PrefBlog

DBRS has announced that it has:

downgraded the rating of the preferred shares (the Preferred Shares) issued by Canadian Banc Corp. (the Company) to Pfd-3 from Pfd-3 (high). The Company invests in a portfolio of common shares (the Portfolio) issued by the six largest Canadian banks: Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank. Each of the six banks generally represents no less than 5% and no more than 20% of the net asset value (NAV) of the Portfolio. In addition, up to 20% of the NAV of the Portfolio may be invested in equity securities of Canadian or foreign financial services corporations other than the banks listed above.

Dividends from the Portfolio are used to pay holders of the Preferred Shares floating cumulative monthly dividends at an annual rate equal to the prevailing prime rate in Canada plus 1.5%, with a minimum annual rate of 5% and a maximum annual rate of 8%. Holders of the Class A Shares are entitled to receive monthly cash distributions targeted to be 10% annually based on the volume-weighted average market price of the Class A Shares for the last three trading days of the preceding month.

DBRS Morningstar expects the monthly cash distributions to the holders of the Class A Shares and operating expenses to cause an average grind on the NAV of the Portfolio of approximately 3.5% until the end of the term. An asset coverage test in place mitigates the effects of the grind by not permitting the Company to make monthly distributions to the Class A Shares if the dividends of the Preferred Shares are in arrears or if the NAV of the Portfolio falls below 1.5 times (x) the principal amount of the outstanding Preferred Shares. In addition, no special distributions can be made to the Class A Shares if, after such distributions, the NAV is below $25. This ensures a sufficient level of protection to the holders of the Preferred Shares.

The main form of credit enhancement available to the Preferred Shares is a buffer of downside protection. As of July 15, 2020, the amount of downside protection available to the Preferred Shares was 41.9%. The Preferred Share dividend coverage ratio was approximately 1.2x.

Following the stock market sell-off in response to the worldwide spread of Coronavirus Disease (COVID-19) and various geopolitical news in March 2020, the Preferred Shares experienced a decline in downside protection. Although the credit quality of the underlying assets of the Portfolio is strong, the Portfolio is concentrated in the financial services industry, which has suffered deep declines. The downside protection level partially recovered; however, it remains below the required level for a Pfd-3 (high) rating. The floating nature of dividend distributions to the Preferred Shares and Class A Shares, while mitigated by predetermined ranges of dividend yields, may potentially increase the volatility of the protection available to holders of the Preferred Shares in a high interest rate environment. Considering the decline in downside protection and the Portfolio performance metrics, DBRS Morningstar downgraded the rating on the Preferred Shares to Pfd-3 from Pfd-3 (high).

The maturity date is December 1, 2023. On maturity, the holders of the Preferred Shares will be entitled to the value of the Portfolio, up to the face value of the Preferred Shares, in priority to the holders of the Class A Shares. The Class A Shareholders will receive the remaining value of the Company. The term may be extended beyond the termination date for additional terms of five years each as determined by the Company’s board of directors.

DBRS Morningstar also considered the following constraints:

(1) The reliance on the Portfolio manager to generate additional income through methods such as option writing.

(2) The monthly cash distributions to holders of the Class A Shares.

(3) The dependence of the downside protection available to holders of the Preferred Shares on the value of the underlying common shares, which are subject to share price volatility.

BK.PR.A has a NAVPU of 16.80 as of July 31 for asset coverage of 1.7-:1 and downside protection (a different statement of the same idea) of 40.5%.

This entry was posted on Tuesday, August 11th, 2020 at 9:08 pm and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.