OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDRs) of Och-Ziff Capital Management Group LLC (OZM), OZ Management LP, OZ Advisors LP, OZ Advisors II LP, and Och-Ziff Finance Co. LLC at 'BBB-'. The $400 million of senior unsecured notes issued by Och-Ziff Finance Co. LLC have also been affirmed at 'BBB-'. The Rating Outlook is Stable.

KEY RATING DRIVERS - IDRs

The rating affirmations and Stable Outlook reflect OZM's established franchise and long-term performance track record, particularly in the firm's core multi-strategy hedge fund business; appropriate leverage and interest coverage metrics; strong profitability; and a seasoned management team. Key rating constraints include the elevated level of market risk due to the meaningful amount of net asset value (NAV)-based management fees; key man risk associated with the firm's founder and CEO, Daniel Och; less diversified, albeit improving, assets under management (AUM) relative to higher-rated alternative investment manager peers; and potential reputational and financial risks associated with the ongoing regulatory investigation by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ).

OZM has demonstrated relatively consistent long-term investment performance, with its multi-strategy platform reporting only three negative years since inception in 1994. For the first nine months of 2015 (9M15), however, performance of the multi-strategy funds has been more challenged, which along with outflows, led overall AUM to decline to $44.6 billion at Sept. 30, 2015 from $47.5 billion at year-end 2014. In particular, OZM's flagship multi-strategy fund, OZ Master Fund, was down 2.1% (net) for 9M15, while the multi-strategy funds as a whole have experienced five consecutive quarters of aggregate outflows, totalling $5.1 billion.

Nevertheless, OZM remains one of the largest hedge fund managers in the world, with significant growth and diversification of its AUM post-crisis. OZM has actively grown its credit and real estate businesses, which have served to offset performance declines and outflows in the multi-strategy platform. While the newer products tend to generate lower management fees, they provide increased AUM and fee diversity, which is viewed positively by Fitch.

The expansion into credit and real estate has also allowed the company to increase the amount of longer-term committed capital (defined as AUM with initial commitment periods of three years or more) to 36.8% of AUM at 3Q15. Despite the continued increase in longer-term AUM, Fitch believes OZM's profitability remains more susceptible to market risk than more highly-rated alternative investment manager peers, since the majority of OZM's management fees are based on NAV, whereas private equity-oriented alternative asset managers benefit from a greater proportion of fees that are based on committed capital. OZM does not publicly disclose an exact amount of AUM against which fees are assessed on the basis of NAV, but the company's filings indicate that their multi-strategy funds and opportunistic credit funds are 'generally' based on NAV. Together these two represented 77% of AUM at 3Q15.

Core operating performance has been strong, driven mainly by consistent growth in management fees, which increased to $660.3 million for the trailing 12 months (TTM) ending 3Q15, up from $628.9 million for TTM 3Q14. The average management fee rate for 9M15 was 1.41% of total AUM, compared to 1.46% at YE2014 and 1.53% at YE2013. The continued decline has been driven primarily by increased AUM from collateralized loan obligations (CLOs) and credit and real estate funds, which generate lower management fees than multi-strategy funds. The average fee rate decline is not viewed negatively by Fitch given the increased earnings diversity and stability that accompanies it.

In its analysis of OZM, Fitch primarily relies on the company's non-GAAP reporting of economic income. Fitch takes a corporate approach, in which the focus is on debt service and cash flow coverage rather than balance sheet analysis. Fitch uses fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) as a proxy for cash flow in its review of OZM's debt service, which consists of management fees, less compensation expenses (including salary and 25% of bonuses), excluding incentive income, less operating expenses plus depreciation and amortization.

The company's FEBITDA, as calculated by Fitch, declined to $233.2 million for TTM 3Q15, down 11.6% from TTM 3Q14. The Fitch-calculated FEBITDA margin at TTM 3Q15 was 35.2%, which is at the lower end of OZM's historical range of 35%-45%, but still near the top of the alternative investment manager peer group. Fitch believes the declines in FEBITDA and FEBITDA margin are primarily attributable to increased non-compensation expenses, namely legal expenses, and to a lesser extent, reduced absolute AUM levels.

OZM also has the capacity to periodically generate a substantial amount of incentive income, which is directly tied to the performance of the funds, and thus can vary depending on the market environment. For example, between 2012 and 2014, OZM averaged $747.4 million of annual incentive income generation, whereas in 2008 and 2011, OZM generated only $12.2 million and $65 million in incentive income, respectively.

