S&P Global Ratings has announced that it has downgraded four UK water utilities, after they accepted the final determination of Ofwat’s price review (PR19) in December.

The ratings agency has lowered the credit ratings for the following companies:

• Affinity Water Finance PLC
• Sutton and East Surrey Water PLC
• United Utilities PLC
• Wessex Water Services Finance PLC

Eleven of the fourteen U.K. water utilities rated by S&P have accepted the new, tougher regulation published in December 2019, while three appealed to the Competition and Markets Authority (CMA). Bristol Water, which has also appealed to the CMA, is not included in S&P’s rating analysis. This is the third successive appeal by Bristol Water against Ofwat's Final Determination - the company previously appealed at both PR09 and PR14.

The ratings agency said that for the eleven water utilities, the outcome of PR19 implies lower regulatory returns from April 2020, higher pressure on operating performance, and a likely deterioration of credit metrics.

Of the three companies that appealed, S&P is placing ratings on two on CreditWatch negative, as the outcome of the appeal remains uncertain. The third company has seen its outlook turn negative as the ratings agency believes the FD exacerbates downside risks.

S&P said:

“In our opinion, the three utilities' decision to appeal generally reflects their view that the FD does not allow them to meet the challenges they face in the next regulatory period and beyond, and their concerns that it doesn't adequately capture customers' priorities in the long term.”

The latest move follows S&P’s downgrade of Welsh Water’s debt and the affirmation of Severn Water’s credit rating earlier this month.

Ofwat aiming to rebalance interests of stakeholders toward consumers and away from financiers

The ratings agency believes that the next regulatory period will be challenging for the sector and that Ofwat’s Final Determinations will put pressure on the credit quality of U.K. water utilities in the upcoming five year AMP7price control period which starts on April 1, 2020.

According to S&P, Ofwat is aiming to rebalance the interests of stakeholders toward consumers and away from financiers.

S&P commented:

“Water companies will …earn lower returns in AMP7 while being required to maintain high efficiency and meet demanding regulatory targets on leakage reduction, decreased service interruption, and improved customer service.

“Furthermore, the range of rewards and penalties pertaining to operating delivery incentives (ODIs) is skewed to the downside, representing significant risk, particularly for the worst performers.”

“In AMP7, water companies face higher pressure on operating performance, and ultimately about a 10% increase in debt.”

In terms of operating efficiency, S&P sees Anglian Water Services as the industry leader, with outperformance on its operating expenditures and capex projected at around 9% over AMP6, and net ODI rewards of around £50 million. However, it believes the potential for the company to significantly outperform on its future cost allowances is currently limited. “This is because there is currently a 12% gap between the regulator's view and the company's estimate of efficient costs to be incurred over AMP7 to deliver its business plan,” S&P said.

However, despite the tighter regulation, the ratings agency said it continues to assess the U.K. regulatory framework for water utilities as strong, supporting its view that the utility companies have excellent business risk profiles.

“We think the sector will generally retain good access to capital. We also consider the sector's long and stable track record of independent regulation that allows for the full recovery of operating, capital, and financing costs, alongside strong ring-fencing conditions” the ratings agency said: