DBRS Downgrades High Income Preferred Series 2 Shares to Pfd-5 (low)

DBRS has today downgraded the Series 2 Shares issued by High Income Preferred Shares Corporation (the Company) to Pfd-5 (low) , with a Negative trend, from Pfd-4. The Series 1 Shares have been confirmed at Pfd-2 (low) with a Negative trend. Both ratings have been removed from Under Review with Negative Implications, where they were placed on October 24, 2008.

At inception, the Company issued 1.26 million Series 1 Shares at $25 per share, 1.26 million Series 2 Shares at $14.70 per share and privately placed 1.26 million Equity Shares at $3.54 per share. The termination date for each series of shares is June 29, 2012 (the Redemption Date).

Approximately 33% of the gross proceeds from the initial offering were used to enter into a forward agreement with Canadian Imperial Bank of Commerce (the Counterparty) to provide for the full repayment of the Series 1 Shares principal on the Redemption Date. The remaining net proceeds from the initial offering were invested in a portfolio of common shares (the Managed Portfolio), which initially provided asset coverage to the Series 2 Shares of about 1.8 times (downside protection of 44%). In addition to providing coverage to the Series 2 Shares principal, the Managed Portfolio is used to pay annual fees and expenses, as well as cumulative monthly distributions to the Series 1 Shares and Series 2 Shares (5.85% and 7.25% per annum, respectively). The Series 1 Shares dividends rank equally (pari passu) with the Series 2 Shares dividends.

The Managed Portfolio is actively managed by Lawrence Asset Management Inc. (the Manager). The Manager has the ability to engage in option writing to generate additional income. Since inception, the Managed Portfolio’s net asset value (NAV) has declined 48%, from about $27 to $13.94 per share (as of November 28, 2008), which is less than the Series 2 Shares principal amount of $14.70 per share.

Both Series 1 Shares and Series 2 Shares dividends have been suspended subsequent to the March 31, 2008, distribution. Assuming that the dividends continue to be suspended until the Redemption Date, the Company will owe $6.22 per Series 1 Share and $4.53 per Series 2 Share in unpaid dividends on the Redemption Date. Currently, there are 377,000 Series 1 Shares outstanding and 655,000 Series 2 Shares outstanding (0.576 Series 1 Shares for every Series 2 Share). As a result, a total of $8.11 in combined Series 1 Shares and Series 2 Shares dividends will be owed on the Redemption Date for every Series 2 Share outstanding.

On the Redemption Date, the holders of the Series 1 Shares and Series 2 Shares will be entitled to receive all cumulative dividends that are in arrears in priority over the Series 2 Shareholders’ principal repayment. The Managed Portfolio NAV of $13.94 provides downside protection of 42% over the remaining Series 1 Shares and Series 2 Shares dividends of $8.11 per Series 2 Share. As a result, the ultimate payment of cumulative dividends to the Series 1 Shareholders and Series 2 Shareholders is likely.

The full Series 1 Shares principal is guaranteed, subject to the Counterparty meeting its obligations as part of the Series 1 Shares Forward Agreement. The DBRS rating confirmation of the Series 1 Shares is based on the full principal protection, as well as the current likelihood that all Series 1 Shares cumulative dividends will be repaid, based on the NAV coverage over the remaining Series 1 Shares and Series 2 Shares dividends. The Series 1 Shares rating trend is Negative due to the risk of further deterioration in the NAV from the active management and option writing on the Managed Portfolio’s holdings.

The downgrade of the Series 2 Shares is based on the level of capital appreciation required over the remaining term of the Company in order to fully cover the repayment of the Series 2 Shares unpaid dividends and initial principal. The probability of the holders of the Series 2 Shares not receiving full principal on the Redemption Date is significantly high. A total annualized return of approximately 15% is required from the Managed Portfolio in order for the Series 2 Shareholders to receive full principal and unpaid dividends.

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

The applicable methodology is Split Share Issuers: A Performance Overview, which can be found on our website under Methodologies.

This is a Structured Finance rating.