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By clicking “I AGREE”, you indicate that you understand and intend these terms and conditions to be the legal equivalent of a signed, written contract and equally binding, and that you accept such terms and conditions as a condition of viewing any and all Moody’s information that becomes accessible to you (the “Information”). References herein to “Moody’s” include Moody’s Corporation. and each of its subsidiaries and affiliates..

 

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Announcement:

Moody's reviews 12 UK water groups for downgrade

20 Dec 2019

London, 20 December 2019 -- Moody's Investors Service (Moody's) has today placed on review for downgrade 12 UK-based regulated water companies and two high-yield holding companies.

The rating actions follow publication by the Water Services Regulation Authority (Ofwat), the economic regulator for water companies in England and Wales, of its final determination for the forthcoming regulatory period. The determination includes a significant cut in allowed returns which, in conjunction with challenging performance targets and gaps between allowed and requested expenditure, will weigh on credit quality.

RATINGS RATIONALE

Today's rating actions take into account (1) companies' exposure to a significant cut in allowed wholesale returns to ca. 2.42% real in cash terms from 2020 on a 50:50 blended inflation basis, compared with 3.6% in the current period; (2) material reductions in total expenditure allowances compared with companies' requests; and (3) challenging performance targets, which Moody's expects could lead to financial penalties for most companies. Specifically, the rating review reflects the anticipated pressure on companies' financial metrics, particularly interest coverage, absent a more favourable determination following any referrals to the Competition and Markets Authority (CMA), material balance sheet strengthening or significant outperformance. For some, the deterioration could be commensurate with a ratings downgrade in excess of one notch.

Prior to today's action, Moody's had negative outlooks on 80% of the UK water groups as well as the sector, highlighting the risk that lower returns and increasing cash flow volatility will erode credit quality unless shareholders are willing to support rapid de-gearing.

On 16 December 2019, Ofwat published its final determination for the five-year regulatory period commencing 1 April 2020 (AMP7) for the water and wastewater companies operating in England and Wales. As previously flagged by the regulator, the determination includes a significant cut in allowed cash returns to ca. 2.42% for the wholesale activities at the start of the new period, which incorporates the regulator's decision to link half of the regulatory assets to the Consumer Prices Index adjusted for housing costs (CPIH), with the rest remaining linked to the Retail Prices Index (RPI). As the share of regulatory assets linked to CPIH grows over time, Moody's estimates that most companies will have an average allowed cash return of around 2.5% over AMP7. On an RPI-stripped basis, for comparison with the current period, allowed returns will fall to 1.92% (1.96% including retail margin) from 3.6% (3.74% including the retail margin), a nearly 50% cut. This will put particular pressure on companies with expensive and long-dated debt, including Southern Water, Yorkshire Water and most of the smaller water-only companies, although Portsmouth Water and South Staffs Water were able to convince the regulator to include a small company premium of 33bps in their cost of debt allowance.

In the draft determination, Ofwat's allowances for "base" operating and maintenance expenditure for companies rated by Moody's, excluding enhancement projects but including retail costs, were GBP1.9 billion less than companies said they needed to spend. The gap reduced substantially at final determination and stands now at only GBP203 million overall, approximately 0.3% of the industry's GBP72 billion average regulatory capital value (RCV, in 2017/18 prices, excluding South West Water). However, roughly GBP1.3 billion of the gap was closed due to different business plan assumptions, where companies may have set themselves much more challenging targets or proposed cheaper short-term solutions in their response to the draft determination. Ofwat, in comparison, has upped its allowances compared with the draft determination only by just over GBP330 million (again all numbers excluding South West Water). Anglian Water and Bristol Water retain sizeable base cost gaps and Sutton & East Surrey Water continues to exhibit a very large retail cost differential.

Moody's believes that companies remain at risk of materially overspending their allowances. Under the totex sharing mechanism, up to half of this overspend would be added to the RCV in 2025 or recovered over the 2025-30 period but would result in higher debt and weaker cash flow over AMP7.

