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Favourable trends emerge for US private equity industry, says Fitch

Favourable trends are emerging for the US private equity industry, supported by improved valuations and conditions in the capital markets, according to a report issued by Fitch Ratings.

Since August 2009, Fitch has assigned initial long-term issuer default ratings to several alternative asset managers, including:

• The Blackstone Group: ‘A+’ on 10 August 2009;
• Oaktree Capital Management: ‘A-‘ on 16 November 2009;
• Fortress Investment Group: ‘BBB’ on 24 February 2010; and
• KKR: ‘A’ on 9 August 2010

The rating outlook on each is stable.

The investment grade rating profiles of these entities are generally supported by the size and predictability of management fees, a growing base of fee-earning assets under management, relatively low leverage, the potential generation of meaningful incentive income, bench strength in the management teams, diverse investor profiles, and the subordination of general partner interests to outstanding indebtedness.

Ratings constraints include key man risk, which is often institutionalized throughout many limited partnership agreements, reputational risk, which can impact an asset manager’s ability to raise future funds, and legal and regulatory risk, which could in some way alter the alternative asset space.

Since receiving credit ratings, Blackstone, Oaktree, and KKR have accessed the public debt markets with term deals to supplement bank credit facilities and to better match funding duration with the use of debt proceeds, which is often co-investments in fund vehicles that can last 12 years or more (although investments are not normally that long).

Fitch believes public issuance from the private equity sector may increase over time as other firms seek to deploy similar strategies, given positive market receptivity to the recent bond deals.

The private equity industry has not been immune to the affects of the struggling economy, as 2009 results demonstrated, but performance to date in 2010 has been encouraging. Fitch believes that opportunities abound in the current environment given ample investor capital to deploy and evidence that some of the best performing private equity vintage returns, historically, were made at or near the bottom of the cycle.

Many alternative asset managers have expanded into new products, like private equity-style credit funds in order to take advantage of lending gaps in the small and middle market space, in addition to distressed credit opportunities, although traditional buyout opportunities remain.

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