DBRS Confirms Canaccord Genuity Group Inc. Preferred Shares at Pfd-3 (low) with a Stable Trend

DBRS Limited (DBRS) confirmed the Cumulative Preferred Shares rating of Canaccord Genuity Group Inc. (CF or the Company) at Pfd-3 (low) with a Stable Trend. The Company has a Support Assessment of SA3, which implies no expected systemic support to the Company.

KEY RATING CONSIDERATIONS
Underpinning CF’s rating is its solid positioning in Canada, with increasing market share in middle market equity underwriting and a growing wealth management franchise. Internationally, the performance of the Company’s capital markets business continues to improve as it focuses on core competencies, complemented by a few accretive acquisitions, particularly in wealth management, which are increasing the contribution of stable revenues to the overall businesses.

The rating also considers CF’s low returns and weak results in recent years as the Company’s capital markets business focuses on sectors that are prone to volatility. 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 recurring revenue. While CF’s wealth management expansion is contributing to earnings stability, it has also resulted in increased operational risk as the Company integrates its various acquisitions, in addition to higher debt levels and lower tangible common equity, which are also factored into the current rating level.

RATING DRIVERS
Although DBRS considers CF as being well placed in its current rating category, over the longer term, further franchise diversification that contributes to sustained and improving earnings trends across businesses could positively pressure the rating.

If CF’s tangible common equity levels continue to decline, or if the Company continues to increase its leverage levels, this could lead to negative rating pressure. Sustained earnings deterioration would also add negative rating pressure. Furthermore, given CF’s high reliance on market confidence to support franchise momentum, any significant operational or reputational issues would likely negatively affect the rating.

RATING RATIONALE
CF continues to reduce its concentration risk and diversify its franchise outside of its traditional Canadian market. In Q1 2020, the Company reported that 66% of its capital markets revenue was generated outside Canada and 96% of investment banking and advisory revenue was sourced outside of the resource sector (DBRS notes that CF has a March 31 year-end). The acquisition of Petsky Prunier LLC in the United States (U.S.) will also help diversify revenues with the addition of advisory fees to CF’s U.S., which is otherwise focused on equity capital market. Furthermore, over the last few years, the Global Wealth Management business has provided a stable source of fee-based revenue, contributing 40% to consolidated net revenues in Q1 2020. CF continues to scale up this business through the acquisitions of McCarthy Taylor Ltd. and Thomas Miller Wealth Management in the United Kingdom (U.K.), Thomas Miller private client activities on the Isle of Man, and the addition of experienced advisory teams in Canada with total assets under administration of $67.6 million as of June 30, 2019. Furthermore, the Company also announced its intent to acquire Patersons Securities Limited in Australia, subject to shareholder approval, which would complement the existing Australian capital markets and wealth management businesses.

CF reported net income of $61 million in F2019, its highest level since 2011, and $22 million in Q1 2020 after the payment of preferred dividends. Earnings have demonstrated solid improvement in recent periods, with the Company benefiting from its franchise diversification efforts and a constructive capital markets operating environment while also containing expenses effectively. However, DBRS notes that the Company’s strength lies in certain sectors of the capital markets businesses, which tend to be more volatile and thus have presented an element of inconsistency in CF’s earnings in the past. While the growth of the wealth management franchise should help to offset this earnings volatility, the Company will need to demonstrate success over the longer term with organic growth, including increasing assets under management, retaining advisory teams and improving profitability.

Risk management processes are generally good with appropriate monitoring of credit and counterparty exposures. While CF has updated some of its operating platforms, DBRS sees that systems and processes can be enhanced further to prevent operational risk issues, especially as the Company expands internationally through acquisitions. Furthermore, 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, which could negatively impact capital markets earnings; therefore, properly assessing counterparty risk, including a counterparty’s ability to meet margin calls, remains critical.

Liquidity is good, given the nature of the business and a relatively liquid balance sheet that includes cash and other liquid assets. As of June 30, 2019, the Company had sufficient cash and liquid assets to meet any short-term liability needs, and although cash flows have been volatile in recent quarters, the fixed-charge coverage ratio continues to show improvement.

Capitalization levels have declined over the last year as the Company increased its leverage levels to finance its most recent acquisitions. In DBRS’s opinion, tangible common equity (TCE) has substantially weakened, reaching a low of 1.7% in Q1 2020 versus 5.3% in Q1 2019. This erosion of TCE is a result of the Company’s most recent international acquisitions, which have caused CF to recognize a large amount of associated goodwill and other intangibles as a result of adopting International Financial Reporting Standards 16 (Leases). In addition, long-term debt as a percentage of total capitalization increased to 29% in Q1 2020 versus 20% in Q1 2019, as the Company repaid its existing subordinated debt with new convertible debentures that are almost double the size at $133 million, as well as increased the size of its bank loan by almost $30 million over the course of the year to finance its U.K. acquisitions. Although DBRS sees the benefit that CF’s earnings would derive from growing the wealth management business, financing these acquisitions through a significant increase in leverage and further weakening capital could pressure the rating.

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

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (June 2019) and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2018), which can be found on our website under Methodologies & Criteria.

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 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.

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