September 19, 2017 / 5:59 PM / a year ago

Fitch Revises N M Rothschild's Outlook to Stable; Affirms IDR at 'BBB+'

(The following statement was released by the rating agency) LONDON, September 19 (Fitch) Fitch Ratings has revised N M Rothschild & Sons Limited's (NMR) Outlook to Stable from Positive, while affirming the firm's Long-Term Issuer Default Rating (IDR) at 'BBB+' and Short-Term Issuer Default Rating at 'F2'. The perpetual subordinated notes issued by NMR's subsidiary, Rothschilds Continuation Finance PLC (RCF), have been upgraded to 'BBB-' from 'BB+'. NMR is a UK-domiciled subsidiary of Paris-based Rothschild & Co (R&Co), the finance holding company of one of Europe's largest financial advisory groups. Together with Paris-based Rothschild Martin Maurel (RMM, 'A'/Negative), NMR is R&Co's main operating subsidiary. KEY RATING DRIVERS IDRS AND SENIOR DEBT The revision of NMR's Rating Outlook to Stable largely reflects Fitch's view that despite improvements in NMR's asset quality and leverage in recent years, they have not been sufficiently meaningful as to fully offset the inherent cyclicality in NMR's relatively concentrated business model. NMR's reliance on UK-based activity - where we expect more challenging advisory conditions - also means that any further progress in financial metrics will likely be slower than previously expected by Fitch. The affirmations of NMR's IDRs reflect the institution's strong European and, to a lesser extent, global advisory (GA) franchise, good levels of profitability which have remained robust through multiple economic cycles, an increasingly low-risk balance sheet, low leverage, strong capitalisation and healthy liquidity. NMR's IDRs are primarily constrained by the monoline nature of the business model and the inherent cyclicality of the financial advisory industry. The GA business accounts for the vast majority of NMR's revenue, with the remainder attributable to growing credit management and, to a lesser extent, the real estate debt management business. The GA business benefits from the overall Rothschild franchise, which is strong in the UK and Europe, particularly in UK and French mid-cap markets. R&Co enjoys strong league table positions in UK and European M&A, restructuring and equity advisory and continues to improve its position in the rankings. Rothschild's franchise in North America and Asia is less well-established, which means that unlike some of its peers it lacks a globally dominant franchise. Profitability levels are strong at NMR, underpinned by lower loan impairment charges, lower funding costs and the resilient performance of the core advisory business. GA revenue is well diversified by sector (the largest sector generally accounts for around 20% of gross fee income) but somewhat concentrated in its home market (the UK generally accounts for around 60% of fees). NMR's cost base is high, reflecting the company's business model, but NMR has demonstrated an ability to adjust its cost base to ensure adequate profitability in adverse market conditions. NMR's credit risk arises predominantly from the legacy loan book (mainly comprising secured UK commercial property loans), which has a high level of impaired loans. In financial year ended March 2017, NMR made progress in reducing this exposure by GBP43 million to leave the legacy loan portfolio standing at GBP117 million (GBP81 million net of provisions). Additionally, NMR's reserve coverage is, in our view, adequate as illustrated by a small provision write-back in 2017. Credit exposure related to European CLO risk retention rules is small in NMR, but larger in NMR's subsidiary, Five Arrows Managers LLP (FAM). Given NMR's expansion plans for its credit management business we expect CLO-related credit risk to moderately increase in 2018. NMR's gross debt/EBITDA ratio (including 50% of its outstanding subordinated perpetuals as debt in line with Fitch's equity credit approach) stood at around 0.7x at FYE17, which compares well with securities firm peers. NMR's common equity Tier 1 (CET1) ratio at FYE17 was a sound 36.3% (FYE16: 21.7%). While internal capital generation is sound, dividend pay-out ratios are high relative to banks but in line with other cash-generative businesses such as investment managers or advisory firms. NMR's dividend pay-out ratio could increase following the retirement of NMR's banking license, as capital requirements have reduced (NMR is now solely regulated by the UK's Financial Conduct Authority). However, we believe that management intends to maintain NMR's absolute capital base at current levels. NMR's adjusted business model as a result of the retirement of the banking license has drastically reduced funding needs, with all customer deposits fully repaid in 2016. External debt is limited to GBP124 million of perpetual subordinated notes, carried at historical fair value. Liquidity is sound with a strong interest coverage ratio boosted by resilient earnings and lower interest costs. As a fully owned subsidiary of R&Co, NMR's disclosure and reporting requirements are less extensive than those of listed peers and R&Co manages its businesses largely across segments (e.g. GA) as opposed to legal entities. Since 2016, NMR reports on an unconsolidated basis. Family ownership has also resulted in a stable management team and distinct corporate culture. The programme ratings of RCF, a fully owned subsidiary of NMR, are driven by an unconditional and irrevocable guarantee by NMR. The ratings are equalised with NMR's IDRs. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The upgrade of RCF's perpetual subordinated notes (upper Tier 2 notes) to 'BBB-' from 'BB+' reduces the notching of the notes to two notches below NMR's Long-Term IDR from three notches, reflecting Fitch's expectation of lower loss probability in light of NMR retiring its bank license. Under Fitch's corporate hybrid criteria, the notes qualify for 50% equity credit. RATING SENSITIVITIES IDRS AND SENIOR DEBT NMR's ratings are primarily sensitive to the stability and resilience of GA revenue, and the resultant impact on NMR's profitability, leverage and interest coverage. Improvements in NMR's non-European GA franchise reducing the firm's reliance on the UK and, to a lesser extent, continental European market, for revenue generation could support a positive rating action as could improvements in EBITDA margin. An inability to generate adequate GA revenue in more challenging domestic market conditions or to swiftly adjust the cost base would be rating-negative. However, NMR has demonstrated the robustness of its business model during past downturns and the counter-cyclical restructuring business could aid stability. More aggressive capital or liquidity management following the return of its banking licence or worsening leverage metrics, though not expected by Fitch, would also be rating-negative. In addition, NMR's ratings remain sensitive to damage to Rothschild's reputation or franchise, which would impair the ability to attract new GA business. The programme ratings of RCF are primarily sensitive to a change in NMR's Long-Term IDR. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Similarly, the ratings for the subordinated notes are primarily sensitive to a change in NMR's Long-Term IDR. The rating actions are as follows: N M Rothschild & Sons Limited Long-Term IDR: affirmed at 'BBB+'; Outlook revised to Stable from Positive Short-Term IDR: affirmed at 'F2' Rothschilds Continuation Finance PLC Senior unsecured programme affirmed at 'BBB+'/'F2' Perpetual subordinated notes (guaranteed by NMR): upgraded to 'BBB-' from 'BB+' Contact: Primary Analyst Nalini Kaladeen Director +44 20 3530 1806 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Marc Ellsmore Associate Director +44 20 3530 1438 Committee Chairperson Nathan Flanders Managing Director +1 212 908 0827 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Global Non-Bank Financial Institutions Rating Criteria (pub. 10 Mar 2017) here Non-Financial Corporates Hybrids Treatment and Notching Criteria (pub. 27 Apr 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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