DBRS Morningstar Assigns Long-Term Ratings of BBB (low) to Apollo Debt Solutions BDC with a Stable Trend

DBRS, Inc. (DBRS Morningstar) has assigned a Long-Term Issuer Rating of BBB (low) and a Long-Term Senior Debt Rating of BBB (low) to Apollo Debt Solutions BDC (ADS or the Company). The trend on the ratings is Stable. The Company’s Intrinsic Assessment (IA) is BBB (low), while its Support Assessment is SA3, resulting in ADS’ final ratings positioned in line with its IA.

KEY RATING CONSIDERATIONS
The ratings reflect the strong franchise underpinned by ADS’ affiliation with Apollo Asset Management, Inc. (Apollo), a global alternative asset manager with $513 billion of assets under management (AUM), with a decades-long strong track record. Apollo has more than $373 billion of AUM dedicated to credit strategies, with $31 billion in direct lending across multiple investment vehicles and funds. ADS is a newly formed business development company (BDC) that started full investment operations in January 2022. The Company has already raised more equity from the retail distribution markets than Apollo’s other publicly-listed BDC, Apollo Investment Corporation (AINV), which has a different investment strategy. Apollo manages a number of other investment vehicles with a similar large corporate strategy to ADS, including an institutionally-focused private fund, Apollo Origination Partnership (AOP), with over $2 billion of commitments. The Company does not have an explicit guarantee from Apollo, but as the broad credit platform is highly strategic for Apollo, we believe that implicit support benefits the ratings.

The ratings are constrained by ADS’ limited earnings power as the Company is in the midst of ramping its investment portfolio and rotating assets that are initially invested in lower yielding broadly syndicated loans (BSLs) into higher yielding direct lending large corporate investments. The Company’s investments in BSLs and other quoted assets will experience more market volatility than its private credit assets, which may add to short-term earnings challenges. The ratings also consider ADS’ concentration risk in the investment portfolio that is somewhat mitigated by the focus on first lien, senior secured loans, and top concentrations should moderate as the portfolio grows and more large investments are originated. The Company’s funding profile is narrow as it exclusively relies on secured forms of wholesale funding, but ADS benefits from Apollo’s broad banking relationships, which enable it to put large credit facilities in place. We consider ADS’ leverage target as appropriate for the underlying assets and supportive of the ratings.

The Stable trend reflects our view that the geopolitical instability in Europe, as well as the rising interest rate environment and heightened inflationary pressures, while increasing risk to the continued U.S. economic recovery, will not overly burden U.S. private middle market and large companies. We remain cautious on portfolio valuations, which may be negatively affected from the pullback in public equity markets and widening of credit spreads, particularly with ADS’ balance of Level 2 assets. However, the Company’s portfolio has been originated in the current macroeconomic environment, and its portfolio companies have generally been able to navigate margin compression, inflationary pressures and increased borrowing costs.

RATING DRIVERS
Demonstrated sustained strong operating performance combined with improved funding sources that unencumber the balance sheet while maintaining sound credit fundamentals would lead to a ratings upgrade. Indications that the Company’s portfolio composition, operating performance or capitalization is significantly worse than expectations would result in a ratings downgrade. A material increase in non-accrual investments or a sizable loss that significantly reduces the Company’s capital buffer to regulatory requirements would result in a ratings downgrade.

RATING RATIONALE
The Company’s strong franchise is supported by its external advisor, Apollo Credit Management LLC (the Advisor), an affiliate of Apollo. Apollo’s alternative asset management franchise was founded in 1990, and serves institutional and individual investors through three primary investment strategies: private equity, credit and real assets. Apollo has deep insights in the credit markets with over $31 billion of direct lending-focused AUM and broad expertise across industries from more than 650 investment professionals, which ADS has access to through its Advisor. Additionally, as one of the largest alternative managers, Apollo has significant corporate, financial sponsor and banking counterparty relationships, which provides ADS substantial inbound deal flow and financing capacity.

