Fitch Ratings has affirmed
The Rating Outlook has been revised to Stable from Negative.
The 'A-' rating and Stable Rating Outlook assigned to
KEY RATING DRIVERS
IDRs AND SENIOR DEBT
The Outlook revision reflects the improvement in the firm's asset quality metrics, as evidenced by declines in non-accruals on a cost and fair value basis, a reduction in paid-in-kind (PIK) accruals, and the recognition of unrealized portfolio appreciation and net realized gains in 1H21. Fitch believes these improvements in credit, in combination with strong origination activity and earnings and growth in balance sheet equity, resulting from capital raising activities, reduce the downside risk to the firm's asset coverage cushion.
Dividend coverage has also improved in recent quarters, with stronger earnings and declines in PIK accruals and the firm's funding profile remains peer-superior with over 85% of debt being unsecured at
The rating affirmation reflects Ares' scalable platform, moderate portfolio concentrations, demonstrated access to the debt and equity markets historically, strong funding flexibility, solid liquidity, an experienced management team, and access to investment resources from its investment adviser,
Rating constraints include above-average exposure to equity investments, including
Rating constraints for the BDC sector more broadly include the market impact on leverage, given the need to fair-value the portfolio each quarter, dependence on access to the capital markets to fund portfolio growth and a limited ability to retain capital due to dividend distribution requirements. Additionally, the competitive underwriting environment has yielded deterioration in terms in the middle market, including fewer/looser covenants and higher underlying leverage.
As of
Ares' portfolio remains largely focused on senior secured positions, which represented about 71% of the portfolio at 2Q21. Second lien investments are above the peer average, at 24% of the portfolio, but are typically extended to larger, more established companies. The average net debt to EBITDA ratio for underlying portfolio investments was 6.0x at 2Q21, up 30 basis points from a year ago, while interest coverage for portfolio investments remained flat, at 2.9x. The weighted average EBITDA of Ares' portfolio investments remains well-above peer, amounting to
Ares' net investment income (NII) rose 24.4% in the first six months of 2021, adjusting for the GAAP accrual of incentive income, compared with the same period in 2020, as capital structuring fees nearly tripled with very strong origination volume. The weighted average yield on the debt and income producing portfolio was 8.8% in the quarter, down 10 basis points from a year ago. NII as a percentage of the average portfolio at cost was 5.4% for 1H21, up from 4.9% a year ago.
Leverage, as measured by gross debt (at par) to equity, amounted to 1.16x at
NII coverage of the dividend, adjusted for non-cash incentive payment accruals, was 118.8% in 1H21. Adjusting further for net PIK income, coverage remained above 100%, which was a meaningful improvement from a year ago. Net PIK (interest and dividends) accounted for 0.6% of investment income in 1H21, which is down from 11.1% a year ago, given slower accruals and increased collection activity. Fitch believes Ares' track record of PIK collection is solid longer term.
The equalization of the secured and unsecured debt ratings with the long-term IDR reflects solid collateral coverage for all classes of debt given that Ares has a largely unsecured funding profile and is subject to a 150% asset coverage limitation.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade include an increase in leverage that is not commensurate with the risk profile of the portfolio, or an inability to maintain sufficient cushion to asset coverage to account for valuation volatility. Outsized portfolio growth that results in a weaker portfolio credit profile, including meaningful up-ticks in underlying portfolio leverage and/or deterioration in portfolio company interest coverage or covenants, which signal the potential for asset quality issues down the road, would also likely pressure ratings. Negative rating actions could also result from a spike in non-accrual levels or weaker cash income dividend coverage.
Fitch believes higher leverage, resulting from the passage of the Small Business Credit Availability Act, increases the sensitivity of the ratings to downward pressure, at least until the strategy is executed upon and credit performance of recent underwriting vintages can be fully assessed.
Factors that could, individually or collectively, lead to positive rating action/upgrade, include very strong and differentiated asset quality performance of recent vintages, which will be evaluated in combination with the stability and consistency of Ares' operating performance, asset quality, valuation, and underlying portfolio metrics, including leverage and interest coverage. The maintenance of a strong funding profile, ample liquidity, and consistent core operating performance would also be necessary to yield positive rating action. Although not envisioned, a material reduction in leverage which was not accompanied by an offsetting increase in the portfolio risk profile could also contribute to positive rating momentum.
The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a material reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONSENTITY/DEBT RATING PRIOR
Ares Capital Corporation LT IDR BBB Affirmed BBB
senior unsecured
LT BBB Affirmed BBB
senior secured
LT BBB Affirmed BBB
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
(C) 2021 Electronic News Publishing, source