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Rating Action:

Moody's downgrades Thames Water and confirms ratings of Kemble

24 Mar 2020

London, 24 March 2020 -- Moody's Investors Service (Moody's) has today downgraded to Baa2 from Baa1 the Corporate Family Rating (CFR) of Thames Water Utilities Ltd. (Thames Water). Concurrently, Moody's has downgraded Thames Water Utilities Finance Plc's senior secured (Class A) debt rating to Baa1 from A3 and its subordinated (Class B) debt rating to Ba1 from Baa3. The outlook on the ratings is stable.

Moody's has confirmed the B1 senior secured rating of Thames Water (Kemble) Finance PLC (Kemble Water). The outlook on the rating is stable.

These rating actions conclude the rating review initiated on 20 December 2019, following publication by the Water Services Regulation Authority (Ofwat), the economic regulator for water companies in England and Wales, of its final determination for the forthcoming five-year regulatory period, commencing on 1 April 2020 (AMP7).

A complete list of affected ratings appears at the end of this press release.

RATINGS RATIONALE

RATINGS RATIONALE -- THAMES WATER

Today's rating actions follow Thames Water's decision to accept Ofwat's final determination for AMP7. The downgrades take into account (1) the significant cut in allowed wholesale returns to ca. 2.42% real in cash terms, compared with 3.6% in the current AMP6 regulatory period, (2) material revenue reductions as a result of operational underperformance in AMP6, (3) challenging performance targets in AMP7 that Moody's expects to result in further financial penalties, and (4) credit negative changes to financial policy, as evidenced by an increase in RPI-linked debt and swap restructurings that weaken the effectiveness of Thames Water's covenants.

Moody's expects that Thames Water will have an adjusted interest coverage ratio (AICR) of around 1.3x over the AMP7 period and leverage, measured by adjusted net debt to regulatory capital value (RCV) above 80%, weaker than Moody's revised guidance for a Baa1 CFR of at least 1.4x and no more than 80%, respectively.

Thames Water's Baa2 CFR reflects, as positives, (1) stable cash flow from the provision of monopoly water and wastewater services under a well-established, transparent and predictable regulatory regime, (2) debt structural features, including distribution lock-up covenants, dedicated liquidity, and intercreditor and security arrangements, which provide additional creditor protection for event risk and enhance recovery prospects in an event of default, and (3) lower average cost of debt and less risk in relation to derivative contracts than highly-leveraged peers.

However, the CFR is constrained by (1) relatively high financial leverage, (2) a track record of weak operational performance with associated financial penalties and (3) regulatory and financing decisions that temporarily increase headroom to Thames Water's dividend lock-up covenants in AMP7, weakening creditor protections.

Thames Water has recently executed GBP2.1 billion of new RPI-linked swaps that will allow it to defer a portion of interest payable from AMP7 into later periods, improving cash flow and Moody's AICR at the price of increasing the mismatch between the company's CPI-linked RCV and RPI-linked debt in AMP8. Moody's regards this as indicative of an increased tolerance for financial risk, a credit negative.

The Baa1 rating of the Class A bonds reflects the strength of the debt protection measures for this class of bonds and their senior position in the cash waterfall and following any enforcement of security, and the issuer's low probability of default. However, the rating of the Class A bonds also factors in super-senior obligations which would rank ahead of the senior notes in a default scenario, as well as the subordinated Class B debt which, while contractually subordinated, serve to reduce the operator's financial flexibility.

The Ba1 rating of the Class B bonds reflects the same default probability as factored into the Baa2 CFR but also Moody's expectation of a heightened loss severity for the Class B debt following any default, given its subordinated position.

RATINGS RATIONALE -- KEMBLE

Confirmation of Kemble's B1 senior secured rating reflects a deterioration in the credit quality of the consolidated Kemble group, offset by management action to increase near-term cash flows and reduce the risk of dividend lock-ups at Thames Water.

In addition to the considerations for Thames Water, the rating of Kemble reflects (1) higher leverage because of GBP1.1 billion of additional debt at the holding company, (2) the terms of the Thames Water financing structure, which includes various cash-trapping provisions, and (3) provisions of Thames Water's licence that could limit the operating company's ability to make payments to Kemble.

RATING OUTLOOK

The stable outlook reflects Moody's expectation that, despite operational underperformance and expenditure above regulatory allowances, Thames Water will achieve an AICR of around 1.3x, on average, over AMP7, and maintain net debt/RCV of 80-85%, including Moody's adjustments.

WHAT COULD CHANGE THE RATING UP/DOWN

Thames Water's ratings could be upgraded if the company achieved significantly improved operational performance, supporting an AICR sustainably above 1.4x and net debt/RCV below 80%.

The ratings could be downgraded if operational performance was below Moody's expectations, and in particular if its AICR was expected to fall below 1.2x, or if net debt/RCV rose above 85%.

Given structural subordination, an upgrade of Kemble is not anticipated. Kemble's rating could be downgraded if the rating of Thames Water were downgraded, or if weaker cash flow at Thames Water meant that financial or rating triggers limiting dividend payments were more likely to be triggered. Financial triggers in Thames Water's financing structure include (1) Class A RCV gearing in excess of 75% or senior RCV gearing in excess of 85%, or (2) Class A adjusted interest cover ratio below 1.30x or senior adjusted interest cover ratio below 1.10x. Rating triggers include a Class A or corporate rating below Baa3/BBB- from any agency.

In addition, downward rating pressure at Thames Water and Kemble Water could result from (1) adoption of more aggressive financial policies, (2) a significant increase in business risk for the sector as a result of legal and/or regulatory changes leading to a reduction in the stability and predictability of regulatory earnings, which in each case are not offset by other credit-strengthening measures, or (3) unforeseen funding difficulties.

Thames Water is the largest of the 10 water and sewerage companies in England and Wales by both RCV and number of customers served. The company provides drinking water to around nine million customers and sewerage services to around 15 million customers in London and the Thames Valley. Kemble Water is the financing subsidiary of Kemble Water Finance Limited, which owns Thames Water through intermediate holding companies including Thames Water Limited.

The principal methodology used in these ratings was Regulated Water Utilities published in June 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

LIST OF AFFECTED RATINGS

Downgrades:

..Issuer: Thames Water Utilities Finance Plc

....Backed senior secured MTN Program, Downgraded to (P)Baa1 from (P)A3

....Backed Subordinate MTN Program, Downgraded to (P)Ba1 from (P)Baa3

....Backed Subordinate Regular Bond/Debenture, Downgraded to Ba1 from Baa3

....Backed Senior Secured Regular Bond/Debenture, Downgraded to Baa1 from A3

..Issuer: Thames Water Utilities Ltd.

....LT Corporate Family Rating, Downgraded to Baa2 from Baa1

Confirmations:

..Issuer: Thames Water (Kemble) Finance PLC

....Backed Senior Secured Regular Bond/Debenture, Confirmed at B1

Outlook Actions:

..Issuer: Thames Water (Kemble) Finance PLC

....Outlook, Changed To Stable From Rating Under Review

..Issuer: Thames Water Utilities Finance Plc

....Outlook, Changed To Stable From Rating Under Review

..Issuer: Thames Water Utilities Ltd.

....Outlook, Changed To Stable From Rating Under Review

REGULATORY DISCLOSURES

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.

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.

Graham Taylor
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.
© 2020 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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