DBRS Places Ratings of Brookfield Renewable Power Inc. and Brookfield Renewable Power Fund Under Review with Developing Implications

DBRS has today placed the Senior Unsecured Debentures and Notes rating of Brookfield Renewable Power Inc. (BRPI) Under Review with Developing Implications. DBRS has also placed the Issuer Rating and Income Fund rating of Brookfield Renewable Power Fund (the Fund) and the Preferred Shares, Series 1 (the Preferred Shares) rating of the Fund affiliate Brookfield Renewable Power Preferred Equity Inc. (Equity Inc.) Under Review with Developing Implications. These rating actions follow the announcement of a proposed transaction in which a new publicly traded partnership, Brookfield Renewable Energy Partners (BREP), would acquire all of the units of the Fund and the equity interests in all of BRPI’s U.S., Brazilian and Canadian power assets not already owned by the Fund (collectively, the Transaction). The Fund’s board of trustees has recommended that Fund security holders vote to approve the Transaction.

On a simplified basis, the new BREP entity would be the combination of the current BRPI and Fund (both rated BBB (high)), with no incremental debt and an increased percentage of generation under contract, but it would exclude BRPI’s infrastructure investments. Key aspects of the Transaction include the following:

(1) The existing C$1.1 billion of corporate-level medium-term notes (MTNs) at BRPI would become an obligation of a BREP subsidiary and fully guaranteed by BREP.

(2) Equity Inc.’s C$250 million of Preferred Shares, currently guaranteed on a subordinated basis by the Fund, would become an obligation of another BREP subsidiary and similarly guaranteed on a subordinated basis by BREP.

(3) BREP would exchange its units with the Fund’s on a one-for-one basis and pay for BRPI’s generating assets with BREP units. Post-Transaction, it is expected BREP will have approximately 265.2 million units outstanding, with BRPI owning approximately 73% of BREP on a fully exchanged basis, and existing Fund unitholders owning 27% of BREP (the Fund is currently held 34% by BRPI, 66% by the public).

(4) BRPI will control the general partner of BREP and provide management services to BREP under an agreement. BREP will also be the vehicle through which BRPI will invest in renewable power assets in the future.

(5) BRPI would enter into a 25-year contract to acquire BREP’s currently un-contracted U.S. generation at an initial price of $75 per megawatt hour (MWh). BRPI would also amend the existing power purchase agreement it has with the Fund’s Ontario assets, increasing the current average price it receives to approximately C$88/MWh from approximately C$68/MWh. In addition, third-party power purchase agreements on the Brazilian assets will be transferred to BREP.

(6) BRPI’s non-generation infrastructure investments, namely, a 28% indirect ownership interest in Brookfield Infrastructure Partners L.P. (BIP) and a 10% interest in Transelec S.A. Chile (Transelec), will not be acquired by BREP.

BRPI MTNs
The Transaction offers a number of positives to the BRPI noteholders:

(1) One layer of subordination between BRPI and the Fund’s operating assets will be removed. The BRPI noteholders will be structurally moving ahead of both Equity Inc.’s Preferred Shares and the Fund’s public unitholders.

(2) Existing market price risk on the currently un-contracted U.S. generating portfolio will be mitigated, resulting in BREP having a 100% contracted generation portfolio. The weighted average power purchase agreement term will also increase materially, from approximately 13 years to approximately 24 years.

(3) Based on long-term average generation levels, BREP is expected to generate considerable annual EBITDA and cash flow from operations, estimated at approximately $1.1 billion and $550 million, respectively. DBRS estimates (based on the number of BREP units, stated unit distribution and target payout ratio) that BREP will have distributable cash flows in the area of $450 million annually.

(4) BREP will have access to the public equity market rather than being wholly dependent on its indirect parent, Brookfield Asset Management Inc. (BAM, rated A (low), R-1 (low) and Pfd-2 low) for equity funding.

(5) The Transaction will eliminate bondholders’ exposure to the non-core infrastructure segment, resulting in a more focused pure-play renewable energy company.

However, DBRS believes there are some negative aspects from the perspective of a BRPI noteholder: (1) not having the benefit of the infrastructure investments, which, while modest in size, provided some diversification as well as an approximate 10% of BRPI’s cash flow, and (2) BREP will have the added cost of management fees payable to BRPI, including a base fee of $20 million annually, as well as 1.25% on increases in BREP’s total capitalization. There will also be an incentive-based distribution payable to BRPI linked to growth in distributions.