ADS initiated investment operations in January 2022 and is structured as a perpetual, non-listed BDC. The Company has grown its equity and investment portfolio to $1.4 billion of equity and $2.6 billion at fair value as of March 31, 2022. Subsequent to quarter end, ADS raised an additional approximately $250 million of equity ($1.6 billion of total equity) and grew its investment portfolio to $3.0 billion at fair value as of April 30, 2022. ADS’ investment strategy is to focus on senior secured large corporate debt investments (companies with $75+ million of EBITDA) and to a lesser extent, BSLs, and middle market direct lending. The Company has co-investment exemptive relief from the SEC, which allows investments to be allocated across Apollo’s other investment vehicles, which should help diversify the portfolio while allowing the platform to speak for large ticket sizes ($1.5+ billion). Apollo has also managed a public BDC, AINV since 2004 which has a different investment strategy that ADS. Apollo has other investment vehicles including AOP, which focuses on investing in large corporate lending situations since 2020, and the broader Apollo franchise has invested in these types of loans as part of broader fund mandates. AOP has generated an unlevered yield of approximately 8.9% on $1.5 billion of deployed capital through these large corporate borrowers.

The Company’s earnings power is relatively limited as the investment portfolio is heavily weighted towards lower yielding BSL investments as the Company rotates into large corporate direct loans and middle market investments. Over the long-term, we expect earnings to normalize as the portfolio is shifted into the Company’s investment strategy. However, we anticipate that ADS’ earnings may be slightly more volatile than other BDCs, given the potential mark-to-market fluctuations in large corporate loans and BSLs may be wider than traditional middle market private credit assets. At 1Q22, net investment income (NII) was acceptable at $15.9 million and net change in net assets (net income) was $3.0 million.

ADS’ limited track record (outside of the Advisor) and vintage concentration are ratings constraints to the risk profile of the Company. Three of the Company’s largest investments at 1Q22 constitute 14% of the investment portfolio. As new equity is raised and investments are deployed into larger transactions, we expect concentrations to dissipate. The Company’s focus on first lien, floating rate loans (99.5% first lien, 99.3% floating-rate at 1Q22) mitigates some credit and interest rate risk, and the BSL portion of the portfolio by its nature is well-diversified and liquid. Nevertheless, there is elevated market risk from the Company’s exposure to Level 2 assets. As expected, none of ADS’ investments were on non-accrual as of 1Q22, given the newly originated portfolio and BSLs.

Given ADS’ reliance on secured credit facilities, funding is narrow and would benefit from unsecured debt issuance. At April 30, 2022, the Company had $1.1 billion of debt outstanding. As a newly formed BDC, ADS has no substantial near-term debt maturities with its three facilities (over $2.8 billion of commitments) with five year maturities due 2027, and will be amended and extended in the future. At 1Q22, the facilities have $2.1 billion of unused capacity, with $499 million available to be drawn based on the borrowing base and $258 million of cash, compared with $290 million of unfunded commitments, giving ADS solid – though in flux – liquidity. The Company continues to raise equity at $100 million to $250 million per month.

Capitalization is strong, with the Company targeting a leverage ratio of 1.00x to 1.25x debt-to-equity over the long-term, well inside of regulatory limits of 2.0x. At 1Q22, ADS’ leverage was 0.54x, and adjusted for unsettled trades and cash, net leverage was 0.93x. As of April 30, 2022, leverage was 0.71x and net leverage was 0.94x. We believe that the Company’s leverage target and current leverage has sufficient cushion to the asset coverage ratio (ACR) regulatory limit to absorb valuation volatility from the investment portfolio. We estimate that on April 30th, 2022, ADS’ cushion would be approximately $1.0 billion, implying that ADS would need to incur a loss on 34% of its investment portfolio to breach the buffer to the ACR.

As a perpetual, non-traded entity, ADS shares are less liquid than other public-listed BDCs whose shareholders can openly trade shares in the listed stock exchange. Expected liquidity for shareholders is on a quarterly basis through a share repurchase program, which repurchases shares at net asset value (or 98% of NAV if holding is under one year), limited to 5% of the shares outstanding. The Board of Trustees has discretion to amend or suspend the share repurchase program if in the best interests of the Company and shareholders, particularly in times of extreme market dislocation. As a BDC, the Company is required to distribute 90% of its ordinary income and net short-term capital gains as dividends for tax purposes, and this inherent inability to retain organic capital to support balance sheet growth is a ratings constraint for the BDC industry.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

DBRS Morningstar notes that this Press Release was amended on June 13, 2022 to reflect minor edits.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2021): https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating include Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212 806-3277