DBRS Assigns Pfd-3 (low) Rating to Canaccord Financial Inc.

DBRS has today assigned a Pfd-3 (low) rating to the Preferred Share obligations of Canaccord Financial Inc. (Canaccord or the Company). The rating reflects the strength of the Company’s business franchise as the largest independent (non-bank-owned) full-service investment dealer in Canada with capability in retail distribution, equity and fixed income capital markets, and M&A advisory work.

The Company has traditionally been a leader in Canadian equity underwritings in terms of the number of deals led with a focus on mid- and small-cap companies in the resource extraction industries. The 2010 acquisition of Genuity Capital Markets (Genuity) added substantially to the Company’s capabilities in advisory services while broadening the Company’s industry coverage to include more non-resource and larger cap companies; a reflection of Genuity’s pre-existing business relationships. The Canadian capital markets business is complemented by attractive capital markets operations in both the United States and the United Kingdom which add to the Company’s diversification by geographical location of its underwriting and investor clients, and by industrial sector. Nevertheless, the business model of the Company exposes it directly to the health of equity capital markets, commodity prices, corporate profitability, investor confidence and the global economy generally, all of which are highly correlated. The Company’s prominent position in its chosen markets and revenue synergies achieved across the various business segments also support the assigned rating.

The high level of employee share ownership at over 50% ensures that there is good alignment between stakeholders which is reinforced by the strongly entrepreneurial culture.

Because the Company is primarily an agency trader with no large equity inventories or proprietary positions and a relatively small, albeit growing, fixed income business, financial leverage is relatively conservative. The Company’s conservative business operations do not require substantial amounts of regulatory capital or liquidity. The capital markets business employs traditional short-term collateralized banking facilities required to operate as a broker-dealer. The Company’s cash flow from operations is capable of supporting current operations including a small dividend obligation on its common shares. There are few liquidity concerns given the Company’s small principal investment and uncollateralized inventory positions. Collateral requirements are conservative. Regulatory capital thresholds are easily exceeded at all regulated subsidiaries.

The nature of the Company’s products and services as well as the natural resource-orientation of its client base expose it to a great deal of revenue volatility related to economic and market cycles, including both capital and commodity markets. However, the absence of operating leverage and a flexible cost base, notably variable compensation arrangements accounting for over 80% of total wage costs, mitigate the full impact of revenue volatility on net earnings and cash flow available to the Company to service its financial obligations including the preferred shares. Adjusting variable compensation allowed the Company to report a positive operating margin in each of the last five years notwithstanding the financial crisis.

Prior to the issue of the preferred shares, the only non-operating debt was a $15 million subordinated credit facility issued to the Company’s Canadian operating subsidiary, Canaccord Genuity Corp. Growth in larger underwriting opportunities following the acquisition of Genuity, a growing fixed income business, and international acquisition opportunities in the wake of the financial crisis have convinced the Company to increase its available capital in the form of low-cost preferred shares. The new issue is expected to increase the Company’s debt plus preferred share ratio as a percentage of capitalization to 13.2% (14.7% if the $15 million underwriter option is exercised) and the debt plus preferred share ratio to EBITDA to 0.70 times (0.78 times), both of which DBRS regard as being reasonable for the rating notwithstanding the inherently volatile nature of the Company’s business. On the basis of earnings for the fiscal year ended March 31, 2011, the pro forma fixed charge coverage ratio is expected to be in excess of 15 times with no credit for any prospective earnings on the preferred share proceeds.

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

The applicable methodology is Global Methodology for Rating Banks and Banking Organizations, January 14, 2010. The Methodology has been adjusted to reflect the absence of financial leverage.