Fitch warns of ratings pressure and cash lock-up risk in AMP8

Cash lock-ups could be on the cards for more water companies in AMP8, according to analysis by Fitch Ratings.

In a new publication, UK water companies after the draft determination (DD), the agency reviews companies against three key credit ratios: net debt/regulatory capital value (RCV), cash post maintenance coverage ratio (PMICR) and nominal PMICR. It said those with two or more ‘low’ headroom assessments will find it challenging to maintain their existing ratings for AMP8 (see table). Moreover: “In some cases, companies within this category may face significant challenges in sustaining a rating at least one notch above Ofwat’s new licence condition, which requires a minimum credit rating above ‘BBB’/Negative. Companies falling to this level or below will be subject to a regulatory cash-lock up.”

Fitch stressed this was a preliminary view based on the DDs and company business plans, and that higher visibility would come with the Final Determinations (FD) and companies’ final considerations about their financial policy for AMP8. Moreover it highlighted it had not made assumptions about potential outcome incentive performance (beyond track record) or incentives relating to business plan grades given these could change at FD.

The agency said equity injections would also be contingent on the FDs, and observed: “Companies with low ratings headroom, coupled with weak operational and environmental performance, are likely to find it more challenging to secure fresh equity.” It further mooted the possibility that additional equity raises could be used to pay fines resulting from Ofwat and the Environment Agency wastewater compliance investigations, should these materialise – as that would mitigate the credit impact resulting from the levying of fines.

Elsewhere, the note highlighted challenges related to key building blocks factors – such as the pay-as-you-go, post-financeablilty adjustments and run-off rates – as well as totex and frontier shift challenges. Fitch said Ofwat’s movement in base costs and protections including real price effects (which now cover 55% of costs up from 30% in AMP7) and cost-sharing rates were positive.

There was also commentary on individual company positions.