Morningstar DBRS Confirms Canadian Banc Corp.'s Preferred Shares at Pfd-3 (low)

DBRS Limited (Morningstar DBRS) confirmed its credit rating of Pfd-3 (low) on the Preferred Shares issued by Canadian Banc Corp. (the Company). The Company invests in a portfolio of common shares (the Portfolio) of the six largest Canadian banks (the core holdings). The Company may also invest up to 20% of the net asset value (NAV) in equity securities of Canadian or foreign corporations other than the core holdings. As of August 31, 2024, 65.9% of the Portfolio holdings were common shares of the six largest Canadian banks: Royal Bank of Canada (18.8%), The Toronto-Dominion Bank (12.0%), National Bank of Canada (11.1%), Canadian Imperial Bank of Commerce (8.9%), Bank of Montreal (7.7%), and The Bank of Nova Scotia (7.4%), while 17.4% of the portfolio was invested in five well-known US financial services companies (Morgan Stanley, JP Morgan Chase, Bank of America, Goldman Sachs and Citigroup Inc) and 16.7% was held in cash & cash equivalents. The Company has not hedged its USD exposure to currency fluctuations; however, it closely monitors USD/CAD currency movements.

Holders of the Preferred Shares receive monthly distributions at a rate of Prime + 1.5% per annum (minimum 5.0%, maximum 8.0%), currently close to 8.0%. Holders of Class A Shares are entitled to receive monthly cash distributions targeted to be at a rate of 15% annually based on the volume weighted average market price of the Class A shares for the last three trading days of the preceding month. No monthly distributions to the Class A Shares will be made if the dividends of the Preferred Shares are in arrears or the NAV per unit (one notional unit consists of one Preferred Share and one Class A Share) falls below $15.0.

The termination date was extended in 2023 to December 1, 2028 from December 1, 2023. On maturity, the holders of the Preferred Shares will be entitled to the value of the Portfolio, up to the face value of the Preferred Shares, in priority to the holders of the Class A Shares. The Class A Shareholders will receive the remaining value of the Company. The term may be extended beyond the termination for additional terms of five years each, as determined by the Company's board of directors. Shareholders will be provided with a special retraction right in connection with any such extension.

As of October 31, 2024, the downside protection increased to 53.1% from 44.2% as of October 31, 2023. Dividend coverage based on the current dividend yield on the Portfolio was at 0.6x (times). 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 together with the dividend coverage below 1x, are likely to create an average annual grind on the Portfolio's NAV equivalent to 7.8% over the remaining term to maturity. To supplement Portfolio income, the Manager may engage in covered call option writing on all, or a portion of the securities held in the Portfolio or rely on realized capital gains.

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

The Company:

(1) On November 23, 2023
Completed an overnight treasury offering of Preferred Shares, raising approximately $85.0 million in gross proceeds. The Preferred Shares were offered at a price of $9.80 per share for a yield to maturity of 8.16%.

(2) On January 19, 2024
Renewed its At-the-Market-Equity Program (ATM Program) effective until June 18, 2025, which allows maximum gross proceeds of $280 million. The ATM Program allows the Company to issue Class A Shares and Preferred Shares from time to time at the Company's discretion.

(3) On May 27, 2023
Announced that the Toronto Stock Exchange (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 commenced on May 29, 2024 and will terminate on May 28, 2025.

Considering the credit quality of the portfolio, as well as the amount of downside protection, the projected grind in the portfolio from expected distributions on the Class A Shares and dividend coverage below 1 time and the unhedged FX exposure, Morningstar DBRS confirmed the credit rating on the Preferred Shares at Pfd-3 (low).

The main constraints to the credit rating are the following:

(1) Market fluctuations could affect the Company's NAV. Resulting volatility in prices along with 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.

(2) Reliance 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.

(3) The high concentration of the portfolio in one industry (banking).

(4) Potential foreign exchange risk because the income received on the portfolio is not hedged all the time.

(5) Stated monthly distributions on the Class A Shares may 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.

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transactions' respective press releases at issuance.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

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 21, 2024), https://dbrs.morningstar.com/research/434794.

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

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-DBRS@morningstar.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.

Morningstar DBRS 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
DBRS Tower, 181 University Avenue, Suite 700
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://dbrs.morningstar.com/about/methodologies.

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

For more information on this credit or on this industry, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.