Fitch Affirms Apollo Investment at 'BBB-' and Removes Rating Watch; Assigns Negative Outlook

Midcap Financial Investment

21/06/2018 14:42

(The following statement was released by the rating agency)


Fitch Ratings-New York-June 21: Fitch Ratings has affirmed the 'BBB-' Long-Term 
Issuer Default Rating (IDR), secured debt rating and unsecured debt rating of 
business development company (BDC) Apollo Investment Corporation (Apollo 
Investment). Fitch has also removed the ratings from Rating Watch Negative and 
assigned a Negative Rating Outlook. 

The 'A-' ratings and Positive Outlook for Apollo Investment's external manager, 
Apollo Global Management, LLC (Apollo Management), are unaffected by these 
actions.

The rating actions follows Fitch's broader review of the implications of relaxed 
regulatory leverage limits on BDCs set forth in the Small Business Credit 
Availability Act (SBCAA) signed into law on March 23, 2018. The SBCAA reduced 
BDCs' asset coverage requirement to 150% from 200%, which effectively allows 
BDCs to increase leverage to 2.0x from 1.0x, subject to Board of Director and/or 
shareholder approval. On April 4, 2018, Apollo Investment announced that its 
Board of Directors approved the application of the modified asset coverage 
requirements set forth in the SBCAA. On May 18, 2018, Apollo Investment 
announced that its leverage target, as measured by debt-to-equity, will increase 
to a range of 1.25x-1.40x from a range of 0.65x-0.75x. 

KEY RATING DRIVERS 

IDR AND SENIOR DEBT

The removal of the Negative Rating Watch reflects Fitch's belief that Apollo 
Investment has the capacity to increase leverage to its 1.25x-1.40x target, at 
the current rating level, provided the company is able to successfully de-risk 
the portfolio by rotating into more first lien securities over time, while 
materially reducing exposure to second lien loans, unsecured debt, equity 
investments, legacy investments, and its aircraft financing business, Merx 
Aviation Financing, LLC (Merx). 

The Negative Outlook reflects heightened execution risk associated with the 
planned portfolio mix shift given Apollo Investment's mixed track record and the 
highly competitive environment. The Negative Outlook also reflects reduced asset 
coverage cushion which leaves Apollo Investment more exposed to covenant 
pressure should credit spreads widen or asset values otherwise decline. 

Fitch expects that first lien investments will increase materially from 50.4% of 
total investments at March 31, 2018, while Merx will be reduced from 17.9% at 
March 31, 2018. Fitch views this shift favorably, as it should reduce the risk 
profile of the portfolio (as evidenced by more senior positions in the capital 
structure, reduced underlying portfolio company leverage metrics, and lower 
portfolio yields) and result in better credit performance. Still, this is not 
the first time Apollo Investment has shifted its portfolio strategy, and the 
firm's long-term track record in credit is weaker than that of its BDC peers, 
having generated cumulative net realized losses of $1.2 billion from inception 
through March 31, 2018. 

Apollo Investment's shift into first lien positions is expected to be supported 
by its exemptive order relief with affiliate MidCap Financial (MidCap), a 
platform Apollo Management acquired in 2013 and that has been in operation since 
2008. MidCap's roots are in healthcare lending, but the firm's products and 
strategies have expanded over time to include first lien leveraged loans and 
asset-based loans across a variety of industries, in addition to life sciences 
investments. Apollo Investment has been ramping its participation in MidCap 
deals in recent quarters and is expected to participate in these lending 
opportunities more significantly going forward to effectuate the portfolio 
shift. MidCap's credit performance has been solid since inception, although the 
credit environment has been relatively benign for the majority of its existence.

The Negative Outlook incorporates that Apollo Investment is not able to increase 
its leverage ratio above 1.0x until April 2019, which is 12 months after the 
receipt of board approval. This suggests that the portfolio shift will occur 
gradually, which Fitch believes is prudent. In addition, Apollo Investment will 
need to address covenants in its bank credit facility, which currently limits 
the company's asset coverage to 200%. 

