DBRS Morningstar Confirms Financial 15 Split Corp. Preferred Shares at Pfd-3

DBRS Limited (DBRS Morningstar) confirmed the rating of the Preferred Shares issued by Financial 15 Split Corp. (the Company) at Pfd-3. The Company invests in a portfolio (the Portfolio) consisting primarily of common shares of 15 high-quality North American financial services companies: Bank of America Corporation; Bank of Montreal; The Bank of Nova Scotia; Canadian Imperial Bank of Commerce; CI Financial Corp.; Citigroup Inc.; The Goldman Sachs Group, Inc.; Great-West Lifeco Inc.; JPMorgan Chase & Co.; Manulife Financial Corporation; National Bank of Canada; Royal Bank of Canada; Sun Life Financial Inc.; The Toronto-Dominion Bank; and Wells Fargo & Company. The Company may invest up to 15% of the Net Asset Value (NAV) in securities of issuers other than the core 15, and no more than 10% of the NAV may be invested in any single issuer. As of August 31, 2022, only 1.4% of the Portfolio was also invested in the other two companies, namely Fifth Third Bancorp and AGF Management, and 21% was held in cash.

A portion of the Company’s Portfolio is exposed to currency risk because it includes securities denominated in U.S. dollars (USD), while the NAV of the Company is expressed in Canadian dollars. The Company has not entered into currency-hedging contracts for the USD portion of the Portfolio, although the Company may use derivatives for hedging purposes. As of August 31, 2022, 36.3% of the Portfolio was invested in USD-denominated assets.

The Company established an at-the-market (ATM) equity program in October 2019, which was renewed and is currently effective until December 22, 2023. The ATM equity program allows the Company to issue Preferred Shares and Class A Shares to the public from time to time at the Company’s discretion through the Toronto Stock Exchange or any other marketplace in Canada where the shares are listed. The Company also issues Preferred Shares and Class A Shares from time to time through overnight offerings. Preferred Shares and Class A Shares are issued only on a basis that an equal number of Preferred Shares and Class A shares will be outstanding at all material times.

The Company’s termination date is December 1, 2025. At maturity, the holders of the Preferred Shares will be 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. The termination date can be extended for additional terms of five years at the Company’s discretion, but shareholders are provided with a special retraction right in connection with such extension.

Holders of the Preferred Shares used to receive cumulative monthly cash dividends at a rate of 6.75% annually until November 2022. However, with effect from December 1, 2022, this rate has been increased to 7.50% annually. The distribution rate is set by the board of directors annually and subject to a minimum of 5.5% until 2025. Holders of the Class A Shares are currently receiving monthly distributions of $0.1257 per share, equivalent to 10.1% per annum on the issue price of $15.00. No distributions will be paid to the Class A Shares if the NAV per unit falls below $15. The NAV per unit remained above $15 during 2022, and distributions to the Class A Shares were regularly paid out.

As of January 31, 2023, the downside protection available to holders of the Preferred Shares was 46.1%. The downside protection was on a downward trend from February 2022 to September 2022. However, there has been some improvement from October 2022 onwards. The current Preferred Share dividend coverage ratio is approximately 0.5 times (x), indicating that current dividend income is not enough to fully cover the targeted distributions on the Preferred Shares & Class A Shares and hence, there is an estimated annual grind of approximately 8.3% per year for the remaining term of the Preferred Shares. To supplement dividend income received on the Portfolio, the Company may engage in option writing.

The confirmation of the rating takes into consideration the current level of downside protection available to the Preferred Shares, the dividend coverage ratio below one time, the expected grind on the Portfolio arising from the current distributions to the Class A Shares, the exposure to foreign currency risk, and the remaining term to maturity.

The main constraints to the rating are the following:

(1) The downside protection available to holders of the Preferred Shares depends on the value of the common shares held in the Portfolio. The current phase of high inflation and economic slowdown can continue to drive volatility—of price and changes in the dividend policies—of the underlying issuers, which may result in significant reductions in the Preferred Shares dividend coverage or downside protection from time to time.

(2) Reliance on the manager to generate a high yield, through methods such as option writing, on the investment portfolio to meet distributions and other expenses without having to liquidate portfolio securities.

(3) The monthly cash distributions to holders of the Class A Shares which create grind on the Portfolio.

(4) The concentration of the Portfolio in one industry.

(5) The unhedged portion of the USD-denominated Portfolio that exposes the Portfolio to foreign currency
risk.

ENVIRONMENTAL, SOCIAL, 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 DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

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

The principal methodology applicable to the ratings is Rating Canadian Split Share Companies and Trusts (June 22, 2022; https://www.dbrsmorningstar.com/research/398704).

Other methodologies referenced in this transaction are listed at the end of this press release. These may be found at: https://www.dbrsmorningstar.com/about/methodologies.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

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.

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

The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.