DBRS Limited (DBRS Morningstar) changed the trend on RF Capital Group Inc.’s (RF Capital or the Company) Cumulative Preferred Shares to Stable from Positive. DBRS Morningstar also confirmed the Cumulative Preferred Shares rating at Pfd-4 (high). The Company’s Support Assessment is SA3.
KEY RATING CONSIDERATIONS
The trend change to Stable from Positive reflects in part the weaker macroeconomic outlook, which is likely to result in continued market uncertainty and slower growth in investable assets, both of which are factors that can negatively affect RF Capital’s earnings and the timely realization of its strategic goals. Moreover, RF Capital has ambitious growth plans that require significant investment. While DBRS Morningstar views these investments positively in the long term, the growth initiatives, including expenditures on technology platforms, have pressured profitability and free cash flow in recent quarters. Future investments are not expected to adversely affect earnings in the same manner.
The rating confirmation recognizes the Company’s solid wealth management franchise, which is underpinned by its good reputation and stability in assets under administration (AUA) and its continued progress in executing its strategic vision. A significant portion of revenues are fee based, supporting the consistency of underlying earnings. DBRS Morningstar sees operational risk as a key risk for the Company to manage and expects that investments and upgrades to various technology platforms to help service clients should provide a longer-term benefit to RF Capital’s operational capabilities as well as its expense base. The rating also considers that RF Capital could face challenges in executing its ambitious strategy for future growth. Furthermore, in order to grow the business through advisor acquisition, RF Capital may require an increase in leverage.
Continued franchise momentum and return to consistent profitability, while maintaining solid balance sheet fundamentals, would lead to a rating upgrade. Conversely, DBRS Morningstar would downgrade the rating if RF Capital’s acquisition strategy leads to a material increase in leverage or if there are any significant operational or reputational issues.
RF Capital’s rating benefits from its long-standing presence and good reputation in Canada, where it operates in the independent wealth advisory space. At $35.4 billion in AUA as of May 31, 2023, the Company is one of the larger independent players in an industry dominated by the wealth management arms of the large Canadian banks and is further aiming to grow in this space both organically and through acquisitions. To achieve its desired scale, RF Capital has embarked on an ambitious multiyear growth strategy, aiming to grow its AUA nearly threefold to $100 billion in the next three to five years and its adjusted EBITDA to between $200 million and $300 million. To that end, the Company has made significant investments in advisor recruitment and support and succession planning initiatives. RF Capital has also made considerable investments in recent years in its technology, including moving its advisory platform to Fidelity Clearing Canada’s (Fidelity) uniFide platform and partnering with Envestnet to support its advisors via digital tools, among other items. While positive for the Company’s long-term growth prospects, the investments have resulted in significant nonrecurring implementation costs in the short term, which in turn has reduced EBITDA. Operational risk remains high relative to historical levels, although it has declined from the prior year as the Company completes its technology projects. Supplier risk is moderately higher than before, given the outsourcing of several business functions. The weaker macroeconomic outlook for Canada may also affect the Company’s ability to realize its strategic goals in a timely manner, including its planned foray into opportunistic acquisitions and strategic partnerships, as well as potentially reduce its net flows and, in turn, its fee-based revenues.
At $67.8 million, wealth management revenue declined in Q1 2023 compared with Q1 2022, driven in part by a modest decline in AUA and lower fee revenue. Conversely, interest revenue increased because of higher interest rates. At 90% at Q1 2023, a high proportion of commissionable revenue is fee based, a key support for the rating. The adjusted EBITDA margin (which excludes transformation costs and the amortization of acquired intangibles) stood at 14.9% in Q1 2023 versus 12.5% in Q1 2022 as an increase in gross margin more than offset an increase in adjusted operating expenses.
Following the sale of its capital markets business in 2019 and the more recent move to use Fidelity as the provider of custody, clearing, and trade settlement services, RF Capital’s on balance sheet risk is minimal and reduced compared with prior years. Market fluctuations can result in a decline in AUA or increase in redemption rates and fund outflows, adversely affecting earnings. Expense management is critical to maintaining earnings, given the largely fixed nature of operating costs (not including variable advisor compensation). The material progress made in increasing the Company’s scale, as well as the realization of run-rate operating expense savings from the transition to the Fidelity platform, can be expected to improve future profitability. Nonetheless, DBRS Morningstar expects earnings to remain muted over the next year.
The Company is sufficiently funded and has in place a $200 million revolving credit facility (out of which $80.5 million was drawn at Q1 2023) to facilitate investments in platforms, recruiting, and finance advisor team acquisition. The Company reported a fixed-charge coverage ratio (using adjusted EBITDA) of 4.1 times (x) for 2022. Furthermore, RF Capital holds appropriate working capital levels to manage its day-to-day liquidity needs. Regulatory capital requirements are minimal and well within the Company’s capacity. The Company employs a moderate amount of leverage with debt (including 25% of preferred shares per DBRS Morningstar criteria) to adjusted EBITDA of 2.7x in Q1 2023.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
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/396929 (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Investment Management Companies (December 7, 2022; https://www.dbrsmorningstar.com/research/407010). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929) in its consideration of ESG factors.
The following methodology has also been applied:
-- DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 20, 2022; https://www.dbrsmorningstar.com/research/404248)
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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.dbrsmorningstar.com.
The rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action.
DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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