DBRS Comments on Capital Power Income L.P.’s BBB (high), Under Review with Negative Implications Ratings

On June 21, 2011, DBRS maintained Capital Power Income L.P.’s (CPILP or the Partnership) ratings Under Review with Negative Implications, pending a full review of the acquisition of CPILP by Atlantic Power Corporation (ATP, not rated by DBRS) (the Transaction). Upon further assessment, DBRS is now of the opinion that, if it closes as currently anticipated, the Transaction is expected to result in a downgrade of CPILP’s ratings to non-investment-grade category. DBRS expects to assign an Issuer Rating of BB to CPILP, a security rating of BB to CPILP’s Senior Unsecured & Medium Term Notes, and a recovery rating of RR4 (indicating an expected recovery of 30% to 50%) on the Senior Unsecured Debt & Medium-Term Notes, currently rated BBB (high). DBRS would also potentially downgrade the Cumulative Preferred Shares of CPILP’s affiliate, CPI Preferred Equity Ltd., to Pfd-4 from Pfd-3. The rating actions would result in the assignment of Stable trends.

CPILP and ATP jointly announced that ATP intends to acquire, directly and indirectly, all of the outstanding limited partnership units of CPILP. ATP agreed to pay a purchase price of approximately C$1.1 billion using a combination of cash and ATP shares, with the cash component capped at C$507 million. As part of the agreement, CPILP will sell its Roxboro and Southport facilities, located in North Carolina, to CPC subsidiary, Capital Power L.P. (CPLP, rated BBB, with a Stable trend), for a purchase price of approximately C$121 million (through a reduction in outstanding CPILP units).

In June 2011, DBRS had assumed, based on publicly available information on ATP and on the proposed financing of the Transaction, that the ratings of CPILP would be downgraded yet remain investment-grade. However, further review of the details of the Transaction, forecast financial profile, complex financial structure and subordination implications of the combined entity warrant a non-investment-grade rating. Post-acquisition benefits such as an increase in the average power purchase agreement (PPA) term, asset base and market capitalization, as well as greater diversification of fuel source, geography and counterparty risk, are offset by combined credit metrics that are weaker than initially anticipated. Also, an October 2011 equity offering by ATP that was moderately less than expected should result in modestly higher total debt.

Pursuant to the proposed ATP bond offering, CPILP and various subsidiaries are expected to provide guarantees that were not previously contemplated:

(1) CPILP will be guaranteeing ATP’s new $300 million secured credit facility.

(2) CPILP will be guaranteeing ATP’s intended $460 million senior unsecured bond issuance. The guarantees of the intended ATP bonds will be senior unsecured obligations of the respective guarantors and will rank equally in right of payment with all of the guarantors existing and future senior debt of the guarantor and will be effectively subordinated in right of payment to all secured debt of each guarantor.

(3) Only CPILP’s C$210 million bonds will receive a senior unsecured guarantee from ATP (with the guarantee being an obligation of ATP and subordinate to its secured $300 million credit facility). The US$415 million of CPILP subsidiary bonds (in three separate issues of US$150 million, US$75 million and US$190 million) will receive no guarantee from ATP.

Due to the binding of ATP and CPILP through the guarantees, DBRS views the entities as a combined credit; therefore, the expected CPILP Issuer Rating of BB is based on an assessment of the combined entity. All of CPILP’s bonds are expected to be fully subordinated to ATP’s $300 million credit facility and CPILP’s C$210 million bonds are expected to rank pari passu with ATP’s intended US$460 million of bonds. Based on the recovery prospects under the current complex guarantee/subordination structure, CPILP’s remaining US$415 million bonds could, in theory, be at a disadvantage vis-à-vis CPILP’s C$210 million and ATP’s US$460 million bonds.

Despite the guarantee from ATP extending only to CPILP’s C$210 million bonds and not to the remaining US$415 million bonds, DBRS does not believe that a rating differential currently exists based on the current estimated default scenarios utilized in the recovery analysis pursuant to DBRS’s Rating Methodology for Leverage Finance. However, while not currently expected, under certain circumstances there could exist materially improved recovery prospects for ATP in the future, and a scenario may result wherein there may be a rating differential between CPILP’s C$210 million bonds and the remaining US$415 million debentures. DBRS notes that this is difficult to estimate at this point.

ATP has also stated that it intends to secure a senior secured term loan to serve as a bridge facility in the event that the proposed US$460 million bond offering does not close as anticipated. If this bridge facility is used to fund the Transaction, DBRS does not expect this drawing to have any impact on CPILP’s expected ratings. DBRS anticipates that the loan will carry guarantee/subordination implications similar to the proposed bond offering.

DBRS expects that a final review of CPILP’s ratings will follow shortly after the November 1, 2011, shareholder vote and a full review of the final guarantee documentation to be provided by ATP.

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

The applicable methodologies are Rating Companies in the Non-Regulated Electric Generation Industry and DBRS Rating Methodology for Leveraged Finance, which can be found on our website under Methodologies.