Rating action

Scope Ratings GmbH (Scope) has today assigned a first-time public rating to the notes issued by Borkum Riffgrund 2 Investor Holding GmbH as follows:

Senior secured notes, EUR 815m: new rating of A-

The notes were issued mainly to partially refinance the construction of an offshore wind farm in the German North Sea.

Transaction overview

The project underlying the senior notes is a fully operational offshore wind farm in the German North Sea with a capacity of 465 MW.

The project is sponsored by Ørsted and Gulf Energy Development, which each hold a 50% stake.

Development and construction were managed by Ørsted. Construction commenced in Q3/2017 and was completed on schedule in Q1/2019. Final taking-over occurred in Q2/2019.

Maintenance and servicing of the wind turbine generators will initially be delivered by MHI Vestas via a pass-through service and warranty agreement for the first five years, including a production-based availability warranty of 96%, and thereafter by Ørsted.

Ørsted (or an affiliate) also manages the operation and maintenance of the wind farm and provides a route-to-market for the electricity produced by the wind farm under two separate power purchase agreements for a period of 20 years.

Rating rationale

The A- rating reflects the total expected loss (EL) of 0.20% over the loan’s life until maturity (equivalent to a 3.67-year constant-exposure expected risk horizon). Key drivers are low risks during operation, especially regarding sponsors and revenue generation, as well as strong financials and resilience to cash flow stress scenarios. The risk of structural subordination is mitigated by a defined cap, the project’s financial strength, a robust governance and security framework, and the sponsors’ strong economic interests and funding obligations.

Construction risks account for 0.0% of total EL. Construction started in the third quarter of 2017 and was completed on schedule in the first quarter of 2019. Final acceptance took place in Q2 2019.

Operational risks contribute 40.2% of total EL. The initial five-year service contract and warranty period by MHI Vestas and the largely fixed-fee operating and maintenance agreement by Ørsted as well as a maintenance reserve mitigate risks from operating expenditure uncertainties. Potential counterparty risks regarding the service providers are low because of their long-standing track records, strong market positions, good credit standing and significant commitment to the project.

Revenue risks account for 19.9% of total EL. Priority dispatch of electricity, the absence of price risk due to regulated fixed feed-in tariffs, and the generally good quality and reliability of the offshore wind resource mitigate the risk of revenue fluctuations. The project’s strong economic rationale, negligible risk of retroactive regulatory change in Germany, and high barriers to entry compensate for the project’s significant dependence on subsidies.

Financial strength risks account for 28.0% of total EL. The transaction has average coverage ratios and demonstrates good resilience to cash flow stresses. Refinancing risk is low thanks to the relatively small balloon amount. A balloon reserve account in combination with mandatory cash sweeps, regulated floor prices for 10 years after maturity, and the fact that the notes mature at least 15 years before the project life ends further reduce refinancing risk at maturity.

Project structure and compliance risks account for 11.8% of total EL. The sponsors’ funding obligations significantly reduce the likelihood of credit impairment events and compensate for the lack of direct access to the assets. The risk of structural subordination is very low and mitigated by the defined cap, the financial strength of the project, the robust governance and security framework as well as the extensive experience, good credit quality and economic interests of the sponsors.

Key rating drivers

• Experienced sponsors (positive). All sponsors are well-experienced, have good credit quality and high technical capabilities, and have significant economic incentives.
   
• Low operational risks (positive). Ørsted will operate and maintain the project for 20 years. O&M contract prices are largely fixed. The O&M budget includes a sizable maintenance reserve based on the expected variable O&M charges (three-year rolling allocation). For the initial five project years, MHI Vestas provides O&M for the turbines via a comprehensive pass-through service warranty agreement.
   
• Stable and predictable long-term revenues (positive). No price risk due to high fixed feed-in tariffs and a regulated price floor until operating year 20. The good quality and reliability of offshore wind yield in the German North Sea mitigate resource risk.
   
• Strong resilience to cash flow stresses (positive). The project demonstrates good resilience to cash flow stress scenarios, including lower wind turbine availability and average wind speeds, higher inflation, and variable operating costs.
   
• Limited refinancing risk (positive) The notes are almost fully amortising to a small balloon (12%) and mature about 15 years before the project life ends. The period of regulated electricity price floors, which is almost twice as long as the time needed to repay the balloon based on P90 production divided by 1.34x, the absence of external debt, and a balloon reserve account further reduce refinancing risk.
   
• Structural subordination (negative). The notes may be structurally subordinated to the sponsors’ funding obligations during the operating phase in certain scenarios. The risk of structural subordination is very low and is mitigated by the defined cap, the financial strength of the project, the robust governance and security framework, as well as the extensive experience, good credit quality and economic interests of the sponsors.
   
