Do not let Thames Water’s bondholders wriggle off the hook | Nils Pratley

What is the new government’s policy on Thames Water? We’ll get a firmer guide – maybe – after regulator Ofwat gives its verdict on all the English and Welsh water companies’ business plans on Thursday. In the meantime, all we have to go on is this pre-election comment from Jonathan Reynolds, now the business secretary: “I wouldn’t want to see a nationalisation. I think there should be a solution that falls short of that.”

That statement raises more questions than it answers, unfortunately. Which type of nationalisation would Labour not wish to see? A full-fat, permanent return to public ownership? Or also the temporary “special administration” variety in which Thames’s balance sheet would be straightened out before a return to the private sector?

If Reynolds merely meant that permanent nationalisation is a bad idea, many of us would agree. The state’s last grand adventure into building infrastructure, which is what water companies do, was the financial catastrophe called HS2. It is too easy to imagine a repeat in which over-worked departmental officials are given the runaround by sharp private sector contractors who would inevitably do much of the actual work at Thames. Customers might end up no better off.

But there is a problem if the Labour government is also signalling that it is reluctant to press the “special admin” button. The threat of special administration is surely essential in the current unstable position. It is one way to impose on Thames the solution that has always looked the simplest way out of the financial mess – a debt-for-equity swap in which shareholders are wiped out while bondholders, owed £15.2bn collectively, take a hefty haircut.

Thames’s current shareholders, as it happens, have already given up. They have written down the value of their stakes and declared the company to be “uninvestable”. But that still leaves the bondholders, who are hoping to escape intact if Ofwat is sufficiently generous with its increases in bills.

The company’s business plan involves a 44% rise over the next five years, which equates to 59% after inflation, to fund the bulk of a £19.8bn investment programme. On that basis, Thames’s management thinks it has a chance of raising £3.25bn in fresh equity from new shareholders while also avoiding losses for lenders.

Come on, though, a hike of 59% is extreme. Everybody knows bills have to rise meaningfully, but 59% would smell suspiciously like a case of billpayers bailing out bondholders by stealth. The cleaner outcome would be a debt write-down to bring the leverage ratio, currently 80%, to the 55%-60% level that regulators regard as financially resilient.

If Thames was towing, say, £10bn of borrowings rather than £15bn, the balance sheet would be transformed and the company would look a far more investable proposition. It would be a credible re-set moment. Thames would have financial breathing space while its new chief executive attempts the trickier task of improving the operational performance.

We’ll see where Ofwat lands on bills, but Thursday’s draft determination is just the start of the horse-trading and political lobbying before the final decision in December. It is why ministers should be careful about what they mean when talking about preferred outcomes. Do not rule out special administration: it may yet be needed to impose a debt-for-equity swap that would probably have happened already if Thames were listed on the stock market.

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If Reynolds and co are scared of upsetting bondholders because the government is relying on some of the same source of capital to finance new energy infrastructure, they need to get over it. Financial markets are quite capable of viewing Thames for what it is – a special case of extreme financial engineering. On the right terms, they’ll still show up for the windfarms and gigafactories.

Worry instead about the fury of Thames customers if they are bounced into a stitch-up for the benefit of bondholders.

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