UK’s privatisation model under fire amid Thames Water crisis; squeezed households run down savings – business live | Business

Introduction: UK water sector faces biggest crisis since Thatcher

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

Britain’s model of privatised utilities is facing its biggest crisis since Margaret Thatcher was selling off the family silver in the 1980s.

Thames Water, the UK’s latest water company, is in emergency talks with the water regulator Ofwat, ministers and government departments, amid concerns it needs a multibillion cash injection to keep operating.

The water company, which serves 15 million customers, could be put into temporary national ownership by ministers to secure a refinancing package.

A map showing Thames Water’s

Yesterday, Thames Water said it was working “constructively” with its shareholders on injecting more equity into the company, to support its “turnaround and investment plans”.

Thames Water’s shareholders injected £500m in March, and had committed to a further £1bn in funding, but it is understood discussions about further funding faltered after the board was warned billions more would be needed.

Estimates presented to ministers and regulators suggesting the company could be facing a hole of £10bn in its finances, the Guardian revealed last night.

Thames Water has accrued a £14bn debt pile – around a quarter of the privatised water industry’s collective debt burden of £60bn. Thatcher sold them off debt-free, and endowed them with a further £1.5bn of public money, known as a “green dowry”, to help with improving their networks.

A graphic showing how much debt is owed by water companies

Since privatisation, shareholders have been paid £72bn in dividends, while bills have risen 40% in real terms.

Green MP Caroline Lucas told parliament last night that “privatisation of water was a serious mistake and it needs to be permanently rectified.”

Caroline Lucas, “Water companies had no debt when privatised. They have since borrowed £52 billion and paid £72 billion in dividends. Meanwhile we have a sewage scandal. Privatisation of water was a serious mistake and it needs to be permanently rectified.”

— Farrukh (@implausibleblog) June 28, 2023

Environment minister Rebecca Pow, though, insisted that “The sector as a whole is financially resilient”, adding:

“Government of course is confident that Ofwat as the economic regulator of the water industry is working closely with any company that would be facing financial stress.”

A former Thames executive told the Guardian the water company faced “intractable” problems that were rooted in “over 100 years of underinvestment”.

There are estimates that the water industry needs to spend £70bn in total over the coming decades to fix the sewage discharge problem, and secure water supplies.

Thames Water’s difficulties have highlighted the key question – is it really possible to keep bills down, make profits and invest to make water clean? Or would nationalisation. removing the pressure to pay shareholders, help?

The consortium that took over ownership of Thames Water in 2017 has not taken a dividend since, but the company has paid internal dividends – including £37m in the year to March 31 2022.

The agenda

  • 8.30am BST: Sweden’s Riksbank interest rate decision

  • 9.30am BST: UK mortgage approvals figures for May

  • 10am BST: Eurozone confidence figures for June

  • 1pm BST: German inflation report for June

  • 1.30pm BST: US Q1 GDP report (final reading)

  • 1.30pm BST: US weekly jobless figures

Key events

Just in: The US economy grew faster than previously estimated at the start of this year.

New official data show US GDP grew at an annual rate of 2% in January-March, the equivalent of a quarterly growth rate of 0.5%.

Growth had previously estimated at an annualised rate of 1.3%.

The upgrade is because exports and consumer spending rose faster than previously estimated.

Water privatisation might be a shitty idea because it pumped fat dividends to shareholders for no risk, or because investors (including pension funds) will lose huge sums when the companies go tits-up, but screwing up on both counts is quite the achievement.

— Paul McNamara (@M_PaulMcNamara) June 29, 2023

Over in the eurozone, the latest inflation data paints a mixed picture.

Annual inflation in Germany has risen to 6.4% in June, up from 6.1% in May, further from the European Central Bank’s 2% target.

On an EU-harmonised basis, German inflation rose to 6.8% from 6.7%.

Core inflation (stripping out food and energy), a measure closely watched by central bankers, rose to 5.8% from 5.4%.

The increase is partly due to ‘base effects’, as train travel and petrol in Germany was subsidised a year ago, making it cheaper than today.

