DBRS Morningstar Confirms Canaccord Genuity Group Inc. Cumulative Preferred Shares at Pfd-4 (high), Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the Cumulative Preferred Shares rating of Canaccord Genuity Group Inc. (CG or the Company) at Pfd-4 (high) with a Stable trend. The Company has a Support Assessment of SA3, which implies no expected systemic support.

KEY RATING CONSIDERATIONS
The rating confirmation recognizes CG’s solid niche franchise, with a growing wealth management presence across various geographies. Since 2018 the Company has made several acquisitions, namely in the U.S., the United Kingdom (U.K.), and Australia, and CG notes that the successful platform expansion has contributed to efficiencies of scale and added to bottom line profit growth. While CG’s wealth management expansion is contributing to earnings stability, in DBRS Morningstar’s opinion such international expansion can also result in increased operational risk as the Company must successfully monitor activities across various geographies. Furthermore, while CG has demonstrated success in its capital markets businesses that are integral to the value of its franchise, the ratings also consider this exposure and the associated market risk and execution risk.

RATING DRIVERS
As the Company continues to diversify its franchise, DBRS Morningstar will look for CG’s ability to continue to sustain earnings momentum, which would drive a ratings upgrade. DBRS Morningstar will also look for confirmation that systems and processes are continuously enhanced in order to prevent operational risk issues, especially as the Company expands through acquisitions into its existing core businesses. Demonstrating continued success in its global business growth absent any notable operational risk issues would result in a rating upgrade.

Conversely, weakened credit fundamentals combined with inconsistent earnings would result in a rating downgrade. Furthermore, given CG’s high reliance on market confidence to support its franchise, any material operational or reputational issues would result in a rating downgrade, as would material negative stresses to the Company’s liquidity or funding profiles.

RATING RATIONALE
CG is a Canadian-based financial institution that focuses on capital markets activities and wealth management. It had $7.1 billion in assets and $94.9 billion in assets under administration as of Q1 2022, with operations in the U.S., the U.K., and Australia. CG has been scaling up its businesses through acquisitions over the last few years, with a U.S. capital markets acquisition in 2019, and continued acquisitions in the wealth management space, particularly in the U.K. Most recently, in April 2021, the Company announced the acquisition of the private client investment management business of Adam & Company based in Scotland, which was completed on October 1, 2021.

The Company reported Q1 2022 revenue of $519 million, up 37% year over year. CG is benefitting from its franchise diversification efforts and an active capital markets operating environment while also containing expenses effectively. Despite economic concerns from the Coronavirus Disease (COVID-19) pandemic, CG’s capital markets businesses, particularly its U.S. franchise, saw markedly increased activity in the middle-market segment, while its wealth management business benefitted from increased client assets across its different geographies. DBRS Morningstar expects that the successful expansion of CG’s wealth management franchise will continue growing the Company’s stable revenues, helping to offset historic earnings volatility CG experienced from its capital markets business. Furthermore, in DBRS Morningstar’s view the Company should continue to benefit from driving organic growth, including increasing client assets.

Risk management processes are generally good with appropriate monitoring of credit and counterparty exposures. DBRS Morningstar notes the increased risk with an expanding global franchise, where operational risks become increasingly challenging to manage. Furthermore, DBRS Morningstar considers in the rating the notable market risk inherent in capital markets businesses. While CG has a long history of managing risk/reward associated with these businesses, DBRS Morningstar continues to note the risk in managing inventory positions associated with a small number of client relationships within its Australian and Canadian capital markets businesses that can drive mark-to-market volatility. For example, DBRS Morningstar monitors the Company’s inventory, tag-end inventory, and illiquid inventory positions. While the Company has proven successful in its margin lending business, DBRS Morningstar notes the Company from time to time has accounts with margin deficits or negative equity.

CG has been gradually reducing leverage levels since 2019, when, according to DBRS Morningstar calculations, debt and preferred shares to capitalization decreased to 32% for Q1 2022 from a peak of 47% in Q2 2020. To note, in DBRS Morningstar’s leverage calculations, preferred shares and contingent consideration are considered as debt. Debt had been used to finance its U.K. acquisitions, including the addition of certain bank loans, while the issuance of convertible debentures provided working capital to fund growth initiatives and activities in the Company’s wealth management operations. The convertible debentures were redeemed in April 2021. In July 2021, a U.K. subsidiary of CG issued convertible preference shares to HPS Investment Partners, LLC (HPS). HPS invested in CG’s U.K. wealth management division by acquiring GBP 125 million ($218 million) in convertible preferred shares. Meanwhile, fixed charge coverage has averaged 9.0 times (x) over the most recent five years, and increased to a very high 41.1x in Q1 2022.

Furthermore, improving earnings is benefitting debt and preferred shares to EBITDA, which was at 1x in Q1 2022 versus a historical average of 3.7x over the last five years. Although DBRS Morningstar recognizes the benefit that CG’s earnings are deriving from growing the wealth management platform, which is also supportive of internal capital generation, a longer track record of success would benefit the rating. CG reported equity of $1.1 billion as of Q1 2022, up 22% from a year earlier.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Global Methodology for Rating Investment Management Companies (December 7, 2020; https://www.dbrsmorningstar.com/research/370957) and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021; https://www.dbrsmorningstar.com/research/386355). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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