One of the last BDCs to report IQ 2017 earnings is the smallest BDC: OHA Investment Corporation (NASDAQ:OHAI) . As we promised yesterday in BDC News Of The Day , we have reviewed OHAI's press release, 10-Q and Conference Call transcript. Warning: his is going to be dismal:
Unfortunately for troubled OHAI the results for the quarter were bad across the board. The BDC Reporter undertook an analysis of the BDC back in March 2017, and the outlook was not encouraging even then. Since NGP Investment turned over the Investment Advisor reins to Oak Hill Advisors in September 2014 Net Asset Value Per Share has dropped from $9.20 to $3.99 at year end 2016; total investment assets have shrunk drastically and the distribution has been slashed to just 2 cents a quarter. Here's how we summed up the BDC's prospects a few months ago:
."..while there's still a slim chance that OHAI will get itself out of this jam, it's also possible the BDC may have to restructure or file for Chapter 11. Most likely of all is a continued deterioration as all parties involved (the advisor, the lender, the Board and the shareholders) read the tea leaves".
"Continued deterioration" is what we've gotten in the last quarter. The biggest item of news is that OHAI's biggest remaining investment - Castex Energy 2005 LP - was placed on non-accrual and its fair market valuation reduced. Almost as telling, there were no positive developments where the several other deeply troubled portfolio investments are concerned, adding to the existing gloom. As a result, the value of the entire portfolio dropped (16%) from IVQ 2016. Income, as compared to a year previously in the financials, has dropped by more than half, and the BDC only eked out a nominal GAAP profit of $0.2mn. As we'll see even that number is a bit of a fiction. Net Asset Value is now $61.0mn or $3.02 a share, less than one-third of the BDC's value Before The Fall.
PROFIT: SLIM TO NONE
We say the minuscule Net Investment Income is a fiction because so much of the income is derived from Pay-In-Kind that may never be collected, principally due to OHAI continuing to book income from its $17.2mn loan to OCI Holdings (which has nothing to do with the energy sector) at very high rates, but in non cash form. Here is what the footnote in the 10-Q says on the subject:
During the fourth quarter of 2016, we executed a series of amendments to our note purchase and security agreement with OCI Holdings, LLC, or OCI, to allow the company to PIK its LIBOR+12% cash interest for November and December 2016. Also, default interest of $0.1 million and current interest of $0.4 million was added to the principal balance in the fourth quarter 2016. Effective January 31, 2017, we executed a seventh amendment to our note purchase and security agreement with OCI to allow the company to PIK its LIBOR+12% cash interest through March 31, 2017. OCI remains in financial covenant default and while in default, we are earning an additional 2% cash interest and 2% PIK interest.
No wonder then that $1.445mn of the $2.455mn of Investment Income earned in the IQ of 2017 was in PIK form. On a cash basis, OHAI's costs are outpacing its income by about $1.2mn a quarter, and nearly $5mn a year.
NO RELIEF AHEAD
Nor is there much hope for a dramatic change any time soon. On the contrary. On the Conference Call, the BDC spelled out the problems with the Castex investment, which appear to be only worsening. Here is an extract:
As noted in our 10-Q, the entity through which Castex produces and develops oil and natural gas may undergo a restructuring, bankruptcy, asset sale or other transactions that could adversely affect the fair value of our investment in Castex and our expected return. I would like to emphasize that there is no guarantee that the outcome of such a transaction would be favorable to us or would enhance the value of our preferred LP interest. Also, we are subject to the risk that Castex or its creditors may make business decisions with which we disagree and that Castex management may take risks or otherwise act in ways that are adverse to our interests.
