Nicholas Marshi's  Instablog

BDC Reporter: Prospect Capital announced today 3 additional multi-family investments in it's real estate subsidiary, continuing a new investment initiative launched a few months ago. Management has not been very forthcoming about this new venture, which bears some resemblance to American Capital's much more well known and much broader asset management business. Prospect may eventually take their internally grown Real Estate Investment Trust public. All we know for the moment is that Prospect has acquired a number of garden apartments around the south-east, attracted by the current yield characteristics of this type of real estate asset.

Does Prospect Capital's management have the expertise, capital and vision to build a real estate empire alongside the traditional commercial lending which remains the bulk of the Company's business ? Only time will tell.

Prospect's management has always been more idiosyncratic in their investment strategies than the average BDC. Remember the frustrating, failed attempt to grab Allied Capital away from Ares Capital a few years ago. Also controversial is their capital raising policy. To the frustration of many investors and analysts, the Company continues to be continuously raising capital without any evident improvement in earnings per share, but ever increasing management fees. Whether this real estate venture, which we will guess will absorb a couple of hundred million dollars at least before we see what happens next, will benefit only management or will help shareholders, remains to be seen.

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Disclosure: I am long PSEC.

BDC Reporter: Today, Oppenheimer downgraded the stock of Business Development Company newbie OFS Capital. We thought it would be useful to provide some context around the story. The fly in the ointment is what is happening-or not-about the Company's intention to convert the investment in it's SBIC investment into a wholly-owned subsidiary.

We read the IQ Conference Call (best as we can-transcriptions make some of the language goofy). Certainly, management had to admit on the call that there was considerable uncertainty about converting their separately owned SBIC into a subsidiary, and getting heir hands on that large amount of cheap capital. Otherwise, the Company's remaining cash and unused Revolver capacity won't be sufficient to cover their current dividend. Here's the basic language in the Earnings Report:

"Simultaneously, we continue to work towards converting our Tamarix Capital Partners L.P. (Tamarix LP) investment into a drop-down small business investment company fund (SBIC) within OFS Capital. We are working to obtain the necessary investor and regulatory approvals. "

Here is what the CEO Bob Pittson said early in the Conference Call about the process of getting the SBIC into the Company:

"... I want to update everyone on our progress and converting the SBIC fund into a drop-down subsidiary. I personally had conversations with a large number of third-party investors in the fund. Based on these discussions, we will soon be sending out a proposal to acquire all their commitments on which $4.5 million is currently funded. We are also finalizing a drop-down documentation, which will be submitted to the SBA for their approval. While we are generally pleased with our progress, there are number of variables that could impact consummation of the drop-down and we cannot provide guidance as to the timing or ultimate outcome. The company [ph] required unanimous consent, there are by my count about 20 potential stakeholders including SBA, who's non-approval could materially alter the drop-down process or derail the process in its entirety".

Later on, following an analyst's question the CEO made it clear that if SBIC and shareholder approvals from the 20 "stakeholders" are not received, the strategy of OFS will be to invest $25mn in the SBIC anyway (as a minority investor). If approvals are received, the goal is to invest $75mn to maximize the SBIC leverage.

"We currently have a firm commitment to invest. I think we're roughly at $19 million to $20 million in commitment for the fund, but there is overarching commitment depending on the diversification of investors in the fund, that commitment can move up to $25 million, if we don't become a drop-down. In case of becoming a drop-down, our plan is to and our discussions with the SBA involves committing $75 million in capital to that to maximize the benefits and roll the fund to $225 million."

The CEO spelled out later why the economics of the planned SBIC subsidiary are so critical to the Company's future:

"(At the time of the roadshow in October 2012) we were looking at the SBIC fund generating a rate of return fully utilizing the leverage and looking at today's interest rates where they're above 20% rate of return on that investment and the senior loan fund itself, is kind of below teens maybe 12% depending on how much leverage, we can put into that.

The strategy works, concert with one another getting that exemptive relief essentially creates the ability to create a little more leverage in the BDC with very low cost long-term capital. So really does drive our profitability. ...Our interest rates haven't moved much, maybe there's been a little competition and compression in maybe risk premium side. I'd still hold to mid teens kind of rate of return off of this business model, net of management, based management fees."

The CEO went on to explain that the projected risk-adjusted return at the SBIC should be very good, especially as OFS intends to provide uni-tranche financing in the SBIC rather than pure mezzanine debt. That means a portion of the assets will be higher up in the capital structure and losses should be lower than in a pure mezzanine vehicle.

