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South East Water owners provide £150mn loan to ease financing pressures

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The owners of South East Water, under investigation for severe supply failures, have provided a £150mn loan to a unit in the utility group as it struggles with higher financing costs on its debt. 

The regional monopoly, which provides water for 2.3mn customers across Kent, Sussex, Surrey and Berkshire, is already on regulator Ofwat’s watch-list for financially at-risk companies. 

In accounts filed in January, SE Water’s parent company, HDF Holdings, said its shareholders lent its Luxembourg-based financial subsidiary £150mn to replace third-party debt that was due to be repaid in December. The parent company’s owners include NatWest’s pension fund, a Canadian pension fund and an Australian infrastructure investor.

The loan decision underscores the stretched finances of several of the water companies in England and Wales, which are struggling with higher interest rates on their debt at a time when they are under pressure to invest in infrastructure. The 16 regulated water companies have racked up £64bn in borrowings after being privatised with no debt 34 years ago.

Financing costs at the SE Water group increased by £56.2mn to more than £130mn in the year to 31 March 2023 as the bonds it had issued rose in line with inflation, HDF’s accounts showed.

HDF warned that a future “severe but plausible” downside scenario “where it is hit by higher energy, chemical and operational costs” could provoke a “trigger event” in the South East Water group. In this situation, the refinancing enabled the interest on the shareholder loans to be added to the capital on the group’s balance sheet, the accounts said.

Adam Leaver, professor of accounting at Sheffield University, said the “holding company is sinking in debt”.

“This switch to shareholder loans is unlikely to resolve the basic leverage problem and suggests that problems are storing up for the future.”

South East Water Ltd, the only part of the group regulated by Ofwat, posted a £74mn pre-tax loss compared with a loss of £37.2mn the previous year. Despite this, it paid a £9mn dividend for the year ended March 2023 and has asked Ofwat to approve a 20 per cent increase in customer bills between next year and 2030, even before inflation.

South East Water’s financial structure flow chart

SE Water said: “In common with many utility companies, South East Water’s cost of financing increased year to year predominately due to the inflationary environment. The loss before tax was due to the increase in finance costs and operating costs in the year.”

Last June, the company failed to deliver water to thousands of customers for more than a week, prompting an investigation by Ofwat.

Consequences could include fines or being brought under the government’s special administration scheme for restructuring or sale, said Ofwat. However, industry sources believe that to be unlikely. 

The group’s loan comes as concerns grow over the financial stability of Thames Water, which is struggling under an £18bn group debt mountain. 

Several water companies need shareholders to inject cash to improve operations and pay down debt. However, in some cases, including Thames Water, the cash injection has been received from shareholders in the form of a loan rather than fresh equity.

SE Water declined to clarify the interest to be paid on the new shareholder loan. In a statement, Andrew Farmer, chief financial officer, said: “Refinancing loans that are reaching maturity is an activity in the ordinary course of business and in this instance the decision was taken to refinance the loan through shareholder loans rather than through external debt.”

SE Water has £1.23bn of borrowings and the second-highest regulatory gearing — the debt a company has as a proportion of its regulatory capital base — at 74 per cent, below Thames Water’s 80 per cent, according to Ofwat. The amount of equity in the company shrunk 60 per cent from £162,958 at 31 March 2022 to £64,774 a year later.  

Other operational pressures at SE Water include being singled out by the Drinking Water Inspectorate for failing to ensure that water leaving the company’s treatment works had “received sufficient preliminary treatment to prepare it for disinfection”. 

SE Water said it was liaising with the DWI and had “proposed a number of schemes to improve our monitoring of the disinfection process”.

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