Fitch Ratings agency has assigned Bazalgette Tunnel Limited's initial £1 billion revolving credit facility (RCF) a 'BBB+' rating and assessed the Outlook as Stable.

Bazalgette Tunnel Ltd, a consortium of Allianz Infrastructure Luxembourg I S.a.r.l., Bazalgette (Investments) Ltd, IPP (Bazalgette) Ltd, Dalmore Capital 14 GP Ltd and DIF Bid Co Ltd (none of which are associated companies of Thames Water) was officially designated by industry regulator Ofwat as the infrastructure provider (IP) to deliver the Tideway Tunnel Project in August.

The RCF is a 10-year bridge financing component of the borrower's £2.9 billion financing plan for the design, construction and operation of the Thames Tideway Tunnel and associated infrastructure. The RCF is expected to be refinanced through senior secured debt issuances during the project's construction.

Fitch said the rating reflects the “substantial protection afforded to the project by strong support commitments from the UK government against completion and funding risk during construction.”

In addition, the project will be remunerated on the basis of a regulatory framework that Fitch regards as transparent and largely proven, under the supervision of well-established sector regulator, Ofwat, commenting:

“We consider the project's operational risk profile to be low. Fitch's financial analysis highlights the resiliency of financial metrics under reasonably severe downside scenarios thanks to reasonably conservative leverage targets.”

Fitch said the financial metrics and leverage targets for the project could in fact suggest a higher rating. However, the rating is weighted down by the uncertainty on the operational regulatory environment resulting from the length of the construction period. The ratings agency’s  analysis spans beyond RCF maturity in 2025 as other senior debt ranking pari passu to the RCF will be outstanding when the project reaches the operational stage.

Completion risk is well-managed and mitigated

Commenting on key ratings drivers, in terms of completion risk, Fitch described the project's construction as “inherently complex and lengthy.” However, in Fitch's opinion, completion risk is well managed and mitigated thanks to the project's detailed planning, the involvement of several experienced contractors and personnel, a supportive regulatory framework under Ofwat's supervision and a strong support package from the UK government, which aims at providing liquidity and additional equity should severe stress scenarios materialise.

Fitch said £1.274 billion will be injected by the sponsors in the first years of construction ahead of expected debt issuance which is sized in line with the "most prudent overspend case."

Fitch said the works will use proven technology and the construction plan, budget and schedule have been well developed drawing on directly relevant peers. The contractors were appointed following a rigorous selection process and have ample experience of similar works in London (Crossrail, Lee Tunnel and Northern Line, for example). The contracts are not fixed-price but the contractors will be incentivised through the sharing of cost savings and overruns. Overall liquidity for contractor replacement is high due to a number of adequate contractors available on the market.

Cost overruns: Govt can opt either to fund additional costs or discontinue project and pay compensation

Other key drivers flagged up by Fitch in reaching its assessment include:

Additional layers of protection include regulatory mechanisms and backstop support from the UK government.

• Revenues will be earned from the start of construction with costs being added to the regulated capital value (RCV) 12 months in advance, cushioning the impact of delays.
• Cost overruns are shared 60% with customers and the impact on the project will only be felt from completion of construction when the adjustment of RCV will occur.
• Delays in completion will result in a reduction in weighted average cost of capital (WACC) for the duration of the delay.
• In the event of cost overruns of more than 30% above P50, the project can request the government funds the additional costs. The government would then be obliged to do so or to discontinue the project and pay compensation sufficient to repay the senior debt and close hedging contracts.

Revenue: risk is stronger

Fitch said the project’s revenue structure is based on the well-established approach used for the UK water sector and regulated by Ofwat, subject to the adjustments for the construction period. The issuer will not be exposed to volume risk but will have exposure to tariff risk every five years during operations. The ratings agency commented:

“The main revenue driver will be the WACC, as opex is expected to be very small. BTL's risk profile differs in many respects from a typical water utility as it will operate a single new build asset rather than a large existing network. Ofwat has indicated that the WACC applicable to the project should be lower (by some 50bps) than other water utilities. In Fitch's opinion, the regulator's discretion over the project's key revenue drivers is lower than the sector average, given the limited operating and capital requirement post construction.”

On operational risk, Fitch described this as very low as the tunnel uses proven technology, relies on gravity to transfer the sewage and has few moving parts. The main operating responsibilities of the project company are 10 year reviews of tunnel condition.

In terms of infrastructure development and renewal, the ratings agency said that once completed, the assets will be brand new, with few moving parts and an economic life of 120 years. It is not expected that there will be significant need for major refurbishment for at least the first 10 years.

Fitch's rating case reflects a downside scenario whereby the construction process is delayed by 18 months and costs increase to 30% above P50 (the level beyond which government support would be triggered).

In terms of peer analysis, Fitch said that Bazalgette Tunnel Ltd compares well with other secured and covenanted financings such as Wessex Water and Northumbrian Water, which are rated one notch higher at 'A-' despite weaker debt metrics.

Fitch added that the rating differentiation reflects BTL’s greenfield single project nature (rather than a large operating network) and the lack of visibility on the operational regulatory environment given the long construction period ahead.