Credit Opinion: Investcorp Bank B.S.C.

Transcription

1 Credit Opinion: Investcorp Bank B.S.C. Global Credit Research - 30 Oct 2015 Manama, Bahrain - Off Shore Ratings Category Moody's Rating Outlook Stable Bank Deposits Ba2/NP Baseline Credit Assessment ba2 Adjusted Baseline Credit Assessment ba2 Investcorp Capital Limited Outlook Stable Bkd Senior Unsecured Ba2 Investcorp S.A. Outlook Stable Bkd Senior Unsecured Ba2 Contacts Analyst Phone Melina Skouridou, CFA/Limassol Christos Theofilou, CFA/Limassol Sean Marion/London Marina Hadjitsangari/Limassol Key Indicators Investcorp Bank B.S.C. (Consolidated Financials)[1] [2][3]06-15 [2][3]06-14 [4]06-13 [4]06-12 [4]06-11 Total Assets (USD million) 2, , , , ,858.6 Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross Loans / Total Deposits (%) [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Early adoption of IFRS 15 [3] Basel III - transitional phase-in; IFRS [4] Basel II; IFRS Opinion SUMMARY RATING RATIONALE

2 The Ba2 deposit rating assigned to Investcorp Bank B.S.C. (Investcorp) is in line with its ba2 baseline credit assessment (BCA) and reflects its strong franchise in the Gulf Cooperation Council (GCC) countries as a provider of alternative investments, mainly in the US and Europe but also in the Middle East and North Africa, to Gulf investors. The ratings also reflect Investcorp's significant deleveraging of its balance sheet since 2009, its strong liquidity profile and the ongoing improvement in its earnings quality as fees from assets under management (AUM), its most stable revenue stream, recover. Nevertheless, Investcorp's ratings remain constrained by the risks inherent in its business model; mainly the higher volatility in its earnings and its fairly high, relative to its capital, investments in alternative assets. The small size of Investcorp's operations, on global scale, represents further constraints. Rating Drivers - Financial leverage and asset risks remain significant - Investcorp benefits from a strong liquidity profile - Investcorp benefits from a strong niche market position in the GCC - Investcorp's earnings profile remains inherently volatile, although fee revenue is gradually recovering Rating Outlook All ratings carry a stable outlook. Upward pressure on Investcorp's ratings could result from a sustained increase in earning power which will improve its financial leverage profile. What Could Change the Rating - Down Negative pressure on Investcorp's ratings could result from a weaker financial position driven by material investment losses, increased financial leverage and/or significantly weakened business prospects. DETAILED RATING CONSIDERATIONS FINANCIAL LEVERAGE AND ASSET RISK REMAIN SIGNIFICANT Although we view positively Investcorp's strengthening of its balance sheet, financial leverage and asset risks remain significant and are key rating drivers. As of fiscal year ending June 2015 (FYE 2015) the level of coinvestments (mainly private equity, hedge funds and smaller investments in US real estate that Investcorp carries on its balance sheet), accounted for around 2x equity or 1x equity and long-term debt. The portfolio is fairly granular in terms of sectors and regions as well as single investments, with only two exposures accounting for more than 10% of capital. The hedge fund investments maintain a relatively liquid profile and act as a liquidity buffer for the firm. We expect the level of co-investments to stabilise at current levels, as a percentage of longterm debt and equity, and remain a significant source of risk to Investcorp's capital buffers. We exclude from our equity calculation the USD225 million of preferred shares outstanding as of June 2015 (down from USD511 million as of June 2013) which we believe are not loss absorbing on a going-concern basis but would rather absorb losses after the point of non-viability. In our assessment we focus particularly on Investcorp's higher-risk mid-market corporate and real estate investments, which accounted for around 130% of Moody's-adjusted tangible common equity as of June 2015 (around 200% as of FY 2009). We note Investcorp's thorough selection process and active management of portfolio companies following the acquisition, which could help contain negative valuation adjustments. Nevertheless, Investcorp's capital base remains vulnerable to a deterioration in the financial position of any of its large investments. Risks are currently accentuated by potential volatility in valuations, given the fragile operating environments where some of these companies operate, particularly those in Europe. We view the ratio of illiquid risk assets to tangible common equity as a more appropriate measure of Investcorp's capitalisation and financial flexibility than either (1) the otherwise strong regulatory common equity Tier 1 ratio of 21.1% and Tier 1 ratio of 28.5% as of June 2015; or (2) the otherwise weak, although improving, financial leverage (total Moody's-adjusted debt-to-ebitda) ratio of 5.7x as of June 2015 (8.3x as of June 2014). Our adjusted-debtto EBITDA calculation is higher than the 4.4x Investcorp reports because our debt calculation includes USD225 million of preferred securities outstanding. As the company continues to repay preference shares, the two ratios

