OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR), secured debt rating, and unsecured debt rating for Solar Capital, Ltd. (Solar) at 'BBB-'. The Rating Outlook has been revised to Negative from 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 the release, 'Fitch Takes Several Negative Rating Actions Following BDC Peer Review', available at www.fitchratings.com.

KEY RATING DRIVERS - IDRs and SENIOR DEBT

The rating affirmation reflects Solar's low balance sheet leverage, sound liquidity, proactive dividend realignment and a demonstrated willingness to moderate portfolio growth and move up the investment capital structure in what is viewed as a highly competitive underwriting environment.

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.

The revision of Solar's Outlook to Negative from Stable reflects Fitch's expectation for increased equity exposure, growing investment concentration, and a riskier total leverage profile, primarily resulting from the launch and any substantial funding under the Senior Secured Unitranche Loan Program (SSLP) in the future. Funding under Solar's SSLP total commitment would also push the firm's non-qualifying assets past the 30% limit, as outlined in the Investment Company Act of 1940. While the limitation is an incurrence test, meaning the sole immediate impact to Solar would be to restrict the addition of further non-qualifying assets to its balance sheet until it got back in compliance, Fitch views the strategy as somewhat aggressive as it could garner increased scrutiny from the SEC and reduce investment flexibility down the road.

Solar recently launched the SSLP, a joint venture with PIMCO, in which each party committed \$300 million to fund equity in the program. Targeted leverage for the program is 1.5x and funding is expected to be provided by third parties. A fully ramped portfolio would provide \$1.5 billion of buying power, and allows Solar more flexibility to invest in unitranche opportunities while utilizing off balance sheet leverage to earn low to mid-teen returns.

At Dec. 31, 2014, prior to funding the SSLP, Solar had above average exposure to equity investments at 31.5% of the portfolio at fair value, versus the investment grade-rated peer average of 16.2%.. Solar's equity exposure is primarily related to its \$297.5 million strategic ownership of Crystal Financial LLC (Crystal), which was acquired in 2012. Crystal is a diversified finance company with a \$478 million portfolio of first lien asset-based-loans to 27 borrowers, funded with third party non-recourse leverage facilities similar to the SSLP. Crystal's debt to equity was 0.85x at Dec. 31, 2014, and Fitch has observed the metric to range between 0.5x - 1.0x, based on investment activity.

Although Fitch believes any volatility of the Crystal investment may be somewhat mitigated by the underlying portfolio diversity of investments in asset-based loans, relative to an equity investment in an individual company, the added layer of leverage and Solar's first loss position in the investment are noted weaknesses.

Additional portfolio equity exposure may develop over time due to growth in the life sciences venture lending platform, an asset class which often comes with warrants. As of Dec. 31, 2014, the venture lending platform accounted for 5.5% of total investments or approximately \$56 million with \$1.0 million of equity and warrants. Given greater volatility in the valuation of equity investments, Fitch expects Solar to operate with more conservative leverage, so as not to breach asset coverage limitations.

Solar's balance sheet leverage, measured by debt to equity, was 0.24x at Dec. 31, 2014, or 0.09x net of actual cash on balance sheet, which is well-below the peer average and the firm's target of 0.7x. Low leverage reflects management's conservatism in a highly competitive operating environment, as investment exits outpaced originations, and the investment portfolio declined 29.7% at cost, since Dec. 31, 2012. Repayments are expected to decline in 2015, likely resulting in net growth funded by incremental leverage.

The growth of the SSLP, which introduces off-balance sheet leverage similar to Crystal, could also negatively impact the firm's balance sheet leverage. If Solar funded its full commitment to the SSLP with borrowings, all else equal, the leverage ratio would increase to 0.56x. While this metric is still below many investment grade-rated peers, Solar already has the most significant portfolio concentrations in the industry on a reported basis. At Dec. 31, 2014, top ten investments accounted for 53.3% of assets and 68.1% of equity, compared to the investment grade peer average of 39.8% and 67.5%, respectively. If the SSLP is fully funded with borrowings, Solar's top ten concentrations would increase to approximately 61% of assets and 97.5% of equity, assuming no additional balance sheet growth.

Solar's income-producing portfolio yield, at cost, was 9.9% at Dec. 31, 2014, down from 14.2% at Dec. 31, 2012, versus the peer averages of 10.7% and 12.0%, respectively. The steep decline in Solar's yield was due to spread compression combined with the portfolio shift into more floating rate, senior secured positions. Management is expected to deploy dry powder into attractive investment opportunities over time, including growth in the SSLP.

Strong refinancing volume and high portfolio turnover have been particularly evident at Solar, as management has opportunistically shifted into senior secured loans. At Dec. 31, 2014, 79% of the portfolio, excluding Crystal, was originated since 2013. Only 9% of the total portfolio was invested in subordinated notes and preferred equity compared with 43% at Dec. 31, 2012. However, Solar's direct investments on the balance sheet are predominantly in second-lien positions, which typically exhibit higher risk as they are subordinated to first-lien holders and carry higher leverage multiples. Net investment income diminished materially in 2014, reflecting a smaller portfolio, given realizations of large legacy investments, and a lower portfolio yield, given Solar's move up the capital structure. Fitch believes that 2014 profitability benefited from prepayment and origination fees due to the high churn of the portfolio, but anticipates that Solar can continue to earn its dividend with the redeployment of portfolio proceeds into new investment originations and higher earnings from the SSLP.

Liquidity remains sound with \$145 million of balance sheet cash and \$490 million of availability on secured revolving facilities, subject to borrowing base requirements, at Dec. 31, 2014. Cash flows from investment repayments and exits have been significant, amounting to \$749 million in 2014, while new investments were \$699 million.

Solar prudently cut its quarterly dividend in 3Q13 from \$0.60 to \$0.40, and net investment income of \$1.56 per share in 2014 adequately covered dividends of \$1.55 per share.

As of Mar. 11, 2015, Solar's stock was trading at a 9.8% discount to net asset value, which currently restricts the firm from accessing the equity markets. Fitch would view equity market access favorably, as it would allow for flexibility in managing leverage and portfolio concentrations.

RATING SENSITIVITIES - IDRs and SENIOR DEBT

The ratings of Solar could be downgraded if equity exposure and investment concentrations materially grow without maintaining a conservative leverage profile. Negative rating momentum could also develop from asset quality deterioration, declines in operating performance and dividend coverage, a reduction in funding flexibility, impairment of the liquidity profile, and/or increased regulatory scrutiny resulting from the an increase in the firm's non-qualifying assets above the 30% limit.

A revision of the Outlook to Stable may be driven by demonstrated operating performance of Solar's SSLP and Crystal investments, given relatively outsized exposure to those investments. An absence of material portfolio losses (realized or unrealized), in addition to operating consistency, the maintenance of strong dividend coverage, appropriate leverage, and demonstrated access to the debt and equity markets would also be viewed favorably.

Headquartered in New York, NY, Solar is an externally managed BDC, founded in November 2007 and completed an initial public offering in February 2010. As of Dec. 31, 2014, the company had investments in 43 portfolio companies amounting to approximately \$1.0 billion.

Fitch has affirmed the following ratings:

Solar Capital Ltd.
--Long-term IDR at 'BBB-';
--Senior Secured Debt at 'BBB-'; and
--Senior Unsecured Debt at 'BBB-'.

The Rating Outlook has been revised to Negative from Stable.