16 Risk Return and Financeability - southernwater.co.uk · Southern Water – Water for Life...

Southern Water – Water for Life Five-Year Business Plan Chapter 16: Risk, Return and Financeability

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Chapter 16

Summary

This chapter sets out detail as to how our Business Plan has aligned risk and return across

the price controls. This will ensure a financeable plan that delivers for our customers.

Resilience in the round will enable us to deliver our ambitious vision/

We have developed a robust financial plan that supports the company’s overall business plan.

Our financial plan is focused on our customers’ priorities and is financeable and resilient on both

a notional and an actual capital structure basis.

We face a number of challenges to financeability, including a substantially lower WACC as

indicated by Ofwat’s early view in the methodology, stretching upper quartile performance

commitments, and increased Totex resulting, for example, from the obligations in the Water

Industry National Environment Programme and sustainability reductions required in our Water

Resources Management Plan programmes.

Our response to these challenges involves substantial increase in the equity of the Licensed

company (Southern Water Services Limited) which will be used to reduce debt to 70% of RCV by

April 2020, and reduce our interest cost by c£425m in the decade to 2030. This is being achieved

through our shareholders, members of the Greensands Group, subscribing for £700m of additional

equity1 in the regulated company.

This capital injection will support the financeability of our plan over AMP7 and well beyond at

reduced financial risk and enhance our flexibility to withstand shocks. It will also ensure that we

can deliver the operations and service levels that our customers expect now and over the long

term with extra confidence and protect customers from potential adverse developments.

The additional equity is being funded by our shareholders through issuance of debt via other group

companies outside the regulated company ring fence, and will reduce gearing and interest costs

in the regulated company. The interest costs and financial risks of this debt are borne uniquely

by our shareholders.

Our Board, with independent non-executive directors forming the largest single group, will be the

sole authority for any dividends paid to equity which will be consistent with our dividend policy,

instrument of appointment, and other relevant legislation, to ensure that any dividend paid is

considered in the best interests of Southern Water, and that it is consistent with our performance

commitments and service levels to customers. The business plan has a base case dividend yield

below 5% in both the actual and notional capital structures.

We have a long history of successfully accessing financial markets to finance our activities on an

ongoing basis and can rely on these markets to provide long-term and cost-effective financing for

RR 1, 2, 3, 4 LR 1, 2 CA 1, 2, 3


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RCV-regulated water and sewerage companies based on both the transparency of the regulation,

and the stability of Ofwat’s approach. We have lived through significant market challenges in the

past and are confident that we can continue to attract investor demand for debt and equity into

AMP7 and beyond, provided the sector’s regulation remains held by these investors in high regard.

We are financeable in the notional capital structure, meeting the requirements of a BBB credit

rating. Ofwat’s indicative allowed return represents a significant reduction from the last price

control which as a consequence has a significant negative impact on financial headroom.

We are financeable in the actual structure at our target credit ratings of A-/A-/BBB+ for S&P, Fitch

and Moody’s respectively2. This is a stronger credit rating than the notional capital structure, due to

the additional protection afforded to creditors under our Whole Business Securitisation.

We have carefully considered the risks we face, and have tested out our financeability under a

wide range of severe, reasonable, and plausible scenarios. We can maintain financial resilience in

all but the most severe scenarios where, in the implausible absence of any mitigation, we would

face some issues. In these scenarios the mitigation plans we have in place, combined with the very

low probability of occurrence, mean that they do not impact the Board’s ongoing assessment that

the regulated company is financially resilient. This process builds on the work we regularly

undertake, most recently captured in our Long Term Viability Statement.

We have responded to the themes of affordability, resilience, customer service, and innovation and

produced a financial plan that supports our overall plan to deliver the extra levels of service that

our customers want, while proposing a bill reduction of 3% in average combined bills.3

We have adopted a PAYG ratio similar to that at PR14 and consistent with the natural rate.

We have used the RCV run-off rate to smooth bill profiles in line with what our customers tell

us they prefer.

We have taken into account customers’ views and taken care to design other aspects of our risk

and return package to meet their needs, such as our stretching ODIs, and our customer

affordability proposals.

Chapter headlines at a glance

We have responded to Ofwat’s early view of cost of capital when testing actual and

notional financeability

The Board have confirmed that the plan is financeable on both notional and actual

capital structures

Actual financeability is underpinned by a transformational equity injection that is underway

and will be completed well before the beginning of AMP7

The plan demonstrates a clear understanding of the risks that could impact delivery.

We have undertaken rigorous stress testing, both gross and net of mitigating actions

Our bill profile delivers what our customers have asked for in terms of affordability

Our finances and approach to financial resilience are a key part of our response to developing

resilience in the round

Our actions in improving financial resilience build on our ambition to maintain and grow the

trust and confidence of our customers to transparently deliver the service levels they expect


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16.1 Board Statement

A well evidenced plan that is financeable on both actual and notional capital structures

The Board has considered the financeability of the Plan and confirms that it is financeable on both

the notional and actual capital structure and the Plan protects customer interests in both the short

and long term. (See TA 2.1 Statement of Board Assurance, statement 12.)

16.2 Key themes for financeability at PR19

We have adopted Ofwat's early view of the cost of capital in testing financeability

Testing financeability over AMP7

Our assessment of our ‘ability to raise finance’ at a reasonable cost under our business plan

has to be done with respect to a notionally financed, efficient company, as well as with respect

to our actual financial structure.

In each case, the assessment of financeability requires us to:

Determine what relevant ratios / measures to use for the assessment;

Determines the appropriate thresholds/ critical ratios that are consistent with our plan

being financeable.

The importance of access to finance

We are required to maintain investment grade credit rating as a licence condition. An issuer is

considered to be investment grade if its credit rating is Baa3 or higher by Moody’s, or BBB- or

higher by S&P and Fitch; an investment grade rating typically indicates a low risk of default on debt.

Ensuring that our plan is financeable is therefore a critical component of fulfilling our licence duties.

An investment grade credit rating is also fundamental to ensuring that we can meet the overall

financing requirements of our plan, retain appropriate headroom without excessive financial risk,

and hence deliver on our obligations and commitment to customers.

We have in place a robust, well-established, securitised capital structure that supports our ability to

raise additional capital when needed, ensures our strong resilience, reduces likelihood of default

and hence protects ability to deliver for customers at minimum risk.

We strongly believe the securitisation of our business to be an important safeguard for customers

and helps to align the interests of our customers and investors.

