October 17, 2022
What are the chances the BDC Credit Reporter would write about two power plant credits in a row, and downgrade both to CCR 4 ? The common thread here is Cion Investment (CION) - the only BDC lender to both companies. We just wrote about Homer City Generation. This article is about Heritage Power LLC - or HEP -which owns a 2,389 MW portfolio of 16 gas or oil-fired power plants located in New Jersey, Ohio, and Pennsylvania.
The company has been underperforming - by the BDC Credit Reporter's standards - since the IVQ 2021 when CION discounted its first lien debt by (16%). By the end of June 2022, the discount was up to (23%). At that point we rated HEP CCR 3 on our 5 point scale.
However, we've subsequently learned from the public record - mostly from Moody's and Bloomberg Law - that the challenges facing the company deserve a lower rating - down to CCR 4. The ratings group itself downgraded the company's 2026 Term Loan - amongst other facilities - to Caa2 from B2 in July. We can't quote here all that Moody's said but the gist is that cash flow is expected to drop sharply from mid-year. Most important of all, there is some question as to whether the company can avoid a default in the next 12-18 months without a large cash infusion.
The par value of CION's loan is $8.6mn, but the cost is $6.7mn and the value $5.2mn. Just in the last couple of quarters, the par value has increased from $4.9mn, suggesting the BDC has been increasing its exposure. This might be for a defensive tactical reason or because the BDC's external manager considers the debt under-valued. The income at risk if HEP defaults is roughly ($0.8mn) on an annual basis, but this is an ever changing number as rates move further upwards. For the moment, we're assuming a 25%-50% write off if HEP goes to the wall, but that's just an educated guess.
We expect to be hearing from and about HEP before long as there is some question as to whether a letter of credit facility will get refinanced in 2023, which might lead to a default. At this point we expect CION's external manager must be having lender's regret about getting involved with Pennsylvania power plants. In both cases, though, CION might yet get away scot free, but the odds seem to be diminishing.
As we did for Homer City Generation, we question why CION underwrote this kind of borrower. This is a business with much regulatory risk and where revenues get fixed in long term contracts but input costs can rise unexpectedly, squeezing or eliminating profits. This is a relatively recent relationship for CION, dating back only to the IQ 2021 - a year and a half ago.