Moody’s puts Southern Water on review for downgrade

Moody’s has put Southern Water on review for downgrade, following Ofwat’s PR24 Draft Determination (DD). The action affected the Baa3 backed and underlying senior secured ratings of SW (Finance) I PLC (Southern Water) but not the A1 backed senior secured ratings of bonds subject to a financial guarantee by Assured Guaranty UK.

The ratings agency said the review for downgrade reflected factors including: 

• The prospect of severe Outcome Delivery Incentive (ODI) penalties – despite Southern’s turnaround plan, operational performance remains weak and average annual net ODI penalties of £35m are expected in AMP7, excluding customer service and per capita consumption incentives. The DD expects an 81% pollution cut compared to the first four years of AMP7. Moody’s said the company would face an average annual penalty of £19m on this measure even if it performed in line with its business plan, rising to over £60m annually if performance remains at the level achieved in financial year 2024. The company would also face material penalties for bathing water quality even if achieves its business plan targets, and for leakage and external sewer flooding if performance improves less quickly than anticipated.

• Totex allowances below the level needed to fund the investment programme – AMP8 allowances are 11% below business plan proposals. The company has incurred totex more than £900m above its regulatory allowances in the first four years of AMP7 as it has invested to improve performance.

• Likely under-performance on financing costs. 

Moody’s estimated Southern will need £4.5bn of debt and equity over the period to 2030, including £800m of net equity contributions. It observed: “Although Southern Water's controlling shareholder has contributed £905m of equity to the operating company and £718m to its holding companies since September 2021, there is no certainty that it would make further contributions if the Final Determination (FD) makes continued low returns likely, particularly given limitations on dividends and additional leverage at holding companies. Southern Water's ultimate shareholders have received no dividends since March 2017, and the operating company is prohibited from making further distributions because of two separate trigger events under its Common Terms Agreement. From April 2025, Southern Water will be unable to make distributions without prior written consent from Ofwat if it continues to have a rating from any agency that is below Baa2/BBB with a stable outlook.”

Moody’s will conclude its review at the latest once the PR24 FDs are released. It added: “We may revise our view of the regulatory framework following Ofwat's FD, in particular the stability, predictability and supportiveness of regulation and the ability of companies consistently to recover their costs and earn an adequate return. This would result in downward rating pressure.”