DBRS has announced (on 2023-11-22, they say, but I swear I looked and didn’t see it) that it:
upgraded the Issuer Rating, long-term obligations, and preferred shares credit ratings of Brookfield Corporation (BN or the Company) and its guaranteed subsidiaries, including BN’s Issuer Rating and Senior Notes to “A” from A (low) and its Preferred Shares rating to Pfd-2 from Pfd-2 (low). In addition, DBRS Morningstar confirmed the short-term credit ratings of BN and its guaranteed subsidiaries at R-1 (low). All trends are Stable. These actions remove the long-term and preferred share ratings on BN and its subsidiaries from Under Review with Positive Implications as well as the short-term ratings from Under Review with Developing Implications where they were placed on September 27, 2023, to conduct a review of the Company and the methodological approach to the credit ratings. For more information, please see the related press release here: https://www.dbrsmorningstar.com/research/421150/dbrs-morningstar-places-certain-ratings-of-brookfield-corporation-and-its-subsidiaries-under-review-with-positive-implications.
During the course of its review, DBRS Morningstar conducted a credit analysis of Brookfield Asset Management Ltd. (BAM) using the “Global Methodology for Rating Investment Management Companies” and of Brookfield Reinsurance Ltd. (BNRE) using the “Global Methodology for Rating Insurance Companies and Insurance Organizations.”
KEY CREDIT RATING CONSIDERATIONS
BN’s and its guaranteed subsidiaries credit ratings reflect the Company’s (1) position as the parent company of BAM (75% ownership), (2) position as the substantial owner of BNRE (majority economic interest), (3) position as the parent company of Brookfield Property Partners L.P. (BPY, rated BBB (low) with a Stable trend by DBRS Morningstar; 100% ownership), (4) position as the parent company of Brookfield Renewable Partners L.P. (BEP, rated BBB (high) with a Stable trend by DBRS Morningstar; 46% ownership), and (5) strong consolidated credit metrics, liquidity profile, and industry diversification. For each BN business that contributes a material portion of the Company’s consolidated distributable earnings or already had a DBRS Morningstar public credit rating, DBRS Morningstar assessed its credit quality based on its proportionate contribution, adjusted for BN’s ownership interest in the subsidiary (the Composite Rating). DBRS Morningstar then adjusted the Composite Rating for the following overlay factors: (1) the structural subordination on the leveraged cash flows from BNRE, BPY, and BEP, (2) the Company’s superior industry diversification, and (3) BN’s very strong liquidity. The result is an overall Issuer Rating of “A.”CREDIT RATING DRIVERS
The credit ratings on the Company and its guaranteed subsidiaries reflect those of its primary business units and operating companies, namely BAM, BNRE, BPY, and BEP. Significant improvement in the credit risk profiles of one or more of these businesses may result in an upgrade of BN’s credit ratings.Conversely, a deterioration in the credit risk profile(s) of BN’s primary business units and operating companies; a material increase in debt at the Company; debt at BAM that causes debt at BN to be structurally subordinated to a greater percentage of its cash flows; or a deterioration in governance controls may result in a downgrade of BN’s credit ratings.
CREDIT RATING RATIONALE
These credit rating actions reflect DBRS Morningstar’s assessment of BN’s key subsidiaries and overlay factors, including the following:
Subsidiaries
BAM—BAM’s credit profile benefits from its position as one of the largest alternative asset managers in the world, with more than $440 billion of fee-bearing capital, the majority of which is long term (10+ years) or perpetual in nature. Assets under management (AUM) have grown significantly in the last five years, indicative of BAM’s strong fundraising abilities, capital resources, and investment track record. BAM’s capital-light business model, growth in AUM, and high margins have resulted in strong earnings, the majority of which are distributed to BN. BAM also has no corporate debt and very strong liquidity. DBRS Morningstar’s assessment of BAM’s credit profile also considers that the nature of the funds it manages are relatively illiquid and that the current macroeconomic environment could result in increased impairments, defaults, and lower valuations in some of its investments. DBRS Morningstar notes that while in the short-term, this would not have a significant impact on the credit profile of BAM, in the medium to long term this could impact the ability for the business to continue to grow its fee-bearing capital.BNRE—BNRE’s credit profile is supported by the expectation of improved market position and franchise strength over the near to medium term, particularly in the Annuity and Property and Casualty (P&C) business lines; improved earnings stability as it develops a sizable base of recurring premium revenues; and strong investment from BN to execute on its growth plan and to meet capital requirements. DBRS Morningstar’s assessment of BNRE’s credit profile also considers a limited track record of operations to assess historical profitability of the consolidated entity; the risk and uncertainty related to its aggressive growth plans; and that the credit and market risk of its investment portfolio, its financial leverage, and its capital needs are high relative to other insurers.
