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

DBRS Limited (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 provider of investment banking and capital markets products and services to its targeted market of mid-sized, primarily Canadian, companies. However, DBRS remains very cautious about the continuing adverse market environment. While GMP’s results in the early part of 2014 demonstrated the Company’s ability to weather weak market conditions, the continuation of the Negative trend reflects the challenges posed by the dramatic decline in oil and gas prices as indicated by GMP’s losses in Q4 2014. To the extent that GMP can adjust to this changed environment, the trend could return to Stable, but sustained weakness in results that indicated a significant deterioration in GMP’s franchise strength or earnings power would likely increase the negative pressure on the rating.

The confirmation of the rating recognizes the growing prospects for GMP’s wealth management business, some overall improvement in its diversity compared to prior years and the Company’s demonstrated resilience. At the same time, it considers GMP’s 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, particularly in the resource and energy sectors where many of GMP’s clients operate.

Overall, GMP’s franchise represents a moderate presence in the overall broker market. GMP has appropriate distribution capabilities for its mid-market niche, and the results of the past few years demonstrate that it has capacity to withstand a subdued market environment characterized by slow activity. However, extended and deep weak-market activity remains a material risk. GMP results have historically benefited from a variable cost structure, which includes a high proportion of incentive compensation. However, compensation ratios in late 2014 indicate that the Company’s ability to vary incentive compensation may not be as flexible as expected, at least in the short term. At the same time, although the Company is more diverse geographically and by business line than in the past, the weak market environment has not yet allowed the Company to benefit fully from the originally anticipated opportunities. Richardson GMP’s acquisition of Macquarie Private Wealth positions it well to begin contributing positively in the coming year to the bottom line of GMP’s wealth management segment.

While total 2014 earnings of $14.3 million were up from $9.6 million in 2013, the year did finish with a quarterly loss of $6.9 million in Q4 2014 due to practically non-existent investment banking activity in the wake of the collapse of oil prices in the last half of 2014. DBRS continues to monitor developments for signs of whether GMP’s ability to adjust to this environment is waning. An extended period of weakness without the Company being able to generate more positive results remains a concern.

Risk management is generally good with appropriate processes for managing credit and counterparty exposure. Most of the Company’s trading activities are as an agent, not a principal, which significantly reduces its market risk exposure. GMP engages in underwriting activities that are managed through guidelines and approval processes to constrain the overall risk to the Company. While underwriting risk is generally manageable, occasional relatively large underwriting can elevate GMP’s risk exposure, which is a concern, especially in the current environment. Credit risk is limited and is primarily secured margin lending.

Liquidity is good given GMP’s business profile and relatively liquid balance sheet. The mix of capital at the corporate holding company involves significant preferred shares that constrain further leverage. Capital is above regulatory requirements in the regulated broker-dealer subsidiaries. DBRS notes favourably the Company’s decision to preserve capital, and expects GMP to continue a prudent approach to retaining capital and limit its share buyback activity, given the tough market environment.

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.

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, Preferred Share and Hybrid Criteria for Corporate Issuers, and Rating Holding Companies and Their Subsidiaries, which can be found on the DBRS website under Methodologies.