DBRS Downgrades IO’s Short-Term Rating to R-1 (middle), Confirms Long-Term Rating at AA

DBRS has today confirmed both the Issuer Rating and Senior Unsecured Debt of the Ontario Infrastructure and Lands Corporation (Infrastructure Ontario or IO) at AA, with Stable trends. However, the Commercial Paper (CP) rating has been downgraded to R-1 (middle), with a Stable trend, as a result of the continued deterioration in IO’s liquidity-to-CP ratio below the 1.5 times level required by DBRS’s liquidity support criteria. This issue was identified during last year’s rating review and management had originally indicated its intention to operate the CP program to meet the standard, but recently suggested otherwise. Nonetheless, Infrastructure Ontario maintains a solid credit profile, bolstered by the sound credit quality of its loan portfolio, risk management practices and a solid liquidity cushion.

IO’s loan portfolio continues to see marked growth, rising to $4.26 billion loans outstanding by December 31, 2012, from $3.77 billion at March 31, 2012. Municipalities continue to constitute the lion’s share of the loan portfolio at more than 74%, and account for eight of the top ten loan commitments. DBRS takes comfort in the strong provincial oversight of this sector, and estimates that approximately 85% of the municipal debt in Ontario is serviced by entities with credit characteristics consistent with ratings in the AA-range. Nonetheless, the loan portfolio continues to diversify into non-municipal sectors. To mitigate the risks of expanding into sectors with weaker credit fundamentals, IO has refined its credit risk underwriting and monitoring practices, including the recent addition of a credit watch list to actively identify and track at-risk borrowers and work with them to find viable solutions to ensure compliance. Additionally, the existence in most loan agreements of the intercept mechanism as a positive enforcement tool offers protection to bondholders. Loan originations are expected to continue over the medium term, but applications are forecast to decline somewhat to within the $750 million range from the $1 billion range and stabilize thereafter over the near term.

Operating performance remained sound, with a $16.7 million operating surplus reported for F2012, as steady performance in the project delivery and lending program was further supported by efficiency gains in the real estate management operations following the amalgamation, which took place in F2011. DBRS expects IO to post modest levels of net income in the years ahead as the loan portfolio has surpassed its break-even point and sufficient economies of scale can be derived.

To support the growth of the loan portfolio, total debt increased by 14% year-over-year in F2012; though this increase was through subordinated debt issued to the Province. Senior debt, in fact, declined by 7% to $1.85 billion as at March 31, 2012, as CP outstanding declined and Infrastructure Renewal Bonds (IRBs) remained unchanged at $1.25 billion. This trend is expected to continue, and should drive IO’s loan-to-senior debt ratio (which stood at 2.0 times by fiscal year-end 2012) higher as the loan portfolio grows, and refinancing of future maturing IRBs is expected to be funded by the Province rather than with senior debt. DBRS notes that existing senior debtholders stand to benefit as this transpires.

The reserve fund stood at $931.5 million by fiscal year-end 2012, and is expected to have remained fairly constant in F2013. DBRS notes that while this level is no longer sufficient to justify a short-term rating of R-1 (high) given recent usage of the CP program, it still leaves considerable flexibility to further grow the loan portfolio provided the overall quality of the loan portfolio is maintained.

Notes:
All figures are in Canadian unless otherwise noted.

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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Base General Methodology for Corporate Companies (Appendix 1: Credit-Specific Considerations), which can be found on our website under Methodologies.