DBRS Morningstar Changes Trends on Northwestern Hydro Acquisition Co III LP to Negative from Stable, Confirms Ratings at A (low)

DBRS Limited (DBRS Morningstar) changed the trends on Northwestern Hydro Acquisition Co III LP’s (the Issuer) Issuer Rating, Senior Secured Bonds - Series 2038-1, and Senior Secured Bonds - Series 2038-2 to Negative from Stable and confirmed the ratings at A (low). The Issuer is a nontaxable limited partnership owned by Manulife Financial Corporation (rated A (high) with a Stable trend by DBRS Morningstar), Axium Infrastructure Canada II LP, and the Tahltan First Nation. The Issuer holds a 27.5% stake in Northwest Hydro LP, 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 Province of British Columbia is rated AA (high) with a Stable trend by DBRS Morningstar). ProjectCo has been selling electricity to British Columbia Hydro and Power Authority (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.

The Negative trends stem from (1) several years of debt service coverage ratios (DSCRs) below the level required of the current rating caused by consistently higher-than-budgeted costs due to one-time events as well as continuing operational issues that ProjectCo is currently addressing and (2) the likelihood that DSCRs will continue to underperform in the foreseeable future. DBRS Morningstar recognizes volatility of waterflows and generation as a significant factor that causes financial results in run-of-river hydro projects to fluctuate and initially did not view the unplanned costs from multiyear repair programs as structural in nature. However, DBRS Morningstar believes the relatively persistent occurrence of one-off operations incidents either causing lost generation or requiring unbudgeted expenditures increases the risk of similar incidents recurring in future years.

Continuing on a trend from 2019 and 2020, 2021 waterflows largely met or exceeded P-50 levels as the river system hydrology appeared to remain in an upswing cycle; however, generation and revenue was adversely affected by ice buildup events in winter, several flooding-related events in the summer high generation season, and a temporary shutdown of the transmission line carrying power out to the grid. Reduced generation due to these incidents have resulted in a productivity factor of 87%, representing a break in the previous trend of steadily improving productivity, with the impact of the June flooding events accounting for a significant portion of the shortfall.

Total operating expenses for the year were above rating-case forecasts by more than 30%, due in significant part to the cost of repairs for damage caused by the flooding, adding to various one-time expense items, elevated labour costs, and on-going multiyear expenditures required to address reinforcement requirements at the Forrest Kerr intake, and for regulatory monitoring. As a result, achieved DSCR was 1.35 times (x), which is below DBRS Morningstar’s forecast last year in the mid-1.40x range and well below the rating range expectation of 1.50x or above. Further, DBRS Morningstar estimates a projected DSCR of 1.40x for 2022 (assuming waterflows at long-term historic average), as on-going repair capital expenditures continue to weigh on project costs. Although on-going cost items are projected to eventually subside over the next few years, DBRS Morningstar notes that these costs will significantly pressure DSCRs in the foreseeable future below the rating range. In addition, DBRS Morningstar also notes the likelihood of elevated labour costs while ProjectCo takes steps to better manage resource scheduling to address overtime and improve incident response times as an additional risk factor that could affect DSCRs.

On this basis and the likely prospect of continued pressured DSCRs in the next few years, DBRS Morningstar has changed the trends to Negative while confirming the ratings at A (low). Going forward, DBRS Morningstar expects to closely monitor the costs of repair, which have already been budgeted, as well as the occurrence and nature of any additional operational issues. A negative rating action is likely if these activities run over the currently anticipated budget, if additional one-time operational issues are uncovered, or if the interest-only DSCR otherwise continues to materially underperform rating-case expectations.

ESG CONSIDERATIONS
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/373262.

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

The principal methodology is Rating Project Finance (August 18, 2021; https://www.dbrsmorningstar.com/research/383185), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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 did have 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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