Fitch will also continue to monitor Apollo Investment's ability to retain its 
financial flexibility. At March 31, 2018, 63.3% of Apollo Investment's debt was 
unsecured, which is above the peer average and is viewed favorably by Fitch. 
Failure to maintain economic access to the unsecured markets over time, such 
that secured debt represents a more meaningful component of the capital 
structure, could yield negative rating actions. Apollo Investment has indicated 
that it does not plan to redeem its 6.875% senior unsecured notes due in 2043, 
but the company could look to expand its usage of cost-efficient secured funding 
for first lien investments. 

 

Apollo Investment's ratings continue to be supported by its affiliation with the 
broader Apollo Management platform, which provides access to investment 
resources and deal flow, solid funding flexibility and adequate dividend 
coverage. The ratings are constrained by Apollo Investment's weaker-than-peer 
track record in credit and exposure to challenged oil & gas investments, 
structured products and other equity positions, which are currently above the 
peer average, as well as its meaningful concentration in aircraft financing. 
However, all of these exposures are expected to decline with the planned 
portfolio rotation. 

Rating constraints for the BDC sector include the capital markets' impact on 
leverage, given the need to fair value the portfolio each quarter, dependence on 
access to the capital markets to fund portfolio growth, and a limited ability to 
retain capital due to dividend distribution requirements. Additionally, the 
competitive underwriting environment in the middle market has resulted in 
deterioration in terms, including fewer/looser covenants, higher underlying 
leverage and tighter spreads. Fitch believes this backdrop could contribute to 
asset quality deterioration in the sector when the cycle turns, and BDCs with 
higher leverage, reduced asset coverage cushion, more limited access to deal 
flow and/or looser underwriting standards are likely to experience weaker 
performance. 

RATING SENSITIVITIES

IDR AND SENIOR DEBT

Fitch could downgrade the ratings by one notch if Apollo Investment's leverage 
ratio increases without a meaningful improvement in the risk profile of the 
portfolio, as evidenced by a material increase in first lien investments, a 
reduction in underlying portfolio company leverage, and a decline in the 
portfolio yield. The ratings may also be downgraded if leverage increases above 
1.4x or if portfolio valuations deteriorate meaningfully, thereby reducing the 
cushion to asset coverage and credit facility covenant requirements. A spike in 
non-accrual levels, meaningful realized or unrealized losses, a meaningful 
reduction in unsecured debt as a percentage of total debt, or deterioration in 
dividend coverage could also result in negative rating actions.

A revision of the Outlook to Stable would be dependent on a measured increase in 
leverage, in concert with a shift into more first lien positions, strong asset 
quality performance, demonstrated stability of asset coverage cushion, and an 
ability to maintain economic access to the unsecured debt markets to ensure 
financial flexibility. An Outlook revision would also be dependent upon an 
improvement in operating consistency and the maintenance of strong dividend 
coverage. 

Headquartered in New York, NY, Apollo Investment is an externally-managed BDC, 
organized on Feb. 2, 2004. As of March 31, 2018, the company had investments in 
90 portfolio companies amounting to approximately $2.3 billion.

Fitch has affirmed the following ratings and removed them from Negative Rating 
Watch:

Apollo Investment Corporation

--Long-Term IDR at 'BBB-';

--Senior secured debt and revolver at 'BBB-'; 

--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Negative.

Contact: 

Primary Analyst

Sean Pattap

Senior Director 

+1-212-908-0642

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

Secondary Analyst

Johann Juan

Director

+1-312-368-3339

Committee Chairperson

Nathan Flanders

Managing Director

+1-212-908-0827

Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: 
elizabeth.fogerty@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Non-Bank Financial Institutions Rating Criteria (pub. 22 Mar 2018)

https://www.fitchratings.com/site/re/10023420

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