London, 11 May 2020 -- Moody's Investors Service, (Moody's) has today affirmed
the Baa1 / Prime-2 (P-2) ratings of Eastern Power Networks
PLC (EPN), London Power Networks PLC (LPN) and South Eastern Power
Networks PLC (SPN), the three electricity distribution network operators
(DNOs) owned by UK Power Networks Holdings Limited (UKPN). The
outlook on all ratings is stable.
A full list of affected ratings is provided towards the end of this press
release.
RATINGS RATIONALE
The affirmation of the Baa1 ratings reflects Moody's expectation
of continued strong operational performance by all UKPN's DNOs over
the remainder of the current regulatory period (RIIO-ED1),
which runs until March 2023. The DNOs continue to underspend regulatory
allowances for operating costs and capital expenditure (total expenditure,
totex) and earn significant rewards for performance against regulatory
targets. Incentive income for the last two years of RIIO-ED1
will also moderate downward pressure on interest coverage metrics in the
first two years of the next price control (RIIO-ED2), when
Moody's expects materially lower allowed returns.
UKPN's DNOs collectively outperformed regulatory totex allowances
by 16% in the first four years of the eight-year RIIO-ED1
period and, under their regulatory determination, keep 53.5%
of these savings. Whilst UKPN expect the extent of outperformance
to moderate in the second half of RIIO-ED1, to 6%,
the group is still forecasting 11% outperformance (ranging from
9-13% across its DNOs) for the entire regulatory period.[1]
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 network reliability, UKPN's
DNOs have either capped out on incentive income (EPN and LPN usually)
or achieved material incentive income thus achieving the vast majority
of the GBP54.5 million (in 2018/19 prices) pot available per annum
for this incentive in RIIO-ED1. Performance on BMCS has
improved throughout the regulatory period, with Moody's expecting
a further material step-up in 2019/20. Since the regulatory
targets are fixed for the duration of the control, this has resulted
in material and growing earnt incentive revenue on this measure (72%,
or GBP8.95 million, of the maximum in 2018/19). On
all incentives, over the first half of RIIO-ED1, UKPN's
DNOs have collectively averaged over GBP60 million per annum of incentive
income, c. 10% of the consolidated UKPN group's
Funds From Operations (FFO) or 0.26x interest expense in 2018/19.
UKPN's DNOs currently have significant financial flexibility at
the current rating level due to the strong operational performance supporting
interest coverage metrics and the DNOs typically being geared at or slightly
above the regulatory assumption (65%). However, Moody's
expects the headroom on interest coverage to materially reduce from the
start of RIIO-ED2 in April 2023 as a result of (1) a material cut
in allowed equity returns; and (2) less highly powered incentives,
on cost efficiency and on outputs carrying financial incentives,
reducing the scope for significant outperformance against the regulatory
settlement. Moody's anticipates a two-step decline
in interest coverage metrics over RIIO-ED2, initially in
year 1 (2023/24), from the lower allowed returns, and then
in year 3 (2025/26) when earnt incentive income from RIIO-ED1 is
no longer received (incentive income is received with a two-year
lag).
The ratings of all UKPN's DNOs are constrained by the high financial
leverage of the consolidated UKPN group, reflected in net debt /
regulated asset value (RAV) around 87% at March 2019, and
primarily attributable to additional debt, mainly in the form of
shareholder loans, at UKPN. In RIIO-ED2, Moody's
expects leverage of the consolidated group to trend slightly down under
its assumptions of (1) debt in the unregulated business slightly decreasing
whilst the RAV of the regulated business grows; and (2) the DNOs
being geared at or slightly above regulatory assumptions (in the mid-to-high
60s in percentage terms, compared to our guidance of 75%).
Interest expense on the shareholder loans, which carry a 9.95%
interest rate, accounted for almost 30% of the consolidated
UKPN group's interest expense in 2018/19 despite accounting for
less than 15% of the consolidated group's net debt.
Consequently, the rating agency anticipates the pressure on adjusted
interest coverage measures to be greater for the consolidated group than
for UKPN's DNOs in RIIO-ED2. Of UKPN's DNOs,
we expect EPN to have slightly weaker interest coverage metrics than LPN
and SPN in RIIO-ED2 due to the higher cost of embedded debt,
assuming all companies perform in line with the regulatory determination.
Moody's believes that UKPN'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, however with a three year time
lag.
The Baa1 ratings of UKPN's DNOs also positively reflect their monopoly
position as the licenced provider of electricity distribution services
in their service areas (London (LPN), the east of England (EPN),
and the south east of England (SPN)) and the well-established and
transparent regulatory regime in Great Britain, which underpin their
very low business risk profile.
RATINGS OUTLOOK
The stable outlook for the ratings of UKPN reflects Moody's expectation
that management will maintain a financial profile for all UKPN DNOs in
line with guidance for the current rating, supported by the DNO's
(and indeed the UKPN group's) continuing strong operational performance
on both regulatory cost allowances and outputs carrying financial rewards
during the remainder of RIIO-ED1.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Given the high level of leverage of the consolidated UKPN group upward
rating pressure is not anticipated.
Downward rating pressure would arise at UKPN's DNOs if either:
(1) Net debt / RAV rose above 75% at the licenced entity or above
the high 80s (including shareholder loans) in percentage terms for the
consolidated UKPN group; or (2) adjusted interest coverage appeared
likely to fall below 1.4x at the DNOs or 1.2x for the consolidated
UKPN group, on an underlying basis.
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.
Headquartered in London, UKPN owns three of the 14 regulated electricity
distribution networks in Great Britain and is the second largest electricity
distribution network group by regulated asset value, GBP6.4
billion at 31 March 2020.
LIST OF AFFECTED RATINGS
Affirmations:
..Issuer: Eastern Power Networks PLC
....LT Issuer Rating, Affirmed Baa1
....ST Issuer Rating , Affirmed P-2
....Senior Unsecured MTN Program, Affirmed
(P)Baa1
....Senior Unsecured Regular Bond/Debenture,
Affirmed Baa1
..Issuer: London Power Networks PLC
...LT Issuer Rating, Affirmed Baa1
....ST Issuer Rating, Affirmed P-2
....Senior Unsecured MTN Program, Affirmed
(P)Baa1
....Senior Unsecured Regular Bond/Debenture,
Affirmed Baa1
..Issuer: South Eastern Power Networks PLC
....LT Issuer Rating, Affirmed Baa1
....ST Issuer Rating, Affirmed P-2
....Senior Unsecured MTN Program, Affirmed
(P)Baa1
....Senior Unsecured Regular Bond/Debenture,
Affirmed Baa1
Outlook Actions:
..Issuer: Eastern Power Networks PLC
....Outlook, Remains Stable
..Issuer: London Power Networks PLC
....Outlook, Remains Stable
..Issuer: South Eastern Power Networks PLC
....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.
REFERENCES/CITATIONS
[1] Ofgem: RIIO-1 Electricity Distribution Annual Report
2018-19, February 2020 https://www.ofgem.gov.uk/publications-and-updates/riio-1-electricity-distribution-annual-report-2018-19
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
Asst Vice President - 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:
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