It's no secret that Apollo Investment (AINV +2.32%) has big oil and gas exposure. Some 13.2% of its overall portfolio was dedicated to debt and equity investments in oil and gas companies as of Sept. 30.
Naturally, many are starting to wonder if Apollo's investments may weigh on its performance. With oil prices plummeting, the company's concentrated investments in energy could result in loan losses, defaults, and markdowns on some of its biggest investments.
Apollo's underwriting
On the company's second fiscal quarter conference call, managers explained the company's underwriting requirements. Specifically, Apollo mentioned:
- 70% of its oil and gas investments are first- and second-lien investments with minimum proven developed producing reserve coverage of 1 times debt.
- Its lending agreements require its borrowers to hedge at least 80% of their production for two to three years.
- Its debt investments were underwritten with the base-case assumption of $80 oil prices.
This is consistent with the company's presentations, which have detailed Apollo's focus on lending to companies that have hedged their production (lowering their exposure to oil price fluctuations) and lending only against proved developed producing reserves (a more conservative measure of potential production).
Apollo's exposures
Apollo Investment breaks out its investments in its quarterly and annual filings. Its most recent quarterly filings show $486.6 million of oil and gas investments at cost, marked at $484.8 million in fair value. All in all, as of the last quarterly filing, declining oil prices hadn't yet had a marked impact on the company's balance sheet.
Furthermore, I calculate from its filings that roughly 96% of its investments at cost were debt investments. Debt investments should have more resiliency to oil prices than equity or warrants, given that they are ahead of equity holders in the event of financial stress.
As with any BDC, there is little that outsiders can know about the financials of its underlying portfolio companies. However, we can attempt to quantify a "worst case" event and its impact on the company's income.
The very worst of worst cases
Assuming interest income from its oil and gas investments were to go to zero -- an unlikely, complete and total loss -- net investment income in the most recent quarter would look more like $55.2 million, rather than the actual figure of roughly $65.7 million, a roughly 16% reduction. A 50% decline in oil-and-gas-related interest income would slash net investment income by about 8%.
Losses would be more pronounced in the company's net asset value. All in all, oil and gas investments make up roughly 24% of net assets at fair value. A 50% across-the-board reduction in fair values would create a 12% decline in net asset value.
With Apollo Investment trading at a near-10% discount to net asset value, it seems the potential for losses is largely baked in to the current share price, assuming, of course, you believe a 50% haircut is likely, and Apollo Investment is worth at least book value.
Given what we've been told about the company's underwriting, it stands to reason that probable losses are likely lower than half the company's oil and gas exposure. Even still, it pays to play it safe with assumptions where there is little available information.