#Inflation re-accelerated in Germany again due to base effects. The comparison effect from last year, when the Berlin govt offered citizens ultra-cheap rail tickets & subsidized gasoline, pushed up consumer-price growth to 6.4% in June from 6.1% in May and vs 6.3% expected. Food…

— Holger Zschaepitz (@Schuldensuehner) June 29, 2023

But in Spain, inflation has dropped below the 2% level.

Spain’s consumer prices rose 1.9% year-on-year in June, their slowest increase since March 2021, preliminary data from the National Statistics Institute (INE) showed on Thursday.

Spain is the first among the euro zone’s large economies to have inflation fall below 2%, the European Central Bank’s target, the Economy Ministry said in a statement.

Bloomberg Intelligence: Thames Water special administration could lead to 25% debt haircut

Thames Water might need to write off a quarter of its debt if the government takes control of the company, according to a Bloomberg Intelligence report.

Paul Vickars, senior credit analyst at Bloomberg Intelligence, says that if Thames Water enters a special administration regime, finding a new owner may require a haircut of up to 25% on the nominal value of its ring-fenced debt, of aroudn £14bn.

Vickars writes:

A special administration regime would facilitate a transfer to new owners but leave ring-fenced bondholders unable to enforce any security and with no guarantee of being made whole in a new financial structure.

Taking a 25% haircut would reduce Thames Water’s regulatory gearing to “the notional 60% set by Ofwat to enable a company to finance its operations at high grade level”, Vickars says, which a new owner could reasonably stipulate.

As explained earlier, Thames Water’s complicated structure means that the operating company (the bit actually supplying clean water and taking waste away) is ringfenced inside a Whole Business Securitisation (WBS) shell along with the holding company and financing company.

But there are holding companies outside the ringfence, which have also issued debt, and rely on dividends from the WBS to service it.

Vickars writes that they are most at risk from a government takeover:

“The risk of Thames Water being placed into a special administration regime is most acute for bonds outside of the securitization ring-fenced group, namely the £400m 4.625% 2026 bond from Thames Water Kemble Finance Plc that has fallen by 35 points to a price of about 50*.

The Class B second-lien instruments within the ring-fenced group look to be next in line, though by some distance, with the £250 million 2.875% 2027 bond from Thames Water Utilities Finance Plc down by 4 points to a price of 79.”

Thames Water might need to write down £3.6 billion of debt if the government takes over control, according to a Bloomberg Intelligence report

— Bloomberg (@business) June 29, 2023

* – ie: half its face value.

In the City, shares in water companies have dropped this morning as investors fret about their long-term financial resilience, given the scale of investment needed to hit environmental improvement targets.

Severn Trent are among the third-biggest faller on the FTSE 100 index, down 3%. United Utilities, which supplies water in the North West of England, have dropped by 1.6%.

Pennon Group, which services the South West of England, and the Bristol and Bournemouth regions, are down 3% on the FTSE 250 index of medium-sized firms.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, says investors are reassessing the longer-term implications for other firms in the sector.

Streeter writes:

Shares in Severn Trent, Pennon and United Utilities have fallen back more steeply amid the focus on the costs looming for firms which are set to become under increasing pressure to meet environmental targets set by Ofwat. Although their immediate financial situation is considered to be more stable compared to other companies, who have been red flagged by regulators for their high levels of debt and dividend payments, the scale of the mountain to climb in terms of the investment needed is sparking fresh concerns.

Arguably, publicly listed companies have fewer shadows to hide in when it comes to transparency about dividend payments than firms with more complicated investment structures. However, as the next regulatory timeframe looms for the period 2025 to 2030, there is set to be much bigger demands from regulators on infrastructure improvements to reduce sewage spills, increase capacity, and meet net zero targets. Capital expenditure will have to increase sharply as a result – United Utilities, Severn Trent and Pennon have already had to push up spending, but budgets will need to expand, and debt levels will rise as a result.

Drought likely in Cumbria and Lake District, government committee told

Helena Horton

Helena Horton

Cumbria and the Lake District are likely to be plunged into drought, leaked minutes from the government’s National Drought Group reveal, with reservoir levels in the regions having dropped significantly.

