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Rating Action:

Moody's changes to negative outlook on Thames Water (Kemble) Notes

11 Feb 2014

Affirms ratings of senior secured notes

London, 11 February 2014 -- Moody's Investors Service has today changed to negative from stable the outlook on the senior secured notes issued by Thames Water (Kemble) Finance PLC (Kemble Finance). Concurrently, Moody's has affirmed the B1 rating of the senior secured notes issued by Kemble Finance.

The negative outlook reflects the risk that the ongoing price review for the UK water industry, which will set tariffs for the five-year period commencing 1 April 2015 (AMP6), will result in reduced financial flexibility and capacity to meet debt service obligations.

RATINGS RATIONALE

Kemble Finance is a financing subsidiary of Kemble Water Finance Limited (Kemble), a holding companies for Thames Water Utilities Ltd. (Thames Water, Baa1 stable corporate family rating). Guidance issued by Ofwat on 27 January 2014 suggests that allowed returns for the UK water sector and, therefore, Thames Water will likely fall from the current 5.1% to 3.85% (vanilla real) from the start of the next five year regulatory period in April 2015. Today's outlook change reflects the increased likelihood that cash flow generation at Thames Water will be curtailed by a challenging regulatory price review, which Moody's expects to significantly reduce the amount of dividends being upstreamed to the Kemble holding company level.

Whilst Moody's expects Kemble Finance to remain in a position to meet its debt service payments , the assigned negative outlook reflects the increased risk exposure to cash flow shortages should Thames Water be faced with additional pressures, such as low inflation, operational underperformance or cost overruns in their capex programme.

Moody's rating of the Kemble Finance notes is a function of (1) the credit quality of the Kemble group; (2) the priority position in relation to operating cash flows as well as recovery proceeds in a default scenario pertaining to creditors at the operating company, Thames Water, resulting in the deeply subordinated position of the Kemble Finance Notes; and (3) the terms of the Kemble Finance Programme.

Moody's considers the consolidated credit quality of the Kemble group to be consistent with a rating at the bottom of the Baa range.

The B1 rating assigned to Kemble Finance's GBP400 million 7.75% senior secured notes due January 2019 (the Kemble Finance notes) reflects (1) the low business risk profile of Thames Water, as the monopoly provider of water and wastewater services in its area; (2) the stable and transparent regulatory framework for the water sector in England and Wales; (3) the high level of gearing at Thames Water and other debt in the group including the Kemble Finance notes (debt can increase up to 92.5% of Thames Water's RCV before a distribution lock-up comes into effect); (4) the terms of the ring-fenced, highly-leveraged, financing structure previously executed by Thames Water (the Thames Water Programme); (5) the large capital investment programme planned by Thames Water for the current regulatory period; and (6) the terms of the Kemble Finance Programme including a cash trapping provision.

The current ratings and negative outlook factor in the additional pressure from the ongoing price review for the UK water industry, which will set tariffs for the five-year period commencing 1 April 2015 (AMP6). Although the proposed reduction in the allowed return is a credit negative, Moody's believes that Thames Water will be able to absorb the challenges of a tough price review within their current ratings. However, equity returns will fall and the companies' future financial flexibility to offset additional cash flow stresses will be limited.

Reduced dividend flows will result in declining cash inflows for Kemble, and could ultimately lead to debt service shortfalls. Whilst Moody's believe that this risk may only materialise in a downside scenario, the additional risk of reduced financial headroom to withstand additional shocks at the operating company level and the resulting impact on distributions to Kemble is reflected in a negative outlook. Moody's expects further clarity on the ongoing price review, with companies updating certain aspects of their business plans and the regulator finalising incentive packages over the coming months. The rating agency believes that the final regulatory package will provide sufficient certainty on the potential financial flexibility at the operating company level and the resulting headroom for distributions to the Kemble holding company. At that point, Moody's will also assess shareholder's strategy on future dividend requirements or other potential measures to maintain credit quality at Kemble.

WHAT COULD CHANGE THE RATING UP/DOWN

Given the current negative outlook, there is no upgrade potential. The outlook could be stabilised, if it becomes clear, by the time of the final price determination in December 2014, that Thames Water is unlikely to be materially constrained in its ability to upstream sufficient dividend payments to cover Kemble Finance's debt service requirements.

Negative pressure on the Kemble Finance notes could follow a material deterioration in the group's financial metrics such that dividend lock-ups at the Thames Water level are more likely to be breached (under the terms of the Thames Water Programme, there is a distribution lock-up at the operating company if (1) Class A RCV gearing or Senior (Class A and Class B) RCV gearing exceeds 75% or 85% respectively; or (2) Class A Adjusted Interest Cover Ratio or Senior Adjusted Interest Cover Ratio falls below 1.30x or 1.10x, respectively). Such deterioration could be the result of serious underperformance in operating or capital expenditure at Thames Water, or adverse macro-economic developments, including deflation. Negative funding conditions, particularly in the light of the refinancing of the Kemble Finance notes towards the end of AMP6, or adverse changes in the regulatory framework or structure of the water sector in England and Wales may also cause downward rating pressure at Kemble Finance. Finally, Moody's notes that it would likely strain the credit profile of Thames Water (and hence Kemble) if Thames Water were required to deliver the main construction works associated with the Thames Tideway Tunnel (estimated construction cost GBP4.1 billion). The rating agency believes that this scenario is unlikely due to the UK government's ongoing consultation for appointing a specified infrastructure provider, but an incremental risk related to Thames Water's involvement with the Thames Tideway Tunnel project may remain.

PRINCIPAL METHODOLOGY

The principal methodology used in this rating was Global Regulated Water Utilities published in December 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Thames Water (Kemble) Finance PLC is the financing subsidiary of Kemble Water Finance Limited, an intermediate holding company in the Thames Water Group. The principal operating subsidiary in the group is Thames Water Utilities Ltd., a regulated WaSC operating in London and the Thames Valley area. Thames Water is the largest of the ten WaSCs in England and Wales by both RCV and the number of customers served. Thames Water provides drinking water to around 8.8 million customers and sewage treatment for a residential population of around 14 million in London and the Thames Valley. Kemble Water Finance Limited is ultimately owned by a consortium led by Macquarie's European Infrastructure Funds.

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 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 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 rating action, and whose ratings may change as a result of this 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
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

Monica Merli
MD - Infrastructure Finance
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 to negative outlook on Thames Water (Kemble) Notes
No Related Data.
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