In particular, our securitised structure:

Improves overall financial standing

Protects creditors, allowing more efficient financing

Reduces risk of financial distress

Enhances and strengthens the regulatory ring-fence between the company

and the rest of the group

Focusses the company on the core businesses

Results in tight control of the financials of the company

Provides additional constraints and ensures managerial discipline through covenants


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Enhances and strengthens the regulatory ring-fence between the company

and the rest of the group

Accessing capital markets at an efficient cost will continue to be a priority during AMP7. In

particular, with our additional statutory obligations as a result of WINEP and WRMP, this is a key

enabler of successful delivery for the c.50% of wholesale Totex customers do not fund immediately

via bills.

The assets we invest in are both capital intensive and long lived. This means that there is a timing

difference between the point at which we incur costs and the point at which we bill customers,

which affects affordability and intergenerational equity. As a result, as we have done over previous

AMPs, we have to carefully manage our cash flow position, as measured by key financial ratios,

to ensure that we can both deliver these investments and remain financeable.

However the timing difference between expenditure and revenues has also increased. This is a

result of the substantially lower real indicative WACC, which will have an immediate downward

impact on bills, and therefore revenue, and a relatively high inflation component of the total return

(which is added to the RCV and delayed associated cash flow benefits).

Consequently the period over which our cash inflows are generated has increased and we see

a weakening in cashflow based interest cover ratios. This will be mitigated through the planned

restructuring by reducing interest costs by £60m p.a. over 2020-2025.

In light of this, we consider below:

Our funding requirements and challenges to financeability; and

Our capital structure including debt and equity funding.

Funding requirements and challenges to financeability

Overview of key assumptions in the Business Plan 1. Scale of Totex programme

Our Business Plan for AMP7 will see an increase in total expenditure relative to AMP6.

We anticipate a real wholesale Totex expenditure of c.£3.8bn, driven by increased enhancement

spend. All enhancement spend is treated as slow money (capital spend) and the increase therefore

presents a more significant financing challenge than we have previously seen.


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Figure 1: Overview of Totex by type of expenditure

2. PAYG and run off rates

We have held our PAYG and run off rates relatively constant compared with PR14, with some

re-balancing across the wholesale controls to achieve the bill reductions in both water and

wastewater price controls and to take into account the economic nature of forecast Totex.

(Further details on the analysis that supports the rates proposed in our plan are set out in section 16.7 below.)

3. Weighted Average Cost of Capital

We have adopted Ofwat’s early view of the cost of capital (“WACC”) in the preparation of our

Business Plan. The central estimate of Ofwat’s early view stands at 2.4% real (RPI-based),

representing a reduction of 1.34 percentage points from the PR14 Appointee WACC of 3.74%

(RPI-based). This is a more than one third reduction in the WACC.

Adopting Ofwat’s early view of the cost of capital has a significant impact in reducing customer’s

bills. The adopted WACC means that our projected revenue allowance increases more slowly,

at the same time as we are forecasting an increase to the projected Totex investment.

Overall the lower real WACC, combined with the reduction of revenues derived from legacy

adjustments, is projected to result in a fall in our EBITDA of 9% in the first year of AMP7,

and a 11% fall in EBIT relative to AMP6 on average. This poses a significant challenge for

financeability and financial resilience over AMP7.

Despite some adverse commentary around the basis on which the WACC has been set we have

nonetheless adopted Ofwat’s early view in setting our plan, in order to concentrate on delivering for

our customers. We have considered the impact the low cost of capital has on our ability to raise

finance at high investment grade rating, and lower headroom and ability to withstand cost, output

and macroeconomic shocks, i.e. our overall financial resilience.

On this point, we note, and discuss in detail in the following sections, that:

The lower real WACC results in more of our returns coming from indexation of the RCV

as opposed to immediately through bills

The low WACC and the ending of a PR09 revenue uplift also allows us to accommodate

the significant investment programme without increasing customer bills

At the same time, this places pressure on our EBIT and EBITDA resulting in weaker cashflow

metrics on both actual and notional basis

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The transition to CPIH means that bills are higher than they would otherwise have been,

but we have balanced the needs of affordability and financeability.

We note that Ofwat’s Cost of Debt allowance for new debt is based on the average of the A and

BBB iBoxx Corporate Non-financials indices, and therefore assumes that an efficient, notionally

financed water company can achieve cost of debt consistent with a strong BBB, weak A credit

rating (BBB+/A-).

Figure 2: Impact of capital injection and re-financing on interest costs

4. Residential retail margin

We have also adopted in our plan a retail margin of 1% consistent with Ofwat PR19 final

methodology. This is consistent with our view of the retail margin at PR14 and we do not believe

that there have been material changes to the nature and risks of our retail activities that warrants

a change in the allowed margin.

5. Financing outperformance mechanism

With the recent ‘Putting the Sector Back in Balance’ consultation, Ofwat has introduced a

mechanism for sharing of benefits from high gearing. Under the proposed mechanism, companies

whose gearing is 10% above the notional gearing assumption of 60% will need to share gearing

outperformance on equity.

By increasing our equity by £700m, our intention is that our capital structure is planned

not to exceed Ofwat’s gearing tolerance level of 70% debt to RCV, on average over AMP7.

The significant reduction in gearing under the plan from current levels means:

that we will reduce our sensitivity to needing to raise finance financial markets; and

that the financing outperformance mechanism proposed by Ofwat will not trigger in our case.

Therefore, where we have been testing our financial resilience by running downside scenarios

we have not been adjusting the AMP7 cash flows as a result of gearing moving above 70%.

Any financial penalty, under Ofwat’s suggested approach, would be applied to allowed revenues

as part of PR 2024. Although the cashflows should not be impacted in the base case, we continue

to disagree with Ofwat’s rationale for the introduction of such a mechanism to regulate gearing.

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16.3 Base case financeability under the notional financial structure

Responding to the challenge means balancing resilience, affordability, and financeability

Notional financeability is tested to demonstrate that:

the credit rating assumption in the allowed WACC is consistent with the financial ratios

we can achieve in the round on a notional basis; and

more broadly, that we will be able to finance our business functions at an investment grade

credit rating, consistent with our licence duties, to deliver our plan for customers and control

our financial risk.

Ofwat assumes that the efficient company with the notional structure can raise finance at

investment grade A-/BBB+ credit rating. To establish notional financeability, we compare our target

credit rating with credit ratios for BBB+/Baa1, the lower bound of that range, which qualifies as

‘high’ or ‘strong’ investment grade rating and is consistent with Ofwat’s PR14 approach. (At PR14,

Ofwat commented that our A3/A- notional target ratio was high). This target is also consistent with

our requirement to maintain an investment grade credit rating, while appropriately balancing the

needs of investors and customers.

