DBRS Morningstar Confirms Solar Senior Capital at BBB, Trend Revised to Negative

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Solar Senior Capital Ltd. (SUNS or the Company), including the Company’s Long-Term Issuer Rating of BBB. At the same time, DBRS Morningstar has revised the trend on the ratings to Negative from Stable. DBRS Morningstar has also assigned a rating of BBB, Negative trend to SUNS’ $85.0 million 3.90% Senior Unsecured Notes due March 2025. The Company’s Intrinsic Assessment (IA) is BBB, while its Support Assessment is SA3, resulting in SUNS’ final ratings positioned in line with its IA.

KEY RATING CONSIDERATIONS
The Negative trend reflects DBRS Morningstar’s view that business development companies (BDCs) are facing considerable headwinds over the near-term, given their focus on lending to U.S. middle market companies, many of which are significantly pressured in the current environment. Given the abrupt and severe economic contraction caused by the Coronavirus Disease (COVID-19), combined with the uncertainty of the magnitude and duration of the downturn, DBRS Morningstar sees the potential for fair value markdowns on SUNS’ investment portfolio resulting in reduced profitability and potentially higher balance sheet leverage. Investments on non-accrual status are likely to rise over the near-term, further pressuring profitability and balance sheet fundamentals. These concerns are somewhat mitigated by support from private equity sponsorship, which may invest additional capital in their portfolio companies although support may be selective.

Supporting the ratings is SUNS’ sound franchise and position within the larger Solar Capital Partners (SCP or the Advisor) platform. Given that SUNS has been deliberately under-levered, it is well-positioned to make new investments during a potential market disruption when risk adjusted returns are typically more attractive. This also allows the Company a significant leverage buffer as compared to its requirements, which is helpful in this uncertain environment. In addition to conservative leverage, the Company’s strong balance sheet includes long-dated funding and sound credit performance to date. The ratings also incorporate the Company’s narrow funding profile that was recently enhanced by the Company’s inaugural senior unsecured note issuance completed despite general market volatility. While DBRS Morningstar sees SUNS as having strong underwriting and investment monitoring capabilities, the challenging and uncertain environment will have an impact on the performance of its investment portfolio.

RATING DRIVERS
DBRS Morningstar sees a reversion to a Stable trend as unlikely for the duration of the coronavirus pandemic-related downturn. Over the longer-term, the trend could revert back to Stable if the Company were to sustain appropriate balance sheet fundamentals, while generating acceptable earnings despite the headwinds from the downturn.

Conversely, should the coronavirus pandemic be sustained longer than anticipated leading to a severe and prolonged economic downturn that results in significantly weakened credit fundamentals the ratings would be downgraded. A significant deterioration in the buffer to debt facility covenants or regulatory requirements could also result in a ratings downgrade.

RATING RATIONALE
SUNS’ franchise is sound, benefiting from its’ relationship with SCP, including the increasing scale of the platform as well as SCP’s well-established and seasoned management team that have invested through several business and economic cycles. In DBRS Morningstar’s view, this investment expertise and acumen should allow SUNS to make the necessary adjustments to navigate the current challenging environment. SCP’s national direct origination platform focuses on lending to upper middle market companies reflecting the Advisor’s view that these portfolio companies have the scale, access to capital, and better resources to navigate an economic downturn. At December 31, 2019, the Adviser had over $6.5 billion of investable capital, including leverage, across its BDCs, private credit funds and separately managed accounts, with over $3.0 billion available to make new investments. Importantly, SUNS has received co-investment exemptive relief from the SEC so it may invest alongside other SCP private credit funds, BDCs and separately managed accounts, allowing SCP greater flexibility to negotiate terms of co-investments. DBRS Morningstar views this exemptive relief favorably, as it allows SCP to participate in the larger deals that are common in the upper middle market space.

SUNS’ has good earnings generation ability reporting annual profits each year since inception. Earnings are anchored by solid recurring investment income, which could be impacted if portfolio companies are unable to make interest payments for a period, or if loans are restructured. DBRS Morningstar expects near-term earnings generation to be challenged given the likelihood of some unrealized losses on the investment portfolio due to the economic fallout from the coronavirus. We note that the BDC investment valuation process includes a meaningful amount of subjectivity given the illiquid nature of the portfolio investments held. Indeed, at December 31, 2019, all of SUNS’ investment portfolio was considered Level 3 assets. While credit spreads have widened and the outlook for the U.S. economy has deteriorated, the impact these inputs will have on 1Q20 fair value marks remains uncertain. Further, fair value marks also include consideration of the credit profile of the underlying portfolio companies, which may offset some of the pressure from general market inputs. SUNS’ investment portfolio at fair value was 99.5% of cost at year-end 2019, and since 2016, the portfolio at fair value has been 98% or higher of cost each quarter illustrating low volatility. As of December 31, 2019, SUNS’ weighted average investment rating was 2, on its internal rating scale from “1 (performing above expectations)” to “4 (performing well below expectations)”, indicating that the majority of the portfolio was performing within expectations.

Credit performance at SUNS has been strong and better than the BDC peer average demonstrating SCP’s disciplined and conservative investment strategy combined with underwriting that has been tested through several business and economic cycles. The comprehensive portfolio totaled approximately $664.6 million at December 31, 2019, including the underlying loan portfolios at Gemino and North Mill. At December 31, 2019, SUNS had no investments on non-accrual status, and have averaged just 0.47% of investments at cost over the last 12 quarters. Importantly, the Company’s comprehensive portfolio is primarily first lien senior secured loans and generally has no exposure to cyclical industries that are likely to be hardest hit by the sudden and severe shock to the U.S. economy from the coronavirus pandemic including, hospitality, retail, leisure, gaming, and energy. Nevertheless, DBRS Morningstar anticipates that SUNS will experience some level of weakness in the performance of its investment portfolio.

SUNS’ funding profile is viewed as narrow but appropriately managed and aligned with its investment portfolio. DBRS Morningstar considers SUNS recent $85.0 million private placement of five-year senior unsecured notes in the midst of a very challenging new issuance market as enhancing the Company’s funding profile and illustrating the strength of the franchise. The Company has no refinancing requirements until 2023 and has sufficient liquidity relative to unfunded commitments as well as potential new investments over the near-term. Further, while the Company has no intention to issue new equity, SUNS’ has received shareholder approval each year to issue equity below net asset value, if necessary.

Capital management at SUNS has been disciplined. The Company’s net debt-to-equity ratio was 0.65x at March 27, 2020, well below both regulatory and covenant limits of 2.0x, as well as inside the management’s long-term target of 1.25x to 1.50x.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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 2019), which can be found on our website under Methodologies & Criteria: https://www.dbrsmorningstar.com/research/350802/global-methodology-for-rating-non-bank-financial-institutions.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. 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 have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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.

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