NEW YORK--(BUSINESS WIRE)--Fitch Ratings has published Corporate Capital Trust's (CCT) long-term Issuer Default Rating (IDR) and secured debt ratings of 'BB+'. The Rating Outlook is Stable.
KEY RATING DRIVERS
The ratings reflect the strength of CCT's relationship with CNL Fund Advisors Company (CNL) and KKR Asset Management LLC (KAM), low leverage, relatively low portfolio concentrations, limited exposure to equity investments, strong asset quality and adequate dividend coverage. CNL has demonstrated its ability to raise and administer capital in the retail market over a long period of time, while KAM has a strong and established track record underwriting credit and has strong access to deal flow, given its affiliation with KKR & Co. L.P. (KKR).
Rating constraints include a limited operating history as a business development company (BDC), weaker-than-peer earnings yields, a fully secured funding profile, exposure to short-duration funding, and the potential that CCT will be unable to access the equity markets for capital following the expiration of issuing authority, likely in 2015, barring an accelerated liquidity event.
Leverage, as measured by debt to equity, amounted to 0.28 times (x) at March 31, 2014, which is below the rated peer group average of 0.48x. Fitch believes there is tolerance for higher leverage levels over the longer term, given CCT's focus on the senior part of the capital structure. At March 31, 2014, first and second lien senior debt accounted for 77.5% of the investment portfolio, which compares to a rated peer average of 56.9% at Dec. 31, 2013. Exposure to equity investments, which can experience meaningful valuation volatility, was a very low 4% at 1Q14, which compares to a rated peer average of 19.8% at year-end 2013.
The investment portfolio was relatively more diverse than peers, with the top 10 investments accounting for 28.8% of assets and 41.9% of equity at March 31, 2014. Still, Fitch expects portfolio concentrations to increase modestly over time, as CCT transitions the portfolio away from broadly syndicated credit into directly originated transactions. That said, CCT is likely to maintain a greater exposure to liquid credit than the peer group, as the firm co-invests alongside other KKR credit vehicles, which would include CLOs in addition to less liquid direct senior lending and mezzanine funds.
CCT's operating history is relatively short, having only recently completed three full years of investment operations. Net investment income has been on an upward trajectory given 519% growth in the investment portfolio in 2012 followed by 189% growth in 2013. Net investment income more than tripled in 2013, adjusting for expense reimbursements and the non-cash accrual of incentive income for GAAP. However, the net investment income yield on the portfolio was 4.2% as of year-end 2013, which is nearly 200 bps below the peer average, given the lower revenue yield. CCT is expected to close that gap over time, with a greater focus on more illiquid credits.
CCT's funding profile is fully secured, consisting of two special purpose vehicles (SPVs), a total return swap (TRS) and a corporate revolver. Borrowing capacity is nearly $1.36 billion, and $436 million was outstanding at March 31, 2014. CCT's current debt maturity profile is relatively short, with $387.4 million of outstanding borrowings maturing within 364 days at 1Q14. Fitch expects CCT will look to extend its debt maturity profile over time with term debt issuance.
CCT's liquidity profile is considered sound with $86 million of balance sheet cash, $149.9 million of short-term liquid investments, and $517.6 million of availability on various secured funding facilities, subject to borrowing base requirements, at Dec. 31, 2013. Additionally, cash flows from investment repayments and exits were significant in 2013, amounting to $925.1 million, and a meaningful portion of the portfolio was considered liquid, with about 55% of the portfolio considered level 2 for valuation purposes.
Dividend coverage, which adjusts for non-cash incentive payment accruals and realized gains, was sound, amounting to 97.4% in 2013. Coverage would have been even stronger if adjustments were made for participation in the dividend reinvestment program (DRIP), but Fitch believes DRIP participation tends to decline over time.
The Stable Outlook reflects Fitch's expectations for continued operating consistency, improved earnings yields, given the gradual shift into less-liquid direct originations, and the maintenance of good asset quality, modest leverage, and strong dividend coverage.
However, Fitch sees a number of emerging industry challenges that could pressure ratings, or at least increase rating differentiation amongst BDCs over a longer-term horizon. These challenges include a potential increase in regulatory leverage limits and increased competition, which are yielding tighter market spreads and looser underwriting terms, including higher underlying portfolio company leverage and weaker covenant packages. Should competition continue to intensify, market yields could decline further, which would reduce earnings generation and pressure dividend coverage for the space.
Positive rating momentum for CCT could develop over time with increased funding flexibility, including an extension of the debt maturity profile, access to the public unsecured debt markets, and the ability to issue public equity for growth capital. Other positive rating factors would include an improvement in net investment income yields, a continuation of solid asset quality performance, particularly given the competitive market environment, and stronger cash earnings dividend coverage.
Conversely, negative rating actions would be driven by an extended increase in leverage above the targeted range of approximately 0.67x (asset coverage of 250%), resulting from increased borrowings or material realized or unrealized depreciation, and/or a meaningful increase in the proportion of equity holdings without a commensurate decline in leverage. A spike in non-accrual levels, an inability to refinance near-term debt maturities, and weaker cash income dividend coverage would also be viewed unfavorably from a ratings perspective.
CCT is an externally managed business development company, organized in June 2010 and commencing investment operations in July 2011. As of Dec. 31, 2013, the company had investments in 97 portfolio companies amounting to approximately $1.9 billion.
Fitch has published the following ratings with a Stable Outlook:
Corporate Capital Trust
-- Long-term Issuer Default Rating BB+';
-- Secured Debt Rating 'BB+'.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
-- 'Global Financial Institutions Criteria' (January 2014);
-- 'Investment Manager and Alternative Funds Criteria' (December 2013).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
Investment Manager and Alternative Funds Criteria