Fitch Revises Och-Ziff's Outlook to Negative on AUM Outflows; Ratings Affirmed at 'BBB-'
Fitch Ratings has revised Och-Ziff Capital Management Group LLC's (OZM) Rating Outlook to Negative from Stable. At the same time, Fitch has affirmed OZM's Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'BBB-'.
KEY RATING DRIVERS - IDR AND SENIOR UNSECURED DEBT
The revision of the Rating Outlook to Negative from Stable follows yesterday's reported $3.2 billion decline in assets under management (AUM) for the month of June, representing a decline of 7.5% versus the prior month. While the AUM decline was driven in part by performance pressure generally consistent with the broader hedge fund universe, outsized investor redemptions appear to be the primary driver in OZM's case. Year-to-date through June 2016, the net return of the OZ Master Fund, which represents more than 50% of OZM's AUM, was -2.14% while overall AUM was down 13.8% over the same time period.
The material outflows in June follow OZM's announced establishment of a $200 million reserve on May 3, 2016 reflecting the probable and estimatable amount of a potential monetary settlement with the Securities and Exchange Commission and Department of Justice in regards to an on-going Foreign Corrupt Practices Act (FCPA) investigation.
From a quantitative perspective, Fitch believes that the combination of increased AUM outflows, elevated debt as a result of recent (and potential future) reserves, and on-going legal expenses have the potential to further pressure OZM's leverage, interest coverage and liquidity resources over the Outlook horizon. From a qualitative perspective, Fitch believes the AUM outflows and on-going regulatory investigation signal increased pressure on OZM's franchise and fund-raising capability.
On OZM's first quarter 2016 (1Q16) earnings call, the company's CFO stated that it is "probable that the final amount of the monetary settlement will be greater than the reserve, but at this point in time we're unable to reasonably estimate what that amount would be." OZM also stated that it is still expecting resolution of the investigation by "midyear". Fitch does not have any information regarding the outcome of the on-going investigation aside from what OZM has publicly disclosed.
During 2Q16, OZM drew $120 million of its $150 revolving credit facility and held the proceeds in cash to pre-fund the potential monetary settlement, which reduced available liquidity resources and increased leverage. Pro forma for the draw, Fitch-calculated debt to FEBITDA increased to 3.5x from 2.7x for the trailing 12 months (TTM) ending 1Q16. Between 2011 and TTM 3Q15, Fitch-calculated leverage was under 2.0x. Fitch would view sustained debt to EBITDA in excess of 3.5x as a negative rating driver.
Resolution of the FCPA investigation would likely begin to reverse OZM's current earnings drag from elevated legal expenses, albeit with some lag. Without the on-going legal expenses, earnings (and thus leverage and interest coverage) could improve, assuming there are not offsetting AUM outflows. Assuming the settlement does not include a guilty plea on the part of OZM and/or material additional cost, it could also reduce investor uncertainty with respect to OZM's franchise. Lastly, OZM has the discretion to meet settlement obligations or repay outstanding revolver indebtedness via cash on hand ($228.7 million at 1Q16), retained earnings (as was retained in 1Q16) and other capital raising transactions including voluntary partner capital contributions.
The rating affirmations reflect OZM's long-term performance track record, particularly in the firm's core multi-strategy hedge fund business; acceptable leverage and interest coverage metrics; strong core profitability; and a seasoned management team.
Key rating constraints beyond those articulated in the Negative Outlook rationale above include the elevated level of market risk due to the meaningful amount of net asset value-based management fees; key man risk associated with the firm's founder and CEO, Daniel Och; and less diversified, albeit improving, AUM relative to higher-rated alternative investment manager peers.
The affirmations of IDRs assigned to OZ Management LP, OZ Advisors LP and OZ Advisors II LP maintain the equalization of the ratings with those assigned to OZM, reflecting the joint and several guarantees amongst the entities.
The affirmation of the senior unsecured debt maintains the equalization with OZM's IDR reflecting the expectation of average recovery prospects for the instrument.
RATING SENSITIVITIES - IDR AND SENIOR UNSECURED DEBT
OZM's ratings could be downgraded if the on-going FCPA investigation and/or investment underperformance lead to AUM outflows, increased debt, or elevated expenses which translate into sustained leverage above 3.5x, interest coverage below 5.0x or materially reduced liquidity resources. If Fitch believes that OZM's franchise or fund-raising capability has been materially impaired, this could also contribute to negative rating actions. To the extent that an FCPA settlement includes a guilty plea on behalf of OZM, this could increase the magnitude of any potential negative rating action. OZM's ratings continue to remain sensitive to a key man event with respect to Daniel Och.
A revision of the Outlook to Stable from Negative would be contingent upon a resolution of the FCPA investigation which does not materially impact OZM's financial position, fund-raising capabilities or franchise, combined with a stabilization of OZM's investment performance and flows. Put another way, a financially-manageable resolution of the FCPA investigation would not be likely to result in a revision of the Outlook to Stable until such time as Fitch could reasonably determine the longer-term impacts on OZM's franchise and fund-raising capabilities.
Thereafter, positive rating drivers could include a continued increase in AUM and fee diversity, particularly towards committed capital structures, seasoning in some of the firm's newer businesses, and rebounds in margins, leverage, interest coverage and liquidity toward historical levels. A reduction in key man risk through broader key man triggers at the fund level, a more diverse voting structure, and continued development of the senior leadership group, would also be viewed positively.
The senior unsecured debt rating is equalized with OZM's IDR and therefore, would be expected to move in tandem with any changes to OZM's IDR. Were OZM to incur material secured debt, this could result in the unsecured debt being rated below OZM's IDR.
OZM is an alternative investment manager with expanding credit and real estate businesses. The firm managed $39.2 billion of AUM (as of July 1, 2016), with 638 employees in eight offices worldwide (as of March 31, 2016).
Fitch has affirmed the following ratings:
Och-Ziff Capital Management Group LLC
OZ Management LP
OZ Advisors LP
OZ Advisors II LP
-- Long-Term IDRs at 'BBB-'.
Och-Ziff Finance Co. LLC
-- Long-Term IDR at 'BBB-';
-- $400 million senior unsecured debt at 'BBB-'.
The Rating Outlook has been revised to Negative from Stable.
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
Fitch Ratings, Inc.
Nathan Flanders, +1-212-908-0827
33 Whitehall St.
New York, NY 10004
Meghan Neenan, CFA, +1-212-908-9121
Joo-Yung Lee, +1-212-908-0560
Media Relations, New York
Hannah James, +1-646-582-4947