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Rating Action:

Moody's assigns (P)Baa3 rating to FGC's proposed LPN programme and first LPN series; stable outlook

27 Nov 2012

London, 27 November 2012 -- Moody's Investors Service has today assigned a provisional (P)Baa3 rating to the proposed RUB100 billion loan participation notes (LPN) programme and the proposed first series of the notes under the programme to be issued by, but with limited recourse to, Federal Grid Finance Limited, a special vehicle (SPV) incorporated in Ireland, of FGC UES (FGC). The notes will be issued in series for the sole purpose of financing loans to FGC (under a facility agreement with Federal Grid Finance Limited). The outlook on the rating is stable.

Moody's issues provisional ratings in advance of the final sale of securities, and these ratings represent only Moody's preliminary opinion. Upon a conclusive review of the transaction and associated documentation, Moody's will endeavour to assign definitive ratings to the notes. A definitive rating may differ from a provisional rating.

RATINGS RATIONALE

The (P)Baa3 rating assigned to the proposed LPN programme and notes reflects the Baa3 issuer rating of FGC. Federal Grid Finance Limited will issue the notes under the programme for the sole purpose of financing loans to FGC and therefore the noteholders rely solely on FGC's creditworthiness to service and repay the debt. FGC's obligations under the respective loans are assumed to rank pari passu with all its other unsecured and unsubordinated financial indebtedness (apart from any obligations mandatorily preferred by law). The noteholders will benefit from certain covenants made by FGC in the underlying facility agreement, including a negative pledge and restrictions on mergers and disposals. The notes also contain a change of control clause should the Russian Federation cease to own or control (directly or indirectly) in excess of 50% of the issued and outstanding voting share capital of FGC. FGC will use the proceeds of the respective loans in the ordinary course of its business.

Moody's regards FGC as a government-related issuer (GRI). In accordance with Moody's GRI rating methodology, the Baa3 issuer rating of FGC and the (P) Baa3 rating of the proposed notes reflect the combination of the following inputs: (1) the company's baseline credit assessment (BCA) -- a measure of its standalone credit quality -- of ba; (2) the Baa1 local-currency rating of the Russian government; (3) Moody's assessment that there is "high" default dependence between FGC and the Russian government; and (4) Moody's view that FGC would benefit from "strong" government support in a financial distress.

On 23 November 2012, Moody's downgraded FGC's issuer rating to Baa3 from Baa2. The downgrade reflects Moody's view that the Russian government will distance itself from FGC in the course of the restructuring of the Russian grid sector in line with a Decree on OJSC Russian Grids (Russian Grids) of the President of Russia, published on 22 November 2012. Specifically, the one-notch downgrade of FGC's issuer rating reflects Moody's belief that this restructuring will reduce the probability that the government will provide extraordinary support to the company in a distress situation. Moody's adjusted downwards the probability of state support factored into the company's issuer rating to "strong" from "high", which reduced the uplift to the BCA, albeit it remains unchanged at ba.

In June 2012, the Russian government transferred IDGC Holding (Ba1 developing), the holding company for a few major regional and interregional distribution grid companies, under management of FGC, the Russian transmission grid business. However, thereafter, the government has been working out a new strategy for the development of the grid sector, including a further alliance of the two entities. In accordance with the mentioned Presidential Decree, the grid sector is now to be consolidated on the basis of IDGC Holding. The government will transform IDGC Holding, which will be renamed Russian Grids, into a management company for distribution grid businesses and FGC's transmission grid business. The management company will direct the development of the domestic grid sector to increase the quality and reliability of services, control costs and interlink investments in transmission and distribution grids. The government will contribute its stake in the FGC to the management company. As a result, the government's direct ownership of FGC will be replaced by an indirect one.

Moody's expects the government's effective ownership and control over FGC through the management company to be materially below the 75% plus one share currently required under Russian law. Moody's understands that the Presidential Decree requires the government's effective control over FGC to be at least 50% plus one share and requests that a shareholder agreement between the government and Russian Grids be developed, which will enable the government to maintain control over FGC's operations. However, the rating agency considers that the planned change to FGC's ownership structure and position in the corporate framework of the state-controlled grid sector will distance the company from the government and complicate their interaction. Moody's would expect this to reduce the probability of extraordinary state support in a distress situation.

FGC's ba BCA remains constrained by the evolving regulatory regime in the Russian grid sector, its changing configuration and the company's significant investment programme, which exerts pressure on its financial profile. However, the sustainability of the company's regulated and strategically important business as the national transmission grid operator continues to underpin the BCA.

OUTLOOK

The stable outlook on the (P)Baa3 rating of the proposed LPN programme and notes reflects the stable outlook on FGC's issuer rating, which, in turn, considers that the Presidential Decree contains a reasonably detailed plan of the grid sector restructuring. In Moody's view, the plan highlights the Russian government's clear intention to maintain control over FGC, and the rating agency would expect state support for the company to remain strong. Moody's notes that there are execution risks associated with the plan. The agency also notes uncertainties associated with the evolving regulation and the government's developing strategy for the grid sector. However, the outlook reflects Moody's expectation that the steps outlined in the Presidential Decree will be executed in the coming months in a way that does not negatively affect FGC's business and financial risk profile.

WHAT COULD CHANGE THE RATING UP/DOWN

An upgrade of the rating of the proposed LPN programme and notes would require an upgrade of FGC's issuer rating, which Moody's considers to be unlikely at this stage given the above mentioned execution risks and uncertainties.

Negative pressure on the rating of the proposed LPN programme and notes would arise from negative pressure on FGC's issuer rating, which could result from (1) unexpected changes to the new restructuring plan or its implementation, signalling weakening support from the government; (2) a negative shift in the developing regulatory regime and deteriorating margins; (3) a failure of the company to manage its investment programme in line with the tariff regulation and contain a deterioration of its financial profile, with funds from operations (FFO) interest coverage and FFO/net debt falling materially and persistently below 3.5x and 25%, respectively; (4) pressured liquidity.

PRINCIPAL METHODOLOGIES

The methodologies used in this rating were Regulated Electric and Gas Networks published in August 2009, and Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Headquartered in Moscow, Russia, JSC Federal Grid Company of Unified Energy System is the monopoly electricity transmission system operator in the Russian Federation. The company's revenues, approximately 96.5% of which are transmission revenues fully regulated by the state, amounted to RUB139.6 billion (around $4.7 billion) in 2011 (other operating income of RUB7.8 billion, primarily from non-core activities, is not included). The Russian government currently directly owns 79.55% of the company's ordinary shares.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant 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 relevant 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 relevant 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.

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

Information sources used to prepare the rating are the following : parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

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The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

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.

Ekaterina Botvinova
Vice President - Senior Analyst
Infrastructure Finance
Moody's Investors Service Limited, Russian Branch
7th floor, Four Winds Plaza
21 1st Tverskaya-Yamskaya St.
Moscow 125047
Russia
Telephone: +7 495 228 6060
Facsimile: +7 495 228 6091

Monica Merli
MD - Infrastructure Finance
Infrastructure Finance
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Moody's assigns (P)Baa3 rating to FGC's proposed LPN programme and first LPN series; stable outlook
No Related Data.
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