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Rating Action:

Moody's affirms Thames Water's Baa1 CFR on Ofwat decision; stable outlook

26 Feb 2015

Moody's also affirms B1 debt rating of holding company Kemble

London, 26 February 2015 -- Moody's Investors Service has today affirmed the Baa1 corporate family rating (CFR) of Thames Water Utilities Limited (Thames Water), following the conclusion of the regulatory price review and the company's acceptance of the final price determination published by the Water Services Regulation Authority's (Ofwat), the economic regulator for the water companies in England and Wales, on 12 December 2014.

The rating agency also affirmed the A3 senior secured and Baa3 subordinated debt ratings of the Class A and Class B notes, respectively, issued by Thames Water's financing subsidiaries, Thames Water Utilities Finance Limited, and Thames Water Utilities Cayman Finance Limited.

Concurrently, Moody's has affirmed the B1 rating on the GBP400 million guaranteed senior secured bonds due April 2019, issued by Thames Water (Kemble) Finance PLC (Kemble), a finance subsidiary of Thames Water's intermediate holding company Kemble Water Finance Limited. The outlook on all ratings is stable.

RATINGS RATIONALE

-- AFFIRMATION OF THAMES WATER'S Baa1 CFR

Today's decision to affirm Thames Water's Baa1 CFR primarily reflects (1) a final regulatory price determination that is broadly in line with the company's business plan submission; (2) reduced risks in relation to Thames Water's involvement with the Thames Tideway Tunnel (TTT) project; (3) a conservative financial and dividend policy during the ongoing TTT procurement process; and (4) credit metrics forecast to remain around 80% of net debt to regulatory capital value (RCV) and around 1.3x or better for the adjusted interest coverage, broadly in line with Moody's guidance for the current rating.

Thames Water is involved in the early development of the TTT project. While the completion of the TTT project through a government-specified infrastructure provider will ring-fence Thames Water from the main construction risk, a credit positive, Moody's still believes that the company is exposed to reputational and financial challenges that other companies in the sector do not face. In affirming Thames Water's rating and stabilizing the outlook Moody's takes into account (1) the progress that has been made to-date on the procurement of construction consortia and equity holders for the infrastructure provider; and (2) a specific uncertainty mechanism embedded within Thames Water's final determination that will protect the company against additional cost due to any delays in the TTT procurement process and potential additional preparatory works that would be taken on by Thames Water. Furthermore, management's conservative approach to limit distributions during the infrastructure provider procurement process will allow the operating company to maintain additional financial flexibility to offset potential cost pressures.

In addition, Thames Water is the only WaSC that received regulatory total expenditure allowances in excess of its business plan submission for both water and wastewater services, which provides larger opportunity for cost outperformance. This, coupled with a capital structure that shows limited risks in relation to adverse derivative contracts, and overall average cost of debt broadly in line with current regulatory assumptions, put Thames Water in a stronger financial position than some of its highly-leveraged peers, which Moody's considers sufficient to offset the incremental risks related to the TTT project.

Moody's also rates the two classes of notes issued by Thames Water Utilities Finance Limited and Thames Water Utilities Cayman Finance Limited, and guaranteed by Thames Water. The A3 rating of the Class A bonds reflects their structural seniority relative to the Class B bonds, and the Baa3 rating of the Class B bonds reflects their structural subordination to the Class A bonds.

-- AFFIRMATION OF B1 RATING ON KEMBLE'S GBP400 MILLION NOTES

Moody's decision to affirm the B1 rating of Kemble's GBP400 million 8-year notes due April 2019 (the Kemble Notes) primarily reflects that while the lower return allowance for the operating water company reduces the flexibility to upstream dividends, Thames Water will retain some financial flexibility due to management's prudent approach to its financial policy, and liquidity at the holding company is expected to provide back-stop cover for debt service over a period well in excess of 18 months.

Moody's expects that dividend distributions from Thames Water will be limited to the amount needed to cover the debt service of the Kemble Notes and other external debt and administrative costs at Kemble, i.e. the cash dividend cover is unlikely to be materially higher than 1.0x, at least over the early years of the next five-year regulatory period. However, the rating agency views this as an artificially low ratio, given that the operating company would have additional flexibility. Moody's believes that the retention of cash at the operating company is overall credit positive because of the potential incremental risks posed by the involvement in the TTT project. Nevertheless, should cash lock-ups be triggered at the operating company, such cash would no longer be available for the benefit of holding company lenders at Kemble.

Given that Thames Water's final determination includes scope for outperforming total expenditure allowances, Moody's expects that Kemble's cash dividend coverage will increase to at least 2.0x in the later years of AMP6. The additional cash maintained within Kemble, together with at least a GBP65 million revolving credit facility will also provide adequate back-stop liquidity at current rating levels.

RATIONALE FOR STABLE OUTLOOK

The stable outlook on Thames Water's ratings reflects Moody's expectation that Thames Water's financing structure should be relatively resilient to downside scenarios due to the cash-trapping triggers designed to ensure that cash is retained in the company if certain ratio thresholds are breached. Such cash could then be used to absorb the effect of possible downsides. Moody's also believes that key uncertainties resulting in incremental risks that the company is exposed to in relation to the TTT project are adequately mitigated through a specific mechanism for an interim price review in certain circumstances outside of management's control.

The stable outlook on Kemble's ratings reflects Moody's expectation that (1) certain favourable elements of the final price determination, particularly in relation to the TTT uncertainty mechanism, reduce the risk at the operating company level; and (2) a conservative financial profile at the operating company level with lower leverage around 80% compared to the 85% trigger level will provide additional headroom to offset operational challenges. Whilst actual distributions to Kemble will be kept at the minimum required to cover the Kemble debt service requirements in the initial years of AMP6, Moody's believes the risk reduction measures taken at the Thames Water level mitigate other challenges represented by a lower allowed return. Although financial headroom is reduced, Kemble debt service should not be endangered, particularly considering additional liquidity held at the holding company, and Moody's expects cash dividend coverage to improve over the AMP6 period.

WHAT COULD CHANGE THE RATING -- UP/DOWN

Given (1) the overall consolidated Kemble Water group's funding structure; (2) Moody's expectation that both Thames Water and Kemble will likely maintain a highly-leveraged financial profile; (3) the reduced financial flexibility due to lower allowed returns over the next regulatory period; and (4) continuing exposure to certain interface works with the TTT project, there is limited potential for any rating upgrade. Upward rating pressure would require a material and permanent improvement in debt protection measures.

Negative pressure on the Thames Water and Kemble ratings could derive from a deterioration of the operational or financial performance, resulting in the company persistently exceeding leverage of around 80% or exhibiting an Adjusted Interest Cover Ratio of consistently less than 1.3x. In addition, (1) a significant increase in business risk for the sector as a result of, for example, legal and regulatory changes leading to material competition; or (2) Thames Water being required to deliver the main part of the TTT project (e.g., in the event that the preferred delivery model is not successful), could also result in negative rating pressure.

Further negative pressure on the Kemble Notes could follow from (1) negative funding conditions, which could increase refinancing risk; or (2) adverse conditions at the operating company that could significantly impact its ability to upstream dividends.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Regulated Water Utilities published in December 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Thames Water Utilities Limited (Thames Water) is the largest of the ten water and sewerage companies (WaSCs) in England and Wales by both RCV and number of customers served. Thames Water provides drinking water to around 8.8 million customers and sewage treatment for a residential population of around 14 million in London and the Thames Valley.

Thames Water is the major subsidiary of Thames Water Limited which was acquired by Kemble Water Limited, a consortium led by Macquarie's European Infrastructure Funds, in 2006.

Thames Water (Kemble) Finance PLC (Kemble Finance) is the financing subsidiary of Kemble Water Finance Limited (Kemble), an intermediate holding company in the Thames Water Group, where Thames Water is the principal operating subsidiary.

List of affected ratings

Affirmations:

..Issuer: Thames Water Utilities Ltd.

.... Corporate Family Rating, Affirmed Baa1

..Issuer: Thames Water Utilities Finance Limited

....BACKED Senior Secured Regular Bond/Debenture, Affirmed A3

..Issuer: Thames Water Utilities Cayman Finance Limited

....BACKED Subordinate Medium-Term Note Program, Affirmed (P)Baa3

....BACKED Senior Secured Medium-Term Note Program, Affirmed (P)A3

....BACKED Subordinate Regular Bond/Debenture, Affirmed Baa3

....BACKED Senior Secured Regular Bond/Debenture, Affirmed A3

..Issuer: Thames Water (Kemble) Finance PLC

....BACKED Senior Secured Regular Bond/Debenture, Affirmed B1

Outlook Actions:

..Issuer: Thames Water Utilities Ltd.

....Outlook, Changed To Stable From Negative

..Issuer: Thames Water Utilities Finance Limited

....Outlook, Changed To Stable From Negative

..Issuer: Thames Water Utilities Cayman Finance Limited

....Outlook, Changed To Stable From Negative

..Issuer: Thames Water (Kemble) Finance PLC

....Outlook, Changed To Stable From Negative

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Stefanie Voelz
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Monica Merli
MD - Infrastructure Finance
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms Thames Water's Baa1 CFR on Ofwat decision; stable outlook
No Related Data.
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