NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded GFI Group Inc.'s (GFI) long-term Issuer Default Rating (IDR) and senior unsecured debt rating to 'BB-' from 'BB' and maintained the Rating Outlook at Negative. A complete list of rating actions is at the end of this release.
Inter-dealer brokers (IDBs) continue to face a challenging operating environment as global trading activity remains subdued reflecting persistently low volatility, the more onerous regulatory environment for their dealer clients, and the uncertainty associated with structural regulatory reforms of the over-the-counter (OTC) derivatives markets. Fitch believes some of these trends will continue impacting brokerage revenues in the near to intermediate term.
However, discipline on expenses, particularly compensation and debt pay downs have helped stabilize profit margins, leverage and interest coverage metrics for most IDBs. A return to aggressive compensation practices or large cash/debt funded acquisitions could put pressure on the IDB sector or individual companies.
KEY RATING DRIVERS - IDRS AND SENIOR DEBT
GFI's downgrade reflects increased pressure on the company's liquidity position, driven by increased working capital requirements, continued earnings pressure and continuation of the approximately $6 million quarterly dividend payment to shareholders. GFI's ratings are supported by its established position in the credit IDB space and the attractive technology platform and recurring revenue contribution from its Trayport and Fenics subsidiaries, which are subscription-based businesses with predictable revenues and high operating margins.
The Negative Outlook reflects Fitch's expectation that GFI's operating performance will be challenged in the near term due to persistently low industry trading volumes, which in Fitch's view will impact GFI more than its peers due to its smaller scale and less diversified business model. Lower earnings, combined with continued regulatory related costs, could further impact liquidity levels.
GFI's cash flow from operations declined to $19 million in 2013, from $48.7 million in 2012, as a result of higher working capital from increased accounts receivables, regulatory capital needs and start-up costs associated with setting up the company's swap execution facility (SEF). GFI's cash position, which it defines as cash and cash equivalents and cash held at clearing organizations excluding customer cash, declined to $221 million at the end of the first quarter of 2014 (1Q'14), compared to $247 million at year-end 2012 (YE12). Fitch believes that a majority of this cash is restricted for regulatory and clearing capital needs and the unrestricted cash position relative to debt has declined year-over-year.
Although leverage, measured as debt to adjusted EBITDA, remained flat at 2.6x between trailing 12 months (TTM) 1Q'14 and fiscal year 2012 (FY12), interest coverage, measured as adjusted EBITDA to interest expense, weakened to 3.2x at TTM 1Q'14, compared to 3.5x at FY12, due to step up in interest rates following a ratings downgrade of the senior notes. The interest rate is now at its maximum of 10.375%, and Fitch expects the interest expense to stabilize at current levels.
GFI's operating performance in 2013 and 1Q'14 continued to be pressured, but not at the same magnitude as the sharp decline experienced in 2012, as a decrease in financial brokerage revenues were offset by increased software, analytics, and market data (mainly Trayport and Fenics) revenues coupled with reduced expenses from cost cutting efforts. Fitch-calculated EBITDA, which does not give credit to amortization of sign-on bonuses and adds back non-recurring non-cash charges, increased slightly to $96.4 million for TTM ended 1Q'14, from $95 million at YE12.
Although software, analytics, and market data revenues increased 8% year-over-year to $91 million in 2013, they only accounted for 12% of GFI's 2013 net revenues. Fitch expects the company to grow the revenue and earnings contribution from these relatively high-margin businesses, which could improve and diversify GFI's earnings profile.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
GFI's ratings could come under pressure if the company's liquidity levels, as measured under various metrics including cash flow from operations, balance sheet cash and Fitch-calculated EBITDA, continue to weaken. A further decline in interest coverage or an increase in leverage ratio could also pressure ratings.
A revision of the Outlook to Stable could be driven by a sustained improvement in GFI's earnings and liquidity profile, increased contribution from its software, analytics, and market data business segments, while maintaining or improving its leverage and interest coverage ratios.
Fitch has taken the following rating actions:
GFI Group Inc.
--Long-term IDR downgraded to 'BB-' from 'BB';
--Senior unsecured debt downgraded to 'BB-' from 'BB'.
--Short-term IDR affirmed at 'B'.
The Rating Outlook is maintained at Negative.
Additional information is available on www.fitchratings.com.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (January 2014);
--'Securities Firms Criteria' (January 2014);
--'2013 Outlook: Securities Firms (November 2013);
--'Inter-Dealer Brokers: Challenges and Opportunities from New Regulations (Oct. 2, 2013).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
Securities Firms Criteria
2013 Outlook: U.S. Securities Firms
Inter-Dealer Brokers: Challenges and Opportunities from New Regulations