As one of the world’s leading mezzanine and credit managers, Intermediate Capital Group spends every waking hour analysing, interrogating - and worrying over - the way companies manage their balance sheets. So it should come as no surprise that the firm is pretty handy at managing its own.
Just weeks after Fitch Ratings revised ICG’s outlook from stable to negative, largely due to big syndicated bank loan maturities that it has to refinance in mid-2013, the firm was able to finalise a three-year extension of those maturities. Issuance of a £35m (€43m) retail bond also signals an effort to diversify funding.
“We constantly need to refresh our balance sheet,” says Christophe Evain, who took over as CEO in 2010. “The retail bond was part of that. We’ve been talking about refinancing concerns across Europe in our space for a number of years, in leveraged buyouts and other corporates, and we need to be seen to be doing the right thing for our own balance sheet.”
But investors might also have concerns about the assets on that balance sheet as well as the liabilities. Proprietary capital now only accounts for about a quarter of ICG’s investment assets but, thanks to the long history of the firm as a mezzanine finance provider, it is much more focused in riskier mezzanine and equity instruments than the third-party assets, which are mixture of mezzanine and credit. Moreover, while 75% of the proprietary investment is mezzanine, one-third of that is junior mezzanine, paid in kind.
“Am I comfortable with this risk profile?” asks Evain. “Absolutely. Given that our balance sheet gearing is at a historic low of 66% of our shareholders’ funds, I feel very comfortable going into a recession with that. Southern Europe is a limited part of our exposure - about 10% in Spain and Italy only. Would that be a problem if Spain left the euro? Probably - but it would be a big problem for anyone, and a bigger problem for a lot of other people than it would be for us.”
While some of its weaker, cyclical portfolio companies will find the macro environment challenging, ICG is comfortable with its provisioning, and two-thirds of its companies are performing better than they were a year ago. Moreover, significant value has been realized from eight recent exits. The firm is looking solid.
Maybe a little too solid? After hitting £18 before the Lehman collapse, ICG’s shares dropped to about £2 and have bounced between £2.50 and £3.50 ever since Q3 of 2009, despite a steady dividend raised by 6% for 2012. This is partly explained by rights issues totalling £526m (€647m) in 2008 and 2009, which helped both to pay down some debt and to position for the post-crash credit value opportunity. Could ICG afford to take on some more debt of its own?
“We do have some headroom to push the gearing up a bit,” says Evain. “But I’d rather focus on raising more funds and generating more profits from fund management than increasing gearing.”
This really sums up ICG’s strategy: to move from the balance-sheet-intensive profits of proprietary investment, where mezzanine-sized returns are required to keep shareholders happy, to the balance sheet-light profits of fund management fees, where steady money can be made while taking less investment risk. But while third-party assets make up 75% of the firm’s investments, they currently deliver just 20% of its profits. Will the move significantly change ICG’s profitability profile?
“The balance sheet will remain pretty much where it is today in terms of size, while a growing part of the profits will come from fund management,” says Evain. “I don’t know that it’s less profitable, but it’s certainly more predictable - a lot of the funds we are managing are long-term commitments. Arguably that will be more valuable as it gives shareholders visibility.”
The share price simply reflects the equity market malaise, he suggests, and the fact that ICG gets tarred with the same brush as the rest of the financial sector. That is ironic, he suggests, because the obligation to de-leverage and divest that afflicts banks is precisely the type of opportunity that ICG was readying to exploit on its own balance sheet with its rights issue, and for third-party clients with the 2008 launch of its €843m loans-focused Recovery fund, and the 2010 acquisition of a €1.4bn loan portfolio from the Royal Bank of Scotland.
The opportunity fits with the turn to fund management, which will bring the scale and breadth required to address the new lending landscape, while maintaining the conservatively-managed balance sheet that the times require.
“We used to be geared three times, and my view was that it was neither possible nor desirable to stay at that level,” Evain says. “With the banks moving away from lending, alternative lenders will have to come in and pick up the slack. That’s why managing institutional money is an increasingly important part of the business.”
Not that ICG is new to the game. It raised its first European mezzanine fund in 1998. Seven more mezzanine and minority equity funds have followed, along with 17 credit funds and collateralised debt obligations (CDOs).
No CDOs have been raised since 2007 but the slack has been taken up with the successful launch of another closed-ended loans fund, Senior Debt Partners, which followed an open-ended listed unit trust, European Loan fund, and ICG’s first high yield bond fund.
“We don’t want to become a high-yield business - but we will continue to be providers of yield in the alternative credit space, including strategies that are more capital markets-driven and less origination-driven,” says Evain.
However, mezzanine remains the core of what ICG does. Third-party mezzanine assets were up 7% for the 2011-12 financial year thanks to ICG’s most recent mezzanine fundraising, Europe V, which welcomed €900m from third-party clients - and the mezzanine experience feeds into its work in loans and high yield. “Sitting in the European LBO sector we see all of these companies - not because they put on roadshows, but because we have invested with them already and developed relationships with their private equity sponsors,” says Evain.
The mezzanine culture also lies behind the firm’s most diversification move: the 2010 acquisition of a 51% stake in Longbow Real Estate Capital, the UK commercial real estate credit specialist. “We talk the same language,” says Evain. “It’s all about protecting that downside when you are in that middle position in the capital structure, and understanding that the best way to do that is to generate yield. Longbow is currently UK-only, and we plan to address the commercial real estate debt opportunity across Europe with them.”
So, while raising capital through funds has never been a problem for ICG, it has been investing over the last two years in its distribution team, culminating in the hiring of Andreas Mondovits as head of distribution, from UBS Asset Management. The ambition is to double third-party assets, building on the 80% that already comes from sovereign wealth funds, pension funds and insurance companies.
“In Europe there is growing institutional interest in alternative credit, but also very little institutional fund management experience because Europe has always been a banking market,” says Evain. “That’s an indication of the potential, and the direction in which we should all be heading. When equities are mostly drifting and German sovereign bonds are delivering virtually no yield, why wouldn’t institutional investors put more money into credit, high yield, mezzanine? Europe is set for a long period of low growth, and that has to be good for debt as the best-protected asset class.”
Especially, one might add, if your portfolio companies take the same care with their balance sheets as ICG.