DBRS Morningstar Confirms Rating of Pfd-3 (high) on E Split Corp. Preferred Shares

DBRS Limited (DBRS Morningstar) confirmed the rating of Pfd-3 (high) on the Preferred Shares issued by E Split Corp. (the Company). The Company invests in a portfolio primarily comprising common shares of Enbridge Inc. (the Portfolio) in accordance with the Company’s investment objectives, strategy, and restrictions. The Company may invest up to 10% of the Portfolio in securities of any other issuer as determined by the Manager. The Maturity Date is June 30, 2023. The term of the Company may be extended beyond the Maturity Date for additional terms of five years as determined by the Company’s board of directors.

The Preferred Shares receive fixed quarterly cumulative preferential cash distributions of $0.13125 (or $0.525 annually) per share, representing a yield of 5.25% per year on the issue price of $10.00. The Class A Shares currently receive cash distributions of $0.13 per share, corresponding to an annual yield of 10.4% on the $15.00 issuance price. No distributions will be paid on the Class A Shares if (1) the distributions payable on the Preferred Shares are in arrears or (2) in respect of a cash distribution by the Company, the net asset value per unit is less than $15.00.

The Portfolio provides approximately 52.2% of downside protection to holders of the Preferred Shares as of May 4, 2020. The dividend coverage ratio is 2.6 times (x). Distributions to the Class A Shares are anticipated to cause an average annual grind of 3.9% on the Portfolio until the end of the term. The Company can write covered call options or engage in security lending to generate additional income.

The confirmed rating of Pfd-3 (high) considers the level of downside protection, dividend coverage available to holders of the Preferred Shares, and potential grind on the Portfolio arising from the targeted distributions to the Class A Shares.

The main constraints to the rating are as follows:

(1) The downside protection available to holders of the Preferred Shares depends solely on the market value of the Enbridge Inc. common shares in the Portfolio, which will fluctuate over time.

(2) There is a lack of diversification, as at least 90% of the Portfolio will entirely consist of Enbridge Inc.’s common shares.

(3) Changes in the dividend policy of Enbridge Inc. may reduce the Preferred Shares’ dividend coverage and downside protection over time.

(4) Additional yield earned on the Portfolio to cover Class A Share distributions without having to liquidate Portfolio securities will depend on the Manager’s skill in generating supplementary income through methods such as option writing and securities lending.

(5) Stated monthly distributions on the Class A Shares, which will create a grind on the Portfolio, are mitigated by an asset coverage test of 1.5x, which ensures sufficient levels of downside protection to the holders of the Preferred Shares.

Coronavirus Disease (COVID-19) Analytical Considerations

Global macroeconomic forecasts have shifted dramatically amid the rapid spread of the coronavirus and associated responses from governments, corporations, and households. In the context of this highly uncertain environment, DBRS Morningstar released a commentary on global macroeconomic scenarios and their implications for credit ratings, which can be found at: https://www.dbrsmorningstar.com/research/359679.

Under the moderate scenario, DBRS Morningstar expects a significant economic contraction in Canada and the United States in 2020 that will be followed by a recovery in subsequent years. DBRS Morningstar analyzed the sensitivity of the current rating on the Preferred Shares to the impact of this scenario on the levels of downside protection and dividend coverage. While the current environment remains negative and uncertain, the confirmation takes into account the remaining term to maturity, which includes a modest recovery in the economy based on the referenced DBRS Morningstar moderate global macroeconomic scenario.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is Rating Canadian Split Share Companies and Trusts (June 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

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@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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