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CREDIT OPINION 23 January 2017

British Columbia, Province of Update to Discussion of Key Credit Factors

Update

Summary Rating Rationale

RATINGS

British Columbia, Province of Domicile

British Columbia, Canada

Long Term Rating

Aaa

Type

LT Issuer Rating

Outlook

Stable

Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date.

The Aaa issuer and debt ratings assigned to British Columbia reflect the diverse and relatively strong provincial economy, track record of prudent fiscal management and a high degree of flexibility to accommodate revenue and expenditure pressures. These positive elements helped the province return to balanced budgets in 2013/14 following the 2009 recession, faster than most other Canadian provinces, and the province has posted a plan of continued balanced budgets across its rating horizon. Although British Columbia's debt burden increased between 2009-2014 before stabilizing at slightly below 90% of revenues, the extended low interest rate environment has helped to ensure that interest expense, and therefore debt affordability, remains manageable. The Aaa rating anticipates that the debt burden will remain at or below current levels across the medium-term. British Columbia also has a Prime-1 (P-1) rating assigned to its commercial paper program. Exhibit 1

Strong revenue growth will be a key driver behind the stabilization of the province's debt burden

Contacts Michael Yake 416-214-3865 VP-Senior Analyst [email protected] Adam Hardi CFA AVP-Analyst [email protected]

416-214-3636

Alejandro Olivo 52-55-1253-5742 Associate Managing Director [email protected] David Rubinoff 44-20-7772-1398 MD-Sub Sovereigns [email protected]

Source: Moody's Investors Service, British Columbia budget and financial statements

National Peer Comparisons British Columbia is rated at the higher end of Canadian provinces, which span a range of Aaa to Aa3. British Columbia has demonstrated strong fiscal management and performance in recent years, as evidenced by the quick return and maintenance of balanced budgets following the 2009 recession and limited increase of its debt burden during the years it produced deficits. The province's diverse economy, in both industrial mix and external trade partners, has also helped British Columbia avoid the economic difficulties impacting several other Canadian provinces presently.

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Credit Strengths »

Track record of prudent fiscal planning

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Strong economic growth, supported by a large and diversified economy

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Ability to record surpluses in periods of continued natural resource price weakness

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Considerable fiscal policy flexibility to adjust revenues and expenses to meet fiscal challenges

Credit Challenges »

High debt burden for rating category with continued financing pressures for capital expenditures

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Growing contingent liability of BC Hydro given its constrained financial strength

Rating Outlook The outlook is stable reflecting the assumption of continued surpluses across the medium-term and expected stabilization of the debt burden and interest expense.

Factors that Could Lead to a Downgrade »

Net direct or indirect debt exceeding forecasts and reaching 95% of revenue would reduce fiscal flexibility and put pressure on the rating

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A deterioration of debt affordability due to a higher than expected rise in interest rates and adjusted interest expense approaching 5% of revenue would also exert downward pressure on the rating

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A loss in fiscal discipline and a return to consecutive deficits

Key Indicators Exhibit 2

British Columbia, Province of

[1] Corresponds to calendar year. 2016-18 figures correspond to British Columbia's 2016/17 Q1 update [2] 2017F revenue corresponds to provincial 2016/17 Q2 updates, 2018F revenue reflects forecasts from 2016/17 Budget Source: Moody's Investors Service, British Columbia financial statements and 2016/17 Budget and Quarterly Updates

Profile British Columbia is the third largest Canadian province by population and fourth largest provincial economy. Located on Canada's western coast, British Columbia is an important hub for goods shipped to and from Asia. The export markets of British Columbia are more diversified than Canada and other provinces. While Canada typically sees over three-quarters of exports flow to the US, this market accounts for about half of British Columbia exports. Other key markets for the province include China (17%), Japan (10%) and other Asian countries (9%). This wide diversification of sectors and markets reduces the vulnerability of the provincial economy from sector-specific or trading partner-specific shocks. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

