Fitch Affirms N M Rothschild at 'BBB+'; Outlook Positive
At the same time, Fitch has affirmed NMR's Viability Rating (VR) at 'bbb+',Support Rating at '5', Support Rating Floor at 'No Floor' and simultaneously withdrawn them.
The VR, SR and SRF were withdrawn due to a reorganisation of the rated entity, notably the return of NMR's banking licence, which results in Fitch assessing NMR under its Global Non-Bank Financial Institutions (NBFI) criteria.
NMR is a UK-domiciled subsidiary of Paris-based Rothschild & Co (R&Co, previously Paris-Orleans), the finance holding company of one of Europe's largest financial advisory groups. Together with Paris-based Rothschild & Cie Banque (RCB, A/Stable), NMR is R&Co's main operating subsidiary.
Following the sale of its leasing subsidiary (Five Arrows Leasing) to Paragon Group of Companies PLC (BBB-/Stable), NMR announced in April 2016 that it intended to retire its banking licence and redeem its remaining customer deposits. All customer deposits had been redeemed by early August 2016 and NMR received Prudential Regulation Authority approval to relinquish its licence on 19 September.
The Positive Outlook on NMR reflects progress made in winding down legacy assets (predominately UK commercial real estate exposure), which over time will result in diminishing tail risk from legacy asset-related credit events and improving capitalisation and leverage metrics.
KEY RATING DRIVERS
NMR's VR reflected Fitch's assessment of the institution's standalone strength as a bank. Following the return of its banking licence, Fitch assesses NMR under its NBFI criteria. As Fitch typically does not assign VRs to NBFI (apart from cases where sovereign support is likely which, in our view, is not the case with NMR), Fitch has affirmed and simultaneously withdrawn NMR's VR. Since prior to the withdrawal, NMR's Long-Term IDRs were driven by the institution's VR, the key rating drivers for NMR's IDRs (see below) also apply to the now withdrawn VR.
IDRS AND SENIOR DEBT
NMR's IDRs are underpinned by the institution's dominant European and, to a lesser extent, global advisory franchise (GA), sound track record in generating adequate profitability through multiple economic cycles, increasingly low-risk and liquid balance sheet, low leverage and strong capitalisation.
The IDRs also reflects NMR's well-managed exposure to reputational, operational and conduct risks, but also a heavy cost and the inherent cyclicality of the financial advisory industry. NMR's GA division accounts for the vast majority of the institution's revenue, while a nascent credit management division represents most of the remainder.
The GA franchise benefits from NMR being part of the wider Rothschild group and its operational integration into R&Co has increased since the reorganisation of the Rothschild group in 2014 and 2015. GA revenue is fairly well diversified by advisory type and sector (no sector accounted for more than 15% of GA revenue in the financial year to end-March 2016) and NMR enjoys strong league table positions in UK and European M&A, restructuring and equity advisory, with slightly improved rankings in 1H16.
After the UK's vote in June 2016 to leave the EU, we believe the outlook for M&A, notably in the UK, has become more uncertain, which could affect NMR's advisory pipeline in 2H16 and 2017, as it accounts for a sizeable proportion of advisory revenue. However, we expect any negative impact to remain limited to M&A advisory revenue, with at least partial compensation from increasing revenue from NMR's restructuring franchise. The latter tends to benefit from more challenging operating environments such as in 2009 and 2010 when the global financial crisis led to a rise in the proportion of restructuring-related advisory revenue. In addition, NMR has demonstrated an ability to swiftly adjust its cost base and to ensure adequate revenue in adverse market conditions.
NMR's asset quality benefitted from progress in reducing legacy exposures in FY16 (gross legacy loans accounted for 26% of NMR's unconsolidated Fitch Core Capital (FCC) compared with 66% of consolidated FCC at FYE15). While we expect progress in winding down legacy assets to be slower in 2H16 and 2017, partly because of negative repercussions of the Brexit vote, we believe that tail risk from NMR's legacy assets is now becoming immaterial. Credit exposure related to European CLO retention rules at FYE16 was small but given NMR's expansion plans for its credit management business we expect CLO-related credit risk to moderately increase in 2017.
NMR's adjusted business model and the sale of Five Arrows has drastically reduced funding needs and as of early August 2016, NMR had repaid all its customer deposits in anticipation of the return of its banking licence. External debt is limited to GBP124m perpetual subordinated notes, carried at historical fair value. Liquidity is sound with both NMR's internal liquidity guidance and liquidity coverage ratios comfortably exceeding regulatory minima.
NMR's common equity Tier 1 (CET1) ratio at FYE16 was a sound 21.7% (FYE15: 14.2%) and its gross debt/EBITDA ratio (excluding customer deposits and including 50% of its outstanding perpetual subordinated debt as debt in line with Fitch's equity credit approach) stood at around 0.7x, which compares well with securities firm peers. While internal capital generation is sound, dividend pay-out ratios are high relative to banks. The latter is, however, in line with other cash-generative businesses such as investment managers or advisory firms.
As a fully-owned subsidiary of R&Co, NMR's disclosure and reporting requirements are less extensive than those of listed peers and 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 Rothschild Continuations Finance PLC (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.
SUPPORT RATING AND SUPPORT RATING FLOOR
NMR's Support Rating (SR) of '5' and Support Rating Floor (SRF) of 'No Floor' reflect our view that while support from the authorities is possible, it cannot be relied upon. We have withdrawn both SR and SRF in light of NMR's return of its banking licence since Fitch does not typically assign sovereign support-driven SRs or SRFs to privately-owned non-bank financial institutions in developed countries.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The rating of RCF's perpetual subordinated notes (upper Tier 2 notes) is based on the guarantee provided by NMR. Under Fitch corporate hybrid criteria, the notes are rated three notches below NMR's Long-Term IDR and qualify for 50% equity credit.
IDRS AND SENIOR DEBT
We expect market conditions for UK and European M&A to be more challenging in 4Q16 and 2017 and evidence that NMR is able to generate adequate GA revenue under these conditions while maintaining stable or improved earnings, capitalisation and leverage metrics would support an IDR upgrade in 2017. Given NMR's continued reliance on the GA division for revenue generation, any upside would be limited to one notch.
A material drop in GA revenue would lead to a revision of NMR's Outlook to Stable. In addition, NMR's ratings remain sensitive to damage to its reputation or franchise, which would impair the ability to attract new GA business. More aggressive capital or liquidity management following the return of its banking licence, though not expected by us, would also be rating-negative.
NMR's compensation ratio remains high relative to many of its peers but we view this as a feature of the company's advisory profile. An inability to swiftly adjust its cost base to falling fee levels in a more adverse market environment, resulting in weaker financial flexibility, would also be rating-negative.
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 Positive
Short-Term IDR: affirmed at 'F2'
Viability Rating: affirmed at 'bbb+'; withdrawn
Support Rating: affirmed at '5'; withdrawn
Support Rating Floor: affirmed at 'No Floor'; withdrawn
Rothschild Continuations Finance PLC
Senior unsecured programme rating affirmed at 'BBB+'/ 'F2'
Hybrid debt (guaranteed by NMR): affirmed at 'BB+'