Selangor Water Sector-Related Debt Ratings - 2011 Credit Commentary Report

These rating actions reflect the increasingly challenged liquidity positions of the affected issuers arising from the unresolved deadlock in negotiations between the Selangor government, federal government and the water concessionaires on the restructuring of the state's water sector. MARC believes that the unresolved deadlock significantly reduces the likelihood that the restructuring process will be brought to a successful and timely conclusion in the immediate term. The negative outlooks on the ratings, with the exception of VCSB's bank guaranteed BaIDS, reflect MARC's concerns with the continuing deterioration in liquidity positions of the affected issuers and increased likelihood of missed payments on the rated obligations with approaching debt maturities. The rating agency is also of the view that the refinancing of any significant debt maturities in the coming months would be challenging on  account of  the  weakened  credit profiles  of  the affected issuers.  Additionally, MARC  believes  that following the downgrades, PNSB and PNHB may become more vulnerable to a possible declaration of an event-of-default due to rating triggers within their rated debts, increasing the likelihood of cross-default and cross-acceleration. MARC will evaluate continuing negative pressures as they unfold over the coming months and will take appropriate rating action as required.

The prolonged deadlock in the restructuring of the Selangor water sector has raised questions regarding the state and federal governments’ stance toward providing timely direct financial support to the affected issuers, particularly given the approaching debt maturities for many of the rated issues over the coming months.

The current rating actions do not take into account the probability of bond buybacks by authorities to protect existing bondholders from potential credit-related losses. Interventions of this nature do not alter the probability of timely payment by the rated issuers (i.e. default risk), although it is acknowledged that they do mitigate exposure to potential credit losses on the part of existing bondholders. The individual credit ratings on the outstanding Selangor water sector-related issuances continue to represent the agency's opinions on the corresponding default likelihood associated with each of the rated instruments. Accordingly, further rating downgrades are likely should the creditworthiness of the issuers weaken further.

SYABAS

The downgrades of SYABAS' short-term and long-term debt ratings are driven by MARC's assessment of the water distributor's unaudited results for the 12 months ended December 31, 2010 (FY2010) and its unresolved January 2009 water tariff hike. At the same time, the ratings have been removed from MARCWatch Negative and outlook is revised to negative. MARC believes that SYABAS' creditworthiness has weakened further in recent months on account of its rising trade payables and the continuing cash flow mismatch between costs and revenues. SYABAS recently reduced its monthly payments to water treatment operators to 42% of invoiced amounts from 45% previously to conserve its liquidity. MARC notes that the water distributor has no debt maturities until 2013 and should have sufficient cash on its balance sheet to support its debt service needs through November 2011.

In order to return to a stable outlook, MARC would need to see a material strengthening in SYABAS' liquidity position and cash flow generation. A stable outlook would also require a significant reduction in SYABAS' trade payables.
 
PNSB, PNHB and RUNH

The downgrades in PNSB’s senior debt rating on its BaIDs and subordinated debt ratings on both its A Notes and RUB reflect further erosion of PNSB’s credit profile stemming from increased offtaker credit risk. MARC continues to equalise PNSB’s long-term debt rating with that of its single offtaker, SYABAS, to reflect the chronic and worsening collection problem. MARC believes that PNSB’s accounts receivable levels are becoming unmanageable, and should SYABAS’ creditworthiness weaken further, PNSB’s credit profile would be similarly impacted. MARC takes some comfort that PNSB’s debt service reserve account (DSRA) is fully funded to meet the BaIDS principal repayment of RM180.0 million maturing in October 2011. However, the rating agency is concerned that PNSB may not have sufficient liquidity to fund its debts obligations on the A Notes should the put option be exercised on November 18, 2011 with RM328.13 million still outstanding.
 
PNHB’s RUN which are secured by PNSB’s A Notes have been downgraded to reflect the rating of the underlying A Notes. Accordingly, the short-term and long-term ratings on RUNH’s CP and MTN have been lowered to reflect the identical rating considerations for PNHB’s RUN.

