DBRS Morningstar Confirms Rating on Dividend 15 Split Corp. II’s Preferred Shares at Pfd-3 (low)

DBRS Limited (DBRS Morningstar) confirmed the rating on the Preferred Shares issued by Dividend 15 Split Corp. II (the Company) at Pfd-3 (low). The Company holds a portfolio of common shares (the Portfolio) listed on the Toronto Stock Exchange (TSX). The shares are issued by the following 15 companies: Bank of Montreal, The Bank of Nova Scotia, BCE Inc., CI Financial Corp., Canadian Imperial Bank of Commerce, Enbridge Inc., Manulife Financial Corporation, National Bank of Canada, Royal Bank of Canada, Sun Life Financial Inc., TELUS Corporation, Thomson Reuters Corporation, The Toronto-Dominion Bank, TransAlta Corporation, and TC Energy Corp. Up to 15% of the net asset value (NAV) of the Portfolio may be invested in equity securities of issuers other than the companies listed above. An individual portfolio holding may represent no more than 10% of the NAV of the Company at the time of purchase. Quadravest Capital Management Inc (the Manager) actively manages the Portfolio.

Dividends received from the Portfolio’s underlying common shares are used to pay fixed cumulative monthly cash distributions of $0.04792 per Preferred Share, yielding 5.75% annually on the original issue price of $10. Holders of the Class A Shares receive regular monthly cash dividends targeted at $0.10 per Class A Share, yielding 8% per annum on the original issue price of $15. No monthly distributions to the Class A Shares are made if the dividends of the Preferred Shares are in arrears or if the Company’s NAV per unit falls below $15. Distribution to the Class A Shares have remained suspended since June 2022 as the NAV per unit dropped below $15. This was largely triggered by the tightening of monetary policy on account of high inflation, bond market rates, and mortgage rates reaching levels not seen for more than 15 years, affecting interest rate sensitive sectors in the economy and adversely affecting the earnings potential of financial services companies and, as a result, the overall NAV of the Company.

The termination date is December 1, 2024. At maturity, the holders of the Preferred Shares will be entitled to the value of the Company up to the face amount of the Preferred Shares in priority to the holders of the Class A Shares. Holders of the Class A Shares will receive the remaining value of the Company.

As of May 31, 2023, the downside protection stood at 27.9% compared with 30.4% as on June 30, 2022. Dividend coverage based on the current dividend yield on the Portfolio is 0.8 times (x). Without giving consideration to the capital appreciation potential or any source of income other than the dividends earned by the Portfolio, the targeted monthly distributions to the Class A Shares are likely to create a grind on the Portfolio’s NAV equivalent to 0.7% over the remaining term to maturity. However, the Company has an option of extending the term by five years. If that is exercised, the anticipated grind over next five years will be around 0.8%. The Company can write covered call options in respect of some or all of the Portfolio’s common shares to generate additional income to supplement the dividends received on the Portfolio.

DBRS Morningstar notes the following announcements from the Company during the last 12 months:

(1) On May 19, 2023: The Company renewed its at-the-market equity program (ATM Program) that allows the Company to issue shares of the Company to the public from time to time at the Company’s discretion, effective until June 18, 2025, unless terminated prior to such date by the Company. This ATM Program replaces the prior program established in April 2022 that has terminated. The maximum gross proceeds from the issuance of the shares will be $350,000,000.

(2) On May 25, 2023: The Company announced that the TSX has accepted its notice of intention to make a Normal Course Issuer Bid (the NCIB) to purchase its Preferred Shares and Class A Shares through the facilities of the TSX and/or alternative Canadian trading systems. The NCIB will commence on May 29, 2023, and terminate on May 28, 2024. Pursuant to the NCIB, the Company proposes to purchase, from time to time, up to 3,106,904 Preferred Shares and 3,098,274 Class A Shares of the Company, representing 10% of the public float of 31,069,049 Preferred Shares and 30,982,749 Class A Shares.

Considering the downside protection level, dividend coverage below 1.0x, and the time to maturity, DBRS Morningstar confirmed the rating on the Preferred Shares at Pfd-3 (low).

The main constraints on the rating are the following:

(1) The downside protection available to holders of the Preferred Shares depends on the value and dividend policies of the securities in the Portfolio. In current times, valuation is exposed to market fluctuations resulting from high inflation, economic slowdown, global supply chain disruptions, and the Russia-Ukraine war.

(2) Volatility of prices and changes in the dividend policies of the underlying issuers may result in significant reductions in the Preferred Shares’ dividend coverage or downside protection from time to time.

(3) Dividends and interest received on the Portfolio are currently unable to fully cover distributions on the Preferred Shares.

(4) The Company relies on the Portfolio manager to generate additional income, through option writing, to meet distributions and other trust expenses without having to liquidate the Portfolio’s securities.

(5) Stated monthly distributions on the Class A Shares will likely create a grind on the Portfolio. This risk is mitigated by an asset coverage test of 1.5x that ensures sufficient levels of downside protection to the holders of the Preferred Shares.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) 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).

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

The principal methodology applicable to the rating is Rating Canadian Split Share Companies and Trusts (June 16, 2023; https://www.dbrsmorningstar.com/research/415986).

Other methodologies referenced in this transaction are listed at the end of this press release.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

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 info@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.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.