DBRS Places Enbridge Inc., Enbridge Pipelines Inc. and Enbridge Income Fund Under Review with Developing Implications

DBRS Limited (DBRS) has today placed all ratings of Enbridge Inc. (ENB), Enbridge Pipelines Inc. (EPI) and Enbridge Income Fund (EIF or the Fund) as follows Under Review with Developing Implications:

-- Enbridge Inc., Issuer Rating of A (low)
-- Enbridge Inc., Medium-Term Notes & Unsecured Debentures rated A (low)
-- Enbridge Inc., Cumulative Redeemable Preferred Shares rated Pfd-2 (low)
-- Enbridge Inc., Commercial Paper rated R-1 (low)
-- Enbridge Pipelines Inc., Issuer Rating of “A”
-- Enbridge Pipelines Inc., Medium-Term Notes and Unsecured Debentures rated “A”
-- Enbridge Pipelines Inc., Commercial Paper rated R-1 (low)
-- Enbridge Income Fund, Issuer Rating of BBB (high)
-- Enbridge Income Fund, Senior Unsecured Long-Term Notes rated BBB (high)

The rating actions follow the announcement that ENB will increase its common share dividend by 33% and its common share dividend policy to a range of 75% to 85% of adjusted earnings from the previous range of 60% to 70%. ENB also plans to transfer its Canadian liquids pipelines business, consisting of EPI and Enbridge Pipelines (Athabasca) Inc. (EPA), and certain renewable power generation assets (which are currently held within EPI) to its Canadian affiliate, EIF (the Transaction). Finally, ENB is considering the potential for public debt holders of ENB to exchange up to $4 billion of ENB debt for new notes of EIF. The DBRS ratings of Enbridge Gas Distribution Inc. and Enbridge Energy Partners, L.P. are not affected by today’s announcement, although the latter’s rating would be reviewed in the event that ENB’s “potential parallel U.S. restructuring plan” comes to fruition.

The Transaction is targeted for completion by mid-2015. The current rating actions reflect uncertainty associated with the ongoing corporate developments, percentage take-up of the debt exchange and the future funding strategy among the entities within ENB’s organization. For clarity, DBRS does not rule out potential future rating changes for any of the entities placed Under Review today and will provide updates as more information becomes available. Please see the relevant sections of this press release for details of the Transaction Assets and Financing Strategy as Proposed.

Potential Impact on ENB
From a consolidated perspective, the Transaction would have a minimal impact on ENB’s business risk profile, although ENB would move away from its current hybrid holding company (holdco)/operating company structure and closer to a pure holdco structure, which could potentially have negative financial risk profile impacts. The business risk profile of the Fund would improve substantially following the Transaction, reflecting the fact that it would own a 100% interest in EPI and EPA, while EPI’s business risk profile would essentially remain unchanged.

From a financial risk perspective, DBRS expects a mix of factors to affect ENB’s future ratings. Firstly, a material increase in dividend payout combined with the proposed Transaction would mean that ENB would have to rely more on external funds to finance its portion of capex which, while substantial over the 2014 to 2018 period, would be reduced on a direct-to-ENB basis. Secondly, direct external debt at ENB would be reduced by the proposed debt exchange, although the sizable preferred shares outstanding at ENB would remain unchanged and would continue to weigh on ENB’s credit metrics. Finally, since all assets of EPI and EPA would be transferred to the Fund, holders of ENB’s direct external debt would be further away from the cash flow of the Transferred Assets than is currently the case. Dividend distributions from the Transferred Assets would have to be used to support debt service at the Fund before dividends could then be distributed to ENB. At this time, there are uncertainties with respect to the debt exchange details and the future financing needs at the ENB level as well as the amount of dividends to be received at ENB. Consequently, while DBRS believes that Under Review with Developing Implications is the appropriate rating action at this time, DBRS does not rule out a negative rating action in the future based on further analysis.

Potential Impact on EPI
DBRS does not currently expect material changes from a business risk profile perspective or from a credit metric perspective at EPI. EPI is expected to increase its commercial paper (CP) program from $0.3 billion to approximately $2.3 billion and is expected to finance the debt portion of its organic growth with its own debt issues rather than funds on-lent from ENB, as currently provided. With respect to equity injections, DBRS does not expect any significant changes to the total amount of equity injection required, although the sources of this funding following the Transaction would be from both EIF and ENB compared with only ENB at present. This raises issues with respect to potential “equity overhang” at EIF. In the event of the “equity overhang,” common equity is expected to be raised at ENB. As a result, the ratings of this entity would likely be confirmed should there be no material changes in the terms of the proposed restructuring.

