DBRS Morningstar Confirms Apollo Debt Solutions BDC Long-Term Ratings at BBB (low), Trend Stable

DBRS, Inc. (DBRS Morningstar) confirmed the Long-Term Issuer Rating and Long-Term Senior Debt rating of Apollo Debt Solutions BDC (ADS or the Company) at BBB (low). The trend on all 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 confirmation is supported by ADS’ strong franchise through its affiliation with Apollo Global Management, Inc. (Apollo), a global alternative asset manager with $597.7 billion of assets under management (AUM) at March 31, 2023, which has an extensive track record in credit strategies, including direct lending. The Company has had adequate profitability, with top line revenue benefitting from higher base rates while overall profitability has been constrained by unrealized losses, particularly with mark-to-market fluctuations in the broadly syndicated loan (BSL) portfolio. The confirmation also considers ADS’ investment portfolio composition of sponsor-backed first lien loans to large corporates, the Company’s low leverage and solid credit performance in a newly originated portfolio.

The Stable trend reflects that despite the turmoil in the U.S. banking system and a weakening economic operating environment, ADS may benefit from the pullback in bank lending as it is less capital constrained than other BDCs and has ample capacity to grow its investment portfolio in a lender-friendly environment with higher yields and improved loan documentation. The failures of Silicon Valley Bank (SVB), Signature Bank (Signature), and First Republic Bank (First Republic) had minimal direct impact on ADS and its portfolio companies, though overall regional bank stress and financial market volatility may continue to pressure even large corporate borrowers that ADS targets. The scale and revenue mix of these large portfolio companies should better equip them to handle deteriorating market conditions compared to smaller competitors. The lender-friendly private credit origination market with higher spreads and stronger documentation is balanced by business development company (BDC) regulatory capital constraints from leverage discipline and lack of traditional sponsor-driven M&A pushing deal flow.

RATINGS DRIVERS
Sustained strong operating performance combined with funding diversity that further unencumbers the balance sheet while maintaining sound credit fundamentals would lead to a ratings upgrade. Conversely, the ratings would be downgraded if operating performance were to deteriorate, including a notable loss that erodes net asset value, or if there is significant credit deterioration above our expectations.

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’s credit platform with $438.1 billion of AUM represents the largest component of Apollo’s AUM with multiple investment vehicles and funds which have co-investment exemptive relief to invest in assets across the platform. While there is no explicit guarantee from Apollo on behalf of ADS, we view the benefits from Apollo’s significant corporate, financial sponsor and banking counterparty relationships as core to providing ADS substantial inbound deal flow and financing capacity.

ADS is a perpetual, non-traded BDC with a $4.3 billion investment portfolio at fair value as of March 31, 2023, primarily focused on lending to large sponsor-backed corporates with more than $75 million of EBITDA. The investment portfolio is comprised of 98% first lien debt, 1% second lien debt, and 1% unsecured and other investments at 1Q23 with the majority (approximately 64%) invested in large corporate debt investments, with the balance maintained in BSLs for liquidity purposes. The median EBITDA of the portfolio companies at 1Q23 was $234 million. The Apollo platform is able to underwrite large transactions ($1.5+ billion) while allocating portions of the transaction across multiple investment vehicles to preserve diversification across funds, including ADS, which has 133 portfolio companies with an average investment size of approximately $32 million at 1Q23.

The Company’s earnings power has been somewhat limited through 2022, as the portfolio ramped into higher yielding large corporate loans over the year, but had unrealized losses from mark-to-market fluctuations on its BSL and investment portfolio, which constrained net change in net assets (net income) to $2.8 million for FY 2022. However, in 1Q23 net income rebounded to $109.7 million as the portfolio stabilized and regained some of its marks from valuation fluctuations. Top line revenue has been strong, as the predominantly (98% at 1Q23) floating-rate portfolio was buoyed by overall base rate increases and a growing investment portfolio, with net investment income of $147.9 million for FY 2022, and $59.3 million for 1Q23. The weighted average yield at cost of the investment portfolio increased to 10.8% at 1Q23 compared to 5.2% at 1Q22.

ADS’ risk profile is considered moderate, with ADS’ still limited track record and vintage concentration factored into the assessment. However, given the lender-friendly market and capital position we expect the underlying investment portfolio will continue to strengthen. Credit performance has been strong with no debt investments on non-accrual, but the investment portfolio is still fairly new, so we do expect a degree of credit deterioration to occur over time. Mitigating some credit risk, the portfolio is comprised of 98% first lien debt to large sponsor-backed borrowers with the revenue diversification and scale to navigate worsening economic conditions.

ADS has a narrow funding profile reliant on secured credit facilities. The Company issued $200 million of private placement debt (10% of debt outstanding at 1Q23) in December 2022 in multiple tranches with well-staggered maturities, which helped unencumber assets. ADS entered into interest rate swaps for these fixed rate borrowings to match its floating-rate assets and hedge potential interest rate risk. The remainder of the funding profile consists of secured borrowings from ADS’ revolving credit facility and three SPV facilities, with $1.8 billion of borrowings at 1Q23 and maturities in 2027. ADS anticipates the wall of maturities in 2027 will be amended and extended on a regular basis, as the facilities were all put into place during 2022 with 5-year stated terms. At 1Q23, the Company had significant liquidity coverage with $1.3 billion of undrawn credit facility capacity and $58.8 million of cash compared to $318.8 million of unfunded commitments.

Capitalization continued to be strong. At 1Q23, ADS’ leverage was 0.87x, below its target leverage of 1.00x to 1.25x debt-to-equity, and well below the regulatory limit of 2.0x. Importantly, we believe the Company’s current leverage and target range has sufficient cushion to the asset coverage ratio (ACR) regulatory limit to absorb potential valuation volatility from the investment portfolio. At 1Q23, the cushion would be approximately $1.3 billion, implying that the Company would need to take a full loss on 30% of the $4.3 billion investment portfolio at fair value to breach the ACR limit. Redemptions have been manageable with ADS receiving $131 million of share repurchase requests during 1Q23 compared with the new equity proceeds of $171.2 million in April and $89.8 million in May, respectively.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) 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. (May 17, 2022)

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions: https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions. (September 2, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings: https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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