20180126Avista to Staff_DR_118(H1) Attachment C.PDF

INFRASTRUCTURE AND PROJECT FINANCE
CREDIT OPINION
16 November 2016
Update
RATINGS
Hydro One Inc.
Domicile Toronto, Ontario,Canada
Long Term Rating A3
Type Senior Unsecured -
Dom Curr
Outlook Stable
Please see the ratings section at the end of this report
for more information. The ratings and outlook shown
reflect information as of the publication date.
Contacts
Gavin Macfarlane 416-214-3864
VP-Sr Credit Officer
[e-mail]
Natividad Martel,
CFA
212-553-4561
VP-Senior Analyst
[e-mail]
Jim Hempstead 212-553-4318
Associate Managing
Director
[e-mail]
Hydro One Inc.
Regulated Electric T&D Company
Summary Rating Rationale
As a government related issuer, Hydro One Inc.'s (HOI) A3 rating reflects its baseline credit
assessment (BCA) of baa1 with a one notch uplift attributable to the moderate probability
of extraordinary support from the Province of Ontario vs. our previous assumption of strong
support prior to the partial privatization of HOI. HOI's BCA of baa1 is derived from our
Regulated Electric and Gas Utilities rating methodology, and reflects its low business risk
profile driven by its supportive regulatory environment. We expect cash flow from operations
to remain predictable and financial metrics to remain weak for the ratings primarily as a
result of the existing allowed return on equity and deemed capital structure established
by the regulator. The one notch uplift attributed to HOI as a government related issuer
incorporates our expectation of an enduring, albeit weaker link between HOI and the
Province.
Exhibit 1
Historical CFO pre-W/C, Debt and CFO pre-W/C to Debt
Source: Moody's Investors Service
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MOODY'S INVESTORS SERVICE INFRASTRUCTURE AND PROJECT FINANCE
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
2 16 November 2016 Hydro One Inc.: Regulated Electric T&D Company
Credit Strengths
» Supportive regulatory environment
» Predictable cash flow and stable financial metrics
» Relationship with the Province of Ontario
Credit Challenges
» Reduced ownership by the province below 40% may impact support
» High Leverage
Rating Outlook
The outlook on Hydro One is stable, reflecting the expectation of a stable, ongoing relationship with the Province and a BCA that
remains unchanged based on our favorable regulatory assessment and predictable cash flow generation.
Factors that Could Lead to an Upgrade
Moody's could upgrade the ratings if we change the BCA of Hydro One to a3 from baa1. This could result from more favorable
regulatory outcomes or a sustained improvement in financial metrics including CFO pre-W/C to debt in the high teens (11.3% at
9/30/2016). A one notch upgrade of the Province would not lead to an upgrade of Hydro One.
Factors that Could Lead to a Downgrade
A downgrade of Hydro One's BCA would lead to a downgrade of the senior unsecured rating, so long as Moody's opinion of likely
support from the Province remains unchanged or reduces. This could result from a deterioration in regulatory outcomes or a
deterioration in financial metrics, including CFO pre-W/C to debt below 11% on a sustained basis (11.3% at 9/30/2016). A one notch
downgrade of the Province would not lead to a downgrade of Hydro One. Further reductions in government ownership of Hydro One
Limited down to 40% would not lead to further negative rating action all else being equal. A reduction in government ownership below
40% or a reduction in implied "moderate" support could also lead to a downgrade.
Key Indicators
Exhibit 2
Hydro One Inc.
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.
Source: Moody's Financial Metrics™
Detailed Rating Considerations
SUPPORTIVE REGULATORY ENVIRONMENT
The supportive regulatory environment is a key driver of HOI's credit quality and baa1 BCA. Supporting our view, HOI's monopoly
position as a Transmission and Distribution (T&D) company with no commodity price risk underpins its credit strength. We expect
the regulatory environment to remain relatively transparent, predictable and broadly credit supportive. The legislative and judicial
underpinnings are well developed and we expect them to remain unchanged. Rates for the transmission business are established
using cost of service principles with frequent cost of service rate resets. Distribution rates are established through an incentive rate
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mechanism, with periodic cost of service rate resets. The company does not have any direct commodity risk exposure since commodity
costs are a pass through for the distribution business. The company does have some exposure to volume risk that is typically driven
by weather variability and the underlying performance of the economies in its service territories. The company has inherently lower
business risk as a T&D business compared to the price, volume, operational or environmental risks typically associated with generation
activities. The company does not have any supply obligations.