Potential Impact on the Fund
DBRS expects a positive impact from a business risk profile perspective following the dropdown of EPI and EPA to the Fund (in addition to the October 2014 transaction in which the Fund acquired a 50% interest in Alliance Pipeline L.P. (the U.S portion of the Alliance System) and a 100% interest in Class A in Southern Lights Pipelines). This positive business risk impact would reflect a significant increase in the Fund’s scope and size as well as the fact that EPI and EPA assets are all liquids pipelines assets that are under long-term contracts with minimal volume risk and no price risk. From a financial risk profile perspective, the Fund’s direct external debt would be expected to increase to $6.5 billion from $2.5 billion (assuming the intercompany loan exchange is completed). However, the debt holders at the Fund would benefit from substantial cash distributions from EPI before EIF makes cash distributions to ENB. This benefit is expected to more than offset the incremental debt that the Fund would assume in connection with the Transaction. However, due to some uncertainties with respect to details of the debt restructuring associated with the Transaction, DBRS currently believes that Under Review with Developing Implications is the appropriate rating action at this time. DBRS could potentially upgrade the Fund’s ratings should there be no material changes to the expected terms of the Transaction and debt exchange.

The Transaction Assets
(1) The Canadian liquids pipelines assets to be dropped down from ENB to the Fund include:
• All Canadian Mainline assets owned by EPI, including the residual interest in the Southern Lights diluent pipeline.
• All Regional Oil Sands Pipelines owned by EPA (currently owned by ENB).
• Both EPI and EPA would be transferred from direct ownership by ENB to direct ownership by the Fund.
• Total liquids pipelines assets are estimated by DBRS to have generated $864 million of segment earnings (54% of ENB’s total segment earnings), of which the Canadian Mainline accounted for $519 million (32% of ENB’s total segment earnings) and Regional Oil Sands Pipelines accounted for $189 million (12% of ENB’s total segment earnings) in the 12-month period ended September 30, 2014.
• These assets are considered to be the core component of ENB’s ratings.

(2) The Canadian renewable power generation assets (all operational and currently owned by EPI) to be dropped down to the Fund include:
• Québec assets: Lac Alfred Wind Farm, Maissif-du-Sud Wind Farm and Saint-Robert-Bellarmin Wind Farm Projects.
• Alberta assets: Blackspring Ridge Wind Project.
• These assets generated $15 million of earnings in 2013.

(3) The book value of the Transaction Assets is estimated to be approximately $17 billion ($16 billion for the liquids pipelines assets and $1 billion for renewable generation assets).

Financing Strategy - Restructuring as Proposed
(1) ENB would maintain its 19.9% interest in Enbridge Income Fund Holdings Inc. (EIFH) (which holds an 85.6% interest in the Fund) following the dropdown of EPI and EPA.

(2) EIFH is expected to acquire an increasing interest in the Transaction Assets through investments in the equity of the Fund over a period of several years consistent with its equity funding capability (expected to be $600 million to $800 million per year from 2015 through 2018).

(3) There are uncertainties with respect to cash consideration and preferred unit consideration (i.e., ECT preferred) of the Fund entities that would be issued to ENB. However, the Transaction would be structured in such a way that ENB would increase its economic interest in the Fund to 90% from 66%, and then would decline to approximately 80% by 2018 as EIFH increases its investments in the Fund. Any cash consideration would be financed with EIFH issuing public common equity.

(4) Upon completion of the Transaction, the Fund would hold a 100% interest in EPI and EPA. As a result, the size of the Fund’s consolidated assets would increase substantially.

(5) Along with all Transaction assets, EPI would remain responsible for its own current debt. All the debt at EPI would remain non-recourse to the Fund and ENB. There is currently no external debt at EPA.

(6) EPI’s CP program would be increased to approximately $2.3 billion from $0.3 billion currently, to be fully backed with its own credit facilities.

(7) ENB’s Canadian CP program would be reduced to $0.5 billion from $2.5 billion following the Transaction. As result, DBRS expects ENB’s direct credit facilities to be reduced. ENB’s U.S. CP program at USD 2.1 billion would remain unchanged.

(8) ENB has an inter-company loan of $4.0 billion outstanding to EPA. ENB is considering the potential to accommodate public debt holders who may have a desire to hold their notes closer to the Canadian Liquids Pipelines businesses instead of continuing to have access to the diversified sources of cash flow that will continue to service ENB’s debt. This could include offering holders of ENB notes the ability to exchange a portion but not all of their (Canadian dollar-denominated) notes for new notes of EIF. The portion which could be exchanged would correspond to the approximately $4.0 billion of intercompany debt that EIF would otherwise assume as a component of the purchase price. Assuming that this exchange is completed, the amount of non-consolidated debt at the Fund would increase by $4.0 billion (currently $2.5 billion). Furthermore, non-consolidated debt at ENB would be reduced as a result of this exchange.

Notes:
All figures are in Canadian dollars 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are Rating Pipeline and Diversified Energy Companies (January 2014) and Rating Holding Companies and Their Subsidiaries (January 2014), which can be found on our website under Methodologies.