NEW YORK--(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.
KEY RATING DRIVERS - ISSUER DEFAULT RATING AND SENIOR UNSECURED DEBT
The affirmation of Lazard's ratings reflects the company's relatively low-risk balance sheet and significant franchise as a global independent financial advisor and investment manager. The ratings continue to reflect the reduction of Lazard's financial leverage, strengthening of interest coverage and strong operating performance. Rating constraints include a relatively narrow product offering, the cyclicality of its businesses and high compensation expenses relative to other financial institutions.
Both the financial advisory and asset management businesses continued to perform well for the trailing 12 months (TTM) ended second quarter 2015 (2Q15), supported in part by favorable market conditions. Financial advisory revenues increased 5% to $1.268 billion for the TTM 2Q15 from $1.207 billion at year-end (YE) 2014 driven by an increase in mergers and acquisitions (M&A) and strategic advisory revenues. Restructuring revenues increased slightly but remained low, reflecting the industry-wide low level of corporate restructuring. Lazard has advised on a number of large transactions, including Reynolds American's (RAI) acquisition of Lorillard and Siemen's acquisition of Dresser-Rand.
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 dominant position in the league tables globally.
Asset management contributed almost half of Lazard's operating revenues for TTM 2Q15. In Fitch's view, this business continues to serve as an important source of revenue diversity for the firm. Assets under management (AUM) of $203.1 billion at June 30, 2015 were 3% higher than at Dec. 31, 2014 driven by market appreciation of $9.1 billion and net inflows of $2.6 billion. Lazard's AUM is concentrated in global equities, with an emphasis on emerging markets. Fitch believes this potentially exposes the firm to increased outflows in a risk-off environment, as investors may decide to reduce their allocations to emerging market equities more rapidly than other sectors.
Lazard's cash flow leverage benefitted from an increase in its adjusted EBITDA. Leverage, as calculated by Fitch, declined to 1.06x at 2Q15 from 1.11x at YE14. Interest coverage improved to 18.8x at 2Q15 from 13.9x at YE14, due to the improvement in EBITDA metrics and the refinancing of debt at a lower interest rate. Fitch expects Lazard's credit metrics to remain relatively consistent with current levels.
Lazard continues to remain focused on controlling compensation expenses while attracting and retaining talented professionals. At first half 2015 (1H15), the firm's compensation ratio (as calculated by Lazard) was 55.6% as compared with 56.6% in 1H14. Lazard should continue to benefit from the cost saving initiatives announced in 2012 to keep the compensation ratio to the targeted range of mid- to high-50%. Fitch would view a longer-term reduction in the expense base positively. Lazard's reported compensation expenses in 1H15 continue to be affected by the amortization of prior years' deferred incentive compensation and are down slightly compared with the same period of 2014.
The amount of capital returned to the firm's shareholders increased in 1H15, as compared with 1H14. Total capital returned to shareholders including common dividends, share repurchases and employee tax obligations were $423 million for 1H15, 21.2% higher than the 1H14 and well in excess of cash flow from operations. Common dividends and share repurchases to cash flow from operations declined to 1.5x at 1H15 from 4.0x at 1H14, however up from 0.5x at YE13. 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 equalization of Lazard's senior unsecured debt rating with its IDR reflects the priority claim on operating cash flows given the absence of secured debt in the capital structure.
RATING SENSITIVITIES - ISSUER DEFAULT RATING AND SENIOR UNSECURED 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 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 or the incurrence of material reputational damage. Ratings could also be impacted by a change in strategy that includes a more balance sheet intensive business, although this is not expected by Fitch. 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.
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. Additionally, although not currently envisioned, were Lazard to assume material secured debt that effectively subordinate the payment priority of the unsecured debt, this could result in the unsecured debt being rated lower than the IDR.
Lazard is a well-established global investment bank that operates two main businesses: financial advisory and asset management. Financial advisory remains the cornerstone of the franchise and includes both M&A and restructuring. Asset management has a solid foothold, and average assets under management levels have trended higher over the past several years.
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. 28 Apr 2015)
Dodd-Frank Rating Information Disclosure Form