DBRS Comments on Canadian Hydro Developers, Inc.’s Project Debt Issuance

DBRS Limited (DBRS) today notes that Canadian Hydro Developers, Inc.’s (CHD or the Company; rated BBB with a Stable trend by DBRS) parent company, TransAlta Renewables Inc., announced that it priced a $159 million Senior Secured Amortizing Debt due June 30, 2032 (Project Debt), under the newly created special-purpose entity, New Richmond L.P. (the Wind Project). The Wind Project is wholly owned by CHD.

Net proceeds of the Project Debt are expected to be predominantly used by CHD to (1) acquire CHD’s sister company, Western Sustainable Power Inc. (WSP), which owns various wind assets in Alberta, and (2) repay $27 million outstanding in CHD Senior Unsecured Debentures (CHD Debentures), due June 2016. The Project Debt offering is expected to settle on or around June 3, 2016.

Located on the Gaspè Peninsula, the Wind Project has a capacity of approximately 68 megawatt (MW) generated by 33 wind turbines, and has a long-term power purchase contract with Hydro-Québec (rated A (high) with a Stable trend by DBRS). WSP owns various wind farms located in Southern Alberta with total net capacity of 353 MW, and has long-term power purchase agreements with TransAlta Corporation (TAC; rated BBB with a Negative trend by DBRS).

Pro forma for the Project Debt and the $27 million debt repayment, CHD’s consolidated debt levels would increase by $132 million to approximately $846 million from $714 million (comprised of the $227 million CHD Debentures and $487 million of asset-level debt secured by the Melancthon-Wolfe wind and Pingston hydroelectric facilities). Incremental cash flow from the WSP acquisition is expected to offset the effect of the Project Debt financing. As a result, overall key credit metrics are not expected to be affected materially by the Project Debt issuance.

CHD’s business risk assessment (BRA), albeit moderately weakening, is expected to remain reasonable for the BBB rating category. As a result, DBRS does not anticipate the Project Debt issuance will result in any negative rating action for the current CHD ratings.

Furthermore, the Project Debt issuance would not materially affect the current ratings of TAC given that (1) structural subordination related to CHD’s debt has already been incorporated into TAC’s current ratings and (2) the remaining Project Debt proceeds, after the $27 million debt repayment, are expected to ultimately support a growth capital investment at TransAlta Renewables Inc. (i.e., South Hedland; a 150 MW combined cycle gas power station under construction in South Hedland, Western Australia), reducing potential funding requirements from TAC.

CURRENT BRA AND FRA ANALYSIS
In October 2015, CHD issued $442 million 3.834% Series 1 Senior Secured Amortizing Bonds due December 31, 2028 (rated BBB with a Stable trend by DBRS) under Melancthon Wolfe Wind LP (Melancthon). Net proceeds of the offering were largely distributed to TransAlta Renewables Inc. to fund its growth capital investment project. As a result, CHD’s consolidated debt levels increased by $332 million to approximately $714 million in 2015 from $379 million in 2014. While higher leverage has negatively affected CHD’s financial flexibility, the Company’s key credit metrics have remained within the BBB rating category, based on (1) leverage of 35.4% as at March 31, 2016 (30% to 50% for the BBB rating range), (2) cash flow-to-debt of 17.0% for the 12-months ended March 31, 2016 (LTM 2016) (15% to 35% for the BBB rating range) and (3) EBITDA-interest coverage of 5.41 times (x) in LTM 2016 (4.0x to 7.0x for the BBB rating range). Prior to the $442 million project bond issuance, CHD had significant financial flexibility within the current rating category — key credit metrics were in the weak “A”/strong BBB range. Leverage was in the weak “A” rating range, while the other two key metrics, cash flow-to-debt and EBITDA-interest coverage, were in the strong BBB rating range.

CHD’s BRA also weakened following the project bond issuance but remained within the BBB range, supported by the following: (1) 100% of the Company’s capacity is contracted under power purchase agreements with investment-grade counterparties and (2) there is no project construction risk. CHD is not expected to be involved with any new project developments. The rating incorporates CHD’s weakened plant and geographical diversification on a non-consolidated basis with the removal of the Melancthon wind assets.

BRA AND FRA POST-PROJECT BOND ISSUANCE
CHD’s BRA is expected to weaken moderately, but remain within the BBB range, supported by the following same positive rating drivers discussed in the current BRA and financial risk assessment (FRA) analysis section: (1) 100% of the Company’s capacity is contracted under long-term power purchase agreements with investment-grade counterparties and (2) there is no project construction risk. CHD is not expected to be involved with any new project developments. However, CHD’s counterparty risk deteriorates as a greater portion of revenues is generated from TAC, which has a weak investment-grade rating. CHD’s other counterparties have strong investment-grade ratings, ranging from A (high) to AA (high).

Incremental cash flow from the WSP acquisition is expected to partly offset the effect of the Project Debt financing. As a result, overall key credit metrics are expected to remain in the weak BBB rating range as follows: (1) consolidated cash flow-to-debt to range from 15% to 17% (versus 15% to 35% for the BBB range), (2) consolidated EBITDA-to-interest to range from 4.0 times (x) to 5.0x (versus 4.0x to 7.0x for the BBB range) and (3) consolidated debt-to-capital to range from 37% to 39% (versus 30% to 50% for the BBB range).

Given that the existing and future project debt holders will have first priority in satisfaction of their claim on their respective project assets, DBRS also conducted non-consolidated analysis by removing all project-financed asset cash flow and book values from CHD, and flowing up free cash flow distribution from the project-financed assets (after principal, interest payments and capital investment) to CHD. Incremental cash flow from the WSP acquisition is expected to fully offset the effect of New Richmond project financing. As a result, overall deconsolidated key credit metrics are expected remain relatively unchanged.

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

The applicable methodology is Rating Companies in the Independent Power Producer Industry.

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