DBRS Upgrades FortisBC Inc. to A (low)

DBRS has today upgraded the ratings of FortisBC Inc.’s (FortisBC or the Company) Secured Debentures and Unsecured Debentures to A (low) from BBB (high). The trends on both ratings are maintained at Stable. Rather than by one defining event, the upgrade is driven by a number of factors, including: 1) the Company is well through its large capital expenditure program, which has been ongoing for several years, and has demonstrated an ability to execute as planned; 2) FortisBC has maintained stable credit metrics over the past five years, despite the continued capital expenditure-driven free cash flow deficits; 3) a continued supportive regulatory environment; 4) the Company’s increased size and scale; and 5) strong parental support from Fortis Inc. over the years, as demonstrated by consistent equity injections to maintain FortisBC’s financial profile.

As FortisBC has successfully invested considerable capital (increasing total assets by approximately 65% since 2005) and continues to invest sums considerably in excess of cash flow levels, the Company’s credit metrics have nonetheless remained extremely resilient. This can be attributed largely to the fact that most expenditures have been concentrated in the distribution business, where invested capital generally enters rate base (and earnings begin) reasonably quickly. The primary focus of the capital program is for the expansion and improvement of FortisBC’s transmission and distribution systems in order to meet demand growth and achieve increased reliability. The elevated capital expenditures may approach $650 million (net of customer contributions) over the next five years, resulting in free cash flow deficits that will continue to be funded with a combination of incremental debt financing and equity support from parent company Fortis Inc. to maintain its capital structure at the regulatory-approved levels. Fortis Inc. has in the past regularly invested incremental equity in FortisBC as needed. DBRS notes that it has also resolved the Positive trend assigned to Fortis Inc.’s Unsecured Debentures and Preferred Shares, upgrading the ratings to A (low) and Pfd-2 (low), respectively, and changing its trends to Stable (see separate press release).

The regulatory environment remains stable and supportive, providing a strong cost-of-service/rate-of-return rate-setting methodology with some performance-based rate (PBR) setting attributes. The cost-of-service framework allows for full recovery of all forecast and prudently incurred power purchase costs, operating expenses and capital expenditures within a reasonable time frame. The British Columbia Utilities Commission (BCUC) approved a settlement agreement pertaining to the Company’s 2010 rates, which incorporated the expected increase in FortisBC’s return on equity (ROE) to 9.90%, up from 8.87% in 2009. The ROE increase stemmed from a positive 2009 decision which also determined that the automatic adjustment mechanism that was used to determine the ROE on an annual basis will no longer apply, and the ROE as determined will apply until changed by the BCUC. The Company’s deemed capital structure remains unchanged at 60% debt/40% equity. While the increase in ROE is positive, there does remain uncertainty as to when and how ROE levels will be adjusted in the future.

The capital expenditure program has resulted in the Company exhibiting growth that is considered strong for a regulated utility, with the rate base growing at approximately 10% per year over the past five years. The Company’s increased size, with total assets of approximately $1.2 billion, should provide it with improved economies of scale, operating efficiencies and access to capital. While DBRS had in the past viewed the FortisBC’s size as a negative factor, this is no longer a material issue given its now-larger presence.

DBRS expects key credit metrics to improve modestly over the coming years as a result of the recent favourable regulatory decisions, as capital assets are added to rate base, and as capital expenditures level off.

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

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas and Pipelines), which can be found on the DBRS website under Methodologies.