Affinity Water Programme Finance Limited — Moody’s changes Affinity Water’s outlook to stable, affirms ratings

Rating Action: Moody’s changes Affinity Water’s outlook to stable, affirms ratingsGlobal Credit Research – 16 Apr 2021London, 16 April 2021 — Moody’s Investors Service (Moody’s) has today affirmed the Baa1 corporate family rating (CFR) of Affinity Water Limited (Affinity Water) as well as the A3 senior secured debt rating of Class A notes and Baa3 subordinated rating of Class B notes issued by its finance subsidiaries and guaranteed by Affinity Water. Concurrently, the rating agency changed the outlook on all issuers to stable from negative.This rating action reflects financial measures that the company has undertaken since the December 2019 publication by the Water Services Regulation Authority (Ofwat), the economic regulator for water companies in England and Wales, of its final determination for the five-year regulatory period commencing April 2020 (AMP7).[1] These measures create financial flexibility in the face of challenging performance targets over the AMP7 period.A full list of affected ratings is attached towards the end of this press release.RATINGS RATIONALEToday’s rating affirmation with a stable outlook reflects Moody’s view that, considering recent measures, Affinity Water will maintain financial ratios in line with guidance for its current ratings. Lower allowed returns for the AMP7 period and challenging regulatory targets will weigh on financial metrics. However, interest cover ratios will be supported by an increase in the proportion of the company’s inflation-linked debt as a result of new derivative transactions.Over the past year, the company has executed new derivatives with a notional amount of GBP250 million and interest rates linked to the consumer prices index (CPI) measure of inflation. These swaps do not include any requirement for frequent accretion pay-down nor break clauses and will reduce cash interest costs for the company over the next 10-16 years.Affinity Water entered into its first super-senior retail prices index (RPI) linked swap in August 2018, with a notional amount of GBP135 million linked to Affinity Water Finance (2004) Plc’s GBP250 million bonds due in 2026, and also carries just under GBP350 million RPI-linked and GBP62 million CPI-linked notes at March 2020 (including inflation accretion to the balance sheet date).The company’s derivatives portfolio links to its underlying debt structure and better aligns its debt service with an inflation-linked cash flow stream under the regulatory tariff setting model. Rates are relatively close to current market levels and the mark-to-market (MTM) exposure is limited, with Moody’s estimating a current MTM liability below 5% of Affinity Water’s regulatory capital value (RCV). The super-senior swap MTM could, however, grow in the future to the detriment of the credit quality of bonds.Considering the new derivatives, Moody’s expects Affinity Water’s adjusted interest coverage ratio (AICR) to average around 1.5x and gearing, measured by net debt to RCV, to remain just under 80% over AMP7. This also takes into account the lower allowed returns as well as around GBP20 million negative legacy adjustments (for AMP6 performance) and expected performance penalties over the period. The company will also have some flexibility against revenue and cost implications from the coronavirus pandemic. Coronavirus effects will result in year-on-year volatility and metrics in the near term could fall below the minimum 1.3x AICR rating guidance within a single year. However, because volume-related under-recovery of revenues will be trued up with a two-year lag, average metrics over the AMP7 period is expected to remain well in line with the Baa1 guidance.The rating affirmation also positively reflects Affinity Water’s low business risk profile as a monopoly provider of water services operating under a well-established, transparent and predictable regulatory framework and the benefit to creditors from the bond covenant and security package. Affinity Water’s Baa1 CFR takes into account the benefit to creditors from the company’s covenant and security package. Key creditor protections include (1) a cash trapping mechanism, designed to maintain and restore credit quality by preventing distributions and retaining cash in the company if certain financial ratios are breached; (2) liquidity facilities (and/or cash reserves) equal to 12 months of debt service; (3) a first-ranking fixed charge over Affinity Water’s shares, plus first-ranking fixed and floating charges over all of the company’s assets, rights and undertakings; (4) the agreement by financial creditors to give up their individual rights to petition for insolvency proceedings and (5) restrictions on debt maturity concentration.RATING OUTLOOKThe stable outlook reflects Moody’s expectation that Affinity Water’s metrics will remain in line with the rating agency’s guidance for a Baa1 CFR over the current regulatory period (1 April 2020 — 31 March 2025), including RCV-gearing no higher than 80% and an AICR of at least 1.3x.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGUpward rating pressure is not currently anticipated given (1) management’s intention to maintain overall gearing close to a target level of 80%; and (2) the challenges presented by the final determination, including lower allowed returns and risk of operational performance penalties over AMP7.Conversely, the ratings could be downgraded if (1) Affinity Water’s key financial metrics appeared likely to fall persistently outside of Moody’s guidance for the current rating (as highlighted above); (2) there was a material change in the regulatory framework for the UK water sector leading to a significant increase in the company’s business risk, not offset by other credit-strengthening measures; or (3) the company experienced unforeseen funding difficulties.The principal methodology used in these ratings was Regulated Water Utilities published in June 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1121971. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology. LIST OF AFFECTED RATINGS Affirmations: ..Issuer: Affinity Water Finance (2004) Plc….Backed Senior Secured Regular Bond/Debenture, Affirmed A3..Issuer: Affinity Water Finance Plc….Backed Subordinate Regular Bond/Debenture, Affirmed Baa3….Backed Senior Secured Regular Bond/Debenture, Affirmed A3..Issuer: Affinity Water Limited….LT Corporate Family Rating, Affirmed Baa1Outlook Actions:..Issuer: Affinity Water Finance (2004) Plc….Outlook, Changed To Stable From Negative..Issuer: Affinity Water Finance Plc….Outlook, Changed To Stable From Negative..Issuer: Affinity Water Limited….Outlook, Changed To Stable From NegativeAffinity Water Limited is the largest of the six water-only companies (WoCs) in England and Wales in terms of customers served. It is the second largest by RCV (after South East Water Limited, funded through its finance subsidiary, South East Water (Finance) Limited, whose debt is rated Baa2 stable) with an RCV of GBP1.2 billion as at March 2020 (including the regulatory midnight adjustment, which takes into account performance over the 2015-20 period). For the 12 months ended 31 March 2020, Affinity Water reported revenue of GBP307 million and operating profit of GBP44 million. The company supplied water to around 1.3 million household customers and over 66,000 local businesses (equivalent to a population of over 3.6 million people) across parts of Bedfordshire, Berkshire, Buckinghamshire, Essex, Hertfordshire, Surrey, Kent and London.Since May 2018, Affinity Water’s ultimate shareholders are Allianz Capital Partners (36.6% share), HICL Infrastructure (36.5%) and DIF Infrastructure (26.9%).REGULATORY DISCLOSURESFor 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_1243406.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on www.moodys.com.REFERENCES/CITATIONS[1]https://www.ofwat.gov.uk/regulated-companies/price-review/2019-price-review/final-determinations/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 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. 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