Research: Rating Action: Moody’s downgrades Catalyst Higher Education (Sheffield) plc’s underlying rating from A3 to Baa2; outlook remains stable

London, 31 May 2022 — Moody’s Investors Service (“Moody’s”) today downgraded the underlying rating of the £156.8 million indexed senior covered bond due 2045 to Baa2 from A3 (the Bonds ) issued by Catalyst Higher Education (Sheffield) plc (CHE or ProjectCo). The outlook remains stable.

RATINGS RATIONALE

The downward revision reflects Moody’s view that (1) project rental price growth will be significantly lower than RPI inflation over the next two academic years 2022/23 and 2023/24; and (2) longer-term rental price growth will be limited by the availability of low-cost private sector student accommodation in a more favorable location. CHE’s facilities management (FM), life cycle costs and debt service costs are contractually tied to RPI inflation; therefore, rental price growth below the RPI will weaken financial metrics.

The University of Sheffield (UoS) and CHE have agreed rental rates for the 2022/23 academic year. The average rental price (net of a utility cost component) received by CHE will only increase by 1.5% from 2021/22 levels, against an actual RPI inflation rate of 11 .1% over the 12 months to April 2022.

The average gross rental rate (including the utility cost component) increased by approximately 2.8%. However, since the utility cost component has increased by approximately 20%, the rental rate received by CHE (which is net of the utility cost component) has only increased by 1.5%. . Therefore, any significant future increase in utility costs is likely to dampen CHE’s rental revenue growth.

Historically, rental prices have risen above RPI inflation since the opening of ProjectCo accommodations in 2009/10 until 2018/19. The next three academic years to 2021/22 have seen fixed rental rates due to a combination of (1) increased competition from new private sector accommodation; (2) residences appearing tired and in need of renovations (since when have the majority of common areas been renovated); and (3) uncertainty about the college experience during the pandemic.

Moody’s believes that future growth in rental prices will be limited by the availability of low-cost private sector housing at a level similar to that of CHE. Therefore, Moody’s current base case assumes that long-term rental price growth will be 0.5% below RPI. On the positive side, demographic data shows that the number of UK residents of university age will increase significantly over the next ten years. If this results in an increase in student numbers at UoS and other higher education institutions in Sheffield, it would support higher rents.

In recent years, room occupancy levels have been below the financial close baseline assumption of 96%. This was mitigated by additional rent payments that the UoS is required to make under the Project Agreement (PA). The special provision requires the UoS to guarantee 96% room occupancy if certain criteria are met. While this provides considerable occupancy risk mitigation, the project still faces rental price risk. Additionally, as part of the AP, the UoS guarantees a Minimum Rent Payment (MRP) on an RPI-indexed basis. However, an MRP-only scenario would result in a low average debt service coverage ratio (DSCR) of 1.10x (with a minimum DSCR of 1.00x).

CHE’s underlying Baa2 rating positively reflects: (1) a long-term collaborative agreement with UoS to develop and renovate a portion of UoS student accommodation and provide certain facilities management services; (2) revenue support mechanisms within the PA through which the UoS provides financial support in certain circumstances; (3) satisfactory operational performance with minimal service failure points (SFPs) and financial deductions; (4) a range of creditor protections built into the financing structure, such as debt service and maintenance reserves; and (5) UoS is a solvent counterparty under the AP.

However, the rating also reflects the following challenges: (1) ProjectCo’s high debt ratio, which reduces its ability to withstand unexpected stresses; (2) exposure to changes in RPI inflation rates, as the rent-setting mechanism does not include an automatic pass-through of inflation, unlike costs and debt servicing; (3) a recent history of rental price growth below the RPI and (4) the availability of low cost private sector housing acts as a constraint on project rental price increases.

The CHE Notes benefit from an unconditional and irrevocable guarantee of principal and interest provided under a financial guarantee insurance policy issued by Assured Guaranty UK Limited (AG, rated A1 stable). The Bonds’ A1 rating is unchanged and reflects the higher of (i) AG’s insurance financial strength rating and (ii) the underlying rating.

