OREANDA-NEWS. March 23, 2015. Fitch Ratings has affirmed Anglian Water Services Financing Plc's (AWF) senior secured ratings for its class A debt (both wrapped and unwrapped) at 'A' and its class B debt at 'BBB+', all with Negative Outlook.

The rating actions reflect the efficiency challenge embedded in the final determination of tariffs for the period April 2015 to March 2020 (AMP6), neutral revenue adjustments related to the 2010-15 period, adequate interest cover and Fitch's expectation of gearing being reduced to around 80% net (class A and class B) debt/regulatory asset value (RAV) by 2020.

The Negative Outlook reflects our expectation of gearing remaining above 80% in the near term. Fitch will await first evidence of actual performance and shareholder distribution during the upcoming price control period to reassess its forecast and expected leverage reduction.

The ratings also take into account Anglian Water's market leading operational and regulatory performance, and the secured nature of the group's financing structure, which benefits from structural enhancements, including trigger mechanisms (such as dividend lock-up provisions tied to financial, positive and negative covenants) and debt service reserve liquidity.

AWF is the debt-raising vehicle of Anglian Water. Anglian Water is one of 10 appointed water and sewerage companies (WaSC) in England and Wales.

KEY RATING DRIVERS

Deleveraging over AMP6
Fitch expects the company to use efficiencies generated over the course of AMP6 to reduce leverage to 70% for class A and 80% (senior, i.e. consolidated position of class A and class B debt). This is in contrast with the trend over AMP5 of Fitch-calculated leverage increasing to the current levels of 73% and 83%. Fitch has slightly tightened the guidelines for gearing to 70% from 73% for class A debt and to 80% from 83% for senior debt due to a less supportive position from (the regulator for the UK water sector) Ofwat on financeability during the recent price control process.

Adequate Interest Cover
Fitch calculates forecast post-tax and post-maintenance interest cover (PMICR) of around 1.6x for class A debt, and around 1.3x for senior debt for AMP6. Forecast credit metrics are commensurate with our guidelines of 1.5-1.6x for class A and of 1.2-1.3x for senior debt. Our forecasts represent a decline from the same metrics over AMP5 of 1.9x for class A and 1.6x for senior debt, which mainly driven by the lower cost of capital chosen by the regulator of 3.75%.

These financial ratios differ from Anglian Water's investor report and the newly implemented pay-as-you-go profiling of revenues will have an impact on financial ratios reported in the investor report.

Operational Outperformance Expected
Fitch expects the company to achieve capex and opex outperformance over AMP6 given its track record, new processes and implementation of efficiencies which management has identified for the next five years. We expect the company to start outperforming in capex early in the price control. Anglian Water already has in place contracts with an alliance of partners to deliver its GBP2bn capital programme, which included comprehensive sharing mechanisms to target outperformance. Our forecasts include combined totex outperformance and Outcome Delivery Incentive for leakage outperformance of GBP148m, in nominal terms over the five-year period.

Anglian Water has met all of its regulatory output to date with regard to its capital expenditure programme and is reinvesting capital expenditure efficiencies of around GBP206m achieved during the first four years of the price control in additional projects for the benefit of customers. Achieved opex efficiencies of around GBP15m are in addition to operational costs absorbed by the company of around GBP50m related to the adoption of private sewers, carbon reduction commitment and bad debt costs.

Robust Performance vs. Regulatory Targets
Anglian Water is one of the top quartile performers in the industry. Over the first four years of AMP5 the company improved its regulatory performance and positioned itself well to confront the challenges that the new price control may bring in April 2015. For financial year ended 31 March 2014 (FY14), Anglian Water reported stable asset serviceability in all four areas for its networks, including wastewater infrastructure, which was assessed as marginal in FY13.

In addition, Anglian Water continues to be an industry leader in terms of leakage as a result of the implementation of a proactive leakage control and reactive repair work programme. The company also ranked joint top among water and wastewater companies for the service incentive mechanism (SIM), a measure that captures quantitative and qualitative performance of customer service.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Regulated revenues in line with the final determination of tariffs for April 2015 to March 2020, ie assuming no material over- or under- recoveries
- Combined totex outperformance and Outcome Delivery Incentive leakage outperformance of GBP148m in nominal terms over the five-year period
- Slight underperformance in retail costs
- Non-appointed EBITDA of around GBP7.7m per annum
- Retail price inflation of 0.75% for FY15, 1% for FY16, 2% for FY17 and 2.5% thereafter

RATING SENSITIVITIES

Positive: The current Outlook is Negative and we therefore do not consider an upgrade as likely. Future developments that may, individually or collectively, lead to a revision of the Outlook to Stable include:
- For class A debt forecast gearing sustainably at or below 70% and PMICR above 1.5x and for senior debt gearing at or below 80% and PMICR above 1.2x

Negative: Future developments that may, individually or collectively, lead to a downgrade:
- For class A debt forecast gearing sustainably above 70% or PMICR below 1.5x
- For class B debt forecast gearing sustainably above 80% or PMICR below 1.2x
- A decline in operational or regulatory performance
- Regulatory decisions such as moving additional parts of the value chain away from RAV-based regulation or swapping RPI indexation for CPI indexation

LIQUIDITY

As of 30 September 2014, the group had GBP697.9m in cash and cash equivalents and GB420m of undrawn committed bank facilities (maturing in 2016) and GBP60m of European Investment Bank facilities available. This will provide sufficient liquidity for scheduled debt maturities, capital expenditure, operating requirements and dividends well into 2016. The company has recently renewed and increased committed bank facilities to GBP500m (maturing 2020), all of which remain undrawn.

In addition, debt service reserve liquidity of GBP279m and operating and maintenance reserve liquidity of GBP96m are in place in accordance with the group's secured and covenanted financing documentation. However, this back-up liquidity is only available for addressing liquidity needs during financial distress.