The Ninepoint Third Eye Capital fund: commencing with a promising rating of PoS

The Ninepoint Third Eye Capital fund has more red flags than a banquet hosted by the Chinese Communist Party.

This post has a lot of information about Third Eye Capital, and it’s mostly for their clients and people who want to work with them.

I haven’t been very clear about how I feel about Third Eye Capital (aka TEC). I will now make that right. Some people have said they wouldn’t touch it with a ten-foot pole. Security analysts use a special term to talk about an investment opportunity they don’t like. This is called “PoS.” I don’t say that because I get too many complaints about how salty my language is. We think that Ninepoint’s private debt fund, Third Eye Capital, is a PoS.

You might remember that the CEO of Third Eye Capital, Arif N. Bhalwani, CFA, sent us two long, whiny emails. One thing he didn’t say about us is that we have something against him. And you can be sure that I didn’t know much about Third Eye Capital before I got some information about it. Information from a source that is just as far away and unconnected as Third Eye.

We just follow the facts and bring to light analysis that is of interest to the public. Arif says that the troubled King Street Food Company loan we talked about before is a small weight with good prospects. We’d be the first ones to say that it’s not the worst thing they have to deal with.

Borrowers of Third Eye Capital

You will notice that the Ninepoint Third Eye Capital fund doesn’t name its borrowers in its marketing materials, and that the audited statements only list the borrowers’ initials. That’s a little strange, but our team’s research helped us match the initials to different TEC borrowers. Aside from the letters game, the matches are based on how Third Eye has worked with each of the entities listed.

Here are some of the people we think are a good match:

 Ninepoint Third Eye Capital fund has more red flags

A thing that some of TEC’s borrowers have in common and that makes up more than 30% of the assets of the Ninepoint Third Eye fund.

Many of the people who borrow from TEC have something in common. Their board of directors is made up of TEC’s most important managers. We’ll talk about how this happens in a bit. Here’s what we saw in the company’s files:

Arif, Mark Horrox, and Dev Bhangui are all on the investment team at Ninepoint.

We asked Arif why the Annual Financial Statements of Ninepoint TEC Private Credit Fund do not disclose any loans or investments in related parties, and he replied:

Because Ninepoint-TEC Private Credit Fund (“NTPC”) has no control or significant influence over any of its portfolio companies, its portfolio investments are not considered NTPC related parties. Despite the fact that TEC entities manage or advise various funds that participate in the equity of portfolio companies (including those where the funds collectively own more than 50% of the fully diluted ownership), TEC lacks control or significant influence because each fund has different investment objectives, time horizons, and restrictions.

There is no single fund with a majority of voting equity or significant influence over the portfolio companies.
If you are a governance expert, please help me understand his response and why it does not create a conflict worth disclosing.

The Third Eye Workout Guide

Ninepoint Co-CEO John Wilson described their private debt funds as “conservative,” which we believe does not apply to Third Eye. Investors who purchased the Ninepoint-Third Eye fund expecting a consistent stream of income may be surprised by its involvement in workouts, distressed financing, and equity-like exposures.

According to various conversations we’ve had, the general public’s perception of TEC is that every loan is secured by valuable assets with a low loan-to-value ratio. When things go wrong, TEC will be able to simply sell the assets and recoup their initial investment, the thinking goes. This thesis cannot be supported by our findings.

Before we begin our discussion, we must again quote Arif:

There is a significant dissonance between reality and the implication underlying your questions. You inquire about loans we made that were the subject or result of court-supervised restructurings or arrangements, the specifics of which you obtained from public records.

That record describes events and outcomes related to dozens of court actions, applications, motions, rulings, appeals, judgements, and orders conducted in open, transparent, and fair legal forums over several years. As I stated in my email to you on September 23, we have occasionally and in exceptional circumstances had to intervene, takeover, or reorganize the assets and businesses of defaulted borrowers.

TEC does not make loans to companies with the intent of taking them over; however, in exceptional circumstances, we must be prepared to do so in order to protect our investors’ capital. Distressed borrower restructurings necessitate highly specialized and one-of-a-kind skills and experience, and TEC has made this a core competency.

TEC has a proven track record of taking over defaulted borrowers, repairing them, and then harvesting or selling them for a significant profit. Restructurings are complex public processes that are costly and intimidating to the uninitiated, but it is precisely this complexity and inefficiency that gives us an advantage.

It would be naive to believe that a lender has never made a bad loan. As a result, as Arif admits, Third Eye has been forced to intervene and seize the assets of defaulted borrowers. Third Eye being involved in insolvencies is not “rare,” and we question the claim of a “exceptional track record of taking over defaulted borrowers, fixing them, and then harvesting or selling them for significant value.”

