DBRS Morningstar Downgrades Hydro Ottawa Holding Inc. to A (low), Changes Trend to Stable

DBRS Limited (DBRS Morningstar) downgraded the Issuer rating and Senior Unsecured Debt rating of Hydro Ottawa Holding Inc. (Hydro Ottawa or the Company) to A (low) from “A.” Concurrently, DBRS Morningstar also changed the trends to Stable from Negative. The downgrades reflect the significantly higher EBIT proportion that Hydro Ottawa’s growing non-regulated generation business contributes to the Company’s results following the completion of the 12-megawatt (MW) Chaudière Falls North LP Refurbishment in February 2020, and the anticipated growth of this segment to account for approximately 35% of EBIT once the refurbishment of the 27 MW Hull Energy LP facilities (Hull Energy Refurbishment) is completed. DBRS Morningstar considers the non-regulated business to be higher risk than Hydro Ottawa’s regulated distribution business, and views the substantially increased earnings proportion from this segment to be a material and permanent shift in the business mix and risk profile of the Company. In 2019, DBRS Morningstar changed the trends to Negative in anticipation of a likely downgrade. As non-regulated EBIT has been exceeding 20%, DBRS Morningstar also includes the “Rating Companies in the Independent Power Producer Industry” methodology in its assessment of Hydro Ottawa.

Despite the growing importance of its generation business, Hydro Ottawa’s business risk profile continues to benefit from its stable regulated electricity distribution operations in the City of Ottawa (100% owner of Hydro Ottawa). This stable and essential nature of the business underpinned Hydro Ottawa’s relative resilience to the effects of the Coronavirus Disease (COVID-19) pandemic in the first half of 2020, the largest effects of which to date have been an increase in payment arrears at the height of the pandemic lockdown and a moderate delay of several months in the Hull Energy Refurbishment, originally scheduled for completion by the end of 2020. DBRS Morningstar notes that the amount in arrears has begun to decrease with the easing of lockdown measures and expects deferral accounts approved by the Ontario Energy Board to accrue costs or lost revenues related to the pandemic will provide further mitigation. This stability is partly offset by the Company’s growing portfolio of non-regulated electricity generation assets. While these are largely supported by long-term contracts with the Independent Electricity System Operator (rated A (high) with a Stable trend by DBRS Morningstar), this business segment does involve higher volume and operational risk, leading to more volatile earnings and cash flows.

Hydro Ottawa’s financial risk profile weakened beginning in 2018 because of a large capital expenditure program for maintaining distribution infrastructure, connecting new customers, and the Refurbishments. DBRS Morningstar notes that the Company issued $290.5 million of project-level debt in July 2019 through a financing vehicle to finance the Refurbishments. Pursuant to the terms of this debt, $67 million is due to become non-recourse to the Company later in 2020 following the completion of Chaudière Falls North, while the remaining $223 million is anticipated to become non-recourse in 2021 after completion of Hull Energy Refurbishment. DBRS Morningstar expects the Company’s key credit metrics to strengthen as distributions from the Refurbishments will then accrue to the Company and the $290 million of debt will be taken off the balance sheet. However, should the Company’s key credit metrics deteriorate to a level no longer commensurate with the current rating category, considering the mix of the regulated and non-regulated businesses, further negative rating actions may occur.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (September 16, 2019), Rating Companies in the Independent Power Producers Industry (May 19, 2020) and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.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@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.

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

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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