Based on the key ratios used by credit rating agencies, and Ofwat at previous AMPs, we set out

the following key financial ratio targets which we use to test financeability over AMP7. We have

selected the metrics given primacy by both the rating agencies and Ofwat and the relevant

thresholds for a Baa1/BBB+ rating under the notional financing structure:

AICR (Moody’s): The minimum threshold for Baa1 is 1.5x

FFO / Net Debt (S&P): The minimum threshold for BBB+ is 9%

Net Debt / RCV (Ofwat): The maximum threshold for Baa1/BBB+ is 70%

Table 1 below indicates our expected performance across AMP7, for a notionally financed

company under our proposed business plan:

Table 1: Key credit metrics – notional financing structure base case


Adjusted Interest Coverage Ratio (Moody’s) 1.23 1.43 1.46 1.42 1.51

Net Debt / RCV (Ofwat) 62% 63% 64% 64% 61%

FFO / Net Debt (S&P) 12.2% 12.3% 11.8% 11.6% 11.9%

Table 1 above shows that the notional financial structure would not be consistent with a Baa1

rating under Moody’s rating methodology, reflecting cash flow pressures driven by the overall

reduction in returns at PR19 and increased Totex, both of which are driven by factors that are not

within our control.

Specifically:

AICR: Our plan achieves the Baa2 1.3x target in the base case under the notional financing

structure, however is below the Baa1 1.5x threshold on average.

Net debt to RCV: Gearing is comfortably within the target gearing range for Baa1. Cash flow

pressure is significant and if we were to assume a dividend yield of 5% (consistent with Ofwat’s

illustrative assumption of what would be reasonable) would increase gearing to c.67% by the

end of AMP7 under the notional structure.

FFO / Net Debt: Southern achieves c.12% FFO / NET debt, which is comfortably above S&P’s

9% threshold for BBB+.


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The ratios above indicate that we will be able to achieve investment grade credit rating, but are

insufficient for achieving substantially stronger investment grade rating, of Baa1/BBB+, in particular

due to the AICR shortfall against the Baa1 threshold.

A mechanistic approach of Moody’s methodology would suggest that the notional structure is

able to achieve a rating of Baa2, which is lower than the credit rating of A/BBB assumed in the

WACC. This indicates that Ofwat’s WACC allowance, and particularly the Cost of Equity, may be

insufficient for achieving the target credit rating Ofwat assumes over AMP7, which implies that the

notional company may not be able to issue debt at the allowed cost of debt assumed by Ofwat.

This may put the sector under risk of a credit downgrade.

16.4 Base case financeability under the actual financial structure

Early identification of financeability constraints has allowed us to put in place mitigating

action in the form of a £700m equity injection

Actual financeability is tested to demonstrate that we can be expected comfortably to finance our

business activities over the AMP at an investment grade credit rating, consistent with our licence

duties, in light of our actual financing and capital structure choices. This is critical to ensuring that

we can deliver our overall Business Plan and our commitments to customers.

We are a securitised company and as such have a significant number of covenants that

are linked to the credit quality of our business. The report by KMPG – “Putting the Sector

back in Balance” comments:

“At their core, securitisations include numerous provisions limiting the risk borne by lenders

by placing security over cash flows to ensure that debt is serviced and financial distress is

avoided, e.g. through financial and operational covenants linked to maintenance of financial

ratios above certain thresholds, standby liquidity facilities, cash lock ups that act as a buffer

to ensure that potential disruptions to normal operations do not affect debt payments, and

hence do not result in distress.”4

Securitised structures restrict risk to debt providers, and therefore achieve lower cost of debt than

would be otherwise possible, at the expense of equity where risk becomes more concentrated.

Credit rating agencies recognise this for. For example, Moody’s provide a 1.5 notch uplift to UK

securitised business to reflect this reduced risk.

Our current actual credit ratings are as follows:

Table 2: Overview of current credit ratings – actual financing structure

S&P Fitch Moody’s

Corporate Family Rating N/A N/A Baa2

Class A (senior secured) A- A- Baa1

Class B (subordinated) BBB BBB Ba1

Outlook Stable Stable Negative


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Response to the early identification of financeability constraints

1. £700m increase in equity

As a whole business securitisation (WBS), a covenanted structure which enables higher gearing

whilst ensuring our financial risk remains consistent with a strong investment grade credit rating

and reducing the likelihood of default at a target gearing level. During AMP6, we operated our

business such that our RCV was financed with debt up to 80% of RCV.

Our existing capital structure comprises of a portfolio of mostly sterling bonds, issued and listed on

the London Stock Exchange. Because the regulatory framework sets revenue allowances in real

terms, indexed to inflation (RPI to date), we are exposed to inflation risk and as a result need to

carefully manage our cashflow position, specifically the mismatch between revenues which are set

in real terms, and interest on our liabilities typically set in nominal terms.

We have been exposed to RPI in all price controls to date, and hence have used RPI index-linked

finance to hedge or manage the inflation exposure, through a mixture of index linked debt and

(non-speculative) derivatives. We continue to own a significant portfolio of index linked debt

relative to peers, currently at 65% of total debt as at 31 March 2018, which creates in period

cash flow benefits due to the lower in period cash interest paid on index-linked debt, alleviating

pressure on cash-based ratios used by the rating agencies (e.g. Moody’s AICR).

However, during AMP5, faced with “tightening” Adjusted ICR5, we chose prudently to increase our

inflation hedge, and match our debt balance and interest costs to our inflation linked RCV and

revenues, via RPI index-linked swaps (“inflation swaps”).

These have regular accretion payments (every five years) and are an appropriate solution relative

to swaps with mandatory break provisions. They were also treated as non-cash payments by rating

agencies at the time.

However, since executing these inflation swaps, Moody’s, due to the five yearly accretion

payments, has decided to ignore the cash flow benefit of these inflation swaps in calculating

coverage ratios and treat inflation accretion on these swaps as annual cash interest payments,

which does not reflect their five yearly timing. This means our Moody’s Adjusted Interest Cover

Ratio is lower than another company with the same capital structure and interest costs but without

the accretion payments.

We have modelled a number of potential financial constraints over AMP7 and in light of this have

carried out an early and extensive review of our capital structure. Following our early identification

of the challenges we might face as we moved into AMP7 we engaged NM Rothschild to support a

strategic review of our existing capital structure to assess mitigating options to address these

identified financeability constraints. In addition, we have commissioned KPMG LLP to review our

financeability and undertake stress testing of our AMP7 plan.

