DBRS Assigns Rating of A (low), Stable Trend, to Northwestern Hydro Acquisition Co Inc.’s CAD 650 Million Bond Issuance

DBRS Limited (DBRS) assigned a rating of A (low) with a Stable trend to the $650 million 16.5-year bullet Senior Secured Bonds (the Bonds) issued by Northwestern Hydro Acquisition Co Inc. (the Issuer). The proceeds of the Bonds were used to refinance the bank debt under a bridge credit facility that was used by the Issuer to acquire a 35% stake in Coast Mountain Hydro Limited Partnership (CMHLP or ProjectCo) from its previous owner, AltaGas Ltd. (AltaGas or the Seller; rated BBB, UR-Dev. by DBRS). The acquisition closed on June 22, 2018.

The Issuer is a taxable corporation that is wholly and indirectly owned by Axium Infrastructure Canada II LP (Axium; 60% ownership) and The Manufacturers Life Insurance Company (Manulife; rated AA (low), Stable by DBRS; 40% ownership) (together with Axium, the Sponsors) through a series of intermediate entities. DBRS views both Axium and Manulife as experienced infrastructure investors with strong track records of investing in, acquiring and operating infrastructure assets, including renewable assets.

ProjectCo is a special-purpose vehicle (SPV) created to own and operate three operational run-of-river hydro-generating facilities (the Project) located in northwest British Columbia (BC). ProjectCo has been selling electricity to British Columbia Hydro and Power Authority (BC Hydro; rated AA (high), Stable by DBRS) under three separate 60-year Energy Purchase Agreements (EPAs) since the three facilities achieved commercial operating date (COD) status in 2014 and 2015. The EPAs feature fixed-energy pricing, which is indexed to BC’s consumer price index (CPI) for the entire contract term. The relatively complex energy pricing formula of the EPAs could potentially cause volatility in effective prices. This concern, however, is partially alleviated by the relatively stable historical hydrology profile observed at the project sites. The A (low) rating is underpinned by (1) fixed-price EPAs with prices fully indexed to inflation; (2) reliable technology and new hydro assets with expected low operating risk and capex requirements; (3) the expected stable hydrology/generation profile; (4) robust debt covenant package with an escalating debt service coverage ratio (DSCR) profile; and (5) strong Sponsors with experience in infrastructure asset investment and management. The primary rating constraints include (1) uncertainty in hydrology/generation forecasts; (2) the Sponsors’ minority ownership interest with potential for further dilution; (3) potential volatility of effective energy pricing introduced by the relatively complex EPA pricing formula; (4) refinancing risk, albeit risk that is considered manageable; and (5) potential change of future cash tax introduced by the Issuer’s taxable corporate structure.

Debt servicing of the Bonds will rely on distributions to be upstreamed from ProjectCo, and therefore bondholders only have an equity interest in ProjectCo instead of having direct security over the underlying assets and cash flow. This structure is inherently weaker than a typical project finance structure where an issuer has full and direct control over the underlying assets and cash flow. On the other hand, the debt covenant package provides bondholders with credit protections akin to a traditional project finance transaction, with features including a comprehensive security package, blocked accounts, cash flow waterfall, debt service reserve account (DSRA), operations and maintenance reserve account (OMRA) and an additional liquidity reserve account, funded by cash or letters of credit (LOCs) at the Sponsors’ level, with no recourse to the Issuer, and a restricted payment test with a minimum DSCR requirement of 1.20 times (x). Furthermore, the structural weakness (or structural subordination) is effectively mitigated through a robust governance framework and debt covenants that grant bondholders veto power over management and financial decisions that could adversely affect bondholders’ interest. The debt structure features an escalating DSCR (effectively an Interest Coverage Ratio (ICR)) curve, with an initial DSCR at 1.51x, averaging at 1.64x over the 16.5-year debt term and progressively rising to 2.10x by debt maturity in 2034. This DSCR profile is consistent with the “A” rating level. DBRS does not view the refinancing risk as a material concern because the remaining contractual cash flow to 2074 provides a healthy deemed average DSCR of 1.70x, assuming the Bonds must fully amortize before the EPAs expire. The refinancing DSCR is considered to be in the high investment-grade rating category.

A rating upgrade is unlikely in the near to medium term given the refinancing uncertainty and the relatively low starting DSCR. A negative rating action can be triggered by consistent and material operating underperformance that causes the DSCR to fall outside of the minimum requirement for the “A” rating category.

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

The principal methodology is Rating Project Finance, which can be found on dbrs.com under Methodologies.

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 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.

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