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Rating Action:

Moody's affirms ratings of Northern Powergrid; stable outlook

13 May 2020

London, 13 May 2020 -- Moody's Investors Service, (Moody's) has today affirmed the senior unsecured ratings of Northern Powergrid Holdings Company (NPg Holdings), the parent company for the Northern Powergrid (NPg) group of companies, and five rated subsidiaries. The outlook on all ratings is stable.

The ratings affirmed are for NPg Holdings (Baa1 stable), Northern Powergrid Yorkshire plc (NPg Yorkshire) (A3 stable), Northern Powergrid (Northeast) Limited (NPg Northeast) (A3 stable), Northern Electric plc (A3 stable), Northern Electric Finance plc (A3 stable) and Yorkshire Power Finance Limited (Baa1 stable).

A full list of affected ratings is provided towards the end of this press release.

RATINGS RATIONALE

The affirmation of the ratings of the NPg group of companies reflects Moody's expectation of (1) continued solid operational performance by the group's two main subsidiaries over the remainder of the current regulatory period, RIIO-ED1, which runs until March 2023; (2) stronger interest coverage metrics as a result of the group locking in significantly lower financing costs in 2019 and its most expensive existing debt falling away over the 2020-22 period; and (3) the continuation of a prudent financial policy.

The group's two electricity distribution networks operators (DNOs), NPg Northeast and NPg Yorkshire, account for the vast majority of the NPg group's earnings, 87% in FY2019, and assets. Operational performance over the first half of RIIO-ED1 has been solid, reflected in significant rewards earnt for performance against regulatory targets. In its determination for RIIO-ED1, the regulator (Ofgem) provided for significant financial incentives and penalties for companies' performance against defined operational targets. The highest-powered incentive is on network reliability followed by that on the broad measure of customer service (BMCS). On both metrics, NPg's DNOs have earnt material incentive income, GBP29 million per annum on average over the first half of RIIO-ED1 - 6% of the consolidated group's Funds From Operations (FFO) and 0.25x interest expense in FY2019.

Moody's expects earnt incentive income to be at least at current levels for the remainder of RIIO-ED1 reflecting NPg's continued improvements on these metrics and the only modest tightening of the regulatory targets within period, none on BMCS. This material incentive income, paid with a two year lag and thus expected to continue in the first two years of the next price control (RIIO-ED2), has helped moderate downward pressure on adjusted interest coverage metrics of the DNOs during the first half of RIIO-ED1 from falling allowed returns, due to the continued low interest rate environment.

With limited financing and refinancing requirements during this period, the group has been particularly affected by the impact of low yields. Funding costs have not fallen in line with allowed returns. However, almost 30% of the consolidated NPg group's outstanding debt at December 2019 (including its most expensive instruments) matures over 2020-22.

In 2019 the group's DNOs pre-funded upcoming debt maturities at a weighted average coupon below 2.5%, equivalent to a 25% reduction in the group's interest expense in FY2019, with a tenor of at least 30-years. Consequently, as this expensive debt is retired, Moody's expects NPg to materially outperform the regulatory cost of debt allowance in the second half of RIIO-ED1, particularly at NPg Yorkshire. This will materially support interest coverage metrics and more than offset the underperformance against regulatory allowances for controllable operating and capital expenditure (together total expenditure, totex) over the second half of RIIO-ED1.

Whilst NPg's DNOs have outperformed regulatory totex allowances by 6% over the first half of RIIO-ED1 this was due to phasing of spend (back-loading) during the control rather than underlying outperformance; NPg forecast totex broadly in line with allowances for the regulatory period as a whole. Moody's expects the headroom on interest coverage metrics to reduce from the start of RIIO-ED2 in April 2023 due to (1) a material cut in allowed equity returns; (2) less highly powered incentives, on cost efficiency and on outputs carrying financial incentives, reducing the scope for significant outperformance against the regulatory settlement; and (3) limited debt maturities during RIIO-ED2. These pressures will be greater at NPg Northeast than NPg Yorkshire.

The ratings of the NPg group of companies are supported by the group's prudent financial policy. This is reflected in leverage levels both for its DNOs and the consolidated group at levels well below peers and, for its DNOs, regulatory assumptions. This reflects the covenant in a December 2022 bond preventing the DNOs issuing debt if senior net debt / Regulated Asset Value (excluding non-recourse project finance debt, currently in the group's metering business) for the consolidated NPg group, NPg Holdings, would exceed 65%. Due to debt at holding companies above the DNOs (NPg Holdings and Yorkshire Power Finance Limited), this effectively limits Net Debt / RAV to the low 50s in percentage terms. Whilst this covenant falls away in 2022, we expect NPg to continue to pursue a prudent financial policy with senior net debt / RAV around current levels. In the long-term, i.e. after the 2022 and 2028 bonds at the holding companies have been repaid, Moody's anticipates the DNOs will be geared broadly in line with regulatory assumptions and the only additional debt at NPg to be non-recourse project finance debt.

The proportion of earnings from the group's unregulated business has increased in recent years with the growth in the smart metering business in the UK, which along with NPg Northeast are Northern Electric plc's main subsidiaries. Moody's estimate metering comprised 18% of the consolidated NPg group's FFO in FY2019 and based on committed investments this to remain broadly stable over the period to 2025. The metering business generates relative stable cash flows though Moody's does not view the earnings as the same quality as from the regulated networks.

