UPDATE 26 June: Ares Capital Corporation had its credit rating downgraded by S&P from BBB to BBB-, making it the only BDC to maintain its investment-grade rating after receiving approval to up its leverage profile.
An upgrade for ARCC is not likely in the near future, associate director and ARCC analyst Trevor Martin told PDI. The firm could risk further downgrade, he explained, if the firm’s debt to adjusted total equity (TAE) – a metric S&P uses that backs out joint venture equity investments and any unrealised appreciation or depreciation – increases to more than 1.5x or if that same ratio increases to more than 1x and several earnings metrics deteriorate.
Those benchmarks include a realised return average investment falling below 5 percent, recurring earnings at 3x interest coverage after taking out mark-to-market volatility, associated fees or PIK income. S&P anticipates ARCC’s debt to TAE to be between 1.0x and 1.3x over the next 12-24 months.
Ares Capital Corporation’s (ARCC) board of directors has unanimously approved a measure allowing the firm to up its leverage profile, becoming the latest business development company to take advantage of the new statutory 2:1 debt-to-equity profile limit for BDCs.
The New York-based firm, which announced the development in a Monday statement, also reduced its management fee to 1 percent on borrowed funds that take the firm’s leverage above the previous 1:1 limit. The firm will still charge a 1.5 percent management fee on assets below a 1:1 ratio.
Currently, ARCC does not plan on polling its shareholders, but in an investor presentation it said it “reserve[s] the right” if the BDC wants to “accelerate implementation”. Because ARCC pursued the increased leverage through a board vote, the firm must wait 12 months before it can tap the additional borrowing capacity. A shareholder vote would allow the BDC to access it the next day.
ARCC also disclosed it is now targeting a debt-to-equity ratio of 0.9x-1.25x and said it would pursue a “similar mix of assets”, ARCC chief executive Kipp deVeer said in the statement.
“With no meaningful change to our strategy and a modest increase in leverage, we believe we can deliver higher earnings for shareholders while maintaining our conservative risk profile,” he added.
ARCC did not respond to further inquiries.
Firms have taken different tracks in implementing the new statutes.
Apollo Investment Corporation also asked its board to sign off on the a leverage increase, while Goldman Sachs BDC put it up to a shareholder vote. The latter planned to reduce its management fee if its investors signed off on the proposal, which they overwhelmingly did earlier this month.
Others, such as TCG BDC, have asked both their boards and their shareholders to bless the change and received approval from both constituencies.
In the presentation, ARCC said it worked with lenders, ratings agencies, fixed income investors, shareholders and investment banks. The firm also said it would work to maintain its investment-grade standing, which S&P currently lists as BBB. The ratings agency has maintained that the BB+ rating, which is non-investment grade, is the “starting point” for any BDC that moves forward with an increase in leverage capacity.
ARCC is on CreditWatch negative, a status S&P assigned the BDC after it came out in support of raising its leverage limits shortly after the Small Business Credit Availability Act was signed into law by US President Donald Trump. In a statement announcing its decision, S&P noted that the designation meant there was “at least a one-in-two chance” it would lower the rating within three months.
S&P has held sway over multiple BDCs in the bumpy road to implementing a higher leverage standard. After receiving the go-ahead from its shareholders to up its leverage capacity, GSBD won a BBB investment-grade rating from Fitch Ratings.
But S&P did not take so kindly to the change, downgrading GSBD’s credit label to BB+, which constituted junk status. GSBD asked S&P to withdraw the firm’s rating, a request S&P granted. At least one other BDC, Apollo Investment Corporation (AINV), was also downgraded to a BB+ status, though AINV did not ask S&P to withdraw its rating.
Editor’s note: GSBD was downgraded to a BB+ rating before its withdrawal, not a BB- rating.