OREANDA-NEWS. Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDRs) of Oaktree Capital Group, LLC and its related entities (collectively Oaktree) at 'A'. The Rating Outlook is Stable. Approximately $850 million of unsecured debt is affected by these actions. A complete list of ratings is detailed at the end of this release.

Today's rating actions have been taken as part of a periodic peer review of the alternative Investment Manager (IM) industry, which comprises seven publicly rated global firms. Fitch's outlook for the sector is stable, reflecting the relative stability of core operating fundamentals, given the locked-in nature of a large portion of fee revenue, modest but increased leverage levels, manageable near-term obligations relative to available liquidity resources, increasing asset under management (AUM) diversity, and investors' increasing allocation to alternative investments, particularly those managed by alternative IMs with strong franchises such as those included in Fitch's peer review. While fund realization activity has increased significantly over the last three years, leading to the amortization of existing AUM, managers have continued to replace capital, and therefore fees, with follow-on funds and expansion into other product categories through step-out strategies, seed investments, and/or acquisitions.

The variable cost structure of the alternative IMs has contributed to relatively steady cash flows through cycles. Fee-related earnings before interest, taxes, depreciation, and amortization (FEBITDA) margins had been trending down in recent years, given lower fee rates on new product categories, higher fundraising costs, and because the cost of doing business has risen with increased regulation and administrative costs associated with operating as public companies. However, FEBITDA margins have turned a corner more recently as many alternative IMs have begun to raise follow-on funds for newer strategies, which adds scale to the platform. The FEBITDA margin for 'A' category alternative IMs averaged 35.5% for the trailing 12 months (TTM) ended Sept. 30, 2015, which compared to a 34.9% average for 2012.

Leverage levels have increased across the industry, as issuers have taken advantage of the low interest rate environment to issue long-duration funding and have also used debt financing for acquisition purposes. Average leverage, defined as debt divided by FEBITDA, was 3.54x for 'A' category firms for the TTM ending Sept. 30, 2015, which compared to an average of 2.55x at year-end 2012. Fitch believes the issuances have been largely opportunistic and views the reduction in refinancing risk favorably. Over time, Fitch expects leverage levels to migrate toward historical averages, as cash proceeds are deployed into FEBITDA-generating opportunities and recent acquisitions begin to contribute to consolidated results.

While core issuer fundamentals remain solid, alternative IMs continue to have record levels of capital to invest at a time when conditions are increasingly challenging. Therefore, there is more capital chasing fewer deals, which could lead to significant fund underperformance if competition bids prices up further. Outsized vintage concentration could potentially exacerbate this issue. While most of the large managers have operated through a variety of market cycles, and have demonstrated investment restraint, pressure for returns from limited partners remains high, given the length of time that interest rates have been at low absolute levels. That said, a meaningful portion of the industry's uncalled capital is not yet earning fees, often referred to as shadow AUM, which could provide some material upside to alternative IM FEBITDA as the capital is deployed.

KEY RATING DRIVERS

IDRs AND SENIOR DEBT

The rating affirmations for Oaktree reflect its strong position as a global alternative IM, solid investment track record, experienced and deepened management team, large base of fee-earning assets under management (FAUM), strong blended management fee rate, given the absence of a step-down in the management fee percentage once closed-end funds enter their liquidation period, a lack of reliance on transaction and monitoring fees for revenue, incentive income-generating capability, growing investment income from Oaktree's investment in DoubleLine, solid liquidity, and subordination of general partner interests to outstanding indebtedness.

Rating constraints for the alternative IM space include 'key man' risk, which is institutionalized throughout many limited partnership agreements; reputational risk, which can impact the company's ability to raise future funds; and legal and regulatory risk, which could alter the alternative asset space. Rating constraints more specific to Oaktree include lower relative AUM diversity, higher exposure to net asset value (NAV)-based fees, and reduced operating margins, which could impact the firm's financial flexibility.

FAUM amounted to $76.5 billion at Sept. 30, 2015, down about 3.4% from 3Q14, due largely to realizations in closed-end funds and negative valuation movements in open-end funds. Open-end fund FAUM declined 5.5% over the TTM ended Sept. 30, 2015, as relatively neutral net flows were hurt by foreign exchange and market value declines. Closed-end FAUM is down 2% year-over-year and 7.1% below year-end 2011 levels, given continued realizations in legacy funds.

Still, the decline in FAUM overshadows what has been a very strong fundraising period for the firm. For the TTM ended Sept. 30, 2015, Oaktree received $16.8 billion in closed-end capital commitments. Fitch expects FAUM to grow in coming quarters, as $17.2 billion of capital was raised but not yet earning management fees as of Sept. 30, 2015. Fees will be turned on when funds begin their investment period or when the capital is deployed, which will provide meaningful upside to Oaktree's revenue.

The firm's newest distressed debt funds, Oaktree Opportunities Fund X and Xb, had nearly $9.9 billion of aggregate committed capital at Sept. 30, 2015, including $2.8 billion in Fund X, which should start its investment period and, thus, full management fees in 2016.

