Fri 04/09/2021 10:01 AM
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Relevant Documents:
Greensands Holdings FY’20 Annual Report
Greensands Holdings Interim Report Sept. 20
Southern Water H1 Interim Report
Southern Water 2019/20 Annual Report
Southern Water STID Proposal
Southern Water Services Prospectus
Greensands Covenant Compliance Certificate
Southern Water Financing Compliance Certificate
Investor Report SWS Financing Group
Ofwat Price Review 2019


Some advisors are monitoring the debt of Greensands Holdings, the parent company of U.K. water utility Southern Water, amid concerns over the credit ratings of its operating company and the handling of its holdco and midco’s liabilities, sources told Reorg. Greensands relies on Southern Water’s dividends to service its debt. A potential credit downgrade of Southern Water would trigger a prolonged dividend lockup, which would prevent it from paying dividends to the holding group. As a consequence, Greensands Holdings may need support from its lenders to deal with its debt obligations, sources added. Continue reading for our EMEA Core Credit team's update on Greensands Holdings' debt, and request a trial for access to our analysis and reporting on hundreds of other stressed, distressed and performing credits in the region. 

While a full-blown restructuring is not on the horizon, the company may need to engage in a liability management exercise should a potential dividend lockup period last for a considerable amount of time, sources said. In its most recent annual report, Southern Water said “the company will not pay any dividends until it is clear that to do so would not be detrimental to the company’s financial position.” Its board decided not to declare an ordinary share dividend for 2019/20 and it is unclear what the company plan is for 2020/2021, sources said. Over the past couple of years, Southern Water’s cash flows and margins have deteriorated as a result of regulatory changes in the sector, which lowered prices for consumers, and the impact of the Covid-19 pandemic.

Southern Water is the only operating company in Greensands Holdings. All companies above it rely on dividend payments from the operating company to service their debt obligations, according to the parent group’s annual report. Currently, Greensands Holdings’ balance sheet shows £557.5 million in cash, £492 million of which is at the operating company Southern Water level.

In total Greensands, at holdco and midco level, has £1.252 billion of debt in the form of facility agreements and RCF, with maturities ranging from 2022-2030. Greensands has a £125 million facility agreement due in 2022. Reorg estimates that at midco and holdco level it has about £55 million of annual interest payments on its facility agreements and RCF (assuming facility agreements have a 0% floor and the RCF has a rate of LIBOR+4.5%). In addition, as of Sept. 30, 2020, there was £40 million undrawn committed bank facilities at Southern Water (Greensands) Financing, part of the group’s holdco. There is also a £360 million unsecured eurobond issued to shareholders, which has a 12% PIK interest and is not traded at Greensands Europe Ltd., part of the holdco.

Sources pointed out that Southern Water’s midco and holdco level debt is unlikely to trade and less likely to trade at discount as the current investor base is seen as supportive. The debt consists mostly of facility agreement debt alongside an RCF.

Southern Water did not provide a comment. The group’s organizational chart is below:

The group’s capital structure is below:






























































































































































































































































































































































































































































































































Southern Water Ltd


09/30/2020

EBITDA Multiple

(GBP in Millions)

Amount

Price

Mkt. Val.

