DBRS Morningstar Downgrades Rating on Brompton Split Banc Corp.’s Preferred Shares to Pfd-3 From Pfd-3 (high)

DBRS Limited (DBRS Morningstar) downgraded its rating on the Preferred Shares issued by Brompton Split Banc Corp. (the Company) to Pfd-3 from Pfd-3 (high). The Preferred Shares have experienced a drop in downside protection (to 46.8% in July 2023 from 50.2% in July 2022) as a result of the decline in the portfolio’s net asset value (NAV) in response to the volatility in the stock market, which was triggered by the mix of the global high inflationary environment, tighter monetary policies, and various geopolitical events, such as the Russia-Ukraine war.

The Company invests in a portfolio of common shares (the Portfolio) issued by the six major banks in Canada—Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and The Toronto-Dominion Bank—and one exchange-traded fund (ETF), Brompton North American Financials Dividend ETF. Up to 10% of the Portfolio may be invested in global financial companies from time to time. The Portfolio portion allocated to the major banks remains approximately equally weighted.

Distributions on the Preferred Shares are made quarterly in the amount of $0.15625, yielding 6.25% annually on the original $10.00 issue price. Distributions on the Class A Shares are made monthly in the amount of $0.10 per share. No monthly distributions to the Class A Shares will be made if distributions to the Preferred Shares are in arrears or the NAV of the Company falls below 1.5 times (x) the principal amount of the outstanding Preferred Shares.

As of July 27, 2023, the downside protection stood at 46.8% compared with 50.2% as on July 31, 2022. Dividend coverage based on the current dividend yield on the portfolio was 1.3x. 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 5.7% over the remaining term to maturity. The Company can write covered call options for some or all of the portfolio’s common shares to generate additional income to supplement the dividends received on the portfolio. In addition, the Company may enter into Securities Lending Agreements in order to generate an alternative source of income.

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

The Company:
1) On September 26, 2022
Announced that the distribution rate for the Preferred Shares for the new five-year term from November 30, 2022, to November 29, 2027, will be $0.625 per annum (6.25% on the original issue price of $10) payable quarterly.

2) On November 24, 2022
Completed the treasury offering of preferred shares (Preferred Shares) for aggregate gross proceeds of approximately $74 million. The Preferred Shares were offered at a price of $9.55 per Preferred Share for an annualized yield to maturity of 7.5%.

3) On April 19, 2023
Completed the treasury offering of Class A Shares and Preferred Shares for aggregate gross proceeds of approximately $30 million. The Class A Shares were offered at a price of $10.80 per Class A Share for a distribution rate of 11.1% on the issue price, and the Preferred Shares were offered at a price of $9.85 per Preferred Share for a yield to maturity of 6.7%.

4) On April 27, 2023
Renewed its “at-the-market equity program” (ATM Program) that will be effective until May 27, 2025, with maximum gross proceeds of $75 million for each of the Class A and Preferred Shares. The ATM Program allows the Company to issue Class A Shares and Preferred Shares from time to time at the Company’s discretion.

Considering the decline in the amount of downside protection, the remaining term to maturity, concentration in one industry and the projected grind on the portfolio, DBRS Morningstar downgraded the rating on the Preferred Shares to Pfd-3 from Pfd-3 (high).

The main constraints to 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 sticky inflation, economic slowdown, and the Russia-Ukraine war.

(2) Volatility of price 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) 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.

(4) 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, 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/416785 (July 4, 2023).

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

The principal methodology applicable to the credit 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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit 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 credit rating action.

This is a solicited credit rating.

DBRS Limited
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Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

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

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/410863.

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