The outcome of our strategic review was a requirement to reduce our interest costs, which will be

implemented through series of actions, noted below. They will be implemented through a £700m

equity injection into the operating business, equivalent to a rights issue of that amount.

These actions will address any constraints on financeability over AMP7 that would have existed

absent our proactive response:

£425m reduction in interest costs in the 10 years to 2030 – targeted to reduce the ongoing

interest expense and increase interest coverage ratios;


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Pre-payment of £400m Class B debt – to facilitate our desire to operate our company with debt

to RCV at 70%.

The support of our shareholders in undertaking this capital injection is critical to ensuring we can

successfully deliver a resilient Business Plan.

Financial resilience will be demonstrated via:

Improvement of our interest cover ratios through reduced interest costs. This totals £425m over

the 10 years to 2030 and c. £66m p.a. in AMP7.

Reduction in our debt to RCV from 80% to 70% through pre-payment of Class B debt and

additional equity.

The benefit of reducing gearing is two-fold: firstly, it reduces pressures on gearing ratios in our

credit rating assessment; and secondly, it means that our customers will benefit from further

enhanced risk transfer to investors.

We have obtained external assurance6 that our debt, following this capital injection, will continue to

achieve a strong investment grade credit rating A-/A-/Baa1. This will ensure that we have more

headroom to implement our plan, deliver for customers and address the challenges of PR19

Our target credit ratings following our equity injection will be:

Table 3: Overview of target credit ratings post equity injection – actual financing structure

S&P Fitch Moody’s

Corporate Family Rating N/A N/A Baa1

Class A (senior secured) A- A- Baa1

Outlook Stable Stable Negative

For our actual financeability assessment, we target A-/A-/Baa1 credit ratings with S&P, Fitch, and

Moody’s respectively. This is much stronger than the minimum investment grade licence obligation.

We consider this is a strong investment grade rating (two notches above the minimum IG rating of

BBB-/Baa3).

Based on rating agency guidance, we consider an AICR of 1.2x (Moody’s) and FFO / Net Debt

(S&P) to be the key ratios consistent with achieving at least Baa2. Key ratings targets for Moody’s

are set out below based on our current rating:

We set out the following key financial ratio targets for a Baa1/BBB+ rating, which we use to test

financeability over AMP7 under the actual financing structure:

AICR (Moody’s): The minimum threshold for Baa1 is 1.2x

FFO / Net Debt (S&P): The minimum threshold for BBB+ is 6%

Net Debt / RCV (Ofwat): The maximum threshold for Baa1/BBB+ is 80%


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Under the actual capital structure, we are projected to achieve the following financial ratios

over AMP7:

Table 4: Key credit metrics – actual financing structure base case


Adjusted Interest Coverage Ratio (Moody’s) 1.28 1.36 1.39 1.41 1.49

Net Debt / RCV 70% 70% 70% 70% 70%

FFO / Net Debt (S&P) 10.60% 10.62% 10.45% 10.75% 11.10%

Overall, this indicates that in the base case, we are able to meet Moody’s/S&P’s ratio requirements

over AMP7 at Baa1/BBB+ and hence secure strong financial position to ensure continued access

to capital markets.

AICR: We achieve the 1.3x target in the base case, consistent with the Baa1 target. However,

in the absence of our upfront capital injection ratios would be below target throughout AMP7.

Net debt to RCV: Gearing is within the target gearing range for Baa1. Gearing is capped at

70%, and is forecast to be below Ofwat’s threshold for highly geared companies under the

actual capital structure.

FFO / Net Debt: We achieve on average 10.9% FFO / NET debt, which is above S&P’s >7%

requirement for a ‘stable’ outlook at BBB+.

Financing our Business Plan over AMP7

Our total financing requirement, defined as the average increase in net debt under the actual

capital structure, is forecast to be £570m over AMP7, which is significantly less than our

requirement in AMP6 despite the increase in Totex investment, reflecting the upfront injection of

equity by our shareholders.

We plan to meet our financing requirements from a combination of sources, in addition to the

additional equity being raised, including retained earnings and issuance of new fixed rate debt,

including revolving credit facilities.

Planned debt raising over AMP7 is expected to be done with fixed rate instruments, which

departs from historical financing and is aimed at containing inflation exposure, particularly given

the absence of a liquid CPI-linked debt financing market (there is not CPIH linked debt). We note,

however, that the use of fixed rate debt increases pressure on cash based metrics relative to

index-linked debt alternatives.

16.5 Risks

We have a clear understanding of the risks that can impact delivery of our plan. These have

been rigorously quantified, tested, and mitigating actions are in place

Risk analysis is integral to how we manage our business. We have used our internal risk

management framework and the corporate risk register as a starting point, supplemented by

quantitative modelling.

We have developed severe but plausible scenarios that cover the principal risks facing the

business to stress test our plan and ensure we are resilient to the risks we face, as well as

considering the Ofwat scenarios.


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Ofwat is also requiring companies to demonstrate financial resilience ‘in the round’ by showing the

impact on credit ratios from a specified set of shocks. Our analysis of the impact of these shocks is

set out below.

We have informed our judgement of risk exposure through the implementation of a stochastic

modelling approach at the Appointee level, carried out with the assistance of Oxera.

We have developed scenarios based on a combined impact of risk factors where reasonable but

also bearing in mind that not all risks will materialise simultaneously. Our analysis is informed by

historical performance, market analysis, expert judgement, discussions with executive

management and the senior management team and our knowledge of the extent and efficiency of

potential mitigating actions available to the company.

The modelling approach used comprises three stages:

1. Identification of shocks: identifying any assumptions in the business plan where a discrepancy between the planned and out-turn outcome could have a material impact on our financial performance.

2. Estimating the impact of each shock: defining the level of uncertainty for each of the shocks.

3. Estimating the overall impact for each prescribed scenario: aggregating the identified shocks together and estimating an overall impact for each of the scenarios identified.

Potential implications of downside scenarios on our financeability

In the past, in case of shocks, both Moody’s and S&P’s have tolerated ratios falling below

thresholds without negative consequences for the rating, when the shocks have been transient

(e.g. 2010/11 and 2011/2012, where adjusted AICR fell to 0.7).

Therefore, we consider that while a transient shock that breaches AICR and FFO/ Net debt targets

in the short term does not pose a risk of downgrade, the risk of downgrade might materialize if we

experience a prolonged and sustained drop in either of the key ratios, over an extended period.

