MorningStar DBRS

DBRS, Inc. (Morningstar DBRS) confirms 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 the credit ratings has been revised to Positive from Stable. The Company’s Intrinsic Assessment (IA) is BBB (low), while its Support Assessment is SA3, resulting in ADS’ final credit ratings positioned in line with its IA.

KEY CREDIT RATING CONSIDERATIONS

The trend revision to Positive from Stable reflect ADS’ continued funding diversification, and improved operating performance through 1Q24 and 2023 with earnings power driven by higher weighted average portfolio yields combined with mark-to-market gains and limited credit losses. The Company’s franchise strength, capital inflows and conservative leverage profile are also supportive of the trend revision.

The credit ratings confirmation reflects ADS’ strong franchise which is supported by its affiliation with Apollo Global Management, Inc. (Apollo), a global alternative asset manager with $671 billion of assets under management (AUM) at March 31, 2024, with the Company’s scaled $8.5 billion investment portfolio focused on private credit to large cap borrowers. The investment portfolio generates significant investment income, predominantly consisting of interest income with paid-in-kind interest comprised of just 2% of total investment income over both 1Q24 and 2023. However, we expect net investment income to moderate over the medium-term as base rates continue to be at peak levels with higher-for-longer rates expected until inflationary pressures decrease. Though ADS has a limited track record, non-accruals have been low at just 0.1% of the investment portfolio at cost at 1Q24. The credit ratings also consider ADS’ further asset unencumberance, as its unsecured funding composition increased to 50% of drawn funding at 1Q24 combined with conservative leverage of 0.56x gross debt-to-equity, well below its target range of approximately 1.0x through the cycle.

CREDIT RATING DRIVERS

The credit ratings would be upgraded with sustained strong earnings and asset level credit performance while maintaining leverage at or below the Company’s target range. Conversely, meaningfully worse operating performance would lead to a revision of the trend to Stable. A material increase in non-accrual investment well above our expectations or operating with leverage substantially higher than its target range for a sustained period would result in a credit ratings downgrade.

CREDIT RATING RATIONALE

Franchise Building Block (BB) Assessment: Good
ADS’ franchise benefits from its relationship with its external advisor, Apollo Credit Management LLC (the Advisor), an affiliate of Apollo, a global alternative asset manager with $476 billion of AUM dedicated to credit investments with corporate, asset-based finance and insurance solutions strategies. Apollo has continued to grow its direct lending business, in which ADS is among the largest vehicles of capital. ADS lends to large corporate borrowers with EBITDA of approximately $250 million and at the top of the capital stack, with the $8.5 billion investment portfolio comprised of 99.7% first lien investments across 222 portfolio companies at 1Q24.

Earnings Building Block (BB) Assessment: Moderate
The Company has improved its earnings profile which has benefitted from higher-for-longer base rates with a weighted average yield on the total investment portfolio of 11.2% at 1Q24. Net investment income (NII) in 2023 and 1Q24 was $309.3 million and $128.4 million, respectively, while net increase in net assets resulting from operations (net income) over the same periods was $116.2 million and $165.8 million, as mark-to-market valuations improved for the assets held on the balance sheet while realized losses from credit deterioration was minimal. We expect NII to moderate in the medium-term as the benefit from higher-for-longer rates abates while profitability may be constrained if credit losses worsen as the investment portfolio seasons.

Risk Building Block (BB) Assessment: Good / Moderate
ADS’ risk profile is acceptable, as the Company’s limited track record and vintage concentrations are factored into the assessment. To date, credit performance has been strong with just 0.1% of the investment portfolio at cost on non-accrual. The Company lends to both sponsor-backed and non-sponsored large corporates with a target portfolio company generating approximately $250 million of EBITDA. At that scale, portfolio companies typically have diverse revenue streams and more flexibility to weather worsening economic conditions. These corporates may also seek a broadly syndicated loan financing, but may prefer the private credit financing for execution certainty, shorter closing timelines and customized loans. Payment-in-kind (PIK) interest income was $11.4 million for 2023 (1.9% of total investment income), and $5.2 million for 1Q24 (2.3% of total investment income), significantly lower than the 5% average of BDCs under our coverage universe. Payment on PIK is normally received only in the event of payoff, unlike cash interest income which is at risk if a portfolio company defaults.

Funding and Liquidity Building Block (BB) Assessment: Moderate
The funding profile has diversified with funding consisting of a revolving credit facility, multiple asset-backed SPV facilities, a CLO warehouse, and both private placement and public unsecured bond issuances with well-laddered maturities. Nonetheless, the revolving facilities for now cluster in maturity around 2027, given the start of ADS’ significant investment operations in 2022. The Company plans to amend and extend these facilities on a regular basis. Unsecured funding comprised 50% of outstanding debt at 1Q24, significantly improved from 10% at 1Q23, as the Company issued $650 million of 6.9% public unsecured notes due 2029 in March 2024. Liquidity consisted of $2.5 billion of capacity under the credit facilities, subject to a borrowing base, and $189 million of cash and cash equivalents compared to $1.1 billion of unfunded commitments, of which $604 million were delayed draw term loans at 1Q24.

Capitalization Building Block (BB) Assessment: Moderate
Capitalization continues to be strong and is supportive of the credit ratings, with ADS’ target range of approximately 1.0x debt-to-equity through the cycle. The Company has operated well below its range at 0.56x gross debt-to-equity at 1Q24, as origination volume has been lower than anticipated and equity inflows has been high with monthly inflows ranging from $250 million – $500 million. 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 1Q24, the cushion was approximately $3.9 billion, implying that the Company would need to take a full loss on 45% of the $8.5 billion investment portfolio at fair value to breach the ACR limit. Redemptions have been manageable with ADS receiving approximately $126 million of share repurchase requests during 1Q24 compared with the new equity proceeds of $507 million in April and $437 million in May, respectively.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS  

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
 
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (January 23, 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (April 15, 2024): https://dbrs.morningstar.com/research/431187/global-methodology-for-rating-non-bank-financial-institutions. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/about/methodologies.

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

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

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

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit 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. Morningstar DBRS’ outlooks and credit ratings are monitored.

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