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A leading debt-rating agency is warning about governance problems at Hydro One Ltd. after the state of Washington cited political interference from the Ontario government in rejecting the utility’s first major acquisition.

Standard & Poor’s, which has already lowered the company’s credit rating once, said in a report that it could downgrade it again “if the Ontario government intervenes further in [Hydro One’s] business or operating decisions, resulting in additional governance deficiencies that we consider severe.” S&P has an A-minus rating on the debt after cutting it from an A rating in September. A lower rating usually means higher borrowing costs.

Last Wednesday, Washington’s utilities regulator said no to Hydro One’s proposed $4.4-billion acquisition of power company Avista Corp., making it unlikely that the cross-border deal goes through. In its ruling, the regulator noted that Hydro One’s chief executive officer retired and its entire board of directors resigned under pressure from newly elected Ontario Premier Doug Ford; it took issue with the precedent this set.

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“The province’s role is not limited to that of a minority shareholder in a publicly traded corporation,” the Washington Utilities and Transportation Commission wrote. "There appears to be nothing that would prevent this level of interference from occurring again.”

In response, Ontario Energy Minister Greg Rickford said the government has the right to make decisions it feels will lead to lower hydro rates, a promise made during the spring election campaign, but he did not elaborate on the connection between rates and the U.S. deal. (Ontario remains a 47-per-cent owner of Hydro One after privatizing it in 2015.)

On Monday, Standard & Poor’s issued a new report on Hydro One, and for the second time in four months, the rating agency called out governance issues at the utility. The agency ultimately did not downgrade the company again – but it did raise concerns about the utility’s future.

“In our assessment, the [Washington regulatory] decision weakens Hydro One’s ability to track, adjust and control the execution of its strategy, and raises broader concerns regarding Hydro One’s governance and strategic direction as it seeks a permanent CEO,” S&P wrote.

The rating agency also noted that another downgrade could still materialize over the next 12 months if Avista deal is revived, because of additional debt the company would take on, or if the Ontario government exerts more influence on the company’s affairs.

Late Monday, Hydro One and Avista announced they will appeal the regulator’s ruling within a week. Once the petition is filed, the regulator has 20 days to state whether it will grant the reconsideration.

“We have reviewed the decision carefully and believe there are a number of aspects of the decision that serve as grounds for reconsideration,” Hydro One’s acting chief executive Paul Dobson said in a statement. “Our petition for reconsideration is being finalized and will be publicly available once it is filed.”

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When the Avista acquisition was announced in July, 2017, former Hydro One CEO Mayo Schmidt argued that the utility needed to diversify its earnings. But since then a number of forces have made the deal mildly dilutive to Hydro One’s earnings in its first year. In other words, it would be a drag on the utility’s earnings per share.

Because of the short-term financial implications, some investors and analysts have praised the state of Washington’s rejection of the deal, and Hydro One’s shares have climbed 4 per cent higher since.

However, there are also questions about Hydro One’s growth potential in the long run. “While some shareholders may be relieved if the Avista merger does not proceed, the reasons cited in the order are damning, making it hard to conceive the company could meaningfully expand beyond Ontario," CIBC World Markets analyst Robert Catellier wrote in a recent report.

Hydro One declined to comment on the S&P report. Sydney Stonier, a spokesperson for Ontario’s Energy Minister, wrote in an e-mail that the government “will always stand up for the largest shareholder of Hydro One, the people of Ontario. We are confident that the renewed leadership and direction at Hydro One will make responsible business decisions that are in the best interest of their shareholders.”

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