This communication is intended for insurers, reinsurers, asset managers, banks, and building societies only. It is published for informational purposes only, and does not constitute advice.

With Thames Water hitting the headlines, we take a closer look at its debt issuances and consider any reflections for insurers with exposure.

What happened?

Thames Water Utilities Ltd (‘Thames Water’) is responsible for public water supply and wastewater treatment in Greater London and surrounding areas. Thames Water was founded in 1989 during privatisation of the water industry in England and Wales. Following international expansion, it’s now one of the world’s largest water companies.

It’s been widely reported that Thames Water has around £14 billion in debt. This represents around 80% of the total value of the business, making it one of the most indebted water companies in England and Wales. But rising inflation has significantly increased interest payments on more than half of Thames Water’s debt, pushing the company into financial crisis.

There are also concerns for the wider water sector in England and Wales, which includes 11 companies providing water and sewerage services. Since privatisation, the UK water sector has taken on large amounts of debt, the affordability of which is coming under pressure from rising inflation, increased input costs and higher rates. According to Ofwat, the sector’s combined debt reached over £60 billion last year and more than half of the sector’s debt is inflation-linked. S&P Global has negative outlooks for two-thirds of the UK water companies it rates, indicating the possibility of downgrades.

However, the position in the capital structure, and any seniority or security attaching to the debt, will be fundamental in determining downgrade, default or loss outcomes.

What is Thames Water’s capital structure?

As noted above, the company has c.£14 billion of debt in issue, with more than half linked to inflation. Thames Water’s capital structure is complex, making it far from straightforward to work through their various debt issues while considering the impact of the current market environment on their finances.

The majority of the debt outstanding is securitised against the business. The debt issued by three ring-fenced utilities is secured by all the assets in a whole-business securitisation, with cross-guarantees in place and covenant protections to prevent cash from being used elsewhere in the business. All Thames Water’s operating assets are held within the whole-business securitisation.

This is positive from a security perspective, but it doesn’t protect investors from mark-to-market fluctuations.

What’s the position of Thames Water’s debt?

The largest part of the securitised debt (£10 billion) is rated BBB (ie investment grade) with a stable outlook from the major rating agencies. This reflects the secured and guaranteed nature of the debt. Therefore, the main short-term concerns are mark-to-market valuations and fluctuations in prices. The prices of the securitised bonds have fallen, but not dramatically so. And while spreads have widened, they don’t yet imply a severe risk of default or distress for these bonds.

In sterling markets, Thames Water has c.£4 billion (face value) in the Sterling Corporate and Collateralised Index, representing 0.9% of that index. Prior to the recent news, these Thames Water bonds had large discounts to face value, but this was a reflection of their long maturity and very low coupon rates. In other words, longer-dated bonds have been discounted more generally as market yields have risen. The recent news had a relatively small impact on prices: a fall of between 1% and 4% depending on maturity, based on bonds in the Sterling Collateralised Index.

We’ve also identified a further c.€2.8 billion of euro issuance. The parent company issues debt in the euro currency high yield market – this debt was already rated B with a negative outlook, so it was seen as a higher risk by the rating agencies. In our view, these bonds will incur heavy losses if the company enters administration. The bonds were trading at 55 pence in the pound at COB on 28 June, having closed at 86 pence in the pound on 27 June, equating to a 36% fall in price. From our initial research, we believe investors’ exposure is unlikely to be material.

Considerations for insurers

Considerations for insurers will be to understand which (if any) Thames Water debt they might have exposure to on their balance sheet. As set out in above, we have identified three principal sources of debt. It would be prudent for insurers to consider their holdings of Thames Water debt and the potential for losses under different scenarios.

It may also be prudent to understand exposure to debt from other UK water utilities, which also have high debt levels.

If you have any questions or wish to discuss any aspect further, please get in touch with a member of our team.

This communication has been compiled by Hymans Robertson LLP, and is based upon their understanding of events as at 6 July 2023. It is designed to be a general summary of the debt of Thames Water and possible implications for asset owners, it does not constitute investment advice and is not specific to the circumstances of any particular insurer, asset owner, employer or pension scheme. Please note where reference is made to legal matters, Hymans Robertson LLP is not qualified to provide legal opinions and you may wish to seek independent legal advice. Hymans Robertson LLP accepts no liability for errors or omissions. Please note the value of investments, and income from them, may fall as well as rise and you should not make any assumptions about the future performance of your investments based on information contained in this document. Further, investments in developing or emerging markets may be more volatile and less marketable than in mature markets. Exchange rates may also affect the value of an investment.