2015 BDC ROUNDTABLE September 9-10, 2015
Speaker Biographies
Achieving Nirvana: The Corporate Credit Rating
Daphne Frydman, Partner, Sutherland Asbill & Brennan LLP Daphne Frydman helps companies in the financial services industry raise capital for their operations through a broad range of financing and other deals including structured finance, life insurance reserve securitizations, including XXX and AXXX reserve securitization financings, and general corporate finance transactions including credit facilities, senior debt financing, structured finance, convertible notes and retail notes.
Ovadiah Jacob, Vice President Global-Lead Financial Institutions Ratings Advisory Ovadiah Jacob is a seasoned ratings advisor and credit risk manager, with experience managing high performance teams to tight deadlines. Ovadiah advises investment banking clients and facilitates the execution of sell-side and buy-side M&A. He also works with clients and constituents to facilitate initial and follow-on debt and equity capital raises. Ovadiah also co-chaired Goldman’s credit review committee for North America & EMEA Financial Institutions and is a senior member of Goldman’s credit team covering healthcare, insurers, banks and financial services companies.
Brian Valik, Vice President, Investment Banking, Goldman Sachs Brian has worked for ten years at Goldman Sachs covering Financial Institutions within the Investment Banking Division. Currently he leads the Business Development Company coverage effort on behalf of Goldman and also covers a number of U.S. regional bank clients. Prior to working at Goldman he spent time at Arthur Andersen and Morgan Stanley as an auditor and financial analyst. Brian has a B.S. in Accounting from Rutgers University where he graduated cum laude, and an MBA from the University of Chicago Booth School of Business.
Achieving Nirvana: The Corporate Credit Rating
Goldman, Sachs & Co.
September 2015 I. Executive Summary Why Consider Obtaining a Credit Rating?
Benefits Key considerations
Will require all-encompassing view of the business Operating including preparation of detailed financials Will require incremental time/resources Discipline Potentially beneficial in preparing business for IPO
Provides increased credibility and security for the Risk of failing to obtain the desired rating; may affect company story future funding plans — Mitigants: would not attempt to obtain formal rating Credibility Potential ‘halo’ effect which may help relationship with unless confident of BBB category; can keep rating counterparties non-public
Accelerates market transparency and credibility Not immediately necessary from funding perspective – though will become increasingly relevant over time Access to Facilitates raising of wholesale funding Wholesale Non-equity capital instruments not required at this time Funding Even if no debt issued immediately, increases – given size, flexibility to diversify funding structure as part of IPO Rating unlikely to be a game-changer for the IPO story
Executive Summary 2 Can Companies Obtain Guidance from Rating Agencies Without Obtaining a Formal Rating?
Point-in-time Indication Formal Ongoing Rating Companies can obtain 1 2a 2b either an Initial Rating Services Private Ongoing Rating Public Ongoing Rating initial indication or formal rating Moody’s and Fitch offer the Ratings Moody’s, S&P and Fitch offer traditional Possible to proceed directly to a public from rating Assessment Service (RAS) while S&P Primary Rating services; such ratings rating through the same process as agencies offers the Rating Evaluation Service do not need to be made public but are obtaining a private rating without (RES) for unrated companies “official” credit ratings Also possible to convert a private rating having to These are “analytical tools” for Rating will generally be maintained to a public rating immediately, at any make such a Companies considering a first-time rating over time by the rating agencies point step public Overview The ratings determined through the Allow the company to build RES/RAS process are considered to be a relationships with the agencies and “point-in-time” judgment publicise the rating only when ready These services are designed to increase Can only bring a single agreed certainty for the client by getting rating business plan scenario to the agencies, agencies’ views on the credit or unlike the RES/RAS services impact of a proposed transaction(s)
No ongoing commitment to retain ratings Builds relationship with rating agencies Helps to facilitate public debt market Results remain entirely confidential until No obligation to publish; possible to access only when public Pros plans are made public walk away if outcome is unfavourable Benefits previously outlined around IPO Opportunity to ask agencies to review Possible to convert to public rating process multiple business plan ‘scenarios’ immediately at any time
Fees Requires ongoing management No benefit to proceeding directly to a Will require management’s time commitment and costs public rating rather than obtaining a Ratings will become stale over time If company decides to forego the private rating first and publicizing if indicative ratings, it may be harder to outcome is favourable Cons change a rating determination in future Can be difficult to withdraw public ratings Possible negative effect on IPO if publicizing a rating lower than analyst expectations
Process 8-10 weeks 8-10 weeks 8-10 weeks, or immediately at any time Timeline after having obtained a private rating
Executive Summary 3 How Does the Rating Agency Process Work?
