Ofwat’s plans to strengthen water company financial resilience through licence changes would be credit positive for operating companies but credit negative for holding companies, Moody’s has said.
In a sector comment paper, the ratings agency observed for operating companies: “Cash would be retained at an earlier point and available to address potential performance or other issues before the loss of an investment-grade rating, which in itself could lead to a loss of licence. However, trapped dividends may be modest for most companies that are currently rated Baa2 and make only limited distributions. If trapped dividends are used to reduce borrowing, gearing will decline over time. Interest coverage, which currently constrains the credit quality of many water companies, would similarly improve with lower gearing, but likely much more slowly.”
However: “Greater restrictions on dividend payments by operating companies will be credit negative for holding companies reliant on this income to service their own debt. It will also reduce the scope for using holding company debt to bolster operating companies' credit quality through the injection of equity.”
Moody’s said it currently rates debt issued by three holding companies and of these “Kemble [Thames] appears most exposed following Ofwat's proposals” – but that the new £1.5bn shareholder equity injection could allow Thames to create additional headroom within its Baa2 stable rating before implementation of the tightened lock-up trigger on 1 April 2025.
Ofwat’s proposals seek to:
• raise the cash lock-up trigger to BBB/Baa2 with negative outlook (from currently Baa3 negative), effective from 1 April 2025;
• require that dividend policies and dividends declared or paid should take account of service delivery for customers and the environment over time, current and future investment needs and financial resilience over the long term; and
• require companies to maintain investment grade issuer credit ratings with at least two credit rating agencies and to notify Ofwat of changes to credit ratings.
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