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Rating Action:

Moody's changes outlook on Northumbrian Water's Baa1 ratings to negative; affirms ratings

22 Jan 2016

London, 22 January 2016 -- Moody's Investors Service ("Moody's") has today changed to negative from stable the outlook on the Baa1 issuer rating of Northumbrian Water Ltd. ("NWL") and the Baa1 senior unsecured debt ratings of Northumbrian Water Finance Plc, guaranteed by NWL. At the same time, Moody's has affirmed all ratings.

RATINGS RATIONALE

-- OUTLOOK CHANGE TO NEGATIVE --

Today's decision to change the outlook to negative reflects the risk that NWL and its parent Northumbrian Water Group Limited ("NWG") may fail to return credit metrics to levels consistent with current ratings absent significant outperformance against regulatory assumptions and at least moderate inflation.

Whilst NWL's stand-alone leverage (expressed as net debt to Regulatory Capital Value or RCV) of around 70% at 31 March 2015 is well aligned with Moody's expectation for the current Baa1 rating, its parent NWG entered the new five-year regulatory period (AMP6, April 2015 -- March 2020) with consolidated leverage (including shareholder loans and certain debt relating to the securitization of the Kielder reservoir and two Scottish PFI projects) in excess of 100% of NWL's RCV. This was largely due to a sizeable downward adjustment to NWL's RCV (-3.8%). While Moody's ascribes some value to the regulatory ring-fencing provisions, included within NWL's licence, if the current level of gearing were to be sustained then it would constrain NWL's rating at a lower level.

Similar to its peers, NWL is operating under a challenging price determination for AMP6. The Water Services Regulation Authority ("Ofwat"), the regulator for water companies in England and Wales set a weighted average cost of capital of 3.74% (real, post-tax) for the industry, as compared to 5.1% in the previous five-year period. Under the regulator's final determination, NWL must reduce prices by an average of 1% in real terms over AMP6 while the allowed wholesale total expenditure ("totex") package of GBP2.3 billion (in 2012/13 prices) is expected to result in a 1% real terms increase in the company's RCV over the period.

In Moody's view, NWG's dividend policy combined with the allowances set by the regulator in the final price determination leave little financial flexibility to absorb potential negative economic pressures such as low or negative inflation which may create further headwinds for the group in reducing leverage to around 100%, the level that Moody's sees as commensurate with a Baa1 rating at NWL, taking into account the partial insulation of its credit quality from that of the wider group.

-- AFFIRMATION OF THE RATING --

The rating affirmation recognizes (1) NWL's track record of delivering significant cost efficiencies in AMP5, which positions it well to exceed regulatory targets in AMP6, and (2) Moody's expectation that its ultimate shareholder CK Hutchison Holdings Limited (A3 stable) would exhibit a conservative funding approach to NWL if performance or operating conditions were to deteriorate, similar to the relatively prudent financial policy it has applied to its other UK regulated utility holdings.

NWL's current Baa1 ratings take into account (1) the stable cash flows generated from the provision of monopoly water services under a well-established, transparent and predictable regulatory regime, (2) a high leverage when factoring in the debt, including GBP1 billion of shareholder loans, at its parent NWG, and (3) the regulatory ring-fencing and lower stand-alone leverage at NWL which support an uplift from the consolidated credit quality of the group.

OUTLOOK

The outlook is negative, reflecting the risk that NWG's leverage could stay above Moody's guidance in the absence of material outperformance against regulatory assumptions and at least moderate inflation.

WHAT COULD MOVE THE RATING UP/DOWN

Given the negative outlook, Moody's does not expect upwards rating pressure. Strong outperformance against regulatory assumptions and/or high inflation would be required for Moody's to consider stabilizing the outlook on NWL's ratings.

NWL's ratings could be downgraded if (1) NWG's consolidated leverage remains permanently well in excess of 100%, or (2) NWL's stand-alone financial profile deteriorates, translating into net debt (including the Kielder securitisation debt) to RCV above 80% or an adjusted Interest Cover Ratio below 1.4x on a continuous basis. More generally, a material adverse change to the UK water regulatory framework, or unforeseen funding difficulties could result in a rating downgrade.

The principal methodology used in these ratings was Regulated Water Utilities published in December 2015. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Northumbrian Water Ltd. is the eighth-largest of the ten water and sewerage companies in England and Wales with a RCV close to GBP3.8 billion at 1 April 2015. It is the main subsidiary of Northumbrian Water Group Limited, whose ultimate parent is Hong Kong-based conglomerate CK Hutchison Holdings Limited.

REGULATORY DISCLOSURES

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

Paul Marty
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

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

Moody's changes outlook on Northumbrian Water's Baa1 ratings to negative; affirms ratings
No Related Data.
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