Fitch Takes Several Negative Rating Actions Following Business Development Company Peer Review

NEW YORK--()--Fitch Ratings has completed an annual peer review of 10 rated Business Development Companies (BDCs). Based on this review, Fitch has affirmed the long-term Issuer Default Ratings (IDRs) of:

--American Capital, Ltd. (ACAS)
--Apollo Investment Corporation (Apollo)
--Ares Capital Corporation (Ares)
--BlackRock Capital Investment Corporation (BKCC)
--Corporate Capital Trust (CCT)
--Fifth Street Finance Corp. (FSC)
--FS Investment Corp (FSIC)
--PennantPark Investment Corporation (PNNT)
--Solar Capital, Ltd (Solar)
--TPG Specialty Lending (TSLX)

The IDRs of the affirmed BDCs are largely in the 'BBB' rating category, with the exception of ACAS, CCT, and FSC, which have long-term IDRs of 'BB-', 'BB+', and 'BB+', respectively.

Fitch has also revised the following Rating Outlooks:

--Ares to Stable from Positive;
--Apollo to Negative from Stable;
--Solar to Negative from Stable.

The Rating Outlooks for BKCC and FSC remain Negative. All other Rating Outlooks are Stable.

The revision of Ares' Outlook to Stable from Positive reflects the challenging market backdrop and its expected impact on the firm's larger-than-average exposure to fee income. The revision of Apollo's Outlook to Negative from Stable reflects the firm's higher-than-average leverage levels combined with a higher-risk portfolio, in Fitch's opinion, given outsized portfolio exposure to oil & gas, aviation finance, and more-highly levered structured investments. The revision of Solar's Outlook from Stable to Negative reflects expectations for increased equity exposure, from an already outsized level, and growing investment concentrations, given the firm's investment in Crystal Financial LLC and the launch of its Senior Secured Unitranche Loan Program. The long-term IDR of FSC was downgraded to 'BB+' from 'BBB' and assigned a Negative Outlook on Feb. 23, 2015. There have been no material changes to the firm's credit profile since that review.

Please refer to company specific press releases published today, and available on Fitch's website, for further rating rationale on each issuer.

These negative rating actions follow the publication of Fitch's Negative Sector and Rating Outlooks for BDCs in October 2014. At that time the agency highlighted a number of developments and challenges in the space, which were expected to weigh on issuer ratings over the near term. Chief among the concerns driving today's rating actions is the continuation of a competitive underwriting environment, which continues to pressure portfolio yields and dividend funding capacity. To offset potential earnings declines, several BDCs have engaged in activities that have likely weakened their risk profiles, including starting new industry verticals, launching more highly-levered off-balance sheet funds, employing higher balance sheet leverage, and investing down the capital structure into more junior capital positions.

Additional sector challenges that have developed in recent months include the significant decline in the price of oil, which has resulted in unrealized portfolio depreciation on BDC energy investments, and declines in BDC share prices below net asset value (NAV), which precludes most from accessing the equity markets for growth capital over at least the near term.

The combination of these factors, combined with some issuer-specific trends, has led to the negative rating actions taken today. However, Fitch's affirmation of the majority of BDC ratings reflect relative stability in core operating performance, a continuation of strong asset quality metrics, improved funding flexibility, limited near-term debt maturities, stable dividend coverage, and the maintenance of leverage levels at-or-below managements' targeted ranges. However, no firm is immune to the continuing challenges posed by the operating environment, and future management actions that Fitch believes materially alter the risk profile of the firm would result in negative rating actions.

Asset quality metrics remained relatively pristine in 2014, with several firms reporting no non-accrual investments. However, credit metrics are at unsustainable levels, in Fitch's opinion. While strong portfolio company performance has been supported by an improving economic environment, low interest rates are likely masking some potential underlying company-specific issues, as issuers have been able to refinance themselves out of trouble rather easily in recent years. Fitch believes asset quality metrics are likely to deteriorate over the near term; however, the pace of deterioration will be somewhat dependent upon the rate of change in interest rates, the backdrop of the broader economic environment and the quality of individual firms' underwriting. Investments in the energy sector will certainly pose some credit challenges in 2015, which could drive investment restructuring activity for those BDCs with outsized exposure to the space. Asset quality performance may vary significantly across the industry, which could drive further rating differentiation over time.

The average net investment income (NII) yield on rated BDC portfolios (excluding ACAS given its equity focus, higher non-accruals, and materially lower leverage) was up modestly in 2014, despite a decline in coupon yields, as fee income rose with strong portfolio refinancing and repayment activity, operating efficiencies continued to materialize, and incentive income acted as a cushion for some firms that earned below hurdle rates for the year. There has been evidence of yield spread widening in the broadly syndicated markets in recent months, which could trickle down to the middle market in 2015, although Fitch believes some BDCs may be challenged to take advantage of that trend, should repayment activity slow materially, as access to new investment capital is currently limited given BDC share prices and balance sheet leverage levels. As a result, portfolio growth rates are expected to slow this year, which will put some pressure on BDCs that are more heavily reliant on fee income for dividend funding.

Funding flexibility continues to improve, with several firms accessing the institutional debt markets for the first time in 2014. Four rated BDCs issued an aggregate of $1.8 billion of public notes in 2014, up from one BDC issuing $600 million in 2013. Ares' most recent issuance priced 100 basis points inside its inaugural deal in 2013, with a coupon of 3.875% for a five-year note. Fitch believes the increased unsecured debt issuance diversifies BDCs' funding sources and adds additional financial flexibility.

