DBRS Morningstar Downgrades Rating on Dividend Growth Split Corp.’s Preferred Shares to Pfd-3 (low) from Pfd-3

DBRS Limited (DBRS Morningstar) downgraded its rating on the Preferred Shares issued by Dividend Growth Split Corp. (the Company) to Pfd-3 (low) from Pfd-3. The Preferred Shares have experienced a considerable drop in downside protection (to 31.5% in June 2023 from 38.9% in May 2022) as a result of the decline in the portfolio’s net asset value (NAV) in response to the volatility in the stock market, which was triggered by the mix of the global high inflationary environment, tighter monetary policies, and various geopolitical events, such as the Russia-Ukraine war. The Company’s maturity date is September 27, 2024. The board of directors may extend the term of the Company and the shares by successive terms of up to five years, provided that shareholders are given an optional retraction right at the end of each successive term.

The Company invests in a portfolio consisting primarily of equity securities of Canadian dividend growth companies. In addition, the Company may hold up to 20% of the total assets of the portfolio directly in global dividend growth companies or indirectly through exchange-traded funds for diversification and improved return potential. To qualify for inclusion in the portfolio, at the time of investment and at the time of each periodic reconstitution and/or rebalancing, each dividend growth company included directly in the portfolio must (1) have a market capitalization of at least $2.0 billion and (2) have a history of dividend growth. Investments will generally be equal weighted at the time of investment; however, after rebalancing the portfolio, the Company may hold nonequal weight positions.

Dividends received from the portfolio are used to pay fixed cumulative quarterly dividends equal to $0.55 per annum (p.a.) to each Preferred Shareholder, yielding 5.5% on the original issue price of $10.00. Holders of Class A Shares receive monthly distributions targeted at $1.20 p.a. The NAV test in place prevents any distributions to the Class A Shares if the Company’s NAV falls below 1.5 times (x) the principal amount of the outstanding Preferred Shares. Distributions to the Class A Shares are currently suspended.

As of June 8, 2023, the downside protection stood at 31.5%, compared with 38.9% as on May 30, 2022. Dividend coverage based on the current dividend yield on the portfolio was 0.6x. Without giving consideration to the capital appreciation potential or any source of income other than the dividends earned by the portfolio, the targeted monthly distributions to the Class A Shares are likely to create a grind on the portfolio’s NAV equivalent to 1.4% over the remaining term to maturity. The Company can write covered call options for some or all of the portfolio’s common shares to generate additional income to supplement the dividends received on the portfolio. The Company can engage in securities lending.

Considering the amount of downside protection, the term extension, and the projected grind on the portfolio, DBRS Morningstar downgraded the rating on the Preferred Shares to Pfd-3 (low) from Pfd-3.

The main constraints to the rating are as follows:

(1) The downside protection available to holders of the Preferred Shares depends on the value and dividend policies of the securities in the portfolio. In current times, valuation is exposed to market fluctuations resulting from high inflation, economic slowdown, global supply chain disruptions, and the Russia-Ukraine war.

(2) Volatility of price 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.

(3) Dividends and interest received on the portfolio are currently unable to fully cover distributions on the Preferred Shares.

(4) 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.

(5) 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 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 rating is Rating Canadian Split Share Companies and Trusts (June 16, 2023; https://www.dbrsmorningstar.com/research/415986).

Other methodologies referenced in this transaction are listed at the end of this press release.

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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this 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 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.