CAPITAL STRUCTURE FINANCING PLANS Equity Limited’s (“THESL”) capital structure and financing...
Transcript of CAPITAL STRUCTURE FINANCING PLANS Equity Limited’s (“THESL”) capital structure and financing...
Toronto Hydro-Electric System Limited EB-2010-0142
Exhibit E1 Tab 1
Schedule 1 ORIGINAL Page 1 of 5
COST OF CAPITAL 1
2
The purpose of this evidence is to provide an overview of Toronto Hydro-Electric System 3
Limited’s (“THESL”) capital structure and financing plans for 2010 through 2011. 4
Detailed schedules on capital structure and debt issuances can be found at Exhibit E1, 5
Tabs 2-4, Schedule 1 and Exhibit E1, Tabs 2-4, Schedule 2, respectively. 6
7
CAPITAL STRUCTURE 8
THESL’s capital structure for ratemaking purposes is set according to the Board’s Cost 9
of Capital guidelines issued November 30, 2006 and as confirmed in the Report of the 10
Board on the Cost of Capital for Ontario’s Regulated Utilities issued December 11, 2009. 11
For THESL, the debt:equity split for the test year is set at 60:40. The debt component in 12
each year includes a deemed four percent short-term debt component. 13
14
FINANCING PLANS 15
Equity 16
The City of Toronto is the sole shareholder of Toronto Hydro Corporation (“THC”). 17
THC, in turn, owns THESL. 18
19
The company attempts to maintain an actual capital structure that mirrors the deemed 20
structure by making or foregoing dividend payments to THC, thereby balancing retained 21
earnings, and through managing its debt load. As is described in the next section, due to 22
the significant expenditures expected over the test year, an additional capital expenditure-23
related debt issuance will be required in 2011, however, the Company’s debt-to-equity 24
ratio is forecast to remain at or slightly below its deemed debt component. 25
26
For the purposes of the prefiled evidence, the forecast Return on Equity (“ROE”) used to 27
determine Cost of Capital in the test year is based on the 2010 approved ROE. The 28
Toronto Hydro-Electric System Limited EB-2010-0142
Exhibit E1 Tab 1
Schedule 1 ORIGINAL Page 2 of 5
approved 2010 Return on Equity was 9.85 percent. 1
2
THESL has used the above ROE forecast for the purpose of calculating revenue 3
requirement for the test year in this application. THESL will rely on the ROE forecast 4
produced by the OEB in early 2011, as described in the Board’s Cost of Capital 5
guidelines to determine the final revenue requirement. 6
7
Financial Market Overview and Forecast 8
2009 was a year of extreme volatility in financial markets, stemming primarily from the 9
world financial crisis which began in late 2007 and the subsequent worldwide slowdown 10
in economic activity. 11
12
Canadian government bond yields reached historic lows in early 2009 as investors sought 13
the safety of sovereign debt. Ten-year bonds reached the 2.70 percent mark and thirty-14
year bonds fell below 3.60 percent. These bonds were down from levels of 70-100 basis 15
points higher just a few months earlier. At the same, however, Corporate spreads 16
widened beginning in late 2008 and remained high until mid 2009. 17
18
While the worst of the crisis appears to be behind us, financial markets have not returned 19
to the state they were in prior to the crisis, and are not expected to return to those levels. 20
Government bond rates have increased from the lows of early 2009, and are expected to 21
increase through 2010 and 2011. Corporate debt spreads, which had tightened in late 22
2009 and early 2010 have begun to widen again, and are expected to increase modestly 23
over the forecast period. Nevertheless, unless there is a general return to overall risk 24
aversion, the high spreads of late 2008 and early 2009 are not expected in the forecast 25
period. 26
Toronto Hydro-Electric System Limited EB-2010-0142
Exhibit E1 Tab 1
Schedule 1 ORIGINAL Page 3 of 5
Medium and Long-Term Debt 1
THESL’s debt is issued at the THC level via medium term notes in the Canadian public 2
debt market. This obligates THC to obtain and maintain credit ratings. THC’s debt 3
obligations are rated by DBRS and S&P as follows: 4
5
Rating Agency Short-Term Debt Long-Term Debt
DBRS R-1 (Low) A-High
Standard & Poor’s Not rated A
The most recent ratings report from DBRS is provided in Exhibit E1, Tab 6, Schedule 1. 6
S&P has not given permission to release its ratings report on the Company. The utility is 7
assigned debt through promissory notes between the utility and the parent. The 8
promissory notes are written on the same terms as the parent debt as the borrowing is 9