Maturity

Rate

Yield

Book

Market


£350M Senior Fixed Rate Bonds A1 due 2029

350.0

133.1

350.0

Mar-31-2029

6.192%

1.590%

£150M Index-Linked Bonds A2a due 2034

282.0

279.3

282.0

Mar-31-2034

3.706%

1.030%

£35M Limited Index Bonds A2b due 2034

65.9


65.9

Mar-31-2034

3.706%


£350M Fixed Rate Bonds A4 due 2026

350.0

123.7

350.0

Mar-31-2026

6.640%

1.510%

£150M Index-linked Bonds A5 due 2023

252.0


252.0

Mar-31-2023

3.816%


£350M Fixed Rate Bonds A7 due 2021 1

350.0


350.0

Mar-31-2021

5.000%


£150M Fixed Rate Bonds A8 due 2041

150.0

144.2

150.0

Mar-31-2041

5.000%

1.970%

£200M Fixed Rate Bonds A9 due 2052

200.0

152.2

200.0

Mar-31-2052

4.500%

2.010%

£300M Fixed Rate Bonds A10 due 2056

300.0

172.3

300.0

Sep-30-2056

5.125%

2.070%

£175M USPP Fixed Rate Loan due 2031

175.0


175.0

2031

2.780%


£75M USPP Fixed Rate Loan due 2036

75.0


75.0

2036



£165M Artesian Index-linked Bonds due 2033

314.4


314.4

2033

4.076%


£156.5M Artesian Index-linked Bonds due 2032

248.2


248.2

2032

3.635%


Total Class A OpCo Debt - Southern Water Finance Limited

3,112.5

3,112.5

7.4x

7.4x

New £825M Sustainable Bond 1

825.0


825.0




Other Unsecured Loans

30.3


30.3




Deferred Proceeds/Payments 2

93.9


93.9




Total Other OpCo Debt - Southern Water Finance Limited

949.2

949.2

9.6x

9.6x

£60M EIB Index Linked Class A Loan due 2025 3

51.7


51.7

Aug-2025



£40m EIB Index Linked Class A Loan due 2026 3

41.0


41.0

May-2026



Class B Preference shares 4

69.8


69.8

Mar-31-2038



Finance Leases

30.4


30.4




Total OpCo Debt - Southern Water Services Limited

192.9

192.9

10.1x

10.1x

Revolving Credit Facility

100.0


100.0




£125M Facility Agreement due 2022

125.0


125.0

2022

GBP LIBOR + 3.250%


£75M Facility Agreement due 2025

75.0


75.0

2025

GBP LIBOR + 4.000%


£150M Facility Agreement due 2025

150.0


150.0

2025

GBP LIBOR + 5.250%


£100M Facility Agreement due 2026

100.0


100.0

2026

GBP LIBOR + 5.250%


£250M Facility Agreement due 2025

250.0


250.0

2025

GBP LIBOR + 5.250%


£50M Facility Agreement due 2025

50.0


50.0

2025

GBP LIBOR + 2.500%


£175M Facility Agreement due 2025

175.0


175.0

2025

3.930%


£25M Facility Agreement due 2025

25.0


25.0

2025

3.650%


£75M Facility Agreement due 2028

75.0


75.0

2028

3.940%


£52M Facility Agreement due 2030

52.0


52.0

2030

4.030%


£35.3M Facility Agreement due 2023

35.3


35.3

2023

3.384%


£19.6M Facility Agreement due 2025

19.6


19.6

2025

3.681%


£19.6M Facility Agreement due 2028

19.6


19.6

2028

4.020%


Total HoldCo and MidCo Debt

1,251.5

1,251.5

13.0x

13.0x

£360M Unsecured PIK Eurobond due 2038 5

1,401.4


1,401.4

2038

12.000%


Total Eurobond Shareholder Loans

1,401.4

1,401.4

16.3x

16.3x

Total Debt

6,907.5

6,907.5

16.3x

16.3x

Less: Cash and Equivalents

(577.5)

(577.5)

Net Debt

6,330.0

6,330.0

15.0x

15.0x

Operating Metrics

LTM Revenue

817.7

LTM Reorg EBITDA

422.7


Liquidity

RCF Commitments

100.0

Less: Drawn

(100.0)

Other Liquidity

415.0

Plus: Cash and Equivalents

577.5

Total Liquidity

992.5

Credit Metrics

Gross Leverage

16.3x

Net Leverage

15.0x


Notes:
The capital structure is on a post-IFRS 16 basis. EBITDA calculated as operating profit plus D&A. Apart from the £825M new sustainable bonds issuance and £330M RCF repayment at Southern finance, we assumed the capital structure remained largely unchanged compared with March 31, 2020, due to lack of disclosure in the interim report. Total available amount of RCF at Greensands Finance was not disclosed. Other liquidity includes £375M committed undrawn bank facility at opco level and £40M at holdco level. Market data as of April 7, 2021.
1. In May 2020, Southern Water Services Finance Ltd raised €825 of additional financing under sustainability framework. The use of the proceeds included investment in the business plan 2020 to 2025 of SWS and the repayment of a £350.0 million bond maturing 31 March 2021. This also replaced the short-term revolving credit facility of £700.0 million that was in place from 31 March 2020.
2. Including £8.2M deferred bond premium, £4.6M deferred glit lock proceeds and £81.1M deferred proceeds.
3. With interest rate of 0%
4. Redeemable at their nominal value plus the share premium paid, on March 31, 2038 or at the company’s option anytime earlier.
5. Issued by Greensands Europe Ltd. To the shareholders of the ultimate parent company with limited recourse obligations of the issuer.



As of March 31, 2020, Fitch rated Southern Water’s class A debt BBB+ with a negative outlook, while Standard & Poor likewise gave the debt a BBB+ rating with a negative outlook. Moody’s had a Baa3 rating with a stable outlook.

In its interim report, Southern Water said that a further credit ratings downgrade following its downgrade in 2019 would result in a trigger event under its common terms agreement, which would put restrictions on the payment of dividends. It also noted that a trigger event would occur “if any two of the credit ratings would fall to BBB (S&P and Fitch) or Baa2 (Moody’s) or below.” Moreover, a default could occur if any two of the credit ratings are less than the minimum rating required for the status of investment grade, BB+ (S&P), BB+ (Fitch) or Ba1 (Moody’s). The ring-fenced structure of the Whole Business Securitisation, or WBS, financing group of Southern Water was designed such that a default at this level would mean that Southern Water could operate as usual but, as mentioned, this would impact its ability to provide money to the parent group.

