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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

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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

 

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Leveraged loan fund assets inch higher in May but remain down YTD

leveraged loan fund aum

In May, loan mutual funds’ assets under management inched up $504 million, or 0.37%, to $138.5 billion, according to data from Lipper FMI and public filings. The gain follows a $607 million advance in April. Despite these modest gains, AUM was still down $2.8 billion at the end of May from $141.3 billion at the end of 2014.

As the chart above illustrates, a punishing nine-month run in which AUM declines averaged $3.8 billion a month came to an end in January. In the four months since, AUM is up by an average of $457 million a month. – Steve Miller

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Ares forms new middle-market lending venture with AIG-backed Varagon

Ares Capital Corporation has named Varagon Capital Partners, which is backed by insurer AIG, as its new partner for middle-market lending.

The new joint venture, called the SDLP (Senior Secured Loan Program), will originate and hold first-lien loans, including stretch senior and unitranche loans, of up to $300 million, a joint Ares-Varagon statement today said.

“The SDLP will work to follow on with the success that Ares Capital enjoyed with its previous senior loan joint venture, the Senior Secured Loan Program (SSLP), with GE Capital… The program will provide sponsors and management teams with continued access to flexible capital with speed and certainty and without syndication requirements,” the statement said.

“As a long-term investor, AIG is attracted to the strong investment fundamentals of middle-market credit,” said Brian Schreiber, AIG’s Chief Strategy Officer, in the statement.

The fate of Ares Capital’s venture with its former partner, GE Capital, had been in question. The two companies cooperated on the $9.6 billion SSLP venture, with Ares supplying 20% of funding, and GE 80%. Financial details of the new venture were not given.

General Electric announced this month it would sell Antares Capital to Canada Pension Plan Investment Board (CPPIB) and focus on its core industrial businesses. GE Antares specializes in middle-market lending to private-equity backed transactions, but it was unclear if Ares and CPPIB would work together longer term.

Ares has been working with potential parties on a new venture, including non-U.S. regulated banks and non-banks such as asset managers, insurance companies, and combinations thereof. However, there is no guarantee Ares will reach a deal.

Varagon, a direct lending platform to middle-market companies, was formed in 2013. It is backed by AIG and affiliates of Oak Hill Capital Management.

Ares Capital is a BDC that trades on the Nasdaq under the symbol ARCC and invests in debt and equity of private middle-market companies. A subsidiary of Ares Management, which trades on the New York Stock Exchange as ARES, manages Ares Capital.

LCD defines middle-market lending as lending to companies that generate annual EBITDA of $50 million or less, or involving deals of $350 million or less in size, although definitions vary among lenders. – Abby Latour

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As stocks rise, regulations tighten, private equity shops see smaller slice of leveraged loan pie

 

private equity loan volume

As tough as 2015 has been for leveraged loan activity overall – new-issue volume in the U.S. is down 32% year-over-year, to $205 billion through June 12 – private equity has suffered a disproportionate drop, fostered by a combination of regulatory pressure and sky-high equity prices.

All told, private equity-backed issuers’ share of leveraged loan volume has receded to a six-year low of 43%, or $87.7 billion of $204.6 billion, from 54% last year. And this doesn’t include the looming set of large corporate deals, featuring Charter Communications and Avago Technologies. Factoring in those transactions, PE’s share drops to 39%.

The challenging regulatory and market environment notwithstanding, LBO loans as a share of overall leveraged loan volume has inched to a post-credit-crunch high of 18% in the year to date, from 16% in 2014. Still, LBO activity remains far short of its boom-year highs.

Few participants expect the LBO engine to shift into a higher gear until purchase multiples fall to more IRR-friendly levels (assuming at that point economic growth persists). Until then, strategic buyers will likely dominate the M&A game. Certainly, that’s been the case in 2015, with corporates taking 53% of overall M&A-related leveraged loan volume, also a seven-year high, or $58 billion of $110 billion. Pro forma for the calendar, that share jumps to an all-time high of 61%.

Follow Steve on Twitter for leveraged loan news and insights.

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Sabine Oil skips interest payment on acquired Forest Oil bonds after loan default

Sabine Oil & Gas yesterday did not make the coupon payment due to holders of the $578 million left outstanding of Forest Oil 7.25% notes due 2019 that were assumed via the merger of the two companies late last year. Instead of making the approximately $21 million payment, the company will enter a typical 30-day grace period amid “continuing discussions with its creditors and their respective professionals,” according to a statement.

As previously announced, Sabine retained financial advisor Lazard and legal advisor Kirkland & Ellis to address strategic alternatives related to its capital structure. Cash on hand is approximately $277 million, which provides liquidity to fund operations, filings show.

The bonds changed hands yesterday at 21.5, which was fairly rangebound as compared to recent prints, trade data show. Other Sabine issues trade a bit lower, such as the 9.75% notes due 2017, which changed hands in blocks at 15.5, data show.

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).

Recall Sabine entered into a 30-day grace period after skipping a $15.313 million interest payment due to its second-lien lenders on April 21. Since that time, the issuer late last month inked a forbearance agreement to the end of June, barring any defaults under the forbearance agreement or if any other creditor accelerates payment (see “Sabine nets forbearance agreement to 2L TL as grace period ends,” LCD News, May 22, 2015).

