Morningstar DBRS Confirms Credit Ratings on Nova Scotia Power Inc. at BBB (high) and R-2 (high), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Nova Scotia Power Inc.'s (NSPI or the Company) Issuer Rating and Unsecured Debentures & Medium-term Notes rating at BBB (high), and the Commercial Paper rating at R-2 (high). All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
The ratings of Nova Scotia Power Inc. are based on its integrated electricity operations under the Nova Scotia Utility and Review Board (NSUARB). The Stable trends reflect the Company's key credit metrics, which are in line with the BBB rating category.

There were several positive developments for NSPI in 2024. In April, the NSUARB approved for the sale of $117 million of fuel-adjustment mechanism (FAM) regulatory assets from NSPI to the Province of Nova Scotia (the Province; rated A (high) with a Stable trend). NSPI will collect this amount from customers on behalf of the Province over a 10-year period. In September 2024, the federal government also finalized an agreement with NSPI, NSP Maritime Link Inc. (NSPML; Maritime Link Financing Trust rated (P) AAA with a Stable trend), and the Province for a federal loan guarantee of $500 million of debt to be issued by NSPML. Proceeds from this issuance have been transferred to the Company and applied against the FAM regulatory asset balance. NSPI will collect this amount from customers on behalf of NSPML over a 28-year period. These two transactions (1) will reduce debt at the Company by $617 million, (2) reduce regulatory lag for NSPI disposing of the balance in the FAM, and (3) reduce rate pressure on customers as the recovery is spread over a much longer period.

Furthermore, in April 2024, the Province enacted Bill 404 - Energy Reform (2024) Act. Bill 404 enacts the More Access to Energy Act, which provides for the establishment and transition to the Nova Scotia Independent Energy System Operator (NSIESO). The NSIESO will be tasked with operating the Provincial electricity grid as well as energy forecasting and resource planning. This will streamline NSPI's responsibilities so it can focus on its operations as an integrated utility. Importantly, while the Company will still be required to adhere to climate change regulations, and as the dominant utility in the Province, be involved in the transition, the responsibility for procuring renewable energy in the Province and meeting targets under the Renewable Electricity Regulations (RER) are expected to be transferred to the NSIESO.

While these developments will strengthen NSPI's financial metrics and reduce uncertainty under the RER, Morningstar DBRS remains concerned about potential political interference in the next regulatory review process. During the recent November Provincial election, the Progressive Conservative's platform included a proposal to cap electricity rate increases at the average increase across the country. Should legislation be enacted by the Province that, once again, diminishes the NSUARB's independence and affects the Company's ability to fully recover its costs in its next General Rate Application (GRA), a negative rating action would likely occur.

CREDIT RATING DRIVERS
A positive credit rating action could occur if (1) the regulatory process for the next GRA is conducted free of any interference and with the NSUARB's full independence on the determination of rates, (2) establishment of the NSIESO, which will reduce NSPI's exposure to penalties under the RER, and (3) key credit metrics in line with the "A" credit rating category. A negative credit rating action could occur if there were further political interference in the regulatory process for NSPI, or if key credit metrics weaken to a level no longer supportive of the current ratings (i.e., cash flow-to-debt remaining below 10% for a sustained period).

EARNINGS OUTLOOK
Earnings for NSPI have generally been very stable, reflecting the regulated nature of its operations. The Company has an FAM in place that allows it to recover actual fuel costs from customers through annual rate adjustments. Earnings increased in 2023 because of a base-rate increase of 1.8% effective February 2023; however, NSPI achieved a return on equity (ROE) of 8.25%, which was below the approved regulated ROE band of 8.75% to 9.25%. Morningstar DBRS does not expect the Company's financial performance to materially improve until the next GRA and rates are rebased which Morningstar DBRS expects to occur in 2026.

FINANCIAL OUTLOOK
NSPI's key credit metrics strengthened in the last 12 months ended September 30, 2024, because of the stronger earnings and cash flows, and the reduction in debt following the sale of the $117 million balance in the FAM to the Province. Morningstar DBRS expects the Company's metrics to further strengthen in 2024 following the $500 million transfer from NSPML, proceeds of which have been used to pay down debt. NSPI has a significant capital expenditures (capex) program however (around $630 million annually for the next three years), as the Company invests in reliability of the network and growth in the customer base. Morningstar DBRS expects NSPI to be prudent in financing its capex and dividends to maintain key credit metrics in line with the BBB credit rating range. NSPI's parent company, Emera Inc., has historically been supportive of the Company by maintaining a flexible dividend payout policy (none paid in 2023 and 2024) and providing equity injections ($308 million received in 2023) to maintain leverage in line with the regulatory capital structure.

CREDIT RATING RATIONALE
NSPI's credit ratings are supported by its low-risk regulated electricity business, good franchise strength, and its reasonable financial profile. This is offset by the heightened political interference in the ratemaking process, unfavourable generation mix, and regulatory lag.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a relevant effect on the credit analysis.

Environmental (E) Factors
The following Environmental factor had a relevant effect on the credit analysis: Carbon and Green House Gas (GHG) costs. Morningstar DBRS considers the Company's transition from reliance on coal-based generation (51% of 2023 installed generation capacity) to lower-emitting sources to be a challenge, as coal-fired generation is mandated to be phased out, and 80% of electricity sales are to be from renewable sources by 2030. Morningstar DBRS notes that once the NSIESO is established, the responsibility of procuring renewable energy in the Province will transition away from NSPI. However, significant investments will still be needed by the Company, including substantial funding support from both the Provincial and Federal governments.

There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024; https://dbrs.morningstar.com/research/437781).

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of NSPI, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of NSPI, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of NSPI, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Regulated Utility and Independent Power Producer Industries (November 25, 2024), https://dbrs.morningstar.com/research/443429.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186 which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186)
-- Morningstar DBRS Criteria: Approach to ESG Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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