Fidelity Responds to Moody's Outlook Downgrade

A significant portion of Fidelity's revenues continues to depend on the vitality of the domestic equity markets, and last year the company saw net outflows from its higher-margin equity funds due to weak investment performance of several flagship funds.

This, in part, is shifting the company's revenue mix toward lower-margin businesses.

Moody's also believes that the company's non-core investments, which have grown over the past few years, have a significantly higher risk profile than Fidelity's core financial services businesses.

However, despite it's outlook downgrade, Moody's nonetheless reaffirmed Fidelity's A2 senior debt rating, which it said reflects "Fidelity's strong market position in asset management and well-diversified sources of revenue. It is a leader in several investment-related sectors, including mutual funds, brokerage services, advice and retirement planning services, and human resources benefits administration."

Fidelity's profitability and debt-servicing metrics, while improving, are still low for the rating category and significant leverage and a relatively modest equity base limit its financial flexibility, Moody's said. Furthermore, the company's private ownership and involved capital structure add complexity to the credit profile, which the ratings agency characterized as 'incrementally negative.'

Through subsidiaries, Fidelity engages in private equity investments, real estate development, telecom, building supplies, and other activities that have pressured its overall earnings, Moody's said. These investments are not closely related to Fidelity's core financial services businesses and increase the company's earnings volatility and balance sheet risk. While these activities may provide some diversity to the income mix, their overall contribution in recent years have been limited and, in some cases, negative.

Fidelity's rating could be downgraded, Moody's warned, if the following trends do not stabilize or improve:

1. persistent material net outflows,
2. significant financial leverage as evidenced by Moody's adjusted total debt-to-EBITDA ratio above 2.5x and Moody's EBITDA to interest ratio below 4x,
3. net income profit margins below 15%, and
4. increasing exposure of the company's capital to non-core investments.

The company's outlook could return to stable if:

1. pressure on the financial metrics identified above is reduced,
2. Fidelity sustains its leadership positions across multiple business lines, particularly its long term mutual funds business, and maintains strong liquidity,
3. the company's dependence on internal debt financing to support its long-term funding needs is reduced, and
4. balance sheet risk from non-core investments is reduced.

The last rating action on Fidelity was on June 30, 2010, when the company's senior debt rating was affirmed at A2 with a stable outlook.