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31 Jul 2007
Moody's assigns Baa3 rating to Ares Capital Corp.
New York, July 31, 2007 -- Moody's Investors Service assigned a Baa3 long-term issuer rating
to Ares Capital Corporation (ARCC). In the event ARCC issues senior
unsecured debt obligations, they would be rated at the same level
as the issuer rating. The outlook for the rating is stable.
The Baa3 issuer rating is supported by ARCC's robust performance
as a Business Development Company (BDC). The company maintains
a diversified investment portfolio, with limited individual investment
exposure (ARCC's largest single exposure is approximately 5%
of the total portfolio). In addition, ARCC is invested across
many industries and geographies that provide sufficient diversification
in the event of a regional or business sector downturn.
While the period since ARCC's IPO in 2004 can be characterized as
a relatively benign credit environment, Moody's notes the
company's impressive portfolio quality with only one investment
valued to recover less than full principle as of the first quarter of
2007. A primary reason for this strong performance is ARCC's
concerted effort to originate new investments that are senior in the capital
structure. While this protection is often at the expense of margin,
ARCC has demonstrated an ability to gain excess yield over the market.
In Moody's view, this is due, in part, to ARCC's
large portfolio of potential investments that are evaluated for the greatest
return for level of risk, and its ability to provide financing to
a company for all segments of the capital structure.
From a financial metrics perspective, ARCC is well positioned.
This is due to the company's substantial equity base. BDC
regulations require ARCC to effectively maintain leverage below one to
one (debt to equity), which is a significant ratings factor.
ARCC's substantial equity cushion provides its debt holders with
considerable protection in the event portfolio valuations decline.
In its brief history, ARCC has operated with leverage metrics well
below the one-to-one threshold.
The rating is also supported by ARCC's experienced management team.
The ARCC investment committee, which approves all new investments,
is comprised of partners from Ares Management LLC. This is a ratings
strength given the firm's historical performance. In addition,
ARCC has a competitive advantage due to its ability to leverage off its
relationships with the investment community through Ares Management.
Moody's said that there are a number of risks that balance these
positive attributes. First, although ARCC's profitability
since its 2004 IPO has been strong, the portfolio's rapid
growth, lack of seasoning, and unproven performance during
a more challenging economic cycle are key risks to the rating.
To address Moody's view of these risks, ARCC will need to
maintain strong performance coupled with limited portfolio deterioration
through a more challenging credit and economic cycle.
As mentioned previously, ARCC's investments in first lien
securities and the resulting secured coverage is a ratings positive.
However, the yields earned on the first lien securities are substantially
greater than the market. While Moody's believes that part
of the excess spread is due to ARCC's investment selection and structuring,
the greater yields also imply increased risk versus a typical first lien
investment. Again, ARCC's ability to demonstrate continued
strong credit performance during a more stressed environment would support
ARCC has exhibited substantial growth in its portfolio since its IPO.
Moody's notes that this growth has come at a time when there has been
very limited stress in the US economy and in corporate credit generally.
While growth to date appears well managed, there is a risk that
the portfolio will not perform as anticipated when conditions weaken and
that the firm's resources could become strained as expansion continues.
As ARCC continues to expand and invest in a greater number of portfolio
companies, it will be important for its management and operations
team to grow in concert with the investment base.
In Moody's opinion, there is an added risk to the reliance
on Ares Management as the source of both management and operating support
for ARCC. In the event an unforeseen event causes stress at Ares
Management, it could lead to a disruption at ARCC, whether
through increased employee turnover (due to the unforeseen event) or,
at a minimum, distraction away from ARCC operations.
ARCC invests primarily debt and to a lesser extent equity in middle market,
private companies. Due to the nature of these investments,
portfolio valuation of its investments is subjective and difficult.
This is mitigated through ARCC's current investment structure (largely
first lien debt); however, an increase in equity investments
would increase this risk. In addition, if ARCC operates with
leverage near the one-to-one leverage restriction,
there is a risk that if valuations were overestimated, it could
violate BDC guidelines, impair investor confidence, reduce
its ability to originate business, and diminish its competitive
standing and franchise value.
ARCC, as with other BDCs, has limited internal capital generation
given its requirement to pay out substantial dividends. In order
to grow, ARCC needs to frequently tap the public equity market.
Therefore, it is important for the company to maintain investor
confidence and a solid equity valuation.
Finally, there is a risk that greater competition could impact portfolio
yields or lead to adverse investment selection as more companies enter
ARCC's competitive space. ARCC's ability to differentiate
itself from other market participants with its product offerings and operations
expertise is also significant to the rating.
What Could Change the Rating -- UP
The rating could go up if ARCC demonstrates continued strong operating
performance through a credit cycle while meeting its growth objectives
without stress on the resources of the company or impairment to the franchise.
Moreover, maintenance of a secured investment structure with minimal
deterioration in credit quality would also be positive for the rating.
What Could Change the Rating -- DOWN
The rating could decline if ARCC's portfolio performance materially
weakens, if it has a substantial impairment on its investment portfolio,
or if it experiences a protracted reduction in realized yields due to
greater competition. Although not expected, a significant
change in the company's capital structure that pressures the BDC guideline
covenants could also lead to a lower rating. In addition,
failure to increase and retain key personnel to accommodate the expected
growth objectives could also pressure the rating.
The following rating was assigned:
Long-Term Issuer RatingBaa3
Ares Capital Corporation (NASDAQ: ARCC) is headquartered in New
York, NY and reported assets of approximately $1.5
billion at March 31, 2007.
Financial Institutions Group
Moody's Investors Service
Financial Institutions Group
Moody's Investors Service
No Related Data.
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