Fitch Affirms Apollo Global Management & Subsidiaries at 'A-'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of the various subsidiaries of Apollo Global Management LLC (collectively, Apollo) at 'A-'. The Rating Outlook is Stable. See the full list of ratings at the end of this release.

Today's rating actions have been taken as part of a periodic peer review of the Alternative Investment Manager (IM) industry, which comprises seven publicly rated global firms. Fitch's outlook for the sector is stable, reflecting the relative stability of core operating fundamentals, given the locked-in nature of a large portion of fee revenue, modest but increased leverage levels, manageable near-term obligations relative to available liquidity resources, increasing asset under management (AUM) diversity, and investors' increasing allocation to alternative investments, particularly those managed by alternative IMs with strong franchises such as those included in Fitch's peer review.

Fee-earning AUM (FAUM) growth has slowed considerably for the rated peer group, as numerous strategies have record levels of uncalled capital to invest. Fundraising is expected to moderate to some extent, as a result, but management fees are expected to retain their resiliency, as capital not yet earning management fees (shadow AUM) remains elevated and realizations of legacy investments have declined. While an increase in market dislocations would impact the valuations and realization of existing investments, it could also result in stronger management fee growth, as uncalled capital would be invested at a faster pace. That said, Fitch does not expect a widespread distress cycle to emerge over the near term.

The variable cost structure of the alternative IMs has contributed to relatively steady cash flows through cycles. Fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) margins rebounded modestly in 2015 and 2016 as many alternative IMs have begun to realize the scale benefits of follow-on funds and adjacent strategies. The FEBITDA margin for 'A' category alternative IMs averaged 41.6% for the trailing 12 months (TTM) ended Sept. 30, 2016, which compared to a 35.6% average for 2015 and Fitch's quantitative benchmark range of 30%-50% for 'A' category alternative IMs. Still, dispersion in the group is significant, with a more than 25 percentage point differential between the highest and lowest performer, driven by differences in strategy and product mix. Fitch believes higher margins provide enhanced operating flexibility through cycles.

Gross realized incentive income has steadily declined since peaking in 2014, driven by the length of time valuations have been at elevated levels, a less supportive IPO environment, and a reduction in the average age of fund investments. Exit activity has declined in 2016 and is likely to moderate further, which points to likely reductions in distributable earnings. That said, incentive income accruals remain strong and Fitch believes realized incentive income may be less volatile than pre-crisis experience given the increased diversity of product platforms.

Leverage levels have increased across the industry, as issuers have taken advantage of the low interest rate environment to issue long-duration funding for the purpose of funding balance sheet co-investments, acquisitions, and, in some instances, to pre-fund maturities. Average leverage, defined as debt divided by FEBITDA, was 3.16x for 'A' category firms for the TTM ending Sept. 30, 2016, which compares to Fitch's quantitative benchmark range of 0.5x-2.5x for 'A' category alternative IMs. Fitch believes the issuances have been largely opportunistic and views the reduction in refinancing risk favorably. Over time, Fitch expects leverage levels to generally decline to the benchmark range as FEBITDA growth is driven by cost controls, increased scale, continued fundraising, and the gradual deployment of FAUM that earns fees on invested capital.

Counterbalancing the up-tick in leverage is the maintenance of strong liquidity profiles. Several firms remain in a negative net debt position and 2016 saw the introduction of perpetual preferred issuances by two issuers in the sector, with proceeds, to date, used to improve operating flexibility and liquidity. Debt maturities are negligible for the sector in 2016-2018. Payout ratios remain relatively high, but Fitch believes alternative IMs retain the ability to reduce shareholder distributions as necessary to meet obligations. While several share repurchase programs were announced over the last 12 months, execution is expected to remain opportunistic and is not expected to impair the sector's overall liquidity.

KEY RATING DRIVERS

The rating affirmations reflect Apollo's strong competitive position as a global alternative IM; its experienced management team; solid investment track record; large investor base; predictable management fee streams given significant FAUM and limited exposure to assets that earn fees based on net asset value; incentive income-generating capability; solid liquidity; and the subordination of general partner interests to outstanding indebtedness.