In light of the missed interest payment, S&P in April cut Sabine’s corporate and debt ratings to D, triggering a default in the S&P LSTA Leveraged Loan Index. At the time, it was the third Index issuer to default this year after Walter Energy’s downgrade to D after skipping April 15 bond coupons and Caesars Entertainment Operating Company‘s bankruptcy in January, but since Sabine’s default, Patriot Coal last month became the fourth Index issuer to default following its Chapter 11 filing.

Wilmington Trust has replaced Bank of America Merrill Lynch as administrative agent on the second-lien loan, according to a June 1 filing.

Note the company in May also inked a forbearance agreement with lenders to its reserve-based revolver that also runs to June 30.

As of May 8, the company had a cash balance of approximately $276.9 million, which it said provides substantial liquidity to fund its current operations. – Staff Reports

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Colt Defense files Chapter 11; sponsor Sciens to purchase assets

Colt Defense today filed for Chapter 11 in Wilmington, Del., the company announced, saying that the filing would “allow for an accelerated sale of Colt’s business operations in the U.S. and Canada.”

Colt said its current sponsor, Sciens Capital Management, has agreed to act as a stalking horse bidder in the proposed asset sale. Details of the deal were not provided.

The company did say, however, that it would be soliciting competing bids and that it has appointed an independent committee of its board of managers to manage the process and evaluate bids.

Colt’s existing secured lenders have also agreed to provide a $20 million DIP facility to allow for continuation of operations during the Chapter 11 process, which the company said it expects to complete in 60-90 days.

As reported, since April Colt had been seeking consents from its noteholders for an uptier exchange offer or, alternatively, approvals for a proposed prepackaged reorganization plan implementing the exchange. Despite several extensions to the proposed exchange/prepackaged plan, however, the company fell far short of the participation threshold, and allowed the offer to expire on June 12.

O’Melveny & Myers LLP is the company’s legal counsel, and Perella Weinberg Partners is acting as financial advisor. Mackinac Partners is the company’s restructuring advisor. – Alan Zimmerman

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Judge approves $145M bankruptcy loan for Boomerang Tube, victim of oil-price downturn

The bankruptcy court overseeing the Chapter 11 proceedings of Boomerang Tube gave interim approval to the company’s proposed $145 million DIP facility.

The DIP comprises a $60 million term loan facility and an $85 million revolver. Court documents show that interest under the term portion would be at L+1,100, while interest under the revolver would be at L+450.

The interim approvals give the company access to $40 million of the term loan, consisting of $35 million of immediate borrowing capacity, and an additional $5 million thereafter upon certain circumstances. The company would have access to the entire revolver, subject, of course, to the facility’s borrowing base restrictions.

A final hearing on the DIP is scheduled for July 10, in Wilmington, Del. – Alan Zimmerman

 

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Antares Capital to expand junior debt offering under new owner

Antares Capital will expand its product offering in subordinated, or junior debt under new ownership by the Canada Pension Plan Investment Board (CPPIB).

Antares Capital expects to underwrite, and potentially hold, second-lien and mezzanine debt as a result of the new partnership, according to David Brackett and John Martin, who will lead the group under its new owner. Historically, GE Capital and GE Antares had almost focused entirely on senior secure loans.

After weeks of speculation over who would buy the business, GE today announced plans to sell Antares Capital to CPPIB as part of a $12 billion transaction. Speculation had focused on a non-bank lender as the buyer of pieces of the GE Capital assets up for sale, including of a company trying to enter middle market lending.

In buying the GE business, CPPIB makes a debut in the U.S. middle market business with a splash. 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.

Until now, CPPIB’s focus had been on larger deals. Its junior debt business included high-yield bonds and mezzanine debt. Since 2009, CPPIB’s credit investments have totaled $17 billion, through primary and secondary market purchases. CPPIB’s credit investments are managed by a team of 36 globally.

CPPIB will retain Antares’ team. Antares employs around 300, led by managing partners Brackett and Martin, who have led Antares since its formation. Antares will operate as an independent, stand-alone company.

Moreover, Antares will strengthen its unitranche loan product via the new partnership.

“CPPIB Credit Investments will stand ready to immediately invest follow-on capital into Antares post-closing to support origination of unitranche loans for its clients at scale, as we believe this is a differentiated product that will support Antares’ market leading position,” CPPIB said in a statement today.

Any impact on middle market lending overall as a result of GE Capital’s exit is likely to be minimal.

“There truly isn’t going to be any void. Whatever we’ve been able to provide in the past is what we’ll be able to provide in the future,” said Martin in an interview with LCD News.

The Antares purchase will open CPPIB’s credit investment portfolio to the U.S. middle market. GE Antares specializes in middle market lending to private-equity-backed transactions.

“They had been studying the market for some time and liked the risk-reward scenario. This gave them an opportunity to enter the market in a meaningful way, with scale,” said Brackett in the interview.

The geographic footprint of Antares will likely remain much as it is today, with its headquarters in Chicago, a significant presence in New York, and operations near Atlanta. Antares Capital will operate as an independent business, and retain the name.

The sale is expected to close in the third quarter.

The Senior Secured Loan Program (SSLP), so far not part of the sale, 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. Without an agreement, the program may be wound down (see GE’s sale to CPPIB leaves fate uncertain for $9.6B SSLP partnership).

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 and focus on its core industrial businesses. – Abby Latour

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