STABLE OUTLOOK

The outlook is stable, reflecting Moody’s expectation that (1) CHE-managed student residence occupancy rates will remain supported by UoS under the PA; and (2) lease levels will be consistent with Moody’s base case assumption.

FACTORS THAT MAY LEAD TO AN IMPROVEMENT OR DEGRADATION OF THE RATING

Upward pressure on CHE’s underlying rating would build following a sustained recovery in occupancy rates and an increase in rent levels beyond current expectations, coupled with consistent application of contractual provisions of PA. However, this is unlikely in the near future.

Negative pressure on CHE’s underlying rating would develop due to (1) depressed occupancy rates or rental price growth significantly below RPI; (2) inconsistent application of contractual protections to limit ProjectCo’s exposure to the risk of lower than expected occupancy levels; (3) evidence of strains on the relationship between project parties, particularly with respect to contractual protections built into the PA; (4) poor service delivery, resulting in a substantial increase in SFPs or financial deductions; or (5) any adverse external event, such as the pandemic, resulting in pressure on revenue and cash flow generation.

The main methodology used in this rating was the Methodology for Privately Financed Public Infrastructure Projects (PFI/PPP/P3) published in June 2021 and available on https://ratings.moodys.com/api/rmc-documents/72487. You can also visit the Scoring Methodologies page at https://ratings.moodys.com for a copy of this methodology.

CHE is a special purpose company which in 2006 signed an AP with the UoS to redevelop and renovate part of the university’s student accommodation and associated infrastructure and to provide certain FM services for 40 years. Housing is mostly new construction, with some limited renovations around existing student campuses. The project has been fully operational since September 2009.

REGULATORY INFORMATION

For details on key rating assumptions and Moody’s sensitivity analysis, see the Methodological Assumptions and Sensitivity to Assumptions sections in the Disclosure Form. Rating symbols and definitions from Moody’s are available at https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security, this announcement provides certain regulatory information regarding each rating of a subsequently issued bond or note of the same series, category/class of debt, security or under a program for which ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a media provider, this announcement provides certain regulatory information relating to the credit rating action on the media provider and each particular credit rating action for securities whose credit ratings are derived from the support provider’s credit rating. For the provisional ratings, this press release provides certain regulatory information relating to the provisional rating assigned, and to a final rating that may be assigned after the final issuance of the debt, in each case where the structure and conditions of the transaction n have not changed prior to the final rating being assigned in a way that would have affected the rating. For more information, please see the issuer/transaction page of the respective issuer at https://ratings.moodys.com.

For all relevant securities or rated entities receiving direct credit support from the lead entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action , the associated regulatory information will be that of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to the jurisdiction: Ancillary services, Disclosures to the rated entity, Disclosures to be provided by the rated entity.

The rating has been communicated to the rated entity or its designated agent(s) and issued without modification as a result of such communication.

This rating is requested. Please refer to Moody’s Policy for the Designation and Assignment of Unsolicited Credit Ratings available on its website. https://ratings.moodys.com.

The regulatory information contained in this press release applies to the credit rating and, if applicable, the outlook or rating revision relating thereto.

Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis are available at https://ratings.moodys.com/documents/PBC_1288235.

The worldwide credit rating on this credit rating announcement was issued by one of Moody’s affiliates outside the EU and is approved by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main. -le-Main 60322, Germany, in accordance with Article 4(3) of Regulation (EC) No 1060/2009 on credit rating agencies. Further information on the EU approval status and the Moody’s office that issued the credit rating can be found at https://ratings.moodys.com.

Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and Moody’s legal entity that issued the rating.

Please see the issuer/transaction page at https://ratings.moodys.com for additional regulatory information for each credit rating.

Kunal Govindia
Vice President – Senior Analyst
Infrastructure Finance Group
Moody’s Investors Service Ltd.
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Kevin Maddick
Associate General Manager
Infrastructure Finance Group
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