OZM's credit ratios have remained stable over the past several years, and compare well to the alternative investment manager peer group. Fitch-calculated debt-to-FEBITDA stood at 1.9x at TTM 3Q15, compared to 1.6x as of Dec. 31, 2014, both of which are consistent with the range OZM has operated within since 2011. The increase in leverage was driven by the decline in FEBITDA and a $2 million increase in debt associated with the financing of a corporate aircraft.

Fitch-calculated FEBITDA-to-interest expense was 12.2x at TTM 3Q15, down from 33.5x at YE2014 reflecting reduced FEBITDA in the numerator and increased interest expense in the denominator as a result of the higher cost of the senior unsecured debt issued in November 2014 (4.50%) relative to the prior secured term loan (L+150). The decline in interest coverage was anticipated by Fitch, given the change in funding costs, and remains consistent with the assigned ratings.

Given management's expectation for legal expenses to remain elevated in coming quarters, Fitch would expect OZM's leverage to increase and its interest coverage to decrease, all else equal. Fitch believes OZM has moderate cushion to absorb further leverage increases and interest coverage decreases without affecting its rating. Fitch's leverage and interest coverage benchmarks for investment managers who assess management fees on the basis of NAV are less than 3.0x and greater than 6.0x, respectively, for the 'BBB' rating category.

Fitch views the ongoing regulatory investigation into the company's conduct related to the Foreign Corrupt Practices Act as a rating constraint, given the uncertainty surrounding the outcome and the potential reputational and financial impacts it could have. While the disclosure of the investigation has not materially impacted the company's fund-raising ability to date, Fitch believes a materially adverse outcome could impact OZM's future fund flows, fundraising and franchise.

Non-compensation expenses remain elevated, relative to historical averages, primarily due to increased legal expenses associated with the on-going regulatory investigation. OZM has publicly disclosed that it expects legal expenses to remain elevated through mid-2016, suggesting a resolution of the investigation is unlikely at least until that time. In assessing the impact of any settlement on OZM's ratings, Fitch would consider the effects on OZM's financial position, franchise and funds flows.

OZM is a publicly traded holding company, and its primary assets are ownership interests in the operating group entities (OZ Management LP, OZ Advisors LP and OZ Advisors II LP), which earn management and incentive fees and are indirectly held through two intermediate holding companies. OZM conducts substantially all of its business through the operating group entities.

Och-Ziff Finance Co. LLC serves as the debt issuing entity for OZM's unsecured debt issuance, and benefits from joint and several guarantees from the management and incentive fee-generating operating group entities. Fitch's analysis of the unsecured debt relies on the joint and several guarantees provided by the operating group entities.

The senior unsecured debt rating is equalized with OZM's IDR reflecting the expectation of average recovery prospects for the instrument. This expectation reflects the minimal secured debt ($50.7 million secured loan associated with the 2015 purchase of a corporate aircraft) in front of the unsecured debt in OZM's capital structure.

RATING SENSITIVITIES - IDRs and SENIOR UNSECURED DEBT

Fitch views upward momentum as limited until and unless the company is able to stabilize recent performance and outflow pressures in its multi-strategy funds and successfully resolve the SEC/DOJ investigation without material impact to its financial position, fund-raising capabilities or franchise.

Thereafter, positive rating drivers could include a continued increase in AUM and fee diversity, particularly towards committed capital structures, seasoning in some of the firm's newer businesses, and sustained conservatism in leverage and liquidity levels. A reduction in key man risk through broader key man triggers at the fund level, a more diverse voting structure, and continued development of the senior leadership group, would also be viewed positively.

Negative rating drivers could include material declines in investment performance which negatively affect the company's ability to maintain AUM and generate fees, meaningful deterioration in operating margins, leverage or interest coverage metrics and/or a key man event. An adverse outcome with respect to the ongoing regulatory investigation could also result in negative rating pressure.

The senior unsecured debt rating is equalized with OZM's IDR and therefore, would be expected to move in tandem with any changes to OZM's IDR. Although not expected by Fitch, were OZM to incur material secured debt, this could result in the unsecured debt being rated below OZM's IDR.

OZM is a leading alternative investment manager, with expanding credit and real estate businesses. The firm managed $44.6 billion of AUM at Sept. 30, 2015, with 657 employees in eight offices worldwide.

Fitch has affirmed the following ratings:

Och-Ziff Capital Management Group LLC
OZ Management LP
OZ Advisors LP
OZ Advisors II LP
--Long-term IDRs at 'BBB-'.

Och-Ziff Finance Co. LLC
--Long-term IDR at 'BBB-';
--$400 million senior unsecured debt at 'BBB-'.

The Rating Outlook is Stable.