The borrowers we discuss in this post are significant to the overall Ninepoint Third Eye fund, accounting for more than half of the value of their investments, and should compel investors to ask serious questions, as we did. The King Street Food Company pattern will appear several times. This pattern is roughly as follows:

TEC makes an ostensibly “overcollateralized” loan to an ostensibly “underappreciated” company, with the prospect of receiving double-digit interest rate payments and, in some cases, significant equity sweeteners. A clear indication of faith in the underlying business fundamentals.

As time passes, the company’s assets can’t generate enough cash flow and struggle to turn a profit. The financial situation deteriorates. Third Eye makes concessions.
The company declares bankruptcy and petitions the court for creditor protection.
The collateral is placed on the market, and none of the offers received provide a purchase price sufficient to repay senior lenders (primarily, Third Eye) in full.

TEC emerges from the process as the buyer of the assets and assigns them to a new entity controlled by key TEC personnel, blurring the lines between borrower and lender. And, while the process is overseen by the court, it is not the court’s responsibility to scrutinize how a creditor accounts for profit or loss on their books. Consider a court policing how a bank accounts for loans to insolvent entities. That just doesn’t happen! Now for some examples of this pattern.

One of the oldest vintage TEC loans… USA Synthetic Fuels Corp morphs into American Future Fuels Corp

In 2012, the predecessor fund of the Ninepoint-Third Eye fund purchased some notes from a subsidiary of USA Synthetic Fuels Corporation. The borrower had lofty goals, intending to build a synthetic natural gas facility to convert coal, petroleum coke, and biomass into environmentally friendly energy sources. The SEC then announced in mid-2014 that USA Synthetic Fuel’s accounting practices were being investigated. The company filed for Chapter 11 bankruptcy in March 2015.

TEC had an outstanding claim of $31.6 million and agreed to buy out all of USA Synthetic Fuel’s assets. They paid $15 million using their claim as currency (ie a credit bid). As part of the agreement, TEC assumed all liabilities related to the notes issued in 2012. The assets were purchased under the name of a newly formed company, American Future Fuels Corporation.

When TEC first acquired the USA Synthetic Fuels project following its bankruptcy in 2015, Arif expressed confidence, telling a local newspaper, “We remain very enthusiastic about the project and have the means and conviction to see that project eventually get built” (Incidentally, Arif always expresses himself with supreme confidence. He is very smooth and knows all the best words.)

However, three years later, American Future Fuels Corporation sold the land on which the project was to be built for US$1.9 million. “I just felt that the folks who owned it in Toronto did not have a plan for development,” the city’s mayor said of the transaction.

American Future Fuels Corp invests in an oil and gas producer, and Conifer emerges.

In June 2017, American Future Fuels Corporation abandoned its predecessor’s goal of producing clean energy. They chose to invest just under US$19 million in preferred equity in Accel Energy Limited, the parent company of Accel Canada Holdings Limited, an oil and gas producer in Northern Alberta. That agreement paved the way for additional investments in this new oil venture.

Then, between November 2017 and April 2018, TEC committed over $240 million in loans to Accel Canada Holdings. The Ninepoint-Third Eye fund alone committed $135 million (10% of current AUM). In connection with the credit agreements, Accel Canada Holdings issued warrants to TEC to acquire 15.0% of the company’s equity. Accel Canada Holdings Limited went bankrupt two years after TEC made its initial investment.

In an affidavit, TEC’s Mark Horrox summarized the company’s insolvency as follows:

“TEC is by far the largest creditor of the ACCEL Entities, and as such, it will be impacted and potentially prejudiced more materially than any other creditor in this restructuring.” The ACCEL Entities and their affiliates owe over $350 million to TEC, while Stream (or possibly Regent/ICC) is owed approximately $90 million.”
Stream Assets Financial Winterfresh LP was a secured creditor of a subsidiary, Accel Energy Canada Limited. TEC claimed seniority over the subsidiary, but Stream disagreed. Accel Canada Holdings also had a $41 million debt to ARC Resources, which was a residual balance from an asset sale previously funded by TEC.

When the collateral was placed on the market prior to the pandemic, none of the bids received were commercially and/or economically viable, and none were acceptable to the secured creditors. Then, Stream and TEC each made a bid for the assets. When comparing the bids, the monitor told the Court that Stream’s offer provided “no recovery of the approximately $335 million owed to Third Eye.” To choose a bid, the Judge asked the parties to negotiate. TEC and Stream reached a non-disclosure agreement.

Following King Street Food Company’s lead, TEC purchased the assets. Again, Mark Horrox stated that they paid $471 million, which “comprised of a credit bid of existing debt owed by ACHL to the secured lenders arranged by TECC in the amount of approximately $335 million, and approximately $136 million in cash to pay certain amounts.” It’s worth wondering if some of the cash went to Stream to compensate for their seniority. In any case, $471m is a lot of money in the context of a $3 billion AUM firm, don’t you think?

