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Fitch Maintains Towergate's Negative Outlook
December 8, 2016 / 1:15 PM / in a year

Fitch Maintains Towergate's Negative Outlook

(The following statement was released by the rating agency) LONDON, December 08 (Fitch) Fitch Ratings, London-8 December 2016: Fitch Ratings has affirmed TIG Finco PLC's (Towergate) Long-Term Issuer Default Rating (IDR) at 'B-'. The Outlook remains Negative. Fitch has also affirmed Towergate's GBP75m super senior secured notes at 'BB-'/'RR1' and downgraded the GBP425m senior secured notes due 2020 to 'B-'/'RR4' from 'B'/'RR3'. Over the last year, Towergate has successfully reduced costs through its transformation plan, but continued declines in sales led to both falling earnings and leverage remaining high for the assigned 'B-' IDR. The Negative Outlook reflects the uncertainty related to the deleveraging path and tight liquidity position, partly due to regulatory fines, but supported by disposal proceeds and monetisation of certain legacy assets by shareholders. In particular, progress on the transformation plan has been slow to date relative to Fitch's expectations and we see its delivery as critical to the success of the business. KEY RATING DRIVERS Delivery of Transformation Plan Critical: As part of Towergate's turnaround and restructuring plan, the management team has put in place a three-year transformation programme centred on a leaner cost structure and a more decentralised management of client accounts, which represents an unwinding of the original small business units (SBU) plan in its core broking division. The operational improvements from this plan are essential in allowing Towergate to stabilise its business and resume growth. Due to the ongoing nature of this plan, execution risk remains high. Delays in this programme would negatively impact both the delivery on revenue growth and improvements in FCF. Leading Insurance Intermediary, Experienced Management: Towergate maintains its leading position as an independent insurance intermediary in the UK, albeit at lower margins. Since its debt restructuring completed in April 2015, the group has been able to both renew and extend capacity with leading insurance providers and develop new business lines, such as its Bishopsgate London wholesale business. Fitch believes the management team's experience and reputation have been essential in achieving these objectives. Leverage Remains Elevated: FFO adjusted leverage and the FFO Fixed Charge Coverage ratio remain weak and will not be aligned with a 'B-' IDR by end-2016; however, we expect these key credit metrics to return to levels more consistent with the rating, at around 7.5x and 1.5x, respectively, by end-2017. The primary drivers of continued improvements in these credit metrics will be a reduction in restructuring costs and the materialisation of cost savings that should result in improving EBITDA margins; however, profit progression is subject to execution risks and a longer-than-expected deleveraging path could result in a downgrade to 'CCC'. We expect EBITDA margins to improve to 17.6% by FYE16 from 16.5% in 2015. Historically, margins have been above 20% and remain below those of 'B-' rated peers. Free Cash Flow Under Pressure: Towergate's cash flow has been negatively impacted by material exceptional items, such as restructuring costs, legacy customer redress payments for UCIS misselling, rebates of upfront payments from insurance companies and loss corridor payments relating to certain legacy underwriting actions. As a result, Towergate remains FCF negative. While these payments are difficult to predict, Fitch expects their magnitude to decrease, which, along with improving profitability, may support the group's financial flexibility. Support from Shareholders Key: As part of the 2015 restructuring, HPS Investment Partners LLC (formerly Highbridge Principal Strategies LLC) became the lead investor and largest shareholder. Throughout 2015, HPS played an important role in providing additional liquidity to Towergate through the sale of The Broker Network and by securitising a portion of the PaymentShield book. In combination, these actions injected GBP54m into the business. Subsequently, Madison Dearborn Partners LLC (MDP) acquired the second-largest shareholding in Towergate and it could invest additional equity in 1Q17, as disclosed in MDP's September 2016 tender documents. Average Recovery Prospects for Senior Noteholders: In its recovery analysis, Fitch adopted a going-concern approach, as the resultant enterprise value is higher than the liquidation approach. We assume a post-hypothetical restructuring EBITDA of GBP47.6m, which represents a 17% discount to Fitch's GBP57.4m pro forma 2016 EBITDA, and use a distressed EV/EBITDA multiple of 5x, reflecting Towergate's competitive advantage as it would take time for competitors to mirror its distribution capabilities, its expertise in niche markets and the relationship with leading insurers. Fitch considers the project Lunar facility as subordinated to the senior secured creditors. Therefore, we assess senior secured creditors' expected recoveries at 33%, consistent with an 'RR4' Recovery Rating and a 'B-' bond rating. DERIVATION SUMMARY Towergate has significantly smaller scale than its publicly rated insurance broker peers and has a less diverse product line. While its expertise in niche, high-margin product lines and its leading position among UK insurance brokers underpin a sustainable business model, its higher financial risk and underperforming business lines constrain the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Modest positive sales growth during 2017-2019 - Transformation plan leads to EBITDA margins improving to 22% by 2018 - GBP65m total ETV payments during 2017-2020 - Improving working capital management with outflows declining from GBP15m to GBP5m by 2018 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action (revision of the Outlook to Stable) - Evidence of financial metrics coming back into line with 'B-' peers, such as FFO fixed charge cover above 1.5x and FFO adjusted gross leverage below 7.5x on a sustained basis - Further evidence of shareholder commitment through a capital raising or progress towards refinancing high-cost debt - EBITDA margins trending above 20% Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Declining liquidity trending below GBP20m - FFO adjusted gross leverage remaining above 7.5x and FFO fixed charge cover remaining below 1.5x on a sustained basis and sustained negative FCF - Lack of improvement in EBITDA margin, suggesting no efficiency gains realised from the restructuring LIQUIDITY Constrained Liquidity: At end-3Q16, Towergate had GBP25m in operating cash and it is expected to receive GBP26m in proceeds from the Project Lunar facility. Towergate's liquidity has been negatively impacted by exceptional items, such as restructuring costs, regulatory fines and payments to its insurance partners. These items are unpredictable and, in combination with negative FCF, may lead to a further decline in liquidity. Offsetting this risk are potential cash inflows from the release of trapped cash, improved working capital management and the raising of new equity. Contact: Supervisory Analyst Brendan Condon Director +44 20 3530 1599 Fitch Ratings Limited 30 North Colonnade London E14 5GN Principal Analysts Athanasios Smprinis Analyst +44 20 3530 1643 Graham Coutts Director +44 20 3530 1654 Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Date of Relevant Rating Committee: 5 December 2016 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments Stub Period - Includes the pro forma 2015 results prior to the formation of TIG Finco plc on 2 April 2015. Restricted Cash - we exclude cash from segregated accounts and funds that are required to be held by the regulator (GBP149m as of FYE15) from our computation of readily available cash. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1016106 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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