DBRS Confirms Ratings on Power Financial

DBRS has today confirmed the ratings on the Senior Debt and Preferred Shares of Power Financial Corporation (PWF or the Company) at AA (low) and Pfd-1 (low), respectively. The rating trends remain Stable. The financial strength of PWF is largely derived from its controlling interests in two of Canada’s leading financial service providers: Great-West Lifeco Inc. (GWO – Senior Debt rated AA (low)), one of the three largest life insurance concerns in Canada, and IGM Financial Inc. (IGM – Senior Debt rated A (high)), the largest mutual fund complex in Canada as measured by long-term assets under management (AUM) on June 30, 2011. These two holdings provide the Company with stable recurring earnings and dividends while providing it with diversification by product, distribution channels and geography – even through the depths of the financial crisis. Both of these subsidiaries, in turn, benefit from the Company’s hands-on governance, strategic oversight, and risk-averse culture.

The Company’s business strategy hinges strongly on the manufacture and sale of insurance protection and wealth management products in its major subsidiaries for both individuals and groups. Within the individual retail markets, the Company is primarily, if not wholly, exposed to the financial advice-giving channel, consisting of career agents and consultants, independent financial advisors and brokers. The Company believes strongly that there is a large retail market that appreciates and is prepared to pay for financial advice given the relatively short investment horizons for baby boomers coming into their retirement, as well as the increasing complexity of financial products and solutions. Correspondingly, one of the Company’s core operating strengths is its expertise in managing this sort of distribution and sales channel. However, given the meager investment returns of the last few years, the relatively high cost of these distribution channels is becoming more apparent to both regulators and retail investors at the same time as lower-cost alternatives and more readily accessible bank-branch distribution models start to gain market share. The Company therefore faces challenges in achieving organic sales growth using its current distribution model.

While PWF has exposure to institutional fund management at both Mackenzie Financial Corporation and Putnam Investments, LLC (Putnam), it recognizes that growth in the institutional fund management segment is not necessarily consistent with the broader company focus on retail wealth management. Nonetheless, the Company acknowledges that any growth in AUM contributes to earnings that it would not otherwise have. Overall market growth for retirement savings could stem from the growing realization that the onus for providing pension income and post-retirement health benefits is shifting from governments to individuals and their employers, which could favour established financial institutions, such as GWO and IGM. GWO has achieved efficient scale in the U.S. market for retirement savings plans and administrative services. With new product introductions, many in conjunction with Putnam’s asset management business, GWO can be expected to become an increasingly effective competitor.

Given an uncertain economic environment that could limit organic growth, DBRS expects that PWF will take advantage of its strong financial position to pursue small tactical acquisitions in the financial services arena. Pressures on regulatory capital adequacy could conceivably encourage a number of financial institutions to sell certain business lines at opportunistic prices, which would complement and leverage those of the Company. Achieving additional scale in Putnam through the acquisition of incremental AUM with a shared distribution channel, for example, would bring its financial results closer in line with the Company’s original targets for Putnam, while supporting broader growth initiatives. That PWF retains the ability to consider such value-added acquisitions in the current environment is a testament to its conservative financial profile and its long-term perspective.

The Company’s 28.3% indirect equity interest in Pargesa Holding S.A. (Pargesa), a Geneva-based holding company, provides an incremental advantage in the form of additional geographic and industry diversification. Pargesa indirectly holds investments in European industrial companies (oil and gas, chemicals, energy, water and waste services, specialty minerals, cement and building material, and wines and spirits). While Pargesa provides a small but growing stream of dividends to the Company’s operating cash flow (approximately 5% of dividends received by PWF), it is largely managed to maximize net asset value over the long term.

Despite solid growth in reported income at GWO and IGM, the Company has elected not to increase its common dividend in order to retain cash and add to financial flexibility in relatively uncertain economic and market environments. In the same conservative vein, the Company has extended its consolidated debt maturity profile, and in the course of 2010, repaid its outstanding soft-retractable preferred shares, replacing them with perpetual preferred shares, which represent higher-quality capital.

With a 16.9% total unconsolidated debt ratio at the end of June 2011, the Company’s capitalization remains conservative, with only modest double leverage, exercised through the use of perpetual preferred shares. If such shares are treated as permanent equity, double leverage is close to non-existent. Debt service coverage ratios are strong at over 15 times on an earnings basis and just under 8.5 times on a cash flow basis. Liquidity is also not a source of concern, with close to $525 million in cash and short-term securities at the holding company pro forma the November 1, 2011, dividend payment of close to $250 million and additional stores of liquidity at both GWO and IGM. Such retention of liquid assets in the current uncertain economic environment reflects a unified and consistent approach to risk management across the organization. Financial flexibility is additionally enhanced by the proven access by the Company and its investee companies to capital-market funding should the Company require funding for an opportunistic acquisition.

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.