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

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

KEY RATING CONSIDERATIONS
In confirming the rating for GMP, DBRS considers the Company’s solid franchise in Canada with strong positioning amongst small- to mid-cap investment banking clients while also acknowledging the continued headwinds GMP faces, which are challenging revenue generation and driving inconsistent profitability. Pressure on earnings in recent years has negatively affected common equity, though working capital remains solid. As continued losses reduce the Company’s loss-absorbing capital base, DBRS sees continued increasing leverage as potentially adding pressure to the current rating level.

RATING DRIVERS
If GMP maintains franchise momentum across its businesses, while also demonstrating improving returns in both its Capital Markets and Wealth Management businesses, there could be positive pressure on its rating. Declining leverage would also contribute to positive ratings pressure.

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 rating would likely come under pressure. Furthermore, any significant operational or reputational issues would likely pressure the rating.

RATING RATIONALE
GMP’s franchise is supported by its solid positioning in Canada, where it provides capital markets and wealth management related products and services to small- and mid-cap clients. Its Capital Markets segment is focused on investment banking activities, notably equity underwriting and advisory. The Company’s Wealth Management business operates through Richardson GMP, where GMP has an approximate 32% 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. The number of transactions within the commodities sector remains at historical lows, which is a core strength for GMP. The Company’s expansion into other sectors, including cannabis and blockchain, has contributed to revenues, but also brings along heightened reputational risks. DBRS sees GMP as well positioned to leverage its franchise and benefit from an improving operating environment, while also recognizing the continued environmental headwinds.

GMP’s earnings remain challenged given the current operating environment. Revenues have demonstrated improving trends in recent quarters, and GMP has taken steps to refocus its businesses and reduce costs, which should contribute to bottom-line improvement. DBRS recognizes the ebb and flow of the Capital Markets businesses that drives earnings volatility, but continued losses indicate the Company has still not diversified enough to sustain profitability through challenging market cycles. 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. DBRS notes that GMP has reported net losses in five of the last nine quarters. Despite this, GMP is typically cash-flow positive, supporting its ability invest in its businesses and service debt payments.
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 at Q1 2018, the Company had sufficient cash and liquid assets available to meet any short-term liability needs. In conjunction with its acquisition of FirstEnergy, GMP issued an unsecured promissory note with current principal outstanding of $28 million, down from about $40 million at issuance in 2016, which has a maximum term of five years. The note will be paid down via profits from the GMP FirstEnergy business, which may limit the earnings benefit of the acquisition over the term of the note. When assessing the Company’s fixed charge coverage ratio, GMP has not generated sufficient EBITDA to cover its fixed charges over the past three years. This metric improved in Q1 2018, and DBRS would view sustained improvement positively.

Capitalization is acceptable but weakening, with a total assets/total common equity ratio of 11.7 times (x), up from 10.9x as at the end of 2017. Leverage is increasing with higher assets and lower equity levels. With its issuance of the promissory note related to the GMP FirstEnergy acquisition, the ratio of debt plus preferred shares-to-capital is an elevated 44%. This ratio has been trending upward since 2013, reflecting net losses that have reduced equity capital levels. If this ratio continues to trend upward, combined with increasing leverage, DBRS anticipates there could be ratings pressure. Declining equity levels raise concerns regarding the Company’s ability to absorb losses if there were an unforeseen stress event. DBRS notes that working capital of about $185 million is good and capital levels remain well above regulatory net capital requirements.

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 on the issuer page at www.dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (May 2017) and Preferred Share and Hybrid Security Criteria to Corporate Issuers (December 2017), which can be found on dbrs.com under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Lisa Kwasnowski, Senior Vice President, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG

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

For more information on this credit or on this industry, visit www.dbrs.com.