Moody's downgrades Investcorp Bahrain to Ba2/NP/D; outlook negative

The ratings of its subsidiary, Investcorp S.A., were downgraded to the same level. Moody's also assigned a negative outlook to the bank's ratings.

Today's downgrade concludes Moody's review of Investcorp's ratings, which was initiated in November 2008. At the time, Moody's downgraded Investcorp by one notch to Baa3/Prime-3/D+ and subsequently downgraded further to Ba1/Not-Prime/D+ in May 2009, with the ratings remaining on review for further possible downgrade.

Moody's explains that this latest rating action is driven by the continued fragility of Investcorp's financial condition, which is better reflected by a rating in the middle of the Ba category. The rating agency arrived at this decision after assessing the combined effect of the bank's successful placement of $500.0m of preference shares with investors in Q4 2008-09 (fiscal year ending June 2009) and the $269m loss it recorded in H2 2008-09. The result for the year was a total loss of $780.6m.

Moody's believes Investcorp's financial strength is constrained by modest tangible common equity levels relative to risk assets (assuming 50% equity credit for the preference shares), high private equity (PE) investment concentrations and a very challenging PE transaction environment that limits its fee-earning capacity.

"Although current capital ratios would be consistent with a rating at the upper end of the Ba category under normal operating circumstances, they are currently vulnerable to further mark-to-market losses on its investments, without relief from predictable earning streams," explains George Chrysaphinis, a Vice President-Senior Analyst in Moody's Financial Institutions Group.

Moody's notes that transaction-based fee generation seems to be correlated to asset-based returns, especially during periods of prolonged or severe capital market disruption.

"The Ba2/Not-Prime/D rating is supported by Investcorp's sound liquidity profile, where cash resources currently exceed maturing debt for the next two fiscal years," adds Mr. Chrysaphinis. "Moody's expects Investcorp to successfully refinance at least part of its maturing long- and medium-term debt over the next few months."

Furthermore, Moody's acknowledges that Investcorp is pursuing appropriate strategies for overcoming the pressure on its financial strength, although the rating agency recognises that a return to profitability depends to a large degree on factors outside the bank's control. More specifically, Moody's notes: (i) the successfully executed moves to shore up capitalisation through the issue of preference shares and the de-leveraging of risk assets; (ii) the rationalisation of operating expenses at a time when earnings visibility is weak; (iii) the utilisation of committed medium-term revolving facilities to pay off shorter-term finance and to increase on-balance-sheet cash balances; (iv) the active performance management of the bank's PE investments to help the companies survive the difficult economic environment and to position them for strong profit growth once the economy recovers; and (v) the bank's enhanced relationship management, which it uses to defend its valuable customer franchise and, as far as possible, to secure a rapid pick-up in its investment placement activities.

Moody's says that the negative outlook on the bank's ratings reflects concerns about the timing and strength of a potential recovery in the global economy and in investor appetite for alternative investments.

"A recovery in investment portfolio profitability and a return to robust fee generation are required to cover the bank's substantial interest and operating expenses. Any material loss in fiscal year 2009-10, or a delay in the recovery of profitability beyond 2010-11, would put further pressure on the bank's financial condition and franchise value -- and would be likely to lead to a rating downgrade," cautions Mr. Chrysaphinis.

Alternatively, Moody's points out that the bank's ratings could potentially be upgraded if there is evidence of: (i) a robust and sustainable recovery in earnings generation; (ii) increasing client assets under management; and/or (iii) a material improvement in capital metrics.

Moody's also reiterates its view that there is little probability of systemic support for Investcorp as a wholesale bank under the Central Bank of Bahrain's definition. As such, the rating agency does not impute any uplift for the bank's deposit ratings as a result of such support.

The following debt issued by Investcorp Capital Ltd, the bank's wholly owned subsidiary, was also downgraded to Ba2, with a negative outlook:

- $50.0m 8.08% Guaranteed Global Medium-Term Notes due 12 July 2032.

- EUR538.18m ($689.87m) Guaranteed Global Medium-Term Note Programme.

- $20.0m Floating-Rate Guaranteed Global Medium-Term Notes Series 8 due 7 April 2012.

- JPY20bn ($203.61m) 3.5% Guaranteed Euro Medium-Term Notes Series 002 due 29 March 2030.

Moody's last rating action on Investcorp was implemented on 18 May 2009 when the ratings were downgraded to Ba1/Not-Prime/D+ and were kept on review for further possible downgrade.

The principal methodologies used in rating Investcorp Bank B.S.C was Moody's "Global Securities Industry Methodology", published in December 2006 and "Bank Financial Strength Ratings: Global Methodology", published in February 2007 and available on Moody's website in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

Headquartered in Manama, Bahrain, Investcorp reported total balance sheet assets of $3.62bn at the end of June 2009.