OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR), secured debt rating, and unsecured debt rating of Ares Capital Corporation (Ares) at 'BBB'. The Rating Outlook has been revised from Positive to Stable.

These actions are being taken in conjunction with a broader industry review, which includes 10 business development companies (BDCs). For more commentary on the broader sector review, please see 'Fitch Takes Several Negative Rating Actions Following BDC Peer Review', available at 'www.fitchratings.com'.

KEY RATING DRIVERS

The Outlook revision for Ares is driven largely by the challenging market backdrop, which is likely to pressure the sector's, earnings, asset quality, portfolio valuation, dividend funding, and equity market access over the near-to-intermediate term. While Fitch believes Ares is relatively well positioned, given its senior portfolio focus, credit track record, available liquidity, and term-funding profile, it will not be immune to market pressures.

In particular, fee income accounts for a larger-than-average proportion of Ares' revenue, and is correlated with origination activity. A decline in originations, which could be driven by slower portfolio repayments and/or an inability to access the equity markets for growth capital, would pressure fee income and, therefore, dividend coverage. However, Ares has carried over about \$0.58 per share of prior period taxable income into 2015 to cushion any potential dividend shortfall for some time.

Additionally, origination and refinancing activity has been strong in recent years, which means Ares, and others, have meaningful exposure to more competitively originated 2013 and 2014 vintages, which Fitch believes could lead to asset quality deterioration down the road. Still, Fitch believes Ares has retained its underwriting discipline to date, as evidenced by a continued focus on the senior part of the capital structure, modest declines in investment yields, and relative stability in underlying portfolio company metrics. The firm has also generated cumulative net realized portfolio gains since inception, which includes the performance of pre-crisis vintages, which evidences a strong credit culture.

Unrealized portfolio depreciation is expected to increase for the sector in 2015, driven by credit normalization and, more specifically, the potential impact of oil price volatility on energy investments. The recognition of material depreciation would inflate leverage ratios at a time when access to the equity markets is limited or non-existent. As a result, Fitch would view BDCs which operate with a sufficient leverage cushion to withstand potential valuation volatility favorably. Fitch believes Ares' energy exposure is manageable under stress, with concentrations in oil & gas consistent with the peer average, according to the agency's calculations. Ares reports direct oil & gas exposure of 1.3% of the portfolio, at fair value, at Dec. 31, 2014.

Today's affirmation of Ares' ratings reflects its relatively low leverage, demonstrated access to the debt and equity markets historically, consistent operating performance in a difficult market environment, moderate portfolio concentrations, strong funding flexibility, solid liquidity, experienced management team, access to deal flow and investment resources from asset manager, Ares Capital Management, LLC, and ample dividend coverage.

Rating constraints include the capital markets impact on leverage, given the need to fair value the portfolio each quarter, dependence on the capital markets to fund portfolio growth, and a limited ability to retain capital due to dividend distribution requirements.

Fitch continues to believe that Ares has the strongest capital structure in the BDC space, with unsecured debt accounting for 86.1% of total debt outstanding, at par, at Dec. 31, 2014, as the company has continued to opportunistically access the capital markets for term financing. In November 2014, Ares completed its second public institutional deal, issuing \$400 million of five-year notes at a coupon of 3.875%. In January 2015, the company re-opened the issuance, adding \$200 million of notes.

At Dec. 31, 2014, the weighted average maturity of Ares' debt was 6.5 years, while the weighted average stated interest rate was 4.9%. The amount of fixed rate debt in the capital structure positions the firm to benefit from a rising rate environment, as the majority of assets are floating rate. While Fitch believes secured borrowings may increase in 2015, as it is currently the company's cheapest source of funding, unsecured debt is expected to continue to account for the majority of debt financing.

Leverage, as measured by debt to equity, amounted to 0.74 times (x) at YE14, or 0.71x net of cash, which is within the firm's targeted range of 0.65x to 0.75x. However, leverage has declined since year-end, as proceeds from net portfolio repayments (\$426 million through Feb. 20, 2015) have been used to reduce debt. Fitch believes leverage may decline modestly over the near term to ensure proper cushions for potential valuation movements, particularly as access to the equity markets may be more uncertain over the near-term.