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Detailed Rating Considerations The Province of British Columbia's Aaa rating combines (1) a baseline credit assessment (BCA) for the province of aaa, and (2) a high likelihood of extraordinary support coming from the federal government in the event that the province faced acute liquidity stress. TRACK RECORD OF PRUDENT FISCAL PLANNING AND OF MANAGING FISCAL PRESSURES EFFECTIVELY British Columbia incorporates several measures of prudence into its annual budget to minimize the impacts of potential downward pressures. Given the recent track record of many provincial economies underperforming compared to expectations, this prudent approach has helped the province manage the downward pressures effectively. One of these measures is the ongoing practice of adopting economic growth forecasts, including real GDP growth and natural gas prices, that are below private sector consensus forecasts. This is partly explained by the province's practice of not including potential growth factors until they are firmly in place. This allows the province greater flexibility to accommodate a negative shock to the economy should one arise. Another measure is the use of forecast allowances. The province incorporates forecast allowances to reflect potential revenue volatility. Currently these levels are CAD350 million for 2016/17, increasing to CAD500 million in 2017/18 and 2018/19. Finally, the province includes contingencies in each year of the budget horizon. These contingencies equal CAD450 million in 2016/17 and CAD500 million in both 2017/18 and 2018/19. Combined, the allowances and contingencies are slightly larger than the forecasted surpluses, and provide the province with a financial cushion if needed while still allowing the targeted outcomes to be achieved. STRONG ECONOMIC GROWTH SUPPORTED BY A LARGE AND DIVERSIFIED ECONOMY British Columbia's economy is among the strongest in Canada with real GDP growth outpacing or matching the national average every year since 2011. In 2016, real GDP growth Is forecasted at 2.7%, and moving forward the province is projecting growth of between 2.2% and 2.3% over the next four years. In 2015, the latest year for which there is data, there were ten different industries that on an individual basis accounted for a minimum of 5% of provincial GDP, with real estate and rental leasing showing representing the highest concentration at almost 20%. In our view, the economy of British Columbia, along with a level of taxation that is at the lower end of Canadian provinces, represents an important credit positive for the Aaa rating. The large and diverse economy provides the province with a large base on which to apply a productive tax base, ensuring that provincial revenues are not strongly impacted by a decline in one particular sector. Furthermore, the current low tax environment offers British Columbia the flexibility to raise taxes if revenues were to fall below expected levels while still remaining competitive with other jurisdictions. ABILITY TO RECORD SURPLUSES IN PERIODS OF CONTINUED NATURAL RESOURCE PRICE WEAKNESS Although diversified, the economy of British Columbia has an important natural resource sector, primarily natural gas and forestry products. During the period 2003/04-2008/09, natural resource revenue accounted for an average 11% of the province's revenue and, in the face of high prices for natural gas, helped the province post sizeable surpluses. Since then, however, revenue derived from natural resources has fallen in each successive year. Natural resource revenues are expected to fall by 8.7% in 2016/17, which largely reflects the reduced revenue from natural gas and volatility in the forestry sector. The latest Softwood Lumber Agreement (SLA) with the US, which was signed in 2006, expired in October 2015, and a further one year moratorium on tariffs expired in October 2016. The lack of an SLA agreement has created uncertainty in the provincial forestry industry, and any additional economic challenges related to this will persist until a new agreement is reached. Despite these challenges, the province is expected to post a stronger than expected consolidated surplus in 2016/17 largely due to higher personal income tax revenues and continued growth in provincial property transfer tax revenues. The province is forecasting revenue growth to average 2.7% annually over the next three years, which includes a slight decrease in revenue in 2018. The large surplus in 2015/16 allowed the province to contribute CAD100 million into the BC Prosperity Fund, a fund that was initially planned to receive funding from LNG related activities. While no further transfers to the fund are budgeted for, transfers may still be authorized by Treasury Board depending on the final surplus results in future years. The long-term goals of the BC Prosperity Fund are to reduce the province's debt over time, establish a long-term legacy fund and to help fund investments in key areas of public policy.

