England's water utilities are currently facing increased scrutiny in the bond market due to the financial turmoil at Thames Water Ltd., highlighting concerns over the sector's debt levels.
The bond market has shown signs of apprehension, with the risk premium on bonds from the sector witnessing a rise. This unease stems from the financial struggles of Thames Water, which have brought the spotlight onto the debt challenges and deteriorating infrastructure within the industry. Rathbones Group Plc’s head of fixed income, Bryn Jones, disclosed that he liquidated his investments in UK water company bonds following the revelation of Thames Water’s financial predicaments.
“The situation at Thames is not mirrored across all UK water firms, yet the repercussions are felt industry-wide,” Jones remarked. “The sector’s leading company facing adversity inevitably affects the rest, particularly their bond spreads.”
Bonds from Southern Water Services Finance Ltd. have seen a 13 basis points increase since their March 19 pricing, while Northumbrian Water Finance Plc’s notes experienced a four basis points rise since March 22. This performance is lackluster compared to other investment-grade bonds, which generally saw narrowing spreads in their initial trading period.
A representative for Southern Water stated via email, “Following the implementation of a turnaround strategy, we continue to bolster our financial health,” referencing the £1.5 billion of equity capital raised since 2021.
Northumbrian Water has yet to respond to inquiries for comment.
Thames Water’s parent company, Kemble Water Finance Limited, recently announced it would halt interest payments and not fulfill a loan repayment due at the end of April, exacerbating the crisis at the UK’s largest water utility. Thames Water was previously identified by the regulator Ofwat as one of the most indebted water utilities in Britain, with a debt to regulatory capital base ratio of 77.5%.
The report highlighted six water providers with gearing exceeding 70%, including Thames, Yorkshire, Affinity, Portsmouth, South East, and SES, with Portsmouth Water showcasing the highest regulatory gearing at 78.4% due to loans for the Havant Thicket Reservoir project. Ofwat recommends a gearing level of 55%.
“High gearing, the rising cost of inflation-linked bonds, and poor operational performance have led to Thames Water’s downfall, posing potential risks to similarly positioned companies,” stated Paul Vickars, a credit analyst at Bloomberg Intelligence.
For instance, Yorkshire Water Finance Plc is grappling with substantial inflation-linked debt, with its bonds trading at a spread of 172 basis points, an increase from 168 at the beginning of the month.
Yorkshire Water has not yet provided a comment.
Investors are particularly concerned about the safety of Thames Water’s operating company bonds from default under new insolvency regulations introduced this year. The debt of Thames Water Utilities Finance Plc, previously considered protected, has seen a decline.
“If bondholders within Thames Water’s ring-fenced structure face losses, it could raise alarm for other, more stable water companies,” explained Gordon Shannon, a portfolio manager at Twenty Four Asset Management. “This scenario would elevate issuance costs and, ultimately, consumer water bills nationwide.”
