Fitch downgrades Thames Water holding company

Ratings agency Fitch has downgraded Kemble Water Finance Limited, one of the holding companies for Thames Water, from B+ to B with a negative outlook.

The change is partly in response to Ofwat’s recent decision to raise the trigger level for the cash lock-up conditions within water companies’ licences by one grade and require water companies to link dividends directly to their operational performance.

The cash lock-up conditions currently prevent water companies from paying out dividends without prior approval from Ofwat if any of their credit ratings fall to the minimum investment grade of BBB-/Baa3 with a negative outlook.

From the beginning of the next asset management period on 1 April 2025, this trigger will be raised by one grade to BBB/Baa2 with a negative outlook. The regulator will also introduce three-month grace period following a downgrade to this rating during which the cash lock-up conditions will not apply and water companies can request a subsequent exemption.

From 17 May 2023, water companies will also be required to maintain at least two credit ratings and link dividends to the operational performance of the company, including customer service levels and environmental performance.

Explaining its decision to downgrade the company, Fitch said Ofwat’s decision would “increase the vulnerability of Kemble and its creditors” as it relies on Thames Water Utilities Limited – the regulated utility – to service its debts. The agency said both of Thames’ ratings are setting at BBB with a stable outlook (or equivalent), “implying limited rating headroom before a cash lock-up is triggered under Ofwat’s new licence condition”.

Fitch did note the possibility of an appeal by water companies against the licence changes to the Competition and Markets Authority by 18 April , saying if this happened “the timeline for licence modifications is likely to be protracted”.

The ratings agency said the risk of a cash lock-up may also be mitigated by “proactive steps” taken by Thames’ management, including the injection of £1.5 billion of fresh equity from shareholders by April 2025, of which £500 million will come during the current financial year.

However, Fitch also highlighted Thames’ “weak operational performance,” particularly in relation to the customer measure of experience (C-Mex) and internal sewer flooding. It said the downgrade assumes Thames will incur around £180 million of net outcome delivery incentive penalties for the last three years of the current asset management period ending in March 2025.

Furthermore, the ratings agency said it expects Thames to overspend its totex allowances by around £2 billion over the current asset management period as it seeks to turn around its operational performance.