DBRS Confirms GMP Capital Inc. Cumulative Preferred Shares Rating at Pfd-4 (high), Stable Trend

DBRS, Inc. (DBRS) has today confirmed the Cumulative Preferred Shares rating of GMP Capital Inc. (GMP or the Company) of Pfd-4 (high) with a Stable trend. The Company’s Support Assessment is SA3.

Underpinning the current rating is GMP’s solid franchise in Canada, focused on the extractive resource sector, which was further enhanced by the acquisition of FirstEnergy Capital Corp. (FirstEnergy) in September 2016. While the addition of FirstEnergy strengthens the Company’s position in the oil and gas sector, complementing its already strong position in the mining sector, it also deepens GMP’s reliance on the stressed resource sector. The rating level considers the headwinds facing the Company that are challenging revenue generation and driving inconsistent profitability. DBRS sees GMP as having a relatively conservative risk profile, but DBRS notes that the Company does have exposure to bought deals that can consume the balance sheet and working capital if not fully distributed. Capitalization levels are solid, though capital generation through retained earnings has been limited.

In maintaining a Stable trend, DBRS sees the rating as appropriately balancing GMP’s solid franchise and credit fundamentals with the significant challenges it faces in generating consistent earnings. The Company’s ability to generate revenues is being constrained by low activity levels in its focus sectors and GMP lacks sufficient diversification to offset the pressure. The Company has taken the appropriate steps to refocus its businesses and reduce costs during this challenging period, which should contribute to an earlier recovery in overall earnings.

GMP’s franchise is supported by its solid positioning in Canada, where it offers capital markets and wealth management related products and services. Its Capital Markets segment is skewed toward investment banking activities, notably equity underwriting and caters to middle market clients in Canada. The Company’s Wealth Management business operates through Richardson GMP, where GMP has an approximate 31% ownership stake and focuses on high net worth individuals. While the Company has maintained solid positioning amongst capital markets participants, there is increased competition for middle market clients from the larger banks and some foreign competitors. DBRS will look for further indications that GMP is well positioned to leverage its franchise and benefit from an improving operating environment.

From an earnings perspective, DBRS sees the headwinds facing the Company as continuing to be challenging. Indeed, GMP has reported net losses attributable to common shareholders in four out of the past five fiscal years. With revenues generally trending downward, DBRS sees the Company as lacking the sufficient scale and diversity outside of its core commodities-related sectors to offset the continued weakness in these markets. Richardson GMP, as the largest independent wealth management franchise in Canada, provides some diversity but has yet to contribute meaningfully to the Company’s earnings. Furthermore, GMP issued a promissory note in conjunction with the FirstEnergy transaction, with the note being paid down over five years from GMP FirstEnergy profits. DBRS sees this as potentially limiting the benefit of the acquisition over the term of the note. While growing revenues remains a challenge, the Company’s reduced cost base following its restructuring is contributing to a modestly improving bottom line.

Risk management processes are generally good, with systems and processes in place that limit excessive risk taking. GMP is regularly exposed to underwriting commitments and the risk is managed under established guidelines and approval procedures that limit the overall risk to the Company. GMP is exposed to market risk through its principal trading activities that focus on holding liquid securities and liability trading in names that it knows well, with these positions actively supervised. Credit risk is assumed through margin lending to clients of GMP, or as an introducing broker for Richardson GMP. Trading activities are subject to limits and other risk parameters, while margin lending is typically well-collateralized.

Given the nature of the business and a relatively liquid balance sheet that includes cash and other liquid assets, liquidity is good. As of Q1 2017, the Company had sufficient cash and liquid assets available to meet any short-term liability needs. Furthermore, GMP generated positive cash flow in four of the past five fiscal years, as well as in Q1 2017.

Capitalization is acceptable with a total assets/total common equity ratio of 9.5 times, though leverage is increasing with lower equity levels. With its issuance of a promissory note, the ratio of debt plus preferred shares-to-capital has increased to 40% as of Q 2017, up from 34% a year earlier. This ratio has been trending upward since 2013, reflecting net losses that have reduced equity capital levels. With working capital of about $150 million, capital levels remain well above regulatory net capital requirements. Despite this, DBRS expects that franchise investments could be hindered as the Company balances the need to generate returns and grow capital through retained earnings while continuing to invest in the franchise and compensate employees.

RATING DRIVERS
DBRS remains concerned that GMP is lacking the sufficient sector diversification to weather a continued challenging operating environment. If the Company is unable to return to sustainable profitability, particularly if capital levels continue to be eroded, or if pressure on cash flows increases, the ratings would likely come under pressure. Furthermore, any significant operational or reputational issues would likely pressure ratings.

While a rating upgrade over the intermediate term is unlikely, if GMP is able to improve returns in both its Capital Markets and Wealth Management businesses, while diversifying away from the Resource sector, these developments could put positive pressure on its rating.

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

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (May 2017) and Preferred Share and Hybrid Criteria for Corporate Issuers (December 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, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: February 1, 2011
Last Rating Date: May 26, 2016

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