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Rating Action:

Moody's upgrades Ares Capital Corporation to Baa3, positive outlook

03 Oct 2018

New York, October 03, 2018 -- Moody's Investors Service ("Moody's") upgraded Ares Capital Corporation's (Ares Capital) corporate family and senior unsecured ratings to Baa3 from Ba1. The rating outlook is positive. This follows the company's announcement that is has entered into an amended credit agreement with its bank syndicate that revises its asset coverage covenant to align with its recently lowered regulatory minimum asset coverage requirement. Moody's will subsequently withdraw the Baa3 corporate family rating as this rating is Moody's anchor rating for non-investment grade issuers (ratings below Baa3). This concludes Moody's review of Ares Capital's ratings initiated on June 25, 2018.

Upgrades:

..Issuer: Allied Capital Corporation

....Senior Unsecured Regular Bond/Debenture, Upgraded to Baa3 from Ba1, Positive From Rating Under Review

..Issuer: Ares Capital Corporation

.... Corporate Family Rating, Upgraded to Baa3 from Ba1, Positive From Rating Under Review

Outlook Actions:

..Issuer: Ares Capital Corporation

....Outlook, Changed To Positive From Rating Under Review

RATINGS RATIONALE

The upgraded Ares Capital ratings are based on Moody's expectation that Ares Capital will maintain a larger cushion in relation to its revised 150% minimum asset coverage ratio (ACR) bank covenant than it has maintained versus its previous covenant level of 200%. In Moody's view, the increased cushion meaningfully reduces Ares Capital's probability of defaulting its bank credit agreement. The rating upgrade is also based on Moody's expectation that Ares Capital will use incremental leverage allowed under the revised covenant to invest in a mix of investments that reflect its historical bias toward senior secured loans and that investment portfolio quality should strengthen as leverage increases. Ares Capital's strong track record of asset quality performance, profitability, and liquidity management also support the rating upgrade.

Ares Capital in June decided to adopt a revised 150% regulatory minimum ACR requirement applying to business development companies (BDCs) under an election permitted under the Small Business Credit Availability Act passed earlier this year. The 150% regulatory ACR requirement becomes effective on the anniversary of approval by Ares Capital's Board of Directors, or June 21, 2019. Transition to the lower ACR requirement and covenant could be accelerated if approved by shareholders.

Ares Capital expects to transition to a leverage range of 0.9x - 1.25x debt to equity over the next few years, corresponding to an ACR range of approximately 210% - 180%. The company's ACR measured 255% at June 30. Leverage within the company's target range provides a 20% to 40% cushion against the lowered 150% regulatory ACR requirement, whereas historically the company's cushion has ranged between 15% and 25% of the existing 200% ACR requirement. Because of the larger cushion, Ares Capital will be better able to withstand deterioration in operating performance and portfolio fair values and is less likely to breach its bank ACR covenant.

Ares Capital expects to maintain an investment strategy that is oriented toward senior secured loans, including first lien, second lien and unitranche loans, which are less risky than subordinated loans and equity investments. At June 30, senior secured loans accounted for 76% of Ares Capital's investment portfolio, a higher proportion than many peer BDCs. The amended bank credit agreement revises the company's borrowing base advance rates, favoring first lien senior secured loans over second lien and junior securities at the higher leverage levels allowed under the revised ACR covenant. This creates an incentive for the company to use incremental leverage to invest in higher quality loans. While asset coverage will weaken as the company increases leverage, Moody's expects that Ares Capital's portfolio quality would result in minimal losses to creditors in the event of default and liquidation.

Ares Capital's strong earnings and low earnings volatility, its record of successfully resolving underperforming loans of acquired companies, and its solid prospects for consistent operating performance over the intermediate horizon support the ratings upgrade. The current lending environment is competitive, a function of strong capital inflows from private equity providers, banks and other finance companies, but Moody's expects that Ares Capital will continue to prioritize credit underwriting diligence amidst pressure on yields, resulting in a moderate pace of portfolio growth and leverage increase.

Ares Capital effectively manages its liquidity risks by maintaining ample borrowing availability under committed lines, a well-laddered debt maturity profile, and an ability to access unsecured debt and equity capital. BDCs are exposed to significant credit and market value risks associated with investments in highly levered and illiquid middle market companies, distribute nearly all earnings because most are registered investment companies, and encounter limitations on their ability to raise equity capital if share price declines to less than net asset value. However, Ares Capital effectively mitigates these risks by maintaining multi-year committed borrowing capacity and by annually obtaining a waiver from shareholders of restrictions on its ability to issue equity below net asset value.

The positive rating outlook reflects Moody's expectation that Ares Capital's transition to its target leverage range will be accompanied by strong asset quality and earnings and that liquidity will continue to be effectively managed.

Moody's could upgrade Ares Capital's ratings if the company 1) sustains an ACR coverage ratio of 190% (or approximately 1.1x debt/tangible equity); 2) increases and maintains the proportion of senior debt investments in its portfolio of at least 80%; and 3) generates profitability that compares strongly with BDC peers, taking into consideration differences in investment strategies.

Moody's could downgrade the ratings if the company 1) reduces asset coverage to less than 175% (or debt/tangible equity increases to more than approximately 1.3x); 2) reduces the proportion of senior debt investments to less than 65%; 3) pays dividends that exceed net investment income on a regular basis; 4) increases the ratio of secured debt to gross tangible assets to more than 30%; or 5) generates materially weaker or more volatile profitability.

The principal methodology used in these ratings was Finance Companies published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Mark L. Wasden
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Ana Arsov
MD - Financial Institutions
Financial Institutions Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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