OREANDA-NEWS. Fitch Ratings has placed RWE AG's Long-term Issuer Default Rating (IDR) and senior unsecured rating of 'BBB+', Short-term IDR of 'F2' and the subordinated notes rating 'BBB-' on Rating Watch Negative (RWN). Fitch has also placed on RWN the 'BBB+' rating of RWE Finance B.V.'s notes, which are guaranteed by RWE.

The RWN follows the announcement that a material group re-organisation will see the issuer contribute its renewables, networks and retail divisions (more than 65% of existing EBITDA) into a new subsidiary, which will remain majority owned by RWE, but will create an extra layer of complexity and uncertainty for RWE's creditors. RWE expects the approval of its Supervisory Board for the transaction after which additional detail will become available.

Fitch expects to resolve the RWN once more details are available on creditor protection at the RWE AG and RWE Finance B.V. level, and the longer-term financing plans for RWE group entities are clearer. Additional details could be communicated to the market on 8 March 2016 at FY15 results.

KEY RATING DRIVERS
Material Group Reorganisation
RWE will contribute its networks, renewables and retail divisions into an independently listed subsidiary (NewCo), 10% of which will be sold to investors through an initial public offering in 2H16. RWE will remain the majority shareholder of NewCo with an initial stake of 90% but this could decrease over time. Initially RWE's cash flow profile is not expected to change much, since assets will be replaced with shares in NewCo and NewCo will return cash to RWE through dividends and interest payments are routed to the parent through inter-company loans at the NewCo level.

Transaction Details Still Uncertain
The exact details of the transaction have yet to be decided. However, management announced that NewCo aims for a 3.0x-3.5x net debt/EBITDA ratio. As a first step, some of RWE's debt is expected to be 'economically transferred' to NewCo through intercompany loans. Issues such as upstream guarantees and the exact ranking of any intercompany loans are still uncertain. Material changes may require RWE AG and RWE Finance B.V. bondholders' consent on a case-by-case basis. There are no immediate plans to raise any direct external debt at NewCo. Fitch will analyse how proposed changes will affect the ratings of RWE AG and and RWE Finance B.V. once more information on the transaction is available.

Nuclear Provisions Collateral Unchanged
RWE's management believes that the German government will not object to the restructuring due to legal issues with the nuclear provisions. In their view, the existing collateral (assets) against nuclear provisions is merely being replaced by either cash or NewCo shares. RWE also stated that in the eventuality of an external nuclear fund being created, shares in NewCo could be contributed to the fund as assets. In this case, the shares will be treated by the company as effectively sold. The creation of an external nuclear fund and any funding requirements related to it are not currently in Fitch's rating case, but we would regard it as a potential negative trigger from the existing rating.

Credit Metrics Remain Weak
Our latest forecasts show nuclear- and lease-adjusted funds from operations (FFO) net leverage at moderately above 4.0x for 2015 and 2016 and fixed charge cover around 3.5x for the existing RWE group. This reflects lower earnings from conventional generation as hedges roll off, which are only partly offset by newly commissioned renewables capacity, efficiency measures and positive FX effects from sterling. We expect leverage to improve to about 4.0x in 2017 mainly due to the nuclear fuel tax expiring, but the underlying business drivers have been negative as reflected in the Negative Outlook on the rating since 2 July 2015.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for RWE include:
- Germany electricity forward price of EUR32/MWh and clean dark spread of around EUR3.0-3.5/MWh.
- Utilisation of provisions and negative cash-flow items not represented in EBITDA to increase to around EUR1bn (outflows) per annum over the medium term.
- FFO in 2015 and 2016 to be broadly flat.
- Low to mid-triple-digit million working capital outflows each year.
- Capital expenditure in line with group guidance.

RATING SENSITIVITIES
Negative: Future developments that may lead to negative rating action include:
- Group reorganisation where current creditor's recourse to operating cash flows weakens.
- Lease- and nuclear-adjusted FFO net leverage above 4.0x and corresponding fixed charge cover below 4x on a sustained basis.
- Increasing carbon costs with impact on RWE's conventional generation segment; the group has a very high carbon footprint.
- Other elements of energy market reform in Germany (or possibly in other countries) creating additional costs that cannot be passed on to consumers.
- Establishing a public nuclear fund, depending on timing of funding requirements.
- Corporate activity or less restraint on capital expenditure.
- Weak financial results resulting in negative free cash flow beyond 2015.

Positive: Rating upside is limited. Future developments that may lead to a stabilisation of the ratings include:
- A visible improvement in forecast financial metrics with lease- and nuclear-adjusted FFO net leverage below 4.0x and corresponding fixed charge cover above 4.0x, assuming the current business profile and group structure.
- The German Constitutional Court rendering the nuclear fuel tax as unconstitutional, with funds being returned to the nuclear operators directly.

The rating sensitivities highlight that downside risks dominate. Fitch may also take negative rating action as and when government policies reinforce any of these negative rating sensitivities.

LIQUIDITY
RWE's liquidity remains strong. As of 30 September 2015, the group held EUR2.6bn of cash and cash equivalents, EUR6.4bn of short-term securities (after deducting around EUR600m for restricted holdings, an estimate reflecting historical levels; the precise amount was not disclosed for September 2015) and EUR4bn of committed, undrawn revolving credit facilities with maturity in March 2020. The group has short-term maturities of EUR2.2bn.