3 should converge, but will not entirely align since the second adjustment we make is to normalise EBITDA. We normalise EBITDA by (1) replacing asset-based income with a 5% return on fiscal year-end balance sheet investments; and (2) replacing the fiscal year's performance fees with a five-year performance fee average discounted by 25%. INVESTCORP BENEFITS FROM A STRONG LIQUIDITY PROFILE Investcorp's credit profile also benefits from its good liquidity management practices and strong liquidity position. Since 2009, Investcorp has embarked on deleveraging its balance sheet, with a reduction in its market funding reliance. The company does not face any maturities until 2017 and maintains a significant liquidity buffer in the form of cash and a revolving credit facility. Investcorp reduced its stock of long- and medium-term debt to USD763 million as of June 2015, from USD1.9 billion in June In addition to lower volumes of debt, Investcorp has diversified and lengthened the maturity profile of its funding base. The next bond repayment is in November 2017 when a USD250 million bond matures, followed by the maturity of the CHF125 million bond that matures in June Investcorp must also refinance its USD175 secured revolving facility that expires in Feb 2017 as well as a USD400 million revolving loan that expires in July The company has cash and interbank balances of USD339 million as of June 2015, while accessible liquidity (cash, interbank and committed revolving facilities) stood at USD864 million, which almost fully covers the USD964 million outstanding debt that matures in the next four years. At the same time, the company's counderwriting arrangement reduces on-balance-sheet liquidity requirements, whereby a portion of private equity deals are jointly underwritten by third-party investors without recourse to the company. As part of our liquidity assessment, we compare the company's net cash capital with its liquid net assets. The company's net cash capital is the surplus of a firm's sources of long-term capital (principally common equity and long-term debt) beyond its uses of long-term capital (principally illiquid asset and haircuts on securities inventory). Investcorp had a material net cash capital surplus, with a ratio of net cash capital to liquid net assets at 40% as of June INVESTCORP BENEFITS FROM A STRONG NICHE MARKET POSITION IN THE GCC Investcorp has a limited scale and global franchise position. With total AUM of USD10.6 billion (client AUM of USD 8.9 billion) as of June 2015, the company has a limited market share (far below 1%) of global alternative AUM. Nevertheless, the company's strong niche market position in the GCC as an Arab-based provider of international alternative investments supports its credit profile. We expect that Investcorp's niche market position will continue to benefit from (1) a strong reputation and recognisable brand name in the GCC, which is a consequence of its robust 30-year plus track record; (2) its long-standing customer relationships with high-net-worth individuals and institutional investors in the GCC; and (3) a good reputation in adding value to its portfolio companies through active management that supports its competitive position in acquiring deals. Although we note the weaker growth prospects of the GCC as a result of the low oil prices, which we do not expect to rebound to previous strong levels over the next 1-2 years, we expect less impact on Investcorp's main targeted markets of Saudi Arabia, the United Arab Emirates and Qatar. This is owing to the significant buffers that these countries have accumulated. We note the company's significant growth potential as the GCC is home to a high number of high-net-worth and ultra-high-net-worth individuals. According to reports, the Middle East and Africa are home to at least 7,130 ultra-high-net-worth individuals with a combined net worth in excess of USD1 trillion and a minimum of USD30 million each. Investcorp has consolidated its regional market position over recent years as a result of weaknesses in some regional competitors, and the company's own ability to realise and return profitable investments to its clients. A main pillar to Investcorp's strategy is to expand its AUM in hedge funds particularly with institutional investors in the US and Europe. The company has increased its product offering in hedge funds with the launch of Alternative Beta this calendar year, a product which offers weekly liquidity and aims to increase portfolio diversification as it maintains limited correlation with bonds and equities. However, the product is nascent and its take off depends on Investcorp's reputation, as well as establishing a strong track record of performance. With AUM of around USD 4.02 billion as of June 2015, hedge funds account for around 38% of Investcorp's total AUM; the company believes it has the capacity to double this number in the next five years.

