NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the ratings of three inter-dealer brokers (IDBs) including the following:
ICAP plc (ICAP)
ICAP Group Holdings plc (IGHP)
--Long-term Issuer Default Rating (IDR) to 'BBB' from 'BBB+';
--Senior debt to 'BBB' from 'BBB+'.
Tullett Prebon plc (Tullett)
--IDR to 'BBB-' from 'BBB'.
BGC Partners Inc. (BGC)
--IDR to 'BBB-' from 'BBB'.
The Rating Outlooks for ICAP, Tullett, and BGC's are Stable.
Fitch has affirmed GFI Group, Inc.'s (GFI) long-term IDR has at 'BB', and its Outlook remains Negative.
A full list of rating actions follows at the end of this press release.
The downgrades of ICAP, Tullett and BGC reflect the persistently challenging operating and earnings environment for IDBs, which are driven mainly by revenues pressures and, to a certain extent, operating leverage in voice broking activities. This results in weaker earnings, margin pressure, and varying degrees of increases in gross leverage metrics. EBITDA and earnings volatility has been greater than previously anticipated. Fitch considers some of the earnings challenges to be due to structural factors such as regulatory changes, as well as due to cyclical factors such as a flat yield curve.
Proposed regulatory changes could increase the competition that IDBs face on certain products that could be traded over exchanges, increase costs in terms of trade reporting, compliance and risk management, and may potentially shrink their revenue base by restricting activities of global banking institutions, which are the primary clients of IDBs.
All IDBs have responded to revenue pressures by looking to reduce costs, including renegotiating their compensation expense, which has been the biggest expense contributor. However, there has been an increase in core gross leverage metrics - to varying degrees - due to weaker EBITDA and, for BGC, higher gross debt. IDBs must continue to incur technology and development costs and invest in their business to align themselves with the industry developments, for example more electronic/hybrid trading.
The Outlooks are Stable for all but GFI, which is further challenged by its smaller size and limited scale and revenue diversity. The Stable Outlooks on ICAP, Tullett and BGC reflect Fitch's expectation that revenues will remain pressured but not to the same magnitude as experienced in 2012, (for ICAP, FY13), and that management's efforts to streamline their compensation expense bases and reduce debt levels will help stabilize profit margins and stabilize or improve leverage and interest coverage.
Company-specific rating drivers are discussed below.
ICAP plc
KEY RATING DRIVERS
Fitch has downgraded the IDR and senior debt rating of ICAP and IGHP to 'BBB' from 'BBB+'. Despite ICAP having a more diversified strategy than other IDBs, with two-thirds of its operating profit coming from electronic and post-trade and information, revenues fell by 12% year on year at FY13 with statutory operating profit falling 61% and EBITDA falling by 21% (or 18% adjusting for LIBOR-related legal costs). Management cost exercises and stable revenues in the post-trade and information sector helped mitigate the decline, but Fitch still considers EBITDA and earnings volatility to be greater than previously anticipated. In addition, ICAP faces increased legal costs, possible fines/litigation and heightened reputation risk arising from investigations into its potential involvement in the LIBOR scandal.
Due to earnings pressure across all broking product areas and a lag in a material rebasing of compensation levels, leverage and interest coverage ratios deteriorated moderately in FY13, with leverage (measured as Gross Debt to Adjusted EBITDA) calculated by Fitch to be 1.7x (or 1.6x adding back LIBOR-related legal costs), up from 1.4x at FY12. Ratios remain comfortably below ICAP's leverage covenant of 3.0x gross debt/EBITDA and above the interest coverage covenant of 5.0x. Despite an improvement in H213, Fitch anticipates that the margin pressure in voice broking will continue in the short to medium term relative to previous years as revenue will continue to be pressured and renegotiations of the cost base will take time to come through.
In Fitch's opinion ICAP's diversification strategy means it is relatively better placed to face regulatory/market uncertainties than other IDBs, despite potential challenges related to expansion, as emphasised for example by the FY12 and FY13 goodwill impairments of the voice broking business, Link.
