DBRS Finalizes Provisional Rating of Consumers’ Notes

DBRS has today finalized the “A” provisional rating assigned to The Consumers’ Waterheater Operating Trust’s (CWOT) issue of $330,000,000 of Senior Notes (Senior Notes) at “A”, with a Stable trend. The Senior Notes are comprised of $60 million of 6.20% Series 2009-1 Senior Notes due April 30, 2012, and $270 million 6.75% of Series 2009-2 Senior Notes due April 30, 2014. The Senior Notes offering closed today.

The net proceeds from the Senior Notes were used to repay existing indebtedness, including CWOT’s $310,000,000 Bridge Credit Facility (Bridge). The Bridge, which matures January 28, 2010, was used to fully refinance $275,000,000 of Series 2003-1 A-1 Secured Notes (A-1 Notes), which were repaid as expected in January 2008, and to fully repay drawings under CWOT’s then $35,000,000 revolving credit facility.

While the Senior Notes rank equally with CWOT'S existing $225,000,000 Series 2003-1 A-2 Secured Notes (A-2 Notes, rated AAA), and $35,000,000 Credit Facility, the “A” rating incorporates the assumption that the A-2 Notes will be refinanced by the expected final payment date of January 28, 2010, and that a Release Date will occur. After the occurrence of a Release Date, it is expected that the Senior Notes will lose a number of the structural protections of the A-2 Notes and will transition to a more corporate-style offering, with fewer covenants, less restrictions and no security.

Before the Release Date, the Senior Notes will benefit from a number of provisions inherent in the existing A-2 Notes, including: 1) Security; 2) A cash sweep mechanism under which a cash sweep occurs under any of the following: a) the A-2 Notes are not fully repaid on January 28, 2010; b) a termination of the Origination Agreement; c) if net indebtedness of CWOT exceeds 70% of the net present value of total projected cash flow; and d) if adjusted EBITDA-to-net interest is less than 3.6 times (x). The Senior Notes, A-2 Notes and the Credit Facility would all participate on a pro rata basis from a Cash Sweep Event; and 3) Line of business limitations which essentially restrict CWOT to portfolios of water heaters and gas-fired equipment.

Following the Release Date, the Senior Notes will become senior unsecured debt of CWOT, with terms including: 1) As opposed to the pre-Release Date structure: unsecured, no cash sweep mechanism, no financial maintenance covenants and a less restrictive line of business limitation; and 2) The lone financial covenant will govern additional debt, with debt incurrence provisions including a pro forma incurrence EBITDA-to-net interest requirement of at least 3.8x. While the post-Release Date structure is not as restrictive on lines of business, incurrence EBITDA in the aforementioned test will only include 50% of EBITDA from non-core investments. Core will include water heaters, gas-fired equipment and renewable energy equipment, or investments therein. Additionally, the Senior Notes include: 1) A Change of Control provision at a purchase price of 101% if there is a credit rating downgrade to below BBB (low) or equivalent within 60 days as a result of such Change of Control; and 2) Asset Dispositions: After the Release Date, except in the normal course of business, the Issuer will be not be entitled to sell assets in excess of 3% of the total assets of the issuer in any financial year unless the net proceeds from such dispositions are applied to a redemption of the Senior Notes on a pro rata basis. Notwithstanding the forgoing, no such redemption will be required if (i) the pro forma ratio of incurrence EBITDA-to-net interest expenses is equal to or greater than 3.8x to 1.0x or (ii) the proceeds of the dispositions are not used to pay distributions/dividends or purchase units held by anyone other than a Guarantor.

The Senior Notes were offered under a prospectus supplement dated February 6, 2009; and issued under a Tenth Supplemental Indenture dated February 13, 2009 and Master Indenture dated December 17, 2002. If the Release Date occurs, the Senior Notes will then be governed by a replacement indenture and new supplemental.

Should CWOT not fully refinance the $225 million of A-2 Notes on January 28, 2010, a Cash Sweep Event will occur and all the secured debt, including the Senior Notes, will participate proportionately in the cash sweep. In the event a Cash Sweep Event was to occur, this would block essentially all distributions from CWOT to The Consumers’ Waterheater Income Fund. Additionally, any amount of CWOT’s Bridge that is outstanding would need to be either refinanced or extended by its January 28, 2010 maturity date.

Negligible impact on credit metrics is expected as a result of the Senior Notes offering, as proceeds will be used to refinance existing debt. Financial results for the LTM ending September 30, 2008, were in line with historical levels with EBITDA interest coverage of 5.3x, EBITDA less maintenance capex-to-interest at 2.9x and cash flow-to-debt at 23%. However, DBRS anticipates that credit metrics could be modestly impacted as a result of increased competition, increased SG&A due to acquisitions, higher capital expenditures and a deteriorating economy which will result in fewer housing starts. However, DBRS anticipates that credit metrics will remain within the “A” category.

The “A” rating is largely based on the expected continuation of stable cash flows from CWOT’s large portfolio of rental water heaters. The business risk of the underlying water heater rental business is viewed as moderately low given CWOT’s large presence in the market (providing for both economies of scale and brand awareness), the limited significant competition for its existing base of customers, and operating risk mitigated by its arrangements with Direct Energy.

On March 26, 2008, DBRS assigned a provisional rating of “A” to a proposed CWOT offering similar in many aspects to the current Senior Notes. That provisional rating was discontinued on May 27, 2008 when CWOT did not proceed with that offering.

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

The applicable methodology used is a combination of General Rating Methodology for Non-Financial Companies and an analysis of the structure, allocation of cash-flows to senior secured notes as well as other structural mitigants.

This is a Corporate rating.