NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR), secured debt rating, and unsecured debt rating for Ares Capital Corporation (Ares) at 'BBB'. The Rating Outlook remains Positive.
These actions are being taken in conjunction with a broader industry review, which includes seven business development companies (BDCs), and coincides with the publication of an industry report: 'Business Development Companies - A Comparative Analysis: 2013', which is available on Fitch's website.
KEY RATING DRIVERS
The ratings affirmations reflect Ares' low leverage, demonstrated access to debt and equity markets, consistent operating performance in a difficult market environment, moderate portfolio concentrations, strong funding flexibility, solid liquidity, experienced management team, access to deal flow and investment resources from investment adviser, Ares Capital Management LLC, and ample dividend coverage.
Rating constraints include the capital markets impact on leverage -- given the need to fair value the portfolio each quarter -- dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.
The Positive Rating Outlook reflects the fact that while there remains potential upward rating momentum, operating performance and strategic execution need to be evaluated over an extended period of time, particularly given the very competitive market environment, which has seen meaningful spread compression and looser underwriting terms, including higher underlying leverage levels and weaker covenant packages. Still, Fitch believes Ares has retained its underwriting discipline to date, as evidenced by a continued focus on the senior part of the capital structure, modest declines in investment yields, and relative stability in underlying portfolio company metrics.
Fitch believes Ares has the strongest capital structure in the BDC space, with unsecured debt accounting for 94% of total debt outstanding, at par, at Dec. 31, 2013, as the company has continued to opportunistically access the capital markets for term financing. In November 2013, Ares completed its first public institutional deal, issuing $600 million of five-year notes at a coupon of 4.875%. In January 2014, the company re-opened the issuance, adding $150 million of notes at a premium to par.
At Dec. 31, 2013, the weighted average maturity of Ares' debt was 7.9 years, while the weighted average interest rate was 5.3%. The amount of fixed-rate debt in the capital structure positions the firm to benefit from a rising rate environment, as the majority of its assets are floating rate. While Fitch believes secured borrowings may increase in 2014, as it is currently the company's cheapest source of funding, unsecured debt is expected to continue to account for the majority of debt financing.
Leverage, as measured by debt to equity, amounted to 0.63x at YE13, or 0.60x net of cash, which is below the targeted range of 0.65x to 0.75x. Fitch believes current leverage levels reflect management conservatism due to the competitive capital markets environment. Still, leverage is expected to migrate to the targeted range over time as attractive investment opportunities arise.
Ares' net investment income grew 15.3% year-over-year in 2013, adjusting for the GAAP accrual of capital gains incentive fees, given an increase in interest income, as portfolio growth offset about 100 basis points of yield compression, and the receipt of additional dividends from portfolio company, Ivy Hill Asset Management, L.P. Net realized gains were $63.7 million for the year, and Ares remains the only publicly rated BDC to have generated cumulative net realized gains since inception. Fitch expects net investment income to be relatively stable in the near term, as market conditions are more challenging for growth.
Ares' liquidity profile remains sound with $149.6 million of balance sheet cash and $1.8 billion of availability on various secured revolving facilities, subject to borrowing base requirements, at Dec. 31, 2013. Cash flows from investment repayments and exits have been significant, amounting to $1.7 billion in 2013. Additionally, cash earnings coverage of the dividend, which adjusts for net paid-in-kind interest and non-cash capital gains incentive fee accruals, was strong, at 105.6% in 2013. Coverage would have been even stronger adjusting for the payment of the special dividend. Ares also estimates it has approximately $0.82 of spillover income per share from 2013 to 2014, which supports further dividend consistency over the near-term, despite the competitive market environment.
RATING SENSITIVITIES
Ares' rating could be upgraded over the outlook horizon provided the company continues to demonstrate measured portfolio growth in the face of what Fitch believes is a competitive credit environment. This will be evaluated in the context of the stability and consistency of Ares' operating performance, asset quality, valuation, and underlying portfolio metrics, including leverage and interest coverage. Specifically, up-ticks in underlying portfolio leverage, and/or deterioration in portfolio company interest coverage or overall portfolio yields, could signal the potential for asset quality issues down the road, which would likely lead to an Outlook revision.
Conversely, negative rating actions would be driven by an extended increase in leverage above the targeted range, resulting from increased borrowings or material 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 and weaker cash income dividend coverage would also be viewed unfavorably from a ratings perspective.
Headquartered in New York, NY, Ares is an externally managed business development company, organized on April 16, 2004. As of Dec. 31, 2013, the company had investments in 193 portfolio companies amounting to approximately $7.6 billion.
Fitch has affirmed the following ratings with a Positive Outlook:
Ares Capital Corporation
--Long-term IDR at 'BBB';
--Senior Secured Debt at 'BBB';
--Senior Unsecured Debt at 'BBB'.
Allied Capital Corporation
--Senior Unsecured Debt at 'BBB'.
The Rating Outlook is Positive.
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
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
Additional Disclosure
Solicitation Status
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