Other popular summer holiday destinations including Devon and Cornwall are also likely to be hit by water supply problems, the group heard, and holidaymakers may be be told to curb their use.

Sources present at the meeting – at which attenders included officials from No 10, farming groups, water companies and the water minister, Rebecca Pow – told the Guardian experts warned the high levels of visitors to drought-stricken areas in summer was potentially unsustainable.

Though the country has enjoyed some rainfall over recent weeks, it has not been enough to offset the prolonged dry weather and increased water use. The leaked minutes, seen by the Guardian, reveal:

“Some reservoirs have seen large drops in recent weeks, and there are concerns in the Lake District, where at Haweswater and Thirlmere there was a decrease of 13% in reservoir stocks between the end of April and end of May 2023. The Teesdale reservoir group in north-east England also recorded a 13% drop over this time. Water companies continue to closely monitor the position and take action to reduce demand and maximise storage.”

Here’s the full story:

Bill Blain: UK’s long-saga of economic decline is turning critical

The Thames Water crisis risks creating a potential investment crisis in the UK, warns Bill Blain, strategist at Shard Capital.

Blain points out that the public utility privatisations decades ago have left “a legacy of underinvestment and broken services”.

And he fears that “the imminent collapse” of the UK’s largest water company will become the fundamental crisis point when “the country’s long-saga of economic decline turned critical”.

Blain writes:

Economic success is all about confidence and common sense. This is not about the collapse of a single company – it’s about how 40 years of miscalculations, mistakes, and the primacy of political will over common sense, have finally come due.

Today’s crisis will have massive market, political and economic consequences as the travails of Thames Water ultimately reveal just how disjointed, hollowed-out, ineffective, but most importantly, how bust and broken the last 40 years has left the UK economy

Global investors looking at the UK today see “a nation of decaying infrastructure, a massive bill to rebuild it, a planning process that actively stops anything – and a nation showing little realisation of the crisis”, Blain adds.

An engineer walking inside a section of the Thames Tideway Tunnel.
An engineer walking inside a section of the Thames Tideway Tunnel. Photograph: Kirsty O’Connor/PA

One of the biggest shareholders in Thames Tideway, which is building a 25km Super Sewer under London, has reassured its investors that the project is independent of Thames Water.

International Public Partnerships Limited, which owns a 18% stake in Tideway, has issued a statement to the City, saying that “in order to provide clarity” to its investors, “Tideway is a completely separate company to Thames Water”.

It added:

“Whilst Thames Water does possess a licence requirement to collect Tideway’s revenues from its customers and pass those amounts to Tideway, statutory and regulatory protections are provided in the event that Thames Water encounters difficulties.”

It said that if Thames Water falls into a special administration regime (SAR) [temporary nationalisation], the process is designed to “mitigate the risk of disruption” to Tideway collecting its revenues, as well as to protect water customers.

Tideway will also be allowed to recover any shortfall later.

Tideway can also directly charge some customers to use the tunnel, IPPL adds, although this option is “unlikely to be utilised”.

Thames Water offered £17.5m to debt collectors

Jillian Ambrose

Debt-ridden Thames Water offered to pay debt collectors up to £17.5m to recover unpaid water bills weeks before crisis talks to rescue the failing water company, my colleague Jillian Ambrose reports.

Thames, which has debts of over £14bn, opened a tender for debt collection agencies earlier this month which promised a commission to agents able to recover water debt under a three-year contract.

The company, which serves 15 million customers in London and surrounding areas, reported unpaid bills totaling £36m at the end of September 2022 which is likely to be higher as rising costs continue to press on hard-hit households.

The water company added.

“With the cost of living rising, we recognise the importance of collecting debt in a socially responsible manner.”

Squeezed households ran down bank savings at record pace in May

UK households ran down their bank savings at a record pace last month, new Bank of England data shows.

During May, households withdrew £4.6bn from banks and building societies, which is the highest level of household withdrawals on record.

This was only partly balanced by £800m moved into National Savings and Investment accounts, by savers looking for higher rates than are available from deposit accounts.

It is a sign that households are now using savings to sustain living standards, says Daniel Mahoney, UK economist at Handelsbanken.