In January 2021, Southern Water forwarded a security trust and intercreditor deed, or STID, amendment proposal to its creditors, seeking consent to refinance maturing debt and further draw on its RCF during a trigger event. According to Fitch, Southern Water received consent for its proposal from lenders in February. However, the agreement with lenders has not altered the fact that a dividend lockup will take place should a trigger event occur.

Southern Water’s ability to pay dividends to the midco or holdco companies is subject to other covenants, including a cash interest cover ratio - consolidated EBITDA to cash interest cover - covenant and a net debt to regulatory capital value, or RCV, ratio covenant. RCV is a measure set by the U.K.’s Water Services Regulation Authority, or Ofwat, and represents the company’s market value plus the value of accumulated capital investment assumed at each price review.

An overview of the RCV to net debt ratio and covenants is below:

As a result of regulatory pressure, Southern Water and other companies in the sector have seen a contraction in headroom under their financial covenants. Fitch noted in September 2020 that issuers have already cut their costs and dividends to the minimum acceptable levels and any further reduction would represent a threat to operational service delivery or debt serviceability at the holding company level.

As for the cash interest cover, the minimum target trigger level, under which dividends by Southern water are not permitted, from 2018 to 2019 was at 1.3x, while the 2019-20 performance stood at 1.7x. However, Moody’s noted in March 2020 that the interest cover covenant currently provides limited protection to opco creditors because Southern Water’s use of derivatives “allows the company to mask certain operational and financial weaknesses.”

An overview of interest and dividend payments in 2019-20 is below:

Under Pressure

Southern Water has seen its margins and cash flows come under pressure due to regulatory changes which have implemented price cuts for consumers. Additionally, the company suffered in the Covid-19 crisis as some customers delayed or were not able to pay bills on time. This led to a £17.5 million bad debt charge in the six months ended Sept. 30, 2020.

A summary table for Southern Water’s cash conversion is below:

The wider Greensands group recorded revenue before regulatory settlement of £878 million for the ended March 31, 2020, up from £876.3 million a year earlier. Operating profit before regulatory settlement amounted to £201.6 million, down from £247 million at the end of fiscal 2019.

Regulation of U.K. Water Sector

Water companies in the U.K. are typically privately-run and are regulated by Ofwat. In England and Wales, there is normally just one water company in a given region so these companies are effectively monopolies with the regulator carrying out a price review every five years, also known as an Asset Management Plan, or AMP. The regulator last carried out a review in 2019, which featured a significant cut in allowed returns via linking some of the prices to the consumer price index adjusted for housing costs and linking other prices to the retail price index.

The regulator also sets strict performance targets. At the time, Moody’s estimated that most of the 17 monopoly water and wastewater service companies will have an average allowed cash return of around 2.5% over the AMP period until 2025. On an Retail Prices Index, or RPI, stripped basis, for comparison with the last period, allowed returns fell to 1.92% (1.96% including retail margin) from 3.6% (3.74% including the retail margin), a nearly 50% cut, according to the ratings agency.

Moody’s noted that this is a particular problem for companies with expensive long-dated debt such as Southern Water and Yorkshire Water. The five-year AMP period commenced on April 1, 2020. Four companies, Anglian Water, Bristol Water, Northumbrian Water, and Yorkshire Water appealed against the regulator’s price controls. On March 17, the U.K. Competition and Markets Authority determined that the return to investors would be 3.2% compared with 4.67% in the previous price control period. This will improve those companies’ credit metrics somewhat.

An overview of the average private customer bill over the five-year regulatory period for the regulated water companies is below:

Water Challenges

Southern Water is not the only U.K. water company which has seen its financial performance deteriorate as well as covenant headroom shrink due to regulatory changes. Fitch ratings highlighted that Affinity Water, Anglian Water, Thames Water, Dwr Cymru and Yorkshire Water may be at risk of triggering credit events. The ratings agency also said the pandemic has added challenges, including slightly higher bad debts, lower net water consumption and lower inflation expectations. Water companies have already been stretched against their financial covenants and negative rating sensitivities, so they have limited headroom to withstand further shocks, the ratings agency commented.

Early in the pandemic, Ofwat allowed non-household customers to defer primary water charges, which also negatively affected the financial performance of water companies. Fitch highlighted that lower inflation expectations in 2021 would also result in lower regulated capital value indexation and consequently higher gearing for most issuers in the sector.

As a result of these factors, several water companies have received a downgrade from ratings agencies in recent years, which included Fitch downgrading Greensands UK Ltd. to CC from B- in October 2019 due to Greensands probably not receiving any operating cash inflows. At the time, the ratings agency noted that cash payments from the midco are Greensands’ only source of cash, which could lead to a payment default or debt restructuring event in the medium term.

Thames Water initially hired restructuring advisor Gleacher Shacklock at the end of 2019 amid concerns over the company’s financial position due to the price review. However, the company was able to address these concerns by issuing £250 million of senior secured notes due 2026 in September 2020. This was followed by a £100 million tap to the £250 million notes in January.

-- Thomas Baker, Aurelia Seidlhofer, Noor Sehur, Shenda Xu and Luca Rossi.
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