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On the expenditure side, the province has also demonstrated an ability to control and maintain low expense growth, much of which has been achieved through wage control over the past several years. In 2014 the province initiated the current 5 year wage mandate, which called for wage increases totaling 5.5% across this period, with the potential to supplement the negotiated wage increases with half of the difference between actual real GDP growth reported in the Provincial Economic Accounts by Statistics Canada and the real GDP growth forecasted by the Economic Forecast Council. Since 2014, this increase has occurred annually driven by the routinely higher than forecasted provincial economic growth. With these wage restrictions in place, total expenditure growth has been reduced from an average annual increase of 4.8% during the period 2006-2011 to 2.8% over the period 2012-2016. The 2016/17 budget forecasted average adjusted expenditure growth to be 2.0% annually, approximately two-thirds of total expenditures to be consumed by health and education spending. Since the release of the 2016/17 budget, the Supreme Court of Canada issued a ruling in favour of the provincial teacher's union, who had been seeking a reversal of the provincial government's 2002 decision to remove the union's ability to negotiate class size and composition. As a result, the provincial government will need to increase educational spending compared to what was presented in the 2016/17 budget. We therefore expect that average expense growth in education will increase and surpass the 1.8% average annual growth the province had previously forecasted across the 2016/17-2018/19 period. Although the province had contingency funds set aside for an unfavourable outcome, it may still put some downward pressure on the province's planned level of surpluses. However, we believe it continues to have sufficient flexibility to continue to record balanced budgets. CONSIDERABLE FISCAL POLICY FLEXIBILITY TO ADJUST REVENUES AND EXPENSES TO MEET FISCAL CHALLENGES The Province of British Columbia, like all Canadian provinces, enjoys significant flexibility in its financial management. Compared to their counterparts in other countries, such as the German Länder and the Australian states, Canadian provinces enjoy far greater autonomy in terms of both the spending and revenue sides of their budgets. Unfettered access to a broad range of tax bases and the ability to alter expenditure programs provide Canadian provinces such as British Columbia with substantial flexibility to meet fiscal challenges. HIGH DEBT BURDEN FOR RATING CATEGORY WITH CONTINUED FINANCING PRESSURES FOR CAPITAL EXPENDITURES After increasing following the 2009 recession and subsequent funding of deficits, the province's debt burden has begun to stabilize, albeit at a high level compared to many other global Aaa-rated peers. The province's net direct and indirect debt relative to revenues measured 86.8% as of March 31, 2016. British Columbia no longer requires debt in order to finance operations, however some debt accumulation will continue across the budget horizon relating to capital expenditure. Though we expect the debt burden to fall slightly on the back of higher revenues in 2017, overall we expect it will remain roughly stable over the budget horizon. Total capital spending by the province will equal CAD20.6 billion over the budget forecast period 2017-2019. Of this amount, taxpayer supported capital spending is expected to equal just over CAD12 billion, CAD8.2 billion of which will come from borrowing, which is roughly in line with the levels announced in recent budgets. An additional CAD8.6 billion is expected to be spent on power and infrastructure projects amongst the province's self-supporting entities, of which CAD5.2 billion will be financed by borrowing. Nevertheless we anticipate that the province’s net direct and indirect debt will only increase by CAD2.8 billion over the next three years (once adjustments are made for self-supporting debt and debt retirement), an increase that is considered manageable within the current fiscal framework. Concern of the high debt burden is mitigated by the manageable level of interest expense. Given the low interest rate environment and the province's ability to lock in debt at lower rates than in the past when the debt burden reached similar levels, British Columbia's debt burden is expected to remain affordable over the rating horizon. Furthermore, adjusted interest payments, which are forecasted to consume 3.3% of revenues in 2016/17, are expected to remain relatively stable over the planning horizon - a level that remains lower than most Canadian provinces and preserves a high degree of fiscal flexibility. GROWING CONTINGENT LIABILITY OF BC HYDRO GIVEN ITS CONSTRAINED FINANCIAL STRENGTH The province issues debt on behalf of BC Hydro, the wholly-owned electric utility company of British Columbia. Given its steady revenue stream that generates sufficient revenue and cash flow to support operations including interest payments, we view BC Hydro as a self-supporting entity and therefore exclude the related debt from our debt metrics of the province. We note, however, that BC

