DBRS Changes Under Review Status of Enbridge Inc. Ratings to Negative, Maintains Enbridge Pipelines Inc. and Enbridge Income Fund Ratings Under Review with Developing Implications

DBRS Limited (DBRS) has today changed the status of the following ratings of Enbridge Inc. (ENB) to Under Review with Negative Implications from Under Review with Developing Implications, where they were placed on December 3, 2014:
-- Enbridge Inc., Issuer Rating of A (low)
-- Enbridge Inc., Medium-Term Notes & Unsecured Debentures rated A (low)
-- Enbridge Inc., Cumulative Redeemable Preferred Shares rated Pfd-2 (low)
-- Enbridge Inc., Commercial Paper rated R-1 (low)

For the rationale for the change to the status of ENB’s ratings, please see “Potential Impact on ENB - Update.”

DBRS has also maintained the following ratings of Enbridge Pipelines Inc. (EPI) and Enbridge Income Fund (EIF) at Under Review with Developing Implications, where they were placed on December 3, 2014:
-- Enbridge Pipelines Inc., Issuer Rating of “A”
-- Enbridge Pipelines Inc., Medium-Term Notes and Unsecured Debentures rated “A”
-- Enbridge Pipelines Inc., Commercial Paper rated R-1 (low)
-- Enbridge Income Fund, Issuer Rating of BBB (high)
-- Enbridge Income Fund, Senior Unsecured Long-Term Notes rated BBB (high)

For the rationale for maintenance of the Under Review with Developing Implications status of EPI’s and EIF’s ratings, please see “Potential Impact on EPI - Update” and “Potential Impact on EIF - Update,” respectively.

BACKGROUND
The December 3, 2014, rating actions followed the announcement that ENB plans to transfer its Canadian liquids pipelines business, consisting of EPI and Enbridge Pipelines (Athabasca) Inc. (EPA) as well as certain renewable power generation assets (which are currently held within EPI) to its Canadian affiliate, EIF (the Transaction). Secondly, ENB also announced plans to increase its common share dividend by 33% and its common share dividend policy to a range of 75% to 85% of adjusted earnings from the previous range of 60% to 70%. Finally, ENB announced that it was considering the potential for public debtholders of ENB to exchange up to approximately $4 billion of ENB debt for new notes of EIF. The DBRS ratings of Enbridge Gas Distribution Inc. (EGD) and Enbridge Energy Partners, L.P. (EEP) were not affected by the December 3, 2014, announcement, although DBRS noted that it expects the ratings of EEP and ENB will be placed Under Review in the event that ENB’s “potential parallel U.S. restructuring plan” were announced.

The Transaction was originally targeted for completion by mid-2015. The December 3, 2014, rating actions reflected uncertainty associated with the ongoing corporate developments, percentage take-up of the debt exchange and the future funding strategy among the entities within ENB’s organization. For clarity, DBRS did not rule out any potential future rating changes for any of the entities placed Under Review at that date. Please see the relevant sections of this press release for details of the Transaction Assets and Financing Strategy as proposed.

In addition to the Transaction, during Q4 2014, ENB and EPI began formalizing a plan to transfer EPI’s ownership interest in Enbridge Energy Company, Inc. (EECI, wholly owned by EPI) to ENB (the Plan). EECI directly holds the U.S. assets of EPI, which include certain liquids pipeline assets, EEP and certain of EPI’s renewable energy projects. The transfer of EECI was originally expected to be completed by mid-2015.

ENB and EIF have reached an agreement to proceed with the Transaction. The Transaction is subject to customary regulatory approvals and closing conditions as well as a vote of the public shareholders of Enbridge Income Fund Holdings Inc. (EIFH), which is expected to occur on August 20, 2015, with closing expected to follow shortly thereafter. The Transaction is also subject to completion of the Plan. ENB has decided not to proceed with a debt exchange with EIF.

POTENTIAL IMPACT ON ENB - UPDATE
DBRS does not expect material changes to ENB’s consolidated business risk profile as a result of the Transaction and the Plan, which would continue to be supported by the relatively low business risk of its portfolio of assets with roughly 85% to 90% of its segment earnings derived from low-risk, mostly regulated and/or contracted operations. About 60% of ENB’s segment earnings have been derived from encumbered entities (including EPI, EIF, EEP and EGD) that are mostly low-risk, mostly regulated and/or contracted operations that also provided a steady stream of dividends, although encumbered by prior ranking debt, to ENB.

On a modified consolidated basis, however, ENB would move away from its current hybrid holding company (holdco)/operating company structure and closer to a pure holdco structure, which would have negative credit risk profile impacts. DBRS notes that the potential for a follow-up U.S. Dropdown Transaction involving ENB and EEP has not been factored into its analysis of the rating impact on ENB of the subject Transaction and Plan.

