(Repeat for additional subscribers)
April 29 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Germany-based HSE Netz AG’s (HSE Netz) Long-term Issuer Default Rating (IDR) at ‘BBB-’ with a Stable Outlook and its senior unsecured rating at ‘BBB’.
The ratings reflect the low business risk of HSE Netz’s network assets and the early stage of development of German incentive-based regulation. The ratings also reflect target leverage of between 6x and 7x on a funds from operations (FFO) adjusted net basis and structural enhancements of the financing structure, including a debt service reserve account.
Forecast Financials in Line with Ratings
Under the Fitch rating case, we expect FFO adjusted net leverage to increase to above 6x and FFO interest cover to decline to 2.4x-2.5x in the medium term. These metrics remain within Fitch’s ratio guidelines for the ‘BBB-’ IDR of below 7x FFO adjusted net leverage and above 2.25x FFO interest cover.
Profit-and-Loss Transfer Agreement
In 2013 HSE Netz entered into a profit-and-loss transfer agreement with its parent to optimise the tax position of the group. At the same time, this agreement provides for a termination without notice in case the bond provisions are infringed. As a result, HSE Netz continues to be required to fund the day-to-day operations of the regulated business, maintain a debt service reserve of EUR16.5m and retain monthly instalments for the bond coupon, before being able to pay any dividends.
Residual cash flow available for distribution as stipulated by the bond provisions is the limiting factor for dividends, not net income. This sufficiently ring-fences the operating company from the parent, which is judged to have weaker credit quality than HSE Netz at this point in time.
Formalistic Approach of the German Regulator
Given the Federal Network Agency’s formalistic approach of applying provisions of laws, ordinances and regulations, some legal structures of network businesses do not allow for all required assets to be captured in filings for the tariff-setting process. As a result, some assets may not be remunerated. Also, costs that are not incurred in the year of the cost audit (for example due to timing of expenditure) are mostly not recognised by the regulator, among them actual debt costs.
Overall, it appears that management teams are required to spend too much time on the regulatory process to navigate rules that are not in line with the spirit of what regulation is trying to achieve. A little more substance over form and economic reasoning by the regulator would clearly be positive for the regulatory framework in Germany.
HSE Netz is considering options to change the legal structure of its regulated network activities. Currently HSE Netz is the asset owner, Verteilnetzbetreiber (VNB) Rhein-Main-NeckarGmbH & Co. KG is the asset operator and some work streams are carried out by service providers, such as the execution of the capital expenditure programme. The group is exploring all options to improve the efficiency of its operational practices and remove redundant tasks.
The company’s ultimate target is to implement cost reductions prescribed for the second regulatory period (efficiency score of 86.4% for gas and 91.7% expected for electricity) and to reduce the complexity of future regulatory filings. Fitch will assess potential changes to the group structure as and when details become available.
Negative: Future developments that could lead to negative rating action include:
- FFO adjusted net leverage increasing above 7x or FFO net interest cover falling below 2.25x.
- Changes to the regulatory framework leading to an increase in business risk.
- Difficulties in meeting the efficiency targets embedded into price limits.
Positive: Future developments that could lead to positive rating actions include:
- A stronger business profile, alongside positive developments of German network regulation. In particular, a regulatory approach founded on sound economic principles aimed at balancing both consumer and investor interests, and improvements in transparency and predictability would lead Fitch to take a more favourable view on German regulation.
- FFO adjusted net leverage falling below 6x on a sustained basis and FFO net interest cover comfortably above 2.5x.
HSE Netz does not have any committed, undrawn credit facilities. The company relies for liquidity on prudent planning of monthly cash management as part of ordinary treasury activities. As a fall-back, HSE maintains a debt service reserve of EUR16.5m (representing a minimum of three-month lease payments from VNB) in accordance with the transaction documentation. Furthermore HSE Netz holds additional cash against contingent liabilities. Once those liabilities lapse, the excess cash will be repatriated to the parent company.