KBRA Upgrades Ratings for Blue Owl Capital Corporation II
17 Sep 2024 | New York
KBRA upgrades the issuer and senior unsecured debt ratings to BBB+ from BBB for Blue Owl Capital Corporation II ("OBDC II" or "the company"). The Outlook for the ratings is revised to Stable from Positive in conjunction with the rating upgrade.
Key Credit Considerations
The upgrade and ratings are supported by OBDC II's ties to the $95 billion Blue Owl Credit platform that maintains a strong reputation and leadership position in the $1.7 trillion private credit markets. OBDC II's experienced management team that has decades of experience working in the private markets has built a high credit quality direct lending platform to finance mainly sponsor-backed portfolio companies in the upper middle market. Management has implemented a comparatively favorable and comprehensive set of risk management tools to ensure solid liquidity, funding, and asset quality in less favorable markets. The company has SEC exemptive relief to co-invest with other funds managed by Blue Owl Credit Advisors LLC ("Adviser") and its affiliates, as well as the company's diversified $2.0 billion investment portfolio of 176 portfolio companies with a focus on senior secured first lien loans (80%) to upper middle market companies in less cyclical sectors as of June 30, 2024. The percentage of senior secured first lien loans is up from 68.4% as of December 31, 2023, as a portion of the company's second lien loans repaid. For traditional financing, excluding the company's joint ventures and certain investments that fall outside of the typical borrower profile (91.3% of total debt investments), weighted average annual EBITDA and revenue were $179 million and $827 million, respectively.
The ratings also reflect the company's comparatively stronger funding profile among KBRA rated BDCs. The company's funding sources include a committed revolving credit facility, SPV asset facilities, a CLO, and senior unsecured notes. The company's solid percentage of senior unsecured debt to total debt of 50% provides for financial flexibility and less asset encumbrance for the benefit of the senior unsecured noteholders. The company has comfortable liquidity with $320 million of available bank lines of credit and approximately $48 million of unrestricted cash set against $100 million of notes due November 2024. The company had $255 million of unfunded commitments where a portion are tied to covenants and transactions and are not expected to be drawn.
KBRA views the company's gross and net leverage as conservative at 0.76x and 0.72x, respectively, which is low relative to peers, reflecting the company's more restrictive regulatory asset coverage requirement of 200%. The company was established as a BDC prior to the Small Business Credit Availability Act (SBCAA), reducing regulatory asset coverage to 150%; the company has thus far chosen to maintain the more restrictive coverage requirement. KBRA views the company's asset coverage ratio of 229% as prudent, allowing for an adequate cushion for less favorable economic conditions. Credit quality remains solid with non-accruals as a percent of cost and FV at 2.5% and 1.0%, respectively, while 88.5% of the portfolio maintains an internal performance rating of 1 or 2, signifying that the loans are performing at or above underwriting expectations as of June 30, 2024.
The company's profitability is solid with net investment income (NII) as a percent of average total investments of 5.6% for 1H24. Going forward, NII will be pressured from the Federal Reserve's path to cut interest rates along with competitive pressures. We expect NII and margins to decline from currently high levels but remain within our rating expectations. The strengths are counterbalanced by the industrywide potential risk related to the company's illiquid investments, retained earnings constraints as a Regulated Investment Company (RIC), and the potential for increased non-accruals with a more uncertain economic environment with high base rates, inflation, and geopolitical risk. KBRA believes that OBDC II and other Blue Owl BDCs will remain comparatively resilient.
Blue Owl Capital Corporation II is an externally managed, non-diversified closed-end management investment company that has elected to be treated as a Business Development Company under the 1940 Act and has elected to be treated as an RIC, which, among other things, mus distribute to its shareholders at least 90% of the company's taxable income. The company commenced operations in April 2017 and is managed by Blue Owl Credit Advisors LLC ("Adviser"), an affiliate of Blue Owl Capital, Inc. (NYSE: OWL), which had ~$192 billion of AUM as of June 30, 2024. The company's investment strategy coincides with the strategies of Blue Owl Capital Corporation (KBRA Issuer/Senior Unsecured Debt Ratings BBB+ / Stable Outlook), Blue Owl Capital Corporation III (KBRA Issuer/Senior Unsecured Debt ratings BBB+ / Stable Outlook), and Blue Owl Credit Income Corp. (KBRA Issuer/Senior Unsecured Debt Ratings BBB+ / Stable Outlook).
Rating Sensitivities
Given the rating upgrade, ratings are unlikely to be upgraded further in the medium term. A rating downgrade and/or Outlook change to Negative could be considered if there is a significant downturn in the U.S. economy with a greater-than-expected negative impact on OCIC’s earnings performance, asset quality, and leverage. A significant change in senior management and/or risk management policies could also lead to negative rating action.
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