Fitch Places Apollo Investment Corp's 'BBB-' Ratings on Watch Negative

Midcap Financial Investment

21/05/2018 14:04

(The following statement was released by the rating agency)


Fitch Ratings-New York-May 21: Fitch Ratings has placed 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) on Rating Watch Negative. The 'A-' ratings and Positive Rating 
Outlook assigned to Apollo Investment's external manager, Apollo Global 
Management, LLC (Apollo Management), are unaffected by these actions.

The rating action follows the announcement by Apollo Investment 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. 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 Small Business Credit Availability 
Act (SBCAA) signed into law on March 23, 2018. The SBCAA reduced the asset 
coverage requirement to 150% from 200%, which effectively allows BDCs to 
increase their leverage to 2.0x from 1.0x, subject Board of Directors and/or 
shareholder approval. 

KEY RATING DRIVERS 

IDR AND SENIOR DEBT

The Rating Watch Negative reflects the heightened possibility of a downgrade 
over the next six months in light of Apollo Investment's plans to materially 
increase leverage against a highly competitive underwriting market backdrop. In 
addition, the platform has a mixed historical track record of executing 
strategic portfolio shifts, and there is potential for reduced financial 
flexibility. Fitch is in the process of finalizing its analytical approach to 
the relaxed regulatory leverage limits in the BDC sector and assessing the 
potential tradeoff between higher leverage and lower portfolio risk. Fitch 
expects to conclude that assessment in the next one to two months, at which 
point it will seek to resolve the Rating Watch Negative. 

Fitch recognizes 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. Apollo Investment will also need to address covenants in its bank 
credit facility, which currently limits the company's asset coverage to 200%. 

In connection with the announced intention to increase its leverage target, the 
company also plans to rotate the portfolio into more first lien securities over 
time, while materially reducing exposure to second lien investments, equity 
investments, legacy investments, and its aircraft financing business, Merx 
Aviation Financing, LLC (Merx). 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 and reduced underlying 
portfolio company leverage metrics) and result in better credit performance. 

Fitch believes there is a degree of execution risk associated with the planned 
portfolio mix shift. This is not the first time Apollo Investment has materially 
altered its portfolio strategy, and its 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. However, the 
company's shift into first lien positions will be supported by its exemptive 
order relief with affiliate MidCap Financial (MidCap). Apollo Management 
acquired the platform in 2013, but the business has been in operation since 
2008. While MidCap's roots are in healthcare lending, 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, which had been ramping up its participation in 
MidCap deals in recent quarters, is expected to participate in these lending 
opportunities more materially going forward. MidCap's credit performance has 
been solid since inception, although the credit environment has been relatively 
benign for the majority of its existence.

Fitch will also continue to monitor Apollo Investment's ability to retain its 
financial flexibility, particularly in light of negative pressure on its 
ratings. At March 31, 2018, 63.3% of Apollo Investment's debt was unsecured, 
which Fitch views favorably. 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 call its 6.875% senior 
unsecured notes due 2043 but could look to expand access to secured funding. 

 

Apollo Investment's 'BBB-' ratings continue to be supported by its affiliation 
with the broader Apollo Management platform, which provides access to investment 
resources and deal flow, and Apollo Investment's solid funding flexibility. The 
ratings are constrained by Apollo Investment's 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.

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 has yielded deterioration in terms in the 
middle market, 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, 
more limited access to deal flow and looser underwriting standards are likely to 
experience weaker performance. 

RATING SENSITIVITIES

IDR AND SENIOR DEBT

Fitch expects to resolve the Rating Watch Negative upon completion of its 
broader sector review of relaxed regulatory leverage limits, combined with a 
more detailed assessment of Apollo Investment's specific planned portfolio shift 
relative to its increased leverage target. 

Fitch could downgrade Apollo Investment's ratings if the agency concludes that 
the portfolio shift and expected risk reduction is not sufficient to offset the 
risk associated with the higher leverage target. The magnitude of a potential 
downgrade would likely be one notch. 

Alternatively, Fitch could remove the Negative Rating Watch and assign a 
Negative Rating Outlook if it concludes that the planned risk-return tradeoff is 
appropriate, but execution risk associated with affecting the planned changes 
remains elevated. In that case, revision of the Outlook to Stable from Negative 
would be dependent on a measured increase in leverage, in concert with a shift 
into more first lien positions, strong asset quality performance, and an ability 
to maintain economic access to the unsecured debt markets to ensure financial 
flexibility.

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 placed the following ratings on Rating Watch Negative:

Apollo Investment Corporation

--Long-Term IDR 'BBB-';

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

--Senior unsecured debt 'BBB-'.

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

Meghan Neenan, CFA

Managing Director

+1-212-908-9121

Media Relations: Hannah James, New York, Tel: + 1 646 582 4947, Email: 
hannah.james@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

Additional Disclosures 

Solicitation Status 

https://www.fitchratings.com/site/pr/10031501#solicitation

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https://www.fitchratings.com/regulatory

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