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Alt managers show strong bond recoveries in runoff test, says Fitch

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A Fitch Ratings analysis of three of the largest US alternative investment managers shows that each firm should be able to sufficiently cover outstanding debt obligations, including 30-year bonds, under a 10-year runoff scenario.

This would be achieved through fee-related cash flows and discounted asset realisations. 

The runoff analysis complements Fitch's standard, going-concern evaluation of alternative investment managers, which takes into account franchise strength, management quality, performance strength and ability to continue to raise additional assets under management.

In Fitch's opinion, The Blackstone Group, LP (Blackstone, A+/Stable) has the most flexibility when it comes to debt repayment under the runoff analysis, as it generates sufficient cumulative operating cash flows over a runoff horizon to repay all outstanding debt. Blackstone's superior performance under the analysis is driven by the firm's lower than peer leverage and higher than peer fee-related earnings (FRE) margin. KKR & Co LP (KKR, A/Stable) and The Carlyle Group LP (Carlyle, A-/Stable) have sufficient resources for debt repayment when a discounted liquidation of balance sheet investments is added to cumulative cash flows. Fitch believes the analysis supports each issuer's assigned rating level.

Fitch's runoff test assumes a key man event has occurred at each firm, thus halting any further limited partner investments, and forcing a gradual liquidation of all investment funds. All uncalled capital for funds in their investment periods is immediately removed from fee-earning assets under management and all redeemable funds (largely hedge funds) are assumed to be run off within two years. The test assumes managers would accumulate operating cash flows for debt repayments over the runoff horizon based largely on the generation of management fees. Fitch also assumes that segment operating margins (FRE margins) increase gradually over the runoff period, as fundraising costs, operating expenses and headcount is reduced in a wind-down scenario.

Fitch's runoff analysis provides no credit for interest and dividend income, investment income and potential incentive income generation; all of which can be material. Fitch also assumes cash balances are depleted, when, in reality, several alternative investment managers operate in negative net debt positions. Conversely, Fitch also assumes that shareholder distribution payments are halted immediately. Failure to cut dividends could considerably reduce debt repayment flexibility.

Secondary sources of repayment are balance sheet investments assuming substantial (50%) valuation haircuts. Balance sheet investments vary widely among three alternative managers as of the end of first-quarter 2015, ranging from USD868 million for Carlyle, to USD3.8 billion for Blackstone and USD10.0 billion for KKR. While Fitch views the majority of these investments as illiquid, the majority could likely be exited, at a discount, over the runoff horizon, thus serving as a source of debt collateral.

As of 13 May, 2015, there were three alternative investment managers with 30-year bonds outstanding, comprising total issuance of USD3.2 billion. A 30-year bond tenor materially exceeds typical private equity fund lives, which generally last about 10-12 years. However, Fitch views alternative investment managers as going-concern entities first and foremost, with the expectation that fundraising will continue to result in a laddering of fund maturities over time, yielding a steady stream of cash flows. That said, an analysis of the absolute amount of fee-generating capacity and balance sheet investment to support outstanding debt provides additional analytical comfort, particularly given the severity of the model assumptions over the runoff horizon.

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