DBRS Downgrades Energy Split Corporation Preferred Shares to Pfd-5

DBRS has today downgraded the Class B, Preferred Shares (the Preferred Shares) issued by Energy Split Corporation (the Company) to Pfd-5 from Pfd-4 (low), with a Stable trend. The rating has been removed from Under Review with Negative Implications.

Investors in the Company’s Preferred Shares and Capital Shares gain exposure to a portfolio of selected oil and gas royalty trusts (the Portfolio) through a forward purchase and sale agreement (the Forward Agreement) with the Bank of Nova Scotia (the Counterparty). The Counterparty pays the Company the economic return provided by the Portfolio, which is held by an underlying fund (the Royalty Fund). In return, a portfolio of common shares of Canadian public companies acquired from proceeds of the Company’s initial offering is 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 Portfolio.

The holders of the Preferred Shares receive fixed preferred tax-efficient quarterly distributions yielding 4.5% per annum. The holders of the Capital Shares are entitled to leveraged tax-efficient distributions that are in excess of distributions paid to the Preferred Shares and all operating expenses of the Company.

All of the downside protection available to the Preferred Shares has been eroded. Based on the most recent net asset value (NAV), holders of the Preferred Shares would experience a loss of approximately 17% of their initial issuance price if the Forward Agreement were terminated and proceeds distributed.

The Company’s dividend policy has been to pay quarterly distributions to the Capital Shares equal to the excess income available from the quarter after paying Preferred Shares dividends and other Company expenses. On February 18, 2009, DBRS downgraded the Preferred Shares to Pfd-4 (low) and left the rating Under Review with Negative Implications. It was noted that the Company’s dividend policy allowed for a very high level of payouts to the Capital Shares compared to what would be expected based on the asset coverage available to the Preferred Shares. On February 26, 2009, the Company declared a distribution of $0.60 per Capital Share and announced a revision of its distribution policy. On the next distribution date (June 16, 2009), the Company will not pay a distribution on the Capital Shares if the NAV at the time of declaration, after giving effect to the distribution, would be less than or equal to the original issue price of the Preferred Shares. Considering the current NAV of the Company and the amount of excess income available, DBRS believes that the revised policy is not restrictive enough in limiting payouts to the Capital Shares.

As a result of the current asset coverage and dividend policy for payouts to the Capital Shares, DBRS has downgraded the rating of the Preferred Shares to Pfd-5. A main constraint to the rating is that volatility of the market price and changes in distribution policies of the oil and gas trusts in the Portfolio may result in reductions in asset coverage or dividend coverage from time to time.

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.