Our indicative modelling of Moody’s methodology indicates that our AICR ratio falls to below 1 over

a sustained period of several years may trigger a downgrade event, and similarly the risk of

downgrade for S&P would materialize if FFO / Net Debt fell below 7%.

Southern Water scenarios

We have developed P10 and P90 scenarios and additional severe scenarios based on our analysis

of the corporate risk register and modelling of risk exposure. This shows that all equity returns are

exposed to risk at PR19 and emphasises the importance of demonstrating our resilience to severe

but plausible downside shocks. The range is slightly narrower than at PR14 – this reflects the fact

that the PR19 RoRE is post mitigation, whereas the PR14 range did not take into account a

comprehensive suite of potential actions that could the mitigate the impact of P10 scenarios.


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Figure 3: Notional RoRE range – P10/P90

Additional scenarios have also been developed to consider large but plausible downsides, using

our judgement about what might realistically happen, in a similar way to considering the individual

risks in the P10/90 scenario.

Our additional scenarios consider the following event-driven shocks that could potentially occur:

a prolonged drought, severe wet weather; and a major compliance failure.

(Further details on the approach to the development of these company specific scenarios and the underlying risks are provided in TA 16.1.)

Results for the three Southern Water scenarios and for selected P10 scenarios are set

out in the table below.

Table 5: Actual Capital Structure – Impact of company scenarios on adjusted interest cover ratio (Moody’s)

Adjusted Interest Coverage Ratio (Moody’s) FY21 FY22 FY23 FY24 FY25

Actual base case 1.28 1.36 1.39 1.41 1.49

Southern: Prolonged drought 1.15 1.23 1.27 1.36 1.45

Southern: Bad weather 0.97 1.35 1.38 1.41 1.49

Southern: Major compliance failure 0.64 1.28 1.31 1.34 1.43

P10 ODI 1.07 1.15 1.19 1.21 1.30

P10 Totex 0.93 1.03 1.06 1.08 1.16

P10 CMEX and DMEX 1.21 1.29 1.33 1.36 1.44

P10 Revenues 1.25 1.33 1.36 1.39 1.47


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Table 6: Actual Capital Structure – Impact of company scenarios on FFO / Net Debt (S&P)

FFO / Net Debt (S&P) FY21 FY22 FY23 FY24 FY25

Actual base case 10.60% 10.62% 10.45% 10.75% 11.10%

Southern: Prolonged drought 10.19% 10.20% 10.01% 10.58% 10.91%

Southern: Bad weather 9.66% 10.58% 10.42% 10.70% 11.08%

Southern: Major compliance failure 8.62% 10.27% 10.11% 10.48% 10.81%

P10 ODI 9.98% 9.98% 9.78% 10.12% 10.45%

P10 Totex 9.36% 9.23% 8.89% 9.01% 9.28%

P10 CMEX and DMEX 10.40% 10.43% 10.26% 10.57% 10.92%

P10 Revenues 10.51% 10.53% 10.36% 10.67% 11.02%

The size of the impacts, while large, is within our ability to manage and to preserve investment

grade ratings.

In each case, the scenarios have been allowed to run without significant re-planning or

re-budgeting, so in the event that some of these severe events materialised there would

be a reasonable expectation of action being taken to mitigate the impact.

Ofwat prescribed resilience scenarios

In its recent decision on Putting the Sector Back in Balance, Ofwat has set out scenarios

that companies need to model and demonstrate resilience against, set out in Ofwat’s position

statement. We have considered these scenarios carefully as per Ofwat’s guidelines. This has

proven useful in considering different risks and potential magnitude of risks we could be exposed

to. Our proposed AMP7 Business Plan achieves the following AICR (Moody’s) and FFO/ Net debt

(S&P) ratios under Ofwat’s prescribed scenarios.

Table 7: Actual Capital Structure – Impact of Ofwat prescribed resilience scenarios on AICR (Moody’s)

Adjusted Interest Coverage Ratio (Moody’s) FY21 FY22 FY23 FY24 FY25

Actual base case 1.28 1.36 1.39 1.41 1.49

Ofwat: high inflation 1.10 1.17 1.20 1.23 1.30

Ofwat: low inflation 1.52 1.62 1.65 1.67 1.74

Ofwat: Totex underperformance 0.98 1.07 1.11 1.13 1.21

Ofwat: increased bad debt 1.26 1.34 1.37 1.40 1.48

Ofwat: ODI penalty 0.72 1.35 1.38 1.40 1.48

Ofwat: financial penalty 1.23 1.31 1.35 1.37 1.45

Ofwat: debt refinancing 1.24 1.24 1.24 1.20 1.26

Ofwat: combined scenario 0.64 0.74 0.80 0.82 0.90


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Table 8: Actual Capital Structure – Impact of Ofwat prescribed resilience scenarios on FFO / Net Debt (S&P)

FFO / Net Debt (S&P) FY21 FY22 FY23 FY24 FY25

Actual base case 10.6% 10.6% 10.4% 10.8% 11.1%

Ofwat: high inflation 9.8% 9.8% 9.7% 10.1% 10.4%

Ofwat: low inflation 11.4% 11.4% 11.2% 11.4% 11.8%

Ofwat: Totex underperformance 9.5% 9.4% 9.1% 9.3% 9.6%

Ofwat: increased bad debt 10.5% 10.5% 10.6% 10.4% 10.7%

Ofwat: ODI penalty 8.9% 10.6% 10.4% 10.7% 11.1%

Ofwat: financial penalty 10.5% 10.5% 10.3% 10.6% 11.0%

Ofwat: debt refinancing 10.5% 10.3% 10.1% 10.2% 10.5%

Ofwat: combined scenario 8.4% 8.4% 8.3% 7.9% 8.0%

We have provided commentary below on scenarios that could have the most significant impact on

our financial resilience, focussing on Ofwat’s prescribed Totex underperformance, combined and

high inflation scenarios based on the actual capital structure.

Totex underperformance of 10%

A 10% increase in Totex over the AMP leads to AICR falling below our 1.0x threshold in 2021 and

below 1.2x throughout the AMP, a risk which if it materializes on a persistent basis over the AMP

could lead to a rating downgrade.

However, we do not consider that this is a plausible scenario given that, to date, our business

has not experienced a persistent shock of that magnitude over such an extended period and

our modelling of risks has not identified a plausible scenario that could lead to this level of shock.

For example, the lead time for major schemes is 1-3 years so a scenario where there is a 10%

increase in Capex relative to plan in each year of AMP7 is highly unlikely. A Capex shock

of this magnitude would also require significant overruns on around 40 of our largest projects,

which are all subject to robust and rigorous project management and are subject to senior

management scrutiny.