Mahoney explains:

This provides strong evidence that households are dipping into excess savings built up during the pandemic (estimated to be circa £200bn) to sustain living standards during the current cost of living squeeze caused by the high inflation environment.

A net ~£4bn withdrawal of household savings took place in May (which includes a small rise in NS&I deposits)

Too early to say if households are finally running down pandemic-era savings: one data point doesn’t make a trend. But worth keeping an eye on this in coming months

— Alpesh Paleja (@AlpeshPaleja) June 29, 2023

Charlotte Nixon, mortgage and financial planning expert at Quilter, says these “scary figures” show the impact of the cost of living on people’s finances.

Nixon explains:

This morning’s Money and Credit statistics for May now look very out of date as they paint a much rosier picture than the one we currently are suffering even though they are still nothing to celebrate about. These figures don’t account for the last few weeks of mortgage mayhem which will have further muddied these incredibly turbulent waters.

However, there were problematic signs appearing in May as people raided their savings during the month. Households, on net, withdrew £4.6bn from banks and building societies, which marked the highest level of household withdrawals on record (for this monthly series starting in October 1997). These scary figures show just what an impact the cost of living is having on people’s finances.

There have been calls for banks, which have been quick to up mortgage rates, to also raise the interest rates on their savings accounts too. However, bank executives have rebuffed this request saying that if they were to do this then mortgage rates would need to get pushed even higher for them to still achieve their margins.

However, this might be short-sighted as it is not helping incentivise people to save when times are this tough and as a result we have seen that the combined net flow of both household deposits with banks and building societies and National Savings and Investment (NS&I) accounts amounted to -£3.8 billion in May which was a significant fall from £5.3 billion in April. With people’s incomes stretched they want to be getting a decent return on savings if they can even afford to save at all.

Analysts at Capital Economuics fear that UK mortgage lending will remain weak over the coming months, despite the rise in mortgage approvals in May.

They explain:

The interest rate on newly drawn mortgages continued to rise by 10 basis points, from 4.46% to 4.56%.

But this precedes most of the recent surge in mortgage rates, which climbed to just above 6.0% last week for the first time since 2007. That suggests mortgage lending and housing activity will take a big step down in June and July.

UK mortgage approvals nudge higher

Back in the UK housing market, there has been a small uptick in the number of new home loans being agreed.

New Bank of England data shows there were 50,000 new mortgage approvals for house purchases in May, up from 49,000 in April.

Approvals for remortgaging also rose, from 32,500 to 33,600.

Overall, net repayments on mortgage debt dropped from a record £1.5bn in April, to £0.1bn in May (meaning borrowers paid back £100m more than they borrowed).

Mortgage lending in May saw net repayments down from record high in April of £1.5b to £0.1 bn of mortgage debt in May. But net approvals for house purchases inc’d from 49,000 in April to 50,500 in May & remortgaging approvals also marginally inc’d to 33,600 in May @bankofengland

— Emma Fildes (@emmafildes) June 29, 2023

Hina Bhudia, partner at Knight Frank Finance, points out that mortgage approvals are still well below the long run average, as rising interest rates dampen demand.

Bhudia explains:

Rising mortgage rates are showing few signs of slowing and pretty much all of the major lenders have repriced higher over the past week.

“The pressure on borrowers is likely to continue until we see two or perhaps three encouraging inflation figures. If that happens, swap rates should ease and we’d expect lenders to pass that through to borrowers quite quickly.

“In the meantime, higher mortgage rates will continue to drag on activity. It’s going to be a subdued summer in the property market.”

Here is a company schematic (courtesy of JPMorgan, via the FT), which shows the complex structure of Thames Water:

The FT’s Bryce Elder explained it thus:

RWE sold Thames Water in October 2006 to Kemble Water Holdings Ltd, a consortium led by Macquarie. Almost immediately the buyers formed a Whole Business Securitisation (WBS) that allowed the group to be loaded with more debt, boosting shareholder returns while insulating the structurally senior bits of the company.

