CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Lazard Group LLC's (Lazard) Long-Term Issuer Default Rating (IDR) and senior unsecured debt ratings at 'BBB+'. The Rating Outlook remains Stable. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
IDR AND SENIOR DEBT
Lazard's IDR and senior debt ratings continue to reflect the company's significant franchise as a global independent financial advisor and investment manager, a balance sheet light business model, relatively low cash flow leverage, good interest coverage and strong operating performance. Ratings are constrained by the inherent cyclicality of the firm's businesses, a higher compensation ratio compared to other financial institutions more broadly and an assets under management (AUM) concentration in emerging market equities, an asset class prone to periods of meaningful performance volatility.
The performance of both the financial advisory and asset management businesses was challenged in the trailing 12 months (TTM) ending June 30, 2016, by lower market activity. The volume of deals in the mergers and acquisitions (M&A) advisory space reduced about 15% globally in the first half of 2016 (1H16) compared to 1H15, resulting in 23% lower revenues for Lazard's strategic advisory business period over period. Total financial advisory revenues declined 11% period over period, somewhat offset by increased restructuring activity, which more than doubled in 1H16 versus 1H15. Management fees were also about 9% lower, due to markets decline resulting in lower average AUM and partially due to AUM allocation to lower fee generating products. Despite the decreased revenues in both of Lazard's key business segments, EBITDA margins remained solid at 42% for TTM ending June 30, 2016. Fitch's EBITDA calculation includes an adjustment for amortization of deferred non-cash incentive compensation, which was $347 million for the TTM ending June 30, 2016.
Fitch continues to view Lazard's independence as an important competitive advantage in its advisory business, compared to larger peers with significant capital markets and trading operations. While the number of independent advisory firms continues to increase, Lazard maintains a solid position in the league tables globally.
Asset management contributed 48% of Lazard's operating revenues for TTM ending June 30, 2016, providing revenue diversity for the firm. AUM increased 3% in 1H16 to reach $192 billion at June 30, 2016, driven by market appreciation. Net client flows averaged 1.8% in 2012-2015, reducing to about zero in 1H16. Fitch attributes the more recent trend to investors periodic risk aversion, particularly to emerging market equities relative to other sectors.
For the TTM ending June 30, 2016, Lazard reported that the compensation ratio was 56.1%, slightly up compared to 55.4% in 2015. Fitch would view a longer-term reduction in the expense base positively. Lazard's reported compensation expenses in 1H16 include the amortization of prior years' deferred incentive compensation.
Lazard continues to maintain a conservative leverage profile. Cash flow leverage, as expressed by gross debt to adjusted EBITDA, was 1.07x for the TTM ending June 30, 2016, a modest increase from 1.01x at year-end 2015 (YE15) due to a minor EBITDA decrease. Interest coverage was 18.4x for TTM ending June 30, 2016, improving from 18.1x at YE15, helped by the reduction of interest expense following the refinancing of debt at a lower interest rate. Fitch expects Lazard's credit metrics to remain relatively consistent with current levels, although periods of reduced M&A activity and/or weaker investment performance will impact cash flow leverage.
Lazard returns material amounts of capital to its shareholders. Total capital returned to shareholders, including common dividends, share repurchases of Class A common stock and the satisfaction of employee tax obligations in lieu of share issuances upon vesting of equity grants, was $491 million for 1H16, well in excess of the $65 million of cash flow from operations for 1H16, but these amounts have historically converged towards year-end. In addition, the firm plans to gradually increase its quarterly dividend payment and at a minimum seeks to repurchase shares to offset the dilution from year-end share-based compensation. Given the low capital requirements of the business and Lazard's strategy of actively returning capital to shareholders, the reduction in equity capital is incorporated into the ratings. Fitch will continue to assess the capital management strategy in the context of future potential rating momentum.
The senior debt ratings are equalized with Lazard's IDR, reflecting the largely unsecured funding profile and available unencumbered asset coverage to the senior debt. At June 30, 2016, the senior debt consisted of $500 million of 4.25% senior notes due in 2020, $400 million of 3.75% senior notes due in 2025 and $98.35 million (outstanding portion of original $600 million issuance) of 6.85% senior notes due in 2017. Fitch believes that Lazard has sufficient resources for the upcoming maturity, given that it held $1.3 billion in cash, bank deposits and short-term investments at June 30, 2016.
IDR AND SENIOR DEBT
Rating upside is viewed as limited for the foreseeable future due to the company's relatively narrow product offering, and cyclicality of its businesses and high compensation expenses relative to other financial institutions. Longer-term positive drivers include further development of the asset management business with a more diversified product offering and investor base, and a sustained increase in operating margins while maintaining conservative leverage levels.
The rating and/or the Rating Outlook could be pressured by significant declines in financial performance, materially weaker market conditions leading to lower advisory activity and/or AUM outflows, or the incurrence of material reputational damage. Current ratings incorporate the cyclical nature of Lazard's businesses and reflect an expectation that EBITDA will vary with broad business and market cycles. Sizeable acquisitions that result in higher leverage or reduced interest coverage ratios could also trigger a downgrade. A change in strategy that led to a more balance sheet intensive business model could also pressure the ratings.
The rating assigned to the senior unsecured debt is equalized with Lazard's IDR, and therefore would be expected to move in tandem with any change in Lazard's IDR.
Fitch has affirmed the following ratings:
Lazard Group LLC
--Long-Term IDR at 'BBB+'; Outlook Stable;
--Senior debt rating at 'BBB+'.
Additional information is available on www.fitchratings.com
Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016)
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