Overall, DBRS views the positives as outweighing the negatives for the BRPI noteholders since moving ahead of the Fund’s Preferred Shareholders and public unitholders provides a meaningful benefit and the added cash flow provided by the contracts on the U.S. assets is expected to more than make up for the loss of the BIP cash flow and the management fee payments. BREP’s coverage credit metrics (both consolidated and non-consolidated) are expected to marginally improve over BRPI’s. BREP’s consolidated debt-to-capital ratio is expected be approximately 40% (noting that DBRS’s metric focus is more on interest coverage and cash-flow-to-debt value, both consolidated and non-consolidated, than on debt-to-capital). Therefore, DBRS views the Transaction as a modest improvement in both business and financial risk for the BRPI MTNs.

EQUITY INC. PREFERRED SHARES
Equity Inc.’s Preferred Shares will become the obligation of a BREP subsidiary, guaranteed on a subordinate basis by BREP, mimicking the current structure under which the Preferred Shares are guaranteed on a subordinate basis by the Fund. Similar to the Fund, BREP would feature a contracted generation portfolio, with a weighted-average term of approximately 24 years. For the Preferred Shareholders, DBRS views the Transaction as offering a number of positive aspects that reduce business risk:

(1) BREP would be a much larger and more diverse renewable generator than the Fund, with the addition of contracted assets in the United States and Brazil. BREP’s approximate $13 billion in total assets would be more than double the Fund’s current size (C$5.6 billion as of June 30, 2011). BREP’s generating capacity (approximately 4,400 MW) is also substantially larger than that of the current Fund (approximately 1,700 MW). As mentioned above, BREP is expected to generate $1.1 billion annual EBITDA and $550 million cash flow from operations, based on long-term average hydrology and production levels. The added geographic diversity would result in lower exposure to weak hydrology in any one area.

(2) Average contract prices for the Ontario generation operations, which represent approximately 50% of the Fund’s production, will increase from C$68/MWh to C$88/MWh.

(3) Counterparty exposure to BRPI will be reduced. Currently, BRPI is the counterparty on more than 70% of the Fund’s revenues (DBRS estimate); with the addition of the new assets, this concentration is expected to decline to the range of 50% to 60%.

(4) BREP is expected to have improved access to equity capital given its larger market capitalization and broader investor base.

However, the Transaction is expected to increase the financial risk from the perspective of the Preferred Shareholders as post-Transaction, the Preferred Shares would rank behind the C$1.1 billion of MTNs as opposed to behind the minimal levels of Fund-level debt that existed historically. Additionally, many of the U.S. and Brazilian generating assets have existing non-recourse project debt (as do many of the Fund’s current assets). DBRS views this negative effect as being balanced by the above-mentioned improvement in business risk resulting from the much larger, diverse contracted asset base and, therefore, as neutral from the perspective of an Equity Inc. Preferred Shareholder.

BREP
The Transaction is on a simplified basis the combination of two BBB (high) rated entities, with additional contract protection, no incremental debt, and excluding BRPI’s infrastructure investments. DBRS views BREP’s business and financial risk profiles as consistent with those of both BRPI and the Fund. As noted earlier, DBRS anticipates BREP having coverage credit metrics (consolidated and non-consolidated) marginally stronger than the current BRPI, assuming long-term average generation levels. Estimated annual distributable cash flow of approximately $450 million (based on long-term average generation levels) would provide both the MTN holders and Preferred Shareholders with a significant cushion of downside protection.

Liquidity arrangements including credit lines are expected by DBRS to be adequate and commensurate with an entity the size of BREP.

As such, DBRS expects that, upon closing of the Transaction on the terms and conditions currently envisioned, the existing BRPI, Fund and Equity Inc. ratings will all be discontinued, with new ratings expected to be assigned as follows: BREP issuer rating of BBB (high), BREP subsidiary MTNs (guaranteed by BREP) of BBB (high) and BREP subsidiary preferred shares (guaranteed by BREP on a subordinate basis) of Pfd-3 (high), all with Stable trends.

DBRS’s review will include pertinent Transaction documentation, including an expected information circular and the MTN and preferred share guarantees. The Transaction is subject to a number of approvals, including Fund unitholders, Equity Inc. Preferred Shareholders and BRPI debenture and MTN holders, as well as various regulatory, government, corporate and contract consents, assignments and approvals. Closing is expected to occur by the end of 2011.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on our website under Methodologies.