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Hydro's total reported debt has risen considerably since 2008, increasing from CAD8.1 billion as of March 31, 2008 to an estimated CAD18.1 billion as of March 31, 2016, and is expected to continue to rise to over CAD20 billion the medium-term as the utility moves forward on the construction of a CAD8.8 billion hydroelectric dam (Site C) as part of its Integrated Resource Plan. The anticipated increase in debt continues to pressure the province’s rating since it raises the contingent liability of British Columbia. BC Hydro has flexibility to increase utility rates to ensure that its own revenues will continue to support its operations and debt payments. However, once adjusting net income to take into consideration the extensive use of largely debt financed regulatory asset accounts, BC Hydro posts some metrics that are among the weakest of Canadian provincial utilities. With the province gradually eliminating the level of dividends it will require BC Hydro to pay (reducing by CAD100 million each year starting in 2017/18 until a floor of zero is reached), the utility will be in a better position to reinvest its net income into its own operations. Furthermore, the current 10-year rates plan allows for the full or partial recovery of almost all of the regulatory accounts, with the exception of the accounts for Site C which will be recovered only once the projects come into service. While we do not expect to alter our medium-term view that this debt is self-supporting, we note that should BC Hydro's financial position deteriorate, the possibility that it would require some support from the province will increase. We will continue to monitor BC Hydro's financial strength over the coming years through the construction and initial operations of Site C.

Extraordinary Support Considerations While British Columbia's baseline credit assessment of aaa already places the province in the Aaa rating bracket, Moody's also considers the likelihood of extraordinary support coming from the federal government (Canada, rated Aaa, stable) to prevent a default by the province, should this extreme situation ever occur. The high likelihood of support reflects Moody's assessment of the federal government's incentive to minimize the risk of potential disruptions to capital markets if British Columbia or any province were to default. It also indicates a moderately positive federal government policy stance as illustrated by the flexibility inherent in the system of federal-provincial transfers.

Output of the Baseline Credit Assessment Scorecard In the case of British Columbia, the BCA matrix generates an estimated BCA of aa1, close to the rating committee's assigned BCA of aaa. The matrix-generated BCA of aa1 reflects (i) an idiosyncratic risk score of 2 (presented below) on a 1 to 9 scale, where 1 represents the strongest relative credit quality and 9 the weakest; and (ii) a systemic risk score of Aaa, as reflected in the sovereign bond rating for Canada. The idiosyncratic risk scorecard and BCA matrix, which generate estimated baseline credit assessments from a set of qualitative and quantitative credit metrics, are tools used by the rating committee in assessing regional and local government credit quality. The credit metrics captured by these tools provide a good statistical gauge of stand-alone credit strength and, in general, higher ratings can be expected among issuers with the highest scorecard-estimated BCAs. Nevertheless, the scorecard-estimated BCAs do not substitute for rating committee judgments regarding individual baseline credit assessments, nor is the scorecard a matrix for automatically assigning or changing these assessments. Scorecard results have limitations in that they are backward-looking, using historical data, while the assessments are forward-looking opinions of credit strength. Concomitantly, the limited number of variables included in these tools cannot fully capture the breadth and depth of our credit analysis.

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Rating Methodology and Scorecard Factors Exhibit 3

British Columbia, Province of

Source: Moody's Investors Service

Ratings Exhibit 4

Category BRITISH COLUMBIA, PROVINCE OF

Outlook Issuer Rating Senior Unsecured Commercial Paper Other Short Term

Moody's Rating

Stable Aaa Aaa P-1 (P)P-1

Source: Moody's Investors Service

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REPORT NUMBER

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British Columbia, Province of: Update to Discussion of Key Credit Factors