Fitch Expects to Rate KKR & Co.'s Unsecured Debt 'A'

NEW YORK--()--Fitch Ratings expects to assign a rating of 'A' to KKR Group Finance Co. III LLC's (a subsidiary of KKR & Co. L.P. [KKR]) new unsecured notes. The issuance is a re-opening of the entity's 5.125% notes due in 2044.

Proceeds from the issuance are expected to be used for general corporate purposes, including to fund acquisitions and investments such as funding commitments to existing funds, seeding new fund strategies, and potential acquisition opportunities. Most of these would be expected to generate incremental fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) and/or a balance sheet cash yield for the firm.

KEY RATING DRIVERS

The notes are expected to rank equally with existing notes issued from KKR Group Finance Co. LLC, and KKR Group Finance Co. II LLC. The IDR and unsecured debt ratings of KKR Group Finance Co. III LLC reflect joint and several guarantees on indebtedness at the finance subsidiaries by KKR Management Holdings L.P. and KKR Fund Holdings L.P., which collect all fee-and-carry income from underlying funds, in addition to a guarantee from KKR and KKR International Holdings, L.P.

KKR's business model continues to evolve in a different manner relative to other Fitch-rated alternative investment managers, as the firm increasingly uses its balance sheet to make investments and generate cash yield. The size of its portfolio has grown from $4.8 billion at the end of 2012 to $9.8 billion at the end of 2014, as the balance sheet is used to seed new investment strategies and finance co-investment commitments to the funds. As a result of this evolution, Fitch assesses the firm's creditworthiness on both a cash flow and balance sheet leverage basis.

At Dec. 31, 2014, KKR's cash flow leverage (debt/FEBITDA) was 3.25x, on a trailing 12-month (TTM) basis, adjusting for cash fees received for the management of KKR Financial Holdings, LLC (KFN), but eliminated in consolidation, and an estimated compensation load of 30% on incentive income. Fitch believes leverage would be modestly lower if the full run-rate impact of the Avoca Capital acquisition and the BlackGold Capital Management minority stake were included.

KKR's cash flow leverage was above the 'A' category peer average of 2.79x at Dec. 31, 2014 and will increase with this expected issuance; however, Fitch's calculation does not give credit for the interest income the firm has been able to generate from its balance sheet investments, which is expected to be a somewhat stable, recurring, source of cash income. Interest income also has the potential to grow, as KKR continues to rotate the balance sheet away from private equity co-investments and individual portfolio company investments and towards more credit-oriented fund co-investments.

Fitch's calculation of cash flow leverage metrics continues to exclude dividend income, investment income, and carried interest, which can be significant, but are believed to be less predictable over time.

On a balance sheet leverage basis, KKR's debt-to-tangible equity was 0.15x at year-end 2014, which is low, on an absolute basis, and at the low-end of the peer group. Balance sheet leverage will increase modestly with this debt issuance, but will remain below the peer average.

Following KKR's acquisition of KKR Financial Holdings LLC (KFN), on April 30, 2014, Fitch began evaluating consolidated leverage metrics as part of its assessment of KKR's credit profile. At Dec. 31, 2014, KFN had approximately $844.2 million of debt, providing 50% equity credit for KFN's perpetual preferred securities. If KFN's debt is added to KKR's debt and KFN's recurring EBITDA is added to KKR's FEBITDA, consolidated cash flow leverage was about 3.23x and consolidated balance leverage was 0.24x at Dec. 31, 2014.

While KKR's consolidated and pro forma cash flow leverage ratios are higher than Fitch's general tolerance of 2.5x for alternative investment managers in the 'A' category this is mitigated by the very low balance sheet leverage which results in substantial asset coverage for outstanding debt in addition to contractual management fee streams. The expectation of increased FEBITDA and interest income generation over time and KKR's superior liquidity position are additional mitigants.

