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

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Senior Secured Bonds, Series 2038-1 and Series 2038-2 (together, the Bonds) ratings of Northwestern Hydro Acquisition Co III LP (the Issuer) at A (low) with Stable trends. The Issuer is a non-taxable limited partnership owned by Manulife Financial Corporation (Manulife; rated “A” with a Stable trend by DBRS Morningstar), Axium Infrastructure Canada II LP (Axium; together with Manulife, the Sponsors), and the Tahltan First Nation. The Issuer holds a 27.5% stake in Northwest Hydro LP (NWHLP) 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.

Results for 2019 significantly improved following several years of underperforming hydrology, including an exceptionally challenging year in 2018. Generation levels reached 1,205 gigawatt hours (GWh), representing an increase of 20% from 2018 and 96% of the forecasted long-term average generation (LTAG) of 1,256 GWh. The improvement almost exclusively resulted from increased water flows, which returned to 93% of LTAG. Net productivity, a key measure of actual to achievable generation, also increased to 96%, continuing a trend of general improvement from 85% in 2015. ProjectCo continues to make progress on operating improvements and DBRS Morningstar views the steady increase as indicative of ProjectCo’s ability to operate and maintain the facilities effectively. Actual operating costs for 2019 and budgeted costs for 2020 also remain relatively in line with rating-case expectations. Project performance, however, remains primarily constrained by resource availability and volatility. DBRS Morningstar notes that, without the late-year spike in November 2019 that nearly doubled waterflows from normal levels, generation performance in 2019 would have tracked noticeably lower than actual results. On the other hand, the overall improving trend for the year suggests that the hydrological cycle could be nearing the end of its current downcycle.

Debt servicing on the Bonds relies on distributions upstreamed from ProjectCo. Despite the much improved water flows in 2019, the timing of the BC Hydro cash settlements resulted in a relatively weaker reported debt service coverage ratio (DSCR) of 1.27 times (x). On an accrual basis, however, the DSCR would have been 1.44x, which better reflects actual performance and is within the lower bounds of rating expectations. Given that the Project is only two months into the current year, the Issuer’s 2020 DSCR projection of 1.50x is based on base-case assumptions. Because the Issuer only holds a minority stake in ProjectCo, bondholders only have recourse to the equity interest in ProjectCo instead of direct security over the underlying assets and cash flow as in a more standard project structure. This weakness is largely mitigated by the Sponsors’ collective majority interest in NWHLP and by strong contractual protections in the security package.

DBRS Morningstar may take negative rating action if the interest-only DSCR continues to materially underperform compared with the rating case.

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

The principal methodologies are Rating Project Finance and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships, which can be found on dbrs.com under Methodologies & Criteria.

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 info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.

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