DBRS Confirms Canaccord Genuity Preferred Shares at Pfd-3 (low), Trend Revised to Negative

DBRS, Inc. (DBRS) has today confirmed its rating of the Cumulative Preferred Shares of Canaccord Genuity Group Inc. (Canaccord Genuity or the Company) at Pfd-3 (low). The trend has been revised to Negative from Stable. This rating action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

Underpinning the current rating is the continued resilience of Canaccord Genuity’s franchise, despite the prolonged challenging operating environment. The Company has successfully integrated recent acquisitions, improved geographic diversity, enhanced its wealth management business segment and demonstrated resilience through the extended weak market environment. Furthermore, throughout this challenging period, the Company has maintained its sound risk profile while continuing to enhance risk systems and processes.

The Negative trend reflects the significant headwinds facing the Company, which are driving weak results and low returns. While Canaccord Genuity’s variable expense structure is an important factor underpinning its solid expense control, results were notably weak 9M 2016, resulting in an inability to reduce compensation commensurately. DBRS views this as appropriate from a franchise perspective, given the Company’s need to retain and attract top talent. The challenge is balancing the need to generate returns and grow capital through retained earnings, which continue to be significantly challenged, while continuing to invest in the franchise. DBRS expects that the Company’s earnings will remain significantly pressured over the near to medium term.

Signs of sustained earnings deterioration would likely add negative rating pressure, particularly if capital levels continue to be eroded. Increased pressure on the Company’s cash flows could also pressure the rating. Furthermore, as with all broker-dealers, any significant reputational issues would likely pressure ratings. On the other hand, further franchise diversification that contributes to sustained and improving earnings trends across businesses would provide support to the current rating level.

The Company’s increasing geographic diversity has made a greater contribution to overall results, with international results generally offsetting weaker results in its traditional Canadian market. Canaccord Genuity has also developed into a more diverse institution in recent years by expanding Wealth Management in the United Kingdom and Europe to complement its traditional capital markets advisory businesses. The Wealth Management business is bringing a more stable source of fee-based revenue, with assets under administration and management now just above $34 billion compared with $17 billion just four years ago.

Canaccord Genuity reported a sizable net loss of $336 million in 9M 2016, which included a sizable goodwill impairment as well as restructuring costs. Excluding these items, the Company still reported a net loss of $2.7 million in 9M 2016 as compared with net income of $40.9 million in 9M 2015. (DBRS notes that Canaccord Genuity has a March 31 year-end.) Earnings are expected to remain under pressure in Q4 2016 given the current challenging market environment, as well as some further restructuring costs and a high compensation ratio. Over the remainder of the year, DBRS sees significant earnings headwinds and will continue to monitor the impact on the Company’s franchise strength and business positioning.

Risk management processes are generally good, with appropriate credit and counterparty exposure control processes. The Company conducts most of its trading activities as an agent, not a principal, which significantly reduces its market risk exposure. Canaccord Genuity is regularly exposed to underwriting commitments, but the risk is managed under established guidelines and approval procedures that limit the overall risk to the Company. Credit risk is primarily in low risk, secured margin lending. Given the challenging operating environment, properly assessing counterparty risk, including a counterparty’s ability to meet margin calls, remains critically important.

Given the nature of the business and a relatively liquid balance sheet that includes cash and other liquid assets, liquidity is good. Nonetheless, the ratio of debt plus preferred shares-to-capital has increased to 28% as of December 31, 2015, from 20% a year ago, reflecting the sizable net loss that has reduced absolute capital levels. Importantly, regulatory net capital exceeds requirements at all of the regulated subsidiaries.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other applicable methodologies include the Preferred Share and Hybrid Criteria for Corporate Issuers (January 2016). These can be found at http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. 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.

Lead Analyst: Lisa Kwasnowski
Rating Committee Chair: Michael Driscoll
Initial Rating Date: June 6, 2011
Most Recent Rating Update: March 26, 2015