DBRS Confirms Ratings on Power Financial Corporation at AA (low), Pfd-1 (low)

DBRS has today confirmed the long-term and preferred shares ratings of Power Financial Corporation (PWF, the Company or the Group) 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 rating of AA (low)), one of the three largest life insurance concerns in Canada, and IGM Financial Inc. (IGM – senior rating of A (high)), one of the largest mutual fund complexes in Canada as measured by long-term assets under management (AUM) on June 30, 2012. These two interests, accounting for approximately 90% of the Company’s earnings, dividends and asset value, are a source of stable recurring earnings and cash flow. Under the strategic leadership of the Company, both GWO and IGM have become increasingly diversified as they have grown both organically and by acquisition. The Company has correspondingly increased its exposure to the wealth management business in all of its chosen geographies. Both of these subsidiaries, in turn, benefit from the Company’s hands-on governance, and risk-averse culture.

The Company’s business strategy consists of taking long-term investment positions in a limited number of well-positioned business franchises which are self-sustaining from a capital perspective. Part of the free cash flow that these investments yield passes through to the Company in the form of a steady stream of dividends, which supports the creditworthiness and debt service ability of the Company. Acquisitions, when they occur, are targeted at reinforcing existing market positions, rather than expanding into unfamiliar business lines or geographical markets.

The Company’s investments are presently focused on the manufacture and sale of insurance protection and wealth management products in its major subsidiaries for both individuals and groups across chosen geographies. Within the individual retail markets, the Company is primarily exposed to the financial advice-giving channel, consisting of career agents and consultants, independent financial advisors, and brokers. The Company strongly believes that there exists a large retail market for financial advice, given the growing requirement to fund retirement savings pools as the baby boomer generation matures and government sources of financial protection come under funding pressures. Correspondingly, one of the Company’s core operating strengths is its expertise in managing these sorts of distribution and sales channels. However, given the meagre investment returns of the last few years, the relatively high cost of these distribution channels is coming under the scrutiny of legislators and retail investors at the same time as lower-cost alternatives and more readily accessible bank-branch distribution models gain market share. The Company therefore faces some challenges in achieving organic sales growth in its subsidiaries using current distribution models.

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. For example, achieving additional scale in Putnam through the acquisition of incremental AUM with a shared distribution channel would bring its financial results closer to the Company’s original target 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 some 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 does pay a small dividend, which is normally passed through to the Company, it is primarily managed to maximize net asset value over the long term.

The Company’s financial leverage has been maintained at the same level for the past ten years. At a 17.6% unconsolidated total debt ratio at the end of June 2012, the Company’s capitalization remains conservative, with no double leverage when the perpetual preferred shares are treated as permanent equity. Debt service coverage ratios are similarly strong at between 13 and 15 times on an operating earnings basis and between 8 and 9 times on a cash flow basis. Liquidity is not a source of concern, with close to $1 billion in cash and short-term securities at the holding company at June 30, 2012, in addition to stores of liquidity at both GWO and IGM with which to shore up regulatory capital or to facilitate potential strategic acquisitions. 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 markets funding, notably perpetual preferred shares.

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

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.