OREANDA-NEWS. Fitch Ratings has affirmed Intermediate Capital Group plc's (ICG) Long-Term Issuer Default Rating (IDR) and senior unsecured notes issued under its euro medium-term note (EMTN) programme at 'BBB-'. The Outlook on the Long-Term IDR is Stable.

ICG is a London-domiciled listed investment firm with a long-established niche franchise in investing its own capital and increasingly third-party funds in mezzanine, collateralised loan obligations (CLO), real estate and other assets. At end-March 2016, it had EUR19.3bn third party assets under management (AuM).

KEY RATING DRIVERS

LONG-TERM IDR AND SENIOR DEBT

ICG's Long-Term IDR reflects the company's well-established franchise, increasing share of more stable fee-based earnings in its revenue mix and Fitch's expectation that balance sheet leverage will not materially increase beyond its current level, as adjusted for the group's pending special dividend payment. The rating also takes into account ICG's direct credit and market risk exposure in its proprietary investment assets, higher earnings volatility (compared with traditional investment managers) and anticipated pressure on revenue as the company shifts its revenue mix from more profitable direct investments to lower-margin third-party AuM.

ICG's fund management activities (which are largely in the form of closed-end funds) performed well in the year to end-March 2016 (FY16; pre-tax profit up by 18% yoy to GBP61.2m), supported by sound fundraising across its product range and by most strategies meeting or exceeding their internal rate of return targets. Fundraising remained relatively concentrated with the two most successful funds (a mezzanine and a credit fund) accounting for more than half of the EUR5.2bn new money raised. ICG's continued success in asset management relies to a large extent on fund performance and the company's ability to successfully launch new funds. The latter is sensitive to market sentiment towards the asset classes in which ICG specialises, which can change quickly.

Internally reported non-current financial assets increased by 6% yoy to GBP1,798m at end-March 2016, largely as a result of moderate follow-on investments and more substantial fair value and foreign currency gains outstripping realisations. Pre-tax income from investment assets (adjusted for fair value movements on derivatives) was 13% lower yoy in FY16 (GBP114.4m) as the average volume held across the year reduced, along with a shift in the mix as to the proportion which was interest-bearing.

Increasing product and geographical diversification supports the ratings. This includes ambitious growth plans in North America and Asia Pacific (40% of the investor base at end-March 2016) and above-average growth of its asset management activities relative to its investment activities (35% of adjusted pre-tax profit in FY16 compared with 28% in FY15). Nonetheless, we believe that in the medium term ICG's earnings will remain significantly influenced by the potentially volatile profitability of its investment-related activities.

As long as ICG's exposure to investment assets remains material, it is exposed to higher impairment and/or lower capital gains in its proprietary investments. We expect that provisions will remain below or close to a long-term average of around 2.5% of total portfolio size (2.3% in FY16), helped by lower concentration levels and stronger performance of the post-crisis investment portfolio.

ICG's leverage increased during FY16 as a result of sizeable partly debt-funded capital returns but remained within our tolerance level for the rating. Including an already announced special dividend payment of GBP200m to be paid out in July 2016, ICG's end-March 2016 pro forma gross debt/tangible equity ratio stood at 0.95x (compared with a pro forma 0.74x when a previous special dividend was declared at end-March 2015). Gross debt excludes GBP1.9bn of borrowings in ICG's CLO funds, which have to be consolidated under IFRS 10 but which are not direct ICG obligations. We understand that ICG has now finalised its capital return programme and we would therefore not expect leverage to further increase.

While balance sheet leverage presently remains Fitch's principal metric when assessing ICG, as the company continues to grow its asset management business, we will increasingly use cash flow metrics (such as gross debt/EBITDA) to complement the balance sheet leverage assessment.

The rating of ICG's senior unsecured notes is in line with its Long-Term IDR, reflecting Fitch's expectation for average recovery prospects given that most of ICG's funding is unsecured.

The Stable Outlook on ICG's Long-Term IDR reflects our view that ICG should continue to report adequate profitability while maintaining leverage at current levels.

RATING SENSITIVITIES

LONG-TERM IDR AND SENIOR DEBT

Downside risk to ICG's Long-term IDR primarily relates to increasing leverage, higher impairments in its investment portfolio or material net new money outflows or underperformance in its asset management activities. In particular, the Long-Term IDR could be downgraded if ICG's adjusted gross debt/tangible equity leverage exceeded 1.0x on a sustained basis without simultaneous retention of significant unrestricted cash.

While ICG's exposure to UK-domiciled assets is considerable (around 30% of investment assets were UK-related at end-March 2016), in our view ICG is relatively well positioned to withstand the impact of a worsening macroeconomic environment following the UK's vote to leave the European Union in the referendum on 23 June. On-balance sheet foreign currency risk is hedged, with the exception of investments in overseas subsidiaries, whose capital is fairly modest. Fee income is hedged, and operating expenses largely in pounds. In addition, the vast majority of AuM is in closed-end structures, limiting liquidity risks and, in the case of the mezzanine funds which earn fees upon commitment, giving ICG the flexibility to delay investment decisions should the investment environment remain challenging.

In the medium term, a sharp increase in interest rates which would impair the quality of underlying UK assets and make alternative investments in general less attractive could be negative for ICG's rating. While at end-March 2016 77% of portfolio companies recorded EBITDA in line with or above the previous year, we expect this proportion to fall as the operating environment in the UK and other European markets deteriorates.

Upside rating potential is currently limited given ICG's increased leverage and the company's still sizeable exposure to balance sheet investments. In the medium term, reduced balance sheet investments and an increasing contribution from more stable fee-based asset management revenues could provide upside potential to ICG's rating.

ICG's senior unsecured debt rating is primarily sensitive to any change in ICG's Long-Term IDR.