DBRS Confirms Brookfield Asset Management Inc. Ratings, Trend Changed to Stable

DBRS has confirmed the Issuer Rating and Senior Notes and Debentures of Brookfield Asset Management Inc. (BAM or the Company) at A (low), along with confirmation of its Commercial Paper at R-1 (low) and its Preferred Shares and Preferred Securities at Pfd-2 (low). At the same time, DBRS has revised the trends of these ratings to Stable from Negative.

The trend change reflects the combination of (1) increased financial flexibility to BAM, as 85% of its invested capital is now in listed companies (compared to DBRS’s estimate of 70% a year ago); (2) increased proportion and predictability of its asset management fees under the current corporate structure, a large proportion of which are fixed or based on sizes of investment under management, rather than performance or investment gains; and (3) improved financial metrics in 2013 due to strong operating cash flows from its investments and asset management fees, reduced corporate debt level and settlement of its contingent swap liabilities. With the improvements in 2013, BAM’s financial metrics with funds from operations (FFO, as defined by the Company) to debt of 38% and FFO interest coverage of 6.0 times (x) in 2013 (adjusted to exclude from FFO the one-time carried interests on private funds of $565 million) have exceeded the respective levels of 35% and 5.5x, targets DBRS had indicated in its previous report as necessary to maintain the current rating (“Funds from operation” are defined by BAM as “net income prior to fair value changes, depreciation and amortization, and deferred income taxes, and it also includes BAM's proportionate share of FFO in its equity accounted investments”). The trend revision also factors into DBRS’s expectation that the Company will maintain these financial metrics generally in line with these targets for the foreseeable future.

Through the listing of the Brookfield Property Partners as the last of the three flagship companies managing assets in the core business segments in April 2013, the Company’s corporate reorganization is now complete (see Corporate Structure section of the accompanying report for details). DBRS believes that the reorganization has benefited BAM in a number of ways. First, each of the listed flagship companies have independent access to debt and equity markets to fund their own operations, allowing BAM more flexibility to decide whether or not to participate when they raise funds in these markets. Second, BAM can now generate higher fee-based income from these flagship companies (through management contract arrangements), as well as from its private funds. Finally, about 75% of BAM’s own invested capital is now invested in flagship companies with increasing trading volume and liquidity (as BAM reduces its proportional shareholding in them over time), giving the Company an additional channel to monetize its investments, as and when there is an unexpected funding need. Another 10% of invested capital is invested in other smaller listed companies.

As an asset manager and investment company, BAM receives cash distributions from its operating assets primarily in the form of asset management fees and dividends for its invested capital, each contributing to approximately half of total distributed cash flow. DBRS’s review of these cash receipts leads to its conclusion that about three-quarters of cash flows are relatively stable and predictable, as they are either (1) committed through contractual arrangements by companies or investors for funds under BAM’s management, or (2) dividend distributions from flagship companies with substantial scale and operating asset ownerships.

DBRS understands that the majority of asset management fees are base fees that are contractually committed and fixed or based on capitalization-based formulae (for flagship and listed companies) or on committed and invested capital (for private funds and public securities). DBRS estimates these base fees, which have historically been relatively stable, as contributing three-quarters of total management fees or about one-third of total distributed cash flows to BAM. Performance base fees, which are largely dependent upon operating performances, dividend distribution or return on investments, are relatively smaller. Supplementing these fee receipts are dividends received from listed companies and distributed from private funds in return for BAM’s equity interests. DBRS believes the proportion of dividend from the flagship will be similar to the 75% of its capital invested in them. Based on BAM’s disclosure from its Supplemental Information in Q4 2013, DBRS estimates these distributed cash flows to BAM to be in the range of 75% to 80% of FFO (not including extraordinary items and disposition gains) and expects a similar proportion will be distributed in the future.

With improved operating results and distributed cash flows from its operating assets, reduction of company-level debt and settlement of swap contingent liabilities (included as company-level debt) with American International Group, Inc. (AIG), BAM’s company-level financial metrics in 2013 have improved to reach the targets DBRS indicated for its current rating level. The improved operating results during the year reflect (1) increased capacity and normalized hydrology in the renewable energy segment; (2) higher contribution due to completion of rail expansion in Australia, contribution from acquired toll roads in South America and energy distribution assets in the U.K. in the infrastructure segment; and (3) higher fee contribution following the listing of the flagship companies. In addition, BAM also benefits from disposition proceeds from a number of asset disposals, with disposition gains aggregating to $1.3 billion and carried interests of $565 million recognized during the year. Although DBRS excludes them from FFO due to its non-recurring nature, they provide additional resources for company-level debt reduction. In addition, the settlement of the AIG swap in September 2013 (with marked-to-market liabilities of $1.4 billion) with a lump-sum $905 million payment (mostly debt-financed) also contributed to debt reduction. Going forward, DBRS believes BAM to be able to maintain its company-level financial metrics in line with DBRS’s stated targets, if the Company so desires. This expectation is premised on the increased importance of steadier fee-based cash flow and dividend streams from the flagship companies, which are now all listed and must meet investors’ dividend expectations.

With the increased importance of base asset management fees from both flagship companies and private funds that are not directly affected by return on investments or distribution, DBRS believes that BAM’s overall business risk profile has moderately improved under the current reorganized structure. While the aggressive use of debt (albeit non-recourse) at the core business segments (renewable energy, properties and infrastructure) remains an area of concern, DBRS understands that the debt has been used to finance expansion of operating assets that have improved their respective scale and diversity over time. Although BAM’s invested capital in private funds and other opportunistic investments remain the weaker part of its investment portfolio, DBRS understands that a large proportion (about two-thirds in 2013) of FFO and distributed cash flow from private funds is derived from fund management fees, payable by investors, based on the size of capital committed or invested in the funds. These base fees are not affected by return of the funds or performance of the more volatile underlying assets in the funds. While DBRS believes that BAM’s exposure to these higher-risk investments is currently manageable, material increase in either the proportion of BAM’s invested capital in such investments or the Company’s reliance on performance-based fees from them could weaken its overall business risk profile.

BAM’s rating remains supported by its strong liquidity and financial flexibility, which has been further strengthened in the past two years with the listing of all its flagship companies. At a company level, BAM had access to $814 million of cash and financial assets and unused committed bank facilities of about $2.0 billion as at December 31, 2013. After the listing of Brookfield Property Partners, 85% of BAM’s invested capital is now invested in listed assets. Total market valuation of these listed assets (as at March 28, 2014) and its cash balance will be adequate to cover 5.5x of company-level debt of $3.980 billion at year-end 2013, compared to 4.6x a year ago.

While pressure to the rating is much alleviated during 2013, in order to maintain the rating, DBRS expects BAM to maintain its financial metrics generally in line with stated expectations, with FFO debt coverage at a company level of at least 35% (30% on adjusted basis) and FFO interest coverage in excess of 5.5x (5.0x on adjusted basis). The adjustments are in accordance with DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions), published on December 19, 2013, and are discussed in the Financial Adjustments on Preferred Shares and Hybrid section of the report. In addition, DBRS expects that overall business risk profiles would not materially deteriorate due to significant investments in higher-risk businesses, that approximately three-quarters of annual FFO will be distributed in cash to BAM and that company-level liquidity will remain strong.

Notes:
All figures are in U.S. 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.

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

The applicable methodologies are Rating Holding Companies and Their Subsidiaries and Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions) - (December 2013), which can be found on our website under Methodologies.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.