The ratings on Intermediate Capital Group PLC (ICG), a U.K.-based mid-market private equity and mezzanine finance-focused investor and fund manager, reflect Standard & Poor's Ratings Services' view of its solid business profile and adequate financial profile, which is underpinned by what we consider to be fairly aggressive financial management, considerable credit risk, and adequate liquidity.
ICG is one of the largest private-equity related companies in Europe and has a good track record of strong relative investment performance and ability to raise funds. ICG's specialty is investing in mezzanine debt of private equity-sponsored leveraged middle-market companies in Europe, Asia, and the U.S., both through funds and its own balance sheet. We recognize the competitive advantage of ICG's network of established local teams to source its mezzanine and private equity investments in the underserved middle-market space, which in our view gives it power over pricing and terms. ICG also manages credit funds that make investments in the senior debt and high-yield bonds of leveraged companies.
We view credit risk as high because of its large, individual principal investments in leveraged companies. Credit write-downs were 2.9% of the portfolio in the year to Mar 31, 2012 (which compares to a 5% average over the prior five years and a peak of 11.8% in 2009). That said, in our view it has a relatively good track record of realizing value on its investments and since inception in 1989 has a reported average realized return of 1.6x and an internal rate of return (IRR) of 18%. We view ICG's mezzanine and private equity risk mitigation practices of securing a Board seat and taking an active role in the management of the companies invested to be important mitigants to its credit risk.
We consider ICG's financial management to be fairly aggressive, considering the level of credit risk it takes and the lumpy nature of its cash flow. We take comfort from the strong downward trend in balance sheet leverage since the financial crisis and the strategic focus to grow fee income. Debt to adjusted tangible equity (ATE) was still quite high, in our opinion, at March 31, 2012 at 0.75x. This represents a marked improvement from a peak of 3.2x in 2009. We also consider that the company's debt services metrics are relatively low for the rating with EBITDA excluding unrealized gains/losses and adjusted for PIK (payment-in-kind securities)/interest expense at 4.1x in the year to March 31, 2012 by our measures. We take some comfort from the resilience of ICG's net interest margin, adjusted for PIK, which was 5.9% in the year to March 31, 2012 by our measures.
We view management's efforts to grow the lower risk, fee-based funds management business as a supportive development for the ratings. Over time, a greater source of more dependable recurring revenue could lead to more stable and supportive coverage metrics. Moreover, ICG is in the process of raising a range of funds, and from different geographies, which highlights to us the successful evolution of the firm toward a broader product offering.
The stable outlook reflects our view that ICG's asset quality and credit performance are not likely to deteriorate materially, notwithstanding the weak economic environment in some of its chosen markets. It also reflects our expectation that ICG will continue to successfully raise funds and that the expansion of its non-European businesses will be carefully managed. Our ratings assume that ICG will maintain gross debt below 1x adjusted tangible equity and interest coverage (excluding unrealized gains/losses and PIK) comfortably above 3x.
We could lower the ratings if ICG's leverage or debt service metrics deteriorate below our expectations, if fund raising falters, or asset quality deteriorates. The ratings could also be strained by a more aggressive growth strategy outside of its core areas of expertise. An upgrade would be predicated on a commitment to more conservative financial management, including a sustained improvement in leverage, debt service metrics, and liquidity. However, we consider this unlikely in the medium term.
Related Criteria And Research
-- Rating Private Equity Companies' Debt And Counterparty Obligations, March 11, 2008
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