The Rating Rating Decision Preparation Rating Meetings Committee & Follow-Up
Schedule meetings with the Presentations typically last 2-3 hours Turnaround time is generally 4-6 Once ratings are determined, the agencies weeks agencies will communicate the decisions to the Company Prepare Rating Agency Presentation Unless the Company has opted for a Coordinate dry runs with non-public rating, the will agencies Further detail Management Team draft a press release, which will be sent to the Company for review Agencies will continue to monitor ratings as long as the company has debt outstanding
GS Credit Rating Advisory team will Facilitate meetings and arrange Leading into committee, additional GS can work with the Company and work with management to craft and scheduling to maximise convenience follow-up questions from the lead the agencies to more effectively test a credit story analysts are possible, which the GS appeal potential unsatisfactory GS would attend the meeting as a will be able to handle directly outcomes Due diligence process to understand silent participant to ensure that key the company’s key credit credit points are conveyed, that Leverage lead analyst relationships GS would assist in addressing any characteristics potential misunderstandings are to provide rating outlooks ahead of possible credit concerns of the rating addressed and that any need for the committee process agencies, e.g. helping to coordinate Contribution to definition of financial follow-up information is recorded an appeal process How can GS strategy vs. credit rating objective Help? Advise and provide comments on written materials prepared by the company Facilitate dialogue with rating agencies Rehearsal of management involved in the ratings meetings including likely agency questions
The entire ratings process typically takes 6 to 8 weeks
Executive Summary 4 GS Can Bring Significant Expertise to Bear on the Ratings Process Lessons Learned from Previous Assignments
The key to a successful This can be achieved by arranging quarterly conference calls where financial results and key business developments relationship with rating are shared and annual meetings where financial results, key business developments, strategy, industry and market agencies is to maintain open updates are discussed lines of communication
Rating analysts are often skeptical; after all, there is little downside to being overly conservative. Effective ratings Ratings analysts are paid to management involves enfranchising the ratings analyst by encouraging them to think of the business and resultant be pessimists – strong ratings as something that they are invested in management teams can convert them into cautious This is achieved by laying out credible plans for growth and development, identifying the challenges and then optimists meeting the challenges and achieving the plans. With time, the analysts will develop trust in management and the strength of the business, which will in turn be reflected in the ratings
History is interesting to analysts and it may inform performance of a business but it helps to focus rating analysts on Ratings should be what the business is capable of and where management sees the business going in the future. Part of this is helping prospective the rating analysts to appreciate how you will get there. An earnings bridge is one mechanism that is useful to achieve this
Management should provide their analysts with credit stress tests that reflect the challenges and opportunities the business has coming up in the future Stress testing is important for ratings When rating analysts get a candid view of what risks the business faces then they do not have to create their own more imaginative downside scenarios. It helps to inform these stress tests with real world experience and loss data. When ratings agencies develop their own stress tests in a vacuum they are often more punitive than necessary
Developed governance with clear lines of responsibility, articulated risk appetites, and good risk monitoring and Established risk management, reporting are helpful to give rating agencies comfort that a business is not likely to underperform their plans. This governance, controls, and was a key distinguishing factor in a number of IPO/ratings advisory combinations that optimized the ratings risk appetites are important outcomes (SMBC Aviation Capital, VOYA, Synchrony)
Executive Summary 5 II. Further Details on Rating Agency Process Typical Materials Provided to the Agencies
Rating Agency Presentation – Considerations Comparison with Bond Process Materials Illustrative simplified outline Content is very similar to slides developed for a bond road show or communications with banks — Executive Summary including rating objective and overview — Typically more comprehensive and more detailed
— Introduction to the company — Includes projections and clear comments on company strategy — Understanding the company’s markets Q&A materials prepared for both rating agencies and — Detailed business review potential investors
— Comprehensive financial review including financial policy, Leverages standard legal documentation (offering past performance and projections memorandum, description of notes, etc.)