Fitch considers ICAP's refinancing risk as low and liquidity is supported by the June 2013 refinancing of its USD880 million unsecured revolving credit facility (RCF) with a three-year GBP425 million RCF, incorporating a USD200 million swingline facility. Credit and market risks in its IDB businesses are also considered low because of the name give up or matched principal conventions employed.
IGHP is a fully controlled, non-operating subsidiary of ICAP and the obligor of the group's bank facilities, loans and debt, with the exception of the group's subordinated debt, retail bond and European Commercial Paper. IGHP is covenanted to consolidate at least 85% of the group's EBITDA, supporting the alignment of its ratings with ICAP.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
The Outlook is Stable, for the reasons cited earlier. However, Fitch notes that should regulatory developments be significantly detrimental to its business model or if EBITDA performance is materially worse than FY13, leading to further weakening in core leverage metrics, the Outlook may be revised to Negative and/or downgraded. Large LIBOR-related payments, should they materialise, could also place pressure on ratings.
Nonetheless, should regulation end up opening further opportunities and a larger customer base as well as creating a more simplified and liquid market for certain products, then Fitch would view this as a positive to the ratings.
Tullett Prebon plc
KEY RATING DRIVERS
Fitch downgraded the IDR and senior debt rating of Tullett to 'BBB-' from 'BBB' for the reasons outlined earlier in this rating action commentary. Tullett is the second-largest IDB, focused mainly on foreign exchange, interest rate derivatives, government and corporate bonds.
Despite being more focused on voice/hybrid broking, which has been the area under greater margin compression across the sector, revenues were relatively more resilient than peers', down 7% in 2012 and 4% year-over-year in 4M13, in part due to acquisitions. However, EBITDA fell by 17% in 2012 (or by 13% adjusting for legal costs). Tullett reported a loss before tax of GBP34.7 million at end-2012 (2011: GBP119.2 million profit) which included a non-cash charge of GBP123 million related to the write-down of the carrying value of goodwill from its North American business following the poaching of employees by BGC in 2009.
Following recent acquisitions in the Americas (Covencao in Brazil and a few small U.S. bolt-ons) and the initial front-loading of costs, Fitch expects the profit contribution from the Americas to improve in 2013. Tullett's overall margins have historically been lower than those of market leader ICAP, although the voice business has enjoyed better margins. Fitch views Tullett's actions on costs and restructuring (which began in 2011) as positive mitigants to the revenue pressures being experienced, but they have not been sufficient to stop the decline in earnings.
Tullett's senior bond issue in December 2012 has been used to refinance bank borrowings, including GBP30m since end-2012. As a result, its gross level of financial debt is broadly the same today as it was a year ago. Adjusting for the repayments in early 2013, pro forma gross debt/ EBITDA was around 1.8x at end-2012 (1.6x adjusting EBITDA for legal costs). This compares with 1.5x at end-2011 (1.4x adjusting for legal costs), adjusting for the similar GBP30m bank repayment made in early 2012. This means the weakening in these pro forma gross leverage metrics is due to EBITDA pressure, rather than higher indebtedness. Interest cover fell to 8.4x in 2012 from 9.4x in 2011. Covenant headroom is comfortable. Fitch notes there is a base level of term debt which the company operates with, and therefore there is likely to be limited scope for debt amortisation, although surplus cash may be held at the holding company level to pre-fund upcoming maturities.
Credit and market risks are considered low because of the name give up or matched principal conventions employed. Refinancing risk is also low and liquidity satisfactory, with very limited debt repayments before 2016.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
As with the other IDBs Tullett's IDR and senior debt ratings are sensitive to changes in the financial profile, including leverage and interest coverage, its ability to contain earnings pressure, as well as to regulatory developments. Ratings may come under further pressure should these developments be decidedly more negative for Tullett or its customers (global banks) than currently assumed by Fitch or if Tullett fails to adjust its business model to new market realities, supported by investment in technology without materially jeopardising free cash flow generation. Equally, should Tullett materially improve margins or successfully diversify its earnings, Fitch would view this as a positive for the rating.
