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

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating as well as the Series A Bonds and Series B Bonds (together, the Bonds) ratings of MPT Finco Inc. (the Issuer) at BBB with Stable trends. The rating confirmations reflect the Issuer’s financial resiliency and flexibility in dealing with poor hydrology and heavy capital spending in 2021. The confirmations also consider the significant improvement in hydrology for the first half of 2022. The Stable trends are supported by the expected further improvement of financial ratios in 2023, assuming that the hydrology and the capital spending return to historical norms.

The 10-year fixed-rate Bonds of approximately $628 million ($573 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 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.

In 2021, the MPT Portfolio only generated 65% of the forecast long-term average generation (LTAG), which was on par with the forecast P90 (see Notes) generation level. For the last 12 months (LTM) ended June 30, 2022, energy generation improved to 83% of the LTAG, which was roughly at the estimated P75 generation level. In 2021, DBRS Morningstar’s adjusted debt service coverage ratio (DSCR) of 1.09 times (x; normalized for expansionary capital expenditure (capex)) was quite weak, compared with the rating case projection of 1.80x. The weak DSCR was mainly driven by lower-than-expected hydrology despite well-controlled operations and maintenance (O&M) cost. For the LTM 2022, the adjusted DSCR improved to 1.48x following the improved hydrology. Although the MPT Portfolio, similar to other hydro plants in Ontario, recorded poor hydrology in 2021, it has since improved significantly in 2022. DBRS Morningstar believes that this level of generation volatility is still within MPT Assets’ historical band. DBRS Morningstar notes that capex was quite heavy in 2021 and 2022, representing 200% and 300% of the normalized annual capex level of approximately $10 million, estimated by the independent engineer (IE). For the past two years, the Sponsor (defined in the following paragraph) has been undertaking major upgrades to Red Rock Unit 1 and Unit 2 to increase capacity. The Red Rock Unit 1 upgrade is expected to be completed in May 2023 and capex will start to level off in 2023 and beyond. Based on the historical capital spending pattern and the IE’s opinion, DBRS Morningstar believes that the heightened capex levels in 2021 and 2022 are not indicative of future spending levels because a significant portion of the spending is related to capacity upgrade. For 2021, capex was funded by a combination of operating cash flow and equity injection. For the LTM 2022, 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 capex funding shortfall. There has been no covenant breach despite the stressed cash flow for the past 18 months.

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; rated BBB (high) with a Stable trend by DBRS Morningstar). Although unrated, DBRS Morningstar’s Internal Assessment indicates that BBCC’s current credit quality constrains the ratings to the BBB category. Based on the LTAG, the forecast minimum DSCR of 1.68x is consistent with that of the contracted hydro projects in DBRS Morningstar’s “A” rating category, without considering 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, DBRS Morningstar believes that future recontracting uncertainty with potential merchant exposure increases the refinancing risk. DBRS Morningstar’s 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 the BBB range, according to DBRS Morningstar’s “Global Methodology for Rating Project Finance.”. DBRS Morningstar notes that the spot and forward merchant power prices in the relevant markets have spiked in the past 12 months or so, driven by the increased natural gas prices. Despite the positive movement of short-term merchant power prices, DBRS Morningstar 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 have changed in favour of power producers. DBRS Morningstar 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.

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 offtaker’s credit quality—which can be volatile, (2) refinancing risk, (3) relatively high interannual hydrological variability, and (4) future 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 (see Notes) are subject to customary Separateness Covenants in the Trust Indenture. DBRS Morningstar 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. DBRS Morningstar notes that it did not receive a substantive nonconsolidation legal opinion for this transaction.

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: sustained high capex levels beyond the initial forecast to stress credit metrics, 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.

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

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

PXX means exceedance probabilities. A P50-P90-P99 value describes the estimated minimum electricity generation with a probability of 50%, 90%, or 99% in any given year (P50, one-year P90, and one-year P99).

Project Entity means (1) prior to the Second Closing Date, each of MPT, Mississagi Property Inc. (MPI), Mississagi Power Trust Holdings LP, and Mississagi Power Trust Holdings Inc. and (2) from and after the Second Closing Date, each of MPT and MPI.

The principal methodology applicable to the rating is the Global Methodology for Rating Project Finance (September 6, 2022; https://www.dbrsmorningstar.com/research/402400). The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.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 info@dbrsmorningstar.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.

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

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577