PREDICTABLE CASH FLOW AND STABLE, ALBEIT WEAK FINANCIAL METRICS
We expect the company to continue to generate stable cash flow, a key credit strength. Underpinning this stability, cash flow from
operations is generally a function of the company's rate base, its deemed capital structure (established by the regulator), the allowed
return on equity (currently about 9%) and depreciation. We have assumed that the company continues to perform broadly in line
with the levels established by the regulator. While the company continues to move forward with a large capital program that could
exceed a total of $3 billion for 2016 and 2017. We believe that a combination of frequent cost of service rate resets in the transmission
business and an approved rate base for 2015-2017 for the distribution business, mitigates the downward pressure the large capital
program would otherwise place on financial metrics. We expect that HOI's CFO Pre-W/C to Debt will be maintained between 11-14%
in 2016-2017.
RELATIONSHIP WITH THE PROVINCE OF ONTARIO
In accordance with Moody's Government Related Issuer (GRI) rating methodology, HOI's A3 rating reflects the following:
» Aa2/Stable local currency rating of the Province of Ontario.
» High default dependence as a result of HOI's exposure to virtually all facets of the provincial economy and its operational and
financial proximity to the government.
» Moderate probability of extraordinary support from the Province reflecting the strategic importance of HOI to the provincial
economy as an essential service provider, the partial planned privatization of Hydro One and the medium to long term decline
in political willingness to provide support. The Province's stated objective in the privatization of HOI was to improve corporate
performance.
We believe the Province will continue to have effective control over Hydro One. Following a series of offerings, the government's
nominations over the board of directors will decline to 40%, with an assumption that the province maintains a 40% equity interest
in Hydro One Limited as broadly required by legislation. HOI is restricted from selling a large portion of its regulated transmission or
distribution business and will continue to be regulated by the Ontario Energy Board (OEB). In addition, limitations have been placed on
other shareholders that restrict their equity interest in Hydro One to less than 10%. Further, the government may seek to remove the
board of directors at its discretion. However, since the government has stated its intent is to engage Hydro One as an investor, this has,
in our view reduced the long term probability of "strong" support. Mitigating its control somewhat the government has implemented a
pre-defined set of criteria to promote an independent, professional board with relevant expertise and a commercial orientation. These
changes have been made in a stated attempt to improve the efficiency of Hydro One and they also reduce the government ties to the
company. We do not believe any public policy mandates in the past several years have had a material negative affect on credit quality
and the probability of further public policy initiatives has declined with the initial equity offering. Nonetheless, material acquisitions
outside of Ontario could reduce the probability of extraordinary support from the Province.
Liquidity Analysis
Hydro One has adequate liquidity.
Hydro One has demonstrated its ability to readily access capital markets. Up to $1.5 billion can be issued under its commercial paper
(CP) program which is backstopped by a bank syndicated committed revolver of $2.3 billion maturing in June 2021. At 30 September
2016, HOI had about $1.1 billion in CP borrowings and no revolver borrowings outstanding. HOI terminated two of its credit facilities in
the third quarter of 2016 and replaced them with a single facility for the same combined amount of $2.3 billion. HOL has its own $250
million committed credit facility that expires in November of 2021.
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4 16 November 2016 Hydro One Inc.: Regulated Electric T&D Company
Hydro One relies in part on debt to finance its ongoing capex. The company has issued long-term debt of $1.4 billion in the first three
quarters of 2016 and had cash and cash equivalents balance of $128 million as of September 30, 2016. Together with available credit
facilities and estimated operating cash flows of around $1.3-1.6 billion in the next 12 months these funds will be sufficient to finance
around $50 million long-term debt maturities, capex of around $1.5 billion and dividends of about $700 million.
Profile
Hydro One Inc. (HOI) is an electricity transmission and distribution company. HOI is about 70% indirectly owned by the Province of
Ontario; however, its ownership position in Hydro One will likely decline to about 40% over the next several years. Hydro One Limited
(HOL) is the publicly traded vehicle that owns 100% of HOI. HOI is regulated by the Ontario Energy Board (OEB) under cost-of-service
and incentive rate frameworks. The transmission business owns and operates virtually all of Ontario's electricity transmission system
representing 50% of HOI's total assets of $24 billion as at 30 June 2016. The distribution business serves about 1.3 million customers
and owns a substantial portion of the province's electricity distribution system representing 38% of HOI's total assets. HOI began
operations in 1999, pursuant to the Electricity Act 1998, when the former Ontario Hydro was restructured into five entities: Ontario
Power Generation Inc. (OPG), the Independent Electricity System Operator (IESO), Ontario Electricity Financial Corporation (OEFC),
the Electricity Safety Authority and HOI. The Province does not guarantee HOI's debt obligations.
Rating Methodology and Scorecard Factors
Exhibit 3
Hydro One Inc.
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.[2] As of 9/30/2016(LTM);[3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures.Source: Moody’s Financial Metrics™
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Ratings
Exhibit 4
Category Moody's Rating
HYDRO ONE INC.
Outlook Stable
Senior Unsecured -Dom Curr A3
Commercial Paper P-2
Source: Moody's Investors Service
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