Successful access to the unsecured debt markets and the ability to refinance bank facilities has allowed BDCs to push out debt maturities. Debt coming due in 2015 is limited to Apollo's $225 million of secured private placement notes. However, the maturity wall does increase meaningfully in 2016, as approximately $1.1 billion of convertible notes, issued by rated-BDCs in 2011, come due, in addition to about $200 million of aggregate private placement notes from BKCC and Apollo, and $595 million of secured revolver borrowing at ACAS. Fitch believes BDCs may seek to pre-fund these maturities in 2015 should market conditions be attractive. Conversely, volatility in the capital markets may force certain BDCs to cut origination activity in 2015, as cash flows from portfolio repayments are used to repay maturing debt.

Access to the equity markets was challenged in 2014 and is expected to remain so in 2015, as several factors have combined to weigh on BDC share prices, in Fitch's view. These include the removal of BDCs from select equity indices in 2014, and more recently, market expectations for credit losses to increase from unsustainable lows, the potential for further dividend cuts to follow continued asset yield pressure, and potential valuation declines from portfolio energy exposures.

On average, rated BDCs were trading at an 8.1% discount to NAV at March 11, 2015, with a range of a 28.5% discount for ACAS to a 15.2% premium for TSLX. Fitch believes that BDCs trading at or above NAV are better positioned to capitalize on investment opportunities, while BDCs with constrained equity access for an extended period may experience damage to their franchises and funding profiles, particularly if they are unable to support struggling investments with follow-on capital.

Average leverage levels ticked-up in 2014 compared to 2013, given strong origination activity and a decline in equity issuance, partially offset by elevated portfolio repayment activity, which increased 54.3%, on average, year over year through the first nine months of 2014 (excluding ACAS). The average leverage ratio at Dec. 31, 2014, was 0.63x (excluding CCT, which has yet to report), which compares to 0.57x at year-end 2013 and internal management targets in the 0.6x?0.8x range. Fitch believes leverage levels could rise in 2015 as BDCs seek to maintain NII and dividend payments in the face of challenging asset yields. Additionally, firms may have a tougher time managing leverage should they be precluded from accessing the equity markets.

Dividend coverage, as measured by NII divided by dividend payments, improved in 2014 as several firms cut their dividends in recent years, which Fitch views as prudent. NII coverage averaged 102% for the first nine months of 2014. Cash income coverage remains somewhat weaker due to the accrual of paid-in-kind (PIK) interest and other non-cash earnings, though cash realizations of previously accrued PIK have been solid in recent years. Fitch believes additional dividend cuts may be necessary in 2015, particularly if pricing rationalization does not materialize, as fee income generation is likely to slow with reduced origination activity. More-than-temporary declines in dividend coverage are likely to yield negative rating momentum.

Additional information is available at 'www.fitchratings.com.'

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria' (January 2014);
--'Investment Manager and Alternative Funds Criteria' (December 2013).

Applicable Criteria and Related Research:

Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Investment Manager and Alternative Funds Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=725057

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Contacts

Primary Analyst - Apollo, Ares, BKCC, CCT, FSIC
Secondary Analyst - ACAS, FSC, PNNT, Solar, TSLX
Meghan Neenan, CFA, +1-212-908-9121
Senior Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Primary Analyst - ACAS, FSC, PNNT, Solar, TSLX
Secondary Analyst - Apollo, Ares, BKCC, CCT, FSIC
Johann Juan, +1-312-368-3339
Director
or
Committee Chairperson
Joo-Yung Lee, +1-212-908-0560
Managing Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com
Norma Cenizo, Buenos Aires, +54 11 5235 8105
norma.cenizo@fitchratings.com
Pola Chiang, Taipei, +886 2 8175 7617
pola.chiang@fitchratings.com
Thamar D'Santiago, Caracas, +58 212 286 3356
thamar.desantiago@fitchratings.com
Isabel Diaz, Santiago, +56 2 499 3300
isabel.diaz@fitchratings.com
Peter Fitzpatrick, London, +44 20 3530 1103
peter.fitzpatrick@fitchratings.com
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Primary Analyst - Apollo, Ares, BKCC, CCT, FSIC
Secondary Analyst - ACAS, FSC, PNNT, Solar, TSLX
Meghan Neenan, CFA, +1-212-908-9121
Senior Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Primary Analyst - ACAS, FSC, PNNT, Solar, TSLX
Secondary Analyst - Apollo, Ares, BKCC, CCT, FSIC
Johann Juan, +1-312-368-3339
Director
or
Committee Chairperson
Joo-Yung Lee, +1-212-908-0560
Managing Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com
Norma Cenizo, Buenos Aires, +54 11 5235 8105
norma.cenizo@fitchratings.com
Pola Chiang, Taipei, +886 2 8175 7617
pola.chiang@fitchratings.com
Thamar D'Santiago, Caracas, +58 212 286 3356
thamar.desantiago@fitchratings.com
Isabel Diaz, Santiago, +56 2 499 3300
isabel.diaz@fitchratings.com
Peter Fitzpatrick, London, +44 20 3530 1103
peter.fitzpatrick@fitchratings.com
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com