done on behalf of the corporation’s affiliates. A fee of five basis points is charged for 10
administration. 11
12
As of June 1, 2010, THESL had outstanding long-term debt in the amount of $1,360 13
million, detailed in Table 2. 14
15
Table 2: Medium and Long-Term Debt 16
Description Maturity Principal Rate
$980M Prom Note May 6, 2013 490,115,478 6.16%
$180M Prom Note May 6, 2013 180,000,000 6.16%
$245M Prom Note Nov 14, 2017 245,057,739 5.20%
$245 Prom Note Nov 12, 2019 245,057,739 4.54%
$200M Prom Note May 20, 2040 200,000,000 5.59%
The principal amount of $490.1 million on the $980 million Promissory Note reflects the 17
outstanding balance as of June 1, 2010. The rate of 6.16 percent shown is the actual rate 18
THESL pays on this note, however, for rate making purposes, the rate is 5.36 percent, 19
Toronto Hydro-Electric System Limited EB-2010-0142
Exhibit E1 Tab 1
Schedule 1 ORIGINAL Page 4 of 5
which reflects the rate as allowed under the Board’s cost of capital guidelines for this 1
debt, as approved in EB-2007-0680. Forecast new debt issuance for the 2010 to 2011 2
period is driven primarily by THESL’s capital plans and by the repayment requirements 3
of the maturing debt. Details of the forecast debt issues are in Table 3. 4
5
Table 3: Forecast Long-Term Debt Issues 6
Description Issue Date Term Principal Underlying
Govt Bond
Rate
Corporate
Spread
Forecast
Forecast
Coupon
Rate
$100 M Capex Issue Dec 15, 2011 10 Years $100,000,000 4.175 1.58 5.75%
Replacement of
$245.1M maturing Dec
30, 2011
Dec 15, 2011 10 Years $245,057,739 4.175 1.58 5.75%
Forecasted debt rates are based on the most recent projection of equivalent term 7
Government of Canada Bonds, as provide by the Conference Board of Canada (see 8
Exhibit C1, Tab 4, Schedule 2, Appendix A), plus THESL’s estimate of corporate 9
spreads at the time of issuance (inclusive of the five basis point admin fee). 10
11
Preferred Shares 12
THESL has no plans to issue any preferred shares over the 2010-2011 period. 13
14
Short-Term Debt 15
Over the 2010-2011 period THESL does not forecast the need to issue short-term debt. 16
Together with the planned debt issues, cash levels are sufficient to fund short-term needs 17
throughout the forecast term. THC maintains a short-term credit facility available for 18
THESL to draw upon in the event short-term funds are required. 19
20
As outlined in the Cost of Capital Guidelines by the Board, short-term debt is deemed 21
throughout the forecast as four percent of the company’s capital structure for ratemaking 22
Toronto Hydro-Electric System Limited EB-2010-0142
Exhibit E1 Tab 1
Schedule 1 ORIGINAL Page 5 of 5
purposes. For the purposes of the prefiled evidence, the forecast rate applied for the 1
determination of 2011 revenue requirement is the 2010 approved rate of 2.07 percent. 2
The final short-term rate will be updated according to the Cost of Capital guidelines prior 3
to the May 1, 2011 distribution rates implementation date. 4
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 2
Schedule 1ORIGINAL
Page 1 of 2
Table 1: 2007 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,144.9 61.8 5.50 3.40 5 Short Term Debt - - - - 6 1,144.9 61.8 3.40 78 Preferred Shares - - - - 9 Common Equity 706.3 38.2 9.03 3.45
10 1,851.1 100.0 6.85
Table 2: 2008 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,252.4 63.9 5.49 3.51 5 Short Term Debt - - - - 6 1,252.4 63.9 3.51 78 Preferred Shares - - - - 9 Common Equity 706.3 36.1 9.79 3.53
10 1,958.7 100.0 7.04
Cost of Capital
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 2
Schedule 1ORIGINAL
Page 2 of 2
Table 3: 2009 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,230.9 60.5 5.46 3.31 5 Short Term Debt - - - - 6 1,230.9 60.5 3.31 78 Preferred Shares - - - - 9 Common Equity 803.1 39.5 6.15 2.43
10 2,034.1 100.0 5.74
Table 4: 2009 Board-ApprovedCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,140 56.0 5.50 3.08 5 Short Term Debt 81 4.0 1.33 0.05 6 1,221 60.0 3.13 78 Preferred Shares - - - - 9 Common Equity 814 40.0 8.01 3.20
10 2,034.9 100.0 6.34
Cost of Capital
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 2
Schedule 2ORIGINAL
Page 1 of 2
Table 1: 2007 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 980,230,955 5.36% 365 52,540,3793 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 48 1,675,7926 Financing Costs1 318,9057 Avg of Monthly Debt Outstanding 1,192,457,726 5.50% 65,623,076
Notes:1. Includes amortized issue costs
Table 2: 2008 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 735,173,206 5.36% 365 39,405,2843 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 Financing Costs1 457,7536 Avg of Monthly Debt Outstanding 1,160,230,945 5.49% 63,694,039
Notes:1. Includes amortized issue costs
Medium and Long-Term Debt Costs - 2007 and 2008
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 2
Schedule 2ORIGINAL
Page 2 of 2
Table 3: 2009 Historical YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 735,173,206 5.36% 365 39,405,2843 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 2nd tranche City Note Replacement Nov 12, 2009 Nov 12, 2019 245,057,739 4.54% 50 1,524,0586 Financing Costs1 479,2487 Avg of Monthly Debt Outstanding 1,193,800,498 5.46% 65,239,592
Notes:1. Includes amortized issue costs
Table 4: 2009 Board-ApprovedCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 735,173,206 5.36% 365 39,405,2843 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 2nd tranche City Note Replacement Dec 15, 2009 Dec 15, 2019 245,057,739 7.25% 17 826,9196 Financing Costs1 411,4867 Avg of Monthly Debt Outstanding 1,171,644,593 5.50% 64,474,691
Notes:1. Includes amortized issue costs
Medium and Long-Term Debt Costs - 2009
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 3
Schedule 1ORIGINAL
Page 1 of 1
Table 1: 2010 Bridge YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,276.6 60.0 5.36 3.21 5 Short Term Debt - - 2.07 - 6 1,276.6 60.0 3.21 78 Preferred Shares - - - - 9 Common Equity 851.1 40.0 9.85 3.94
10 2,127.7 100.0 7.15
Table 2: 2010 Board-ApprovedCol. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,199 56.0 5.38 3.01 5 Short Term Debt 86 4.0 2.07 0.08 6 1,284 60.0 3.10 78 Preferred Shares - - - - 9 Common Equity 856 40.0 9.85 3.94
10 2,140.7 100.0 7.04
Cost of Capital
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 3
Schedule 2ORIGINAL
Page 1 of 1
Table 1: 2010 Bridge YearCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 490,115,467 5.36% 365 26,270,1893 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 2nd tranche City Note Replacement Nov 12, 2009 Nov 12, 2019 245,057,739 4.54% 365 11,125,6216 $200M Debenture May 20, 2010 May 20, 2040 200,000,000 5.59% 226 6,922,4117 Financing Costs1 645,6268 Avg of Monthly Debt Outstanding 1,284,066,561 5.36% 68,794,850
Notes:1. Includes amortized issue costs
Table 2: 2010 Board-ApprovedCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 490,115,467 5.36% 365 26,270,1893 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 2nd tranche City Note Replacement Nov 12, 2009 Nov 12, 2019 245,057,739 4.54% 365 11,125,6216 Capex Debt Issue June 1, 2010 June 1, 2040 200,000,000 5.79% 214 6,789,3707 Financing Costs1 695,6988 Avg of Monthly Debt Outstanding 1,277,491,219 5.38% 68,711,881
Notes:1. Includes amortized issue costs
Medium and Long-Term Debt Costs - 2010
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 4
Schedule 1ORIGINAL
Page 1 of 1
Table 1: Col. 1 Col. 2 Col. 3 Col. 4 Col. 5
1
2 Principal Component Cost RateReturn
Component3 ($ Millions) (%) (%) (%)4 Medium and Long-Term Debt 1,313.9 56.0 5.38 3.01 5 Short Term Debt 93.9 4.0 2.07 0.08 6 1,407.8 60.0 3.09 78 Preferred Shares - - - - 9 Common Equity 938.5 40.0 9.85 3.94
10 2,346.3 100.0 7.03
Notes:
Cost of Capital
2011 Test Year
1) Cost of Equity and Short-Term debt based on 2010 approved rates. To be updated according to Cost of Capital guidelines
Toronto Hydro-Electric System LimitedEB-2009-0139
Exhibit E1Tab 4
Schedule 2ORIGINAL
Page 1 of 1
Table 1: Col. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7
1 Description Issue Date Maturity Principal ($) Coupon RateEffective
DaysCarrying Cost
($)2 $980M City Note May 6, 2003 May 6, 2013 490,115,467 5.36% 365 26,270,1893 $180M Debenture May 6, 2003 May 6, 2013 180,000,000 6.16% 365 11,088,0004 1st tranche City Note Replacement Nov 14, 2007 Nov 14, 2017 245,057,739 5.20% 365 12,743,0025 2nd tranche City Note Replacement Nov 12, 2009 Nov 12, 2019 245,057,739 4.54% 365 11,125,6216 $200M Debenture May 20, 2010 May 20, 2040 200,000,000 5.59% 365 11,180,0007 Capex Issue Dec 15, 2011 Dec 15, 2021 100,000,000 5.75% 17 267,8088 3rd tranche City Note Replacement Dec 15, 2011 Dec 15, 2021 245,057,739 5.75% 17 656,2859 Financing Costs1 676,996
10 Avg of Monthly Debt Outstanding 1,376,302,127 5.38% 74,007,902
Notes:1. Includes amortized issue costs
Medium and Long-Term Debt Costs - 2011
Toronto Hydro-Electric System LimitedEB-2010-0142
Exhibit E1Tab 5
Schedule 1ORIGINAL
Page 1 of 1Canadian Interest and Exchange Rate Forecasts
Table 1: Quarterly ForecastCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7 Col. 8
1 Year
30-Day Commerical Paper (%)
90-Day Commercial Paper (%)
Prime Rate (%)
5 Year Govt Bonds (%)
10 Year Govt Bonds (%)
Long-Term Govt Bonds (%)
Exchange Rate ($Cdn/US)
2 2006:1(A) 3.70 3.82 5.33 4.04 4.15 4.19 1.1553 2006:2(A) 4.27 4.34 5.92 4.41 4.53 4.58 1.1224 2006:3(A) 4.32 4.33 6.00 4.05 4.16 4.24 1.1215 2006:4(A) 4.32 4.32 6.00 3.96 4.05 4.12 1.1396 2007:1(A) 4.35 4.34 6.00 4.01 4.10 4.17 1.1727 2007:2(A) 4.37 4.45 6.00 4.42 4.42 4.38 1.0988 2007:3 (A) 4.90 4.94 6.25 4.41 4.46 4.48 1.0459 2007:4 (A) 4.67 4.78 6.17 4.04 4.16 4.26 0.982
10 2008:1 (A) 3.83 3.79 5.58 3.28 3.72 4.11 1.00411 2008:2 (A) 3.15 3.19 4.75 3.27 3.66 4.08 1.01012 2008:3 (A) 3.18 3.32 4.75 3.18 3.66 4.10 1.04213 2008:4 (A) 2.51 2.62 3.83 2.32 3.26 3.89 1.21214 2009:1 (A) 1.22 1.19 2.83 2.03 2.96 3.72 1.24515 2009:2 (A) 0.61 0.61 2.25 2.38 3.37 3.97 1.16716 2009:3 (A) 0.39 0.41 2.25 2.63 3.41 3.93 1.09717 2009:4 (A) 0.36 0.38 2.25 2.62 3.43 3.96 1.05618 2010:1 0.35 0.42 2.00 2.46 3.25 3.82 1.04019 2010:2 0.35 0.45 2.00 2.25 3.03 3.57 1.01820 2010:3 0.65 0.76 2.29 2.27 2.99 3.49 1.00621 2010:4 1.17 1.28 2.79 2.42 3.08 3.52 1.00022 2011:1 1.77 1.88 3.37 2.67 3.24 3.62 0.99623 2011:2 2.66 2.76 4.25 3.12 3.59 3.89 0.99224 2011:3 3.22 3.31 4.79 3.40 3.80 4.06 0.98925 2011:4 3.72 3.82 5.29 3.71 4.04 4.26 0.98726 2012:1 4.22 4.32 5.79 4.04 4.31 4.48 0.985
Table 2: Annual AveragesCol. 1 Col. 2 Col. 3 Col. 4 Col. 5 Col. 6 Col. 7 Col. 8
1 Year
30-Day Commerical Paper (%)
90-Day Commercial Paper (%)
Prime Rate (%)
5 Year Govt Bonds (%)
10 Year Govt Bonds (%)
Long-Term Govt Bonds (%)
Exchange Rate ($Cdn/US)
2 2006 (A) 4.15 4.20 5.81 4.12 4.22 4.28 1.1343 2007 (A) 4.57 4.63 6.10 4.22 4.28 4.32 1.0744 2008 (A) 3.17 3.23 4.73 3.01 3.58 4.05 1.0675 2009 (A) 0.65 0.65 2.40 2.41 3.29 3.90 1.1426 2010 0.63 0.73 2.27 2.35 3.09 3.60 1.0167 2011 2.84 2.94 4.43 3.23 3.67 3.96 0.991
Source: Conference Board of Canada, March 18, 2010
Rating Report
Report Date:
November 19, 2009
Previous Report:
October 8, 2008
1 Corporates: Energy
Analysts
Robert Filippazzo
+1 416 597 7340
Michael Caranci
+1 416 597 7304
The Company
Toronto Hydro
Corporation is a holding
company with the
following subsidiaries:
Toronto Hydro-Electric
System Ltd., which
distributes electricity,
and Toronto Hydro
Energy Services Inc.,
which provides street
lighting and expressway
lighting services, as well
as energy-efficient
products and services.
Toronto Hydro’s sole
shareholder is the City
of Toronto (the City),
rated AA by DBRS.
Recent Actions
November 4, 2009
Short-Term Rating
Confirmed; Long-Term
Rating Upgraded
Toronto Hydro Corporation
Rating
Debt Rating Rating Action Trend
Short-Term Issuer Rating R-1 (low) Confirmed Stable
Senior Unsecured Debentures & MTNs A (high) Upgraded Stable
Rating Rationale
DBRS has upgraded the rating on the Senior Unsecured Debentures & MTNs of Toronto Hydro Corporation (Toronto Hydro or the Company) to A (high) from “A”; the trend has been changed to Stable from Positive. Toronto Hydro’s Short-Term Issuer Rating has been confirmed at R-1 (low), with a Stable trend. On September 26, 2008, DBRS changed the trend on the Company’s Senior Unsecured Debentures & MTNs rating to Positive from Stable. That action reflected a number of factors, including (1) the continued improvement over time of Toronto Hydro’s business risk profile, driven by the sale of higher-risk, non-regulated businesses; (2) demonstrated stable financial metrics in the face of declining regulatory-approved return on equity (ROE) levels and a heightened capital expenditure program, which had resulted in consistent free cash flow deficits; and (3) the expectation of near-term rate base growth, which would primarily be funded with cash flow and cash on hand. The trend change also reflected the stable regulatory environment, which provided Toronto Hydro-Electric System Ltd. (THESL or LDC) with a reasonable framework to carry out its future capital and workforce renewal plans while maintaining a stable credit profile. At the time of its last review, DBRS stated that it would consider an upgrade of the Senior Unsecured Debentures & MTNs rating if Toronto Hydro continued to exhibit strong financial and operating performance and retained a substantial portion of the proceeds (as anticipated) from the sale of Toronto Hydro Telecom Inc. (THTI) and if there were no negative regulatory and/or political actions over the near term. (Continued on page 2.)
Rating Considerations
Strengths Challenges (1) Low business risk profile (2) Strong franchise area (3) Solid credit metrics/balance sheet (4) Strong reliability measures/operational efficiency (5) Divestiture of non-regulated/non-core businesses
(1) Significant capital investment program (2) Approved ROE sensitive to long-term interest rates (3) Earnings sensitive to volume of electricity sold (4) Significant external financing required
Financial Information
12 mos ended For the year ended December 31
Jun. 2009 2008 2007 2006 2005
Total adjusted debt (CAD millions) (1) 1,240 1,240 1,241 1,216 1,216
Total adj. debt-to-capital (%) (1) 55.6% 55.8% 57.2% 57.7% 59.0%
Cash flow/total debt (%) (1) 18.1% 17.6% 17.9% 17.9% 16.6%
Cash flow/capital expenditures (times) 1.04 1.01 0.74 1.18 1.44
EBITDA gross interest coverage (times) (1) 3.92 3.85 4.08 4.12 3.83
Operating cash flow (CAD millions) 224 218 223 218 202
Core net income (CAD millions)* 41 54 59 77 64
Reported net income (CAD millions) 153 169 83 92 92
*DBRS adjusted to non-recurring one time items
(1) DBRS adjusted debt and interest expense for operating leases.
2 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Rating Rationale (Continued from page 1.)
The Company’s continued financial and operating performance, coupled with the availability of the proceeds from the sale of THTI (approximately $100 million) to partially fund its ongoing capital expenditure program, and the expectation of no material change in the Company’s dividend policy going forward provides DBRS with the comfort necessary to upgrade the rating to A (high). DBRS believes that Toronto Hydro is well positioned to maintain credit metrics commensurate with its new rating category over the medium term as the Company should receive higher base rates to recover significant capital investments, as well as benefit from lower interest expense from refinancing of higher-cost maturing issues. On November 12, 2009, the Company issued $250 million of 4.49% senior unsecured debentures due 2019 (Series 3). Proceeds from the issue will be used primarily for repayment of the second 6.11% $245.1 million installment of the City Note due December 31, 2009. Toronto Hydro continues to benefit from the Ontario Energy Board’s (OEB) decision to approve cost-of-service settlements for the Company, given its expectation of higher capital expenditures. This differs from the originally proposed incentive rate-adjustment mechanism that followed the rebasing of distribution rates in 2006. Currently, Toronto Hydro is in the third year of its five-year capital plan to modernize the electricity distribution system. DBRS expects capital investment to average approximately $300 million per year through 2011 (although the distribution company has filed a higher capital requirement in its 2010 cost-of-service application with the OEB), which is projected to result in manageable free cash flow deficits over the medium term. However, the Green Energy Act could lead the Company to invest more on its current system to, for example, render it capable of two-way power flow in order to accommodate the potential for new renewable generation that comes on line. While the Company will continue to incur free cash flow deficits (in the expected range, on average, of $100 million to $150 million per year), current cash on hand ($265 million as of June 30, 2009) should be sufficient to internally fund the majority of cash flow deficits through 2010. This will allow for rate base growth, with modest addition of incremental debt. This, in conjunction with higher base rates to recover significant capital investments and the potential for lower interest expense from the refinancing of higher-cost maturing issues, should have a positive impact on the Company’s financial metrics through the build-out cycle.
Organizational Chart
Toronto Hydro CorporationPromissory Note= $735 million
Senior Unsecured Debentures=$475 million A (high)CP/ ST obligations R-1(low)
LT debt= $1,207 million
Toronto Hydro- Electric System
Limited(THESL or LDC)
Regulated electric distribuiton
Toronto Hydro Energy Services(TH Energy)
Energy Services, street lighting andexpressway lighting services
Non-RegulatedRegulated
As at June 30, 2009
3 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Rating Considerations Details
Strengths (1) Toronto Hydro is predominantly a regulated electric distribution company that operates in an improved regulatory environment. The Company’s regulated business model provides a high degree of stability to earnings and cash flows over the longer term.
(2) Toronto Hydro is one of the largest municipally owned local distribution companies (LDCs) in Canada, serving a large customer base (689,000 customers) in a strong franchise area. Approximately 90% of Toronto Hydro’s electricity sales are to residential and general service customers; demand is relatively stable year over year, as these customers are less sensitive to economic cycles.
(3) While Toronto Hydro’s earnings have declined modestly from 2006 levels, due to lower regulated approved ROEs and significantly lower contributions from non-regulated businesses, the Company has been able to maintain stable financial metrics with an adjusted debt-to-capital ratio at 55.6%, EBITDA interest coverage at 3.92 times and cash flow-to-debt at 18.1% (12 months ended June 30, 2009). Over the next two years, DBRS expects the Company to fund capital expenditure-related cash flow deficits out of cash on hand, which will underpin Toronto Hydro’s credit metrics through the capital program.
(4) THESL continues to exceed OEB service level targets, which should provide a stable platform to maintain a constructive relationship with the regulators.
(5) Toronto Hydro’s business risk profile has improved gradually over the years as higher-risk, non-regulated operations have continued to represent a decreasing proportion of consolidated operations. Challenges (1) The Company is in the middle of a significant capital expenditure program to replace aging assets and enhance the reliability of the system. DBRS expects capital investment to average approximately $300 million per year through 2011 (although the distribution company has filed a higher capital requirement in its 2010 cost-of-service application with the OEB), which is projected to result in manageable free cash flow deficits over the medium term. However, the Green Energy Act could lead the Company to invest more in its current lines to make them two-way flow in order to accommodate the potential of new renewable generation that comes on line. (2) Regulatory-allowed ROE levels are low and could continue to decline if longer-term interest rates decline. The ROE of 8.01% in 2009 is down from 8.57% in 2008. The impact of the lower ROE on earnings was somewhat offset as the equity component of the capital structure increased to 40% in 2009 from 35% in 2007. However, earlier in 2009, the OEB commenced a proceeding to examine the ROE formula. This proceeding is largely concluded, and a decision is expected from the OEB by mid-December 2009. (3) Earnings and cash flows for electricity distribution companies are partially dependent on the volume of electricity sold, given that rates typically include a variable charge component. Seasonality, economic cyclicality and weather variability have a direct impact on the volume of electricity sold and, hence, on revenue earned from electricity sales. (4) Toronto Hydro is dependent upon the debt markets to refinance the $735 million City promissory note (the City Note) and fund longer-term capital investments in THESL. Over the next six years, Toronto Hydro will have to refinance 80% ($960 million) of its outstanding debt, exposing itself to interest rate risk. However, because much of this debt was incurred for THESL, a market-based interest rate on third-party debt should be fully recoverable from ratepayers. Furthermore, DBRS believes the Company will go to the market with longer-dated debentures and spread out the maturities in an effort to better match debt obligations with its average asset life and lessen the refinancing of a high percentage of outstanding debt during a short period of time. The Company recently sold $250 million of debt to pre-fund the second 6.11% $245.1 million installment of the City Note due December 31, 2009. Maintaining adequate access to the debt markets is critical during this refinancing and build-out cycle.
4 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Regulation
Toronto Hydro’s electricity distribution operations are regulated by the Ontario Energy Board (OEB) under the Electricity Act, 1998 (the Electricity Act), as modified by the following noteworthy amendments:
• The Electricity Pricing, Conservation and Supply Act, 2002 (Bill 210) – December 9, 2002;
• The Ontario Energy Board Amendment Act, 2003 (Bill 4) – December 18, 2003; and
• The Electricity Restructuring Act, 2004 (Bill 100) – December 9, 2004.
Currently, THESL operates under cost-of-service regulation with a deemed ROE of 8.01%.
In February 2009, the OEB provided final approval for 2009 base distribution revenue requirements and rate base of $483 million and $2,035 million, respectively. THESL has filed a cost-of-service rate application for 2010 distribution rates. The Company is seeking a revenue requirement of $529 million and a rate base of $2,162 million.
In support of the Province of Ontario’s decision to install smart meters throughout Ontario by 2010, THESL launched its smart meter project in 2006. The project objective is to install smart meters and the supporting infrastructure by the end of 2010 for all residential and commercial customers. THESL had installed approximately 611,000 smart meters as at June 30, 2009.
On December 15, 2008, THESL applied to the OEB to recover Lost Revenue Adjustment Mechanism (LRAM) and Shared Savings Mechanism (SSM) amounts related to Conservation and Demand Management (CDM) programs undertaken in 2007. The total amount of the recovery sought is $3,700,000. On September 22, 2009, the OEB approved the application in its entirety, and rates to recover the $3.7 million will take effect on May 1, 2010.
Earnings and Outlook
12 mos ended For the year ended December 31
(CAD millions) Jun. 2009 2008 2007 2006 2005
Net operating revenues * 511 498 498 521 512
Operating expenses 215 205 190 194 191
EBITDA* 296 293 307 326 321
EBIT* 136 136 163 189 189
Gross interest expense 74 75 74 79 83
Payments in lieu of income taxes* 28 20 46 51 56
Core net income* 41 54 59 77 64
Reported net income 153 169 83 92 92
Return on equity 4.3% 5.6% 6.5% 8.9% 7.7%
Operating margin 27% 27% 33% 36% 37%
Reported regulated EBIT 147 149 170 187 194
Reported non-regulated EBIT (11) (11) (5) 23 30
% of EBIT non-regulated -8% -8% -3% 11% 13%
*DBRS adjusted to exclude mark-to-market in revenues, tax recovery settlements and income from discontinued ops.
Summary Earnings, as measured by EBIT, have trended lower since 2006, driven by lower regulatory-approved ROE levels and significantly lower earnings contribution from non-regulated businesses, which have been divested.
Operating expenses have steadily increased over the years, reflective of investments made by THESL into the hiring of new apprentices in the electrical trades and annual general wage increases, investments in new business activities and, more importantly, the increase in maintenance costs for the Company’s aging infrastructure.
Gross interest expense continues to decline as a result of lower interest costs on long-term debt.
5 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
The historical variance between DBRS’s core net income and reported net income reflects the previous mark-to-market gains on non-regulated energy contracts (2004-2006), discontinued earnings associated with the Company’s waterheater business in 2007, and the one-time tax recovery settlement and income from discontinued operations in 2008.
While it appears that the Company has consistently earned below approved ROEs, the difference is largely due to the equity base at Toronto Hydro relative to the THESL rate base.
Outlook DBRS expects earnings to remain relatively flat over the medium term as the Company should receive higher base rates to recover significant capital investments, as well as benefit from the potential for lower interest expense from the upcoming refinancing of higher-cost maturing issues. Additionally, the Company will benefit from a higher equity component of the capital structure, which increased to 40% in 2009.
DBRS believes gross interest expense should trend lower over the medium term as Toronto Hydro refinances higher-cost maturing issues.
The underlying fundamentals of Toronto Hydro’s electricity distribution business remain favourable, and should generate reasonable returns over the longer term.
Financial Profile and Outlook
Cash Flow Statement 12 mos ended For the year ended December 31
(CAD millions) Jun. 2009 2008 2007 2006 2005
Net income (before non-recurring) 41 54 59 77 64
Depreciation and amortization 160 156 152 137 132
Other non-cash adjustments 23 8 12 4 6
Cash Flow From Operations * 224 218 223 218 202
Dividends paid (100) (116) (46) (46) (68)
Capital expenditures (216) (215) (301) (185) (140)
Gross Free Cash Flow (93) (113) (124) (14) (7)
Changes in working capital 21 34 (17) (145) 100
Net Free Cash Flow (71) (79) (141) (158) 94
Acquistions 0 0 0 0 (60)
Dispositions 1 1 2 1 5
Change in regulatory assets (increase)/ decrease (77) 17 64 (4) 21
Non-recurring / Other 14 10 (80) 40 23
Cash Flow before Financing (134) (52) (155) (122) 82
Net debt financing 5 5 5 0 0
Customer deposits / repayment of capital lease 6 4 (2) 1 (22)
Net Cash provided by discontinued operations 171 168 38 1 1
Net Change in Cash 47 124 (114) (121) 62
Key Financial Ratios
Total adjusted debt (1) 1,240 1,240 1,241 1,216 1,216
Total adj. debt-to-captial (1) 55.6% 55.8% 57.2% 57.7% 59.0%
Cash flow/total adj. debt (1) 18.1% 17.6% 17.9% 17.9% 16.6%
EBITDA gross interest coverage (times) (1) 3.92 3.85 4.08 4.12 3.83
EBIT gross interest coverage (times) (1) 1.81 1.81 2.18 2.39 2.27
Dividend payout ratio 244% 217% 79% 60% 106%
*Operating cash flow adjusted to exclude mark-to-market in revenues. (1)DBRS adjusted debt and interest expense for operating leases.
Summary Operating cash flow has remained relatively flat since 2006. However, the heightened capital expenditures over this period combined with dividends continue to result in free cash flow deficits. These deficits have been funded out of cash on hand, with no increases in debt.
While not reflected in the cash flow statement, in July 2008, Toronto Hydro closed the sale of THTI for $200 million in cash. Retained sale proceeds of approximately $100 million were added to the Company’s cash balance and will be used to fund future capital investment in the utility.
6 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Cash flow from operations has benefited from higher depreciation and amortization as well as the timing of billing and collection activities and the payment of electricity rebates. While the Company continues to generate consistent free cash flow deficits, key credit metrics have improved gradually, as debt levels have been constant with a growing equity base and lower interest expense on the City Note and the refinancing of maturing issues. Outlook Operating cash flow should trend higher over the medium term, underpinned by growing earnings and higher depreciation commensurate with increases in capital expenditures. Capital expenditures for THESL are planned to increase through 2011. To this end, THESL is seeking a capital budget of $425 million as part of its 2010 cost-of-service rate application. This, in conjunction with Toronto Hydro’s current dividend policy, will increase cash needs through the capital build-out cycle. However, THESL is only expected to ramp up to the higher capital expenditure level once OEB approval is obtained. While the Company will continue to incur free cash flow deficits (of approximately $150 million per year), current cash on hand ($265 million as of June 30, 2009) should be sufficient to internally fund the majority of cash flow deficits through 2010. This will allow for rate base growth with modest addition of incremental debt. This, in conjunction with higher base rates to recover significant capital investments and the potential for lower interest expense from the refinancing of higher-cost maturing issues, should have a positive impact on the Company’s financial metrics through the build-out cycle.
Long-Term Debt Maturities and Bank Lines
As at June 30, 2009
Repayment
schedule % CDN millions
2009 20% 245 Credit Facility (CAD millions) Amount Drawn/LOCs Available Expiry
2010 0% 0 Three year revolving credit facility 500 45 455 5/3/2010
2011 20% 245
2012 0% 0
2013 39% 470 Long-term debt Int. rate Jun. 2009 Dec. 2008
2014 0% 0 Senior unsecured debentures 5.6% 475 475
Thereafter 21% 250 Promissory note payable to the City 6.1% 735 735
Total 1,210 Total debt 1,210 1,210
Long-Term Debt As at June 30, 2009, the debt repayment schedule is significant, with approximately 80% of long-term debt refinanced by 2013. Most of these maturities are notes owed to the City, but also include the $225 million in third-party debt issued in 2003. However, we note that on November 12, 2009, the Company issued $250 million of 4.49% senior unsecured debentures due 2019 (Series 3). Proceeds from the issue will be used primarily for repayment of the second $245.1 million installment of the City Note due December 31, 2009. Refinancing maturing issues should be well within Toronto Hydro’s financing capacity as evidenced in its recent issuance, given its low level of business risk and solid financial profile. In December 2008, Toronto Hydro re-filed an MTN shelf prospectus which is intended to be used to repay outstanding amounts of the City Note and for general corporate purposes, including capital expenditures for THESL.
7 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
The debenture indenture includes the following covenants: ¯ Any additional indebtedness is subject to a 75% capitalization ratio test. ¯ Negative pledge clause. ¯ Limitations on designated subsidiary indebtedness.
The $735 million City Note ranks pari passu with the senior unsecured debentures.
Liquidity As of June 30, 2009, the Company had a $500 million credit line, of which $455 million was available. This facility, in addition to stable operating cash flow and a substantial cash balance of $265 million, gives the Company strong liquidity to support its working capital needs over the medium term. DBRS notes that Toronto Hydro currently does not have a commercial paper program.
8 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Balance Sheet Toronto Hydro Corporation(CAD millions) As of As at December 31 As of As at December 31
Assets 2009 2008 2007 Liabilities and Equity Jun. 2009 2008 2007
Cash + short-term investments 265 340 216 Short-term debt 245 245 -
A/R + unbilled revenue 396 398 432 A/P + accruals 293 312 309
Inventories/tax receivables 27 29 28 Other current liab. 5 4 11
Prepaids and other 5 3 2 Current Liabilities 543 561 320
Current Assets 693 770 678 Customer deposits 30 30 24
Net fixed assets 1,869 1,854 1,845 Long-term debt 962 962 1,206
Investments held to maturity 51 53 75 Employment benefits 156 153 144
Future income tax asset 297 3 15 Other liabilities 351 92 73
Regulatory assets 52 26 19 Shareholders' equity 990 981 929
Intangibles & other assets 70 75 64 Total 3,032 2,780 2,696
Total 3,032 2,780 2,696
Ratio Analysis 12 mos ended For the year ended December 31
Liquidity Ratios Jun. 2009 2008 2007 2006 2005
Current ratio 1.28 1.37 2.12 1.44 1.13
Total debt-to-capital (1) 55.6% 55.8% 57.2% 57.7% 59.0%
Cash flow/total debt (1) 18.1% 17.6% 17.9% 17.9% 16.6%
Cash flow/capital expenditures 1.04 1.01 0.74 1.18 1.44
(Cash flow-dividends)/capital exp. 0.57 0.47 0.59 0.93 0.95
Debt/EBITDA (1) 4.19 4.23 4.04 3.73 3.79
Common dividend payout ratio 244.3% 216.9% 78.6% 60.1% 106.3%
Deemed equity 40% 40% 35% 35% 35%
Coverage Ratios
EBITDA gross interest coverage (1) 3.92 3.85 4.08 4.12 3.84
EBITDA net interest coverage (1) 4.44 4.69 5.27 5.34 4.65
EBIT gross interest coverage (1) 1.81 1.81 2.18 2.39 2.27
EBIT net interest coverage (1) 2.03 2.19 2.80 3.09 2.75
Profitability/Operating Efficiency
Operating margin 5.7% 5.8% 7.0% 8.6% 7.4%
Net margin (before extras.) 8.0% 10.8% 11.8% 14.8% 12.5%
Return on average equity (before extras.) 4.2% 5.6% 6.5% 8.9% 7.7%
Electricity Throughputs (million kWh) % 2008 2007 2006 2005
Residential 21% 5,216 5,332 5,352 5,724
General service 69% 17,415 17,837 17,583 18,085
Large users 10% 2,508 2,591 2,592 2,563
Total (million kWh) 25,139 25,760 25,527 26,372
Growth in electricity throughputs -2.4% 0.9% -3.2% 3.4%
Customers % 2008 2007 2006 2005
Residential 89% 605,509 601,515 599,080 597,469
General service 11% 78,589 78,349 78,978 79,162
Large users 0% 47 49 49 47
Total 684,145 679,913 678,107 676,678
Growth in customer base 0.6% 0.3% 0.2% 0.5%
(1) DBRS adjusted debt and interest expense for operating leases.
Financial results reflect adjustment to exclude mark-to-market in revenues, tax recovery settlement and Discontinued Ops.
9 Corporates: Energy
Toronto Hydro
Corporation
Report Date:
November 19, 2009
Rating
Debt Rating Rating Action Trend
Short-Term Issuer Rating R-1 (low) Confirmed Stable
Senior Unsecured Debentures & MTNs A (high) Upgraded Stable
Rating History
Current 2008 2007 2006 2005
Short-Term Issuer Rating R-1 (low) R-1 (low) R-1 (low) R-1 (low) R-1 (low)
Senior Unsecured Debentures & MTNs A (high) A A A A
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