OREANDA-NEWS. December 15, 2015. Fitch Ratings has affirmed Berg Water Project's (BWP), Vaal River Eastern Sub-System Augmentation Project's (VRESAP), Mooi-Mgeni Transfer Scheme phase 2's (MMTS-2), Komati Water Scheme Augmentation Project's (KWSAP) and Mokolo Crocodile Water Augmentation Project's (MCWAP) National Long-term ratings at 'AA+(zaf)' with Stable Outlooks and National Short-term ratings at 'F1+(zaf)'. The five South African water projects were implemented and are funded by Trans-Caledon Tunnel Authority (TCTA).

The ratings apply to the projects' debt instruments (bank facilities and commercial paper programmes). The five projects are carried out by TCTA on behalf of the South African government through the Department of Water and Sanitation (DWS).

The affirmation primarily reflects the projects' flexible tariffs. TCTA projects achieve high ratings (on the National Rating scale) because the associated major risks (construction cost overrun, delay, volume and supply, financial) are covered by the flexible tariff mechanism, which is designed to pass on these risks to the end-users, backstopped by the DWS. The tariff mechanism therefore helps mitigate most of the risks in the projects, resulting in the ratings being close to those of the sovereign.

The projects are supported by a high level of government involvement and commitment through the inclusion of DWS in the tariff payment and debt service arrangement. The one-notch difference from the sovereign's rating reflects the lack of an explicit guarantee, some execution risk and political risks (the tariff can be adjusted, provided the government makes or ratifies the decision). Fitch takes comfort that the five projects are strategic: they are required by the South Africa government and implemented under its supervision. Moreover, TCTA is a "schedule 2 state enterprise", acting on an arms-length basis for the state.

Four of the five projects are complete (MCWAP was completed in 2015) and operations for these projects have been handed over to the DWS. MMTS-2 is nearing completion with water delivery expected in March 2016. For the completed projects, debt is amortising in line with expectations. Tariff adjustments have been made (in particular for VRSEAP) to compensate for lower than forecast demand.

All residual risk is expected to be captured directly by the DWS (in respect, for example, of operation and maintenance activities and costs) or by the tariff agreement flexibility, which acts as a permanent "re-opener". In practice, this is a function of the ability of the tariff to be amended in a timely manner. To mitigate this residual risk, two instruments are in place:
-Planning (semi-annual, annual, three-year cycles) of demand and relevant forward tariff settlements and budget cycles cover the risk of progressive, ie mid-term discrepancy between actual development and initial business plan
-Liquidity (short-term debt and committed revolving credit facility covering approximately 20% of outstanding debt) mitigates any short-term discrepancy.

KEY RATING DRIVERS
Completion Risk: Stronger
Construction of MMTS-2, including construction of the pipeline, is delayed partly due to local geological conditions and a railway crossing. The other projects are complete and have been handed over to the DWS for operations. MCWAP is currently in the defects liability period.

TCTA's experience in planning, design and implementation, substantially mitigates completion risk. Fitch also takes comfort from the construction contract terms, which include claw-back terms for cost overruns and delays.

Revenue Risk: Stronger
The ratings primarily reflect the role of the flexible tariff including a catch-all tariff mechanism, which adjusts to accommodate lower demand. DWS is responsible for ensuring that the tariff is paid to TCTA, which holds the right to receive tariff payments from the user. DWS is liable for all amounts billed and not received as well as for the late receipt of income.

Cost Risk: Stronger
Once complete, operations and maintenance and major maintenance responsibilities are retained by the DWS, leaving the debt immune from works' timing and cost considerations. The economic life of the assets is anticipated to exceed debt maturity.

Debt Structure: Midrange
Long-term financing is provided by well-established domestic financial institutions and is denominated in South African rand. All long-term debt is amortising and designated senior unsecured and rank pari passu between the different lenders. Some debt is floating rate (target proportion after construction is a maximum of 30%). Fitch believes that the project has strong protection against risks stemming from its debt structure.

Financial Analysis
Leverage at peak debt (usually at completion) is high. Leverage is also high in the first year of operations, although it falls rapidly as tariff inflation and consumption growth result in some EBITDA growth as well as amortisation. While leverage in the initial years is high for the rating category, it factors in an off-take agreement with the government for the debt lifetime, with a price set at a level that repays debt; and an asset with a life well in excess of the 20 years' debt repayment. Fitch believes that the strong contractual structure mitigates the leverage level.

RATING SENSITIVITIES
A (multi-notch) downgrade would be triggered by government failure to execute its contractual obligations.

Another potential driver of a downgrade would be an exhaustion of liquidity combined with a loss of access to alternative sources of funding in a context of a temporary and severe disruption affecting the projects.