DBRS Places Fortis Inc. Under Review with Developing Implications Following CH Energy Group Inc. Acquisition Announcement

DBRS has today placed the A (low) Unsecured Debentures and Pfd-2 (low) Preferred Shares ratings of Fortis Inc. (Fortis or the Company) Under Review with Developing Implications. This action follows the announcement that the Company has agreed to acquire CH Energy Group Inc. (CHG) for a total consideration of approximately US$1.5 billion, including the assumption of US$500 million of debt on closing (the Acquisition). The purchase price represents an approximate 10.5% premium above the most recent closing price of CHG. The Acquisition is expected to close within 12 months and is subject to CHG shareholder approval, as well as various regulatory approvals.

CHG’s principal businesses consist of: (1) Central Hudson Gas & Electric Corporation (Central Hudson), which is a regulated utility in New York State with approximately 300,000 electric customers and 75,000 gas customers. Central Hudson accounted for 97% of CHG’s consolidated net income and 93% of assets in 2011. (2) A non-regulated fuel delivery business (3% of net income), which serves 56,000 customers in the mid-Atlantic region. CHG’s total assets were US$1.7 billion as of December 31, 2011, while net income and operating cash flow in 2011 were US$45 million and US$115 million, respectively. Pro forma the CHG acquisition (i.e., post-acquisition), DBRS estimates that CHG will account for 11% of Fortis’s total assets and 12% of Fortis’s total net income (based on December 31, 2011). The Acquisition is expected to be immediately accretive to earnings and cash flow.

In reviewing Fortis’s rating in light of the proposed Acquisition, DBRS’s analysis is focused on (1) the impact of the Acquisition on the business risk profile of Fortis, and (2) the financial impact of the transaction on the Company’s credit profile.

(1) BUSINESS RISK PROFILE – NEUTRAL IMPACT
Based on our preliminary review, DBRS views the proposed Acquisition as neutral with respect to Fortis’s business risk profile. Currently, approximately 90% of Fortis’s consolidated earnings are contributed by its regulated businesses (gas and electric transmission, distribution, generation and storage), with the remaining earnings coming from hotel properties and non-regulated generation. The proposed Acquisition is expected to slightly improve the Company’s earnings mix toward the regulated businesses, since 97% of CHG’s earnings are generated from regulated gas and electric transmission and distribution. In addition, the regulatory framework in New York is viewed as reasonable in terms of operating and capital cost recovery and returns on investment. CHG has no exposure to commodity price risk since all gas and power purchase costs are passed through to customers. Over the longer term, the Acquisition should help maintain the current mix of regulated and non-regulated earnings as Fortis continues to increase its exposure to non-regulated businesses, including the non-regulated hydroelectric Waneta Expansion Project (estimate: $450 million Fortis share, 51% equity interest) expected to be in service in 2015.

(2) FINANCIAL RISK PROFILE – NEGATIVE IMPACT
The focus of DBRS’s analysis is on Fortis’ non-consolidated capital structure (parent level) and cash flow from the subsidiaries to the parent to service the parent’s debt and corporate expenses. On a non-consolidated basis, the cash flow-to-interest expense ratio was strong at 4.43 times (x) in 2011, while debt-to-capital was near 20%. DBRS notes that, at 20%, non-consolidated leverage is at the upper end of the range for the A (low) rating category.

Fortis expects to use its multi-year committed credit facility to finance the purchase in the short term (Fortis’s available credit facility was $845 million at the parent level as at December 31, 2011). The Company intends to finance the acquisition on a long-term basis, consistent with its current non-consolidated capital structure.

DBRS will further review the Company’s financing plan when it is finalized and expects that the Company will finance the Acquisition in such a way that the 20% debt-to-capital structure at the non-consolidated level will be maintained. Any material increase in leverage could cause Fortis’s credit risk profile to deteriorate to a level that is no longer commensurate with the current A (low) rating.

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

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