OREANDA-NEWS. Fitch Ratings has affirmed Kelda Finance (No.2) Limited's (Kelda) Long-term Issuer Default Rating (IDR) at 'BB' and senior secured rating at 'BB+'. The Outlook on the Long-term IDR is Stable. A full list of rating actions on Kelda and its subsidiaries is available at the end of this commentary.

The affirmation reflects Yorkshire Water's adequate dividend capacity in comparison with the debt service requirements of Kelda, even though Yorkshire Water faces pressure on its credit metrics stemming from Ofwat's final determination of tariffs for the period April 2015 to March 2020 and a recent reduction of retail price inflation (RPI). The ratings also take into account Yorkshire Water's solid financial and regulatory performance.

Kelda is a holding company of Yorkshire Water Services Limited (Yorkshire Water; class A debt A/Stable, class B debt BBB+/Stable), the regulated, monopoly provider for water and wastewater services that supplies 4.9 million people in the former county of Yorkshire and North Derbyshire (see separate rating action commentary "Fitch Revises Yorkshire Water's Senior Secured Class A Debt Outlook to Stable; Affirms Ratings" dated 23 February 2016 on www.fitchratings.com).

Kelda Finance (No.3) PLC (FinCo) is the financing vehicle for Kelda, which guarantees the issued bonds together with its parent, Kelda Finance (No.1) Limited.

KEY RATING DRIVERS
Adequate Dividend Cover at Kelda
Fitch expects the Kelda group to maintain credit metrics in line with our guidelines, ie dividend cover at around 5.8x (assuming RPI increases to 2.5% by financial year to March 2018) and consolidated net debt/regulatory asset value (RAV) below 85%. Our post-maintenance and post-tax interest cover (PMICR) forecast is at 1.2x.

Fitch notes that the GBP265m of incremental debt at the holding level only represents less than 5% of RAV and incurs an annual finance charge of around GBP15m-GBP18m. The reduced dividend stream from Yorkshire Water expected for the current price control will still allow comfortable servicing of the debt.

However, if RPI remains materially below 1.5% for an extended period of time, dividend stream from Yorkshire Water would be further reduced. This could lead to negative rating action for Kelda's ratings.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for Yorkshire Water 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
- Operating expenditure outperformance of GBP50m in nominal terms over the five-year period
- Retail costs in line with allowances
- Non-regulated EBITDA of around GBP2.5m per annum
- RPI of 1.3% for FY16, 2% for FY17 and 2.5% thereafter
- Capital expenditure outperformance of GBP130m in nominal terms over the five-year period

In addition, for Kelda Finance we assume:
- Incremental debt at holding company level to remain at around GBP265m
- An annual finance charge at the holding company level of between GBP15m-GBP18m

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
- A sustained decline of dividend cover below 2.5x
- RPI remaining materially below 1.5% over an extended period of time
- Group gearing above 85% on a sustained basis
- Marked deterioration in operating and regulatory performance of Yorkshire Water or a material change in business risk of the UK water sector

Positive: Upside is limited unless Yorkshire Water materially reduces its regulatory gearing.

LIQUIDITY
As of 30 September 2015, the holding company had available a GBP30m undrawn, committed revolving credit facility with maturity in October 2022. The next debt maturity is GBP200m in February 2020.

FULL LIST OF RATING ACTIONS

Kelda Finance (No.2) Limited
-Long-term IDR affirmed at 'BB', Stable Outlook
-Senior secured rating affirmed at 'BB+'

Kelda Finance (No.3) PLC
-GBP200m bonds, 5.75%, February 2020, guaranteed by Kelda Finance (No. 2) Limited, senior secured rating affirmed at 'BB+'