Fitch Rates Hydro-Quebec's US$3B Medium-Term Note Program 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA-' rating to Hydro-Quebec's (HQ) filing of US$3 billion medium-term note (MTNs) program update. Proceeds from this MTN program will fund a portion of HQ's capital program and/or refinance maturing debt.

Fitch also affirms the following HQ ratings:

--Long-term Issuer Default Rating (IDR) at 'AA-';

--Short-term IDR at 'F1+';

--$41.5 billion parity unsecured debentures and medium-term notes at 'AA-';

--Commercial paper at 'F1+' (authorized up to maximum issuance of $3.5 billion; only $23 million currently outstanding).

The Rating Outlook is Stable.

SECURITY

HQ's debt is secured by the net revenues of the consolidated HQ system. Commercial paper notes are on parity with outstanding unsecured debentures and medium-term notes. HQ's bonds and commercial paper are further secured by an irrevocable and unconditional payment guarantee by the Province of Quebec (long-term IDR 'AA-'; short-term IDR 'F1+'; Outlook Stable by Fitch).

KEY RATING DRIVERS

PROVINCIAL GUARANTEE: HQ's credit ratings are driven by an irrevocable and unconditional guarantee provided by the government of Quebec. This guarantee extends to both the long- and short-term HQ ratings noted above, and ranks equally in right of payment with all other unsecured obligations for borrowed money of the province of Quebec.

LOW COST HYDROELECTRIC POWER: On a stand alone basis, HQ is an integrated utility with low-cost and largely carbon-free hydroelectric power resources (average of 2.14 cents per kWh production cost for 2010).

COMPETITIVE ELECTRIC RATES: HQ's distribution division, regulated on a cost-of-service basis, maintains some of the lowest retail rates in North America (average revenue of 6.82 cents per delivered kWh as of April 2011). The Regie de l'energie approved a distribution rate decrease of 0.41%, effective April 1, 2011. While the approval of a rate decrease is a concern, HQ's continued solid financial performance offsets this concern.

RESERVOIRS SUPPORT HYDROPOWER OPERATIONS: HQ's hydropower resource base benefits from substantial reservoirs which help mitigate exposure to variable hydrological conditions as occurred in fiscal year 2010.

SOUND FINANCIAL POSITION: HQ has a history of solid financial performance, with cash flow from operations coverage of interest ranging from 1.73x to 2.08x for the past five years, and equity-to-total capitalization presently stable at 33.3%.

LARGE CAPITAL PROGRAM: HQ is currently in the midst of a substantial capital program, with associated construction risks related to the build-out of several large hydroelectric and transmission projects through 2020. Positively, the projects are proceeding on time and within budget.

INCREASING LEVERAGE: The capital expenditure program is estimated at $20 billion from 2010 - 2013, of which, approximately 60% will be debt financed. Leverage will increase to 70% debt-to-capitalization in FY 2013, from 66.7% as of nine months ended 9/30/11. This level of debt is slightly above our rating category median (53%), but supportable at the 'AA-' given HQ's sound financial position and the provincial guarantee.

FINANCIAL METRICS WILL TIGHTEN THROUGH 2013: Financial metrics have tightened modestly through the capital expenditure program thus far, as projected in HQ's Strategic Plan for 2009 - 2013, but should remain adequate for the 'AA-' rating category.

WHAT COULD TRIGGER A RATING ACTION

The key rating driver for HQ is the credit strength of the province of Quebec, given the explicit guarantee.

CREDIT SUMMARY

HQ is a vertically integrated electric system in Canada, providing electric service to virtually all of Quebec, or 4 million customer accounts. Ownership of over 36,671 MW of installed generating capacity and over 33,000 kilometers of transmission lines places HQ among the largest electric systems in North America.

HQ is comprised of four principal operating divisions: Hydro-Quebec Production (power generation); Hydro-Quebec TransEnergie (transmission service); Hydro-Quebec Distribution; and Hydro-Quebec Equipement et Services partagees and Societe d'energie de la Baie James (construction division). Transmission and distribution services are provided under regulated tariffs; while generation services are unregulated. For FY 2010, the production division continued to supply the majority of HQ consolidated net income, accounting for 63.8% of net margins. For FY 2011, the reliance on net income from the unregulated production division is projected to rise to 67.5%, as off-system sales continue to grow.

Consolidated net income reached $2.5 billion for FY 2010, exceeding the budgeted target of $2.4 billion. HQ distributed a dividend of $1.886 billion to its sole shareholder, the Province of Quebec. Net income for the nine months ended Sept. 30, 2011 stands at $2.2 billion, and HQ is on track to meet or exceed its budget of $2.4 billion. Liquidity, in the form of current cash reserves, had declined in FY2010 to $1.3 billion, but the reserves have recovered to $2.1 billion through the third quarter of FY2011. This improvement reflects the positive impact of a colder winter, strengthening electricity sales within Quebec, and successful cost containment efforts.

Going forward, HQ is projecting reasonable kWh sales growth (2.3% per year or less native load growth through 2013), increasing off-system sales, continued timely progress on its construction projects, and moderate distribution rate increases (of 1.7% in 2012 and 2.5% in 2013). With modest debt maturities in 2012 and 2013, HQ should be able to sustain cash flow interest coverage in the 1.75x range and equity capitalization of roughly 30%.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 20, 2011);

--'Public Power Rating Guidelines' (Jan. 11, 2012).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

U.S. Public Power Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=665815

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Contacts

Fitch Ratings
Primary Analyst
Michael Mohammed Murad, +1-212-908-0757
Associate Director
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Lina Santoro, +1-212-908-0522
or
Committee Chairperson
Dennis Pidherny, +1-212-908-0783
Senior Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
Email: sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Michael Mohammed Murad, +1-212-908-0757
Associate Director
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Lina Santoro, +1-212-908-0522
or
Committee Chairperson
Dennis Pidherny, +1-212-908-0783
Senior Director
or
Media Relations:
Sandro Scenga, +1-212-908-0278
Email: sandro.scenga@fitchratings.com