Rating Action: Moody's changes Bristol Water's outlook to stable; affirms ratingGlobal Credit Research - 30 Mar 2021London, 30 March 2021 -- Moody's Investors Service (Moody's) has today changed the outlook for Bristol Water plc (Bristol Water) to stable from negative and affirmed the Baa2 backed senior secured debt rating.This rating action follows the publication, on 17 March 2021, of the summary final determination by the Competition and Markets Authority (CMA).[1] In February 2020, Bristol Water, along with three of its larger peers, rejected the December 2019 settlement by the economic regulator for water and wastewater companies in England and Wales, the Water Services Regulation Authority or Ofwat, for the five-year regulatory period that began in April 2020 (AMP7). The redetermination by the CMA, the highest appeals body for regulatory settlements in the UK, supersedes the previous determination from Ofwat and applies to the full five-year period but the cumulative cash benefit will now flow through the last three financial years of AMP7.RATINGS RATIONALEToday's rating action reflects the CMA's redetermination, which includes (1) an allowed wholesale return of 3.3% (deflated by the Consumer Prices Index adjusted for housing costs, or CPIH) for Bristol Water (including a 30 bps small company adjustment to the cost of debt allowance); and (2) an overall wholesale expenditure allowance of GBP432 million, broadly in line with the company's revised business plan following representations to Ofwat's draft determination. Specifically, the change of outlook to stable and affirmation at Baa2 reflects Moody's view that the more favourable CMA settlement will allow Bristol Water to maintain financial ratios in line with guidance for the current rating.The CMA's allowed wholesale return for Bristol Water is 38 bps above Ofwat's determination of 2.92% (CPIH-deflated). Half of the company's regulated assets as at March 2020 will continue to be inflated by the Retail Prices Index (RPI), with the remainder and all new additions being inflated CPIH. As a result, Bristol Water's wholesale cash return will be roughly 2.8-2.9% over the period, compared with 2.4-2.5% under Ofwat's determination.The CMA's allowance for wholesale total expenditure of GBP432 million was broadly in line with the company' statement of case and its August 2019 business plan. The main uplift was in relation to base operating and maintenance costs with the appeals body reflecting latest available cost data from the financial year 2019/20.On operational performance commitments, Moody's expects Bristol Water will not suffer/receive any major penalties/rewards on a net basis over AMP7. However, the company struggled to meet some of its targets under the Outcome Delivery Incentives (ODIs) mechanism for the previous AMP6 period and will continue to face an overall revenue reduction in AMP7 of ca. GBP5 million (in 2017/18 prices) associated with its AMP6 ODI performance. Bristol Water also remains exposed to the risk of severe weather events causing significant penalties.Reflecting the CMA's redetermination, Moody's base case scenario results in Bristol Water exhibiting an Adjusted Interest Coverage Ratio (AICR) of around 1.4x on average over AMP7 (excluding the income from grants and contributions), above the 1.3x minimum guidance for the current Baa2 rating. Gearing is forecast to remain below 70% of net debt to RCV, thus leaving headroom against the maximum 85% for the Baa2 rating, which would also help to offset credit pressure of an AICR slightly below guidanceBristol Water's rating continues to be constrained by the company's small size and relatively inflexible financing structure, which increases risk exposure in an environment of falling returns, somewhat offset by the structural enhancements included in the company's bond covenant and security package. Key supporting features include (1) a cash trapping mechanism, which is designed to help maintain and restore credit quality by preventing distributions and retaining cash within the company in downside scenarios; (2) liquidity facilities (and/or cash reserves) equal to six months' of debt service; (3) a first-ranking fixed charge over the shares in the company, plus first-ranking and floating charges over all the assets, rights and undertakings of Bristol Water; and (4) a mandatory sinking fund arrangement to reduce refinancing risk.Finally, the Baa2 rating continues to be underpinned by the company's low business risk profile as a monopoly provider of water services operating under a well-established, transparent and predictable regulatory framework.RATING OUTLOOKThe rating outlook is stable reflecting Moody's view that Bristol Water will be able to maintain financial metrics in line with the current Baa2 ratings, following higher return and cost allowances under the CMA determination.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGGiven the company's long-dated financing structure and limited RCV growth over AMP7, Moody's expects that Bristol Water will continue to face challenges in an environment of generally low returns. The rating agency, therefore, considers a rating upgrade to be unlikely over the medium term.The rating could be downgraded if Bristol Water was likely to exhibit an AICR significantly below 1.3x and gearing, calculated as net debt to RCV, in excess of 85%, roughly in line with the company's distribution lock-up trigger levels.In addition, downward rating pressure could result from a significant increase in business risk for the sector as a result of legal and/or regulatory changes leading to a reduction in the stability and predictability of regulatory earnings, which is not offset by other credit strengthening measures, or the company facing unforeseen funding difficulties.The principal methodology used in this rating was Regulated Water Utilities published in June 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1121971. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.Bristol Water plc is the third largest of the six water only companies (WoCs) in England and Wales with a RCV of GBP549 million as of 31 March 2020 (including the regulatory midnight adjustment to reflect performance over AMP6). The company provides water services to a population of about 1.2 million people, supplying domestic and commercial properties within an area of 2,400 square kilometres in the South West of England.Bristol Water is majority owned by iCON Infrastructure; the iCON Infrastructure Partners III, L.P. fund acquired Capstone Infrastructure Corporation's 50% stake in April 2016 and a further 30% stake from SUEZ (Baa1 stable) in December 2016. The remaining 20% is owned by ITOCHU Corporation (A3 stable) who has held its stake since May 2012.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.This rating is solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.REFERENCES/CITATIONS[1]https://assets.publishing.service.gov.uk/media/604fa141e90e077fe7a5f45a/-_CMA_water_redeterminations_-_summary_-_online_version_---_-.pdfPlease see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Stefanie Voelz VP - Senior Credit Officer Infrastructure Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Neil Griffiths-Lambeth Associate Managing Director Infrastructure Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. 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