S&P: Waddell & Reed Financial Inc. 'BBB/A-2' Ratings Affirmed; Outlook Remains Negative
"The rating affirmation primarily reflects WDR's strong level of unrestricted cash and cash equivalents, which far outweighs the company's debt obligations," said S&P Global credit analyst Trevor Martin. Despite this, the outlook remains negative because of the company's continued weak short-term investment performance and net outflows. We believe recent secular headwinds for active managers may make it more difficult for WDR to reverse the flow trend. Moreover, the company experienced a higher level of turnover the last few years, with portfolio managers departing and a new CEO in August 2016.
Similar to many highly rated asset managers, WDR maintains ample liquidity on the balance sheet. As of June 30, 2016, the company had $467 million of cash and cash equivalents. A small portion of this is restricted due to regulatory requirements at subsidiaries, but we net the remaining amount from debt in our leverage calculation. In our opinion, the surplus cash will decline as the company maintains its dividend and continues to repurchase shares. But we still expect it to remain high relative to the company's outstanding debt. At the same date, the company had $362 million of investment securities.
Over the next 18-24 months, we expect WDR to continue to lose assets, albeit at a slower pace. We believe AUM could drop to $80 billion to $85 billion in 2016 and $75 billion to $80 billion the following year. Although we expect investment performance to rebound, we believe it will remain muted and that it will take time for the company to revert to net inflows on a sustained basis.
We are likely to lower the rating if the decline in AUM is more rapid than we anticipate or if the company's flow performance significantly trails peers'. We could also lower the rating if investment performance remains poor over the short-term, although that would likely result in continued outflows.
We believe an upgrade is unlikely over the next 18-24 months. We would likely revise the outlook to stable if we see a reversal of the outflow trend across several quarters combined with a lower level of volatility in AUM. Additionally, a revision to stable would be contingent upon the company improving its investment performance.