-- 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
-- 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.
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.
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.
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
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. All ratings affected
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