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Rating action

Scope Ratings GmbH (Scope) has today affirmed its B+/Stable issuer rating on Hungary’s investment holding company Lexholding Zrt. Scope has also affirmed its B+ rating on the senior unsecured debt category.

Rating rationale

The affirmation of the issuer rating is supported by the sufficient total cost cover and the balanced financing structure with only moderate external financial debt. The issuer rating is still constrained by the limited gross asset value and a complex structure with different businesses, cross-ownerships and financing structures (credit-negative ESG factor).

Scope applied its newly published Investment Holding Companies Rating Methodology in assessing Lexholding's corporate credit quality. Lexholding's business model exhibits characteristics of both investment holding companies and group corporates. The combination of minority and majority stakes in holdings, as well as the receipt of dividend and management fees, align with the characteristics of an investment holding company. On the other hand, the provision of shared services such as IT and HR indicates a corporate group structure.

Considering Lexholding's long-term investment approach for its strategic portfolio, with potential rotations of opportunistic assets like commercial real estate and limited influence on management decisions at the level of portfolio companies, Scope has determined that continuing to use the investment holding methodology is appropriate in assessing Lexholding's credit quality.

The investment holding methodology also takes into account the company's investment philosophy as an additional factor in assessing its business risk profile. However, it is important to note that the track record of portfolio value development is limited due to Lexholding reporting under local generally accepted accounting principles with cost basis accounting. This limits the company's ability to develop its portfolio value. Additionally, the limited divestments during the analysed period restrict the assessment of management’s competence and the company's ability to rotate assets.

Lexholding's business risk profile is constrained by:

1. portfolio sustainability: the company heavily relies on BAV Zrt.’s cash inflow, which constitutes over 70% of total cash inflows and poses a risk to the sustainability of Lexholding's portfolio. Any adverse developments or changes in BAV Zrt.'s financial performance could have a significant impact on Lexholding's cash flow stability and overall portfolio sustainability.
    
2. portfolio liquidity: Lexholding's investment strategy includes a substantial focus on unlisted assets. Investing in such assets can present challenges in terms of liquidity. Unlisted assets typically have limited trading platforms, making it more difficult to sell or exit positions quickly. This lack of liquidity can hinder Lexholding's ability to adjust its portfolio or address unexpected cash flow requirements.
    
3. geographical diversification: the operations of Lexholding's core holdings are predominantly concentrated in the Hungarian market. This lack of geographical diversification exposes the company to risks associated with local economic conditions, regulatory changes, and other market-specific factors. Enhancing geographical diversification can help mitigate these risks and provide a more balanced risk profile.

Scope does not consider the delayed investments in the planned modernisation and renovation of the existing real estate portfolio as inefficient management. Instead, these reflect a cautious spending pattern following the economic recession experienced in 2022. However, this could signal a soft covenant breach as the partial cash from bond proceeds earmarked for the renovation and modernisation of existing real estate has been parked in the real estate fund for two years.

Lexholding has initiated discussions with bond holders regarding the proposed change in the use of bond proceeds within the real estate division. The company has recently implemented a redefined investment strategy, which involves a portfolio of fully operational assets that are currently generating cash flow. Scope has evaluated this adjusted strategy and doesn’t not foresee any negative impact on the issuer rating of the company. In fact, the revised strategy offers several potential benefits: i) it eliminates development risk by focusing on existing assets; and ii) it enables immediate cash flow generation as opposed to renovation projects, where cash flow typically starts only after the completion of the pipeline, which usually takes three to four years.

Scope estimates that total cost cover will remain above 1.0x over the next few years, supported by: i) the relatively stable nature of management fees implemented at the level of core holdings; ii) broadly stable net interest on shareholder loans; iii) resumed dividend payments from core portfolio companies (i.e. pledged loans, ground transportation); and iv) no significant increase in dividend payouts shielded by bond covenants.

Liquidity continues to be adequate. Due to the absence of short-term debt, along with positive free operating cash flow and a significant cash buffer of around HUF 0.6bn as of FY 2022, there are no refinancing risks that would necessitate the sale of any shareholdings.

One or more key drivers of the credit rating action are considered an ESG factor.

Outlook and rating-change drivers

The Outlook is Stable and reflects Scope’s view that the company should maintain a recurring coverage of mandatory holding costs at above 1.0x in the medium term. Lexholding's senior unsecured bond issued under the Hungarian Central Bank’s Bond Scheme has an accelerated repayment clause. The clause requires Lexholding to repay the nominal amount (HUF 15bn) within 90 days if the bond rating falls below B-, which could have a default implication.

A positive rating action might be warranted upon an improvement in portfolio sustainability and/or portfolio liquidity.

A negative rating action may be warranted if transparency remained limited in the medium term, mainly due to a complex organisational structure, and/or if total cost cover dropped to below 1.0x on a sustained basis. This could occur if the financial position of the dividend-paying undertakings deteriorated significantly, requiring a recovery programme and/or limiting their ability to pay dividends or management fees to Lexholding.

Long-term debt rating

Scope has affirmed the senior unsecured debt rating at B+ including the HUF 15.0b (ISIN HU0000359955) bond. This reflects Scope’s expectation of a ‘superior’ recovery for senior unsecured debt in the hypothetical event of a company default. The recovery analysis is based on a hypothetical default scenario in 2025, which assumes outstanding senior unsecured debt of HUF 15.0bn with no senior secured loans. The half of bond proceeds (HUF 7.5bn) have been deployed already with a focus on investments in real estate; the rest has been invested in the open-ended real estate fund.

Scope constrained the debt category rating to the same level as the issuer rating given the risk that Lexholding could raise higher-ranking debt that would dilute the recovery for senior unsecured debtholders.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and/or Outlooks, (General Corporate Rating Methodology, 15 July 2022; Investment Holding Companies Methodology, 19 May 2023), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With the Rated Entity or Related Third Party participation     YES
With access to internal documents                                         YES
With access to management                                                  YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Zurab Zedelashvili, Associate Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 6 July 2020. The Credit Ratings/Outlooks were last updated on 8 July 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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