Morningstar DBRS Confirms Credit Ratings on PSS Generating Station LP at A (low) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the credit rating on the Series 1 Senior Secured Bonds (the Bonds) of PSS Generating Station LP (New Post Creek) (the Issuer) at A (low) with Stable trends. The Bonds were issued to partially finance the construction of the 28-megawatt (MW) hydroelectric run-of-river project on the Abitibi River and a seven-kilometre (km) transmission line (together, the Project or the Facility).

The $245 million Bonds are secured by the physical assets and material contracts of the Issuer. They have an interest-only (IO) feature for the first 10 years and start amortizing in October 2026, with a projected minimum debt service coverage ratio (DSCR) of 1.50 times (x). Furthermore, according to the Issuer's operating budget, the costs related to audit, financing, environmental monitoring, legal, and letter of credit are relatively modest and are not expected to have a material negative effect on the DSCR.

KEY CREDIT RATING CONSIDERATIONS
The Project reached its Commercial Operation Date (COD) on March 31, 2017, well ahead of the targeted February 2018 COD and within budget. Construction risk was covered by the unconditional and irrevocable guarantee from Ontario Power Generation Inc (OPG; rated A (low) with a Stable trend) that covers all obligations, liabilities, and indebtedness of the Issuer under the Bonds, and OPG's guarantee will only fall away immediately following the Recourse Release Date (RRD). Because the Issuer has yet to achieve all the requirements for recourse release, the OPG guarantee remains in place.

The Issuer continues to make progress and is getting closer to achieving recourse release. Furthermore, the Issuer confirmed it has executed the water-power lease agreement and is nearing completion of the transmission easement.

The Project's operating and financial performances in 2023 and H1 2024 have been in line with Morningstar DBRS' expectations. As the Project is still relatively new, outages during 2023 have largely been for planned maintenance. The availability of both turbine units in 2023 was well above the contractual threshold of 80%. In H1 2024, the availability of both turbine units remained above the contractual thresholds while completing additional maintenance. The Project's next biennial maintenance program for the turbine units will take place in H1 2025.

The Project's DSCR for the year ended December 31, 2023, was in line with Morningstar DBRS' expectations at 1.80x. Morningstar DBRS believes the DSCR should remain relatively stable in 2024-25 (assuming there are no unexpected major outages) before declining to below 1.70x in 2026 as the debt service payment is scheduled to gradually increase with the principal payment on the Bonds beginning in October 2026.

The credit ratings are limited by potential merchant risk and refinancing risk following the end of the Hydroelectric Energy Supply Agreement (HESA). If HESA is not renewed, the portion of the Bonds remaining unamortized is estimated to be approximately 20%. Morningstar DBRS sees refinancing risk mitigated by the asset's long life of approximately 90 years, as estimated by the independent engineer, and proper maintenance, as required by the Trust Indenture. Morningstar DBRS also believes the 20% remaining debt amount of approximately $49 million is modest and has a refinancing profile that would likely have investment-grade metrics.

CREDIT RATING DRIVERS
Morningstar DBRS believes a positive credit rating action on the Issuer is unlikely even if a positive credit rating action were taken on the current guarantor, OPG. This is because the OPG guarantee is expected to fall away shortly upon achieving recourse release. After the RRD, a positive credit rating action is still unlikely because (1) the Project's financial performance is unlikely to materially exceed Morningstar DBRS' expectations given its primarily fixed-revenue stream under the HESA with the Independent Electricity System Operator (IESO), and (2) the Project has exposure to refinancing risk. Conversely, a negative credit rating action may be taken if OPG's credit quality deteriorates materially before the RRD. After the RRD, Morningstar DBRS may take a negative credit rating action if the Project's DSCR is materially and persistently below 1.50x as a result of any unexpected major outages and/or materially higher-than-expected operating and major maintenance costs.

FINANCIAL OUTLOOK
Morningstar DBRS expects the DSCR to remain relatively stable at around 1.81x in 2024-25, underpinned by the HESA such that, irrespective of any production variation, the Issuer will continue to receive fixed revenue from the IESO. The Issuer is projected to maintain a minimum DSCR of around 1.50x after 2025 once the Bonds start to amortize.

CREDIT RATING RATIONALE
The credit rating strength of the Issuer is underpinned by (1) the long-term energy contract (HESA) with the high credit-quality IESO; (2) the favourable contractual framework of the HESA, which insulates the Project from hydrological volatility or power price risk; (3) the full guarantee from OPG until the RRD; and (4) OPG as an experienced owner and operator. The challenges include (1) refinancing risk, albeit in the remote future, with potential for merchant exposure; and (2) exposure to long-term operating and major maintenance risks.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant 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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

RATING DRIVERS AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of Rating Drivers
In the analysis of the Issuer, the Rating Drivers listed in the principal methodology "Global Methodology for Rating Project Finance" are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of the Issuer, the following FRA factor listed in the principal methodology "Global Methodology for Rating Project Finance" is considered more important: DSCR (the sole FRA factor).

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

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

Morningstar DBRS applied the following principal methodologies:
-- Global Methodology for Rating Project Finance (April 15, 2024),https://dbrs.morningstar.com/research/431188
-- Morningstar DBRS Global Corporate Criteria (April 15, 2024),https://dbrs.morningstar.com/research/431186

The following methodology has also been applied:

Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024),
https://dbrs.morningstar.com/research/437781

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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