29th May 2020

Locked-In Fees Protect Investment Co's Leverage from Asset Write-Down

London/Frankfurt - Declines in asset values as a result of the coronavirus pandemic are likely to put pressure on the balance-sheet leverage of rated European investment companies, Fitch Ratings says in a new report. However, both Intermediate Capital Group PLC (ICG, BBB/Stable) and Tikehau Capital SCA (BBB-/Stable) entered this period of market volatility with sound leverage metrics and their credit profiles further benefit from locked-in fees relating to their third-party closed-end fund activities, which have increased strongly since the 2008 global financial crisis.

Reflecting their business models, which combine balance-sheet-driven investment company and third-party investment management activities, Fitch takes a hybrid approach when assessing ICG's and Tikehau Capital's leverage, allocating a portion of the debt to the balance-sheet business (measured using a gross debt/tangible equity ratio) and a portion of the debt to the fee-generating business (measured using a gross debt/EBITDA metric). Based on this, both ICG's and Tikehau Capital's leverage positions are commensurate with their respective rating level.

In the case of Tikehau Capital, tangible equity supports about four-fifths of allowed debt, with the remainder supported by its fast-growing but still small investment management business. ICG's fee-generating business supports about half of allowable debt (based on ICG's consolidated EBITDA), significantly more than during the 2008 global financial crisis, when ICG's third-party investment management business was considerably smaller. Fee generation at both ICG and Tikehau Capital benefits from fees predominately being charged on committed or invested capital (and only to a lesser extent on more variable net asset values). For instance, as of end-September 2019, ICG's "locked-in" fees amounted to GBP1.6 billion, or about 130% of outstanding gross debt.

Both ICG and Tikehau Capital have meaningful exposures to balance-sheet investments (in the form of fund co-investments and direct balance-sheet investments) with total investments amounting to about 1.7x tangible equity for ICG (at end-September 2019) and about 0.9x at Tikehau Capital (at end-2019). ICG's exposures mainly relate to relatively granular fund co-investments. Tikehau Capital's investments, while smaller, are more concentrated and include meaningful exposure to listed equities (about EUR495 million at end-2019) indicating potentially higher risk of mark-to-market or impairment losses. Unlisted investments are subject to more infrequent valuations (often twice a year except in exceptional circumstances) and we think it is likely that valuations, once performed, will suffer as a result of the pandemic.

Fitch assumes any increases in balance-sheet leverage to be temporary (largely driven by fair-value changes). However, should leverage increases relate to permanent asset impairments, then this could ultimately put pressure on ICG's and Tikehau Capital's ratings. A material increase in gross debt/tangible equity ratios without the prospect of a reduction of balance-sheet leverage to more normalised levels by end-2021 could lead to negative rating actions, in particular if in conjunction with a more subdued outlook for investment management activities.

In addition, both ICG's and Tikehau Capital's ratings remain sensitive to key sensitivities as detailed in their most recent rating action commentary, published on 14 January 2020 and 27 January 2020, respectively.

The report, "EMEA Investment Companies Dashboard", is published today and can be found on www.fitchratings.com.

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