OREANDA-NEWS. December 15, 2015. Fitch Ratings has affirmed Viridian Group Investments Limited's (VGIL) Long-term Issuer Default Rating (IDR) at 'B+'. Fitch has also affirmed Viridian Group Fundco II Limited's notes senior secured rating at 'B+' and Viridian Group Limited's (VGL) and Viridian Power and Energy Holdings Limited's (VPEHL) super senior revolving credit facility (RCF) senior secured rating at 'BB+'. The Outlook on the IDR is Stable.

The affirmation reflects VGIL's adequate operating and financial performance and our expectation that the company would slow down the pace of its investments and generate substantial positive free cash (FCF) flow from the financial year ending 31 March 2017 onwards. At the same time the ratings are under pressure from adverse regulatory developments of the last 12 months and from considerable cash interest payments on a subordinated shareholder loan.

Financial metrics have limited headroom at the current rating. Headroom could further decrease if investments increase. Transition to the I-SEM (integrated single electricity market) in 4Q17 could also be credit-negative for Viridian.

KEY RATING DRIVERS
Possible Change of Control
VGIL's ultimate shareholders are currently assessing strategic options for their interest in the company, which may or may not lead to a sale in due course. A change of ownership would trigger change of control clauses in VGIL's super-senior RCF, senior secured notes and its parent company's PIK (payment in kind) instrument. In the event of a sale, we would assess its rating impact once more details are available.

Successful Refinancing
In February 2015 the company refinanced its 11.1% EUR313m and USD250m senior secured notes due 2017 with EUR600m 7.5% senior secured notes due 2020. Proceeds were also used to pay down GBP64m of the subordinated shareholder loan (13.5% interest-bearing), which is currently classified as an equity-like PIK instrument by Fitch. As a result of the refinancing, the company has substantially reduced its interest costs, extended its debt maturity profile, but also increased its leverage.

Unfavourable Regulatory Developments
In 2015, a number of adverse regulatory changes took place, including a 10% capacity pot reduction from 1 January 2016, early termination of renewable obligation support for onshore wind and removal of levy exemption certificates in Northern Ireland. These developments will have a moderately negative impact on VGIL's financial profile, in particular, in FY17, when the full-year impact of capacity pot reduction will feed through.

Adverse Market Dynamics
Single Market Price (SMP) has been continuously declining since 2013, largely due to falling gas prices, but also due to increasing renewables contribution to the single electricity market. Given large amount of wind capacity in the pipeline and the government's ambitious renewable targets, merit order and SMP will be negatively impacted in the medium- to long-term. Unless gas prices rebound, we do not expect SMP to recover.

VGIL's renewable PPAs segment would be impacted by lower SMP. Contracts with wind farms in Ireland are largely based on fixed price, while Northern Ireland's portfolio is mostly variably priced. REFIT contracts in Ireland benefit from floor price protection.

VGIL's two CCGT plants, Huntstown 1 and Huntstown 2, have been running at less than 10% unconstrained utilisation in the last 12 months. These plants are used for system support and are profitable due to capacity payments.

Transition to I-SEM Potentially Negative
The Irish Single Electricity Market (SEM) regulators are working on a detailed design of the new all-island electricity market, I-SEM, which will be compatible with the electricity markets of continental Europe. I-SEM introduction is planned for 4Q17. We expect greater electricity price convergence between Ireland and continental Europe, with SMP approaching European levels in the medium term. We also expect lower capacity payments, which will be allocated based on a competitive auction. In addition to capacity payments, a larger pool of ancillary payments would be introduced (increased to GBP235m from GBP40m-GBP50m currently), including payments for operating reserve or voltage support.

The company's CCGTs could be disadvantaged, depending on their ability to compensate lower capacity payments with ancillary services' earnings. The overall timing and magnitude of the impact is still uncertain.

Stretched Financial Ratios
Fitch expects VGIL's funds from operations (FFO) adjusted net leverage to remain broadly at the negative rating guideline of 5.0x in the next three years. Interest cover is forecast to remain 2.1x versus the guideline of 2.0x. In our updated forecast deleveraging is much slower than what we had expected a year ago. This is due to adverse market and regulatory developments, as well as more conservative assumptions on PIK instrument interest payments. Leverage headroom for the current rating is limited.