In addition to base cost overspend, Moody's estimated that, under the draft determination, rated companies could incur up to GBP1.4 billion of underperformance penalties if they achieved leakage, mains replacements, sewer flooding and other operational targets in line with their business plans. While any penalties will be paid with a two-year lag and may thus only bite in the later part of the period, the majority of penalties would still affect cash flows during the AMP7 period. In addition, the calibration of targets and incentive rates means that severe weather events could carry disproportionate downside risk. As part of the rating review, Moody's will assess the changes in the final determination to the calibration of incentives and associated risk of penalties as well as individual companies' plans to mitigate any underperformance.

Companies must decide before 16 February 2020 whether to accept the final determination. If they do not then Ofwat will refer it to the CMA for review, which will take between six to twelve months to decide upon the matter. This means that even if appeals are successful, the final determination will still apply until March 2021, creating immediate pressure on companies' cash flow and key credit metrics.

The rating review will consider (1) the company-specific total expenditure allowances and operational performance incentives; (2) potential management and shareholder actions to improve financial flexibility, for example through de-gearing the business, and the ability to achieve this in a timely manner; and (3) companies' decisions to accept or reject the final determinations. Moody's will endeavor to conclude the review for each of the affected companies within the next three months.

For more detailed information on individual issuers, please see the following press releases:

Ratings placed on review:

https://www.moodys.com/research/Moodys-reviews-Anglian-Water-and-Ospreys-ratings-for-downgrade--PR_414370

https://www.moodys.com/research/Moodys-reviews-Welsh-Waters-A2-ratings-for-downgrade--PR_414415

https://www.moodys.com/research/Moodys-reviews-Northumbrians-Baa1-rating-for-downgrade--PR_414420

https://www.moodys.com/research/Moodys-reviews-Severn-Trents-A3Baa1-ratings-for-downgrade--PR_414430

https://www.moodys.com/research/Moodys-reviews-Thames-Water-and-Kemble-Waters-ratings-for-downgrade--PR_414419

https://www.moodys.com/research/Moodys-reviews-Yorkshire-Waters-ratings-for-downgrade--PR_414422

https://www.moodys.com/research/Moodys-reviews-Wessex-Waters-A3-rating-for-downgrade--PR_414418

https://www.moodys.com/research/Moodys-reviews-Affinity-Waters-ratings-for-downgrade--PR_414424

https://www.moodys.com/research/Moodys-reviews-Bristol-Waters-Baa1-rating-for-downgrade--PR_414426

https://www.moodys.com/research/Moodys-reviews-Portsmouth-Waters-Baa1-ratings-for-downgrade--PR_414427

https://www.moodys.com/research/Moodys-reviews-South-Staffs-Waters-Baa2-ratings-for-downgrade--PR_414443

https://www.moodys.com/research/Moodys-reviews-SES-Waters-Baa1-rating-for-downgrade--PR_414439

Water and sewerage companies:

- Anglian Water and Osprey: Moody's reviews Anglian Water's and Osprey's ratings for downgrade

- Dwr Cymry/Welsh Water: Moody's reviews Welsh Water's A2 ratings for downgrade

- Northumbrian Water: Moody's reviews Northumbrian's Baa1 rating for downgrade

- Severn Trent: Moody's reviews Severn Trent's A3/Baa1 ratings for downgrade

- Thames Water: Moody's reviews Thames Water's and Kemble Water's ratings for downgrade

- Yorkshire Water: Moody's reviews Yorkshire Water's ratings for downgrade

- Wessex Water: Moody's reviews Wessex Water's A3 rating for downgrade

Water-only companies:

- Affinity Water: Moody's reviews Affinity Water's ratings for downgrade

- Bristol Water: Moody's reviews Bristol Water's Baa1 ratings for downgrade

- Portsmouth Water: Moody's reviews Portsmouth Water's Baa1 rating for downgrade

- South Staffs Water: Moody's reviews South Staffs Water's Baa2 rating for downgrade

- Sutton & East Surrey Water: Moody's reviews SES Water's Baa1 rating for downgrade

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: London +44-20-7772-5456, New York +1-212-553-0376, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at [email protected] or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Stefanie Voelz
VP - Senior Credit Officer
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Neil Griffiths-Lambeth
Associate Managing Director
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2022 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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