(Bloomberg) -- Thames Water Utilities Finance Plc’s top-ranked bonds were cut to junk by S&P Global Ratings on Wednesday, with the rating agency warning that the firm’s liquidity problems were unlikely to improve in the near term.
It follows Moody’s Ratings in taking the debt below investment-grade, putting it firmly in breach of its operating license, and increases the pressure on the regulator Ofwat to take action as the company falls deeper into crisis.
S&P also said it didn’t expect the company’s liquidity problems to improve in the near term and that questions remain about how the regulator’s proposed oversight regime will be implemented. It warned that some bondholders could be completely wiped out in the case of a hypothetical default.
The company’s Class A debt was downgraded to BB, two notches below investment-grade, while its Class B debt - deemed riskier- was lowered to B, five steps into junk territory, echoing a similar move by Moody’s. S&P revised Thames Water’s business risk downward citing “difficulties the company is facing in financing its large and inflexible capital expenditure, which is driven by regulatory requirements.”
It said that it expected a 70% recovery in the Class A notes and zero in the Class B.
S&P notes that it is “essential” to raise new equity from either new or existing shareholders, but doesn’t expect the process will be completed before the final determination by UK regulator Ofwat.
Thames Water reiterated in a statement on Wednesday following the downgrade that it “continues to work with Ofwat to maintain the ongoing financial resilience of the business” and that it’s engaging with investors and creditors to seek new equity and explore other options to bolster its liquidity.
With both ratings agencies stripping Thames Water of its investment-grade status, the company’s bonds are no longer eligible for Bloomberg’s high-grade bond indexes, effectively barring it from billions of dollars of passive and exchange-traded funds that track them. It would likely be eligible for less closely-followed high yield gauges, such as the Bloomberg Pan-European High Yield Index.
Thames Water’s whole business securitization structures means it doesn’t meet the requirements for the ICE BofA fixed income indexes.
On top of that, with the two downgrades to junk, Thames Water has breached the terms of its operating license, which requires it to maintain investment-grade score from two ratings companies. The company has been engaging with the regulator about this matter, as earlier reported by Bloomberg.
Ofwat Wait
The regulator earlier this month put forward plans that would make it harder for the UK’s largest utility to raise new equity, and rejected a proposal to hike bills by 43%. A final ruling is expected by the end of the year. Formal talks between the company and creditors started after the regulator’s announcement.
S&P is maintaining a negative outlook on Thames Water’s debt pile. The agency has decreased the ratings gap between the more senior and more junior bonds because it believes that a risk of default for both has increased. With that in mind, Class B is seen as increasingly risky as its goal is to “protect and absorb losses” for the Class A holders.
Trading activity for Thames Water assets picked up after the Ofwat draft ruling and the Moody’s downgrade from last week. Single trading desks sold hundreds of millions of pounds in bonds over just a couple of days, and £300 million of Class B private debt changed hands last week.
One of Thames Water’s creditors is currently trying to offload £300 million of the utility firm’s senior debt.
--With assistance from Abhinav Ramnarayan.
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