DBRS Morningstar Confirms Northwestern Hydro Acquisition Co III LP at A (low), Stable

DBRS Limited (DBRS Morningstar) confirmed Northwestern Hydro Acquisition Co III LP’s (the Issuer) Issuer Rating; Senior Secured Bonds - Series 2038-1; and Senior Secured Bonds - Series 2038-2 at A (low) with Stable trends. The Issuer is a nontaxable limited partnership owned by Manulife Financial Corporation (Manulife; rated A (high) with a Stable trend by DBRS Morningstar), Axium Infrastructure Canada II LP (together with Manulife, the Sponsors), and the Tahltan First Nation. The Issuer holds a 27.5% stake in Northwest Hydro LP, which, in turn, owns Coast Mountain Hydro Limited Partnership (CMHLP or ProjectCo). CMHLP is a special-purpose vehicle that owns and operates three run-of-river hydro facilities in northwest British Columbia (the Project). ProjectCo has been selling electricity to British Columbia Hydro and Power Authority (BC Hydro; rated AA (high) with a Stable trend by DBRS Morningstar) under three separate 60-year Energy Purchase Agreements (EPAs) since 2014. The EPAs feature fixed-energy pricing, which is indexed to British Columbia’s consumer price index for the entire contract term.

Actual results for 2020 were adversely and significantly affected by BC Hydro's invocation of provisions in the contract curtailing production due to the Coronavirus Disease (COVID-19) pandemic and its impact on electricity demand in the Province of British Columbia. Despite significantly improving waterflows, which reached more than 100% of the 60-year long-term average (as measured at Water Services Canada’s reference gauge 60 kilometers from the site), BC Hydro's curtailment of non-firm energy purchases over a period of high generation in spring and early summer resulted in significantly pressured debt service coverage ratio (DSCR) of 1.20 times (x). However, DBRS Morningstar does estimate that without the impact of the curtailment, the Project would have achieved an actual DSCR in the low 1.40x range, more accurately reflecting actual hydrology performance and within the range of the current project rating. In its public statements, BC Hydro has stated high power generation by independent power producers over the early periods of the coronavirus pandemic as one specific reason for the curtailment, and DBRS Morningstar will continue to monitor industry developments in the wake of this action for any implications on the Issuer.

Curtailment impact aside, DBRS Morningstar generally views the performance of the Project positively. Hydrology appears to be on an upcycle swing following several years of underperformance, including an exceptionally challenging year in 2018 when waterflows recorded an almost 60-year low. Net productivity, adjusted for the curtailment, was 96%, continuing an overall trend of general improvement since 2015. DBRS Morningstar views this improving trend as supportive of the Project’s ability to operate effectively.

However, operating costs for 2020 were above rating case forecasts by almost 20%. DBRS Morningstar does note that a portion of this cost increase is related to one-time items, notably transition and set-up costs associated with the Sponsors assuming operating and maintenance (O&M) responsibilities following AltaGas Ltd.'s (AltaGas; rated BBB (low) with a Stable trend by DBRS Morningstar) decision in May 2020 not to continue acting as O&M contractor. The transition is not viewed as having a negative impact on the Project, particularly as the same personnel team currently managing the operations has been fully transferred from AltaGas to the new structure. DBRS Morningstar also views the Sponsors' engagement of an outside advisor to project operations positively and believes that O&M transition and integration work is now largely complete.

Other items contributing to cost overruns include unplanned regulatory approval-related costs, as well as minor efficiency improvement projects and some unplanned maintenance and repairs. However, repairs and other work associated with addressing the issues uncovered by the broken steel plate that arose in 2019 may be problematic over the short term as maintenance windows and cost overruns above initial projections of several million dollars annually are expected over the next several years to properly address the issue. Although DBRS Morningstar ultimately does not view these repairs as structural in nature, the expected cost overruns do have the potential to pressure coverage ratios below that expected for the rating level over a period of several years as a result.

DBRS Morningstar estimates a projected DSCR for 2021 in the mid-1.40x range, due largely to the aforementioned cost overruns and taking into account the impact of the five-year Firm Energy Reset. This compares to an Issuer-budgeted DSCR of 1.68x for the same period due to differences in assumptions of revenue generation and recovery. DBRS Morningstar will closely monitor the progress of the maintenance and repair work and may take a negative rating action if these activities run over the currently anticipated budget, if additional issues are uncovered, or if the interest-only DSCR otherwise continues to materially underperforms rating case expectations.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is Rating Project Finance (September 1, 2020; https://www.dbrsmorningstar.com/research/366229), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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 did have 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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