Instead, our modelling of risks suggests that a severe shock could equate to 6.3% of Totex.

Mitigations would be to address systematic problems with capex procurement and would depend

on the root cause of the issue:

Default to lump sum / fixed price tendering

Re-negotiate contracts to change the balance of risk and return between company and supplier

Change contractors if there was a systematic cost over-run problem.

Seek more from our transformation programme to identify more cost savings

ODI penalty (3% on RORE)

An ODI penalty equivalent to 3% of RORE in one year (£63m, directly feeding through to FFO)

would result in AICR falling to 0.7, similar to the levels experienced in 2010/11 and 2011/12. We do

not consider this to be a downgrade risk because, in the past, Moody’s and S&P have tolerated

shocks of the same magnitude over a period of two consecutive years without downgrading our


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business. This shock translates to a penalty of c. £65m in one year, which we consider to be

unrealistic based on historic performance.

Our RORE modelling indicates that ODI penalties are more likely to lie in the range of £23m –

£28m per annum which is considerably lower than Ofwat’s proposed scenario, and will not result in

AICR breaching the 1.0x target. This means that an ODI shock is unlikely in isolation to lead to a

downgrade and that we are resilient to plausible ODI downside scenarios.

An ODI penalty could for example be driven by a failure of one of our assets. Our response to

asset failure would of course depend on the nature of the failed asset and the trigger event. In the

event of a penalty we would take immediate action to reduce the impact of such a failure on our

customers and change operating procedures.

In the longer term and again depending on the cause, we would look to make targeted investments

to resolve any underlying system or asset issues and provide enhanced senior management

oversight and attention to ensure that the ODI penalty is non-recurring.

Combined scenario (10% Totex underperformance, 10% retail underperformance, ODI penalty 1.5% of RORE, 1% revenue penalty)

We have carried out extensive modelling of the potential scale of our risk exposures over AMP7

and the correlation and inter-dependencies between these risks. We have also explicitly modelled

trigger events that could lead to combination scenarios where macroeconomic, environmental or

asset conditions lead to severe but plausible downside exposure for our business.

We are resilient to all of the severe, event-driven scenarios we have modelled as part of our

extensive stochastic modelling of risk. A combined scenario comprised of persistent, material

Totex underperformance and ODI penalties is highly unlikely and would require a number of often

uncorrelated risks to materialise simultaneously.

For example, we have modelled a P10 ODI scenario that is very conservative and is equivalent to

1.2% of RoRE in any given year. This is lower than the persistent ODI penalties assumed under

the combined scenario and reflects our view this scenario is not probable.

In the absence of operational and business mitigation the combined scenario would pose a

significant challenge to our resilience, as the scale of the scenario is such that a number of key

metrics including Moody’s AICR and S&P’s FFO / Net Debt would fall below levels consistent

with an investment grade rating.

We consider this scenario to be highly unlikely. Nonetheless we agree it is important to think about

and plan for such an eventuality, and what might happen in the case of a permanent shock which

cannot be accommodated under the current financial structure. If the combined scenario happened

we have a range of immediate and more long-term measures we could take, such as re-planning

work in the short term and considering more investment in the long term if it became clear that one

or more ODIs was likely to incur large penalties or if we were likely to significantly underperform on

Totex, as set out above. We are confident that that our targeted operational and business

response, as set out above for Totex and ODIs, combined with the injection of additional capital,

would ensure that we would be able to maintain our investment grade rating and address the

underlying drivers of such a scenario within the AMP.

In the case of downgrade by one notch (from our base case target of Baa1) we expect that there

would be several impacts on our business – including an increased cost of new debt – but that


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there would not be a material impact on our ability to deliver our customers’ priorities and meet

our obligations.

Our Modern Compliance Framework and efficiency improvement programmes which are already

in place will ensure that the risk of a “combined scenario” is close to zero.

As well as the general overhaul of our organisational culture, compliance and information

management as detailed above, we have commenced two specific programmes of

transformational change:

Water First is our multi-AMP improvement programme, developed with the DWI, to embed

public health protection at the heart of our water services. It spans our people, processes,

systems, culture, training, risk management, information management supported by asset

improvements and expanded catchment management.

Environment+ is our holistic environmental improvement programme, which has started and

is designed to ensure we are improving our environmental performance. It is transforming the

way we protect, respect and enhance the environment by improving our performance,

capability, compliance, sustainability and resilience.

High inflation (1% increase)

A high inflation scenario of the magnitude of 1% sustained increase in RPI and CPI inflation

reduces AICR to 1.1x over the AMP, primarily driven by our RPI inflation exposure via swap

accretion payments. This leads to higher interest costs (higher AICR denominator), without

an offsetting increase in the FFO (to the extent that CPI-linked revenue increase is to an

extent offset by higher opex payments and capital allowances).

We consider that this will not result in a rating downgrade of the business given that the 1.0x AICR

threshold that would likely trigger a downgrade would not be breached. Having said that, we also

consider that this scenario is not likely given official monetary policy by the Bank of England of

inflation targeting at 2%.

We are also resilient to plausible high inflation scenarios: where outturn inflation has increased

significantly in the past, this has typically been for a relatively short period of time and rating

agencies have looked through short term impacts on ratios on the basis that our swap payments

are predominantly every 5 years and do not impact on annual flows, and it is expected that inflation

shocks will typically revert to the Bank of England target and so a high inflation scenario would not

be long-term. However if a high inflation scenario were to persist in the long term, or if such a

scenario seemed likely, we would review our financing strategy in light of emerging

macroeconomic conditions to ensure our resilience in the long term.

Even though we view a high inflation scenario to be unrealistic in the long term, if necessary,

we would respond to such a shock by reducing dividends and if necessary making further capital

injection to support resilience and liquidity.

Interest rate increase of 2%

An unexpected interest rate increase of 2% over the AMP period would lead to higher interest

costs and downward pressure on AICR. However, we do not consider this to pose a rating

downgrade risk given that our resulting AICR remains above the 1.0x threshold. This means

that even in the event of a sustained increase in rates from the beginning of the AMP, we would

have sufficient headroom to maintain our investment grade rating and to finance our activities.


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The introduction of the iBoxx true up mechanism provides additional protection and would largely

offset a significant increase in interest rates during AMP7. We would expect this to be taken into

account by rating agencies.

