DBRS Confirms Rating on Co-operators Financial Services at BBB

DBRS has today confirmed the rating of the Senior Unsecured Debentures of Co-operators Financial Services Limited (CFSL or the Company) at BBB, with a Stable trend. The rating reflects the Company’s ownership of Co-operators General Insurance Company (Co-op General), the third largest general insurance company in Canada (see separate press release published today) and Co-operators Life Insurance Company (Co-op Life). Co-op Life is a diversified life insurance company whose products are distributed through the Co-op General agency sales force, as well as through Canadian credit unions following the 2009 acquisition of CUMIS Group Limited (CUMIS) from CUNA Mutual Group in partnership with Central 1 Credit Union. Another source of potential earnings contribution includes Addenda Capital Inc. (Addenda), a large institutional manager of fixed-income investments and the seventh largest pension fund manager in Canada. The Company continues to create a more diversified and more profitable financial services group through broadening of distribution channels and product offerings, and revenue and expense synergies as part of its vision of being the preferred provider of financial services to the Canadian co-operative movement

CFSL’s financial profile has recently become less conservative, with consolidated debt plus preferred-to-total capitalization of over 23% at the end of March 2010, up from 18.9% at the end of 2009, reflecting a $150 million senior debt issue that was completed in March 2010. The estimated unconsolidated debt plus preferred share-to-capitalization ratio, at 18.7% at the end of March (up from 10.7% as of the end of 2009), remains within bounds for a financial holding company of this rating and credit profile, especially where there is little financial leverage in the related operating subsidiaries. Double leverage as calculated by DBRS will have increased with the recent debt issue to almost 120%, but remains reasonable given the Company’s limited access to equity capital and the regulated nature of its major operating subsidiaries.

The consolidated debt service coverage ratio has been declining as the Company’s financial leverage has increased. At current leverage and profitability, it seems to be approximately 4.0 times, which is reasonable. On an unconsolidated basis, expected normalized cash flow from dividends and interest payments from subsidiary companies more than cover the Company’s estimated fixed charges. Both major subsidiaries have additional capital and liquidity, which ensures that the Company’s debt service requirements can be met on a timely basis. Addenda represents an additional potential source of cash flow as its earnings start to normalize given its generally limited appetite for growth capital.

The Company’s strategy is focused on growth, both organic and by acquisition, while reducing exposure to more volatile auto insurance in favour of faster-growing life and health insurance and wealth management lines, which is expected to enhance overall Company diversification and earnings stability in the long run. Greater focus on the value of the customer relationship to both the agent and the Co-op group has become the driver of revenue growth and profitability. The recent acquisition of CUMIS represents an opportunity to more broadly distribute the Company’s products while extracting certain cost efficiencies.

Generally speaking, the recent rating upgrade at Co-op General should have caused a similar increase in the CFSL rating. However, since the Co-op General rating upgrade largely reflects the long-term benefit of a number of corporate initiatives which are already discounted in the CFSL rating, the incremental upgrade at Co-op General was not sufficient to change the existing rating, though it is fair to argue that CFSL is notionally a stronger entity as long as its operating subsidiaries are better positioned for long-term financial performance. While CFSL’s rating is limited by the corresponding ratings at its operating subsidiaries, the diversification of the Company’s consolidated product spectrum and distribution channels also supports the rating. Within the CFSL group there are also strategic revenue and expense synergies associated with shared costs, distribution and cross-selling opportunities within the Company’s broader franchise as framed by the common values and vision of the co-operative movement.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Parent/Holding Companies and Their Subsidiaries, which can be found on our website under Methodologies.

This is a Corporate Finance (Financial Institutions) rating.