Moody’s: Ofwat has traded weaker ratings for lower bills

Changes in how Ofwat and Ofgem interpret their financeability duty are putting investment grade credit ratings at risk for water and energy network companies, Moody’s cautioned.

In a new report, the ratings agency highlighted significant revenue and returns cuts looming for water from 2020, which will weaken credit metrics. It said regulators’ “increasingly narrow interpretation of the financeabiity duty” [a requirement to ensure companies can finance their functions] – which features progressively moving responsibility onto companies – “means that actual companies’ credit metrics may no longer support strong investment grade ratings”.

Moody’s said: “There is a clear risk that the average sector rating of Baa1 today could fall to Baa2, which would be below the strong investment-grade rating level that regulators were focusing on in the past.”

Moody’s vice president and senior credit officer, Stefanie Voelz, commented: “UK regulators appear willing to accept weaker ratings on the basis of actual company performance as the price to pay for ensuring lower customer bills and greater public legitimacy.”

She added: “Highly leveraged companies with expensive long-dated debt or weak operational performance are most exposed to lower allowed returns.”

The report found while covenants are credit positive, “the devil is in the detail”. “Although restrictions included in covenanted financing structures enhance the credit quality of operating companies, regulatory changes and financial structuring by some companies have reduced their effectiveness. As a consequence, rating downgrades may trigger lock-up provisions in credit agreements or licences before financial ratio breaches bite. Where covenants or rating triggers do result in trapping cash at operating companies, Moody’s sees increasing risk that they could cut off the distributions needed to service debt at rated holding companies.”