Fitch Expects to Rate Ares Capital's Unsecured Notes 'BBB'
Fitch views the firm's ability to access the institutional bond market favorably, as it provides Ares with enhanced funding flexibility, in Fitch's opinion.
KEY RATING DRIVERS
The expected rating is equalized with the ratings assigned to Ares' existing senior unsecured debt as the new notes will rank equally in the capital structure. The equalization of the unsecured ratings with the secured debt rating reflects Ares' relatively low leverage, its focus on senior debt investments, and Fitch's expectation that proceeds from the issuance will be used to repay a portion of secured debt outstanding, thus increasing the amount of unsecured funding in the capital structure.
Existing ratings for Ares reflect its relatively low leverage, demonstrated access to the debt and equity markets historically, 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 asset manager, 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. Ares transition of its leveraged investment partnership to Varagon Capital Partners (Varagon) from GE Capital Global Holdings, LLC (GE Capital) is viewed as posing a near-term rating constraint given the associated execution risks, potential profitability impacts and the introduction of a new underwriting partner.
The Stable Outlook reflects Fitch's expectations for relative operating consistency, despite the decline in the SSLP, and the maintenance of solid asset quality, modest leverage, strong liquidity, and ample dividend coverage.
Senior debt ratings are primarily linked to changes in the Long-Term Issuer Default Rating (IDR), but are also sensitive to changes in recovery prospects for the debt class.
Ares's ratings could be negatively affected by outsized portfolio growth which results in a weaker portfolio credit profile. Specifically, up-ticks in underlying portfolio leverage, and/or deterioration in portfolio company interest coverage or covenants, could signal the potential for asset quality issues down the road, which would likely pressure ratings. Negative rating actions could also result from a spike in non-accrual levels and weaker cash income dividend coverage.
Additionally, Ares's ratings could be negatively affected by an inability to execute on the integration of American Capital, Ltd. (ACAS), such that structured product and equity exposures remain elevated for a sustained period of time or leverage does not decline commensurately.
Upward rating momentum is viewed as limited over the outlook horizon of 12-24 months, particularly given the execution risk associated with the ACAS transaction and the current challenging market backdrop. Fitch believes Ares has the potential to achieve a higher rating over the longer-term, although likely no higher than 'BBB+' given Ares's reliance on wholesale funding sources, the market value sensitivity of the business model combined with the illiquidity of the majority of its investments, and the limited ability to retain capital.
An upgrade would be conditioned primarily upon very strong and differentiated asset quality performance of recent vintages. This 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, relatively low leverage, and consistent core operating performance, would also be necessary to yield positive rating actions.
Headquartered in New York, NY, Ares is an externally managed BDC, organized on April 16, 2004. As of Dec. 31, 2015, the company had investments in 218 portfolio companies amounting to approximately $9.1 billion.
Fitch expects to assign the following rating:
Ares Capital Corporation:
--Unsecured Debt at 'BBB(EXP)'.
Existing ratings for Ares are as follows:
Ares Capital Corporation
--Long-Term IDR of 'BBB';
--Senior Secured Debt of 'BBB';
--Senior Unsecured Debt of 'BBB'.
Allied Capital Corporation
--Senior Unsecured Debt of 'BBB'.
The Rating Outlook is Stable.