-- We believe Cantor's profitability and business have suffered from a prolonged period of unsettled regulatory, competitive, and market conditions, affecting most institutional brokers, particularly in the inter-dealer segment, as well as from management's expansion strategy.
-- As a result, we've lowered our ratings on Cantor Fitzgerald L.P., including its issuer credit rating, to 'BBB-' from 'BBB'. The outlook is now stable.
-- We expect that Cantor is likely to face a prolonged period of unsettled business and market conditions that will constrain profitability but that the firm should remain profitable, maintain a modest risk profile, and avoid material funding pressure.
Rating Action On Dec. 3, 2012, Standard & Poor's Ratings Services lowered its ratings on Cantor Fitzgerald L.P., including its issuer credit rating, to 'BBB-' from 'BBB'. We have also affirmed our 'BBB-' rating on Cantor's subsidiary, BGC Partners Inc. The outlook on Cantor Fitzgerald is stable.
Rationale The rating reflects our view that Cantor's profitability and business have suffered from a prolonged period of lower trade volumes, unsettled securities markets, and competitive and regulatory changes affecting most institutional brokers, particularly inter-dealer brokers. Given our belief that these conditions are likely to continue, as well as Cantor's increased business risk from management's expansion efforts, we believe the company's profitability and business profile are now more consistent with a 'BBB-' rating. We affirmed the ratings on BGC because we now consider it a "core" subsidiary of Cantor as a result of increased evidence of the strong strategic, management, and operational connections between the two entities.
Our ratings on Cantor are based on the company's franchise as a midsize, agency sales- and trading-focused institutional securities broker. The ratings are also based on its adequate financial profile as a result of its relatively modest exposure to principal risk, adequate liquidity, and reliance on short-term wholesale funding. We believe management's opportunistic growth strategy increases operational and business risks and potentially increases the company's financial risks. Over the last year, Cantor has been hiring and investing in several business lines, increased activity and leverage at Cantor Commercial Real Estate (CCRE), and expanded into the commercial real estate brokerage business via two large acquisitions in less than nine months. The expansion has been largely low cost and has not added much debt, but management recently did take on some modest incremental principal risk from increased inventory of equities and corporate debt. We believe Cantor's strategy of operating with lower leverage and limiting its inventory to mostly low risk U.S.
Treasury and agency securities helps to mitigate the inherent confidence sensitivity of a wholesale-funded institutional broker business. We view Cantor's capitalization as a potential issue because we believe leverage at the firm's core brokerage subsidiary, Cantor Fitzgerald & Co., is high, the firm's partnership model limits its ability to retain capital, and capital at BGC and CCRE is not readily available to support the core brokerage business, if needed, because the firm does not fully own those subsidiaries. The rating action also reflects our generally negative outlook for the U.S. institutional brokerage sector. We believe that investors' concern over Europe's ongoing economic and sovereign debt woes, a cooling U.S. economy, and potential U.S. fiscal cliff are likely to continue to dampen trade activity and risk appetite. Given the pervasive nature of these macroeconomic issues, we expect securities markets will likely remain, at best, bumpy as long as major policy and economic issues remain unsettled. Lower trade volumes and regulatory uncertainty have hit the inter-dealer broker segment particularly hard, causing BGC's cash earnings to decline over 25% in the third quarter of 2012, versus the same period in 2011. As Cantor's commercial real estate services business comes more on line, it should help offset some of this decline.
Outlook The stable outlook reflects our expectation that a prolonged period of unsettled business and market conditions will likely constrain profitability but that the firm should remain profitable, maintain a limited risk profile, and avoid funding pressure. We also expect such conditions to encourage management's expansion and diversification efforts but that this will not materially erode the financial profile or increase principal risk.
Should Cantor materially increase its principal risk exposure or leverage, or suffer an unexpected loss, we could downgrade the firm--likely by one notch. Specifically, if the adjusted total equity-to-adjusted assets ratio of consolidated or non-BGC and non-CCRE business were to fall materially from the most recent reported levels, we could lower the ratings. Given the outlook for the sector and Cantor's opportunistic strategy and capital policies, it is unlikely we would upgrade the company in the near term.
Related Criteria And Research Rating Securities Companies, June 9, 2004
Ratings List Downgraded To From Cantor Fitzgerald L.P. Issuer Credit Rating BBB-/Stable/-- BBB/Negative/-- Senior Unsecured BBB- BBB Ratings Affirmed BGC Partners Inc. Issuer Credit Rating BBB-/Stable/-- Senior Unsecured BBB-
