DBRS Limited (DBRS Morningstar) removed the Issuer Rating and the Senior Secured Bonds (the Bonds) rating of H2O Power Limited Partnership (H2O) and Watergen Canada Holdings Inc. (Watergen; together with H2O, the Issuers or Co-Borrowers) from Under Review with Negative Implications and confirmed the Issuer Rating and the Bonds ratings at A (low) with Stable trends.
The Issuers own and operate eight hydroelectric power generation facilities (the Facilities) with a total capacity of approximately 151 megawatts in Ontario and sell virtually all the electricity generated to the Independent Electricity System Operator (IESO) grid. At this time, DBRS Morningstar does not consider the current credit profile of IESO as constraining either the Issuer Rating or the Bonds rating. The Facilities have a 20-year contract (approximately 6.5 years remaining) for existing hydroelectric generation facilities with the IESO (the IESO Contract) through November 2029. The Facilities have been in operation since the early 1900s. The $460.05 million Bonds are partially amortizing during the term of the IESO Contract with a balloon repayment of 20% ($92.01 million) at bond maturity in November 2029.
The ratings remain supported by (1) the strength of the 20-year fixed-price IESO Contract with a highly rated offtaker, (2) a strong operating history and hydrology record, and (3) an experienced owner and operations team. The ratings are constrained by (1) hydrology risk, (2) refinancing risk, and (3) capital expenditure (capex) and operations and maintenance (O&M) risks.
On June 2, 2022, DBRS Morningstar placed the ratings Under Review with Negative Implications because of the potential for a breach of a financial covenant under the financing documents, considered an event of default (EOD), as there was a risk that the Issuer could fail to maintain a debt service coverage ratio (DSCR) of at least 1.0 times (x), which is calculated quarterly (in the periods ending February, May, August, and November) based on last 12 month (LTM) financial results, for the period ending May 31, 2022, and/or August 31, 2022, as well as possibly for the period ending November 30, 2022, or beyond. DBRS Morningstar notes that the lenders had provided an irrevocable waiver for the anticipated default for the periods ending May 31, 2022, and August 31, 2022. The potential for the anticipated default was due to a combination of (1) extremely low DSCRs in 2021 that were affecting 2022 DSCR levels as the DSCR calculations for period ending May 31, 2022, and/or August 31, 2022, are LTM based and (2) the capex incurred for planned replacement of two transformers, which is presently underway and will be completed by Q2 2023.
DBRS Morningstar notes that the project performance in 2022 turned out better than expected as hydrology and generation recovered from two low hydrology years in 2020 and 2021. The generation in 2022 was approximately 902 gigawatt hours (GWh), approximately 5% higher than the P50 forecast of 857.6 GWh, resulting in a DSCR for 2022 of 1.55x; excluding capex incurred in 2022 for transformer replacements (considered a one-time expense), the DSCR would have been approximately 1.76x. The project availability in 2022 was high at approximately 97.3%. The hydrology and generation remains healthy for Q1 2023. In 2023, the project is expected to have a high overall capex because of various planned activities including additional capex related to the transformer replacements causing the DSCR for 2023 to be in the 1.55x to 1.60x range; excluding capex related to the transformer replacements, the DSCR is expected be in the 1.60x to 1.65x range. DBRS Morningstar expects the long-term DSCR projection to remain around 1.65x, which is consistent with the assigned ratings. In addition, there is no change in DBRS Morningstar's assessment of the refinancing risk at this time.
DBRS Morningstar may take a positive rating action if the financial performance is materially better than projections on a consistent basis and the refinancing risk is mitigated. Further, a negative rating action could result from materially lower-than-expected financial performance on a consistent basis.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
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).
All figures are in Canadian dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodology:
Global Methodology for Rating Project Finance (September 6, 2022) https://www.dbrsmorningstar.com/research/402400
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.
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This is a solicited credit rating.
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