Rating constraints for the alternative IM space include 'key man' risk, which is institutionalized throughout many limited partnership agreements, reputational risk, which can impact the company's ability to raise future funds, and legal and regulatory risk, which could alter the alternative asset space.

Rating constraints more specific to Apollo include its large revenue exposure to insurance affiliate Athene Holding Ltd. (Athene), which accounts for a meaningful percentage of management fees and introduces potential regulatory and reputational risks, and leverage above Fitch's tolerance level for 'A' category alternative IMs.

FAUM amounted to $148.7 billion at Sept. 30, 2016, up about 13.4% year-over-year, as inflows, particularly in credit, far surpassed more modest realizations and outflows. The sizeable FAUM base provides for a relatively stable fee stream over time and only a small percentage of FAUM (7.1%) earned fees based on net asset value as of June 30, 2016. However, there are meaningful fee concentrations related to Athene and private equity Fund VIII, L.P. (Fund VIII) given their sizes. Apollo earns a 40 basis point management fee, with certain limited exceptions, on about $66.5 billion of Athene assets, which represented approximately a quarter of run-rate base management fees in third quarter 2016 (3Q16). Fees for Fund VIII should be relatively stable over the near term, but the fund was 65% committed or deployed at Sept. 30, 2016, given a record quarter of private equity investment activity in 2Q16. As a result, Apollo currently anticipated that fundraising for Fund IX will begin in 4Q16, and would have to gather as much capital as the largest fund in the firm's history (Fund VIII) and the largest buyout fund raised since the financial crisis, in order to fully replace the fees (assuming no change in the blended fee rate). Fitch believes a potential reduction in private equity management fees, in the event Fund IX is smaller, could be offset by continued growth in credit and real estate strategies.

Apollo had approximately $24.4 billion of un-invested capital to put to work at Sept. 30, 2016, at a time when valuations remain high and credit market conditions competitive. Fitch believes outsized concentrations in current vintages could lead to fund underperformance down the road. Still, Apollo has operated through a variety of market cycles and demonstrated investment restraint, and Fitch expects the firm to be very selective, particularly in this investing environment. The firm's average entry multiple for Fund VIII, as of Sept. 30, 2016, was below 6.0x, compared with an industry average closer to 10x-11x. While lower purchase multiples are more favorable, all else equal, long-term fund performance will determine whether Apollo is able to underwrite more conservative transactions or if the lower multiples corresponded to other investment risks such as those concerning earnings volatility, challenged industries, investment complexity, or otherwise.

Apollo's core operating performance, as measured by FEBITDA, was strong in the first nine months of 2016. Management fees ticked-up on FAUM growth and advisory and transaction fees benefited from record private equity capital deployment in 2Q16, which included a meaningful amount of co-investment capital. The FEBITDA margin was approximately 49.1% for the TTM ended Sept. 30, 2016, which is at the top end of the peer group. Apollo's business really hit scale in 2012, and the firm has been able to maintain peer-superior operating margins. Fitch believes margins could decline modestly in 4Q16 and 2017, with more normalized transaction fees, but they will remain at the upper end of the peer group.

At June 30, 2016, Apollo had established a $52 million legal reserve in connection with an ongoing SEC regulatory matter principally concerning the acceleration of fees from fund portfolio companies. Industry peers have faced similar inquiries and have settled for various amounts. Fitch believes the financial impact is manageable and the question of fee sharing is not likely to be an ongoing issue for Apollo, as Fund VIII provides for management fee offset to give limited partners 100% of transaction fees.

Apollo continues to generate realized carried interest, although the amount declined significantly in 2015 and the first three quarters of 2016 given that the firm's realization cycle started earlier than the peer group. Net realized carried interest was nearly $1.5 billion in 2013, $931 million in 2014, $221.5 million in 2015, and $31.8 million in the first nine months of 2016. That said, the potential for future carry remains strong, as Apollo had $527 million of carried interest receivable, net of profit sharing expense, at 3Q16, assuming all funds were liquidated at net asset value. This balance is linked largely to private equity funds, and Fund VIII in particular, which began generating carry for the firm in 2Q16 - relatively early in the fund's life. While carried income is inherently volatile over time, the potential for meaningful incentive income does help support the firm's credit profile.