• Volatile operating performance (negative). Conservative rating case assumptions based on P90 production and debt service coverage of more than 1.3x, as well as regulatory compensation and robust reserves, mitigated the operating underperformance in the first nine months of 2021. The shortfall was mainly due to lower-than-expected wind speeds, energy curtailments, grid outages, and negative price events, with the last three largely covered by regulatory compensation.
   
• Significant dependency on subsidies (negative). Low regulatory risks, the strong project rationale, and high barriers to entry mitigate the risk of potential retroactive subsidy cuts.

Rating-change drivers

• Positive: A stronger operational track record in terms of revenues or faster deleveraging compared to Scope’s rating case could result in a rating upgrade.
   
• Negative: Lower energy production or consistently lower cash flows in the operating phase than assumed in our rating case could lead to a rating downgrade.

Quantitative analysis and assumptions

The total EL on the rated instrument is commensurate with a A- rating. We calculated an EL of 0.20% over the lifetime of the instrument (equivalent to a constant exposure expected risk horizon of 3.67 years) under our rating case scenario (Scope’s rating case), which is more conservative than the sponsor’s base case scenario. Our rating case on the wind farm assumes P90 electricity production and 96% technical availability.

We calculated an expected impairment likelihood of 1.08% for this project, commensurate with a PD strength of bbb when expressed using the levels of our idealised PD curves, as per our methodology. The project’s PD strength and EL results from the aggregated risk of the construction and operational phases.

We have calculated a total expected recovery rate of 81.23% on credit impairments for the project. The total expected recovery rate is the probability-weighted average recovery rate of all 16 credit impairment events.

We performed a detailed estimation of the expected severity of the three credit impairment events that are most relevant for investors. These are: i) Revenue deterioration; ii) Debt repayment or cash flow liquidity issues; and iii) Legal, environmental or compliance issues. These three credit impairment events contribute c. 0.07% (or 33.63% of total) to the senior notes’ total expected loss of 0.20%.

Sensitivity analysis

Scope tested the resilience of the Credit Rating against deviations of the main input parameters. The Credit Rating on the notes is robust, showing limited sensitivity to sizeable changes in analytical assumptions.

• The model-implied Credit Rating would be BB+ if all 23 risk factor scores are reduced by one level
   
• The model-implied Credit Rating would be BBB-, or one rating category lower, if the most relevant risk factor scores are reduced by two levels.
   
• A 25% haircut to the expected recovery rate implies a rating of BBB.

Stress testing
Scope Ratings’ General Project Finance Methodology considers a rating case that embeds stress when compared to the sponsor’s base case. Additionally, the recovery analysis takes into consideration the extreme events in the recovery distribution curves. These elements can be considered a form of stress testing. The stresses of the rating case incorporate haircuts to the cash flows for investors using the project’s financial model.
Scope Ratings stressed the key inputs to the project’s financial model based on the conditions implied by the respective credit impairment event. For example, the stresses applied to estimate the expected recovery rate in revenue deterioration events cover two key revenue drivers: expected energy yield and turbine availability. Scope Ratings derived the expected recovery rate by calculating the net present value of all cash flows available for debt service under the assumptions of the respective most relevant credit impairment event.

Cash flow analysis
Scope Ratings relied on the project’s financial model originally prepared by Global Infrastructure Partners and updated by Gulf Energy Development for the cash flow analysis of the transaction. The cash flow analysis incorporates Scope Ratings’ own assumptions over the economic life of the project, considering the transaction’s main structural features, such as the notes’ priorities of payment, the notes’ size and coupons. The cash flow analysis is used to assess the different risk factors and recovery risk factors as well as to determine the expected recovery of the top three credit impairment events, considered in Scope Ratings’ Project Finance Methodology.

Methodology
The methodologies used for this Credit Rating, (General Project Finance Rating Methodology, 15 November 2021; Methodology of Counterparty Risk in Structured Finance, 13 July 2021) are available on https://www.scoperatings.com/#!methodology/list.
The model used for this Credit Rating is (Project Finance Expected Loss Model, Version 1.2), available in Scope Ratings’ list of models, published under https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-EU. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Rating: public domain, the Rated Entity, the Rated Entities’ Related Third Parties, third parties and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the instrument to be satisfactory. The information and data supporting the Credit Rating originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Rating and the principal grounds on which the Credit Rating is based. Following that review, the Credit Rating was not amended before being issued.

Regulatory disclosures
This Credit Rating is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Rating is UK-endorsed.
Lead analyst Torsten Schellscheidt, Executive Director
Person responsible for approval of the Credit Rating: Aaron Konrad, Executive Director
The Credit Rating was first released by Scope Ratings on 7 February 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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