Continued Investment in Renewables
Renewables remain the core component of the company's long-term growth strategy. In addition to the currently operational 34MW, VGIL is developing projects with a combined capacity of 168MW. The company also owns 24MW of renewable capacity via minority participation and has 31MW in various stages of obtaining planning permission and grid connections. VGIL is looking to acquire further early-stage development projects and grow its overall portfolio to 300MW. Around GBP40m of equity investments are expected in FY16, which will be reflected as restricted group capex. Bond documentation allows VGIL to make GBP70m of investments in renewable assets.

Non-recourse project financing facilities are in place for operational and under construction wind farms. As at 30 September 2015 GBP56.4m of project finance bank facilities were included within VGIL's financial liabilities, up from GBP30.2m a year ago. The significant increase in the facilities is due to the company's active investment phase. VGIL expects renewables investments to slow down from FY17. Fitch considers these obligations as off- balance sheet as they are non-recourse and are secured over the assets of specific projects.

Shareholder Loans and Project Finance
Fitch excludes VGIL's shareholder loans and non-recourse project finance debt from the leverage calculations. These liabilities are outside the restricted group and are not impacting either the probability of default or recovery rates. Shareholder loans are structurally and contractually subordinated to all other debt of the group and have no independent enforcement rights.

Since September 2014 Viridian has been quarterly electing to cash-pay interest on its interest-bearing subordinated shareholder loan (junior facility A, raised at VGHL level, outside of the restricted group) as opposed to deferring it. Junior facility A bears an annual interest rate of 13.5%. The interest-bearing portion of the subordinated shareholder loan amounted to GBP176m at 30 September 2015. Cash interest payments have been reducing the company's FCF and slowing down deleveraging. We continue to rate the restricted group according to its debt, but we are taking into account the dividend policy that would service the junior facility A, which results in more conservative ratios.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Near-zero unconstrained utilisation of both Huntstown 1 and 2 for FY16-FY19.
- System marginal price flat at 55 EUR/MWh before the I-SEM introduction, declining thereafter.
- 10% capacity pot reduction implemented from 1 January 2016 until I-SEM introduction in 4Q17. Capacity payments reduced by 20% post I-SEM introduction.
- Renewable PPAs segment growth due to new own renewables coming on stream, partially offset by lower SMP forecast.
- Margins in the currently regulated Power NI business to slowly decline, reflecting customer attrition and tariff decrease from 1 April 2015.
- Gradual market share gain of the new retail supply business in the Republic of Ireland ('RoI Domestics') over FY16-FY19,
- EBITDA from procurement of power from Ballylumform power station mirrors the regulatory determinations for FY16-FY17, and zero thereafter.
- Capex reflects predominantly investments in renewables assets and is funded from internally generated cash flow. Average capex spending assumed at GBP25m per annum for FY16-FY19.
- GBP24m annual cash interest payment on shareholder loan.

RATING SENSITIVITIES
Positive: An upgrade is unlikely in the near term. In the longer term, we could consider a positive rating action should FFO adjusted net leverage decrease below 4x on a sustained basis and FFO interest cover trend towards 3x.

Negative: Further adverse regulatory changes, increase in investments or a failure to generate substantial positive FCF from FY17 onwards would be negative for the ratings. We could consider a negative rating action if FFO adjusted net leverage weakens further to above 5x and FFO interest cover falls below 2x on a sustained basis.

LIQUIDITY
Liquidity is adequate as debt maturities were extended to 2020 as part of the refinancing. Liquidity is further supported by cash and short-term deposits of GBP70.9m and a fully undrawn RCF of GBP100m at 30 September 2015. Fitch projects negative FCF of GBP44m in FY16.

FULL LIST OF RATING ACTIONS

Viridian Group Investments Limited
- Long-Term IDR: affirmed at 'B+'; Outlook Stable

Viridian Group Fundco II Limited
- Senior secured rating: affirmed at 'B+'/'RR4'

Viridian Group Limited
- Senior secured rating: affirmed at 'BB+'/'RR1'

Viridian Power and Energy Holdings Limited
- Senior secured rating: affirmed at 'BB+'/'RR1'