16.6 Trust, Transparency and Legitimacy

Transparency and legitimacy are at the heart of our plan. We have developed a deep

understanding of the priorities of our customers and we will be completely transparent

as to our progress in delivery

We have carried out rigorous testing of the plan to balance financeability over 2020-25, securing

resilience in the long-term and improving affordability, as set out above.

We continue to support Ofwat’s aims regarding the governance and legitimacy of the water sector.

We have started a process to review and refine our existing dividend policy to reflect Ofwat’s 31

July 2018 position statement. We expect to publish the revised dividend policy in our 2018/19

Annual Report and Annual Performance Report. The formulation of this revised dividend policy will

incorporate a wide range of measures, including financial measures, customer performance

measures and public service value measures that apply to our wider stakeholders and gauge our

contribution to society at large.

We also plan to reflect the principles set out in the Ofwat consultation on performance-related

executive pay in line with our response to the consultation. Our plans to further revise our

executive pay policy will build on the principles in our existing remuneration policy (updated less

than 12 months ago), which already considers performance across a balanced set of outcomes for

stakeholders. We will maintain a link to things our customers value; we will continue to report

transparently on performance against bonuses; and we will formally review our policy annually.

We have also taken on board recent public concerns about the complexity of financial structures in

the sector, in particular the use of offshore holding and finance companies, and are closing our

Cayman Island finance subsidiary to enhance customer trust and confidence in our plan.

Providing a fair balance between customers and investors

We are very aware of the trade-off between financeability and affordability, and have sought to

balance this and long-term resilience whilst going as far as we can to reduce bills. Our customers

were clear that they did not want an artificially large reduction today that would come at a cost to

future generations.

Overall, customers are looking for transparency and clarity around the levels and profile of bills.

To shape our Business Plan for PR19, we have enhanced the quality of our engagement, by

using a range of innovative tools and techniques.

A key part of our engagement has been to understand customer willingness and ability to pay.

We have tested our plan extensively with customers and overall customers have shown strong

support for our plan:

Our plan will result in a 3% real reduction in average bills across AMP7, and this closely

reflects customer willingness to pay. We have engaged with customers in detail around the

acceptability of bills in the context of our plan.

Our customers want us to deliver on the basics, protect the environment, ensure we have a

service fit for future generations, and to use water efficiently and wisely.


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Our customers prioritise a good service and high levels of responsiveness when things

go wrong.

Given these priorities most customers think that our bills, which will decrease over AMP7, are

affordable and appropriate at the levels in our plan, and support our plan to invest in the

network.

Although our bills will decrease over AMP7, our customers told us they would actually support

an increase in bills to ensure that we do not put off the investments we need to make to meet

our commitments and deliver on their priorities.

We also heard strongly that customers want a flatter profile of bills over time, with a preference

for an upfront reduction and flat profile thereafter, so we have sought to reflect this in the plan.

We are achieving an overall bill reduction through responding to the challenge of a markedly lower

WACC and using the roll off of the revenue correction mechanism to absorb the cost pressures

associated with our plan and impact of the transition to CPIH.

Figure 4: Bill movement between PR14 and PR19

A 3% bill reduction has been achieved by:

Responding to the significant reduction in the WACC based on Ofwat’s early view of the WACC

PAYG and run off rates based on natural rates, with limited changes from PR14

Unwind of significant legacy adjustments (predominantly RCM adjustments) in AMP6

that do not recur in AMP7

Offset by a material increase in the scale of the Totex programme and the transition to

CPIH (all else equal the impact of a higher CPIH WACC increases bills).


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We have used customer research and affordability models to ensure we can create supportive

tariffs and approaches for those who need them.

Our package of PCs and ODIS reflects customer and stakeholder research, and is based on

detailed insight:

We have set stretching performance targets on our ODIs to ensure that the balance of risk

and return is appropriate

Most of our ODIs are financial, aligning our customer and shareholder interests

We are targeting upper quartile or better on all performance commitments that are high priority

for our customers

We are introducing caps and collars because our customers tells us they don’t like bill volatility

We are in particular limiting any rewards to ensure customers do not pay more than they have

said they are prepared to

We are proposing that the average bill will not move by more than £5 up/down (in NPV neutral

way) between two years to limit bill volatility.

Our special cost factor claims have been discussed with customers and the CCG and have

support from both. We are not arguing for increased margins or special cost pressures in retail

to help minimise bills for our customers. We are using PAYG and RCV run off rates to balance

financeability and affordability, ensuring we can still deliver bill reductions despite cost increases

from delivering more.

We have carried out rigorous testing of the PAYG and run off rates to determine impact on bills.

The PAYG and run off rates underpinning the Plan support our financial resilience, and will also

enable an average bill reduction of 3% (in real terms) for dual service customers. For detailed

justification of the PAYG and run off see section 16.7 below.

Overall, we have sought to maintain the principle of inter-generational fairness and have not

departed from natural rates or scaled back the ambition of our Totex programme to achieve

further bill reductions.

We are not using run off or PAYG rates to address financeability concerns under the notional or

actual capital structures. On balance the adjustments to re-calibrate our PR14 PAYG and run off

rates do not materially impact bills at the Appointee level, all else being equal.

Our Board is satisfied that customers’ views are accurately represented in our Business Plan,

through the regular attendance of our CCG Chair at Board meetings and subsequent feedback,

with at least one Board member attending each CCG meeting, as well as the deep-dive work of the

PR19 Customer and Pricing Sub-Committee.

Defined benefit pension deficit

We recognise the importance of managing our defined benefit pension deficit and that this

comprises an important part of financial resilience. We have developed a Business Plan that is

financially resilient whilst making significant progress in repair our current deficit. Our financing

plan fully reflects and incorporates our projected pension costs, however we are not seeking

additional funding from customers above those allowed by previous agreement with Ofwat.

We have included increased deficit recovery contributions to the pension scheme in our plan:

£87m deficit repair payments over AMP7; and

a further £101m in AMP8.


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We believe this level of deficit recovery payments reflects an appropriate balance between the

pension scheme and other demands on our resources. We continue to work with the scheme

Trustee in managing the scheme’s assets and liabilities.

Our recovery plan and investment strategy will reduce the deficit over the next five years. We

remain confident that we have a strong employer covenant with sufficient financial headroom

to adapt to any changes in circumstances over the recovery plan length to 2028.

16.7 Financial Levers A bill profile that responds to our customer's priorities

RCV Run-off rates

The run-off rate of the RCV determines the amount of the RCV that is depreciated and recovered

within year. A higher run-off rate results in the return of invested capital over a shorter period of

time through depreciation and vice versa. When choosing our run-off rate, we have to balance the

requirement to recover enough cash within year to finance our operations and capital expenditure

and the desire to earn a long term return on capital invested. We have also had to carefully

consider the impact of run off rates on customer bills, as all else being equal an increase in run off

rates increases bills and increases the proportion of our asset lives that current customers fund.