All of that is in the future, and at a time when loan spreads are under pressure, so the uncertainty about getting the SBIC subsidiary approvals is weighing on the stock price. Not helping is that management admits the time being spent on getting the SBIC approved has kept OFS from booking much in new uni-tranche deals.

The good news here is that the existing portfolio of 58 senior loans is performing well, with only one non-performing loans on nearly a quarter billion of assets. However, management did mention that pricing pressure in the market, has caused the syndicates in which OFS is invested to lower rates on 15% of the portfolio in recent weeks. There is no reason to believe that this won't continue, and only makes more important the ability to invest bi-laterally at higher rates through the SBIC.

There's too much uncertainty here for Oppenheimer, which downgraded the stock. The price has been stumbling, down $2 off the IPO price and could go lower until the uncertainty about the Company's likely business model is resolved.

Disclosure: I am long OFS.

Today, NPG Capital (ticker: NGPC)updated it's Registration Statement. We have no reason to believe a stock or debt offering is imminent, but we used the opportunity to read the filing.

The Company's stock has been on a downtrend since February 19th, when it peaked at $7.59. As we write the stock is at $6.84, and has been as low as $6.58, a drop of 13% in two months, more than 2x the drop in the BDC sector as a whole over that period as measured by the industry exchange traded Note with the ticker BDCS. In fact, NGPC is trading at a near 30% discount to Net Asset Value, at a time when most BDCs boast a premium. Clearly something is wrong at the Company (which is not news to us or existing shareholders), but what exactly ?

We reviewed the filing for hints and here's what we found:

BORROWER GMX RESOURCES HAS FILED FOR BANKRUPTCY

1. The Company's investment in GMX Resources is going sour. Here's the run-down from the filing, which brings developments almost up to date:

"On September 19, 2012, GMX Resources, Inc., or GMX, consummated an exchange offer for its outstanding 5% Senior Convertible Notes due 2013, or the 2013 Notes, pursuant to which holders tendering the 2013 Notes received new Senior Secured Second-Priority Notes due 2018, or the 2018 Notes, and shares of GMX common stock. We tendered our 2013 Notes in the exchange offer, and consequently received 2018 Notes with a face value of $12.7 million and 3,646,368 shares of GMX common stock. We sold 671,270 shares of GMX common stock in 2012. Effective January 3, 2013, GMX executed a 1-for-13 reverse stock split; consequently, our 2,975,098 shares were converted into 228,853 post-split shares, which we sold in March 2013 for an average price of $3.28 per share, or $0.8 million, resulting in a realized short-term capital loss of $1.6 million, or $0.07 per common share. Interest on the 2018 Notes accrues at a rate of 9% per annum and is payable quarterly (commencing March 4, 2013) at GMX's option, in cash or, with respect to interest paid prior to September 19, 2014, either in the form of cash, GMX common stock, or a combination thereof. The number of shares of GMX stock, if any, to be issued in lieu of cash interest is calculated by assigning a value per share equal to the product of (a) 0.75 and (b) the 10-day volume weighted average price ending the business day prior to the interest payment date.

On March 4, 2013, GMX announced that it failed to make its interest payment on the 2018 Notes, which was due on March 4, 2013. Under the indenture, this failure to pay does not constitute an event of default unless it continues for thirty days; however, it does constitute an event of default under another GMX debt security, which could potentially trigger cross-default features and acceleration of substantially all of GMX's indebtedness. GMX has announced that it has engaged a financial advisor to assist GMX in its ongoing exploration of financing alternatives, including a potential restructuring of GMX's balance sheet in light of its current liquidity and cash needs. GMX has announced that if it is not able to successfully implement a consensual alternative for restructuring its balance sheet, or in order for GMX to implement a financial alternative, GMX may voluntarily seek protection under the U.S. Bankruptcy Code. As of December 31, 2012, we recorded a 100% reserve, totaling $0.4 million, or $0.02 per share, on our interest receivable from GMX as of such date.

On April 1, 2013, subsequent to the date we filed our Annual Report on Form 10-K, GMX filed for protection under Chapter 11 of the U.S. Bankruptcy Code. At December 31, 2012, the fair value of the GMX Notes was $7.4 million".

If NGPC ends up writing off the full face value of the $12.7mn in Notes that's quite a hit for a small company with only 14 investments. We calculate the potential loss on the debt, using the info in the filing, at $0.25 per share on Net Asset Value, and a potential 5% drop in Investment Income over 2012′s level, and an even greater hit to Net Investment Income.

