Debt finance for water investment, a sharp contrast

UK water companies have raised £4.5bn of new debt in 2024

Source: GWI

The recent downgrade by S&P and Moody’s of Thames Water’s bonds to below investment grade has led to investors, unable to hold sub-investment grade debt, to offload Thames’ bonds. According to Bloomberg last week, the Bank of Montreal has sold about £300m of Thames’ debt at a 30% discount to face value. The Moody’s downgrade was predicated on, among other issues, the likelihood of the fine of up to 10% of wastewater turnover from Ofwat which was confirmed this week at £104m.

The downgrade triggered Ofwat to accelerate the implementation of its previously-announced Turnaround Oversight Regime. Ofwat announced on 7 July, that an independent monitor will be appointed to report on the company’s progress, including progress against its transformation plan. The monitor will report back to Ofwat frequently and be entitled to access to company information. Thames must: develop and deliver a suitable operational business plan to achieve turnaround; take the steps required to deliver an equity raise; and make new non-executive director board appointments. Raising new equity at Thames will be challenging without signs of operational improvement.

In sharp contrast, South West Water and Severn Trent have successfully raised £750m of new debt this week. Severn Trent’s £135m bond issue was 4.5x oversubscribed. Severn Trent and United Utilities have also both shown this year that the Euro-denominated bond market is open for business. It is likely that more companies will have to diversify beyond their core sterling investor base in order to optimise borrowing costs and avoid over-supply. The sector needs to raise new debt to finance its AMP8 investment programmes. New issuance will also inform Ofwat’s view of the industry’s cost of capital before the Final Determinations in December 2024.

Last week, Moody’s put South East Water on review for downgrade, following similar action for Southern Water’s Baa3 rating on 30 July. The change in outlook for Southern reflects Moody’s view that the company is likely to incur heavier financial penalties. Moody’s said: “The AMP8 Draft Determination includes a significant increase in penalty rates for underperformance on measures where Southern Water has historically been a poor performer.” It pointed out that Ofwat will require Southern to reduce its pollution incidents by 81% compared to the first four years of AMP7 – against less than 30% for most other companies in the sector. Southern was not fined by Ofwat in this week’s announcement. In contrast to Thames, its owners Macquarie injected a further £550m of equity into Southern in August 2023. Its Turnaround Plan will also need to deliver operational improvements to reassure its capital providers.