There are three main ring-fenced debt entities — Thames Water Utilities Holdings Ltd, opco Thames Water Utilities Ltd and Thames Water Utilities Finance PLC. The debt they issue is secured by all the assets in the WBS and there are cross-guarantees in place, as well as covenant protections to prevent cash leaking upwards.

But holding companies outside the WBS ringfence have also issued debt, most notably Thames Water Kemble Finance PLC. These holdcos don’t own any of Thames Water’s operating assets so are completely reliant on dividends from the WBS.

Labour MP Thangam Debbonaire, shadow leader of the House of Commons, says there has been a regulatory failure, and a system failure, in the water industry.

Debbonaire adds that the 1989 sale of the water industry “privatised the profits, and nationalised the risk”, leaving customers paying higher bills, and sewage on the beaches.

Debbonaire also suggests that 15 million people don’t know if they’ll have clean water by Saturday.

However, I’d suggest there’s no real risk of taps running dry – if Thames Water enters temporary nationalisation, it will keep operating (and Ofwat’s statement this morning does cite Thames Water’s ‘strong liquidity’).

Tim Short, a former investment banker at Credit Suisse First Boston, has written about the “Seven common misconceptions about the Thames Water crisis” for the Financial Times’s Alphaville site.

The first misconception, he says, is that “If Thames Water is crushed by its debt pile the water will run out”.

Short writes:

It’s important to be clear about which debt we are talking about. Thames Water relies heavily on securitisation; in the jargon this is a Whole Business Securitisation. The paper is nearly all ringfenced in a security package at what’s called OpCo, short for operating company.

The OpCo has manageable debt levels of around 0.75 of Regulated Capital Value at investment grade. The RCV can be thought of as the critical assets the company needs to provide safe clean water.

That means you could sell the assets and pay off all the debt in OpCo. Whatever happens, there’s no obvious risk to supply.

Away from the water crisis, UK mortgage rates are continuing to rise, adding to the pressure on borrowers.

Data firm Moneyfacts reports that:

  • The average 2-year fixed residential mortgage rate today is 6.37%, up from 6.30% on Wednesday

  • The average 5-year fixed residential mortgage rate today is 5.94%, up from 5.91% on Wednesday

There are currently 4,430 residential mortgage products available, a small increase on the 4,407 on offer yesterday.

Ofwat: Thames Water has significant issues to address

Just in: Britain’s water regulator Ofwat has said Thames Water needs to improve its financial resilience, but it insists the company still has strong liquidity.

In a statement issued a day after the government held emergency talks about the future of country’s biggest supplier, an Ofwat spokesperson said:

“Over the last day or so, there has been a lot of commentary about financial resilience in the water sector with considerable focus on Thames Water in particular.

“We have been clear that Thames Water has significant issues to address – their environmental record and leakage performance, for example, are poor. Alongside the turnaround of their operational performance, they need to improve their financial resilience too.

“But that is all in the context of a company that has strong liquidity – it recently received an additional £500 million from shareholders and has £4.4bn of cash and committed funding.

“Overall, the sector is continuing to attract international capital and is especially attractive to long term investors such as pension funds. Indeed, there has been an additional equity injection of around £2bn since 2020, with companies acting to strengthen their financial position.

Ofwat adds that it will continue to keep companies’ financial resilience under “close scrutiny” and ensure companies take action to ensure that they have the financial backing to deliver for customers and the environment.

Ministers must take some accountability for the quality of the UK’s regulators, says Labour MP Darren Jones.

Jones told BBC Breakfast that we wouldn’t be in the current situation if Thames Water hadn’t indebted itself so much, taken out so much wealth from the business for its shareholders, and paid its executives high salaries rather than investing in its infrastructure.

Feargal Sharkey has also told GMB that the water companies have been “effectively ramraided by their owners for cash”.

Those shareholders have made off with £72bn, Sharkey says – which could have been spent fixing leaking pipes and addressing the sewage problems.

.@Feargal_Sharkey has campaigned tirelessly about improving our water facilities and has accused firms of leaving the nation’s waterways in a desperate state.

He joins Kate and Ben to discuss the current water crisis.

— Good Morning Britain (@GMB) June 29, 2023


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