DBRS Confirms Ratings on IGM Financial Inc. at A (high) and Pfd-2 (high), Stable

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debentures rating of IGM Financial Inc. (IGM or the Company) at A (high) and the First Preferred Shares rating at Pfd-2 (high). The trends are Stable.

IGM is a consistently profitable financial services company in Canada, reflecting a leading market position in the mutual fund manufacturing and distribution market through the operations of both Investors Group Inc. (IG) and Mackenzie Financial Corporation (Mackenzie). The rating is primarily based on the profitability, operating cash flow and business strengths of the Company’s IG subsidiary, while also recognizing the complementary positive contribution of diverse products, brands and distribution channels offered through Mackenzie and Investment Planning Counsel Inc.

While IGM is in a strong position, mutual fund manufacturers such as IG and Mackenzie face the challenge of ensuring that their product offerings and service quality evolve to meet the needs of advisors and their customers. IGM is in a competitive business that is being pressured by banks, insurance companies and lower cost investment options such as exchange-traded funds, all of which are trying to take advantage of the aging demographics of savers and retirees. At the same time, meeting increasing regulatory requirements remains a challenge and a source of incremental costs in the financial advisory business

The nature of IGM’s business exposes it to market volatility through management fees, which are calculated based on the market value of assets under management (AUM). Although this dynamic has been helpful in the past, it can also quickly create negative trends in income and cash flow. DBRS sees IGM as well positioned to withstand significant changes in the market value of the funds it manages.

During Q2 2015, one of Mackenzie’s institutional wealth management partners re-assigned sub-advisory responsibilities for four fixed income mandates, totalling $10.3 billion of AUM, resulting in negative net sales of $9.8 billion for the first six months of 2015 (6M 2015) for IGM in aggregate. The lost mandate caused total AUM for IGM to decline to $133.4 billion as at August 2015, a 7.4% decline from a year earlier.

While net income is up modestly for 6M 2015 compared with 6M 2014, Company revenues are naturally tied to the market value of funds under management and consequently will fluctuate with the markets. Distribution expenses, which account for the bulk of the Company’s expenses, are similarly tied to the market value of AUM and therefore provide a partial earnings hedge against the worst of equity market volatility.

With the help of its exclusive consultant network, IG has recorded positive net sales each year since the financial crisis except 2012, which saw net redemptions of just over 1% of AUM. The IG distribution model – which relies on close communication between consultants and customers – yields a lower redemption rate than that of the industry.

By contrast, the Mackenzie business model, which caters to third-party distribution, is more vulnerable to underlying fund performance and investor sentiment. Deterioration in these factors is typically reflected in the higher redemption rate. Net sales for Mackenzie were positive for F2014 and F2013, following net redemptions for the five years prior. Unfortunately, this improving trend has stalled with the mandates lost in Q2.

Selling and distribution expenses are somewhat variable, with certain distribution expenses also being tied to the level of gross sales and AUM. This has the benefit of maintaining margins in a business downturn. The Company has demonstrated good administrative expense management, benefiting from good economies of scale, efficient work processes and shared service arrangements with its sister companies.

In addition to strong profitability, the Company’s credit rating also benefits from strong cash flows (which comfortably cover the upfront distribution costs of mutual fund sales), strong liquidity and a conservative financial profile. The Company’s ratio of debt plus preferred shares-to-total capitalization remains appropriate for the rating.

As a member of the Power Financial Corporation (Power) group of companies, IGM benefits from the additional financial flexibility of having a strategic shareholder and the associated strong governance and risk avoidance management model that is typical of Power subsidiaries.

IGM originates a portfolio of residential mortgages as a service to financial planning clients within the context of a broad financial plan. These are funded partially with sales to mutual funds, various securitizations and whole loan sales. While the quality of borrowers tends to be high, drawn from individuals who have investments and financial plans with IG’s consultants, the business is nevertheless atypical for most asset management firms. A slowdown in the Canadian residential mortgage market would likely have a limited impact on IGM earnings generation, while a downturn in the residential mortgage market could hurt asset quality indicators and ultimately have an impact on provisioning levels, although it is unlikely to be material for IGM.

While an increase in diversification may have a positive impact on IGM’s credit quality, DBRS notes also that factors with potential negative implications include a decline in debt coverage metrics, a sale of the Company by Power, the emergence of noteworthy credit losses in the mortgage portfolio or growth in credit risks.

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 methodology is DBRS’s Rating Companies in the Asset Management Industry (January 2015). Additionally, DBRS’s Preferred Share and Hybrid Criteria for Corporate Issuers (January 2015) is utilized for assessing the preferred shares, and Rating Holding Companies and Their Subsidiaries (January 2015) is used to assess the holding company nature of IGM Financial Inc.

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.