Moody's believes that NPg's DNOs like other European energy networks have low exposure to the coronavirus outbreak. This reflects that there is a true-up mechanism in the distribution licence which facilitates the recovery of any potential under-recovery of allowed revenue with a two-year delay, i.e. in regulatory year 2022/23 for the expected under-recovery in 2020/21 regulatory year. This true-up also extends to any energy supplier bad debts network licensees may suffer with a three-year delay.

However, the sharp recession caused by the coronavirus outbreak, and in particularly the large fall in commodity prices, will likely slow the growth of NPg other notable unregulated business, its hydrocarbon exploration subsidiary (through CalEnergy Resources Limited, CER). Moody's understands investment decisions were due to be taken in 2020 on two projects where CER's share of project capex would have been over GBP150 million in both cases, following on from the investment decision taken on phase one of a project in late 2019 (Thames Pipeline Catchment Area) with capex of over GBP200 million. Moody's believes the impact on NPg Holdings' credit quality from the commitments made so far is limited in the short term as (1) the acquisition and majority of the development costs can be financed from equity (deferral of dividends, none were paid in FY2019); and (2) NPg Holdings' has some financial flexibility at the current rating level on leverage. When these projects enter the operational phase, Moody's will review its ratio guidance for the NPg Holdings to reflect that the high business risk profile of these activities due to their volatile cash flows.

RATINGS OUTLOOK

The stable outlook for all six NPg entities reflects Moody's expectation that management will maintain a financial profile in line with guidance for the current ratings.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

NPg Northeast, Northern Electric Finance Plc, Northern Electric Plc, NPg Yorkshire

An upgrade of NPg's DNOs, NPg Northeast's financing subsidiary (Northern Electric Finance Plc) and Northern Electric plc is not currently anticipated reflecting that (1) ratings are constrained by leverage at NPg Holdings; and (2) Moody's expectation of a deterioration in interest coverage metrics in RIIO-ED2.

Downward rating pressure would arise at these entities if either: (1) Net debt / RAV rose above 68% at the licensed entity or above the low 70s in percentage terms for NPg Holdings; or (2) adjusted interest coverage appeared likely to fall below 1.6x either at the DNOs or NPg Holdings, on an underlying basis.

Northern Powergrid Holdings

An upgrade of NPg Holdings is not currently anticipated given (1) the continued growth of the unregulated business; and (2) the declining allowed returns and likely reduced scope for outperformance in RIIO-ED2. However, upwards rating pressure could follow if net debt/RAV appeared likely to fall sustainably below the low 60s in percentage terms.

Yorkshire Power Finance Limited

An upgrade of Yorkshire Power Finance Limited, the financing vehicle of NPg Yorkshire's immediate holding company (Yorkshire Power Group), is not currently anticipated reflecting that ratings are constrained (1) by leverage at NPg Holdings; and (2) Moody's expectation of a deterioration of interest coverage metrics in RIIO-ED2.

Downward rating pressure at Yorkshire Power Finance Limited if for Yorkshire Power Group either adjusted interest coverage appeared likely to fall below 1.6x on an underlying basis or Net Debt / RAV appeared likely to rise above 68%.

The principal methodology used in these ratings was Regulated Electric and Gas Networks published in March 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1059225. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Northern Powergrid Holdings is the parent undertaken for the Northern Powergrid group of companies. Its two main operating subsidiaries are its regulated electricity distribution networks in Great Britain which had a combined regulated asset value of GBP3.3 billion at 31 March 2020. The group has grown its unregulated business in recent years, primarily through investments in its smart metering business, with the non-distribution business accounting for 13% of operating profit in 2019.

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: Northern Electric Finance Plc

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed A3

....Underlying Senior Unsecured Regular Bond/Debenture, Affirmed A3

..Issuer: Northern Electric plc

....LT Issuer Rating, Affirmed A3

..Issuer: Northern Powergrid (Northeast) Limited

...LT Issuer Rating, Affirmed A3

..Issuer: Northern Powergrid (Yorkshire) plc

....LT Issuer Rating, Affirmed A3

....Senior Unsecured Regular Bond/Debenture, Affirmed A3

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed A3

....Underlying Senior Unsecured Regular Bond/Debenture, Affirmed A3

..Issuer: Northern Powergrid Holdings Company

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa1

....Underlying Senior Unsecured Regular Bond/Debenture, Affirmed Baa1

..Issuer: Yorkshire Power Finance Limited

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa1

Outlook Actions:

..Issuer: Northern Electric Finance Plc

....Outlook, Remains Stable

..Issuer: Northern Electric plc

....Outlook, Remains Stable

..Issuer: Northern Powergrid (Northeast) Limited

....Outlook, Remains Stable

..Issuer: Northern Powergrid (Yorkshire) plc

....Outlook, Remains Stable

..Issuer: Northern Powergrid Holdings Company

....Outlook, Remains Stable

..Issuer: Yorkshire Power Finance Limited

....Outlook, Remains Stable

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

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.

Philip Cope
AVP-Analyst
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Neil Griffiths-Lambeth
Associate Managing Director
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 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
Client Service: 44 20 7772 5454

No Related Data.
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