BPY—BPY’s credit profile benefits from its market position as a preeminent global real estate company; its high-quality assets (particularly the BPY Core Office and Retail segment) with long-term leases to large, recognizable investment-grade-rated tenants; and its superior diversification by property, tenant, and geography. BPY’s credit profile is constrained by its weak financial risk assessment as reflected in its highly leveraged balance sheet and low EBITDA interest coverage, a riskier retail leasing profile in terms of lease maturities and counterparty risk relative to its Core Office segment, and a higher-risk opportunistic Limited Partnership Investments segment composed of hotel, office, retail, mixed-used, housing, and alternative assets.
BEP—BEP’s credit profile is supported by its long-term contracts with diverse, solid-credit counterparties; its diversified and large generation asset portfolio; and its low environmental risk, low-cost and high-quality assets. DBRS Morningstar’s assessment also considers BEP’s expansion risk; refinancing and recontracting risk at the project level; and hydrology and wind resource risk.
Overlay Factors
Structural Subordination—DBRS Morningstar notes that BN finances its assets on a non-recourse basis without any parental guarantees or cross-collateralization. BN’s debt is structurally subordinated to the leveraged cash flows from BNRE, BPY, and BEP; however, there is no corporate debt held at BAM, which, along with Direct Investments, accounted for 54% of consolidated distributable earnings in the last 12 months ended September 30, 2023.Diversification—DBRS Morningstar believes that the Company benefits from cash flow stability resulting from superior industry diversification of its business units and operating companies. BN’s cash flows are generated from diversified businesses comprising asset management, insurance solutions, real estate, private equity, infrastructure, and renewable power.
Liquidity—DBRS Morningstar considers BN’s liquidity to be very strong because of its $1.5 billion in cash and financial assets, $2.5 billion in undrawn and committed credit facilities, and $4.6 billion in annualized distributions at September 30, 2023. DBRS Morningstar also notes that, including perpetual affiliate liquidity and uncalled private fund commitments, BN and its subsidiaries had a total of $119 billion in liquidity as of September 30, 2023.
Issues affected are (deep breath): BN.PF.A, BN.PF.B, BN.PF.C, BN.PF.D, BN.PF.E, BN.PF.F, BN.PF.G, BN.PF.H, BN.PF.I, BN.PF.J, BN.PF.K, BN.PF.L, BN.PR.B, BN.PR.C, BN.PR.K, BN.PR.M, BN.PR.N, BN.PR.R, BN.PR.T, BN.PR.X and BN.PR.Z. Not to be forgotten is the Brookfield Investments Corporation, BRN.PR.A, which is not tracked by HIMIPref™.
Thanks to Assiduous Reader peet for bringing this to my attention!
So Brookfield Corp preferred shares represent 15% of my investments now (everything except house).
On top of that I also own BN common shares with 4.5% weight.
I put a lot of faith into the credit rating of BN given by credit agencies. In my mind, Pfd-2 or BBB (Fitch) is super safe.
I am looking at the risk of my portfolio before some crisis happen, and I have the impression that 15% in one single place for fixed income is a weakness. Although, I still think BN reset pref are the best value in the market and I see minimum 20% appreciation upside in next two years + dividends for some of the shares BN.PF.G, BN.PR.R, BN.PF.L and BN.PR.T.