BGC Partners Inc.
KEY RATING DRIVERS
The downgrade of BGC's long-term IDR and senior debt ratings from 'BBB' to 'BBB-' reflects the persistently challenging operating and earnings environment facing its IDB business. This is due in part to structural factors as well as cyclical factors, increased concentration in low margin voice/hybrid IDB and commercial real estate brokerage segments after the pending sale of its high-margin eSpeed electronic trading platform, the potential execution risks related to the deployment of proceeds from the eSpeed sale. It also reflects BGC's significant interrelationship with its parent, Cantor Fitzgerald L.P. (Cantor), who is also facing some pressures in many of its core operating businesses. The ratings also incorporate key man risk and concentrated decision making across the two firms.
Over the past two years, BGC's management has taken a number of steps to transform its business in light of challenging operating conditions, first by expanding into commercial real estate (CRE) brokerage business with two large acquisitions, and then recently by announcing the sale of its on-the-run benchmark two-, three-, five-, seven-, 10-, and 30-year fully-electronic trading platform for U.S. Treasuries (eSpeed). This sale is expected to generate $1.23 billion in proceeds for BGC, including $750 million in cash this quarter. Fitch believes that both strategies will lead to more concentration of revenues in cyclical and low-margin businesses, which will continue to make the company's earnings susceptible to capital market trends.
Financial brokerage revenues, excluding CRE brokerage revenues, fell 11% and 6% for FY12 and 1Q13, year-over-year. While financial brokerage revenues remain pressured, BGC's expansion in to real estate brokerage space is driving costs higher, particularly in the compensation area, further pressuring margins. Real estate brokerage is expected to continue to generate relatively lower margins, until critical scale is achieved.
Historically, BGC has operated at lower leverage levels compared to its IDB peers. However, the company's opportunistic debt funded acquisitions in recent years, particularly in the CRE brokerage space, have coincided with very challenging industry operating trends in the financial brokerage space, which has resulted in weakened leverage and interest coverage metrics.
Fitch calculated leverage, measured as gross debt to trailing 12 month (TTM) adjusted EBITDA, increased to 2.4x at 1Q13, from 1.5x in FY11 and 0.9x in FY10. At the same time, increased borrowing costs from recent longer-term debt issuances have resulted in weakening in interest coverage, measured as TTM adjusted EBITDA to interest expense, to 5.3x in 1Q13, from 9.6x in FY11 and 14.6x in FY10. Both metrics are expected to improve as the company has represented that it intends to hold $150 million of eSpeed proceeds in reserve to pay down its $150 million April 2015 convertible note obligation to Cantor, and invest a portion of the proceeds in cash generative business activities.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
Fitch's current ratings assume that the company will use a portion of the proceeds from the eSpeed sale to repay a portion of its outstanding debt, which should improve pro forma leverage and interest coverage metrics. The ratings could come under pressure, absent such debt pay-down or material improvement in top line EBITDA.
The ratings could also come under pressure if regulatory changes materially impact the profitability or viability of certain business lines. Further, any changes in Cantor's ratings could also result in changes to BGC's ratings. Positive rating momentum, although limited in the medium term, will be driven by sustained improvement in leverage, interest coverage, and profitability metrics.
GFI Group, Inc.
KEY RATING DRIVERS
The affirmations of GFI's long-term IDR and senior unsecured debt ratings at 'BB' are supported by GFI's attractive technology platform and recurring revenue contribution, albeit to a smaller extent, from its Trayport and Fenics subsidiaries, which are subscription-based businesses with more predictable revenue streams and high operating margins. The Negative Outlook reflects GFI's continued sensitivity to the challenging operating environment, given its smaller scale and lack of revenue diversity.
