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Rating Action:

Moody's downgrades KEDNY to Baa1; stable outlook

10 Nov 2020

London, 10 November 2020 -- Moody's Investors Service (Moody's) has today downgraded to Baa1 from A3 the long-term issuer and senior unsecured ratings of The Brooklyn Union Gas Company (KEDNY), a local gas distribution company operating in downstate New York and ultimately owned by National Grid plc (National Grid, Baa1 negative). The outlook on all ratings has been changed to stable from ratings under review. This rating action concludes the review process initiated on 14 August 2020.

The review was prompted by KEDNY's persistently weak credit metrics and the absence of a timely and favourable resolution to the company's ongoing rate case settlement in downstate New York.

RATINGS RATIONALE

The rating downgrade to Baa1 reflects Moody's expectation that whilst KEDNY's key credit metrics will strengthen over the primary term of its next rate plan, they will remain below the rating agency's amended minimum ratio guidance of 19% for the A3 rating level given the more challenging operating environment.

In recent years, KEDNY has exhibited the weakest key credit metrics of National Grid's US regulated subsidiaries. KEDNY's cash flow from operations pre-working capital (CFO pre-WC) to debt has averaged 10.0% over the last three financial years, well below Moody's guidance for the A3 rating level.

Like other New York utilities, KEDNY's cash flow metrics have been depressed by (1) the regulatory framework offering one of the lowest allowed return on equity (ROE) amongst the US states (both equity thickness and authorised ROE); and (2) the impact of US tax reform, which has resulted in lower revenues for KEDNY since January 2019. However, KEDNY's cash flow metrics have fallen short of peers due to its (1) weak operating performance resulting in achieved ROE being well below authorised levels (below 8% compared to authorized 9.0 % in current rate plan); (2) very large investment programme, with average rate base growth of almost 20% over the last three financial years; and (3) material and growing environmental remediation liabilities.

The operating environment for New York utilities, particularly for gas LDCs, has become more challenging, in Moody's view, since National Grid made its April 2019 rate case filing for KEDNY and KeySpan Gas East Corporation (KEDLI, A3 negative), its sister gas LDC company in downstate New York. The state regulator (the Public Service Commission, PSC) has continued to cut allowed returns in determinations made, to-date, in 2020 (to authorised ROE of 8.8 % whilst retaining a 48% equity layer); and appears to have placed greater emphasis on affordability, with extensive coronavirus-related provisions included in rulings made since the pandemic hit the state, including back-loading, levelisation, of rate increases.

At the same time, political rhetoric and actions taken towards various state utilities have increased. New York State Governor Andrew Cuomo has formally threatened to revoke several utility operating licenses, including KEDNY's (in November 2019 following utility-imposed service moratoriums on new gas connections for certain service territories amid state restrictions on incremental supply opportunities), and this month published a bill outlining formal process for doing so, with more severe penalties for underperformance.

Moody's believes that KEDNY has been most adversely impacted by these developments, both from a business risk and financial profile perspective. There remains no enduring solution to address security of supply in downstate New York, with the agreement reached last year running only until September 2021. The independent monitor, set-up as part of the settlement, has been critical of aspects of National Grid's proposed solutions and its work in this area. There is growing opposition to large scale investment in gas infrastructure (part of National Grid's originally proposed solution), against the backdrop of New York's ambitious decarbonisation agenda, and all of KEDNY's operations are gas, as compared to majority electricity for all other utilities except KEDLI.

In addition, KEDNY requires the largest rate increases for a sustained improved in its financial profile - in its original filing it requested a $237 million increase (resulting in a 12% average bill increase) in rate year one (commencing April 2020) with further increases in the additional data years provided. However, settlement discussions have been protracted. They were put on hold in late 2019, during the dispute with the Governor Cuomo, and although they recommenced in June 2020, negotiations to develop a joint proposal with the PSC are still ongoing. In the meantime, the PSC recently ordered a deferral of rate increases to January 2021. While the make-whole provision in the PSC's May 2020 order of the deferral of rate increases is neutral for KEDNY (true-up from 1 April 2021, rate year 2), Moody's now expects rate increases to be less than half of what KEDNY originally requested.

KEDNY's Baa1 rating is underpinned by the low business risk of gas distribution activities governed by a transparent and established regulatory regime that provides a suite of cost recovery provisions and generally consistent cash flow generation. KEDNY's credit quality also benefits from a prudent financial policy, reflected in debt / regulatory capitalisation below regulatory assumptions in recent years -- in part due to its immediate holding company providing net equity injections totalling $850 millions over the last four financial years.

RATIONALE FOR STABLE OUTLOOK

The stable outlook reflects Moody's expectation that KEDNY will (1) conclude a multi-year rate case settlement with the PSC capable of supporting CFO pre-WC / debt of at least 15%, on average, over the primary term of its forthcoming rate plan; and (2) reach an enduring solution to resolve security of supply concerns in downstate New York.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Upward rating pressure is not currently anticipated given KEDNY's very weak cash flow metrics and Moody's expectation that there will only be modest strengthening in the next rate plan. However, upward rating pressure could arise if (1) KEDNY was expected to exhibit CFO pre-WC to debt of at least 19%, on average, over the primary term of its next rate plan, without a material increase in gas depreciation rates; (2) there was an enduring solution to resolve security of supply constraints in downstate New York; and (3) political intervention moderated.

Downward rating pressure could arise if (1) following publication of the joint proposal, KEDNY's CFO pre-WC / debt was expected to fall persistently short of 15%; or (2) there was a deterioration in the stability and predictability of regulatory environment, including no multi-year rate case settlement; or (3) increased political interference resulted in a deterioration of the stability and predictability of the regulatory framework. The support to KEDNY's credit quality from its membership of the wider National Grid group, whose credit quality Moody's currently assesses as A3 negative, would also be taken account of.

The principal methodology used in these ratings was Regulated Electric and Gas Utilities published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1072530. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

KEDNY is a local distribution company engaged in the transportation and sale of natural gas to around 1.3 million customers in the boroughs of Brooklyn, Staten Island and Queens in New York City. KEDNY is regulated by the New York Public Services Commission and is ultimately owned by National Grid Plc (Baa1 negative). KEDNY's rate base of $4,555 million at 31 March 2020 represents around 18% of National Grid's rate base in the United States.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

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.

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

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

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.

Philip Cope
Asst Vice President - Analyst
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.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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