NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a Long-term Issuer Default Rating (IDR) and unsecured debt rating of 'A+' to FMR LLC (Fidelity). The Rating Outlook is Stable.
KEY RATING DRIVERS
IDR AND SENIOR DEBT
Fidelity's ratings reflect its leading franchises in the asset management and distribution businesses, strong investment performance through a variety of market cycles, diverse business model, which yields more stable earnings performance over time, limited balance sheet risk, unsecured funding profile, strong liquidity, manageable and flexible payout ratio, sound risk management infrastructure, and experienced management team. The ratings also reflect Fidelity's potential earnings benefits from rising interest rates related to current money market fee waivers and depressed spread income on brokerage balances.
Rating constraints include higher-than-peer cash flow leverage (debt/EBITDA) ratios, the absence of an articulated leverage target, the sensitivity of the business model to changes in market conditions and investor appetite for actively-managed investment products, relatively low operating margins, due, in part, to a higher-cost capital structure but also active reinvestment in the business, and modest key man risk associated with the involvement of the Johnson family. The modest exposure to non-financial businesses is also viewed as a relative weakness, given the potential drag on operating earnings and reputational risk, and the impact on overall organizational complexity.
Fitch believes Fidelity has an extremely strong market position, as the largest manager of money market mutual funds, the largest distributor of mutual funds, the largest administrator of defined contribution plans, and one of the largest retail brokerage platforms. The diversity of the product offerings has allowed the firm to weather economic cycles, market volatility, and investor trends, including recent growth in passively managed strategies, with no material impact to the firm's overall credit profile. Fitch believes the firm will continue to develop new products and strategies to respond to market trends and generational changes in the customer base in an effort to maintain its strong market share. At March 31, 2015, the firm had $5.2 trillion in assets under administration (AUA) and $2.1 trillion of assets under management (AUM), reflecting compound annual growth of 9.2% and 6.3% over the last ten years, respectively.
Fidelity is primarily an active-oriented investment manager, with approximately 89% of its AUM in actively managed investment strategies as of March 31, 2015. Over the last 10 years, active investment products have become challenged by investor appetite for passive-oriented investment products, although active products still represented more than 80% of total U.S. long-term equity funds at year-end 2014 according to the ICI. Fidelity has successfully navigated these evolving dynamics by delivering strong performance on the majority of its actively-managed funds, while also expanding its offering (or distribution) of passive investment products to meet investor preferences. While increased investor appetite for passive investments remains a long-term challenge, Fitch believes there will remain material demand for active investment products; particularly those which are able outperform net of fees.
Fidelity's operating performance has been relatively stable over time, despite depressed market values during the financial crisis and, more recently, the impact of the low interest rate environment on brokerage spread income and money market fee waivers. Fitch believes there is upside to the firm's earnings profile over the near-to-intermediate term as interest rates rise and actively managed strategies, potentially, return to favor. That said; the firm does have lower EBITDA margins than the traditional investment manager peer group amounting to 24.1% on a trailing 12 month (TTM) basis through March 31, 2015. The lower margins are depressed by higher compensation expenses, due to accounting requirements for phantom stock, and higher funding costs, given the firm's higher-cost subordinated debt issuances to owners and employees.
However, Fitch believes Fidelity's private ownership structure has allowed the firm greater flexibility when it comes to investing in new products, services, and infrastructure, regardless of the market environment, as it is not pressured to meet quarterly return expectations from public shareholders and analysts. It may also offer Fidelity the flexibility to make opportunistic acquisitions/investments during periods of market dislocation.
As the largest manager of U.S. money market funds, Fidelity is expected to feel the effects of money market fund regulation and potential changes in investor appetite for money market fund types that will become subject to floating net asset values (NAV) and potential liquidity fees and redemption gates during times of stress. That said, fee waivers associated with the low interest rate environment have already dampened the revenue contribution of this business to Fidelity's overall financial performance, and if investors simply move assets to government funds from prime funds (in order to avoid the variable NAV and fees and gates) this would have a limited impact on Fidelity's business.
In assessing Fidelity's debt obligations, Fitch affords the subordinated Series A notes, the junior subordinated notes, promissory notes, and the subordinated notes (that are maturing beyond five years), 50% equity credit given Fidelity's ability to defer interest payments, the effective maturity of greater than five years, limited covenants, and the absence of non-standard events of default.
Under this construct, Fitch calculates the firm's leverage (debt/EBITDA) to be 1.48x on a TTM basis through March 31, 2015. This leverage profile is within Fitch's general tolerance level for 'A' category traditional investment management firms, but it is meaningfully above the 'A' category average of 0.39x. Fitch does consider the fact that 100% of the subordinated debt is held by owners and employees of the firm, which aligns their interests with the equity holders and reduces the potential for execution of any acceleration claims. On a senior debt basis, Fitch calculates leverage to be 0.88x on a TTM basis at March 31, 2015, which is modest, but still above the peer group. Additionally, the firm does not have a stated leverage target and senior leverage has been as high as 1.46x within the last five years. Fitch would view a more explicit commitment to a leverage target or range favorably.
Fidelity's senior unsecured debt rating is equalized with the IDR, reflecting the largely unsecured funding profile and available unencumbered asset coverage to the unsecured debt.
Fitch believes Fidelity has a very strong liquidity profile, consisting of investments in the firm's own money market mutual funds. This is significant when compared to modest near-term debt maturities and the size of the firm's core balance sheet, and compares favorably to peers. Shareholder distributions are not outsized, in Fitch's opinion.
Seed capital investments as of March 31, 2015 accounted for about 7.7% of tangible capital. This is below the traditional investment manager peer group average and does not pose meaningful balance sheet risk. Fitch does not expect seed capital commitments to change materially, given the already significant size and diversity of the firm's AUM.
Fidelity does have some investments in non-financial businesses, such as the soon-to-be majority owned Colt Telecom, in addition to co-investments in other industries with its Investor Entities (shareholders and employees) managed by the firm's Devonshire unit. The debt obligations of these investments are non-recourse to Fidelity, but Fitch believes the investments pose potential reputational risk to the firm, in addition to a potential drag on earnings performance.
The Stable Outlook reflects Fitch's expectation that Fidelity will maintain its strong market position, by generating strong investment returns and responding to market and investor trends with new products and services, and continue to generate consistent earnings performance, strong liquidity, and a relatively stable leverage profile.
RATING SENSITIVITIES
IDRS AND SENIOR DEBT
Positive rating momentum could develop over time as a result of a sustained decline in leverage, a more explicit commitment to a leverage target, and an improvement in operating margins, which could provide the firm with more earnings flexibility during market cycles. Positive rating actions could also result from further evidence that the recent shift of investor capital into passively managed strategies is more cyclical than secular, as increased inflows into actively managed strategies would be expected to benefit managers like Fidelity. Additional revenue diversification away from the asset management business and towards the distribution businesses could also contribute to positive rating momentum.
Negative rating momentum could develop from declines in investment performance or other reputational damage which lead to material outflows, thus impacting the firm's earnings, leverage, and liquidity position. Adverse regulatory scrutiny of Fidelity or the asset management business more broadly, or a material increase in balance sheet commitments to non-financial businesses could also be viewed negatively.
Fitch has assigned the following ratings:
FMR LLC
--Long-term IDR 'A+';
--Unsecured Debt 'A+'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com.'
Applicable Criteria
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987738
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987738
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.