DBRS Confirms Canaccord Genuity Group Inc. Preferred Shares at Pfd-3 (low), Trend Changed to Stable

DBRS, Inc. (DBRS) confirmed the Cumulative Preferred Shares rating of Canaccord Genuity Group Inc. (CF or the Company) at Pfd-3 (low). The trend has been revised to Stable from Negative. The Company’s Support Assessment is SA3.

KEY RATING CONSIDERATIONS
Underpinning CF’s rating is its important positioning in the Canadian capital markets with strong investment-bank positioning among middle-market clients in Canada as well as its growing wealth management business and international presence. In Canada, CF has been demonstrating improving market share in equity capital markets and mergers and acquisitions. The Company is also expanding is wealth management business through the onboarding of advisors in Canada and acquisitions in the United Kingdom.

The ratings also consider the headwinds facing CF that have driven weak results and low returns in recent years. DBRS sees inconsistent profitability as a concern at the current rating level and will look for continued success in the wealth management business to drive consistent earnings. While CF’s wealth management expansion is contributing to earnings stability, it has also resulted in increased debt levels and lower tangible common equity, which is also factored into the current rating level.

RATING DRIVERS
Over the medium term, positive rating pressure is unlikely. Over the longer term, further franchise diversification that contributes to sustained and improving earnings trends across businesses could positively pressure the rating.

Signs of sustained earnings deterioration would likely add negative rating pressure, particularly if capital levels eroded. Increased pressure on the Company's cash flows could also pressure the rating. Furthermore, given CF's high reliance on market confidence to support franchise momentum, any significant operational or reputational issues would likely pressure ratings.

RATING RATIONALE
Demonstrating its franchise diversification, CF reported 71% of its capital-markets revenues were generated outside Canada and 88% of investment-banking and advisory revenues were from sectors outside resources. The Company’s increasing business and geographic diversification has helped to offset headwinds in its traditional Canadian market. Specifically, the Global Wealth Management business is bringing a more stable source of fee-based revenue, contributing 41% of consolidated net revenues in Q1 2019. (DBRS notes that CF has a March 31 year-end.) CF’s 2017 acquisition of Hargreave Hale Limited (Hargreave Hale) in the United Kingdom bolstered the Company’s scale, adding $13.5 billion in assets under administration (AUA) and significantly contributing to its total AUA of $66 billion at Q1 2019.

CF reported a net income of $3 million in FY2018 and $15 million in Q1 2019 after the payment of preferred dividends. Earnings are showing some improvement with franchise diversification contributing to revenue growth and good focus on cost control also benefiting the bottom line. While earnings have not rebounded to levels that align with the franchise potential, the Company is benefiting from a more constructive capital markets operating environment.

Risk management processes are generally good with appropriate monitoring of credit and counterparty exposure. While DBRS sees that systems and processes can be enhanced further to prevent operational risk issues, this has been factored into the current rating level. CF 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. CF is exposed to market risk through its principal trading activities, which are actively supervised. Credit risk is assumed through CF’s wealth management business as the Company conducts trading activity on behalf of, and provides margin loans to, clients. Trading activities are subject to limits and other risk parameters while margin lending is typically well collateralized.

DBRS notes the risk in managing important relationships and, although the Company has procedures in place to manage its inventory positions, it maintains aged positions resulting from activities undertaken to support clients that bring important business to CF. These positions have the potential to experience mark-to-market losses. Given the challenging operating environment, properly assessing counterparty risk, including a counterparty’s ability to meet margin calls, remains critical.

DBRS notes that technology enhancements are more limited at CF than at larger investment-banking peers, which are generally the large universal banks with significant resources and regulatory oversight. This could result in weaker execution capabilities, risk management and compliance oversight as well as less flexibility to adapt to changing customer preferences. DBRS notes that CF has made good investments in its technology and systems in its wealth management business and will look for further investment within the capital markets businesses as well.

Given the nature of the business and a relatively liquid balance sheet that includes cash and other liquid assets, liquidity is good. As of June 30, 2018, the Company had sufficient cash and liquid assets to meet any short-term liability needs. Furthermore, cash flows have generally been positive and the fixed-charge coverage ratio continues to improve.

Capitalization is satisfactory with a total assets/total common equity ratio of 6.9 times, which is generally in line with recent leverage levels. Tangible common equity has weakened with the acquisition of Hargreave Hale and the associated goodwill. As of Q1 2019, tangible common equity/tangible assets of 5.3% is low compared with historical levels, averaging 6.6% over the past five full fiscal years. Long-term debt as a percentage of total capitalization is also increasing with higher debt levels, though DBRS sees this as acceptable, given that leverage is used to grow the wealth management business. Importantly, working capital of $564 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 (July 2018) and Preferred Share and Hybrid Criteria for Corporate Issuers (December 2017), 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, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: June 6, 2011
Last Rating Date: April 13, 2017

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.