I’m unsure of partially selling now because I still see good value, but I might miss something. I’m looking for feedback. Do you think I should at least lower my weight from 15% to 10% to de-risk a little my portfolio?
Thanks.
FWIW I’m in the same boat as far as an unreasonable percentage of my net worth is in BN prefs (BN.PR.K in my case).
It’s definitely more than like a normal portfolio theory would say you should have there. I think it’s a function of how good you think the opportunity is and what your financial situation is like otherwise… is it a catastrophe for your life if there’s a BN blowup or just annoying.
If you’re thinking about the question the answer is probably yes… minimum regret theory if things work out you’ll still be happy and if they go down at least you sold some.
“an unreasonable percentage of my net worth is in BN prefs (BN.PR.K in my case).”
BN.PR.K is a Floater paying 70% of Prime, issued in the 1980s. At it’s current market price of $11.30, it yields 9.2%.
I’ve been thinking about this issue and it’s other twin sisters BN.PR.B/C (also 70% Prime Floaters). I think now is a decent time to buy them. Here are some random thoughts:
– as far as I can tell, they have always paid their dividend. There is a non-zero chance that they may suspend the dividend someday but that chance is barely above zero.
– Back in the 80s, clearly investors thought of these floaters as a type of money market fund – buy for inflation protection and capital preservation. This idea was destroyed by the credit risk worries of various crises. James also published some work on them busting the idea that they were money market equivalents.
– there is a non-zero chance that they may be called at some future point. More likely the current NCIB just keeps getting renewed and the outstanding volume gets chipped away and/or a SIB surfaces.
– The current spread of 4.5% to prime will narrow as Prime falls but won’t disappear. I think we may be at an inflection point here. With prices for B/C/K below 50% of par, they are just too for BN expensive to keep and to speculators looking at that spread. Point being, downside seems limited.
– Preferred shares are now BNs most expensive funding source. They have added insurance float to their capital mix and fee-bearing funds are much more important now. They have solid access to debt markets (even BPY can borrow there reasonably). So why keep preferred shares in the mix at all? BN is often criticised for their complexity. If I was Flatt, I’d seriously consider retiring all of the BN preferreds over time. Maybe they just don’t need them anymore?
I believe the current NCIB has only bought BPOs and it stopped even doing that when they recovered a bit. The floaters seem like good candidates but no indication they’re going to touch them yet. It’d be nice but I’m not counting on it.
The long term yield looks really good I think… 30 year Canadas are around 3.3% which would equate to 8.5% at these prices. Even at 2.3% it’s still a 7% yield.
“I’ve been thinking about this issue and it’s other twin sisters BN.PR.B/C (also 70% Prime Floaters). I think now is a decent time to buy them.”
stusclues, Prime it will come down for sure but the question is how far. The collective wisdom seems to assume down to somewhere around 2.5% next year. Given that the historical spread of Prime to the BOC’s policy or overnight rate for the last 25 or so years has always been 2% -2.5% , I am factoring in an eventual current yield of around 4.5% for any new buys. I already hold lots of both “K” and “B”.
Errata, sorry!
“I am factoring in an eventual current yield of around 4.5% for any new buys”
should read “around 6.75%” at the current pricing for “K and “B”.
well… long rates have been blowing up in the UK for a few weeks now. 10 year yields have gone from 3.75% in mid Sept to 4.57% this morning.
Trump election blowing out US rates… having gone from 3.6% to 4.47% today. massive move overnight on that Trump win.
I hate to say it, but that Bank of Canada has got a serious problem. our rates haven’t reacted yet. but i think it’s a matter of time. why would anyone lend Canada money when you can get 1.2%+ more on US treasuries? oh.. and the loonie keeps tanking….
So Brookfield Corp preferred shares represent 15% of my investments now (everything except house).
On top of that I also own BN common shares with 4.5% weight.
I give Pfd-2 group preferreds an equity weight of 1/3 – just as an approximation. It’s a wild-ass guess, so don’t ask for ponderous tomes detailing any justification! The 1/3 figure is meant to include fundamental risk but to ignore price risk – which I think should usually be ignored (or, at least, be given a low weight) in the context of a portfolio intended to be held for the long term. It’s the whole Security of Income vs. Security of Principal thing.
