S&P Affirms Willis ‘BBB-‘ Ratings

Standard & Poor’s Ratings Services announced that it has affirmed its “BBB-” counterparty credit and senior unsecured debt ratings on Willis Group Holdings Ltd. and has revised the outlook to stable from negative.

The rating actions could be an indication that the big brokers – Marsh, Aon and Willis – will be less severely affected by the loss of contingent commission income than has been feared.

“The outlook revision reflects our belief that Willis will continue to be successful, as highlighted by first- and second-quarter 2005 results, in implementing a revised business model addressing the elimination of $71 million of volume and profit-based contingent commission revenue that constituted 11.3 percent of consolidated pretax income in 2004,” noted S&P credit analyst Donovan Fraser. “The rating action also contemplates the reduced potential that ongoing regulatory investigations will trigger allegations that would materially impact Willis’ competitive or financial condition. This is because of recent regulatory and private-party settlements and the passage of time.”

S&P said: “The current ratings and outlook are further supported by Willis’ good and improving competitive position, industry-leading operating margins, and very strong financial profile. On July 1, 2005, the company issued senior notes totaling $600 million comprised of five-year $250 million and 10-year $350 million notes. The senior notes replaced $450 million of private term loans with the remainder available for general corporate purposes, and represents a more stable and long-term capital structure with a favorable debt maturity schedule.”

“In addition to $71 million of volume and profit-based contingent commission revenue, other market remuneration of $77 million constituted a further 12.3 percent of consolidated pretax income in 2004. Although the company has differentiated between the two forms of compensation agreements and anticipates recouping the latter through itemized fees, as of June 30, 2005, the company had collected $8 million in such fees down from $42 million as of the same period in 2004.”

S&P seemed to view the decline in Willis’ contingent commission revenues as less serious than might have been the case. It said that “notwithstanding the significant decline in alternate compensation agreements, the company had an industry-leading ROR of 24 percent as of June 30, 2005. Operating margins for full-year 2005 might be further compressed due to seasonality and increased expenses for executive retention and recruitment coupled with severance costs.”

Significantly S&P stressed: “Total revenue of $1.21 billion as of June 30, 2005, increased by 2 percent compared with the same period in 2004, despite the loss of contingent commission revenue in addition to a softening rate environment as demonstrated by flat organic growth in the second-quarter of 2005 down from 2 percent in first quarter 2005. Willis has strong liquidity with $156 million of cash on hand and a $150 million revolving credit facility that remains undrawn as of June 30, 2005. Cash flow from operations has historically been very strong and has tracked earnings, however as of June 30, 2005, the company had a cash outflow of $77 million compared with positive cash flow generation of $276 million as of the same period in 2004.

“The significant change in cash flow from operations is primarily due to a reclassification of about $200 million in fiduciary funds under new United Kingdom regulations. The full-year 2005 impact is expected to be about $150 million; thereafter the company’s cash flow is expected to normalize at higher levels than the current year. The company has a very strong financial profile as measured by pro forma debt-to-capital of 30 percent and GAAP interest coverage of 25x as of June 30, 2005.

“Adjusted financial leverage (incorporating the imputed debt on noncancelable operating leases) measured 40 percent as of year-end 2004, in line with the peer group average.

“Adjusted fixed-charge coverage measured 9.4x as of year-end 2004, in line with the company’s strong earnings profile. Although operating margins are lower than historical levels due to the loss of contingent commission revenue, ROR for full-year 2005 is expected to remain more than 20 percent and debt-to-total capital is expected to approximate 30 percent though it might temporarily fluctuate due to acquisition related activity.”

S&P also said it “believes that Willis’ good competitive position might be further enhanced by executive defections from key competitors and the increased propensity for customers to request alternate quotes on long standing accounts with other global insurance brokers. The company has made a strategic investment in recent high profile hires from its competitors while simultaneously realigning its cost structure. To the extent that the company is able to maintain strong margins and increase market share, this might lead to a positive rating action.”

It cautioned, however, that if “Willis’ margins were to decline significantly, or if the company experiences an adverse change to its competitive position or financial profile due to regulatory investigations, Standard & Poor’s will actively consider a negative rating action.”