UK regulated utilities will see significant cuts in revenues and weaker credit metrics from the start of the next regulatory period as regulators limit returns, Moody's Investors Service said in a new report on the water, energy transmission and gas distribution sectors.
While regulators must ensure utility companies can finance their functions, their increasingly narrow interpretation of the “financeability” duty means that actual companies’ credit metrics may no longer support strong investment grade ratings.
“UK regulators appear willing to accept weaker ratings on the basis of actual company performance as the price to pay for ensuring lower customer bills and greater public legitimacy,” said Stefanie Voelz, a Moody’s Vice President - Senior Credit Officer. “Highly leveraged companies with expensive long-dated debt or weak operational performance are most exposed to lower allowed returns.”
Covenants are credit positive, but the devil is in the detail. Although restrictions included in covenanted financing structures enhance the credit quality of operating companies, regulatory changes and financial structuring by some companies have reduced their effectiveness.
Highly leveraged companies with expensive long-dated debt or weak operational performance are most exposed to lower allowed returns - Stefanie Voelz, a Moody's Vice President - Senior Credit Officer
As a consequence, rating downgrades may trigger lock-up provisions in credit agreements or licences before financial ratio breaches bite. Where covenants or rating triggers do result in trapping cash at operating companies, Moody’s sees increasing risk that they could cut off the distributions needed to service debt at rated holding companies.
Regulatory price reviews are still not finalised. Although current draft proposals by UK water and energy regulators point towards increasing risks, things may yet improve, because:
- the decisions are not final;
- companies have the ability to appeal to the Competition and Market Authority for a redetermination, if they disagree with the regulators’ final decisions;
- management and shareholders may be able to take additional measures to protect credit quality.
Subscribers can access the report at: http://www.moodys.com/researchdocumentcontentpage.aspx? docid=PBC_1194105