The rating agency presentation provides all details required by credit analysts to perform their analysis
— Standard book c. 40-65 pages, 2-hour meeting
— Shared within the rating agency as main source of company information
— Contains confidential information including projections
Other relevant information to be shared with such as market research, financial statements, debt documentation, etc.
Further Details on Rating Agency Process 7 The Rating Process Overview of the Key Steps
The Rating Rating Decision & Preparation Rating Meetings Committee Follow-Up
Most time consuming phase depending on complexity of the business and availability of information Preparation Important due diligence phase aimed at defining a convincing credit story for the company A rating book is the final output and follows due diligence sessions with the CEO, CFO and other senior management
Separate meetings for each rating agency are customary A key rating factor is the rating agencies’ views on company management. In order to form a view, the rating agencies Rating Meetings will expect to meet with the senior management, particularly when a first-time rating is obtained Information will be shared with the rating agencies on a confidential basis
A rating committee makes the initial rating decision and will also discuss and vet any future rating actions The committee usually consists of approximately 5 to 10 people, including analysts covering similar companies The Rating Committee globally, regional experts, and senior members of the rating agency analytical staff. Discussions are driven by a lead analyst Each member has one vote and the rating decision is arrived at by majority
Ratings and draft press releases are communicated by the rating analysts. At this stage the company’s options will be: — Accept and make the ratings public Rating Decision & Follow-Up — Appeal to the rating committee if not satisfied with the ratings although subject to sharing material new information — Accept the rating outcomes but request them to stay confidential. Ratings will stay private and cannot be disclosed by the Company externally (only senior management, shareholders)
Further Details on Rating Agency Process 8 The Rating Process Step 1 – Preparation for Rating Agency Meetings
The preparation of the rating presentation will be the most time consuming process step as the quality of the materials has a profound impact on the rating outcome. We would seek to leverage existing materials (including those prepared for the banking license application)
The Rating Rating Decision & Preparation Rating Meetings Committee Follow-Up
The company will be required to disclose detailed information on often confidential items such as general strategy, historic financials, Information financial projections for the next 5 years, financial policy Requirements This information will be used for determining the credit rating and will be treated in a confidential manner by the agency The materials typically include the following: Presentation — Introduction to the company: management, company description, competitive environment Materials — Division by division: performance drivers, pricing power and capacity, strategy and outlook — Financial profile: historical developments, current trading, short-term and long-term projections Usually 2 people dedicated to the ratings preparation process (Finance / Treasury Department) Resource Selective support from the operating divisions and key input from senior management e.g. on strategy Requirements A point person would co-ordinate the process internally and serve as the main contact for the rating agencies going forward Due diligence process to understand the company’s key credit characteristics Contribution to definition of financial strategy vs. credit rating objective Goldman Sachs Advise and provide comments on written materials prepared by the company Assistance Facilitate dialogue with rating agencies Rehearsal of management involved in the ratings meetings including likely agency questions
This stage of the process is typically split between an information gathering phase, and a rating agency presentation preparation phase Resources: 2 people in Finance / Treasury, including point person
Further Details on Rating Agency Process 9 The Rating Process Step 2 – Meetings with the Rating Agencies
The meeting with the rating agencies requires senior management attention, in particular in the context of an initial rating exercise
The Rating Rating Decision & Preparation Rating Meetings Committee Follow-Up
