NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded GFI Group Inc.'s long-term Issuer Default Rating (IDR) and senior unsecured debt rating to 'BB' from 'BBB-'. The short-term IDR is also downgraded to 'B' from 'F3'. The Rating Outlook is revised to Negative. A complete list of rating actions is at the end of this release.
KEY RATING DRIVERS - IDRs AND SENIOR DEBT
The downgrade of GFI's rating reflects a sustained decline in profitability, increasing leverage, deteriorating interest coverage, and a weaker liquidity profile. Ratings 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 predictable revenues and high operating margins.
Fitch believes that the regulatory changes in the OTC markets, the ongoing restructuring and deleveraging in the banking sector, along with a flat yield curve and lower overall market volatility have profoundly lowered GFI's trading volumes. As a result, profitability and margins continue to be pressured in the inter-dealer brokerage (IDB) industry. As the smallest of the top five IDBs, GFI has been more susceptible to margin pressures, due to its relatively smaller scale, lower revenue/product diversity and higher fixed-cost base, compared to its larger IDB peers.
GFI experienced sharp declines in earnings and EBITDA, particularly in the second half of 2012. Its GAAP net loss widened to $10.0m for 2012, from $3.2 million in 2011. Fitch-calculated EBITDA, which excludes amortization of sign-on bonuses, declined 19% to $94.6 million in 2012, from $117 million in 2011. Subsequently, leverage measured as gross debt to adjusted EBITDA, increased to 2.6x in 2012, from 2.1x in 2011. Interest coverage, measured as adjusted EBITDA to interest expense, declined to 3.5x in 2012 from 4.5x in 2011. Absent an increase in EBITDA levels, interest coverage ratio is expected to further deteriorate as the coupon on GFI's $250 million 8.375% senior notes stepped up to 9.625%, based on interest-rate step-ups.
In addition, decline in EBITDA levels had impacted the amount GFI could borrow under its $129.5 million bank credit facility due to a maximum leverage covenant of 2.5x. In March 2013, GFI amended and extended the bank credit facility to relax certain financial covenants, including increasing the maximum leverage to 3.0x. (Leverage as per the bank covenant measured 2.1x at Dec. 31, 2012). However, the amendment also resulted in reducing the total capacity from $129.5 million to $75 million effective immediately and further declining to $56.3 million in December 2013, with a final maturity in December 2015. Fitch recognizes that the increase in leverage covenant gives the company additional flexibility but views the absolute reduction in total capacity negatively, particularly when operating cash flows continue to be stressed.
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 compared to the 2011 expense base. Fitch believes that this is achievable considering the company has already achieved expense reduction of $31 million in 2012, and needs to reduce an incremental $19 million in expenses for 2013 to achieve its target. However, Fitch is concerned about the impact these actions may have on GFI's competiveness in attracting and retaining brokers, considering the company's smaller scale compared to its larger peers.
Despite the above mentioned challenges, the company continued to pay approximately $6 million in quarterly dividend to its shareholders ($24 million annually). Continuation of the current dividend policy, without a commensurate increase in earnings or cash flows, particularly in light of the firm's reduced contingent liquidity is viewed as a credit negative.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
The revision of the Rating Outlook to Negative reflects industry-wide pressures facing inter-dealer brokers and, in particular, GFI's sensitivity to market conditions given its smaller scale and lack of revenue diversity. While all IDBs face challenges with the reduced trading volume and regulatory uncertainty, GFI's profitability is particularly challenged under these conditions, as demonstrated by recent results. Fitch expects potentially further profitability erosion if such conditions persist.
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 downgraded GFI's ratings as follows:
--Long-term IDR to 'BB' from 'BBB-';
--Short-term IDR to 'B' from 'F3';
--Senior unsecured debt to 'BB' from 'BBB-'.
The Rating Outlook is Negative.
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).
Applicable Criteria and Related Research
Global Financial Institutions Rating Criteria
Securities Firms Criteria