Oaktree's core operating performance was down in the first three quarters of 2015 as management fees declined in-line with FAUM and core compensation ticked-up. As a result, the firm's FEBITDA margin declined, to 31.4%, which was slightly below the peer-group average on a TTM basis. Even so, Fitch expects the firm to reach an inflection point in 2016, as record levels of undeployed AUM gradually begin to generate fees, which will allow for margin expansion given the scalability of the platform.

Performance fees and investment income have come down, as Oaktree's realization cycle started a bit earlier than the peer group, given its credit focus. However, accrued performance fees remain strong, amounting to $1.7 billion at Sept. 30, 2015, or nearly $900 million net of associated compensation expense. Fitch does not view the accrual as a liquid asset, but it does point to potential future income generation and cash flow.

Oaktree's leverage, as measured by long-term debt divided by FEBITDA, amounted to 3.61x on a TTM basis at Sept. 30, 2015, which compares to 3.26x at year-end 2014. The uptick reflects the decline in FEBITDA. However, leverage is overstated by $100 million of 2016 debt maturities which were effectively pre-funded with Oaktree's 2014 senior note issuance. Removing the 2016 maturities from total debt reduces leverage to 3.19x, which is still above Fitch's general leverage tolerance for 'A' category firms of 2.5x. Fitch believes leverage may increase a bit further over the next few quarters as fund realizations yield a decline in management fees, but leverage is expected to decline to 2.5x or below over the medium term, as capital not yet earning fees begins to generate fees in 2016-17.

Additionally, if Fitch were to include non-performance investment income that Oaktree earns from its investment in DoubleLine, leverage would be approximately 2.65x on a TTM basis, removing the 2016 maturities from total debt. This income stream, which is tied largely to management fees, has increased significantly over time as DoubleLine's FAUM has grown. Fitch will continue to monitor the stability and predictability of this income stream over time, but it has improved the firm's cash flow generation in recent periods.

Fitch believes Oaktree has a solid liquidity profile. At Sept. 30, 2015, Oaktree had $417.2 million of balance sheet cash, $656.1 million of government securities, and $500 million of borrowing capacity on its bank revolver. This compares to $100 million of debt maturities in 2016 and $436.6 million of aggregate general partner commitments to the funds as of Sept. 30, 2015.

In 2Q14, Oaktree increased its standard payout ratio from 80% to 85% of its distributable earnings, retaining the rest for fund co-investments, possible corporate transactions, and enhanced liquidity. Fitch is comfortable with the updated policy, given the firm's sound liquidity position, but would expect the firm to reduce shareholder distributions should corporate cash demands increase.

In October 2014, Oaktree appointed its first CEO, Jay Wintrob, who had been an outside director of the company since 2011 and who ran AIG's life and retirement division until September 2014. Wintrob will be focused on the day-to-day administration of the firm in addition to a variety of strategic initiatives. Fitch believes the CEO appointment reflects the growth, diversity, and continued globalization of the platform and an addition to executive management depth. Given Wintrob's prior experience on the board, Fitch does not expect wholesale strategic changes resulting from this change.

The Stable Outlook reflects Fitch's expectations that management fees will increase in 2016 as shadow AUM begins to generate management fees, which will allow for modest margin expansion and balance sheet deleveraging. The Outlook also reflects the agency's belief that Oaktree will grow/retain FAUM through the raising of new and expansion of existing fund strategies and retain a solid liquidity profile in order to fund operations and meet co-investment commitments to the funds.

RATING SENSITIVITIES

IDRs AND SENIOR DEBT

Fitch believes positive rating momentum for Oaktree is limited, given its current rating levels and the nature and risk profile of the business, including the impact that key man events and/or reputational damage can have on the franchise and future fundraising prospects. However, positive momentum could develop over time with a meaningful reduction in key man risk, an increase in fund and fee diversity, enhanced stability of incentive income through a variety of market cycles, stronger funding diversity, and declines in leverage.

Declines in investment performance, a key man event, and/or legislative risk which negatively impact the company's ability to raise FAUM and generate fees, meaningful increases in leverage, and/or impairment of the liquidity profile could result in negative rating action.

Oaktree is a global alternative investment management firm with a focus on credit and contrarian, value-oriented investing. FAUM amounted to $76.5 billion at Sept. 30, 2015 and total AUM was $100.2 billion. The company's Class A units are listed on the NYSE under the ticker 'OAK'.

Fitch has affirmed the following ratings:

Oaktree Capital Group, LLC
Oaktree Capital Group Holdings, L.P.
Oaktree Capital I, L.P.
Oaktree Capital II, L.P.
Oaktree AIF Investments, L.P.
-- Long-term IDR at 'A'.

Oaktree Capital Management, L.P.
-- Long-term IDR at 'A';
-- Unsecured debt at 'A'.

The Rating Outlook is Stable.