Fitch has lowered Marsh's senior debt rating four notches since the announced civil suit brought against the company by New York Attorney General Elliot Spitzer and allegations of collusion and price rigging. Regardless of the ultimate outcome of the suits, Fitch believes that Marsh will suffer a material decline in its franchise value as a result of the allegations, especially given recent reputation issues suffered in its Putnam mutual fund unit, tied to improper trading practices.
The rating action follows recent reports of potential penalties and settlement costs in addition to continued analysis on the potential long-term impacts from recent investigations on Marsh's operating capabilities and balance sheet position. Fitch has considered various scenarios that will influence both future operating performance and financial leverage levels in the near future. Considerations in Fitch's analysis include:
-- Marsh will eliminate contingent commission revenue, which totaled $845 million in 2003. Contingent commissions provided less than 10% of total revenues in recent periods, but likely contributed 25-35% to total pre-tax earnings. Further, while Marsh may try to offset lost contingent commissions through increases in fees or traditional commission payments, Fitch believes that in the near term a majority of earnings generated by contingent commissions will not be recaptured;
-- Fitch expects Marsh to experience some reduction in general profit margins within its insurance brokerage business, even excluding the impact of lost contingent commissions, on the thought that traditionally high margins in this business will no longer be tolerated by Marsh's clients given recent controversies and need for Marsh to regain credibility and trust. Heightened disclosures of commission levels will further contribute to margin pressures;
-- Fitch believes that Marsh will experience both revenue reductions, and related challenges in shedding fixed costs, due to a likely reduction in market share resulting from recent controversies. This risk could be lessened if other brokers, especially number two positioned Aon, are ultimately named in civil or criminal actions;
-- The likely need to fund fines, penalties and litigation settlements could prove to be a significant cash drain, place near-term pressure on financial leverage ratios and cause one time earnings charges. Fitch also believes Marsh could be susceptible to cash-based restructuring charges, and non-cash goodwill write-downs;
-- Fitch believes Marsh will experience an increase in borrowing costs due to the impact of recent downgrades and the need to ultimately term out short-term borrowings. Pressures on borrowing costs could be mitigated to the extent Marsh generates cash flow that can be used to reduce its sizeable short-term debt burden.
Given that there still exists significant uncertainties as to the ultimate magnitude of the above noted items, Fitch has constructed several scenarios to 'stress' the impact of the fall out from recent developments on key financial measurements at Marsh. In Fitch's opinion, under a reasonable range of stress scenarios, Marsh's cash flow coverage ratio - measured as pretax earnings before interest, depreciation and amortization expense (EBITDA) relative to total interest costs - will likely to drop to within a range of 4-8 times (x) in the foreseeable future. This is a meaningful deterioration from historical levels of approximately 15x.
Further, financial leverage, as measured by total debt relative to EBITDA, would increase to a range of between 2.0x and 3.5x under that same scenarios (barring debt pay-downs). This is a sharp unfavorable increase fr