April 26, 2022
Today Ares Capital (ARCC) – one of two BDC lenders to PhyMed Management, LLC – an anesthesiology company – reported its IQ 2022 results, which included a sharp write-down of the value of its second lien loan and marking the obligation as non-performing. At cost ARCC invested $56mn in the debt – due in September 2022 – but has now written the fair market value to just $14mn. Last quarter, according to Advantage Data, ARCC valued this loan at $52mn. That was only a (5%) discount to par and would have rated the company as performing normally – a rating of 2 on our standard 5 point scale.
A second BDC lender in the same loan – SLR Investment (SLRC) has advanced $38mn and was valuing its exposure at $37mn, and performing normally at year end. SLRC has not yet reported IQ 2022 performance, but expect to see a drastic drop in the value of this investment.
Obviously, something has gone wrong in the last few months to take PhyMed from performing to non-performing (aka CCR 5) so quickly. We have searched the public record for an explanation but none is readily forthcoming as yet.
For the two BDCs involved, with $94mn advanced, the impact on income will be material from the non accrual. In a sign – with the benefit of hindsight – that not all was right at PhyMed – the loan at ARCC was being charged an interest rate of 15% at year-end 2021, mostly in PIK form. For SLRC, this facility is the 5th largest in its portfolio at year end 2021, representing 1.8% of assets and is showing on its 2021 10-K with a 16% yield. Between ARCC and SLRC, nearly ($15mn) in annual interest income will be forgone until this issue is resolved.
Moreover – in the absence of any other information – the sharp drop in the valuation ascribed by ARCC on what is a second lien obligation leaves open the possibility that ultimately a significant – if not complete – realized loss might be the eventual outcome. Should ARCC write-off the full exposure, the loss on a net asset value per share basis would be ($0.11). The BDC – the largest in the sector – just reported a $58mn net realized gain for the IQ 2022. PhyMed may end up cancelling those gains when this matter is settled out. (We’ll wait to calculate the corresponding number for SLRC which has just merged with a sister BDC, and whose share count we don’t have at hand to make the calculation).
Hope springs eternal, and it’s possible PhyMed will be rescued in some way. We’ll add the name to our daily searches of the public record and wait to see what ARCC and SLRC have to say – if anything – on their upcoming earnings conference calls. At the moment, though, this looks like a very sharp and material reversal for both BDCs.