DBRS Confirms GMP Preferred Shares at Pfd-3 (low) with Negative Trend

DBRS has today confirmed the Pfd-3 (low) rating on the Cumulative Preferred Shares of GMP Capital Inc. (GMP or the Company). The trend remains 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, primarily Canadian, companies, many of whom operate in the resource and energy sectors. Given the current adverse market environment and DBRS’s belief that these conditions are not likely to turn favourable in the near term, the assigned rating and Negative trend recognize the Company’s demonstrated resilience but also its disproportionate exposure to market conditions and the continuing poor operating environment for the industry. The Company’s capital markets business continues to be vulnerable to the uncertain global economic outlook and a lack of investor confidence.

Overall, the franchise represents a moderate presence in the overall broker market. GMP has appropriate distribution capabilities for its mid-market niche and has the capacity to withstand a subdued market environment characterized by a lack of activity; however, extended and deep weak market activity remains a material threat. GMP has had weaker revenues lately but incorporates sound cost controls thanks to a highly variable cost structure, which represents a good ability to manage costs over time. Risk management processes are good, with acceptable credit and counterparty exposure. Liquidity is quite good given the nature of the business, and while capitalization borders on aggressive at the corporate holding company it is well above regulatory requirements in the regulated broker-dealer subsidiaries.

While the Company is more diverse geographically and by business line than in the past, largely through the 2011 acquisition of U.S.-based Miller Tabak Roberts Securities, LLC (MTR) and a smaller expansion in Australia, the weak market environment has not yet allowed the Company to benefit fully from the originally anticipated opportunities.

The Company’s risk exposures are somewhat mitigated by 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 market tone continues to be very negative and is particularly unfriendly for broker-dealers. Additionally, the Company is more aggressively capitalized than it had been in earlier cycles following the $115 million issue of preferred shares in Q1 2011 and over $72 million in share buybacks during 2011, resulting in a total debt-to-capitalization ratio of over 30%, which is in the upper range of what is acceptable in this rating category. Without strong earnings, total debt-to-cash flow is increasing, and fixed charge coverage ratios have fallen to levels that are in the lower bounds of what is perceived as acceptable for this rating category. DBRS does recognize that the current environment represents a low point in the cycle and thus metrics are expected to be in the weaker end of the ranges; however, an extended period of weakness without the Company being able to generate more positive results remains a concern. DBRS notes favourably the Company’s decision to preserve capital in the current uncertain environment by cutting its common share dividend in half in 2012 and not utilizing its share buyback program in the past year. DBRS expects GMP to continue a prudent approach to retaining capital given the tough market environment.

DBRS also recognizes positively the earnings benefit likely to come from the recent review of operations and resulting changes that will reduce fixed expenses. With the continuing slump in underwriting and trading activities, the highly variable nature of GMP’s expense base is key to weathering the continuing storm.

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 2012), which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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