ATP OIL AND GAS ROYALTY INVESTMENT UP IN THE AIR

2. There is a great deal of uncertainty whether NGP Capital Resources big, risky bet on ATP Oil & Gas is going to pay off. Here's the language from the filing:

" In 2011 and 2012, we purchased from ATP Oil & Gas Corporation, or ATP, limited-term ORRIs in certain offshore oil and gas producing properties operated by ATP in the Gulf of Mexico, including $25.0 million advanced on July 3, 2012. Under this arrangement, we own the right to portions (ranging from 5.0% to 10.8%) of the monthly production proceeds from the various oil and gas properties subject to the ORRI in ATP's Gomez and Telemark properties. The terms of the ORRI provide that it will terminate after we receive payments that equal our investments in the ORRI plus a time-value factor that is calculated at a rate of 13.2% per annum. On August 17, 2012, ATP filed for protection under Chapter 11 of the U.S. Bankruptcy Code, and received authorization to incur debtor-in-possession financing of approximately $600 million. ATP failed or refused to deliver our proportionate share of production proceeds for the production months of May and June 2012, which proceeds were due to be distributed on July 31, 2012 and August 31, 2012, respectively. On August 23, 2012, the bankruptcy judge presiding over ATP's case signed an order allowing ATP to pay amounts received after August 17, 2012 to those parties entitled to receive them, including the ORRI holders, provided that the owners of the ORRIs execute the Disgorgement Agreement providing for the repayment to ATP of any amounts that the bankruptcy court later finds to have been inappropriately paid. We executed the Disgorgement Agreement and began receiving monthly distributions in September 2012 from ATP of our share of production proceeds received by ATP after August 17, 2012. On October 17, 2012, we filed a lawsuit against ATP in the U.S. Bankruptcy Court, seeking a declaration that the ORRIs are valid, fully enforceable, and not voidable. ATP has responded by seeking a determination that the ORRIs are not enforceable as a conveyance, but rather are in the nature of a debt instrument. In that connection, ATP seeks disgorgement of amounts paid to us in accordance with the Disgorgement Agreement. This lawsuit is currently pending and trial is scheduled for April 30 - May 1, 2013. We intend to vigorously defend our position that the ORRIs constitute real property interests and are fully valid and enforceable pursuant to their terms. Our unrecovered investment as of December 31, 2012 was $37.0 million, and we had received $8.9 million subject to the Disgorgement Agreement, of which $2.9 million was recorded as investment income in our statement of operations for the year ended December 31, 2012. Our unrecovered investment as of February 28, 2013 was $33.6 million, and we had received $13.1 million subject to the Disgorgement Agreement [Emphasis added by the BDC Reporter]."

Later on in the filing is greater detail about the legal arguments going back and forth, which deserves detailed reading by any existing or prospective investor:

"On August 17, 2012, ATP filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code, in the U.S. Bankruptcy Court for the Southern District of Texas. We own limited term ORRIs in certain offshore oil and gas producing properties operated by ATP. On August 23, 2012, the bankruptcy judge presiding over ATP's case signed an order (Docket No. 191) allowing ATP to pay amounts received after August 17, 2012 to those parties entitled to receive them, including the ORRI holders, provided that the owners of the ORRIs execute an agreement providing for the repayment to ATP of any amounts that the bankruptcy court later finds to have been inappropriately paid (the "Disgorgement Agreement"). We executed the Disgorgement Agreement and began receiving monthly distributions in September 2012 from ATP of our share of production proceeds received by ATP after August 17, 2012. As of December 31, 2012, our unrecovered investment was $37.0 million, and we had received $8.9 million subject to the Disgorgement Agreement, of which $2.9 million was recorded as investment income in 2012. As of February 28, 2013, our unrecovered investment was $33.6 million, and we had received $13.1 million subject to the Disgorgement Agreement.

On October 17, 2012, we filed a lawsuit against ATP styled: NGP Capital Resources Company v. ATP Oil & Gas Corporation , Adv. Proc. No. 12-03443, in the U.S. Bankruptcy Court for the Southern District of Texas, seeking a declaration that the ORRIs are valid, fully enforceable and not voidable. ATP filed an answer and counterclaim in which it (a) denies that the ORRIs are valid and enforceable, (b) seeks a declaration that (i) the ORRIs are a financing agreement and not a true sale and (ii) the ORRIs are executory contracts that are subject to rejection under 11 U.S.C. Sec. 365, and (c) seeks disgorgement from us of amounts paid to us since August 17, 2012, the date of filing of ATP's Chapter 11 proceeding. The United States has sought to intervene in the lawsuit arguing that the underlying leases are unexpired leases of real property or executory contracts (and not real property conveyances), subject to rejection by ATP. Certain service companies holding mechanics and materialman's lien privileges have intervened in the lawsuit for the purpose of establishing that their liens and privileges are superior to our rights. The Bank of New York Mellon Trust Company, N.A., the secondary lien holder, has also intervened in the lawsuit, arguing (i) the ORRIs are a financing agreement and not a true sale, (ii) our claims are barred, waived, released and/or otherwise foreclosed by the express terms of the conveyance of the ORRIs, and (iii) either we have not met a condition precedent or we failed to perform or substantially perform our contractual obligations. The issues in the lawsuit have been bifurcated. This lawsuit is currently pending and trial is scheduled for April 30 - May 1, 2013. We intend to vigorously defend our position that the ORRIs constitute real property interests and are fully valid and enforceable pursuant to their terms.

