DBRS Confirms Toronto Hydro at A (high) and R-1 (low), Stable

DBRS has today confirmed the Issuer Rating of Toronto Hydro Corporation (THC or the Company) at A (high), along with the ratings of its Senior Unsecured Debentures & MTNs at A (high) and Commercial Paper rating at R-1 (low), respectively. All trends are Stable. The rating confirmation reflects THC’s low business risk profile and reasonable financial risk profile. However, THC faces financial challenges due to its aging infrastructure replacement program that could pressure its balance sheet. DBRS views leverage rising above the regulatory capital structure as high for the current rating category and could potentially trigger a negative rating action.

THC’s business risk profile is supported by a reasonable regulatory environment in Ontario and stable earnings from regulated business accounting for virtually all of the Company’s earnings and cash flow. The regulatory framework for distribution utilities in Ontario is shifting from the current third-generation incentive regulatory mechanism (IRM) to the renewed regulatory framework. Under Ontario Energy Board’s (OEB) renewed regulatory framework, the Company’s electricity distribution business (LDC) is expected to file under custom incentive regulation (CIR) in Q3 2014 for rates effective 2015 to 2019. DBRS views CIR as well-suited to distributors such as THC with large, broad, multi-year capital investments that require certainty of funding in advance, as capex decisions will be driven by pre-approval from the OEB. Given that CIR is new and the forecasting period is five years (compared to three years under the earlier framework), THC’s cash flow could be affected if the LDC is unable to recover large unforeseen discrepancies between forecasts and actual capex and operating expenses in a timely manner. The current rating is based on DBRS’s expectation that the implementation of the renewed regulatory framework in Ontario will not have a material impact on the credit profile of THC.

THC’s financial metrics are currently commensurate with an “A” rating range. However, financial metrics could weaken and may not be commensurate with the current ratings, as significant capital expenditure is needed to replace the Company’s aging infrastructure (approximately $400 million approved by OEB for 2014), resulting in higher free cash flow deficits. In recent years, THC has funded these deficits with a combination of asset sales and debt, maintaining leverage close to the regulatory capital structure (60% debt to 40% equity). DBRS is concerned that the rising leverage could pressure Company’s balance sheet as cash balances have been depleted, and going forward it will likely depend entirely on debt due to its limited access to equity markets. DBRS will monitor regulatory developments subsequent to the Company’s CIR filings in Q3 2014 and OEB approval expected in Q2 2015, with a view to a potential negative rating action should leverage exceed the regulatory capital structure.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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