DBRS Morningstar Releases Commentary on the Recent Issuances of Limited Recourse Capital Notes of Canadian Insurance Companies

DBRS Limited (DBRS Morningstar) released a commentary titled “Canadian Banks and Insurance Companies Begin to Issue LRCNs After OSFI Ruling” that discusses the capital implications and advantages of Limited Recourse Capital Notes (LRCNs) for federally regulated financial institutions.

The commentary highlights the following:
-- Regulatory capital treatment of LRCNs provides a potentially better value proposition over preferred shares because they can be included as Tier 1 capital.
-- Tax treatment of interest on LRCNs provides an additional incentive compared with preferred shares. The interest paid on LRCNs is tax deductible while preferred share dividends are paid after tax.
-- Canadian insurance companies have a significant number of outstanding preferred shares that could be replaced by LRCNs in the near term.

“LRCNs are considered hybrid debt instruments that receive a capital treatment closer to common equity; as such, they can be used to meet regulatory capital requirements subject to OSFI's rules. The new net debt could potentially increase financial leverage and lead to the deterioration of fixed-charge coverage ratios in the short term,” says Victor Adesanya, Vice President, Insurance. “However, some of the recent issuers have so far used LRCNs to replace more expensive debt so financial leverage may not change materially for these issuers. DBRS Morningstar anticipates that the impact over the medium term will be manageable based on the relatively conservative starting financial position with which most Canadian insurance companies entered the Coronavirus Disease (COVID-19) pandemic.”

Notes:
The commentary is available at www.dbrsmorningstar.com.

For more information on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577