Morningstar DBRS Confirms Northwestern Hydro Acquisition Co Inc.'s Credit Ratings at BBB, Changes Trends to Stable

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating of Northwestern Hydro Acquisition Co Inc. (the Issuer) and the credit rating of its $650 million Senior Secured Bonds at BBB. All trends changed to Stable from Negative. The trend change is supported by the improvements in cost control in 2024 and expected better coverage ratios in 2025 and beyond.

The Issuer is a special-purpose vehicle owned by Axium Infrastructure Inc. (Axium) and Manulife, the Project Sponsors, which own 35% of Coast Mountain Hydro Limited (CMH or ProjectCo), the operating company that holds three run-of-river hydro generating facilities in northwestern British Columbia. The Project Sponsors hold a total of 85% in the operating company, collectively through their ownership in Northwestern Hydro Acquisition Co II LP and Northwestern Hydro Acquisition Co III LP, each with a 27.5% ownership stake in the operating company.

KEY CREDIT RATING CONSIDERATIONS
In 2022 and early 2023, the Project Sponsors engaged in a reset of the operating budget, structurally increasing their baseline operating cost estimate by almost $10 million annually for the next five years and identifying a clear program of capital expenditures (capex) and other repairs and maintenance to address ongoing issues. As a result of the baseline cost reset and the continued underperformance, Morningstar DBRS downgraded the Issuer's credit ratings twice in 2023 and 2024 to BBB from A (low) while maintaining a Negative trend. At the time of the downgrades, Morningstar DBRS noted that demonstrated ability to maintain the revised budget would be a key factor in rating stability.

In 2024, the generation was 1.4% lower than the rating case, mainly driven by the lower-than-P50 hydrology level, frazil ice, and sediment management issues that occurred in Q1 and Q4 2024. However, with no major operational issues occurring, operations and maintenance (O&M) costs and capex were well controlled by ProjectCo, aligned with its 2024 budget. On an accrual basis, the resultant 2024 debt service coverage ratio (DSCR) was 1.30 times (x) after netting out the effect of the credit facility repayment, which is also in line with the Morningstar DBRS forecast.

With more certainty in the ancillary revenues from an agreement with a mining company to build a direct interconnection line in 2025 and beyond, and the improvements in cost control to follow the revised budget, Morningstar DBRS changed the trends to Stable from Negative. Morningstar DBRS expects coverage ratios to gradually rise back to the originally forecast 1.50x range over several years. Morningstar DBRS will continue to closely monitor the ProjectCo's O&M costs and capex to assess whether it can consistently adhere to the budget.

CREDIT RATING DRIVERS
A negative rating action may be triggered by continued cost overruns in the budgeted O&M costs and capex, and material and sustained deterioration of the coverage ratios. A positive rating action may be triggered by sustained, multi-year demonstration of adherence to budgeted costs and improved coverage ratios being consistent with (or better than) the Morningstar DBRS rating case.

FINANCIAL OUTLOOK
Morningstar DBRS' rating case projection shows a forward minimum DSCR of 1.34x in 2025, rising to 1.50x by 2026. However, this projection is based on a P-50 hydrology level, and a downswing in the hydrology cycle or material cost overruns could lead to a lower achieved DSCR.

CREDIT RATING RATIONALE
The credit ratings are supported by strengths that include (1) 60-year fixed price Electricity Purchase Agreements (EPAs), fully indexed to British Columbia inflation, with highly rated BC Hydro; (2) New assets with a long remaining asset life and proven technology; and (3) Favourable debt package for bondholders. The challenges include (1) O&M cost and capex uncertainty; (2) Hydrology and energy production uncertainty inherent in a run-of-river project; (3) Potential for dilution of ownership stake from exercise options granted to the Tahltan Central Council (TCC); and (4) Refinancing risk.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or 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) https://dbrs.morningstar.com/research/437781

RATING DRIVER 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" was 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 methodology:

Global Methodology for Rating Project Finance (December 10, 2024)
https://dbrs.morningstar.com/research/444393

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (February 3, 2025; https://dbrs.morningstar.com/research/447186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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