DBRS Downgrades GMP Capital Inc. Preferred Share Rating to Pfd-4 (high)

DBRS, Inc. (DBRS) has today downgraded the Cumulative Preferred Shares rating of GMP Capital Inc. (GMP or the Company) to Pfd-4 (high) from Pfd-3 (low). The trend is now Stable. This concludes the review of the rating that was initiated on January 14, 2016, following GMP’s announcement that it is undertaking a series of fundamental organizational changes.

The downgrade reflects DBRS’s view that GMP’s franchise positioning and earnings are weakened relative to past levels at a time when the headwinds facing GMP remain challenging. Indeed, GMP has reported net losses attributable to common shareholders in three out of the past four fiscal years, as well as a loss in Q1 2016. To cope with the difficult operating environment, the Company is executing a restructuring plan to reduce costs and refocus its franchise on its core competencies and markets. While DBRS views the restructuring as prudent, it reduces the scope of the Company’s capital markets franchise and diversity of its revenue streams, both of which had previously supported the rating. Moreover, DBRS expects that the Company will continue to face significant headwinds given its focus on commodities-related sectors, limiting the Company’s ability to generate capital through retained earnings.

The Stable trend reflects DBRS’s view that the restructuring, combined with the run-off of certain guaranteed compensation arrangements in 2016, has better positioned GMP’s franchise to return to sustainable profitability.
GMP’s restructuring includes office closures in the United Kingdom and Australia, while streamlining its franchise in Canada and reducing headcount in the United States related to its energy business. This reorganization is in response to permanent structural and regulatory changes across the industry, which have been taking shape for some time, as well as persistently challenging market conditions. This reorganisation, while important from a cost-savings perspective, lessens the scope of GMP’s franchise and reduces diversity. Importantly, it refocuses the franchise on GMP’s core capabilities in Canada, the United States and Asia, where the Company expects to realize synergies across these geographies, given its niche focus on the commodities sector. Complementing the capital markets business, GMP also retains a 31% stake in Richardson GMP, the largest independent wealth management franchise in Canada. While wealth management does provide some diversification, DBRS notes that Richardson GMP has yet to contribute meaningful core earnings to GMP.

While annualized expense savings of approximately $40 million post-restructuring should contribute to bottom-line results, DBRS expects revenues to remain pressured over the near to medium term. In fact, revenues have generally trended downward over the past five years, while expenses have been flat or increasing. Given GMP’s focus on the mining and energy sectors (56% of 2015 investment banking revenues), the adverse environment is having a notable impact. The elevated expense base can be partly attributed to investing in franchise expansion and fixed compensation costs associated with the U.S. energy business, some of which will be reversed with the reorganization.

With earnings pressured, including a sizable net loss of $30 million in 2015, the Company’s ability to generate capital through retained earnings has been much reduced. This trend continued in Q1 2016 with a net loss of $3 million. While capital levels remain well above regulatory net capital requirements, DBRS expects that franchise investments will be challenged as the Company balances the need to generate returns and grow capital through retained earnings while continuing to invest in the franchise. Furthermore, DBRS sees that business positioning could be further eroded if GMP were to lose ground relative to larger peers who have more resources to adapt and invest during this sustained downturn in the energy markets.

RATING DRIVERS

If GMP is unable to return to sustainable profitability, particularly if capital levels continue to be eroded, or if pressure on cash flows increase, the ratings could come under pressure. Furthermore, as with all broker-dealers, any significant reputational issues would likely pressure ratings. While a rating upgrade over the short term is unlikely, if GMP is able to improve returns in both its capital markets and wealth management businesses, while reducing its reliance on the resource sector by building out other sectors, these developments could put positive pressure on its rating.

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

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (December 2015) and Preferred Share and Hybrid Criteria for Corporate Issuers (January 2016), which can be found on our website under 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: February 1, 2011
Most Recent Rating Update: January 14, 2016

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.