Morningstar DBRS Confirms Credit Rating on Dividend 15 Split Corp. II’s Preferred Shares at Pfd-3 (low)

DBRS Limited (Morningstar DBRS) confirmed the credit rating on the Preferred Shares issued by Dividend 15 Split Corp. II (the Company) at Pfd-3 (low). The Company holds a portfolio of common shares (the Portfolio) listed on the Toronto Stock Exchange (TSX). The shares are issued by the following 15 companies: Bank of Montreal, The Bank of Nova Scotia, BCE Inc., CI Financial Corp., Canadian Imperial Bank of Commerce, Enbridge Inc., Manulife Financial Corporation, National Bank of Canada, Royal Bank of Canada, Sun Life Financial Inc., TELUS Corporation, Thomson Reuters Corporation, The Toronto-Dominion Bank, TransAlta Corporation, and TC Energy Corp. Up to 15% of the net asset value (NAV) of the Portfolio may be invested in equity securities of issuers other than the companies listed above. An individual portfolio holding may represent no more than 10% of the NAV of the Company at the time of purchase. Quadravest Capital Management Inc (the Manager) actively manages the Portfolio.

In the announcement made in March 2024, the current termination date has been extended from December 1, 2024 to December 1, 2029. This maturity date can be further extended for additional terms of five years at the Company’s discretion. At maturity, the holders of the Preferred Shares are entitled to the value of the Company, up to the face amount of the Preferred Shares, in priority to the holders of the Class A Shares. Holders of the Class A Shares will receive the remaining value of the Company.

Dividends received from the Portfolio’s underlying common shares are used to pay fixed cumulative monthly dividends of $0.04792 per Preferred Share, yielding 5.75% annually on the original issue price of $10.00. In connection with the extension, the Company will have the right to amend the rate of cumulative preferential monthly dividends to be paid to the Preferred Shares for the five year renewal period, which will be announced no later than September 30, 2024. Holders of the Class A Shares receive regular monthly cash dividends targeted at $0.10 per Class A Share, yielding 8% per annum on the original issue price of $15.00. No monthly distributions to the Class A Shares are made if the dividends of the Preferred Shares are in arrears or if the Company’s NAV per unit falls below $15.00. During January 2023 to February 2024, the Company’s NAV per unit remained below $15.00 resulting in suspension of distributions to Class A shareholders during this period.

The Company may issue shares to the public from time to time, at the Company’s discretion, under an at-the-market equity program (the “ATM Program”). Any Class A Shares or Preferred Shares sold in the ATM Program will be sold through the TSX or any other marketplace in Canada on which the Class A Shares and Preferred Shares are listed, quoted or otherwise traded at the prevailing market price at the time of sale. During the year ended November 30, 2023, there were no Preferred Shares sold through the ATM Program.

As of May 31, 2024, the downside protection stood at 34.1% compared with 27.9% as on May 31, 2023. Dividend coverage based on the current dividend yield on the Portfolio is 1.0 times (x) indicating that the current dividend income earned by the Company is enough to fully cover the Company’s operating expenses and targeted distributions on the Preferred Shares. To further supplement the Portfolio income, the Company may engage in covered call and put options writing on all or a portion of the shares held in the Portfolio. Without giving consideration to the capital appreciation potential or any source of income other than the dividends earned by the Portfolio, the distributions to the Class A Shares are likely to create a grind on the Portfolio’s NAV equivalent to 0.3% per year over the next five years. However, the grind in the portfolio is mitigated by the asset coverage test of 1.5x.

Considering the downside protection level, the dividend coverage, the term extension and the expected grind, Morningstar DBRS confirmed the credit rating on the Preferred Shares at Pfd-3 (low).

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

(1) On March 12, 2024: The Company announced that it will extend the termination date of the Company a further five year period from December 1, 2024 to December 1, 2029.

(2) On May 27, 2024: The Company 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 will commence on May 29, 2024 and terminate on May 28, 2025.

The main constraints on the rating are the following:

(1) Volatility of prices and 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) The Company relies 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) Stated monthly distributions on the Class A Shares will likely 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.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) 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 Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

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 16, 2023; https://dbrs.morningstar.com/research/415986).

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 analyzes 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 dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.