Moody's today confirmed the Baa1 corporate family rating (CFR) of Anglian Water, as well as the A3 senior secured and Baa3 subordinated debt ratings of the Class A and Class B notes issued by Anglian Water Services Financing plc. The outlook on the ratings is negative. Concurrently, Moody's has downgraded to B1 from Ba3 the senior secured ratings of Anglian Water (Osprey) Financing plc (Osprey), Anglian Water's unregulated holding company.
The A2 rating of those Anglian Water bonds that are subject to a financial guarantee by Assured Guaranty (Europe) plc (A2 stable) of timely payments of scheduled interest and principal will continue to reflect the insurance financial strength rating of the guarantor.
The rating actions follow Anglian Water's announcement that it will not accept the revenue limits set by the Water Services Regulation Authority (Ofwat) for the five-year regulatory period starting in April 2020 (AMP7). Ofwat will now refer its determination to the Competition and Markets Authority (CMA), which will form its own conclusion on the price controls. The redetermination is likely to take at least six months and may be extended by a further six months.
These rating actions conclude the rating review initiated on 20 December 2019, following publication of Ofwat's final determination.
Ratings Rationale - Anglian Water
Today's rating action reflects Moody's expectation that, although the company will not have certainty over its revenues and investment programme for a further 6-12 months, the eventual determination is likely to support credit metrics that are weakly positioned but consistent with Anglian Water's assigned ratings. Confirmation of the ratings also incorporates Moody's expectation that management will seek to defend credit quality as may be necessary. The negative outlook reflects the risk that Anglian Water may be unable to perform in line with regulatory targets for AMP7, as they may be revised by the CMA.
Ofwat's final determination included a significant cut in allowed cash returns to 2.42% at the start of the new period, and provided an allowance for operating and capital expenditure that was around GBP750 million less than the company's business plan. A large part of this gap was attributable to differing views on population growth in Anglian Water's service area and resulting investment needs.
The CMA's eventual redetermination may provide a higher or lower allowed return, and may increase or reduce cost allowances. However, even if the CMA fully allows Anglian Water's investment plan, Moody's estimates that the company's financial metrics will still have very little headroom against the agency's minimum requirements for the current rating (gearing, measured by net debt to RCV, below 80% and AICR above 1.3x). Conversely, if the appeal does not result in a significant improvement in allowances, Moody's expects that Anglian will modify its investment profile to limit the adverse impact on credit metrics. As a result, the company is likely to remain weakly positioned for the Baa1 CFR unless the CMA arrives at very different conclusions from those in Ofwat's final determinations, and any operational underperformance is likely to result in negative ratings pressure.
The ratings remain supported by (1) Anglian Water's solid business risk profile as the monopoly provider of essential water and sewerage services; (2) its relatively stable and predictable cash flow, generated under a transparent and well-established regulatory regime; (3) its track record of strong operational performance; and (4) the creditor protections incorporated in its financing structure. These strengths are offset by the current high level of gearing, at around 78% of net debt/ regulatory capital value (RCV), although Anglian Water has committed to maintain leverage below 80% and announced plans to reduce leverage from current levels.
Ratings rationale - Osprey
The downgrade of Osprey's ratings reflects the likelihood of weaker cash flow at Anglian Water, which increase the risk that it may breach cash-trapping triggers in its financing structure and operating licence. Although Osprey maintains an 18-month liquidity reserve, a persistent stoppage of dividends from Anglian Water would mean a breach of Osprey's default covenant for cash dividend cover of at least 2.0x. In addition to formal cashtrapping mechanisms, Anglian Water may be unable or unwilling to pay sufficient dividends, net of equity injections, to cover interest costs at Osprey if doing so results in unsustainable gearing increases at the operating company, although this is not current anticipated.
The stable outlook reflects Moody's view that Osprey will remain adequately positioned at the new B1 rating under plausible outcomes from the appeals process.
What could change the ratings up/down
Anglian Water's outlook could be stabilised if the CMA's redetermination provides for significantly stronger cash flow, if Anglian Water is able to demonstrate outperformance, or if the company takes balance-sheetstrengthening measures.
Anglian Water's rating could be downgraded if the CMA's redetermination provides for a lower allowed return, lower cost allowances or greater operational penalties that are not adequately mitigated by management action. In particular, Anglian Water's rating could be downgraded if Moody's concluded that the eventual regulatory settlement is likely to result in Anglian Water having gearing, measured by net debt to RCV, materially above 80% or AICR persistently below 1.3x.
An upgrade of Osprey is not currently anticipated. In the longer term, ratings could be upgraded if there was a significant increase in headroom to cash-trapping covenants at Anglian Water.
Osprey's rating could be downgraded if weaker than anticipated cash flow at Anglian Water means that financial or rating triggers limiting dividend payments are more likely to be triggered. Financial triggers in Anglian 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 in any one year, or below 1.40x or 1.20x, respectively, on a three-year average. Rating triggers include two or more ratings below Baa2 for Anglian Water's Class A debt or below Baa3 for its Class B debt.
In addition, downward rating pressure at Anglian Water and Osprey 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.
Anglian Water Services Ltd. is the fourth-largest of the 10 water and sewerage companies in England and Wales by RCV and the largest in terms of geographical area. The company serves 27,500 square kilometres across East Anglia and the English Midlands as well as around Hartlepool, providing water and wastewater services to around 6.3 million customers. Anglian Water (Osprey) Financing plc is the financing subsidiary of Osprey Acquisitions Limited, an intermediate holding company in the Anglian Water Group.