Moody's Investors Service has placed the Baa1 corporate family rating of Yorkshire Water Services Limited on review for downgrade, primarily reflecting what it describes as the rising risk associated with the company's significant derivatives portfolio.

Moodys’ decision comes  despite the company having received a regulatory price determination broadly in line with its business plan, as published by Ofwat in December 2014.

"Our decision to place Yorkshire Water's rating on review for downgrade, despite the company receiving a solid price review outcome, reflects the fact that a continuing low interest rate environment creates significant mark-to-market losses on the company's sizeable derivatives portfolio," says Stefanie Voelz, a Moody's Vice President -- Senior Analyst and lead analyst for Yorkshire Water. "This increases the negative pressure on Yorkshire Water's credit quality."

At the same time, the rating agency also placed under review for downgrade the A3 senior secured and Baa3 subordinated debt ratings for Class A and Class B notes issued by Yorkshire Water Services Finance Limited, Yorkshire Water Services Bradford Finance Limited and Yorkshire Water Services Odsal Finance Limited (all issuance guaranteed by Yorkshire Water).

The decision to place Yorkshire Water's ratings on review for downgrade reflects Moody's view that, despite having received a final regulatory price determination that is broadly in line with the company's business plan submission, the company's credit quality continues to be pressured by its sizeable derivatives portfolio and the material deterioration in the mark-to-market value (MTM) of that derivatives portfolio.

Yorkshire Water holds a portfolio of inflation-linked derivatives with a notional amount of approximately £1.3 billion, equivalent to approximately 23% of the company's regulatory capital value (RCV). The company's derivatives portfolio is very sensitive to movements in interest rates, and a fall (or rise) on rates can see the MTM of the portfolio increase (or reduce) significantly. In the continuing low interest rate environment, the MTM value of these inflation-linked swaps stood at £1.6 billion as at March 2014.

Moody's believes that the negative MTM has become a persistent feature within the company's capital structure.

The ratings agency considers positively limited operational pressures, taking into account that

a. Yorkshire Water's final price determination has been largely in line with the company's business plan submission;

b. the company has a solid operational performance track record; and

c. management took a prudent approach to financial policy, with gearing reduced to 80% of net debt to RCV.

However, Moodys believes that these positive aspects are not sufficient to fully offset the risk embedded within the company's derivatives portfolio.

The rating agency said it will endeavour to conclude the review within the next three months.