Thames Water and a number of other highly leveraged businesses are ringing alarm bells as the cost of servicing debt skyrockets. Photo: José Sarmento Matos/Bloomberg
When Margaret Thatcher privatized Britain's water industry in the late 1980s, the then prime minister canceled her £5 billion debt.
This decision cleared the way for water companies to enter a new era. released, with an additional £1.5 billion government subsidy to help them on their journey.
Three decades later, British water companies have amassed a whopping £60bn of debt built up over years of lower interest rates. As lending conditions tighten and rates continue to rise, the entire water industry is currently struggling with the financial grindstone.
But fears are growing that the problems in the water industry could herald a wider crisis brewing in corporate Britain.
Dozens of leading air carriers, from Asda to Aston Martin, also lashed out in good times with cheap debt. While politicians and regulators have focused on the recent mortgage crisis, the real issue facing the UK may be the looming corporate credit crunch. UK Plc's current debt dilemma.
3006 Thames debt
Most of this debt was purchased when the company was owned by Macquarie, an Australian investment bank, between 2006 and 2016. Under his management, Thames Water's debt has grown to over 80 percent of its regulatory cost of capital (RCV), a metric used to determine the value of its assets.
While Macquarie points to the billions of pounds it invested in upgrading Thames Water's infrastructure while owning the company, critics allege that the group also stole billions from Thames Water. through dividends and loans.
The company is now owned by a group of investors including the Ontario Municipal Employees' Retirement Scheme (Omers) and the University Pension Scheme (USS), the UK's largest pension fund.
Trouble erupted this week after chief executive Sarah Bentley quit unexpectedly on Tuesday after less than three years at the helm.
Bentley has been brought in to implement an eight-year overhaul plan, but it is believed to be was complicated by the fact that the company's shareholders were unwilling to provide the necessary additional capital. Last year they invested £500m in Thames Water but are still resisting another £1bn requested by the business.
Thames Water said earlier this week that it «continues to work constructively with its shareholders.» as the company seeks additional funds for its recovery plan.
However, Thames is not alone in facing problems due to a huge pile of debt. In December, water regulator Ofwat warned that it had concerns about the financial strength of five water utilities, including Thames.
Service providers are saddled with over £60bn of debt, most of which was taken on during the long period of low interest rates that followed the 2008 global financial crisis.
United Kingdom
As Bank of England rate increases lead to increase in borrowing costs, the finances of water companies will come under strong pressure in the coming months. To make matters worse, more than half of Thames Water's debt is also related to inflation, which is a general trend for the entire sector.
In the latest Financial Strength Report, the watchdog warned that a key driver of the increase in debt among water companies was the impact of high inflation on index-linked debt.
It said: “The value of indexed debt generally rises with inflation. With over 50% of sector debt indexed for inflation and the vast majority of it linked to the [Retail Price Index], the impact as of March 31, 2022 was material.”
While Thames Water remains in talks with investors about investing new capital in the company, others have had better success. This week Yorkshire Water raised £500m from shareholders to bolster its finances.
Meanwhile, the water industry's recent problems caused by rising interest rates also threaten to reveal a broader debt problem in the economy as a whole.
Warnings about high levels of corporate debt are not new, but concerns are growing. Back in 2019, the Bank of England warned that a huge corporate debt bubble was a fundamental threat to financial stability.
And in 2021, Bank Governor Andrew Bailey issued another warning, saying: “Companies that increase their share of borrowed funds beyond safe and sustainable levels, find themselves in a much less sustainable position when the shock comes, and we had a very strong one.
“Companies should have a very clear message: leverage matters. This is important for the sustainability of your own financial situation. So you have to consider that.”
As interest rates continue to rise from record lows, companies face the prospect of significant cost increases as they try to refinance debt.
2306 B.C. interest rate
In its latest Financial Stability Report, Threadneedle Street cautions: “There are a number of vulnerable companies with low liquidity, weak profitability or high leverage. And some businesses are facing other challenges due to higher debt service costs, lower revenues and continued supply chain disruptions.
“This pressure is expected to continue to grow in 2023, especially for smaller companies that are less able to protect themselves from higher rates.”
Major British companies that have built up significant pile debt in recent years through financial engineering include supermarket giants Asda and Aston Martin. There is no suggestion that any company is currently facing financial difficulties.
Aston reported in March that its annual losses more than doubled, partly due to expensive debt. The cost of servicing high interest debt for the year was £139 million. Lawrence Stroll, its chairman, was looking to cut down on his massive debt pile.
Asda is also clumsy under the weight of £6bn of debt, and the supermarket's £2.3bn gas station deal with EG Group — another business owned by Moshin Issa and his brother Zuber — has left the supermarket mired in even more debt.
The EG deal will see the Blackburn billionaires load Asda with £770m of high-interest loans from private equity firm Apollo, as well as £450m from Asda's owners Issas, private equity backers TDR Capital. and American retail giant Walmart. Apollo loans are supposed to have a maturity date of 2029.
They are far from the only ones. Morrisons was left with an estimated £6bn net dent after the supermarket was bought by private equity firm CD&R; Heathrow Airport's holding company is £19bn in debt; and AA, which has flipped repeatedly between private equity and the stock market, has a net debt of £2.3bn.
None of these companies are currently struggling. However, servicing the pile of debt is getting more expensive.
While the political focus remains on the rising cost of mortgages, the impact of higher interest rates could wreak havoc in quieter sectors of the economy as well. Highly leveraged companies may soon be alarming.
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