Investors fear Thames Water contagion, Barclays says

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A failure at Thames Water could spread to other water companies and other essential infrastructure, according to investors surveyed by Barclays Research.

Three-quarters of investors believed that the potential failure of an unlisted water company such as Thames Water carried “industry-wide” contagion risks, Barclays said in a note on Tuesday.

It warned that the cost of raising debt could increase across the industry at a time when £45bn-£50bn was needed between 2025 and 2030, based on Moody’s ratings, the note said.

“We consider that the Thames Water situation may have broader severe sector ramifications,” Dominic Nash and Peter Crampton of Barclays said.

“Failing to preserve Thames Water’s investment grade status and exposing the senior opco bondholders to material losses would lead debt investors to question the resilience and the sustainability of the UK water regulatory framework”.

The opco, or operating company, is the regulated entity overseen by Ofwat. Bonds held at this level of the corporate structure have previously been considered bulletproof but Thames Water’s travails have challenged this view.

The findings by Barclays come days after contingency plans drawn up by officials were revealed, whereby some lenders to Thames Water face losses of as much as 40 per cent if the utility ends up being temporarily renationalised by the UK government. Chancellor Jeremy Hunt said last week that the government would never insure investors “against bad decisions made by management or shareholders”.

Thames Water, the UK’s biggest water company, provides water and sewage services to 16mn people, or around 25 per cent of the population. It is struggling with higher interest rates on its £18bn group debt and its parent company said earlier this month that it was in default.

Market jitters have now grown so much that even the top-ranked bonds in the so-called “regulatory ringfence” around the core utility are trading at substantial discounts. Distressed debt funds such as Elliott Management have scooped up some of these bonds, betting that eventual losses will not be as steep as feared, however.

Thames Water still needs to find more than £3bn in equity to cover a five-year business plan required by the UK regulator to fix chronic leaks and sewage spills. But investors — including the pension funds USS and Omers as well as the Chinese and Abu Dhabi sovereign wealth funds — have deemed the company “uninvestable” and are refusing to invest any more money into the business, blaming restrictive regulation from Ofwat.

Seventy per cent of investors surveyed by Barclays said Ofwat’s regulatory regime was unhelpful in attracting capital, while 79 per cent expect the water companies to keep missing regulatory targets until 2030. This could exacerbate the “performance issues of low-return companies, making them less likely to attract capital”, the investors warned.

Water assets are considered the most risky of the regulated utilities but nearly two-thirds of investors also said they believed that the sector’s poor performance could affect investor appetite for other infrastructure such as gas and power, the Barclays note added.

Barclays’s survey was based on nearly 80 responses from credit and equity institutional investors, conducted in the week to April 19.

Water UK, which represents the industry, said: “Investors have choices and it should act as an alarm that investors consider the UK’s water industry as much riskier than elsewhere. This is another sign that Ofwat will need to think seriously about their approach.”

Thames Water declined to comment.

Ofwat said that its next regulatory period would “put customer and environmental priorities at the heart of the water sector”.

“In order to drive this change we need to ensure that the sector attracts investment and is fair to bill payers,” it added.

“We also need to see companies deliver the performance that customers expect and that they are run in a way that meets customers’ expectations.”

Additional reporting by Robert Smith in London