and Office of Comptroller of the Currency shows that little has changed among lending practices since the March 2013 leveraged lending guidance was released. The report found that the volume of loans that are rated with negative implications by rating agencies – referred by the agencies as a criticized asset – remained unchanged in 2014 from the prior year, at roughly $341 billion, or 10% of total loan commitments.

Leverage loans, as reported by agent banks, make up roughly 23%, or $767 billion, of the annual Shared National Credits (SNC) review – a review that was established in 1977 to review any formal loan, commitment, and asset such as stock, notes, and bonds extended to borrowers by a federally supervised institution and includes commitments that FBOs and nonbanks such as securitization pools, hedge funds, and insurance companies participate in. In the SNC review, leverage loans accounted for roughly $255 billion, or 75% of “criticized” SNC assets. The report also notes that roughly a third of leverage loans were criticized.

A full report of the shared national credits program 2014 review and the leverage loan supplement are attached, downloadable here:  Shared National Credits Program 2014 Review  &  Leveraged Loan Supplement.

The report also included a leveraged loan supplement that identifies several areas where institutions need to strengthen compliance the March 2013 guidance, including provisions addressing borrower repayment capacity, leverage, underwriting, and enterprise valuation [attach PDF]. In addition, examiners noted risk-management weaknesses at several institutions engaged in leveraged lending including lack of adequate support for enterprise valuations and reliance on dated valuations, weaknesses in credit analysis, and overreliance on sponsor’s projections.

The LSTA released a statement this afternoon stating that leverage lending is a critical for the U.S. economy and encouraged agencies to continue evaluating leveraged loans on a “nuanced basis, balancing the importance of a safe system, while ensuring that credit-worthy companies are still able to access the financing they need. – Richard Kellerhals


Red October: Second-liens suffer in rough month for leveraged loan market

Second-lien chart 1REV

It’s no great surprise, but second-lien prices have fallen further than first-lien prices during the loan market’s October setback. Indeed, the average bid of first-lien paper in the S&P/LSTA Leveraged Loan Index has dropped 0.34 points, to 97.87 on Oct. 24, from 98.21 on Sept. 30. Over the same period, the average second-lien bid has slumped 1.42 points, to 97.86, from 99.28.

LCD subscribers can click here for full story, analysis, and the following charts from this article:

  • Monthly returns
  • Average Spread to maturity for leveraged loans
  • Averaged new-issue yield to maturity
  • Second-lien volume

– Steve Miller

Follow Steve on Twitter for an early look at LCD analysis, plus market commentary.


Leveraged loan funds see largest outflow since Aug. 2011, led by mutual funds


Cash outflows from bank loan funds swelled to $1.66 billion during the week ended Oct. 22, up from a $946 million outflow in the previous week, according to Lipper. The reading reflects mutual fund outflows of $1.56 billion, plus a $98 million outflow from the exchange-traded fund segment, and it represents the largest outflow since the $2.12 billion recorded for the week ended Aug. 17, 2011.

The latest reading represents the 26th outflow in the past 28 weeks, for a net redemption of $16.8 billion over that span.

The trailing four-week average deepens to negative $1.22 billion from negative $897 million last week and negative $807 million two weeks ago. The four-week average surpasses the previous high reading of negative $944 million for the four weeks ended Aug. 24, 2011.

The year-to-date fund-flow reading pushes deeper into negative territory, at roughly $9.68 billion, based on a net withdrawal of $9.71 billion from mutual funds against a net inflow of $32 million to ETFs. In the comparable year-ago period, inflows totaled $46.65 billion, with 11% tied to ETFs.

The change due to market conditions was positive $322 million, versus total assets of $96.9 billion at the end of the observation period. The ETF segment comprises $7.4 billion of the total, or approximately 8%. – Joy Ferguson


Leveraged loan fund outflows reach nearly $1B, led by mutual funds, 14th straight week of outflows


Cash outflows from bank loan funds increased to $946 million during the week ended Oct. 15, according to Lipper. The reading reflects mutual fund outflows of $869 million plus a $76 million outflow from the exchange-traded fund segment.

The latest reading is an uptick from an outflow of $825 million last week and it represents the 25th outflow in the past 27 weeks, for a net redemption of $15 billion over that span.

The trailing four-week average deepens to negative $897 million per week, from negative $807 million last week and negative $686 million two weeks ago. This is the largest average since a negative $944 million reading for the four weeks ended Aug. 24, 2011.

The year-to-date fund-flow reading pushes deeper into negative territory, at roughly $8 billion, based on a net withdrawal of $8.2 billion from mutual funds against a net inflow of $131 million to ETFs. In the comparable year-ago period, inflows totaled $45.9 billion, with 11% tied to ETFs.

The change due to market conditions was negative $829 million, versus total assets of $98.3 billion at the end of the observation period. The ETF segment comprises $7.4 billion of the total, or approximately 8%. – Joy Ferguson


CLO roundup: U.S. nears volume record as Europe AAAs see new low

The CLO market returned to form last week as eight managers printed deals in the U.S. and Europe, for a total of $3.88 billion, according to LCD. Of this, the U.S. priced six for $2.8 billion, while Europe priced two for just over $1 billion. Global volume stands at $110.56 billion in the year to date, according to LCD.

Year-to-date issuance in the U.S. is $95.87 billion from 177 deals, nearing the all-time high of $97.01 billion in 2006. Given the near-term pipeline, which holds at least six CLOs for roughly $3 billion, it’s highly likely the record will be broken this week. In the same period last year, issuance stood at $60 billion from 124 deals.

LCD subscribers can click here for full story, analysis, and the following charts:

  • Recent deals
  • European arbitrage CLO issuance and institutional loan volume
  • Deal pipeline
  • Global CLO volume

. - Sarah Husband

Follow Sarah on Twitter for the latest CLO market news and insight.