Moody’s has either maintained negative outlooks for five UK-based regulated water utilities and changed one high-yield holding company - the ratings agency’s actions relate to the companies it considers most exposed to the likely cut in allowed returns from 2020.

The actions follow the publication on 13th December by Ofwat  of its final methodology for the 2019 price review (PR19), including guidance on allowed cost of capital for the period from April 2020 to March 2025 (AMP7).

The respective current ratings for all the companies have been affirmed.

Moody’s said the actions specifically reflects the risk that companies may not maintain a financial profile in line with Moody's guidance for its current rating levels, taking into account:

• their financial leverage and capital structure;
• the cost and maturity profile of their debt in the context of likely financing and refinancing requirements over the 2020-25 period.

Commenting on the final methodology, Moody’s said that while it included small changes to the total expenditure incentive regime as well as outcome delivery targets, overall efficiency requirements “will likely remain challenging. “

Companies with the highest leverage and/or expensive and long-dated debt are particularly exposed to the cut in returns, the agency said. The smaller water-only companies also reported higher debt cost linked to their relatively infrequent funding.

However, Moody's said it also considers that the PR19 process is in the early stages and the reduction may be less than currently proposed and/or mitigated by other aspects of Ofwat's final determination.

The rating agency also takes into account that management have some time to adapt financial policies and bolster financial flexibility ahead of AMP7.  In addition, to varying degrees, shareholders have demonstrated a willingness to support companies' credit quality in the past, albeit low yields and high mark-to market loss may have eroded incentives to provide additional equity.

Outlook changed from stable to negative for four companies:

Moody's has changed the outlook from stable to negative for the following companies:

• Anglian Water (Osprey) Financing plc
• Portsmouth Water Ltd
• Severn Trent Plc (inc subsidiary Dee Valley Water)
• Yorkshire Water Services Ltd

The ratings agency has also maintained the existing negative outlook for Northumbrian Water Ltd and Southern Water Services Ltd.

Holding company Osprey outlook changed to negative due to risk exposure through Anglian Water

The change in holding company Osprey's outlook to negative from stable reflects its risk exposure through its core subsidiary Anglian Water, Moody’s said.  The agency described the level of dividend distributions available to Osprey, its primary source of income to meet interest payments on its debt, as “highly sensitive” to Anglian Water's operational and financial performance against regulatory assumptions. The likely cut in allowed returns and more challenging efficiency targets exposed Osprey to potentially reduced financial flexibility and headroom against its financial covenants.

 Anglian Water's net debt was 79% of its RCV as at 31 March 2017; however, including the Osprey debt, consolidated gearing at the holding company level is at 87% of Anglian Water's RCV. The level of gearing is above both the sector average of around 70% and the 62.5% gearing assumed by Ofwat at the previous PR14 price controls  and above the 60.0% the regulator has proposed for PR19.  

OAL is indirectly owned by a consortium comprising Canada Pension Plan Investment Board, Colonial First State Global Asset Management (the asset management division of Commonwealth Bank of Australia), Industry Funds Management and 3i Group plc. Earlier this week 3iGroup confirmed that it had sold its 15% stake in OAL to a consortium of Dalmore Capital and GLIL Infrastructure LLP, the infrastructure investment joint venture between five local Government pension funds.

The sale is conditional on certain third party consents and completion is expected in early 2018. Estimated gross proceeds for 3i Infrastructure are approximately £395 million. This compares to a valuation of £288 million at 30 September 2017.

Northumbrian, Yorkshire & Southern Water net debt above sector average of 70%

While Severn Trent Water's net debt (which Moody’s said includes a sizeable pension deficit) at consolidated group level was around 69% of its RCV, broadly in line with the sector average,  the agency said that nevertheless financial metrics would remain outside of guidance for current ratings, if gearing remained at current levels and no outperformance or rewards were achieved over AMP7.

Northumbrian Water's net debt was just over 70% of its RCV as at 31 March 2017, or 76% when including the debt associated with the Kielder reservoir, while Yorkshire Water's net debt was around 77% of its RCV and Southern Water's net debt was over 80% of its RCV as at 31 March 2017.