MARC is mindful that the minimum rating requirements on the PNSB’s BaIDS and PNHB’s RUN will be breached with the current rating downgrades. The outlook on all ratings of debt issued by PNSB, PNHB and RUNH remains negative. Improvement in SYABAS’ creditworthiness and PNSB’s receivables collection position would be key considerations towards a stable outlook.

SPLASH and VCSB

The downgrade of SPLASH’s long-term debt rating and short-term debt rating reflects similar concerns as to the impact of increased single offtaker credit risk on the water treatment operator’s credit profile as well as implications for upcoming debt maturities despite the recent shareholders’ undertaking to fund any payment shortfall on its BaIDS and MMTN due in July and November 2011 respectively. SPLASH has been cutting dividends to conserve liquidity, barring an improvement in its receivables collection and absent any other mitigating developments.

Consequently, VCSB’s BaIDs rating has been downgraded in view of SPLASH’s inability to upstream dividends, tempered by an undertaking provided by its parent, Kumpulan Perangsang Selangor Bhd (KPSB), to provide liquidity support for the BaIDs. The undertaking obligates KPSB to cover shortfalls in debt service for the BaIDs in the event that upstreamed dividends from SPLASH or available liquidity at VSCB is insufficient to fund the debt servicing needs on the BaIDs and BG BaIDS. KPSB is a 56%-owned subsidiary of Selangor state government-owned Kumpulan Darul Ehsan Bhd (KDEB). MARC believes that there is a high likelihood that VCSB would need to rely on support from its parent to meet its August 2011 RM20 million BaIDs principal repayment in full and in a timely manner.

MARC has also considered negative credit implications of the Selangor water sector challenges for KPSB's credit profile in the agency's qualitative assessment of its capacity to provide support to VCSB. As an investment holding company with strategic stakes in major water supply and water-related entities, KPSB's earnings and cash flow generation at holding company level has been substantially affected by the diminished dividend-paying capacity of the water treatment operators. 

The rating on VCSB’s BG BaIDs was affirmed on the strength of the irrevocable and unconditional bank guarantee from Public Bank Bhd, which is rated AAA/Stable by MARC on a public information basis.

The outlook on all ratings of debt issued by SPLASH and VCSB, with the exception of VCSB’s BG BaIDS, remains negative.

TMSB

MARC removed TMSB’s state-supported rating from MARCWatch Negative and has withdrawn the rating.  Going forward, TMSB’s rating will reflect its standalone rating which MARC has affirmed at B.  MARC has phased out the state support assumptions to reflect the agency’s belief that the likelihood of TMSB receiving timely financial assistance from the state government to meet its rated obligation is becoming increasingly remote.

TMSB’s financial risk profile is expected to remain constrained due to ongoing liquidity and cash problems at its principal operating subsidiary and water treatment operator, Konsortium Abass Sdn Bhd (ABASS).

ABASS filed and served a writ of summons on SYABAS on March 30, 2011. The water treatment operator is seeking cash payments of RM149.5 million for outstanding invoices and interest of RM6.2 million from SYABAS. The latter has until April 8, 2011 to file its answer, failing which ABASS may enter a judgement against the water distributor (SYABAS filed appearance on April 5, 2011). More importantly, KPSB cautioned in its announcement to Bursa Malaysia on March 30, 2011 that ABASS would face difficulties in meeting its operational and financial obligations in the event it loses the lawsuit.

TMSB does not have the liquidity to meet its future coupon and principal obligations on its FRSB. TMSB is expected to rely heavily on advances from holding company KPSB to meet its upcoming April 2011 coupon payment of RM15.37 million. Support uplift from KPSB, nonetheless, has not been incorporated in the current rating action for TMSB in light of the absence of a legal obligation on the part of the parent to provide support as well as the observed lack of propensity to provide support to ABASS to date.