DBRS Morningstar Changes Trend of British Columbia Ferry Services Inc. to Negative

DBRS Limited (DBRS Morningstar) changed the trend on the A (high) Issuer Rating and Senior Secured Bonds rating of British Columbia Ferry Services Inc. (BC Ferries or the Company) to Negative from Stable. The rating action is reflective of the significant impact of the Coronavirus Disease (COVID-19) on key financial metrics during F2021 and the uncertainties in the speed of financial recovery, which partly depends on the continuation of collaboration with the Province of British Columbia (the Province; rated AA (high) with a Stable trend by DBRS Morningstar) to implement service-level adjustments to match demand.

The Company is expected to have sufficient liquidity, including the proceeds from the previous bond issuance and the available capacity under its credit facilities, to cover all financial obligations in F2021. While DBRS Morningstar expects the ratings to be maintained under its base-case forecast, material deviations from our base-case assumptions could have a negative rating impact. Conversely, DBRS Morningstar expects the trend to be revised to Stable once traffic volume is meaningfully recovered and the debt service coverage ratio (DSCR) is sufficiently restored.

Passenger and vehicle volumes during the first two months of 2020 increased by approximately 5% and 3%, respectively, compared with the same period in 2019. However, after the World Health Organization declared the coronavirus a pandemic on March 11 and a series of containment measures by governments took effect, BC Ferries saw significant traffic volume drop in March, with the monthly passenger volume down 42% compared with last year. An even more severe impact was observed by the Company in April as stringent lockdown measures were imposed by the government during the second half of March. Passenger volume in April is estimated to have decreased by approximately 85% compared with April last year, with vehicle volume being somewhat less affected by the coronavirus.

Since the outbreak, BC Ferries has employed a series of mitigation measures to help protect passengers and staff, such as additional cleaning and disinfecting; allowing passengers on closed car decks; suspending baggage handling; closing food and retail services, including vending machines; requiring passengers to use an electronic form of payment; and screening all customers for coronavirus symptoms for any route longer than 30 minutes. The Company also decided to defer the annual tariff increase in light of the coronavirus and introduced a 1.5% fuel rebate on April 1, 2020.

The Province agreed to amend the Coastal Ferry Services Contract to allow BC Ferries to lower ferry capacity on major routes by approximately 50% without reducing Ferry Transportation Fees, which accounted for around 20% of the Company’s total revenues in F2019, providing valuable flexibility for the Company to manage its costs. Such agreement took effect on April 4, 2020, for a 60-day period and may be extended on a month-to-month basis by mutual agreement. Although BC Ferries does not expect to lay off regular employees, it has reduced the full salaries and benefits of regular employees who are not working to 75%. The Company has also decided to defer over 40% of capital expenditures in F2021.

Even though the pandemic curve seems to be flattening in the Province and businesses are reopening cautiously, the shadow of the coronavirus may linger, depending on how fast people begin to feel safe again sharing space in public transit, to what extent work-from-home culture has been cultivated during the lockdown, and to what extent jobs lost will be refilled after lockdown is lifted. DBRS Morningstar assumes that there will be some success in containment within Q2 2020, with limited recovery during Q2 2020, followed by a gradual relaxation of restrictions and economic recovery in Q3 2020, leading to a notable rise in traffic volume starting in Q3 2020. Based on these assumptions and the Company’s inputs, DBRS Morningstar forecasts that BC Ferries’ tariff, catering, and retail revenues in F2021 would be 40% below the F2019 level. Further assuming that the Province will continue providing relief through service-level adjustments during the rest of F2021, DBRS Morningstar forecasts the Company’s total revenues and EBITDA in F2021 to be approximately 31% and 74% lower than their F2019 levels, respectively.

BC Ferries’ speed of recovery from the Great Recession seemed to lag behind the average economy of the Province. Notwithstanding, the Company only saw modest decline in EBITDA during the Great Recession and was able to fully recover EBITDA within two years post-recession with higher tolls. The stability is mainly supported by the core customer base that is formed by the population living and working on Vancouver Island and in Greater Vancouver and surrounding areas. Based on the Company’s historical performance, DBRS Morningstar considers a full recovery of EBITDA during Performance Term (PT) 5 to be plausible, although a full volume recovery to the pre-crisis level may not occur until PT6 (starting from April 1, 2024). DBRS Morningstar assumes that annual traffic volume would gradually recover during the remainder of PT5 but remain approximately 6% below the pre-crisis level in F2024. DBRS Morningstar further assumes that BC Ferries will increase fares to the annual price caps and that the Province will continue providing service-level adjustments corresponding to the speed of demand recovery (together with the assumptions mentioned in the previous paragraph, the DBRS Morningstar Base Case).

The Company has no immediate refinancing needs, with no Senior Secured Bonds maturing until 2034. Under the DBRS Morningstar Base Case scenario, the annual DSCR in F2021 is forecast to fall slightly below 1.0 times (x). The Company expects to have sufficient unrestricted cash and short-term investments to cover all necessary operational and capital expenditures as well as all financial obligations during F2021, including the obligation triggered by a lower-than-1.50x DSCR to upsize debt service reserves to 12 months from six months. The Company also has a $155 million credit facility, which is currently undrawn, to provide additional liquidity. DBRS Morningstar understands that both the creditors of the $155 million credit facility and the creditors of the KfW loans (for the procurement of Salish Class vessels) have agreed to effectively waive the 1.25x DSCR covenant breach during F2021, which would otherwise trigger a draw stop and potentially a cross-default of the Senior Secured Bonds.

Under the DBRS Morningstar Base Case scenario, the annual DSCR is forecast to rise above 2.5x in F2022 (April 1, 2021, to March 31, 2022). However, the DBRS Morningstar Base Case could be revised, as the coronavirus pandemic continues to develop rapidly. DBRS Morningstar will monitor BC Ferries closely and will revisit its analysis if the underpinning assumptions for the DBRS Morningstar Base Case have become materially different.

DBRS Morningstar notes that there is material deviation from the methodology, “Rating Public-Private Partnerships,” as DBRS Morningstar used EBITDA instead of cash flow available for debt service to calculate DSCR.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

DBRS Morningstar notes that the above press release was amended on June 29, 2020, to add a sentence regarding material deviation. The amendment was minor and would not impact the understanding of the reader.

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

The principal methodology is Rating Public-Private Partnerships (August 23, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 [email protected].

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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