Moody’s expects PR24 to yield equity for Thames – but warns of contagion risk if it doesn’t

Moody’s base case assumption is that Thames Water will ultimately be able to secure a regulatory determination that provides a balance of risk and reward that supports future equity injections.

In a new paper in which it sets out answers to questions it is frequently asked, Moody’s pointed in explanation to Ofwat’s “long-standing track record of transparent and predictable regulation, which includes allowances for efficient costs and a fair return". It also pointed to the regulator's duty to ensure that companies can ‘finance the proper carrying out of their statutory functions’.

Moody’s went on to highlight that Thames has enough liquidity to continue with its current investment plan and fulfil financial requirements until at least the end of May 2025. “However, to maintain credit quality, it will need to replenish its liquidity ahead of the final determination and also obtain equity financing during AMP8 to support the ambitious investment programme.”

The agency’s positive assumption on the outcome of PR24 extended to the wider sector. The paper said: “Overall, we believe that an independent regulator with a long-standing track record of being transparent and striving to set a fair return, will find a balance that allows investors to continue to provide funds to the sector.” 

According to Moody’s, special administration for Thames would be a last resort for Government. But if that did happen, and if senior creditors bore consequent losses, this would “likely fall under our definition of a default and this would have to be reflected in credit rating”.

Given companies are required to maintain investment grade ratings under their licences (and under the highly covenanted structures many have), a sub investment grade rating would not be sustainable. “It would likely reduce access to and increase the cost of debt, leading to underperformance of regulatory cost of debt allowances, which would in turn further weaken financial metrics.” Investment funds with minimum rating requirements may also be required to sell their holdings.

Moody’s said there is contagion risk "in the event of a price determination that does not provide a fair balance of risk and return, as well as in any special administration scenario that results in losses for bondholders”. This applies to any successor entity to Thames, the wider water sector, and also potentially to similarly regulated sectors in the UK.

Although there are differences, Moody’s analysis found Southern Water is most exposed to contagion of all the water companies.