Separately, the Official Committee of Unsecured Creditors of ATP (the "Committee") filed a motion (the "Motion") requesting authority from the U.S. Bankruptcy Court to be allowed to bring a fraudulent transfer action against us, in which the Committee seeks to allege (a) that ATP was insolvent at the time of the assignment of the ORRIs to us (b) that ATP received less than fair value from us in exchange for the assignments of the ORRIs and (c) as a result, the assignments should be set aside. The Company vigorously denies these allegations and opposes the Motion. The Motion has been abated until a date after May 1, 2013″

If NGPC loses in court, the Company will have to "disgorge" $13.1mn to ATP, and may see their investment pushed down the balance sheet of the bankrupt company. Management is confident they are on solid ground, but if they are not..

Sadly, there's more as ATP is seeking to close down some of it's wells from which NGPC is receiving royalties, and this too may affect cash flow in the short term. Here's the language in the filing:

"On February 24, 2013, ATP filed an emergency motion for an order approving the shut-in of the Debtor's Gomez Properties and granting related relief [Docket No. 1494] (the "Shut-In Motion"). As more fully set forth in the Shut-In Motion, ATP asserts that the Gomez Properties should be shut-in because their continued operation negatively affects ATP's cash flow. The Gomez Properties are burdened by the ORRIs, and we receive distributions of production proceeds attributable to our interests in the Gomez Properties. An emergency hearing was conducted by the Court on February 28, 2013, and on that date the Court entered its Order Regarding Shut In of Gomez Wells [Docket No. 1531] (the "Gomez Order"). The Gomez Order sets a final hearing on the Shut-In Motion for March 28, 2013 and reflects an interim compromise by certain ORRI holders and contains provisions for the accrual and distribution of production proceeds generated from the Gomez wells for the period March 1, 2013 through the date any order is entered authorizing the shut in of the Gomez wells. To the extent the Court grants the Shut-In Motion and the Gomez wells are shut-in, the cash flows attributable to the ORRIs will be negatively affected."

IF WORSE COMES TO WORST

The rest of the Company's energy loans and a couple of newly booked health care investments appear to be performing normally. However, should both these troubled situations go the wrong way, the Company's revenues could drop by as much as a third, and Net Investment Income by more than half. The Company is carrying the ATP investment at close to fair value, and has no liability booked for the potential disgorgement proceeds. If worse came to worse the Company could have to write off in excess of $50mn (adding together the FMV of the GMX Notes, the "unrecovered" ATP investment and the $13.1mn potential to be "disgorged). The potential hit to the NAV would be $2.57, which could bring the book NAV to $7.00, just above the current price.

IMPACT ON BORROWING FACILITY

Unfortunately, NGPC is not swimming in liquidity right now after making several major new loans. We are worried that should the worst come to pass (and that may not turn out to be the case) this loss of asset value and Net Investment Income might result in a default under the Company's Revolver debt. Here are the covenants we worry most about (quoting from the filing):

maintaining a ratio of net asset value to consolidated total indebtedness (excluding net hedging liabilities) of not less than 2.25:1.0,

maintaining a ratio of net asset value to consolidated total indebtedness (including net hedging liabilities) of not less than 2.0:1.0,

maintaining a ratio of EBITDA (excluding revenue from cash collateral) to interest expense (excluding interest on loans under the Treasury Facility) of not less than 3.0:1.0″

Admittedly some of the assets NGPC owns can be readily sold, so we're not anticipating anything threatening the existence of the business, but losing access to the Revolver would compound an already grim situation and make rebounding that more difficult.

CONCLUSION

There is trouble ahead potentially for NGP Capital. The next few weeks will be critical. If the Company's views on ATP win the day, and the GMX bankruptcy leaves some value to the Company neither asset value or cash flow will be much impacted. If matters go the other way, Net Asset Value and cash flow and the direction of the Company will all be affected.

Disclosure: I am long NGPC.