TEXT-S&P cuts ConvergEx Group rating to 'B', outlook is stable
Overview -- ConvergEx Group's earnings and debt-to-EBITDA leverage in the first nine months of 2012 were weaker than we expected because of sluggish market activity and slower-than-expected debt reduction. -- Also, the U.S. Department of Justice and the SEC are investigating the firm, which heightens our concerns about its enterprise risk management. We also believe the escalating legal costs could inhibit the company's financial flexibility. -- We are lowering our long-term counterparty credit rating on ConvergEx to 'B' from 'B+'. In addition, we are lowering our debt rating on the firm's first-lien senior secured credit facility to 'B' from 'B+' and our rating on its second-lien credit facility to 'CCC+' from 'B-'. -- The stable outlook reflects our expectation that ConvergEx will gradually reduce debt and maintain interest coverage and leverage metrics that are more in line with the 'B' rating category. Rating Action On Nov. 30, 2012, Standard & Poor's Ratings Services lowered its long-term counterparty credit rating on ConvergEx Group LLC to 'B' from 'B+'. The outlook is stable. We also lowered our rating on ConvergeEx's first-lien senior secured credit facilities to 'B' from 'B+' and our rating on its second-lien secured credit facility to 'CCC+' from 'B-'. The recovery ratings on the first-lien and second-lien debt remain '4' and '6', respectively. Rationale Standard & Poor's rating action on ConvergEx is based on the company's weakened financial profile due to high debt leverage and subpar operating performance, including its weak interest coverage, declining overall earnings, less-than-adequate cushion against its covenants, the increasing level of costs and affected business lines in relation to the ongoing SEC and Department of Justice (DoJ) investigations, weak risk management, and negative tangible equity. The company's low-risk, institutional trade execution business model and well-positioned investment technology business partly offset these weaknesses. ConvergEx was formed in October 2006 in a highly leveraged transaction. As a result, the company has since carried a heavy debt load, with negative tangible equity and weak interest coverage. ConvergEx completed a debt restructuring at the end of 2010, in which it refinanced $750 million of debt into a $610 million first-lien term loan due in 2016 and a $140 million second-lien term loan due in 2017. This transaction significantly improved the duration of the company's debt maturity profile. As of Sept. 30, 2012, the first-lien debt outstanding was $581.5 million, and second-lien debt was $140 million. ConvergEx has trailing-12-months (as of Sept. 30) adjusted EBITDA of $152 million, and we continue to view its debt-to-EBITDA ratio of 4.8x as high and its EBITDA-to-cash interest coverage ratio of 3.2x as weak. The company's revenue is divided into two primary streams: investment technologies and investment services. Revenue growth has slowed in both businesses in 2012. Investment technologies revenue was down 3.1% (as of Sept. 30, 2012) compared with the same period in 2011, and investment services revenue was down 38.7%. In our opinion, the investment technologies and investment services businesses complement each other and have fairly low risk. The company has partially grown through acquisitions, which were financed primarily with cash on hand, which resulted in lower-than-expected debt reduction associated with its formation in October 2006. The SEC and U.S. DoJ have been conducting parallel investigations since August 2011 regarding certain nonelectronic trade execution practices conducted through ConvergEx's Bermuda subsidiary that conducted high-touch execution business, ConvergEx Global Markets (CGM). Since the launch of the investigation, ConvergEx has closed its trading desks in Bermuda and Hong Kong, including the termination of its employees that violated ConvergEx's Code of Conduct and has enhanced its policies, procedures, and disclosures. But at the same time, ConvergEx has incurred substantial costs in legal fees (which may continue to escalate) since the launch of the investigation in August 2011, which hurt the company's financial performance in the first nine months of 2012. We continue to view ConvergEx's risk management as weak, and we will revisit our assessment once the investigation results are complete. The on-balance-sheet liquidity is a weakness for the ratings, in our opinion. We believe ConvergEx is a non-balance-sheet business that has limited needs for liquidity to fund operations beyond simple trade payables. However, the nature and timing of ultimate resolution are currently unclear, and we think any substantial settlement amount may inhibit the company's current liquidity profile. Excess cash decreased to $66 million as of Sept. 30, 2012, from $82 million a year earlier. ConvergEx has substantial negative tangible equity (negative $497 million as of Sept. 30, 2012). However, since the company doesn't need the balance sheet for its business operations, we consider this less of a risk for the company than we would for a broker that trades principal positions. ConvergEx remains one of the largest independent institutional equity-trading brokers in the U.S. The company's two main business lines, investment technologies and investment services, appear to complement each other, and revenue is split approximately 74% and 26%--the latter including the institutional equity and options trading business. We believe that a portion of the technology revenue is still directly related to brokerage activity, but the segment (especially the software platforms business) has shown resiliency in 2012 in the face of declining trading volumes. We continue to view ConvergEx's institutional broker model as having inherently lower risk than some traditional brokerages because it involves no proprietary trading, and it does not require ConvergEx to hold a securities inventory. ConvergEx's growth between 2006 and 2011 reflects the company's significant investment in its investment technologies group. Management has grown this group both organically by expanding offerings abroad and increasing levels of product development and through acquisitions. In our view, this segment provides the company with diverse revenue streams and a good niche position. Outlook The stable outlook reflects our expectation that ConvergEx will gradually reduce its debt and will not materially change its credit profile over the next 12-18 months. If ConvergEx reduces debt more than we expect, maintains an interest coverage ratio of more than 4.0x, and reduces its debt-to-EBITDA leverage ratio to less than 4.5x on a sustainable basis, we could raise the ratings. Conversely, if the company's liquidity profile weakens substantially, or if interest coverage or leverage deteriorates to within 0.5x of covenant levels, we could lower the ratings. Related Criteria And Research Rating Securities Companies, June 9, 2004 Ratings List Downgraded To From ConvergEx Group LLC Counterparty Credit Rating B/Stable/-- B+/Stable/-- Senior Secured B B+ Recovery Rating 4 4 Subordinated CCC+ B- Recovery Rating 6 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. 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