Historically, our RCV run-off has been set at the higher end of the industry. At PR14, our

wastewater run off rate was set at the higher end across the WaSCs, and for water, our average

run-off rate was marginally above the WaSC average, but broadly consistent with other WaSCs.

Figure 5: Average PR14 run off rates

(Source: Ofwat, Final Determinations, 2014 1Yorkshire Water 2014 wholesale water and wastewater business plan)

Throughout the development of our PR14 business plan, we made use of the regulatory levers

provided under the total expenditure regime to keep bills affordable for customers. Our plan

included material reductions in our RCV run-off rates compared to AMP5. This ‘slowing’ of RCV

depreciation enabled us to protect our customers from bill increases in excess of inflation.

At PR14 there was a significant reduction in run off rates from AMP5 (water: 8.2%; wastewater:

6%) to ensure affordable bills for customers and to achieve a real reduction in bill levels. Without


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our intervention to reduce the pace of RCV run-off average customer bills would have increased

by 5.5% more than inflation between 2015 to 2020.

There was a substantial reduction of run-off rates in water (from 8.2% to.4.2% in water, 1.1%

below the natural rate) to achieve a consistent movement in bills for all customers and avoid

an increase in bills for water customers, whilst wastewater bills fall.

Figure 6: Run off rates – 2015-25

We have adopted a similar approach to determining run off rates at PR19, and used run off rates to

carefully calibrate revenues across water and wastewater and ensure that there is a bill reduction

for both water and wastewater customers, in line with our customers’ focus on affordability and

preference for flat bills over time.

We have reduced our water run off rate from 4.2% at PR14 to 3.4% at PR19 to achieve a reduction

in bills for our water customers, and offset this by increasing our wastewater run off rate from 5.6%

to 6.2%.

As a result, we have an average run off rate of 5.1% at the Appointee level, which is consistent

with our natural rate and slightly higher than the weighted average run off rate at PR14. PAYG rates

Our PAYG ratio proposed for PR19 does not significantly differ from that proposed at PR14,

although it remains below the industry average for water wastewater services.

The PAYG ratio, or ‘fast money’, determines the amount of the total expenditure (Totex) that

is recovered within period (i.e. treated as operating expenditure in previous AMPs), while its

complement proportion (1-PAYG) is added to the RCV and recovered in future periods through

a return of and on the RCV (i.e. treated as capital expenditure, or referred to as ‘slow money’).

We set an appropriate PAYG ratio based on detailed bottom up analysis (by project) of the

economic nature of Totex. Figure 7 below shows how our PR14 PAYG ratio compares to

other WaSCs over AMP6. Our PAYG ratio proposed for PR19 does not significantly differ from

that proposed at PR14, although it remains below the industry average for water and

wastewater services.

-%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25

Total RCV run off rate to be applied ~ water Total RCV run off rate to be applied ~ wastewater


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Figure 7: Average PR14 PAYG rates

We have carried out a detailed, bottom up analysis by wholesale price control of the economic

nature of planned Totex to determine what proportion should be treated as fast money and what

proportion should be treated as slow money.

Figure 8: PAYG rates 2015-25

Our starting point was to determine what spend is capital and what is operating in nature. All opex

(accounting) is treated PAYG and recovered in year. We have then disaggregated capex between

enhancement spend and ongoing maintenance spend.

We have identified ongoing non-enhancement work and calibrated the PAYG such that the value

of our network (excluding enhancements) is maintained, without adding to it. This means that a

proportion of maintenance spend (capitalised in the statutory accounts) is treated as fast money

and results in a mismatch between our PAYG based on the natural economic rate and the natural

accounting rate.

-%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25

Total PAYG rate ~ water resources Total PAYG rate ~ water network plus

Total PAYG rate ~ wastewater network plus Total PAYG rate - bioresources


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The volatile PAYG profiles reflect the “lumpy” nature of the enhancement expenditure and

the significant proportion of overall Totex that relates to these programmes in each control.

The mismatch creates a P&L benefit each year (as revenues exceed operating costs) however

does not translate into a cash benefit and reflects (1) PAYG rates that continue to be lower than

industry average; and (2) the characteristics of our supply area.

For example, environmental considerations are particularly important to us and mean we have

to meet a number of National Environment Programme obligations, which drives enhancement

projects and the overall weighting of fast and slow money.

Average PAYG rates have decreased slightly from PR14 at the Appointee level to reflect our

analysis of the economic nature of expenditure under our plan. Overall, all else being equal, the re-

calibration of PAYG and run off to reflect natural rates and smooth bill impacts has resulted in no

material impact to bills at PR19.

Technical Annexes:

TA.16.1 Oxera paper on risks. Risk assessment: Methodology and assumptions

TA.16.2 Detailed explanatory slides on capital injection and group financing structure

TA.16.3 Our approach, evidence, and assurance of financial resilience

1 Equity to be injected by way of purchase of ordinary shares in Southern Water Services Limited and/or repayment of part of existing

“round-tripping” intercompany loan. 2 These target credit ratings are for our secured Class A debt. The Whole Business Securitisation currently has two tranches of

secured debt: Class A – Senior, and Class B – Junior. The Class A debt is up to 75% net debt to RCV. The Class B debt, consistent

with our AMP6 target gearing of 80% net debt to RCV, is the difference. 3 The calculated bill reduction for a dual service customer is 3.2%. This is based on our forecast actual bill for 2019-2020 and Ofwat’s

bill analysis for AMP7. Ofwat’s model reflects an allocation of retail revenues based on a 1.3 times multiplier for dual service

customers. Our actual bills use a difference allocation method. This clarification applies to all references of bill reductions of c. 3% in

the plan. 4 See KPMG: Putting the sector back in balance https://www.ofwat.gov.uk/wp-content/uploads/2018/04/Kelda-Project-Stoddart-

KPMG-Report-Final-160518-clean-final.pdf 5 In financial years 2010/11 and 2011/12 6 This has included completion of ratings assessments with credit rating agencies.

https://www.ofwat.gov.uk/wp-content/uploads/2018/04/Kelda-Project-Stoddart-KPMG-Report-Final-160518-clean-final.pdf

https://www.ofwat.gov.uk/wp-content/uploads/2018/04/Kelda-Project-Stoddart-KPMG-Report-Final-160518-clean-final.pdf

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