Fitch Ratings does not anticipate any current impact to Ares Capital Corporation's (Ares Capital) 'BBB' ratings resulting from General Electric Corporation's (GE) announcement that it plans to divest the majority of General Electric Capital Corporation (GECC).
Ares Capital and GECC currently co-invest in first lien senior secured loans of middle market companies through the Senior Secured Loan Fund LLC (SSLP). The fund, which was formed in December 2007, had $9.9 billion of funded commitments at Dec. 31, 2014. Ares Capital's investment in the fund, amounting to nearly $2.1 billion, at fair value, at year-end 2014, is the firm's largest investment, accounting for 22.9% of the portfolio and 39.1% of balance sheet equity. Ares owns 87.5% of the SSLP subordinated certificates, which Fitch views as fund equity, while GECC owns the remaining 12.5% of the subordinated certificates and all of the senior notes. The ratio of senior notes to subordinated certificates was about 3.3 times (x) at year-end 2014.
With GE's announced plan to divest the majority of GECC, it is unclear to Fitch what will happen to the SSLP partnership between Ares Capital and GECC. Fitch believes there are a variety of potential outcomes, but two possible scenarios include a run-off of the fund assets over time or the sale of the GECC's fund interests (either with or without the remainder of GECC's middle market assets) to a new strategic partner. This view is not informed by any specific knowledge of discussions between the parties.
If an orderly run-off of the fund is the ultimate outcome, Fitch would look to assess the impact to Ares' market position, earnings, and dividend coverage over time. An orderly run-off of the fund would free up investment capital on Ares Capital's balance sheet, which could be redeployed into new portfolio investments, including the refinancing of SSLP investments. While earnings spreads could come under pressure, as Fitch estimates that the yield on the subordinated certificates could be higher than what may be achieved by investing directly in stretch senior or unitranche loans on the balance sheet, this could be offset by higher origination fees, an increase in sales or syndications, and/or a higher secured funding mix, among other things.
Fitch believes Ares Capital's deal flow would remain robust in any case, reflecting its competitive position in the middle market and its strong underwriting track record through the financial crisis. To the extent that the GECC platform was run-off rather than sold to a third party as a going concern, this would be viewed as a competitive benefit to all middle market lenders, Ares Capital included.
Should GECC's interest in the SSLP be transferred to a new strategic partner, Fitch would need to consider the partner's existing profile and position in the middle market, its ability to onboard and leverage the GECC platform (should it purchase GECC's broader middle market business), and whether any changes to the SSLP structure and terms result. Provided that the partner was suitable, the investment strategy was consistent and the structure/terms were not materially changed, Fitch would not expect such an occurrence to impact Ares Capital's ratings.
Fitch has historically viewed the relationship with GECC as attractive, as it has provided Ares Capital with enhanced access to deal flow, underwriting capabilities, investment capital, and returns. The weighted average yield on the SSLP subordinated certificates, at fair value, was 13.5%, at Dec. 31, 2014, which compared to an 8.4% yield on first and second lien senior secured loans on the balance sheet. Fitch believes the enhanced yield from the fund, driven by Ares' subordinated certificate position, has helped to support strong earnings coverage of the dividend, as yield spread compression in the market has reduced portfolio yields overall in recent years.
Fitch has long considered the off-balance sheet risk associated with Ares' investment in the SSLP when assessing the firm's overall credit profile. The SSLP's ratio of senior notes to subordinated certificates is higher than the debt to equity ratio on the balance sheet (3.3x versus 0.76x at YE14), but the assets in the fund benefit from the strong underwriting track record at Ares Capital and GECC.
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