Fitch Rates Cantor Fitzgerald's L-T IDR 'BBB'; Outlook Stable


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October 6, 2009 2:49 PM EDT

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a long-term Issuer Default Rating (IDR) of 'BBB' and short-term IDR of 'F2' to Cantor Fitzgerald, L.P. (Cantor). The Rating Outlook is Stable.

The ratings incorporate a number of quantitative and qualitative factors, many of which are outlined in the criteria report 'Rating Methodology for Securities Firms and Investment Companies' dated April 21, 2006. The Stable Outlook reflects Fitch's expectations that low risk businesses remain primary revenue generators, profitability is sustained, risk appetite is controlled, liquidity is readily accessible, operational risk management is effective and capital levels are sufficient to support the franchise.

A key ratings consideration is Cantor's moderate risk profile. In its primary role as intermediary, the company takes limited balance sheet risk. As principal, it matches buyers and sellers with little, if any, gap between the two sides in delivery-versus-payment settlement. And in 'give-up' transactions, Cantor arranges the trade between third parties; the negotiated terms are then executed directly between the buyer and seller. Cantor provides a variety of fixed income and equity products in this sales and distribution model, including agencies, treasuries, MBS, corporate debt, global equities, and derivatives.

Counterparty risk appears to be well-managed through client selection, netting and collateral agreements and use of exchanges. Trading limits are established based on internal risk ratings, anticipated estimated trading activity and potential exposure to the instruments traded. The client base is diversified in each of the three main business segments. Aggregate customer exposures are closely monitored for concentrations. Losses due to counterparty default have been both rare and modest.

Market risk is also contained. Limits are in place and positions are reviewed by senior management daily. There is no proprietary trading conducted; unmatched or open positions may only be held temporarily to facilitate customer flows and Cantor maintains stringent monitoring of aged inventory. Inventory is limited in size, comprised of highly liquid securities, with high turnover.

The company has enjoyed steady revenue growth over the past several quarters, gaining marketshare in a number of select business lines. Operating profits have been generated consistently since fiscal year 2006 (FY06), even during the recent global economic turmoil. The company has taken advantage of increased opportunities as the larger, public securities firms retrench and smaller firms seek scale. And while Fitch views operational risk management as a key issue for all securities firms, it is especially important for Cantor given its recent and anticipated growth. As the company continues to pursue organic and acquired growth, it will be challenged to obtain the technical and human resources needed to successfully address integration and ongoing operational risks.

Beyond infrastructure, a number of the targeted businesses, such as prime brokerage, will also require more capital resources. Fitch will follow the company as its expansion efforts evolve, with particular interest in revenue diversity, earnings generation, and resource allocation (capital, personnel, and systems).

Compensation expense is by far the largest expense category for Cantor, which is common for companies in the broker-dealer sector. This expense usually falls in the range of 48%-52% of net revenues for the larger, public firms. For Cantor, however, the compensation expense ratio was 60.8%, 61.4% (57.6% excluding one-time adjustment) and 59.1% in FY07, FY08 and first half 2009 (1H09), respectively. Cantor's high compensation ratio can be attributed to three primary factors: (1) The company has a variable compensation policy; most of the revenue generating employees and partners are paid a small salary, plus a percentage of the net revenues they generate. (2) A number of non-cash items related to various stock-based award programs make up a component of compensation expense; allocations under these programs are non-cash items. (3) Forgivable loans to employees, and salary/bonus advances are provided by the company; the resulting amortization expense is included in compensation expense. The variable compensation rate - the most significant influence on the ratio - ranges between 40%-60%, depending on the business segment, product, employee's experience, and book of business.

Liquidity is managed on an operating entity basis, under the centralized authority of executive management at the holding company. With this structure, the franchise can efficiently deploy available resources internally. Excess liquidity is maintained at the main operating companies as well as at the holding company. Intercompany and external facilities are in place to address any funding gaps that may arise. Access to secured government facilities such as the primary dealer credit facility (PDCF) and the term securities loan facility (TSLF) are available. (There is no utilization currently.) General collateral funding via FICC is also available. The company also has uncommitted repo and stock loan facilities in place, although these may be less reliable in times of general market stress, despite high collateral quality.

Cantor is a broadly held partnership. There were approximately 1,000 Cantor and BGC Partners, Inc. (BGCP) partners at June 30, 2009. The capital structure, primarily designed to attract and motivate talent, provides a basic level of support for the balance sheet. Each partner is targeted to maintain a minimum investment, but most hold interests in excess of targeted minimums. These interests vest, and are non-tradable. Because of the illiquid nature of most equity purchases by and awards to partners, this capital is considered relatively sticky. Liquidation of individual partnership interests is subject to some constraints, namely: non-compete agreements, deferred payouts over a number of fiscal periods, an aggregate limit on redemptions, minimum capital covenants, and net capital requirements. Non-controlling (minority) interest and founding/working partners' capital constitute additional ownership interests that are available to support balance sheet assets.

When given the opportunity to monetize partnership interests, partners often leave their investments in equity shares, because yields are so attractive. Fitch views such demonstrated commitment positively. Not only do these interests provide fundamental support to the going concern, but large ownership holdings by active employees and partners often tend to naturally temper risk appetite, so as not to jeopardize an individual's personal wealth.

There are multiple layers in the Cantor partnership structure, with various capital classes entitled to specific distributions. Some classes receive pre-tax distributions; BCG's public shareholders receive post-tax distributions. The end result is a high level of earnings distribution. As a result, growth in the capital base is primarily from direct ownership investment. At this time, the capital base is considered low, absolutely and relative to peers. But because the company's core trading businesses are not capital intensive and have limited credit risk, such modest levels are more tolerable. Should the company radically alter its business model such that trading intermediation is no longer the primary activity and/or more capital intensive activities are conducted, a concomitant increase in capital levels would be necessary to maintain the current ratings.

Presently, the company's capital has to support a large matched book business. And because of capital levels vis-a-vis total balance sheet size, the company's leverage levels fall on the higher end of the range for broker-dealers. Further, like its peers, Cantor's leverage multiples are declining. Nevertheless, near-term leverage levels may fluctuate over the next several years; adjusted and net adjusted leverage must be monitored.

Management has an ambitious plan to increase the number of product lines over the next 12-24 months. Among the areas targeted for growth and/or development are energy, commodities, foreign exchange, equity derivatives, commercial real estate, and prime brokerage. In theory, the expenses and capital outlays would be determined, in large part, by the variable compensation cost structure. Financial commitments would also be limited by the intermediary trade activity, and inherently low capital requirement for advisory services. Systems and procedures are already in place for sales and trading activities, so the addition of new instruments to trade may not entail radically different technology or personnel. However, some new businesses such as prime brokerage will have significant systems, legal and administrative functions that will have to be created and/or enhanced.

The business of Cantor and its subsidiaries is primarily wholesale and institutional brokerage of over-the-counter (OTC) financial instruments and related derivatives. Treasury dealer, repo and securities lending, investment banking, and market data and analytics round out the menu of products and services. The major subsidiaries of this private partnership are: Cantor Fitzgerald & Co. (CFCo), the U.S. broker-dealer; Cantor Fitzgerald Europe, the UK broker-dealer; and BGC Partners, Inc. (BGCP), formerly eSpeed Inc. Headquartered in New York City, Cantor has 18 offices in Europe and Asia. Cantor is owned by CF Group Management, Inc., the managing general partner, and several hundred limited partners.

Fitch rates Cantor Fitzgerald, L.P. as follows:

--Long-term IDR at 'BBB';

--Short-term IDR at 'F2'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. 


    Source: Fitch Ratings

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