Nov 08 - Fitch Ratings has affirmed Catchment Tay Limited's (Catchment Tay) GBP81.1m senior secured notes, due 2028 at 'BBB-'. The Outlook is Positive.
The Positive Outlook reflects the continuing progress between Catchment Tay, Scottish Water and other project parties towards formally recognising a revised tariff framework (in the form of an Official Variation to the concession) that is expected to significantly reduce revenue volatility through altered prices and thresholds of the water volume bands under which Catchment Tay generates revenue. The company has been successfully receiving revenue on this informally revised basis since January 2009. Although the Official Variation has been delayed beyond the agency's expectations, progress by the project parties has continued, and it is now expected to be completed on or before 31 March 2013.
The key rating factors for Catchment Tay are i) successful completion of the Official Variation to the concession with regard to the revised tariff framework; ii) wastewater volume risk; iii) the project's continued ability to discharge treated water within acceptable output specifications; and iv) the asset's physical condition and capital expenditure (capex) requirements. Fitch has also conducted cash flow forecasts and ratio analysis which support both the Positive Outlook and the affirmation.
The interim tariff framework increases protection to adverse volumes, whilst simultaneously decreasing the scope for overperformance, thereby reducing the project's exposure to volatility in wastewater volume. The project remains exposed to long-term decline in volumes associated with persistent economic deterioration in the Dundee area of Scotland, mitigated to some extent by the network's increasing efficiency. However, since operations began in 2002, actual water flows have been significantly higher than originally expected, with average volumes over the past five years of 38.8m cubic metres (39.0m cubic metres average for the past three years). To reach breakeven levels would likely require a period of exceptionally low rainfall combined with a major (uninsured) outage. Historical performance suggests this is a low probability event.
Performance under the concession contract is measured by the project's ability to discharge treated water at certain output specifications. Non-compliance results in no revenue earned for the relevant day. Catchment Tay's performance has been extremely consistent, with only one day of non-compliance since operations began, so this extremely strong operational performance is clearly a credit positive. Fitch also notes that the new operator and co-sponsor, Veolia Water UK Limited, appears to be operating the project adequately. The project's technical advisor (TA), Halcrow Group Limited, opined that the system has been maintained well and considers the standard of operations to be higher than at similar businesses elsewhere in the UK. Fitch expects the solid performance to continue.
The agency understands that the TA considers Catchment's actual capex performance and expenditure plans adequate. Although the current 12-month look-forward maintenance reserve mechanism is relatively weak for a project of this nature, this reflects the material level of capex smoothing/reprofiling that has occurred since financial close. Furthermore, Fitch takes comfort from the fact that the network is regularly inspected by Catchment Tay, Scottish Water, noteholder-appointed experts and the project's insurers. The assets also have an expected useful life well in excess of note maturity.
Fitch has reviewed Catchment Tay's actual performance in 2011 and over the first ninth months of 2012 as well longer term forecasts, and concluded that the project remains broadly in line with the original base case. Both the senior ADSCR and LLCR stood equally at 1.55x as at September 2012, which is comfortably above lock-up levels. Whilst Fitch does not regard Catchment Tay as an availability-based project, the agency considers PFI-style projects as relevant benchmarks as part of its rating assessment.
Fitch ran several sensitivities, including a break-even analysis in reduction in wastewater volume, 20% increase in operating costs and capex as well as sensitivities assuming low inflation or increased noncompliance with output specification. The agency considers all results to be robust and consistent with the project's current ratings.
Formal approval of the revised tariff framework would trigger an upgrade, while a long-term reduction in wastewater volume, a prolonged period of poor operational performace or a significant increase in life cycle costs would put the ratings under pressure for a downgrade.
Catchment Tay operates a wastewater treatment system in the Dundee area of eastern Scotland under a private finance initiative (PFI) contract with Scottish Water which expires in December 2029. The project has been operating since 2002.