DBRS expects the combination of the Transaction and the Plan to have a negative impact on ENB’s credit risk profile mainly due to the following factors:

(1) Following completion of the Transaction and the Plan, holders of ENB’s direct external debt would be further away from the cash flow of the assets transferred to EIF (the Transferred Assets). Dividends from the Transferred Assets would be needed to service EIF debt prior to the payment of common dividends to EIFH’s public shareholders and payment of preferred and common share dividends to ENB, the latter of which would be available to meet the obligations to ENB’s external debt and preferred shareholders. Conversely, as part of the Plan, ENB’s direct external debt holders would be closer to EEP’s assets, which would be owned directly by ENB (through EECI) rather than through EPI (and then EECI) following completion of the Plan. For context, however, the Transferred Assets accounted for more than 40% of ENB’s 2014 segment earnings compared with 12% for EEP.

DBRS estimates that, based on full-year 2014 results (and pro forma the dropdown of ENB’s 66.7% interest in Alberta Clipper Pipeline U.S. to EEP on January 2, 2015), the Transaction and Plan would (a) reduce ENB’s unencumbered segment earnings to 13% from 24% of total segment earnings; (b) reduce ENB’s once-encumbered segment earnings to 51% from 59% and (c) increase ENB’s twice-encumbered segment earnings to 36% from 17%. Similarly, based on current DBRS ratings and full-year 2014 results (and pro forma the January 2, 2015, Alberta Clipper Pipeline U.S. dropdown to EEP), DBRS estimates that the weighted-average credit rating of the entities that pay distributions directly to ENB and its related parties would decline to BBB (high) from A (low).

(2) The initial 33% increase in ENB’s common share dividend and its move to a higher dividend payout ratio range (75% to 85% of adjusted earnings, converting to 40% to 50% of available cash flow from operations), combined with the impacts of the Transaction and the Plan, would result in higher consolidated ENB funding needs. Consequently, ENB would be relying more heavily on dividends from (and external funding at) its directly encumbered subsidiaries (including EIF) to finance the direct-to-ENB portion (including its joint ventures with EEP) of the substantial consolidated growth capital expenditure (capex) program over the 2015 to 2018 period. This factor would be at least partly offset by the offloading of at least part of the direct-to-ENB funding needs to EIF. DBRS’s ENB ratings incorporate expected improvement in ENB’s credit metrics on both fully and modified consolidated bases as longer-dated organic growth projects come on-stream and begin to generate cash flow in the later years of its five-year growth capex program.

Given the large growth capex programs at EPI and EPA, EIF would also be expected to inject common equity into EPI and EPA in order to support their key credit metrics during a period of large free cash flow deficits. This could reduce the funds available to pay dividends to ENB that support servicing of ENB’s debt and preferred shares and to pay dividends to EIFH’s public common shareholders. Balancing of these competing requirements will be a challenge.

Based on its review to date, DBRS expects to downgrade all of ENB’s ratings by one notch, with Stable trends, upon completion of the Transaction; therefore, DBRS believes that Under Review with Negative Implications is the appropriate rating action at this time.

POTENTIAL IMPACT ON EPI - UPDATE
DBRS’s EPI ratings continue to be based on the business and financial risk profiles of its regulated Canadian Mainline (Mainline) liquids pipeline, which has fully supported EPI’s direct external debt. The Mainline currently accounts for about two-thirds of the liquids pipeline export capacity from western Canada. Consequently, the plan to transfer EECI ownership from EPI to ENB does not affect EPI’s DBRS ratings.

DBRS does not expect material changes from a business risk profile perspective or from a credit metric perspective with respect to EPI’s DBRS ratings as a result of the Transaction. The vast majority of EPI’s direct and consolidated growth capex program is related to liquids pipelines projects that are supported by low-risk long-term contractual and/or regulatory frameworks.

DBRS expects the Transaction to be neutral to EPI’s credit risk profile mainly due to the following:

(1) Funding of the debt component of EPI’s large growth capex program directly by EPI (including increasing its commercial paper (CP) program to $2.0 billion from $0.3 billion), rather than through funds on-lent by ENB, can be expected to result in weaker near- to medium-term Mainline debt metrics prior to placement of the projects into service. EPI’s Mainline target capitalization remains 55% debt/45% equity. Any material increase in this target capitalization ratio, which is not expected, would be viewed negatively by DBRS. While DBRS expects EPI to substantially restore its key Mainline credit metrics to 2010-2011 ranges over the medium term, it will closely monitor these metrics during the construction period.

(2) With respect to funding of the common equity component of EPI’s large growth capex program, DBRS does not expect any significant changes to the total amount of common equity injection required, although the sources of this funding following the Transaction would potentially be from both EIF and ENB compared with only ENB at present. DBRS believes that the potential for a common equity overhang at EIF is mitigated by the ENB backstop.

Based on its review to date, DBRS expects to confirm EPI’s ratings with Stable trends upon completion of the Transaction.

