Moody's ratings agency has downgraded Southern Water’s senior secured debt to Baa2 from Baa1 and placed the Baa2 ratings under review for further downgrade, reflecting the risks associated with the continuing Environment Agency investigation and the price review process.
The rating action follows the 25 June announcement by water regulator Ofwat that it intends to impose financial penalties for Southern Water's significant breaches of its licence conditions and statutory duties.
The company will have to pay a penalty of £3 million during the current financial year as well as return to its customers around £123 million (in 2017/18 prices) over the course of the next five-year regulatory period 2020-25, which includes underperformance penalties the company avoided paying in the period 2010 to 2017.
Moody’s said the rating action reflects the additional pressure that the planned £126 million fine and repayment to customers will exert on Southern Water's financial profile in the context of already limited flexibility and Moody's expectation of a tough regulatory price review.
The penalties reflect material failures of both Southern Water's environmental risk management, which resulted in higher-than-permitted discharges during the 2010-17 period, and of its corporate governance, which permitted "widespread and deliberate measures" by employees to prevent accurate water samples from being taken.
In its notice to the company, Ofwat cited "failures of corporate culture and governance within the company". The ratings agency said it recognised that Southern Water had already taken significant steps to address the deficiencies identified by Ofwat.
“However, satisfying regulators that past problems have been fully addressed is likely to consume a significant amount of the company's managerial focus”, Moody's said.
In addition to the penalties to be imposed by Ofwat, Southern Water and its employees may face criminal charges resulting from the ongoing investigation by the UK's Environment Agency, the national environmental regulator.
The Baa2 ratings are under review for further downgrade, reflecting the risks associated with the continuing Environment Agency investigation and the price review process.
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