Fitch Affirms Ares Management at 'BBB+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Ares Management, L.P. and its subsidiaries (collectively, Ares) at 'BBB+'. The Rating Outlook is Stable. See the full list of rating actions 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, and manageable near-term obligations relative to available liquidity resources. The outlook is also supported by 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 compares 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. However, 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

IDRS AND SENIOR DEBT

The rating affirmations reflect the firm's solid competitive position as a global alternative IM, its experienced management team, solid investment track record, strong and predictable fee-related earnings (FRE), given meaningful fee-earning assets under management (FEAUM), relatively stable distributable earnings compared to peers due to the significant FRE component, and the subordination of general partner interests to outstanding indebtedness.

Rating constraints include lower FEBITDA margins than peers, weaker revenue diversity given a heavier credit concentration, more limited incentive income upside, and a weaker liquidity profile relative to peers as evidenced by its historically positive net debt position. Similar to other alternative IM ratings, Ares' ratings are also constrained by '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 IM space.

At June 30, 2016, Ares' total debt amounted to $250 million, consisting of public unsecured notes. Based on this debt balance, Fitch calculates the firm's leverage (debt/FEBITDA) was 2.21x on a TTM basis at June 30, 2016, at the high end of Fitch's quantitative leverage benchmark of 0.5x-2.5x for alternative IMs in the 'A' rating category. This baseline calculation excludes the Part I incentive fees Ares earned from Ares Capital Corporation, a publicly traded business development company managed by the firm, and assumes a 60% compensation ratio on that revenue. If the net Part I incentive fees were included in FEBITDA, leverage would be 1.55x, which is well below the peer average.

Ares' FEBITDA margin (FEBITDA/fee revenue) was 20.3% on a TTM basis as of June 30, 2016, which is significantly below the peer average of 33.4% and at the low end of Fitch's quantitative earnings benchmark of 20%-30% for alternative IMs in the 'BBB' rating category. The lower margin reflects the firm's higher compensation ratio as compared to peers, on both a base and incentive income basis. Fitch does not expect the firm to materially adjust its compensation policy going forward; therefore, FEBITDA margin expansion will be heavily dependent upon Ares' ability to scale its operating segments more effectively. At June 30, 2016, Ares had $15.7 billion of AUM available for future deployment, which is largely due to its $7.85 billion closing on its fifth private equity fund. Ares estimates that this will translate into approximately $186.3 million of incremental annual management fees once the fund's investment period begins, which Fitch views positively for potential margin expansion.

Ares' liquidity profile is adequate, but viewed as weaker than many higher-rated peers that operate in negative net debt positions. At June 30, 2016, Ares had about $264.6 million of balance sheet cash and $1.03 billion of borrowing capacity on its corporate revolver, which compares to $250 million of long-term debt and $619.9 million of unfunded commitments. Ares paid out 92% of distributable earnings to shareholders in the TTM ended June 30, 2016, which is well above the peer average and is above the company's target of 80%-90%, but Fitch believes the firm could reduce its payout ratio to boost its liquidity profile, as necessary.

Ares' interest coverage (FEBITDA/interest expense) was 6.47x as of the TTM ended June 30, 2016, which is in the mid-range of Fitch's quantitative coverage benchmark of 4.0x-8.0x for alternative IMs in the 'BBB' rating category. When adding Part I fees to FEBITDA, interest coverage improves to 9.23x, which is above the peer average.

At June 30, 2016, Ares had $95.3 billion of AUM, $66.8 billion of which was fee-earning. FEAUM has expanded at a compound annual rate of approximately 11.9% since 2011 although it was down 2.1% in first half 2016 (1H16), largely due to reductions in leverage in the Senior Secured Loan Program (SSLP) and other liquid credit vehicles. Approximately 12% of the firm's AUM is invested in permanent capital vehicles, while 66% of AUM has an investment tenor of three or more years. The locked-in nature of the firm's capital is viewed favorably as it provides for more predictability of fees and cash flows over time.