If you accept that weighting, then your exposure to BN is (15% * 1/3) + 4.5% = 9.5%, which I think is too high. I believe that exposure to an issuer should be capped at about 5% equity weight – lightning can strike anywhere at any time.
So I would aim to reduce your exposure over time – making opportunistic sales when circumstances permit and not buying any more.
Back in the 80s, clearly investors thought of these floaters as a type of money market fund … James also published some work on them busting the idea that they were money market equivalents.
That was Are Floating Prefs Money Market Vehicles?
Preferred shares are now BNs most expensive funding source.
Sure, but they give another layer of first-loss protection to senior bonds and makes the debt-equity ratio look better. It’s worth paying an extra dollar for preferred share funding if it saves you two dollars in bond funding costs!
stusclues, Prime it will come down for sure but the question is how far. The collective wisdom seems to assume down to somewhere around 2.5% next year.
Well, not Prime, but the overnight policy rate may well reach those levels!
For the past while in PrefLetter, I have been comparing the BN floaters with BN Straight Perpetuals – a little algebra allows one to determine the average level of Prime required in the future to make an investor indifferent as to which of the two to purchase.
You get a pretty low number! A number that, I believe, we won’t even reach until the opening of COVID Part II, let alone average. And as long as Prime is above this number, you’re just getting paid extra money relative to the straights.
“Sure, but they [preferred shares] give another layer of first-loss protection to senior bonds and makes the debt-equity ratio look better.”
I agree. This is why, IMO, we don’t see more aggressive buybacks across the universe of preferred shares. Since borrowing to retire prefs harms the debt-equity calculation, it is up to free cash flow to do the job. Companies usually (but not always correctly) they have other good uses for FCF.
In BN’s case though, the inclusion of (very low cost) insurance float does give them another source of funds to consider for this purpose.
stusclues, Prime it will come down for sure but the question is how far. The collective wisdom seems to assume down to somewhere around 2.5% next year.
Well, not Prime, but the overnight policy rate may well reach those levels!
James, I screwed up my original post and you’re absolutely right of course about this correction. My “errata” which posted an implied current yield of 6.75% for the BN floaters could have been clearer but at least used the right numbers:
Assumed Overnight Policy Rate around 2.5% + Assumed Spread of 2% = Assumed Prime of 4.5% = Assumed Current yield of 6.75%.
I believe that exposure to an issuer should be capped at about 5% equity weight – lightning can strike anywhere at any time.
Thanks for this very illuminating perspective. A fresh way to look at risk of holding a concentrated position in preferreds.
A fresh way to look at risk of holding a concentrated position in preferreds.
I should point out that this suggested limit is separate from and on top of my rules of thumb that apply solely within a preferred share portfolio – 10% for Pfd-2 group, 1% for Pfd-3 group. Both those numbers are the raw preferred share weight, not equity-equivalent!
And for the Pfd-3 group, equity equivalent weight is 1/2 of the raw preferred share rate; that’s another wild-ass guess.
Maybe you can boost the Pfd-3 group cap somewhat for SplitShare preferreds, if you want to get all fancy-pants about it.
And again note that these levels are wild-ass guesses with no theoretical justification whatsoever. But they seem to work OK in practice.
I believe the current NCIB has only bought BPOs and it stopped even doing that when they recovered a bit. The floaters seem like good candidates but no indication they’re going to touch them yet.
Way back when, during the Credit Crunch, when everybody was convinced the bank bail-outs would ignite global double-digit inflation, floaters were trading well above par and I couldn’t understand why they weren’t being called. I mentioned this to a plugged-in Bay Street type and was told, after inquiries, that it was a ‘tax thing’. Some kind of grandfathered sweetheart deal from time of issue.
I never learned anything more about it than that bare assertion, but it’s a good story, anyway ….
I think the chance of BN prefs suffering catastrophic loss is very low, so a 15% weighting is fine.