DBRS Finalizes BBB Rating with a Stable Trend on TransAlta OCP LP’s $344.7 Million Bond Issuance

DBRS Limited (DBRS) finalized its provisional rating of BBB with a Stable trend on the $344.7 million Senior Secured Amortizing Bonds due August 5, 2030 (the Bonds), issued by TransAlta OCP LP (the Issuer), a special-purpose vehicle. TransAlta Corporation (TransAlta; rated BBB (low) with a Stable trend by DBRS) indirectly and wholly owns the Issuer through two subsidiaries: Keephills 3 Limited Partnership (K3LP) and TransAlta Generation Partnership (TGP), each a limited partner (LP) of the Issuer. TransAlta is also an LP of the Issuer, holding approximately 0.0001% of the Issuer's equity interest. TransAlta is one of Canada’s largest independent power producers, with approximately $10.3 billion in assets and a significant generation fleet in the Province of Alberta (Alberta or the Province; rated AA with a Negative trend by DBRS). In 2016, TransAlta and the Plant Owners (defined below) entered an Off-Coal Agreement (the OCA) with the Province for the cessation of coal-fired emissions from certain Alberta-based generators and certain other performance obligations in exchange for annual off-coal payments until 2030. The OCA provides incentives and compensation for K3LP, TGP and TransAlta Cogeneration, L.P. (together with K3LP and TGP, the Plant Owners) as well as TransAlta (together with the Plant Owners, the TransAlta OCP Entities) to retire these generators, which are adversely affected by the 2015 Alberta Climate Leadership Plan. The transaction monetizes the remaining 13 off-coal payments of approximately $37.3 million per annum (net amount) from the Alberta government under the OCA. The Issuer will advance the bond proceeds to TransAlta as a demand intercompany loan pursuant to the Intercompany Loan Agreement, which TransAlta will use to pay down its corporate-level third-party debt. The off-coal payments will flow to the Issuer as capital contributions from its LPs, the proceeds of which will be used to service the Bonds.

The enhanced structural features and debt covenant package (i.e., comprehensive security package, TransAlta’s performance covenants, Intercompany Loan Agreement, bare trust agreements, etc.) of the transaction are intended to insulate the Bonds from TransAlta’s corporate-level debt. Based on the relatively benign nature of the performance obligations under the OCA, DBRS reasonably expects that TransAlta will continue to perform its contractual and legal obligations under the OCA even in the event of an insolvency of any of the TransAlta OCP Entities, assuming these parties continue to operate under a formal restructuring. Accordingly, it is conceivable that the off-coal payments will continue to flow to the Issuer as capital contributions, and the Issuer will continue its debt service obligations as long as the structural and contractual features of the transaction will be respected during an insolvency proceeding of any TransAlta OCP Entity. However, DBRS notes that the Issuer is not structured to be bankruptcy remote from the TransAlta OCP Entities and the Issuer has no direct right, title and interest to the off-coal payments (equitable and beneficial interest to the payments from the Province remains with the Plant Owners). Therefore, there is a material risk that the capital contributions and the related security interests in the off-coal payments could be subject to the insolvency risks associated with any of the TransAlta OCP Entities. As a result, DBRS provides only a moderate one-notch rating uplift from TransAlta’s rating as opposed to moving the Bonds’ rating closer to Alberta’s rating. The Bonds’ rating is further underpinned by TransAlta’s solid credit quality, which is the rating starting point due to the Issuer’s dependence on TransAlta’s performance covenants and further linkage through the intercompany loan. DBRS notes that the minimum debt service coverage ratio of 1.05 times is low. This, however, is justified by (1) the virtually fixed cash flow stream over the debt term and (2) TransAlta’s supplemental semi-annual payments on the intercompany loan, which offers a significant cash flow buffer for any unexpected cost increase.

The rating is expected to move with TransAlta’s rating because of the structural linkage between the Issuer and TransAlta. Any movement of TransAlta’s rating will likely trigger a similar rating action on the Bonds.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The principal methodology is Rating Project Finance (February 2018), which can be found on www.dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrs.com.