UK water firms face a tough market for new debt after the Thames crisis

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Investors are demanding a higher premium to take on the debt of Britain’s top-rated water companies in the wake of the Thames Water crisis.

Companies with better credit ratings, including Welsh Water, United Utilities and Anglian Water, traded or issued new sterling debt this week in the first significant wave of issuance since parent company Thames defaulted at the beginning of this year.

But investors have demanded a cheaper price for water bonds, driving up corporate borrowing costs and renewing concerns that the industry will have to divert a greater proportion of its customers’ bills to service interest on the collective £64bn mountain. The industry warned last week that its borrowing costs would increase as a result of Ofwat’s planned new regulatory regime by 2030.

UK water company debt prices have been under pressure as the crisis at Thames, which serves 16 million customers in London and surrounding regions, has unfolded this year. Thames defaulted on debt over the summer and the company sought to raise equity after warning it had enough cash to survive until May.

On Tuesday, Welsh Water priced a £600m 20-year bond at a premium of 1.38 percentage points to UK gilts. Although spread and size were both helped after Welsh received an application of more than £1.2bn, this was a level more expensive than comparable energy utilities. Water company debt has previously tended to be issued at a lower yield to gilts than energy company bonds such as National Grid and SSE.

In marketing documents to investors, Welsh Water admitted that “increased scrutiny of the performance and financial resilience of Thames Water and other water and sewerage companies . . . each could damage investor confidence in the UK water sector.”

On the same day, Anglian Water mandated BNP Paribas, HSBC and SMBC to market its own 20-year sterling green bond, with debt investors privately waiting for the utility to pay a similar premium. The company said it is also exploring a 15- to 20-year inflation-linked bond.

“Issuers don’t know when the next Thames title will come out. So when you see a period of ‘benign’ markets in the water sector, we will see issuers looking to take advantage of that,” said Jonathan Owen, portfolio manager at TwentyFour Asset Management.

The higher premiums demanded underline the tougher scrutiny water companies have faced since last December, when investors began to look at the financial health of Thames, Britain’s biggest water distributor.

In July, Thames’ credit rating was downgraded to junk status by Moody’s and S&P, leaving it in breach of its licensing conditions, which stipulate it must maintain two investment-grade ratings. In the same month, Severn Trent accessed the debt market, but the final spread price of a £350m bond was a premium of around 20 basis points to outstanding debt, despite its credit profile stronger.

“Prior to December last year, you would expect the (strongest) water companies to trade within National Grid by five to 10 basis points; in April, that went up to 20 broads,” Owen said. “We had even more fighting in the sector when Severn came to market and that gap widened to 40 (basis points).”

In another sign of industry jitters, United Utilities this week chose to increase the size of its existing bond by £150m. While this method of raising new debt — known as a “faucet” — restricts the scale of debt a company can raise, investors said it can also help borrowers stay under the radar when raising cash.

Industry lobby group Water UK warned last week that Ofwat’s recent proposals would likely make it impossible for the sector to attract the investment it needs and reduce the UK’s attractiveness to international investors.

The industry had set out to invest £105 billion over the next five years, but Ofwat proposed to cut this by £17 billion.