Fitch Ratings has warned that Ofwat's recent draft price review determinations published are likely to have a negative impact on the credit quality of rated UK water companies.

The regulator’s draft determinations for water companies classified as 'slow track' and 'significant scrutiny' propose a reduction in the allowed weighted average cost of capital (WACC), tight total costs (totex) allowances and stringent outcome delivery incentives (ODI) targets.

According to the ratings agency, this will put further pressure on the companies' financial metrics. The likelihood that the companies will not achieve allowed return on regulatory equity

(RoRE) has increased – Fitch said it will be incorporating this in its forecasts for each company in the next few months.

Based on the determinations, Fitch now expects half of the rated companies to underperform on either totex or ODIs in the AMP7 2020-25 regulatory price period For the other half, the agency said it will be assuming no totex outperformance and significantly lower ODI rewards.

Ofwat updated its early view of cost of capital, reflecting falling interest rates. The revised figure, including the retail margin is now 3.19%, 21bp below 3.40% in the previous draft. In Fitch's view this reduction will result in further pressure on cash-based post maintenance coverage ratios (PMICRs) and reduce financeability.

Financeability assessments of Southern and Thames Water which propose a dividend rate of 1.8% could put pressure on the credit quality of intermediate holding companies positioned outside the regulatory ring-fence, Fitch added.

In addition, performance commitment targets require every company to perform in line with targets set by the companies in the upper quartile.

The regulator's view on wholesale total efficient costs remained largely unchanged from its initial assessment of business plans. Except for the adjustment to totex for Real Price Effects associated with labour costs, which resulted in the efficiency frontier shift declining to 1.1% from 1.5% previously, Ofwat rejected most of the cost adjustments requested by the companies,

Ofwat has said that no additional expenditure would be allowed to achieve upper quartile performance targets. Fitch-rated companies with the largest adjustment to totex allowances are Anglian Water (21%), Yorkshire Water (18%), Thames Water (16%) and Dwr Cymru (15%).