DBRS Confirms TMX Group Limited at A (high) and R-1 (low), Stable Trend

DBRS, Inc. (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Debt rating of TMX Group Limited (TMX or the Group) at A (high), and the Group’s Commercial Paper rating at R-1 (low). The trends remain Stable. The terms of the Senior Unsecured Debt rank it pari passu with bank debt (of which none is outstanding), and consequently, it has been set equal to the Issuer Rating. The Group has appropriate liquidity backstops provided by well-rated banks to support its Commercial Paper program, which in turn supports the application of DBRS’s standard short-term to long-term rating mapping. This action follows a review of the Group’s performance and prospects.

The rating confirmation reflects the strength of the Group’s franchise, including its leading market positions across a diversified set of businesses, including exchanges and clearing houses, where TMX can leverage its strong franchise to deliver high-quality execution, facilitate capital raising and provide data services and analytics, among other things. In Canada, TMX is easily the preeminent player in the businesses where it competes, with significant market shares across a breadth of products. Furthermore, DBRS views the Group as having strong risk management capabilities and governance, but notes that it continues to be challenging to manage risk across a large, complex and diverse organization.

The ratings also consider TMX’s pressured, but improving, financial metrics, which have only recently reached levels that comfortably fit into the current rating range. Given the still-challenging operating environment, particularly in the resource sector where TMX has a strong focus, earnings will likely remain challenged. Importantly, the Group has made progress with reducing its debt levels following the 2012 Maple transaction, which contributes to lower leverage. As TMX anticipates that it will continue to pay down its debt with free cash flow, strong earnings generation remains critical.

TMX is the leading provider in Canada in equities, fixed income, derivatives and energy markets of services encompassing listings for issuers, trading, clearing, settlement and depository facilities, information services and products, and technology services. While TMX is the preeminent player in Canada for many of its business activities, the Group faces competition from exchanges and other service providers looking to enter the Canadian market. Nevertheless, DBRS views barriers to entry as high. Critical to TMX’s continued business positioning is its ability to continue to advance and innovate its technology offerings, while further diversifying outside of the resource sector.

Earnings continue to show improvement on an underlying basis, with net income trending positively as the Group is well-positioned to benefit from growing volumes, given its highly scalable technology infrastructure. Positive operating leverage contributed to H1 2016 net income of $105 million and a return on average common equity of 7.4%. While TMX’s earnings were pressured in 2014 and 2015, this was due to non-cash goodwill impairment charges, mainly related to BOX, listings and equity trading. While these investments have been marked to their recoverable value effective YE2015, the continued challenging operating environment could further impact the value of TMX’s goodwill and intangible assets, which remained sizable at $4.4 billion at Q2 2016.

Risk management, reputational risk issues and governance are critical for TMX’s exchanges and clearing-house operations. TMX uses various means to mitigate risk in its activities, including extensive controls, collateral agreements, margin arrangements, delivery versus payment processes, risk sharing by its members, the ability to assess members to cover losses and legal superpriority positioning, which DBRS views as appropriate. TMX businesses do not actively take direct market risk, as they are not making markets or taking proprietary positions in the markets they facilitate. TMX appears to be successfully managing operational risk, as operational losses have not been notable.

Important to DBRS’s rating of TMX is the Group’s structure, as well as its regulatory oversight. From a structural perspective, TMX has a strong and stable shareholder base, with significant ownership by prominent participants in the Canadian investment industry. With no externally issued debt by its operating subsidiaries (excluding operating/clearing lines), DBRS’s analysis is generally done on a consolidated basis. DBRS considers that the importance of the Group’s operations, such as the Canadian Depository for Securities Limited (CDS) and the Toronto Stock Exchange, to the Canadian financial system could potentially prompt government intervention in the event of a major capital markets disruption; however, DBRS does not anticipate that the holding company, TMX, would benefit from such intervention. From a regulatory perspective, TMX subsidiaries have extensive oversight by various regulators, providing an additional level of scrutiny at the operating subsidiary level.

DBRS views the Group’s financial metrics as satisfactory and improving. Following the Maple transaction, TMX’s debt level became elevated, though debt levels continue to decline as the Group focuses on de-leveraging. DBRS expects the Group to make continual progress in its de-leveraging efforts in order to meet its leverage target of 2.0 times (x) to 3.0x (debt-to-EBITDA). Importantly, operational cash flows are sufficient to cover interest costs and improving as the Group continues to simplify and integrate its various systems and infrastructure to lower its cost base. Cash flows remain critical to TMX’s de-leveraging efforts.

RATINGS DRIVERS
Given the challenging operating environment, and TMX’s relatively high levels of leverage, DBRS views any positive rating action as limited over the medium term. Continued successful execution of its strategy, including expansion outside of the resource sector and further cost reductions, as well as continued improvement in credit fundamentals, including reduced debt leverage, improving interest coverage and improving earnings, could add positive ratings pressure over the longer term.

While DBRS views TMX’s business risk profile as strong, its financial risk profile remains pressured, resulting in limited tolerance for any weakening in the Group’s financial profile. If there is any perceived weakening of TMX’s franchise, indicated by a notable loss of market share or reduction in its critical scale advantages, this could also negatively pressure the rating. The operating subsidiaries of TMX have no externally issued debt other than operating/clearing lines. Any change in the Group’s debt structure, resulting in structural subordination in TMX’s outstanding debt, would likely lead to a re-examination of the holding company’s debt ratings.

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

The applicable methodologies are the General Corporate Methodology, including the TMX-specific section in the Appendix (June 2016), DBRS Criteria: Rating Holding Companies and Their Subsidiaries (January 2015) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 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: Roger Lister
Initial Rating Date: September 13, 2013
Most Recent Rating Update: September 29, 2015

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.