Separate meetings for each rating agency are customary
A key rating factor is the rating agencies’ views on the company’s management. In order to form a view, the rating agencies will expect to meet with senior management, particularly when a first-time rating is obtained
Typical meeting agenda: Meeting — Introduction — Business overview, strategy — Presentation of the company’s divisions — Financials and projections
Goldman Goldman Sachs would attend the meeting as a silent participant to ensure that key credit points are conveyed, that potential Sachs’ misunderstandings are addressed and that any need for follow-up information is recorded Assistance
Management participation required
Meeting duration: 2-3 hours per agency
On-site visits welcomed to evidence asset quality to credit analysts
Further Details on Rating Agency Process 10 The Rating Process Step 3 – The Rating Committee
The rating committee makes the rating decision, which draws heavily on the materials provided during the agency meeting with the company
The Rating Rating Decision & Preparation Rating Meetings Committee Follow-Up
In preparing their rating committee materials, the rating analyst typically draws heavily on the materials provided during the Follow-Up management meeting Requirements However, additional follow-up questions from the lead analysts are quite likely In the context of increasing regulatory requirements, certain critical pieces of information will need to be verified by the rating agencies A rating committee is the key decision making body for every rating agency, both for the initial rating as well as any follow-on rating action Committee The committee usually consists of approximately 5 to 10 people, including analysts covering similar companies globally and the relevant team leader (managing director) Each member has one vote and the rating decision is arrived at by majority vote
The lead analyst provides the analysis and the material supporting his opinion (typically taken from the company’s presentation book), Lead effectively leading the meeting Analyst’s Role It follows that ideally the company’s lead analyst becomes the supporting “spokesperson” for the company at the committee meeting
In the current environment, the rating committee would be expected to convene usually c. 4 weeks after the analyst has met the company, subject to having received all information requested
Further Details on Rating Agency Process 11 The Rating Process Step 4 – Assigning the Rating
The rating committee makes the rating decision, which draws heavily on the materials provided during the agency meeting with the company
The Rating Rating Decision & Preparation Rating Meetings Committee Follow-Up
Rating Decision Following the rating decision by the rating committee, the agency will provide its conclusions
If the company accepts the rating decision and is happy with the rating being publicized, rating analysts will prepare a press Acceptance of statement, which will be sent to the company shortly before publication Rating Decision This will give the company the opportunity to correct inaccuracies and object to misleading wording
The company will have the option to appeal the ratings decision Ratings Appeal In order for the appeal to be accepted, the company would need to provide material new information, which could convince the analyst / committee to re-assess its previous decision
Confidential Should the company decide not to release ratings at the time of the rating committee, the company can seek to obtain a confidential Ratings rating, which can be converted into a public credit rating at a time convenient for the company and supportive of its financial strategy
Goldman Goldman Sachs would assist the company in addressing possible credit concerns of the rating agencies, e.g. helping to coordinate an Sachs’ appeal process Assistance
Ratings outcome communicated to the issuer usually on the day of committee decision Publication of the new rating including supporting research can be coordinated with the execution of the bond process
Further Details on Rating Agency Process 12 Key Milestones of a Long Term Relationship
CEO and CFO should lead the initial ratings meeting to maximize impact The ongoing relationship would typically be maintained by the company’s treasury function Significant synergies can be achieved by running the ratings process in parallel with the license application and any bond process
Indicative Management Time Commitment by Stage
