DBRS Confirms Crown Capital Partners Inc. at BB (low), Stable Trend

DBRS Limited (DBRS) confirmed the Long-Term Issuer Rating of Crown Capital Partners Inc. (CCP or the Company) at BB (low) with a Stable trend. CCP has a Support Assessment of SA3, which reflects the expectation of there being no timely external support. This results in a final rating that is equivalent to the Company’s Intrinsic Assessment.

KEY RATING CONSIDERATIONS
The rating reflects CCP’s business model of being a niche player in the commercial lending space primarily for loans in the range of $10 million to $25 million. The Company has a long track record with minimal credit losses and is run by an experienced senior management team, which has established a well-articulated strategy for the Company. To diversify earnings, CCP launched Crown Capital Power LP, a fund to provide investors with attractive, utility-like income through the direct ownership of Integrated Energy Platforms that provide electricity under long-term contracts to mid- to large-scale electricity users, such as manufacturers, hotels and condominiums.

The rating also considers CCP’s modest scale and the limited diversification of its portfolio. DBRS notes that a recessionary environment could create headwinds that overwhelm earnings given CCP’s focus on lending to lower-middle-market companies, which may be less able to cope with an adverse environment. DBRS views lending to these companies as inherently riskier than lending to larger corporates. Furthermore, CCP’s relatively high dividend payout results in lower retention of earnings, somewhat limiting the Company’s ability to grow capital organically. In addition, despite expanding the senior management team, DBRS sees a high degree of key man risk with CCP, given the importance of the founders of the Company to its day-to-day operations.

RATING DRIVERS
DBRS could see positive rating pressure should CCP continue to build scale and diversify earnings while maintaining a strong track record of low credit losses. In addition, evidence of CCP’s ability to successfully navigate an economic downturn or other significant challenges could also benefit the rating.

Conversely, a sustained deterioration in earnings would likely lead to negative rating implications. In addition, DBRS could see negative rating implications if credit deterioration within CCP’s investment portfolio were to consume significant time and effort of senior management, which would thereby limit CCP’s growth opportunities.

RATING RATIONALE
CCP, a publicly listed company on the Toronto Stock Exchange under the symbol CRWN, is a Canadian-based specialty finance company that has a long track record as an originator and manager of funds for third-party investors, which are focused on lending to Canadian lower-middle- and middle-market companies. CCP has established itself as a niche lender for loans in the range of $10 million to $25 million, given that competition in this space tends to be relatively thin outside the large banks. The Company is regulated by the Alberta Securities Commission, as it is registered under securities law as an investment fund manager in Alberta and Ontario as well as a portfolio manager in Alberta, Manitoba and Saskatchewan. In addition, the Company is registered as an exempt market dealer in Alberta, British Columbia, Manitoba, Ontario and Saskatchewan. The Company was originally founded by Crown Life Insurance Company to manage its private equity and debt investments and was purchased in 2002 by its senior management team. The majority of this management team is still at the helm and actively involved in CCP’s day-to-day operations. CCP maintains conservative underwriting of its investments, which has contributed to its strong track record of low credit losses. However, DBRS notes that the limited diversification of its portfolio by industry and geography is a rating constraint.

CCP’s earnings power remains solid as a majority of the Company’s revenue consists of interest income, which provides CCP with stable and predictable cash flows so long as the Company continues to invest its capital in a prudent manner. DBRS notes that the Company’s earnings are generally sufficient, with net income of $7.1 million in 2018, which was up compared with $6.7 million in 2017. However, investments may not perform as expected or loans may be prepaid in advance of maturity dates. Although prepayment fees would be received, these prepayments are unpredictable and introduce reinvestment risk, which could potentially have an impact on earnings generation. In addition, in DBRS’s view, CCP lacks the scale and diversification necessary to support sustainable earnings growth through a potential broad economic downturn or if an industry-specific downturn were to affect a sector(s) in which the Company is most concentrated.

As a result of the limited diversification of Crown Capital Partner Funding LP’s (previously Capital Fund IV, LP) portfolio by industry and geography, DBRS considers CCP’s risk profile as elevated, which also reflects the limited number of investments. In addition, the Company’s focus on lending to lower-middle- and middle-market companies also elevates CCP’s risk profile, as DBRS views lending to these companies as inherently riskier than lending to larger corporates. However, given the structure of the third-party investor funds, CCP’s exposure to credit risk is somewhat minimized, as any credit risk is primarily borne by the third-party institutional investors in the fund. Risk is further mitigated by the hands-on approach of management and the close working relationships they foster with the investee companies. CCP is able to monitor investee company financial performance as a result of the rigorous reporting requirements each investee company is required to complete and submit to CCP on a regular basis. To date, CCP has a strong track record of low credit losses and a proven ability to work out problem loans.

CCP’s funding and liquidity profile is viewed as narrow by DBRS given that the Company relies on a $35 million senior secured revolving credit facility with the Alberta Treasury Branches and Business Development Bank of Canada to fund its investment activities. As at December 31, 2018, CCP had drawn $18 million on this credit facility. On June 13, 2018, CCP issued $20 million of 6.0% convertible unsecured subordinated debentures for net proceeds of $18.7 million. These proceeds were used to repay the indebtedness under the Company’s credit facility, which would subsequently be available to be drawn, as required, to fund new financing transactions by CPP. These convertible debentures will mature on June 30, 2023.

CCP is not subject to minimum capital ratios since it is not a federally regulated lender. From DBRS’s perspective, CCP maintains an adequate amount of capital that is appropriately aligned with the risk and earnings profile of the business. The Company’s capital mainly consists of retained earnings and common equity that was generated through the initial public offering in July 2015, which DBRS views as sound. As a result of being a publicly listed company, CCP can access the equity markets to raise additional capital that could be used to fund any future growth plans of the Company.

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

The applicable methodology is Global Methodology for Rating Non-Bank Financial Institutions (November 2018), which can be found on our website under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada