Fitch Affirms Hydro-Quebec's C$45.7 Billion Unsecured Debt at 'AA-'; Outlook to Stable

NEW YORK--()--Fitch Ratings has affirmed the following ratings for Hydro-Quebec (HQ) (outstanding par amounts as of Dec. 31. 2015):

--Long-Term Issuer Default rating at 'AA-';

--Short-Term Issuer Default rating at 'F1+';

--C$45.7 billion parity unsecured debentures and medium-term notes at 'AA-';

--US$3.5 billion or equivalent in C$ commercial paper program (CP) at 'F1+'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

HQ's debt, including the CP, is an unsecured obligation of the utility and further supported by an unconditional payment guarantee by the Province of Quebec (rated 'AA-'/Stable Outlook).

KEY RATING DRIVERS

PROVINCIAL OUTLOOK CHANGE: The revised Outlook for HQ reflects Fitch's recent revision of the Province's Rating Outlook to Stable from Negative (June 14, 2016). HQ's foremost rating driver is the Province's irrevocable and unconditional payment guarantee of HQ debt. The guarantee extends to the vast majority of long- and short-term debt of HQ, and ranks equally in right of payment with all other unsecured obligations of the Province.

LOW-COST HYDROELECTRIC POWER: HQ maintains one of the lowest-cost hydroelectric generating systems in North America. This favorably 'green' resource is supported by substantial reservoirs which provide a distinct energy storage advantage over neighboring Canadian and U.S. hydro-based utilities.

SOUND FINANCIAL POSITION: HQ has exhibited strong financial performance over the past five years, with average annual debt service coverage of 1.80x (2015 peer median is 1.43x), after accounting for transfers to the province as operating expenses. Net income, for the second year in a row, was robust at C$3.1 billion, primarily due to cold winter weather boosting native demand and a higher volume of export sales than anticipated.

LARGE CAPITAL PLAN: HQ has been investing heavily in utility infrastructure since 2009. Capital expenditures for the past five years have approximated C$20 billion and HQ projects spending another C$18.1 billion through 2020. The capital additions have been needed to meet load growth, maintain reliable service and provide generation for the production division's profitable export sales.

MANAGEABLE DEBT: HQ's debt structure is similar to corporate utilities, with mainly bullet maturities, as opposed to amortizing debt. Positively, HQ staggers debt maturities to alleviate debt paydown and refinancing risk. With modest debt coming due from 2023-2034, HQ's debt capacity remains adequate going forward. Leverage is moderate as measured by debt-to-funds available for debt service (FADS) of 5.5x, but slightly weaker than the peer median of 4.8x (2015). Equity capitalization has been stable and is projected to remain at approximately 30% through 2020.

INCREASING BUSINESS RISK: Prospectively, HQ's consolidated business profile could be subject to greater margin volatility as it increases its reliance on more variable export sales from its production division and the utility explores power-related investments outside of Quebec for added revenue growth.

SIZEABLE CP PROGRAM: HQ's US$3.5 billion CP program is supported by a syndicated credit facility sized at C$2 billion which expires in April 2021. While the credit facility does not fully cover the maximum liquidity exposure of the CP program, it is rated 'F1+' due to the support provided by the provincial guarantee (Short-Term rating of 'F1+) and HQ's considerable unrestricted cash and equivalents of C$2.6 billion as of Dec. 31, 2015.

RATINGS SENSITIVITIES

CHANGE IN CREDIT QUALITY OF QUEBEC: Fitch traditionally rates Hydro-Quebec in line with the Province of Quebec, given the provincial ownership of HQ, considerable transfers from HQ to the province, and the province's guarantee of HQ's debt.

UTILITY FUNDAMENTALS SOUND: Although unlikely at the current rating level, HQ's rating could be revised separately from rating action on the province, if Fitch determined that HQ's utility operations, projected financial performance, and independence from the province supported a higher rating than that provided by the guarantee.

CREDIT PROFILE

Hydro-Quebec is a vertically integrated electric system in Canada, providing electric service to 4.2 million customers in Quebec. HQ is among the largest electric systems in North America, with installed generating capacity of 36,912 MW, as of Dec. 31, 2015. HQ generates roughly 99% of its energy through low-cost, environmentally valuable, hydroelectric power.

HQ is composed of four principal operating divisions: HQ Production (power generation); HQ TransEnergie (transmission division); HQ Distribution; and HQ Equipement et Services Partages and Societe d' energie de la Baie-James (designs, builds and refurbishes generation and transmission facilities). Both the HQ Transmission and Distribution divisions are subject to rate and regulatory oversight by the Province's utility commission, the Regie' de l'energie. HQ's unregulated production division generates the largest proportion of HQ consolidated net income - 67.7% for FYE2015.

PROVINCIAL OUTLOOK STABILIZED

The key driver supporting HQ's Outlook revision to Stable is the June 14, 2016 rating action taken on the Province. Fitch affirmed Quebec's 'AA-/F1+' IDRs and revised the Outlook to Stable from Negative, reflecting the Province's success in achieving fiscal budgetary balance in 2015 and the likelihood of continued stronger operating performance prospectively.

The current provincial rating essentially provides a lower boundary for HQ's ratings. Although unlikely at the current rating level, HQ's rating could be revised separately from rating action on the province, if Fitch determined that HQ's utility operations, projected financial performance, and independence from the province supported a higher rating than that provided by the guarantee.

STABLE FINANCIAL PERFORMANCE

HQ is a self-supporting utility with a history of stable consolidated financial performance. Debt service coverage is strong, ranging from 1.91x-2.88x since fiscal 2011. Coverage of full obligations, which incorporates HQ's dividend payment and other substantial transfers to the Province as operating expenses, is very solid for the rating category at 1.40x-2.21x. HQ's business divisions have been able to sufficiently raise rates, meet project development on time and within budget, and take advantage of increasing export sales to generate net income.

HQ also maintains solid liquidity levels, with several external bank credit lines, in aggregate contributing to an ample 501 days operating liquidity for FYE2015. Fitch anticipates HQ will maintain its conservative financial and operating practices going forward.

For additional information please see the Fitch press release dated Dec. 18, 2015, available at www.fitchratings.com.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Public Power Rating Criteria (pub. 18 May 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1006275

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1006275

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Lina Santoro
Analytical Consultant - Power
+1-212-908-0522
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Christopher Hessenthaler
Senior Director
+1-212-908-0773
Additional information is available at 'www.fitchratings.com'.
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Lina Santoro
Analytical Consultant - Power
+1-212-908-0522
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Committee Chairperson
Christopher Hessenthaler
Senior Director
+1-212-908-0773
Additional information is available at 'www.fitchratings.com'.
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com