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Fitch Affirms Tullett Prebon at 'BBB-'; Outlook Stable
September 30, 2016 / 5:16 PM / a year ago

Fitch Affirms Tullett Prebon at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, September 30 (Fitch) Fitch Ratings has affirmed Tullett Prebon plc's (Tullett) Long-Term Issuer Default Rating (IDR) of at 'BBB-'. The Outlook is Stable. At the same time, Fitch has affirmed the rating of Tullett's senior unsecured debt at 'BBB-'. The rating actions have been taken in conjunction with Fitch's periodic inter-dealer brokers peer review (see 'Fitch Reviews Inter-Dealer Brokers' on KEY RATING DRIVERS LONG-TERM IDR AND SENIOR DEBT The affirmation of Tullett reflects our view that following the planned acquisition of ICAP's global broking business, expected to close in 4Q16, Tullett's company profile will benefit from a much-enlarged global franchise in voice and hybrid brokerage. This should improve the institution's economies of scale and mitigate sector-wide earnings pressure on voice and hybrid broking revenue. However, the ratings also take into account Tullett's increased leverage (gross debt/adjusted EBITDA) which based on our estimates will approach 2.4x after the transaction's close, just below our 2.5x 'BBB' threshold for negative rating action. Following the ICAP global broking acquisition, Tullett will become the largest traditional inter-dealer broker by financial broking revenue with a strengthened franchise in the US where its operations have been sub-scale in recent years. The transaction will be largely financed through the issuance of new Tullett shares and GBP450m in senior debt, which Tullett intends to issue by end-2017. Under our base case (which assumes moderate revenue attrition from overlapping desks), Tullett's post-transaction revenue base will almost double. We view Tullett's profitability as adequate and the acquisition should in the medium-term be supportive of Tullett's EBITDA margin (EBITDA/revenue of 16.3% in 1H16). However, front-loaded costs to achieve post-transaction savings, notably with regard to support function and IT systems, will likely lead to a reduced EBITDA margin in 2017 before recovering in 2018 and beyond. Given the complementary nature and considerable size of the acquired businesses, planned cost synergies (and associated costs-to-achieve) are sizeable compared with Tullett's pre-transaction EBITDA. Cyclical (eg. low interest rates) and structural (eg. deleveraging of banks) factors will in our view continue to exert pressure on Tullett's core revenue in traditional broking in the medium-term. In 1H16, Tullett was able to compensate lower revenue from traditional businesses such as interest rate derivatives or treasury products with improved revenue from its equities franchise and notably its recently strengthened energy and commodities businesses. Nonetheless, Tullett remains less diversified than its peers and thus more reliant on developments in traditional broking businesses. Tullett's risk appetite is low and we do not expect the acquired businesses to materially alter the company's risk profile. Tullett's broking businesses are predominately transacted on a "name give-up" basis which does not expose Tullett to counterparty risk ("matched principal" and "execution only" transactions which give rise to counterparty and settlement risks accounted for a moderate 20% and 5% of brokerage revenue in 2015). Operational risk, while more significant than credit or market risk, is well-controlled and litigation exposure is in line with peers. The transaction includes a warranty from ICAP that covers the potential exposure to the outcome of the US dollar ISDAFIX rates investigation. However, at least during the early stages of the integration period, we view execution and operational risk as elevated. Tullett's leverage (1.4x at end-1H16 or 2.0x if sizeable exceptional costs are deducted from EBITDA) will in our base case increase to around 2.4x after the transaction's close. This assumes a fall in combined revenue of around 5% but also assumes that all expected front and back office cost savings are realised. We view leverage under 2.5x as commensurate with Tullett's ratings. As of end-July 2016, Tullett's outstanding debt, GBP220m in total, consisted of GBP80m senior notes maturing in 2019 and a GBP140m draw-down on its GBP250m revolving credit facility (RCF) to repayGBP141.1m senior notes that matured in July 2016. Upon closing of the transaction, Tullett will enter into a GBP470m bridge facility to repay the RCF draw-down and GBP330m in debt that will have been acquired as part of the transaction. Tullett intends to refinance the bridge facility (which matures at end-2017) by issuing senior debt of a similar amount. We therefore expect Tullett's debt levels to peak at GBP550m before falling to around GBP450m in 2019. Tullett's EBITDA/interest expense cover (around 6x in 1H16) has historically been stable and commensurate with the 'BBB' rating category. Tullett operates with an investment firm consolidation waiver, which requires it to meet consolidated capital requirements at waiver expiry. We expect the terms of the new waiver (necessary following the acquisition) to include similar requirements to reduce a wider capital deficit, defined as the shortfall between its capital resources and its consolidated capital requirements ("excess goodwill"). We view the requirement to reduce the shortfall as positive for creditors as it will require Tullet to improve the quality and size of its capital base. RATING SENSITIVITIES LONG-TERM IDR AND SENIOR DEBT Given the increase in Tullett's post-transaction leverage and our view that pressure on traditional broking revenue will likely persist, upside is limited in the short- to medium-term and would require a material reduction in leverage in conjunction with further diversification in Tullett's product offering and client base. On the downside, Tullett's ratings are primarily sensitive to greater-than-expected revenue decline or material delay in realising cost synergies, both of which would negatively affect Tullett's EBITDA. Should Tullett's gross debt/adjusted EBITDA exceed 2.5x on a sustained basis, this would put Tullett's Long-Yerm IDR under pressure. A material delay in refinancing the bridge facility post-transaction, which could indicate the expectation of higher interest expenses (and lower EBITDA cover) would also be rating-negative. In the medium-term, inability to eliminate excess goodwill in line with expectations, for instance, due to earnings pressure in conjunction with an unchanged dividend policy, could also lead to a downgrade. Similar to all IDB peers, Tullett's ratings are also sensitive to outsized operational losses and negative repercussions from regulatory or legal investigation. Contact: Primary Analyst Christian Kuendig Senior Director +44 20 3530 1399 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Luis Garrido Analyst +44 20 3530 1631 Committee Chairperson Sean Pattap Senior Director +1 212 908 0642 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: Additional information is available on Applicable Criteria Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1012487 Solicitation Status here Endorsement Policy here ail=31 ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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