Ratings agencies move in different directions on Yorkshire Water

Fitch Ratings downgraded Yorkshire Water Services Finance Limited's (YWSF) and Yorkshire Water Finance Plc's (YWF) senior secured Class A debt to 'BBB+' from ‘A-' last week and affirmed its subordinated Class B debt at 'BBB-'. The outlooks are stable.

It said the downgrade of Class A debt reflects the significant derivatives liabilities of Yorkshire Water Services (YWS). The stable outlook reflects its expectation that YWS will gradually deleverage towards 70% by the end of the five-year price control period, ending March 2030 (AMP8), after a peak in the 2026 financial year. Moreover, it believes management is committed to maintaining the rating. 

MtM liabilities

Fitch has removed the one-notch uplift for sector-specific recovery for its UK water portfolio when mark-to-market (MtM) liabilities related to super senior derivatives exceed 10% of Regulatory Capital Value (RCV).  This follows its revised view of the sector, reflecting its increased risk profile.

The derivative liabilities for YWS were £1.8bn, 19% of RCV at financial year end-March 2024. This is the key driver of the Class A debt rating downgrade. Fitch expects to reinstate the one-notch uplift if MtM liabilities consistently reduce in the future.

This contrasts with the Baa2 (lower) stable rating of Moody’s for YWSF’s senior secured debt. Moody’s changed the outlook to stable from negative on 4 February because of the better final determination and because a forthcoming equity injection (via repayment of an inter-company loan) will provide the company with sufficient flexibility, its believes, to maintain financial ratios well in line with minimum guidance for the current ratings, even in a scenario of modest underperformance. 

Rising sector risk

Fitch also believes that the final determination has provided a reasonable outcome for most UK water companies, especially compared with the draft determination. But it believes the sector faces a heightened risk of fines related to operational and environmental under-performance.

Fitch forecasts net in-period Outcome Delivery Incentive penalties of £67m cumulatively for AMP8, compared with £20m of penalties assumed by Moody’s.

Fitch expects that YWS will incur penalties mainly in internal sewer flooding, storm overflows, and compliance risk index. Fitch also forecasts about £75m in total fines from the Environment Agency and Ofwat as baseline cash outflows, due to heightened regulatory scrutiny and stricter controls on wastewater networks. This includes the £47m Ofwat fine proposed by the regulator last August.