On May 24, 2016, Apollo accessed the public debt markets for the second time, issuing $500 million of notes that mature in 2026 with a coupon of 4.4%, and $200 million of the proceeds were used to pay down the bank term loan, while the remainder is expected to be used to boost liquidity and for general corporate purposes, including the funding of share repurchases, co-investment commitments, seeding new investments and/or for opportunistic acquisitions, which would be expected to contribute to FEBITDA growth.

In 2016, Apollo also issued $33.9 million of secured term debt to fund the firm's retained interest in its European CLOs. At Sept. 30, 2016, total secured term debt for this purpose amounted to $66.4 million. In late 2016, Apollo will also be subject to risk retention requirements in the U.S. Fitch would view a sustained increase in debt to fund risk retention negatively, as it would increase the firm's consolidated leverage ratio. Fitch believes risk retention is akin to co-investments in managed funds and should be funded with repayments from legacy investments, retained earnings, and/or available cash.

Apollo's leverage, as measured by corporate debt divided by FEBITDA, was 2.67x at Sept. 30, 2016 on a TTM basis, which was modestly above Fitch's quantitative benchmark of 0.5x-2.5x for 'A' category alternative IMs. Fitch expects the firm's leverage to decline to 2.5x over the medium term as incremental fees are earned from growth in FAUM.

Fitch believes Apollo's liquidity profile is sound. Apollo's cash balance amounted to approximately $926.9 million at Sept. 30, 2016 and availability on the corporate credit facility was $500 million. Claims on corporate liquidity include unfunded commitments to the various funds of approximately $548 million at 3Q16, although Fitch believes the company has significant discretion over the timing of funding commitments. Apollo distributed approximately 96% of its distributable earnings year-to-date in 2016, which is at the high end of the peer group, but Fitch believes the firm could reduce its payout ratio to boost its liquidity profile, as necessary.

In February 2016, Apollo's board authorized the repurchase of up to $250 million in aggregate of class A shares, including up to $150 million through a share repurchase and up to $100 million through a reduction of class A shares to be issued to employees to satisfy associated tax obligations in connection with the settlement of equity-based awards granted under the incentive plan. Apollo spent $48 million on share repurchases in the first nine months of 2016, including open-market repurchases and repurchase of shares issued to employees. Several peers have also established repurchase programs over the past year given unit-price underperformance. Fitch recognizes the potential accretion provided by the program and is comfortable with the targeted amount, given the firm's liquidity position.

The Stable Outlook reflects Fitch's expectations that management will continue to generate stable management and advisory fees, grow/retain FAUM through the raising of new and expansion of existing funds, albeit at a much more moderate pace near term, sustain recent operating margins, reduce leverage, and retain a solid liquidity profile in order to meet near-term debt maturities and co-investment commitments to funds.

RATING SENSITIVITIES

Positive rating momentum could develop from a demonstrated ability and commitment to operate with leverage at or below 2.5x, an increase in fee diversity, and/or stronger liquidity.

Declines in investment performance, a key-man event, and/or legislative risk which negatively impact the company's ability to raise FAUM and generate fees, sustained increases in leverage, and/or impairment of the liquidity profile could result in negative rating action. Furthermore, ratings could be adversely affected if the relationship between Apollo and Athene were to materially change as a result of regulatory scrutiny, outsized fines/penalties, or loss of management or sub-advisory fees.

Apollo is a global alternative investment manager specializing in private equity, credit and real estate. FAUM amounted to $148.7 billion at Sept. 30, 2016 and total AUM was $188.6 billion. The company's Class A shares are listed on the NYSE under the ticker APO.

Fitch has affirmed the following ratings:

Apollo Management Holdings, L.P.

Apollo Management, L.P.

Apollo Capital Management, L.P.

Apollo International Management, L.P.

AAA Holdings L.P.

Apollo Principal Holdings I-X, L.P.

Apollo Principal Holdings XI, LLC

ST Holdings GP, LLC

ST Management Holdings, LLC

--Long-term IDR at 'A-';

--Unsecured debt rating at 'A-'.

AMH Holdings (Cayman), L.P.

--Long-term IDR at 'A-'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016)

https://www.fitchratings.com/site/re/884128

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014226

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014226

Endorsement Policy

https://www.fitchratings.com/regulatory

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