PrefBlog

DBRS has announced that it:

has downgraded its credit rating on the Preferred Shares issued by North American Financial 15 Split Corp. (the Company) to Pfd-4 from Pfd-4 (high). The downgrade is based on the deterioration in downside protection to 32.7% as of January 31, 2024, from 34.7% as of January 31, 2023; the increase in the Preferred Shares’ distribution rate to 9.50% annually on the Preferred Share’s redemption value of $10.0 for the fiscal year beginning December 1, 2023, from 7.75% annually for the fiscal year beginning December 1, 2022; a decline in the dividend coverage ratio to 0.4 times (x); a projected grind of 4.0% per year over the remaining term; and unhedged foreign currency exposure.

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 on August 31, 2023, 10.7% of the Portfolio was also invested in Fifth Third Bancorp, U.S. Bancorp, and Morgan Stanley, and 12% was held in cash. Quadravest Capital Management Inc. is acting as the manager (the Manager) for this Company.

A portion of the Company’s Portfolio is exposed to currency risk as 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, 2023, 50.1% of the Portfolio was invested in USD-denominated assets.

The Fund has an at-the-market equity program (the ATM Program) effective until September 9, 2024, unless terminated prior to such date by the Company. The ATM Program allows the Company to issue Preferred Shares and Class A Shares to the public from time to time at the Company’s discretion. The maximum gross proceeds from the issuance of the shares could be $350.0 million. During the period ended May 31, 2023, 1,982,000 Preferred Shares were sold through the ATM Program at an average selling price of $9.58 per Preferred Share, raising gross proceeds worth $19.0 million. During the same period, 2,939,800 Class A Shares were sold through the ATM Program at an average selling price of $5.49 per Class A Share, raising gross proceeds worth $16.2 million.

The Company’s termination date is December 1, 2024. 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 will be provided with a special retraction right in connection with such extension.

The Preferred Shares distribution rate is set by the board of directors annually and subject to a minimum of 5.5% annually until 2024. Holders of the Preferred Shares used to receive cumulative monthly cash dividends at a rate of 6.75% annually until November 30, 2022. However, with effect from December 1, 2022, this rate increased to 7.75% annually and further to 9.50% with effect from December 1, 2023. Class A shareholders are entitled to receive monthly cash dividends currently targeted to be $0.11335 per Class A share, equivalent to 9.0% annually on the issue price of $15.0. No distributions will be paid to the Class A Shares if the NAV per unit (Unit, consisting of one Preferred Share and one Class A Share) falls below $15.0. Because the NAV per Unit fell below $15.0, distributions to Class A shareholders have been suspended since March 2023.

As of January 31, 2024, the asset coverage ratio was at 1.5x. The downside protection available to holders of the Preferred Shares was 32.7%. The dividend coverage stood at 0.4x, indicating that the current dividend income earned by the Company is not enough to fully cover the Company’s expenses and targeted distributions on the Preferred Shares, which increases the reliance on the Manager to generate a high yield to meet distributions and other expenses without having to liquify portfolio securities. To supplement the Portfolio income, the Company may engage in covered call options and put option writing on all or a portion of the shares held in the Portfolio.

Recent Updates/Treasury Offerings

(1) On May 25, 2023
The Company announced that the Toronto Stock Exchange (the TSX) has accepted its notice of intention to make a Normal Course Issuer Bid (the NCIB) to purchase its Preferred Shares and Class A Shares through the facilities of the TSX and/or alternative Canadian trading systems. The NCIB commenced on May 29, 2023, and terminates on May 28, 2024. Pursuant to the NCIB, the Company proposes to purchase, from time to time, if it is considered advisable, up to 5,408,428 Preferred Shares and 5,514,879 Class A Shares of the Company.

(2) On September 21, 2023
The Company announced that the Preferred Shares distribution rate for the fiscal year beginning December 1, 2023, will be $9.50% per annum, in comparison with the previous rate of 7.75% on the initial issue price of $10.0.

The main constraints to the credit rating are the following:

(1) Volatility in stock prices, along with 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.

(2) A Preferred Shares’ dividend coverage that is less than one time.

(3) 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.

(4) The monthly cash distributions to holders of the Class A Shares which create grind on the Portfolio. This risk is mitigated by a NAV test. Because the NAV per Unit fell below $15.0, distributions to Class A shareholders have been suspended since March 2023.

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

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

This entry was posted on Thursday, February 15th, 2024 at 8:42 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.