4 Investcorp's franchise strength is constrained by its reliance on its core function as in investment management, with no auxiliary services offered in order to diversify revenues and earnings. This constraint is partly mitigated by the company's (1) broad product range among alternative investments, such as private equity, real estate and hedge funds, its wide geographical coverage (spanning the US, Europe, the Middle East and Turkey) and its good customer granularity, compared with those of its regional competitors. Investcorp also has a broader coverage of the GCC region than its peers, with a team of dedicated relationship managers, operating through a regional office in Bahrain but also through local offices in Saudi Arabia and Abu Dhabi. INVESTCORP'S EARNINGS PROFILE REMAINS INHERENTLY VOLATILE, ALTHOUGH FEE REVENUE IS GRADUALLY RECOVERING The company's gross revenue can be broken down into three components: (1) AUM fees, (2) deal fees and (3) asset-based income. AUM fees have been the most stable source of income (of around USD111 million as of June 2015) over the past three fiscal years, albeit negatively affected by the reduction in higher-yielding AUM, particularly hedge funds. Under favourable market conditions, Investcorp could also target deal fees of around USD200 million (FYE 2015: USD197 million, FYE 2014: USD216 million, FYE 2013: USD199 million). This income component is less predictable and depends on acquisition and placement of new investments, the sale and exit of investments (realisations), and the performance of existing investments. Asset-based income is the most volatile profitability component, as it is based on the annual return on Investcorp's proprietary investments of approximately USD1.2 billion (as of June 2015). The five year average yield on Investcorp's corporate investments was 5.48%, 6.0% for real estate investments, and 2.78% on hedge funds. During FY2015, net income of $116.7 million, grew by 13% relative to FY2014 mainly due to strong performance in corporate co-investments including some large realisations, modest growth in AUM fees, and contained expenses. Fee income at $308 million was lower than $316 million in FY2014 mainly because of lower performance fees. Asset-based income grew significantly by 53% with the under-performance of hedge fund investments recovering in the second half of the year from a decline in the first half of the fiscal year and a strong performance of corporate and real estate co-investments. SOURCE OF FACTS AND FIGURES CITED IN THIS REPORT Unless noted otherwise, data related to system-wide trends is sourced from the Central Bank of Bahrain and providers of alternative asset management industry data (Pitchbook, HedgeFund Research). Bank-specific figures originate from Investcorp's annual reports, bond prospectuses and Moody's Banking Financial Metrics. Unless noted otherwise, we have sourced data relating to system-wide trends and market shares from the central bank. Bank-specific figures originate from banks' reports and Moody's Banking Financial Metrics. All figures are based on our own chart of account and may be adjusted for analytical purposes. Please refer to the document: "Financial Statement Adjustments in the Analysis of Financial Institutions" ( published on 16 March Given Investcorp's wholesale banking licence in Bahrain, we use the Moody's Banks Rating Methodology, published in March 2015 as the primary methodology. However, we also use Moody's methodology "Asset Managers: Traditional and Alternative", published in February 2014, as a secondary methodology to capture certain aspects of its private equity and fund management business profile. As a point of reference, the bank rating methodology's scorecard has a ba3-ba1 range outcome, while the overall asset management firm's scorecard outcome is Ba2. Notching Considerations GOVERNMENT SUPPORT Investcorp's deposit rating does not benefit from any ratings uplift as a result of external support because Investcorp is not part of the domestic retail banking system, despite its prominence as a provider of alternative investments in the GCC and its designation by the local regulator as a systemically important institution. ABOUT MOODY'S BANK SCORECARD STANDARD Our Scorecard is designed to capture, express and explain in summary form our rating committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the

5 output of our Scorecard may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Investcorp Bank B.S.C. Macro Factors Weighted Macro Profile Strong Financial Profile Factor Historic Ratio Macro Adjusted Score Solvency Asset Risk Problem Loans / Gross Loans Credit Trend Assigned Score Key driver #1 12.0% b1 b1 Market risk Capital TCE / RWA 21.7% aa2 ba1 Nominal leverage Profitability Net Income / Tangible Assets 2.5% aa2 baa1 Earnings quality Combined Solvency Score a3 ba1 Liquidity Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets 38.8% ba3 ba3 16.4% baa3 baa3 Combined Liquidity Score ba2 ba2 Key driver #2 Financial Profile ba1 Qualitative Adjustments Adjustment Business Diversification 0 Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments 0 Sovereign or Affiliate constraint Scorecard Calculated BCA range A2 baa3 - ba2 Assigned BCA ba2 Affiliate Support notching 0

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