OREANDA-NEWS. Fitch Ratings has downgraded UK care provider Elli Investments Ltd's (Elli) senior secured notes to 'B-'/Recovery Rating 'RR2' (85% recoveries) from 'B'/'RR1' (100%) and senior unsecured notes to 'CC'/'RR6' (0%) from 'CCC+'/'RR3' (52%) based on its updated recovery analysis. Elli's Long-Term Issuer Default Rating (IDR) has been affirmed at 'CCC'. A full list of rating actions is attached at the end of this commentary.

KEY RATING DRIVERS
Operational Challenges
The affirmation of the 'CCC' IDR reflects Fitch view's that Elli will continue to face operational challenges and constraints on profitability and cash flows. This is based on pressures on the group's cost base associated with the increase in national living wage from April 2016 and uncertainty around the impact of the consequent increase in local authorities' fees.

According to management, the majority of local authorities that are Elli Investments' customers have adopted the 2% "social care" levy permitted by the UK Treasury this year. This increases flexibility around fee payments, although local authorities also have other competing spending priorities for social care. Fitch therefore expects continued pressure on the group's underlying operating performance despite a stabilisation of occupancy rates and increasing care standards as evidenced by a declining embargo rate.

The affirmation of the IDR also assumes that a liquidity shortfall and payment default on the notes can be avoided over the next nine to 12 months if the group continues to supplement depressed operating cash flows with permitted non-core asset disposals throughout the year (Fitch assumes GBP50m disposal proceeds during 2016, similar to 2015). Fitch therefore views the strategic options still available to the group with regard to asset disposals to bolster liquidity as underpinning the 'CCC' rating; however, failure to raise such proceeds would put pressure on liquidity and ratings in the short-term. Fitch also views continued asset disposals to bolster liquidity as a prerequisite to facilitating discussions with stakeholders in debt restructuring and achieving a sustainable capital structure, expected in 2H16.

Recovery Prospects
Fitch has updated its recovery analysis to reflect the independent, external valuation published as part of the group's 2015 annual results (leading to a GBP 224m property impairment). In its recovery analysis, Fitch has adopted the liquidation value approach as the resultant enterprise value is higher than the going concern enterprise value, primarily derived from the group's freehold and long-leasehold properties. Fitch believes that a 35% discount to the assets' current market value provided by an independent valuer in April 2016 is deemed fair in a distress case.

Recovery expectation for the super senior term loan is still high at 100%/'RR1' while recovery expectation on the senior secured notes and the senior unsecured notes has respectively deteriorated to 85%/'RR2' and 0%/'RR6'.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Fitch's key assumptions within the rating case for 2016 include:

-EBITDA in line with 2015 performance.
-Capex of GBP48m in 2016
-Disposals of uneconomic care homes for GBP50m, in line with proceeds raised in 2015

RATING SENSITIVITIES
Negative: Future developments that could, individually or collectively, lead to negative rating actions include:
- Absence of committed additional liquidity within the next six months in a context of unchanged or deteriorating operating performance.

Positive: Fitch would expect a restructure of the underlying business model, supported by a sustainable capital structure and adequate liquidity as prerequisite for a positive rating action. Future developments that could, individually or collectively, lead to a positive rating action include:
-Funds from operations (FFO) adjusted gross leverage to or below 6.5x (2015: 11.4x) on a sustained basis.
-FFO fixed charge cover at 1.1x or above (2015: 0.8x) on a sustained basis.
-Improvement in liquidity providing visibility on the repayment of the GBP40m term loan maturing in December 2017.

LIQUIDITY
Fitch expects Elli Investments to rely on additional liquidity by end-2016 to avoid a liquidity shortfall, with permitted property disposals being the most obvious source. At end-March 2016, the group's cash balance was GBP50m. The group currently has no other available or committed liquidity buffers.

FULL LIST OF RATING ACTIONS

Elli Investments Limited
Long-term IDR: affirmed at 'CCC'
Senior unsecured notes: downgraded to 'CC'/'RR6'/0% from 'CCC+'/'RR3'/52%

Elli Finance (UK) plc
Super senior term loan: affirmed at 'B'/'RR1'/100%
Senior secured notes: downgraded to 'B-'/'RR2' /85%' from 'B'/'RR1'/100%