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, sustain operating margins, operate with appropriate leverage, and retain an adequate liquidity profile in order to meet debt service obligations and co-investment commitments to its funds.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The affirmation of Ares' preferred unit rating at 'BBB-' maintains the two-notch differential with Ares' Long-Term IDR in accordance with Fitch's 'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis' dated February 2016. The preferred unit rating includes two notches for loss severity, reflecting its subordination and heightened risk of non-performance relative to other obligations, namely existing unsecured debt.

Fitch affords the preferred units 100% equity credit given the non-cumulative nature of the dividends, the fact that the preferred units are perpetual, and the issuer's option to elect a coupon step-up of 500 basis points in lieu of redemption in the event of a change in control.

The preferred units do not benefit from joint and several guarantees from the Ares Operating Group, which consists of Ares Holdings L.P., Ares Domestic Holdings L.P., Ares Offshore Holdings L.P., Ares Investments L.P., and Ares Real Estate Holdings L.P., given the registration requirements. However, Ares contributed the proceeds from the issuance to the Ares Operating Group, which each issued a new series of preferred units with economic terms designed to mirror those of the preferred issuance. This included an inability to declare distributions on common units unless distributions have been declared and paid (or funds for payment are set aside) on the preferred units with respect to a particular period. These terms help to provide a credit benefit to offset the lack of a guarantee, by structurally prioritizing the preferred units above all common units.

RATING SENSITIVITIES

IDRS AND SENIOR DEBT

Positive rating momentum could be driven by sustained improvements in the FEBITDA margin, increased fee revenue diversity, stronger balance sheet liquidity levels, and the maintenance of leverage below 2.5x.

Negative rating actions could result from material declines in investment performance, a key-man event, and/or legislative risk which negatively impact the company's ability to raise FEAUM and generate fees, meaningful increases in leverage, a decline in the FEBITDA margin, and/or further weakening of the liquidity profile.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The preferred unit rating is primarily sensitive to changes in Ares' Long-Term IDR, and would move in tandem with any changes to the IDR. In addition, were Fitch's recovery expectations with respect to the preferred units change, this could result in a widening of the notching between Ares' IDR and the preferred units.

Headquartered in Los Angeles, CA, Ares is a global alternative IM offering funds across a variety of strategies, including credit, private equity and real estate. At June 30, 2016, Ares had $66.8 billion of FEAUM, largely across its liquid and illiquid credit strategies. Ares was founded in 1997 and completed its initial public offering on May 7, 2014. The stock is listed on the NYSE under the ticker symbol ARES.

Fitch has affirmed the following ratings:

Ares Management, L.P.

-- Long-Term IDR at 'BBB+';

-- Preferred Units at 'BBB-'.

Ares Management LLC

Ares Investments Holdings LLC

Ares Offshore Holdings, L.P.

Ares Finance Co. II LLC

-- Long-Term IDR at 'BBB+'.

Ares Holdings L.P.

Ares Domestic Holdings L.P.

Ares Investments L.P.

Ares Real Estate Holdings L.P.

-- Long-Term IDR at 'BBB+';

-- Bank Credit Facility at 'BBB+'.

Ares Finance Co. LLC

-- Long-Term IDR at 'BBB+';

-- Senior Unsecured Debt at 'BBB+'.

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

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)

https://www.fitchratings.com/site/re/878264

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014220

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014220

Endorsement Policy

https://www.fitchratings.com/regulatory

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.

The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.

View source version on businesswire.com: http://www.businesswire.com/news/home/20161102006726/en/

Fitch Ratings
Primary Analyst
Meghan Neenan, CFA
Senior Director
+1 212-908-9121
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jared Kirsch, CFA
Associate Director
+1 212-908-0332
or
Committee Chairperson
Sean Pattap
Senior Director
+1 212-908-0642
or
Media Relations:
Hannah James, New York, + 1 646-582-4947
Email: [email protected]

Source: Fitch Ratings

---

Serious News for Serious Traders! Try StreetInsider.com Premium Free!

---

You May Also Be Interested In

• AI and memory not a classic bubble, but future returns uncertain - strategist
• JPMorgan Downgrades Thai Union Group PCL (TU:TB) (TUFBY) to Underweight
• Wall Street sees Muse as Meta’s next big catalyst after Connect event