Morningstar DBRS Confirms MPT Finco Inc.’s Ratings at BBB With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating as well as the ratings on the Series A Bonds and Series B Bonds (together, the Bonds) of MPT Finco Inc. (the Issuer) at BBB with Stable trends. The 10-year fixed-rate Bonds of approximately $628 million ($548 million outstanding) are used to finance the operations of four cascading operational hydro-generating facilities owned by Mississagi Power Trust (MPT) with a total capacity of 488 megawatts (MW) on the Mississagi River in Northern Ontario (the MPT Portfolio or MPT Assets). Both tranches of Bonds rank pari passu and partially amortize on a pro rata basis to mature on November 30, 2029, with an aggregate balloon amount of $350 million, subject to refinancing.

KEY CREDIT RATING CONSIDERATIONS
The rating confirmations reflect the MPT Portfolio’s improved hydrology and the Issuer’s resilient financial performance notwithstanding the heightened capital spending levels over the past 24 months. The Stable trends are supported by the expected further improvement of financial ratios in 2024 and beyond, assuming that the hydrology and the capital spending levels return to historical average.

In 2022, energy generation improved significantly from the very poor hydrology encountered in 2021, notwithstanding that availability was adversely affected by the outage because of the Red Rock overhaul project. The MPT Portfolio generated energy at 92% of the forecast long-term average generation (LTAG) in 2022. Adjusting for generation loss from the outage, generation level would exceed the LTAG by 7%. For the last 12 months ended September 30, 2023 (LTM 2023), energy generation was at 91% of the LTAG despite continuing outage as the Red Rock overhaul project continued. The operations and maintenance (O&M) cost were well controlled during the review period. The resultant adjusted debt service coverage ratio (DSCR) of 1.63 times (x; normalized for expansionary capital expenditure (capex)) in 2022 significantly improved from the 2021 level. For the LTM 2023, the adjusted DSCR of 1.42x was adversely affected by the heavy capex despite lower-than-expected O&M cost. Morningstar DBRS notes that capex remained elevated due to major upgrades to Red Rock Unit 1 and Unit 2 to increase capacity, which is expected to be completed by January 2024. Because of the construction delay by the contractor, MPT expects to claim Liquidated Damages (LDs) payment in 2024. Management indicates that capital spending levels will begin to normalize in 2024. For 2022 and LTM 2023, capex was funded by a combination of operating cash flow and equity injection. For LTM 2023, the improved operating cash flow was largely sufficient to fund the capex after debt service. The forward-looking capex reserves remain undrawn as the Sponsor has indicated and proved that it has the willingness and capacity to inject equity to bridge any potential capex funding shortfall. There was no covenant breach despite the stressed cash flow in 2021 because of poor hydrology.

CREDIT RATING DRIVERS
A rating upgrade is unlikely in the near term unless satisfactory recontracting of the MPT Assets occurs well before the refinancing date. A negative rating action may be triggered by any of the following: a material deterioration of the PPA offtaker’s credit quality to constrain the ratings further, a material and sustained deterioration of credit metrics and/or asset quality, or heightened refinancing risk toward debt maturity.

FINANCIAL OUTLOOK
On and after March 1, 2021, MPT Portfolio’s cash flow was supported by one power purchase agreement (PPA): the Mississagi Energy Revenue Support Agreement (MERSA) with the effective offtaker being Brookfield BRP Canada Corp. (BBCC), an entity affiliated with Brookfield Renewable Partners L.P. (the Sponsor or BEP; rated BBB (high) with a Stable trend by Morningstar DBRS). Although unrated, Morningstar DBRS’ assessment indicates that BBCC’s credit quality does not constrain the Issuer’s current rating. Based on the LTAG, the forecast minimum DSCR of 1.71x is consistent with that of the contracted hydro projects in Morningstar DBRS’ “A” rating category, without the consideration other factors. However, the ratings are further constrained by the refinancing risk. The MPT Portfolio appears to be well positioned for recontracting with the Independent Electricity System (IESO) at debt maturity because of its significant storage capacity as an emissions-free peaker, which is of great importance to Northern Ontario’s grid stability. Nonetheless, Morningstar DBRS believes that future recontracting uncertainty with potential merchant exposure increases the refinancing risk. Morningstar DBRS’ base refinancing case conservatively assumes a non-PPA renewal scenario. Under such a scenario, the base-case project loan coverage ratios (PLCRs) of 2.0x to 2.6x at P90 to P50 generation levels, respectively, still indicate ample cash flow to support a successful refinancing; however, this level of PLCR constrains the ratings to BBB, according to Morningstar DBRS’ “Global Methodology for Rating Project Finance.” Morningstar DBRS notes that the spot and forward merchant power prices in the relevant markets spiked in 2021–22 but declined significantly over the past 12 months, driven by the volatility of the natural gas prices. Despite the significant movement of short-term merchant power prices, Morningstar DBRS has made no major adjustment to the key price assumption in PLCR calculation. It remains to be seen whether the long-term fundamentals of electricity supply-demand will change over the next few years. Morningstar DBRS does not assign ratings beyond the term of the Bonds but assesses the probability of a successful refinancing based on the MPT Assets’ remaining economic value at the refinancing point.

CREDIT RATING RATIONALE
The MPT Portfolio’s strengths include (1) fully contracted cash flow with a creditworthy offtaker, (2) a unique peaking hydro portfolio that is important to Northern Ontario’s grid stability, (3) high-quality assets with a reliable operating history, and (4) a highly experienced owner/operator with robust credit quality. The challenges include (1) constraint of the direct offtaker BBCC’s credit quality, which can be potentially volatile, (2) refinancing risk, (3) relatively high interannual hydrological variability, and (4) capex risk. The Bonds are structured as a project finance transaction with standard features, including a cash flow waterfall subject to blocked accounts. The key reserve accounts include a six-month debt service reserve account and a forward-looking capex reserve account to be funded by cash or nonrecourse letters of credit. The equity distribution lockup test is set at a minimum DSCR of 1.20x. The Issuer and each Project Entity are subject to customary Separateness Covenants in the Trust Indenture. Morningstar DBRS relied solely on the separateness features applicable to the Issuer and each Project Entity to take comfort that such parties will remain legally and operationally separate and apart from the Sponsor and any of the Sponsor’s affiliates. Morningstar DBRS notes that it did not receive a substantive nonconsolidation legal opinion for this transaction.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

RATING DRIVER AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of Rating Driver Factors
In the analysis of the Issuer, the Rating Driver factors listed in the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of the Issuer, the following FRA factor was considered more important: PLCR.

(C) Weighting of the Rating Driver and the FRA
In the analysis of the Issuer, the FRA carries greater weight than the Rating Driver.

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Project Finance (September 12, 2023)
https://dbrs.morningstar.com/research/420425/global-methodology-for-rating-project-finance

The following methodology has also been applied:

Global Criteria: Guarantees and Other Forms of Support (March 28, 2023)
https://dbrs.morningstar.com/research/411694/dbrs-morningstar-global-criteria:-guarantees-and-other-forms-of-support

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at [email protected].

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