Moody’s downgrades Investcorp

Moody's Investors Service has downgraded the long- and short-term deposit ratings and the bank financial strength rating (BFSR) of Bahrain-based Investcorp Bank B.S.C. to Baa3/Prime-3/D+ from Baa2/Prime-2/C-. The ratings of its subsidiary Investcorp S.A. were also downgraded, while the deposit ratings were kept on review for possible further downgrade.
The decision to downgrade the ratings reflects near-term pressures on the bank's financial strength as well as Moody's view on some of the longer-term challenges for the alternative investment sector, as a whole. The rating agency highlights: (i) the weakened capitalisation metrics, following material mark-to-market losses incurred on its proprietary investments in funds of hedge funds (FoHF), (ii) the requirement for a larger capital cushion to support the bank's proprietary investments, within the context of a very challenging operating environment for hedge fund and private equity (PE) businesses, and (iii) the pressure on earning capacity from possibly prolonged difficult market conditions.
Moody's said that the value of Investcorp's FoHF investments declined by about 10% in the quarter ended September 2008. With FoHF holdings of USD 2.02 bln at the end of June 2008, this resulted in mark-to-market losses of about USD 200 mln for Investcorp, equivalent to 17% of equity. Moody's estimates that capital levels at the end of September were about USD 900 mln, equivalent to about 26% of combined PE and FoHF assets of USD 3.5 bln. The bank reported a Basel II capital adequacy ratio of 13% at the end of September, down form 18% in June 2008.
Moody's elaborated that Investcorp is planning to raise additional capital and to reduce its FoHF investments in the near term.
"These moves would bring risk assets (essentially PE and FoHF investments) down to about two times capital, which Moody's believes is a more appropriate level for an investment grade rated firm with Investcorp's business profile and franchise characteristics," added George Chrysaphinis, a Moody's Vice President – Senior Analyst.
Moody's continues to hold a positive view on Investcorp's fee-generating business model and on the prospects for further franchise enhancement over the medium-to-long term. The rating agency notes (i) the very strong growth in assets under management to USD 12.8 bln in the financial year to June 2008 from its core Gulf Cooperation Council market and also new markets, (ii) the success of product-broadening activities and marketing activities — in both PE and FoHF businesses — and also (iii) the further enhancement of its risk management infrastructure and processes.
This follows another rating action earlier in the week, when Moody's downgraded
Kuwait-based Gulf Bank's bank financial strength rating (BFSR) to C- from C and its long-term local and foreign currency deposit ratings to A1 from Aa3, remaininh on review for possible further downgrade.
The ratings were originally placed on review on 28 October following Gulf Bank's announcement that it had incurred potentially sizeable losses. Although the bank has not yet clarified the extent and circumstances of these losses, Monday’s downgrades reflect Moody's view that the bank's C BFSR is no longer sustainable.
The as-yet-undisclosed losses relate to the bank's exposures to complex foreign exchange derivative instruments marketed to a very small number of its customers, reportedly for hedging purposes. Moody's understands that Gulf Bank conducted the transactions on a back-to-back basis — maintaining a hedged position — but that the failure of one of its customers to meet a margin call revealed the level of counterparty risk borne. Losses were realised when Kuwait's central bank instructed the bank to close its positions to the counterparties selling these derivatives, regardless of whether the corresponding customers were performing. Given that positions with performing customers remain open, the bank is no longer hedged and now bears not only elevated customer credit risk but also additional market risk, according to Moody’s.
Moody's believes that it is probable that Gulf Bank will need to raise fresh equity to meet regulatory requirements, with both the authorities and the largest shareholders announcing that they would be prepared to inject capital as needed. It is not yet clear what form the recapitalisation will take or what the state's and existing shareholders' participation will be, thus the bank may emerge with an altered ownership structure after rehabilitation.