DBRS Confirms Ratings on DundeeWealth Inc. at BBB

DBRS has today confirmed the Issuer and Senior Debt ratings for DundeeWealth Inc. (DW or the Company) at BBB and the corresponding Preferred Shares, Series 1 rating at Pfd-3. All ratings have a Stable trend. The rating confirmations are derived largely from the solid financial and operating performance of the Company’s investment management operation, which continues to outpace the results for the industry in terms of gross sales of long-term funds and low redemptions. Innovative, responsive and award-winning products and funds, good penetration of the Dundee advisor network and the national accounts channel, combined with good relative fund performance, have maintained the Company’s sales momentum for several consecutive years, providing the basis for strong and stable recurring cash flows.

In addition to the strong sales results in the mutual fund segment, stronger equity markets and good relative fund performance lifted year-end assets under management (AUM) by 42% over year-end 2008 and at the end of Q1 2001, by 51% over the year-ago figure and 7.4% on a quarter-over-quarter basis. Average AUM in 2009 was generally unchanged, but combined with a lower average management fee, reduced management fee revenue by almost 7% in the year. Total investment management revenues were unchanged, however, due to a $32.6 million performance fee earned on $7.4 billion in funds to which such fees apply. (DBRS tends to discount performance fees as they are not a predictable contributor to revenues or income.) With a 50% recovery in average AUM in Q1 2010 over year-ago levels, investment management revenues increased by over 56%, which was also reflected in a 92% increase in EBITDA.

In addition to the strong recovery in the investment management division, the Company has been increasingly focused on restoring profitability in the brokerage division, which includes the retail distribution and capital markets segments. A restructuring initiative resulted in a 25% reduction in headcount and fixed costs as back office and administrative functions for the two segments were combined, which gave rise to a similar reduction in the brokerage division’s SG&A expense in 2009 (a 10% reduction for the Company in total). The sale of the Company’s Québec distribution operation in 2008, combined with continuing education programs, has increased the average productivity of retail advisors, bringing the retail distribution segment closer to profitability. A new management team is leveraging the Dundee Group’s specific industry and market expertise in a more-focused capital markets segment, where profitability was temporarily lifted by a bounce-back in principal trading revenues in 2009 and a recovery in institutional and corporate advisor commissions and corporate finance fees in 2010. Overall, EBITDA and pre-tax income for the brokerage division turned positive in 2009 and stayed positive in Q1 2010, following five years of losses.

Over the course of the past few years, there have been a number of events that have temporarily altered the financial profile of the Company: the purchase of a 16.3% interest in its operations from the Caisse de dépôt et placement du Québec (2007), the purchase of close to $400 million of illiquid investments from Dundee Bank of Canada (Dundee Bank), subsequent writedowns of illiquid securities in 2007 and 2008, the injection of $348 million in equity with the sale of 18% of the Company to the Bank of Nova Scotia (BNS), and the 2009 sale of most of its asset-backed commercial paper (ABCP)-related floating-rate notes (FRNs) for $139 million. The net impact of these transactions has been to take the Company’s total financial leverage (including preferred shares) from 8.2% in 2006 to 26.6% as of Q1 2010. Similarly, total debt, including preferred shares, has increased to about 2.0 times EBITDA from 0.3 times in 2006.

In 2009, strong earnings, reductions in working capital, and the $139 million proceeds on the sale of the ABCP FRNs translated into an increase of $285 million in cash and equivalents, which has returned DW’s net debt position to favourable levels. How the Company chooses to deploy its $367 million in cash will be strategically significant. While there are few M&A opportunities in the Canadian investment management industry that could absorb this much cash, the Company continues to be interested in expanding its asset management franchise into the United States and Europe, where a larger acquisition opportunity is more likely to arise in the long run. While any of these events would prompt a review of the current rating, DBRS is generally comfortable that the current ratings reflect a substantial amount of downside risk, which is consistent with the Company’s recent experience with strategic initiatives.

DBRS acknowledges the progress that the Company has made in enhancing the profitability of its business platforms as it increasingly focuses on its strengths in the asset management business. The build-out of the retail distribution operation over the past ten years, while not necessarily profitable on a stand-alone basis, yields tremendous revenue synergies for the investment management division as the share of each advisor’s assets under administration (AUA) is increasingly invested in Dynamic and Goodman investment products (32.8% of mutual fund AUA at March 31, 2010, were in Goodman mutual funds compared with 25.8% at March 31, 2009, and 11% in 2004). Nevertheless, earnings volatility and the rapid evolution of the Company’s financial profile following substantial strategic initiatives, such as the building and subsequent disposition of Dundee Bank, negatively affect the Company’s risk profile.

While the Company is still controlled by Dundee Corporation and, ultimately, Ned Goodman, the shareholder agreement with BNS provides for two nominees to the 12-member board, which DBRS regards favourably in terms of independent oversight and strategic risk management. BNS is well-placed to take out the interests of the Goodman family in the Company, should it thrive or not. In the meantime, the asset-gathering success of the Company, which has seen its share of the Canadian mutual fund industry AUM almost double to 4% at year-end 2009 (Source: IFIC), suggests that BNS has an attractive option on a successful wealth management business where BNS is currently underrepresented compared with its peer group. This option provides a measure of downside protection for the Company’s rating.

DW’s Senior Debt benefits from an explicit guarantee from Goodman & Company, the Company’s asset management subsidiary, which generally accounts the vast majority of its earnings.

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

The applicable methodology is Rating Mutual Fund Companies, which can be found on our website under Methodologies

This is a Corporate (Financial Institutions) rating.