Preparation of Rating Agency On-Going Due DiligenceDue Diligence Rehearsal Follow Up theDue Presentation Diligence Meetings Relationship
CEO Minimal – 2-3 hours 2-4 hours – Minimal
4 hours (excl. CFO 2 weeks (oversight) 4-5 hours 4 hours Minimal Annual preparation)
Finance / Treasury / 4 hours (excl. 4-6 weeks (part time) 4-5 hours 4 hours As required Quarterly Investor Relations preparation)
Senior Operating 2-3 hours (excl. 2 weeks (input) 4-5 hours 2-4 hours Minimal Minimal Management preparation)
2-3 hours (excl. Strategy / Planning 2 weeks (input) – – Minimal Minimal preparation)
Further Details on Rating Agency Process 13 III. S&P BDC Rating Methodology Application of S&P Rating Methodology Issuer Credit Rating Summary
S&P’s rating process will start with an anchor, then incorporate company specific factors to derive the stand- alone credit profile, and finally layers in the potential for external influence to arrive at issuer credit rating
Anchor: This is assigned based on sector and country. It reflects the economic and industry risk a sector faces SACP or GCP: Stand-alone credit profile (SACP) or group credit profile (GCP) is formed by adjusting the anchor based on entity specific factors: capital, leverage, and earnings (CLE); risk position; funding and liquidity; and comparable rating Summary adjustments ICR: Arrived after determining relevant extraordinary government, group, or other external influences. Most external influences are not applicable for BDCs
Entity Specific
Entity-specific anchor Country adjustments (when External Influence and Sector applicable) specific Government influence PRIMARY FACTORS: Stand- alone Group influence Issuer Anchor Business Position Credit Credit Guarantees or other Rating Capital, leverage and Profile external influence earnings (SACP) Rating above the Risk Position sovereign Funding and Liquidity
Comparable ratings analysis
S&P Key Credit Factors For U.S. Business Development Companies, December 9, 2014 and S&P Nonbank Financial Institutions Rating Methodology, December 9, 2014
15 Application of S&P Rating Methodology S&P Credit Rating Methodology
Preliminary anchor is set 2 notches below U.S. bank anchor to reflect the typical incremental risks that BDCs face Step 1: Anchor relative to banks. If industry risk changes, then factor in any sector-specific adjustments, and the final anchor would reflect the new level of industry risk due to sector specific anchor adjustment
Factors that determine the SACP are business position; capital, leverage, and earnings (CLE); risk position; funding and liquidity, and the comparable ratings adjustment, if applicable SACP can be up to +2 notches or -5 notches per factor than the anchor Business position: When earnings are less stable or BDC lowers asset quality to meet dividend requirements, S&P assesses BDC’s business stability at “moderate” or lower. It is rare to assess business position as “strong” given the limited diversity inherent in a BDC’s business model CLE: Consider regulatory capital and equity sufficiency, by assessing leverage to arrive at an initial capital assessment. If asset coverage ratio is 200% - 220%, then SACP is capped at bb+. If <200%, then capped at b+. — Leverage = (total funded debt + preferred stock) / adjusted total equity Step 2: Entity- — Qualitative assessments of historical and expected levels and volatility of return on average portfolio investments, Specific SACP non-deal-dependent income interest coverage, and non-deal-dependent income coverage of both interest and dividends. S&P also assesses the quality of capital and financial flexibility
Risk position: Likely to range from “Moderate” to “Weak” or “Very Weak” driven by concentration from single obligor in excess of 15% of adjusted total equity or in excess of 50% for the company’s top five exposures
Funding and Liquidity: Assessed in three steps: 1) calculate the stable funding ratio and liquidity coverage measure 2) consider qualitative and quantitative factors 3) combine steps 1 and 2 to determine impact on SACP
Comparable rating adjustment: Comparative set includes other entities in the same sector and country of domicile. Positive assessment results in +1 notch and negative assessment is -1 notch from the SACP
Step 3: External Influence Adjustments to the SACP based on group or government influence, guarantees, or the application of the rating above and Sovereign the sovereign criteria Rating Limitation
S&P Key Credit Factors For U.S. Business Development Companies, December 9, 2014 and S&P Nonbank Financial Institutions Rating Methodology, December 9, 2014