POTENTIAL IMPACT ON EIF - UPDATE
DBRS’s EIF ratings continue to be supported by the relatively low business risk of its portfolio of diversified assets and its moderate financial risk profile. DBRS expects a positive impact on EIF’s business risk profile as a result of the Transaction based on a significant increase in EIF’s scope and scale as well as the fact that the vast majority of the Transferred Assets are liquids pipelines assets supported by low-risk long-term contractual and/or regulatory frameworks with minimal volume risk and no price risk.

DBRS expects the Transaction to have a positive impact on EIF’s credit risk profile mainly due to the following factors:

(1) Following completion of the Transaction low-risk and stable cash distributions from EPI and EPA (the latter after servicing its approximate $4 billion loan from ENB) would result in stronger initial EIF modified consolidated credit metrics. The positive impact also reflects that dividends from the Transferred Assets will have to service the EIF debt before being distributed to ENB and EIFH; however, dividend payments to both ENB (common and preferred) and EIFH public common shareholders would also rise based on the Transaction’s equity-based financing as well as to support higher common dividend payout ratios at both ENB and EIFH.

(2) Over the medium term, a moderate amount of multi-year debt issuance by EIF (in support of growth capex at EPA) and common equity issuance by EIFH (in support of growth capex at both EPA and EPI) would be required. In addition, EIF will target a common dividend payout ratio of 90% of available cash flow. Consequently, a rising proportion of the dividends received from the Transferred Assets could be needed to service EIF’s growing debt service payments and EIFH’s growing dividend payments, potentially leading to rising external funding needs over the medium term. The amount of capital to be issued at EIF and EIFH is substantial for an Issuer with a limited track record of large-scale capital raises. EIFH’s common equity issuance would be backstopped by the injection of common equity into EPI by ENB in order to deal with any common equity overhang that could develop at EIFH.

Based on its review to date, DBRS expects to confirm EIF’s ratings at BBB (high) and assign a Positive trend upon completion of the Transaction.

THE TRANSACTION ASSETS
(1) The Canadian liquids pipelines assets to be dropped down to EIF from ENB include:
-- All Mainline assets owned by EPI, including the residual interest in the Southern Lights diluent pipeline.
-- All Regional Oil Sands Pipelines owned by EPA (currently owned by ENB).
-- Both EPI and EPA would be transferred to direct ownership by EIF from direct ownership by ENB.
-- Total liquids pipelines assets are estimated by DBRS to have generated $858 million of segment earnings (52% of ENB’s total segment earnings), of which the Mainline accounted for $500 million (30% of ENB’s total segment earnings) and Regional Oil Sands Pipelines accounted for $181 million (11% of ENB’s total segment earnings) in 2014.
-- These assets are considered to be the core component of ENB’s ratings.

(2) The Canadian renewable power generation assets (all operational and currently owned by EPI with a combined generation capacity of 830 megawatts) to be dropped down to the Fund include:
-- Québec assets: Lac Alfred Wind Farm (67.5% interest), Massif-du-Sud Wind Farm (80% interest) and Saint-Robert-Bellarmin Wind Farm (50% interest) Projects.
-- Alberta assets: Blackspring Ridge Wind Project (50% interest).

(3) The book value of the Transaction Assets is estimated to be approximately $17 billion ($16 billion for the liquids pipelines assets and $1 billion for renewable generation assets).

FINANCING STRATEGY – RESTRUCTURING AS PROPOSED
(1) ENB would maintain its 19.9% interest in EIFH (which holds an approximate 10% interest in the Fund) following the dropdown of EPI and EPA.

(2) EIFH is expected to acquire an increasing interest in the Transferred Assets through investments in the equity of the Fund over a period of several years, consistent with its equity-funding capability (expected to be $600 million to $800 million per year from 2015 through 2018). In total, ENB expects approximately $3 billion of its forecasted future equity requirements will be satisfied through EIFH through 2018.

(3) The Transaction would be structured in such a way that ENB would increase its economic interest in the Fund to approximately 90% from 66%, and then would decline to approximately 80% by 2018 as EIFH increases its investments in the Fund.

(4) Upon completion of the Transaction, the Fund would hold a 100% interest in EPI and EPA. As a result, the size of the Fund’s consolidated assets would increase substantially.

(5) Along with all Transaction assets, EPI would remain responsible for its own current debt. All debt at EPI would remain non-recourse to EIF and ENB. There is currently no external debt at EPA.

(6) EPI’s CP program would be increased to approximately $2.0 billion from $0.3 billion currently, to be fully backed with its own credit facilities.

(7) ENB’s Canadian CP program would be reduced to $0.8 billion from $2.5 billion following the Transaction. As result, DBRS expects ENB’s direct credit facilities to be reduced. ENB’s U.S. CP program at USD 2.1 billion would remain unchanged.

(8) ENB has an intercompany loan of approximately $4 billion outstanding to EPA that will remain outstanding following the Transaction.

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 methodologies are Rating Companies in the Pipeline and Diversified Energy Industry (January 2015), Rating Holding Companies and Their Subsidiaries (January 2015), DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 2015) and Preferred Share and Hybrid Criteria for Corporate Issuers (January 2015), which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.