OCI Holdings -which the BDC still values close to par- has its own business challenges which do not appear to be going away. This, too, was discussed on the Conference Call:
Although not a significant driver of value change during the quarter, I would like to point out that we have reduced the value of our equity investment in OCI Holdings by $200,000. As a reminder, we have a 20.8% diluted equity ownership in OCI's common equity and $18.1 million of principal amount of subordinated notes in OCI. OCI is a home health provider of pediatric therapy services to Medicaid patients in Texas and has negatively been impacted by Medicaid reimbursement rate reductions, which were proposed in June of 2015 and implemented by the State of Texas effective December 15, 2016. Even prior to the implementation of these reductions, OCI experienced pressures on rates in certain parts of their business and reductions in visit volumes. As a result, recent operating performance and cash flow have declined. Advocacy groups continue to challenge the Medicaid reimbursement rate reductions and are asking the Texas State legislature to restore funding in its current legislative session. The Texas House of Representatives has included significant Medicaid rate restorations for pediatric therapy services in their proposed budget. However, there is no guarantee that the final biannual Texas budget will reflect these restorations. Therefore, the long-term impact on OCI remains uncertain. Also subsequent to quarter end, we executed an eighth amendment to our note purchase and security agreement with OCI that allows the company to continue to PIK its LIBOR plus 12% cash interest through June 30, 2017.
By our count, OHAI had 15 portfolio company assets with a supposed fair market value of $88mn at March 31, 2017 , but only 9 with no issues to contend with valued at $50mn, two of which have subsequently been sold. Total debt outstanding under the Midcap Financial Trust Revolver is $41mn, leaving very little nominal value.
Remarkably, the Revolver is not yet in default and - on paper - OHAI still has the ability to draw and repay. The 10-Q points out that OHAI has $16mn in "a delayed draw term loan, which is committed for one year, and is available to us to grow our investment portfolio and operate our business". We'd be very surprised if OHAI will ever get access to those funds, especially as the repayment date would be now less than a year away. In fact, the recent sales of a couple investments shortly after making them (for a profit !) suggests to the BDC Reporter that building cash might be the BDC's main priority.
BY THE GRACE OF…
Looking at the key covenants called out in the 10-Q, OHAI is getting close to default on the requirement that "Debt" should not exceed 50% of Fair Market Value. Just looking at the March 2017 results that percentage was already at 45%. Then there's the Debt To Tangible Net Worth, which is supposed to remain under 0.80 to 1.00, calculated monthly. In fact, OHAI is probably not in default only because the valuations of OCI Holdings (which is effectively not paying most of its obligations) and Castex Energy remain so high. OCI has a cost of $19.7mn in the form of Subordinated Notes and equity, but is valued still at $17.2mn. Castex Energy, which has not been paying its obligations for years, is on non-accrual and is probably headed for bankruptcy as we've shown, is still valued at $32.9mn. Write either of those assets down - or both - and OHAI would be in default.
SORRY TO HAVE TO SAY
Although there was no admission of such by the Investment Advisor, who actually spent a portion of the Conference Call discussing market conditions in the overall leveraged lending market, OHAI seems doomed. The BDC Reporter - given that the Investment Advisor is providing shareholders with no guidance- will offer its view of what might happen next. First, the distribution appears in doubt given the drop in earnings, and the negative cash earnings which will erode OHAI's cash reserves. Moreover, due to the different way GAAP and Tax income are counted, shareholders may be assessed more taxable income than they receive in a pay-out. See the Q&A section.
From the recent asset sales, we get the impression OHAI is in wind up mode. Amusingly, on the Conference Call an "Unidentified Analyst" suggested a liquidation is what the Investment Advisor should do. No comment was forthcoming from the long suffering CEO Steven Wayne. Nonetheless, we expect that's where this is likely to go and before long.
NOT OUR JOB
Of course, we're just making reasoned judgments based on what we read. What the OHAI shareholders deserve is a fuller admission by the Investment Advisor of what the way forward looks like. As far back as March 2016 we asked : "What Is The Way Forward" ? " in an article on these pages. We will conclude this review of OHAI's IQ 2017 results by quoting what we said more than a year ago, which remains as pertinent as ever:
The very legitimate question that has to be asked is what is OHAI's end-game ? With no liquidity to grow the portfolio, and a long, hard slog ahead on many key investments that could result in further (and possibly) complete write-offs; no prospect of any equity capital raise with the stock trading vastly below NAV and (even now) the possibility that the dividend could drop further, OHAI has effectively become a "zombie". Or, to characterize another way, the Company is (almost literally) half a distressed debt fund and half a small, disparate portfolio of higher risk loans. The advisor cannot make the transition to a "normal" state because of the overhang of the energy investments. Thus, a "zombie".
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.