DBRS Confirms Energy Split Corp. II Preferred Shares at Pfd-2 (low)

DBRS has today confirmed the rating of Pfd-2 (low) with a Stable trend to the ROC Preferred Shares (the Preferred Shares) issued by Energy Split Corp. II (the Company).

On October 23, 2007, at a special shareholders meeting, the termination date of both the Preferred Shares and the Capital Yield Shares (the Capital Shares) was extended three years to December 16, 2010 (the Redemption Date). On December 17, 2007, the Company called approximately 22% of the outstanding Preferred Shares for redemption on a pro rata basis. Following the redemptions and a subdivision of the remaining Preferred Shares, the split share structure provided downside protection of 55% to the Preferred Shares (after expenses).

The investors of the Preferred Shares and Capital Shares gain exposure to a portfolio of Canadian oil and gas income trusts (the Royalty Trust Portfolio) through a forward purchase and sale agreement (the Forward Agreement) with the Bank of Nova Scotia (the Counterparty). On the Redemption Date, the Counterparty will pay the Company the economic return provided by the Royalty Trust Portfolio, which will be held by an underlying fund. In return, a portfolio of common shares of Canadian public companies acquired from proceeds of the initial offering was pledged to the Counterparty. The Forward Agreement is structured to provide tax-efficient distributions to the Company’s Shareholders based on the performance of the Royalty Trust Portfolio.

The holders of the Preferred Shares now receive a fixed cumulative preferential tax-efficient quarterly distribution equal to an annual yield of 5.00%, increasing from 4.25% per annum prior to the reorganization. The distributions are made by quarterly unwinds of the Forward Agreement which consist of return of capital distributions and capital gains dividends. At the time of reorganization, the weighted-average yield from the Royalty Trust Portfolio was about 13.4%, which provides adequate coverage to the Preferred Share distributions.

On the Redemption Date, the Preferred Shareholders will be repaid the face value of their shares, and the remaining funds will be distributed to the Capital Shareholders.

The main constraints to the Pfd-2 (low) rating are the following:

• Income trusts typically distribute a mix of income and capital, which can grind down the NAV of the portfolio over time.
• The high correlation of the Royalty Trust Portfolio to the price of oil and natural gas
• Regulatory risk as it relates to the federal government’s proposed taxation policy on income trusts

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