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Investors are demanding a higher premium to take on the debt of Britain’s most highly rated water companies in the wake of the crisis at Thames Water.
Companies with stronger credit ratings, including Welsh Water, United Utilities and Anglian Water, have marketed or issued new sterling debt this week in the first significant wave of issuance since the parent company of Thames defaulted on its debt earlier this year.
But investors have demanded a cheaper price for water bonds, raising corporate borrowing costs and renewing concerns that the industry will need to divert a higher proportion of its customers’ bills to servicing the interest on its collective £64bn debt mountain. The industry last week warned that its borrowing costs would be pushed higher as a result of Ofwat’s planned new regulatory regime to 2030.
Prices of UK water company debt have been under pressure as the crisis at Thames, which serves 16mn customers in London and surrounding regions, has unfolded this year. Over the summer Thames defaulted on its debt and the company has been trying to raise fresh equity, having warned it only has enough cash to survive until May.
On Tuesday, Welsh Water priced a £600mn 20-year lower-ranking bond at 1.38 percentage points over UK gilts. Although the spread and size were both helped after Welsh received more than £1.2bn of demand, that was a more expensive level than comparable energy utilities. Water companies’ debt has previously tended to be issued at a lower yield over gilts than the bonds of energy companies such as National Grid and SSE.
In marketing documents directed at investors, Welsh Water conceded that “the increased scrutiny regarding the performance and financial resilience of Thames Water and other water and sewerage companies . . . could each affect investor confidence in the UK water sector.”
The same day, Anglian Water mandated BNP Paribas, HSBC and SMBC to market its own 20-year sterling green bond, with debt investors privately expecting the utility to have to pay a similar premium. The company said it was also exploring a 15 to 20-year inflation linked bond.
“Issuers don’t know when the next Thames headline’s going to come out. So when you see a period of kind of ‘benign’ markets in the water sector, we’re going to see issuers try to take advantage of that,” said Johnathan Owen, a portfolio manager at TwentyFour Asset Management.
The higher premiums being sought underscore the tougher analysis that water companies have faced since last December, when investors began to probe the financial health of Thames, the UK’s largest water distributor.
In July, Thames’ credit rating was slashed to “junk” status by Moody’s and S&P, leaving it in breach of its licensing conditions, which state that it must maintain two investment grade ratings. The same month Severn Trent tapped the debt market, but the final spread pricing of a £350mn bond was roughly a 20 basis-point premium compared with its outstanding debt, despite its stronger credit profile.
“Before December last year, you would expect [the strongest] water companies to trade inside National Grid by five to 10 basis points; in April that blew to 20 wider,” said Owen. “We had further struggles in the sector when Severn came to market and that gap widened to 40 [basis points].”
In a further sign of the industry’s nervousness, this week United Utilities opted to increase the size of its existing bond by £150mn. While this method of raising new debt — known as a “tap” — restricts the scale of debt a company can raise, investors said it can also help borrowers stay under the radar when raising cash.
Industry lobby group Water UK warned last week that Ofwat’s recent draft proposals would likely make it impossible for the sector to attract the investment needed and reduce the UK’s attractiveness to international investors.
The industry had set out plans to invest £105bn over the next five years but Ofwat had proposed cutting this by £17bn.