DBRS Confirms Capital Power Income L.P. at BBB (high) and Pfd-3 with Negative Trends

DBRS has today confirmed the ratings of the Senior Unsecured Debt & Medium Term Notes of Capital Power Income L.P. (the Partnership or CPILP) and the Cumulative Preferred Shares of CPI Preferred Equity Ltd. at BBB (high) and Pfd-3, respectively, both with Negative trends. The confirmation is based on the reasonably stable cash flow from its long-term power contracts, strong operational efficiency and diversification of assets. The trend was changed to Negative in April 2009 when the Partnership’s leverage ratio came under pressure, reaching a high of 55% during the year due to a series of unrealized fair-value losses that led to a decline in Partner’s equity, which moved the Partnership closer to its 65% debt-to-capitalization maintenance covenant, thus reducing its financial flexibility. The Partnership has partially addressed the potential problem by reducing distributions by 30% and issuing $100 million of preferred shares. The distribution reduction resulted in the conservation of approximately $40 million in cash annually, and the preferred share proceeds were used for debt reduction, which DBRS considers positive.

Although the Partnership has taken steps to address its capital structure, cash flow from operations results are expected to be modestly lower in 2010 compared with 2009 as a result of lower operating margins at the Ontario plants and the Williams Lake, British Columbia, plant and lower contracted prices on the foreign exchange contracts settling in 2010. While initially driven by the rising leverage ratios, the trends on the ratings now remains Negative as DBRS continues to monitor the Partnership’s financial performance and pending the final decision in the third or fourth quarter of 2010 of the North Carolina arbitration on the power purchase agreements (PPAs). The decision will largely dictate the economics of two facilities in which the Partnership recently invested US$87 million in enhancement capital expenditures. A positive decision and maintenance of stable cash flows could result in the trend being returned to Stable.

The Partnership’s generating portfolio has a mix of PPAs, with a weighted-average life of approximately 11 years, which underpins the cash flow. It also continues to achieve strong operating efficiencies, with five-year average availability at 93%, reflecting the young fleet of generating assets and sound operational and maintenance practices. Approximately 51% (DBRS estimate) of the operating margins originate from facilities that have PPAs with a weighted-average life greater than ten years, while 83% of the operating margins are derived from PPAs with a weighted-average life greater than five years.

Renegotiating and re-contracting PPAs that expire in the near to medium term remain key challenges for the Partnership. Currently, DBRS estimates that approximately 20% of total installed capacity (17% of operating margin) with PPAs will expire within five years. DBRS estimates that maintenance and development capex over the medium term will track 2009 levels as the Partnership undertakes enhancement projects on some of its plants.

In pursuing its growth strategy, DBRS expects the Partnership will continue to seek growth opportunities that are accretive to cash flow. We expect that such projects will be financed in such a way that its debt-to-capital remains at 50% or less and that cash flow and interest coverage ratios are not reduced from current levels. Any material acquisition largely financed with debt could lead to a deterioration in key credit metrics and have negative implications for the credit rating. The Partnership currently has access to $325 million in revolving credit facilities to fund its growth strategy.

The Partnership has maintained that it does not expect to make any material cash income tax payments until at least 2015 because of the tax pools available to offset taxable income; therefore, the Partnership has no compelling need to convert to a corporation at this time, but it will continue to evaluate its options. In October 2009, the Preferred Shares rating was downgraded by one notch to Pfd-3 from Pfd-3 (high) as a result of the issuance of $100 million of preferred shares, which increased the amount of preferred equity in the capital structure to a level DBRS views as high.

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

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas, and Pipelines), which can be found on our website under Methodologies.

This is a Corporate (Utilities & Independent Power Utilities) rating.