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Rating Action:

Moody's assigns Baa2 to Welsh Water's new junior notes

10 Feb 2020

London, 10 February 2020 -- Moody's Investors Service (Moody's) has today assigned a Baa2 subordinated rating to the proposed GBP200 million junior notes to be issued by Dwr Cymru (Financing) UK Plc under the company's GBP4.0 billion multi-currency programme. The rating outlook is stable.

This rating action follows today's announcement by Dwr Cymru Cyfyngedig (Welsh Water, CFR: A3 stable) that it intends to re-introduce a junior class of debt within its financing structure.

RATINGS RATIONALE

The Baa2 rating of the junior notes, two notches below Welsh Water's A3 corporate family rating (CFR), reflects (1) their subordinated position relative to the senior debt, which ranks ahead in the cash flow waterfall; and (2) the limited decision-making ability of junior note holders so long as senior debt remains outstanding. The two-notch differential takes into account Moody's view that the senior and junior classes of debt have similar probabilities of default but the loss severity for the junior tranche will be significantly greater, post any default.

As announced today, Welsh Water intends to issue GBP200 million notes, which will rank junior to the existing debt issued by Dwr Cymru (Financing) UK Plc. Under the terms of its highly-covenanted financing structure the company is permitted to have a subordinated class of debt (referred to as Class C in the documentation) as part of its capital structure. At inception of its current financing arrangements in 2001, Welsh Water issued GBP250 million Class C notes, equivalent to around 12-13% of total debt at that point in time. However, all previously outstanding Class C notes were repaid in 2005 and 2010, respectively, and, save for the proposed transaction, Welsh Water has not issued any junior class of debt since.

Moody's does not expect the re-introduction of junior debt into Welsh Water's capital structure to result in any ratings uplift for the senior debt relative to the CFR. This is because the planned quantum of junior notes, at roughly 5% of aggregate senior and junior debt, is modest while the tenor of the notes, around six years, implies that they may not be a permanent part of the capital structure. The limited proportion of junior debt, in particular, means that they offer limited loss-absorption capacity for senior creditors, relative to sector peers with highly-covenanted financing structures. The A3 rating of Welsh Water's senior bonds is therefore unaffected by this rating action and remains in line with the A3 CFR.

Finally, the Baa2 rating considers the relatively strong positioning of the CFR in the A3 category, which is underpinned by (1) Welsh Water's low business risk profile as the monopoly provider of essential water and sewerage services in Wales, with stable and predictable cash flows generated under a transparent and well-established regulatory regime; (2) a low level of gearing around 60%, calculated as the group's consolidated net debt to regulatory capital value (RCV); (3) the not-for-profit status of Welsh Water's ultimate parent company, Glas Cymru Holdings Cyfyngedig, which allows Welsh Water to manage the distribution of its profits in order to maintain the company's publicly stated gearing target of 60% net debt to RCV; and (4) the decision by the Welsh Government not to implement retail competition for incumbent water companies operating wholly or mainly in Wales in April 2017, which evidenced a cautious approach to market reform.

RATINGS OUTLOOK

The stable outlook reflects Moody's expectation that the company will be able to maintain financial metrics in line with guidance for its A3 CFR (as outlined below).

WHAT COULD CHANGE THE RATING

The ratings could be considered for an upgrade, if Welsh Water appeared likely to exhibit a ratio of net debt to RCV consistently at or below 55% and an AICR comfortably above 1.5x. Any upgrade would also have to take into account the evolution of the regulatory and business risks at that point in time.

Conversely, the ratings could be downgraded if Welsh Water's financial metrics was likely to deteriorate, such that gearing, measured by net debt to RCV, would increase above 65%, and AICR remain persistently below 1.35x.

In addition, downward rating pressure could result from (1) diversification away from Welsh Water's core regulated water and wastewater business that would result in an increase of the overall business risk, or credit risk implications for Welsh Water from future developments of the wider Glas Cymru group; and/or (2) a significant increase in business risk for the sector as a result of legal and/or regulatory changes leading to a reduction in the stability and predictability of regulatory earnings, which in each case are not offset by other credit-strengthening measures; or (3) or the company facing unforeseen funding difficulties.

PRINCIPAL METHODOLOGY

The principal methodology used in this rating was Regulated Water Utilities published in June 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Dwr Cymru Cyfyngedig is the sixth-largest UK water utility by RCV, providing water and sewerage services to approximately 3 million people in a region that covers most of Wales and certain adjoining areas of England.

Welsh Water's ultimate parent company is Glas Cymru Holdings Cyfyngedig (Glas Cymru), a not-for-profit organisation. In the financial year ending 31 March 2019, Welsh Water had a RCV of just under GBP5.7 billion, and the Glas Cymru group reported revenues of GBP782 million and operating profit of GBP69 million, primarily attributable to Welsh Water.

REGULATORY DISCLOSURES

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.

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
VP - Senior Credit Officer
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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