Morningstar DBRS Confirms Credit Ratings on H2O Power Limited Partnership and Watergen Canada Holdings Inc. at A (low) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the Senior Secured Bonds (the Bonds) rating of H2O Power Limited Partnership (H2O) and Watergen Canada Holdings Inc. (Watergen; together with H2O, the Issuers or Co-Borrowers) at A (low) with Stable trends. The Issuers own and operate eight hydroelectric power generation facilities (the Facilities) with a total capacity of approximately 151 megawatts in Ontario. Morningstar DBRS notes that the financial performance was below projections in 2023 largely because of unfavourable hydrology; however, the credit ratings confirmations reflect expectations that the financial performance should improve in 2024 and generally be in line with initial projections for the foreseeable future.

KEY CREDIT RATING CONSIDERATIONS
Morningstar DBRS notes that the project performance in 2023 was below projections largely because of poor hydrology. The generation in 2023 was 795 GWh, approximately 7% lower than the long-term average generation (LTAG) forecast of 857.6 GWh resulting in a debt service coverage ratio (DSCR) of 1.43 times (x) versus an expected DSCR of around 1.57x. Besides lower generation in 2023, the project had a high overall capex of approximately $6.8 million because of various planned activities including some one-time expense related to the transformer replacements causing the DSCR to be lower. The project availability in 2023 was high at approximately 99.2%. Further, there is no change in Morningstar DBRS' assessment of the refinancing risk, which does not constrain the credit ratings at this time. Based on discussions with the Issuer, the hydrology and generation are expected to recover in 2024 as forecasts do not currently depict a drought re-occurring in 2024 summer; however, overall, the generation is still expected to be slightly lower than LTAG. The credit rating confirmations reflect expectations that the financial performance should improve and be close to initial projections in 2024 and beyond. Morningstar DBRS notes that, in July 2023, an unexpected partial breach on Twin Falls generating station's East Wingwall occurred, which was materially repaired prior to the end of the year. Based on information provided by the Issuer, business interruption and capital costs incurred are recoverable through insurance.

CREDIT RATING DRIVERS
Morningstar DBRS may take a positive credit rating action if the financial performance is materially better than projections on a consistent basis and the refinancing risk is largely mitigated. Further, a negative credit rating action could result from materially lower-than-expected financial performance on a consistent basis and/or an increase in refinancing risk.

FINANCIAL OUTLOOK
In 2024, the financial performance is expected to improve as generation is projected to be closer to the LTAG. In 2024, the DSCR is expected to be in the 1.55x to 1.60x range. The DSCRs are projected to be around or above 1.60x beyond 2024.

CREDIT RATING RATIONALE
The credit ratings remain supported by (1) the strength of the 20-year fixed-price IESO Contract with a highly rated offtaker, (2) a strong operating history and hydrology record, and (3) an experienced owner and operations team. The credit ratings are constrained by (1) hydrology risk, (2) refinancing risk, and (3) capital expenditure (capex) and operations and maintenance risks.

The Facilities sell virtually all the electricity generated to the Independent Electricity System Operator (IESO) grid. At this time, Morningstar DBRS does not consider the current credit profile of IESO as constraining either the Issuer Rating or the Bonds rating. The Facilities have a 20-year contract (approximately 5.5 years remaining) for existing hydroelectric generation facilities with the IESO (the IESO Contract) through November 2029. The Facilities have been in operation since the early 1900s. The $460.05 million (initial debt amount) Bonds are partially amortizing during the term of the IESO Contract with a balloon repayment of 20% ($92.01 million) at bond maturity in November 2029.

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 Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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 H2O Power Limited Partnership and Watergen Canada Holdings Inc., the Rating Driver factors listed in the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
-- In the analysis of H2O Power Limited Partnership and Watergen Canada Holdings Inc, the following FRA factor listed in the methodology is considered more important: DSCR (this is the only applicable factor).

(C) Weighting of the Rating Drivers and the FRA
-- In the analysis of H2O Power Limited Partnership and Watergen Canada Holdings Inc, the FRA carries greater weight than the Rating Driver Factors.

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Project Finance (15 April 2024)
https://dbrs.morningstar.com/research/431188/global-methodology-for-rating-project-finance

Morningstar DBRS credit ratings may use of one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

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/431153.

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@morningstar.com.

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 info-DBRS@morningstar.com.

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