S&P BDC Rating Methodology 16 Application of S&P Rating Methodology Standalone Rating Summary
S&P’s rating process will start with a standalone rating (SACP) that incorporates both macroeconomic inputs and company specific factors, and then layers in the potential for group support
Capital and earnings may be assessed in the “strong” or “very strong” category — Ratings would be capped at BB+ if asset coverage ratio is ≤ 220% Earnings assessments will take the following points into account: Summary — Realized return on average portfolio investments in the last 12 months has been less than 3x and we expect it to remain below 3x over at least the next year — Non-deal dependent income interest coverage in the last 12 months has been less than 3x — Non-deal dependent income interest coverage of both interest and dividend in the last 12 months has been less than 1x
Business Capital and Group Anchor SACP Risk Position SACP Position Earnings Support -0- bbb+ Likely +2 Possible S&P bbb Possibly – 1 Stand-Alone bbb- BBB- Likely 0 Likely – 2 BBB- BBB- Credit Profile bb+ Possibly -1
bb bb-
Business Position – possible -1 notch driven by robust earnings stability derived from realized gains, transaction fees and interest income. Qualitative Risk Position – Likely to range from “Moderate” to “Weak” or “Very Weak” driven by concentration from single Assessments obligor in excess of 15% of ATE or in excess of 50% for the Company’s top five exposures Support - A higher rating due to group support is unlikely in the BDC framework
S&P Banks Methodology
17 S&P Rating Factor Assessments of BDCs
S&P rates the following population of BDCs. Most companies are rated in the low BBB range
Business Capital, Leverage, and Risk Company Anchor Position Earnings Position Funding/Liquidity Rating American Capital Ltd. bbb- Moderate Very Strong Very weak Adequate/Adequate BB/Stable
Apollo Investment Corp. bbb- Adequate Very Strong Moderate Adequate/Adequate BBB/Negative
Ares Capital Corp. bbb- Adequate Very Strong Moderate Adequate/Strong BBB/Stable
BlackRock Capital Investment Corp. bbb- Moderate Very Strong Moderate Adequate/Adequate BBB-/Stable
Corporate Capital Trust bbb- Adequate Very Strong Weak Adequate/Adequate BBB-/Negative
Fifth Street Finance Corp. bbb- Adequate Strong Moderate Adequate/Adequate BBB-/Stable
FS Investment Corp. bbb- Adequate Very Strong Moderate Adequate/Adequate BBB/Stable
Hercules Technology Growth Capital Inc. bbb- Moderate Very Strong Moderate Adequate/Adequate BBB-/Stable
Main Street Capital Corp. bbb- Adequate Very Strong Moderate Adequate/Adequate BBB/Stable
PennantPark Investment Corp. bbb- Adequate Very Strong Weak Adequate/Adequate BBB-/Stable
Prospect Capital Corp. bbb- Adequate Very Strong Moderate Adequate/Strong BBB/Negative
Solar Capital Ltd. bbb- Adequate Very Strong Moderate Moderate/Adequate BBB-/Stable
TCP Capital Corp. bbb- Moderate Very Strong Moderate Adequate/Adequate BBB-/Stable
TPG Specialty Lending Inc. bbb- Adequate Very Strong Moderate Moderate/Adequate BBB-/Stable
S&P Reports
S&P BDC Rating Methodology 18 S&P BDC Financial Metrics
Realized EBITDA Return on return on Debt/adj excluding Realized Total Adjusted average average usted gains/losses EBITDA portfolio total portfolio portfolio total and PIK / excluding investments equity investments investments Debt/ equity interest PIK/interest Company Rating (Mil. $) (Mil. $) (%) (%) equity (x) (x) expense (x) expense (x) As of LTM June 30, American Capital Ltd. BB/Stable 4333 1.9 6 0.15 0.18 9.4 9.3 5,511 2014 LTM March 31, Apollo Investment Corp. BBB/Negative 3,350 1,744.80 2.2 6.3 0.77 0.86 3.57 3.4 2015 LTM March 31, Ares Capital Corp. BBB/Stable 7,800 2953.8 7.4 7.3 0.62 1.04 3.6 3.9 2014 BlackRock Capital BBB-/Stable 1,236 637.3 11.7 10.7 0.6 0.74 3.9 6.4 Q1 RTM 2015 Investment Corp. Fifth Street Finance LTM December 31, BBB-/Stable 2,722 1,345.31 1.89 4.82 0.99 1.03 3.26 2.92 Corp. 2014 LTM December 31, FS Investment Corp. BBB/Stable 4,183 2,241 4.68 6.55 0.79 0.83 4.41 5.02 2014 Hercules Technology BBB-/Stable 1,238.70 767.9 5.4 7.1 0.9 0.8 3.7 4.2 Q2 RTM 2015 Growth Capital Inc. Main Street Capital LTM December 31, BBB/Stable 1,572.40 851.8 7 7.8 0.75 0.83 5.03 6.01 Corp. 2014 PennantPark Investment BBB-/Stable 1,300.40 848.2 1.1 9.2 0.74 0.67 3.7 5.5 Q2 RTM 2015 Corp. LTM December 31, Prospect Capital Corp. BBB/Negative 6,523.70 2,532 5.7 3.7 0.77 1.13 3.28 2.29 2014 Solar Capital Ltd. BBB-/Stable 1,043.00 914.9 1.1 0.8 0.24 0.24 4.96 3.34 Q1 2015 TPG Specialty Lending LTM December 31, BBB-/Stable 1,263.50 815.3 7.5 9 0.47 0.49 7.82 7.89 Inc. 2014
