Thames refinancing raises leverage questions

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Macquarie has ambitious leverage targets for its new protégé. The outcome of the Kemble loan refinancing could have knock-on effects elsewhere in the sector.

Macquarie has ambitious leverage targets for its new protégé. The outcome of the Kemble loan refinancing could have knock-on effects elsewhere in the sector.

The group of financial investors that paid £8 billion for Thames Water last year will struggle to restructure the company along the same lines as highly geared companies in the sector.

The Kemble consortium, led by Australia’s Macquarie Bank, intends to increase Thames’ debt leverage to 85% of the water company’s regulated asset value (RAV) to help repay the acquisition debt and enhance its own equity returns.

To do so, it will need to refinance half of the £4 billion acquisition loan package with a £2 billion securitisation-style financing of the regulated Thames water business. The remaining £2 billion would then have to be refinanced at the holding company level.

To date, the rating agencies have allowed companies such as Southern Water and Anglian Water to raise 75% of their RAV as debt at the single-A level, and a further 10% at the triple-B level, and Kemble is looking for a similar arrangement at Thames.

But given Thames’ recent history of problems with industry regulator Ofwat – over missed targets for fixing leaks in water pipes and inadequate standards of customer service – it seems highly improbable that the agencies will give the company as much latitude as others in the sector. Fines for further failures on either count could exceed £60 million and have a serious impact on revenues (and hence the ability to repay debt).

“If we were to rate the new Thames debt, we probably wouldn’t give it the same ratings for the same structure,” confirmed one rating agency analyst. “Its ratings would probably be discounted a notch – you
wouldn’t expect us to rate a poorly-managed company the same as a well-managed one.”

James Sparrow, a utilities analyst at Royal Bank of Scotland, considers Kemble’s gearing target to be optimistic. “I think it’s very toppy given the risks facing that particular company,” he said. “Maybe they’ll get up to 85%, but I think it will be a bit of a stretch.”

If Kemble attempts to leverage Thames up to this level on lower ratings than the industry norm, there is a risk that Ofwat would intervene. The regulator amended the terms of the company’s licence last year to allow it to impose a cash lock-up on the regulated business if its credit rating threatens to drop below investment grade status (Baa3/BBB-).

Sparrow added that the consortium faces a big challenge in refinancing the £2 billion of holding company debt at economic cost, given the group has very little other than the revenues of Thames Water with which to service the debt. “There will have to be a lot of debt outside the securitisation,” he said. “I think Thames could be the one that goes wrong.”

Standard & Poor’s nevertheless said it expects to see more securitisation-type financings in the UK water sector this year. S&P analyst William Ferrera said such debt still offers water companies a cheaper source of finance than the senior unsecured bond markets – although the gap has narrowed – and further deals would not necessarily depend on there being more takeovers in the sector.