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Announcement:

Moody's assigns/maintains negative outlook on 6 UK water groups

19 Dec 2017

London, 19 December 2017 -- Moody's Investors Service (Moody's) has today assigned or maintained negative outlooks for five UK-based regulated water utilities and one high-yield holding company; the respective ratings have been affirmed.

These actions follow publication, on 13th December, by the Water Services Regulation Authority (Ofwat), the economic regulator for water companies in England and Wales, of its final methodology for the 2019 price review (PR19), including guidance on allowed cost of capital for the period from April 2020 to March 2025 (AMP7).

RATINGS RATIONALE

Today's actions relate to the companies that Moody's considers most exposed to the likely cut in allowed returns from 2020, as guided by the regulator in its final PR19 methodology. Specifically, it reflects the risk that companies may not maintain a financial profile in line with Moody's guidance for its current rating levels, taking into account (1) their financial leverage and capital structure; and (2) the cost and maturity profile of their debt in the context of likely financing and refinancing requirements over the 2020-25 period.

Ofwat published its final methodology for PR19, setting out requirements and expectations for companies' business plans and the regulator's assessment of these. Compared with the July draft consultation, the final methodology includes small changes to the total expenditure incentive regime as well as outcome delivery targets, but overall efficiency requirements will likely remain challenging. The regulator is proposing to reward companies whose business plans it assesses as exceptional or enhanced, but the monetary adjustment will provide limited relief against the low headline return.

As part of its methodology, Ofwat provided guidance on the allowed cost of capital for AMP7. Given the continuing low yield environment, a cut in allowed returns is to be expected and the regulator has guided to a reduction to 2.3% (real, assuming Retail Prices Index, or RPI, inflation) from currently 3.6% for the regulated water and wastewater wholesale activities. The regulator's proposal to link revenue and asset inflation to a measure of the Consumer Prices Index, adjusted for housing costs (CPIH) will increase the overall allowed return, albeit at the expense of future growth in the regulatory capital value (RCV). Nevertheless, the allowed cost of capital will still fall by around 0.8%, assuming a 100bps wedge between RPI and CPIH.

Companies with the highest leverage and/or expensive and long-dated debt are particularly exposed to the cut in returns. The smaller water-only companies also report higher debt cost linked to their relatively infrequent funding. While companies that refinance in the current low interest rate environment will benefit, average maturities of the sector are quite long, at around 16 years. This reflects nominal fixed rate debt with maturities closer to 10 years, while inflation-linked funding tends to extend beyond 20 years. Therefore, actual capital structures may not evolve in line with Ofwat's chosen debt indices.

However, in taking today's action, Moody's also considers that the PR19 process is in the early stages and the reduction may be less than currently proposed and/or mitigated by other aspects of Ofwat's final determination. The rating agency also takes into account that (1) management have some time to adapt financial policies and bolster financial flexibility ahead of AMP7; and (2) to varying degrees, shareholders have demonstrated a willingness to support companies' credit quality in the past, albeit low yields and high mark-to-market loss may have eroded incentives to provide additional equity.

Moody's notes the regulator's duties, in particular to ensure that efficient companies can finance their functions but also Ofwat's focus on a notional capital structure, with notional gearing proposed at 60% of the RCV for PR19, to set the allowed return.

Finally, the rating agency also considers the UK water companies' sound business risk profile as monopoly providers of essential water and sewerage services and the stable cash flows generated under a transparent and well-established regulatory regime.

For more detailed information on individual issuers, please see the following press releases:

Assignment/Affirmation of negative outlooks:

- Anglian Water (Osprey) Financing plc: Moody's changes outlook to negative on Osprey, affirms ratings - https://www.moodys.com/research/Moodys-changes-outlook-to-negative-on-Osprey-affirms-Ba3-rating--PR_377345

- Northumbrian Water Ltd.: Moody's affirms Northumbrian Water's Baa1 rating, negative outlook - https://www.moodys.com/research/Moodys-affirms-Northumbrian-Waters-Baa1-rating-negative-outlook--PR_377218

- Portsmouth Water Limited: Moody's affirms Portsmouth Water's rating and changes outlook to negative -https://www.moodys.com/research/Moodys-affirms-Portsmouth-Waters-rating-and-changes-outlook-to-negative--PR_377192

- Severn Trent Plc: Moody's changes outlook to negative on Severn Trent, affirms ratings - https://www.moodys.com/research/Moodys-changes-outlook-to-negative-on-Severn-Trent-affirms-ratings--PR_377344

- Southern Water Services Limited: Moody's affirms Southern Water's ratings, negative outlook - https://www.moodys.com/research/Moodys-affirms-Southern-Waters-ratings-negative-outlook--PR_377221

- Yorkshire Water Services Limited: Moody's changes outlook to negative on Yorkshire Water, affirms ratings -- https://www.moodys.com/research/Moodys-changes-outlook-to-negative-on-Yorkshire-Water-affirms-ratings--PR_377343

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

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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