Fitch Ratings has maintained DDM Holding AG's (DDM) and DDM Debt AB (publ)'s (DDM Debt) 'B-' Long-Term Issuer Default Ratings (IDRs) on Rating Watch Negative (RWN).

DDM Debt's EUR200 million senior bonds' (SE0015797683) long-term rating has also been maintained on RWN.

Key Rating Drivers

The RWN primarily reflects Fitch's view that despite moderate improvements in 3Q22, DDM's liquidity position remains tight and its cash-generating capacity in the short term might be weaker than Fitch previously assumed due to material investments in illiquid, non-core assets. In particular, the announced investment in Nordiska Kreditmarknadsaktiebolaget (publ) (Nordiska), which is to acquire Swiss Bankers Prepaid Services AG (Swiss Bankers) in 1Q23, will lead to a significant liquidity outflow (CHF40 million) while not immediately generating recurring revenue.

The acquisition also materially increases DDM's exposure to equity investments, which could lead to a less favourable capitalisation and leverage assessment and Fitch putting more emphasis on DDM's balance sheet capitalisation (gross debt/tangible equity).

Apart from large investments outside its core debt purchasing business, the ratings also reflect DDM's weak profitability, elevated leverage and the absence of contingent liquidity following the expiry of its revolving credit facility (RCF) in 2022.

Non-Core Investments: Since 2021, DDM has announced several investments, partly funded with proceeds from a bond issue in 2021. These include the planned acquisition of Swiss Bankers, which will be structured through acquiring a minority stake in a small Sweden-based bank Nordiska, but also the recent investments in related-party fintech company Omnione S.A (Omnio) and debt servicer AxFina Holding SA (AxFina).

We view investments in Nordiska/Swiss Bankers and Omnio as negative for DDM's credit profile because these companies have limited synergies with DDM's core debt purchasing business model and could undermine its cash-generating capacity. Although the acquisition of a 50.2% stake in AxFina was more complementary to DDM's business model, the transaction weighed on DDM's already weak liquidity and leverage metrics.

Tight Liquidity: At end-3Q22, DDM had EUR58 million in unencumbered cash but we expect this to be largely consumed by the Nordiska/Swiss Bankers transaction in 1Q23. DDM's funding profile is mainly long-term, primarily consisting of a EUR200 million bond maturing in 2026. The next coupon for the EUR200 million notes is due in April 2023 (EUR8.5 million). DDM did not have an RCF at end-3Q22, while its EBITDA/interest expense ratio was a modest 3.3x in the trailing 12-month (TTM) to end-3Q22.

Elevated Leverage: DDM's gross debt/EBITDA ratio was a high 4.1x at end-3Q22 (end-2021: 5.3x). The improvement in 9M22 was driven by strong collections in 3Q22. Its net debt/EBITDA ratio was 3.0x at end-3Q22, but we expect the cash buffer to be largely consumed by investment activity in 1Q23. DDM's gross debt/tangible equity ratio, which is Fitch's core benchmark metric for investment companies, deteriorated to 21x at end-3Q22, due to a decline in tangible equity caused by goodwill from the AxFina acquisition.

Volatile Collections: Gross collections were EUR73 million in the TTM to end-3Q22, (2021: EUR61 million), supported by strong collections of EUR23 million in 3Q22 (2Q22: EUR16 million). This was driven by one transaction in Croatia, reflecting the concentrated nature of DDM's secured non-performing loans. Collections in the TTM to end-3Q2 were broadly stable compared with 2018-2019, while gross collections (EUR123 million) in 2020 were inflated by EUR60 million due to DDM's exit from Greece.

Weak Profitability: DDM's TTM EBITDA was EUR51 million at end-3Q22, which was above EUR38 million in 2021 but weaker compared with previous years and expectations at the time of the bond issuance. As a result of lower revenue from invested assets, higher finance expenses due to an increase in outstanding debt, and loss on fair value investments, DDM reported a modest net loss in 2021 and 9M22.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A materially weaker liquidity position following the closing of the Nordiska/Swiss Bankers acquisition combined with weak projected cash generation, which could jeopardise DDM's ability to service its debt obligations or execute its strategy.

Further marked deterioration in profitability and leverage, including from negative results on financial investments.

Signs that planned acquisitions are materially increasing DDM's exposure to operational or legal risks.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The RWN on DDM's issuer and issue ratings reflects that upside for the ratings is limited.

An affirmation of the ratings would require stabilisation of DDM's liquidity position after the Swiss Bankers/Nordiska acquisition.

An upgrade in the medium term would require improvement in DDM's recurring profitability and leverage metrics, both in terms of cash-flow and balance-sheet leverage, including a gross debt/adjusted EBITDA ratio comfortably below 4.5x on a sustained basis.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The rating on DDM Debt's senior secured notes reflects Fitch's expectation of average recoveries, resulting in an equalisation of the bonds' rating with DDM's.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured notes' rating is principally sensitive to changes in DDM Debt's Long-Term IDR. Worsening recovery expectations, for instance as a result of a layer of more senior debt, could lead Fitch to notch the secured notes' rating down from DDM Debt's Long-Term IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

DDM has an ESG Relevance Score of '4' for governance structure, primarily reflecting the recent material increase in related-party transactions.

DDM has an ESG Relevance Score of '4' for management strategy reflecting DDM's more opportunistic strategy when compared to other debt purchasing peers.

DDM has an ESG Relevance Score of '4' for financial transparency, in view of the significance of internal modelling to portfolio valuations and associated metrics such as estimated remaining collections. This has a moderately negative influence on the rating, but is a feature of the debt purchasing sector as a whole, and not specific to DDM.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

(C) 2022 Electronic News Publishing, source ENP Newswire