DBRS Confirms Enbridge Income Fund at BBB (high), Stable

DBRS has today confirmed the rating of the Senior Unsecured Long-Term Notes of Enbridge Income Fund (EIF or the Fund) at BBB (high) with a Stable trend. The rating confirmation reflects EIF’s consistent operating performance and fairly stable credit profile. In addition, EIF intends to focus on steadily growing its business and maintaining its credit metrics in line with the credit rating, following a restructuring plan (Restructuring) expected to be implemented on December 15, 2010, in response to the pending taxation of income trusts in 2011. Balance sheet leverage will likely rise over the Bakken expansion period to 2013, partly mitigated by incremental cash flow from the Saskatchewan expansions outlined below. DBRS expects EIF to balance its growth prospects with prudent financing discipline going forward. EIF benefits from long-lived assets with low sustaining capex and strong contractual arrangements, primarily through its 50% interest in Alliance Pipeline Limited Partnership (Alliance Canada; rated A (low), see separate report), the Canadian portion of the Alliance pipeline system (Alliance). This segment has represented the bulk of EIF’s earnings and cash flow (71%/62% of 9M 2010 earnings/distributable cash flow). While uncertainties exist during the contract renewal period to December 1, 2010, the pipeline’s economic value extends beyond the contract term due to its competitive tolls to ship rich natural gas (gas plus liquids in one pipeline) to Chicago.

Full re-contracting is not required for Alliance to meet its debt obligations. The Saskatchewan System (26%/24%), the growth driver in the near to medium term, and the smallish non-regulated power operations (3%/5%) supported by contractual arrangements also provide diversification.

The Restructuring entails establishing a new taxable corporate holding company, Enbridge Income Fund Holdings Inc. (EIFH), for the purpose of holding all the public interest (28% economic interest) and a portion of Enbridge Inc.’s interest (Enbridge – total 72%) in the Fund. All publicly held trust units (Units) and a portion of the Units held by Enbridge will be exchanged for shares in EIFH on Restructuring, and preferred units (Preferreds), currently all held by Enbridge, will have exchange rights for the Units, both on a one-for-one basis. However, the Fund’s redemption option on the Preferreds will be terminated. It will remain a non-taxable entity. The Restructuring will have no impact on the current rating. Enbridge, the sponsor for the Fund, currently has a 42% direct ownership interest and 72% economic interest, including the Preferreds.

The Saskatchewan System through its Westspur expansion in 2008 and the current $140 million expansion (Saskatchewan Expansion – $84 million spent to September 30, 2010) expected to be operational in December 2010 should raise its earnings and cash flow contribution versus that of Alliance. This would somewhat weaken EIF’s business risk profile, although the impact would be partly mitigated by the higher tolls on a cost-of-service basis on project completion, which should ensure recovery of the capital investments within a reasonable time period. Medium-term growth is driven by the Bakken Expansion, a joint project with its affiliate, Enbridge Energy Partners L.P. (EEP), to take advantage of the light sweet crude oil in the Bakken area (Manitoba, Saskatchewan and Montana, North Dakota). It is anticipated to increase takeaway capacity by 145,000 b/d, expandable to 325,000 b/d with an estimated cost of approximately $190 million for EIF for the Canadian portion and US$370 million for EEP for the U.S. portion.

EIF’s high consolidated debt-to-capital ratio of 69% at September 30, 2010 is primarily due to the proportional consolidation of non-recourse debt of Alliance Canada (approximately $700 million included in consolidated debt of $1.16 billion (DBRS defined)). The latter is self-financing with a regulated capital structure of 70%/30% debt/equity, which ensures stable cash distributions to EIF. The unconsolidated leverage of 44% is a more meaningful measure, and, while trending upwards from 2006, is still acceptable as it is composed of 38% senior debt (approximately $358 million), with the balance being Preferreds owned by Enbridge since inception in 2003, which will have the option to convert to Units following Restructuring. The debt levels are adequately supported by cash flow (cash flow-to-total debt of 0.24 times (unconsolidated) estimated by DBRS for the 12 months ended September 30, 2010 (LTM)). The Preferreds continue to carry an 85% equity treatment by DBRS, given Enbridge’s demonstrated commitment to the Fund. Enbridge extended a $100 million credit facility to EIF in June 2009 for contingency purposes, which was cancelled in June 2010 when EIF upsized its existing $150 million third-party credit line to $300 million ($138 million available), enhancing its liquidity position. On November 8, 2010, the Fund issued $100 million senior notes, which should cover most of the funding requirements for its Bakken Expansion over the next year. DBRS expects further capital investments to be funded by a combination of debt and equity, over time, to maintain the Fund’s credit profile.

In addition to the uncertainties regarding contract renewals at Alliance Canada beyond 2015 mentioned above, EIF’s credit metrics are limited by its significant payout based on operating cash flow in the 80% to 95% range, which will likely prevail after Restructuring, requiring external funding for any major expansions or acquisitions. Excluding the Preferreds payout, the ratio reduces to 40% to 48%. Two of the four Saskatchewan pipeline systems are exposed to throughput risk. However, following the economic and commodity pricing fallout from Q3 2008 to Q1 2009, throughput rose in the past year due to improving crude oil prices and greater drilling activities in southern Saskatchewan. The expansion programs mentioned above are underpinned by developments in the prolific Bakken formation. Further, there are limited alternative transportation means in the areas serviced by the Saskatchewan System, apart from expensive trucking.

Note:
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.