This time, the bid was assigned to another newly formed entity called Canadian Future Fuels Corp. CFFC eventually purchased all of the Accel entities’ assets. The entire insolvency procedure lasted nearly two years. Canadian Future Fuels Corp has since changed its name to Conifer Energy Inc. This is not what we would call an exit from a troubled loan. The secured lender became the owner of the borrower’s assets. The same assets that were unable to cover their debt costs and that no one seemed to like. It appears to be a case of kicking the can down the road.

What about the state of Accel’s assets? Earlier this year, Accel Energy Canada spilled over 100,000 litres of “sour emulsion” from a pipeline. There was no reported impact on water bodies or wildlife. However, the receiver expressed concerns about the age and condition of some of Accel’s assets as an ongoing risk of more serious incidents.

Third Eye recently signed the United Nations Principles for Responsible Investment pledge and is committed to incorporating ESG into its investment decisions. The ESG commitment contradicts TEC’s decision last year to only acquire half of the wells of another failed borrower, Ranch Energy Corporation.

The remaining wells were dumped into BC’s Orphan Site Reclamation Fund, doubling the number of orphan wells in the province. Erikson National Energy was given these assets. You can learn more about Erikson’s business ventures by reading this article.

Remember the Accel warrants? According to their December 31, 2020 audited statements, Ninepoint-TEC Private Credit Fund believes that the value of ACHL warrants has increased. ARC Resources, on the other hand, “re-estimated the likelihood of collection as zero percent” and wrote off their claim, despite the fact that it had a higher priority than warrants. Here are the audited financial statements for ARC. Who is right? We will leave it up to the reader to decide. In summary, here is the discrepancy:

As you can see, we had good reason to question Arif about their expected credit losses. Rather than responding to specifics, he simply rambled on:

You question our provisioning for expected credit losses. Our valuation framework is strong, with multiple checks and balances involving internal committees and multiple parties independent of and external to our investment team or fund management in general.

This includes a large expert, third-party valuation firm responsible for independent oversight of the valuation process and independent verification of key determinants of valuation analyses prepared by the valuation manager (another outside party) to provide objective loan portfolio valuations every quarter.

Our internal control environment has been lauded as “best-in-class,” and it is regularly put to the test through operational due diligence audits conducted on behalf of and for our direct institutional clients, including Ninepoint Partners.

If you feel safe because of the oversight provided by firms such as Ninepoint and Montrusco Bolton, you could ask investors in the Ninepoint Trade Finance Fund and the Montrusco Bolton/Ardenton Private Equity Income Fund what they think about those firms’ ability to supervise an advisor.

Ninepoint recently removed their Ninepoint Trade Finance Fund from their website. The fund, which was advised by Highmore Group, lost more than 6.5% in June and continued to lose money in subsequent months. A precipitous drop for a fund marketed as senior secured and “fully collateralized and insured.” More on the Highmore saga can be found here.

Montrusco also took the references for the MBI/Ardenton fund offline after the fund’s advisor and debtor, Ardenton Capital, declared bankruptcy. Montrusco is currently involved in the CCAA restructuring in the hopes of recouping investor funds. Arif’s equivalent at Ardenton Capital resigned over the summer, claiming that business operations are not his strong suit. He was also supposed to be a private equity manager.

If you still believe auditors are infallible, let me remind you that the Ninepoint-Third Eye fund is audited by KPMG, Bridging Finance’s auditor.

Third Eye isn’t the only private debt manager with a stake in the Accel entities. JBC-BC Holdings also had a $21 million exposure to Accel Canada Holdings Limited’s preferred shareholder. JBC-BC is directed by R. Christopher Morris and has the same mailing address as RCM Capital, one of the private lenders duped by Gary Ng and Bridging’s lender of last resort. As a result, another entity represented by Christopher Morris, DGDP-BC Holdings, engaged in a protracted legal battle with TEC over the terms of the DIP financing provided to the Accel Entities.

A borrower who has been targeted by an investigative short seller.

Aemetis Advanced Fuels Keyes is a division of Aemetis Inc, which is traded on the Nasdaq under the symbol AMTX. The company had more than $200 million in accumulated losses over the last ten years, with only two of the ten years reporting an operating profit.

Since 2008, Third Eye has financed this deficit with over $150 million in loans and $30 million in preferred equity. However, AMTX has not made a net profit since 2014 due to TEC’s business expertise, which Arif claims is how they add value as a lender.

Of course, in the meme-stock era, losses indicate a lack of vision. So, with recent announcements of entering the EV truck industry and producing “below zero carbon renewable fuel,” the stock price has increased by 8x in the last year, reaching nearly US$600 million in market cap. Insiders have recently been selling their stock.

Skeptics were drawn to this price movement. Two damning reports on the company have been issued by Culper Research, an investigative short seller. Nate Anderson of Hindenburg Research, who has a history of calling BS on EV transportation companies (such as Nikola and Lordstown Motors), also expressed his concerns.

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