Ares' net investment income (NII) grew 5.2% year over year in 2014, adjusting for the GAAP accrual of the capital gains incentive fee, given an increase in interest and fee income, as portfolio growth offset about 30 basis points of yield compression and a decline in dividend payments from Ivy Hill Asset Management. While Fitch expects relatively stable interest income in 2015, NII has the potential to decline should origination activity fall materially. Fee income accounted for 16.5% of revenue in 2014 compared to 15.2% in 2013.

The investment portfolio remains relatively diverse at Dec. 31, 2014, with the top 10 investments accounting for about 68.5% of stockholders' equity when including the Senior Secured Loan Program (SSLP) and 32% when excluding the SSLP. At Dec. 31, 2014, Fitch calculated the SSLP's ratio of senior notes to subordinated certificates and members' capital to be approximately 3.3x. The leverage in the SSLP does impact Ares' combined leverage profile, but the fund has provided strong investment returns for the company and has a strong credit track record since its inception in 2007. The SSLP is co-managed with General Electric Capital Corporation, which Fitch believes, enhances Ares underwriting profile and its access to deal flow.

Ares' liquidity profile remains sound with \$194.6 million of balance sheet cash and \$1.6 billion of availability on various secured revolving facilities, subject to borrowing base and leverage restrictions, at Dec. 31, 2014. Cash flows from investment repayments and exits have been significant, amounting to \$3.4 billion in 2014, although Fitch believes the pace of repayment could slow in 2015, particularly if loan yields increase.

Ares does not have any debt maturing in 2015; however, \$805 million of convertible notes mature in 2016. Fitch believes the company will seek to refinance these maturities with unsecured issuance, should market conditions be attractive, or with secured revolver borrowings.

NII coverage of the dividend, which adjusts for non-cash incentive payment accruals and special dividends, was strong, amounting to 99.2% in 2014. Ares also has approximately \$0.58 of spillover income per share, which Fitch believes supports dividend consistency over the near term, despite the potential decline in NII coverage.

RATING SENSITIVITIES
Ares's ratings could be negatively affected by outsized portfolio growth which results in a weaker portfolio credit profile. Specifically, up-ticks in underlying portfolio leverage, and/or deterioration in portfolio company interest coverage or covenants, could signal the potential for asset quality issues down the road, which would likely pressure ratings.

Negative rating actions could also result from an extended increase in leverage above the targeted range, resulting from increased borrowings or material unrealized depreciation, and/or a meaningful increase in the proportion of equity holdings without a commensurate decline in leverage. A spike in non-accrual levels and weaker cash income dividend coverage would also be viewed unfavorably from a ratings perspective.

Upward rating momentum is viewed as limited over the outlook horizon of 12-24 months, particularly given the challenging market backdrop. Fitch believes Ares has the potential to achieve a higher rating over the longer-term, although likely no higher than 'BBB+' given Ares's reliance on wholesale funding sources, the market value sensitivity of the business model combined with the illiquidity of the majority of its investments, and the limited ability to retain capital.

An upgrade would be conditioned primarily upon very strong and differentiated asset quality performance of recent vintages. This will be evaluated in combination with the stability and consistency of Ares' operating performance, asset quality, valuation, and underlying portfolio metrics, including leverage and interest coverage. The maintenance of a strong funding profile, ample liquidity, relatively low leverage, and consistent core operating performance, would also be necessary to yield positive rating actions.

Headquartered in New York, NY, Ares is an externally managed BDC, organized on April 16, 2004. As of Dec. 31, 2014, the company had investments in 205 portfolio companies amounting to approximately \$9 billion.

Fitch has affirmed the following ratings:

Ares Capital Corporation
--Long-term IDR at 'BBB';
--Senior Secured Debt at 'BBB';
--Senior Unsecured Debt at 'BBB'.

Allied Capital Corporation
--Senior Unsecured Debt at 'BBB'.

The Rating Outlook is revised to Stable from Positive.