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Southern Water would default on its debt if Moody’s and S&P further downgraded the utility’s credit rating, just as it borrowed £300mn from hedge funds.
The heavily indebted group, which is controlled by Australian infrastructure investor Macquarie, is rated one notch above “junk” territory by Moody’s and S&P. Both agencies have warned they could further downgrade Southern Water’s credit ratings, which would take the company below investment-grade.
Downgrades from the two would not only make borrowing costs more expensive, but also trigger a default across its £6bn debt pile, according to Southern’s bond documentation.
Southern is among the UK’s most indebted water companies, and struggling with rising borrowing costs.
While not in the same degree of financial peril as Thames Water, the UK’s largest water utility, which serves 16mn households, Southern has come under pressure in debt markets due to concerns over its credit rating and the potential for debt covenant breaches.
Southern, which supplies 4.7mn customers in the south-east of England, has also asked water regulator Ofwat to allow it to increase the average annual household water bill to £734 by the end of the next regulatory period, higher than any other water company in the UK.
S&P downgraded Southern last week after the company, according to documents seen by the FT, issued £300mn of top-ranking bonds at an annual interest rate of 7.75 per cent.
On top of the steep coupon payments, the bond was issued at a deep discount to face value: Southern raised £272mn but is still on the hook to repay £300mn to the lenders in 2031.
These discounts juice the returns for bondholders, with £200mn of the issue raised at 90p in the pound and £100mn at 92.5p, equating to yields for Southern’s new lenders of 10 per cent and 9.2 per cent, respectively.
In another indication of the strain on the utility’s access to capital, Southern had to raise the bond in a private process primarily aimed at hedge funds, according to people familiar with the sale. Investors in the £300mn bond include US hedge funds King Street Capital Management and Sculptor Capital Management, the people added.
King Street and Sculptor declined to comment.
The interest rates on the new bond are nearly three times higher than Ofwat’s assumed cost of borrowing for the sector. In its draft proposals for upcoming regulatory allowances, published in July, the watchdog said it expected water companies to issue new debt at an annual cost of 3.36 per cent.
S&P said last week that Southern, which is seeking nearly £4bn in borrowings over the next five years, “is likely to face persistently high financing costs over the next regulatory period, probably well above its regulatory allowances”.
“This was highlighted by a recent £300mn bond issuance at a significantly higher cost than assumed in Ofwat’s cost-of-new-debt allowance in its draft determination,” it added.
The rating agency said it could go on to downgrade the utility “by one or two notches, after Ofwat publishes its final determination”, which is due around the end of the year.
Southern Water said in a statement that it continued to maintain three investment-grade credit ratings from Standard & Poor’s, Moody’s and Fitch.
“Our recent bond issue was oversubscribed and we continue to maintain strong liquidity,” the company said. “As part of our 2025-30 business plan, we anticipate our funding will be strengthened further with additional equity from our shareholders following clarity from Ofwat.”
In a previous statement Southern described S&P’s ratings action last week as “disappointing”.
Ofwat said: “We will continue to engage with the company and closely monitor its progress as it delivers its turnaround plan to improve performance and financial resilience. We will publish our Final Determinations for all companies on 19 December.”
Thames Water lost its investment-grade rating in July and has since been downgraded further to the lowest reaches of junk.