Fitch calculates that the firm was in a negative net debt position at year-end 2014, adjusting for the funding of certain investments to be contributed to funds currently being raised. KKR also has a meaningful amount of liquid assets in its investment portfolio which are expected to be exited over time, and could be deployed into interest and fee generating investments. Fitch also believes that KKR has a more conservative distribution policy than the peer group, as it retains 60% of realized balance sheet gains, other than income from KFN, which is 100% distributed.

Fitch expects KKR's cash flow leverage to decline over time as retained earnings and cash proceeds from the debt issuance are deployed into fee-generating opportunities, such as acquisitions and new fund strategies.

RATING SENSITIVITIES

Given the joint and several guarantees on indebtedness from KKR, the ratings assigned to KKR Group Finance Co. III LLC are sensitive to changes in KKR's ratings and Outlook.

The Stable Outlook for KKR reflects Fitch's expectation that KKR will continue to generate consistent management fees, interest income, and fee-related earnings, grow fee-earnings assets under management (FAUM) through follow-on funds and expansion into new private equity and fixed income products, manage cash flow leverage down over time with the generation of incremental fees and cash yields, and maintain solid balance sheet leverage and liquidity profiles. The Stable Outlook incorporates an expectation that leverage may remain above the peer average and Fitch's general tolerance level of 2.5x for 'A' rated alternative investment managers, offset by the company's very low balance sheet leverage, consistent with Fitch's hybrid approach to the assessment of the company's credit risk profile.

Negative rating action could be driven by declines in investment performance which negatively impact the company's ability to raise FAUM and generate fees, sustained meaningful increases in cash flow or balance sheet leverage as a result of increased debt issuance, a failure to generate additional FEBITDA and interest income, or balance sheet asset impairment and/or material reduction of the firm's liquidity profile. Positive rating momentum could be driven by an increase in fund and fee diversity and a sustained reduction in cash flow leverage.

Founded in 1976, KKR is one of the largest alternative asset managers in the world with $83 billion of FAUM at Dec. 31, 2014. The company's common units are listed on the NYSE under the ticker 'KKR'.

Fitch expects to assign the following rating:

KKR Group Finance Co. III LLC

-- Senior unsecured debt at 'A (EXP)'.

Existing ratings for KKR are as follows:

KKR & Co. L.P.

-- Long-term IDR 'A'.

KKR Management Holdings L.P.

-- Long-term IDR 'A'.

KKR Fund Holdings L.P.

-- Long-term IDR 'A'.

KKR International Holdings, L.P.

-- Long-term IDR 'A'.

KKR Group Finance Co. LLC

KKR Group Finance Co. II LLC

KKR Group Finance Co. III LLC

-- Long-term IDR at 'A';

-- Senior unsecured debt at 'A'.

The Rating Outlook is Stable.

Existing Ratings for KFN are as follows:

KKR Financial Holdings LLC

-- Long-term IDR 'A-';

-- Unsecured debt 'A-';

-- Preferred stock 'BBB'.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

-- 'Global Financial Institutions Criteria' (January 2014);

-- 'Investment Manager and Alternative Funds Criteria' (December 2013).

Applicable Criteria and Related Research:

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Investment Manager and Alternative Funds Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=725057

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981117

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Contacts

Fitch Ratings
Primary Analyst
Meghan Neenan, CFA Senior Director
+1-212-908-9121 Fitch Ratings, Inc.
33 Whitehall
New York, NY 10004
or
Secondary Analyst
Mohak Rao, CFA
Director
+1-212-908-0559
or
Committee Chairperson
Joo-Yung Lee
Managing Director
+1-212-908-0560
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Meghan Neenan, CFA Senior Director
+1-212-908-9121 Fitch Ratings, Inc.
33 Whitehall
New York, NY 10004
or
Secondary Analyst
Mohak Rao, CFA
Director
+1-212-908-0559
or
Committee Chairperson
Joo-Yung Lee
Managing Director
+1-212-908-0560
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com