Amid continued volatility in equity markets, the performance of the global asset managers rated by Standard & Poor's Ratings Services weakened in First Quarter 2009, as assets under management (AUM) continued to decline, hurting top-line revenues in the process. As in the two previous quarters, market depreciation largely caused the drop in AUM, but net outflows were a substantially greater contributor to AUM declines than they had been in previous quarters.

In this context, a handful of rated asset managers' performance in first-quarter 2009 was harder hit, and we took negative rating actions on these because of their weakened debt-servicing ability. Overall, however, the industry remained profitable, as cost-cutting measures began to produce positive effects on operating margins. Individually, most of the rated asset managers also performed within the parameters of our stress test, although the performance was weaker than we expected for some.

Company Rating (as of May 27, 2009) Outlook
Affiliated Managers Group (AMG) BBB- Stable
AllianceBernstein (AB) AA- Stable
BlackRock (BLK) AA- Stable
DundeeWealth BBB- Stable
Eaton Vance (EV) A- Stable
F&C Asset Management BBB- Negative
FMR A+ Negative
Franklin Resources (BEN) AA- Stable
GAMCO Investors (GBL) BBB Stable
IGM Financial A+ Negative
Invesco Holding Co. (IVZ) BBB+ Stable
Janus Capital Group (JNS) BB+ Stable
Legg Mason (LM) BBB+ Negative
Marsico Parent Co. CCC+ Negative
Nuveen Investments B- Stable
Schroders A Negative
Waddell & Reed Financial (WDR) BBB Stable

Although we do not necessarily believe that the worst is over, the recent modest recovery in equity markets, which began at the very end of the quarter, leaves room for cautious optimism. In particular, market appreciation in recent weeks has spurred growth in AUM for many of the asset managers that we rate, and augurs well for better performance in the current quarter. That said, although the sector may now appear to be more on the winning side of the battle, the war is clearly not over, given the substantial loss in value of aggregate AUM.

In this context, we expect the rated asset managers to continue to take measures to stabilize their financial performance in response to a still-vulnerable operating environment. We continue to believe that the larger, more globally diversified and, in particular, less-leveraged asset managers will be most successful in stabilizing their performance in the near term.

Following a devastating fourth-quarter 2008 during which the major global indexes dropped by 20% or more, 2009 began on a somber note, with all major global indexes continuing their slide, although at a slower pace. Markets experienced a modest recovery at the March quarter end, but the improvement was insufficient to stem the impact on AUM.

Net outflows—some substantial (Legg Mason, AllianceBernstein), others less so (Janus, Franklin, Schroders, F&C, IGM)—were also a larger contributor to the drop in first-quarter AUM. Net outflows have been decelerating, but some asset managers experienced a reversal in flows. Invesco, for example, benefited from $9 billion in net inflows in the first quarter. In aggregate, AUM at the rated asset managers for the quarter ended March 31, 2009, dipped 13% sequentially. As a result, aggregate top-line revenues also decreased (30%) in the March quarter. Although management initiatives to reduce or control costs continued across the board, the improvement in operating expenses was not enough to offset the decline in revenues.

Operating margins were necessarily reduced, but remained generally satisfactory on an individual basis for most of the rated asset managers. The significantly weaker operating performance of a handful of rated managers (Legg Mason, AllianceBernstein), however, reduced the rated sector operating margin, with the aggregate pretax income-to-revenues ratio in substantial decline.

The equally sharp decline in some managers' operating cash flow has increased our concern for their debt-servicing ability. Specifically, Nuveen's and Janus's ability to service their debt has been substantially impaired, resulting in negative rating actions during the quarter.

We continue to believe that the current environment is presenting emerging opportunities for the asset-management sector. We expect a new round of consolidation in the industry, as well as the opportunity (for U.S. managers) to participate in the government's plans to manage toxic banking assets. BlackRock is already managing a number of assets on behalf of the U.S. government and private parties, and AllianceBernstein was recently named as one of three managers chosen by the U.S. Treasury to manage investments in Troubled Asset Relief Program assets.

Sector consolidation opportunities are already burgeoning, with Lincoln Financial Group's planned sale of its $100 billion third-party investment division; Bank of America's (BAC) reported intention to sell $340 billion mutual fund manager Columbia Management; and interest from a number of parties to acquire $1.5 trillion manager Barclays Global Investors, following Barclays' (BCS) agreement to sell its iShares ETF unit.

Strategic rationale, acquisition financing, and debt leverage metrics will decide the sector consolidation's ratings impact (if any) on rated asset managers.

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