DBRS Confirms GMP Preferred Shares at Pfd-3 (low), Trend Changed to Negative

DBRS has today confirmed the Pfd-3 (low) rating on the Preferred Share obligations of GMP Capital Inc. (GMP or the Company), but has changed the trend on the rating to Negative. The rating reflects the strength of the Company’s business franchise as a premier provider of investment banking and capital markets products and services to its targeted market of mid-sized Canadian companies, most of whom operate in the resource and energy sectors. The change in trend, however, reflects the current adverse market environment for the Company’s resource-oriented clients and DBRS’s belief that these conditions are not likely to turn favourable in the short term. While the Company has invested in geographical and business line diversification, largely through the 2011 acquisition of U.S.-based Miller Tabak Roberts Securities, LLC (MTR), which has provided new market opportunities and revenues, the weak market environment has caused earnings to remain weak since Q2 2011.

The business model of the Company hinges on a number of variables, including the general health of equity capital markets, commodity prices, the outlook for corporate profitability and economic growth, as well as investor confidence. Generally, DBRS would expect all of these factors to move in synchronization, making GMP highly leveraged to the state of commodity markets and the overall state of the global economy. The current environment of market and economic uncertainty caused the Company’s revenues to fall by over 30% in 2011 and by over 18% in the first nine months of 2012, even following the 2011 acquisition of MTR. Investment banking fees, commissions and asset management fees have recently been weak, as has the Company’s contribution from its Richardson GMP partnership. A return to positive principal investing income reflects the fixed-income business contributed by the MTR acquisition. While variable compensation has fallen in line with revenues, the increased fixed salaries associated with recent growth initiatives have put downward pressure on earnings. Earnings before non-recurring items fell 65% in 2011 and 72% in the first nine months of 2012.

The Company’s risk exposures are mitigated by the Company’s low capital and liquidity requirements, its strong market position in its chosen niches, its integrated business model and a flexible expense base accompanied by a strong entrepreneurial culture. Nevertheless, the Company is more aggressively capitalized than in earlier cycles, following the $115 million issue of preferred shares in Q1 2011 and $72 million in share buybacks during 2011, resulting in a total debt-to-capitalization ratio of over 30%, which is acceptable for the rating. However, without normal earnings and a higher level of financial leverage, fixed obligations to cash flow as measured by the last 12 months of EBITDA has increased sharply to over 5.0 times and fixed charge coverage ratios have fallen to 2.8 times. DBRS notes favourably the Company’s decision to preserve capital in the current environment of uncertainty by cutting its common share dividend in half, starting with the second-quarter payout, and the absence of any stock repurchase activity in the 2012 year to date.

The slump in underwriting and trading activities, which DBRS does not expect to recover in the short-to-medium-term, given the weak global economic outlook and continued absence of investor confidence, suggests that a Negative trend is appropriate until the Company returns to a healthy and sustainable level of net income, steady capital accumulation and improving capitalization ratios. In the current environment, the Company’s 32.7% interest in Richardson GMP, a high net worth wealth management operation with over $14 billion in assets under administration (AUA), is operating at break-even and is therefore not a source of profitable diversification for the Company. Similarly, the failure of the Company’s investment in EdgeStone Capital Partners, L.P., removes some of its previous potential for earnings diversification.

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

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.

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations, June 29, 2012, adjusted for the Company’s absence of balance sheet leverage. In addition, reference is made to Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions), November 5, 2012. Both can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.