DBRS Confirms Arrow Lakes Power Corporation Series B Bonds at A (high), Stable Trend

DBRS has today confirmed the rating of the Series B Bonds of Arrow Lakes Power Corporation (ALPC or the Company) at A (high) with a Stable trend. The Series B Bonds -- a $350 million, 30-year, fully-amortizing private placement -- prepaid the Series A Bonds in May 2011. ALPC benefits from contracted prices under the 1998 Electricity Purchase Agreement (1998 EPA) with British Columbia Hydro & Power Authority (BC Hydro, rated AA (high) with a Stable trend) of $46/megawatt hour (MWh) in 2011 increasing by 3% per annum (p.a.) through 2015. The Company has entered into a higher-paying successor EPA (the 2010 EPA) commencing January 1, 2016, at improved contract prices (starting at $84/MWh in 2016 adjusted by half the change in the consumer price index (CPI) from January 1, 2010, and adjusted annually at half the annual change in CPI thereafter). Net proceeds after the Series A Bonds were prepaid (and after funding of a project liquidity reserve and debt service reserve) were distributed to the ALPC shareholders (approximately $262 million) to finance the construction of the nearby Waneta hydro project.

ALPC had a net loss of $389,000 for the nine months ending December 31, 2011, versus a forecast net income of $3.7 million. This was due mainly to the timing of the Series A Bonds prepayment expense of $2.8 million, which was incurred in the current fiscal year ending March 31, 2012, instead of the previous fiscal year as originally forecast. An unplanned outage to replace a trunnion seal increased costs by just under $0.5 million. No other maintenance issues were identified, and the earnings underperformance in 2011 is not expected to affect future performance.

The Series B Bonds and distribution of net proceeds significantly increased ALPC leverage. However, the rating continues to be supported by the AA (high) counterparty risk of BC Hydro and the EPA contractual transfer of hydrology and market risk to BC Hydro. Higher leverage reduces the base-case debt service coverage ratio (DSCR) to a minimum of 1.18 times (x) during the remaining life of the 1998 EPA when the Series B Bonds are interest-only.

During that same period, there are two reserves -- a funded liquidity reserve raising base-case DSCR to 1.5x (in each year) and a funded six-month debt service reserve that would raise the base-case DSCR from 1.5x to 2.0x (in a single year). Under the 2010 EPA, the base-case DSCR is generally above 2.0x for the remaining 25-year life (except for a couple of higher maintenance capex years).

The rating is constrained by the single-asset nature of ALPC, its operating risk, and increased leverage due to the Series B Bonds. An unplanned, prolonged outage is the primary credit risk. However, DBRS notes that the Company was able to cope with the outage related to repair of the approach channel from 2004 to 2006 and generated adequate cash flow for debt service, including principal repayments. Insurance payments covered about 80% of the costs associated with both lost revenues and the expenses of repair and replacement, the difference representing about $10 million in asset improvements. Under both EPAs, the outage risk is managed by reserves, proven insurance protection and by the financial capability and liquidity of its provincially owned shareholders and their continued interest in the policy and financial returns of the project.

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

The applicable methodology is Rating Project Finance, which can be found on our website under Methodologies.