Financial resilience and positive returns lacking

(by Verity Mitchell)

Ofwat has published its Monitoring Financial Resilience report for 2024-2025, in which it sets out its assessment of water company financial resilience.

The companies are placed in four categories by Ofwat, as shown in the table:

• Thames remains in Ofwat’s Turnaround Oversight Regime. The regulator said it “expects Thames to deliver a credible and sustainable plan” to restore financial resilience. 

• Southern and South East both remain in the Action Required and Active Engagement category. Both successfully received provisional extra revenue allowances in the Competition and Markets Authority’s (CMA) recent determination. Despite equity pledges or injections of £1.2bn and £275m respectively, the regulator considers that both companies may require further equity and need to improve their performance.

• Six companies are in the Elevated and Enhanced Monitoring category. It is worth noting that Anglian, Northumbrian and Wessex have all also successfully appealed to the CMA to obtain extra revenue. It is likely that Affinity and Yorkshire, also in the category, may require action. Portsmouth’s financial challenge mostly derives from increasing debt to fund the Havant Thicket reservoir project.

• Seven companies remain in the Standard and Routine Monitoring category, including newly promoted SES Water (now owned by Pennon) and South Staffs. Ofwat admits that, compared to companies with equity shareholders, Welsh Water has a more limited equity-raising capacity due to its structure.

• The regulator admitted that the companies have gone some way to strengthen their financial resilience, injecting nearly £5bn into the regulated companies during AMP7. Since March 2025, a further £1.4bn in new equity has been received or committed to support financial resilience, investment and performance improvements where needed.

Gearing

The report shows the high levels of gearing across the sector at the end of the AMP. Significant amounts of new equity funding will be needed to stabilise gearing and underpin the AMP8 investment programme to 2030.

Ofwat reduced notional gearing to 55% for AMP8 but has recognised that most companies appear to be choosing alternative capital structures. For 2024-2025, only SES achieved a gearing level below 60%.

70% gearing remains a threshold above which the regulator has concerns. Eight companies had gearing above 70% at the financial year's end.

Risk/reward balance

The report also highlights how the current regulatory regime has affected companies’ returns over the last five years.

Base returns have been eroded by tough performance targets for most companies, with the data clearly demonstrating the lack of balanced outcomes around the return on regulatory equity (RoRE) from an operational performance perspective. Only two companies achieved a positive return in 2024-2025: Severn Trent and Portsmouth.

Even with the benefit of financing outperformance, ten companies out of 17 did not achieve their base regulatory return. This is one of the factors that has led to the perception of increased regulatory instability within the sector.

Over the five-year price control period, sector performance has resulted in returns below the base return of 4.1% on average. Severn Trent was the only company to report overall operational outperformance. Hafren, Severn Trent, United Utilities and Wessex reported an average RoRE for AMP7 above their base return, primarily due to financing outperformance. Five companies recorded negative returns. This has led to Ofwat introducing another layer of complexity to realign regulatory returns for AMP8: the Outturn Adjustment Mechanism (OAM).

Nine companies did not pay a dividend, in some cases prevented by a dividend lock up imposed by the regulator. However, higher than anticipated inflation allowed significant regulatory capital value growth across the sector. Despite this, the key metrics of debt/regulatory capital value remained elevated. There is an obvious lack of financial stability in the sector. Seven companies remain on negative outlook from one of the rating agencies. Southern and Thames are now sub investment grade.

Ofwat sees AMP8 as an opportunity for investors to provide finance. The new regulator must deliver a reset to ensure that there is some likelihood that more than one company will be able to achieve RoRE outperformance from operational performance and generate cash to contribute to debt reduction.

• Publication of the Monitoring Financial Resilience report was also an opportunity to remind the public of the effects of the Water (Special Measures) Act which came into force in June 2025. This introduced bonus restrictions for chief executives and chief financial officers in water companies that delivered poor environmental and consumer outcomes. The statement confirmed that £4m of bonuses had not been paid to senior executives in six companies.