S&P Reports
S&P BDC Rating Methodology 19 IV. Fitch BDC Rating Methodology Fitch BDC Rating Methodology Key Credit Factors
Sovereign Rating: effective cap on the maximum IDR Economic Environment: macroeconomic variables that impact credit strengths Operating Financial Market Development: Reflects size, concentration and ownership of the financial system, the depth of national capital markets, Environment and the development of infrastructure to support an orderly functioning financial system Regulatory Framework: BDCs are regulated under the Investment Company Act of 1940. If BDC elects to be treated as Regulated Investment Company (RIC) for tax purposes, Fitch views it more negatively Franchise: Reflected in market shares, product leadership, or other competitive measures Business Model: Assessment of business mix: asset / product, service composition, and proportion of revenue and earnings generated Company Profile from key business lines. BDCs’ typical maximum rating category is BBB Organizational Structure: There is impact to IDR when structure is highly opaque and complex. Not necessarily a negative impact, but Fitch will seek to understand why the group structured the way it is
Management Quality: Understanding motivations (compensation and strategic vision) is critical Corporate Governance: Assessed on both a country-specific and issuer specific basis. Considerations include board composition and Management and effectiveness, transparency, and related-party transactions. Fitch will evaluate allocation policies and procedures and board involvement to Strategy limit the risks such conflict may present Strategic Objectives: Reflection of business and financial goals Execution: Whether the institution consistently meets target objections through economic and / or market cycles
Underwriting standards: Considers the firm’s lending standards and how these compare to peers and broader sector. Fitch reviews the portfolio construct, yields, industry and issuer concentrations, and underlying portfolio company statistics Risk Controls: Limits pertaining to industry or issuer concentrations, market risks, and operational controls Risk Appetite Growth: Assessed on an absolute and relative basis based on market opportunities, underwriting considerations, and firm’s own experience and track record in the sector Market Risk: Limiting factor because BDC must mark its portfolio to fair value on a quarterly basis, with unrealized gains and losses recorded on the income statement
Asset Quality: Measures past due and non-accrual levels, overall portfolio valuations, and sales activity. Fitch uses net realized losses as a percentage of portfolio at fair value, as a proxy for net charge-offs Earnings and Profitability: Profitability metrics are separated into two categories: those based on net investment income (NII) and those that aggregate NII and realized and unrealized gains and losses on portfolio investments Financial Profile Capitalization and Leverage: Fitch considers a BDC’s leverage target on an absolute basis, but also relative to portfolio construction and market conditions. Fitch reviews a BDC’s leverage ratio relative to internal target over time to assess legitimacy Funding, Liquidity, and Coverage: Diverse set of available funding sources, track record in accessing the equity markets. When BDC has outsized exposure to PIK earnings, Fitch views it more negatively
Fitch BDC Rating Methodology 21 Fitch BDC Financial Metrics
Fitch rates the following population of BDCs. Most companies are rated in the low BBB range
Total Total Net Net Assets Equity Operating Earnings ROAA ROAE Debt/ Company LT IDR Outlook ($m) ($m) Income ($m) ($m) (%) (%) Equity (x) As of American Capital, Ltd. BB– Stable 7,640 5,472 117 434 6.36 8.19 0.31 December 31, 2014 Nine months ended Apollo Investment Corporation BBB Stable 3,701 1,997 176 87 NA NA 0.8 Dec. 31, 2014. Nine months ended Ares Capital Corporation BBB Positive 9,203 5,250 325 438 NA NA 0.72 Sept. 30. BlackRock Capital Investment For the three months BBB− Negative 1,065 1,023 700 16.7 NA NA 0.44 Corporation ended March 31. N.A. Corporate Capital Trust BB+ Stable 2,972 2,146 130 84 3.21 4.72 0.44 December 31, 2014 FS Investment Corp BBB− Stable 4,355 2,367 247 195 4.43 7.78 0.79 December 31, 2014 Solar Capital, Ltd BBB− Stable 1,196 937 67 48 3.9 5 0.24 December 31, 2014 Nine months ended TPG Specialty Lending BBB− Stable 1,280 839 74 71 NA NA 0.46 Sept. 30
Fitch Reports
Fitch BDC Rating Methodology 22