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Announcement:

Moody's places Southern Water's ratings on review for downgrade

Global Credit Research - 07 Apr 2011

London, 07 April 2011 -- Moody's Investors Service has today placed on review for possible downgrade the Baa1 corporate family rating ("CFR") of Southern Water Serviced Limited ("Southern Water"), one of the ten UK regulated water and sewerage companies. Moody's has also placed on review for possible downgrade the A3 rating of the Class A notes and the Baa3 rating of the Class B notes issued by Southern Water Services (Finance) Limited ("SWSF"), the funding vehicle for Southern Water. The rating review does not apply to the wrapped Aa3 rating of the GBP300 million 4.5% bond due 2056, which benefits from an unconditional and irrevocable guarantee by Assured Guaranty (Europe) Ltd. (previously Financial Security Assurance (UK) Limited).

RATINGS RATIONALE

The review for downgrade is prompted by concerns that weak cash flow generation at Southern Water may mean that the company is unable to maintain over the current regulatory period (April 2010 -- March 2015, or "AMP5") a minimum Moody's adjusted interest cover ratio of 1.2x, the level seen by that the rating agency as commensurate for its Baa1 CFR. Whilst the company may be able to comply with its financial covenants, this will be because of the extensive use of index-linked swaps. While recognising that the existing "pay as you go" index-linked swaps benefit the interest cover ratio as calculated under the terms of the company's highly-leveraged financing structure, they do not, in Moody's view, provide genuine long-term cash flow benefit.

Moody's understands that the GBP877 million of existing swap arrangements provide for a pay down of the ongoing accretion. Whilst these long-dated swaps are not subject to break clauses and give inflation protection to the company, they only achieve a temporary improvement to a company's financial profile as the accretion is paid down during the life of the swap. As the indexation element is excluded in the calculation of the interest cover ratio, these hedging contracts enhance the company's ratios allowing it to maintain headroom under its covenant levels and thus distributions to shareholders. Moody's, therefore, regards this benefit as short lived and not providing a similar level of protection as long-dated index-linked debt.

As part of the review, Moody's will consider Southern Water's cash flow generation also in the context of the operating and capital expenditure efficiency targets set by Ofwat, the UK industry regulator and the shortfall currently experienced by the company versus the revenue assumptions set by Ofwat to determine its price limits for AMP5. In addition, the rating agency will consider whether the existing hedging arrangements may give rise to a number of risks inconsistent with the current rating level (for a detailed discussion of Moody's approach to assessing these risks, please refer to Moody's Special Comment "UK Water Sector: Highly-Leveraged Financing Structures -- An Update" published in June 2010).

Southern Water's ratings could be downgraded if Moody's were to conclude that the company's adjusted interest cover ratio as calculated by the rating agency is likely to remain below 1.2x for an extended period and/or financing and other risks potentially associated with its swap arrangements were regarded as material. Conversely, the current ratings could be maintained if Southern Water can address its current cash flow weakness or otherwise improve its financial profile and can demonstrate the ability to manage swap-related risks in a way that is consistent with its current ratings. Moody's expects to conclude the review within three months.

The principal methodology used in rating Southern Water was Moody's rating methodology for Regulated Water Utilities, published in December 2009.

Southern Water Services Limited is the seventh-largest of ten water and sewerage companies in England and Wales by RCV, providing water and sewerage services to a population of 2.3 and 4 million, respectively, in the south-east of England, including the counties of Kent, East and West Sussex, Hampshire and the Isle of Wight. Since October 2007, Southern Water's ultimate parent company is Greensands Holdings Limited, which is in turn owned by a consortium of specialist funds, including IIF International SW UK Investments Limited (advised by JP Morgan) and UBS AG.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

The rating has been disclosed to the rated entity or its designated agents and issued with no amendment resulting from that disclosure.

Please see the ratings tab on the issuer / entity page on Moodys.com for teh last rating action and the rating history.

London
Joanna Fic
Analyst
Infrastructure Finance
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Monica Merli
MD - Infrastructure Finance
Infrastructure Finance
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

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 places Southern Water's ratings on review for downgrade
No Related Data.
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