On April 19, 2013, Fitch downgraded GFI's rating from 'BBB-' to 'BB', reflecting sustained decline in profitability, increasing leverage, deteriorating interest coverage, and a weaker liquidity profile. Fitch believes that as the smallest of the top five IDBs, GFI has been more susceptible to industry pressures, due to its relatively smaller scale, lower revenue/product diversity and higher fixed-cost base, compared to its larger IDB peers.
Consistent with broader IDB industry trends, GFI experienced lower revenues and earnings in 1Q13, due to reduced risk appetite from clients and lower market volatility. Revenues further fell 6% in 1Q13 from 1Q12, driven by 15% decline in brokerage revenues. Positively, revenues from software, analytics, and market data were robust and increased 11% due to strong growth in Trayport revenues. Still, Fitch calculated EBITDA declined 9% to $86.2 million for trailing 12 months (TTM) ending March 31, 2013, from $94.7 million in FY12.
GFI's management has responded to declining margin pressures by aggressively rationalizing its fixed-cost base, largely through headcount reductions, restructuring compensation agreements and reducing sign-on bonuses/guarantees. These measures are estimated by the company to reduce costs by $50 million in 2013 compared to the 2011 expense base. The compensation ratio declined to 56.1% in 1Q13 from 59.9% in 1Q12 (based on total revenues), the lowest level seen in years driven by company's continued efforts to contain sign-on bonuses and bring the overall cost in line with industry levels.
Leverage, measured as gross debt to TTM adjusted EBITDA, increased to 2.9x at 1Q13 from 2.6x at YE12, due to a decline in cash flows. Interest coverage, measured as TTM adjusted EBITDA to interest expense, further declined to 3.1x at 1Q13 from 3.5x at YE12. Absent an increase in EBITDA levels, interest coverage ratio is expected to further deteriorate as the coupon on GFI's $250 million senior notes (current principal outstanding: $240 million) is expected to increase to 10.375% based on interest-rate step-ups.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
The ratings could be downgraded further if low trading volumes persist and the firm is unable to stabilize earnings or regulatory changes materially impact the profitability or viability of certain business lines. Continued deterioration in earnings as measured by profitability and EBITDA, reduction in interest coverage and liquidity, as well as increased leverage would also lead to further negative ratings actions.
The Outlook could be revised to Stable if GFI is able to demonstrate a sustained improvement to its earnings profile, reduce its cost base, and increase liquidity, while maintaining or improving its leverage and interest coverage metrics.
Fitch has taken the following rating actions:
ICAP plc
--Long-term IDR downgraded to 'BBB' from 'BBB+'; Outlook Stable;
--Short-term IDR and commercial paper downgraded to 'F3' from 'F2';
--Senior debt downgraded to 'BBB' from 'BBB+';
--Subordinated debt downgraded to 'BBB-' from 'BBB'.
ICAP Group Holdings plc
--Long-term IDR downgraded to 'BBB' from 'BBB+'; Outlook Stable;
--Short-term IDR downgraded to 'F3' from 'F2';
--Senior debt downgraded to 'BBB' from 'BBB+'.
Tullett Prebon plc
--Long-term IDR downgraded to 'BBB-' from 'BBB'; Outlook Stable;
--Senior debt downgraded to 'BBB-' from 'BBB';
--Subordinated debt downgraded to 'BB+' from 'BBB-'.
BGC Partners Inc.
--Long-term IDR downgraded to 'BBB-' from 'BBB'; Outlook Stable;
--Short-term IDR downgraded to 'F3' from 'F2';
--Senior unsecured debt downgraded to 'BBB-' from 'BBB'.
GFI Group Inc.
--Long-term IDR affirmed at 'BB'; Outlook Negative;
--Short-term IDR affirmed at 'B';
--Senior unsecured debt affirmed at 'BB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (August 2012);
--'Securities Firms Criteria' (August 2012);
--'Rating FI Subsidiaries and Holding Companies' (August 2012).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686181
Securities Firms Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686137
Rating FI Subsidiaries and Holding Companies
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=795065
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