OREANDA-NEWS. Fitch Ratings has affirmed Bakethin Finance Plc's (Bakethin) guaranteed GBP247.9m 5.87526% secured fixed-rate notes, due 2034, at 'A' with a Stable Outlook.

The affirmation reflects the transaction's on-going stable performance. The rating is supported by the adequate operational performance of Northumbrian Water Limited (NWL; BBB+/Stable), the strong funding status of the UK Environment Agency (EA), and limited refinance risk. Securitised cash flows are in line with expectations at the time of the transaction's issuance, and reserves remain adequate at 7.1% of the outstanding bonds.

KEY RATING DRIVERS
Revenue risk: Stronger
The revenue stream has no exposure to price or volume risk. Under the Water Resources Operating Agreement (WROA), NWL, as owner and operator of the Kielder Reservoir, is responsible for the operation and maintenance of the reservoir on behalf of the EA. In return for NWL's capital investment in the reservoir, the EA is obliged to pay NWL an annual sum and to reimburse the related operating costs incurred by NWL. This annual sum increases with UK RPI inflation, but the transaction benefits from a fixed-to-RPI swap with Belfius Bank until 2034, receiving a 2.56% p.a. fixed increase. The EA's funding structure remains similar to that at close, whereby the EA could obtain liquidity from the UK Treasury's contingencies funds if required.

Revenue risk relates primarily to the possibility of WROA termination (eg by the EA) which is viewed as a remote possibility given, 1) the importance of the reservoir as a strategic reserve, 2) NWL's on-going stable operating and financial performance, and 3) the possibility to replace NWL in the event of underperformance.

Fitch considers low the likelihood of fundamental changes to the EA's view of the Kielder reservoir's importance in light of its role as a strategic back-up basin in times of water shortages and for regulating water flows in the region. Additionally, long-term macroeconomic trends such as demographics are positive with the Office for National Statistics forecasting gradual UK population growth in the medium to long term.

NWL's performance for the year to 31 March 2014 (FY14) relative to the targets set by Ofwat (the economic regulator for the UK water sector) demonstrated solid results. There have been some regulatory changes in the water sector with Ofwat reducing the allowed return on the asset base but as yet these changes have had no impact on the rating or Outlook. The affirmation on 12 January 2015 of NWL's ratings at 'BBB+'/Stable reflected the transparent regulatory framework (with revenue visibility until March 2020), NWL's steady operating and regulatory performance, and gearing in the mid-60% range.

The probability of a breach of the WROA by NWL is viewed as extremely low, and in the event that a breach occurs, the appointment of another water company as operator is viewed as likely, allowing continued payments from the EA. As a regulated company, NWL is subject to the special administration regime set out in the Water Industry Act. The WIA contains provisions enabling the Secretary of State and the Director General of Water Services (DGWS) to secure the general continuity of water supply and sewerage services. In certain specified circumstances (eg breach of a covenant relating to its principal duties to supply water, or bankruptcy), the Court may appoint a special administrator meaning insolvency of NWL would not imply termination of the WROA. If a third party was to acquire the assets, it would assume NWL's role and could also appoint a sub-contractor.

Operating risk: Stronger
Under the terms of the WROA, NWL is required to maintain the reservoir in good condition, and this is ensured by the annual independent engineer's report. To date, the reservoir has been well maintained by NWL, which Fitch views as a strong, stable operator. The transaction also benefits from cash and maintenance reserve accounts amounting to GBP5.6m. All operating and maintenance costs (GBP1.15m in the year ending in March 2014) are effectively reimbursed to NWL by the EA.

Debt Structure: Midrange
The debt is partially amortising (from July 2014) resulting in GBP160.6m of principal (64.8% of original principal) that will require refinancing in 2034. Fitch considers the refinance risk to be low in light of the long forecast remaining lifespan of the reservoir (45 years from 2034), and the higher than expected average RPI since closing, which reduces the refinance risk as it inflates the annual sum (although this could be offset by a period of lower inflation). The debt is also fixed rate.

Security is provided by an assignment of NWL's rights to receive the annual sum from the EA under the WROA. Additionally, creditor interests are guaranteed by Assured Guaranty, who also acts as controlling creditor.

The transaction benefits from an adequate debt service reserve account (exceeding six months forward-looking debt service), which together with the other cash reserves currently covers 7.1% of total principal outstanding. The issuer security trustee is also able to put the bonds to NWL if they are not refinanced in 2034.

Fitch withdrew its 'AA' Insurer Financial Strength rating on Assured Guaranty (Europe) Ltd. and other related entities on 24 February 2010. While the rated bonds benefit from a financial guarantee issued by Assured Guaranty that unconditionally and irrevocably guarantees payments of interest and principal as well as the issuer's payment obligations under the RPI swap, Fitch's rating on the guaranteed bonds does not give credit to Assured Guaranty and solely reflects the project's underlying credit quality.

RATING SENSITIVITIES
Bakethin's ratings may come under downward pressure in the event of a substantial deterioration of NWL's operating or financial performance, the condition of the assets or a downgrade of Belfius Bank (unless accompanied by remedial measures) or an adverse change in the funding status of the EA.

TRANSACTION PERFORMANCE
The latest annual independent engineering report, covering 1 April 2013 to 31 March 2014, suggests that NWL's operating performance under the Water Resources Operating Agreement (WROA) is adequate and as a result no changes in the Kielder Reservoir's 75-year lifespan are expected. NWL has confirmed that this remains the case. The reservoir continues to act as a strategic reserve in times of water shortage in the north-east of England and is also important for regulating river levels in the region.

Bakethin is a securitisation of payments from the EA to NWL under the WROA. NWL is a private limited liability company incorporated in England and Wales, which operates as a "relevant undertaker" under the WIA of 1991, the legislation under which the UK water industry was privatised. The Kielder reservoir is the largest man-made lake in Northern Europe, with a shoreline of 27.5 miles (44.3km) and a usable storage capacity of 200 billion litres of water.