Thames Water’s £14 billion debt crunch highlights issues facing wider sector
(Bloomberg) — Rising debt-servicing costs threaten to swamp some of Britain’s biggest water companies’ finances and undermine many of their recent promises to upgrade crumbling infrastructure.
The problems at Thames — Britain’s biggest water supplier and also its most leveraged — have come to a head with suggestions that it may need state help to deal with its escalating debt. But it is not alone. The sector is drowning in debt.
Water utilities in England and Wales had about £60.6 billion ($76.4 billion) in debt as of March 2022, more than half of which is indexed to inflation, according to Ofwat, the water regulator for the two countries. Inflation in the UK has been stubbornly higher than most other developed nations. To make matters worse for the companies, the interest rates on a vast majority of the water industry’s index-linked borrowings are tied to an older measure, the retail price index, which is running even hotter — 11.3% at the end of May — according to data compiled by Bloomberg.
The privately-owned water companies have been under pressure to spend money to upgrade aging infrastructure without adding to consumer bills at a time when millions of people are struggling with a cost of living crisis. The threat that Thames Water may require a government bailout to stop it from buckling under more than £14 billion of debt has brought the issue into stark relief.
Among the immediate issues facing the industry is the need for significant investment during the next regulatory period between 2025 and 2030. It also needs a reduction in the notional gearing across the sector from 60% to 55% and to deal with heightened regulatory scrutiny from an under pressure Ofwat, according to Martin Young, an analyst at Investec.
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Ofwat named five companies in December, including Thames Water, as being its “highest priority for engagement”. The others were Southern Water Ltd., Yorkshire Water Finance Plc, Sutton and East Surrey Water and Portsmouth Water Ltd. — combined, the five supply almost 25 million customers.
The impact of a sharp increase in the RPI — which includes mortgage interest payments and therefore often rises more quickly than the consumer price index — was most pronounced on Yorkshire Water.
The utility reported that net interest payable in the financial year 2021/2022 had more than doubled to £594.9 million, compared to £223.9 million the year before. This pushed the company into a £368.6 million loss compared to a small profit in 2020-21, its annual accounts show. Similarly, Southern Water saw its net finance costs increase to £113.3 million in the six months to 30 September 2022, compared with £73.1 million in the same period in 2021, largely due to an increase in RPI that added £24 million to its interest bill, company filings show.
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Yorkshire Water KEL’s bonds that fall due in April 2041 dropped deep into distressed territory to 64 pence on the pound on Wednesday after the Thames Water news broke. Its borrowings with the shortest maturity, a November 2026 note, were quoted at 85.5 pence, according to Bloomberg data. A spokesperson for the company said: “We understand the importance of continuing to have robust financial structures in place and we’ve listened to Ofwat’s concerns and taken action.”
In its December report on financial resilience in the water sector, Ofwat urged utilities to maintain a level of financial headroom and fund investment necessary to meet their obligations and commitments to improve performance. The problem for the utilities is that with water bills linked to the CPI including housing costs (CPIH) — after reforms in 2020 — there is a lag between their revenues and the RPI-linked interest payments they are having to make to borrow money
“RPI bond payments will increase with inflation as will other costs. Revenues will also increase under the regulated price formula, but with a lag — so there will be an impact on the profit and loss account,” said Paul Vickars, utilities analyst at Bloomberg Intelligence. In addition, bad debts may also increase with the cost of living crisis. “The difficult macro environment is affecting all water companies, not least Thames which has the highest gearing at 80%,” Vickars added.
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