Fitch Ratings has revised the Outlooks for Yorkshire Water Services Bradford Finance Limited, Yorkshire Water Services Odsal Finance Limited and Yorkshire Water Services Finance Limited to Negative from Stable following Ofwat’s PR14 risk and reward guidance.

The companies are the debt-raising vehicles of Yorkshire Water Services Limited, the regulated monopoly provider of water and wastewater services that supplies 4.9 million people.

Fitch said the rating actions mainly reflect pressure on credit metrics stemming from water industry regulator Ofwat's risk and reward guidance for the price review covering April 2015 to March 2020. The rating also takes into account Yorkshire Water's robust financial and regulatory performance, the company's highly geared and covenanted financing structure and its existing funding position.

Material reduction of earnings in the sector

Ofwat has guided towards a cost of capital of 3.85%, lower than Fitch expected. The ratings agency said that while companies will be able to earn additional returns from incentives, earnings visibility regarding outcome delivery incentives may be limited and scope to outperform their total expenditure will depend on the level at which the regulator sets cost targets and the resulting efficiency challenge for individual companies, relative to their current cost performance.

According to Fitch, although Ofwat appears to have done a lot of modelling regarding the hypothetically possible return on regulatory equity, the regulator has put limited emphasis on the timing and visibility of the returns.

Fitch said it will re-assess companies' scope to outperform, consider funding mechanisms associated with incentives and establish forecasts with detailed sensitivities as the price control process moves forward, commenting:

“At present, our view is that not all companies will be able to supplement earnings to an extent that Fitch's guidelines for interest cover ratios for 2015-2020, commensurate with existing ratings, will be met.”